TAKE TWO INTERACTIVE SOFTWARE INC 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 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 our 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 uncertainties including the uncertainty of the impact of the COVID-19 pandemic and measures taken in response thereto; the effect that measures taken to mitigate the COVID-19 pandemic have on our operations, including our ability to timely deliver our titles and other products, and on the operations of our counterparties, including retailers, including digital storefronts and platform partners, and distributors; the effects of the COVID-19 pandemic on consumer demand and the discretionary spending patterns of our customers; the impact of reductions in interest rates by the Federal Reserve and other central banks, including on our short-term investment portfolio; the impact of potential inflation; volatility in foreign currency exchange rates; other risks included herein; as well as, but not limited to, the risks and uncertainties discussed under the heading "Risk Factors" included in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended March 31, 2020; and our 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. We undertake 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, 2020. Overview Our Business We are a leading developer, publisher, and marketer of interactive entertainment for consumers around the globe. We develop and publish products principally through Rockstar Games, 2K, Private Division, and Social Point. 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, South Korea, 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. We 18 Table of Contents 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 325 million units. The latest installment, Grand Theft Auto V , has sold in over 130 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 30 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. 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 successful externally developed brands, such as Borderlands . 2K's realistic 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 PGA Tour 2K . In March 2020, 2K announced a multi-year partnership with the National Football League encompassing multiple future video games that will be non-simulation football game experiences and will launch starting in fiscal year 2022. Our Private Division label is dedicated to bringing titles from top independent developers to market and is the publisher and owner of Kerbal Space Program . Private Division released The Outer Worlds and Ancestors: The Humankind Odyssey , during fiscal year 2020, and Disintegration during fiscal year 2021, based on new IP from renowned industry creative talent. Private Division has announced that Kerbal Space Program 2 is planned for release in fiscal year 2022. 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 nearly 50 million registered users. We have released two iterations of NBA 2K Online and continue to enhance the title with new features. We have 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. 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 31.6% of our net revenue for the three months ended June 30, 2020. The timing of our Grand Theft Auto product releases may affect our financial performance on a quarterly and annual basis. Economic Environment and Retailer Performance. We continue to monitor economic conditions, including the impact of the COVID-19 pandemic, 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. The COVID-19 pandemic has affected and may continue to affect our business operations, including our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued effects over time. In the first quarter of fiscal year 2021, as in the final quarter of fiscal year 2020, we noted a positive impact to our results that we believe was partly due to increased consumer engagement with our products because of the COVID-19 pandemic related business closures and movement restrictions, such as "shelter in place" and "lockdown" orders, being implemented around the world, as well as the online accessibility and social nature of our products. However, we cannot be certain as to the duration of these effects and the potential offsetting impacts of deteriorating economic conditions and decreased consumer spending generally. We have developed and continue to develop plans to help mitigate the negative impact of the pandemic on our business, such as our transition, based on our concern for the health and safety of our teams, to working from home for the vast majority of our teams, which to date has resulted in minimal disruption. However, these efforts may not be effective, and a protracted economic 19 Table of Contents downturn may limit the effectiveness of our mitigation efforts. Any of these considerations described above could cause or contribute to the risks described under the heading "Risk Factors" included in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended March 31, 2020, and could