CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements. We use words such as "anticipate," "believe," "expect," "intend," "estimate", "plan", "predict", "seek", "goal", "will", "may", "likely", "should", "could" (and the negative of any of these terms), "future" and similar expressions to identify forward-looking statements. In addition, any statements that refer to projections of our future financial performance, trends in our business, projections of markets relevant to our business, uncertain events and assumptions and other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements consist of, among other things, statements related to the impact of the COVID-19 pandemic to our business, industry prospects, our future financial performance, and our business plans and objectives, and may include certain assumptions that underlie the forward-looking statements. These forward-looking statements are not guarantees of future performance and reflect management's current expectations. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that might cause or contribute to such differences include those discussed in Part II, Item 1A of this Quarterly Report under the heading "Risk Factors" in, as well as in other documents we have filed with theSecurities and Exchange Commission ("SEC"), including our Annual Report on Form 10-K for the fiscal year endedMarch 31, 2020 . We assume no obligation to revise or update any forward-looking statement for any reason, except as required by law. OVERVIEW The following overview is a high-level discussion of our operating results, as well as some of the trends and drivers that affect our business. Management believes that an understanding of these trends and drivers provides important context for our results for the three months endedSeptember 30, 2020 , as well as our future prospects. This summary is not intended to be exhaustive, nor is it intended to be a substitute for the detailed discussion and analysis provided elsewhere in this Form 10-Q, including in the remainder of "Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A")," "Risk Factors," and the Condensed Consolidated Financial Statements and related Notes. Additional information can be found in the "Business" section of our Annual Report on Form 10-K for the fiscal year endedMarch 31, 2020 as filed with theSEC onMay 20, 2020 and in other documents we have filed with theSEC . AboutElectronic Arts Electronic Arts is a global leader in digital interactive entertainment. We develop, market, publish and deliver games, content and services that can be played and watched on game consoles, PCs, mobile phones and tablets. We believe that the breadth and depth of our portfolio, live services offerings, and our use of multiple business models and distribution channels provide us with strategic advantages. Our foundation is a collection of intellectual property from which we create innovative games and content that enables us to build on-going and meaningful relationships with a community of players, creators and viewers. Our portfolio includes brands that we either wholly own (such as Battlefield, The Sims, Apex Legends, Need for Speed and Plants v. Zombies) or license from others (such asFIFA , Madden NFL, UFC, NHL and Star Wars). We also offer our players high-quality experiences designed to provide value to players and extend and enhance gameplay. Our live services experiences include extra content, subscription offerings and other revenue generated outside of the sale of our base games. In addition, we are focused on reaching more players whenever and wherever they want to play. We believe that we can add value to our network by making it easier for players to connect to a world of play by offering choice of business model, distribution channel and device. 29 -------------------------------------------------------------------------------- Table of Contents Financial Results Our key financial results for our fiscal quarter endedSeptember 30, 2020 were as follows: •Total net revenue was$1,151 million , down 15 percent year-over-year. On a constant currency basis, we estimate total net revenue would have been$1,193 million , down 11 percent year-over-year. •Live services and other net revenue was$869 million , up 13 percent year-over-year. •Gross margin was 75.2 percent, up 5.2 percentage points year-over-year. •Operating expenses were$716 million , up 6 percent year-over-year. •Operating income was$149 million , down 44 percent year-over-year. •Net income was$185 million , down 78 percent year-over-year. Net income for the three months endedSeptember 30, 2019 was$854 million and included a one-time net tax benefit of$630 million . •Diluted earnings per share was$0.63 , down 78 percent year-over-year driven by the one-time net tax benefit included in net income for the three months endedSeptember 30, 2019 . •Operating cash flow was$61 million , up 65 percent year-over-year. •Total cash, cash equivalents and short-term investments were$6,031 million . From time to time, we make comparisons of current periods to prior periods with reference to constant currency. Constant currency comparisons are based on translating local currency amounts in the current period at actual foreign exchange rates from the prior comparable period. We evaluate our financial performance on a constant currency basis in order to facilitate period-to-period comparisons without regard to the impact of changing foreign currency exchange rates. Trends in Our Business COVID-19 Impact. We are closely monitoring the impact of the COVID-19 pandemic to our people and our business. Since the outbreak of COVID-19, we have focused on actions to support our people, our players, and communities around the world that have been affected by the COVID-19 pandemic. Our People: The wellbeing of our people is our top priority, and to keep everyone as safe as possible, the vast majority of our workforce will be working from home at least untilMarch 2021 . We are offering support and resources to our people, including quarterly payments to assist with work from home costs and care needs, a pandemic care leave program, and additional services for mental and physical health. We have developed a detailed protocol for how we will evaluate the readiness to return to work for each of our offices around the world, accounting for guidance from health authorities and government, the comfort level of our employees, and preparation of our facilities for continued physical distancing. Our Business: With more people staying home, we have seen growth in our business and across the industry. We have continued to execute against our plans, delivering eight new games so far in fiscal 2021, and tens of millions of new players have joined our network. In addition, live services net bookings for the six months endedSeptember 30, 2020 increased more than 28 percent year-over-year. We have also experienced a significant increase in the percentage of our games purchased digitally, and we believe this step-up is likely a permanent structural change driven by shelter-in-place orders resulting from the COVID-19 pandemic. Future Outlook: The full extent of the impact of the COVID-19 pandemic to our business, operations and financial results will depend on numerous evolving factors that we may not be able to predict. For example, we do not know how our products and services will be impacted as the response to the COVID-19 pandemic evolves. Engagement and net bookings could subside as a result of macroeconomic deterioration or other challenges. Additional factors that could impact our business include: our ability to continue to deliver new games and services in a distributed work environment, impacts to our key business partners, foreign exchange rate fluctuations, and other factors included in Part II, Item 1A of this Quarterly Report under the heading "Risk Factors". 