TAKE-TWO INTERACTIVE SOFTWARE, INC.
CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS
The statements contained herein which are not historical facts are considered
forward-looking statements under federal securities laws and may be identified
by words such as "anticipates," "believes," "estimates," "expects," "intends,"
"plans," "potential," "predicts," "projects," "seeks," "should" "will," or words
of similar meaning and include, but are not limited to, statements regarding the
outlook for the Company's future business and financial performance. Such
forward-looking statements are based on the current beliefs of our management as
well as assumptions made by and information currently available to them, which
are subject to inherent uncertainties, risks and changes in circumstances that
are difficult to predict. Actual outcomes and results may vary materially from
these forward-looking statements based on a variety of risks and
20
--------------------------------------------------------------------------------
Table of Contents
uncertainties including those contained herein, in the Company's Annual Report
on Form 10-K for the fiscal year ended March 31, 2019 , in the section entitled
"Risk Factors," and the Company's other periodic filings with the Securities and
Exchange Commission . All forward-looking statements are qualified by these
cautionary statements and speak only as of the date they are made. The Company
undertakes no obligation to update any forward-looking statement, whether as a
result of new information, future events or otherwise.
Our Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") is provided in addition to the accompanying Condensed
Consolidated Financial Statements and notes to assist readers in understanding
our results of operations, financial condition and cash flows. The following
discussion should be read in conjunction with the MD&A and our annual
consolidated financial statements and the notes thereto, included in our Annual
Report on Form 10-K for the fiscal year ended March 31, 2019 .
Overview
Our Business
We are a leading developer, publisher and marketer of interactive entertainment
for consumers around the globe. We develop and publish products through our
labels Rockstar Games , 2K, and Private Division, as well as Social Point , a
leading developer of mobile games. Our products are currently designed for
console gaming systems, such as Sony's PlayStation®4 ("PS4"), Microsoft's Xbox
One® ("Xbox One"), or Nintendo's Switch™ ("Switch"), and personal computers
("PC"), including smartphones and tablets. We deliver our products through
physical retail, digital download, online platforms, and cloud streaming
services.
We endeavor to be the most creative, innovative, and efficient company in our
industry. Our core strategy is to capitalize on the popularity of video games by
developing and publishing high-quality interactive entertainment experiences
across a range of genres. We focus on building compelling entertainment
franchises by publishing a select number of titles for which we can create
sequels and incremental revenue opportunities through virtual currency, add-on
content, and in-game purchases. Most of our intellectual property is internally
owned and developed, which we believe best positions us financially and
competitively. We have established a portfolio of proprietary software content
for the major hardware platforms in a wide range of genres, including action,
adventure, family/casual, racing, role-playing, shooter, sports, and strategy,
which we distribute worldwide. We believe that our commitment to creativity and
innovation is a distinguishing strength, enabling us to differentiate our
products in the marketplace by combining advanced technology with compelling
storylines and characters that provide unique gameplay experiences for
consumers. We have created, acquired, or licensed a group of highly recognizable
brands to match the broad consumer demographics that we serve, ranging from
adults to children and game enthusiasts to casual gamers. Another cornerstone of
our strategy is to support the success of our products in the marketplace
through innovative marketing programs and global distribution on platforms and
through channels that are relevant to our target audience.
Our revenue is primarily derived from the sale of internally developed software
titles and software titles developed by third parties. Operating margins are
dependent in part upon our ability to release new, commercially successful
software products and to manage effectively their development and marketing
costs. We have internal development studios located in Australia , Canada , China ,
Czech Republic , Hungary , India , Spain , the United Kingdom , and the United
States .
Software titles published by our Rockstar Games label are primarily internally
developed. We expect Rockstar Games , our wholly-owned publisher of the Grand
Theft Auto, Max Payne , Midnight Club , Red Dead Redemption, and other popular
franchises, to continue to be a leader in the action/adventure product category
and to create groundbreaking entertainment by leveraging our existing titles as
well as by developing new brands. We believe that Rockstar Games has established
a uniquely original, popular cultural phenomenon with its Grand Theft Auto
series, which is the interactive entertainment industry's most iconic and
critically acclaimed brand and has sold-in over 310 million units. The latest
installment, Grand Theft Auto V, has sold in over 120 million units worldwide
and includes access to Grand Theft Auto Online. On October 26, 2018 , Rockstar
Games launched Red Dead Redemption 2, which has been a critical and commercial
success that set numerous entertainment industry records. To date, Red Dead
Redemption 2 has sold-in more than 25 million units worldwide. Rockstar Games is
also well known for developing brands in other genres, including the L.A. Noire,
Bully, and Manhunt franchises. Rockstar Games continues to expand on our
established franchises by developing sequels, offering downloadable episodes,
content, and virtual currency, and releasing titles for smartphones and tablets.
Our 2K label has published a variety of popular entertainment properties across
all key platforms and across a range of genres including shooter, action,
role-playing, strategy, sports and family/casual entertainment. We expect 2K to
continue to develop new, successful franchises in the future. 2K's internally
owned and developed franchises include the critically acclaimed, multi-million
unit selling BioShock, Mafia, Sid Meier's Civilization, and XCOM series. 2K also
publishes externally developed brands, such as Borderlands. The latest
installment, Borderlands 3, launched on September 13, 2019 . 2K's realistic
21
--------------------------------------------------------------------------------
Table of Contents
sports simulation titles include our flagship NBA 2K series, which continues to
be the top-ranked NBA basketball video game, the WWE 2K professional wrestling
series, and the Golf Club .
Our Private Division label is dedicated to bringing titles from top independent
developers to market and is the publisher of Kerbal Space Program. During fiscal
year 2020, Private Division released The Outer Worlds and Ancestors: The
Humankind Odyssey, based on new IP from renowned industry creative talent.
Private Division has announced that Kerbal Space Program 2 and Disintegration
are planned for release in fiscal year 2021.
Social Point develops and publishes popular free-to-play mobile games that
deliver high-quality, deeply engaging entertainment experiences, including its
two most successful games, Dragon City and Monster Legends. In addition, Social
Point has a robust development pipeline with a number of exciting games planned
for launch in the coming years.
We are continuing to execute on our growth initiatives in Asia , where our
strategy is to broaden the distribution of our existing products and expand our
online gaming presence, especially in China and South Korea . 2K has secured a
multi-year license from the NBA to develop an online version of the NBA
simulation game in China , Taiwan , South Korea , and Southeast Asia . NBA 2K
Online, our free-to-play NBA simulation game, that is based on the console
edition of NBA 2K, which was co-developed by 2K and Tencent, is the top online
PC sports game in China with over 48 million registered users. We have released
two iterations of NBA 2K Online and continue to enhance the title with new
features.
In February 2017 , we expanded our relationship with the NBA through the creation
of the NBA 2K League. Launched in May 2018 , this groundbreaking competitive
gaming league is jointly owned by us and the NBA and consists of teams operated
by actual NBA franchises, who will be joined by a team from Shanghai for the
2020 season. The NBA 2K League follows a professional sports league format:
head-to-head competition throughout a regular season, followed by a bracketed
playoff system and a finals match-up that was held in August of each of the NBA
2K League's first two seasons.
