QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2018
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
Redwood City, California
94065
(Address of principal executive offices)
(Zip Code)
(650) 628-1500
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO ¨
Indicate by check mark whether the registrant has submitted electronically 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
As of February 4, 2019, there were 299,595,570 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
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 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, Mass Effect, Need for Speed, The Sims, Plants v. Zombies and Titanfall) 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.
Our fiscal year is reported on a 52- or 53-week period that ends on the Saturday nearest March 31. Our results of operations for the fiscal year ending March 31, 2019 contains 52 weeks and ends on March 30, 2019. Our results of operations for the fiscal year ended March 31, 2018 contained 52 weeks and ended on March 31, 2018. Our results of operations for the three months ended December 31, 2018 and 2017 contained 13 weeks each and ended on December 29, 2018 and December 30, 2017, respectively. Our results of operations for the nine months ended December 31, 2018 and 2017 contained 39 weeks each and ended on December 29, 2018 and December 30, 2017, respectively. For simplicity of disclosure, all fiscal periods are referred to as ending on a calendar month end.
The Condensed Consolidated Financial Statements are unaudited and reflect all adjustments (consisting only of normal recurring accruals unless otherwise indicated) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The preparation of these Condensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the amounts reported in these Condensed Consolidated Financial Statements and accompanying notes. Actual results could differ materially from those estimates. The results of operations for the current interim periods are not necessarily indicative of results to be expected for the current year or any other period.
These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2018, as filed with the United States Securities and Exchange Commission (“SEC”) on May 23, 2018.
Recently Adopted Accounting Standards
In May 2014, the FASB issued the Accounting Standards Codification (“ASC”) Topic 606, Revenue From Contracts with Customers (the “New Revenue Standard” or “ASC 606”), which replaced ASC Topic 605, Revenue Recognition (the “Old Revenue Standard” or “ASC 605”), including industry-specific requirements, and provided companies with a single principles-based revenue recognition model for recognizing revenue from contracts with customers. The core principle of the New Revenue Standard is that a company should recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers.
We adopted the New Revenue Standard on April 1, 2018, the beginning of fiscal year 2019, using the modified retrospective method. We elected to apply the New Revenue Standard only to contracts that were not completed as of the adoption date. The comparative information for periods prior to April 1, 2018 has not been restated and continues to be reported under the accounting standards in effect for those periods.
The net cumulative effect adjustment upon adoption resulted in an increase to retained earnings of $590 million, net of tax, and included the impact from the following adjustments to our Condensed Consolidated Balance Sheet at April 1, 2018:
BALANCE SHEETS (In millions)
Balance at March 31, 2018
Adjustments due to New Revenue Standard Adoption
Balance at
April 1, 2018
Assets
Receivables, net
$
385
$
158
$
543
Deferred income taxes, net
84
(64
)
20
Liabilities
Accrued and other current liabilities
Sales return and price protection reserves
$
—
$
158
$
158
Deferred net revenue (other)
108
(3
)
105
Deferred net revenue (online-enabled games)
1,622
(673
)
949
Stockholders’ Equity
Retained earnings
$
4,062
$
590
$
4,652
Accumulated other comprehensive income (loss)
(127
)
22
(105
)
The most significant impacts of the New Revenue Standard were:
•
The accounting for our transactions as multiple elements or “bundled” arrangements. Under prior software revenue recognition accounting standards, because we did not have vendor-specific objective evidence of fair value (“VSOE”) for unspecified future updates or online hosting, we were not able to account for performance obligations separately, and therefore, the entire sales price of most transactions that had multiple performance obligations was recognized ratably over the period we expected to provide the future updates and/or online hosting performance obligations (the “Estimated Offering Period”). Under the New Revenue Standard, this VSOE requirement was eliminated and was replaced with a requirement for us to determine our best estimate of the stand-alone selling price of each performance obligation and allocate the transaction price to each distinct performance obligation on a relative stand-alone selling price basis. Therefore, we are now able to account for performance obligations separately.