materially adversely affect our business, financial condition, results of operations, or stock price. Therefore, the effects of the COVID-19 pandemic will not be fully reflected in our financial results until future periods, and, at this time, we are not able to predict its ultimate impact on our business. Additionally, 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 81.6% and 71.5% of net revenue during the three months ended June 30, 2020 and 2019, respectively. As of June 30, 2020 and March 31, 2020, our five largest customers comprised 76.0% and 58.1% 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 67.0% and 48.8% of such balance at June 30, 2020 and March 31, 2020, respectively. We had two customers who accounted for 47.2% and 19.8%, respectively, of our gross accounts receivable as of June 30, 2020 and two customers who accounted for 29.4% and 19.4%, respectively, of our gross accounts receivable as of March 31, 2020. The economic environment has affected our customers in the past and may do so in the future, including as a result of the COVID-19 pandemic. 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. The COVID-19 pandemic may lead to increased consolidation as larger, better capitalized competitors will be in a stronger position to withstand prolonged periods of economic downturn and sustain their business through the financial volatility. 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 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 73.6% of our net revenue by product platform for the three months ended June 30, 2020. The success of our business is dependent upon the consumer acceptance of these platforms and the continued growth in their installed base. When new hardware platforms are introduced, such as those slated for release in calendar 2020 by Sony and Microsoft, demand for interactive entertainment used on older platforms typically declines, which may negatively affect our business during the market transition to the new consoles. The new Sony and Microsoft consoles are expected to provide "backwards compatibility" (i.e. the ability to play games for the previous generation of consoles), which could mitigate the risk of such a decline. However, we cannot be certain how backwards compatibility will affect demand for our products. Further, the COVID-19 pandemic or other events may impact the timing of release and availability of these new consoles, which may also affect demand. We manage our product delivery on each current and future platform in a manner we believe to be most effective to maximize our revenue opportunities and achieve the desired return on our investments in product development. 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 other 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. 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 large selection of our catalog titles. In addition, we aim to drive ongoing engagement and incremental revenue from recurrent consumer spending on our titles through 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. As disclosed in our "Results of Operations," below, net revenue from digital online channels comprised 87.4% of our net revenue for the three months ended June 30, 2020. We expect online delivery of games and game offerings to continue to grow and to become the primary part of our business over the long-term. 20 Table of Contents Product Releases We released the following key titles during the three months ended June 30, 2020: Title Publishing Label Internal or External Development Platform(s) Date Released XCOM: Chimera Squad 2K Internal PC April 24, 2020 BioShock: The Collection 2K Internal/External Switch May 29, 2020 Borderlands Legendary Collection 2K Internal/External Switch May 29, 2020 XCOM 2 Collection 2K External Switch May 29, 2020 The Outer Worlds Private Division External Switch June 5, 2020 Disintegration Private Division External PS4, Xbox One, PC June 16, 2020 Product Pipeline We have announced the following future key titles to date (this list does not represent all titles currently in development): Title Publishing Label Internal or External Development Platform(s) Expected Release Date PGA Tour 2K21 2K External PS4, Xbox One, Switch, PC, Stadia August 21, 2020 NBA 2K21 2K Internal PS4, Xbox One, Switch, PC, Stadia September 4, 2020 WWE 2K Battlegrounds 2K External PS4, Xbox One, Switch, PC, Stadia September 18, 2020 NBA 2K21 2K Internal PS5, Xbox Series X Holiday 2020 Grand Theft Auto V Rockstar Games Internal PS5, Xbox Series X Fiscal 2022 Kerbal Space Program 2 Private Division Internal PS4, Xbox One, PC Fall 2021 21 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 ended March 31, 2020. During the three months ended June 30, 2020 there were no significant changes to the above critical accounting policies and estimates, with the exception of our adoption of Topic 326, Financial Instruments - Credit Losses. 