Trends and Factors Affecting our Business
Product Release Schedule. Our financial results are affected by the timing of
our product releases and the commercial success of those titles. Our Grand Theft
Auto products in particular have historically accounted for a significant
portion of our revenue. Sales of Grand Theft Auto products generated 21.5% of
our net revenue for the nine months ended December 31, 2019 . In October 2018 , we
released Red Dead Redemption 2. Sales of Red Dead Redemption products generated
14.8% of our net revenue for the nine months ended December 31, 2019 . The timing
of our Grand Theft Auto or Red Dead Redemption product releases may affect our
financial performance on a quarterly and annual basis.
Economic Environment and Retailer Performance. We continue to monitor economic
conditions that may unfavorably affect our businesses, such as deteriorating
consumer demand, pricing pressure on our products, credit quality of our
receivables, and foreign currency exchange rates. Our business is dependent upon
a limited number of customers that account for a significant portion of our
revenue. Our five largest customers accounted for 70.0% and 68.3% of net revenue
during the nine months ended December 31, 2019 and 2018, respectively. As of
December 31, 2019 and March 31, 2019 , our five largest customers comprised 63.6%
and 66.6% of our gross accounts receivable, respectively, with our significant
customers (those that individually comprised more than 10% of our gross accounts
receivable balance) accounting for 48.9% and 55.8% of such balance at
December 31, 2019 and March 31, 2019 , respectively. We had two customers who
accounted for 34.4% and 14.4%, respectively, of our gross accounts receivable as
of December 31, 2019 and two customers who accounted for 40.1% and 15.7%,
respectively, of our gross accounts receivable as of March 31, 2019 . The
economic environment has affected our customers in the past and may do so in the
future. Bankruptcies or consolidations of our large retail customers could
seriously hurt our business, due to uncollectible accounts receivables and the
concentration of purchasing power among the remaining large retailers. Certain
of our large customers sell used copies of our games, which may negatively
affect our business by reducing demand for new copies of our games. While the
online and downloadable content that we now offer for certain of our titles may
serve to reduce used game sales, we expect used game sales to continue to
adversely affect our business.
Hardware Platforms. We derive most of our revenue from the sale of software
products made for video game consoles manufactured by third parties, such as
Sony's PS4, Microsoft's Xbox One, and Nintendo's Switch, which comprised 75.9%
of our net revenue by product platform for the nine months ended December 31,
2019 . The success of our business is dependent upon the consumer acceptance of
these platforms and continued growth in their installed base. When new hardware
platforms are introduced, demand for software used on older platforms typically
declines, which may negatively affect our business during the market transition
to the new consoles. Accordingly, our strategy is to focus our development
efforts on a select number of the highest quality titles for these platforms,
while also expanding our offerings for emerging platforms such as tablets,
smartphones and online games.
Online Content and Digital Distribution. The interactive entertainment software
industry is delivering a growing amount of content through digital online
delivery methods. We provide a variety of online delivered products and
offerings.
22
--------------------------------------------------------------------------------
Table of Contents
Virtually all of our titles that are available through retailers as packaged
goods products are also available through direct digital download (from websites
we own and others owned by third parties) as well as a larger selection of our
catalog titles. In addition, we aim to drive ongoing engagement and incremental
revenue from recurrent consumer spending, which is generated from ongoing
consumer engagement and includes revenue from virtual currency, add-on content,
and in-game purchases. We also publish an expanding variety of titles for
tablets and smartphones, which are delivered to consumers through digital
download. Our "Results of Operations" discloses that net revenue from digital
online channels comprised 74.9% of our net revenue by distribution channel for
the nine months ended December 31, 2019 . We expect online delivery of games and
game offerings to continue to grow and to become an increasing part of our
business over the long-term.
Product Releases
We released the following key titles during the nine months ended December 31,
2019 :
Publishing Internal or External
Title Label Development Platform(s) Date Released
Borderlands: Game of 2K External PS4, Xbox One, PC April 3, 2019
the Year Edition
NBA 2K Mobile 2K Internal Android April 17, 2019
Ancestors: The Private Division External PC (digital only) August 27, 2019
Humankind Odyssey
NBA 2K20 2K Internal PS4, Xbox One, Switch, PC, September 6, 2019
iOS, Android
Borderlands 3 2K Internal / External PS4, Xbox One, PC September 13, 2019
WWE 2K20 2K Internal PS4, Xbox One, PC October 22, 2019
The Outer Worlds Private Division External PS4, Xbox One, PC October 25, 2019
Red Dead Redemption 2 Rockstar Games Internal PC November 5, 2019
Red Dead Redemption 2 Rockstar Games Internal Google Stadia November 19, 2019
NBA 2K20 2K Internal Google Stadia November 19, 2019
Sid Meier's 2K Internal PS4, Xbox One November 22, 2019
Civilization VI
Ancestors: The Private Division External PS4, Xbox One December 6, 2019
Humankind Odyssey
Borderlands 3 2K Internal / External Google Stadia December 17, 2019
Product Pipeline
We have announced the following future key titles to date (this list does not
represent all titles currently in development):
Publishing Internal or External
Title Label Development Platform(s) Expected Release Date
Disintegration Private Division External TBA Fiscal 2021
Kerbal Space Program 2 Private Division External PC (digital only) Fiscal 2021
23-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates Our most critical accounting policies, which are those that require significant judgment, include revenue recognition; price protection and allowances for returns; capitalization and recognition of software development costs and licenses; fair value estimates including valuation of goodwill, intangible assets, and long-lived assets; valuation and recognition of stock-based compensation; and income taxes. In-depth descriptions of these can be found in our Annual Report on Form 10-K for the fiscal year endedMarch 31, 2019 . During the nine months endedDecember 31, 2019 , there were no significant changes to the above critical accounting policies and estimates, with the exception of our adoption of Topic 842, Leases. Refer to Note 1 - Basis of Presentation and Significant Accounting Policies in the Notes to our Condensed Consolidated Financial Statements for disclosures regarding our updated lease accounting policies. Recently Adopted and Recently Issued Accounting Pronouncements See Note 1 - Basis of Presentation and Significant Accounting Policies for further discussion. Operating Metric Net Bookings We monitor Net Bookings as a key operating metric in evaluating the performance of our business. Net Bookings is defined as the net amount of products and services sold digitally or sold-in physically during the period and includes licensing fees, merchandise, in-game advertising, strategy guides, and publisher incentives. Net Bookings were as follows: Three Months EndedDecember 31 , Nine Months EndedDecember 31 , Increase/ % Increase/ Increase/ % Increase/ 2019 2018 (decrease) (decrease) 2019 2018 (decrease) (decrease)
