10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended December 31, 2015
OR
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¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period from to
Commission File No. 000-17948
ELECTRONIC ARTS INC.
(Exact name of registrant as specified in its charter)
|
| |
Delaware | 94-2838567 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
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209 Redwood Shores Parkway Redwood City, California | 94065 |
(Address of principal executive offices) | (Zip Code) |
(650) 628-1500
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES þ NO ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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| | | |
Large accelerated filer | þ | Accelerated filer | ¨ |
Non-accelerated filer (Do not check if a smaller reporting company) | ¨ | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO þ
As of February 4, 2016, there were 309,309,470 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.
ELECTRONIC ARTS INC.
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2015
Table of Contents
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Item 1. | | |
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Item 2. | | |
Item 3. | | |
Item 4. | | |
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Item 1. | | |
Item 1A. | | |
Item 2. | | |
Item 3. | | |
Item 4. | | |
Item 6. | | |
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PART I – FINANCIAL INFORMATION
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Item 1. | Condensed Consolidated Financial Statements (Unaudited) |
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
|
| | | | | | | |
(Unaudited) (In millions, except par value data) | December 31, 2015 | | March 31, 2015 (a) |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 2,263 |
| | $ | 2,068 |
|
Short-term investments | 966 |
| | 953 |
|
Receivables, net of allowances of $204 and $140, respectively | 621 |
| | 362 |
|
Inventories | 42 |
| | 36 |
|
Deferred income taxes, net | 46 |
| | 54 |
|
Other current assets | 214 |
| | 247 |
|
Total current assets | 4,152 |
| | 3,720 |
|
Property and equipment, net | 415 |
| | 459 |
|
Goodwill | 1,708 |
| | 1,713 |
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Acquisition-related intangibles, net | 71 |
| | 111 |
|
Deferred income taxes, net | 8 |
| | 13 |
|
Other assets | 116 |
| | 131 |
|
TOTAL ASSETS | $ | 6,470 |
| | $ | 6,147 |
|
| | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
Current liabilities: | | | |
Accounts payable | $ | 128 |
| | $ | 68 |
|
Accrued and other current liabilities | 840 |
| | 794 |
|
Deferred net revenue (online-enabled games) | 1,844 |
| | 1,283 |
|
0.75% convertible senior notes due 2016, net | 333 |
| | 602 |
|
Total current liabilities | 3,145 |
| | 2,747 |
|
Income tax obligations | 63 |
| | 70 |
|
Deferred income taxes, net | 75 |
| | 80 |
|
Other liabilities | 168 |
| | 183 |
|
Total liabilities | 3,451 |
| | 3,080 |
|
Commitments and contingencies (See Note 11) |
| |
|
0.75% convertible senior notes due 2016 (See Note 10) | 7 |
| | 31 |
|
Stockholders’ equity: | | | |
Preferred stock, $0.01 par value. 10 shares authorized | — |
| | — |
|
Common stock, $0.01 par value. 1,000 shares authorized; 310 and 310 shares issued and outstanding, respectively | 3 |
| | 3 |
|
Additional paid-in capital | 1,905 |
| | 2,127 |
|
Retained earnings | 1,161 |
| | 904 |
|
Accumulated other comprehensive income (loss) | (57 | ) | | 2 |
|
Total stockholders’ equity | 3,012 |
| | 3,036 |
|
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 6,470 |
| | $ | 6,147 |
|
See accompanying Notes to Condensed Consolidated Financial Statements (unaudited).
(a) Derived from audited Consolidated Financial Statements.
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
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| | | | | | | | | | | | | | | |
(Unaudited) | Three Months Ended December 31, | | Nine Months Ended December 31, |
(In millions, except per share data) | 2015 | | 2014 | | 2015 | | 2014 |
Net revenue: | | | | | | | |
Product | $ | 625 |
| | $ | 606 |
| | $ | 1,802 |
| | $ | 1,899 |
|
Service and other | 445 |
| | 520 |
| | 1,286 |
| | 1,431 |
|
Total net revenue | 1,070 |
| | 1,126 |
| | 3,088 |
| | 3,330 |
|
Cost of revenue: | | | | | | | |
Product | 439 |
| | 300 |
| | 868 |
| | 899 |
|
Service and other | 107 |
| | 101 |
| | 260 |
| | 296 |
|
Total cost of revenue | 546 |
| | 401 |
| | 1,128 |
| | 1,195 |
|
Gross profit | 524 |
| | 725 |
| | 1,960 |
| | 2,135 |
|
Operating expenses: | | | | | | | |
Research and development | 266 |
| | 283 |
| | 827 |
| | 809 |
|
Marketing and sales | 190 |
| | 169 |
| | 469 |
| | 482 |
|
General and administrative | 97 |
| | 107 |
| | 296 |
| | 287 |
|
Acquisition-related contingent consideration | — |
| | — |
| | — |
| | (2 | ) |
Amortization of intangibles | 2 |
| | 4 |
| | 6 |
| | 11 |
|
Total operating expenses | 555 |
| | 563 |
| | 1,598 |
| | 1,587 |
|
Operating income (loss) | (31 | ) | | 162 |
| | 362 |
| | 548 |
|
Interest and other income (expense), net | 1 |
| | (6 | ) | | (11 | ) | | (20 | ) |
Income (loss) before provision for income taxes | (30 | ) | | 156 |
| | 351 |
| | 528 |
|
Provision for income taxes | 15 |
| | 14 |
| | 94 |
| | 48 |
|
Net income (loss) | $ | (45 | ) | | $ | 142 |
| | $ | 257 |
| | $ | 480 |
|
Earnings (loss) per share: | | | | | | | |
Basic | $ | (0.14 | ) | | $ | 0.46 |
| | $ | 0.83 |
| | $ | 1.54 |
|
Diluted | $ | (0.14 | ) | | $ | 0.44 |
| | $ | 0.77 |
| | $ | 1.49 |
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Number of shares used in computation: | | | | | | | |
Basic | 311 |
| | 311 |
| | 311 |
| | 312 |
|
Diluted | 311 |
| | 323 |
| | 333 |
| | 322 |
|
See accompanying Notes to Condensed Consolidated Financial Statements (unaudited).
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
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| | | | | | | | | | | | | | | |
(Unaudited) | Three Months Ended December 31, | | Nine Months Ended December 31, |
(In millions) | 2015 | | 2014 | | 2015 | | 2014 |
Net income (loss) | $ | (45 | ) | | $ | 142 |
| | $ | 257 |
| | $ | 480 |
|
Other comprehensive income (loss), net of tax: | | | | | | | |
Change in unrealized net gains and losses on available-for-sale securities | (4 | ) | | (1 | ) | | (3 | ) | | (1 | ) |
Reclassification adjustment for net realized gains and losses on available-for-sale securities | 1 |
| | (1 | ) | | — |
| | (1 | ) |
Change in unrealized net gains and losses on derivative instruments | 10 |
| | 1 |
| | 2 |
| | 11 |
|
Reclassification adjustment for net realized gains and losses on derivative instruments | (4 | ) | | 1 |
| | (11 | ) | | 8 |
|
Foreign currency translation adjustments | (16 | ) | | (30 | ) | | (47 | ) | | (31 | ) |
Total other comprehensive income (loss), net of tax | (13 | ) | | (30 | ) | | (59 | ) | | (14 | ) |
Total comprehensive income (loss) | $ | (58 | ) | | $ | 112 |
| | $ | 198 |
| | $ | 466 |
|
See accompanying Notes to Condensed Consolidated Financial Statements (unaudited).
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS |
| | | | | | | |
(Unaudited) | Nine Months Ended December 31, |
(In millions) | 2015 | | 2014 |
OPERATING ACTIVITIES | | | |
Net income | $ | 257 |
| | $ | 480 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation, amortization and accretion | 149 |
| | 165 |
|
Loss on conversion of senior notes | 8 |
| | — |
|
Stock-based compensation | 131 |
| | 108 |
|
Acquisition-related contingent consideration | — |
| | (2 | ) |
Change in assets and liabilities: | | | |
Receivables, net | (268 | ) | | (176 | ) |
Inventories | (6 | ) | | 16 |
|
Other assets | 42 |
| | 137 |
|
Accounts payable | 70 |
| | (29 | ) |
Accrued and other liabilities | (124 | ) | | 68 |
|
Deferred income taxes, net | 6 |
| | 9 |
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Deferred net revenue (online-enabled games) | 562 |
| | 93 |
|
Net cash provided by operating activities | 827 |
| | 869 |
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INVESTING ACTIVITIES | | | |
Capital expenditures | (63 | ) | | (63 | ) |
Proceeds from maturities and sales of short-term investments | 707 |
| | 520 |
|
Purchase of short-term investments | (727 | ) | | (717 | ) |
Net cash used in investing activities | (83 | ) | | (260 | ) |
FINANCING ACTIVITIES | | | |
Payment of senior notes | (293 | ) | | — |
|
Proceeds from issuance of common stock | 86 |
| | 31 |
|
Excess tax benefit from stock-based compensation | 73 |
| | 16 |
|
Repurchase and retirement of common stock | (384 | ) | | (242 | ) |
Net cash used in financing activities | (518 | ) | | (195 | ) |
Effect of foreign exchange on cash and cash equivalents | (31 | ) | | (30 | ) |
Increase in cash and cash equivalents | 195 |
| | 384 |
|
Beginning cash and cash equivalents | 2,068 |
| | 1,782 |
|
Ending cash and cash equivalents | $ | 2,263 |
| | $ | 2,166 |
|
Supplemental cash flow information: | | | |
Cash paid (refunded) during the period for income taxes, net | $ | 28 |
| | $ | (8 | ) |
Cash paid during the period for interest | $ | 3 |
| | $ | 3 |
|
See accompanying Notes to Condensed Consolidated Financial Statements (unaudited).