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 Ended June 30, 2020 2019 Increase/ (decrease) % Increase/ (decrease) Net Bookings $ 996,249 $ 422,240 $ 574,009 135.9 % For the three months ended June 30, 2020, Net Bookings increased by $574.0 million as compared to the prior year period due primarily to Grand Theft Auto Online and Grand Theft Auto V, our NBA 2K franchise, Borderlands 3, which released in September 2019, and Red Dead Redemption 2. 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 Ended June 30, (thousands of dollars) 2020 2019 Net revenue $ 831,310 100.0 % $ 540,459 100.0 % Cost of goods sold 476,689 57.3 % 241,469 44.7 % Gross profit 354,621 42.7 % 298,990 55.3 % General and administrative 102,173 12.3 % 74,833 13.8 % Selling and marketing 84,779 10.2 % 91,821 17.0 % Research and development 73,108 8.8 % 68,963 12.8 % Depreciation and amortization 12,418 1.5 % 11,257 2.1 % Business reorganization — — % 386 0.1 % Total operating expenses 272,478 32.8 % 247,260 45.8 % Income from operations 82,143 9.9 % 51,730 9.6 % Interest and other, net 8,218 1.0 % 10,425 1.9 % Income before income taxes 90,361 10.9 % 62,155 11.5 % Provision for income taxes 1,856 0.2 % 15,875 2.9 % Net income $ 88,505 10.6 % $ 46,280 8.6 % 22 Table of Contents Three Months Ended June 30, 2020 2019 Net revenue by geographic region: United States $ 470,490 56.6 % $ 330,479 61.1 % International 360,820 43.4 % 209,980 38.9 % Net revenue by platform: Console $ 611,685 73.6 % $ 434,814 80.5 % PC and other 219,625 26.4 % 105,645 19.5 % Net revenue by distribution channel: Digital online $ 726,226 87.4 % $ 427,781 79.2 % Physical retail and other 105,084 12.6 % 112,678 20.8 % Net revenue by content: Recurrent consumer spending $ 479,405 57.7 % $ 314,858 58.3 % Full game and other 351,905 42.3 % 225,601 41.7 % Three Months Ended June 30, 2020 Compared to June 30, 2019 (thousands of dollars) 2020 % 2019 % Increase/ (decrease) % Increase/ (decrease) Net revenue $ 831,310 100.0 % $ 540,459 100.0 % $ 290,851 53.8 % Software development costs and royalties (1) 148,047 17.8 % 108,441 20.1 % 39,606 36.5 % Internal royalties 214,063 25.8 % 62,889 11.6 % 151,174 240.4 % Product costs 58,560 7.0 % 47,635 8.8 % 10,925 22.9 % Licenses 56,019 6.7 % 22,504 4.2 % 33,515 148.9 % Cost of goods sold 476,689 57.3 % 241,469 44.7 % 235,220 97.4 % Gross profit $ 354,621 42.7 % $ 298,990 55.3 % $ 55,631 18.6 % _______________________________________________________________________________ (1) Includes $29,033 and $30,798 of stock-based compensation expense in 2020 and 2019, respectively, in software development costs and royalties. For the three months ended June 30, 2020, net revenue increased by $290.9 million as compared to the prior year period. The increase was due to an increase in net revenue of (i) $108.7 million from Grand Theft Auto Online and Grand Theft Auto V, (ii) $63.4 million from our NBA 2K franchise, (iii) $28.5 million from Borderlands 3, which released in September 2019, (iv) $18.0 million from Civilization VI , and (v) $15.8 million from Red Dead Redemption Online . Net revenue from console games increased by $176.9 million and accounted for 73.6% of our total net revenue for the three months ended June 30, 2020, as compared to 80.5% for the prior year period. The increase was due to an increase in net revenue from Grand Theft Auto Online and Grand Theft Auto V, our NBA 2K franchise, Borderlands 3, which released in September 2019, and Red Dead Online, partially offset by a decrease in net revenue from Red Dead Redemption 2. Net revenue from PC and other increased by $114.0 million and accounted for 26.4% of our total net revenue for the three months ended June 30, 2020, as compared to 19.5% for the prior year period. The increase was due to net revenue from Borderlands 3 , Red Dead Redemption 2, which released on PC in November 2019, Grand Theft Auto V, and Civilization VI . Net revenue from digital online channels increased by $298.4 million and accounted for 87.4% of our total net revenue for the three months ended June 30, 2020, as compared to 79.2% for the prior year period. The increase was due to an increase in net revenue from Grand Theft Auto Online and Grand Theft Auto V, our NBA 2K franchise, Borderlands 3, Red Dead Redemption 2 , and Civilization V. Net revenue from physical retail and other channels decreased by $7.6 million and accounted for 12.6% of our total net revenue for the three months ended June 30, 2020, as compared to 20.8% 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 and Grand Theft Auto Online, partially offset by an increase in net revenue from Borderlands 3 , our NBA 2K franchise, our BioShock franchise, Grand Theft Auto V , The Outer Worlds , which released in October 2019, Dragon City , and our WWE 2K franchise . 