Net Bookings$ 888,179 $ 1,568,568 $ (680,389) (43.4) %$ 2,260,935 $ 2,440,314 $ (179,379) (7.4) % For the three months endedDecember 31, 2019 , Net Bookings decreased by$680.4 million as compared to the prior year period due primarily to Red Dead Redemption 2, which released on PS4 and Xbox One inOctober 2018 , partially offset by an increase in Net Bookings from The Outer Worlds, Borderlands 3, Grand Theft Auto Online, Grand Theft Auto V, and Red Dead Online. For the nine months endedDecember 31, 2019 , Net Bookings decreased by$179.4 million as compared to the prior year period due primarily to Red Dead Redemption 2, partially offset by an increase in Net Bookings from Borderlands 3, The Outer Worlds, our NBA 2K franchise, Grand Theft Auto Online, and Red Dead Online. Results of Operations The following tables set forth, for the periods indicated, our Condensed Consolidated Statements of Operations, net revenue by geographic region, net revenue by platform, net revenue by distribution channel, and net revenue by content type: Three Months EndedDecember 31 , Nine Months EndedDecember 31 , (thousands of dollars) 2019 2018 2019 2018 Net revenue$ 930,129 100.0 %$ 1,248,738 100.0 %$ 2,328,429 100.0 %$ 2,129,387 100.0 % Cost of goods sold 437,093 47.0 % 898,484 72.0 % 1,146,810 49.3 % 1,264,730 59.4 % Gross profit 493,036 53.0 % 350,254 28.0 % 1,181,619 50.7 % 864,657 40.6 % Selling and marketing 137,068 14.7 % 161,322 12.9 % 378,455 16.3 % 313,793 14.7 % General and administrative 84,531 9.1 % 70,638 5.7 % 236,023 10.1 % 205,693 9.7 % Research and development 82,520 8.9 % 62,305 5.0 % 227,680 9.8 % 173,582 8.2 % Depreciation and amortization 12,330 1.3 % 10,140 0.8 % 35,611 1.5 % 29,151 1.4 % Business reorganization (246) - % (5,930) (0.5) % 467 - % (6,172) (0.3) % Total operating expenses 316,203 34.0 % 298,475 23.9 % 878,236 37.7 % 716,047 33.6 % Income from operations 176,833 19.0 % 51,779 4.1 % 303,383 13.0 % 148,610 7.0 % Interest and other, net 11,943 1.3 % 8,071 0.6 % 30,422 1.3 % 19,647 0.9 % Income before income taxes 188,776 20.3 % 59,850 4.8 % 333,805 14.3 % 168,257 7.9 % Provision for (benefit from) income taxes 25,134 2.7 % (120,098) (9.6) % 52,068 2.2 % (108,750) (5.1) % Net income$ 163,642 17.6 %$ 179,948 14.4 %$ 281,737 12.1 %$ 277,007 13.0 % 24
--------------------------------------------------------------------------------
Table of Contents
Three Months Ended December 31, Nine Months Ended December 31,
2019 2018 2019 2018
Net revenue by geographic
region:
United States $ 536,841 57.7 % $ 651,568 52.2 % $ 1,361,981 58.5 % $ 1,152,285 54.1 %
International 393,288 42.3 % 597,170 47.8 % 966,448 41.5 % 977,102 45.9 %
Net revenue by platform:
Console $ 679,799 73.1 % $ 1,144,459 91.6 % $ 1,766,431 75.9 % $ 1,811,429 85.1 %
PC and other 250,330 26.9 % 104,279 8.4 % 561,998 24.1 % 317,958 14.9 %
Net revenue by distribution
channel:
Digital online $ 700,321 75.3 % $ 594,722 47.6 % $ 1,743,876 74.9 % $ 1,268,140 59.6 %
Physical retail and other 229,808 24.7 % 654,016 52.4 % 584,553 25.1 % 861,247 40.4 %
Net revenue by content:
Full game and other $ 589,633 63.4 % $ 952,182 76.3 % $ 1,354,607 58.2 % $ 1,351,202 63.5 %
Recurrent consumer spending 340,496 36.6 % 296,556 23.7 % 973,822 41.8 % 778,185 36.5 %
Three Months Ended
Increase/ % Increase/
(thousands of dollars) 2019 % 2018 % (decrease) (decrease)
Net revenue $ 930,129 100.0 % $ 1,248,738 100.0 % $ (318,609) (25.5) %
Software development costs and
royalties(1) 130,985 14.1 % 265,166 21.2 % (134,181) (50.6) %
Internal royalties 166,432 17.9 % 401,382 32.1 % (234,950) (58.5) %
Product costs 90,959 9.8 % 183,208 14.7 % (92,249) (50.4) %
Licenses 48,717 5.2 % 48,728 3.9 % (11) - %
Cost of goods sold 437,093 47.0 % 898,484 72.0 % (461,391) (51.4) %
Gross profit $ 493,036 53.0 % $ 350,254 28.0 % $ 142,782 40.8 %
_______________________________________________________________________________ (1)Includes$33,048 and$96,082 of stock-based compensation expense in 2019 and 2018, respectively, in software development costs and royalties. For the three months endedDecember 31, 2019 , net revenue decreased by$318.6 million as compared to the prior year period. The decrease was due to (i) a decrease in net revenue of$577.2 million from Red Dead Redemption 2, which released inOctober 2018 , partially offset by an increase in net revenue of (ii)$153.9 million from The Outer Worlds which released inOctober 2019 , (iii)$65.8 million from Borderlands 3, which released inSeptember 2019 , and (iv)$45.7 million from our NBA 2K franchise. Net revenue from console games decreased by$464.7 million and accounted for 73.1% of our total net revenue for the three months endedDecember 31, 2019 , as compared to 91.6% for the prior year period. The decrease was due to a decrease in net revenue from Red Dead Redemption 2, partially offset by an increase in net revenue from The Outer Worlds, Borderlands 3, and our NBA 2K franchise. Net revenue from PC and other increased by$146.1 million and accounted for 26.9% of our total net revenue for the three months endedDecember 31, 2019 , as compared to 8.4% for the prior year period. The increase was due to net revenue from Red Dead Redemption 2, which released on PC inNovember 2019 , The Outer Worlds, and Borderlands 3. Net revenue from digital online channels increased by$105.6 million and accounted for 75.3% of our total net revenue for the three months endedDecember 31, 2019 , as compared to 47.6% for the prior year period. The increase was due to an increase in net revenue from The Outer Worlds, Borderlands 3, and our NBA 2K franchise, partially offset by a decrease in net revenue from Red Dead Redemption 2. Net revenue from physical retail and other channels decreased by$424.2 million and accounted for 24.7% of our total net revenue for the three months endedDecember 31, 2019 , as compared to 52.4% for the same period in the prior year period. The decrease in net revenue from physical retail and other channels was due to a decrease in net revenue from Red Dead Redemption 2, partially offset by an increase in net revenue from The Outer Worlds. Recurrent consumer spending is generated from ongoing consumer engagement and includes revenue from virtual currency, add-on content, and in-game purchases. Net revenue from recurrent consumer spending increased by$43.9 million and accounted for 36.6% of net revenue for the three months endedDecember 31, 2019 , as compared to 23.7% of net revenue for the prior year period. The increase in net revenue from recurrent consumer spending is due primarily to an increase in net 25 -------------------------------------------------------------------------------- Table of Contents revenue from our NBA 2K franchise. Net revenue from full game and other decreased by$362.5 million and accounted for 63.4% of net revenue for the three months endedDecember 31, 2019 as compared to 76.3% of net revenue for the prior year period. The decrease in net revenue from full game and other was due to a decrease in net revenue from Red Dead Redemption 2, partially offset by an increase in net revenue from The Outer Worlds and Borderlands 3. Gross profit as a percentage of net revenue for the three months endedDecember 31, 2019 was 53.0% as compared to 28.0% for the prior year period. The increase in gross profit as a percentage of net revenue was due to lower royalties and amortization of capitalized software costs as a percentage of net revenue due primarily to the timing of releases. Net revenue earned outside ofthe United States decreased by$203.9 million and accounted for 42.3% of our total net revenue for the three months endedDecember 31, 2019 , as compared to 47.8% in the prior year period. The decrease in net revenue outside ofthe United States was due to a decrease in net revenue from Red Dead Redemption 2, partially offset by an increase in net revenue from The Outer Worlds and Borderlands 3. Changes in foreign currency exchange rates decreased net revenue by$1.9 million and decreased gross profit by$0.1 million for the three months endedDecember 31, 2019 as compared to the prior year period. Operating Expenses % of net % of net Increase/ % Increase/ (thousands of dollars) 2019 revenue 2018 revenue (decrease) (decrease) Selling and marketing$ 137,068 14.7 %$ 161,322 12.9 %$ (24,254) (15.0) % General and administrative 84,531 9.1 % 70,638 5.7 % 13,893 19.7 % Research and development 82,520 8.9 % 62,305 5.0 % 20,215 32.4 % Depreciation and amortization 12,330 1.3 % 10,140 0.8 % 2,190 21.6 % Business reorganization (246) - % (5,930) (0.5) % 5,684 (95.9) % Total operating expenses(1)$ 316,203 34.0 %$ 298,475 23.9 %$ 17,728 5.9
%
_______________________________________________________________________________
(1)Includes stock-based compensation expense, which was allocated as follows (in
thousands):
2019 2018
Selling and marketing $ 4,113 $ 6,673
General and administrative 14,911 13,790
Research and development 11,327 7,123
Changes in foreign currency exchange rates decreased total operating expenses by
$0.9 million for the three months ended December 31, 2019 , as compared to the
prior year period.
