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 September 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 November 3, 2016 , there were 301,755,509 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 SEPTEMBER 30, 2016
Table of Contents
 
 
 
Page
 
Item 1.
 
 
Condensed Consolidated Balance Sheets as of September 30, 2016 and March 31, 2016
 
Condensed Consolidated Statements of Operations for the Three and Six Months Ended September 30, 2016 and 2015
 
Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended September 30, 2016 and 2015
 
Condensed Consolidated Statements of Cash Flows for the Six Months Ended September 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)
September 30, 2016
 
March 31, 2016 (a)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,746

 
$
2,493

Short-term investments
1,520

 
1,341

Receivables, net of allowances of $105 and $159, respectively
723

 
233

Inventories
50

 
33

Other current assets
221

 
254

Total current assets
4,260

 
4,354

Property and equipment, net
431

 
439

Goodwill
1,709

 
1,710

Acquisition-related intangibles, net
28

 
57

Deferred income taxes, net
366

 
387

Other assets
98

 
103

TOTAL ASSETS
$
6,892

 
$
7,050

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
206

 
$
89

Accrued and other current liabilities
777

 
710

0.75% convertible senior notes due 2016, net

 
161

Deferred net revenue (online-enabled games)
1,067

 
1,458

Total current liabilities
2,050

 
2,418

Senior notes, net
990

 
989

Income tax obligations
86

 
80

Deferred income taxes, net
2

 
2

Other liabilities
156

 
163

Total liabilities
3,284

 
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; 300 and 301 shares issued and outstanding, respectively
3

 
3

Additional paid-in capital
1,153

 
1,349

Retained earnings
2,462

 
2,060

Accumulated other comprehensive loss
(10
)
 
(16
)
Total stockholders’ equity
3,608

 
3,396

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
6,892

 
$
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
September 30,
 
Six Months Ended
September 30,
(In millions, except per share data)
2016

2015
 
2016
 
2015
Net revenue:
 
 
 
 
 
 
 
Product
$
420

 
$
434

 
$
1,104

 
$
1,177

Service and other
478

 
381

 
1,065

 
841

Total net revenue
898

 
815

 
2,169

 
2,018

Cost of revenue:
 
 
 
 
 
 
 
Product
317

 
335

 
407

 
429

Service and other
84

 
74

 
173

 
153

Total cost of revenue
401

 
409

 
580

 
582

Gross profit
497

 
406

 
1,589

 
1,436

Operating expenses:
 
 
 
 
 
 
 
Research and development
291

 
265

 
585

 
561

Marketing and sales
143

 
156

 
271

 
279

General and administrative
111

 
101

 
219

 
199

Amortization of intangibles
1

 
3

 
3

 
4

Total operating expenses
546

 
525

 
1,078

 
1,043

Operating income (loss)
(49
)
 
(119
)
 
511

 
393

Interest and other income (expense), net
(3
)
 
(9
)
 
(11
)
 
(12
)
Income (loss) before provision for (benefit from) income taxes
(52
)
 
(128
)
 
500

 
381

Provision for (benefit from) income taxes
(14
)
 
12

 
98

 
79

Net income (loss)
$
(38
)
 
$
(140
)
 
$
402

 
$
302

Earnings (loss) per share:
 
 
 
 
 
 
 
Basic
$
(0.13
)
 
$
(0.45
)
 
$
1.34

 
$
0.97

Diluted
$
(0.13
)
 
$
(0.45
)
 
$
1.28

 
$
0.90

Number of shares used in computation:
 
 
 
 
 
 
 
Basic
301

 
312

 
301

 
311

Diluted
301

 
312

 
315

 
334

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
September 30,
 
Six Months Ended
September 30,
(In millions)
2016
 
2015
 
2016
 
2015
Net income (loss)
$
(38
)
 
$
(140
)
 
$
402

 
$
302

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Change in unrealized net gains and losses on available-for-sale securities
(1
)
 
