Business context and reporting period
Take-Two Interactive Software, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended December 31, 2018, its fiscal 2019 third quarter. The company develops and publishes games through Rockstar Games, 2K, Private Division and Social Point. Red Dead Redemption 2 launched in October 2018 and was a major driver of the quarter.
Financial results and liquidity
| Metric | Three months ended Dec. 31, 2018 | Nine months ended Dec. 31, 2018 |
|---|---|---|
| Net revenue | $1,248.7 million; up 159.7% year over year | $2,129.4 million; up 58.6% |
| Gross profit / margin | $350.3 million / 28.0% | $864.7 million / 40.6% |
| Operating income / margin | $51.8 million / 4.1% | $148.6 million / 7.0% |
| Net income | $179.9 million; diluted EPS $1.57 | $277.0 million; diluted EPS $2.41 |
| Operating cash flow | Not presented separately for the quarter | $390.2 million, versus $241.1 million in the prior-year period |
| Net bookings | $1,568.6 million; up 139.9% | $2,440.3 million; up 54.5% |
At December 31, 2018, cash and cash equivalents were $1,054.9 million, restricted cash $240.6 million, and short-term investments $545.7 million. The company had no borrowings; $98.3 million was available under its credit facility, which expires August 18, 2019. Current assets were $2,974.8 million and current liabilities $2,099.4 million. Total liabilities were $2,359.7 million.
For the nine months, investing activities provided $22.3 million and financing activities used $348.2 million, including $262.4 million of share repurchases and $85.8 million of tax payments related to net share settlements.
Material changes versus the prior comparable period
- Reported quarterly revenue rose $767.9 million from the prior year, but $762.2 million of that increase reflected adoption of the new revenue standard, Topic 606. For the nine-month period, the standard increased reported revenue by $783.4 million.
- Topic 606 accelerated recognition of revenue, particularly for products including Red Dead Redemption 2, Grand Theft Auto V and NBA 2K. Without the standard, quarterly revenue would have been $486.6 million and net loss $230.7 million; nine-month revenue would have been $1,346.0 million and net loss $96.8 million. The prior-year figures were not restated, so reported comparisons are not directly comparable.
- Net bookings, a company-defined operating metric, increased primarily because of Red Dead Redemption 2, partly offset by lower bookings from Grand Theft Auto V and Grand Theft Auto Online.
- Quarterly gross margin was 28.0%, down from 44.3%; management cited higher royalties and amortization of capitalized software costs, including the timing of royalty recognition. For nine months, gross margin was 40.6%, versus 47.2%.
- Net income included a $108.7 million tax benefit from reducing the valuation allowance on certain U.S. deferred tax assets after the company concluded they were more likely than not to be realized. This materially affected reported earnings.
Outlook, commentary, risks and unusual items
The filing does not provide clear numerical financial guidance. It lists expected releases including Civilization VI: Gathering Storm in February 2019 and Ancestors: The Humankind Odyssey and The Outer Worlds in 2019. Management cautions that results vary with release timing, consumer reception, development and marketing costs, seasonality and platform transitions.
- Red Dead Redemption 2 was described as a critical and commercial success. For the nine months, Red Dead Redemption products represented 35.0% of net revenue; Grand Theft Auto products represented 25.1%.
- Revenue is concentrated among a small number of customers: the five largest generated 68.3% of nine-month revenue and represented 74.5% of gross receivables at December 31. Console platforms accounted for 85.1% of nine-month revenue.
- Foreign exchange, customer credit and collection risk, reliance on third-party console platforms, product-release timing and dependence on major franchises are notable exposures. The company uses currency forwards and a cross-currency swap but says hedging does not eliminate currency risk.
- The company recorded a $7.4 million software-development impairment in the quarter after deciding not to proceed with certain software. Business reorganization was a $5.9 million benefit in the quarter from updated cost estimates; $60.0 million remained accrued for the 2016 plan.
- A former executive’s lawsuit seeks at least $150 million in damages. Twelve claims have been dismissed; several claims remain. The company says it has accrued what it considers adequate amounts and does not expect the matter to have a material adverse effect, while acknowledging the outcome is uncertain.
- The company 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 much reported revenue and earnings growth reflects Topic 606 timing rather than underlying sales and bookings; review the company’s non-adoption comparisons and deferred revenue disclosures.
- Whether Red Dead Redemption 2 engagement and recurrent consumer spending can sustain bookings after the launch period.
- The recurring earnings impact of the $108.7 million deferred-tax-asset valuation-allowance release and other tax benefits.
- Customer and receivables concentration, including the exposure to the two largest receivable balances.
- Future software-development amortization, royalties, product-release performance, and the outcome and accrual adequacy of the Benzies litigation.