Selling and marketing
Selling and marketing expenses decreased by $24.3 million for the three months
ended December 31, 2019 , as compared to the prior year period, due primarily to
lower advertising expenses for Red Dead Redemption 2, which released in October
2018 , partially offset by higher advertising expenses for The Outer Worlds,
Grand Theft Auto Online, Borderlands 3, and Red Dead Online. The decrease was
partially offset by higher personnel expenses due to increased headcount.
General and administrative
General and administrative expenses increased by $13.9 million for the three
months ended December 31, 2019 , as compared to the prior year period, due to
increases in (i) personnel expenses for additional headcount, (ii) increased
professional fees due to an insurance recovery in the prior year period, and
(iii) IT-related expenses for cloud-based services.
General and administrative expenses for the three months ended December 31, 2019
and 2018 included occupancy expense (primarily rent, utilities and office
expenses) of $6.6 million and $5.5 million , respectively, related to our
development studios.
Research and development
Research and development expenses increased by $20.2 million for the three
months ended December 31, 2019 , as compared to the prior year period, due
primarily to increases in (i) production and development expenses for titles for
which technological feasibility has not been established and (ii) personnel
expenses for additional headcount.
26
--------------------------------------------------------------------------------
Table of Contents
Depreciation and Amortization
Depreciation and amortization expenses increased by $2.2 million for the three
months ended December 31, 2019 as compared to the prior year period, due
primarily to IT infrastructure.
Business reorganization
During the three months ended December 31, 2019 , business reorganization expense
increased $5.7 million due to a benefit in the prior year related to updating
estimates for our 2016 Plan, partially offset by updating estimates for our 2018
Plan with no corresponding expense in the prior year period.
Interest and other, net
Interest and other, net was income of $11.9 million for the three months ended
December 31, 2019 , as compared to $8.1 million for the prior year period. The
change was due primarily to higher interest income due to the nature of our
investments, higher invested balances, and higher interest rates on those
investments.
Provision for Income Taxes
The provision for income taxes for the three months ended December 31, 2019 is
based on our projected annual effective tax rate for fiscal year 2020, adjusted
for specific items that are required to be recognized in the period in which
they are incurred. The provision for income taxes was $25.1 million for the
three months ended December 31, 2019 as compared to a benefit for income taxes
of $120.1 million for the prior year period.
When compared to the statutory rate of 21.0%, the effective tax rate of 13.3%
for the three months ended December 31, 2019 was due primarily to tax benefits
of $9.1 million as a result of tax credits anticipated to be utilized and $2.6
million due to a geographic mix of earnings.
In the prior year period, when compared to our statutory rate of 21%, the
effective tax rate of (200.7)% for the three months ended December 31, 2018 was
due primarily to a tax benefit of $108.7 million resulting from changes in our
valuation allowance on certain U.S. deferred tax assets that are
more-likely-than-not to be realized, a tax benefit of $15.4 million due to the
geographic mix of earnings, a tax benefit of $12.0 million for excess tax
benefits from employee stock compensation, and a tax benefit of $6.5 million as
a result of tax credits anticipated to be utilized. To a lesser extent, our rate
was also affected by the Tax Cuts and Jobs Act (herein referred to as the "Tax
Act").
The change in the effective tax rate, when compared to the prior year period's
effective tax rate, is due primarily to decreased benefits from changes in our
valuation allowance, our geographic mix in earnings, and excess benefits from
stock compensation.
We anticipate that additional excess tax benefits or shortfalls from employee
stock compensation, tax credits, and changes in our geographic mix of earnings
could have a significant impact on our effective tax rate in the future. In
addition, we are regularly examined by domestic and foreign taxing authorities.
Examinations may result in tax assessments in excess of amounts claimed and the
payment of additional taxes. We believe our tax positions comply with applicable
tax law, and that we have adequately provided for reasonably foreseeable tax
assessments. It is possible that settlement of audits and/or the expiration of
the statute of limitations could have an impact on our effective tax rate in
future periods.
The accounting for share-based compensation will increase or decrease our
effective tax rate based on the difference between our share-based compensation
expense and the deductions taken on our tax return, which depends on the stock
price at the time of the employee award vesting. Since we recognize excess tax
benefits on a discrete basis, we anticipate that our effective tax rate will
vary from quarter to quarter depending on our stock price in each period.
On June 21, 2018 , the U.S. Supreme Court issued its decision in South Dakota v.
Wayfair, which overturned previous case law that precluded states from requiring
retailers to collect and remit sales tax on sales made to in-state customers
unless the retailer had physical presence in the state. Although this case is
limited to sales tax collection obligations, we continue to monitor the
potential impact of this decision on our state income tax footprint.
On May 19, 2019 , a public referendum held in Switzerland approved the Federal
Act on Tax Reform and AVH (Old-Age and Survivors Insurance ) Financing ("TRAF"),
which was effective for us on January 1, 2020 . The tax reform abolished
preferential tax regimes for holding companies, domicile companies and mixed
companies at the cantonal level. The TRAF allows the cantons to establish
transition rules, the implementation of which may be subject to a ruling from
the canton. Any deferred tax assets arising from tax basis step-up would be
recorded once the cantonal process is complete. As of December 31, 2019 , the
TRAF did not have a material effect on the Company.