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
We develop, market, publish and distribute game software content and services that can be played by consumers on a variety of platforms, including video game consoles (such as the PlayStation 3 and 4 from Sony, and the Xbox 360 and Xbox One from Microsoft), PCs, mobile phones and tablets. We deliver our games and services to our players across multiple platforms, through multiple distribution channels, and directly (online and wirelessly). Some of our games are based on our wholly-owned intellectual property (e.g., Battlefield, Mass Effect, Need for Speed, Dragon Age, The Sims, SimCity, Bejeweled, and Plants vs. Zombies), and some of our games leverage content that we license from others (e.g., FIFA, Madden NFL and Star Wars). We also publish and distribute games developed by third parties (e.g., Titanfall). Our goal is to develop our intellectual properties into year-round businesses available on a range of platforms. Our products and services may be purchased through physical and online retailers, platform providers such as console manufacturers, providers of free-to-download PC games played on the Internet, mobile carriers via streaming and digital downloads, and directly through Origin, our own digital distribution platform.
Our fiscal year is reported on a 52- or 53-week period that ends on the Saturday nearest March 31. Our results of operations for the fiscal year ending March 31, 2016 contains 53 weeks and ends on April 2, 2016. Our results of operations for the fiscal year ended March 31, 2015 contained 52 weeks and ended on March 28, 2015. Our results of operations for the three months ended December 31, 2015 and 2014 contained 13 weeks each and ended on January 2, 2016 and December 27, 2014, respectively. Our results of operations for the nine months ended December 31, 2015 and 2014 contained 40 and 39 weeks, respectively, and ended on January 2, 2016 and December 27, 2014, respectively. For simplicity of disclosure, all fiscal periods are referred to as ending on a calendar month end.
The Condensed Consolidated Financial Statements are unaudited and reflect all adjustments (consisting only of normal recurring accruals unless otherwise indicated) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The preparation of these Condensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the amounts reported in these Condensed Consolidated Financial Statements and accompanying notes. Actual results could differ materially from those estimates. The results of operations for the current interim periods are not necessarily indicative of results to be expected for the current year or any other period.
These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2015, as filed with the United States Securities and Exchange Commission (“SEC”) on May 21, 2015.
Impact of Recently Issued Accounting Standards
In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740). The amendments in this ASU require that all deferred income tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The requirements will be effective for annual periods (and interim periods within those annual periods) beginning after December 15, 2016, and early adoption is permitted. We expect to adopt this new standard in the fourth quarter of fiscal year 2016 and we plan to elect prospective application. We expect the adoption to have an impact only on the classification of deferred income tax liabilities and assets between current and noncurrent in our statement of financial position.
In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Topic 835-30), which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by this ASU. In August 2015, the FASB issued ASU 2015-15, which clarified that debt issuance costs related to line-of-credit arrangements could continue to be presented as an asset and be subsequently amortized over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the arrangement. The requirements will be effective for annual periods (and interim periods within those annual periods) beginning after December 15, 2015, and will require retrospective application. Early adoption is permitted. We do not expect the adoption to have a material impact on our Consolidated Financial Statements.
In April 2015, the FASB issued ASU 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Topic 350-40). The amendments of this ASU will help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement by providing guidance as to whether an arrangement includes the sale or license of software. The requirements will be effective for annual periods (and interim periods within those annual periods) beginning after December 15, 2015. The amendment may be adopted either prospectively to all arrangements entered into or materially modified after the effective date
or retrospectively. Early adoption is permitted. We expect to adopt this new standard in the first quarter of fiscal year 2017. We do not expect the adoption to have a material impact on our Consolidated Financial Statements.
In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330), which requires entities to measure inventory at the lower of cost or net realizable value. Current guidance requires inventory to be measured at the lower of cost or market, with market defined as replacement cost, net realizable value, or net realizable value less a normal profit margin. This ASU simplifies the subsequent measurement of inventory by replacing the lower of cost or market test with a lower of cost or net realizable value test. The requirements will be effective for annual periods (and interim periods within those annual periods) beginning after December 15, 2016, and will require prospective application. Early adoption is permitted. We are currently evaluating the timing of adoption and impact of this new standard on our Consolidated Financial Statements.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments (Topic 825-10), which requires that most equity investments be measured at fair value, with subsequent changes in fair value recognized in net income. The ASU also impacts financial liabilities under the fair value option and the presentation and disclosure requirements for financial instruments.
The requirements will be effective for annual periods (and interim periods within those annual periods) beginning after December 15, 2017. We are currently evaluating the timing and method of adoption and the impact of the new standard on our Consolidated Financial Statements and related disclosures.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The standard permits the use of either the retrospective or cumulative effect transition method. The original effective date for ASU 2014-09 would have required the Company to adopt beginning in its first quarter of fiscal year 2018. In August 2015, the FASB issued ASU 2015-14, which deferred the effective date of ASU 2014-09 by one year and also provides the option to early adopt on the original effective date. We are currently evaluating the timing and method of adoption and the impact of the new revenue standard on our Consolidated Financial Statements and related disclosures.
(2) FAIR VALUE MEASUREMENTS
There are various valuation techniques used to estimate fair value, the primary one being the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the asset or liability. We measure certain financial and nonfinancial assets and liabilities at fair value on a recurring and nonrecurring basis.
Fair Value Hierarchy
The three levels of inputs that may be used to measure fair value are as follows:
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• | Level 1. Quoted prices in active markets for identical assets or liabilities. |
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• | Level 2. Observable inputs other than quoted prices included within Level 1, such as quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities. |
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• | Level 3. Unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of assets or liabilities. |
Assets and Liabilities Measured at Fair Value on a Recurring Basis
As of December 31, 2015 and March 31, 2015, our assets and liabilities that were measured and recorded at fair value on a recurring basis were as follows (in millions):
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| | | | | | | | | | | | | | | | | |
| | | Fair Value Measurements at Reporting Date Using | | |
| | | Quoted Prices in Active Markets for Identical Financial Instruments | | Significant Other Observable Inputs | | Significant Unobservable Inputs | | |
| As of December 31, 2015 | | (Level 1) | | (Level 2) | | (Level 3) | | Balance Sheet Classification |
Assets | | | | | | | | | |
Bank and time deposits | $ | 392 |
| | $ | 392 |
| | $ | — |
| | $ | — |
| | Cash equivalents |
Money market funds | 5 |
| | 5 |
| | — |
| | — |
| | Cash equivalents |
Available-for-sale securities: | | | | | | | | | |
Corporate bonds | 578 |
| | — |
| | 578 |
| | — |
| | Short-term investments |
U.S. Treasury securities | 206 |
| | 206 |
| | — |
| | — |
| | Short-term investments and cash equivalents |
U.S. agency securities | 159 |
| | — |
| | 159 |
| | — |
| | Short-term investments and cash equivalents |
Commercial paper | 63 |
| | — |
| | 63 |
| | — |
| | Short-term investments and cash equivalents |
Foreign currency derivatives | 17 |
| | — |
| | 17 |
| | — |
| | Other current assets and other assets |
Deferred compensation plan assets (a) | 9 |
| | 9 |
| | — |
| | — |
| | Other assets |
Total assets at fair value | $ | 1,429 |
| | $ | 612 |
| | $ | 817 |
| | $ | — |
| | |
Liabilities | | | | | | | | | |
Foreign currency derivatives | 8 |
| | — |
| | 8 |
| | — |
| | Accrued and other current liabilities and other liabilities |
Deferred compensation plan liabilities (a) | 10 |
| | 10 |
| | — |
| | — |
| | Other liabilities |
Total liabilities at fair value | $ | 18 |
| | $ | 10 |
| | $ | 8 |
| | $ | — |
| | |
|
| | | | | | | | | | | | | | | | | |
| | | Fair Value Measurements at Reporting Date Using | | |
| | | Quoted Prices in Active Markets for Identical Financial Instruments | | Significant Other Observable Inputs | | Significant Unobservable Inputs | | |
| As of March 31, 2015 | | (Level 1) | | (Level 2) | | (Level 3) | | Balance Sheet Classification |
Assets | | | | | | | | | |
Bank and time deposits | $ | 175 |
| | $ | 175 |
| | $ | — |
| | $ | — |
| | Cash equivalents |
Money market funds | 7 |
| | 7 |
| | — |
| | — |
| | Cash equivalents |
Available-for-sale securities: | | | | | | | | | |
Corporate bonds | 468 |
| | — |
| | 468 |
| | — |
| | Short-term investments and cash equivalents |
U.S. Treasury securities | 214 |
| | 214 |
| | — |
| | — |
| | Short-term investments |
U.S. agency securities | 180 |
| | — |
| | 180 |
| | — |
| | Short-term investments and cash equivalents |
Commercial paper | 140 |
| | — |
| | 140 |
| | — |
| | Short-term investments and cash equivalents |
Foreign currency derivatives | 18 |
| | — |
| | 18 |
| | — |
| | Other current assets |
Deferred compensation plan assets (a) | 9 |
| | 9 |
| | — |
| | — |
| | Other assets |
Total assets at fair value | $ | 1,211 |
| | $ | 405 |
| | $ | 806 |
| | $ | — |
| | |
Liabilities | | | | | | | | | |
Foreign currency derivatives | 9 |
| | — |
| | 9 |
| | — |
| | Accrued and other current liabilities |
Deferred compensation plan liabilities (a) | 9 |
| | 9 |
| | — |
| | — |
| | Other liabilities |
Total liabilities at fair value | $ | 18 |
| | $ | 9 |
| | $ | 9 |
| | $ | — |
| | |
| |
(a) | The Deferred Compensation Plan assets consist of various mutual funds. See Note 15 in our Annual Report on Form 10-K for the fiscal year ended March 31, 2015, for additional information regarding our Deferred Compensation Plan. |
(3) FINANCIAL INSTRUMENTS
Cash and Cash Equivalents
As of December 31, 2015 and March 31, 2015, our cash and cash equivalents were $2,263 million and $2,068 million, respectively. Cash equivalents were valued at their carrying amounts as they approximate fair value due to the short maturities of these financial instruments.