For example, for an individual sale of a game with both online and offline functionality, we typically have three distinct performance obligations; (1) the software license; (2) a right to receive future updates; and (3) online hosting. The software license performance obligation represents the game that is delivered digitally or via physical disc at the time of sale and typically provides access to offline core game content. The future update rights performance obligation includes 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. The online hosting performance obligation consists of providing the customer with a hosted connection for online playability.
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. For games with services under the New Revenue Standard, generally 75 percent of the sales price is allocated to the software license performance obligation and recognized at a point in time upon delivery (which is usually at or near the same time as the booking of the transaction), and the remaining 25 percent is allocated to the future update rights and the online hosting performance obligations and recognized ratably over the Estimated Offering Period. For sales prior to April 1, 2018, our deferred net revenue balances decreased by $740 million upon adoption of the New Revenue Standard because the software license performance obligation had been delivered in the prior fiscal year.
•
Mobile platform fees. The adoption of the New Revenue Standard also changed how we present mobile platform fees after March 31, 2018. Previously, mobile platform fees retained by third-party application storefronts such as the Apple App Store and Google Play, were reported on a net basis (i.e. as a reduction of net revenue) because we previously determined that generally, the third party was considered the primary obligor. Upon adoption of the New Revenue Standard, we concluded that we are the principal in the transactions, resulting in mobile platform fees now being reported within cost of revenue rather than as a reduction of net revenue. We recognized $64 million of mobile platform fees at April 1, 2018 as an increase to our deferred net revenue balances. Mobile platform fees for the three and nine months ended December 31, 2018 were $48 million and $141 million, respectively, and accordingly
increased both service and other net revenue and cost of revenue by this amount relative to the same period a year ago. While this change also decreased our gross margin percentage, it does not have a material impact on our annual total gross profit or overall profitability.
•
Increased portion of our sales from games with services are presented as service revenue. The amount of the transaction price allocated to future update rights and the online hosting performance obligations are presented as service revenue under the New Revenue Standard (previously, revenue associated with future update rights were generally presented as product revenue). Therefore, for the three and nine months ended December 31, 2018, approximately $105 million and $393 million, respectively, of revenue for future update rights are now presented as service revenue under the New Revenue Standard as compared to product revenue under the Old Revenue Standard.
•
Sales returns and price protection reserves. Upon adoption, our sales returns and price protection reserves are now presented within accrued and other liabilities (previously, these allowances were presented as contra-assets within receivables on our Condensed Consolidated Balance Sheets). We reclassified $158 million of sales returns and price protection reserves on April 1, 2018.
The adoption of the New Revenue Standard impacted our Condensed Consolidated Balance Sheet as of December 31, 2018 and our Condensed Consolidated Statement of Operations for the three and nine months ended December 31, 2018 as follows:
The adoption of the New Revenue Standard accelerated the revenue recognition of prior period game sales into retained earnings, which will result in a one-time increase in cash taxes paid on our Condensed Consolidated Statement of Cash Flows for the fiscal year ending March 31, 2019.
Refer to the following sections of our Condensed Consolidated Financial Statements for the additional disclosures required by the New Revenue Standard:
•
See Note 2 — Summary of Significant Accounting Policies, for our updated revenue accounting policy, including significant judgments, under ASC 606. For a discussion of our revenue recognition policy as it relates to revenue transactions accounted for prior to April 1, 2018, which were accounted for under ASC 605, refer to our Annual Report on Form 10-K for the fiscal year ended March 31, 2018.
•
See Note 10 — Balance Sheet Details, for a discussion on our contract liabilities (“deferred net revenue”) and our remaining performance obligations. We had an immaterial amount of contract assets as of April 1, 2018 and December 31, 2018.
•
See Note 16 — Segment Information, for our disaggregations of revenue.