2

 
1

 
1

Reclassification adjustment for net realized gains and losses on available-for-sale securities
(1
)
 
(1
)
1

(1
)
 
(1
)
Change in unrealized net gains and losses on derivative instruments
(1
)
 
5

 
27

 
(8
)
Reclassification adjustment for net realized gains and losses on derivative instruments
(4
)
 
(4
)
 
(10
)
 
(7
)
Foreign currency translation adjustments
(6
)
 
(32
)
 
(11
)
 
(31
)
Total other comprehensive income (loss), net of tax
(13
)
 
(30
)
 
6

 
(46
)
Total comprehensive income (loss)
$
(51
)
 
$
(170
)
 
$
408

 
$
256


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

5


ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
September 30,
(In millions)
2016
 
2015
OPERATING ACTIVITIES
 
 
 
Net income
$
402

 
$
302

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Depreciation, amortization and accretion
91

 
99

Loss on conversion of senior notes

 
6

Stock-based compensation
96

 
89

Change in assets and liabilities:
 
 
 
Receivables, net
(493
)
 
(379
)
Inventories
(17
)
 
(26
)
Other assets
54

 
39

Accounts payable
133

 
126

Accrued and other liabilities
(34
)
 
(149
)
Deferred income taxes, net
20

 
1

Deferred net revenue (online-enabled games)
(391
)
 
(170
)
Net cash used in operating activities
(139
)
 
(62
)
INVESTING ACTIVITIES
 
 
 
Capital expenditures
(69
)
 
(42
)
Proceeds from maturities and sales of short-term investments
644

 
513

Purchase of short-term investments
(824
)
 
(551
)
Net cash used in investing activities
(249
)
 
(80
)
FINANCING ACTIVITIES
 
 
 
Payment of convertible notes
(163
)
 
(198
)
Proceeds from issuance of common stock
31

 
84

Excess tax benefit from stock-based compensation
37

 
65

Repurchase and retirement of common stock
(256
)
 
(258
)
Net cash used in financing activities
(351
)
 
(307
)
Effect of foreign exchange on cash and cash equivalents
(8
)
 
(21
)
Decrease in cash and cash equivalents
(747
)
 
(470
)
Beginning cash and cash equivalents
2,493

 
2,068

Ending cash and cash equivalents
$
1,746

 
$
1,598

Supplemental cash flow information:
 
 
 
Cash paid during the period for income taxes, net
$
26

 
$
26

Cash paid during the period for interest
$
22

 
$
3

Non-cash investing activities:
 
 
 
Change in accrued capital expenditures
$
(17
)
 
$
(6
)

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 September 30, 2016 and 2015 contained 13 weeks each and ended on October 1, 2016 and October 3, 2015 , respectively. Our results of operations for the six months ended September 30, 2016 and 2015 contained 26 and 27 weeks, respectively, and ended on October 1, 2016 and October 3, 2015 , respectively. For simplicity of disclosure, all fiscal periods are referred to as ending on a calendar month end.
The Condensed Consolidated Financial Statements are unaudited and reflect all adjustments (consisting only of normal recurring accruals unless otherwise indicated) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The preparation of these Condensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the amounts reported in these Condensed Consolidated Financial Statements and accompanying notes. Actual results could differ materially from those estimates. The results of operations for the current interim periods are not necessarily indicative of results to be expected for the current year or any other period.
These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2016 , as filed with the United States Securities and Exchange Commission (“SEC”) on May 27, 2016 .
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.
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.

