Quarterly Report


Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2016
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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES   þ     NO   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
þ
Accelerated filer                   
¨
Non-accelerated filer
(Do not check if a smaller reporting company)
¨
Smaller reporting company 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES   ¨     NO   þ
As of August 4, 2016 , there were 300,764,884 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.

1

Table of Contents

ELECTRONIC ARTS INC.
FORM 10-Q
FOR THE PERIOD ENDED JUNE 30, 2016
Table of Contents
 
 
 
Page
 
Item 1.
 
 
Condensed Consolidated Balance Sheets as of June 30, 2016 and March 31, 2016
 
 
Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended June 30, 2016 and 2015
 
Condensed Consolidated Statements of Cash Flows for the Three Months Ended June 30, 2016 and 2015
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 6.

2

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1.
Condensed Consolidated Financial Statements (Unaudited)
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS  
(Unaudited)
(In millions, except par value data)
June 30, 2016
 
March 31, 2016 (a)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
2,042

 
$
2,493

Short-term investments
1,385

 
1,341

Receivables, net of allowances of $135 and $159, respectively
246

 
233

Inventories
26

 
33

Other current assets
273

 
254

Total current assets
3,972

 
4,354

Property and equipment, net
435

 
439

Goodwill
1,708

 
1,710

Acquisition-related intangibles, net
42

 
57

Deferred income taxes, net
343

 
387

Other assets
105

 
103

TOTAL ASSETS
$
6,605

 
$
7,050

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
44

 
$
89

Accrued and other current liabilities
597

 
710

0.75% convertible senior notes due 2016, net
136

 
161

Deferred net revenue (online-enabled games)
873

 
1,458

Total current liabilities
1,650

 
2,418

Senior notes, net
989

 
989

Income tax obligations
88

 
80

Deferred income taxes, net
2

 
2

Other liabilities
160

 
163

Total liabilities
2,889

 
3,652

Commitments and contingencies (See Note 11)

 

0.75% convertible senior notes due 2016 (See Note 10)

 
2

Stockholders’ equity:
 
 
 
Common stock, $0.01 par value. 1,000 shares authorized; 301 and 301 shares issued and outstanding, respectively
3

 
3

Additional paid-in capital
1,210

 
1,349

Retained earnings
2,500

 
2,060

Accumulated other comprehensive income (loss)
3

 
(16
)
Total stockholders’ equity
3,716

 
3,396

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
6,605

 
$
7,050

See accompanying Notes to Condensed Consolidated Financial Statements (unaudited).
(a) Derived from audited Consolidated Financial Statements.

3



ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 
(Unaudited)
Three Months Ended
June 30,
(In millions, except per share data)
2016
 
2015
Net revenue:
 
 
 
Product
$
684

 
$
743

Service and other
587

 
460

Total net revenue
1,271

 
1,203

Cost of revenue:
 
 
 
Product
90

 
94

Service and other
89

 
79

Total cost of revenue
179

 
173

Gross profit
1,092

 
1,030

Operating expenses:
 
 
 
Research and development
294

 
296

Marketing and sales
128

 
123

General and administrative
108

 
98

Amortization of intangibles
2

 
1

Total operating expenses
532

 
518

Operating income
560

 
512

Interest and other income (expense), net
(8
)
 
(3
)
Income before provision for income taxes
552

 
509

Provision for income taxes
112

 
67

Net income
$
440

 
$
442

Earnings per share:
 
 
 
Basic
$
1.46

 
$
1.42

Diluted
$
1.40

 
$
1.32

Number of shares used in computation:
 
 
 
Basic
301

 
311

Diluted
315

 
335

See accompanying Notes to Condensed Consolidated Financial Statements (unaudited).


4


ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)
Three Months Ended
June 30,
(In millions)
2016
 
2015
Net income
$
440

 
$
442

Other comprehensive income (loss), net of tax:
 
 
 
Change in unrealized net gains and losses on available-for-sale securities
2

 
(1
)
Change in unrealized net gains and losses on derivative instruments
28

 
(13
)
Reclassification adjustment for net realized gains and losses on derivative instruments
(6
)
 
(3
)
Foreign currency translation adjustments
(5
)
 
1

Total other comprehensive income (loss), net of tax
19

 
(16
)
Total comprehensive income
$
459

 
$
426


See accompanying Notes to Condensed Consolidated Financial Statements (unaudited).

5


ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
June 30,
(In millions)
2016
 
2015
OPERATING ACTIVITIES
 
 
 
Net income
$
440

 
$
442

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Depreciation, amortization and accretion
46

 
49

Stock-based compensation
48

 
45

Change in assets and liabilities:
 
 
 
Receivables, net
(12
)
 
219

Inventories
7

 
3

Other assets
(1
)
 
26

Accounts payable
(32
)
 
(16
)
Accrued and other liabilities
(202
)
 
(331
)
Deferred income taxes, net
43

 

Deferred net revenue (online-enabled games)
(585
)
 
(508
)
Net cash used in operating activities
(248
)
 
(71
)
INVESTING ACTIVITIES
 
 
 
Capital expenditures
(40
)
 
(24
)
Proceeds from maturities and sales of short-term investments
276

 
249

Purchase of short-term investments
(317
)
 
(365
)
Net cash used in investing activities
(81
)
 
(140
)
FINANCING ACTIVITIES
 
 
 
Payment of convertible notes
(27
)
 

Proceeds from issuance of common stock
4

 
45

Excess tax benefit from stock-based compensation
33

 
40

Repurchase and retirement of common stock
(129
)
 
(132
)
Net cash used in financing activities
(119
)
 
(47
)
Effect of foreign exchange on cash and cash equivalents
(3
)
 

Decrease in cash and cash equivalents
(451
)
 
(258
)
Beginning cash and cash equivalents
2,493

 
2,068

Ending cash and cash equivalents
$
2,042

 
$
1,810

Supplemental cash flow information:
 
 
 
Cash paid during the period for income taxes, net
$
10

 
$
21

Cash paid during the period for interest
$

 
$
3

Non-cash investing activities:
 
 
 
Change in accrued capital expenditures
$
(13
)
 
$
(9
)

See accompanying Notes to Condensed Consolidated Financial Statements (unaudited).

6


ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1) DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
We are a global leader in digital interactive entertainment. We develop, market, publish and distribute games, content and services that can be played by consumers on a variety of platforms, which include consoles (such as the PlayStation from Sony, and the Xbox from Microsoft), PCs, mobile phones and tablets. Some of our games are based on our wholly-owned intellectual property ( e.g. , Battlefield, Mass Effect, Need for Speed, The Sims and Plants vs. Zombies), and some of our games leverage content that we license from others ( e.g. , FIFA, Madden NFL and Star Wars). We also publish and distribute games developed by third parties ( e.g., Titanfall). Our products and services may be purchased through multiple distribution channels, including physical and online retailers, platform providers such as console manufacturers, providers of free-to-download PC games, mobile carriers and directly through Origin, our own digital distribution platform.
Our fiscal year is reported on a 52 - or 53 -week period that ends on the Saturday nearest March 31. Our results of operations for the fiscal year ending March 31, 2017 contains 52 weeks and ends on April 1, 2017. Our results of operations for the fiscal year ended March 31, 2016 contained 53 weeks and ended on April 2, 2016. Our results of operations for the three months ended June 30, 2016 contained 13 weeks and ended on July 2, 2016 . Our results of operations for the three months ended June 30, 2015 contained 14 weeks and ended on July 4, 2015 . 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, 2016 , as filed with the United States Securities and Exchange Commission (“SEC”) on May 27, 2016 .
Recently Adopted Accounting Standards
In April 2015, the FASB issued ASU 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Topic 350-40). The amendments of this ASU help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement by providing guidance as to whether an arrangement includes the sale or license of software. The requirements will be effective for annual periods (and interim periods within those annual periods) beginning after December 15, 2015. The amendment may be adopted either prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. We adopted ASU 2015-05 in the first quarter of fiscal year 2017. The adoption did not have a material impact on our Consolidated Financial Statements.
Impact of Recently Issued Accounting Standards
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718) : Improvements to Employee Share-Based Payment Accounting , related to simplifications of employee share-based payment accounting. This pronouncement eliminates the APIC pool concept and requires that excess tax benefits and tax deficiencies be recorded in the income statement when awards are settled. The pronouncement also addresses simplifications related to statement of cash flows classification, accounting for forfeitures, and minimum statutory tax withholding requirements. The pronouncement is effective for annual periods (and for interim periods within those annual periods) beginning after December 15, 2016. We are currently evaluating the timing and the impact of this new standard on our Consolidated Financial Statements and related disclosures.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments (Topic 825-10), which requires that most equity investments be measured at fair value, with subsequent changes in fair value recognized in net income. The ASU also impacts financial liabilities under the fair value option and the presentation and disclosure requirements for financial instruments.
The requirements will be effective for annual periods (and interim periods within those annual periods) beginning after December 15, 2017. We are currently evaluating the impact of this new standard on our Consolidated Financial Statements and related disclosures.

