[May 22, 2013] ELECTRONIC ARTS INC. - 10-K - : Management's Discussion and Analysis of Financial Condition and Results of Operations Tweet (Edgar Glimpses Via Acquire Media NewsEdge) 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 is important in order to understand our results for the fiscal year ended March 31, 2013, as well as our future prospects. This summary is not intended to be exhaustive, nor is it intended to be a substitute for the detailed discussion and analysis provided elsewhere in this Form 10-K, including in the "Business" section and the "Risk Factors" above, the remainder of "Management's Discussion and Analysis of Financial Condition and Results of Operations," or the Consolidated Financial Statements and related Notes. About Electronic Arts We develop, market, publish and distribute game software content and services that can be played by consumers on a variety of platforms, including video game consoles (such as the Sony PLAYSTATION 3, Microsoft Xbox 360, and Nintendo WiiU), personal computers, mobile devices (such as the Apple iPhone and Google Android compatible phones), tablets and electronic readers (such as the Apple iPad and Amazon Kindle), and the Internet. Our ability to publish games across multiple platforms, through multiple distribution channels, and directly to consumers (online and wirelessly) has been, and will continue to be, a cornerstone of our product strategy. We have generated substantial growth in new business models and alternative revenue streams (such as subscription, micro-transactions, and advertising) based on the continued expansion of our online and wireless product and service offerings. Some of our games are based on our wholly-owned intellectual property (e.g., Battlefield, Mass Effect, Need for Speed, The Sims, Bejeweled, and Plants v. Zombies), and some of our games are based on content that we license from others (e.g., FIFA and Madden NFL). Our goal is to turn our core intellectual properties into year-round businesses available on a range of platforms. Our products and services may be purchased through physical and online retailers, platform providers such as console manufacturers and mobile carriers via digital downloads, as well as directly through our own distribution platform, including online portals such as Origin. Financial Results Total net revenue for the fiscal year ended March 31, 2013 was $3,797 million, down $346 million as compared to the fiscal year ended March 31, 2012. At March 31, 2013, deferred net revenue associated with sales of online-enabled games decreased by $4 million as compared to March 31, 2012, directly increasing the amount of reported net revenue during the fiscal year ended March 31, 2013. At March 31, 2012, deferred net revenue associated with sales of online-enabled games increased by $43 million as compared to March 31, 2011, directly reducing the amount of reported net revenue during the fiscal year ended March 31, 2012. Without these changes in deferred net revenue, reported net revenue would have decreased by approximately $393 million during fiscal year 2013 as compared to fiscal year 2012. Net revenue for fiscal year 2013 was driven by FIFA 13, Battlefield 3 and FIFA 12. Net income for the fiscal year ended March 31, 2013 was $98 million as compared to a net income of $76 million for the fiscal year ended March 31, 2012. Diluted earnings per share for the fiscal year ended March 31, 2013 was $0.31 as compared to a diluted earnings per share of $0.23 for the fiscal year ended March 31, 2012. Net income increased for fiscal year 2013 as compared to fiscal year 2012 primarily as a result of (1) a $39 million gain on strategic investment from the sale of our investment in Neowiz and (2) a $222 million decrease in operating expenses. The increase in net income was partially offset by (1) a $136 million decrease in gross profit due to an 8 percent decrease in net revenue and (2) a $99 million increase in the provision for income taxes. Trends in Our Business Next-generation Console Systems. Both Microsoft and Sony have announced their plans to release new video game console systems in 2013. In addition, in November 2012, Nintendo released its WiiU, which succeeded the Wii. EA is investing in products and services for these next-generation consoles. In the near term, we expect to continue to develop and market products and services for current-generation consoles including the Xbox 360 and PLAYSTATION 3 while also developing products and services for next-generation console systems. The success of our products and services for these next generation consoles depends in part on the commercial success and adequate supply of these new consoles, our ability to accurately predict which platforms will be successful in the marketplace, and our ability to develop commercially successful products and services for these platforms. Digital Content Distribution and Services. Consumers are spending an ever-increasing portion of their money and time on interactive entertainment that is accessible online, or through mobile digital devices such as smart phones, or through social networks such as Facebook. We provide a variety of online-delivered products and services including those available through our Origin platform. Many of our games that are available as packaged goods products are also available through direct online 24 -------------------------------------------------------------------------------- download via the Internet. We also offer online-delivered content and services that are add-ons or related to our packaged goods products such as additional game content or enhancements of multiplayer services. Further, we provide other games, content and services that are available only via electronic delivery, such as Internet-only games and game services, and games for mobile devices. We significantly increased the revenue that we derive from wireless, Internet-derived and advertising (digital) products and services from $1,159 million in fiscal year 2012 to $1,440 million in fiscal year 2013 and we expect this portion of our business to continue to grow in fiscal 2014 and beyond. Wireless and Internet Platforms; Casual and Mobile Games. Advances in technology have resulted in a variety of platforms for interactive entertainment. Examples include wireless technologies, streaming game services, and Internet-based platforms. These technologies, services and platforms grow the consumer base for our business and have led to the growth of casual and mobile gaming. Casual and mobile games are characterized by their mass appeal, simple controls, flexible monetization (including free-to-play and micro-transaction business models) and fun and approachable gameplay. These games appeal to a larger consumer demographic - including younger and older players and more female players - than video games played on console devices. We expect sales of casual and mobile games for wireless and other emerging platforms to continue to be an important part of our business. Concentration of Sales Among the Most Popular Games. We see a larger portion of packaged goods games sales concentrated on the most popular titles, and those titles are typically sequels of prior games. We have responded to this trend by significantly reducing the number of games that we produce to provide greater focus on our most promising intellectual properties. We published 36 primary packaged goods titles in fiscal year 2011, 22 in fiscal year 2012, 13 in fiscal year 2013, and in fiscal year 2014, we expect to release 11 major titles. Evolving Sales Patterns. Our business has evolved from a traditional packaged goods business model to one where our games are played on a variety of platforms including mobile devices and social networking sites. Our strategy is to transform our core intellectual properties into year-round businesses, with a steady flow of downloadable content and extensions on new platforms. Our increasingly digital, multi-platform business no longer reflects the retail sales patterns associated with traditional packaged goods launches. For example, we offer our consumers additional services and/or additional content available through online services to further enhance the gaming experience and extend the time that consumers play our games after their initial purchase. Our casual and mobile games offer free-to-play and micro-transaction models. The revenue we derive from these services has become increasingly more significant year-over-year. Our service revenue represented 24 percent, 13 percent, and 8 percent of total net revenue in fiscal year 2013, 2012, and 2011, respectively. Recent Developments Stock Repurchase Program. In July 2012, our Board of Directors authorized a program to repurchase up to $500 million of our common stock. 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 fiscal year 2013, we repurchased and retired approximately 22 million shares of our common stock for approximately $278 million under this new program. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). The preparation of these Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, contingent assets and liabilities, and revenue and expenses during the reporting periods. The policies discussed below are considered by management to be critical because they are not only important to the portrayal of our financial condition and results of operations, but also because application and interpretation of these policies requires both management judgment and estimates of matters that are inherently uncertain and unknown. As a result, actual results may differ materially from our estimates. 25 -------------------------------------------------------------------------------- Revenue Recognition, Sales Returns and Allowances, and Bad Debt Reserves We derive revenue principally from sales of interactive software games, and related content and services on (1) video game consoles (such as the PLAYSTATION 3, Xbox 360 and WiiU) and PCs, (2) mobile devices (such as the Apple iPhone and Google Android compatible phones), and (3) tablets and electronic readers (such as the Apple iPad and Amazon Kindle). 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 via the Internet (e.g., full-game downloads, micro-transactions), 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, 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., cannot be played without 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 mobile games), (2) massively multi-player online ("MMO") games (both software game and subscription sales), (3) subscriptions for our 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-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. 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. Online-Enabled Games The majority of our software games can be connected to the Internet 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 to online-enabled software games (e.g., player roster updates to Madden NFL 13) 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 26 --------------------------------------------------------------------------------these online-enabled games over the period we expect to offer the unspecified updates to the consumer ("estimated offering period"). Estimated Offering Period The offering period is not an explicitly defined period and thus, we recognize revenue over an estimated offering period, which is generally estimated to be six months beginning in the month after delivery. 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. During the first quarter of each fiscal year, 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, 2013, we evaluate all online-enabled games released between April 1, 2011 and March 31, 2012. 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. Based on the sum of these two calculations, we then consider the results from prior years, known online gameplay trends, as well as disclosed service periods for competitors' games to determine the estimated offering period for future sales. Similar computations are also made for the estimated service period related to our MMO games, which is generally estimated to be eighteen months. We are currently evaluating our estimated offering period for fiscal 2014. 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 in accordance with ASC 985-605. 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. In accordance with ASC 605, 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. Sales Returns and Allowances and Bad Debt Reserves We reduce revenue primarily 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 in the channel. 