Other Recently Issued Accounting Standards
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The FASB issued this standard to increase transparency and comparability among organizations by recognizing right-of-use assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. In July 2018, the FASB issued ASU 2018-11, Targeted Improvements, which provides entities with optional transition relief by allowing entities to use the effective date of the new lease standard as the date of initial application on transition, instead of at the beginning of the earliest comparative period presented. We anticipate adopting this standard using this optional transition method beginning in the first quarter of fiscal year 2020, when the updated guidance is effective for us, and accordingly, we will not adjust prior periods for the effects of the new lease standard. We are evaluating the impact of this new standard on our Condensed Consolidated Financial Statements, but expect it to have a significant impact to our Condensed Consolidated Balance Sheet as a result of establishing right-of-use assets and lease liabilities for our operating leases with terms of more than 12 months.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This update is intended to make more financial and nonfinancial hedging strategies eligible for hedge accounting. It also amends the presentation and disclosure requirements and changes how companies assess effectiveness. This update is effective for us beginning in the first quarter of fiscal year 2020. Early adoption is permitted. We are currently evaluating the impact of this new standard on our Condensed Consolidated Financial Statements and related disclosures.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326). The standard changes the methodology for measuring credit losses on financial instruments and the timing of when such losses are recorded. In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, which clarifies that receivables arising from operating leases are not within the scope of Subtopic 326-20. Instead, impairment of receivables arising from operating leases should be accounted for in accordance with Topic 842, Leases. ASU 2016-13 is effective for us beginning in the first quarter of fiscal year 2021. Early adoption is permitted beginning in the first quarter of fiscal year 2020. We are currently evaluating the timing of adoption and impact of this new standard on our Condensed Consolidated Financial Statements and related disclosures.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. This update changes the fair value measurement disclosure requirements. It summarizes the key provisions including the new, eliminated, and modified disclosure requirements. This update is effective for us beginning in the first quarter of fiscal year 2021. Early adoption is permitted. We are currently evaluating the timing of adoption and impact of this new standard on our Condensed Consolidated Financial Statements and related disclosures.
In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40). This update requires a customer in a cloud computing service arrangement to follow the internal-use software
guidance in order to determine which implementation costs to defer and recognize as an asset. This update is effective for us beginning in the first quarter of fiscal year 2021. Early adoption is permitted. We are currently evaluating the timing of adoption and impact of this new standard on our Condensed Consolidated Financial Statements and related disclosures.
As discussed in Note 1 — Description of Business and Basis of Presentation, we adopted the New Revenue Standard on April 1, 2018. Other than adoption of this New Revenue Standard, there were no significant changes to our accounting policies during the nine months ended December 31, 2018. Refer to Note 1 — Description of Business and Summary of Significant Accounting Policies in our Annual Report on Form 10-K for the year ended March 31, 2018 for a summary of our other significant accounting policies.
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 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”).
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.
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.
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.
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.
(3) FAIR VALUE MEASUREMENTS
There are various valuation techniques used to estimate fair value, the primary one being the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the asset or liability. We measure certain financial and nonfinancial assets and liabilities at fair value on a recurring and nonrecurring basis.
Fair Value Hierarchy
The three levels of inputs that may be used to measure fair value are as follows:
•
Level 1. Quoted prices in active markets for identical assets or liabilities.
•
Level 2. Observable inputs other than quoted prices included within Level 1, such as quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities.
