Electronic Arts Earnings 2019-03-31
EA 10K Annual Report
| Balance Sheet | Income Statement | Cash Flow |
|---|---|---|
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended March 31, 2019
OR
¨ | 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.) | |
209 Redwood Shores Parkway | 94065 | |
Redwood City, California | (Zip Code) | |
(Address of principal executive offices) | ||
Registrant’s telephone number, including area code:
(650) 628-1500
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Trading Symbol | Name of Each Exchange on Which Registered | ||
Common Stock, $0.01 par value | EA | NASDAQ Global Select Market | ||
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
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, every Interactive Data File required to be submitted 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 such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ | |||
Emerging growth company ¨ | ||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
The aggregate market value of the registrant’s common stock, $0.01 par value, held by non-affiliates of the registrant as of September 28, 2018, the last business day of our second fiscal quarter, was $35,963 million.
As of May 20, 2019, there were 297,261,219 shares of the registrant’s common stock, $0.01 par value, outstanding.
Documents Incorporated by Reference
Portions of the registrant’s definitive proxy statement for its 2019 Annual Meeting of Stockholders (the “2019 Proxy”) are incorporated by reference into Part III hereof. The 2019 Proxy is expected to be filed not later than 120 days after the registrant’s fiscal year end. Except with respect to information specifically incorporated by reference into this Form 10-K, the 2019 Proxy is not deemed to be filed as part hereof.
ELECTRONIC ARTS INC.
2019 FORM 10-K ANNUAL REPORT
Table of Contents
Page | ||
PART I | ||
Item 1 | ||
Item 1A | ||
Item 1B | ||
Item 2 | ||
Item 3 | ||
Item 4 | ||
PART II | ||
Item 5 | ||
Item 6 | ||
Item 7 | ||
Item 7A | ||
Item 8 | ||
Item 9 | ||
Item 9A | ||
Item 9B | ||
PART III | ||
Item 10 | ||
Item 11 | ||
Item 12 | ||
Item 13 | ||
Item 14 | ||
PART IV | ||
Item 15 | ||
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CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements. We use words such as “anticipate,” “believe,” “expect,” “intend,” “estimate”, “plan”, “predict”, “seek”, “goal”, “will”, “may”, “likely”, “should”, “could” (and the negative of any of these terms), “future” and similar expressions to identify forward-looking statements. In addition, any statements that refer to projections of our future financial performance, trends in our business, projections of markets relevant to our business, uncertain events and assumptions and other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements consist of, among other things, statements related to industry prospects, our future financial performance, and our business plans and objectives, and may include certain assumptions that underlie the forward-looking statements. These forward-looking statements are not guarantees of future performance and reflect management’s current expectations. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that might cause or contribute to such differences include those discussed in Part I, Item 1A of this Annual Report under the heading “Risk Factors” beginning on page 9. We assume no obligation to revise or update any forward-looking statement for any reason, except as required by law.
PART I
Item 1: Business
Overview
We are a global leader in digital interactive entertainment, with a mission to inspire the world to play. We develop, market, publish and distribute games, content and services that can be played and watched on a variety of platforms, including game consoles, PCs, mobile phones and tablets.
Our Strategic Pillars
There are three core pillars to our strategy:
•Players First
•Commitment to Digital
•One EA
These strategic pillars are built on our focus of delivering a broad and deep portfolio of games and services that engages players across a wide range of geographies, platforms and business models.
Players First
Players are the foundation of our success, and we are committed to thinking about players first in everything we do. Our goal is to build deep, on-going and meaningful relationships with our players. We aim to build these relationships by creating amazing games and services that deliver long-lasting fun and enduring value, by connecting with our players across platforms and social channels, and by delivering flexibility and innovation in our business models. In fiscal year 2019, we continued to innovate for players by including frontline titles in our Origin Access Premier subscription service, publishing our first free-to-play console game, Apex Legends, and investing in more ways to reach our players, such as cloud gaming and esports.
Our games and services are based on a portfolio of intellectual property that includes established brands such as FIFA, Madden NFL, Star Wars, Battlefield, the Sims and Need for Speed. We also have invested, and will continue to invest, in developing and establishing new brands, and in fiscal year 2019 launched two new intellectual properties – Anthem and Apex Legends. We will continue to develop and publish a broad and deep portfolio of games and services that engage players across geographies, platforms and business models.
Commitment to Digital
Players increasingly purchase our games as digital downloads, as opposed to purchasing physical discs, and engage with the live services that we provide on an ongoing basis. Our live services provide additional depth and engagement opportunities for our players and include in-game purchases, extra content, subscriptions, and esports. For example, the Ultimate Team mode associated with our sports franchises and live services provided for our Battlefield, Star Wars and Sims franchises, have extended the life of those games by engaging players over longer periods of time. The digital transformation also is creating opportunities in platforms, content models and the way in which players engage with our games and services. For example, we
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have leveraged brands and assets from franchises historically associated with traditional gaming, such as FIFA, Madden NFL, Star Wars, The Sims, and SimCity, to create free-to-play games that are monetized through live services provided with the game. We also offer subscription services, such as EA Access, Origin Access and Origin Access Premier, as we look to build deeper relationships with our players and offer increased choice and flexibility for our players to try new games.
The portion of our revenue attributable to our digital business has significantly increased from 59 percent in fiscal year 2017 to 67 percent in fiscal year 2018 and 75 percent during fiscal year 2019. We believe that our digital revenue, which generally has a higher gross margin than our packaged goods revenue, will continue to increase during fiscal year 2020 relative to packaged goods revenue as we continue to focus on developing and monetizing products and services that can be delivered digitally.
One EA
As a global leader in digital interactive entertainment, we have an opportunity to leverage our scale to market and deliver engaging games and services to more players across more platforms. Our “One EA” model provides strategic advantages. For example, we have moved much of our PC and console development to one game engine. This creates operational flexibility as our development teams code on a consistent engine and will allow us to transition our products and services to new platforms quickly and cost-effectively. In addition, we’ve brought together our marketing, publishing and analytics functions as a single go-to-market unit and simplified their processes and decision-making in order to improve effectiveness and build flexibility into our marketing strategies.
We also are strengthening the technology that connects our players to each other and to the games they love. We are adopting consistent, cross-company methodologies to better understand our players’ needs and continue to invest in technological infrastructure that enables us to deliver content that will resonate with players, and provide more choice in the way that players connect with their games, with each other, and with new types of content, including esports broadcasts. This connection also allows us to market and deliver content and services for popular franchises like FIFA, Battlefield and Star Wars to our players more efficiently.
Our Games and Services
We develop, market, publish and deliver games and services that can be played and watched on a variety of platforms, including consoles, PCs, mobile phones and tablets. We market and sell our games and services through digital distribution channels and through retail channels. We believe that flexibility across platforms, distribution channels and business models maximizes the opportunity for players to access and enjoy our games and services and increases engagement with our games and services. New platforms, engagement models and business models are expected to continue to emerge in the future, and we intend to evaluate these opportunities on a case-by-case basis.
Digitally, our console games and services can be purchased through third-party storefronts, such as the digital stores of our console platform partners Sony, Microsoft and Nintendo. Our direct sales to Sony and Microsoft represented approximately 29 percent and 16 percent of total net revenue, respectively, in fiscal year 2019; approximately 27 percent and 16 percent of total net revenue, respectively, in fiscal year 2018; and approximately 19 percent and 17 percent of total net revenue, respectively, in fiscal year 2017. Our mobile and tablet games and services are available through third-party application storefronts such as the Apple App Store and Google Play. Our PC games and services can be downloaded directly through our Origin platform, as well as through third-party online download stores. We also partner with third parties to publish our mobile and PC games and services on their platforms in certain Asian territories, such as our partnerships with Tencent Holdings Limited and Nexon Co. Ltd. for FIFA Online in China and Korea, respectively. Players also can access a selection of our console and PC games and services through our EA Access, Origin Access and Origin Access Premier subscription services. Our packaged goods games are sold directly to mass market retailers, electronics specialty stores and game software specialty stores or through distribution arrangements.
In our games and services, we use brands that we either wholly own (such as Battlefield, The Sims, Apex Legends, Anthem, Need for Speed and Plants v. Zombies) or license from others (such as FIFA, Madden NFL and Star Wars). We develop and publish games and services across diverse genres, such as sports, first-person shooter, action, role-playing and simulation, and offer our games and services through diverse business models and distribution channels, such as retail download, subscription and free-to-play. We believe that the breadth and depth of our portfolio and our flexibility in business models and distribution channels provide us with strategic advantages. These advantages include the opportunity to engage an increasing number of players across more platforms and geographies and a recurring source of revenue from, among other things, our annualized sports franchises (e.g., FIFA, Madden NFL), our console, PC and mobile catalog titles (i.e., titles that did not launch in the current fiscal year), the associated live services and our subscriptions business.
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Our largest and most popular game is FIFA, the annualized version of which is consistently one of the best-selling games in the marketplace. Net revenue from FIFA 19, FIFA 18, and FIFA 17 represented approximately 14 percent of our total net revenue in fiscal year 2019 and approximately 11 percent of our total net revenue in each of fiscal year 2018 and 2017.
Within and alongside our games, we offer live services, including in-game purchases, downloadable content, and esports, that provide additional depth and engagement opportunities for our players. Our live services net revenue comprised 45 percent of our total net revenue during fiscal year 2019 and we expect that live services net revenue will continue to be material to our business. Our most popular live service is the Ultimate Team mode associated with our sports franchises. Ultimate Team allows players to collect current and former professional players in order to build, and compete as, a personalized team. Net revenue from Ultimate Team represented approximately 28 percent, 21 percent and 16 percent of our total net revenue during fiscal year 2019, 2018 and 2017, respectively, a substantial portion of which was derived from FIFA Ultimate Team.
We also are investing in a number of long-term initiatives that we believe will allow us to better serve and deepen our engagement with our players. For example, we focus on esports through our Competitive Gaming Division. We believe that the interest and enthusiasm that surrounds esports will drive engagement and monetization in our live services in addition to providing revenue through partnerships with sponsors and broadcasters. In addition, we are pursuing technology underlying cloud gaming and subscriptions, which we see as future growth opportunities.
Significant Relationships
Sony & Microsoft. Under the terms of agreements we have entered into with Sony Computer Entertainment Inc. and its affiliates and with Microsoft Corporation and its affiliates, we are authorized to develop and distribute disc-based and digitally-delivered software products and services compatible with PlayStation and Xbox consoles, respectively. Under these agreements with Sony and Microsoft, we are provided with the non-exclusive right to use, for a fixed term and in a designated territory, technology that is owned or licensed by them to publish our games on their respective platform. With respect to our digitally-delivered products and services, the console manufacturers pay us either a wholesale price or a “royalty” percentage on the revenue they derive from their sales of our products and services. Our transactions for packaged goods products are made pursuant to individual purchase orders, which are accepted on a case-by case basis by Sony or Microsoft (or their designated replicators), as the case may be. For packaged goods products, we pay the console manufacturers a per-unit royalty for each unit manufactured. Many key commercial terms of our relationships with Sony and Microsoft — such as manufacturing terms, delivery times, platform policies and approval conditions — are determined unilaterally, and are subject to change by the console manufacturers.
The platform license agreements also require us to indemnify the console manufacturers for any loss, liability and expense resulting from any claim against the console manufacturer regarding our games and services, including any claims for patent, copyright or trademark infringement brought against the console manufacturer. Each platform license may be terminated by the console manufacturer if a breach or default by us is not cured after we receive written notice from the console manufacturer, or if we become insolvent. The console manufacturers are not obligated to enter into platform license agreements with us for any future consoles, products or services.
Apple, Google and Other App Stores. We have agreements to distribute our mobile applications and additional content through distributors such as Apple and Google. Our applications are downloaded for mobile devices from third party application storefronts. The distributor charges consumers for content purchased within the application or charges consumers a one-time fee to download the application. Our distribution agreements establish the amounts that are retained by the distributor and the amounts passed through to us. These arrangements are typically terminable on short notice. The agreements generally do not obligate the distributors to market or distribute any of our applications.
Publishing Partners in Asia. We have entered into agreements whereby we partner with certain companies, including Tencent Holdings Limited and Nexon Co., Ltd. or their respective affiliates, pursuant to which these companies publish our mobile and PC free-to-download games in certain Asian territories, including China and Korea. Our players access games from the publishers’ platforms and are charged for additional content purchased within our game environment. The agreements generally establish the amounts that are retained by the publisher, and the amounts passed through to us.
Competition
The market for interactive entertainment is intensely competitive and changes rapidly as new products, platforms, business models and distribution channels are introduced. We also face competition for the right to use certain intellectual property included in our products. We face significant competition from companies such as Activision Blizzard, Take-Two Interactive,
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Ubisoft, Bethesda, Epic Games, NetEase, Tencent, Sony, Microsoft and Nintendo, primarily with respect to developing games and services that operate on consoles, PCs and/or mobile devices.
More broadly, we compete against providers of different sources of entertainment, such as motion pictures, television, social networking, online casual entertainment and music that our players could enjoy in their free time. Important competitive factors in our industry include game quality and ease of use, innovation, compatibility of products with certain platforms, brand recognition, publisher reputation, reliability, security, creativity, price, marketing, and quality of customer service.
Intellectual Property
To establish and protect our intellectual property, we rely on a combination of copyrights, trademarks, patents, patent applications, trade secrets, know-how, license agreements, confidentiality provisions and procedures and other contractual provisions. We actively engage in enforcement and other activities to protect our intellectual property. We also devote financial and operational resources to implement systems, processes and technologies to guard against cyber events and to help protect our intellectual property, employee and consumer data and information technology systems against intrusions or other security breaches. In addition, we engage in activities designed to limit the impact of abuse of our digital products and services, including monitoring our games for evidence of exploitation and re-balancing our game environments in the event that such abuse is discovered.
Governmental Regulation
We are a global company subject to various and complex laws and regulations domestically and internationally, including laws and regulations related to user privacy, data collection and retention, consumer protection, content, advertising, localization, information security, intellectual property, competition and taxation, among others. Many of these laws and regulations are continuously evolving and developing, and the application to, and impact on, us is uncertain. Certain of our business models in particular are subject to new laws or regulations or evolving interpretations and application of existing laws and regulations. For example, the growth and development of electronic commerce, virtual items and virtual currency have prompted calls for new laws and regulations, or the application of existing laws or regulations, to these business models.
Seasonality
We have historically experienced the highest percentage of our net bookings in our third fiscal quarter due to seasonal holiday demand and the launch timing of our games. While we expect this trend to continue in fiscal year 2020, there is no assurance that it will. In addition, we defer the recognition of a portion of our net revenue over an extended period of time. As a result, the quarter in which we generate the highest net bookings may be different from the quarter in which we recognized the highest amount of net revenue.
Employees
As of March 31, 2019, we had approximately 9,700 regular, full-time employees, over 6,000 of whom were outside the United States. We believe that our ability to attract, train, motivate and retain qualified employees is a critical factor in the successful development of our products and services and that our future success will depend, in large measure, on our ability to continue attracting, training, motivating and retaining qualified employees. Approximately 8 percent of our employees, all of whom work for our DICE development studio in Sweden, are represented by a union.
Investor Information
Our website address is www.ea.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and any amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Securities Exchange Act, as amended, are available free of charge on the Investor Relations section of our website at http://ir.ea.com as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). We announce material financial information and business updates through our SEC filings, press releases, public conference calls and webcasts, the Investor Relations section of our website at http://ir.ea.com, our blog at https://www.ea.com/news and through our Twitter account @EA. Except as expressly set forth in this Form 10-K annual report, the contents of our website and/or social media accounts are not incorporated into, or otherwise to be regarded as part of this report.
Company Information
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We were incorporated originally in California in 1982. In September 1991, we were reincorporated under the laws of Delaware. Our principal executive offices are located at 209 Redwood Shores Parkway, Redwood City, California 94065 and our telephone number is (650) 628-1500.