7


In March 2016, the FASB issued ASU 2016-04, Liabilities – Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products . The amendments in the ASU are designed to provide guidance and eliminate diversity in the accounting for derecognition of prepaid stored-value product liabilities. Typically, a prepaid stored-value product liability is to be derecognized when it is probable that a significant reversal of the recognized breakage amount will not subsequently occur. This is when the likelihood of the product holder exercising its remaining rights becomes remote. This estimate shall be updated at the end of each period. The amendments in this ASU are effective for annual periods (and interim periods within those annual periods) beginning after December 15, 2017. Early adoption is permitted. We are currently evaluating the timing of adoption and impact of this new standard on our Consolidated Financial Statements and related disclosures.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The standard permits the use of either the retrospective or cumulative effect transition method. This new revenue standard, as amended by ASU 2015-14, is effective in the first quarter of fiscal year 2019. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net) , which clarifies the guidance in the new revenue standard on assessing whether an entity is a principal or an agent in a revenue transaction. This conclusion impacts whether an entity reports revenue on a gross or net basis. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing, which clarifies the guidance in the new revenue standard regarding an entity’s identification of its performance obligations in a contract, as well as an entity’s evaluation of the nature of its promise to grant a license of intellectual property and whether or not that revenue is recognized over time or at a point in time. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers : Narrow-Scope Improvements and Practical Expedients . which amends the guidance in the new revenue standard on collectibility, noncash consideration, presentation of sales tax, and transition. The amendments are intended to address implementation issues that were raised by stakeholders and provide additional practical expedients to reduce the cost and complexity of applying the new revenue standard. These amendments have the same effective date as the new revenue standard. While we are currently evaluating the method of adoption and the impact of the new revenue standard, as amended, on our Consolidated Financial Statements and related disclosures, we believe the adoption of the new standard may have a significant impact on the accounting for certain transactions with multiple elements or “bundled” arrangements (for example, sales of online-enabled games for which we do not have VSOE for unspecified future updates) because the requirement to have VSOE for undelivered elements under current accounting standards is eliminated under the new standard. Accordingly, we may be required to recognize as revenue a portion of the sales price upon delivery of the software, as compared to the current requirement of recognizing the entire sales price ratably over an estimated offering period. While we are still evaluating the total impact of the new revenue standard, as amended, we believe adoption of this new standard will have a material impact on our Consolidated Financial Statements and related disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The FASB issued this update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The updated guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption of the update is permitted. We are currently evaluating the timing of adoption and impact of this new standard on our 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. ASU 2016-13 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption is permitted for fiscal years, and interim periods within those years, beginning after December 15, 2018. We are currently evaluating the timing of adoption and impact of this new standard on our Consolidated Financial Statements and related disclosures.


(2) FAIR VALUE MEASUREMENTS
There are various valuation techniques used to estimate fair value, the primary one being the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the asset or liability. We measure certain financial and nonfinancial assets and liabilities at fair value on a recurring and nonrecurring basis.

8


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 June 30, 2016 and March 31, 2016 , 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
June 30,
2016
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Balance Sheet Classification
Assets
 
 
 
 
 
 
 
 
 
Bank and time deposits
$
243

 
$
243

 
$

 
$

 
Cash equivalents
Money market funds
308

 
308

 

 

 
Cash equivalents
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
Corporate bonds
713

 

 
713

 

 
Short-term investments and cash equivalents
U.S. Treasury securities
362

 
362

 

 

 
Short-term investments and cash equivalents
U.S. agency securities
155

 

 
155

 

 
Short-term investments
Commercial paper
72

 

 
72

 

 
Short-term investments and cash equivalents
Foreign government securities
114

 

 
114

 

 
Short-term investments
Foreign currency derivatives
37

 

 
37

 

 
Other current assets and other assets
Deferred compensation plan assets (a)
9

 
9

 

 

 
Other assets
Total assets at fair value
$
2,013

 
$
922

 
$
1,091

 
$

 
 
Liabilities
 
 
 
 
 
 
 
 
 
Foreign currency derivatives
4

 

 
4

 

 
Accrued and other current liabilities and other liabilities
Deferred compensation plan liabilities (a)
10

 
10

 

 

 
Other liabilities
Total liabilities at fair value
$
14

 
$
10

 
$
4

 
$

 
 
 



9


 
 
 
 
Fair Value Measurements at Reporting Date Using
 
   
 
 
 
Quoted Prices in
Active Markets 
for Identical
Financial
Instruments
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
 
 
As of
March 31,
2016
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Balance Sheet Classification
Assets
 
 
 
 
 
 
 
 
 
Bank and time deposits
$
345

 
$
345

 
$

 
$

 
Cash equivalents
Money market funds
143

 
143

 

 

 
Cash equivalents
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
Corporate bonds
623

 

 
623

 

 
Short-term investments and cash equivalents
U.S. Treasury securities
407

 
407

 

 

 
Short-term investments and cash equivalents
U.S. agency securities
170

 

 
170

 

 
Short-term investments and cash equivalents
Commercial paper
81

 

 
81

 

 
Short-term investments and cash equivalents
Foreign government securities
122

 

 
122

 

 
Short-term investments and cash equivalents
Foreign currency derivatives
16

 

 
16

 

 
Other current assets and other assets
Deferred compensation plan assets (a)
8

 
8

 

 

 
Other assets
Total assets at fair value
$
1,915

 
$
903

 
$
1,012

 
$

 
 
Liabilities
 
 
 
 
 
 
 
 
 
Foreign currency derivatives
10

 

 
10

 

 
Accrued and other current liabilities and other liabilities
Deferred compensation plan liabilities (a)
9

 
9

 

 

 
Other liabilities
Total liabilities at fair value
$
19

 
$
9

 
$
10

 
$

 
 

(a)
The Deferred Compensation Plan assets consist of various mutual funds. See Note 15 in our Annual Report on Form 10-K for the fiscal year ended March 31, 2016 , for additional information regarding our Deferred Compensation Plan.

(3) FINANCIAL INSTRUMENTS
Cash and Cash Equivalents
As of June 30, 2016 and March 31, 2016 , our cash and cash equivalents were $2,042 million and $2,493 million , respectively. Cash equivalents were valued at their carrying amounts as they approximate fair value due to the short maturities of these financial instruments.
Short-Term Investments
Short-term investments consisted of the following as of June 30, 2016 and March 31, 2016 (in millions):  
 
As of June 30, 2016
 
As of March 31, 2016
 
Cost or
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Cost or
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Gains
 
Losses
 
Gains
 
Losses
 
Corporate bonds
$
709

 
$
2

 
$

 
$
711

 
$
620

 
$
1

 
$

 
$
621

U.S. Treasury securities
350

 
2

 

 
352

 
389

 
1

 

 
390

U.S. agency securities
154

 
1

 

 
155

 
167

 

 

 
167

Commercial paper
53

 

 

 
53

 
50

 

 

 
50

Foreign government securities

114

 

 

 
114

 
113

 

 

 
113

Short-term investments
$
1,380

 
$
5

 
$

 
$
1,385

 
$
1,339

 
$
2

 
$

 
$
1,341


10



The following table summarizes the amortized cost and fair value of our short-term investments, classified by stated maturity as of June 30, 2016 and March 31, 2016 (in millions):  
 
As of June 30, 2016
 
As of March 31, 2016
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Short-term investments
 
 
 
 
 
 
 
Due in 1 year or less
$
661

 
$
661

 
$
571

 
$
571

Due in 1-2 years
400

 
402

 
461

 
462

Due in 2-3 years
314

 
317

 
295

 
296

Due in 3-4 years
5

 
5

 
12

 
12

Short-term investments
$
1,380

 
$
1,385

 
$
1,339

 
$
1,341


(4) DERIVATIVE FINANCIAL INSTRUMENTS
The assets or liabilities associated with our derivative instruments and hedging activities are recorded at fair value in other current assets/other assets, or accrued and other current liabilities/other liabilities, respectively, on our Condensed Consolidated Balance Sheets. As discussed below, the accounting for gains and losses resulting from changes in fair value depends on the use of the derivative instrument and whether it is designated and qualifies for hedge accounting.
We transact business in various foreign currencies and have significant international sales and expenses denominated in foreign currencies, subjecting us to foreign currency risk. We purchase foreign currency forward contracts, generally with maturities of 18 months or less, to reduce the volatility of cash flows primarily related to forecasted revenue and expenses denominated in certain foreign currencies. Our cash flow risks are primarily related to fluctuations in the Euro, British pound sterling, Canadian dollar, Swedish krona, Australian dollar, Chinese yuan and South Korean won. In addition, we utilize foreign currency forward contracts to mitigate foreign exchange risk associated with foreign-currency-denominated monetary assets and liabilities, including third party receivables and payables as well as intercompany balances. The foreign currency forward contracts not designated as hedging instruments generally have a contractual term of approximately 3 months or less and are transacted near month-end. We do not use foreign currency forward contracts for speculative trading purposes.
Cash Flow Hedging Activities
Certain of our forward contracts are designated and qualify as cash flow hedges. The effectiveness of the cash flow hedge contracts, including time value, is assessed monthly using regression analysis, as well as other timing and probability criteria. To qualify for hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedges and must be highly effective in offsetting changes to future cash flows on hedged transactions. The derivative assets or liabilities associated with our hedging activities are recorded at fair value in other current assets/other assets, or accrued and other current liabilities/other liabilities, respectively, on our Condensed Consolidated Balance Sheets. The effective portion of gains or losses resulting from changes in the fair value of these hedges is initially reported, net of tax, as a component of accumulated other comprehensive income (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 June 30, 2016
 