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 27 --------------------------------------------------------------------------------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 partner's 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. In the future, actual returns and price protections may materially exceed our estimates as unsold software products in the distribution channels are exposed to rapid changes in consumer preferences, market conditions or technological obsolescence due to new platforms, product updates or competing software products. While we believe we can make reliable estimates regarding these matters, these estimates are inherently subjective. Accordingly, if our estimates change, our returns and price protection allowances would change and would impact the total net revenue, accounts receivable and deferred net revenue that we report. We determine our allowance for doubtful accounts by evaluating the following: customer creditworthiness, current economic trends, historical experience, age of current accounts receivable balances, changes in financial condition or payment terms of our customers. Significant management judgment is required to estimate our allowance for doubtful accounts in any accounting period. The amount and timing of our bad debt expense and cash collection could change significantly as a result of a change in any of the evaluation factors mentioned above. Fair Value Estimates The preparation of financial statements in conformity with U.S. GAAP often requires us to determine the fair value of a particular item in order to fairly present our financial statements. Without an independent market or another representative transaction, determining the fair value of a particular item requires us to make several assumptions that are inherently difficult to predict and can have a material impact on the accounting. There are various valuation techniques used to estimate fair value. These include (1) the market approach where market transactions for identical or comparable assets or liabilities are used to determine the fair value, (2) the income approach, which uses valuation techniques to convert future amounts (for example, future cash flows or future earnings) to a single present value amount, and (3) the cost approach, which is based on the amount that would be required to replace an asset. For many of our fair value estimates, including our estimates of the fair value of acquired intangible assets, we use the income approach. Using the income approach requires the use of financial models, which require us to make various estimates including, but not limited to (1) the potential future cash flows for the asset or liability being measured, (2) the timing of receipt or payment of those future cash flows, (3) the time value of money associated with the expected receipt or payment of such cash flows, and (4) the inherent risk associated with the cash flows (risk premium). Making these cash flow estimates is inherently difficult and subjective, and if any of the estimates used to determine the fair value using the income approach turns out to be inaccurate, our financial results may be negatively impacted. Furthermore, relatively small changes in many of these estimates can have a significant impact to the estimated fair value resulting from the financial models or the related accounting conclusion reached. For example, a relatively small change in the estimated fair value of an asset may change a conclusion as to whether an asset is impaired. While we are required to make certain fair value assessments associated with the accounting for several types of transactions, the following areas are the most sensitive to these assessments: Business Combinations. We must estimate the fair value of assets acquired, liabilities and contingencies assumed, acquired in-process technology, and contingent consideration issued in a business combination. Our assessment of the estimated fair value of each of these can have a material effect on our reported results as intangible assets are amortized over various estimated useful lives. Furthermore, a change in the estimated fair value of an asset or liability often has a direct impact on the amount we recognize as goodwill, which is an asset that is not amortized. Determining the fair value of assets acquired requires an assessment of the highest and best use or the expected price to sell the asset and the related expected future cash flows. Determining the fair value of acquired in-process technology also requires an assessment of our expectations related to the use of that asset. Determining the fair value of an assumed liability requires an assessment of the expected cost to transfer the liability. Determining the fair value of contingent consideration requires an assessment of the probability-weighted expected future cash flows over the period in which the obligation is expected to be settled, and applying a discount rate that appropriately captures the risk associated with the obligation. The significant unobservable input used in the fair value measurement of the contingent consideration payable are forecasted earnings. Significant changes in forecasted earnings 28 -------------------------------------------------------------------------------- would result in significantly higher or lower fair value measurement. This fair value assessment is also required in periods subsequent to a business combination. Such estimates are inherently difficult and subjective and can have a material impact on our Consolidated Financial Statements. Assessment of Impairment of Goodwill, Intangibles, and Other Long-Lived Assets. Current accounting standards require that we assess the recoverability of our finite lived acquisition-related intangible assets and other long-lived assets whenever events or changes in circumstances indicate the remaining value of the assets recorded on our Consolidated Balance Sheets is potentially impaired. In order to determine if a potential impairment has occurred, management must make various assumptions about the estimated fair value of the asset by evaluating future business prospects and estimated future cash flows. For some assets, our estimated fair value is dependent upon predicting which of our products will be successful. This success is dependent upon several factors, which are beyond our control, such as which operating platforms will be successful in the marketplace. Also, our revenue and earnings are dependent on our ability to meet our product release schedules. In assessing impairment on our goodwill, we first analyze qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The qualitative factors we assess include long-term prospects of our performance, share price trends, and Company specific events. If we conclude it is more likely than not that the fair value of a reporting unit exceeds its carrying amount, we do not need to perform the two-step impairment test. If based on that assessment, we believe it is more likely than not that the fair value of the reporting unit is less than its carrying value, a two-step goodwill impairment test will be performed. The first step measures for impairment by applying fair value-based tests at the reporting unit level. The second step (if necessary) measures the amount of impairment by applying fair value-based tests to the individual assets and liabilities within each reporting unit. Reporting units are determined by the components of operating segments that constitute a business for which (1) discrete financial information is available and (2) segment management regularly reviews the operating results of that component. We determined that it was more likely than not that the fair value of our reporting unit exceeded its carrying amount, and, as such, we did not need to perform the two-step impairment test. To determine the fair value of each reporting unit used in the first step, we use the market approach, which utilizes comparable companies' data, the income approach, which utilizes discounted cash flows, or a combination thereof. Determining whether an event or change in circumstances does or does not indicate that the fair value of a reporting unit is below its carrying amount is inherently subjective. Each step requires us to make judgments and involves the use of significant estimates and assumptions. These estimates and assumptions include long-term growth rates, tax rates, and operating margins used to calculate projected future cash flows, risk-adjusted discount rates based on a weighted average cost of capital, future economic and market conditions and determination of appropriate market comparables. As of our last annual assessment of goodwill in the fourth quarter of fiscal year 2013, we concluded that the estimated fair value of our reporting unit significantly exceeded its carrying amount and we have not identified any indicators of impairment since that assessment. Our estimates for market growth, our market share and costs are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates we are using to manage the underlying business. Our business consists of developing, marketing and distributing video game software using both established and emerging intellectual properties and our forecasts for emerging intellectual properties are based upon internal estimates and external sources rather than historical information and have an inherently higher risk of inaccuracy. If future forecasts are revised, they may indicate or require future impairment charges. We base our fair value estimates on assumptions we believe to be reasonable, but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates. 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 generally at the greater of the contractual rate or an effective royalty rate based on the total projected net revenue for contracts with guaranteed minimums. Significant judgment is required to estimate the effective royalty rate for a particular contract. Because the computation of effective royalty rates requires us to project future revenue, it is inherently subjective as 29 -------------------------------------------------------------------------------- our future revenue projections must anticipate a number of factors, including (1) the total number of titles subject to the contract, (2) the timing of the release of these titles, (3) the number of software units we expect to sell, which can be impacted by a number of variables, including product quality, the timing of the title's release and competition, and (4) future pricing. Determining the effective royalty rate for our titles is particularly challenging due to the inherent difficulty in predicting the popularity of entertainment products. Furthermore, if we conclude that we are unable to make a reasonably reliable forecast of projected net revenue, we recognize royalty expense at the greater of contract rate or on a straight-line basis over the term of the contract. Accordingly, if our future revenue projections change, our effective royalty rates would change, which could impact the amount and timing of royalty expense we recognize. 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. 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 sales. Any impairments or losses determined before the launch of a product are 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 generally using undiscounted cash flows when impairment indicators exist. 