7


In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This update is intended to reduce the existing diversity in practice in how certain transactions are classified in the statement of cash flows. This update is effective for annual periods (and interim periods within those annual periods) beginning after December 15, 2017. Early adoption is permitted, provided that all of the amendments are adopted in the same period. We are currently evaluating the timing of adoption and impact of this new standard on our Consolidated Statements of Cash Flows.
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 will 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 vendor-specific objective evidence of fair value (“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. In addition, based upon what we expect to be our performance obligations under the new standard, as amended, we believe that upon adoption, a larger portion of our bundled arrangements will be presented as service revenue instead of product revenue in our Consolidated Statements of Operations.
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 September 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
September 30,
2016
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Balance Sheet Classification
Assets
 
 
 
 
 
 
 
 
 
Bank and time deposits
$
236

 
$
236

 
$

 
$

 
Cash equivalents
Money market funds
185

 
185

 

 

 
Cash equivalents
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
Corporate bonds
739

 

 
739

 

 
Short-term investments
U.S. Treasury securities
379

 
379

 

 

 
Short-term investments
U.S. agency securities
163

 

 
163

 

 
Short-term investments and cash equivalents
Commercial paper
110

 

 
110

 

 
Short-term investments and cash equivalents
Foreign government securities
115

 

 
115

 

 
Short-term investments
Asset-backed securities
54

 

 
54

 

 
Short-term investments
Foreign currency derivatives
33

 

 
33

 

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

 
9

 

 

 
Other assets
Total assets at fair value
$
2,023

 
$
809

 
$
1,214

 
$

 
 
Liabilities
 
 
 
 
 
 
 
 
 
Foreign currency derivatives
11

 

 
11

 

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

 
10

 

 

 
Other liabilities
Total liabilities at fair value
$
21

 
$
10

 
$
11

 
$

 
 
 



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 September 30, 2016 and March 31, 2016 , our cash and cash equivalents were $1,746 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.

10


Short-Term Investments
Short-term investments consisted of the following as of September 30, 2016 and March 31, 2016 (in millions):  
 
As of September 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
$
738

 
$
1

 
$

 
$
739

 
$
620

 
$
1

 
$

 
$
621

U.S. Treasury securities
378

 
1

 

 
379

 
389

 
1

 

 
390

U.S. agency securities
154

 

 

 
154

 
167

 

 

 
167

Commercial paper
79

 

 

 
79

 
50

 

 

 
50

Foreign government securities

115

 

 

 
115

 
113

 

 

 
113

Asset-backed securities
54

 

 

 
54

 

 

 

 

Short-term investments
$
1,518

 
$
2

 
$

 
$
1,520

 
$
1,339

 
$
2

 
$

 
$
1,341

The following table summarizes the amortized cost and fair value of our short-term investments, classified by stated maturity as of September 30, 2016 and March 31, 2016 (in millions):  
 
As of September 30, 2016
 
As of March 31, 2016
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Short-term investments
 
 
 
 
 
 
 
Due in 1 year or less
$
749

 
$
749

 
$
571

 
$
571

Due in 1-2 years
415

 
416

 
461

 
462

Due in 2-3 years
295

 
296

 
295

 
296

Due in 3-4 years
59

 
59

 
12

 
12

Short-term investments
$
1,518

 
$
1,520

 
$
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.

11


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 September 30, 2016
 
As of March 31, 2016
 
Notional Amount
 
Fair Value
 
Notional Amount
 
Fair Value
 
 
Asset
 
Liability
 
 
Asset
 
Liability
Forward contracts to purchase
$
137

 
$

 
$
2

 
$
148

 
$
5

 
$
1

Forward contracts to sell
$
936

 
$
33

 
$
9

 
$
685

 
$
11

 
$
9

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 $5 million for the three months ended September 30, 2016 and a gain of $4 million for the three months ended September 30, 2015 .
The net impact of the effective portion of gains and losses from our cash flow hedging activities in our Condensed Consolidated Statements of Operations was a gain of $11 million for the six months ended September 30, 2016 and a gain of $7 million for the six months ended September 30, 2015 .
During the three and six months ended September 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 and six months ended September 30, 2016 and 2015 and recognized in interest and other income (expense), net, was immaterial.