•
Level 3. Unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of assets or liabilities.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
As of December 31, 2018 and March 31, 2018, our assets and liabilities that were measured and recorded at fair value on a recurring basis were as follows (in millions):
Fair Value Measurements at Reporting Date Using
Quoted Prices in
Active Markets
for Identical
Financial
Instruments
Significant
Other
Observable
Inputs
Significant
Unobservable
Inputs
As of December 31, 2018
(Level 1)
(Level 2)
(Level 3)
Balance Sheet Classification
Assets
Bank and time deposits
$
31
$
31
$
—
$
—
Cash equivalents
Money market funds
1,574
1,574
—
—
Cash equivalents
Available-for-sale securities:
Corporate bonds
526
526
—
Short-term investments and cash equivalents
U.S. Treasury securities
265
265
—
—
Short-term investments and cash equivalents
U.S. agency securities
61
—
61
—
Short-term investments
Commercial paper
305
—
305
—
Short-term investments and cash equivalents
Foreign government securities
71
—
71
—
Short-term investments
Asset-backed securities
100
—
100
—
Short-term investments
Certificates of deposit
21
—
21
—
Short-term investments
Foreign currency derivatives
53
—
53
—
Other current assets and other assets
Deferred compensation plan assets (a)
11
11
—
—
Other assets
Total assets at fair value
$
3,018
$
1,881
$
1,137
$
—
Liabilities
Contingent consideration (b)
$
125
$
—
$
—
$
125
Accrued and other current liabilities and other liabilities
Foreign currency derivatives
17
—
17
—
Accrued and other current liabilities and other liabilities
Accrued and other current liabilities and other liabilities
Deferred compensation plan liabilities (a)
11
11
—
—
Other liabilities
Total liabilities at fair value
$
189
$
11
$
56
$
122
(a)
The Deferred Compensation Plan assets consist of various mutual funds. See Note 14 in our Annual Report on Form 10-K for the fiscal year ended March 31, 2018, for additional information regarding our Deferred Compensation Plan.
(b)
The contingent consideration represents the estimated fair value of the additional variable cash consideration payable in connection with our acquisition of Respawn Entertainment, LLC (“Respawn”) that is contingent upon the achievement of certain performance milestones. We estimated fair value using a probability-weighted income approach combined with a real options methodology, and applied a discount rate that appropriately captures the risk associated with the obligation. At December 31, 2018, the discount rates used ranged from 3.5 percent to 3.8 percent. At March 31, 2018, the discount rates used ranged from 3.3 percent to 3.6 percent. See Note 6 in our Annual Report on Form 10-K for the fiscal year ended March 31, 2018, for additional information regarding the Respawn acquisition.
(c)
The change in fair value is reported as acquisition-related contingent consideration in our Condensed Consolidated Statements of Operations.
(4) FINANCIAL INSTRUMENTS
Cash and Cash Equivalents
As of December 31, 2018 and March 31, 2018, our cash and cash equivalents were $3,887 million and $4,258 million, respectively. Cash equivalents were valued using quoted market prices or other readily available market information.
Short-term investments consisted of the following as of December 31, 2018 and March 31, 2018 (in millions):
As of December 31, 2018
As of March 31, 2018
Cost or
Amortized
Cost
Gross Unrealized
Fair
Value
Cost or
Amortized
Cost
Gross Unrealized
Fair
Value
Gains
Losses
Gains
Losses
Corporate bonds
$
528
$
—
$
(3
)
$
525
$
629
$
—
$
(5
)
$
624
U.S. Treasury securities
206
—
(1
)
205
212
—
(2
)
210
U.S. agency securities
62
—
(1
)
61
79
—
(1
)
78
Commercial paper
291
—
—
291
109
—
—
109
Foreign government securities
71
—
—
71
53
—
(1
)
52
Asset-backed securities
100
—
—
100
—
—
—
—
Certificates of deposit
21
—
—
21
—
—
—
—
Short-term investments
$
1,279
$
—
$
(5
)
$
1,274
$
1,082
$
—
$
(9
)
$
1,073
The following table summarizes the amortized cost and fair value of our short-term investments, classified by stated maturity as of December 31, 2018 and March 31, 2018 (in millions):
As of December 31, 2018
As of March 31, 2018
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Short-term investments
Due within 1 year
$
876
$
874
$
521
$
520
Due 1 year through 5 years
401
398
561
553
Due after 5 years
2
2
—
—
Short-term investments
$
1,279
$
1,274
$
1,082
$
1,073
(5) DERIVATIVE FINANCIAL INSTRUMENTS
The assets or liabilities associated with our derivative instruments and hedging activities are recorded at fair value in other current assets/other assets, or accrued and other current liabilities/other liabilities, respectively, on our Condensed Consolidated Balance Sheets. As discussed below, the accounting for gains and losses resulting from changes in fair value depends on the use of the derivative instrument and whether it is designated and qualifies for hedge accounting.