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. Income Taxes 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 carry forwards. We record a valuation allowance against deferred tax assets when it is considered more likely than not that all or a portion of our deferred tax assets will not be realized. In making this determination, we are required to give significant weight to evidence that can be objectively verified. It is generally difficult to conclude that a valuation allowance is not needed when there is significant negative evidence, such as cumulative losses in recent years. Forecasts of future taxable income are considered to be less objective than past results, particularly in light of the economic environment. Therefore, cumulative losses weigh heavily in the overall assessment. In addition to considering forecasts of future taxable income, we are also required to evaluate and quantify other possible sources of taxable income in order to assess the realization of our deferred tax assets, namely the reversal of existing deferred tax liabilities, the carry back of losses and credits as allowed under current tax law, and the implementation of tax planning strategies. Evaluating and quantifying these amounts involves significant judgments. Each source of income must be evaluated based on all positive and negative evidence; this evaluation involves assumptions about future activity. Certain taxable temporary differences that are not expected to reverse during the carry forward periods permitted by tax law cannot be considered as a source of future taxable income that may be available to realize the benefit of deferred tax assets. Based on the assumptions and requirements noted above, we have recorded a valuation allowance against most of our U.S. deferred tax assets. In addition, we expect to provide a valuation allowance on future U.S. tax benefits until we can sustain a level of profitability in the United States, or until other significant positive evidence arises that suggest that these benefits are more likely than not to be realized. In the ordinary course of our business, there are many transactions and calculations where the tax law and ultimate tax determination is uncertain. As part of the process of preparing our Consolidated Financial Statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate prior to the completion and filing of tax returns for such periods. This process requires estimating both our geographic mix of income and our uncertain tax positions in each jurisdiction where we operate. These estimates involve complex issues and require us to make judgments about the likely application of the tax law to our situation, as well as with respect to other matters, such as anticipating the positions that we will 30 -------------------------------------------------------------------------------- take on tax returns prior to our actually preparing the returns and the outcomes of disputes with tax authorities. The ultimate resolution of these issues may take extended periods of time due to examinations by tax authorities and statutes of limitations. In addition, changes in our business, including acquisitions, changes in our international corporate structure, changes in the geographic location of business functions or assets, changes in the geographic mix and amount of income, as well as changes in our agreements with tax authorities, valuation allowances, applicable accounting rules, applicable tax laws and regulations, rulings and interpretations thereof, developments in tax audit and other matters, and variations in the estimated and actual level of annual pre-tax income can affect the overall effective income tax rate. We historically have considered undistributed earnings of our foreign subsidiaries to be indefinitely reinvested outside of the United States, and accordingly, no U.S. taxes have been provided thereon. We currently intend to continue to indefinitely reinvest the undistributed earnings of our foreign subsidiaries outside of the United States. RESULTS OF OPERATIONS Our fiscal year is reported on a 52- or 53-week period that ends on the Saturday nearest March 31. Our results of operations for the fiscal years ended March 31, 2013, 2012, and 2011 each contained 52 weeks and ended on March 30, 2013, March 31, 2012, and April 2, 2011, respectively. For simplicity of disclosure, all fiscal periods are referred to as ending on a calendar month-end. Net Revenue Net revenue consists of sales generated from (1) video games sold as packaged goods or as digital downloads and designed for play on video game consoles (such as the PLAYSTATION 3, Xbox 360 and WiiU) and PCs, (2) video games for mobile devices (such as the Apple iPhone and Google Android compatible phones), (3) video games for tablets and electronic readers (such as the Apple iPad and Amazon Kindle), (4) separate software products and content and online game services associated with these products, (5) programming third-party websites with our game content, (6) allowing other companies to manufacture and sell our products in conjunction with other products, and (7) advertisements on our online web pages and in our games. We provide three different measures of our Net Revenue. Two of these measures are presented in accordance with U.S. GAAP - (1) Net Revenue by Product revenue and Service and other revenue and (2) Net Revenue by Geography. The third measure is a non-GAAP financial measure - Net Revenue before Revenue Deferral by Revenue Composition, which is primarily based on method of distribution. We use this third non-GAAP financial measure internally to evaluate our operating performance, when planning, forecasting and analyzing future periods, and when assessing the performance of our management team. Management places a greater emphasis and focus on assessing our business through a review of the Net Revenue before Revenue Deferral by Revenue Composition than by Net Revenue by Product revenue and Service and other revenue. These two measures differ as (1) Net Revenue by Product revenue and Service and other revenue reflects the deferral and recognition of revenue in periods subsequent to the date of sale due to U.S. GAAP while Net Revenue before Revenue Deferral by Revenue Composition does not, and (2) both measures contain a different aggregation of sales from one another. For instance, Service and other revenue does not include the majority of our full-game digital download and mobile sales that are fully included in our Digital revenue. Further, Service and other revenue includes all of our revenue associated with MMO games while software sales associated with our MMOs are included in either Digital revenue or Publishing and other revenue depending on whether the sale was a full-game digital download or a packaged goods sale. Comparison of Fiscal Year 2013 to Fiscal Year 2012 Net Revenue For fiscal year 2013, net revenue was $3,797 million and decreased $346 million, or 8 percent, as compared to fiscal year 2012. This decrease was driven by a $1,181 million decrease in revenue primarily from the Battlefield, Crysis, Dragon Age, Portal, and Need for Speed franchises. This decrease was partially offset by an $835 million increase in revenue primarily from the FIFA, Mass Effect, and FIFA Street franchises. 31 --------------------------------------------------------------------------------Net Revenue by Product Revenue and Service and Other Revenue Our total net revenue by product revenue and service and other revenue for fiscal years 2013 and 2012 was as follows (in millions): Year Ended March 31, 2013 2012 $ Change % Change Net revenue: Product $ 2,738 $ 3,415 $ (677 ) (20 )% Service and other 1,059 728 331 45 % Total net revenue $ 3,797 $ 4,143 $ (346 ) (8 )% Product Revenue For fiscal year 2013, product revenue was $2,738 million, primarily driven by FIFA 13, Battlefield 3, and Madden NFL 13. Product revenue for fiscal year 2013 decreased $677 million, or 20 percent, as compared to fiscal year 2012. This decrease was driven by a $1,224 million decrease primarily from the Battlefield, Crysis, Dragon Age, Portal, and Need for Speed franchises. This decrease was partially offset by a $547 million increase primarily from the Mass Effect, FIFA, and FIFA Street franchises. Service and Other Revenue For fiscal year 2013, service and other revenue was $1,059 million, primarily driven by Star Wars: The Old Republic and FIFA 13 Ultimate Team, as well as Battlefield 3 Premium subscriptions. Service and other revenue for fiscal year 2013 increased $331 million, or 45 percent, as compared to fiscal year 2012. This increase was driven by a $396 million increase primarily from services associated with the FIFA and Battlefield franchises, along with Star Wars: The Old Republic (which launched in December 2011). This increase was partially offset by a $65 million decrease from Pogo-branded online game services and certain franchises including Warhammer and Ultima Online. Net Revenue by Geography Year Ended March 31, (In millions) 2013 2012 $ Change % Change North America $ 1,701 $ 1,991 $ (290 ) (15 )% Europe 1,867 1,898 (31 ) (2 )% Asia 229 254 (25 ) (10 )% Total net revenue $ 3,797 $ 4,143 $ (346 ) (8 )% Net revenue in North America was $1,701 million, or 45 percent of total net revenue for fiscal year 2013, compared to $1,991 million, or 48 percent of total net revenue for fiscal year 2012, a decrease of $290 million, or 15 percent. This decrease was driven by a $657 million decrease from certain franchises including Battlefield, Dragon Age, Portal, Crysis, and Need for Speed franchises. This decrease was offset by a $367 million increase primarily from the Mass Effect franchise, as well as Star Wars: The Old Republic and Kingdoms of Amalur: Reckoning. Net revenue in Europe was $1,867 million, or 49 percent of total net revenue during fiscal year 2013, compared to $1,898 million, or 46 percent of total net revenue during fiscal year 2012, a decrease of $31 million, or 2 percent. We estimate that foreign exchange rates (primarily due to the Euro and Swiss Franc) decreased reported net revenue in Europe by approximately $119 million, or 6 percent, for fiscal year 2013. Excluding the effect of foreign exchange rates from Net revenue in Europe, we estimate that Net revenue in Europe increased by approximately $88 million, or 4 percent, for fiscal year 2013 as compared to fiscal year 2012. Net revenue in Europe increased primarily due to our Battlefield, Crysis, Need for Speed, Dragon Age, and The Sims franchises, partially offset by decreased revenue in our FIFA, Mass Effect, and FIFA Street franchises during fiscal year 2013. Net revenue in Asia was $229 million, or 6 percent of total net revenue for fiscal year 2013, compared to $254 million, or 6 percent of total net revenue for fiscal year 2012, a decrease of $25 million, or 10 percent. We estimate that foreign exchange rates decreased reported net revenue in Asia by approximately $8 million, or 3 percent, for fiscal year 2013. Excluding the effect of foreign exchange rates from Net revenue in Asia, we estimate that Net revenue in Asia decreased by approximately $17 million, or 7 percent, for fiscal year 2013 as compared to fiscal year 2012. Net revenue in Asia decreased primarily due to decreased sales in our Crysis, Battlefield, Portal, Dragon Age, and Alice franchises partially offset by increased revenue in our FIFA, Mass Effect, and Medal of Honor franchises during fiscal year 2013. 32 -------------------------------------------------------------------------------- Supplemental Net Revenue by Revenue Composition As we continue to evolve our business and more of our products are delivered to consumers digitally, we place a greater emphasis and focus on assessing our business through a review of net revenue by revenue composition. Net Revenue before Revenue Deferral, a non-GAAP financial measure, is provided in this section of MD&A, including a discussion of the components of this measure: (1) publishing and other, (2) wireless, Internet-derived, and advertising (digital), and (3) distribution. See "Non-GAAP Financial Measures" below for an explanation of our use of this non-GAAP financial measure. A reconciliation to the corresponding measure calculated in accordance with U.S. GAAP is provided in the discussion below. "Revenue Deferral" in this "Net Revenue" section generally includes the unrecognized revenue from bundled sales of certain online-enabled games for which we do not have VSOE for the unspecified updates. Fluctuations in the Revenue Deferral are largely dependent upon the amounts of products that we sell with the online features and services previously discussed, while the Recognition of Revenue Deferral for a period is also dependent upon (1) the amount deferred, (2) the period of time the software-related offerings are to be provided, and (3) the timing of the sale. For example, most Revenue Deferrals incurred in the first half of a fiscal year are recognized within the same fiscal year; however, substantially all of the Revenue Deferrals incurred in the last month of a fiscal year will be recognized in the subsequent fiscal year. Our total net revenue by revenue composition for fiscal years 2013 and 2012 was as follows (in millions): Year Ended March 31, 2013 2012 $ Change % Change Publishing and other $ 2,028 $ 2,736 $ (708 ) (26 )% Wireless, Internet-derived, and advertising (digital) 1,663 1,227 436 36 % Distribution 102 223 (121 ) (54 )% Net Revenue before Revenue Deferral 3,793 4,186 (393 ) (9 )% Revenue Deferral (3,022 ) (3,142 ) 120 4 % Recognition of Revenue Deferral 3,026 3,099 (73 ) (2 )% Total net revenue $ 3,797 $ 4,143 $ (346 ) (8 )% Net Revenue before Revenue Deferral Publishing and Other Revenue Publishing and other revenue includes (1) sales of our internally-developed and co-published game software distributed physically through traditional channels such as brick and mortar retailers, (2) our non-software licensing revenue, and (3) our software licensing revenue from third parties (for example, makers of personal computers or computer accessories) who include certain of our products for sale with their products ("OEM bundles"). For fiscal year 2013, publishing and other Net Revenue before Revenue Deferral was $2,028 million, primarily driven by FIFA 13, Madden NFL 13, and Need for Speed Most Wanted. Publishing and other Net Revenue before Revenue Deferral for fiscal year 2013 decreased $708 million, or 26 percent, as compared to fiscal year 2012. This decrease was driven by a $1,130 million decrease in sales primarily from the Battlefield and Mass Effect franchises, as well as Star Wars: The Old Republic. This decrease was partially offset by a $422 million increase in sales primarily from the FIFA, Medal of Honor, and Dead Space franchises. Wireless, Internet-derived, and Advertising (Digital) Revenue Digital revenue includes revenue from sales of our internally-developed and co-published game software distributed through direct download through the Internet, including through our direct-to-consumer platform Origin, or distributed wirelessly through mobile carriers. This includes our full-game downloads, mobile and tablet revenue (each of which are generally classified as product revenue with the exception of our MMO game downloads and freemium mobile games which are classified as service revenue) as well as subscription services, micro-transactions, and advertising revenues (each of which is generally classified as service and other revenue). 