12


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 September 30, 2016
 
As of March 31, 2016
 
Notional Amount
 
Fair Value
 
Notional Amount
 
Fair Value
 
 
Asset
 
Liability
 
 
Asset
 
Liability
Forward contracts to purchase
$
89

 
$

 
$

 
$
108

 
$

 
$

Forward contracts to sell
$
485

 
$

 
$

 
$
159

 
$

 
$


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


13


(5) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The changes in accumulated other comprehensive income (loss) by component, net of tax, for the three months ended September 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 June 30, 2016
$
3

 
$
36

 
$
(36
)
 
$
3

Other comprehensive income (loss) before reclassifications
(1
)
 
(1
)
 
(6
)
 
(8
)
Amounts reclassified from accumulated other comprehensive income (loss)
(1
)
 
(4
)
 

 
(5
)
Total other comprehensive income (loss), net of tax

(2
)
 
(5
)
 
(6
)
 
(13
)
Balance as of September 30, 2016
$
1

 
$
31

 
$
(42
)
 
$
(10
)
 
Unrealized Net Gains (Losses) on Available-for-Sale Securities
 
Unrealized Net Gains (Losses) on Derivative Instruments
 
Foreign Currency Translation Adjustments
 
Total
Balances as of June 30, 2015
$
(4
)
 
$
5

 
$
(15
)
 
$
(14
)
Other comprehensive income (loss) before reclassifications
2

 
5

 
(32
)
 
(25
)
Amounts reclassified from accumulated other comprehensive income (loss)
(1
)
 
(4
)
 

 
(5
)
Total other comprehensive income (loss), net of tax

1

 
1

 
(32
)
 
(30
)
Balance as of September 30, 2015
$
(3
)
 
$
6

 
$
(47
)
 
$
(44
)

The changes in accumulated other comprehensive income (loss) by component, net of tax, for the six months ended September 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
1

 
27

 
(11
)
 
17

Amounts reclassified from accumulated other comprehensive income (loss)
(1
)
 
(10
)
 

 
(11
)
Total other comprehensive income (loss), net of tax


 
17

 
(11
)
 
6

Balance as of September 30, 2016
$
1

 
$
31

 
$
(42
)
 
$
(10
)
 
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

 
(8
)
 
(31
)
 
(38
)
Amounts reclassified from accumulated other comprehensive income (loss)
(1
)
 
(7
)
 

 
(8
)
Total other comprehensive income (loss), net of tax


 
(15
)
 
(31
)
 
(46
)
Balance as of September 30, 2015
$
(3
)
 
$
6

 
$
(47
)
 
$
(44
)


14


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

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

Three Months Ended
September 30, 2016

Six Months Ended
September 30, 2016
(Gains) losses on available-for-sale securities




Interest and other income (expense), net
 
$
(1
)
 
$
(1
)
Net of tax

$
(1
)

$
(1
)





(Gains) losses on cash flow hedges from forward contracts
 
 
 
 
Net revenue

$
(4
)

$
(9
)
Research and development



(1
)
Net of tax
 
$
(4
)
 
$
(10
)
 
 
 
 
 
Total (gain) loss reclassified, net of tax

$
(5
)

$
(11
)

The effects on net income of amounts reclassified from accumulated other comprehensive income (loss) for the three and six months ended September 30, 2015 were as follows (in millions):
 
 
Amount Reclassified From Accumulated Other Comprehensive Income (Loss)
Statement of Operations Classification
 
Three Months Ended
September 30, 2015
 
Six Months Ended
September 30, 2015
(Gains) losses on available-for-sale securities
 
 
 
 
Interest and other income (expense), net
 
$
(1
)
 
$
(1
)
Net of tax
 
$
(1
)
 
$
(1
)
 
 
 
 
 
(Gains) losses on cash flow hedges from forward contracts
 
 
 
 
Net revenue
 
$
(6
)
 
$
(14
)
Research and development
 
2

 
7

Net of tax
 
$
(4
)
 
$
(7
)
 
 
 
 
 
Total (gain) loss reclassified, net of tax
 
$
(5
)
 
$
(8
)


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

 
$

 
$
(1
)
 
$
2,077

Accumulated impairment
(368
)
 

 

 
(368
)
Total
$
1,710

 
$

 
$
(1
)
 
$
1,709

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.