As of March 31, 2016
 
Notional Amount
 
Fair Value
 
Notional Amount
 
Fair Value
 
 
Asset
 
Liability
 
 
Asset
 
Liability
Forward contracts to purchase
$
114

 
$
1

 
$
2

 
$
148

 
$
5

 
$
1

Forward contracts to sell
$
834

 
$
36

 
$
2

 
$
685

 
$
11

 
$
9


11


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 $6 million for the three months ended June 30, 2016 and a gain of $3 million for the three months ended June 30, 2015 .
During the three months ended June 30, 2016 and 2015 , we reclassified an immaterial amount of the ineffective portion of gains or losses resulting from changes in fair value into interest and other income (expense), net.
The amount excluded from the assessment of hedge effectiveness during three months ended June 30, 2016 and 2015 and recognized in interest and other income (expense), net, was immaterial.
Balance Sheet Hedging Activities
Our foreign currency forward contracts that are not designated as hedging instruments are accounted for as derivatives whereby the fair value of the contracts are reported as other current assets or accrued and other current liabilities on our Condensed Consolidated Balance Sheets, and gains and losses resulting from changes in the fair value are reported in interest and other income (expense), net, in our Condensed Consolidated Statements of Operations. The gains and losses on these foreign currency forward contracts generally offset the gains and losses in the underlying foreign-currency-denominated monetary assets and liabilities, which are also reported in interest and other income (expense), net, in our Condensed Consolidated Statements of Operations. The fair value of our foreign currency forward contracts was measured using Level 2 inputs.
Total gross notional amounts and fair values for currency derivatives that are not designated as hedging instruments are accounted for as follows (in millions):
 
As of June 30, 2016
 
As of March 31, 2016
 
Notional Amount
 
Fair Value
 
Notional Amount
 
Fair Value
 
 
Asset
 
Liability
 
 
Asset
 
Liability
Forward contracts to purchase
$
132

 
$

 
$

 
$
108

 
$

 
$

Forward contracts to sell
$
175

 
$

 
$

 
$
159

 
$

 
$


The effect of foreign currency forward contracts not designated as hedging instruments in our Condensed Consolidated Statements of Operations for the three months ended June 30, 2016 and 2015 was immaterial, and is included in interest and other income (expense), net.


12


(5) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The changes in accumulated other comprehensive income (loss) by component, net of tax, for the three months ended June 30, 2016 and 2015  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, 2016
$
1

 
$
14

 
$
(31
)
 
$
(16
)
Other comprehensive income (loss) before reclassifications
2

 
28

 
(5
)
 
25

Amounts reclassified from accumulated other comprehensive income (loss)

 
(6
)
 

 
(6
)
Total other comprehensive income (loss), net of tax

2

 
22

 
(5
)
 
19

Balance as of June 30, 2016
$
3

 
$
36

 
$
(36
)
 
$
3

 
Unrealized Net Gains (Losses) on Available-for-Sale Securities
 
Unrealized Net Gains (Losses) on Derivative Instruments
 
Foreign Currency Translation Adjustments
 
Total
Balances as of March 31, 2015
$
(3
)
 
$
21

 
$
(16
)
 
$
2

Other comprehensive income (loss) before reclassifications
(1
)
 
(13
)
 
1

 
(13
)
Amounts reclassified from accumulated other comprehensive income (loss)

 
(3
)
 

 
(3
)
Total other comprehensive income (loss), net of tax

(1
)
 
(16
)
 
1

 
(16
)
Balance as of June 30, 2015
$
(4
)
 
$
5

 
$
(15
)
 
$
(14
)

The effects on net income of amounts reclassified from accumulated other comprehensive income (loss) for the three months ended June 30, 2016 and 2015 were as follows (in millions):
 

Amount Reclassified From Accumulated Other Comprehensive Income (Loss)
Statement of Operations Classification

Three Months Ended
June 30, 2016

Three Months Ended
June 30, 2015
(Gains) losses on cash flow hedges from forward contracts
 
 
 
 
Net revenue

$
(5
)

$
(8
)
Research and development

(1
)

5

Total amount reclassified, net of tax
 
$
(6
)
 
$
(3
)

(6) GOODWILL AND ACQUISITION-RELATED INTANGIBLES, NET
The changes in the carrying amount of goodwill for the three months ended June 30, 2016 are as follows (in millions):
 
As of
March 31, 2016
 
Activity
 
Effects of Foreign Currency Translation
 
As of
June 30, 2016
Goodwill
$
2,078

 
$

 
$
(2
)
 
$
2,076

Accumulated impairment
(368
)
 

 

 
(368
)
Total
$
1,710

 
$

 
$
(2
)
 
$
1,708

Goodwill represents the excess of the purchase price over the fair value of the underlying acquired net tangible and intangible assets. Goodwill is not amortized, but rather subject to at least an annual assessment for impairment by applying a fair value-based test.

13


Acquisition-related intangibles consisted of the following (in millions):
 
As of June 30, 2016
 
As of March 31, 2016
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Acquisition-
Related
Intangibles, Net
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Acquisition-
Related
Intangibles, Net
Developed and core technology
$
412

 
$
(382
)
 
$
30

 
$
412

 
$
(368
)
 
$
44

Trade names and trademarks
106

 
(94
)
 
12

 
106

 
(93
)
 
13

Registered user base and other intangibles
5

 
(5
)
 

 
5

 
(5
)
 

Carrier contracts and related
85

 
(85
)
 

 
85

 
(85
)
 

Total
$
608

 
$
(566
)
 
$
42

 
$
608

 
$
(551
)
 
$
57

Amortization of intangibles for the three months ended June 30, 2016 and 2015 are classified in the Condensed Consolidated Statement of Operations as follows (in millions):
 
Three Months Ended
June 30,
 
2016
 
2015
Cost of service and other
$
8

 
$
8

Cost of product
5

 
4

Operating expenses
2

 
1

Total
$
15

 
$
13

Acquisition-related intangible assets are amortized using the straight-line method over the lesser of their estimated useful lives or the agreement terms, typically from 2 to 14 years . As of June 30, 2016 and March 31, 2016 , the weighted-average remaining useful life for acquisition-related intangible assets was approximately 1.5 years and 1.6 years , respectively.
As of June 30, 2016 , future amortization of acquisition-related intangibles that will be recorded in the Condensed Consolidated Statement of Operations is estimated as follows (in millions):  
Fiscal Year Ending March 31,
 
2017 (remaining nine months)
$
23

2018
17

2019
2

Total
$
42


(7) ROYALTIES AND LICENSES
Our royalty expenses consist of payments to (1) content licensors, (2) independent software developers, and (3) co-publishing and distribution affiliates. License royalties consist of payments made to celebrities, professional sports organizations, movie studios and other organizations for our use of their trademarks, copyrights, personal publicity rights, content and/or other intellectual property. Royalty payments to independent software developers are payments for the development of intellectual property related to our games. Co-publishing and distribution royalties are payments made to third parties for the delivery of products.
Royalty-based obligations with content licensors and distribution affiliates are either paid in advance and capitalized as prepaid royalties or are accrued as incurred and subsequently paid. These royalty-based obligations are generally expensed to cost of revenue at the greater of the contractual rate or an effective royalty rate based on the total projected net revenue for contracts with guaranteed minimums. Prepayments made to thinly capitalized independent software developers and co-publishing affiliates are generally made in connection with the development of a particular product, and therefore, we are generally subject to development risk prior to the release of the product. Accordingly, payments that are due prior to completion of a product are generally expensed to research and development over the development period as the services are incurred. Payments due after completion of the product (primarily royalty-based in nature) are generally expensed as cost of revenue.

Our contracts with some licensors include minimum guaranteed royalty payments, which are initially recorded as an asset and as a liability at the contractual amount when no performance remains with the licensor. When performance remains with the licensor, we record guarantee payments as an asset when actually paid and as a liability when incurred, rather than recording the asset and liability upon execution of the contract. Prepaid royalties are classified as current assets to the extent that such

14


amounts will be recognized in our Condensed Consolidated Statements of Operations within the next 12 months. Royalty liabilities are classified as current liabilities to the extent such royalty payments are contractually due within the next 12 months.
Each quarter, we also evaluate the expected future realization of our royalty-based assets, as well as any unrecognized minimum commitments not yet paid to determine amounts we deem unlikely to be realized through product and service sales. Any impairments or losses determined before the launch of a product are generally charged to research and development expense. Impairments or losses determined post-launch are charged to cost of revenue. We evaluate long-lived royalty-based assets for impairment using undiscounted cash flows when impairment indicators exist. If impairment exists, then the assets are written down to fair value. Unrecognized minimum royalty-based commitments are accounted for as executory contracts, and therefore, any losses on these commitments are recognized when the underlying intellectual property is abandoned ( i.e. , cease use) or the contractual rights to use the intellectual property are terminated.
During the three months ended June 30, 2016 and 2015, 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
June 30, 2016
 
As of
March 31, 2016
Other current assets
$
99

 
$
54

Other assets
60

 
63

Royalty-related assets
$
159

 
$
117

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
June 30, 2016
 
As of
March 31, 2016
Accrued royalties
$
126

 
$
159

Other liabilities
118

 
118

Royalty-related liabilities
$
244

 
$
277

As of June 30, 2016 , we were committed to pay approximately $1,385 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 11 for further information on our developer and licensor commitments.