30 -------------------------------------------------------------------------------- Table of Contents Live Services Business. We offer our players high-quality experiences designed to provide value to players and to extend and enhance gameplay. These live services include extra content, subscription offerings and other revenue generated outside of the sale of our base games. Our net revenue attributable to live services and other was$3,904 million ,$3,358 million and$3,104 million for the trailing twelve months endedSeptember 30, 2020 , 2019, and 2018, respectively, and we expect that live services net revenue will continue to be material to our business. Within live services and other, net revenue attributable to extra content was$3,090 million ,$2,599 million and$2,190 million for the trailing twelve months endedSeptember 30, 2020 , 2019, and 2018, respectively. Extra content net revenue has increased as players engage with our games and services over longer periods of time, and purchase additional content designed to provide value to players and extend and enhance gameplay. Our most popular live service is the extra content purchased for the Ultimate Team mode associated with our sports franchises. Ultimate Team allows players to collect current and former professional players in order to build and compete as a personalized team. Net revenue from extra content sales for Ultimate Team was$1,491 million ,$1,369 million and$1,180 million during fiscal years 2020, 2019 and 2018, respectively, a substantial portion of which was derived fromFIFA Ultimate Team. Digital Delivery of Games. In our industry, players increasingly purchase games digitally as opposed to purchasing physical discs. While this trend, as applied to our business, may not be linear because of product mix during a fiscal year, consumer buying patterns and other factors, over time we expect players to purchase an increasingly higher proportion of our games digitally; therefore we expect net revenue attributable to digital full game downloads to increase over time and net revenue attributable to sales of packaged goods to decrease. Our net revenue attributable to digital full game downloads was$811 million ,$681 million and$714 million during fiscal years 2020, 2019 and 2018, respectively; while our net revenue attributable to packaged goods sales decreased from$1,542 million in fiscal year 2018 to$1,112 million in fiscal year 2019 and$1,076 million in fiscal year 2020. In addition, as measured based on total units sold on Microsoft's Xbox One and Sony's PlayStation 4 rather than by net revenue, we estimate that 49 percent, 49 percent, and 39 percent of our total units sold during fiscal years 2020, 2019 and 2018 were sold digitally. Digital full game units are based on sales information provided by Microsoft and Sony; packaged goods units sold through are estimated by obtaining data from significant retail partners inNorth America ,Europe andAsia , and applying internal sales estimates with respect to retail partners from which we do not obtain data. We believe that these percentages are reasonable estimates of the proportion of our games that are digitally downloaded in relation to our total number of units sold for the applicable period of measurement. We expect the long-term trends in revenue and in the percentage of games digitally downloaded to continue. During fiscal year 2021, the percentage of our games purchased digitally has increased significantly and we believe this step-up is likely a permanent structural change driven by shelter-in-place orders resulting from the COVID-19 pandemic. Increases in consumer adoption of digital purchase of games combined with increases in our live services revenue generally results in expansion of our gross margin, as costs associated with selling a game digitally is generally less than selling the same game through traditional retail and distribution channels. Free-to-Play Games. The global adoption of mobile devices and a business model for those devices that allows consumers to try new games with no up-front cost, and that are monetized through a live service associated with the game, particularly extra content sales, has led to significant sales growth in the mobile gaming industry. Similarly, sales of extra content are the primary driver of our mobile business. We expect the mobile gaming industry to continue to grow during our 2021 fiscal year. Likewise, the consumer acceptance of free-to-play, live service-based, online PC games has broadened our consumer base and has begun to expand into the console market. For example, within our business, we offer Apex Legends as a free-to-play, live service-based PC and console game. We expect extra content revenue generated from mobile, PC and console free-to-play games to remain an important part of our business. Concentration of Sales Among the Most Popular Games. In all major segments of our industry, we see a large portion of games sales concentrated on the most popular titles. Similarly, a significant portion of our revenue historically has been derived from games based on a few popular franchises, several of which we have released on an annual or bi-annual basis. In particular, we have historically derived a significant portion of our net revenue from our largest and most popular game,FIFA , the annualized version of which is consistently one of the best-selling games in the marketplace. Recurring Revenue Sources. Our business model includes revenue that we deem recurring in nature, such as revenue from our annualized sports franchises (e.g.,FIFA , Madden NFL), our console, PC and mobile catalog titles (i.e., titles that did not launch in the current fiscal year), and our live services. We have been able to forecast revenue from these areas of our business with greater relative confidence than for new games, services and business models. As we continue to incorporate new business models and modalities of play into our games, our goal is to continue to look for opportunities to expand the recurring portion of our business. 31 -------------------------------------------------------------------------------- Table of Contents Net Bookings. In order to improve transparency into our business, we disclose an operating performance metric, net bookings. Net bookings is defined as the net amount of products and services sold digitally or sold-in physically in the period. Net bookings is calculated by adding total net revenue to the change in deferred net revenue for online-enabled games. The following is a calculation of our total net bookings for the periods presented: Three Months Ended Six Months Ended September 30, September 30, (In millions) 2020 2019 2020 2019 Total net revenue$ 1,151 $ 1,348 $ 2,610 $ 2,557 Change in deferred net revenue (online-enabled games) (241) (35) (310) (462) Net bookings (a)$ 910 $ 1,313 $ 2,300 $ 2,095 (a) At the beginning of fiscal year 2021, we changed the way in which we present net bookings to align with GAAP net revenue measures. Net bookings from mobile platform partners are now presented gross of platform provider fees. Historically, we presented net bookings from these partners net of platform fees. Net bookings for the three and six months endedSeptember 30, 2019 has been recast for comparability. Net bookings were$910 million for the three months endedSeptember 30, 2020 driven by sales related to Madden NFL 21, Apex Legends, The Sims 4 andFIFA Ultimate Team. Net bookings decreased$403 million or 31 percent as compared to the three months endedSeptember 30, 2019 due primarily to year-over-year change in the launch date of ourFIFA console title from the second quarter in fiscal year 2020 to the third quarter in fiscal year 2021, partially offset by the Star Wars franchise and UFC 4. Full game net bookings were$266 million for the three months endedSeptember 30, 2020 , and decreased$371 million or 58 percent as compared to the three months endedSeptember 30, 2019 due primarily to year-over-year change in the launch date of ourFIFA console title, partially offset by UFC 4 and the Star Wars franchise. Live services and other net bookings were$644 million for the three months endedSeptember 30, 2020 , and decreased$32 million or 5 percent as compared to the three months endedSeptember 30, 2019 . The decrease in live services and other net bookings was due primarily to a decrease in sales of extra content for FIFA Ultimate Team, partially offset by Apex Legends and Star Wars: Galaxy of Heroes. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted inthe 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, including uncertainty in the current economic environment due to the COVID-19 pandemic. As a result, actual results may differ materially from our estimates. Revenue Recognition We derive revenue principally from sales of our games, and related extra content and services that can be played on game consoles, PCs, mobile phones and tablets. Our product and service offerings include, but are not limited to, the following: •full games with both online and offline functionality ("Games with Services"), which generally includes (1) the initial game delivered digitally or via physical disc at the time of sale and typically provide access to offline core game content ("software license"); (2) updates on a when-and-if-available basis, such as software patches or updates, and/or additional free content to be delivered in the future ("future update rights"); and (3) a hosted connection for online playability ("online hosting"); •full games with online-only functionality which require an Internet connection to access all gameplay and functionality ("Online-Hosted Service Games"); •extra content related to Games with Services and Online-Hosted Service Games which provides access to additional in-game content; •subscriptions, such as EA Play and EA Play Pro, that generally offers access to a selection of full games, in-game content, online services and other benefits typically for a recurring monthly or annual fee; and •licensing to third parties to distribute and host our games and content. 