15


Acquisition-related intangibles consisted of the following (in millions):
 
As of September 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

 
$
(395
)
 
$
17

 
$
412

 
$
(368
)
 
$
44

Trade names and trademarks
106

 
(95
)
 
11

 
106

 
(93
)
 
13

Registered user base and other intangibles
5

 
(5
)
 

 
5

 
(5
)
 

Carrier contracts and related
85

 
(85
)
 

 
85

 
(85
)
 

Total
$
608

 
$
(580
)
 
$
28

 
$
608

 
$
(551
)
 
$
57

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

 
$
8

 
$
16

 
$
16

Cost of product
4

 
3

 
9

 
7

Operating expenses
1

 
3

 
3

 
4

Total
$
13

 
$
14

 
$
28

 
$
27

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 September 30, 2016 and March 31, 2016 , the weighted-average remaining useful life for acquisition-related intangible assets was approximately 1.6 years and 1.6 years , respectively.
As of September 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 six months)
$
9

2018
17

2019
2

Total
$
28


(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

16


amounts will be recognized in our Condensed Consolidated Statements of Operations within the next 12 months. Royalty liabilities are classified as current liabilities to the extent such royalty payments are contractually due within the next 12 months.
Each quarter, we also evaluate the expected future realization of our royalty-based assets, as well as any unrecognized minimum commitments not yet paid to determine amounts we deem unlikely to be realized through product and service sales. Any impairments or losses determined before the launch of a product are generally charged to research and development expense. Impairments or losses determined post-launch are charged to cost of revenue. We evaluate long-lived royalty-based assets for impairment using undiscounted cash flows when impairment indicators exist. If impairment exists, then the assets are written down to fair value. Unrecognized minimum royalty-based commitments are accounted for as executory contracts, and therefore, any losses on these commitments are recognized when the underlying intellectual property is abandoned ( i.e. , cease use) or the contractual rights to use the intellectual property are terminated.
During the three and six months ended September 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
September 30, 2016
 
As of
March 31, 2016
Other current assets
$
69

 
$
54

Other assets
54

 
63

Royalty-related assets
$
123

 
$
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
September 30, 2016
 
As of
March 31, 2016
Accrued royalties
$
162

 
$
159

Other liabilities
111

 
118

Royalty-related liabilities
$
273

 
$
277

As of September 30, 2016 , we were committed to pay approximately $1,425 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 September 30, 2016 and March 31, 2016 consisted of (in millions):  

As of
September 30, 2016

As of
March 31, 2016
Finished goods
$
41


$
32

Raw materials and work in process
9


1

Inventories
$
50


$
33


17


Property and Equipment, Net
Property and equipment, net, as of September 30, 2016 and March 31, 2016 consisted of (in millions):  
 
As of
September 30, 2016
 
As of
March 31, 2016
Computer, equipment and software
$
709

 
$
684

Buildings
315

 
313

Leasehold improvements
129

 
129

Equipment, furniture and fixtures, and other
81

 
80

Land
61

 
61

Construction in progress
3

 
15

 
1,298

 
1,282

Less: accumulated depreciation
(867
)
 
(843
)
Property and equipment, net
$
431

 
$
439

During the three and six months ended September 30, 2016 , depreciation expense associated with property and equipment was $28 million and $57 million , respectively. During the three and six months ended September 30, 2015 depreciation expense associated with property and equipment was $30 million and $60 million respectively.
Accrued and Other Current Liabilities
Accrued and other current liabilities as of September 30, 2016 and March 31, 2016 consisted of (in millions):  
 
As of
September 30, 2016
 
As of
March 31, 2016
Other accrued expenses
$
289

 
$
218

Accrued compensation and benefits
175

 
256

Accrued royalties
162

 
159

Deferred net revenue (other)
151

 
77

Accrued and other current liabilities
$
777

 
$
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 $1,067 million and $1,458 million as of September 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 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.