33 -------------------------------------------------------------------------------- For fiscal year 2013, digital Net Revenue before Deferral was $1,663 million, an increase of $436 million, or 36 percent, as compared to fiscal year 2012. This increase is due to (1) a $221 million or 51 percent increase in extra content and free-to-play sales primarily driven by the FIFA and Bejeweled franchises, along with Star Wars: The Old Republic, (2) a $136 million or 47 percent increase in subscription and advertising sales primarily driven by Battlefield 3 Premium subscriptions, (3) an $86 million or 30 percent increase in mobile sales primarily driven by The Simpsons: Tapped Out and FIFA World Class Soccer. These increases were partially offset by a $7 million or 3 percent decrease in full-game download sales primarily driven by Star Wars: The Old Republic and the Battlefield franchise. Distribution Revenue For fiscal year 2013, distribution net revenue was $102 million and decreased $121 million, or 54 percent, as compared to fiscal year 2012, due to a decrease in sales primarily from the Portal franchise and to a lesser extent, our Switzerland distribution business. Revenue Deferral Revenue Deferral for fiscal year 2013 decreased $120 million, or 4 percent, as compared to fiscal year 2012. This decrease was primarily due to a $708 million decrease in Net Revenue before Revenue Deferral related to our publishing and other sales, which was partially offset by a higher percentage of digital sales being deferred and recognized over time, due in part to a 51 percent increase in extra content and free-to-play sales, a 47 percent increase in subscription and advertising revenue, a 30 percent increase in mobile sales, all of which contain an online service component requiring revenue recognition over the period of time that the service is delivered. Recognition of Revenue Deferral Our non-distribution sales are generally deferred and recognized over a weighted average six-month period, and therefore, the related revenue recognized in any fiscal year is primarily due to sales that occurred during the respective twelve months period ended December 31. The Recognition of Revenue Deferral for fiscal year 2013 decreased $73 million, or 2 percent, as compared to fiscal year 2012. This decrease was primarily due to lower publishing sales during the twelve months ended December 31, 2013 as compared to the same period in fiscal year 2012. We anticipate that our fiscal year 2014 net revenue will be lower than our fiscal year 2013 net revenue as a result of a change in our estimated offering period, partially offset by an increase in sales. While we have not completed our evaluation of our estimated offering period for fiscal year 2014, we anticipate our weighted-average estimated offering period for our products and services to be longer than our historical experience of generally six months as consumers are spending more time playing our games online. We do not expect this change in estimated offering period to impact the amount of Net Revenue before Revenue Deferral or operating cash flows we report. We expect net revenue to be up to $500 million lower than Net Revenue Before Deferral in fiscal year 2014 due primarily to the change in estimated offering period. 34 --------------------------------------------------------------------------------Product Revenue and Service and Other Revenue by Revenue Composition Our product and service and other revenue by revenue composition for fiscal years 2013 and 2012 was as follows (in millions): Year Ended March 31 2013 2012 Product revenue: Publishing and other $ 2,164 $ 2,674 Wireless, Internet-derived, and advertising (digital) 472 518 Distribution 102 223 Total product revenue 2,738 3,415 Service and other revenue: Publishing and other 91 87Wireless, Internet-derived, and advertising (digital) 968 641 Total service and other revenue 1,059 728 Total net revenue $ 3,797 $ 4,143 Non-GAAP Financial Measures Net Revenue before Revenue Deferral is a non-GAAP financial measure that excludes the impact of Revenue Deferral and the Recognition of Revenue Deferral on Net Revenue related to sales of games and digital content. We believe that excluding the impact of Revenue Deferral and the Recognition of Revenue Deferral related to games and digital content from our operating results is important to facilitate comparisons between periods in understanding our underlying sales performance for the period, and understanding our operations because all related costs of revenues are expensed as incurred instead of deferred and recognized ratably. We use this non-GAAP financial measure internally to evaluate our operating performance, when planning, forecasting and analyzing future periods, and when assessing the performance of our management team. While we believe that this non-GAAP financial measure is useful in evaluating our business, this information should be considered as supplemental in nature and is not meant to be considered in isolation from or as a substitute for the related financial information prepared in accordance with GAAP. In addition, this non-GAAP financial measure may not be the same as non-GAAP financial measures presented by other companies. Cost of Revenue Total cost of revenue for fiscal years 2013 and 2012 was as follows (in millions): % of % of Change as a Related Related % of Related March 31, 2013 Net Revenue March 31,2012 Net Revenue % Change Net Revenue Cost of revenue: Product $ 1,085 39.6 % $ 1,374 40.2 % (21.0 )% (0.6 )% Service and other 303 28.6 % 224 30.8 % 35.3 % (2.2 )% Total cost of revenue $ 1,388 36.6 % $ 1,598 38.6 % (13.1 )% (2.0 )% Cost of Product Revenue Cost of product revenue consists of (1) product costs, (2) certain royalty expenses for celebrities, professional sports and other organizations, and independent software developers, (3) manufacturing royalties, net of volume discounts and other vendor reimbursements, (4) expenses for defective products, (5) write-offs of post launch prepaid royalty costs, (6) amortization of certain intangible assets, (7) personnel-related costs, and (8) warehousing and distribution costs. We generally recognize volume discounts when they are earned from the manufacturer (typically in connection with the achievement of unit-based milestones); whereas other vendor reimbursements are generally recognized as the related revenue is recognized. 35 -------------------------------------------------------------------------------- Cost of product revenue decreased by $289 million, or 21.0 percent in fiscal year 2013, as compared to fiscal year 2012. The decrease was primarily due to a decrease in the number of titles released, which led to a 19 percent decrease in publishing and other revenue and a 54 percent decrease in distribution revenue, during fiscal year 2013, as compared to fiscal year 2012. Cost of Service and Other Revenue Cost of service and other revenue consists primarily of (1) data center and bandwidth costs associated with hosting our online games and websites, (2) associated royalty costs, (3) credit card fees associated with our service revenue, (4) server costs related to our website advertising business, and (5) platform processing fees from operating our website-based games on third party platforms. Cost of service and other revenue increased by $79 million, or 35.3 percent in fiscal year 2013, as compared to fiscal year 2012. The increase was primarily due to increased server and support costs due to the release of more online-connected and subscription-based titles and related content during fiscal year 2013, as compared to fiscal year 2012. Total Cost of Revenue as a Percentage of Total Net Revenue During fiscal year 2013, total cost of revenue as a percentage of total net revenue decreased by 2.0 percent as compared to fiscal year 2012. This decrease as a percentage of net revenue is primarily due to (1) a 54 percent decrease in distribution revenue which has higher costs and (2) a greater percentage of net revenue from our digital products and services that have a lower cost than our publishing and other products. Research and Development Research and development expenses consist of expenses incurred by our production studios for personnel-related costs, related overhead costs, contracted services, depreciation and any impairment of prepaid royalties for pre-launch products. Research and development expenses for our online products include expenses incurred by our studios consisting of direct development and related overhead costs in connection with the development and production of our online games. Research and development expenses also include expenses associated with the development of website content, software licenses and maintenance, network infrastructure and management overhead. Research and development expenses for fiscal years 2013 and 2012 were as follows (in millions): March 31, % of Net March 31, % of Net 2013 Revenue 2012 Revenue $ Change % Change $ 1,153 30 % $ 1,180 28 % $ (27 ) (2 )% Research and development expenses decreased by $27 million, or 2 percent, in fiscal year 2013, as compared to fiscal year 2012. This decrease was primarily due to (1) a $17 million decrease in incentive-based compensation expense, (2) a $14 million decrease in contracted services, and (3) a $9 million decrease in stock-based compensation expense. These decreases were partially offset by a $17 increase million in personnel-related costs. Marketing and Sales Marketing and sales expenses consist of personnel-related costs, related overhead costs, advertising, marketing and promotional expenses, net of qualified advertising cost reimbursements from third parties. Marketing and sales expenses for fiscal years 2013 and 2012 were as follows (in millions): March 31, % of Net March 31, % of Net 2013 Revenue 2012 Revenue $ Change % Change $ 788 21 % $ 883 21 % $ (95 ) (11 )% Marketing and sales expenses decreased by $95 million, or 11 percent, in fiscal year 2013, as compared to fiscal year 2012. The decrease was primarily due to (1) a $111 million decrease in advertising and promotional spending on our franchises due to fewer frontline title releases as compared to the prior year, (2) a $7 million decrease in contracted services, and (3) a $7 million decrease in incentive-based compensation expense. This was partially offset by a $29 million increase in personnel-related costs. Marketing and sales expenses included vendor reimbursements for advertising expenses of $45 million and $39 million in fiscal years 2013 and 2012, respectively. 