Information About Our Executive Officers
The following table sets forth information regarding our executive officers as of May 23, 2019:
Name | Age | Position | ||
Andrew Wilson | 44 | Chief Executive Officer | ||
Blake Jorgensen | 59 | Chief Operating Officer and Chief Financial Officer | ||
Laura Miele | 49 | Chief Studios Officer | ||
Kenneth Moss | 53 | Chief Technology Officer | ||
Christopher Bruzzo | 49 | Chief Marketing Officer | ||
Joel Linzner | 67 | Executive Vice President, Worldwide Business Affairs | ||
Mala Singh | 48 | Chief People Officer | ||
Matthew Bilbey | 43 | Executive Vice President of Strategic Growth | ||
Kenneth A. Barker | 52 | Senior Vice President, Chief Accounting Officer | ||
Jacob J. Schatz | 50 | Executive Vice President, General Counsel and Corporate Secretary | ||
Mr. Wilson has served as EA’s Chief Executive Officer and as a director of EA since September 2013. Prior to his appointment as our Chief Executive Officer, Mr. Wilson held several positions within the Company since joining EA in May 2000, including Executive Vice President, EA SPORTS from August 2011 to September 2013. Mr. Wilson serves as a director of Intel Corporation and is chairman of the board of the privately-held World Surf League.
Mr. Jorgensen has served as EA’s Chief Financial Officer since September 2012 and as EA’s Chief Operating Officer since April 2018. Prior to joining EA, he served as Executive Vice President, Chief Financial Officer of Levi Strauss & Co. from July 2009 to August 2012. From June 2007 to June 2009, Mr. Jorgensen served as Executive Vice President, Chief Financial Officer of Yahoo! Inc. Mr. Jorgensen earned his M.B.A. from Harvard Business School and his undergraduate degree from Stanford University.
Ms. Miele has served as EA’s Chief Studios Officer since April 2018. Ms. Miele joined the Company in March 1996 and has held several positions at the Company, including Executive Vice President, Global Publishing from April 2016 to April 2018, Senior Vice President of Americas Publishing from June 2014 to April 2016, General Manager of the Company’s Star Wars business from June 2013 to June 2014, and several senior roles in the Company's marketing organization.
Mr. Moss has served as EA’s Chief Technology Officer since July 2014. He served as Vice President of Market Places Technology, Science and Data at eBay Inc. from November 2011 to July 2014. Prior to joining eBay, he co-founded CrowdEye, Inc. and served as its Chief Executive Officer from October 2008 to November 2011. Mr. Moss graduated from Princeton University.
Mr. Bruzzo has served as EA’s Chief Marketing Officer since September 2014. Prior to joining EA, he served as Senior Vice President at Starbucks Corporation from June 2011 to August 2014. Mr. Bruzzo graduated from Whitworth University.
Mr. Linzner has served as EA’s Executive Vice President, Worldwide Business Affairs since April 2016. From March 2005 until April 2016, Mr. Linzner was EA's Executive Vice President, Business and Legal Affairs. Prior to joining EA in July 1999, Mr. Linzner served as outside litigation counsel to EA and several other companies in the video game industry. Mr. Linzner earned his J.D. from Boalt Hall at the University of California, Berkeley, after graduating from Brandeis University.
Ms. Singh has served as EA’s Chief People Officer since October 2016. Ms. Singh was previously employed by EA from 2009 to 2013, serving as Vice President, Human Resources, EA Labels from 2011 to 2013. Prior to rejoining EA, Ms. Singh served as the Chief People Officer of Minted, LLC from January 2014 to October 2016. Ms. Singh earned both her undergraduate and graduate degrees from Rutgers University - New Brunswick.
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Mr. Bilbey has served as EA’s Executive Vice President of Strategic Growth since April 2018. Mr. Bilbey joined EA in 1995 and has held several positions within the Company, including Chief Operating Officer, Worldwide Studios from August 2016 to April 2018 and Senior Vice President, Group General Manager from November 2013 to January 2017.
Mr. Barker has served as Senior Vice President, Chief Accounting Officer since April 2006. From February 2012 to September 2012, he also served as Interim Chief Financial Officer. From June 2003 to April 2006, Mr. Barker held the position of Vice President, Chief Accounting Officer. Prior to joining EA, Mr. Barker was at Sun Microsystems, Inc., as their Vice President and Corporate Controller from October 2002 as well as at Deloitte & Touche as an audit partner. Mr. Barker serves on the Board of Directors of Gatepath, a non-profit organization, and on the Accounting Advisory Board for the University of Notre Dame. Mr. Barker graduated from the University of Notre Dame.
Mr. Schatz has served as EA’s General Counsel and Corporate Secretary since June 2014. Mr. Schatz joined EA in 1999, and prior to his current role, he served as Deputy General Counsel and as Vice President from 2006 to 2014. Mr. Schatz earned his J.D. from Georgetown University Law Center, and received his undergraduate degree from Pomona College. Mr. Schatz is a member of the Bar of the State of California and is admitted to practice in the United States Supreme Court, the Ninth Circuit Court of Appeals and several United States District Courts.
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Item 1A. | Risk Factors |
Our business is subject to many risks and uncertainties, which may affect our future financial performance. If any of the events or circumstances described below occurs, our business or financial performance could be harmed, our actual results could differ materially from our expectations and the market value of our stock could decline. The risks and uncertainties discussed below are not the only ones we face. There may be additional risks and uncertainties not currently known to us or that we currently do not believe could be material that may harm our business or financial performance.
Our business is intensely competitive and “hit” driven. We may not deliver “hit” products and services, or consumers may prefer our competitors’ products or services over our own.
Competition in our industry is intense. Many new products and services are regularly introduced in each major industry segment (console, mobile and PC), but only a relatively small number of “hit” titles account for a significant portion of total revenue in each segment. Our competitors range from established interactive entertainment companies and diversified media companies to emerging start-ups, and we expect new competitors to continue to emerge throughout the world. If our competitors develop and market more successful and engaging products or services, offer competitive products or services at lower price points, or if we do not continue to develop consistently high-quality, well-received and engaging products and services, our revenue, margins, and profitability will decline.
We maintain a relatively limited product portfolio in an effort to focus on developing high-quality and engaging products and services with the potential to become hits. High-quality titles, even if highly-reviewed, may not turn into a hit. Many hit products and services within our industry are iterations of prior hits with large established consumer bases and significant brand recognition, which makes competing in certain categories challenging. In addition, hit products or services of our direct competitors or other entertainment companies may take a larger portion of consumer spending or time than we anticipate, which could cause our products and services to underperform relative to our expectations. Publishing a relatively small number of major titles each year also concentrates risk in those titles and means each major title has greater associated risk. A significant portion of our revenue historically has been derived from products and services based on a few popular franchises, and the underperformance of a single major title could have a material adverse impact on our financial results. For example, we have historically derived a significant portion of our net revenue from sales related to our largest and most popular game, FIFA, the annualized version of which is consistently one of the best-selling games in the marketplace. Any events or circumstances that negatively impact our FIFA franchise, such as product or service quality, competing products that take a portion of consumer spending and time, the delay or cancellation of a product or service launch, or real or perceived security risks could negatively impact our financial results to a disproportionate extent.
The increased importance of live services revenue to our business heightens the risks associated with our limited product portfolio. Live services that are either poorly-received or provided in connection with underperforming games may generate lower than expected sales. Any lapse, delay or failure in our ability to provide high-quality live services content to consumers over an extended period of time could materially and adversely affect our financial results, consumer engagement with our live services, and cause harm to our reputation and brand. Our most popular live service is the Ultimate Team mode associated with our sports franchises. Any events or circumstances that negatively impact our ability to reliably provide content or sustain engagement for Ultimate Team, particularly FIFA Ultimate Team, would negatively impact our financial results to a disproportionate extent.
Our industry changes rapidly and we may fail to anticipate or successfully implement new or evolving technologies, or adopt successful business strategies, distribution methods or services.
Rapid changes in our industry require us to anticipate, sometimes years in advance, the ways in which our products and services will be competitive in the market. We have invested, and in the future may invest, in new business strategies, technologies, distribution methods, products, and services. There can be no assurance that these investments will achieve expected returns. For example, we are investing in the technological infrastructure that we expect will enable us to deliver content that will resonate with players and provide more choice in the way that players connect with their games, with each other, and with new types of content. We also recently expanded our free-to-play business model by launching our first free-to-play console game. Such endeavors may involve significant risks and uncertainties, and no assurance can be given that the technology we choose to implement, the business strategies we choose to adopt and the products and services that we pursue will be successful. If we do not successfully evolve our business in a manner that meets or exceeds player expectations, our reputation and brand may be materially adversely affected and our financial condition and operating results may be impacted. We also may miss opportunities to adopt technology or distribution methods or develop products, services or new ways to engage with our games that become popular with consumers, which could adversely affect our financial results. It may take significant time and resources to shift our focus to alternatives, putting us at a competitive disadvantage.
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Our development process usually starts with particular platforms and distribution methods in mind, and a range of technical development, feature and ongoing goals that we hope to be able to achieve. We may not be able to achieve these goals, or our competition may be able to achieve them more quickly and in a way that better engages consumers. In either case, our products and services may be technologically inferior to those of our competitors, less appealing to consumers, or both. If we cannot achieve our goals within the original development schedule for our products and services, then we may delay their release until these goals can be achieved, which may delay or reduce revenue and increase our development expenses. Alternatively, we may increase the resources employed in research and development in an attempt to accelerate our development of new technologies, either to preserve our product or service launch schedule or to keep up with our competition, which would increase our development expenses.
We may experience security breaches and cyber threats.
Our industry is prone to, and our systems and networks are subject to, cyber-attacks, computer viruses, worms, phishing attacks, malicious software programs and other information security incidents that seek to exploit, disable, damage, disrupt or gain access to our networks, our products and services, supporting technological infrastructure, intellectual property and other assets. We expect these threats to our systems and networks to continue. In addition, we rely on technological infrastructure provided by third-party business partners to support the online functionality of our products and services. These business partners, as well as our channel partners, also are subject to cyber risks and threats. Both our partners and we have expended, and expect to continue to expend, financial and operational resources to implement certain systems, processes and technologies to guard against cyber risks and to help protect our data and systems. However, the techniques used to exploit, disable, damage, disrupt or gain access to our networks, our products and services, supporting technological infrastructure, intellectual property and other assets change frequently, continue to evolve in sophistication and volume, and often are not detected for long periods of time. Our systems, processes and technologies, and the systems, processes and technologies of our business partners, may not be adequate against all eventualities. The costs to respond to, mitigate, and/or notify affected parties of cyber-attacks and other security vulnerabilities are significant. Any failure to prevent or mitigate security breaches or cyber risks, or detect or respond adequately to a security breach or cyber risk, could result in a loss of anticipated revenue, interruptions to our products and services, cause us to incur significant remediation and notification costs, degrade the user experience, cause consumers to lose confidence in our products and services and cause us to incur significant legal and financial costs. This could harm our business, reputation and brand, disrupt our relationships with partners and customers and diminish our competitive position.
The virtual economies that we have established in many of our games are subject to abuse, exploitation and other forms of fraudulent activity that can negatively impact our business. Virtual economies involve the use of virtual currency and/or virtual assets that can be used or redeemed by a player within a particular game or service. The abuse or exploitation of our virtual economies include the illegitimate generation and sale of virtual items, including in black markets. Our online services have been impacted by in-game exploits and the use of automated or other fraudulent processes to generate virtual item or currency illegitimately, and such activity may continue. These abuses and exploits, and the steps that we take to address these abuses and exploits may result in a loss of anticipated revenue, increased costs to protect against or remediate these issues, interfere with players’ enjoyment of a balanced game environment and cause harm to our reputation and brand.
Our business could be adversely affected if our consumer protection, data privacy and security practices are not adequate, or perceived as being inadequate, to prevent data breaches, or by the application of consumer protection and data privacy and security laws generally.
In the course of our business, we collect, process, store and use consumer, employee and other information, including personal information, passwords, credit card information gameplay details and banking information. Although we expend, and expect to continue to expend, financial and operational resources to create and enforce security measures, policies and controls that are designed to protect this information from improper or unauthorized access, acquisition and misuse and/or uninformed disclosure, our security measures, policies and controls may not be able successful against all eventualities. The improper or unauthorized access, acquisition or misuse and/or uninformed disclosure of consumer and other information, or a perception that we do not adequately secure this information or provide consumers with adequate notice about the information that they authorize us to disclose, could result in legal liability, costly remedial measures, governmental and regulatory investigations, harm our profitability, reputation and brand, and cause our financial results to be materially affected. In addition, third party vendors and business partners receive access to information that we collect. These vendors and business partners may not prevent data security breaches with respect to the information we provide them or fully enforce our policies, contractual obligations and disclosures regarding the collection, use, storage, transfer and retention of personal data. A data security breach of one of our vendors or business partners could cause reputational and financial harm to them and us, negatively impact our ability to offer our products and services, and
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could result in legal liability, costly remedial measures, governmental and regulatory investigations, harm our profitability, reputation and brand, and cause our financial results to be materially affected.
We are subject to payment card association rules and obligations pursuant to contracts with payment card processors. Under these rules and obligations, if information is compromised, we could be liable to payment card issuers for the cost of associated expenses and penalties. In addition, if we fail to follow payment card industry security standards, even if no consumer information is compromised, we could incur significant fines or experience a significant increase in payment card transaction costs.
As a global company, we are subject to global data privacy, data protection, localization, security and consumer-protection laws and regulations. These laws and regulations are emerging and evolving in countries worldwide and the interpretation and application of these laws and regulations in the United States, Europe and elsewhere often are uncertain, contradictory and changing. For example, the European General Data Protection Regulation (GDPR) applies to us, creating a range of new compliance obligations regarding the treatment of personal data. In addition, the GDPR contains significant penalties for non-compliance. It is possible that these laws may be interpreted or applied in a manner that is adverse to us, unforeseen, or otherwise inconsistent with our practices or that we may not adequately adapt our internal policies and/or procedures to evolving regulations, any of which could result in litigation, regulatory investigations and potential legal liability, require us to change our practices in a manner adverse to our business or limit access to our products and services in certain countries. As a result, our reputation and brand may be harmed, we could incur substantial costs, and we could lose both consumers and revenue.
We may experience outages, disruptions or degradations in our services, products and/or technological infrastructure.
The reliable performance of our products and services increasingly depends on the continuing operation and availability of our information technology systems and those of our external service providers, including third-party “cloud” computing services. Our games and services are complex software products, and maintaining the sophisticated internal and external technological infrastructure required to reliably deliver these games and services is expensive and complex. The reliable delivery and stability of our products and services could be adversely impacted by outages, disruptions, failures or degradations in our network and related infrastructure, as well as in the online platforms or services of key business partners who offer, support or host our products and services. Possible causes of these outages, disruptions, failures or degradations include natural disasters, power loss, terrorism, cyber-attacks, computer viruses, bugs or other malware or ransomware that may harm our systems or the systems of our external business partners. In addition, the migration of data among data centers and to third-party hosted environments and the performance of upgrades and maintenance on our systems could impact the reliability and stability of our products and services if not managed properly.
If we or our external business partners were to experience an event that caused a significant system outage, disruption or degradation or if a transition among data centers or service providers or an upgrade or maintenance session encountered unexpected interruptions, unforeseen complexity or unplanned disruptions, our products and services may not be available to consumers or may not be delivered reliably and stably. As a result, our reputation and brand may be harmed, consumer engagement with our products and services may be reduced, and our revenue and profitability could be negatively impacted. We do not have redundancy for all our systems, many of our critical applications reside in only one of our data centers, and our disaster recovery planning may not account for all eventualities.
As our digital business grows, we will require an increasing amount of internal and external technical infrastructure, including network capacity and computing power to continue to satisfy the needs of consumers. We are investing, and expect to continue to invest, in our own technology, hardware and software and the technology, hardware and software of external service providers to support our business, but it is possible that we may fail to scale effectively and grow this technical infrastructure to accommodate these increased demands, which may adversely affect the reliable and stable performance of our games and services, therefore negatively impacting engagement, reputation, brand and revenue growth.
Negative perceptions about and responses to our brands, products, services and/or business practices may damage our business, and we may incur costs to address concerns.
Expectations regarding the quality, performance and integrity of our products and services are high. Players may be critical of our brands, products, services, business models and/or business practices for a wide variety of reasons, including perceptions about gameplay fun, fairness, game content, features or services, or objections to certain of our business practices. These negative responses may not be foreseeable. We also may not effectively manage these responses because of reasons within or outside of our control. For example, we have included in certain games the ability for players to purchase digital items, including in some instances virtual “packs”, “boxes” or “crates” that contain variable digital items. The inclusion of variable digital items in certain of our games has attracted the attention of our community and if the future implementation of these features creates a negative perception of gameplay fairness or other negative perceptions, our reputation and brand could be harmed and our revenue could
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be negatively impacted. In addition, we have taken actions, including delaying the release of our games and delaying or discontinuing features and services for our games, after taking into consideration, among other things, feedback from our community even if those decisions negatively impacted our operating results in the short term. We expect to continue to take actions to address concerns as appropriate, including actions that may result in additional expenditures and the loss of revenue. Negative sentiment about gameplay fairness, our business practices, business models or game content also can lead to investigations or increased scrutiny from governmental bodies and consumer groups, as well as litigation, which, regardless of their outcome, may be costly, damaging to our reputation and harm our business.