32 -------------------------------------------------------------------------------- Table of Contents We evaluate and recognize revenue by: •identifying the contract(s) with the customer; •identifying the performance obligations in the contract; •determining the transaction price; •allocating the transaction price to performance obligations in the contract; and •recognizing revenue as each performance obligation is satisfied through the transfer of a promised good or service to a customer (i.e., "transfer of control"). Certain of our full game and/or extra content are sold to resellers with a contingency that the full game and/or extra content cannot be resold prior to a specific date ("Street Date Contingency"). We recognize revenue for transactions that have a Street Date Contingency when the Street Date Contingency is removed and the full game and/or extra content can be resold by the reseller. For digital full game and/or extra content downloads sold to customers, we recognize revenue when the full game and/or extra content is made available for download to the customer. Online-Enabled Games Games with Services. Our sales of Games with Services are evaluated to determine whether the software license, future update rights and the online hosting are distinct and separable. Sales of Games with Services are generally determined to have three distinct performance obligations: software license, future update rights, and the online hosting. Since we do not sell the performance obligations on a stand-alone basis, we consider market conditions and other observable inputs to estimate the stand-alone selling price for each performance obligation. For Games with Services, generally 75 percent of the sales price is allocated to the software license performance obligation and recognized at a point in time when control of the license has been transferred to the customer (which is usually at or near the same time as the booking of the transaction). The remaining 25 percent is allocated to the future update rights and the online hosting performance obligations and recognized ratably as the service is provided (over the Estimated Offering Period). Online-Hosted Service Games. Sales of our Online-Hosted Service Games are determined to have one distinct performance obligation: the online hosting. We recognize revenue from these arrangements as the service is provided. Extra Content. Revenue received from sales of downloadable content are derived primarily from the sale of virtual currencies and digital in-game content that enhance players' game experience. Sales of extra content are accounted for in a manner consistent with the treatment for our Games with Services and Online-Hosted Service Games as discussed above, depending upon whether or not the extra content has offline functionality. That is, if the extra content has offline functionality, then the extra content is accounted for similarly to Games with Services (generally determined to have three distinct performance obligations: software license, future update rights, and the online hosting). If the extra content does not have offline functionality, then the extra content is determined to have one distinct performance obligation: the online-hosted service offering. Subscriptions Sales of our subscriptions are deemed to be one performance obligation and we recognize revenue from these arrangements ratably over the subscription term as the performance obligation is satisfied. Licensing Revenue In certain countries, we utilize third-party licensees to distribute and host our games and content in accordance with license agreements, for which the licensees typically pay us a fixed minimum guarantee and/or sales-based royalties. These arrangements typically include multiple performance obligations, such as a time-based license of software and future update rights. We recognize as revenue a portion of the minimum guarantee when we transfer control of the license of software (generally upon commercial launch) and the remaining portion ratably over the contractual term in which we provide the licensee with future update rights. Any sales-based royalties are generally recognized as the related sales occur by the licensee. Significant Judgments around Revenue Arrangements 33 -------------------------------------------------------------------------------- Table of Contents Identifying performance obligations. Performance obligations promised in a contract are identified based on the goods and services that will be transferred to the customer that are both capable of being distinct, (i.e., the customer can benefit from the goods or services either on its own or together with other resources that are readily available), and are distinct in the context of the contract (i.e., it is separately identifiable from other goods or services in the contract). To the extent a contract includes multiple promises, we must apply judgment to determine whether those promises are separate and distinct performance obligations. If these criteria are not met, the promises are accounted for as a combined performance obligation. Determining the transaction price. The transaction price is determined based on the consideration that we will be entitled to receive in exchange for transferring our goods and services to the customer. Determining the transaction price often requires judgment, based on an assessment of contractual terms and business practices. It further includes review of variable consideration such as discounts, sales returns, price protection, and rebates, which is estimated at the time of the transaction. In addition, the transaction price does not include an estimate of the variable consideration related to sales-based royalties. Sales-based royalties are recognized as the sales occur. Allocating the transaction price. Allocating the transaction price requires that we determine an estimate of the relative stand-alone selling price for each distinct performance obligation. Determining the relative stand-alone selling price is inherently subjective, especially in situations where we do not sell the performance obligation on a stand-alone basis (which occurs in the majority of our transactions). In those situations, we determine the relative stand-alone selling price based on various observable inputs using all information that is reasonably available. Examples of observable inputs and information include: historical internal pricing data, cost plus margin analyses, third-party external pricing of similar or same products and services such as software licenses and maintenance support within the enterprise software industry. The results of our analysis resulted in a specific percentage of the transaction price being allocated to each performance obligation. Determining the Estimated Offering Period. The offering period is the period in which we offer to provide the future update rights and/or online hosting for the game and related extra content sold. Because the offering period is not an explicitly defined period, we must make an estimate of the offering period for the service related performance obligations (i.e., future update rights and online hosting). Determining the Estimated Offering Period is inherently subjective and is subject to regular revision. Generally, we consider the average period of time customers are online when estimating the offering period. We also consider the estimated period of time between the date a game unit is sold to a reseller and the date the reseller sells the game unit to the customer (i.e., time in channel). Based on these two factors, we then consider the method of distribution. For example, games and extra content sold at retail would have a composite offering period equal to the online gameplay period plus time in channel as opposed to digitally-distributed games and extra content which are delivered immediately via digital download and therefore, the offering period is estimated to be only the online gameplay period. Additionally, we consider results from prior analyses, known and expected online gameplay trends, as well as disclosed service periods for competitors' games in determining the Estimated