We transact business in various foreign currencies and have significant international sales and expenses denominated in foreign currencies, subjecting us to foreign currency risk. We purchase foreign currency forward contracts, generally with maturities of 18 months or less, to reduce the volatility of cash flows primarily related to forecasted revenue and expenses denominated in certain foreign currencies. Our cash flow risks are primarily related to fluctuations in the Euro, British pound sterling, Canadian dollar, Swedish krona, Australian dollar, Chinese yuan and South Korean won. In addition, we utilize foreign currency forward contracts to mitigate foreign currency exchange risk associated with foreign-currency-denominated monetary assets and liabilities, primarily intercompany receivables and payables. The foreign currency forward contracts not designated as hedging instruments generally have a contractual term of approximately three months or less and are transacted near month-end. We do not use foreign currency forward contracts for speculative trading purposes.
Certain of our forward contracts are designated and qualify as cash flow hedges. The effectiveness of the cash flow hedge contracts, including time value, is assessed monthly using regression analysis, as well as other timing and probability criteria. To qualify for hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedges and must be highly effective in offsetting changes to future cash flows on hedged transactions. The derivative assets or liabilities associated with our hedging activities are recorded at fair value in other current assets/other assets, or accrued and other current liabilities/other liabilities, respectively, on our Condensed Consolidated Balance Sheets. The effective portion of gains or losses resulting from changes in the fair value of these hedges is initially reported, net of tax, as a component of accumulated other comprehensive income (loss) in stockholders’ equity. The gross amount of the effective portion of gains or losses resulting from changes in the fair value of these hedges is subsequently reclassified into net revenue or research and development expenses, as appropriate, in the period when the forecasted transaction is recognized in our Condensed Consolidated Statements of Operations. In the event that the gains or losses in accumulated other comprehensive income (loss) are deemed to be ineffective, the ineffective portion of gains or losses resulting from changes in fair value, if any, is reclassified to interest and other income (expense), net, in our Condensed Consolidated Statements of Operations. In the event that the underlying forecasted transactions do not occur, or it becomes remote that they will occur, within the defined hedge period, the gains or losses on the related cash flow hedges are reclassified from accumulated other comprehensive income (loss) to interest and other income (expense), net, in our Condensed Consolidated Statements of Operations.
Total gross notional amounts and fair values for currency derivatives with cash flow hedge accounting designation are as follows (in millions):
As of December 31, 2018
As of March 31, 2018
Notional Amount
Fair Value
Notional Amount
Fair Value
Asset
Liability
Asset
Liability
Forward contracts to purchase
$
267
$
—
$
14
$
329
$
2
$
4
Forward contracts to sell
$
1,017
$
49
$
—
$
1,575
$
1
$
48
The net impact of the effective portion of gains and losses from our cash flow hedging activities in our Condensed Consolidated Statements of Operations was a gain of $11 million and a loss of $8 million for the three months ended December 31, 2018 and 2017, respectively.
The net impact of the effective portion of gains and losses from our cash flow hedging activities in our Condensed Consolidated Statements of Operations was a loss of $5 million and a gain of $14 million for the nine months ended December 31, 2018 and 2017, respectively.
The amount excluded from the assessment of hedge effectiveness was a gain of $6 million during the three months ended December 31, 2018 and recognized in interest and other income (expense), net. The amount excluded from the assessment of hedge effectiveness was immaterial for the three months ended December 31, 2017.