Our business depends on the success and availability of platforms developed by third parties and our ability to develop commercially successful products and services for those platforms.
The success of our business is driven in part by the commercial success and adequate supply of third-party platforms for which we develop our products and services or through which our products and services are distributed. Our success also depends on our ability to accurately predict which platforms and distribution methods will be successful in the marketplace, our ability to develop commercially successful products and services for these platforms, our ability to simultaneously manage products and services on multiple platforms and our ability to effectively transition our products and services to new platforms. We must make product development decisions and commit significant resources well in advance of the commercial availability of new platforms, and we may incur significant expense to adjust our product portfolio and development efforts in response to changing consumer preferences. Additionally, we may enter into certain exclusive licensing arrangements that affect our ability to deliver or market products or services on certain platforms. A platform for which we are developing products and services may not succeed as expected or new platforms may take market share and interactive entertainment consumers away from platforms for which we have devoted significant resources. If consumer demand for the platforms for which we are developing products and services is lower than our expectations, we may be unable to fully recover the investments we have made in developing our products and services, and our financial performance will be harmed. Alternatively, a platform for which we have not devoted significant resources could be more successful than we initially anticipated, causing us to not be able to take advantage of meaningful revenue opportunities.
Government regulations applicable to us may negatively impact our business.
We are a global company subject to various and complex laws and regulations domestically and internationally, including laws and regulations related to consumer protection, content, advertising, localization, information security, intellectual property, competition and taxation, among others. Many of these laws and regulations are continuously evolving and developing, and the application to, and impact on, us is uncertain. These laws could harm our business by limiting the products and services we can offer consumers or the manner in which we offer them. The costs of compliance with these laws may increase in the future as a result of changes in interpretation. Any failure on our part to comply with these laws or the application of these laws in an unanticipated manner may harm our business and result in penalties or significant legal liability.
Certain of our business models are subject to new laws or regulations or evolving interpretations and application of existing laws and regulations. For example, the growth and development of electronic commerce, virtual items and virtual currency have prompted calls for new laws and regulations, or the application of existing laws or regulations, that could limit or restrict the sale of our products and services or otherwise impact our products and services. In addition, we include modes in our games that allow players to compete against each other and manage player competitions that are based on our products and services. Although we structure and operate our skill-based competitions with applicable laws in mind, our skill-based competitions in the future could become subject to evolving laws and regulations. New laws related to these business models or changes in the interpretation or application of current laws that impact these business models - each of which could vary significantly across jurisdictions - could subject us to additional regulation and oversight, lessen the engagement with, and growth of, profitable business models, and expose us to increased compliance costs, significant liability, penalties and harm to our reputation and brand.
We are subject to laws in certain foreign countries, and adhere to industry standards in the United States, that mandate rating requirements or set other restrictions on the advertisement or distribution of interactive entertainment software based on content. In addition, certain foreign countries allow government censorship of interactive entertainment software products. Adoption of ratings systems, censorship or restrictions on distribution of interactive entertainment software based on content could harm our business by limiting the products we are able to offer to our consumers. In addition, compliance with new and possibly inconsistent regulations for different territories could be costly, delay or prevent the release of our products in those territories.
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We may not meet our product development schedules or key events, sports seasons and/or movies that are tied to our product and service release schedule to may be delayed, cancelled or poorly received.
Our ability to meet product development schedules is affected by a number of factors both within and outside our control, including feedback from our players, the creative processes involved, the coordination of large and sometimes geographically dispersed development teams, the complexity of our products and the platforms for which they are developed, the need to fine-tune our products prior to their release and, in certain cases, approvals from third parties. We have experienced development delays for our products in the past, which caused us to delay or cancel release dates. We also seek to release certain products and significant content for our ongoing live services - such as within our Ultimate Team live service - in conjunction with key events, such as the beginning of a sports season, major sporting event, or the release of a related movie. If such a key event were delayed, cancelled or poorly received, our sales likely would suffer materially. Any failure to meet anticipated production or release schedules likely would result in a delay of revenue and/or possibly a significant shortfall in our revenue, increase our development and/or marketing expenses, harm our profitability, and cause our operating results to be materially different than anticipated.
Historically our business has been highly seasonal with the highest percentage of our sales occurring in the quarter ending in December. While we expect this trend to continue in fiscal year 2020, there is no assurance that it will be so. If we miss key selling periods for products or services for any reason, including product delays or product cancellations our sales likely will suffer significantly. Additionally, macroeconomic conditions or the occurrence of unforeseen events that negatively impact consumer or retailer buying patterns, particularly during the quarter ending in December, likely will harm our financial performance disproportionately.
Our marketing and advertising efforts may fail to resonate with consumers.
Our products and services are marketed worldwide through a diverse spectrum of advertising and promotional programs, such as online and mobile advertising, television advertising, retail merchandising, marketing through websites and streaming services, event sponsorship, partnerships with influencers and content creators and direct communications with consumers including via email. Furthermore, an increasing portion of our marketing activity is taking place on social media platforms and through streaming networks, influencers and content creators that are outside of our direct control. Our ability to sell our products and services is dependent in part upon the success of these programs, and changes to consumer preferences, actions by influencers or content creators, marketing regulations, technology changes or service disruptions may negatively impact our ability to reach our customers or otherwise negatively impact our marketing campaigns or the franchises associated with those marketing campaigns. Moreover, if the marketing for our products and services is not innovative, agile or fails to resonate with our customers, particularly during the critical holiday season or during other key selling periods, or if advertising rates or other media placement costs increase, our business and operating results could be harmed.
We may not attract, train, motivate and retain key personnel.
The market for technical, creative, marketing and other personnel essential to the development, marketing and support of our products and services and management of our businesses is extremely competitive, particularly in the geographic locations in which many of our key personnel are located. In addition, our leading position within the interactive entertainment industry makes us a prime target for recruiting our executives, as well as key creative and technical talent. We may experience significant compensation costs to hire and retain senior executives and other personnel that we deem critical to our success. If we cannot successfully recruit, train, motivate and retain qualified employees, or replace key employees following their departure, our ability to develop and manage our business will be impaired.
We may experience declines or fluctuations in the recurring portion of our business.
Our business model includes revenue that we deem recurring in nature, such as revenue from our annualized sports franchises (e.g., FIFA, Madden NFL), our console, PC and mobile catalog titles (i.e., titles that did not launch in the current fiscal year), the associated live services and our subscriptions business. While we have been able to forecast the revenue from these areas of our business with greater relative confidence than for new games, services and business models, we cannot provide assurances that consumer demand will remain consistent. Furthermore, we may cease to offer games and services that we previously had deemed to be recurring in nature. Consumer demand may decline or fluctuate as a result of a number of factors, including their level of satisfaction with our games and services, our ability to improve and innovate our annualized titles, our ability to adapt our games and services to new platforms and business models, outages and disruptions of online services, the games and services offered by our competitors, our marketing and advertising efforts or declines in consumer activity generally as a result of economic downturns, among others. The reception to our sports games also depends, in part, on the popularity, reputation and brand of the leagues, organizations and individual athletes with whom we partner. Events and circumstances outside of our control that have a negative
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impact on the popularity, reputation and brand of these partners could also negatively impact sales related to our annualized sports games. Any decline or fluctuation in the recurring portion of our business may have a negative impact on our financial and operating results.
We could fail to successfully adopt new business models.
From time to time we seek to establish and implement new business models. Forecasting the success of any new business model is inherently uncertain and depends on a number of factors both within and outside of our control. Our actual revenue and profit for these businesses may be significantly greater or less than our forecasts. In addition, these new business models could fail, resulting in the loss of our investment in the development and infrastructure needed to support these new business models, as well as the opportunity cost of diverting management and financial resources away from more successful and established businesses. For example, we have devoted financial and operational resources to our subscription offerings without any assurance that these businesses will be financially successful. While we anticipate growth in this area of our business, consumer demand is difficult to predict as a result of a number of factors, including satisfaction with our products and services, our ability to provide engaging products and services, third parties offering their products and services within our subscription, platform providers providing access to our subscription, products and services offered by our competitors, reliability of our infrastructure and the infrastructure of our platform partners, pricing, the actual or perceived security of our and our platform partners information technology systems and reductions in consumer spending levels. In addition, if our subscription offerings are successful, sales could be diverted from established business models. If we do not select a target price that is optimal for our subscription services, maintain our target pricing structure or correctly project renewal rates, our financial results may be harmed.
Acquisitions, investments, divestitures and other strategic transactions could result in operating difficulties and other negative consequences.
We have made and may continue to make acquisitions or enter into other strategic transactions including (1) acquisitions of companies, businesses, intellectual properties, and other assets, (2) minority investments in strategic partners, and (3) investments in new interactive entertainment businesses as part of our long-term business strategy. These transactions involve significant challenges and risks including that the transaction does not advance our business strategy, that we do not realize a satisfactory return on our investment, that we acquire liabilities, that our due diligence process does not identify significant issues, liabilities or other challenges, diversion of management’s attention from our other businesses, the incurrence of debt, contingent liabilities or amortization expenses, write-offs of goodwill, intangibles, or acquired in-process technology, or other increased cash and non-cash expenses. In addition, we may not integrate these businesses successfully or achieve expected synergies. For example, we may experience difficulties with the integration of business systems and technologies, the integration and retention of new employees, the implementation or remediation of the internal control environment of the acquired entity, or the maintenance of key business and customer relationships. These events could harm our operating results or financial condition. We also may divest or sell assets or a business and we may have difficulty selling such assets or business on acceptable terms in a timely manner. This could result in a delay in the achievement of our strategic objectives, cause us to incur additional expense, or the sale of such assets or business at a price or on terms that are less favorable than we anticipated.
We may be unable to maintain or acquire licenses to include intellectual property owned by others in our games, or to maintain or acquire the rights to publish or distribute games developed by others.
Many of our products and services are based on or incorporate intellectual property owned by others. For example, our EA Sports products include rights licensed from major sports leagues, teams and players’ associations and our Star Wars products include rights licensed from Disney. Competition for these licenses and rights is intense. If we are unable to maintain these licenses and rights or obtain additional licenses or rights with significant commercial value, our ability to develop successful and engaging products and services may be adversely affected and our revenue, profitability and cash flows may decline significantly. Competition for these licenses also may increase the amounts that we must pay to licensors and developers, through higher minimum guarantees or royalty rates, which could significantly increase our costs and reduce our profitability.
We rely on the systems of our platform partners who have significant influence over the products and services that we offer on their systems.
A significant percentage of our digital net revenue is attributable to sales of products and services through our significant platform partners, including Sony, Microsoft, Nintendo, Apple and Google. The concentration of a material portion of our digital sales in these platform partners exposes us to risks associated with these businesses. Any deterioration in the businesses of our platform partners could disrupt and harm our business, including by limiting the methods through which our digital products and services are offered and exposing us to collection risks.
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In addition, our license agreements with our platform partners typically give them significant control over the approval, manufacturing and distribution of the products and services that we develop for their platform. In particular, our arrangements with Sony and Microsoft could, in certain circumstances, leave us unable to get our products and services approved, manufactured or distributed to consumers. For our digital products and services delivered via digital channels maintained by, among others, Sony, Microsoft, Nintendo, Apple and Google, each respective platform partner has policies and guidelines that control the promotion and distribution of these titles and the features and functionalities that we are permitted to offer through the channel. In addition, we are dependent on our platform partners to invest in, and upgrade, digital commerce capabilities in a manner than corresponds to the way in which consumers purchase our products and services. Failure by our platform partners to keep pace with consumer preferences could have an adverse impact on our ability to merchandise and commercialize our products and services which could harm our business and/or financial results.
Moreover, certain of our platform partners can determine and change unilaterally certain key terms and conditions, including the ability to change their user and developer policies and guidelines. In many cases our platform partners also set the rates that we must pay to provide our games and services through their online channels, and retain flexibility to change their fee structures or adopt different fee structures for their online channels, which could adversely impact our costs, profitability and margins. In addition, our platform partners control the information technology systems through which online sales of our products and service channels are captured. If our platform partners establish terms that restrict our offerings through their platforms, significantly impact the financial terms on which these products or services are offered to our customers, or their information technology systems experiences outages that impact our players’ ability to access our games or make in-game purchases or cause an unanticipated delay in reporting, our business and/or financial results could be materially affected.
Our business is subject to economic and market conditions, particularly risks generally associated with the entertainment industry.
Our business is subject to economic and market conditions, which are beyond our control. The United States and other international economies have experienced cyclical downturns from time to time. Worsening economic conditions that negatively impact discretionary consumer spending, including inflation, slower growth, recession and other macroeconomic conditions, including those resulting from geopolitical issues and uncertainty, could have a material adverse impact on our business and operating results. For example, the government of the United Kingdom has initiated a process to leave the European Union (“Brexit”) and may do so without an agreement governing the terms and conditions of their exit. Brexit has caused economic and legal uncertainty in the region and may result in macroeconomic conditions that adversely affect our business. In addition, evolving immigration rules and trade regimes could negatively impact our business. We have taken precautionary measures with respect to these matters, in relation to Brexit and otherwise, but given the significant uncertainty our precautions may not be adequate.
We are particularly susceptible to market conditions and risks associated with the entertainment industry, which, in addition to general macroeconomic downturns, also include the popularity, price and timing of our games, changes in consumer demographics, the availability and popularity of other forms of entertainment, and critical reviews and public tastes and preferences, which may change rapidly and cannot necessarily be predicted.
Our business partners may be unable to honor their obligations to us or their actions may put us at risk.
We rely on various business partners, including third-party service providers, vendors, licensing partners, development partners, and licensees in many areas of our business. Their actions may put our business and our reputation and brand at risk. For example, we may have disputes with our business partners that may impact our business and/or financial results. In many cases, our business partners may be given access to sensitive and proprietary information in order to provide services and support to our teams, and they may misappropriate our information and engage in unauthorized use of it. In addition, the failure of these third parties to provide adequate services and technologies, or the failure of the third parties to adequately maintain or update their services and technologies, could result in a disruption to our business operations. Further, disruptions in the financial markets, economic downturns, poor business decisions, or reputational harm may adversely affect our business partners and they may not be able to continue honoring their obligations to us or we may cease our arrangements with them. Alternative arrangements and services may not be available to us on commercially reasonable terms or we may experience business interruptions upon a transition to an alternative partner or vendor. If we lose one or more significant business partners, our business could be harmed and our financial results could be materially affected.
The products or services we release may contain defects, bugs or errors.
Our products and services are extremely complex software programs, and are difficult to develop and distribute. We have quality controls in place to detect defects, bugs or other errors in our products and services before they are released. Nonetheless, these
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quality controls are subject to human error, overriding, and reasonable resource or technical constraints. Therefore, these quality controls and preventative measures may not be effective in detecting all defects, bugs or errors in our products and services before they have been released into the marketplace. In such an event, the technological reliability and stability of our products and services could be below our standards and the standards of consumers and our reputation, brand and sales could be adversely affected. In addition, we could be required to, or may find it necessary to, offer a refund for the product or service, suspend the availability or sale of the product or service or expend significant resources to cure the defect, bug or error each of which could significantly harm our business and operating results.
We may be subject to claims of infringement of third-party intellectual property rights.
From time to time, third parties may claim that we have infringed their intellectual property rights. For example, patent holding companies may assert patent claims against us in which they seek to monetize patents they have purchased or otherwise obtained. Although we take steps to avoid knowingly violating the intellectual property rights of others, it is possible that third parties still may claim infringement.
Existing or future infringement claims against us, whether valid or not, may be expensive to defend and divert the attention of our employees from business operations. Such claims or litigation could require us to pay damages and other costs. We also could be required to stop selling, distributing or supporting products, features or services which incorporate the affected intellectual property rights, redesign products, features or services to avoid infringement, or obtain a license, all of which could be costly and harm our business.
In addition, many patents have been issued that may apply to potential new modes of delivering, playing or monetizing interactive entertainment software products and services, such as those that we produce or would like to offer in the future. We may discover that future opportunities to provide new and innovative modes of game play and game delivery to consumers may be precluded by existing patents that we are unable to license on reasonable terms.
From time to time we may become involved in other legal proceedings.