Offering Period for future sales. We believe this provides a reasonable depiction of the transfer of future update rights and online hosting to our customers, as it is the best representation of the time period during which our games and extra content are played. We recognize revenue for future update rights and online hosting performance obligations ratably on a straight-line basis over this period as there is a consistent pattern of delivery for these performance obligations. Prior toJuly 1, 2020 , these performance obligations were generally recognized over an estimated nine-month period beginning in the month after shipment for games and extra content sold through retail and an estimated six-month period for digitally-distributed games and extra content beginning in the month of sale. During the three months endedSeptember 30, 2020 , we completed our annual evaluation of the Estimated Offering Period, and noted that generally, consumers were playing our games for longer periods of time as players engage with services we provide that are designed to enhance and extend gameplay. Based on this, we concluded that the Estimated Offering Period applied to sales made afterJune 30, 2020 should be lengthened. Revenues for service related performance obligations for games and extra content sold through retail are now recognized over an estimated ten-month period beginning in the month of sale, and revenues for service related performance obligations for digitally-distributed games and extra content are now recognized over an estimated eight-month period beginning in the month of sale, which results in revenue being recognized over a longer period of time. This change in Estimated Offering Period did not impact the amount of net bookings or the operating cash flows that we report. We expect that this change will move the recognition of approximately$300 million in net revenue from fiscal year 2021 into fiscal year 2022. During the three months endedSeptember 30, 2020 , this change to our Estimated Offering Period resulted in an estimated decrease in net revenue of$26 million and net income of$20 million , and a decrease of$0.07 diluted earnings per share. Principal Agent Considerations 34 -------------------------------------------------------------------------------- Table of Contents We evaluate sales to end customers of our full games and related content via third-party storefronts, including digital storefronts such asMicrosoft's Xbox Store ,Sony's PlayStation Store ,Apple App Store , andGoogle Play Store , in order to determine whether or not we are acting as the principal in the sale to the end customer, which we consider in determining if revenue should be reported gross or net of fees retained by the third-party storefront. An entity is the principal if it controls a good or service before it is transferred to the end customer. Key indicators that we evaluate in determining gross versus net treatment include but are not limited to the following: •the underlying contract terms and conditions between the various parties to the transaction; •which party is primarily responsible for fulfilling the promise to provide the specified good or service to the end customer; •which party has inventory risk before the specified good or service has been transferred to the end customer; and •which party has discretion in establishing the price for the specified good or service. Based on an evaluation of the above indicators, except as discussed below, we have determined that generally the third party is considered the principal to end customers for the sale of our full games and related content. We therefore report revenue related to these arrangements net of the fees retained by the storefront. However, for sales arrangements viaApple App Store andGoogle Play Store , EA is considered the principal to the end customer and thus, we report revenue on a gross basis and mobile platform fees are reported within cost of revenue. Income Taxes We recognize deferred tax assets and liabilities for both (1) the expected impact of differences between the financial statement amount and the tax basis of assets and liabilities and (2) the expected future tax benefit to be derived from tax losses and tax credit carryforwards. We record a valuation allowance against deferred tax assets when it is considered more likely than not that all or a portion of our deferred tax assets will not be realized. In making this determination, we are required to give significant weight to evidence that can be objectively verified. It is generally difficult to conclude that a valuation allowance is not needed when there is significant negative evidence, such as cumulative losses in recent years. Forecasts of future taxable income are considered to be less objective than past results. Therefore, cumulative losses weigh heavily in the overall assessment. In addition to considering forecasts of future taxable income, we are also required to evaluate and quantify other possible sources of taxable income in order to assess the realization of our deferred tax assets, namely the reversal of existing deferred tax liabilities, the carryback of losses and credits as allowed under current tax law, and the implementation of tax planning strategies. Evaluating and quantifying these amounts involves significant judgments. Each source of income must be evaluated based on all positive and negative evidence and; this evaluation may involve 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. Every quarter, we perform a realizability analysis to evaluate whether it is more likely than not that all or a portion of our deferred tax assets will not be realized. Our Swiss deferred tax assets realizability analysis relies upon future Swiss taxable income as the primary source of taxable income but considers all available sources of Swiss income based on the positive and negative evidence. We give more weight to evidence that can be objectively verified. However, there is significant judgment involved in estimating future Swiss taxable income over the 20-year period over which the Swiss deferred tax assets will reverse, specifically related to assumptions about expected growth rates of future Swiss taxable income, which are based primarily on third party market and industry growth data. Actual results that differ materially from those estimates could have a material impact on our valuation allowance assessment. Although objectively verifiable, Swiss interest rates have an impact on the valuation allowance and are based on published Swiss guidance. Any significant changes to such interest rates could result in a material impact to the valuation allowance.Switzerland has a seven-year carryforward period and does not permit the carry back of losses. We do not recognize any deferred taxes related to theU.S. taxes on foreign earnings as we recognize these taxes as a period cost. As part of the process of preparing our Consolidated Financial Statements, we are required to estimate our income taxes in each jurisdiction in which we operate prior to the completion and filing of tax returns for such periods. This process requires estimating both our geographic mix of income and our uncertain tax positions in each jurisdiction where we operate. These estimates involve complex issues and require us to make judgments about the likely application of the tax law to our situation, as well as with respect to other matters, such as anticipating the positions that we will take on tax returns prior to our preparing the returns and the outcomes of disputes with tax authorities. The ultimate resolution of these issues may take extended periods of time due to examinations by tax authorities and statutes of limitations. In addition, changes in our business, including 35 -------------------------------------------------------------------------------- Table of Contents acquisitions, changes in our international corporate structure, changes in the geographic location of business functions or assets, changes in the geographic mix and amount of income, as well as changes in our agreements with tax authorities, valuation allowances, applicable accounting rules, applicable tax laws and regulations, rulings and interpretations thereof, developments in tax audit and other matters, and variations in the estimated and actual level of annual pre-tax income can affect the overall effective tax rate.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS The information under the subheading "Other Recently Issued Accounting Standards" in Note 1 - Description of Business and Basis of Presentation
to
the Condensed Consolidated Financial Statements in this Form 10-Q is incorporated by reference into this Item 2.
