Business context and reporting period
Take-Two Interactive Software, Inc. filed this unaudited Form 10-Q for its fiscal first quarter ended June 30, 2016. The company develops and publishes interactive entertainment through Rockstar Games and 2K; its single operating segment is publishing. Unless noted otherwise, financial amounts below are in millions of U.S. dollars.
Financial results and liquidity
| Metric | Three months ended June 30, 2016 | Prior-year period or balance-sheet comparison |
|---|---|---|
| Net revenue | $311.6 | $275.3; up 13.2% |
| Gross profit / margin | $120.2 / 38.6% | $72.7 / 26.4% |
| Operating loss | $(39.0) | $(62.6) |
| Net loss / diluted loss per share | $(38.6) / $(0.46) | $(67.0) / $(0.81) |
| Cash from operating activities | $(47.2) | $105.5 provided |
| Cash and cash equivalents | $796.3 | $798.7 at March 31, 2016 |
| Short-term investments | $392.5 | $470.8 at March 31, 2016 |
| Restricted cash | $318.5 | $261.2 at March 31, 2016 |
| Long-term debt, net carrying amount | $504.4 | $497.9 at March 31, 2016 |
Operating expenses were $159.2, or 51.1% of revenue, versus $135.3, or 49.2%. Selling and marketing rose 56.1% to $71.1, mainly from advertising for Battleborn and the upcoming Mafia III release. The filing reports a $1.4 gain on long-term investments. The company had $98.3 available under its revolving credit facility and no borrowings; $1.7 of letters of credit was outstanding. Current assets were $1,977.7 and current liabilities $1,261.6.
Investing activities provided $72.9, primarily reflecting maturities of bank time deposits; financing activities used $24.3, mainly for tax payments on net share settlements of restricted stock awards. Cash and cash equivalents decreased by $2.4 during the quarter. Management said cash, short-term investments, projected operating cash flow, and credit availability should be sufficient for working capital, capital expenditures, and commitments.
Material changes and operating drivers
- Revenue increased $36.3, chiefly because $102.0 of NBA 2K franchise revenue was recognized from amounts previously deferred for NBA 2K16. This was partly offset by declines of $41.4 in Grand Theft Auto and $21.5 in Evolve.
- Gross margin improved to 38.6%, primarily because internal royalties were lower as a percentage of revenue, reflecting the timing of royalties from Grand Theft Auto performance. Higher NBA 2K16 license expenses partly offset this benefit.
- Software development and royalty costs rose to $63.7 from $50.5; licenses increased to $23.1 from $6.4. The company recorded $9.1 of software development impairment charges, compared with $1.7.
- Digital online revenue was $172.1, or 55.2% of revenue, compared with $154.0, or 55.9%. Recurrent consumer spending represented 57.0% of digital online revenue, up from 53.7%.
- Grand Theft Auto products generated 41.5% of quarterly revenue. The five largest customers represented 68.6% of revenue, up from 60.1% a year earlier.
Outlook, risks, contingencies, and unusual items
The filing provides no quantified financial guidance. Announced releases included XCOM 2, NBA 2K17, Mafia III, WWE 2K17, and Sid Meier's Civilization VI, scheduled from September through October 2016. Management cautioned that results depend on release timing and commercial performance; quarterly results are seasonal and not necessarily indicative of future results.
- Convertible notes: $250.0 principal of 1.75% notes matures December 1, 2016 and holders could convert from June 1 through shortly before maturity. The $287.5 principal of 1.00% notes due 2018 became convertible at holders' option from July 1 through September 30, 2016 after the stock-price conversion condition was met. Management said it currently intended and was able to settle conversions in shares; conversion could dilute shareholders.
- Litigation: Former subsidiary president Leslie Benzies claims damages of at least $150.0 in litigation concerning, among other issues, royalty-plan entitlements and employment separation. Take-Two disputes the claims and says it has accrued an adequate reserve, but the reserve amount is not stated in the filing text.
- Concentration and market risks: Revenue is exposed to the performance of Grand Theft Auto, major customers and console platforms. The company also identified foreign-exchange, customer credit, consumer demand, product returns, and release-schedule risks. It held $261.0 of cash outside the U.S.; repatriation could have tax consequences.
- Accounting changes: The company said adoption of the new revenue-recognition standard may materially affect the allocation and timing of revenue and related cost of goods sold; its impact was still being evaluated.
- The company reported no material changes to the risk factors in its most recent Form 10-K and said disclosure controls were effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of quarterly revenue and margin improvement reflects the recognition of previously deferred NBA 2K16 revenue and royalty timing, rather than recurring trends.
- The cash-flow outlook given negative operating cash flow and development spending for upcoming releases.
- The maturity, conversion, settlement, and potential dilution outcomes for both convertible note issues.
- The status and financial exposure of the Benzies litigation, including the reserve and any outcome beyond it.
- Continued dependence on Grand Theft Auto and a concentrated customer base, and the commercial performance of the announced release slate.