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 $164.5 million and accounted for 57.7% of net revenue for the three months ended June 30, 2020, as compared to 58.3% of net revenue for the 23 Table of Contents prior year period. The increase in net revenue from recurrent consumer spending is due primarily to an increase in net revenue from our NBA 2K franchise, Grand Theft Auto Online, Borderlands 3 , and Red Dead Online . Net revenue from full game and other increased by $126.3 million and accounted for 42.3% of net revenue for the three months ended June 30, 2020 as compared to 41.7% of net revenue for the prior year period. The increase in net revenue from full game and other was due to an increase in net revenue from Grand Theft Auto V, Borderlands 3, our NBA 2K franchise, The Outer Worlds, and our Mafia franchise. Gross profit as a percentage of net revenue for the three months ended June 30, 2020 was 42.7% as compared to 55.3% for the prior year period. The decrease in gross profit as a percentage of net revenue was due to higher royalties as a percentage of net revenue due primarily to the timing of when royalties are earned, partially offset by lower amortization of capitalized software costs as a percentage of net revenue due primarily to the timing of releases. Net revenue earned outside of the United States increased by $150.8 million and accounted for 43.4% of our total net revenue for the three months ended June 30, 2020, as compared to 38.9% in the prior year period. The increase in net revenue outside of the United States was due to an increase in net revenue from Grand Theft Auto V and Grand Theft Auto Online, Borderlands 3, our NBA 2K franchise, and Red Dead Redemption 2 and Red Dead Online. Changes in foreign currency exchange rates decreased net revenue by $1.1 million and decreased gross profit by $0.3 million for the three months ended June 30, 2020 as compared to the prior year period. Operating Expenses (thousands of dollars) 2020 % of net revenue 2019 % of net revenue Increase/ (decrease) % Increase/ (decrease) General and administrative $ 102,173 12.3 % $ 74,833 13.8 % $ 27,340 36.5 % Selling and marketing 84,779 10.2 % 91,821 17.0 % (7,042) (7.7) % Research and development 73,108 8.8 % 68,963 12.8 % 4,145 6.0 % Depreciation and amortization 12,418 1.5 % 11,257 2.1 % 1,161 10.3 % Business reorganization — — % 386 0.1 % (386) (100.0) % Total operating expenses (1) $ 272,478 32.8 % $ 247,260 45.8 % $ 25,218 10.2 % _______________________________________________________________________________ (1) Includes stock-based compensation expense, which was allocated as follows (in thousands): 2020 2019 General and administrative $ 13,200 $ 13,790 Selling and marketing 4,728 6,476 Research and development 6,450 6,591 Changes in foreign currency exchange rates decreased total operating expenses by $2.0 million for the three months ended June 30, 2020, as compared to the prior year period. General and administrative General and administrative expenses increased by $27.3 million for the three months ended June 30, 2020, as compared to the prior year period, due to increases in charitable contributions made in connection with our COVID-19 pandemic response and relief efforts, personnel expenses for additional headcount and higher incentive compensation, and bad debt expense. General and administrative expenses for the three months ended June 30, 2020 and 2019 included occupancy expense (primarily rent, utilities and office expenses) of $7.3 million and $6.1 million, respectively, related to our development studios. Selling and marketing Selling and marketing expenses decreased by $7.0 million for the three months ended June 30, 2020, as compared to the prior year period, due primarily to lower marketing expenses for Borderlands 3 and Red Dead Online, partially offset by higher marketing expenses for Grand Theft Auto Online, and lower trade show and travel expenses due to restrictions as a result of the COVID-19 pandemic . The decrease was partially offset by higher personnel expenses due to increased headcount and higher incentive compensation. Research and development Research and development expenses increased by $4.1 million for the three months ended June 30, 2020, as compared to the prior year period, due primarily to increases in personnel expenses for additional headcount and IT expenses for cloud-based services. These increases were partially offset by lower production and development expenses primarily due to additional 24 Table of Contents capitalization of costs for development on titles having established technological feasibility compared to prior year and lower travel expenses due to restrictions as a result of the COVID-19 pandemic. Depreciation and Amortization Depreciation and amortization expenses increased by $1.2 million for the three months ended June 30, 2020 as compared to the prior year period, due primarily to IT infrastructure and leasehold improvements for new office locations. Business reorganization During the three months ended June 30, 2020, business reorganization expense decreased $0.4 million due to expense in the prior year related to updating estimates for our 2018 Plan with no corresponding expense in the current year. Interest and other, net Interest and other, net was income of $8.2 million for the