RESULTS OF OPERATIONS Our fiscal year is reported on a 52- or 53-week period that ends on the Saturday nearestMarch 31 . Our results of operations for the fiscal year endingMarch 31, 2021 contains 53 weeks and ends onApril 3, 2021 . Our results of operations for the fiscal year endedMarch 31, 2020 contained 52 weeks and ended onMarch 28, 2020 . Our results of operations for the three and six months endedSeptember 30, 2020 contained 13 weeks and 27 weeks, respectively, and ended onOctober 3, 2020 . Our results of operations for the three and six months endedSeptember 30, 2019 contained 13 weeks and 26 weeks, respectively, and ended onSeptember 28, 2019 . For simplicity of disclosure, all fiscal periods are referred to as ending on a calendar month end. Net Revenue Net revenue consists of sales generated from (1) full games sold as digital downloads or as packaged goods and designed for play on game consoles, PCs and mobile phones and tablets (2) live services associated with these games, such as extra-content, (3) subscriptions that generally offer access to a selection of full games, in-game content, online services and other benefits, and (4) licensing our games to third parties to distribute and host our games. Net Revenue Quarterly Analysis Net Revenue Net revenue for the three months endedSeptember 30, 2020 was$1,151 million , primarily driven byFIFA 20, Apex Legends, The Sims 4, and Madden NFL 21. Net revenue for the three months endedSeptember 30, 2020 decreased$197 million , as compared to the three months endedSeptember 30, 2019 . This decrease was driven by a$370 million decrease in net revenue primarily due to year-over-year change in the launch date of ourFIFA console title from the second quarter in fiscal year 2020 to the third quarter in fiscal year 2021 and Anthem, partially offset by a$173 million increase in net revenue primarily from the Star Wars franchise, UFC 4, and Need for Speed Heat.
Net Revenue by Composition
As our business has evolved and management focuses less on the differentiation between our packaged goods business and our digital business and more on our full game sales and live services that extend and enhance gameplay, we have updated our presentation of net revenue by composition to align with this management view. 36 -------------------------------------------------------------------------------- Table of Contents Our net revenue by composition for the three months endedSeptember 30, 2020 and 2019 was as follows (in millions): Three Months Ended September 30, 2020 2019 $ Change % Change Net revenue: Full game downloads$ 163 $ 181 $ (18) (10) % Packaged goods 119 399 (280) (70) % Full game$ 282 $ 580 $ (298) (51) % Live services and other$ 869 $ 768 $ 101 13 % Total net revenue$ 1,151 $ 1,348 $ (197) (15) % Full Game Net Revenue Full game net revenue includes full game downloads and packaged goods. Full game downloads includes revenue from digital sales of full games on console, PC, and mobile. Packaged goods includes revenue from software that is sold physically. This includes (1) net revenue from game software sold physically through traditional channels such as brick and mortar retailers, and (2) software licensing revenue from third parties (for example, makers of console platforms, personal computers or computer accessories) who include certain of our full games for sale with their products (for example, OEM bundles). For the three months endedSeptember 30, 2020 , full game net revenue was$282 million , primarily driven by Madden NFL 21, UFC 4,FIFA 20, Star Wars Jedi: Fallen Order, and Star Wars: Squadrons. Full game net revenue for the three months endedSeptember 30, 2020 decreased$298 million , or 51 percent, as compared to the three months endedSeptember 30, 2019 . This decrease was driven by a$280 million decrease in packaged goods net revenue and an$18 million decrease in full game downloads net revenue, each primarily driven by year-over-year change in the launch date of ourFIFA console title from the second quarter in fiscal year 2020 to the third quarter in fiscal year 2021. Live Services and Other Net Revenue Live services and other net revenue includes revenue from sales of extra content for console, PC and mobile games, licensing revenue from third-party publishing partners who distribute our games digitally, subscriptions, advertising, and non-software licensing. For the three months endedSeptember 30, 2020 , live services and other net revenue was$869 million primarily driven by sales of extra content forFIFA Ultimate Team, Apex Legends, The Sims 4, and Madden Ultimate Team. Live services and other net revenue for the three months endedSeptember 30, 2020 increased$101 million , or 13 percent, as compared to the three months endedSeptember 30, 2019 . This increase was driven by sales of extra content for FIFA Ultimate Team, Madden Ultimate Team, and The Sims 4. Net Revenue Year-to-Date Analysis Net Revenue Net revenue for the six months endedSeptember 30, 2020 was$2,610 million , primarily driven byFIFA 20, The Sims 4, Apex Legends, and Madden NFL 20. Net revenue for the six months endedSeptember 30, 2020 increased$53 million , as compared to the six months endedSeptember 30, 2019 . This increase was driven by a$461 million increase in net revenue primarily from the Star Wars, The Sims, and Madden franchises. This increase was partially offset by a$408 million decrease in net revenue primarily due to year-over-year change in the launch date of ourFIFA console title from the second quarter in fiscal year 2020 to the third quarter in fiscal year 2021 and Anthem. 37 -------------------------------------------------------------------------------- Table of Contents Net Revenue by Composition
Our net revenue by composition for the six months ended