Short-Term Investments
Short-term investments consisted of the following as of December 31, 2015 and March 31, 2015 (in millions):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| As of December 31, 2015 | | As of March 31, 2015 |
| Cost or Amortized Cost | | Gross Unrealized | | Fair Value | | Cost or Amortized Cost | | Gross Unrealized | | Fair Value |
| Gains | | Losses | | Gains | | Losses | |
Corporate bonds | $ | 579 |
| | $ | — |
| | $ | (1 | ) | | $ | 578 |
| | $ | 467 |
| | $ | — |
| | $ | — |
| | $ | 467 |
|
U.S. Treasury securities | 196 |
| | — |
| | (1 | ) | | 195 |
| | 214 |
| | — |
| | — |
| | 214 |
|
U.S. agency securities | 154 |
| | — |
| | — |
| | 154 |
| | 161 |
| | 1 |
| | — |
| | 162 |
|
Commercial paper | 39 |
| | — |
| | — |
| | 39 |
| | 110 |
| | — |
| | — |
| | 110 |
|
Short-term investments | $ | 968 |
| | $ | — |
| | $ | (2 | ) | | $ | 966 |
| | $ | 952 |
| | $ | 1 |
| | $ | — |
| | $ | 953 |
|
We evaluate our investments for impairment quarterly. Factors considered in the review of investments include the credit quality of the issuer, the duration that the fair value has been less than the adjusted cost basis, the severity of the impairment, the reason for the decline in value and potential recovery period, the financial condition and near-term prospects of the investees, our intent to sell and ability to hold the investment for a period of time sufficient to allow for any anticipated
recovery in market value, and any contractual terms impacting the prepayment or settlement process. Based on our review, we did not consider these investments to be other-than-temporarily impaired as of December 31, 2015 and March 31, 2015.
The following table summarizes the amortized cost and fair value of our short-term investments, classified by stated maturity as of December 31, 2015 and March 31, 2015 (in millions):
|
| | | | | | | | | | | | | | | |
| As of December 31, 2015 | | As of March 31, 2015 |
| Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value |
Short-term investments | | | | | | | |
Due in 1 year or less | $ | 441 |
| | $ | 441 |
| | $ | 417 |
| | $ | 417 |
|
Due in 1-2 years | 306 |
| | 305 |
| | 281 |
| | 281 |
|
Due in 2-3 years | 221 |
| | 220 |
| | 244 |
| | 245 |
|
Due in 3-4 years | — |
| | — |
| | 10 |
| | 10 |
|
Short-term investments | $ | 968 |
| | $ | 966 |
| | $ | 952 |
| | $ | 953 |
|
(4) DERIVATIVE FINANCIAL INSTRUMENTS
The assets or liabilities associated with our derivative instruments and hedging activities are recorded at fair value in other current assets/other assets, or accrued and other current liabilities/other liabilities, respectively, on our Condensed Consolidated Balance Sheets. As discussed below, the accounting for gains and losses resulting from changes in fair value depends on the use of the derivative instrument and whether it is designated and qualifies for hedge accounting.
We transact business in various foreign currencies and have significant international sales and expenses denominated in foreign currencies, subjecting us to foreign currency risk. We purchase foreign currency forward contracts, generally with maturities of 18 months or less, to reduce the volatility of cash flows primarily related to forecasted revenue and expenses denominated in certain foreign currencies. Our cash flow risks are primarily related to fluctuations in the Euro, British pound sterling, Canadian dollar, Swedish krona, Australian dollar, Chinese yuan and South Korean won. In addition, we utilize foreign currency forward contracts to mitigate foreign exchange rate risk associated with foreign-currency-denominated monetary assets and liabilities, primarily intercompany receivables and payables. The foreign currency forward contracts not designated as hedging instruments generally have a contractual term of approximately 3 months or less and are transacted near month-end. We do not use foreign currency forward contracts for speculative trading purposes.
Cash Flow Hedging Activities
Certain of our forward contracts are designated and qualify as cash flow hedges. The effectiveness of the cash flow hedge contracts, including time value, is assessed monthly using regression analysis, as well as other timing and probability criteria. To qualify for hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedges and must be highly effective in offsetting changes to future cash flows on hedged transactions. The derivative assets or liabilities associated with our hedging activities are recorded at fair value in other current assets/other assets, or accrued and other current liabilities/other liabilities, respectively, on our Condensed Consolidated Balance Sheets. The effective portion of gains or losses resulting from changes in the fair value of these hedges is initially reported, net of tax, as a component of accumulated other comprehensive income in stockholders’ equity. The gross amount of the effective portion of gains or losses resulting from changes in the fair value of these hedges is subsequently reclassified into net revenue or research and development expenses, as appropriate, in the period when the forecasted transaction is recognized in our Condensed Consolidated Statements of Operations. In the event that the gains or losses in accumulated other comprehensive income are deemed to be ineffective, the ineffective portion of gains or losses resulting from changes in fair value, if any, is reclassified to interest and other income (expense), net, in our Condensed Consolidated Statements of Operations. In the event that the underlying forecasted transactions do not occur, or it becomes remote that they will occur, within the defined hedge period, the gains or losses on the related cash flow hedges are reclassified from accumulated other comprehensive income to interest and other income (expense), net, in our Condensed Consolidated Statements of Operations.
Total gross notional amounts and fair values for currency derivatives with cash flow hedge accounting designation are as follows (in millions):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| As of December 31, 2015 | | As of March 31, 2015 |
| Notional Amount | | Fair Value | | Notional Amount | | Fair Value |
| | Asset | | Liability | | | Asset | | Liability |
Forward contracts to purchase | $ | 148 |
| | $ | 1 |
| | $ | 6 |
| | $ | 108 |
| | $ | — |
| | $ | 8 |
|
Forward contracts to sell | $ | 627 |
| | $ | 14 |
| | $ | 1 |
| | $ | 508 |
| | $ | 18 |
| | $ | 1 |
|
The net impact of the effective portion of gains and losses from our cash flow hedging activities in our Condensed Consolidated Statements of Operations was a gain of $4 million for the three months ended December 31, 2015 and a loss of $1 million for the three months ended December 31, 2014.
The net impact of the effective portion of gains and losses from our cash flow hedging activities in our Condensed Consolidated Statements of Operations for the nine months ended December 31, 2015 was a gain of $11 million and a loss of $8 million for the nine months ended December 31, 2014.
During the three and nine months ended December 31, 2015 and 2014, we reclassified an immaterial amount of the ineffective portion of gains or losses resulting from changes in fair value into interest and other income (expense), net.
Balance Sheet Hedging Activities
Our foreign currency forward contracts that are not designated as hedging instruments are accounted for as derivatives whereby the fair value of the contracts are reported as other current assets or accrued and other current liabilities on our Condensed Consolidated Balance Sheets, and gains and losses resulting from changes in the fair value are reported in interest and other income (expense), net, in our Condensed Consolidated Statements of Operations. The gains and losses on these foreign currency forward contracts generally offset the gains and losses in the underlying foreign-currency-denominated monetary assets and liabilities, which are also reported in interest and other income (expense), net, in our Condensed Consolidated Statements of Operations. The fair value of our foreign currency forward contracts was measured using Level 2 inputs.