36 -------------------------------------------------------------------------------- General and Administrative General and administrative expenses consist of personnel and related expenses of executive and administrative staff, related overhead costs, fees for professional services such as legal and accounting, and allowances for doubtful accounts. General and administrative expenses for fiscal years 2013 and 2012 were as follows (in millions): March 31, % of Net March 31, % of Net 2013 Revenue 2012 Revenue $ Change % Change $ 354 9 % $ 377 9 % $ (23 ) (6 )% General and administrative expenses decreased by $23 million, or 6 percent, in fiscal year 2013, as compared to fiscal year 2012. The decrease was primarily due to (1) a $27 million accrual related to a settlement of a litigation matter recorded in fiscal year 2012, (2) a $12 million decrease in contracted services primarily related to litigation matters, and (3) a $10 million decrease in incentive-based compensation expense. This was partially offset by an increase in personnel-related costs for $26 million. Acquisition-Related Contingent Consideration Acquisition-related contingent consideration for fiscal years 2013 and 2012 were as follows (in millions): March 31, % of Net March 31, % of Net 2013 Revenue 2012 Revenue $ Change % Change $ (64 ) (2 )% $ 11 - % $ (75 ) (682 )% Acquisition-related contingent consideration expense decreased by $75 million, or 682 percent, in fiscal year 2013, as compared to fiscal year 2012, primarily resulting from decreases in our accrual related to our PopCap acquisition. Amortization of Intangibles Amortization of intangibles for fiscal years 2013 and 2012 were as follows (in millions): March 31, % of Net March 31, % of Net 2013 Revenue 2012 Revenue $ Change % Change $ 30 1 % $ 43 1 % $ (13 ) (30 )% Amortization of intangibles decreased by $13 million, or 30 percent, in fiscal year 2013, as compared to fiscal year 2012, primarily due to certain intangible assets from our prior year acquisitions being fully amortized during fiscal year 2012. This decrease was partially offset by $5 million of impairment charges recognized in fiscal year 2013. Restructuring and Other Charges Restructuring and other charges for fiscal years 2013 and 2012 were as follows (in millions): March 31, % of Net March 31, % of Net 2013 Revenue 2012 Revenue $ Change % Change $ 27 1 % $ 16 - % $ 11 69 % During fiscal year 2013, restructuring and other charges increased by $11 million, or 69 percent, as compared to fiscal year 2012, primarily due to (1) $22 million in costs in connection with our fiscal 2013 restructuring, which was initiated in this fiscal year, and (2) a $10 million gain on the sale of our facility in Chertsey, England related to our fiscal 2008 reorganization that was recognized during fiscal year 2012, and for which there was no comparable gain in the current year. These increases were partially offset by costs that were recognized during fiscal year 2012 comprised of (1) $15 million expense adjustment for the amendment of certain licensing agreements related to our fiscal 2011 restructuring plan, and (2) $6 million in IT and other costs to assist in reorganizing certain activities. See the "Liquidity and Capital Resources" section on page 45 for additional information regarding our restructuring plans. We expect to incur $8 million non-cash accretion of interest expense through June 2016, related to the amendment of a licensing and developer agreement under our fiscal 2011 restructuring plan. We do not expect to incur any additional restructuring charges under any other prior plans. 37 -------------------------------------------------------------------------------- Gains on Strategic Investments, Net Gains on strategic investments, net, for fiscal years 2013 and 2012 were as follows (in millions): March 31, % of Net March 31, % of Net 2013 Revenue 2012 Revenue $ Change % Change $ 39 1 % $ - - % $ 39 - % During fiscal year 2013, we sold our investment in Neowiz for proceeds of $72 million, and realized a gain of $39 million, net of costs to sell. We did not recognize any impairment charges or losses on our marketable equity securities during the year ended March 31, 2013. Interest and Other Income (Expense), Net Interest and other income (expense), net, for fiscal years 2013 and 2012 were as follows (in millions): March 31, % of Net March 31, % of Net 2013 Revenue 2012 Revenue $ Change % Change $ (21 ) (1 )% $ (17 ) - % $ (4 ) (24 )% Interest and other income (expense), net increased by $4 million, or 24 percent, during fiscal year 2013 as compared to the fiscal year 2012, primarily due to (1) a $22 million change due to a $1 million loss in the current year compared to a $21 million gain in the prior year in foreign currency forward contract gains and losses, (2) a $9 million increase in interest expense, including the amortization of debt discount recognized in connection with our 0.75% Convertible Senior Notes due 2016, and (3) a $3 million decrease in interest income as a result of decreasing average cash balances. This was partially offset by a $31 million increase in foreign currency transaction gains as compared to the same period in the prior year. Income Taxes Provision for (benefit from) income taxes for fiscal years 2013 and 2012 was as follows (in millions): March 31, 2013 Effective Tax Rate March 31, 2012 Effective Tax Rate $ 41 29.5 % $ (58 ) (322.2 )% Our effective tax rate for the fiscal year 2013 was a tax expense of 29.5%. The fiscal year 2013 effective tax rate differs from the statutory rate of 35.0 percent primarily due to the U.S. losses for which no benefit is recognized and non-deductible stock-based compensation, offset by non-U.S. profits subject to reduced or zero tax rates and the nontaxable change in the estimated fair value of acquisition-related contingent consideration. Our effective tax rate for the fiscal year 2012 was a tax benefit of 322.2 percent. In fiscal year 2012, we recorded approximately $58 million of additional net deferred tax liabilities related to the PopCap and KlickNation Corporation ("KlickNation") acquisitions. These additional deferred tax liabilities create a new source of taxable income, thereby requiring us to release a portion of our deferred tax asset valuation allowance with a related reduction in income tax expense of $58 million. In addition, during the three months ended March 31, 2012, we recorded $48 million of additional tax benefits related to the expiration of statutes of limitations in non-U.S. tax jurisdictions. The fiscal year 2012 effective tax rate differs from the statutory rate of 35.0 percent as a result of the utilization of U.S. deferred tax assets subject to a valuation allowance and non-U.S. profits subject to a reduced or zero tax rate, partially offset by non-deductible stock-based compensation. In addition, the fiscal year 2012 effective tax rate is impacted by tax benefits related to the expiration of statutes of limitations and the resolution of examinations by taxing authorities, as well as a reduction in the U.S. valuation allowance related to the PopCap and KlickNation acquisitions. Our effective income tax rates for fiscal year 2014 and future periods will depend on a variety of factors, including changes in the deferred tax valuation allowance, changes in our business such as acquisitions and intercompany transactions, changes in our international structure, changes in the geographic location of business functions or assets, changes in the geographic mix of income, changes in or termination of our agreements with tax authorities, applicable accounting rules, applicable tax laws and regulations, rulings and interpretations thereof, developments in tax audit and other matters, and variations in our annual pre-tax income or loss. We incur certain tax expenses that do not decline proportionately with declines in our pre-tax consolidated income or loss. As a result, in absolute dollar terms, our tax expense will have a greater influence on our effective tax rate at lower levels of pre-tax income or loss than at higher levels. In addition, at lower levels of pre-tax income or loss, our effective tax rate will be more volatile. 38 -------------------------------------------------------------------------------- Certain taxable temporary differences that are not expected to reverse during the carry forward periods permitted by tax law have not been considered as a source of future taxable income that is available to realize the benefit of deferred tax assets. The American Taxpayer Relief Act of 2012 (the "Act") was signed into law on January 2, 2013. The Act contains a number of provisions including, most notably, an extension of the research tax credit through December 31, 2013. The Act did not have a material impact on our effective tax rate for fiscal 2013 due to the effect of the valuation allowance on our deferred tax assets. We historically have considered undistributed earnings of our foreign subsidiaries to be indefinitely reinvested outside of the United States and, accordingly, no U.S. taxes have been provided thereon. We currently intend to continue to indefinitely reinvest the undistributed earnings of our foreign subsidiaries outside of the United States. Comparison of Fiscal Year 2012 to Fiscal Year 2011 Net Revenue For fiscal year 2012, Net Revenue was $4,143 million and increased $554 million, or 15 percent, as compared to fiscal year 2011. This increase was driven by a $1,312 million increase in revenue primarily from the Battlefield, Crysis, and FIFA franchises. This increase was offset by a $758 million decrease in revenue primarily from the Medal of Honor, FIFA World Cup, and Army of Two franchises, as well as Dante's Inferno, for which there were no iterations in fiscal year 2012. Net Revenue by Product Revenue and Service and Other Revenue Our total net revenue by product revenue and service and other revenue for the fiscal years ended March 31, 2012 and 2011 was as follows (in millions): Year Ended March 31, 2012 2011 $ Change % Change Net revenue: Product $ 3,415 $ 3,181 $ 234 7 % Service and other 728 408 320 78 % Total net revenue $ 4,143 $ 3,589 $ 554 15 % Product Revenue For fiscal year 2012, product revenue was $3,415 million, primarily driven by FIFA 12, Battlefield 3, and Madden NFL 12. Product revenue for fiscal year 2012 increased $234 million, or 7 percent, as compared to fiscal year 2011. This increase was driven by a $937 million increase primarily from the Battlefield, Crysis, and FIFA franchises. This increase was offset by a $703 million decrease primarily from the FIFA World Cup, Medal of Honor, Rock Band, and Army of Two franchises, as well as Dante's Inferno. Service and Other Revenue For fiscal year 2012, service and other revenue was $728 million, primarily driven by (1) Star Wars: The Old Republic, which was launched in the third quarter, (2) our micro-transactions revenue from browser-based games including games played on Facebook such as The Sims Social, and (3) our FIFA Ultimate Team add-on game service. Service and other revenue for fiscal year 2012 increased $320 million, or 78 percent, as compared to fiscal year 2011. This increase was primarily driven by a $351 million increase from certain services associated with the FIFA and The Sims franchises, as well as Star Wars: The Old Republic. This increase was partially offset by a $31 million decrease in service revenue generated by our Pogo-branded online game services and the Warhammer and Ultima Online MMO franchises. In fiscal year 2013, we expect to increase our total service revenue as compared to fiscal year 2012. 