(8) BALANCE SHEET DETAILS
Inventories
Inventories as of June 30, 2016 and March 31, 2016 consisted of (in millions):  

As of
June 30, 2016

As of
March 31, 2016
Finished goods
$
26


$
32

Raw materials and work in process


1

Inventories
$
26


$
33


15


Property and Equipment, Net
Property and equipment, net, as of June 30, 2016 and March 31, 2016 consisted of (in millions):  
 
As of
June 30, 2016
 
As of
March 31, 2016
Computer, equipment and software
$
695

 
$
684

Buildings
316

 
313

Leasehold improvements
129

 
129

Equipment, furniture and fixtures, and other
80

 
80

Land
61

 
61

Construction in progress
8

 
15

 
1,289

 
1,282

Less: accumulated depreciation
(854
)
 
(843
)
Property and equipment, net
$
435

 
$
439

During the three months ended June 30, 2016 and 2015 , depreciation expense associated with property and equipment was $29 million and $30 million , respectively.
Accrued and Other Current Liabilities
Accrued and other current liabilities as of June 30, 2016 and March 31, 2016 consisted of (in millions):  
 
As of
June 30, 2016
 
As of
March 31, 2016
Other accrued expenses
$
204

 
$
218

Accrued compensation and benefits
196

 
256

Accrued royalties
126

 
159

Deferred net revenue (other)
71

 
77

Accrued and other current liabilities
$
597

 
$
710

Deferred net revenue (other) includes the deferral of subscription revenue, deferrals related to our Switzerland distribution business, advertising revenue, licensing arrangements, and other revenue for which revenue recognition criteria has not been met.
Deferred Net Revenue (Online-Enabled Games)
Deferred net revenue (online-enabled games) was $873 million and $1,458 million as of June 30, 2016 and March 31, 2016 , respectively. Deferred net revenue (online-enabled games) generally includes the unrecognized revenue from bundled sales of online-enabled games for which we do not have vendor-specific objective evidence of fair value (“VSOE”) for the obligation to provide unspecified updates. We recognize revenue from the sale of online-enabled games for which we do not have VSOE for the unspecified updates on a straight-line basis, generally over an estimated nine-month period beginning in the month after shipment for physical games sold through retail and an estimated six-month period for digitally-distributed games. However, we expense the cost of revenue related to these transactions generally during the period in which the product is delivered (rather than on a deferred basis).

(9) INCOME TAXES
We estimate our annual effective tax rate at the end of each quarterly period, and we record the tax effect of certain discrete items, which are unusual or occur infrequently, in the interim period in which they occur, including changes in judgment about deferred tax valuation allowances. In addition, jurisdictions with a projected loss for the year, jurisdictions with a year-to-date loss where no tax benefit can be recognized, and jurisdictions where we are unable to estimate an annual effective tax rate are excluded from the estimated annual effective tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter depending on the mix and timing of actual earnings versus annual projections.
We recognize deferred tax assets and liabilities for both the expected impact of differences between the financial statement amount and the tax basis of assets and liabilities and for the expected future tax benefit to be derived from tax losses and tax credit carryforwards. We record a valuation allowance against deferred tax assets when it is considered more likely than not that all or a portion of our deferred tax assets will not be realized. In making this determination, we are required to give significant weight to evidence that can be objectively verified.

16


In addition to considering forecasts of future taxable income, we are also required to evaluate and quantify other possible sources of taxable income in order to assess the realization of our deferred tax assets, namely the reversal of existing deferred tax liabilities, the carry back of losses and credits as allowed under current tax law, and the implementation of tax planning strategies. Evaluating and quantifying these amounts involves significant judgments. Each source of income must be evaluated based on all positive and negative evidence; this evaluation involves assumptions about future activity.
In the fourth quarter of fiscal year 2016, we determined that the positive evidence overcame any negative evidence and concluded that it was more likely than not that the U.S. deferred tax assets were realizable. As a result, we released the valuation allowance against all of the U.S. federal deferred tax assets and a portion of the U.S. state deferred tax assets during the fourth quarter of fiscal year 2016, and we continue to believe those deferred tax assets are realizable as of June 30, 2016. We maintain a valuation allowance related to specific U.S. state deferred tax assets and foreign capital loss carryovers, due to uncertainty about the future realization of these assets.
The provision for income taxes reported for the three months ended June 30, 2016 is based on our projected annual effective tax rate for fiscal year 2017 , and also includes certain discrete items recorded during the period. Our effective tax rate for the three months ended June 30, 2016 was 20.3 percent as compared to 13.2 percent , for the same period of fiscal year 2016 . The effective tax rate for the three months ended June 30, 2016 was reduced, when compared to the statutory rate of 35.0 percent , due primarily to non-U.S. profits subject to a reduced or zero tax rate. The effective tax rate for the three months ended June 30, 2015 was reduced, when compared to the statutory rate of 35.0 percent , by the utilization of U.S. deferred tax assets which were subject to a valuation allowance and non-U.S. profits subject to a reduced or zero tax rate. Conversely, the effective tax rate for the three months ended June 30, 2015 was increased due to a discrete expense of $40 million for excess tax benefits from stock-based compensation deductions allocated directly to contributed capital. The effective tax rate for the three months ended June 30, 2016 differs from the same period in fiscal year 2016 primarily due to the utilization of U.S. deferred tax assets which were subject to a valuation allowance and the discrete expense of $40 million for excess tax benefits from stock-based compensation deductions allocated directly to contributed capital in fiscal year 2016.

During the three months ended June 30, 2016 , we recorded a net increase of $8 million in gross unrecognized tax benefits. The total gross unrecognized tax benefits as of June 30, 2016 is $339 million . A portion of our unrecognized tax benefits will affect our effective tax rate if they are recognized upon favorable resolution of the uncertain tax positions. As of June 30, 2016 , if recognized, approximately $312 million of the unrecognized tax benefits would affect our effective tax rate and approximately $27 million would result in adjustments to deferred tax assets with corresponding adjustments to the valuation allowance.

During the three months ended June 30, 2016 , we recorded a net increase of $1 million for accrued interest and penalties related to tax positions taken on our tax returns. As of June 30, 2016 , the combined amount of accrued interest and penalties related to uncertain tax positions included in income tax obligations on our Condensed Consolidated Balance Sheet was approximately $15 million .
We file income tax returns in the United States, including various state and local jurisdictions. Our subsidiaries file tax returns in various foreign jurisdictions, including Canada, France, Germany, Switzerland and the United Kingdom. The IRS is currently examining our returns for fiscal years 2009 through 2011, and we remain subject to income tax examination by the IRS for fiscal years after 2012.
We are also currently under income tax examination in the United Kingdom for fiscal years 2010 through 2014, and in France for fiscal years 2014 through 2016. We remain subject to income tax examination for several other jurisdictions including in Germany for fiscal years after 2012, in the United Kingdom for fiscal years after 2014, in Canada for fiscal years after 2008, and in Switzerland for fiscal years after 2007.

The timing of the resolution of income tax examinations is highly uncertain, and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year. Although potential resolution of uncertain tax positions involve multiple tax periods and jurisdictions, it is reasonably possible that a reduction of up to $50 million of unrecognized tax benefits may occur within the next 12 months, some of which, depending on the nature of the settlement or expiration of statutes of limitations, may affect the Company’s income tax provision and therefore benefit the resulting effective tax rate. The actual amount could vary significantly depending on the ultimate timing and nature of any settlements.


17


(10) FINANCING ARRANGEMENT
0.75% Convertible Senior Notes Due 2016
In July 2011 , we issued $632.5 million aggregate principal amount of 0.75% Convertible Senior Notes due 2016 (the “Convertible Notes”). The Convertible Notes matured on July 15, 2016. The Convertible Notes were senior unsecured obligations which paid interest semiannually in arrears at a rate of 0.75% per annum on January 15 and July 15 of each year.

The Convertible Notes were convertible into cash and shares of our common stock based on an initial conversion value of 31.5075 shares of our common stock per $1,000 principal amount of Convertible Notes (equivalent to an initial conversion price of approximately $31.74 per share). Upon conversion of the Convertible Notes, holders received cash up to the principal amount of each Convertible Note, and any excess conversion value was delivered in shares of our common stock. The Convertible Notes do not contain any financial covenants.
The carrying value of the Convertible Notes continued to be classified as a current liability and the excess of the principal amount over the carrying value of the Convertible Notes continued to be classified in temporary equity in the Condensed Consolidated Balance Sheets as of June 30, 2016 .
Upon conversion of any Convertible Notes, we delivered cash up to the principal amount of the Convertible Notes and any excess conversion value was delivered in shares of our common stock. During the three months ended June 30, 2016 , approximately $27 million principal value of the Convertible Notes were converted by holders thereof. During the three months ended June 30, 2016 , we repaid $27 million of the principal balance of the Convertible Notes and issued approximately 0.4 million shares of common stock to noteholders with a fair value of $29 million , resulting in a loss on extinguishment of $0.3 million . We also received and cancelled approximately 0.4 million shares of common stock from the exercise of the Convertible Note Hedge during the three months ended June 30, 2016 . Based on the closing price of our common stock of $75.87 at the end of the quarter ended June 30, 2016 , the if-converted value of our Convertible Notes outstanding in aggregate exceeded their principal amount by $189 million .
The carrying and fair values of the Convertible Notes are as follows (in millions):  
   
As of
June 30, 2016
 
As of
March 31, 2016
Principal amount of Convertible Notes
$
136

 
$
163

Unamortized debt discount of the liability component

 
(2
)
Net carrying value of Convertible Notes
$
136

 
$
161

 
 
 
 
Fair value of Convertible Notes (Level 2)
$
312

 
$
338



Subsequent to the quarter ended June 30, 2016 , we repaid the remaining principal balance on the Convertible Notes of $136 million and issued approximately 2.5 million shares of common stock to noteholders on the final maturity date of July 15, 2016. We also received and cancelled approximately 2.5 million shares of common stock from the exercise of the Convertible Note Hedge on July 15, 2016.
Convertible Note Hedge and Warrants Issuance
In July 2011, we entered into certain agreements designed to reduce the potential dilution with respect to our common stock upon conversion of the Convertible Notes (“the Convertible Note Hedge”). We paid $107 million for the Convertible Note Hedge, which was recorded as an equity transaction. The Convertible Note Hedge, subject to customary anti-dilution adjustments, provided us with the option to acquire, on a net settlement basis, approximately 19.9 million shares of our common stock equal to the number of shares of our common stock that notionally underlie the Convertible Notes at a strike price of $31.74 , which corresponds to the conversion price of the Convertible Notes. During the quarter ended June 30, 2016 , we received 0.4 million shares of our common stock under the Convertible Note Hedge.
Separately, in July 2011 we also entered into privately negotiated warrant transactions with certain counterparties whereby we sold to independent third parties warrants (the “Warrants”) to acquire, subject to customary anti-dilution adjustments that are substantially the same as the anti-dilution provisions contained in the Convertible Notes, up to 19.9 million shares of our common stock (which is also equal to the number of shares of our common stock that notionally underlie the Convertible Notes), with a strike price of $41.14 . The Warrants have a dilutive effect with respect to our common stock to the extent that the

