Take-Two Interactive Software, Inc. — Form 10-Q
Reporting period: Quarter and six months ended September 30, 2017 (fiscal 2018). Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where appropriate.
Business context
Take-Two develops, publishes, and markets interactive entertainment through Rockstar Games and 2K, across console, PC, mobile, and online channels. The quarter’s highlighted release was NBA 2K18. The company acquired mobile-game developer Social Point in January 2017.
Financial performance
| Metric | Three months ended September 30, 2017 | Six months ended September 30, 2017 |
|---|---|---|
| Net revenue | $443.6 million, up 5.6% year over year | $861.8 million, up 17.8% |
| Gross profit / margin | $197.0 million / 44.4%, versus 51.1% | $420.7 million / 48.8%, versus 45.7% |
| Operating income (loss) | $(11.3) million, versus $47.2 million | $38.9 million, versus $8.2 million |
| Net income (loss) | $(2.7) million, versus $36.4 million | $57.5 million, versus $(2.1) million |
| Diluted earnings (loss) per share | $(0.03), versus $0.39 | $0.53, versus $(0.03) |
| Cash from operating activities | $1.1 million for the six months, versus cash used of $50.8 million |
For the quarter, lower gross margin and higher operating expenses more than offset revenue growth. For the six-month period, higher revenue and improved gross margin supported higher operating income and a return to net income.
Balance sheet and liquidity
- At September 30, cash and cash equivalents were $749.6 million, short-term investments $513.5 million, and restricted cash $469.1 million. Cash and cash equivalents had declined from $943.4 million at March 31.
- Current assets were $2.46 billion and current liabilities $1.85 billion. Deferred revenue was $822.1 million current and $167.1 million non-current.
- Long-term debt was $52.4 million, representing the net carrying amount of the 1.00% convertible notes; principal outstanding was $54.3 million. No borrowings were outstanding under the revolving credit agreement, with $98.3 million available.
- Cash used in investing activities was $121.5 million and cash used in financing activities was $86.1 million during the six months. Financing cash use was primarily related to net share settlements of stock awards; investing uses included fixed-asset purchases and an asset acquisition.
Material changes and operating drivers
- NBA 2K was the largest cited revenue growth driver: revenue increased by $47.0 million in the quarter and $96.6 million over six months. Grand Theft Auto Online and Grand Theft Auto V, and Social Point titles, also contributed to six-month growth.
- Digital online revenue rose to 68.3% of quarterly revenue and 66.3% of six-month revenue, from 54.9% and 55.1%, respectively. Recurrent consumer spending, including virtual currency, add-on content, and microtransactions, represented 48.3% of quarterly revenue and 44.9% of six-month revenue.
- Quarterly gross margin fell chiefly with higher internal royalties as a share of revenue and $23.3 million of incremental stock-compensation cost in cost of goods sold. Six-month margin improved year over year, primarily due to lower software development costs and product costs as a share of revenue.
- Operating expenses included $12.3 million of business-reorganization costs for the six months and an $11.3 million impairment of acquired Social Point in-process research and development. The company said it did not expect additional costs under the reorganization plan, though estimates could be adjusted.
- Previously cash-settled stock awards were modified to equity awards following shareholder approval. The modification generated $112.8 million of incremental compensation cost, of which $23.3 million was recorded in cost of goods sold and $5.4 million in research and development; $84.2 million was capitalized in software development costs.
- Convertible-note conversions increased share count: $169.4 million principal was settled during the quarter and $213.9 million during the six months, with the company electing to settle in shares. Common shares outstanding were 113.5 million at September 30, compared with 102.6 million at March 31.
Outlook, accounting, and risks
- Revenue recognition estimate: The company extended Grand Theft Auto V’s estimated service period from 41 to 50 months, through December 2018. It expects a material effect on fiscal 2018 statements. For the quarter, the change reduced reported revenue by $78.8 million, operating income by $72.6 million, and net income by $66.2 million compared with the amounts absent the estimate change; the corresponding six-month effects were $104.4 million, $96.4 million, and $88.2 million.
- Accounting outlook: Take-Two plans to adopt the new revenue-recognition standard on April 1, 2018, using the cumulative catch-up method, and anticipates a material financial-statement impact. It said eliminating the vendor-specific fair-value requirement for post-contract support could result in recognizing some software revenue at delivery rather than ratably over an estimated service period.
- Product pipeline: The filing listed L.A. Noire releases for November 2017, L.A. Noire: The VR Case Files for December 2017, and Red Dead Redemption 2 for spring 2018. The filing did not provide quantified financial guidance.
- Tax: The six-month $24.4 million income-tax benefit included $24.5 million of excess tax benefits from stock compensation, along with tax-credit and valuation-allowance effects. Management cautioned that future tax benefits or credits could significantly affect the effective tax rate.
- Concentration and exposure: The five largest customers represented 71.7% of six-month revenue and 70.2% of gross receivables at September 30. Grand Theft Auto products generated 37.4% of six-month revenue; console products generated 81.9%. The company cited customer credit, platform, release timing, seasonality, foreign-exchange, and international-market risks.
- Litigation: A former subsidiary executive’s lawsuit seeks at least $150 million in damages. Take-Two said it intends to defend the matter and believes its accrual is adequate; the amount accrued is not clearly stated in the filing text.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It reported no material changes to the risk factors in its prior annual report.
Most important facts for investors to verify
- How the extended Grand Theft Auto V service period affects fiscal 2018 reported revenue, earnings, and comparability.
- Whether growth in NBA 2K, recurrent consumer spending, and digital channels is sustainable, and how it translates into margins and cash flow.
- The timing and share-count impact of remaining convertible-note conversions, given the notes’ July 2018 maturity.
- The eventual impact of the new revenue-recognition standard and the recoverability of capitalized software development costs.
- Customer receivable concentration, the outcome and accrual adequacy for the Benzies litigation, and any changes to product-release expectations.