39 -------------------------------------------------------------------------------- Net Revenue by Geography Year Ended March 31, (In millions) 2012 2011 $ Change % Change North America $ 1,991 $ 1,836 $ 155 8 % Europe 1,898 1,563 335 21 % Asia 254 190 64 34 % Total net revenue $ 4,143 $ 3,589 $ 554 15 % Net revenue in North America was $1,991 million, or 48 percent of total net revenue for fiscal year 2012, compared to $1,836 million, or 51 percent of total net revenue for fiscal year 2011, an increase of $155 million, or 8 percent. Net revenue in Europe and Asia was $2,152 million, or 52 percent of total net revenue for fiscal year 2012, compared to $1,753 million, or 49 percent of total net revenue for fiscal year 2011, an increase of $399 million, or 23 percent. The rapid increase in revenue outside of North America was primarily the result of increased sales from our FIFA, Battlefield, and Crysis franchises in Europe. Additionally, the value of the U.S. dollar relative to foreign currencies contributed to an increase of total reported net revenue of approximately $143 million (primarily the Swiss Franc and Australian Dollar), or 3 percent of total net revenue. Supplemental Net Revenue by Revenue Composition Our total net revenue by revenue composition for the fiscal years ended March 31, 2012 and 2011 was as follows (in millions): Year Ended March 31, 2012 2011 $ Change % Change Publishing and other $ 2,736 $ 2,781 $ (45 ) (2 )% Wireless, Internet-derived, and advertising (digital) 1,227 833 394 47 % Distribution 223 214 9 4 % Net Revenue before Revenue Deferral 4,186 3,828 358 9 % Revenue Deferral (3,142 ) (2,769 ) (373 ) 13 % Recognition of Revenue Deferral 3,099 2,530 569 22 % Net Revenue $ 4,143 $ 3,589 $ 554 15 % Net Revenue before Revenue Deferral Publishing and Other Revenue For fiscal year 2012, publishing and other Net Revenue before Revenue Deferral was $2,736 million, primarily driven by Battlefield 3, FIFA 12, and Madden NFL 12. Publishing and other Net Revenue before Revenue Deferral for fiscal year 2012 decreased $45 million, or 2 percent, as compared to fiscal year 2011. This decrease was driven by a $1,163 million decrease in sales primarily from the Medal of Honor, Need for Speed, FIFA World Cup, Dragon Age, and Dead Space franchises. This decrease was offset by a $1,118 million increase in sales primarily from the Battlefield, Mass Effect, and FIFA franchises. Wireless, Internet-derived, and Advertising (Digital) Revenue For fiscal year 2012, digital Net Revenue before Deferral was $1,227 million, an increase of $394 million, or 47 percent, as compared to fiscal year 2011. This increase was driven by a $452 million increase in sales primarily from the FIFA and The Sims franchises, as well as Star Wars: The Old Republic. This increase was offset by a $58 million decrease in sales primarily from the Tetris and Warhammer franchises, as well as a decrease in sales generated by our Pogo-branded online services. Distribution Revenue Distribution revenue includes (1) sales of game software developed by independent game developers that we distribute and (2) sales through our Switzerland distribution business. For fiscal year 2012, distribution Net Revenue was $223 million and increased $9 million, or 4 percent, as compared to fiscal year 2011 driven by an $89 million increase in sales in the Portal franchise. This increase was offset by an $80 million decrease primarily driven by a decrease in sales in the Rock Band franchise. 40 -------------------------------------------------------------------------------- Revenue Deferral Revenue Deferral for fiscal year 2012 increased $373 million, or 13 percent, as compared to fiscal year 2011. This increase was primarily due to (1) a 47 percent increase in our current year digital sales and (2) a higher percentage of both our publishing and digital sales being deferred and recognized over time, due in part to a 135 percent increase in full-game download sales and a 47 percent increase in micro-transaction sales, of which both contain an online service component which requires revenue recognition as the service is delivered. Recognition of Revenue Deferral The vast majority of our sales are deferred and recognized over a six month period, and therefore, the related revenue recognized in any fiscal year is primarily due to sales that occurred during the respective twelve months period ended December 31. The Recognition of Revenue Deferral for fiscal year 2012 increased $569 million, or 22 percent, as compared to fiscal year 2011. This increase was primarily due to increased publishing and digital sales during the twelve months ended December 31, 2012, and a higher percentage of those sales being comprised of games sales that have an online service component, as compared to the same period in fiscal year 2011. Product Revenue and Service and Other Revenue by Revenue Composition Our product and service and other revenue by revenue composition for the fiscal years 2012 and 2011 was as follows (in millions): Year Ended March 31, 2012 2011 Product revenue: Publishing and other $ 2,674 $ 2,558 Wireless, Internet-derived, and advertising (digital) 518 409 Distribution 223 214 Total product revenue 3,415 3,181 Service and other revenue: Publishing and other 87 74 Wireless, Internet-derived, and advertising (digital) 641 334 Total service and other revenue 728 408 Total net revenue $ 4,143 $ 3,589 Cost of Revenue Total cost of revenue for fiscal years 2012 and 2011 was as follows (in millions): % of % of Change as a March 31, Related Net March 31, Related Net % of Related 2012 Revenue 2011 Revenue % Change Net Revenue Cost of revenue: Product $ 1,374 40.2 % $ 1,407 44.2 % (2.3 )% (4.0 )% Service and other 224 30.8 % 92 22.5 % 143.5 % 8.3 % Total cost of revenue $ 1,598 38.6 % $ 1,499 41.8 % 6.6 % (3.2 )% Cost of Product Revenue Cost of product revenue decreased by $33 million, or 2.3 percent in fiscal year 2012, as compared to fiscal year 2011. The decrease was primarily due to a 135 percent increase in full-game downloads that have a lower cost than our other products in fiscal year 2012 as compared to fiscal year 2011. Cost of Service and Other Revenue Cost of service and other revenue increased by $132 million, or 143.5 percent in fiscal year 2012, as compared to fiscal year 2011. The increase was primarily due to increased server and support costs due to the release of more online-connected and subscription-based titles and related content during fiscal year 2012 as compared to fiscal year 2011. As our service revenue in 41 -------------------------------------------------------------------------------- fiscal year 2013 is expected to increase as compared to fiscal year 2012, we expect a corresponding increase in our service and support costs. Total Cost of Revenue as a Percentage of Total Net Revenue During fiscal year 2012, total cost of revenue as a percentage of total net revenue decreased by 3.2 percent as compared to fiscal year 2011. This decrease as a percentage of net revenue was primarily due to (1) a greater percentage of net revenue from our digital products, that have a lower cost than our other products, which positively impacted gross profit as a percentage of total revenue by approximately 3.5 percent and (2) a $196 million decrease in the change in deferred net revenue related to certain online-enabled games for fiscal year 2012 as compared to fiscal year 2011, which positively impacted gross profit as a percent of total net revenue by 2.2 percent. These decreases are partially offset by (1) increased expenses related to our online and customer experience initiatives, which negatively impacted gross profit as a percentage of total net revenue by 1.2 percent, (2) an increase in amortization of our acquisition-related intangibles resulting mainly from the PopCap acquisition in fiscal year 2012, which negatively impacted gross profit as a percentage of total net revenue by 0.9 percent, and (3) an increase in sales of our distribution products which carry a higher royalty percentage than our other products, which negatively impacted gross profit as a percentage of total net revenue by 0.9 percent. Research and Development Research and development expenses for fiscal years 2012 and 2011 were as follows (in millions): March 31, % of Net March 31, % of Net 2012 Revenue 2011 Revenue $ Change % Change $ 1,180 28 % $ 1,124 31 % $ 56 5 % Research and development expenses increased by $56 million, or 5 percent, in fiscal year 2012, as compared to fiscal year 2011. This increase was primarily due to (1) a $66 million increase in personnel-related costs and (2) a $13 million increase in facilities-related expenses both primarily resulting from an increase in headcount in connection with recent acquisitions. These increases were partially offset by a $23 million decrease in development costs primarily due to a decrease in titles under development. Marketing and Sales Marketing and sales expenses for fiscal years 2012 and 2011 were as follows (in millions): March 31, % of Net March 31, % of Net 2012 Revenue 2011 Revenue $ Change % Change $ 883 21 % $ 781 22 % $ 102 13 % Marketing and sales expenses increased by $102 million, or 13 percent, in fiscal year 2012, as compared to fiscal year 2011. The increase was primarily due to (1) a $48 million increase in additional personnel-related costs resulting from an increase in headcount in connection with recent acquisitions, (2) a $29 million increase in marketing, advertising and promotional spending, and (3) an $18 million increase in contracted service costs related to online and customer relationship initiatives. Marketing and sales expenses included vendor reimbursements for advertising expenses of $39 million and $31 million in fiscal years 2012 and 2011, respectively. General and Administrative General and administrative expenses for fiscal years 2012 and 2011 were as follows (in millions): March 31, % of Net March 31, % of Net 2012 Revenue 2011 Revenue $ Change % Change $ 377 9 % $ 296 8 % $ 81 27 % General and administrative expenses increased by $81 million, or 27 percent, in fiscal year 2012, as compared to fiscal year 2011. The increase was primarily due to (1) a $35 million increase in contracted service costs related to online initiatives, litigation, and recent acquisitions, (2) a $27 million accrual related to a potential settlement of an on-going litigation matter, (3) a $17 million increase in additional personnel-related costs resulting from an increase in headcount in connection with recent acquisitions, and (4) a $13 million increase in bad debt expense. These increases were partially offset by a $14 million decrease in facility overhead costs. 42 -------------------------------------------------------------------------------- Acquisition-Related Contingent Consideration Acquisition-related contingent consideration for fiscal years 2012 and 2011 were as follows (in millions): March 31, % of Net March 31, % of Net 2012 Revenue 2011 Revenue $ Change % Change $ 11 - % $ (17 ) - % $ 28 165 % Acquisition-related contingent consideration expense increased by $28 million, or 165 percent, in fiscal year 2012, as compared to fiscal year 2011, primarily related to (1) a $19 million prior year decrease of our accrual in connection with our Playfish acquisition resulting from revisions in our estimate of the expected future cash flows over the period in which the obligation was expected to be settled with no comparable revision to decrease the accrual in fiscal year 2012 and (2) a contributing increase of $9 million resulting from contingent consideration from other acquisitions in the current year. Amortization of Intangibles Amortization of intangibles for fiscal years 2012 and 2011 were as follows (in millions): March 31, % of Net March 31, % of Net 2012 Revenue 2011 Revenue $ Change % Change $ 43 1 % $ 57 2 % $ (14 ) (25 )% Amortization of intangibles decreased by $14 million, or 25 percent, in fiscal year 2012, as compared to fiscal year 2011. This decrease was primarily due to certain intangible assets from our prior year acquisitions being fully amortized during the fiscal year 2012. Restructuring and Other Charges Restructuring and other charges for fiscal years 2012 and 2011 were as follows (in millions): March 31, % of Net March 31, % of Net 2012 Revenue 2011 Revenue $ Change % Change $ 16 - % $ 161 4 % $ (145 ) (90 )% Restructuring and other charges decreased by $145 million, or 90 percent, in fiscal year 2012, as compared to fiscal year 2011, due to (1) no new restructuring initiatives in fiscal year 2012 and (2) a gain of $10 million recognized during the second quarter of fiscal year 2012 on the sale of our facility in Chertsey, England related to our fiscal year 2008 reorganization. These items are partially offset by adjustments to the estimated loss for the amendment of certain licensing agreements related to our fiscal 2011 restructuring. Gains on Strategic Investments, Net Gains on strategic investments, net, for fiscal years 2012 and 2011 were as follows (in millions): March 31, % of Net March 31, % of Net 2012 Revenue 2011 Revenue $ Change % Change $ - - % $ 23 1 % $ (23 ) (100 )% We did not recognize any impairment charges or losses during the year ended March 31, 2012. During the year ended March 31, 2011, we realized a gain of $28 million, net of costs to sell, from the sale of our investment in Ubisoft. Interest and Other Income (Expense), Net Interest and other income (expense), net, for fiscal years 2012 and 2011 were as follows (in millions): March 31, % of Net March 31, % of Net 2012 Revenue 2011 Revenue $ Change % Change $ (17 ) - % $ 10 - % $ (27 ) (270 )% Interest and other income (expense), net decreased by $27 million, or 270 percent, during fiscal year 2012 as compared to fiscal year 2011, primarily due to (1) a $19 million increase in interest expense due to our 0.75% Convertible Senior Notes due 2016, which were issued in July 