Business Context and Reporting Period
Company: Electronic Arts Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2008 (Third Quarter of Fiscal 2009)
Business Overview: Electronic Arts develops, markets, publishes, and distributes video game software and content for consoles, PCs, handhelds, and wireless devices. The company operates through reportable segments including EA SPORTS, EA Games, EA Play, and EA Interactive (comprising EA Mobile and POGO).
Key Financial Metrics
| Metric | Three Months Ended Dec 31, 2008 | Nine Months Ended Dec 31, 2008 |
|---|---|---|
| Net Revenue | $1,654 million | $3,352 million |
| Gross Profit | $729 million (44.1% margin) | $1,574 million (47.0% margin) |
| Operating Income (Loss) | $(304) million | $(765) million |
| Net Loss | $(641) million | $(1,046) million |
| Net Loss Per Share (Basic & Diluted) | $(2.00) | $(3.28) |
| Cash and Cash Equivalents | $1,379 million | $1,379 million (Ending Balance) |
| Short-term Investments | $580 million | $580 million (Ending Balance) |
| Total Assets | $5,204 million | $5,204 million (Ending Balance) |
| Total Liabilities | $2,151 million | $2,151 million (Ending Balance) |
| Stockholders' Equity | $3,053 million | $3,053 million (Ending Balance) |
Cash Flow (Nine Months Ended Dec 31, 2008):
- Operating Activities: $(203) million used
- Investing Activities: $3 million provided
- Financing Activities: $77 million provided
Material Changes Versus Prior Period
- Revenue Growth: Net revenue increased 10% ($151 million) for the quarter and 32% ($815 million) for the nine months compared to the prior year periods, driven by strong sales of titles such as Rock Band 2, Madden NFL 09, and FIFA 09.
- Significant Impairment Charges: The company recorded a preliminary goodwill impairment charge of $368 million related to the EA Mobile reporting unit due to adverse economic conditions and a decline in market capitalization.
- Investment Losses: Losses on strategic investments increased significantly, including a $27 million impairment on The9 and a $40 million impairment on Neowiz Corporation investments during the nine-month period.
- Tax Provision: A net discrete tax charge of $244 million was recorded due to an increase in the valuation allowance for U.S. deferred tax assets, as the company determined it was more likely than not that these assets would not be realized given cumulative losses.
- Restructuring: The company announced a cost-reduction plan involving a workforce reduction of approximately 11% (1,100 employees) and the closure of 12 studio locations. Restructuring charges for the quarter were $18 million.
Guidance, Outlook, and Risks
- Restructuring Outlook: The company expects to incur total cash and non-cash restructuring charges between $65 million and $75 million by fiscal 2010. These actions are expected to reduce annual operating expenses by approximately $125 million in fiscal 2010.
- Goodwill Impairment Status: The second step of the goodwill impairment test for EA Mobile is expected to be completed in the fourth quarter of fiscal 2009. Management noted that a material adjustment to the $368 million charge may occur upon completion.
- Tax Outlook: The company expects to provide a valuation allowance on future tax benefits until it can sustain profitability. Fiscal 2009 tax expense is projected to be between $250 million and $275 million.
- Key Risks:
- Economic Environment: Declining consumer spending and conservative retailer ordering are impacting demand, particularly for catalog titles.
- Platform Transition: The industry is transitioning to new-generation consoles (Xbox 360, PS3, Wii), leading to declining sales of prior-generation systems (PlayStation 2, Xbox, GameCube).
- Revenue Recognition: Changes in accounting for online-enabled packaged goods (lack of VSOE) require deferring revenue over six months, creating volatility in reported gross margins.
- Lease Covenants: The company amended its headquarters lease covenants in February 2009 to meet Fixed Charge Coverage Ratio requirements; without the amendment, it would have been in default.
Investor Verification Checklist
- Goodwill Impairment Finalization: Verify the final amount of the EA Mobile goodwill impairment charge in the Q4 2009 filing, as the current $368 million is preliminary.
- Deferred Revenue Recognition: Monitor the impact of the $512 million deferred net revenue balance on future quarterly revenue recognition and gross margin volatility.
- Restructuring Execution: Track the actual costs incurred versus the $65-$75 million estimate and the realization of the projected $125 million in annual cost savings.
- Valuation Allowance: Assess the company's ability to reverse the deferred tax valuation allowance if profitability improves, which would impact future effective tax rates.
- Investment Portfolio: Review the fair value of marketable equity securities ($302 million) and short-term investments ($580 million) for further impairment risks given market volatility.