Total gross notional amounts and fair values for currency derivatives that are not designated as hedging instruments are accounted for as follows (in millions):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| As of December 31, 2015 | | As of March 31, 2015 |
| Notional Amount | | Fair Value | | Notional Amount | | Fair Value |
| | Asset | | Liability | | | Asset | | Liability |
Forward contracts to purchase | $ | 165 |
| | $ | — |
| | $ | — |
| | $ | 99 |
| | $ | — |
| | $ | — |
|
Forward contracts to sell | $ | 573 |
| | $ | 2 |
| | $ | 1 |
| | $ | 173 |
| | $ | — |
| | $ | — |
|
The effect of foreign currency forward contracts not designated as hedging instruments in our Condensed Consolidated Statements of Operations for the three and nine months ended December 31, 2015 and 2014, was as follows (in millions):
|
| | | | | | | | | | | | | | | | | |
| Statement of Operations Classification | | Amount of Gain (Loss) Recognized in the Statement of Operations |
| Three Months Ended December 31, | | Nine Months Ended December 31, |
| 2015 | | 2014 | | 2015 | | 2014 |
Foreign currency forward contracts not designated as hedging instruments | Interest and other income (expense), net | | $ | 13 |
| | $ | 19 |
| | $ | 15 |
| | $ | 38 |
|
(5) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The changes in accumulated other comprehensive income (loss) by component, net of tax, for the three months ended December 31, 2015 and 2014 are as follows (in millions): |
| | | | | | | | | | | | | | | |
| Unrealized Net Gains (Losses) on Available-for-Sale Securities | | Unrealized Net Gains (Losses) on Derivative Instruments | | Foreign Currency Translation Adjustments | | Total |
Balances as of September 30, 2015 | $ | (3 | ) | | $ | 6 |
| | $ | (47 | ) | | $ | (44 | ) |
Other comprehensive income (loss) before reclassifications | (4 | ) | | 10 |
| | (16 | ) | | (10 | ) |
Amounts reclassified from accumulated other comprehensive income (loss) | 1 |
| | (4 | ) | | — |
| | (3 | ) |
Total other comprehensive income (loss), net of tax
| (3 | ) | | 6 |
| | (16 | ) | | (13 | ) |
Balance as of December 31, 2015 | $ | (6 | ) | | $ | 12 |
| | $ | (63 | ) | | $ | (57 | ) |
|
| | | | | | | | | | | | | | | |
| Unrealized Net Gains (Losses) on Available-for-Sale Securities | | Unrealized Net Gains (Losses) on Derivative Instruments | | Foreign Currency Translation Adjustments | | Total |
Balances as of September 30, 2014 | $ | (4 | ) | | $ | 7 |
| | $ | 50 |
| | $ | 53 |
|
Other comprehensive income (loss) before reclassifications | (1 | ) | | 1 |
| | (30 | ) | | (30 | ) |
Amounts reclassified from accumulated other comprehensive income (loss) | (1 | ) | | 1 |
| | — |
| | — |
|
Total other comprehensive income (loss), net of tax
| (2 | ) | | 2 |
| | (30 | ) | | (30 | ) |
Balance as of December 31, 2014 | $ | (6 | ) | | $ | 9 |
| | $ | 20 |
| | $ | 23 |
|
The changes in accumulated other comprehensive income (loss) by component, net of tax, for the nine months ended December 31, 2015 and 2014 are as follows (in millions):
|
| | | | | | | | | | | | | | | |
| Unrealized Net Gains (Losses) on Available-for-Sale Securities | | Unrealized Net Gains (Losses) on Derivative Instruments | | Foreign Currency Translation Adjustments | | Total |
Balances as of March 31, 2015 | $ | (3 | ) | | $ | 21 |
| | $ | (16 | ) | | $ | 2 |
|
Other comprehensive income (loss) before reclassifications | (3 | ) | | 2 |
| | (47 | ) | | (48 | ) |
Amounts reclassified from accumulated other comprehensive income (loss) | — |
| | (11 | ) | | — |
| | (11 | ) |
Total other comprehensive income (loss), net of tax
| (3 | ) | | (9 | ) | | (47 | ) | | (59 | ) |
Balance as of December 31, 2015 | $ | (6 | ) | | $ | 12 |
| | $ | (63 | ) | | $ | (57 | ) |
|
| | | | | | | | | | | | | | | |
| Unrealized Net Gains (Losses) on Available-for-Sale Securities | | Unrealized Net Gains (Losses) on Derivative Instruments | | Foreign Currency Translation Adjustments | | Total |
Balances as of March 31, 2014 | $ | (4 | ) | | $ | (10 | ) | | $ | 51 |
| | $ | 37 |
|
Other comprehensive income (loss) before reclassifications | (1 | ) | | 11 |
| | (31 | ) | | (21 | ) |
Amounts reclassified from accumulated other comprehensive income (loss) | (1 | ) | | 8 |
| | — |
| | 7 |
|
Total other comprehensive income (loss), net of tax
| (2 | ) | | 19 |
| | (31 | ) | | (14 | ) |
Balance as of December 31, 2014 | $ | (6 | ) | | $ | 9 |
| | $ | 20 |
| | $ | 23 |
|
The effects on net income of amounts reclassified from accumulated other comprehensive income (loss) for the three and nine months ended December 31, 2015 were as follows (in millions): |
| | | | | | | | |
|
| Amount Reclassified From Accumulated Other Comprehensive Income (Loss) |
Statement of Operations Classification |
| Three Months Ended December 31, 2015 |
| Nine Months Ended December 31, 2015 |
Gains and losses on available-for-sale securities |
|
|
|
|
Interest and other income (expense), net | | $ | 1 |
| | $ | — |
|
Net of tax |
| $ | 1 |
|
| $ | — |
|
|
|
|
|
|
Gains and losses on cash flow hedges from forward contracts | | | | |
Net revenue |
| $ | (5 | ) |
| $ | (19 | ) |
Research and development |
| 1 |
|
| 8 |
|
Net of tax | | $ | (4 | ) | | $ | (11 | ) |
| | | | |
Total amount reclassified, net of tax |
| $ | (3 | ) |
| $ | (11 | ) |
The net impact from our available-for-sale securities and cash flow hedging activities in our Condensed Consolidated Statements of Operations for the three and nine months ended December 31, 2015 was a gain of $3 million and $11 million, respectively.
The effects on net income of amounts reclassified from accumulated other comprehensive income (loss) for the three and nine months ended December 31, 2014 were as follows (in millions):
|
| | | | | | | | |
| | Amount Reclassified From Accumulated Other Comprehensive Income (Loss) |
Statement of Operations Classification | | Three Months Ended December 31, 2014 | | Nine Months Ended December 31, 2014 |
Gains and losses on available-for-sale securities | | | | |
Interest and other income (expense), net | | $ | (1 | ) | | $ | (1 | ) |
Net of tax | | $ | (1 | ) | | $ | (1 | ) |
| | | | |
Gains and losses on cash flow hedges from forward contracts | | | | |
Net revenue | | $ | (2 | ) | | $ | 3 |
|
Research and development | | 3 |
| | 5 |
|
Net of tax | | $ | 1 |
| | $ | 8 |
|
| | | | |
Total amount reclassified, net of tax | | $ | — |
| | $ | 7 |
|
The net impact from our available-for-sale and cash flow hedging activities in our Condensed Consolidated Statements of Operations for the nine months ended December 31, 2014 was a loss of $7 million. The net impact from our available-for-sale and cash flow hedging activities in our Condensed Consolidated Statements of Operations for the three months ended December 31, 2014 was immaterial.
(6) GOODWILL AND ACQUISITION-RELATED INTANGIBLES, NET
The changes in the carrying amount of goodwill for the nine months ended December 31, 2015 are as follows (in millions): |
| | | | | | | | | | | | | | | |
| As of March 31, 2015 | | Activity | | Effects of Foreign Currency Translation | | As of December 31, 2015 |
Goodwill | $ | 2,081 |
| | $ | — |
| | $ | (5 | ) | | $ | 2,076 |
|
Accumulated impairment | (368 | ) | | — |
| | — |
| | (368 | ) |
Total | $ | 1,713 |
| | $ | — |
| | $ | (5 | ) | | $ | 1,708 |
|
Goodwill represents the excess of the purchase price over the fair value of the underlying acquired net tangible and intangible assets. Goodwill is not amortized, but rather subject to at least an annual assessment for impairment by applying a fair value-based test.
Acquisition-related intangibles consisted of the following (in millions): |
| | | | | | | | | | | | | | | | | | | | | | | |
| As of December 31, 2015 | | As of March 31, 2015 |
| Gross Carrying Amount | | Accumulated Amortization | | Acquisition- Related Intangibles, Net | | Gross Carrying Amount | | Accumulated Amortization | | Acquisition- Related Intangibles, Net |
Developed and core technology | $ | 531 |
| | $ | (474 | ) | | $ | 57 |
| | $ | 531 |
| | $ | (439 | ) | | $ | 92 |
|
Trade names and trademarks | 130 |
| | (116 | ) | | 14 |
| | 130 |
| | (111 | ) | | 19 |
|
Registered user base and other intangibles | 87 |
| | (87 | ) | | — |
| | 87 |
| | (87 | ) | | — |
|
Carrier contracts and related | 85 |
| | (85 | ) | | — |
| | 85 |
| | (85 | ) | | — |
|
Total | $ | 833 |
| | $ | (762 | ) | | $ | 71 |
| | $ | 833 |
| | $ | (722 | ) | | $ | 111 |
|
Amortization of intangibles for the three and nine months ended December 31, 2015 and 2014 are classified in the Condensed Consolidated Statement of Operations as follows (in millions): |
| | | | | | | | | | | | | | | |
| Three Months Ended December 31, | | Nine Months Ended December 31, |
| 2015 | | 2014 | | 2015 | | 2014 |
Cost of service and other | $ | 9 |
| | $ | 8 |
| | $ | 25 |
| | $ | 27 |
|
Cost of product | 3 |
| | 4 |
| | 10 |
| | 11 |
|
Operating expenses | 2 |
| | 4 |
| | 6 |
| | 11 |
|
Total | $ | 14 |
| | $ | 16 |
| | $ | 41 |
| | $ | 49 |
|
Acquisition-related intangible assets are amortized using the straight-line method over the lesser of their estimated useful lives or the agreement terms, typically from 2 to 14 years. As of December 31, 2015 and March 31, 2015, the weighted-average remaining useful life for acquisition-related intangible assets was approximately 2.5 years and 2.8 years, respectively.
As of December 31, 2015, future amortization of acquisition-related intangibles that will be recorded in the Condensed Consolidated Statement of Operations is estimated as follows (in millions):
|
| | | |
Fiscal Year Ending March 31, | |
2016 (remaining three months) | $ | 15 |
|
2017 | 37 |
|
2018 | 17 |
|
2019 | 2 |
|
2020 | — |
|
2021 | — |
|
Total | $ | 71 |
|
(7) ROYALTIES AND LICENSES
Our royalty expenses consist of payments to (1) content licensors, (2) independent software developers, and (3) co-publishing and distribution affiliates. License royalties consist of payments made to celebrities, professional sports organizations, movie studios and other organizations for our use of their trademarks, copyrights, personal publicity rights, content and/or other intellectual property. Royalty payments to independent software developers are payments for the development of intellectual property related to our games. Co-publishing and distribution royalties are payments made to third parties for the delivery of products.
Royalty-based obligations with content licensors and distribution affiliates are either paid in advance and capitalized as prepaid royalties or are accrued as incurred and subsequently paid. These royalty-based obligations are generally expensed to cost of revenue at the greater of the contractual rate or an effective royalty rate based on the total projected net revenue for contracts with guaranteed minimums. Prepayments made to thinly capitalized independent software developers and co-publishing affiliates are generally made in connection with the development of a particular product, and therefore, we are generally subject to development risk prior to the release of the product. Accordingly, payments that are due prior to completion of a product are generally expensed to research and development over the development period as the services are incurred. Payments due after completion of the product (primarily royalty-based in nature) are generally expensed as cost of revenue.
Our contracts with some licensors include minimum guaranteed royalty payments, which are initially recorded as an asset and as a liability at the contractual amount when no performance remains with the licensor. When performance remains with the licensor, we record guarantee payments as an asset when actually paid and as a liability when incurred, rather than recording the asset and liability upon execution of the contract. Prepaid royalties are classified as current assets to the extent that such amounts will be recognized in our Condensed Consolidated Statements of Operations within the next 12 months. Royalty liabilities are classified as current liabilities to the extent such royalty payments are contractually due within the next 12 months.