27
--------------------------------------------------------------------------------
Table of Contents
Net income and earnings per share
For the three months ended December 31, 2019 , net income was $163.6 million , as
compared to $179.9 million in the prior year period. Diluted earnings per share
for the three months ended December 31, 2019 , was $1.43 , as compared to diluted
earnings per share of $1.57 in the prior year period. Diluted weighted average
shares of 114.3 million were 0.5 million shares lower as compared to the prior
year period, due primarily to share repurchases in the last three quarters of
fiscal year 2019. See Note 11 to our Condensed Consolidated Financial Statements
for additional information regarding earnings per share.
Nine Months Ended December 31, 2019 Compared to December 31, 2018
Increase/ % Increase/
(thousands of dollars) 2019 % 2018 % (decrease) (decrease)
Net revenue $ 2,328,429 100.0 % $ 2,129,387 100.0 % $ 199,042 9.3 %
Software development costs and
royalties(1) 451,422 19.4 % 337,603 15.9 % 113,819 33.7 %
Internal royalties 339,312 14.6 % 536,662 25.2 % (197,350) (36.8) %
Product costs 225,162 9.7 % 277,234 13.0 % (52,072) (18.8) %
Licenses 130,914 5.6 % 113,231 5.3 % 17,683 15.6 %
Cost of goods sold 1,146,810 49.3 % 1,264,730 59.4 % (117,920) (9.3) %
Gross profit $ 1,181,619 50.7 % $ 864,657 40.6 % $ 316,962 36.7 %
(1)Includes $91,678 and $107,740 of stock-based compensation expense in 2019 and
2018, respectively, in software development costs and royalties.
For the nine months ended December 31, 2019 , net revenue increased by $199.0
million as compared to the prior year period. The increase was due primarily to
(i) $321.3 million in net revenue from Borderlands 3, which released in
September 2019 , (ii) $153.9 million from The Outer Worlds, which released in
October 2019 , and (iii) an increase of $132.0 million from our NBA 2K franchise.
These increases were offset by a decrease of $419.8 million in net revenue from
Red Dead Redemption 2, which released in October 2018 .
Net revenue from console games decreased by $45.0 million and accounted for
75.9% of our total net revenue for the nine months ended December 31, 2019 , as
compared to 85.1% for the prior year period. The decrease was due to a decrease
in net revenue from Red Dead Redemption 2, our WWE 2K franchise, and Grand Theft
Auto Online, partially offset by an increase in net revenue from Borderlands 3,
our NBA 2K franchise, The Outer Worlds, and Red Dead Online. Net revenue from PC
and other increased by $244.0 million and accounted for 24.1% of our total net
revenue for the nine months ended December 31, 2019 , as compared to 14.9% for
the prior year period. The increase was due an increase in net revenue from
Borderlands 3, Red Dead Redemption 2, which released on PC in November 2019 , and
The Outer Worlds.
Net revenue from digital online channels increased by $475.7 million and
accounted for 74.9% of our total net revenue for the nine months ended December
31, 2019 , as compared to 59.6% for the prior year period. The increase was due
to an increase in net revenue from Borderlands 3, our NBA 2K franchise, and The
Outer Worlds, partially offset by a decrease in net revenue from Red Dead
Redemption 2. Net revenue from physical retail and other channels decreased by
$276.7 million and accounted for 25.1% of our total net revenue for the nine
months ended December 31, 2019 , as compared to 40.4% for the same period in the
prior year period. The decrease was due to a decrease in net revenue from Red
Dead Redemption 2, partially offset by an increase in net revenue from
Borderlands 3.
Recurrent consumer spending is generated from ongoing consumer engagement and
includes revenue from virtual currency, add-on content, and in-game purchases.
Net revenue from recurrent consumer spending increased by $195.6 million and
accounted for 41.8% of net revenue for the nine months ended December 31, 2019 ,
as compared to 36.5% of net revenue for the prior year period. The increase was
due to an increase in net revenue from our NBA 2K franchise, Borderlands 3, and
Red Dead Online, partially offset by a decrease in net revenue from Grand Theft
Auto Online. Net revenue from full game and other increased by $3.4 million and
accounted for 58.2% of net revenue for the nine months ended December 31, 2019
as compared to 63.5% of net revenue for the prior year period. The increase was
due to net revenue from Borderlands 3, The Outer Worlds, The Ancestors, and
Civilization VI, which released on PS4 and Xbox One in November 2019 , partially
offset by a decrease in net revenue from Red Dead Redemption 2, our WWE 2K
franchise, our NBA 2K franchise, and Grand Theft Auto V.
Gross profit as a percentage of net revenue for the nine months ended December
31, 2019 was 50.7% as compared to 40.6% for the prior year period. The increase
in gross profit as a percentage of net revenue was due to lower royalties as a
percentage of net revenue due primarily to the timing of releases.
28
--------------------------------------------------------------------------------
Table of Contents
Net revenue earned outside of the United States decreased by $10.7 million , and
accounted for 41.5% of our total net revenue for the nine months ended December
31, 2019 , as compared to 45.9% in the prior year period. The decrease in net
revenue outside of the United States was due to a decrease in net revenue from
Red Dead Redemption 2, Grand Theft Auto V, and our WWE 2K franchise, partially
offset by an increase in net revenue from Borderlands 3, The Outer Worlds,
Civilization VI, The Ancestors, and Red Dead Redemption Online. Changes in
foreign currency exchange rates decreased net revenue by $9.7 million and
decreased gross profit by $2.8 million for the nine months ended December 31,
2019 as compared to the prior year period.
Operating Expenses
% of net % of net Increase/ % Increase/
(thousands of dollars) 2019 revenue 2018 revenue (decrease) (decrease)
Selling and marketing $ 378,455 16.3 % $ 313,793 14.7 % $ 64,662 20.6 %
General and administrative 236,023 10.1 % 205,693 9.7 % 30,330 14.7 %
Research and development 227,680 9.8 % 173,582 8.2 % 54,098 31.2 %
Depreciation and amortization 35,611 1.5 % 29,151 1.4 % 6,460 22.2 %
Business reorganization 467 - % (6,172) (0.3) % 6,639 (107.6) %
Total operating expenses (1) $ 878,236 37.7 % $ 716,047 33.6 % $ 162,189 22.7 %
(1)Includes stock-based compensation expense, which was allocated as follows (in
thousands):
2019 2018
General and administrative $ 42,054 $ 38,234
Selling and marketing 14,333 16,321
Research and development 28,533 16,314
Changes in foreign currency exchange rates decreased total operating expenses by
$7.9 million for the nine months ended December 31, 2019 , as compared to the
prior year period.
Selling and marketing
Selling and marketing expenses increased by $64.7 million for the nine months
ended December 31, 2019 , as compared to the prior year period, due primarily to
higher advertising expenses for Borderlands 3, Red Dead Online, Grand Theft Auto
Online, and The Outer Worlds, partially offset by lower advertising expenses for
Red Dead Redemption 2. The increase was also due to higher personnel expenses
due to increased headcount.
General and administrative
General and administrative expenses increased by $30.3 million for the nine
months ended December 31, 2019 , as compared to the prior year period, due to
increases in personnel expenses for additional headcount and IT related expenses
for cloud-based service and IT infrastructure.
General and administrative expenses for the nine months ended December 31, 2019
and 2018 included occupancy expense (primarily rent, utilities and office
expenses) of $18.9 million and $16.5 million , respectively, related to our
development studios.