Six Months Ended September 30, 2020 2019 $ Change % Change Net revenue: Full game downloads$ 386 $ 314 $ 72 23 % Packaged goods 255 528 (273) (52) % Full game$ 641 $ 842 $ (201) (24) % Live services and other$ 1,969 $ 1,715 $ 254 15 % Total net revenue$ 2,610 $ 2,557 $ 53 2 % Full Game Net Revenue For the six months endedSeptember 30, 2020 , full game net revenue was$641 million , primarily driven byFIFA 20, Star Wars Jedi: Fallen Order, Madden NFL 21, Need for Speed Heat, and The Sims 4. Full game net revenue for the six months endedSeptember 30, 2020 decreased$201 million , or 24 percent, as compared to the six months endedSeptember 30, 2019 . This decrease was driven by a$273 million decrease in packaged goods net revenue primarily driven by year-over-year change in the launch date of ourFIFA console title from the second quarter in fiscal year 2020 to the third quarter in fiscal year 2021 and Anthem, partially offset by the Star Wars franchise. This decrease was partially offset by a$72 million increase in full game downloads net revenue primarily driven by the Star Wars franchise, Need for Speed Heat, and UFC 4, partially offset by Anthem. Live Services and Other Net Revenue For the six months endedSeptember 30, 2020 , live services and other net revenue was$1,969 million primarily driven by sales of extra content for FIFA Ultimate Team, The Sims 4, Apex Legends, and Madden Ultimate Team. Live services and other net revenue for the six months endedSeptember 30, 2020 increased$254 million , or 15 percent, as compared to the six months endedSeptember 30, 2019 . This increase was driven by sales of extra content for FIFA Ultimate Team, The Sims 4, and Madden Ultimate Team. Cost of Revenue Quarterly Analysis Cost of revenue consists of (1) manufacturing royalties, net of volume discounts and other vendor reimbursements, (2) certain royalty expenses for celebrities, professional sports leagues, movie studios and other organizations, and independent software developers, (3) data center, bandwidth and server costs associated with hosting our online games and websites, (4) inventory costs, (5) payment processing fees, (6) mobile platform fees associated with our mobile revenue (for transactions in which we are acting as the principal in the sale to the end customer), (7) expenses for defective products, (8) write-offs of post launch prepaid royalty costs and losses on previously unrecognized licensed intellectual property commitments, (9) amortization of certain intangible assets, (10) personnel-related costs, and (11) warehousing and distribution costs. We generally recognize volume discounts when they are earned from the manufacturer (typically in connection with the achievement of unit-based milestones); whereas other vendor reimbursements are generally recognized as the related revenue is recognized. Cost of revenue for the three months endedSeptember 30, 2020 and 2019 was as follows (in millions): September 30, September 30, Change as a % of 2020 % of Net Revenue 2019 % of Net Revenue % Change Net Revenue $ 286 25 % $ 405 30 % (29) % (5) % 38
-------------------------------------------------------------------------------- Table of Contents Cost of Revenue Cost of revenue decreased by$119 million , or 29 percent during the three months endedSeptember 30, 2020 , as compared to the three months endedSeptember 30, 2019 . This decrease was primarily due to a decrease in inventory and royalty costs driven by year-over-year change in the launch date of ourFIFA console title from the second quarter in fiscal year 2020 to the third quarter in fiscal year 2021, partially offset by an increase in royalty and inventory costs driven by UFC 4 and Star Wars: Squadrons. Cost of revenue as a percentage of total net revenue decreased by 5 percent during the three months endedSeptember 30, 2020 , as compared to the three months endedSeptember 30, 2019 . This decrease was primarily due to an increase in the recognition of deferred net revenue, partially offset by an increase in royalty costs due to product mix. Cost of Revenue Year-to-Date Analysis Cost of revenue for the six months endedSeptember 30, 2020 and 2019 was as follows (in millions): September 30, September 30, Change as a % of 2020 % of Net Revenue 2019 % of Net Revenue % Change Net Revenue $ 574 22 % $ 592 23 % (3) % (1) % Cost of Revenue Cost of revenue decreased by$18 million , or 3 percent during the six months endedSeptember 30, 2020 , as compared to the six months endedSeptember 30, 2019 . This decrease was primarily due to a decrease in inventory and royalty costs driven by year-over-year change in the launch date of ourFIFA console title from the second quarter in fiscal year 2020 to the third quarter in fiscal year 2021, partially offset by an increase in royalty costs driven by higher sales associated with Madden and Star War franchises and an increase in platform fees driven by higher sales of Star Wars: Galaxy of Heroes, FIFA Mobile, and The Sims Free Play. Cost of revenue as a percentage of total net revenue remained relatively consistent during the six months endedSeptember 30, 2020 , as compared to the six months endedSeptember 30, 2019 . Research and Development Research and development expenses consist of expenses incurred by our production studios for personnel-related costs, related overhead costs, external third-party development costs, contracted services, depreciation and any impairment of prepaid royalties for pre-launch products. Research and development expenses for our online products include expenses incurred by our studios consisting of direct development and related overhead costs in connection with the development and production of our online games. Research and development expenses also include expenses associated with our digital platform, software licenses and maintenance, and management overhead. Research and development expenses for the three and six months endedSeptember 30, 2020 and 2019 were as follows (in millions): September 30, % of Net September 30, % of Net 2020 Revenue 2019 Revenue $ Change % Change Three months ended $ 421 37 % $ 387 29 %$ 34 9 % Six months ended $ 859 33 % $ 768 30 %$ 91 12 % Research and development expenses increased by$34 million , or 9 percent, during the three months endedSeptember 30, 2020 , as compared to the three months endedSeptember 30, 2019 . This increase was primarily due to a$24 million increase in personnel-related costs primarily resulting from an increase in variable compensation and related expenses, and a$13 million increase in stock-based compensation. 