We are currently, and from time to time in the future may become, subject to legal proceedings, claims, litigation and government investigations or inquiries, which could be expensive, lengthy, disruptive to normal business operations and occupy a significant amount of our employees’ time and attention. In addition, the outcome of any legal proceedings, claims, litigation, investigations or inquiries may be difficult to predict and could have a material adverse effect on our business, reputation, operating results, or financial condition.
Our products and brands are subject to the threat of piracy, unauthorized copying and other forms of intellectual property infringement.
We regard our products and brands as proprietary and take measures to protect our products, brands and other confidential information from infringement. We are aware that some unauthorized copying of our products and brands occurs, and if a significantly greater amount were to occur, it could negatively impact our business.
Piracy and other forms of unauthorized copying and use of our content and brands are persistent problems for us, and policing is difficult. Further, the laws of some countries in which our products are or may be distributed either do not protect our products and intellectual property rights to the same extent as the laws of the United States, or are poorly enforced. Legal protection of our rights may be ineffective in such countries. In addition, although we take steps to enforce and police our rights, factors such as the proliferation of technology designed to circumvent the protection measures used by our business partners or by us, the availability of broadband access to the Internet, the refusal of Internet service providers or platform holders to remove infringing content in certain instances, and the proliferation of online channels through which infringing product is distributed all have contributed to an expansion in unauthorized copying of our products and brands.
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We may experience outages, disruptions and/or degradations of our infrastructure.
We may experience outrages, disruptions and/or degradations of our infrastructure, including information technology system failures and network disruptions that harm our ability to conduct normal business operations. These may be caused by natural disasters, cyber-incidents, weather events, power disruptions, telecommunications failures, failed upgrades of existing systems or migrations to new systems, acts of terrorism or other events, including cyber-attacks or malicious software programs that exploit vulnerabilities. System redundancy may be ineffective or inadequate, and our disaster recovery planning may not be sufficient for all eventualities. Such failures or disruptions could prevent access to our products, services or online stores selling our products and services, interruption in our ability to conduct critical business functions, breaches of data security or the loss of critical data. Our corporate headquarters in Redwood City, CA and our studios in Los Angeles, California, Seattle, Washington and in Burnaby, British Columbia are located in seismically active regions, and certain of our game development activities and other essential business operations are conducted at these locations. An event that results in the disruption or degradation of any of our critical business or information technology systems could harm our ability to conduct normal business operations and materially impact our reputation and brand, financial condition and operating results.
A significant portion of our packaged goods sales are made to a relatively small number of retail and distribution partners, and these sales may be disrupted.
We derive a significant percentage of our net revenue attributable to sales of our packaged goods products to our top retail and distribution partners. The concentration of a significant percentage of these sales through a few large partners could lead to a short-term disruption to our business if certain of these partners significantly reduced their purchases or ceased to offer our products. We also could be more vulnerable to collection risk if one or more of these partners experienced a deterioration of their business or declared bankruptcy. Additionally, receivables from these partners generally increase in our December fiscal quarter as sales of our products generally increase in anticipation of the holiday season. Having a significant portion of our packaged goods sales concentrated in a few partners could reduce our negotiating leverage with them. If one or more of these partners experience deterioration in their business, or become unable to obtain sufficient financing to maintain their operations, our business could be harmed.
External game developers may not meet product development schedules or otherwise honor their obligations.
We may contract with external game developers to develop our games or to publish or distribute their games. While we maintain contractual protections, we have less control over the product development schedules of games developed by external developers, and we depend on their ability to meet product development schedules. In addition, we may have disputes with external developers over game content, launch timing, achievement of certain milestones, the game development timeline, marketing campaigns or other matters. If we have disputes with external developers or they cannot meet product development schedules, acquire certain approvals or are otherwise unable or unwilling to honor their obligations to us, we may delay or cancel previously announced games, alter our launch schedule or experience increased costs and expenses, which could result in a delay or significant shortfall in anticipated revenue, harm our profitability and reputation, and cause our financial results to be materially affected.
Our financial results are subject to currency fluctuations.
International sales are a fundamental part of our business. For our fiscal year ended March 31, 2019, international net revenue comprised 61 percent of our total net revenue, and we expect our international business to continue to account for a significant portion of our total net revenue. As a result of our international sales, and also the denomination of our foreign investments and our cash and cash equivalents in foreign currencies, we are exposed to the effects of fluctuations in foreign currency exchange rates. Strengthening of the U.S. dollar, particularly relative to the Euro, British pound sterling, Australian dollar, Chinese yuan and South Korean won, has a negative impact on our reported international net revenue but a positive impact on our reported international operating expenses (particularly when the U.S. dollar strengthens against the Swedish krona and the Canadian dollar) because these amounts are translated at lower rates. We use foreign currency hedging contracts to mitigate some foreign currency risk. However, these activities are limited in the protection they provide us from foreign currency fluctuations and can themselves result in losses.
We utilize debt financing and such indebtedness could adversely impact our business and financial condition.
We have $1 billion in senior unsecured notes outstanding as well as an unsecured committed $500 million revolving credit facility. While the facility is currently undrawn, we may use the proceeds of any future borrowings for general corporate purposes. We may also enter into other financial instruments in the future.
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Our indebtedness could affect our financial condition and future financial results by, among other things:
• | Requiring the dedication of a substantial portion of any cash flow from operations to the payment of principal of, and interest on, our indebtedness, thereby reducing the availability of such cash flow to fund our growth strategy, working capital, capital expenditures and other general corporate purposes; |
• | Limiting our flexibility in planning for, or reacting to, changes in our business and our industry; and |
• | Increasing our vulnerability to adverse changes in general economic and industry conditions. |
The agreements governing our indebtedness impose restrictions on us and require us to maintain compliance with specified covenants. In particular, the revolving credit facility includes a maximum capitalization ratio and minimum liquidity requirements. Our ability to comply with these covenants may be affected by events beyond our control. If we breach any of these covenants and do not obtain a waiver from the lenders or noteholders, then, subject to applicable cure periods, our outstanding indebtedness may be declared immediately due and payable. In addition, changes by any rating agency to our credit rating may negatively impact the value and liquidity of both our debt and equity securities, as well as the potential costs associated with any potential refinancing our indebtedness. Downgrades in our credit rating could also restrict our ability to obtain additional financing in the future and could affect the terms of any such financing.
Changes in our tax rates, exposure to additional tax liabilities, changes to tax laws and interpretations of tax laws could adversely affect our earnings and financial condition.
We are subject to taxes in the United States and in various foreign jurisdictions. Significant judgment is required in determining our worldwide income tax provision, tax assets, and accruals for other taxes, and there are many transactions and calculations where the ultimate tax determination is uncertain. Our effective income tax rate is based in part on our corporate operating structure and the manner in which we operate our business and develop, value and use our intellectual property. Taxing authorities in jurisdictions in which we operate may challenge our methodologies for calculating our income tax provision or its underlying assumptions, which could increase our effective income tax rate and have an adverse impact on our results of operations and cash flows. In addition, our provision for income taxes could be adversely affected by our profit levels, changes in our business, changes in the mix of earnings in countries with differing statutory tax rates, changes in the elections we make, changes in the valuation of our deferred tax assets and liabilities, or changes in applicable tax laws or interpretations of existing tax laws, as well as other factors. For example, the outcome of Altera Corp. v. Commissioner, currently pending before the Ninth Circuit Court of Appeals, as well as future regulations and guidance related to the U.S. Tax Act, could cause us to change our analysis and materially impact our previous estimates and consolidated financial statements. Further changes to U.S. federal, state or international tax laws applicable to corporate multinationals, particularly in Switzerland, where our international publishing business is headquartered, and changes in such jurisdictions’ interpretations, decisions, policies or positions with respect to existing tax laws could adversely affect our effective tax rates, cause us to change the way in which we structure our business or result in other costs.
We are required to pay taxes other than income taxes, such as payroll, sales, use, value-added, net worth, property and goods and services taxes, in both the United States and foreign jurisdictions. Several foreign jurisdictions have introduced new digital services taxes on revenue of companies that provide certain digital services. There is limited guidance about the applicability to these new taxes to our business and significant uncertainty as to of the digital services that will be deemed in scope. If these new taxes are applied to the Company’s revenue in these foreign jurisdictions, it could have an adverse impact on our business and financial performance. Furthermore, we are regularly subject to audit by tax authorities with respect to both income and such other non-income taxes. Unfavorable audit results or tax rulings, or other changes resulting in significant additional tax liabilities, could have material adverse effects upon our earnings, cash flows, and financial condition.
Our reported financial results could be adversely affected by changes in financial accounting standards.
Our reported financial results are impacted by the accounting standards promulgated by the SEC and national accounting standards bodies and the methods, estimates, and judgments that we use in applying our accounting policies. These methods, estimates, and judgments are subject to risks, uncertainties, assumptions and changes that could adversely affect our reported financial position and financial results. In addition, changes to applicable financial accounting standards could impact our reported financial position and financial results. For more information on recently adopted accounting standards and recently issued accounting standards applicable to us, see Part II, Item 8 of this Form 10-K in the Notes to the Consolidated Financial Statements in Note 1 — Description of Business and Basis of Presentation under the subheadings “Recently Adopted Accounting Standards” and “Other Recently Issued Accounting Standards”.
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As we enhance, expand and diversify our business and product offerings, the application of existing or future financial accounting standards, particularly those relating to the way we account for revenue, costs and taxes, could have an adverse effect on our reported results although not necessarily on our cash flows.
Our stock price has been volatile and may continue to fluctuate significantly.
The market price of our common stock historically has been, and we expect will continue to be, subject to significant fluctuations. These fluctuations may be due to our operating results or factors specific to our operating results (including those discussed in the risk factors above, as well as others not currently known to us or that we currently do not believe are material), changes in securities analysts’ estimates of our future financial performance, ratings or recommendations, our results or future financial guidance falling below our expectations and analysts’ and investors’ expectations, factors affecting the entertainment, computer, software, Internet, media or electronics industries, the announcement and integration of any acquisitions we may make, departure of key personnel, cyberattacks, national or international economic conditions, investor sentiment or other factors related or unrelated to our operating performance. In particular, economic downturns may contribute to the public stock markets experiencing extreme price and trading volume volatility. These broad market fluctuations could adversely affect the market price of our common stock.
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Item 1B: Unresolved Staff Comments
None.
Item 2: Properties
Not applicable.
Item 3: 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. The parties reached a settlement in this matter in March 2019 that was not material to the Company’s financial results and on May 7, 2019, the United States District Court for the Northern District of California dismissed the case.
Governmental authorities in Belgium have sought to limit or discontinue the use of in-game mechanics involving a randomized selection of virtual items. On August 10, 2018, we were notified that the Belgian Gambling Commission made a referral to the Belgian Public Prosecutor’s Office regarding the use such mechanics in the FIFA Ultimate Team service included in FIFA 18. On February 1, 2019, we discontinued the sale of FIFA Points in Belgium after discussions with Belgian authorities. We do not expect Belgian authorities to pursue the matter further. The Company does not believe that its products and services violate applicable gambling laws and continues to engage with appropriate governmental authorities in Belgium.
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 Consolidated Financial Statements.
Item 4: Mine Safety Disclosures
Not applicable.
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PART II
Item 5: | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Holders
There were approximately 849 holders of record of our common stock as of May 20, 2019. In addition, a significant number of beneficial owners of our common stock hold their shares in street name. Our common stock is traded on the NASDAQ Global Select Market under the symbol “EA”.
Dividends
We have not paid any cash dividends and do not anticipate paying cash dividends in the foreseeable future.
Issuer Purchases of Equity Securities
In May 2017, a Special Committee of our Board of Directors, on behalf of the full Board of Directors, authorized a program to repurchase up to $1.2 billion of our common stock. We repurchased approximately 0.6 million and 5.0 million shares for approximately $76 million and $570 million under this program, respectively, during the fiscal years ended March 31, 2019 and 2018. This program was superseded and replaced by a new stock repurchase program approved in May 2018.
In May 2018, a Special Committee of our Board of Directors, on behalf of the full Board of Directors, authorized a program to repurchase up to $2.4 billion of our common stock. This stock repurchase program supersedes and replaces the May 2017 program, and expires on May 31, 2020. Under this 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 a specific number of shares under this program and it may be modified, suspended or discontinued at any time. We repurchased approximately 10.4 million shares for approximately $1,116 million under this program during the fiscal year ended March 31, 2019. We are actively repurchasing shares under this program.
The following table summarizes the number of shares repurchased in the fourth quarter of the fiscal year ended March 31, 2019:
Fiscal Month | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as part of Publicly Announced Programs | Maximum Dollar Value that May Still Be Purchased Under the Programs (in millions) | ||||||||||
December 30, 2018 - January 26, 2019 | 1,015,281 | $ | 85.91 | 1,015,281 | $ | 1,498 | ||||||||
January 27, 2019 - February 23, 2019 | 983,646 | $ | 93.59 | 983,646 | $ | 1,406 | ||||||||
February 24, 2019 - March 30, 2019 | 1,230,755 | $ | 98.42 | 1,230,755 | $ | 1,285 | ||||||||
3,229,682 | $ | 93.02 | 3,229,682 | |||||||||||
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Stock Performance Graph
The following information shall not be deemed to be “filed” with the SEC nor shall this information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Exchange Act, as amended, except to the extent that we specifically incorporate it by reference into a filing.
The following graph shows a five-year comparison of cumulative total returns during the period from March 31, 2014 through March 31, 2019, for our common stock, the S&P 500 Index (to which EA was added in July 2002), the NASDAQ Composite Index, and the RDG Technology Composite Index, each of which assumes an initial value of $100. Each measurement point is as of the end of each fiscal year. The performance of our stock depicted in the following graph is not necessarily indicative of the future performance of our stock.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Electronic Arts Inc., the S&P 500 Index, the NASDAQ Composite Index,
and the RDG Technology Composite Index
* | Based on $100 invested on March 31, 2014 in stock or index, including reinvestment of dividends. |
March 31, | |||||||||||||||||||||||
2014 | 2015 | 2016 | 2017 | 2018 | 2019 | ||||||||||||||||||
Electronic Arts Inc. | $ | 100 | $ | 203 | $ | 228 | $ | 309 | $ | 418 | $ | 350 | |||||||||||
S&P 500 Index | 100 | 113 | 115 | 134 | 153 | 168 | |||||||||||||||||
NASDAQ Composite Index | 100 | 118 | 119 | 146 | 176 | 195 | |||||||||||||||||
RDG Technology Composite Index | 100 | 118 | 122 | 152 | 193 | 226 | |||||||||||||||||
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Item 6: Selected Financial Data
ELECTRONIC ARTS INC. AND SUBSIDIARIES
SELECTED FIVE-YEAR CONSOLIDATED FINANCIAL DATA
(In millions, except per share data)
Year Ended March 31, | |||||||||||||||||||
STATEMENTS OF OPERATIONS DATA | 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||
Net revenue (a) | $ | 4,950 | $ | 5,150 | $ | 4,845 | $ | 4,396 | $ | 4,515 | |||||||||
Cost of revenue | 1,322 | 1,277 | 1,298 | 1,354 | 1,429 | ||||||||||||||
Gross profit | 3,628 | 3,873 | 3,547 | 3,042 | 3,086 | ||||||||||||||
Total operating expenses | 2,632 | 2,439 | 2,323 | 2,144 | 2,138 | ||||||||||||||
Operating income | 996 | 1,434 | 1,224 | 898 | 948 | ||||||||||||||
Interest and other income (expense), net | 83 | 15 | (14 | ) | (21 | ) | (23 | ) | |||||||||||
Income before provision for income taxes | 1,079 | 1,449 | 1,210 | 877 | 925 | ||||||||||||||
Provision for (benefit from) income taxes | 60 | 406 | (b) | 243 | (279 | ) | (c) | 50 | |||||||||||
Net income | $ | 1,019 | $ | 1,043 | $ | 967 | $ | 1,156 | $ | 875 | |||||||||
Earnings per share: | |||||||||||||||||||
Basic | $ | 3.36 | $ | 3.39 | $ | 3.19 | $ | 3.73 | $ | 2.81 | |||||||||
Diluted | $ | 3.33 | $ | 3.34 | $ | 3.08 | $ | 3.50 | $ | 2.69 | |||||||||
Number of shares used in computation: | |||||||||||||||||||
Basic | 303 | 308 | 303 | 310 | 311 | ||||||||||||||
Diluted | 306 | 312 | 314 | 330 | 325 | ||||||||||||||
As of March 31, | |||||||||||||||||||
BALANCE SHEETS DATA | 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||
Cash and cash equivalents | $ | 4,708 | $ | 4,258 | $ | 2,565 | $ | 2,493 | $ | 2,068 | |||||||||
Short-term investments | 737 | 1,073 | 1,967 | 1,341 | 953 | ||||||||||||||
Working capital | 4,116 | 3,513 | 2,784 | 1,936 | 973 | ||||||||||||||
Total assets | 8,957 | 8,584 | 7,718 | 7,050 | 6,147 | ||||||||||||||
0.75% convertible senior notes due 2016, net | — | — | — | 163 | 633 | ||||||||||||||
Senior notes, net | 994 | 992 | 990 | 989 | — | ||||||||||||||
Other long-term liabilities | 367 | 506 | 253 | 245 | 333 | ||||||||||||||
Total liabilities | 3,626 | 3,989 | 3,658 | 3,652 | 3,080 | ||||||||||||||
Total stockholders’ equity | 5,331 | 4,595 | 4,060 | 3,396 | 3,036 | ||||||||||||||
(a) | On April 1, 2018, at the beginning of fiscal year 2019, we adopted the New Revenue Standard, which significantly changes how we recognize and report net revenue. Financial data for periods prior to April 1, 2018 has not been restated. For more information on the New Revenue Standard, please see Part II, Item 8 of this Form 10-K in the Notes to Consolidated Financial Statements in Note 1 under the heading “Recently Adopted Accounting Standards”. |
(b) | For the fiscal year ended March 31, 2018, we recognized a tax expense of $235 million due to the application of the U.S. Tax Act, enacted on December 22, 2017. |
(c) | For the fiscal year ended March 31, 2016, we recognized a tax benefit of $453 million for the reversal of a significant portion of our deferred tax valuation allowance. |
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Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
The following overview is a high-level discussion of our operating results, as well as some of the trends and drivers that affect our business. Management believes that an understanding of these trends and drivers provides important context for our results for the fiscal year ended March 31, 2019, as well as our future prospects. This summary is not intended to be exhaustive, nor is it intended to be a substitute for the detailed discussion and analysis provided elsewhere in this Form 10-K, including in the “Business” section and the “Risk Factors” above, the remainder of this “Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)”, and the Consolidated Financial Statements and related Notes.