Research and development
Research and development expenses increased by $54.1 million for the nine months
ended December 31, 2019 , as compared to the prior year period, due primarily to
increases in (i) production and development expenses for titles for which
technological feasibility has not been established and (ii) personnel expenses
due to increased headcount.
Depreciation and Amortization
Depreciation and amortization expenses for the nine months ended December 31,
2019 increased by $6.5 million , as compared to the prior year period, due
primarily to IT infrastructure.
29
--------------------------------------------------------------------------------
Table of Contents
Business reorganization
During the nine months ended December 31, 2019 , business reorganization expense
increased $6.6 million due to a benefit in the prior year related to updating
estimates for our 2016 Plan and updating estimates for our 2018 Plan with no
corresponding expense in the prior year period.
Interest and other, net
Interest and other, net was income of $30.4 million for the nine months ended
December 31, 2019 , as compared to income of $19.6 million for the prior year
period. The change was due primarily to higher interest income due to the nature
of our investments, higher invested balances, and higher interest rates on those
investments, partially offset by foreign currency losses.
Provision for Income Taxes
The provision for income taxes for the nine months ended December 31, 2019 is
based on our projected annual effective tax rate for fiscal year 2020, adjusted
for specific items that are required to be recognized in the period in which
they are incurred. The provision for income taxes was $52.1 million for the nine
months ended December 31, 2019 as compared to a benefit from income taxes of
$108.8 million for the prior year period.
When compared to the statutory rate of 21.0%, the effective tax rate of 15.6%
for the nine months ended December 31, 2019 was due primarily to a benefit of
$15.1 million as a result of tax credits anticipated to be utilized, a tax
benefit of $11.6 million from changes in unrecognized tax benefits due to audit
settlements, and a benefit of $5.8 million from our geographic mix of earnings.
To a lesser extent the rate was also affected by excess tax benefits from
employee stock-based compensation. These benefits were partially offset by a tax
expense of $19.8 million from the reversal of net deferred tax benefits relating
to the Altera case, discussed below.
In the prior year period, when compared to our blended statutory rate of 21%,
the effective tax rate of (64.6)% for the nine months ended December 31, 2018
was due primarily to a tax benefit of $108.7 million as a result of changes in
our valuation allowance on certain U.S. deferred tax assets that are
more-likely-than-not to be realized, a tax benefit of $18.9 million for excess
tax benefits from employee stock compensation, a tax benefit of $15.3 million as
a result of tax credits anticipated to be utilized, and a net tax benefit of
$4.7 million due to the geographic mix of earnings. To a lesser extent, our rate
was also affected by the Tax Act.
The change in the effective tax rate, when compared to the prior year period's
effective tax rate, is due primarily to increased tax expense relating to the
Altera case, discussed below, decreased benefits from changes in our valuation
allowance relating to temporary items and tax carryforwards anticipated to be
utilized, and excess tax benefits from employee stock-based compensation
partially offset by increased discrete tax benefits recorded from changes in
unrecognized tax benefits due primarily to audit settlements.
We anticipate that additional excess tax benefits from employee stock
compensation, tax credits, and changes in our geographic mix of earnings could
have a significant impact on our effective tax rate in the future. In addition,
we are regularly examined by domestic and foreign taxing authorities.
Examinations may result in tax assessments in excess of amounts claimed and the
payment of additional taxes. We believe our tax positions comply with applicable
tax law, and that we have adequately provided for reasonably foreseeable tax
assessments. It is possible that settlement of audits and/or the expiration of
the statute of limitations could have an impact on our effective tax rate in
future periods.
The accounting for share-based compensation will increase or decrease our
effective tax rate based on the difference between our share-based compensation
expense and the deductions taken on our tax return, which depends on the stock
price at the time of the employee award vesting. Since we recognize excess tax
benefits on a discrete basis, we anticipate that our effective tax rate will
vary from quarter to quarter depending on our stock price in each period.
On July 27, 2015 , the U.S. Tax Court issued an opinion in Altera Corp. v.
Commissioner, which concluded that related parties in an intercompany
cost-sharing arrangement are not required to share costs related to stock-based
compensation. In February 2016 , the U.S. Internal Revenue Service appealed the
decision to the U.S. Court of Appeals for the Ninth Circuit . On June 7, 2019 ,
the Ninth Circuit reversed the 2015 decision of the U.S. Tax Court. As a result
of this decision, we are no longer reflecting a net tax benefit within our
financial statements related to the removal of stock-based compensation from our
intercompany cost-sharing arrangement. During the nine months ended December 31,
2019 , we removed the deferred tax asset and a deferred tax liability associated
with this matter, resulting in a cumulative net discrete income tax expense of
$19,826 . The taxpayer requested a rehearing before the full Ninth Circuit which
was denied on November 12, 2019 . The case remains
30
--------------------------------------------------------------------------------
Table of Contents
potentially open for judicial review by the U.S. Supreme Court . As a result, the
final outcome of the case is uncertain. We will continue to monitor ongoing
developments of this matter and potential impacts to our financial statements.
On June 21, 2018 , the U.S. Supreme Court issued its decision in South Dakota v.
Wayfair, which overturned previous case law that precluded states from requiring
retailers to collect and remit sales tax on sales made to in-state customers
unless the retailer had physical presence in the state. Although this case is
limited to sales tax collection obligations, we continue to monitor the
potential impact of this decision on our state income tax footprint.
On May 19, 2019 , a public referendum held in Switzerland approved the Federal
Act on Tax Reform and AVH (Old-Age and Survivors Insurance ) Financing ("TRAF"),
which was effective for us on January 1, 2020 . The tax reform abolished
preferential tax regimes for holding companies, domicile companies and mixed
companies at the cantonal level. The TRAF allows the cantons to establish
transition rules, the implementation of which may be subject to a ruling from
the canton. Any deferred tax assets arising from tax basis step-up would be
recorded once the cantonal process is complete. As of December 31, 2019 , the
TRAF did not have a material effect on the Company.
Net income and earnings per share
For the nine months ended December 31, 2019 , net income was $281.7 million , as
compared to net income of $277.0 million in the prior year period. For the nine
months ended December 31, 2019 , diluted earnings per share was $2.47 as compared
to diluted earnings per share of $2.41 in the prior year period. Diluted
weighted average shares of 114 million were 0.9 million shares lower as compared
to the prior year period, due primarily to share repurchases in the last three
quarters of fiscal year 2019. See Note 11 to our Condensed Consolidated
Financial Statements for additional information regarding earnings per share.
Liquidity and Capital Resources
Our primary cash requirements have been to fund (i) the development,
manufacturing, and marketing of our published products, (ii) working capital,
(iii) acquisitions, and (iv) capital expenditures. We expect to rely on cash and
cash equivalents as well as on short-term investments, funds provided by our
operating activities, and our Credit Agreement to satisfy our working capital
needs.
Short-term Investments
As of December 31, 2019 , we had $699.3 million of short-term investments, which
are highly liquid in nature and represent an investment of cash that is
available for current operations. From time to time, we may purchase additional
short-term investments depending on future market conditions and liquidity
needs.
