Take-Two Interactive Software, Inc. — Form 10-Q
Reporting period: Fiscal third quarter and nine months ended December 31, 2011. Financial statements are unaudited. Unless stated otherwise, figures below are in millions of dollars.
Business context and reporting period
Take-Two develops and publishes interactive entertainment through Rockstar Games and 2K. Its revenue depends on title launches and sales across console, PC, handheld, and digital platforms. The company reported one publishing segment. The nine-month comparison includes unusually strong sales in the prior year from titles including Red Dead Redemption, Mafia II, and Civilization V.
Financial results
| Metric | Quarter ended Dec. 31, 2011 | Quarter ended Dec. 31, 2010 | Nine months ended Dec. 31, 2011 | Nine months ended Dec. 31, 2010 |
|---|---|---|---|---|
| Revenue | $236.3 | $334.3 | $677.7 | $954.6 |
| Gross profit | $109.9 | $145.6 | $265.4 | $385.3 |
| Gross margin | 46.5% | 43.6% | 39.2% | 40.4% |
| Operating income (loss) | $20.2 | $48.7 | $(23.1) | $97.1 |
| Net income (loss) | $14.1 | $40.9 | $(42.0) | $70.5 |
| Diluted EPS | $0.16 | $0.45 | $(0.51) | $0.82 |
Quarterly revenue fell 29.3% year over year; nine-month revenue fell 29.0%. Quarterly gross margin improved, mainly because internal royalty expense was lower than in the prior-year quarter. Nine-month gross margin declined as product mix shifted toward lower-priced products and externally developed titles carried higher royalties. Over the nine months, operating expenses were nearly unchanged in dollars, but rose to 42.6% of revenue from 30.2%, contributing to the operating loss.
Cash flow: For the nine months, operating activities used $54.6 million, compared with $155.2 million provided in the prior-year period. Investing activities used $9.5 million, including $8.0 million for fixed assets. Financing activities provided $243.4 million, primarily from the November 2011 note issuance. Cash increased by $173.0 million to $453.3 million.
Balance sheet and liquidity: At December 31, cash and equivalents were $453.3 million, current assets $752.4 million, and current liabilities $169.1 million. Long-term debt was $311.9 million on a carrying-value basis. The company had $98.2 million available under its revolving credit facility, no borrowings under it, and $1.7 million in letters of credit outstanding. Management stated that cash, expected operating cash flow, and credit availability should cover requirements for at least 12 months. Approximately $148.4 million of cash was held outside the United States.
Debt: In November 2011, Take-Two issued $250 million principal amount of 1.75% convertible notes due 2016. It also had $138 million principal amount of 4.375% convertible notes due 2014. Both issues have conversion features; the company may settle conversions in cash, shares, or a combination, subject to note terms. The revolving credit facility is secured and matures in October 2016. The company reported compliance with applicable debt covenants.
Material changes and management commentary
- Quarterly revenue declined primarily because sales of Red Dead Redemption, Civilization V, Borderlands Game of the Year, and other prior-year releases were lower; L.A. Noire and Nickelodeon Dance partly offset the declines.
- Nine-month revenue was down $276.9 million. Lower sales of prior-year releases, including Red Dead Redemption, Mafia II, and Civilization V, were partly offset by L.A. Noire and Duke Nukem Forever.
- Quarterly net income was $14.1 million versus $40.9 million. For the nine-month period, results shifted from net income of $70.5 million to a net loss of $42.0 million.
- General and administrative expense increased, including higher stock-based compensation tied to restricted-stock awards under the renewed ZelnickMedia management agreement. The agreement runs through May 2015 and raises the maximum annual bonus, subject to performance thresholds.
- Management identified the timing and commercial success of releases as key drivers of results. It cited announced upcoming titles including The Darkness II, Major League Baseball 2K12, Max Payne 3, BioShock Infinite, and Borderlands 2. Grand Theft Auto V was announced without a release date in the filing.
Outlook, risks, and contingencies
The filing provides a release pipeline and liquidity assessment, but no quantified financial guidance. Management cautioned that actual results may differ from forward-looking statements and undertook no obligation to update them. Results are subject to release timing, title performance, seasonality, consumer demand, pricing, product returns, and platform transitions. The five largest customers generated 40.3% of nine-month revenue and represented 61.9% of gross receivables at December 31, 2011. Sales are concentrated in major console platforms; international operations expose the company to foreign-exchange, regulatory, political, and economic risks.
The company had $291.9 million of capitalized software development costs and licenses related to unreleased titles, making title performance and recoverability important. It reported ongoing tax examinations and general legal matters; it stated that reasonably possible losses beyond amounts accrued would not be material unless otherwise disclosed. A shareholder lawsuit related to alleged options backdating was dismissed with prejudice in September 2011. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether forthcoming major releases met announced schedules and sales expectations, particularly given the company’s dependence on title timing and success.
- Whether operating cash flow improves after the nine-month outflow and how much of the cash balance is available domestically, considering $148.4 million was held abroad.
- The terms, potential dilution, cash settlement exposure, and maturity obligations of both convertible note issues.
- Customer and receivables concentration, and whether the disclosed customer exposures or credit quality changed after December 31.
- The recoverability of capitalized development costs for unreleased titles and the effect of stock-based compensation on reported expenses.