About Electronic Arts
We are a global leader in digital interactive entertainment, with a mission to inspire the world to play. We develop, market, publish and deliver games and services that can be played and watched on a variety of platforms, including game consoles, PCs, mobile phones and tablets. In our games and services, we use brands that we either wholly own (such as Battlefield, The Sims, Apex Legends, Anthem, Need for Speed and Plants v. Zombies) or license from others (such as FIFA, Madden NFL and Star Wars). We develop and publish games and services across diverse genres, such as sports, first-person shooter, action, role-playing and simulation, and offer our games and services through diverse business models and distribution channels, such as retail, download, subscription and free-to-play. We believe that the breadth and depth of our portfolio and our flexibility in business models and distribution channels provide us with strategic advantages.
Financial Results
Our key financial results for our fiscal year ended March 31, 2019 were as follows:
• | Total net revenue was $4,950 million, down 4 percent year-over-year. Under the Old Revenue Standard, total net revenue would have been $4,843 million, down 6 percent year over year. |
• | Digital net revenue was $3,710 million, up 8 percent year-over-year. Under the Old Revenue Standard, digital net revenue would have been $3,447 million, down less than 1 percent year over year. |
• | Gross margin was 73.3 percent, down 2 percentage points year-over-year. Under the Old Revenue Standard, gross margin would have been 76.6 percent, up 1 percentage point year-over-year. |
• | Operating expenses were $2,632 million, up 8 percent year-over-year. |
• | Operating income was $996 million, down 31 percent year-over-year. Under the Old Revenue Standard, operating income would have been $1,077 million, down 25 percent year-over-year. |
• | Net income was $1,019 million, down 2 percent year-over-year. Under the Old Revenue Standard, net income would have been $1,086 million, up 4 percent year-over-year. |
• | Diluted earnings per share was $3.33, consistent year-over-year. Under the Old Revenue Standard, diluted earnings per share would have been $3.55, up 6 percent year-over-year. |
• | Operating cash flow was $1,547 million, down 9 percent year-over-year. |
• | Total cash, cash equivalents and short-term investments were $5,445 million. |
• | We repurchased 11 million shares of our common stock for $1,192 million. |
From time to time, we make comparisons of current periods to prior periods with reference to constant currency. For the fiscal year ended March 31, 2019, foreign currency exchange rates did not have a material impact on our net revenue and operating expenses.
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Trends in Our Business
Digital Business. Players increasingly purchase our games as digital downloads, as opposed to purchasing physical discs, and engage with the live services that we provide on an ongoing basis. Our live services provide additional depth and engagement opportunities for our players and include in-game purchases, extra content, subscriptions, and esports. Our net revenue attributable to live services comprised 45 percent of our total net revenue during fiscal year 2019 and we expect that live services net revenue will continue to be material to our business. Our most popular live service is the Ultimate Team mode associated with our sports franchises. Ultimate Team allows players to collect current and former professional players in order to build and compete as a personalized team. Net revenue from Ultimate Team represented approximately 28 percent of our total net revenue during fiscal year 2019, a substantial portion of which was derived from FIFA Ultimate Team. Our digital transformation also is creating opportunities in platforms, content models and the way in which players engage with our games and services. For example, we have leveraged brands and assets from franchises historically associated traditional gaming, such as FIFA, Madden NFL, The Sims, SimCity, and Star Wars, to create free-to-play games that are monetized through live services provided with the game. We also offer subscription services, such as EA Access, Origin Access and Origin Access Premier, as we look to build deeper relationships with our players and offer increased choice and flexibility for our players to try new games.
The portion of our revenue attributable to our digital business has significantly increased from 59 percent in fiscal year 2017 to 67 percent in fiscal year 2018 and 75 percent during fiscal year 2019. We expect this portion of our business to continue to increase during fiscal year 2020 relative to packaged goods revenue as we continue to focus on developing and monetizing products and services that can be delivered digitally.
Technological Infrastructure. As our digital business has grown, our games and services increasingly depend on the reliability, availability and security of our technological infrastructure. We are investing and expect to continue to invest in technology, hardware and software to support our games and services, including with respect to security protections. Our industry is prone to, and our systems and networks are subject to, cyber-attacks, computer viruses, worms, phishing attacks, malicious software programs, and other information security incidents that seek to exploit, disable, damage, disrupt or gain access to our networks, our products and services, supporting technological infrastructure, intellectual property and other assets. We expect these threats to our systems and networks to continue.
Rapidly Changing Industry. We operate in a dynamic industry that regularly experiences periods of rapid, fundamental change. In order to remain successful, we are required to anticipate, sometimes years in advance, the ways in which our products and services will compete in the market. We adapt our business by investing in creative and technical talent and new technologies, evolving our business strategies and distribution methods and developing new and engaging products and services. In fiscal 2019, we launched two new intellectual properties (Anthem and Apex Legends), brought Apex Legends to market as our first free-to-play console product, added frontline titles to our Origin Access Premier subscription service, and invested in more ways to reach our players now and in the future, such as cloud gaming and esports. We expect to continue to invest in our business to remain competitive, including investments in, among other things, technology to connect our players to each other and to the games they love and the infrastructure to power our games and services. We are adopting consistent, cross-company methodologies to better understand our players’ needs and continue to invest in technology that enables us to deliver content that will resonate with players, and provide more choice in the way that players connect with their games, with each other, and with new types of content, including esports broadcasts. This connection also allows us to market and deliver content and services for popular franchises like FIFA, Battlefield and Star Wars to our players more efficiently.
Free-to-Play Games. The global adoption of mobile devices and a business model for those devices that allows consumers to try new games with no up-front cost, and that are monetized through the live service associated with the game, has led to significant growth in the mobile gaming industry. We expect the mobile gaming industry to continue to grow during our 2020 fiscal year. Likewise, the consumer acceptance of free-to-play, live service-based, online PC games has broadened our consumer base, and this free-to-play, live service business model is beginning to gain consumer acceptance with respect to console games. We expect revenue generated from mobile, PC and console free-to-play games to remain an important part of our business.
Concentration of Sales Among the Most Popular Games. In all major segments of our industry, we see a large portion of games sales concentrated on the most popular titles. Similarly, a significant portion of our revenue historically has been derived from games based on a few popular franchises, several of which we have released on an annual or bi-annual basis. In particular, we have historically derived a significant portion of our net revenue from our largest and most popular game, FIFA, the annualized version of which is consistently one of the best-selling games in the marketplace.
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Recurring Revenue Sources. Our business model includes revenue that we deem recurring in nature, such as revenue from our annualized sports franchises (e.g., FIFA, Madden NFL), our console, PC and mobile catalog titles (i.e., titles that did not launch in the current fiscal year), the associated live services and our subscriptions business. We have been able to forecast the revenue from these areas of our business with greater relative confidence than for new games, services and business models. As we continue to incorporate new business models and modalities of play into our games, our goal is to continue to look for opportunities to expand the recurring portion of our business.
Net Bookings. In order to improve transparency into our business, we disclose an operating performance metric, net bookings. Net bookings is defined as the net amount of products and services sold digitally or sold-in physically in the period. Net bookings is calculated by adding total net revenue to the change in deferred net revenue for online-enabled games and, for periods after the fourth quarter of fiscal 2018, mobile platform fees.
The following is a calculation of our total net bookings for the periods presented:
Year Ended March 31, | |||||||
(In millions) | 2019 | 2018 | |||||
Total net revenue | $ | 4,950 | $ | 5,150 | |||
Change in deferred net revenue (online-enabled games) | 182 | 30 | |||||
Mobile platform fees | (188 | ) | — | ||||
Net bookings | $ | 4,944 | $ | 5,180 | |||
Net bookings were $4,944 million for fiscal 2019 driven by sales related to FIFA Ultimate Team, FIFA 19, Madden NFL 19, The Sims 4 and Battlefield V. Net bookings decreased $236 million or 5 percent as compared to fiscal 2018 due primarily to a decrease in Star Wars Battlefront II, Need for Speed Payback and Mass Effect: Andromeda, partially offset by Battlefield V, Anthem and Apex Legends. Digital net bookings were $3,722 million for fiscal 2019 driven by sales of FIFA Ultimate Team, The Sims 4 and Madden NFL 19, an increase of $184 million or 5 percent as compared to fiscal 2018. The increase in digital net bookings was driven by growth in live services which grew $211 million or 10 percent year-over-year, primarily due to growth in bookings associated with FIFA Ultimate Team and bookings from Apex Legends; and full game downloads which grew $56 million or 8 percent year-over-year, due to continued growth in digital downloads of our games. In particular, Battlefield V, Anthem and the FIFA franchise were downloaded at a greater rate than comparable titles in previous fiscal years. These increases were offset by a decrease of $83 million or 13 percent in our mobile business primarily due to declines from aging titles across our portfolio.
Recent Developments
Internal Transfer of Intellectual Property Rights. Subsequent to the fiscal year ended March 31, 2019, we completed an intra-entity sale of some of our intellectual property rights to our Swiss subsidiary, where our international business is headquartered. This transaction will result in the recognition of a deferred tax asset, which we estimate at approximately $2.3 billion, subject to a realizability analysis. For more information, please see Part II, Item 8 of this Form 10-K in the Notes to Consolidated Financial Statements in Note 11 — Income Taxes.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The preparation of these Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, contingent assets and liabilities, and revenue and expenses during the reporting periods. The policies discussed below are considered by management to be critical because they are not only important to the portrayal of our financial condition and results of operations, but also because application and interpretation of these policies requires both management judgment and estimates of matters that are inherently uncertain and unknown. As a result, actual results may differ materially from our estimates.
For a complete discussion of our critical accounting policies and estimates with respect to revenue recognition for revenue transactions occurring prior to April 1, 2018, which were accounted for under ASC 605, Revenue Recognition (the “Old Revenue Standard” or “ASC 605”), refer to Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the subheading Critical Accounting Policies and Estimates included in our Annual Report on Form 10-K for our fiscal year ended March 31, 2018, filed with the SEC on May 23, 2018. With respect to revenue transactions occurring on April 1, 2018 and onward, our revenue recognition accounting policy is set forth below and follows ASC 606, Revenue from Contracts with Customers (the “New Revenue Standard” or “ASC 606”).
Revenue Recognition
We derive revenue principally from sales of our games, and related extra-content and services that can be played by customers on a variety of platforms which include game consoles, PCs, mobile phones and tablets. Our product and service offerings include, but are not limited to, the following:
• | full games with both online and offline functionality (“Games with Services”), which generally includes (1) the initial game delivered digitally or via physical disc at the time of sale and typically provide access to offline core game content (“software license”); (2) updates on a when-and-if-available basis, such as software patches or updates, and/or additional free content to be delivered in the future (“future update rights”); and (3) a hosted connection for online playability (“online hosting”); |
• | full games with online-only functionality which require an Internet connection to access all gameplay and functionality (“Online-Hosted Service Games”); |
• | extra content related to Games with Services and Online-Hosted Service Games which provides access to additional in-game content; |
• | subscriptions, such as Origin Access, Origin Access Premier and EA Access, that generally offers access to a selection of full games, in-game content, online services and other benefits typically for a recurring monthly or annual fee; and |
• | licensing our games to third parties to distribute and host our games. |
Effective April 1, 2018, we evaluate revenue recognition based on the criteria set forth in ASC 606, Revenue from Contracts with Customers.
We evaluate and recognize revenue by:
• | identifying the contract(s) with the customer; |
• | identifying the performance obligations in the contract; |
• | determining the transaction price; |
• | allocating the transaction price to performance obligations in the contract; and |
• | recognizing revenue as each performance obligation is satisfied through the transfer of a promised good or service to a customer (i.e., “transfer of control”). |
Certain of our full game and/or extra content are sold to resellers with a contingency that the full game and/or extra content cannot be resold prior to a specific date (“Street Date Contingency”). We recognize revenue for transactions that have a Street
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Date Contingency when the Street Date Contingency is removed and the full game and/or extra content can be resold by the reseller. For digital full game and/or extra content downloads sold to customers, we recognize revenue when the full game and/or extra content is made available for download to the customer.
Online-Enabled Games
Games with Services. Our sales of Games with Services are evaluated to determine whether the software license, future update rights and the online hosting are distinct and separable. Sales of Games with Services are generally determined to have three distinct performance obligations: software license, future update rights, and the online hosting.
Since we do not sell the performance obligations on a stand-alone basis, we consider market conditions and other observable inputs to estimate the stand-alone selling price for each performance obligation. We recognize revenue from these arrangements upon transfer of control for each performance obligation. For the portion of the transaction price allocated to the software license, revenue is recognized when control of the license has been transferred to the customer. For the portion of the transaction price allocated to the future update rights and the online hosting, revenue is recognized as the services are provided.
Online-Hosted Service Games. Sales of our Online-Hosted Service Games are determined to have one distinct performance obligation: the online hosting. We recognize revenue from these arrangements as the service is provided.
Extra Content. Revenue received from sales of downloadable content are derived primarily from the sale of virtual currencies and digital in-game content to our customers to enhance their gameplay experience. Sales of extra content are accounted for in a manner consistent with the treatment for our Games with Services and Online-Hosted Service Games as discussed above, depending upon whether or not the extra content has offline functionality.
Subscriptions
Revenue from subscriptions is recognized over the subscription term as the service is provided.
Licensing Revenue
In certain countries, we utilize third-party licensees to distribute and host our games in accordance with license agreements, for which the licensees typically pay us a fixed minimum guarantee and/or sales-based royalties. These arrangements typically include multiple performance obligations, such as a time-based license of software and future update rights. We recognize as revenue a portion of the minimum guarantee when we transfer control of the license of software (generally upon commercial launch) and the remaining portion ratably over the contractual term in which we provide the licensee with future update rights. Any sales-based royalties are generally recognized as the related sales occur by the licensee.
Revenue Classification
We classify our revenue as either product revenue or service and other revenue. Generally, performance obligations that are recognized upfront upon transfer of control are classified as product revenue, while performance obligations that are recognized over the Estimated Offering Period or subscription period as the services are provided are classified as service revenue.
Product revenue. Our product revenue includes revenue allocated to the software license performance obligation. Product revenue also includes revenue from the licensing of software to third-parties.
Service and other revenue. Our service revenue includes revenue allocated to the future update rights and the online hosting performance obligations. This also includes revenue allocated to the future update rights from the licensing of software to third-parties, software that offers an online-only service such as our Ultimate Team game mode, and subscription services.