Credit Agreement
On February 8, 2019 , we entered into an unsecured Credit Agreement (the "Credit
Agreement"). The Credit Agreement runs through February 8, 2024 . The Credit
Agreement provides for an unsecured five-year revolving credit facility with
commitments of $200 million , including sublimits for (i) the issuance of letters
of credit in an aggregate face amount of up to $25 million and (ii) borrowings
and letters of credit denominated in Pounds Sterling, Euros and Canadian Dollars
in an aggregate principal amount of up to $25 million . In addition, the Credit
Agreement contains uncommitted incremental capacity permitting the incurrence of
up to an additional $250 million in term loans or revolving credit facilities.
Loans under the Credit Agreement will bear interest at a rate of (a) 0.250% to
0.750% above a certain base rate (5.50% at December 31, 2019 ) or (b) 1.125% to
1.750% above LIBOR (approximately 1.66% at December 31, 2019 ), which rates are
determined by reference to our consolidated total net leverage ratio.
As of December 31, 2019 , there was $198.3 million available to borrow under the
Credit Agreement and we had $1.7 million of letters of credit outstanding. At
December 31, 2019 , we had no outstanding borrowings under the Credit Agreement.
The Credit Agreement also includes, among other terms and conditions, maximum
leverage ratio, minimum cash reserves and, in certain circumstances, minimum
interest coverage ratio financial covenants, as well as limitations on the
Company's and each of its subsidiaries' ability to: create, incur, assume or be
liable for indebtedness; dispose of assets outside the ordinary course; acquire,
merge or consolidate with or into another person or entity; create, incur or
allow any lien on any of its property; make investments; or pay dividends or
make distributions, in each case subject to certain exceptions. In addition, the
Credit Agreement provides for certain events of default such as nonpayment of
principal and interest when due thereunder, breaches of representations and
warranties, noncompliance with covenants, acts of insolvency and default on
indebtedness held by third parties (subject to certain limitations and cure
periods).
31
--------------------------------------------------------------------------------
Table of Contents
Financial Condition
We are subject to credit risks, particularly if any of our receivables represent
a limited number of customers or are concentrated in foreign markets. If we are
unable to collect our accounts receivable as they become due, it could adversely
affect our liquidity and working capital position.
Generally, we have been able to collect our accounts receivable in the ordinary
course of business. We do not hold any collateral to secure payment from
customers. We have trade credit insurance on the majority of our customers to
mitigate accounts receivable risk.
A majority of our trade receivables are derived from sales to major retailers
and distributors. Our five largest customers accounted for 70.0% and 68.3% of
net revenue during the nine months ended December 31, 2019 and 2018,
respectively. As of December 31, 2019 and March 31, 2019 , five customers
accounted for 63.6% and 66.6% of our gross accounts receivable, respectively.
Customers that individually accounted for more than 10% of our gross accounts
receivable balance comprised 48.9% and 55.8% of such balances at December 31,
2019 and March 31, 2019 , respectively. We had two customers who accounted for
34.4% and 14.4% of our gross accounts receivable as of December 31, 2019 ,
respectively, and two customers who accounted for 40.1% and 15.7% of our gross
accounts receivable as of March 31, 2019 , respectively. Based upon performing
ongoing credit evaluations, maintaining trade credit insurance on a majority of
our customers and our past collection experience, we believe that the receivable
balances from these largest customers do not represent a significant credit
risk, although we actively monitor each customer's credit worthiness and
economic conditions that may affect our customers' business and access to
capital. We are monitoring the current global economic conditions, including
credit markets and other factors as it relates to our customers in order to
manage the risk of uncollectible accounts receivable.
We believe our current cash and cash equivalents, short-term investments and
projected cash flows from operations, along with availability under our Credit
Agreement will provide us with sufficient liquidity to satisfy our cash
requirements for working capital, capital expenditures and commitments on both a
short-term and long-term basis.
As of December 31, 2019 , the amount of cash and cash equivalents held outside of
the U.S. by our foreign subsidiaries was $447.3 million . These balances are
dispersed across various locations around the world. We believe that such
dispersion meets the business and liquidity needs of our foreign affiliates. In
addition, we expect for the foreseeable future to have the ability to generate
sufficient cash domestically to support ongoing operations.
Our Board of Directors has authorized the repurchase of up to 14,218 shares of
our common stock. Under this program, we may purchase shares from time to time
through a variety of methods, including in the open market or through privately
negotiated transactions, in accordance with applicable securities laws.
Repurchases are subject to the availability of stock, prevailing market
conditions, the trading price of the stock, our financial performance and other
conditions. The program may be suspended or discontinued at any time for any
reason.
During the nine months ended December 31, 2019 , we did not make any repurchases
of our common stock in the open market. We have repurchased a total of 10,400
shares of our common stock under the program, and as of December 31, 2019 , 3,818
shares of our common stock remained available for repurchase under the share
repurchase program.
Our changes in cash flows were as follows:
Nine Months Ended
December 31,
(thousands of dollars) 2019 2018
Net cash provided by operating activities $ 439,975 $ 390,199
Net cash (used in) provided by investing activities (27,077) 22,278
Net cash used in financing activities (60,745) (348,229) Effects of foreign currency exchange rates on cash, cash equivalents, and restricted cash
(1,705) (15,124)
Net change in cash, cash equivalents, and restricted cash $
350,448
AtDecember 31, 2019 , we had$1,742.4 million of cash and cash equivalents and restricted cash, compared to$1,392.0 million atMarch 31, 2019 . The increase was due to Net cash provided by operating activities from sales of our products, partially offset by the timing of payments. This net increase was partially offset by (1) Net cash used in financing activities, which was primarily for tax payments related to net share settlements of our restricted stock awards and (2) Net cash used in investing activities primarily related to the purchases of fixed assets and purchases of long-term investments. 32 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations and Commitments We have entered into various agreements in the ordinary course of business that require substantial cash commitments over the next several years. Other than agreements entered into in the ordinary course of business and in addition to the agreements requiring known cash commitments as reported in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year endedMarch 31, 2019 , we did not have any significant changes to our commitments sinceMarch 31, 2019 . Legal and Other Proceedings: We are, or may become, subject to demands and claims (including intellectual property claims) and are involved in routine litigation in the ordinary course of business which we do not believe to be material to our business or financial statements. We have appropriately accrued amounts related to certain of these claims and legal and other proceedings. While it is reasonably possible that a loss may be incurred in excess of the amounts accrued in our financial statements, we believe that such losses, unless otherwise disclosed, would not be material. Off-Balance Sheet Arrangements As ofDecember 31, 2019 andMarch 31, 2019 , we did not have any material relationships with unconsolidated entities or financial parties, such as entities often referred to as structured finance or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. International Operations Net revenue earned outside ofthe United States is principally generated by our operations inEurope ,Asia ,Australia ,Canada andLatin America . For the three months endedDecember 31, 2019 and 2018, 42.3% and 47.8%, respectively, and for the nine months endedDecember 31, 2019 and 2018, 41.5% and 45.9%, respectively, of our net revenue was earned outside ofthe United States . We are subject to risks inherent in foreign trade, including increased credit risks, tariffs and duties, fluctuations in foreign currency exchange rates, shipping delays and international political, regulatory and economic developments, all of which can have a significant effect on our operating results. Fluctuations in Quarterly Operating Results and Seasonality We have experienced fluctuations in quarterly and annual operating results as a result of the timing of the introduction of new titles; variations in sales of titles developed for particular platforms; market acceptance of our titles; development and