18


market price per share of our common stock exceeds $41.14 on or prior to the expiration date of the Warrants. The Warrants automatically exercise over a 60 trading day period beginning on October 17, 2016 . Based on the closing price of our common stock of $75.87 at the end of the quarter ended June 30, 2016 , approximately 9.1 million shares of our common stock would be issuable to Warrants holders. The actual amount of shares issuable upon exercise will be determined based upon the market price of our common stock during the 60 day trading period beginning on October 17, 2016 . We received proceeds of $65 million from the sale of the Warrants in fiscal year 2012.
Effect of conversion on earning per share (“EPS”)
The Convertible Notes had no impact on diluted EPS for periods where the average quarterly price of our common stock is below the conversion price of $31.74 per share. Prior to conversion, we included the effect of the additional potential dilutive shares if our common stock price exceeded $31.74 per share using the treasury stock method. If the average price of our common stock exceeds $41.14 per share for a quarterly period, we also include the effect of the additional potential dilutive shares related to the Warrants using the treasury stock method. Prior to conversion, the Convertible Note Hedge was not considered for purposes of the EPS calculation, as its effect would have been anti-dilutive. Upon conversion, the Convertible Note Hedge offset the dilutive effect of the Notes when the stock price was above $31.74 per share. See Note 13 for additional information related to our EPS.
Senior Notes
In February 2016 , we issued $600 million aggregate principal amount of 3.70% Senior Notes due March 1, 2021 (the “2021 Notes”) and $400 million aggregate principal amount of 4.80% Senior Notes due March 1, 2026 (the “2026 Notes,” and together with the 2021 Notes, the “Senior Notes”). Our proceeds were $989 million , net of discount of $2 million and issuance costs of $9 million . Both the discount and issuance costs are being amortized to interest expense over the respective terms of the 2021 Notes and the 2026 Notes using the effective interest rate method. The effective interest rate was 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, beginning on September 1, 2016.
The carrying and fair values of the Senior Notes are as follows (in millions):  
   
As of
June 30, 2016
 
As of
March 31, 2016
Senior Notes:
 
 
 
3.70% Senior Notes due 2021
$
600

 
$
600

4.80% Senior Notes due 2026
400

 
400

Total principal amount
$
1,000

 
$
1,000

Unaccreted discount
(2
)
 
(2
)
Unamortized debt issuance costs
(9
)
 
(9
)
Net carrying value of Senior Notes
$
989

 
$
989

 
 
 
 
Fair value of Senior Notes (Level 2)
$
1,073

 
$
1,039


As of June 30, 2016 , the remaining life of the 2021 Notes and 2026 Notes is approximately 4.7 years and 9.7 years , respectively.

19



The Senior Notes are senior unsecured obligations and rank equally with all our other existing and future unsubordinated obligations, including our Convertible Notes, and any indebtedness that we may incur from time to time under our Credit Facility.

The 2021 Notes and the 2026 Notes are redeemable at our option at any time prior to February 1, 2021 or December 1, 2025, respectively, subject to a make-whole premium. Within one and three months of maturity, we may redeem the 2021 Notes or the 2026 Notes, respectively, at a redemption price equal to 100% of the aggregate principal amount plus accrued and unpaid interest. In addition, upon the occurrence of a change of control repurchase event, the holders of the Senior Notes may require us to repurchase all or a portion of the Senior Notes, at a price equal to 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase. The Senior Notes also include covenants that limit our ability to incur liens on assets and to enter into sale and leaseback transactions, subject to certain allowances.
Credit Facility
In March 2015 , we entered into a $500 million senior unsecured revolving credit facility (“Credit Facility”) with a syndicate of banks. The Credit Facility terminates on March 19, 2020 . The Credit Facility contains an option to arrange with existing lenders and/or new lenders for them to provide up to an aggregate of $250 million in additional commitments for revolving loans. Proceeds of loans made under the Credit Facility may be used for general corporate purposes.

The loans bear interest, at our option, at the base rate plus an applicable spread or an adjusted LIBOR rate plus an applicable spread, in each case with such spread being determined based on our consolidated leverage ratio for the preceding fiscal quarter. We are also obligated to pay other customary fees for a credit facility of this size and type. Interest is due and payable in arrears quarterly for loans bearing interest at the base rate and at the end of an interest period (or at each three month interval in the case of loans with interest periods greater than three months) in the case of loans bearing interest at the adjusted LIBOR rate. Principal, together with all accrued and unpaid interest, is due and payable on March 19, 2020 .

The credit agreement contains customary affirmative and negative covenants, including covenants that limit or restrict our ability to, among other things, incur subsidiary indebtedness, grant liens, dispose of all or substantially all assets and pay dividends or make distributions, in each case subject to customary exceptions for a credit facility of this size and type. We are also required to maintain compliance with a capitalization ratio and maintain a minimum level of total liquidity.

The credit agreement contains customary events of default, including among others, non-payment defaults, covenant defaults, cross-defaults to material indebtedness, bankruptcy and insolvency defaults, material judgment of defaults and a change of control default, in each case, subject to customary exceptions for a credit facility of this size and type. The occurrence of an event of default could result in the acceleration of the obligations under the credit facility, an obligation by any guarantors to repay the obligations in full and an increase in the applicable interest rate.

As of June 30, 2016 , no amounts were outstanding under the Credit Facility.  $2 million of debt issuance costs that were paid in connection with obtaining this credit facility are being amortized to interest expense over the 5 -year term of the Credit Facility.   
Interest Expense
The following table summarizes our interest expense recognized for the three months ended June 30, 2016 and 2015 that is included in interest and other income (expense), net on our Condensed Consolidated Statements of Operations (in millions):  
 
Three Months Ended
June 30,
 
2016
 
2015
Amortization of debt discount
(1
)
 
(6
)
Amortization of debt issuance costs
(1
)
 
(1
)
Coupon interest expense
(11
)
 
(1
)
Total interest expense
$
(13
)
 
$
(8
)


20


(11) COMMITMENTS AND CONTINGENCIES
Lease Commitments
As of June 30, 2016 , we leased certain facilities, furniture and equipment under non-cancelable operating lease agreements. We were required to pay property taxes, insurance and normal maintenance costs for certain of these facilities and any increases over the base year of these expenses on the remainder of our facilities.
Development, Celebrity, League and Content Licenses: Payments and Commitments
The products we produce in our studios are designed and created by our employee designers, artists, software programmers and by non-employee software developers (“independent artists” or “third-party developers”). We typically advance development funds to the independent artists and third-party developers during development of our games, usually in installment payments made upon the completion of specified development milestones. Contractually, these payments are generally considered advances against subsequent royalties on the sales of the products. These terms are set forth in written agreements entered into with the independent artists and third-party developers.
In addition, we have certain celebrity, league and content license contracts that contain minimum guarantee payments and marketing commitments that may not be dependent on any deliverables. Celebrities and organizations with whom we have contracts include, but are not limited to: FIFA (Fédération Internationale de Football Association), FIFPRO Foundation, FAPL (Football Association Premier League Limited), and DFL Deutsche Fußball Liga GmbH (German Soccer League) (professional soccer); Dr. Ing. h.c. F. Porsche AG, Ferrari S.p.A. (Need For Speed and Real Racing games); National Basketball Association (professional basketball); PGA TOUR (professional golf); National Hockey League and NHL Players’ Association (professional hockey); National Football League Properties, PLAYERS Inc., and Red Bear Inc. (professional football); Zuffa, LLC (Ultimate Fighting Championship); ESPN (content in EA SPORTS games); Disney Interactive (Star Wars); Fox Digital Entertainment, Inc. (The Simpsons); Universal Studios Inc. (Minions); and Respawn. These developer and content license commitments represent the sum of (1) the cash payments due under non-royalty-bearing licenses and services agreements and (2) the minimum guaranteed payments and advances against royalties due under royalty-bearing licenses and services agreements, the majority of which are conditional upon performance by the counterparty. These minimum guarantee payments and any related marketing commitments are included in the table below.

The following table summarizes our minimum contractual obligations as of June 30, 2016 (in millions): 
 
 
 
Fiscal Years Ending March 31,
 
 
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Remaining
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
nine mos.)
 
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
Unrecognized commitments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Developer/licensor commitments
$
1,387

 
$
134

 
$
302

 
$
277

 
$
240

 
$
193

 
$
185

 
$
56

Marketing commitments
378

 
60

 
53

 
84

 
65

 
68

 
48

 

Operating leases
247

 
29

 
38

 
34

 
31

 
29

 
23

 
63

0.75% Convertible Senior Notes due 2016 interest (a)

 

 

 

 

 

 

 

Senior Notes interest
290

 
28

 
41

 
41

 
41

 
41

 
20

 
78

Other purchase obligations
97

 
26

 
18

 
12

 
8

 
6

 
5

 
22

Total unrecognized commitments
2,399

 
277

 
452

 
448

 
385

 
337

 
281

 
219

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recognized commitments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
0.75% Convertible Senior Notes due 2016 principal and interest (a)
136

 
136

 

 

 

 

 

 

Senior Notes principal and interest
1,014

 
14

 

 

 

 
600

 

 
400

Licensing and lease obligations (b)
142

 
17

 
23

 
24

 
25

 
26

 
27

 

Total recognized commitments
1,292

 
167

 
23

 
24

 
25

 
626

 
27

 
400

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total commitments
$
3,691

 
$
444

 
$
475

 
$
472

 
$
410

 
$
963

 
$
308

 
$
619

(a)
Subsequent to the quarter ended June 30, 2016 , we repaid the remaining principal and interest balance on the Convertible Notes of $136 million . See Note 10 for additional information regarding our Convertible Notes.