Significant Judgments around Revenue Arrangements
Identifying performance obligations. Performance obligations promised in a contract are identified based on the goods and services that will be transferred to the customer that are both capable of being distinct, (i.e., the customer can benefit from the goods or services either on its own or together with other resources that are readily available), and are distinct in the context of the contract (i.e., it is separately identifiable from other goods or services in the contract). To the extent a contract includes multiple promises, we must apply judgment to determine whether those promises are separate and distinct performance obligations. If these criteria are not met, the promises are accounted for as a combined performance obligation.
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Determining the transaction price. The transaction price is determined based on the consideration that we will be entitled to receive in exchange for transferring our goods and services to the customer. Determining the transaction price often requires significant judgment, based on an assessment of contractual terms and business practices. It further includes review of variable consideration such as discounts, sales returns, price protection, and rebates, which is estimated at the time of the transaction. See below for additional information regarding our sales returns and price protection reserves. In addition, the transaction price does not include an estimate of the variable consideration related to sales-based royalties. Sales-based royalties are recognized as the sales occur.
Allocating the transaction price. Allocating the transaction price requires that we determine an estimate of the relative stand-alone selling price for each distinct performance obligation. Determining the relative stand-alone selling price is inherently subjective, especially in situations where we do not sell the performance obligation on a stand-alone basis (which occurs in the majority of our transactions). In those situations, we determine the relative stand-alone selling price based on various observable inputs using all information that is reasonably available. Examples of observable inputs and information include: historical internal pricing data, cost plus margin analyses, third-party external pricing of similar or same products and services such as software licenses and maintenance support within the enterprise software industry. The results of our analysis resulted in a specific percentage of the transaction price being allocated to each performance obligation.
Determining the Estimated Offering Period. The offering period is the period in which we offer to provide the future update rights and/or online hosting for the game and related extra content sold. Because the offering period is not an explicitly defined period, we must make an estimate of the offering period for the service related performance obligations (i.e., future update rights and online hosting). Determining the Estimated Offering Period is inherently subjective and is subject to regular revision. Generally, we consider the average period of time customers are online when estimating the offering period. We also consider the estimated period of time between the date a game unit is sold to a reseller and the date the reseller sells the game unit to the customer (i.e., time in channel). Based on these two factors, we then consider the method of distribution. For example, games sold at retail would have a composite offering period equal to the online gameplay period plus time in channel as opposed to digitally-distributed software licenses which are delivered immediately via digital download and therefore, the offering period is estimated to be only the online gameplay period.
Additionally, we consider results from prior analyses, known and expected online gameplay trends, as well as disclosed service periods for competitors’ games in determining the Estimated Offering Period for future sales. We believe this provides a reasonable depiction of the transfer of future update rights and online hosting to our customers, as it is the best representation of the time period during which our games are played. We recognize revenue for future update rights and online hosting performance obligations ratably on a straight-line basis over this period as there is a consistent pattern of delivery for these performance obligations. These performance obligations are generally recognized over an estimated nine-month period beginning in the month after shipment for software licenses sold through retail and an estimated six-month period for digitally-distributed software licenses beginning in the month of sale.
Deferred Net Revenue
Because the majority of our sales transactions include future update rights and online hosting performance obligations, which are subject to a recognition period of generally six to nine months, our deferred net revenue balance is material. This balance increases from period to period by the revenue being deferred for current sales with these service obligations and is reduced by the recognition of revenue from prior sales that were deferred. Generally, revenue is recognized as the services are provided.
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Principal Agent Considerations
We evaluate sales to end customers of our full games and related content via third-party storefronts, including digital storefronts such as Microsoft’s Xbox Store, Sony’s PlayStation Store, Apple App Store, and Google Play Store, in order to determine whether or not we are acting as the principal in the sale to the end customer, which we consider in determining if revenue should be reported gross or net of fees retained by the third-party storefront. An entity is the principal if it controls a good or service before it is transferred to the end customer. Key indicators that we evaluate in determining gross versus net treatment include but are not limited to the following:
• | the underlying contract terms and conditions between the various parties to the transaction; |
• | which party is primarily responsible for fulfilling the promise to provide the specified good or service to the end customer; |
• | which party has inventory risk before the specified good or service has been transferred to the end customer; and |
• | which party has discretion in establishing the price for the specified good or service. |
Based on an evaluation of the above indicators, except as discussed below, we have determined that generally the third party is considered the principal to end customers for the sale of our full games and related content. We therefore report revenue related to these arrangements net of the fees retained by the storefront. However, for sales arrangements via Apple App Store and Google Play Store, EA is considered the principal to the end customer and thus, we report revenue on a gross basis and mobile platform fees are reported within cost of revenue.
Payment Terms
Substantially all of our transactions have payment terms, whether customary or on an extended basis, of less than one year; therefore, we generally do not adjust the transaction price for the effects of any potential financing components that may exist.
Sales and Value-Added Taxes
Revenue is recorded net of taxes assessed by governmental authorities that are imposed at the time of the specific revenue-producing transaction between us and our customer, such as sales and value-added taxes.
Sales Returns and Price Protection Reserves
Sales returns and price protection are considered variable consideration under ASC 606. We reduce revenue for estimated future returns and price protection which may occur with our distributors and retailers (“channel partners”). Price protection represents our practice to provide our channel partners with a credit allowance to lower their wholesale price on a particular game unit that they have not resold to customers. The amount of the price protection for permanent markdowns is the difference between the old wholesale price and the new reduced wholesale price. Credits are also given for short-term promotions that temporarily reduce the wholesale price. In certain countries we also have a practice for allowing channel partners to return older products in the channel in exchange for a credit allowance.
When evaluating the adequacy of sales returns and price protection reserves, we analyze the following: historical credit allowances, current sell-through of our channel partners’ inventory of our products, current trends in retail and the video game industry, changes in customer demand, acceptance of our products, and other related factors. In addition, we monitor the volume of sales to our channel partners and their inventories, as substantial overstocking in the distribution channel could result in high returns or higher price protection in subsequent periods.
In the future, actual returns and price protections may materially exceed our estimates as unsold products in the distribution channels are exposed to rapid changes in customer preferences, market conditions or technological obsolescence due to new platforms, product updates or competing products. While we believe we can make reliable estimates regarding these matters, these estimates are inherently subjective. Accordingly, if our estimates change, our returns and price protection reserves would change and would impact the transaction price and thus, the total net revenue and related balance sheet accounts that we report.
Fair Value Estimates
Business Combinations. We must estimate the fair value of assets acquired, liabilities and contingencies assumed, acquired in-process technology, and contingent consideration issued in a business combination. Our assessment of the estimated fair value
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of each of these can have a material effect on our reported results as intangible assets are amortized over various estimated useful lives. Furthermore, the estimated fair value assigned to an acquired asset or liability has a direct impact on the amount we recognize as goodwill, which is an asset that is not amortized. Determining the fair value of assets acquired requires an assessment of the highest and best use or the expected price to sell the asset and the related expected future cash flows. Determining the fair value of acquired in-process technology also requires an assessment of our expectations related to the use of that technology. Determining the fair value of an assumed liability requires an assessment of the expected cost to transfer the liability. Determining the fair value of contingent consideration requires an assessment of the probability-weighted expected future cash flows over the period in which the obligation is expected to be settled, and applying a discount rate that appropriately captures the risk associated with the obligation. The significant unobservable inputs used in the fair value measurement of the contingent consideration payable are forecasted earnings. Significant changes in forecasted earnings would result in significantly higher or lower fair value measurement. This fair value assessment is also required in periods subsequent to a business combination. Such estimates are inherently difficult and subjective and can have a material impact on our Consolidated Financial Statements.
Income Taxes
We recognize deferred tax assets and liabilities for both (1) the expected impact of differences between the financial statement amount and the tax basis of assets and liabilities and (2) 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 carryback 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.
On December 22, 2017, the Tax Cuts and Jobs Act (the “U.S. Tax Act”) was enacted which significantly revised the U.S. corporate income tax system by, among other things, lowering the U.S. corporate income tax rates to 21 percent, generally implementing a territorial tax system, and imposing a one-time transition tax on the deemed repatriation of undistributed earnings of foreign subsidiaries (the “Transition Tax”). We have concluded the accounting under the U.S. Tax Act within the time period set forth in SAB 118, the SEC guidance that allowed for a measurement period of up to one year after the enactment date of the U.S. Tax Act to finalize the recording of the related tax impacts, including the impacts of the Transition Tax, the remeasurement of U.S. deferred tax assets and liabilities as a result of the reduction of the U.S. corporate tax rate, and the accounting policy election related to U.S. taxes on foreign earnings. We recorded tax expense of $235 million related to the U.S. Tax Act for the fiscal year ended March 31, 2018, $192 million of which relates to the Transition Tax. During the fiscal year ended March 31, 2019, we made no material adjustments to our provisional amounts recognized due to the U.S. Tax Act during the fiscal year ended March 31, 2018.
The U.S. Tax Act creates new U.S. taxes on foreign earnings. An accounting policy election is available to either recognize the deferred tax impacts of the U.S. taxes on foreign earnings or to account for them as a period cost. We have elected to account for the impacts of these new taxes as a period cost.
Prior to the U.S. Tax Act, a substantial majority of undistributed earnings of our foreign subsidiaries were considered to be indefinitely reinvested. As a result of the U.S. Tax Act, substantially all previously unremitted earnings for which no U.S. deferred tax liability had been accrued have now been subject to U.S. tax. Any future earnings of our foreign subsidiaries are generally available for repatriation without a material incremental U.S. tax cost.
As part of the process of preparing our Consolidated Financial Statements, we are required to estimate our income taxes in each jurisdiction in which we operate prior to the completion and filing of tax returns for such periods. This process requires estimating both our geographic mix of income and our uncertain tax positions in each jurisdiction where we operate. These estimates involve complex issues and require us to make judgments about the likely application of the tax law to our situation,
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as well as with respect to other matters, such as anticipating the positions that we will take on tax returns prior to our preparing the returns and the outcomes of disputes with tax authorities. The ultimate resolution of these issues may take extended periods of time due to examinations by tax authorities and statutes of limitations. In addition, changes in our business, including acquisitions, changes in our international corporate structure, changes in the geographic location of business functions or assets, changes in the geographic mix and amount of income, as well as changes in our agreements with tax authorities, valuation allowances, applicable accounting rules, applicable tax laws and regulations, rulings and interpretations thereof, developments in tax audit and other matters, and variations in the estimated and actual level of annual pre-tax income can affect the overall effective tax rate.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The information under the subheading “Impact of Recently Issued Accounting Standards” in Note 1 — Description of Business and Basis of Presentation to the Consolidated Financial Statements in this Form 10-K is incorporated by reference into this Item 7.
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RESULTS OF OPERATIONS
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 ended March 31, 2019, 2018 and 2017 contained 52 weeks each and ended on March 30, 2019, March 31, 2018 and April 1, 2017, respectively. For simplicity of disclosure, all fiscal periods are referred to as ending on a calendar month end.
Net Revenue
Net revenue consists of sales generated from (1) full games sold as digital downloads or as packaged goods and designed for play on game consoles and PCs, (2) full games for mobile phones and tablets, (3) live services associated with these games, such as extra-content (4) subscriptions that generally offer access to a selection of full games, in-game content, online services and other benefits, and (5) licensing our games to third parties to distribute and host our games.
We provide two different measures of our Net Revenue: (1) Net Revenue by Product revenue and Service and other revenue, and (2) Net Revenue by Composition, which is primarily based on method of distribution. Management places a greater emphasis and focus on assessing our business through a review of the Net Revenue by Composition (Digital, and Packaged goods and other) than by Net Revenue by Product revenue and Service and other revenue.
Comparison of Fiscal Year 2019 to Fiscal Year 2018
On April 1, 2018, we adopted the New Revenue Standard, which significantly changes the way in which we recognize revenue, including the way in which we present mobile platform fees. We elected to apply the New Revenue Standard using the modified retrospective method. Because of that election, revenue for the fiscal year ended March 31, 2018 has not been restated and is reported under the accounting standards in effect for that period. In order to facilitate year-over-year comparisons, in the Net Revenue and Cost of Revenue tables below, we have quantified the amount of the year-over-year change attributable to (1) the adoption of the New Revenue Standard, (2) the change in the way in which we present mobile platform fees and (3) our operations. The amount attributable to our operations is equivalent to the difference between current and prior period net revenues under the Old Revenue Standard. For more information on the adoption of the New Revenue Standard, including information related to the change in how we report mobile revenue, please see Part II, Item 8 of this Form 10-K in the Notes to Consolidated Financial Statements in Note 1 under the heading “Recently Adopted Accounting Standards”.
Net Revenue
Net revenue from our operations for fiscal year 2019 decreased $307 million, as compared to fiscal year 2018. This decrease was driven by a $742 million decrease in revenue primarily from the Battlefield franchise and Mass Effect: Andromeda. This decrease was partially offset by a $435 million increase in revenue primarily from the FIFA and The Sims franchises.
Net Revenue by Product Revenue and Service and Other Revenue
Our Net Revenue by Product revenue and Service and other revenue for fiscal years 2019 and 2018 was as follows (in millions):
Year Ended March 31, | |||||||||||||||||||||||
Changes due to: | |||||||||||||||||||||||
2019 | 2018 | Total Change | ASC 606 Adoption | Mobile Platform Fees under ASC 606 | Operational | ||||||||||||||||||
Net revenue: | |||||||||||||||||||||||
Product | $ | 1,593 | $ | 2,586 | $ | (993 | ) | $ | (611 | ) | $ | — | $ | (382 | ) | ||||||||
Service and other | 3,357 | 2,564 | 793 | 530 | 188 | 75 | |||||||||||||||||
Total net revenue | $ | 4,950 | $ | 5,150 | $ | (200 | ) | $ | (81 | ) | $ | 188 | $ | (307 | ) | ||||||||
Product Revenue
Product net revenue from our operations for fiscal year 2019 decreased $382 million, as compared to fiscal year 2018. This decrease was driven by a $635 million decrease primarily from Battlefield I and Mass Effect: Andromeda. This decrease was partially offset by a $253 million increase primarily from The Sims 4 and Need for Speed Payback and the UFC franchise.
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Service and Other Revenue
Service and other net revenue from our operations for fiscal year 2019 increased $75 million, as compared to fiscal year 2018. This increase was driven by a $281 million increase primarily from FIFA Ultimate Team and Apex Legends. This increase was partially offset by a $206 million decrease primarily from the Star Wars and Battlefield franchises and Need for Speed 2015, SimCity Mobile and Mass Effect: Andromeda.
Supplemental Net Revenue by Composition
As we continue to evolve our business and more of our products are delivered to consumers digitally, we place a significant emphasis and focus on assessing our business performance through a review of net revenue by composition.
Our net revenue by composition for fiscal years 2019 and 2018 was as follows (in millions):
Year Ended March 31, | |||||||||||||||||||||||
Changes due to: | |||||||||||||||||||||||
2019 | 2018 | Total Change | ASC 606 Adoption | Mobile Platform Fees under ASC 606 | Operational | ||||||||||||||||||
Net revenue: | |||||||||||||||||||||||
Full game downloads | $ | 680 | $ | 707 | $ | (27 | ) | $ | 49 | $ | — | $ | (76 | ) | |||||||||
Live services | 2,216 | 2,083 | 133 | 9 | — | 124 | |||||||||||||||||
Mobile | 814 | 660 | 154 | 17 | 188 | (51 | ) | ||||||||||||||||
Total Digital | $ | 3,710 | $ | 3,450 | $ | 260 | $ | 75 | $ | 188 | $ | (3 | ) | ||||||||||
Packaged goods and other | $ | 1,240 | $ | 1,700 | $ | (460 | ) | $ | (156 | ) | $ | — | $ | (304 | ) | ||||||||
Total net revenue | $ | 4,950 | $ | 5,150 | $ | (200 | ) | $ | (81 | ) | $ | 188 | $ | (307 | ) | ||||||||
Digital Net Revenue
Digital net revenue includes full-game downloads, live services, and mobile revenue. Full game download includes revenue from digital sales of full games on console and PC. Live services include revenue from sales of extra content for console, PC, browser games, game software licensed to our third-party publishing partners who distribute our games digitally, subscriptions, and advertising. Mobile includes revenue from the sale of full games and extra content on mobile phones and tablets.
