Business context and reporting period
Take-Two Interactive Software, Inc. filed this unaudited Form 10-Q for the quarter and six months ended September 30, 2016 (fiscal Q2 2017). The company develops and publishes interactive entertainment through Rockstar Games and 2K, across console, PC and other platforms, with physical and digital distribution. Unless noted otherwise, amounts below are in millions of U.S. dollars.
Financial performance and position
| Metric | Three months ended Sep. 30, 2016 | Prior-year quarter | Six months ended Sep. 30, 2016 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $420.2 | $347.0 | $731.7 | $622.3 |
| Gross profit / margin | $214.6 / 51.1% | $203.0 / 58.5% | $334.7 / 45.7% | $275.7 / 44.3% |
| Operating income | $47.2 | $66.4 | $8.2 | $3.8 |
| Net income (loss) | $36.4 | $54.7 | $(2.1) | $(12.3) |
| Diluted earnings (loss) per share | $0.39 | $0.55 | $(0.03) | $(0.15) |
- Quarterly revenue rose 21.1%, but net income fell about 33%; operating margin was 11.2%, versus 19.1% a year earlier.
- For the six-month period, revenue increased 17.6% and gross margin improved 1.4 percentage points, while the company remained slightly loss-making.
- Operating cash flow was $(50.8), compared with $20.0 provided in the prior-year period. Investing activities provided $55.9, primarily reflecting bank time-deposit maturities; financing used $29.5, principally for tax payments on net share settlements. Cash and cash equivalents declined $28.7 to $770.0.
- At September 30, cash and equivalents were $770.0, short-term investments $404.6 and restricted cash $368.1. Current assets were $2,370.8 versus current liabilities of $1,719.2.
- Debt was $511.6 carrying value, consisting principally of convertible notes; principal outstanding was $537.5. There were no revolver borrowings and $98.3 of borrowing availability, with $1.7 of letters of credit outstanding.
Material changes versus comparable periods
- Quarterly revenue growth chiefly reflected NBA 2K, including recognition of previously deferred NBA 2K16 revenue, and releases including BioShock: The Collection, XCOM 2 and Battleborn. These gains were partly offset by lower Grand Theft Auto and Evolve revenue.
- For the six months, NBA 2K revenue increased $215.5, while Grand Theft Auto revenue declined $113.1 and Evolve declined $44.1, according to management.
- Quarterly gross margin contracted from 58.5% to 51.1%, reflecting higher internal royalties as a share of revenue and increased license expense. Six-month gross margin improved from 44.3% to 45.7%, largely due to lower internal royalties as a share of revenue, partly offset by higher license expense and software impairment.
- Selling and marketing expense increased 46% in the quarter and 51% for the six months, principally because of higher advertising around releases. Six-month software development impairment charges were $11.6, versus $2.1 in the prior-year period.
- Digital online distribution contributed 55.1% of six-month revenue, down from 57.3%; console contributed 83.0%, down from 84.1%. Grand Theft Auto products generated 38.9% of six-month revenue.
Outlook, commentary, risks and unusual items
- The filing provides no explicit numerical financial guidance. The announced pipeline included Red Dead Redemption 2, expected Fall 2017; Mafia III, WWE 2K17 and Civilization VI were listed as released in October 2016.
- Management said cash, short-term investments, projected operating cash flow and available credit should meet short- and long-term working-capital, capital-expenditure and commitment needs. Interim results may not indicate full-year results; performance is affected by release timing and is typically seasonal, with peak shipments in the fourth calendar quarter.
- Key business exposures include dependence on successful game releases and major franchises, customer concentration (the five largest customers generated 69.4% of six-month revenue), console-platform transitions, used-game sales, foreign exchange and international markets. The company noted that a hypothetical 10% strengthening of the U.S. dollar against all currencies would reduce revenue by 3.9%, with some offset expected from local costs.
- A former subsidiary president’s lawsuit seeks damages of at least $150.0. The company disputes the claims, intends to defend itself and says it has accrued an amount it considers adequate; it states the ultimate outcome is not expected to have a material adverse effect, while acknowledging uncertainty. Routine legal matters may result in losses above recorded accruals.
- The $250.0 principal 1.75% convertible notes mature December 1, 2016; the company elected to settle conversions in shares. Holders of the $287.5 principal 1.00% notes could convert through December 31, 2016 under the stated price condition; $8.4 principal was tendered for conversion in the quarter, with October settlement. Both are carried as long-term debt based on intended share settlement.
- Revenue recognition for online-enabled games depends on estimated service periods that management says are subjective and may be revised, potentially materially affecting period results. The company also said adoption of the new revenue standard may materially affect allocation and timing of revenue and related cost of goods sold.
Important facts for investors to verify
- Whether NBA 2K-related deferred revenue recognition and recurring consumer spending sustain revenue after the release-driven quarter, particularly as Grand Theft Auto revenue declined.
- Cash conversion and development spending: operating cash flow was negative $50.8 for the six months despite reported revenue growth.
- The settlement and dilution effects of the 2016 and 2018 convertible notes, including the December 2016 maturity and share conversions.
- Exposure to major customers and franchises, and the outcome and potential financial consequences of the Benzies litigation.
- Future gross-margin trends, software development impairments and the impact of adopting the new revenue-recognition standard.