21


(b)
Lease commitments have not been reduced for approximately $2 million due in the future from third parties under non-cancelable sub-leases. See Note 7 for additional information regarding recognized obligations from our licensing-related commitments.
The unrecognized amounts represented in the table above reflect our minimum cash obligations for the respective fiscal years, but do not necessarily represent the periods in which they will be recognized and expensed in our Condensed Consolidated Financial Statements. In addition, the amounts in the table above are presented based on the dates the amounts are contractually due as of June 30, 2016 ; however, certain payment obligations may be accelerated depending on the performance of our operating results. Up to $32 million of the unrecognized amounts in the table above may be payable, at the licensor’s election, in shares of our common stock, subject to a $10 million maximum during any fiscal year. The number of shares to be issued will be based on fair market value at the time of issuance.
In addition to what is included in the table above, as of June 30, 2016 , we had a liability for unrecognized tax benefits and an accrual for the payment of related interest totaling $88 million , of which we are unable to make a reasonably reliable estimate of when cash settlement with a taxing authority will occur.

Subsequent to June 30, 2016 , we entered into various licensor and marketing agreements with third parties, which contingently commits us to pay approximately $325 million at various dates through fiscal year 2023.
Legal Proceedings
On July 29, 2010, Michael Davis, a former NFL running back, filed a putative class action in the United States District Court for the Northern District of California against the Company, alleging that certain past versions of Madden NFL included the images of certain retired NFL players without their permission. In March 2012, the trial court denied the Company’s request to dismiss the complaint on First Amendment grounds. In January 2015, that trial court decision was affirmed by the Ninth Circuit Court of Appeals and the case was remanded back to the United States District Court for the Northern District of California, where the case is pending.
We are also subject to claims and litigation arising in the ordinary course of business. We do not believe that any liability from any reasonably foreseeable disposition of such claims and litigation, individually or in the aggregate, would have a material adverse effect on our Condensed Consolidated Financial Statements.

(12)  STOCK-BASED COMPENSATION
Valuation Assumptions
We estimate the fair value of stock-based awards on the date of grant. We recognize compensation costs for stock-based awards to employees based on the grant-date fair value using a straight-line approach over the service period for which such awards are expected to vest.

The determination of the fair value of market-based restricted stock units, stock options and ESPP is affected by assumptions regarding subjective and complex variables. Generally, our assumptions are based on historical information and judgment is required to determine if historical trends may be indicators of future outcomes. We determine the fair value of our stock-based awards as follows:

Restricted Stock Units . The fair value of restricted stock units is determined based on the quoted market price of our common stock on the date of grant.

Market-Based Restricted Stock Units . Market-based restricted stock units consist of grants of performance-based restricted stock units to certain members of executive management that vest contingent upon the achievement of pre-determined market and service conditions (referred to herein as “market-based restricted stock units”). The fair value of our market-based restricted stock units is determined using a Monte-Carlo simulation model. Key assumptions for the Monte-Carlo simulation model are the risk-free interest rate, expected volatility, expected dividends and correlation coefficient.

Stock Options and Employee Stock Purchase Plan . The fair value of stock options and stock purchase rights granted pursuant to our equity incentive plans and our 2000 Employee Stock Purchase Plan, as amended (“ESPP”), respectively, is determined using the Black-Scholes valuation model based on the multiple-award valuation method. Key assumptions of the Black-Scholes valuation model are the risk-free interest rate, expected volatility, expected term and expected dividends. The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant for the

22


expected term of the option. Expected volatility is based on a combination of historical stock price volatility and implied volatility of publicly-traded options on our common stock. Expected term is determined based on historical exercise behavior, post-vesting termination patterns, options outstanding and future expected exercise behavior.
There were no ESPP shares issued during the three months ended June 30, 2016 and 2015 . There were an insignificant number of stock options granted during the three months ended June 30, 2016 and 2015 .

The estimated assumptions used in the Monte-Carlo simulation model to value our market-based restricted stock units were as follows:
 
Three Months Ended
June 30,
 
2016
 
2015
Risk-free interest rate
0.8
%
 
1.0
%
Expected volatility
16 - 57%

 
14 - 50%

Weighted-average volatility
29
%
 
26
%
Expected dividends
None

 
None


Stock-Based Compensation Expense
Employee stock-based compensation expense recognized during the three months ended June 30, 2016 and 2015 was calculated based on awards ultimately expected to vest and has been reduced for estimated forfeitures. In subsequent periods, if actual forfeitures differ from those estimates, an adjustment to stock-based compensation expense will be recognized at that time.

The following table summarizes stock-based compensation expense resulting from stock options, restricted stock units, market-based restricted stock units, and the ESPP included in our Condensed Consolidated Statements of Operations (in millions):
 
Three Months Ended
June 30,
 
2016
 
2015
Cost of revenue
$
1

 
$

Research and development
27

 
$
26

Marketing and sales
7

 
5

General and administrative
13

 
14

Stock-based compensation expense
$
48

 
$
45


During the three months ended June 30, 2016 , we recognized a $9 million deferred income tax benefit related to our stock-based compensation expense. During the three months ended June 30, 2015 , we did not recognize any benefit from income taxes related to our stock-based compensation expense due to the U.S. valuation allowance.
As of June 30, 2016 , our total unrecognized compensation cost related to restricted stock units and market-based restricted stock units (collectively referred to as “restricted stock rights”) was $383 million and is expected to be recognized over a weighted-average service period of 1.9 years . Of the $383 million of unrecognized compensation cost, $56 million relates to market-based restricted stock units. As of June 30, 2016 , our total unrecognized compensation cost related to stock options was $7 million and is expected to be recognized over a weighted-average service period of 1.2 years .
During the three months ended June 30, 2016 and 2015 , we recognized $33 million and $40 million , respectively, of excess tax benefit from stock-based compensation deductions; this amount is reported in the financing activities on our Condensed Consolidated Statement of Cash Flows.

23


Stock Options
The following table summarizes our stock option activity for the three months ended June 30, 2016 :  
 
 
Options
(in thousands)
 
Weighted-
Average
Exercise Prices
 
Weighted-
Average
Remaining
Contractual
Term  (in years)
 
Aggregate
Intrinsic Value
(in millions)
Outstanding as of March 31, 2016
 
3,278

 
$
35.09

 
 
 
 
Granted
 
1

 
62.89

 
 
 
 
Exercised
 
(142
)
 
30.69

 
 
 
 
Forfeited, cancelled or expired
 
(26
)
 
35.90

 
 
 
 
Outstanding as of June 30, 2016
 
3,111

 
$
35.30

 
5.27
 
$
126

Vested and expected to vest
 
3,030

 
$
35.41

 
5.20
 
$
123

Exercisable as of June 30, 2016
 
2,381

 
$
36.55

 
4.53
 
$
94

The aggregate intrinsic value represents the total pre-tax intrinsic value based on our closing stock price as of June 30, 2016 , which would have been received by the option holders had all the option holders exercised their options as of that date. We issue new common stock from our authorized shares upon the exercise of stock options.
Restricted Stock Rights
The following table summarizes our restricted stock rights activity, excluding market-based restricted stock unit activity which is discussed below, for the three months ended June 30, 2016 :  
 
 
Restricted
Stock Rights
(in thousands)
 
Weighted-
Average Grant
Date Fair Values
Outstanding as of March 31, 2016
 
7,157

 
$
44.04

Granted
 
2,033

 
74.75

Vested
 
(3,037
)
 
35.00

Forfeited or cancelled
 
(193
)
 
51.92

Outstanding as of June 30, 2016
 
5,960

 
$
58.87


The weighted-average grant date fair values of restricted stock rights granted during the three months ended June 30, 2016 and 2015 were $74.75 and $62.64 , respectively.

24


Market-Based Restricted Stock Units
Our market-based restricted stock units vest contingent upon the achievement of pre-determined market and service conditions. If these market conditions are not met but service conditions are met, the market-based restricted stock units will not vest; however, any compensation expense we have recognized to date will not be reversed. The number of shares of common stock to be received at vesting will range from zero percent to 200 percent of the target number of market-based restricted stock units based on our total stockholder return (“TSR”) relative to the performance of companies in the NASDAQ-100 Index for each measurement period, generally over a one-year, two-year cumulative and three-year cumulative period. In the table below, we present shares granted at 100 percent of target of the number of market-based restricted stock units that may potentially vest. The maximum number of shares of common stock that could vest is approximately 0.7 million for market-based restricted stock units granted during the three months ended June 30, 2016 . As of June 30, 2016 , the maximum number of shares that could vest is approximately 1.3 million for market-based restricted stock units outstanding.
The following table summarizes our market-based restricted stock unit activity for the three months ended June 30, 2016 :  
 
 
Market-Based
Restricted  Stock
Units
(in thousands)
 
Weighted-
Average  Grant
Date Fair Value
Outstanding as of March 31, 2016
 
636

 
$
64.49

Granted
 
353

 
98.04

Vested
 
(558
)
 
50.08

Vested above target
 
238

 
44.99

Forfeited or cancelled
 
(4
)
 
79.81

Outstanding as of June 30, 2016
 
665

 
$
87.31

Stock Repurchase Program
In May 2014, a special committee of our Board of Directors, on behalf of the full Board of Directors, authorized a two-year program to repurchase up to $750 million of our common stock. Since inception, we repurchased approximately 9.2 million shares for approximately $394 million under this program.
 