three months ended June 30, 2020, as compared to $10.4 million for the prior year period. The change was due primarily to lower interest income due to lower interest rates, partially offset by foreign currency gains, including a $3.1 million reclassification from Accumulated other comprehensive loss as a result of discontinuing our cash flow hedge related to our cross-currency swap. Provision for Income Taxes The provision for income taxes for the three months ended June 30, 2020 is based on our projected annual effective tax rate for fiscal year 2021, adjusted for specific items that are required to be recognized in the period in which they are incurred. The provision for income taxes was $1.9 million for the three months ended June 30, 2020 as compared to $15.9 million for the prior year period. When compared to the statutory rate of 21.0%, the effective tax rate of 2.1% for the three months ended June 30, 2020 was due primarily to excess tax benefits of $7.9 million from employee stock-based compensation, tax benefits of $4.9 million from tax credits and geographic mix of earnings. In the prior year period, when compared to our statutory rate of 21%, the effective tax rate of 25.5% for the three months ended June 30, 2019 was due primarily to a tax expense of $19.8 million from the reversal of deferred tax benefits relating to the Altera case, discussed below, partially offset by a tax benefit of $11.6 million from changes in unrecognized tax benefits due to audit settlements. The change in the effective tax rate, when compared to the prior year period's effective tax rate, is due primarily to increased excess tax benefits from employee stock-based compensation in the current period, offset by decreased tax expense related to the Altera case, discussed below, and decreased tax benefits related to the changes in unrecognized tax benefits due to audit settlements. 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. 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. 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 three months ended June 30, 2019, we removed the deferred tax asset and a deferred tax liability associated with this matter from our financial statements, resulting in a cumulative net discrete income tax expense of $19.8 million. The taxpayer in the Altera case requested a rehearing before the full Ninth Circuit which was denied on November 12, 2019. In February 2020, the taxpayer appealed to the U.S. Supreme Court, which denied certiorari on June 22, 2020. 25 Table of Contents 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 TRAF abolished preferential tax regimes at the cantonal level. The cantons established transition rules which provided the Company a step-up in tax basis for which a deferred tax asset of $45.3 million and valuation allowance of $33.4 million were established. It is possible that realization of deferred tax assets relating to the Swiss cantonal basis step-up may change due to changes in forecasted future earnings in Switzerland. On March 27, 2020, the U.S. enacted the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act"), which provides numerous tax and other stimulus measures. Although we are currently reviewing the potential implications of the CARES Act, we do not expect that it will have a material impact to our Consolidated Financial Statements. Net income and earnings per share For the three months ended June 30, 2020, net income was $88.5 million, as compared to $46.3 million in the prior year period. Diluted earnings per share for the three months ended June 30, 2020 was $0.77, as compared to diluted earnings per share of $0.41 in the prior year period. Diluted weighted average shares of 115.0 million were 1.2 million shares higher as compared to the prior year period, due primarily to normal stock compensation activity, including vests as well as grants and forfeitures in the prior year being fully outstanding in the current year period. 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 June 30, 2020, we had $880.8 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. As of June 30, 2020, based on the composition of our investment portfolio and relatively lower interest rates as a result of the recent actions by central banks around the world, including the interest rate cuts by the U.S. Federal Reserve, in response to the COVID-19 pandemic and related adverse economic conditions, we anticipate investment yields may remain low, which would lower our future interest income. Such impact is not expected to be material to our liquidity. Credit Agreement On February 8, 2019, we entered into an unsecured Credit Agreement (the “Credit Agreement”) that 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 (3.25% at June 30, 2020) or (b) 1.125% to 1.750% above LIBOR (approximately 1.63% at June 30, 2020), which rates are determined by reference to our consolidated total net leverage ratio. As of June 30, 2020, there was $198.3 million available to borrow under the Credit Agreement, and we had $1.7 million of letters of credit outstanding. At June 30, 2020, 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 26 Table of Contents 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). 