Each quarter, we also evaluate the expected future realization of our royalty-based assets, as well as any unrecognized minimum commitments not yet paid to determine amounts we deem unlikely to be realized through product and service sales. Any impairments or losses determined before the launch of a product are generally charged to research and development expense. Impairments or losses determined post-launch are charged to cost of revenue. We evaluate long-lived royalty-based assets for impairment using undiscounted cash flows when impairment indicators exist. If impairment exists, then the assets are written down to fair value. Unrecognized minimum royalty-based commitments are accounted for as executory contracts, and therefore, any losses on these commitments are recognized when the underlying intellectual property is abandoned (i.e., cease use) or the contractual rights to use the intellectual property are terminated.
During the three and nine months ended December 31, 2015, we did not recognize any losses or impairment charges on royalty-based commitments. During the three months ended December 31, 2014, we did not recognize any losses or impairment charges on royalty-based commitments. During the nine months ended December 31, 2014, we recognized a loss of $122 million on a previously unrecognized licensed intellectual property commitment. The $122 million loss relates to the termination of certain rights we previously had to use a licensor’s intellectual property. In addition, because the loss will be paid in installments through March 2022, our accrued loss was computed using the effective interest method. We currently estimate recognizing in future periods through March 2022, approximately $24 million for the accretion of interest expense related to this obligation. This interest expense will be included in cost of revenue in our Condensed Consolidated Statement of Operations.
The current and long-term portions of prepaid royalties and minimum guaranteed royalty-related assets, included in other current assets and other assets, consisted of (in millions):
|
| | | | | | | |
| As of December 31, 2015 | | As of March 31, 2015 |
Other current assets | $ | 37 |
| | $ | 70 |
|
Other assets | 47 |
| | 59 |
|
Royalty-related assets | $ | 84 |
| | $ | 129 |
|
At any given time, depending on the timing of our payments to our co-publishing and/or distribution affiliates, content licensors, and/or independent software developers, we classify any recognized unpaid royalty amounts due to these parties as accrued liabilities. The current and long-term portions of accrued royalties, included in accrued and other current liabilities and other liabilities, consisted of (in millions):
|
| | | | | | | |
| As of December 31, 2015 | | As of March 31, 2015 |
Accrued royalties | $ | 216 |
| | $ | 119 |
|
Other liabilities | 123 |
| | 131 |
|
Royalty-related liabilities | $ | 339 |
| | $ | 250 |
|
As of December 31, 2015, we were committed to pay approximately $1,321 million to content licensors, independent software developers, and co-publishing and/or distribution affiliates, but because performance remained with the counterparty (i.e., delivery of the product or content or other factors), such commitments were not recorded in our Condensed Consolidated Financial Statements. See Note 11 for further information on our developer and licensor commitments.
(8) BALANCE SHEET DETAILS
Inventories
Inventories as of December 31, 2015 and March 31, 2015 consisted of (in millions):
|
| | | | | | | |
| As of December 31, 2015 |
| As of March 31, 2015 |
Finished goods | $ | 41 |
|
| $ | 35 |
|
Raw materials and work in process | 1 |
|
| 1 |
|
Inventories | $ | 42 |
|
| $ | 36 |
|
Property and Equipment, Net
Property and equipment, net, as of December 31, 2015 and March 31, 2015 consisted of (in millions):
|
| | | | | | | |
| As of December 31, 2015 | | As of March 31, 2015 |
Computer, equipment and software | $ | 663 |
| | $ | 655 |
|
Buildings | 303 |
| | 315 |
|
Leasehold improvements | 125 |
| | 126 |
|
Equipment, furniture and fixtures, and other | 73 |
| | 73 |
|
Land | 61 |
| | 62 |
|
Construction in progress | 12 |
| | 7 |
|
| 1,237 |
| | 1,238 |
|
Less: accumulated depreciation | (822 | ) | | (779 | ) |
Property and equipment, net | $ | 415 |
| | $ | 459 |
|
During the three and nine months ended December 31, 2015, depreciation expense associated with property and equipment was $31 million and $91 million, respectively. During the three and nine months ended December 31, 2014, depreciation expense associated with property and equipment was $32 million and $96 million, respectively.
Accrued and Other Current Liabilities
Accrued and other current liabilities as of December 31, 2015 and March 31, 2015 consisted of (in millions):
|
| | | | | | | |
| As of December 31, 2015 | | As of March 31, 2015 |
Other accrued expenses | $ | 308 |
| | $ | 298 |
|
Accrued compensation and benefits | 218 |
| | 263 |
|
Accrued royalties | 216 |
| | 119 |
|
Deferred net revenue (other) | 98 |
| | 114 |
|
Accrued and other current liabilities | $ | 840 |
| | $ | 794 |
|
Deferred net revenue (other) includes the deferral of subscription revenue, deferrals related to our Switzerland distribution business, advertising revenue, licensing arrangements, and other revenue for which revenue recognition criteria has not been met.
Deferred Net Revenue (Online-Enabled Games)
Deferred net revenue (online-enabled games) was $1,844 million and $1,283 million as of December 31, 2015 and March 31, 2015, respectively. Deferred net revenue (online-enabled games) generally includes the unrecognized revenue from bundled sales of online-enabled games for which we do not have vendor-specific objective evidence of fair value (“VSOE”) for the obligation to provide unspecified updates. We recognize revenue from the sale of online-enabled games for which we do not have VSOE for the unspecified updates on a straight-line basis, generally over an estimated nine-month period beginning in the month after shipment for physical games sold through retail and an estimated six-month period for digitally-distributed games. However, we expense the cost of revenue related to these transactions during the period in which the product is delivered (rather than on a deferred basis).
(9) INCOME TAXES
We estimate our annual effective tax rate at the end of each quarterly period, and we record the tax effect of certain discrete items, which are unusual or occur infrequently, in the interim period in which they occur, including changes in judgment about deferred tax valuation allowances. In addition, jurisdictions with a projected loss for the year, jurisdictions with a year-to-date loss where no tax benefit can be recognized, and jurisdictions where we are unable to estimate an annual effective tax rate are excluded from the estimated annual effective tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter depending on the mix and timing of actual earnings versus annual projections.
We recognize deferred tax assets and liabilities for both the expected impact of differences between the financial statement amount and the tax basis of assets and liabilities and for the expected future tax benefit to be derived from tax losses and tax credit carryforwards. We record a valuation allowance against deferred tax assets when it is considered more likely than not that all or a portion of our deferred tax assets will not be realized. In making this determination, we are required to give significant weight to evidence that can be objectively verified. It is generally difficult to conclude that a valuation allowance is not needed when there is significant negative evidence, such as cumulative losses in recent years. Forecasts of future taxable income are considered to be less objective than past results. Therefore, cumulative losses weigh heavily in the overall assessment.
In addition to considering forecasts of future taxable income, we are also required to evaluate and quantify other possible sources of taxable income in order to assess the realization of our deferred tax assets, namely the reversal of existing deferred tax liabilities, the carry back of losses and credits as allowed under current tax law, and the implementation of tax planning strategies. Evaluating and quantifying these amounts involves significant judgments. Each source of income must be evaluated based on all positive and negative evidence; this evaluation involves assumptions about future activity. Certain taxable temporary differences that are not expected to reverse during the carry forward periods permitted by tax law cannot be considered as a source of future taxable income that may be available to realize the benefit of deferred tax assets.
In fiscal year 2015, we reported U.S. pre-tax income, compared to U.S. pre-tax losses in each of the last seven fiscal years. We have not yet been able to establish a sustained level of profitability in the U.S. or other sufficient significant positive evidence to conclude that our U.S. deferred tax assets are more likely than not to be realized. Therefore, we continue to maintain a valuation allowance against most of our U.S. deferred tax assets. It is reasonably possible that by the end of fiscal year 2016, we will establish a sustained level of profitability in the U.S. As a result, we may reverse a significant portion of the $539 million valuation allowance recorded against our U.S. deferred tax assets at March 31, 2015 in the fourth quarter of fiscal year 2016. The reversal would result in a noncash income tax benefit for the three months ended March 31, 2016.
The provision for income taxes reported for the three and nine months ended December 31, 2015 is based on our projected annual effective tax rate for fiscal year 2016, and also includes certain discrete items recorded during the period. Our effective tax rate for the three and nine months ended December 31, 2015 was a tax expense of 50.0 percent and 26.8 percent, respectively, as compared to 9.0 percent and 9.1 percent, respectively, for the same periods of fiscal year 2015. The effective tax rate for the three and nine months ended December 31, 2015 and 2014 was reduced, when compared to the statutory rate of 35.0 percent, by the utilization of U.S. deferred tax assets which were subject to a valuation allowance and non-U.S. profits subject to a reduced or zero tax rate. Conversely, the effective tax rate was increased due to a discrete expense of $8 million and $73 million recorded in the three and nine months ended December 31, 2015, respectively, for excess tax benefits from stock-based compensation deductions allocated directly to contributed capital. The effective tax rate for the three months ended December 31, 2015 differs from the same period in fiscal year 2015 primarily due to the difference in pre-tax income. The effective tax rate for the nine months ended December 31, 2015 is higher compared to the same period in fiscal 2015 primarily due to the increase in the discrete expense for excess tax benefits from stock-based compensation deductions.
During the three and nine months ended December 31, 2015, we recorded a net increase of $40 million and $57 million, respectively, in gross unrecognized tax benefits. The total gross unrecognized tax benefits as of December 31, 2015 is $311 million. A portion of our unrecognized tax benefits will affect our effective tax rate if they are recognized upon favorable resolution of the uncertain tax positions. As of December 31, 2015, if recognized, approximately $51 million of the unrecognized tax benefits would affect our effective tax rate and approximately $260 million would result in adjustments to deferred tax assets with corresponding adjustments to the valuation allowance.
During the three and nine months ended December 31, 2015, we recorded a net decrease of $2 million for accrued interest and penalties related to tax positions taken on our tax returns. As of December 31, 2015, the combined amount of accrued interest and penalties related to uncertain tax positions included in income tax obligations on our Condensed Consolidated Balance Sheet was approximately $14 million.