18


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 September 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 and six months ended September 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 and six months ended September 30, 2016 was 26.9 percent and 19.6 percent , respectively, as compared to 9.4 percent and 20.7 percent , respectively, for the same period of fiscal year 2016 . The effective tax rate for the three and six months ended September 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 and six months ended September 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 and six months ended September 30, 2015 was increased due to a discrete expense of $25 million and $65 million , respectively, for excess tax benefits from stock-based compensation deductions allocated directly to contributed capital. The effective tax rate for the three and six months ended September 30, 2016 differs from the same periods in fiscal year 2016 primarily due to the utilization of U.S. deferred tax assets in fiscal year 2016 which were subject to a valuation allowance and the discrete expense for excess tax benefits from stock-based compensation deductions allocated directly to contributed capital in fiscal year 2016.

During the three and six months ended September 30, 2016 , we recorded a net increase of $10 million and $18 million , respectively, in gross unrecognized tax benefits. The total gross unrecognized tax benefits as of September 30, 2016 is $349 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 September 30, 2016 , if recognized, approximately $322 million of the unrecognized tax benefits would affect our effective tax rate and approximately $28 million would result in adjustments to deferred tax assets with corresponding adjustments to the valuation allowance.

During the three and six months ended September 30, 2016 , we recorded a net increase of $1 million and $2 million , respectively, for accrued interest and penalties related to tax positions taken on our tax returns. As of September 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 $16 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 involves multiple tax periods and jurisdictions, it is reasonably possible that a reduction of up to $67 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.


19


(10) FINANCING ARRANGEMENTS
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.
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 September 30, 2016 , approximately $136 million principal value of the Convertible Notes were converted by holders thereof. During the three months ended September 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 with a fair value of $193 million 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 during the three months ended September 30, 2016 . During the six months ended September 30, 2016, we repaid $163 million of the principal balance of the Convertible Notes and issued approximately 2.9 million shares of common stock to noteholders with a fair value of $222 million , resulting in a loss on extinguishment of $0.3 million .
The carrying and fair values of the Convertible Notes are as follows (in millions):  
   
As of
September 30, 2016
 
As of
March 31, 2016
Principal amount of Convertible Notes
$

 
$
163

Unamortized debt discount of the liability component

 
(2
)
Net carrying value of Convertible Notes
$

 
$
161

 
 
 
 
Fair value of Convertible Notes (Level 2)
$

 
$
338


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 three and six months ended September 30, 2016 , we received 2.5 million and 2.9 million shares, respectively, 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 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 that began on October 17, 2016 . Based on the closing price of our common stock of $85.40 at the end of the quarter ended September 30, 2016 , approximately 10.3 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 that began on October 17, 2016 . We received proceeds of $65 million from the sale of the Warrants in fiscal year 2012.

20


Effect of conversion on earning per share (“EPS”)
Prior to conversion of the Convertible Notes, 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.
The carrying and fair values of the Senior Notes are as follows (in millions):  
   
As of
September 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
(8
)
 
(9
)
Net carrying value of Senior Notes
$
990

 
$
989

 
 
 
 
Fair value of Senior Notes (Level 2)
$
1,082

 
$
1,039


As of September 30, 2016 , the remaining life of the 2021 Notes and 2026 Notes is approximately 4.4 and 9.4 years, respectively.