39 -------------------------------------------------------------------------------- Table of Contents Research and development expenses increased by$91 million , or 12 percent, during the six months endedSeptember 30, 2020 , as compared to the six months endedSeptember 30, 2019 . This increase was primarily due to a$60 million increase in personnel-related costs primarily resulting from an increase in variable compensation and related expenses, and a$30 million increase in stock-based compensation. 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 the three and six months endedSeptember 30, 2020 and 2019 were as follows (in millions): September 30, % of Net September 30, % of Net 2020 Revenue 2019 Revenue $ Change % Change Three months ended $ 156 14 % $ 152 11 %$ 4 3 % Six months ended $ 277 11 % $ 262 10 %$ 15 6 % Marketing and sales expenses remained relatively consistent during the three months endedSeptember 30, 2020 , as compared to the three months endedSeptember 30, 2019 . Marketing and sales expenses increased by$15 million , or 6 percent, during the six months endedSeptember 30, 2020 , as compared to the six months endedSeptember 30, 2019 . This increase was primarily due to a$9 million increase in personnel-related costs primarily resulting from an increase in variable compensation and related expenses, and a$6 million increase in stock-based compensation. General and Administrative General and administrative expenses consist of personnel and related expenses of executive and administrative staff, corporate functions such as finance, legal, human resources, and information technology, related overhead costs, fees for professional services such as legal and accounting, and allowances for doubtful accounts. General and administrative expenses for the three and six months endedSeptember 30, 2020 and 2019 were as follows (in millions): September 30, % of Net September 30, % of Net 2020 Revenue 2019 Revenue $ Change % Change Three months ended $ 133 12 % $ 128 9 %$ 5 4 % Six months ended $ 269 10 % $ 238 9 %$ 31 13 % General and administrative expenses increased by$5 million , or 4 percent, during the three months endedSeptember 30, 2020 , as compared to the three months endedSeptember 30, 2019 . This increase was primarily due to a$7 million increase in personnel-related costs driven by an increase in variable compensation and related expenses, and a$5 million increase in stock-based compensation. These increases were partially offset by a$7 million decrease in bad debt expense. General and administrative expenses increased by$31 million , or 13 percent, during the six months endedSeptember 30, 2020 , as compared to the six months endedSeptember 30, 2019 . This increase was primarily due to a$17 million increase in personnel-related costs driven by an increase in variable compensation and related expenses, and a$13 million increase in stock-based compensation. 40
-------------------------------------------------------------------------------- Table of Contents Income Taxes Provision for (benefit from) income taxes for the three months endedSeptember 30, 2020 and 2019 were as follows (in millions): September 30, 2020 Effective Tax Rate September 30, 2019 Effective Tax Rate Three months ended $ (46) (33) % $ (570) (201) % Six months ended $ 57 9 % $ (1,555) (216) % The provision for income taxes for the three months endedSeptember 30, 2020 is based on our projected annual effective tax rate for fiscal year 2021, adjusted for specific items that are required to be recognized in the period in which they are incurred. Our effective tax rates for the three and six months endedSeptember 30, 2020 were negative 33 percent and positive 9 percent, respectively, as compared to negative 201 percent and negative 216 percent, respectively, for the same periods in fiscal year 2020. During the three months endedJune 30, 2019 , we completed an intra-entity sale of some of our intellectual property rights to our Swiss subsidiary, where our international business is headquartered (the "Swiss intra-entity sale"), resulting in the recognition of a$1.17 billion net Swiss deferred tax asset, which will reverse over a 20-year period. Separately, during the three months endedSeptember 30, 2019 ,Switzerland enacted a new statutory tax rate. As a result of the enactment, we remeasured our Swiss deferred tax asset and recognized an additional net tax benefit of$630 million through continuing operations ("Swiss rate change benefit"). In addition, the opinion of theNinth Circuit Court of Appeals inAltera Corp. v Commissioner (the "Altera opinion") resulted in the recognition of$90 million of unrecognized tax benefits related toU.S. uncertain tax positions during the three months endedJune 30, 2019 . Excluding the Swiss intra-entity sale, Swiss rate change benefit and Altera opinion, the effective tax rate for the three and six months endedSeptember 30, 2020 and 2019 would have been 13 percent and 14 percent, respectively. When compared to the statutory rate of 21 percent, the effective tax rates for the three and six months endedSeptember 30, 2020 were lower primarily due to the decreases in unrecognized tax benefits related to prior year tax positions, net of a partial valuation allowance. Every quarter, we perform a realizability analysis to evaluate whether it is more likely than not that all or a portion of our deferred tax assets will not be realized. During the three and six months endedSeptember 30, 2020 , we recognized an additional$41 million of valuation allowance against our deferred tax assets primarily due to the recognition of previously unrecognized tax benefits related to prior year tax positions and a change in current year estimated ordinary income.