Digital net revenue from our operations for fiscal year 2019 decreased $3 million, as compared to fiscal year 2018. This decrease was due to a $76 million decrease in full-game download revenue primarily driven by Battlefield 1 and a $51 million decrease in mobile revenue primarily driven by Madden Mobile and SimCity Mobile, partially offset by a $124 million increase in live services revenue primarily driven by our Ultimate Team game mode.
Packaged Goods and Other Net Revenue
Packaged goods net revenue includes revenue from software that is distributed physically. This includes (1) net revenue from game software distributed physically through traditional channels such as brick and mortar retailers, and (2) our software licensing revenue from third parties (for example, makers of console platforms, personal computers or computer accessories) who include certain of our products for sale with their products (for example, OEM bundles). Other net revenue includes our non-software licensing revenue.
Packaged goods and other net revenue from our operations for fiscal year 2019 decreased $304 million, as compared to fiscal year 2018. This decrease was driven by a $448 million decrease primarily from Battlefield 1 and Mass Effect: Andromeda, partially offset by a $144 million increase primarily from Star Wars Battlefront II, UFC 3 and The Sims 4.
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Cost of Revenue
Cost of revenue for fiscal years 2019 and 2018 was as follows (in millions):
Year Ended March 31, | |||||||||||||||||||||||
Changes due to: | |||||||||||||||||||||||
2019 | 2018 | Total Change | ASC 606 Adoption | Mobile Platform Fees under ASC 606 | Operational | ||||||||||||||||||
Cost of revenue: | |||||||||||||||||||||||
Product | $ | 517 | $ | 822 | (305 | ) | $ | (120 | ) | $ | — | $ | (185 | ) | |||||||||
Service and other | 805 | 455 | 350 | 120 | 188 | 42 | |||||||||||||||||
Total cost of revenue | $ | 1,322 | $ | 1,277 | $ | 45 | $ | — | $ | 188 | $ | (143 | ) | ||||||||||
Cost of Product Revenue
Cost of product revenue consists of (1) manufacturing royalties, net of volume discounts and other vendor reimbursements, (2) certain royalty expenses for celebrities, professional sports leagues, movie studios and other organizations, and independent software developers, (3) inventory costs, (4) expenses for defective products, (5) write-offs of post launch prepaid royalty costs and losses on previously unrecognized licensed intellectual property commitments, (6) amortization of certain intangible assets, (7) personnel-related costs, and (8) warehousing and distribution costs. We generally recognize volume discounts when they are earned from the manufacturer (typically in connection with the achievement of unit-based milestones); whereas other vendor reimbursements are generally recognized as the related revenue is recognized.
Cost of product revenue from operations decreased by $185 million during fiscal year 2019, as compared to fiscal year 2018. This decrease was primarily due to a decrease in inventory and royalty costs associated with Star Wars Battlefront II, which launched during fiscal year 2018, with no comparable royalty-bearing title launched during fiscal year 2019.
Cost of Service and Other Revenue
Cost of service and other revenue consists primarily of (1) royalty costs, (2) data center, bandwidth and server costs associated with hosting our online games and websites, (3) inventory costs, (4) payment processing fees and (5) mobile platform fees associated with our mobile revenue (for transactions in which we are acting as the principal in the sale to the end customer).
Cost of service and other revenue increased by $42 million during fiscal year 2019, as compared to fiscal year 2018. This increase was primarily due to costs associated with Anthem and Apex Legends, which launched as online-only titles during fiscal year 2019 and resulted in significant data center, bandwidth and server usage.
Research and Development
Research and development expenses consist of expenses incurred by our production studios for personnel-related costs, related overhead costs, contracted services, depreciation and any impairment of prepaid royalties for pre-launch products. Research and development expenses for our online products include expenses incurred by our studios consisting of direct development and related overhead costs in connection with the development and production of our online games. Research and development expenses also include expenses associated with our digital platform, software licenses and maintenance, and management overhead.
Research and development expenses for fiscal years 2019 and 2018 were as follows (in millions):
March 31, 2019 | % of Net Revenue | March 31, 2018 | % of Net Revenue | $ Change | % Change | ||||||||||||||
$ | 1,433 | 29 | % | $ | 1,320 | 26 | % | $ | 113 | 9 | % | ||||||||
Research and development expenses increased by $113 million, or 9 percent, in fiscal year 2019, as compared to fiscal year 2018. This $113 million increase was primarily due to (1) a $65 million increase in personnel-related costs primarily resulting from an increase in headcount due to our continued investment in our studios and the Respawn acquisition, partially offset by reduction of variable compensation and related expenses, (2) a $38 million increase in stock-based compensation primarily in connection with the Respawn acquisition, (3) a $22 million increase in facilities-related costs, and (4) an increase in losses of $15 million from our cash flow hedging program in fiscal year 2019 as compared to fiscal year 2018. We use hedges to protect against currency exchange rate movements in our research and development expenses. These increases were partially offset by
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a $41 million decrease in development advances primarily resulting from the extinguishment of development advances payable to Respawn as a result of our acquisition.
Marketing and Sales
Marketing and sales expenses consist of personnel-related costs, related overhead costs, advertising, marketing and promotional expenses, net of qualified advertising cost reimbursements from third parties.
Marketing and sales expenses for fiscal years 2019 and 2018 were as follows (in millions):
March 31, 2019 | % of Net Revenue | March 31, 2018 | % of Net Revenue | $ Change | % Change | ||||||||||||||
$ | 702 | 14 | % | $ | 641 | 12 | % | $ | 61 | 10 | % | ||||||||
Marketing and sales expenses increased by $61 million, or 10 percent, in fiscal year 2019, as compared to fiscal year 2018. This $61 million increase was primarily due to an increase in advertising and promotional spending associated with our 2019 game launches, particularly with respect to the marketing and promotional campaigns associated with our two new intellectual properties, Anthem and Apex Legends.
General and Administrative
General and administrative expenses consist of personnel and related expenses of executive and administrative staff, corporate functions such as finance, legal, human resources, and information technology, related overhead costs, fees for professional services such as legal and accounting, and allowances for doubtful accounts.
General and administrative expenses for fiscal years 2019 and 2018 were as follows (in millions):
March 31, 2019 | % of Net Revenue | March 31, 2018 | % of Net Revenue | $ Change | % Change | ||||||||||||||
$ | 460 | 9 | % | $ | 469 | 9 | % | $ | (9 | ) | (2 | )% | |||||||
General and administrative expenses decreased by $9 million, or 2 percent, in fiscal year 2019, as compared to fiscal year 2018. This $9 million decrease was primarily due to a $24 million decrease in contracted services primarily due to lower legal expenses. This decrease was partially offset by an $11 million increase primarily in IT security costs and a $6 million increase in personnel-related costs resulting from an increase in headcount.
Income Taxes
Provision for income taxes for fiscal years 2019 and 2018 was as follows (in millions):
March 31, 2019 | Effective Tax Rate | March 31, 2018 | Effective Tax Rate | |||||||||
$ | 60 | 5.6 | % | $ | 406 | 28.0 | % | |||||
Our effective tax rate for the fiscal year ended March 31, 2019 was 5.6 percent as compared 28.0 percent for the same period in fiscal year 2018. Our effective tax rate and resulting provision for income taxes for the fiscal year ended March 31, 2019 was significantly lower than the same period in fiscal year 2018 due to the recognition of the impacts of the U.S. Tax Act in fiscal year ended March 31, 2018, a change in the mix of earnings, and the lower statutory tax rate applied to earnings realized in the U.S. The U.S. Tax Act significantly revised the U.S. corporate income tax system by, among other things, lowering the U.S. corporate income tax rate to 21 percent, generally implementing a territorial tax system and imposing the Transition Tax.
We have concluded the accounting under the U.S. Tax Act within the time period set forth in SAB 118, the SEC guidance that allowed for a measurement period of up to one year after the enactment date of the U.S. Tax Act to finalize the recording of the related tax impacts, including the impacts of the Transition Tax, the remeasurement of U.S. deferred tax assets and liabilities as a result of the reduction of the U.S. corporate tax rate, and the accounting policy election related to U.S. taxes on foreign earnings. We recorded tax expense of $235 million related to the U.S. Tax Act for the fiscal year ended March 31, 2018, $192 million of which relates to the Transition Tax. During the year ended March 31, 2019, we made no material adjustments to our provisional amounts recognized due to the U.S. Tax Act during the fiscal year ended March 31, 2018.
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The U.S. Tax Act creates new U.S. taxes on foreign earnings. An accounting policy election is available to either recognize the deferred tax impacts of the U.S. taxes on foreign earnings or to account for them as a period cost. We have elected to account for the impacts of these new taxes as a period cost.
Our effective tax rates for fiscal year 2020 and future periods will continue to depend on a variety of factors, including changes in our business, such as acquisitions and intercompany transactions, our corporate structure, the geographic location of business functions or assets, the geographic mix of income, our agreements with tax authorities, applicable accounting rules, applicable tax laws and regulations, rulings and interpretations thereof, developments in tax audit and other matters, and variations in our annual pre-tax income or loss. We anticipate that the impact of excess tax benefits and tax deficiencies may result in significant fluctuations to our effective tax rate in the future.
Subsequent to the fiscal year ended March 31, 2019, we completed an intra-entity sale of some of our intellectual property rights to our Swiss subsidiary, where our international business is headquartered. The transaction did not result in a taxable gain. Under U.S. GAAP, any profit resulting from this intercompany transaction will be eliminated upon consolidation. However, the transaction resulted in a step-up of the Swiss tax deductible basis in the transferred intellectual property rights and, accordingly, created a temporary difference between the book basis and the tax basis of such intellectual property rights. As a result, this transaction will result in the recognition of a deferred tax asset, which we estimate at approximately $2.3 billion, subject to a realizability analysis. The deferred tax asset will be recognized as a one-time tax benefit in our consolidated financial statements during the three months ending June 30, 2019. This deferred tax asset will reverse over a 20-year period and is subject to a periodic realizability analysis. The deferred tax asset and the one-time tax benefit will be measured based on the Swiss tax rate expected to apply in the years the asset will be recovered. We will not recognize any deferred taxes related to the U.S. taxes on foreign earnings associated with this transfer due to our policy election to recognize these taxes as a period cost. We do not expect the transaction to impact our cash taxes or our operating cash flow in fiscal year 2020.
Comparison of Fiscal Year 2018 to Fiscal Year 2017
For the comparison of fiscal year 2018 to fiscal year 2017, refer to Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for our fiscal year ended March 31, 2018, filed with the SEC on May 23, 2018 under the subheading “Comparison of Fiscal Year 2018 to Fiscal Year 2017.”
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, | |||||||||||
(In millions) | 2019 | 2018 | Increase/(Decrease) | ||||||||
Cash and cash equivalents | $ | 4,708 | $ | 4,258 | $ | 450 | |||||
Short-term investments | 737 | 1,073 | (336 | ) | |||||||
Total | $ | 5,445 | $ | 5,331 | $ | 114 | |||||
Percentage of total assets | 61 | % | 62 | % | |||||||
Year Ended March 31, | |||||||||||
(In millions) | 2019 | 2018 | Change | ||||||||
Net cash provided by operating activities | $ | 1,547 | $ | 1,692 | $ | (145 | ) | ||||
Net cash provided by investing activities | 169 | 622 | (453 | ) | |||||||
Net cash used in financing activities | (1,253 | ) | (643 | ) | (610 | ) | |||||
Effect of foreign exchange on cash and cash equivalents | (13 | ) | 22 | (35 | ) | ||||||
Net increase in cash and cash equivalents | $ | 450 | $ | 1,693 | $ | (1,243 | ) | ||||
For the comparison of fiscal year 2018 to fiscal year 2017, refer to Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for our fiscal year ended March 31, 2018, filed with the SEC on May 23, 2018 under the subheading “Liquidity and Capital Resources”.
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Changes in Cash Flow
Operating Activities. Net cash provided by operating activities decreased by $145 million during fiscal year 2019 as compared to fiscal year 2018. The decrease is primarily driven by lower cash receipts related to a decrease in net bookings and an increase in cash paid for taxes, partially offset by lower royalty payments and higher interest income.
Investing Activities. Net cash provided by investing activities decreased by $453 million during fiscal year 2019 as compared to fiscal year 2018 primarily driven by a $1,478 million decrease in proceeds from the sales and maturities of short-term investments. This was partially offset by a $945 million decrease in the purchase of short-term investments and a $92 million decrease in payments in connection with mergers and acquisitions activity.
Financing Activities. Net cash used in financing activities increased by $610 million during fiscal year 2019 as compared to fiscal year 2018 primarily due to a $591 million increase in the repurchase and retirement of our common stock.
Short-term Investments
Due to our mix of fixed and variable rate securities, our short-term investment portfolio is susceptible to changes in short-term interest rates. As of March 31, 2019, our short-term investments had gross unrealized losses of $1 million, or less than 1 percent of the total in short-term investments, and gross unrealized gains of less than $1 million, or less than 1 percent of the total in short-term investments. From time to time, we may liquidate some or all of our short-term investments to fund operational needs or other activities, such as capital expenditures, business acquisitions or stock repurchase programs.
Senior Notes
In February 2016, we issued $600 million aggregate principal amount of the 2021 Notes and $400 million aggregate principal amount of the 2026 Notes. We used the net proceeds of $989 million for general corporate purposes, including the payment of our formerly outstanding convertible notes and repurchases of our common stock. The effective interest rate is 3.94% for the 2021 Notes and 4.97% for the 2026 Notes. Interest is payable semiannually in arrears, on March 1 and September 1 of each year. See Note 12 — Financing Arrangements to the Consolidated Financial Statements in this Form 10-K as it relates to our Senior Notes, which is incorporated by reference into this Item 7.
Credit Facility
In March 2015, we entered into a $500 million senior unsecured revolving credit facility with a syndicate of banks. As of March 31, 2019, no amounts were outstanding under the credit facility. See Note 12 — Financing Arrangements to the Consolidated Financial Statements in this Form 10-K as it relates to our credit facility, which is incorporated by reference into this Item 7.
Financial Condition
We believe that our cash, cash equivalents, short-term investments, cash generated from operations and available financing facilities will be sufficient to meet our operating requirements for at least the next 12 months, including working capital requirements, capital expenditures, debt repayment obligations, and potentially, future acquisitions, stock repurchases, or strategic investments. We may choose at any time to raise additional capital to repay debt, strengthen our financial position, facilitate expansion, repurchase our stock, pursue strategic acquisitions and investments, and/or to take advantage of business opportunities as they arise. There can be no assurance, however, that such additional capital will be available to us on favorable terms, if at all, or that it will not result in substantial dilution to our existing stockholders.
In May 2018, a Special Committee of our Board of Directors, on behalf of the full Board of Directors, authorized a program to repurchase up to $2.4 billion of our common stock. This stock repurchase program supersedes and replaces the May 2017 program, and expires on May 31, 2020. Under this 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 a specific number of shares under this program and it may be modified, suspended or discontinued at any time. We repurchased approximately 10.4 million shares for approximately $1,116 million under this program during the fiscal year ended March 31, 2019. We are actively repurchasing shares under this program.
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We have a “shelf” registration statement on Form S-3 on file with the SEC. This shelf registration statement, which includes a base prospectus, allows us at any time to offer any combination of securities described in the prospectus in one or more offerings. Unless otherwise specified in a prospectus supplement accompanying the base prospectus, we would use the net proceeds from the sale of any securities offered pursuant to the shelf registration statement for general corporate purposes, which may include funding for working capital, financing capital expenditures, research and development, marketing and distribution efforts, and if opportunities arise, for acquisitions or strategic alliances. Pending such uses, we may invest the net proceeds in interest-bearing securities. In addition, we may conduct concurrent or other financings at any time.
Our ability to maintain sufficient liquidity could be affected by various risks and uncertainties including, but not limited to, those related to customer demand and acceptance of our products, our ability to collect our accounts receivable as they become due, successfully achieving our product release schedules and attaining our forecasted sales objectives, the impact of acquisitions and other strategic transactions in which we may engage, the impact of competition, economic conditions in the United States and abroad, the seasonal and cyclical nature of our business and operating results, risks of product returns and the other risks described in the “Risk Factors” section, included in Part I, Item 1A of this report.
Contractual Obligations and Commercial Commitments
See Note 13 — Commitments and Contingencies to the Consolidated Financial Statements in this Form 10-K as it relates to our contractual obligations and commercial commitments, which is incorporated by reference into this Item 7.
OFF-BALANCE SHEET ARRANGEMENTS
As of March 31, 2019, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated by the SEC, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues and expenses, results of operations, liquidity, capital expenditures, or capital resources that are material to investors.