promotional expenses relating to the introduction of new titles; sequels or enhancements of existing titles; projected and actual changes in platforms; the timing and success of title introductions by our competitors; product returns; changes in pricing policies by us and our competitors; the accuracy of retailers' forecasts of consumer demand; the size and timing of acquisitions; the timing of orders from major customers; and order cancellations and delays in product shipment. Sales of our products are also seasonal, with peak shipments typically occurring in the fourth calendar quarter as a result of increased demand for products during the holiday season. For certain of our software products, we allocate a portion of the amount to be recognized as revenue over an estimated service period, which generally ranges from 9 to 15 months. As a result, the quarter in which we generate the highest net sales volume may be different from the quarter in which we recognize the highest amount of net revenues. Quarterly comparisons of operating results are not necessarily indicative of future operating results. Item 3. Quantitative and Qualitative Disclosures About Market Risk Market risk is the potential loss arising from fluctuations in market rates and prices. Our market risk exposures primarily include fluctuations in interest rates and foreign currency exchange rates. Interest Rate Risk Our exposure to fluctuations in interest rates relates primarily to our short-term investment portfolio and variable rate debt under the Credit Agreement. We seek to manage our interest rate risk by maintaining a short-term investment portfolio that includes corporate bonds with high credit quality and maturities less than two years. Since short-term investments mature relatively quickly and can be reinvested at the then-current market rates, interest income on a portfolio consisting of short-term securities is more subject to market fluctuations than a portfolio of longer-term maturities. However, the fair value of a short-term portfolio is less sensitive to market fluctuations than a portfolio of longer-term securities. We do not currently use derivative financial instruments in our short-term investment portfolio. Our investments are held for purposes other than trading. As ofDecember 31, 2019 , we had$699.3 million of short-term investments, which included$426.3 million of available-for-sale securities. The available-for-sale securities were recorded at fair market value with unrealized gains or losses 33 -------------------------------------------------------------------------------- Table of Contents resulting from changes in fair value reported as a separate component of accumulated other comprehensive income (loss), net of tax, in stockholders' equity. We also had$1,284.9 million of cash and cash equivalents that are comprised primarily of money market funds and bank-time deposits. We determined that, based on the composition of our investment portfolio, there was no material interest rate risk exposure to our Condensed Consolidated Financial Statements or liquidity as ofDecember 31, 2019 . Historically, fluctuations in interest rates have not had a significant effect on our operating results. Under our Credit Agreement, outstanding balances bear interest at our election of (a) 0.250% to 0.750% above a certain base rate (5.50% atDecember 31, 2019 ), or (b) 1.125% to 1.750% above the LIBOR rate (approximately 1.66% atDecember 31, 2019 ), with the margin rate subject to the achievement of certain average liquidity levels. Changes in market rates may affect our future interest expense if there is an outstanding balance on our line of credit. Foreign Currency Exchange Rate Risk We transact business in foreign currencies and are exposed to risks resulting from fluctuations in foreign currency exchange rates. Accounts relating to foreign operations are translated intoUnited States dollars using prevailing exchange rates at the relevant period end. Translation adjustments are included as a separate component of stockholders' equity. For the three months endedDecember 31, 2019 and 2018, our foreign currency translation adjustment was a gain of$18.2 million and a loss of$16.3 million , respectively, and for the nine months endedDecember 31, 2019 and 2018, we recognized a foreign currency translation adjustment loss of$3.2 million and a loss of$40.7 million , respectively. For the three months endedDecember 31, 2019 and 2018, we recognized a foreign currency exchange transaction gain of$1.0 million and a gain of$2.2 million , respectively, and for the nine months endedDecember 31, 2019 and 2018, we recognized a foreign currency exchange transaction loss of$1.7 million and a gain of$2.7 million , respectively, included in interest and other, net in our Condensed Consolidated Statements of Operations. Balance Sheet Hedging Activities We use foreign currency forward contracts to mitigate foreign currency exchange rate risk associated with non-functional currency denominated cash balances and intercompany funding loans, non-functional currency denominated accounts receivable and non-functional currency denominated accounts payable. These transactions are not designated as hedging instruments and are accounted for as derivatives whereby the fair value of the contracts is reported as either assets or liabilities on our Condensed Consolidated Balance Sheets, and gains and losses resulting from changes in the fair value are reported in Interest and other, net, in our Condensed Consolidated Statements of Operations. We do not enter into derivative financial contracts for speculative or trading purposes. AtDecember 31, 2019 , we had$180.7 million of forward contracts outstanding to sell foreign currencies in exchange forU.S. dollars and$56.1 million of forward contracts outstanding to buy foreign currencies in exchange forU.S. dollars, all of which have maturities of less than one year. AtMarch 31, 2019 , we had$116.6 million of forward contracts outstanding to sell foreign currencies in exchange forU.S. dollars and$87.8 million of forward contracts outstanding to buy foreign currencies in exchange forU.S. dollars, all of which have maturities of less than one year. For the three months endedDecember 31, 2019 and 2018, we recorded a loss of$0.6 million and a gain of$10.8 million , respectively, and for the nine months endedDecember 31, 2019 and 2018, we recorded a loss of$1.6 million and a gain of$13.0 million , respectively. As ofDecember 31, 2019 , the fair value of these outstanding forward contracts was an immaterial gain and was included in Prepaid expenses and other, and, as ofMarch 31, 2019 , the fair value of outstanding forward contracts was an immaterial loss and was included in Accrued expenses and other current liabilities. The fair value of these outstanding forward contracts is estimated based on the prevailing exchange rates of the various hedged currencies as of the end of the period. Our hedging programs are designed to reduce, but do not entirely eliminate, the effect of currency exchange rate movements. We believe the counterparties to these foreign currency forward contracts are creditworthy multinational commercial banks and that the risk of counterparty nonperformance is not material. Notwithstanding our efforts to mitigate some foreign currency exchange rate risks, there can be no assurance that our hedging activities will adequately protect us against the risks associated with foreign currency fluctuations. For the three months endedDecember 31, 2019 , 42.3% of our revenue was generated outsidethe United States . Using sensitivity analysis, a hypothetical 10% increase in the value of theU.S. dollar against all currencies would decrease revenues by 4.2%, while a hypothetical 10% decrease in the value of theU.S. dollar against all currencies would increase revenues by 4.2%. In our opinion, a substantial portion of this fluctuation would be offset by cost of goods sold and operating expenses incurred in local currency. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures Based on an evaluation under the supervision and with the participation of management, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures as defined in rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended ("Exchange Act") were effective as of the end of the period 34 -------------------------------------------------------------------------------- Table of Contents covered by this report to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission rules and forms and (ii) accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in Internal Control Over Financial Reporting There were no changes in our internal control over financial reporting during the quarter endedDecember 31, 2019 , which were identified in connection with management's evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Inherent limitations to any system of disclosure controls and procedures include, but are not limited to, the possibility of human error and the circumvention or overriding of such controls by one or more persons. In addition, we have designed our system of controls based on certain assumptions, which we believe are reasonable, about the likelihood of future events, and our system of controls may therefore not achieve its desired objectives under all possible future events. 35
--------------------------------------------------------------------------------
© Edgar Online, source