We file income tax returns in the United States, including various state and local jurisdictions. Our subsidiaries file tax returns in various foreign jurisdictions, including Canada, France, Germany, Switzerland and the United Kingdom. The IRS is currently
examining our returns for fiscal years 2009 through 2011, and we remain subject to income tax examination by the IRS for fiscal years after 2012.
We are also currently under income tax examination in the United Kingdom for fiscal years 2010 through 2013. We remain subject to income tax examination for several other jurisdictions including in France for fiscal years after 2012, in Germany for fiscal years after 2012, in the United Kingdom for fiscal years after 2013, and in Canada and Switzerland for fiscal years after 2007.
The timing of the resolution of income tax examinations is highly uncertain, and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year. Although potential resolution of uncertain tax positions involve multiple tax periods and jurisdictions, it is reasonably possible that a reduction of up to $50 million of unrecognized tax benefits may occur within the next 12 months, some of which, depending on the nature of the settlement or expiration of statutes of limitations, may affect the Company’s income tax provision and therefore benefit the resulting effective tax rate. The actual amount could vary significantly depending on the ultimate timing and nature of any settlements.
On July 27, 2015, the Tax Court issued an opinion (Altera Corp. et al. v. Commissioner) regarding the treatment of stock-based compensation expense in related-party cost-sharing arrangements. At this time, the U.S. Department of the Treasury has not withdrawn its regulations that require the inclusion of stock-based compensation expense in such arrangements. We will continue to monitor developments related to this opinion and the potential impact of these developments on our Condensed Consolidated Financial Statements.
(10) FINANCING ARRANGEMENT
0.75% Convertible Senior Notes Due 2016
In July 2011, we issued $632.5 million aggregate principal amount of 0.75% Convertible Senior Notes due 2016 (the “Notes”). The Notes are senior unsecured obligations which pay interest semiannually in arrears at a rate of 0.75% per annum on January 15 and July 15 of each year, beginning on January 15, 2012 and will mature on July 15, 2016, unless purchased earlier or converted in accordance with their terms prior to such date. The Notes are senior in right of payment to any unsecured indebtedness that is expressly subordinated in right of payment to the Notes.
Following certain corporate events described in the indenture governing the notes (the “Indenture”) that occur prior to the maturity date, the conversion rate as discussed below will be increased for a holder who elects to convert its Notes in connection with such corporate event in certain circumstances. If we undergo a “fundamental change,” as defined in the Indenture, subject to certain conditions, holders may require us to purchase for cash all or any portion of their Notes. The fundamental change purchase price will be 100 percent of the principal amount of the Notes to be purchased plus any accrued and unpaid interest up to but excluding the fundamental change purchase date.
The Indenture contains customary terms and covenants, including that upon certain events of default occurring and continuing, either the trustee or the holders of at least 25 percent in principal amount of the outstanding Notes may declare 100 percent of the principal and accrued and unpaid interest on all the Notes to be due and payable.
We separately account for the liability and equity components of the Notes. The initial carrying amount of the equity component representing the conversion option is equal to the fair value of the Convertible Note Hedge, as described below, which is a substantially identical instrument and was purchased on the same day as the Notes. The initial carrying amount of the liability component was determined by deducting the fair value of the equity component from the par value of the Notes as a whole, and represents the fair value of a similar liability that does not have an associated convertible feature. A liability of $525 million as of the initial date of issuance was recognized for the principal amount of the Notes representing the present value of the Notes’ cash flows using a discount rate of 4.54 percent. The excess of the principal amount of the liability component over its carrying amount is amortized to interest expense over the term of the Notes using the effective interest method. The equity component on the date of issuance was $107 million.
In accounting for $15 million of issuance costs paid in July 2011 related to the Notes issuance, we allocated $13 million to the liability component and $2 million to the equity component. Debt issuance costs attributable to the liability component are being amortized to interest expense over the term of the Notes, and issuance costs attributable to the equity component were netted with the equity component in additional paid-in capital.
The Notes are convertible into cash and shares of our common stock based on an initial conversion value of 31.5075 shares of our common stock per $1,000 principal amount of Notes (equivalent to an initial conversion price of approximately $31.74 per share). Upon conversion of the Notes, holders will receive cash up to the principal amount of each Note, and any excess conversion value will be delivered in shares of our common stock. Prior to April 15, 2016, the Notes are convertible only if (1) the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130 percent of the conversion price ($41.26 per share) on each applicable trading day (the “Sales Price Condition”); (2) during the five business day period after any ten consecutive trading day period in which the trading price per $1,000 principal amount of notes falls below 98 percent of the last reported sale price of our common stock multiplied by the conversion rate on each trading day; or (3) specified corporate transactions, including a change in control, occur. On or after April 15, 2016, a holder may convert any of its Notes at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date. The conversion rate is subject to customary anti-dilution adjustments (for example, certain dividend distributions or tender or exchange offer of our common stock), but will not be adjusted for any accrued and unpaid interest. The Notes are not redeemable prior to maturity except for specified corporate transactions and events of default, and no sinking fund is provided for the Notes. The Notes do not contain any financial covenants.
During the fiscal quarter ended December 31, 2015, the Sales Price Condition was met. As a result, the Notes are convertible at the option of the holder through April 2, 2016, and the carrying value of the Notes continued to be classified as a current liability and the excess of the principal amount over the carrying value of the Notes continued to be classified in temporary equity in the Consolidated Balance Sheets as of December 31, 2015. The determination of whether or not the Notes are convertible is performed on a quarterly basis.
Upon conversion of any Notes, we deliver cash up to the principal amount of the Notes and any excess conversion value is delivered in shares of our common stock. During the nine months ended December 31, 2015, approximately $312 million principal value of the Notes were converted by holders thereof. During the three months ended December 31, 2015, we repaid $95 million of the principal balance of the Notes and issued approximately 1.7 million shares of common stock to noteholders with a fair value of $115 million, resulting in a loss on extinguishment of $2 million. We also received and cancelled approximately 1.7 million shares of common stock from the exercise of the Convertible Note Hedge during the three months ended December 31, 2015. During the nine months ended December 31, 2015, we repaid $293 million principal balance of the Notes and issued approximately 5.1 million shares of common stock to noteholders with a fair value of $341 million, resulting in a loss on extinguishment of $8 million. We also received and cancelled approximately 5.1 million shares of common stock from the exercise of the Convertible Note Hedge during the nine months ended December 31, 2015. Based on the closing price of our common stock of $68.72 at the end of the quarter ended December 31, 2015, the if-converted value of our Notes in aggregate exceeded their principal amount by $395 million. The remaining $19 million of conversion requests received prior to December 31, 2015 will be settled in the quarter ending March 31, 2016.
Subsequent to the quarter ended December 31, 2015 and through February 4, 2016, we received conversion requests for an additional $158 million principal value of the Notes. During the quarter ending March 31, 2016, we expect to settle these conversion requests with at least $177 million in cash and a number of shares of our common stock equal in value to the excess conversion value. Based on the closing stock price of our common stock of $68.72 at the end of the quarter ended December 31, 2015, approximately 3 million shares of our common stock would be issuable to converting holders. The actual amount of shares issuable upon conversion will be determined based upon the market price of our common stock during an observation period following any conversion.
The carrying and fair values of the Notes are as follows (in millions):
|
| | | | | | | |
| As of December 31, 2015 | | As of March 31, 2015 |
Principal amount of Notes | $ | 340 |
| | $ | 633 |
|
Unamortized debt discount of the liability component | (7 | ) | | (31 | ) |
Net carrying value of Notes | $ | 333 |
| | $ | 602 |
|
| | | |
Fair value of Notes | $ | 750 |
| | $ | 1,158 |
|
The fair value of the Notes is classified as Level 2 within the fair value hierarchy. As of December 31, 2015, the remaining life of the Notes is approximately 6.5 months.
Convertible Note Hedge and Warrants Issuance
In July 2011, we entered into privately negotiated convertible note hedge transactions (the “Convertible Note Hedge”) with certain counterparties to reduce the potential dilution with respect to our common stock upon conversion of the Notes. We paid $107 million for the Convertible Note Hedge, which was recorded as an equity transaction. The Convertible Note Hedge, subject to customary anti-dilution adjustments, provides us with the option to acquire, on a net settlement basis, approximately 19.9 million shares of our common stock equal to the number of shares of our common stock that notionally underlie the Notes at a strike price of $31.74, which corresponds to the conversion price of the Notes. As of December 31, 2015, we received 5.1 million shares of our common stock under the Convertible Note Hedge. Subsequent to December 31, 2015, we expect to receive a number of shares under the Convertible Note Hedge substantially equal to the number of shares of common stock to be issued in connection with any conversions of the Notes.
Separately, in July 2011 we also entered into privately negotiated warrant transactions with certain counterparties whereby we sold to independent third parties warrants (the “Warrants”) to acquire, subject to customary anti-dilution adjustments that are substantially the same as the anti-dilution provisions contained in the Notes, up to 19.9 million shares of our common stock (which is also equal to the number of shares of our common stock that notionally underlie the Notes), with a strike price of $41.14. The Warrants have a dilutive effect with respect to our common stock to the extent that the market price per share of our common stock exceeds $41.14 on or prior to the expiration date of the Warrants. Based on the closing stock price of our common stock of $68.72 at the end of the quarter ended December 31, 2015, approximately 8 million shares would be issuable under the Warrants. The Warrants are exercisable for a period of 60 trading days commencing on October 17, 2016. We received proceeds of $65 million from the sale of the Warrants.
Effect of conversion on earning per share (“EPS”)
The Notes have no impact on diluted EPS for periods where the average quarterly price of our common stock is below the conversion price of $31.74 per share. Prior to conversion, we will include the effect of the additional shares that may be issued if our common stock price exceeds $31.74 per share using the treasury stock method. If the average price of our common stock exceeds $41.14 per share for a quarterly period, we will also include the effect of the additional potential shares that may be issued related to the Warrants using the treasury stock method. Prior to conversion, the Convertible Note Hedge is not considered for purposes of the EPS calculation, as its effect would be anti-dilutive. Upon conversion, the Convertible Note Hedge is expected to offset the dilutive effect of the Notes when the stock price is above $31.74 per share. See Note 13 for additional information related to our EPS.