In May 2015, our Board of Directors authorized a program to repurchase up to $1 billion of our common stock. This stock repurchase program, which expires on May 31, 2017, supersedes and replaces the stock repurchase authorization approved in May 2014. Under 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 any specific number of shares under this program and it may be modified, suspended or discontinued at any time. During the three months ended June 30, 2016 , we repurchased approximately 1.9 million shares for approximately $129 million under this program. We continue to actively repurchase shares.

The following table summarizes total shares repurchased during the three months ended June 30, 2016 and 2015 :
 
May 2014 Program
 
May 2015 Program
 
Total
(in millions)
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
Three months ended June 30, 2016

 
$

 
1.9
 
$
129

 
1.9
 
$
129

Three months ended June 30, 2015
1.0
 
$
57

 
1.2

 
$
75

 
2.2
 
$
132


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(13) EARNINGS PER SHARE
The following table summarizes the computations of basic earnings per share (“Basic EPS”) and diluted earnings per share (“Diluted EPS”). Basic EPS is computed as net income divided by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock-based compensation plans including stock options, restricted stock, restricted stock units, common stock through our ESPP, warrants, and other convertible securities using the treasury stock method.
 
Three Months Ended June 30,
(In millions, except per share amounts)
2016
 
2015
Net income
$
440

 
$
442

Shares used to compute earnings per share:
 
 
 
Weighted-average common stock outstanding — basic
301

 
311

Dilutive potential common shares related to stock award plans and from assumed exercise of stock options
4

 
8

Dilutive potential common shares related to the Convertible Notes
2

 
10

Dilutive potential common shares related to the Warrants
8

 
6

Weighted-average common stock outstanding — diluted
315

 
335

Earnings per share:
 
 
 
Basic
$
1.46

 
$
1.42

Diluted
$
1.40

 
$
1.32


For the three months ended June 30, 2016 and 2015 , an immaterial amount of options to purchase, restricted stock units and restricted stock to be released were excluded from the treasury stock method computation of diluted shares as their inclusion would have had an antidilutive effect.


26


Report of Independent Registered Public Accounting Firm


The Board of Directors and Stockholders
Electronic Arts Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of Electronic Arts Inc. and subsidiaries (the Company) as of July 2, 2016 , and the related condensed consolidated statements of operations, comprehensive income (loss), and cash flows for the three-month periods ended July 2, 2016 and July 4, 2015 . These condensed consolidated financial statements are the responsibility of the Company’s management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Electronic Arts Inc. and subsidiaries as of April 2, 2016, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated May 26, 2016, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of April 2, 2016, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/   KPMG LLP
Santa Clara, California
August 9, 2016

27


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Quarterly Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, made in this Quarterly Report are forward looking. Examples of forward-looking statements include statements related to industry prospects, our future economic performance including anticipated revenues and expenditures, results of operations or financial position, and other financial items, our business plans and objectives, including our intended product releases, and may include certain assumptions that underlie the forward-looking statements. We use words such as “anticipate,” “believe,” “expect,” “intend,” “estimate” (and the negative of any of these terms), “future” and similar expressions to help identify forward-looking statements. These forward-looking statements are subject to business and economic risk and reflect management’s current expectations, and involve subjects that are inherently uncertain and difficult to predict. Our actual results could differ materially from those in the forward-looking statements. We will not necessarily update information if any forward-looking statement later turns out to be inaccurate. Risks and uncertainties that may affect our future results include, but are not limited to, those discussed in this report under the heading “Risk Factors” in Part II, Item 1A, as well as in our Annual Report on Form 10-K for the fiscal year ended March 31, 2016 as filed with the Securities and Exchange Commission (“SEC”) on May 27, 2016 and in other documents we have filed with the SEC.

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 three months ended June 30, 2016 , 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-Q, including in the remainder of “Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”),” “Risk Factors,” and the Condensed Consolidated Financial Statements and related Notes. Additional information can be found in the “Business” section of our Annual Report on Form 10-K for the fiscal year ended March 31, 2016 as filed with the SEC on May 27, 2016 and in other documents we have filed with the SEC.
About Electronic Arts
We are a global leader in digital interactive entertainment. We develop, market, publish and distribute games content and services that can be played by consumers on a variety of platforms, which include consoles (such as the PlayStation from Sony and the Xbox from Microsoft), PCs, mobile phones and tablets. Some of our games are based on our wholly-owned intellectual property ( e.g. , Battlefield, Mass Effect, Need for Speed, The Sims and Plants vs. Zombies), and some of our games leverage content that we license from others ( e.g. , FIFA, Madden NFL and Star Wars). We also publish and distribute games developed by third parties ( e.g. , Titanfall). Our products and services may be purchased through multiple distribution channels, including physical and online retailers, platform providers such as console manufacturers, providers of free-to-download PC games, mobile carriers and directly through Origin, our own digital distribution platform.
Financial Results
Our key financial results for our quarter ended June 30, 2016 were as follows:

Total net revenue was $1,271 million , up 6 percent year-over-year. On a constant currency basis, we estimate that total net revenue would have been $1,354 million, up 13 percent year over year.
Digital revenue was $689 million , up 11 percent year-over-year.
International net revenue was $746 million , up 7 percent year-over-year.
Gross margin was 85.9 percent.
Operating expenses were $532 million .
Net income was $440 million , with diluted earnings per share of $1.40 .
Total cash, cash equivalents and short-term investments was $3,427 million .

From time to time, we will make comparisons of current periods to prior periods with reference to constant currency. Constant currency comparisons are based on translating local currency amounts in the current period at actual foreign exchange rates from the prior comparable period. We evaluate our financial performance on a constant currency basis in order to facilitate period-to-period comparisons without regard to the impact of changing foreign currency exchange rates.


28


Trends in Our Business

Digital Transformation . Our business continues to transform from a traditional packaged goods business model to one in which our games and services are sold and delivered digitally, with additional content, features and services helping to extend the life of our packaged goods and digital games. For example, the Ultimate Team mode incorporated into iterations of our FIFA, Madden NFL and NHL franchises and expansion packs available digitally for our Star Wars, Battlefield and Sims franchises have kept many of our players engaged with those games for longer periods of time. Our digital transformation is also creating opportunities in platforms, content models and modalities of play. For example, we have leveraged franchises typically associated with consoles and traditional PC gaming, such as FIFA, Madden NFL, The Sims, SimCity and Star Wars, to create mobile and PC free-to-download games that are monetized through a business model through which we sell incremental content and/or features in discrete transactions. We also provide our EA Access service for the Xbox One and Origin Access service on PC which offer players access to a selection of EA games and other benefits for a monthly or annual fee.

Our digital transformation also gives us the opportunity to strengthen our player network. We are investing in a technology foundation to enable us to build player relationships that can last for years instead of for days or weeks by connecting our players to us and to each other. This connection allows us to market and deliver content and services for popular franchises like FIFA, Battlefield and Star Wars to our players more efficiently. That same foundation also enables new player-centric ways to discover and try new experiences, such as our subscription-based EA Access and Origin Access services.

We significantly increased our digital net revenue from $1,833 million in fiscal year 2014 to $2,199 million in fiscal year 2015 and $2,409 million during fiscal year 2016. We expect this portion of our business to continue to grow through fiscal year 2017 and beyond as we continue to focus on developing and monetizing products and services that can be delivered digitally.

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. Volatility in exchange rates is still very high by historical standards, and macroeconomic events like the United Kingdom’s vote to leave the European Union are injecting even more uncertainty - the British pound sterling fell at the end of the quarter ended June 30, 2016. 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. We estimate that foreign currency exchange rates had a negative impact of $266 million on our reported net revenue during fiscal year 2016 as compared to fiscal year 2015, but the strengthening of the U.S. dollar had a positive impact of $113 million on our reported operating expenses as a significant portion of those expenses are incurred outside the United States.

Mobile and PC Free-to-Download Games . The proliferation of mobile phones and tablets has significantly increased the consumer base for mobile games. The broad consumer acceptance of business models which allow consumers to try new games with no up-front cost and pay for additional content or in-game items, has led to growth in the mobile gaming industry. Likewise, the mass introduction and wide consumer acceptance of free-to-download, micro-transaction-based PC games played over the Internet has also broadened our consumer base. We expect revenue generated from mobile and PC free-to-download games to remain an important part of our business.
We track an estimate of monthly active users (“MAUs”) for our mobile business, which we believe is a useful indicator of player engagement trends for that business. For the three months ended June 30, 2016 , we had average MAUs of over 130 million. MAUs are the aggregate number of individuals who accessed a particular game on a particular device in the last 30 days as of the measurement date. For our calculation, an individual who either plays two of our games on a single device, or the same game on two devices in the relevant period, would be counted as two users. Average MAUs for a particular period is the average of the MAUs at each month-end during that period. MAUs are calculated using internal company data based on tracking the activity of user accounts. We also include in this calculation data provided by our third party publishing partners for certain games that we develop but we exclude information from third party titles that we publish. From time to time, we adjust the calculation for user activity that is inconsistent with our methodology. We believe that the numbers are reasonable estimates of our user base for the applicable period of measurement; however, factors relating to user activity may impact these numbers. Our methodology for calculating MAUs may differ from the methodology used by other companies to calculate this metric.     

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, and many of those titles are sequels of prior games. Similarly, a significant portion of our revenue historically has been derived from games and services based on a few popular franchises, several of

29


which we have released on an annual or bi-annual basis. For example, in fiscal year 2016, net revenue generated from the sale of products and services associated with our three largest franchises accounted for approximately 55 percent of our net revenue. We expect this trend to continue.