2011 and (2) an $8 million increase in foreign currency transaction losses as compared to the same period in the prior year. 43 -------------------------------------------------------------------------------- Income Taxes Benefit from income taxes for fiscal years 2012 and 2011 was as follows (in millions): March 31, 2012 Effective Tax Rate March 31, 2011 Effective Tax Rate $ (58 ) (322.2 )% $ (3 ) (1.1 )% Our effective tax rate for the fiscal year 2012 was a tax benefit of 322.2 percent. Our effective tax rate for the fiscal year 2011 was a tax benefit of 1.1 percent. In fiscal year 2012 we recorded approximately $58 million of additional net deferred tax liabilities related to the PopCap and KlickNation acquisitions. These additional deferred tax liabilities create a new source of taxable income, thereby requiring us to release a portion of our deferred tax asset valuation allowance with a related reduction in income tax expense of $58 million. In addition, during the three months ended March 31, 2012, we recorded $48 million of additional tax benefits related to the expiration of statutes of limitations in non-U.S. tax jurisdictions. Consistent with prior years, the fiscal year 2012 effective tax rate continues to differ from the statutory rate of 35.0 percent as a result of the utilization of U.S. deferred tax assets subject to a valuation allowance and non-U.S. profits subject to a reduced or zero tax rate, partially offset by non-deductible stock-based compensation. In addition, the fiscal year 2012 effective tax rate is impacted by tax benefits related to the expiration of statutes of limitations and the resolution of examinations by taxing authorities, as well as a reduction in the U.S. valuation allowance related to the PopCap and KlickNation acquisitions. In fiscal year 2011, the effective tax rate differs from the statutory rate of 35.0 percent primarily due to U.S. losses for which no benefit is recognized, non-U.S. losses with a reduced or zero tax benefit and non-deductible stock-based compensation expenses, partially offset by tax benefits related to the expiration of statutes of limitations and resolution of examination by taxing authorities. Impact of Recently Issued Accounting Standards In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities, which creates new disclosure requirements about the nature of an entity's rights of offset and related arrangements associated with its financial instruments and derivative instruments. In January 2013, the FASB issued ASU 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, to address concerns expressed by preparers while still providing useful information about certain transactions involving master netting arrangements. The new disclosures are designed to make financial statements that are prepared under U.S. GAAP more comparable to those prepared under International Financial Reporting Standards. The disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein, with retrospective application required. We do not expect the adoption of ASU 2011-11 and ASU 2013-01 to have a material impact on our Consolidated Financial Statements. In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, effective prospectively for fiscal years beginning after December 15, 2012. The amendments of this ASU require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income ("AOCI") by component. In addition, an entity is required to present, either on the face of the statement where net income (loss) is presented or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. We do not expect the adoption of ASU 2013-02 to have a material impact on our Consolidated Financial Statements. 44 --------------------------------------------------------------------------------LIQUIDITY AND CAPITAL RESOURCES As of March 31, (In millions) 2013 2012 Decrease Cash and cash equivalents $ 1,292 $ 1,293 $ (1 ) Short-term investments 388 437 (49 ) Marketable equity securities - 119 (119 ) Total $ 1,680 $ 1,849 $ (169 ) Percentage of total assets 33 % 34 % Year Ended March 31, (In millions) 2013 2012 Change Cash provided by operating activities $ 324 $ 277 $ 47 Cash provided by (used in) investing activities 32 (689 ) 721 Cash provided by (used in) financing activities (345 ) 140 (485 ) Effect of foreign exchange on cash and cash equivalents (12 ) (14 ) 2 Net decrease in cash and cash equivalents $ (1 ) $ (286 ) $ 285 Changes in Cash Flow Operating Activities. Cash provided by operating activities increased $47 million during the fiscal year ended March 31, 2013 as compared to the fiscal year ended March 31, 2012, primarily due to (1) a decrease in prepaid royalty advances, (2) a decrease in royalty payments, and (3) a decrease in marketing and advertising spend as a result of a decrease in the number of titles released as compared to the prior year. These decreases in cash outflows were offset by an increase in personnel-related costs. Investing Activities. Cash provided by investing activities increased $721 million during the fiscal year ended March 31, 2013, as compared to the fiscal year ended March 31, 2012, primarily driven by (1) a $666 million decrease in cash used for acquisitions, the majority of which was used to fund our acquisition of PopCap during the six months ended September 30, 2011, (2) proceeds of $72 million from the sale of our marketable equity securities, (3) a decrease of $66 million in capital expenditures, and (4) a $54 million decrease in the amount of short-term investments purchased in fiscal year 2013 as compared to fiscal year 2012. This was partially offset by a $67 million decrease in proceeds from maturities and sales of short-term investments in fiscal year 2013 as compared to fiscal year 2012. Financing Activities. Cash used in financing activities increased $485 million during the fiscal year ended March 31, 2013, as compared to the fiscal year ended March 31, 2012 primarily due to (1) $617 million in proceeds received from the sale of our 0.75% Convertible Senior Notes due 2016, net of issuance costs that occurred in fiscal year 2012, (2) $65 million in proceeds received from the issuance of Warrants in connection with the Notes in the fiscal year 2012, and (3) a $23 million decrease in proceeds received from issuance of common stock in connection with our Employee Stock Purchase Plan during fiscal year 2013 as compared to fiscal year 2012. This was partially offset by (1) a $122 million decrease in the repurchase and retirement of common stock during fiscal year 2013 as compared to fiscal year 2012, and (2) $107 million paid for the purchase of the Convertible Note Hedge during fiscal year 2012. Short-term Investments and Marketable Equity Securities Due to our mix of fixed and variable rate securities, our short-term investment portfolio is susceptible to changes in short-term interest rates. As of March 31, 2013, our short-term investments had gross unrealized gains of $1 million, or less than 1 percent of the total in short-term investments, and gross unrealized losses of less than $1 million, or less than 1 percent of the total in short-term investments. From time to time, we may liquidate some or all of our short-term investments to fund operational needs or other activities, such as capital expenditures, business acquisitions or stock repurchase programs. Depending on which short-term investments we liquidate to fund these activities, we could recognize a portion, or all, of the gross unrealized gains or losses. Our marketable equity securities as of March 31, 2012 consisted of common shares of Neowiz. The fair value of our marketable equity securities decreased by $119 million in fiscal year 2013. The decrease is attributed to the sale of our 45 -------------------------------------------------------------------------------- investment in Neowiz during fiscal year 2013. We received proceeds of $72 million and realized a gain of $39 million, net of costs to sell. The realized gain is included in gains on strategic investments, net, in our Consolidated Statements of Operations. Contingent Consideration As of March 31, 2013, primarily in connection with our acquisitions of PopCap, KlickNation, and Chillingo Limited ("Chillingo"), we may be required to pay an additional $566 million of cash consideration based upon the achievement of certain performance milestones through March 31, 2015. As of March 31, 2013, we have accrued $43 million of contingent consideration on our Consolidated Balance Sheet representing the estimated fair value of the contingent consideration. We have not paid any earn-out to date for the PopCap acquisition. Fiscal 2013 Restructuring On May 7, 2012, we announced a restructuring plan to align our cost structure with our ongoing digital transformation. Under this plan, we reduced our workforce, terminated licensing agreements, and consolidated or closed various facilities. As of March 31, 2013, we have completed all actions under this restructuring plan. Since the inception of the fiscal 2013 restructuring plan through March 31, 2013, we have incurred charges of $22 million, consisting of (1) $10 million in employee-related expenses, (2) $9 million related to license termination costs, and (3) $3 million related to the closure of certain of our facilities. Substantially all of these costs have been settled in cash as of March 31, 2013, with the exception of approximately $3 million of license and lease termination costs, which will be settled by August 2016. We expect to incur cash expenditures through August 2016 of approximately $2 million through fiscal year 2015 and less than $1 million thereafter. Fiscal 2011 Restructuring In connection with our fiscal 2011 restructuring plan, we expect to incur cash expenditures through June 2016 of approximately (1) $26 million in fiscal year 2014, (2) $18 million in fiscal year 2015, (3) $3 million in fiscal year 2016, and (4) $18 million in fiscal year 2017. The actual cash expenditures are variable as they will be dependent upon the actual revenue we generate from certain games. Financing Arrangement In July 2011, we issued $632.5 million aggregate principal amount of 0.75% Convertible Senior Notes due 2016 (the "Notes"). The Notes are senior unsecured obligations which pay interest semi-annually in arrears at a rate of 0.75 percent per annum on January 15 and July 15 of each year, beginning on January 15, 2012 and will mature on July 15, 2016, unless earlier purchased or converted in accordance with their terms prior to such date. The Notes are convertible into cash and shares of our common stock based on an initial conversion value of 31.5075 shares of our common stock per $1,000 principal amount of Notes (equivalent to an initial conversion price of approximately $31.74 per share). Upon conversion of the Notes, holders will receive cash up to the principal amount of each Note, and any excess conversion value will be delivered in shares of our common stock. We used the net proceeds of the Notes to finance the cash consideration of our acquisition of PopCap, which closed in August 2011. Prior to April 15, 2016, the Notes will be convertible only upon the occurrence of certain events and during certain periods, and thereafter, at any time until the close of business on the second scheduled trading day immediately preceding the maturity date of the Notes. The Notes do not contain any financial covenants. The conversion rate is subject to customary anti-dilution adjustments, but will not be adjusted for any accrued and unpaid interest. Following certain corporate events described in the indenture governing the notes (the "Indenture") that occur prior to the maturity date, the conversion rate will be increased for a holder who elects to convert its Notes in connection with such corporate event in certain circumstances. The Notes are not redeemable prior to maturity, and no sinking fund is provided for the Notes. If we undergo a "fundamental change," as defined in the Indenture, subject to certain conditions, holders may require us to purchase for cash all or any portion of their Notes. The fundamental change purchase price will be 100 percent of the principal amount of the Notes to be purchased plus any accrued and unpaid interest up to but excluding the fundamental change purchase date. The Indenture contains customary terms and covenants, including that upon certain events of default occurring and continuing, either the trustee or the holders of at least 25 percent in principal amount of the outstanding Notes may declare 100 percent of the principal and accrued and unpaid interest on all the Notes to be due and payable. 