LIQUIDITY AND CAPITAL RESOURCES
As of As of (In millions) September 30, 2020 March 31, 2020 Increase/(Decrease) Cash and cash equivalents $ 4,059$ 3,768 $ 291 Short-term investments 1,972 1,967 5 Total $ 6,031$ 5,735 $ 296 Percentage of total assets 53 % 52 % Six Months Ended September 30, (In millions) 2020 2019 Change Net cash provided by operating activities $ 439 $ 195 $ 244 Net cash used in investing activities (61) (1,263) 1,202 Net cash used in financing activities (112) (697) 585 Effect of foreign exchange on cash and cash equivalents 25 (3) 28 Net increase (decrease) in cash and cash equivalents $ 291$ (1,768) $ 2,059 41
-------------------------------------------------------------------------------- Table of Contents Changes in Cash Flow Operating Activities. Net cash provided by operating activities increased by$244 million during the six months endedSeptember 30, 2020 , as compared to the six months endedSeptember 30, 2019 , primarily driven by higher collections due to improved performance as we saw extraordinary levels of engagement during the three months endedJune 30, 2020 as players spent more time at home as a result of the COVID-19 pandemic. This increase is partially offset by higher cash payments for income taxes, higher variable compensation payments related to fiscal year 2020 performance and higher cash payments for royalties. Investing Activities. Net cash used in investing activities decreased by$1,202 million during the six months endedSeptember 30, 2020 , as compared to the six months endedSeptember 30, 2019 , primarily driven by a$625 million increase in proceeds from maturities and sales of short-term investments and a$568 million decrease in the purchase of short-term investments. Financing Activities. Net cash used in financing activities decreased by$585 million during the six months endedSeptember 30, 2020 , as compared to the six months endedSeptember 30, 2019 , primarily driven by a$533 million decrease in the repurchase and retirement of our common stock and a$64 million of contingent consideration payment in connection with our acquisition ofRespawn Entertainment, LLC during the six months endedSeptember 30, 2019 . These decreases were partially offset by a$22 million increase in cash paid to taxing authorities in connection with withholding taxes for stock-based compensation. Short-term Investments Due to our mix of fixed and variable rate securities, our short-term investment portfolio is susceptible to changes in short-term interest rates. As ofSeptember 30, 2020 , our short-term investments had gross unrealized gains of$5 million , or less than 1 percent of the total in short-term investments. From time to time, we may liquidate some or all of our short-term investments to fund operational needs or other activities, such as capital expenditures, business acquisitions or stock repurchase programs. Senior Notes InFebruary 2016 , we issued$600 million aggregate principal amount of the 2021 Notes and$400 million aggregate principal amount of the 2026 Notes. The effective interest rate is 3.94% for the 2021 Notes and 4.97% for the 2026 Notes. Interest is payable semiannually in arrears, onMarch 1 andSeptember 1 of each year. The 2021 Notes are due onMarch 1, 2021 , and we will either re-pay the aggregate principal of the 2021 Notes upon such maturity date or refinance the 2021 Notes prior to maturity. See Note 10 - Fina ncing Arrang ements to the Condensed Consolidated Financial Statements in this Form 10-Q as it relates to our Senior Notes, which is incorporated by reference into this Item 2. Credit Facility OnAugust 29, 2019 , we entered into a$500 million unsecured revolving credit facility ("Credit Facility") with a syndicate of banks. The Credit Facility terminates onAugust 29, 2024 unless the maturity is extended in accordance with its terms. As ofSeptember 30, 2020 , no amounts were outstanding under the Credit Facility. See Note 10 - Financing Arrangements to the Condensed Consolidated Financial Statements in this Form 10-Q as it relates to our Credit Facility, which is incorporated by reference into this Item 2. Return of Capital Program InNovember 2020 , our Board of Directors authorized a program to repurchase up to$2.6 billion of our common stock. This stock repurchase program expires onNovember 4, 2022 . Under this program, we may purchase stock in the open market or through privately negotiated transactions in accordance with applicable securities laws, including pursuant to pre-arranged stock trading plans. The timing and actual amount of the stock repurchases will depend on several factors including price, capital availability, regulatory requirements, alternative investment opportunities and other market conditions. We are not obligated to repurchase a specific number of shares under this program and it may be modified, suspended or discontinued at any time. We are actively repurchasing shares under this program. InNovember 2020 , our Board of Directors initiated a quarterly cash dividend on the Company's common stock and declared a cash dividend of$0.17 per share of common stock. 42 -------------------------------------------------------------------------------- Table of Contents Financial Condition We believe that our cash, cash equivalents, short-term investments, cash generated from operations and available financing facilities will be sufficient to meet our operating requirements for at least the next 12 months, including working capital requirements, capital expenditures, debt repayment obligations, dividends, and potentially, future acquisitions, stock repurchases, or strategic investments. We may choose at any time to raise additional capital to repay debt, strengthen our financial position, facilitate expansion, repurchase our stock, pursue strategic acquisitions and investments, and/or to take advantage of business opportunities as they arise. There can be no assurance, however, that such additional capital will be available to us on favorable terms, if at all, or that it will not result in substantial dilution to our existing stockholders. Our foreign subsidiaries will generally be subject toU.S. tax, and to the extent earnings from these subsidiaries can be repatriated without a material tax cost, such earnings will not be indefinitely reinvested. As ofSeptember 30, 2020 , approximately$2.6 billion of our cash, cash equivalents, and short-term investments were domiciled in foreign tax jurisdictions. All of our foreign cash is available for repatriation without a material tax cost. Our ability to maintain sufficient liquidity could be affected by various risks and uncertainties including, but not limited 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, economic conditions inthe United States and abroad, the impact of acquisitions and other strategic transactions in which we may engage, the impact of competition, the seasonal and cyclical nature of our business and operating results, and the other risks described in the " Risk Factors " section, included in Part II, Item 1A of this report. Contractual Obligations and Commercial Commitments
Note 11 - Commitments and Contingencies to the Condensed Consolidated Financial Statements in this Form 10-Q as it relates to our contractual obligations and commercial commitments, which is incorporated by reference into this Item 2.
OFF-BALANCE SHEET COMMITMENTS As ofSeptember 30, 2020 , we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated by theSEC , that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues and expenses, results of operations, liquidity, capital expenditures, or capital resources that are material to investors. 43
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source