Credit Facility
On March 19, 2015, we entered into a $500 million senior unsecured revolving credit facility (“Credit Facility”) with a syndicate of banks. The credit facility terminates on March 19, 2020, and contains an option to arrange with existing lenders and/or new lenders for them to provide up to an aggregate of $250 million in additional commitments for revolving loans. Proceeds of loans made under the credit facility may be used for general corporate purposes.
The loans bear interest, at our option, at the base rate plus an applicable spread or an adjusted LIBOR rate plus an applicable spread, in each case with such spread being determined based on our consolidated leverage ratio for the preceding fiscal quarter. We are also obligated to pay other customary fees for a credit facility of this size and type. Interest is due and payable in arrears quarterly for loans bearing interest at the base rate and at the end of an interest period (or at each three month interval in the case of loans with interest periods greater than three months) in the case of loans bearing interest at the adjusted LIBOR rate. Principal, together with all accrued and unpaid interest, is due and payable on March 19, 2020.
The credit agreement contains customary affirmative and negative covenants, including covenants that limit or restrict our ability to, among other things, incur subsidiary indebtedness, grant liens, dispose of all or substantially all assets and pay dividends or make distributions, in each case subject to customary exceptions for a credit facility of this size and type. We are also required to maintain compliance with a capitalization ratio and maintain a minimum level of total liquidity.
The credit agreement contains customary events of default, including among others, non-payment defaults, covenant defaults, cross-defaults to material indebtedness, bankruptcy and insolvency defaults, material judgment of defaults and a change of control default, in each case, subject to customary exceptions for a credit facility of this size and type. The occurrence of an event of default could result in the acceleration of the obligations under the credit facility, an obligation by any guarantors to repay the obligations in full and an increase in the applicable interest rate.
As of December 31, 2015, no amounts were outstanding under the Credit Facility. $2 million of debt issuance costs that were paid in connection with obtaining this credit facility are being amortized to interest expense over the 5-year term of the Credit Facility.
The following table summarizes our interest expense recognized for the three and nine months ended December 31, 2015 and 2014 that is included in interest and other income (expense), net on our Condensed Consolidated Statements of Operations (in millions):
|
| | | | | | | | | | | | | | | |
| Three Months Ended December 31, | | Nine Months Ended December 31, |
| 2015 | | 2014 | | 2015 | | 2014 |
Loss on conversion of senior notes | $ | (2 | ) | | $ | — |
| | $ | (8 | ) | | $ | — |
|
Amortization of debt discount | (3 | ) | | (5 | ) | | (14 | ) | | (16 | ) |
Amortization of debt issuance costs | (1 | ) | | — |
| | (2 | ) | | (2 | ) |
Coupon interest expense | (1 | ) | | (2 | ) | | (3 | ) | | (4 | ) |
Other interest expense | — |
| | (1 | ) | | — |
| | (2 | ) |
Total interest expense | $ | (7 | ) | | $ | (8 | ) | | $ | (27 | ) | | $ | (24 | ) |
(11) COMMITMENTS AND CONTINGENCIES
Lease Commitments
As of December 31, 2015, we leased certain facilities, furniture and equipment under non-cancelable operating lease agreements. We were required to pay property taxes, insurance and normal maintenance costs for certain of these facilities and any increases over the base year of these expenses on the remainder of our facilities.
Development, Celebrity, League and Content Licenses: Payments and Commitments
The products we produce in our studios are designed and created by our employee designers, artists, software programmers and by non-employee software developers (“independent artists” or “third-party developers”). We typically advance development funds to the independent artists and third-party developers during development of our games, usually in installment payments made upon the completion of specified development milestones. Contractually, these payments are generally considered advances against subsequent royalties on the sales of the products. These terms are set forth in written agreements entered into with the independent artists and third-party developers.
In addition, we have certain celebrity, league and content license contracts that contain minimum guarantee payments and marketing commitments that may not be dependent on any deliverables. Celebrities and organizations with whom we have contracts include, but are not limited to: FIFA (Fédération Internationale de Football Association), FIFPRO Foundation, FAPL (Football Association Premier League Limited), and DFL Deutsche Fußball Liga GmbH (German Soccer League) (professional soccer); Dr. Ing. h.c. F. Porsche AG, Ferrari S.p.A. (Need For Speed and Real Racing games); National Basketball Association (professional basketball); PGA TOUR (professional golf); National Hockey League and NHL Players’ Association (professional hockey); National Football League Properties, PLAYERS Inc., and Red Bear Inc. (professional football); Zuffa, LLC (Ultimate Fighting Championship); ESPN (content in EA SPORTS games); Disney Interactive (Star Wars); Fox Digital Entertainment, Inc. (The Simpsons); Universal Studios Inc. (Minions); and Respawn (Titanfall). These developer and content license commitments represent the sum of (1) the cash payments due under non-royalty-bearing licenses and services agreements and (2) the minimum guaranteed payments and advances against royalties due under royalty-bearing licenses and services agreements, the majority of which are conditional upon performance by the counterparty. These minimum guarantee payments and any related marketing commitments are included in the table below.
The following table summarizes our minimum contractual obligations as of December 31, 2015 (in millions):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Fiscal Years Ending March 31, |
| | | 2016 | | | | | | | | | | | | |
| | | (Remaining | | | | | | | | | | | | |
| Total | | three mos.) | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 | | Thereafter |
Unrecognized commitments | | | | | | | | | | | | | | | |
Developer/licensor commitments | $ | 1,321 |
| | $ | 32 |
| | $ | 183 |
| | $ | 245 |
| | $ | 220 |
| | $ | 215 |
| | $ | 184 |
| | $ | 242 |
|
Marketing commitments | 315 |
| | 5 |
| | 65 |
| | 51 |
| | 49 |
| | 48 |
| | 49 |
| | 48 |
|
Operating leases | 205 |
| | 8 |
| | 36 |
| | 29 |
| | 25 |
| | 23 |
| | 21 |
| | 63 |
|
0.75% Convertible Senior Notes due 2016 interest (a) | 2 |
| | 1 |
| | 1 |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Other purchase obligations | 39 |
| | 15 |
| | 18 |
| | 3 |
| | 2 |
| | 1 |
| | — |
| | — |
|
Total unrecognized commitments | 1,882 |
| | 61 |
| | 303 |
| | 328 |
| | 296 |
| | 287 |
| | 254 |
| | 353 |
|
| | | | | | | | | | | | | | | |
Recognized commitments | | | | | | | | | | | | | | | |
0.75% Convertible Senior Notes due 2016 principal (a) | 340 |
| | 340 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Licensing and lease obligations (b) | 151 |
| | 5 |
| | 22 |
| | 23 |
| | 24 |
| | 25 |
| | 26 |
| | 26 |
|
Total recognized commitments | 491 |
| | 345 |
| | 22 |
| | 23 |
| | 24 |
| | 25 |
| | 26 |
| | 26 |
|
| | | | | | | | | | | | | | | |
Total commitments | $ | 2,373 |
| | $ | 406 |
| | $ | 325 |
| | $ | 351 |
| | $ | 320 |
| | $ | 312 |
| | $ | 280 |
| | $ | 379 |
|
| |
(a) | We will be obligated to pay the $340 million principal amount of the Notes in cash and any excess conversion value in shares of our common stock upon redemption of the Notes at maturity on July 15, 2016, or upon earlier conversion. During the quarter ended December 31, 2015, the Sales Price Condition was met and as a result, the Notes are currently convertible at the option of the holder though April 2, 2016. During the quarter ending March 31, 2016, we expect to settle at least $177 million in cash and a number of shares of our common stock equal in value to the excess conversion value. See Note 10 for additional information regarding our Notes. |
| |
(b) | Lease commitments exclude the impact of sub-lease income due from third parties totaling approximately $2 million. See Note 7 for additional information regarding recognized obligations from our licensing-related commitments. |
The unrecognized amounts represented in the table above reflect our minimum cash obligations for the respective fiscal years, but do not necessarily represent the periods in which they will be recognized and expensed in our Condensed Consolidated Financial Statements. In addition, the amounts in the table above are presented based on the dates the amounts are contractually due as of December 31, 2015; however, certain payment obligations may be accelerated depending on the performance of our operating results. Up to $32 million of the unrecognized amounts in the table above may be payable, at the licensor’s election, in shares of our common stock, subject to a $10 million maximum during any fiscal year. The number of shares to be issued will be based on fair market value at the time of issuance.
In addition to what is included in the table above, as of December 31, 2015, we had a liability for unrecognized tax benefits and an accrual for the payment of related interest totaling $62 million, of which we are unable to make a reasonably reliable estimate of when cash settlement with the taxing authority will occur.
Legal Proceedings
On July 29, 2010, Michael Davis, a former NFL running back, filed a putative class action in the United States District Court for the Northern District of California against the Company, alleging that certain past versions of Madden NFL included the images of certain retired NFL players without their permission. In March 2012, the trial court denied the Company’s request to dismiss the complaint on First Amendment grounds. In January 2015, that trial court decision was affirmed by the Ninth Circuit Court of Appeals and the case was remanded back to the district court. In October 2015, the Company filed a petition for a writ of certiorari to the United States Supreme Court which is pending.
We are also subject to claims and litigation arising in the ordinary course of business. We do not believe that any liability from any reasonably foreseeable disposition of such claims and litigation, individually or in the aggregate, would have a material adverse effect on our Condensed Consolidated Financial Statements.