The amount excluded from the assessment of hedge effectiveness was a gain of $20 million and $7 million during the nine months ended December 31, 2018 and 2017, respectively, and recognized in interest and other income (expense), net.
Balance Sheet Hedging Activities
Our foreign currency forward contracts that are not designated as hedging instruments are accounted for as derivatives whereby the fair value of the contracts are reported as other current assets or accrued and other current liabilities on our Condensed Consolidated Balance Sheets, and gains and losses resulting from changes in the fair value are reported in interest and other income (expense), net, in our Condensed Consolidated Statements of Operations. The gains and losses on these foreign currency forward contracts generally offset the gains and losses in the underlying foreign-currency-denominated monetary assets and liabilities, which are also reported in interest and other income (expense), net, in our Condensed Consolidated Statements of Operations.
Total gross notional amounts and fair values for currency derivatives that are not designated as hedging instruments are accounted for as follows (in millions):
As of December 31, 2018
As of March 31, 2018
Notional Amount
Fair Value
Notional Amount
Fair Value
Asset
Liability
Asset
Liability
Forward contracts to purchase
$
625
$
1
$
1
$
210
$
1
$
1
Forward contracts to sell
$
1,013
$
3
$
2
$
257
$
—
$
3
The effect of foreign currency forward contracts not designated as hedging instruments in our Condensed Consolidated Statements of Operations for the three and nine months ended December 31, 2018 and 2017 was as follows (in millions):
Statement of Operations Classification
Amount of Gain (Loss) Recognized in the Statement of Operations
Three Months Ended December 31,
Nine Months Ended December 31,
2018
2017
2018
2017
Foreign currency forward contracts not designated as hedging instruments
The changes in accumulated other comprehensive income (loss) by component, net of tax, for the three months ended December 31, 2018 and 2017 are as follows (in millions):
Unrealized Net Gains (Losses) on Available-for-Sale Securities
Unrealized Net Gains (Losses) on Derivative Instruments
Foreign Currency Translation Adjustments
Total
Balances as of September 30, 2018
$
(7
)
$
30
$
(42
)
$
(19
)
Other comprehensive income (loss) before reclassifications
1
22
(11
)
12
Amounts reclassified from accumulated other comprehensive income (loss)
1
(11
)
—
(10
)
Total other comprehensive income (loss), net of tax
2
11
(11
)
2
Balances as of December 31, 2018
$
(5
)
$
41
$
(53
)
$
(17
)
Unrealized Net Gains (Losses) on Available-for-Sale Securities
Unrealized Net Gains (Losses) on Derivative Instruments
Foreign Currency Translation Adjustments
Total
Balances as of September 30, 2017
$
(3
)
$
(58
)
$
(12
)
$
(73
)
Other comprehensive income (loss) before reclassifications
(4
)
(14
)
(12
)
(30
)
Amounts reclassified from accumulated other comprehensive income (loss)
—
8
—
8
Total other comprehensive income (loss), net of tax
(4
)
(6
)
(12
)
(22
)
Balances as of December 31, 2017
$
(7
)
$
(64
)
$
(24
)
$
(95
)
The changes in accumulated other comprehensive income (loss) by component, net of tax, for the nine months ended December 31, 2018 and 2017 are as follows (in millions):
Unrealized Net Gains (Losses) on Available-for-Sale Securities
Unrealized Net Gains (Losses) on Derivative Instruments
Foreign Currency Translation Adjustments
Total
Balances as of March 31, 2018
$
(8
)
$
(89
)
$
(30
)
$
(127
)
Cumulative-effect adjustment from the adoption of ASC 606
—
22
—
22
Cumulative-effect adjustment from the adoption of ASU 2018-02
—
1
—
1
Balances as of April 1, 2018
(8
)
(66
)
(30
)
(104
)
Other comprehensive income (loss) before reclassifications
2
102
(23
)
81
Amounts reclassified from accumulated other comprehensive income (loss)