Recurring Revenue Sources.  Our business model includes revenue that we deem recurring in nature, such as revenue from our annualized titles (such as FIFA and Madden NFL) and associated services, our ongoing mobile business and subscription programs. We have greater confidence in our ability to forecast revenue from these areas of our business than for new offerings.  As we continue to leverage the digital transformation in our industry and incorporate new content 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.

Recent Developments
Stock Repurchase Program. In May 2015, our Board of Directors authorized a program to repurchase up to $1 billion of our common stock. This stock repurchase program expires on May 31, 2017. During the three months ended June 30, 2016 , we repurchased approximately 1.9 million shares for approximately $129 million under this program. As of June 30, 2016 , we had $410 million remaining under this program. We continue to actively repurchase shares.

In February 2016, we announced a new $500 million stock repurchase program. This new program was incremental to the existing two-year $1 billion stock repurchase program announced in May 2015. We completed repurchases under the February 2016 program during the quarter ended March 31, 2016. We repurchased approximately 7.8 million shares for approximately $500 million under this new program.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The preparation of these Condensed 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.
Revenue Recognition, Sales Returns and Allowances, and Bad Debt Reserves
We derive revenue principally from sales of interactive software games, and related content ( e.g ., micro-transactions) and services on consoles (such as the PlayStation from Sony and the Xbox from Microsoft), PCs, mobile phones and tablets. We evaluate revenue recognition based on the criteria set forth in FASB Accounting Standards Codification (“ASC”) 605, Revenue Recognition and ASC 985-605, Software: Revenue Recognition . We classify our revenue as either product revenue or service and other revenue.

Product revenue. Our product revenue includes revenue associated with the sale of software games or related content, whether delivered via a physical disc ( e . g ., packaged goods) or delivered digitally ( e.g., full-game downloads, extra-content), and licensing of game software to third-parties. Product revenue also includes revenue from mobile full game downloads that do not require our hosting support ( e.g. , premium mobile games) in order to utilize the game or related content ( i.e. can be played with or without an Internet connection), and sales of tangible products such as hardware, peripherals, or collectors’ items.

Service and other revenue. Our service revenue includes revenue recognized from time-based subscriptions and games or related content that requires our hosting support in order to utilize the game or related content ( i.e. , can only be played with an Internet connection). This includes (1) entitlements to content that are accessed through hosting services ( e.g., micro-transactions for Internet-based, social network and free-to-download mobile games), (2) massively multi-player online (“MMO”) games (both software game and subscription sales), (3) subscriptions for our Battlefield Premium, EA Access, and Pogo-branded online game services, and (4) allocated service revenue from sales of software games with an online service element ( i.e., “matchmaking” service). Our other revenue includes advertising and non-software licensing revenue.

With respect to the allocated service revenue from sales of software games with a matchmaking service mentioned above, our allocation of proceeds between product and service revenue for presentation purposes is based on management’s best estimate of the selling price of the matchmaking service with the residual value allocated to product revenue. Our estimate of the selling price of the matchmaking service is comprised of several factors including, but not limited to, prior selling prices for the matchmaking service, prices charged separately by other third-party vendors for similar service offerings, and a cost-plus-

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margin approach. We review the estimated selling price of the online matchmaking service on a regular basis and use this methodology consistently to allocate revenue between product and service for software game sales with a matchmaking service.

We evaluate and recognize revenue when all four of the following criteria are met:

Evidence of an arrangement . Evidence of an agreement with the customer that reflects the terms and conditions to deliver the related products or services must be present.

Fixed or determinable fee . If a portion of the arrangement fee is not fixed or determinable, we recognize revenue as the amount becomes fixed or determinable.

Collection is deemed probable . Collection is deemed probable if we expect the customer to be able to pay amounts under the arrangement as those amounts become due. If we determine that collection is not probable as the amounts become due, we generally conclude that collection becomes probable upon cash collection.

Delivery . For packaged goods, delivery is considered to occur when a product is shipped and the risk of loss and rewards of ownership have transferred to the customer. For digital downloads, delivery is considered to occur when the software is made available to the customer for download. For services and other, delivery is generally considered to occur as the service is delivered, which is determined based on the underlying service obligation. If there is significant uncertainty of acceptance, revenue is recognized once acceptance is reasonably assured.

Online-Enabled Games

The majority of our software games and related content have online connectivity whereby a consumer may be able to download unspecified content or updates on a when-and-if-available basis (“unspecified updates”) for use with the original game software. In addition, we may also offer an online matchmaking service that permits consumers to play against each other via the Internet without a separate fee. U.S. GAAP requires us to account for the consumer’s right to receive unspecified updates or the matchmaking service for no additional fee as a “bundled” sale, or multiple-element arrangement.

We have an established historical pattern of providing unspecified updates ( e.g., player roster updates to Madden NFL 16 ) to online-enabled games and related content at no additional charge to the consumer. We do not have vendor-specific objective evidence of fair value (“VSOE”) for these unspecified updates, and thus, as required by U.S. GAAP, we recognize revenue from the sale of these online-enabled games and related content over the period we expect to offer the unspecified updates to the consumer (“estimated offering period”).

Estimated Offering Period

Because the offering period is not an explicitly defined period, we must make an estimate of the offering period. Determining the estimated offering period is inherently subjective and is subject to regular revision based on historical online usage. For example, in determining the estimated offering period for unspecified updates associated with our online-enabled games, we consider the period of time consumers are online as online connectivity is required. On an annual basis, we review consumers’ online gameplay of all online-enabled games that have been released 12 to 24 months prior to the evaluation date. For example, if our evaluation date is April 1, 2016, we evaluate all online-enabled games released between April 1, 2014 and March 31, 2015. Based on this population of games, for all players that register the game online within the first six months of release of the game to the general public, we compute the weighted-average number of days for each online-enabled game, based on when a player initially registers the game online to when that player last plays the game online. We then compute the weighted-average number of days for all online-enabled games by multiplying the weighted-average number of days for each online-enabled game by its relative percentage of total units sold from these online-enabled games ( i.e., a game with more units sold will have a higher weighting to the overall computation than a game with fewer units sold). Under a similar computation, 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 an end consumer ( i.e., time in channel). Based on these two calculations we then consider the method of distribution. For example , physical software games sold at retail would have a composite offering period equal to the online gameplay plus time in channel as opposed to digitally distributed software games which are delivered immediately via digital download and thus have no concept of channel. 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.


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While we consistently apply this methodology, inherent assumptions used in this methodology include which online-enabled games to sample, whether to use only units that have registered online, whether to weight the number of days for each game, whether to weight the days based on the units sold of each game, determining the period of time between the date of sale to reseller and the date of sale to the consumer and assessing online gameplay trends.
Other Multiple-Element Arrangements
In some of our multiple-element arrangements, we sell tangible products with software and/or software-related offerings. These tangible products are generally either peripherals or ancillary collectors’ items, such as figurines and comic books. Revenue for these arrangements is allocated to each separate unit of accounting for each deliverable using the relative selling prices of each deliverable in the arrangement based on the selling price hierarchy described below. If the arrangement contains more than one software deliverable, the arrangement consideration is allocated to the software deliverables as a group and then allocated to each software deliverable.

We determine the selling price for a tangible product deliverable based on the following selling price hierarchy: VSOE ( i.e. , the price we charge when the tangible product is sold separately) if available, third-party evidence (“TPE”) of fair value ( i.e. , the price charged by others for similar tangible products) if VSOE is not available, or our best estimate of selling price (“BESP”) if neither VSOE nor TPE is available. Determining the BESP is a subjective process that is based on multiple factors including, but not limited to, recent selling prices and related discounts, market conditions, customer classes, sales channels and other factors. Provided the other three revenue recognition criteria other than delivery have been met, we recognize revenue upon delivery to the customer as we have no further obligations.

We must make assumptions and judgments in order to (1) determine whether and when each element is delivered, (2) determine whether VSOE exists for each undelivered element, and (3) allocate the total price among the various elements, as applicable. Changes to any of these assumptions and judgments, or changes to the elements in the arrangement, could cause a material increase or decrease in the amount of revenue that we report in a particular period.
Principal Agent Considerations
We evaluate sales of our interactive software games via third party storefronts, including digital storefronts such as Microsoft’s Xbox Games Store, Sony PSN, Apple App Store, and Google Play, in order to determine whether or not we are acting as the primary obligor in the sale to the end consumer, which we consider in determining if revenue should be reported gross or net of fees retained by the storefront. Key indicators that we evaluate in determining gross versus net treatment include but are not limited to the following:

The party responsible for delivery/fulfillment of the product or service to the end consumer
The party responsible for the billing, collection of fees and refunds to the end consumer
The storefront and Terms of Sale that govern the end consumer’s purchase of the product or service
The party that sets the pricing with the end consumer and has credit risk
Based on evaluation of the above indicators, we have determined that generally the third party is considered the primary obligor to end consumers for the sale of our interactive software games. We therefore report revenue related to these arrangements net of the fees retained by the storefront.

Sales Returns and Allowances and Bad Debt Reserves

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 product that they have not resold to end consumers. The amount of the price protection is generally the difference between the old wholesale price and the new reduced wholesale price. In certain countries for our PC and console packaged goods software products, we also have a practice of allowing channel partners to return older software products in the channel in exchange for a credit allowance. As a general practice, we do not give cash refunds.

When evaluating the adequacy of sales returns and price protection allowances, we analyze the following: historical credit allowances, current sell-through of our channel partners’ inventory of our software products, current trends in retail and the video game industry, changes in customer demand, acceptance of our software 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.


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