The Senior Notes are senior unsecured obligations and rank equally with all our other existing and future unsubordinated obligations 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 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

21


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 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 September 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 and six months ended September 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
September 30,
 
Six Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Amortization of debt discount
(1
)
 
(5
)
 
(2
)
 
(11
)
Amortization of debt issuance costs

 

 
(1
)
 
(1
)
Coupon interest expense
(10
)
 
(1
)
 
(21
)
 
(2
)
Total interest expense
$
(11
)
 
$
(6
)
 
$
(24
)
 
$
(14
)

(11) COMMITMENTS AND CONTINGENCIES
Lease Commitments
As of September 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 and PLAYERS 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. (Pets); 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

22


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 September 30, 2016 (in millions): 
 
 
 
Fiscal Years Ending March 31,
 
 
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Remaining
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
six mos.)
 
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
Unrecognized commitments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Developer/licensor commitments
$
1,427

 
$
66

 
$
315

 
$
300

 
$
251

 
$
210

 
$
206

 
$
79

Marketing commitments
503

 
29

 
79

 
111

 
91

 
93

 
74

 
26

Operating leases
234

 
16

 
38

 
34

 
31

 
29

 
23

 
63

Senior Notes interest
278

 
17

 
41

 
41

 
41

 
41

 
19

 
78

Other purchase obligations
93

 
25

 
18

 
13

 
9

 
7

 
4

 
17

Total unrecognized commitments
2,535

 
153

 
491

 
499

 
423

 
380

 
326

 
263

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recognized commitments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior Notes principal and interest
1,004

 
4

 

 

 

 
600

 

 
400

Licensing and lease obligations (a)
136

 
11

 
23

 
24

 
25

 
26

 
27

 

Total recognized commitments
1,140

 
15

 
23

 
24

 
25

 
626

 
27

 
400

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total commitments
$
3,675

 
$
168

 
$
514

 
$
523

 
$
448

 
$
1,006

 
$
353

 
$
663

(a)
Lease commitments have not been reduced for approximately $1 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 September 30, 2016 ; however, certain payment obligations may be accelerated depending on the performance of our operating results. Furthermore, 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 September 30, 2016 , we had a liability for unrecognized tax benefits and an accrual for the payment of related interest totaling $86 million , of which we are unable to make a reasonably reliable estimate of when cash settlement with a taxing authority will occur.
Legal Proceedings
On July 29, 2010, Michael Davis, a former NFL running back, filed a putative class action in the United States District Court for the Northern District of California against the Company, alleging that certain past versions of Madden NFL included the images of certain retired NFL players without their permission. In March 2012, the trial court denied the Company’s request to dismiss the complaint on First Amendment grounds. In January 2015, that trial court decision was affirmed by the Ninth Circuit Court of Appeals and the case was remanded back to the 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.


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(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 purchase rights 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 expected term of the option. Expected volatility is based on a combination of historical stock price volatility and implied volatility of publicly-traded options on our common stock. Expected term is determined based on historical exercise behavior, post-vesting termination patterns, options outstanding and future expected exercise behavior.
There were an insignificant number of stock options granted during the three and six months ended September 30, 2016 and 2015 .
The estimated assumptions used in the Black-Scholes valuation model to value our ESPP purchase rights were as follows:
 
 
ESPP Purchase Rights
 
 
Three Months Ended
September 30,
 
 
2016
 
2015
Risk-free interest rate
 
0.5 - 0.6%

 
0.3 - 0.4%

Expected volatility
 
29 - 32%

 
32
%
Weighted-average volatility
 
31
%
 
32
%
Expected term
 
6 - 12 months

 
6 - 11.5 months

Expected dividends
 
None

 
None


There were no market-based restricted stock units granted during the three months ended September 30, 2016 and 2015 .

Stock-Based Compensation Expense
Employee stock-based compensation expense recognized during the three and six months ended September 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.


24


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

 
$
1

 
$
2

 
$
1

Research and development
27

 
$
25

 
54

 
51

Marketing and sales
8

 
7

 
15

 
12

General and administrative
12

 
11

 
25

 
25

Stock-based compensation expense
$ <