1
5
—
6
Total other comprehensive income (loss), net of tax
Unrealized Net Gains (Losses) on Available-for-Sale Securities
Unrealized Net Gains (Losses) on Derivative Instruments
Foreign Currency Translation Adjustments
Total
Balances as of March 31, 2017
$
(3
)
$
32
$
(48
)
$
(19
)
Other comprehensive income (loss) before reclassifications
(4
)
(82
)
34
(52
)
Amounts reclassified from accumulated other comprehensive income (loss)
—
(14
)
(10
)
(24
)
Total other comprehensive income (loss), net of tax
(4
)
(96
)
24
(76
)
Balances as of December 31, 2017
$
(7
)
$
(64
)
$
(24
)
$
(95
)
The effects on net income of amounts reclassified from accumulated other comprehensive income (loss) for the three and nine months ended December 31, 2018 were as follows (in millions):
Amount Reclassified From Accumulated Other Comprehensive Income (Loss)
Statement of Operations Classification
Three Months Ended December 31, 2018
Nine Months Ended December 31, 2018
(Gains) losses on available-for-sale securities
Interest and other income (expense), net
$
1
$
1
Total, net of tax
$
1
$
1
(Gains) losses on cash flow hedges from forward contracts
Net revenue
$
(13
)
$
(1
)
Research and development
2
6
Total, net of tax
$
(11
)
$
5
Total net (gain) loss reclassified, net of tax
$
(10
)
$
6
The effects on net income of amounts reclassified from accumulated other comprehensive income (loss) for the three and nine months ended December 31, 2017 were as follows (in millions):
Amount Reclassified From Accumulated Other Comprehensive Income (Loss)
Statement of Operations Classification
Three Months Ended December 31, 2017
Nine Months Ended December 31, 2017
(Gains) losses on cash flow hedges from forward contracts
Net revenue
$
9
$
(13
)
Research and development
(1
)
(1
)
Total, net of tax
$
8
$
(14
)
(Gains) losses on foreign currency translation
Interest and other income (expense), net
$
—
$
(10
)
Total, net of tax
$
—
$
(10
)
Total net (gain) loss reclassified, net of tax
$
8
$
(24
)
(7) BUSINESS COMBINATIONS
GameFly Cloud Gaming
On May 3, 2018, we acquired cloud gaming technology assets and personnel from a wholly-owned subsidiary of GameFly, Inc. based in Israel (“GameFly Cloud Gaming”) for total cash consideration of $50 million. The purchase price was allocated to the acquired net tangible and intangible assets based on their estimated fair values as of May 3, 2018, resulting in $43 million allocated to specific intangible assets, and $7 million allocated to goodwill that consists largely of expected synergies and workforce. Substantially all of the $50 million is expected to be deductible for tax purposes. Subsequent to the acquisition, we also granted approximately $4 million in long-term equity in the form of restricted stock units to certain employees.
The results of operations attributable to the assets and personnel acquired in the GameFly Cloud Gaming acquisition and the fair value of the assets acquired have been included in our Condensed Consolidated Financial Statements since the date of acquisition. Pro forma results of operations have not been presented because the effect of the acquisition was not material to our Condensed Consolidated Statements of Operations.
During the nine months ended December 31, 2018, we completed one other acquisition that was not material to our Condensed Consolidated Financial Statements.
(8) GOODWILL AND ACQUISITION-RELATED INTANGIBLES, NET
The changes in the carrying amount of goodwill for the nine months ended December 31, 2018 are as follows (in millions):
As of March 31, 2018
Activity
Effects of Foreign Currency Translation
As of December 31, 2018
Goodwill
$
2,251
$
14
$
(6
)
$
2,259
Accumulated impairment
(368
)
—
—
(368
)
Total
$
1,883
$
14
$
(6
)
$
1,891
Goodwill represents the excess of the purchase price over the fair value of the underlying acquired net tangible and intangible assets.