(12) STOCK-BASED COMPENSATION
Valuation Assumptions
We estimate the fair value of stock-based payment awards on the date of grant. We recognize compensation costs for stock-based payment awards to employees based on the grant-date fair value over the service period for which such awards are expected to vest. For awards with only service conditions that have a graded vesting schedule, we recognize compensation costs on a straight-line basis over the requisite service period for the entire award.
The determination of the fair value of market-based restricted stock units, stock options and ESPP is affected by assumptions regarding subjective and complex variables. Generally, our assumptions are based on historical information and judgment is required to determine if historical trends may be indicators of future outcomes. We determine the fair value of our stock-based payment awards as follows:
| |
• | Restricted Stock Units, Restricted Stock, and Performance-Based Restricted Stock Units. The fair value of restricted stock units, restricted stock, and performance-based restricted stock units (other than market-based restricted stock units) is determined based on the quoted market price of our common stock on the date of grant. Performance-based restricted stock units include grants made in connection with certain acquisitions. |
| |
• | Market-Based Restricted Stock Units. Market-based restricted stock units consist of grants of performance-based restricted stock units to certain members of executive management that vest contingent upon the achievement of pre-determined market and service conditions (referred to herein as “market-based restricted stock units”). The fair value of our market-based restricted stock units is determined using a Monte-Carlo simulation model. Key assumptions for the Monte-Carlo simulation model are the risk-free interest rate, expected volatility, expected dividends and correlation coefficient. |
| |
• | Stock Options and Employee Stock Purchase Plan. The fair value of stock options and stock purchase rights granted pursuant to our equity incentive plans and our 2000 Employee Stock Purchase Plan (“ESPP”), respectively, is determined using the Black-Scholes valuation model based on the multiple-award valuation method. Key assumptions of the Black-Scholes valuation model are the risk-free interest rate, expected volatility, expected term and expected dividends. The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant for the expected term of the option. Expected volatility is based on a combination of historical stock price volatility and implied volatility of publicly-traded options on our common stock. Expected term is determined based on historical exercise behavior, post-vesting termination patterns, options outstanding and future expected exercise behavior. |
There were an insignificant number of stock options granted during the three and nine months ended December 31, 2015.
The estimated assumptions used in the Black-Scholes valuation model to value our stock option grants and ESPP were as follows:
|
| | | | | | | | | |
| | Stock Option Grants | | ESPP |
| | Nine Months Ended December 31, | | Nine Months Ended December 31, |
| | 2014 | | 2015 | | 2014 |
Risk-free interest rate | | 1.1 -1.9% |
| | 0.3 - 0.4% |
| | 0.04 - 0.1% |
|
Expected volatility | | 36 - 40% |
| | 32 | % | | 34 - 35% |
|
Weighted-average volatility | | 38 | % | | 32 | % | | 35 | % |
Expected term | | 4.5 years |
| | 6 - 11.5 months |
| | 6 - 12 months |
|
Expected dividends | | None |
| | None |
| | None |
|
There were no market-based restricted stock units granted during the three months ended December 31, 2015 and 2014.
Stock-Based Compensation Expense
Employee stock-based compensation expense recognized during the three months ended December 31, 2015 and 2014 was calculated based on awards ultimately expected to vest and has been reduced for estimated forfeitures. In subsequent periods, if actual forfeitures differ from those estimates, an adjustment to stock-based compensation expense is recognized at that time.
The following table summarizes stock-based compensation expense resulting from stock options, restricted stock, restricted stock units, performance-based restricted stock units, market-based restricted stock units, and the ESPP included in our Condensed Consolidated Statements of Operations (in millions):
|
| | | | | | | | | | | | | | | |
| Three Months Ended December 31, | | Nine Months Ended December 31, |
| 2015 | | 2014 | | 2015 | | 2014 |
Cost of revenue | $ | — |
| | $ | 1 |
| | $ | 1 |
| | $ | 2 |
|
Research and development | 26 |
| | $ | 22 |
| | 77 |
| | 61 |
|
Marketing and sales | 5 |
| | 6 |
| | 17 |
| | 16 |
|
General and administrative | 11 |
| | 10 |
| | 36 |
| | 29 |
|
Stock-based compensation expense | $ | 42 |
| | $ | 39 |
| | $ | 131 |
| | $ | 108 |
|
During the three and nine months ended December 31, 2015 and 2014, we did not recognize any benefit from income taxes related to our stock-based compensation expense.
As of December 31, 2015, our total unrecognized compensation cost related to stock options was $10 million and is expected to be recognized over a weighted-average service period of 1.7 years. As of December 31, 2015, our total unrecognized compensation cost related to restricted stock, restricted stock units, and market-based restricted stock units (collectively referred to as “restricted stock rights”) was $277 million and is expected to be recognized over a weighted-average service period of 1.4 years. Of the $277 million of unrecognized compensation cost, $31 million relates to market-based restricted stock units.
During the three and nine months ended December 31, 2015, we recognized $8 million and $73 million, respectively, of excess tax benefit from stock-based compensation deductions; this amount is reported in the financing activities on our Condensed Consolidated Statement of Cash Flows.
Stock Options
The following table summarizes our stock option activity for the nine months ended December 31, 2015:
|
| | | | | | | | | | | | | |
| | Options (in thousands) | | Weighted- Average Exercise Prices | | Weighted- Average Remaining Contractual Term (in years) | | Aggregate Intrinsic Value (in millions) |
Outstanding as of March 31, 2015 | | 4,920 |
| | $ | 37.44 |
| | | | |
Granted | | 4 |
| | 66.72 |
| | | | |
Exercised | | (1,473 | ) | | 43.92 |
| | | | |
Forfeited, cancelled or expired | | (52 | ) | | 35.76 |
| | | | |
Outstanding as of December 31, 2015 | | 3,399 |
| | $ | 34.69 |
| | 5.78 | | $ | 116 |
|
Vested and expected to vest | | 3,241 |
| | $ | 34.84 |
| | 5.67 | | $ | 110 |
|
Exercisable as of December 31, 2015 | | 2,263 |
| | $ | 36.18 |
| | 4.57 | | $ | 74 |
|
The aggregate intrinsic value represents the total pre-tax intrinsic value based on our closing stock price as of December 31, 2015, which would have been received by the option holders had all the option holders exercised their options as of that date. The weighted-average grant date fair values of stock options granted during nine months ended December 31, 2014 was $12.01. We issue new common stock from our authorized shares upon the exercise of stock options.
Restricted Stock Rights
The following table summarizes our restricted stock rights activity, excluding market-based restricted stock unit activity which is discussed below, for the nine months ended December 31, 2015:
|
| | | | | | | |
| | Restricted Stock Rights (in thousands) | | Weighted- Average Grant Date Fair Values |
Balance as of March 31, 2015 | | 10,855 |
| | $ | 26.20 |
|
Granted | | 2,743 |
| | 64.45 |
|
Vested | | (5,520 | ) | | 21.66 |
|
Forfeited or cancelled | | (816 | ) | | 34.16 |
|
Balance as of December 31, 2015 | | 7,262 |
| | $ | 43.20 |
|
The weighted-average grant date fair values of restricted stock rights granted during the three and nine months ended December 31, 2015 were $70.57 and $64.45, respectively.
Market-Based Restricted Stock Units
Our market-based restricted stock units vest contingent upon the achievement of pre-determined market and service conditions. If these market conditions are not met but service conditions are met, the market-based restricted stock units will not vest; however, any compensation expense we have recognized to date will not be reversed. The number of shares of common stock to be received at vesting will range from zero percent to 200 percent of the target number of market-based restricted stock units based on our total stockholder return (“TSR”) relative to the performance of companies in the NASDAQ-100 Index for each measurement period, generally over a one-year, two-year cumulative and three-year cumulative period. In the table below, we present shares granted at 100 percent of target of the number of market-based restricted stock units that may potentially vest. The maximum number of common shares that could vest is approximately 0.8 million for market-based restricted stock units granted during the nine months ended December 31, 2015. As of December 31, 2015, the maximum number of shares that could vest is approximately 1.3 million for market-based restricted stock units outstanding.
The following table summarizes our market-based restricted stock unit activity for the nine months ended December 31, 2015:
|
| | | | | | | |
| | Market-Based Restricted Stock Units (in thousands) | | Weighted- Average Grant Date Fair Value |
Balance as of March 31, 2015 | | 663 |
| | $ | 31.82 |
|
Granted | | 395 |
| | 79.81 |
|
Vested | | (742 | ) | | 25.77 |
|
Vested above target | | 371 |
| | 25.77 |
|
Forfeited or cancelled | | (51 | ) | | 40.10 |
|
Balance as of December 31, 2015 | | 636 |
| | $ | 64.49 |
|
Stock Repurchase Program
In May 2014, a special committee of our Board of Directors, on behalf of the full Board of Directors, authorized a two-year program to repurchase up to $750 million of our common stock. Since inception, we repurchased approximately 9.2 million shares for approximately $394 million under this program.
In May 2015, our Board of Directors authorized a program to repurchase up to $1 billion of our common stock. This stock repurchase program, which expires on May 31, 2017, supersedes and replaces the stock repurchase authorization approved in May 2014. Under the May 2015 program, we may purchase stock in the open market or through privately-negotiated transactions in accordance with applicable securities laws, including pursuant to pre-arranged stock trading plans. The timing and actual amount of the stock repurchases will depend on several factors including price, capital availability, regulatory requirements, alternative investment opportunities and other market conditions. We are not obligated to repurchase any specific number of shares under this program and it may be modified, suspended or discontinued at any time.
During the three and nine months ended December 31, 2015, we repurchased approximately 1.8 million and 5.8 million shares for approximately $126 million and $384 million respectively. We continue to actively repurchase shares.
The following table summarizes total shares repurchased during the three and nine months ended December 31, 2015 and 2014:
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| | | | | | | | | | | | | | | | | | | |
| May 2014 Program | | May 2015 Program | | Total |
(in millions) | Shares | | Amount | | Shares | | Amount | | Shares | | Amount |
Three months ended December 31, 2015 | — |
| | $ | — |
| | 1.8 | | $ | 126 |