46 -------------------------------------------------------------------------------- In addition, in July 2011, we entered into privately negotiated convertible note hedge transactions (the "Convertible Note Hedge") with certain counterparties to reduce the potential dilution with respect to our common stock upon conversion of the Notes. The Convertible Note Hedge, subject to customary anti-dilution adjustments, provide us with the option to acquire, on a net settlement basis, approximately 19.9 million shares of our common stock at a strike price of $31.74, which corresponds to the conversion price of the Notes and is equal to the number of shares of our common stock that notionally underlie the Notes. As of March 31, 2013, we have not purchased any shares under the Convertible Note Hedge. We paid $107 million for the Convertible Note Hedge. Separately, we have also entered into privately negotiated warrant transactions with the certain counterparties whereby we sold to independent third parties warrants (the "Warrants") to acquire, subject to customary anti-dilution adjustments that are substantially the same as the anti-dilution provisions contained in the Notes, up to 19.9 million shares of our common stock (which is also equal to the number of shares of our common stock that notionally underlie the Notes), with a strike price of $41.14. The Warrants could have a dilutive effect with respect to our common stock to the extent that the market price per share of its common stock exceeds $41.14 on or prior to the expiration date of the Warrants. We received proceeds of $65 million from the sale of the Warrants. See Note 11 to the Consolidated Financial Statements for additional information related to our 0.75% Convertible Senior Notes due 2016. Credit Facility On August 30, 2012, we entered into a $500 million senior unsecured revolving credit facility with a syndicate of banks. The credit facility terminates on February 29, 2016 and contains an option to arrange with existing lenders and/or new lenders for them to provide up to an aggregate of $250 million in additional commitments for revolving loans. Proceeds of loans made under the credit facility may be used for general corporate purposes. The loans bear interest, at our option, at the base rate plus an applicable spread or an adjusted LIBOR rate plus an applicable spread, in each case with such spread being determined based on our consolidated leverage ratio for the preceding fiscal quarter. We are also obligated to pay other customary fees for a credit facility of this size and type. Interest is due and payable in arrears quarterly for loans bearing interest at the base rate and at the end of an interest period (or at each three month interval in the case of loans with interest periods greater than three months) in the case of loans bearing interest at the adjusted LIBOR rate. Principal, together with all accrued and unpaid interest, is due and payable on February 29, 2016. 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 and a minimum level of domestic liquidity. The credit agreement contains customary events of default, including among others, non-payment defaults, covenant defaults, bankruptcy and insolvency 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 agreement, an obligation by any guarantors to repay the obligations in full and an increase in the applicable interest rate. As of March 31, 2013, no amounts were outstanding under the credit facility. Financial Condition We believe that our cash, cash equivalents, short-term investments, cash generated from operations and available financing facilities will be sufficient to meet our operating requirements for at least the next 12 months, including working capital requirements, capital expenditures, and potentially, future acquisitions, stock repurchases, or strategic investments. We may choose at any time to raise additional capital to strengthen our financial position, facilitate expansion, repurchase our stock, pursue strategic acquisitions and investments, and/or to take advantage of business opportunities as they arise. There can be no assurance, however, that such additional capital will be available to us on favorable terms, if at all, or that it will not result in substantial dilution to our existing stockholders. As of March 31, 2013, approximately $993 million of our cash, cash equivalents, and short-term investments were domiciled in foreign tax jurisdictions. While we have no plans to repatriate these funds to the United States in the short term, if we choose to do so, we would be required to accrue and pay additional taxes on any portion of the repatriation where no United States income tax had been previously provided. 47 -------------------------------------------------------------------------------- In February 2011, our Board of Directors authorized a program to repurchase up to $600 million of our common stock over the following 18 months. We completed our program in April 2012. We repurchased approximately 32 million shares in the open market since under that program, including pursuant to pre-arranged stock trading plans. During fiscal years 2013 and 2012, we repurchased and retired approximately 4 million and 25 million shares of our common stock for approximately $71 million and $471 million, respectively, under that plan. In July 2012, our Board of Directors authorized a new program to repurchase up to $500 million of our common stock. Under this new 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 fiscal year 2013, we repurchased and retired approximately 22 million shares of our common stock for approximately $278 million under this new program. During fiscal years 2013 and 2012, we repurchased and retired approximately 26 million and 25 million shares of our common stock for approximately $(349) million and $(471) million, respectively, for both plans. We have a "shelf" registration statement on Form S-3 on file with the SEC. This shelf registration statement, which includes a base prospectus, allows us at any time to offer any combination of securities described in the prospectus in one or more offerings. Unless otherwise specified in a prospectus supplement accompanying the base prospectus, we would use the net proceeds from the sale of any securities offered pursuant to the shelf registration statement for general corporate purposes, including for working capital, financing capital expenditures, research and development, marketing and distribution efforts, and if opportunities arise, for acquisitions or strategic alliances. Pending such uses, we may invest the net proceeds in interest-bearing securities. In addition, we may conduct concurrent or other financings at any time. Our ability to maintain sufficient liquidity could be affected by various risks and uncertainties including, but not limited to, those related to customer demand and acceptance of our products, our ability to collect our accounts receivable as they become due, successfully achieving our product release schedules and attaining our forecasted sales objectives, the impact of acquisitions and other strategic transactions in which we may engage, the impact of competition, economic conditions in the United States and abroad, the seasonal and cyclical nature of our business and operating results, risks of product returns and the other risks described in the "Risk Factors" section, included in Part I, Item 1A of this report. Contractual Obligations and Commercial Commitments 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: FIFA, FIFPRO Foundation, FAPL (Football Association Premier League Limited), and DFL Deutsche Fußball Liga GmbH (German Soccer League) (professional soccer); National Basketball Association (professional basketball); PGA TOUR, Tiger Woods and Augusta National (professional golf); National Hockey League and NHL Players' Association (professional hockey); National Football League Properties, PLAYERS Inc., and Red Bear Inc. (professional football); Collegiate Licensing Company (collegiate football); Zuffa, LLC (Ultimate Fighting Championship); ESPN (content in EA SPORTS games); Hasbro, Inc. (most of Hasbro's toy and game intellectual properties); and LucasArts and Lucas Licensing (Star Wars: The Old Republic). 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. 48 --------------------------------------------------------------------------------The following table summarizes our minimum contractual obligations as of March 31, 2013, and the effect we expect them to have on our liquidity and cash flow in future periods (in millions): Fiscal Year Ending March 31, Total 2014 2015 2016 2017 2018 Thereafter Unrecognized commitments Developer/licensor commitments $ 1,144 $ 158 $ 178 $ 228 $ 69 $ 53 $ 458 Marketing commitments 223 37 47 35 20 20 64 Operating leases 174 50 44 32 17 13 18 0.75% Convertible Senior Notes due 2016 interest (a) 17 5 5 5 2 - - Other purchase obligations 39 28 9 2 - - - Total unrecognized commitments 1,597 278 283 302 108 86 540 Recognized commitments 0.75% Convertible Senior Notes due 2016 principal (a) 633 - - - 633 - - Licensing and lease obligations (b) 71 25 18 6 20 1 1 Total recognized commitments 704 25 18 6 653 1 1 Total Commitments $ 2,301 $ 303 $ 301 $ 308 $ 761 $ 87 $ 541 (a) Included in the $17 million coupon interest on the 0.75% Convertible Senior Notes due 2016 is $1 million of accrued interest recognized as of March 31, 2013. We will be obligated to pay the $632.5 million principal amount of the 0.75% Convertible Senior Notes due 2016 in cash and any excess conversion value in shares of our common stock upon redemption of the Notes at maturity on July 15, 2016 or upon earlier redemption. The $632.5 million principal amount excludes $(74) million of unamortized discount of the liability component. See Note 11 for additional information regarding our 0.75% Convertible Senior Notes due 2016. (b) See Note 7 for additional information regarding recognized commitments resulting from our restructuring plans. Lease commitments have not been reduced for approximately $6 million due in the future from third parties under non-cancelable sub-leases. Subsequent to March 31, 2013, we entered into various licensor and development agreements with third parties, which contingently commits us to pay up to $163 million at various dates through fiscal year 2020. 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 Consolidated Financial Statements. In addition, the amounts in the table above are presented based on the dates the amounts are contractually due as of March 31, 2013; however, certain payment obligations may be accelerated depending on the performance of our operating results. In addition to what is included in the table above, as of March 31, 2013, we had a liability for unrecognized tax benefits and an accrual for the payment of related interest totaling $260 million, of which approximately $46 million is offset by prior cash deposits to tax authorities for issues pending resolution. For the remaining liability, we are unable to make a reasonably reliable estimate of when cash settlement with a taxing authority will occur. Also, in addition to what is included in the table above as of March 31, 2013, primarily in connection with our PopCap, KlickNation, and Chillingo acquisitions, we may be required to pay an additional $566 million of cash consideration based upon the achievement of certain performance milestones through March 31, 2015. As of March 31, 2013, we have accrued $43 million of contingent consideration on our Consolidated Balance Sheet representing the estimated fair value of the contingent consideration. We have not paid any earn-out to date for the PopCap acquisition. OFF-BALANCE SHEET COMMITMENTS Lease Commitments As of March 31, 2013, we leased certain of our current 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. 49 -------------------------------------------------------------------------------- Director Indemnity Agreements We entered into indemnification agreements with each of the members of our Board of Directors at the time they joined the Board to indemnify them to the extent permitted by law against any and all liabilities, costs, expenses, amounts paid in settlement and damages incurred by the Directors as a result of any lawsuit, or any judicial, administrative or investigative proceeding in which the Directors are sued or charged as a result of their service as members of our Board of Directors. INFLATION We believe the impact of inflation on our results of operations has not been significant in any of the past three fiscal years. [ Back To TMCnet.com's Homepage ]