Acquisition-related intangibles consisted of the following (in millions):
As of December 31, 2018
As of March 31, 2018
Gross
Carrying
Amount
Accumulated
Amortization
Acquisition-
Related
Intangibles, Net
Gross
Carrying
Amount
Accumulated
Amortization
Acquisition-
Related
Intangibles, Net
Developed and core technology
$
460
$
(424
)
$
36
$
417
$
(414
)
$
3
Trade names and trademarks
161
(118
)
43
161
(107
)
54
Registered user base and other intangibles
5
(5
)
—
5
(5
)
—
Carrier contracts and related
85
(85
)
—
85
(85
)
—
In-process research and development
14
—
14
14
—
14
Total
$
725
$
(632
)
$
93
$
682
$
(611
)
$
71
The fair value of acquisition-related intangible assets acquired in the GameFly Cloud Gaming acquisition during the three months ended June 30, 2018 was $43 million, all of which was allocated to developed and core technology, and has a useful life of approximately 4.0 years.
Amortization of intangibles for the three and nine months ended December 31, 2018 and 2017 are classified in the Condensed Consolidated Statement of Operations as follows (in millions):
Three Months Ended December 31,
Nine Months Ended December 31,
2018
2017
2018
2017
Cost of product revenue
1
1
3
1
Operating expenses
6
1
18
4
Total
$
7
$
2
$
21
$
5
Acquisition-related intangible assets are amortized using the straight-line method over the lesser of their estimated useful lives or the agreement terms, ranging from 1 to 9 years. As of December 31, 2018 and March 31, 2018, the weighted-average remaining useful life for acquisition-related intangible assets was approximately 3.7 years and 4.3 years, respectively.
As of December 31, 2018, future amortization of finite-lived acquisition-related intangibles other than in-process research and development that will be recorded in the Condensed Consolidated Statement of Operations is estimated as follows (in millions):
Fiscal Year Ending March 31,
2019 (remaining three months)
$
5
2020
22
2021
22
2022
22
2023
8
Thereafter
—
Total
$
79
(9) ROYALTIES AND LICENSES
Our royalty expenses consist of payments to (1) content licensors, (2) independent software developers, and (3) co-publishing and distribution affiliates. License royalties consist of payments made to celebrities, professional sports organizations, movie studios and other organizations for our use of their trademarks, copyrights, personal publicity rights, content and/or other intellectual property. Royalty payments to independent software developers are payments for the development of intellectual property related to our games. Co-publishing and distribution royalties are payments made to third parties for the delivery of products.
During the three and nine months ended December 31, 2018 and 2017, we did not recognize any material losses or impairment charges on royalty-based commitments, respectively.
The current and long-term portions of prepaid royalties and minimum guaranteed royalty-related assets, included in other current assets and other assets, consisted of (in millions):
As of December 31, 2018
As of March 31, 2018
Other current assets
$
37
$
68
Other assets
30
34
Royalty-related assets
$
67
$
102
At any given time, depending on the timing of our payments to our co-publishing and/or distribution affiliates, content licensors, and/or independent software developers, we classify any recognized unpaid royalty amounts due to these parties as accrued liabilities. The current and long-term portions of accrued royalties, included in accrued and other current liabilities and other liabilities, consisted of (in millions):
As of December 31, 2018
As of March 31, 2018
Accrued royalties
$
186
$
171
Other liabilities
57
74
Royalty-related liabilities
$
243
$
245
As of December 31, 2018, we were committed to pay approximately $721 million to content licensors, independent software developers, and co-publishing and/or distribution affiliates, but performance remained with the counterparty (i.e., delivery of the product or content or other factors) and such commitments were therefore not recorded in our Condensed Consolidated Financial Statements. See Note 13 for further information on our developer and licensor commitments.