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, including digital storefronts and platform partners, and distributors. Our five largest customers accounted for 81.6% and 71.5% of net revenue during the three months ended June 30, 2020 and 2019, respectively. As of June 30, 2020 and March 31, 2020, five customers accounted for 76.0% and 58.1% of our gross accounts receivable, respectively. Customers that individually accounted for more than 10% of our gross accounts receivable balance comprised 67% and 48.8% of such balances at June 30, 2020 and March 31, 2020, respectively. We had two customers who accounted for 47.2% and 19.8% of our gross accounts receivable as of June 30, 2020, respectively, and two customers who accounted for 29.4% and 19.4% of our gross accounts receivable as of March 31, 2020, 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, including as a result of the COVID-19 pandemic. 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. Our liquidity and capital resources were not materially affected by the COVID-19 pandemic and related volatility and slowdown in the global financial markets during the first quarter of fiscal year 2021. As of June 30, 2020, the amount of cash and cash equivalents held outside of the U.S. by our foreign subsidiaries was $594.4 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 to have the ability to generate sufficient cash domestically to support ongoing operations for the foreseeable future. The Tax Cuts and Jobs Act, as enacted in December 2017, includes a number of provisions, which generally establish a territorial-style system for taxing foreign income of domestic multinational corporations. Our current intention is to reinvest indefinitely earnings of our foreign subsidiaries, and therefore we have not recorded any tax liabilities associated with the repatriation of foreign earnings. Our Board of Directors has authorized the repurchase of up to 14.2 million 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 does not require us to repurchase shares and may be suspended or discontinued at any time for any reason. During the three months ended June 30, 2020, we did not make any repurchases of our common stock in the open market. We have repurchased a total of 10.4 million shares of our common stock under the program, and as of June 30, 2020, 3.8 million shares of our common stock remained available for repurchase under the share repurchase program. 27 Table of Contents Our changes in cash flows were as follows: Three Months Ended June 30, (thousands of dollars) 2020 2019 Net cash provided by operating activities $ 445,423 $ 108,535 Net cash (used in) provided by investing activities (247,465) 166,793 Net cash used in financing activities (32,003) (52,118) Effects of foreign currency exchange rates on cash, cash equivalents, and restricted cash and cash equivalents 1,925 (3,201) Net change in cash, cash equivalents, and restricted cash and cash equivalents $ 167,880 $ 220,009 At June 30, 2020, we had $2,161.3 million of cash and cash equivalents and restricted cash and cash equivalents, compared to $1,993.4 million at March 31, 2020. 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 investing activities primarily related to changes in bank time deposits and net purchases of available for sale securities and (2) Net cash used in financing activities, which was primarily for tax payments related to net share settlements of our restricted stock awards. 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 ended March 31, 2020, we did not have any significant changes to our commitments since March 31, 2020. Legal and Other Proceedings: We are, or may become, subject to demands and claims (including intellectual property and employment related 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 of June 30, 2020 and March 31, 2020, 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 of the United States is principally generated by our operations in Europe, Asia, Australia, Canada, and Latin America. For the three months ended June 30, 2020 and 2019, 43.4% and 38.9%, respectively, of our net revenue was earned outside of the 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 full game products are also seasonal, with peak demand typically occurring in the fourth calendar quarter during the holiday season. For certain of our software products with multiple performance obligations, we defer the recognition of our net revenue over an estimated service period, which generally ranges from 6 to 15 months. As a result, the quarter in which we generate the highest net bookings may be different from the quarter in which we recognize the highest amount of net revenue. Quarterly comparisons of operating results are not necessarily indicative of future operating results. 28 Table of Contents