INFLATION
We believe the impact of inflation on our results of operations has not been significant in any of the past three fiscal years.
Item 7A: Quantitative and Qualitative Disclosures About Market Risk
MARKET RISK
We are exposed to various market risks, including changes in foreign currency exchange rates, interest rates and market prices, which have experienced significant volatility. Market risk is the potential loss arising from changes in market rates and market prices. We employ established policies and practices to manage these risks. Foreign currency forward contracts are used to hedge anticipated exposures or mitigate some existing exposures subject to foreign exchange risk as discussed below. While we do not hedge our short-term investment portfolio, we protect our short-term investment portfolio against different market risks, including interest rate risk as discussed below. Our cash and cash equivalents portfolio consists of highly liquid investments with insignificant interest rate risk and original or remaining maturities of three months or less at the time of purchase. We do not enter into derivatives or other financial instruments for speculative trading purposes and do not hedge our market price risk relating to marketable equity securities, if any.
Foreign Currency Exchange Risk
Foreign Currency Exchange Rates. International sales are a fundamental part of our business, and the strengthening of the U.S. dollar (particularly relative to the Euro, British pound sterling, Australian dollar, Chinese yuan and South Korean won) has a negative impact on our reported international net revenue, but a positive impact on our reported international operating expenses (particularly the Swedish krona and Canadian dollar) because these amounts are translated at lower rates as compared to periods in which the U.S. dollar is weaker. While we use foreign currency hedging contracts to mitigate some foreign currency exchange risk, these activities are limited in the protection that they provide us and can themselves result in losses.
Cash Flow Hedging Activities. We hedge a portion of our foreign currency risk related to forecasted foreign-currency-denominated sales and expense transactions by purchasing foreign currency forward contracts that generally have maturities of 18 months or less. These transactions are designated and qualify as cash flow hedges. Our hedging programs are designed to reduce, but do not entirely eliminate, the impact of currency exchange rate movements in net revenue and research and development expenses.
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Balance Sheet Hedging Activities. We use foreign currency forward contracts to mitigate foreign currency exchange risk associated with foreign-currency-denominated monetary assets and liabilities, primarily intercompany receivables and payables. The foreign currency forward contracts generally have a contractual term of three months or less and are transacted near month-end.
We believe the counterparties to our foreign currency forward contracts are creditworthy multinational commercial banks. While we believe the risk of counterparty nonperformance is not material, a sustained decline in the financial stability of financial institutions as a result of disruption in the financial markets could affect our ability to secure creditworthy counterparties for our foreign currency hedging programs.
Notwithstanding our efforts to mitigate some foreign currency exchange risks, there can be no assurance that our hedging activities will adequately protect us against the risks associated with foreign currency fluctuations. As of March 31, 2019, a hypothetical adverse foreign currency exchange rate movement of 10 percent or 20 percent would have resulted in potential declines in the fair value on our foreign currency forward contracts used in cash flow hedging of $159 million or $318 million, respectively. As of March 31, 2019, a hypothetical adverse foreign currency exchange rate movement of 10 percent or 20 percent would have resulted in potential losses on our foreign currency forward contracts used in balance sheet hedging of $84 million or $167 million, respectively. This sensitivity analysis assumes an adverse shift of all foreign currency exchange rates; however, all foreign currency exchange rates do not always move in such manner and actual results may differ materially. See Note 5 — Derivative Financial Instruments to the Consolidated Financial Statements in this Form 10-K as it relates to our derivative financial instruments, which is incorporated by reference into this Item 7A.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our short-term investment portfolio. We manage our interest rate risk by maintaining an investment portfolio generally consisting of debt instruments of high credit quality and relatively short maturities. However, because short-term investments mature relatively quickly and, if reinvested, are invested at the then-current market rates, interest income on a portfolio consisting of short-term investments is subject to market fluctuations to a greater extent than a portfolio of longer term investments. Additionally, the contractual terms of the investments do not permit the issuer to call, prepay or otherwise settle the investments at prices less than the stated par value. Our investments are held for purposes other than trading. We do not use derivative financial instruments in our short-term investment portfolio.
As of March 31, 2019, our short-term investments were classified as available-for-sale securities and, consequently, were recorded at fair value with unrealized gains or losses resulting from changes in fair value reported as a separate component of accumulated other comprehensive income (loss), net of tax, in stockholders’ equity.
Notwithstanding our efforts to manage interest rate risks, there can be no assurance that we will be adequately protected against risks associated with interest rate fluctuations. Fluctuations in interest rates could have a significant impact on the fair value of our investment portfolio. The following table presents the hypothetical changes in the fair value of our short-term investment portfolio as of March 31, 2019, arising from potential changes in interest rates. The modeling technique estimates the change in fair value from immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points (“BPS”), 100 BPS, and 150 BPS.
(In millions) | Valuation of Securities Given an Interest Rate Decrease of X Basis Points | Fair Value as of March 31, 2019 | Valuation of Securities Given an Interest Rate Increase of X Basis Points | ||||||||||||||||||||||||
(150 BPS) | (100 BPS) | (50 BPS) | 50 BPS | 100 BPS | 150 BPS | ||||||||||||||||||||||
Corporate bonds | $ | 328 | $ | 328 | $ | 326 | $ | 324 | $ | 323 | $ | 322 | $ | 321 | |||||||||||||
U.S. Treasury securities | 154 | 154 | 153 | 153 | 152 | 151 | 151 | ||||||||||||||||||||
U.S. agency securities | 44 | 44 | 44 | 44 | 43 | 43 | 43 | ||||||||||||||||||||
Commercial paper | 112 | 112 | 112 | 112 | 112 | 112 | 112 | ||||||||||||||||||||
Foreign government securities | 51 | 50 | 50 | 50 | 50 | 49 | 49 | ||||||||||||||||||||
Asset-backed securities | 54 | 53 | 53 | 53 | 52 | 52 | 51 | ||||||||||||||||||||
Certificates of deposit | 1 | 1 | 1 | 1 | 1 | 1 | 1 | ||||||||||||||||||||
Total short-term investments | $ | 744 | $ | 742 | $ | 739 | $ | 737 | $ | 733 | $ | 730 | $ | 728 | |||||||||||||
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Item 8: Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Page | |
Consolidated Financial Statements of Electronic Arts Inc. and Subsidiaries: | |
Financial Statement Schedule: | |
The following financial statement schedule of Electronic Arts Inc. and Subsidiaries for the years ended March 31, 2019, 2018 and 2017 is filed as part of this report and should be read in conjunction with the Consolidated Financial Statements of Electronic Arts Inc. and Subsidiaries: | |
Other financial statement schedules have been omitted because the information called for in them is not required or has already been included in either the Consolidated Financial Statements or the Notes thereto.
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ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except par value data) | March 31, 2019 | March 31, 2018 | |||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 4,708 | $ | 4,258 | |||
Short-term investments | 737 | 1,073 | |||||
Receivables, net of allowances of $7 and $165, respectively | 623 | 385 | |||||
Other current assets | 313 | 288 | |||||
Total current assets | 6,381 | 6,004 | |||||
Property and equipment, net | 448 | 453 | |||||
Goodwill | 1,892 | 1,883 | |||||
Acquisition-related intangibles, net | 87 | 71 | |||||
Deferred income taxes, net | 35 | 84 | |||||
Other assets | 114 | 89 | |||||
TOTAL ASSETS | $ | 8,957 | $ | 8,584 | |||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 113 | $ | 48 | |||
Accrued and other current liabilities | 1,052 | 821 | |||||
Deferred net revenue (online-enabled games) | 1,100 | 1,622 | |||||
Total current liabilities | 2,265 | 2,491 | |||||
Senior notes, net | 994 | 992 | |||||
Income tax obligations | 233 | 250 | |||||
Deferred income taxes, net | 2 | 1 | |||||
Other liabilities | 132 | 255 | |||||
Total liabilities | 3,626 | 3,989 | |||||
Commitments and contingencies (See Note 13) | |||||||
Stockholders’ equity: | |||||||
Preferred stock, $0.01 par value. 10 shares authorized | — | — | |||||
Common stock, $0.01 par value. 1,000 shares authorized; 298 and 306 shares issued and outstanding, respectively | 3 | 3 | |||||
Additional paid-in capital | — | 657 | |||||
Retained earnings | 5,358 | 4,062 | |||||
Accumulated other comprehensive loss | (30 | ) | (127 | ) | |||
Total stockholders’ equity | 5,331 | 4,595 | |||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 8,957 | $ | 8,584 | |||
See accompanying Notes to Consolidated Financial Statements.
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ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended March 31, | |||||||||||
(In millions, except per share data) | 2019 | 2018 | 2017 | ||||||||
Net revenue: | |||||||||||
Product | $ | 1,593 | $ | 2,586 | $ | 2,640 | |||||
Service and other | 3,357 | 2,564 | 2,205 | ||||||||
Total net revenue | 4,950 | 5,150 | 4,845 | ||||||||
Cost of revenue: | |||||||||||
Product | 517 | 822 | 893 | ||||||||
Service and other | 805 | 455 | 405 | ||||||||
Total cost of revenue | 1,322 | 1,277 | 1,298 | ||||||||
Gross profit | 3,628 | 3,873 | 3,547 | ||||||||
Operating expenses: | |||||||||||
Research and development | 1,433 | 1,320 | 1,205 | ||||||||
Marketing and sales | 702 | 641 | 673 | ||||||||
General and administrative | 460 | 469 | 439 | ||||||||
Acquisition-related contingent consideration | 14 | — | — | ||||||||
Amortization of intangibles | 23 | 9 | 6 | ||||||||
Total operating expenses | 2,632 | 2,439 | 2,323 | ||||||||
Operating income | 996 | 1,434 | 1,224 | ||||||||
Interest and other income (expense), net | 83 | 15 | (14 | ) | |||||||
Income before provision for income taxes | 1,079 | 1,449 | 1,210 | ||||||||
Provision for income taxes | 60 | 406 | 243 | ||||||||
Net income | $ | 1,019 | $ | 1,043 | $ | 967 | |||||
Earnings per share: | |||||||||||
Basic | $ | 3.36 | $ | 3.39 | $ | 3.19 | |||||
Diluted | $ | 3.33 | $ | 3.34 | $ | 3.08 | |||||
Number of shares used in computation: | |||||||||||
Basic | 303 | 308 | 303 | ||||||||
Diluted | 306 | 312 | 314 | ||||||||
See accompanying Notes to Consolidated Financial Statements.
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ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year Ended March 31, | |||||||||||
(In millions) | 2019 | 2018 | 2017 | ||||||||
Net income | $ | 1,019 | $ | 1,043 | $ | 967 | |||||
Other comprehensive income (loss), net of tax: | |||||||||||
Net gains (losses) on available-for-sale securities | 7 | (5 | ) | (4 | ) | ||||||
Net gains (losses) on derivative instruments | 88 | (121 | ) | 18 | |||||||
Foreign currency translation adjustments | (21 | ) | 18 | (17 | ) | ||||||
Total other comprehensive income (loss), net of tax | 74 | (108 | ) | (3 | ) | ||||||
Total comprehensive income | $ | 1,093 | $ | 935 | $ | 964 | |||||
See accompanying Notes to Consolidated Financial Statements.
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ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In millions, share data in thousands)
Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Total Stockholders’ Equity | ||||||||||||||||||
Shares | Amount | |||||||||||||||||||||
Balances as of March 31, 2016 | 300,602 | $ | 3 | $ | 1,349 | $ | 2,060 | $ | (16 | ) | $ | 3,396 | ||||||||||
Total comprehensive income (loss) | — | — | — | 967 | (3 | ) | 964 | |||||||||||||||
Reclassification of equity component of convertible notes | — | — | 2 | — | — | 2 | ||||||||||||||||
Settlement of convertible notes | 2,917 | — | — | — | — | — | ||||||||||||||||
Exercise of convertible note hedge | (2,917 | ) | — | — | — | — | — | |||||||||||||||
Settlement of warrants | 9,645 | — | — | — | — | — | ||||||||||||||||
Stock-based compensation | — | — | 196 | — | — | 196 | ||||||||||||||||
Tax benefit from stock-based compensation | — | — | 65 | — | — | 65 | ||||||||||||||||
Issuance of common stock | 4,626 | — | (55 | ) | — | — | (55 | ) | ||||||||||||||
Repurchase and retirement of common stock | (6,506 | ) | — | (508 | ) | — | — | (508 | ) | |||||||||||||
Balances as of March 31, 2017 | 308,367 | 3 | 1,049 | 3,027 | (19 | ) | 4,060 | |||||||||||||||
Cumulative-effect adjustment from the adoption of ASU 2016-09 | — | — | 9 | (8 | ) | — | 1 | |||||||||||||||
Total comprehensive income (loss) | — | — | — | 1,043 | (108 | ) | 935 | |||||||||||||||
Stock-based compensation | — | — | 242 | — | — | 242 | ||||||||||||||||
Issuance of common stock | 3,332 | — | (42 | ) | — | — | (42 | ) | ||||||||||||||
Repurchase and retirement of common stock | (5,329 | ) | — | (601 | ) | — | — | (601 | ) | |||||||||||||
Balances as of March 31, 2018 | 306,370 | 3 | 657 | 4,062 | (127 | ) | 4,595 | |||||||||||||||
Cumulative-effect adjustment from the adoption of ASC 606 (See Note 1) | — | — | — | 590 | 22 | 612 | ||||||||||||||||
Cumulative-effect adjustment from the adoption of ASU 2018-02 (See Note 1) | — | — | — | (1 | ) | 1 | — | |||||||||||||||
Total comprehensive income | — | — | — | 1,019 | 74 | 1,093 | ||||||||||||||||
Stock-based compensation | — | — | 284 | — | — | 284 | ||||||||||||||||
Issuance of common stock | 2,722 | — | (61 | ) | — | — | (61 | ) | ||||||||||||||
Repurchase and retirement of common stock | (10,985 | ) | — | (880 | ) | (312 | ) | — | (1,192 | ) | ||||||||||||
Balances as of March 31, 2019 | 298,107 | $ | 3 | $ | — | $ | 5,358 | $ | (30 | ) | $ | 5,331 | ||||||||||
See accompanying Notes to Consolidated Financial Statements.
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ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended March 31, | |||||||||||
(In millions) | 2019 | 2018 | 2017 | ||||||||
OPERATING ACTIVITIES | |||||||||||
Net income | $ | 1,019 | $ | 1,043 | $ | 967 | |||||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
Depreciation, amortization and accretion | 145 | 136 | 172 | ||||||||
Acquisition-related contingent consideration | 14 | — | — | ||||||||
Stock-based compensation | 284 | 242 | 196 | ||||||||
Change in assets and liabilities: | |||||||||||
Receivables, net | (88 | ) | (25 | ) | (136 | ) | |||||
Other assets | (24 | ) | 10 | 3 | |||||||
Accounts payable | 59 | (44 | ) | 5 | |||||||
Accrued and other liabilities | 3 | 43 | 190 | ||||||||
Deferred income taxes, net | (16 | ) | 204 | 100 | |||||||
Deferred net revenue (online-enabled games) | 151 | 83 | 81 | ||||||||
Net cash provided by operating activities | 1,547 | 1,692 | 1,578 | ||||||||
INVESTING ACTIVITIES | |||||||||||
Capital expenditures | (119 | ) | (107 | ) | (123 | ) | |||||
Proceeds from maturities and sales of short-term investments | 1,688 | 3,166 | 1,281 | ||||||||
Purchase of short-term investments | (1,342 | ) | (2,287 | ) | (1,917 | ) | |||||
Acquisition, net of cash acquired | (58 | ) | (150 | ) | — | ||||||
Net cash provided by (used in) investing activities | 169 | 622 | (759 | ) | |||||||
FINANCING ACTIVITIES | |||||||||||
Payment of convertible notes | — | — | (163 | ) | |||||||
Proceeds from issuance of common stock | 61 | 78 | 72 | ||||||||
Cash paid to taxing authorities for shares withheld from employees | (122 | ) | (120 | ) | (130 | ) | |||||
Repurchase and retirement of common stock | (1,192 | ) | (601 | ) | (508 | ) | |||||
Net cash used in financing activities | (1,253 | ) | (643 | ) | (729 | ) | |||||
Effect of foreign exchange on cash and cash equivalents | (13 | ) | 22 | (18 | ) | ||||||
Increase in cash and cash equivalents | 450 | 1,693 | 72 | ||||||||
Beginning cash and cash equivalents | 4,258 | 2,565 | |||||||||