filings.toolsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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**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 two wholly-owned labels Rockstar Games and 2K. Our products are currently designed for console gaming systems such as Sony's PlayStation®3 ("PS3") and PlayStation®4 ("PS4") and Microsoft's Xbox 360® ("Xbox 360") and Xbox One® ("Xbox One"); 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 add-on content, microtransactions and online play. 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 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 all platforms and through all 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 for our benefit. Operating margins are dependent in part upon our ability to release new, commercially successful software products and to manage effectively their development costs. We have internal development studios located in Canada, China, Czech Republic, 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 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 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 210 million units. The latest installment, Grand Theft Auto V, was released on Sony's PS3 and Microsoft's Xbox 360 in September 2013, on ony's PS4 and Microsoft's Xbox One in November 2014, and on PC in April 2015. Grand Theft Auto V includes access to Grand Theft Auto Online, which initially launched in October 2013. Rockstar is also well known for developing brands in other genres, including the L.A. Noire, Bully and Manhunt franchises. Rockstar 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 Enemy Unknown series. 2K also publishes successful externally developed franchises, such as Borderlands and Evolve. 2K's realistic sports simulation titles include our flagship NBA 2K series, which has been the top-ranked NBA basketball video game for 14 years running, and the WWE 2K series.
We are continuing our expansion initiatives in the Asia markets, where our strategy is to broaden the distribution of our existing products and establish an 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 2K simulation game in China, Taiwan, South Korea and Southeast Asia. In October 2012, NBA 2K Online, our free-to-play NBA simulation game co-developed by 2K and Tencent, launched commercially on the Tencent Games portal in China. In addition, South Korean-based studio XLGAMES is presently developing Civilization Online, a new online game for the Asian market, which is planned for commercial launch in Korea during our fiscal year 2016.
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 substantial portion of our revenue. Sales of Grand Theft Auto products generated approximately 28.0% of the Company's net revenue for the fiscal year ended March 31, 2015. The timing of our Grand Theft Auto releases varies significantly, which in turn 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 who account for a significant portion of our revenue. Our five largest customers accounted for 64.6%, 39.4% and 52.5% of net revenue during the fiscal years ended March 31, 2015, 2014 and 2013, respectively. As of March 31, 2015 and 2014, our five largest customers comprised approximately 63.9% and 68.3% 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 approximately 54.5% and 59.8% of such balance at March 31, 2015 and 2014, respectively. We had three customers who accounted for approximately 18.5%, 18.4% and 17.6% of our gross accounts receivable as of March 31, 2015 and three customers who accounted for 22.6%, 22.3% and 14.9% of our gross accounts receivable as of March 31, 2014. We did not have any additional customers that exceeded 10% of our gross accounts receivable as of March 31, 2015 and 2014. 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 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 platforms manufactured by third-parties, such as Sony's PS3 and PS4 and Microsoft's Xbox 360 and Xbox One, which comprised approximately 81.4% of the Company's net revenue by product platform for the fiscal year ended March 31, 2015. The success of our business is dependent upon the consumer acceptance of these platforms and the continued growth in the installed base of these platforms. When new hardware platforms are introduced, demand for software based on older platforms typically declines, which may negatively affect our business during the market transition to the new consoles. We continually monitor console hardware sales. 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. Additionally, our development costs are generally higher for
titles during platform transition periods, and we have a limited ability to predict the consumer acceptance of the future platforms, which may affect our sales and profitability. 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 mobile 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 via the Internet (from websites we own and others owned by third-parties). In addition, we aim to drive ongoing engagement and recurrent consumer spending on our titles after their initial purchase, by generating incremental revenues through downloadable offerings, including add-on content, microtransactions and online play. We also publish an expanding variety of titles for tablets and smartphones, which are delivered to consumers through digital download via the Internet. Note 14 to our Consolidated Financial Statements, "Segment and Geographic Information," discloses that net revenue from digital online channels comprised approximately 42.0% of the Company's net revenue by distribution channel for the fiscal year ended March 31, 2015. We expect online delivery of games and game offerings to become an increasing part of our business over the long-term.
Product Releases
We released the following key titles in fiscal year 2015:
| Title | Publishing Label | Internal or External Development | Platform(s) | Date Released | ||||
| NBA 2K15 | 2K | Internal | PS3, PS4, Xbox 360, Xbox One, PC | October 7, 2014 | ||||
| Borderlands: The Pre-Sequel | 2K | Internal/External | Xbox 360, PS3, PC | October 14, 2014 | ||||
| Sid Meier's Civilization: Beyond Earth | 2K | Internal | PC | October 24, 2014 | ||||
| WWE 2K15 | 2K | Internal/External | PS3, Xbox 360 | October 28, 2014 | ||||
| WWE 2K15 | 2K | Internal/External | PS4, Xbox One | November 18, 2014 | ||||
| Grand Theft Auto V | Rockstar Games | Internal | Xbox One, PS4 | November 18, 2014 | ||||
| Grand Theft Auto Online | Rockstar Games | Internal | Xbox One, PS4 | November 18, 2014 | ||||
| Evolve | 2K | External | Xbox One, PS4, PC | February 10, 2015 | ||||
| Sid Meier's Starships | 2K | Internal | PC Mac, iOS | March 12, 2015 | ||||
| Borderlands: The Handsome Collection | 2K | Internal/External | Xbox One, PS4 | March 24, 2015 |
Product Pipeline
We have announced the following 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 | ||||
| Grand Theft Auto V | Rockstar Games | Internal | PC | April 14, 2015 (Released) | ||||
| Grand Theft Auto Online | Rockstar Games | Internal | PC | April 14, 2015 (Released) | ||||
| NBA 2K16 | 2K | Internal | TBA | Fiscal Year 2016 | ||||
| WWE 2K16 | 2K | Internal/External | TBA | Fiscal Year 2016 | ||||
| Battleborn | 2K | External | Xbox One, PS4, PC | Fiscal Year 2016 |
Fiscal 2015 Financial Summary
Our net revenue for fiscal year ended March 31, 2015 was led by titles from a variety of our top franchises, mainly Grand Theft Auto, NBA 2K, Borderlands and WWE 2K. Our net revenue decreased to $1,082.9 million, a decrease of $1,267.6 million or 53.9% from the fiscal year ended March 31, 2014, which
had benefitted from the release of Grand Theft Auto V on Sony's PS3 and Microsoft's Xbox 360 console gaming systems.
For the fiscal year ended March 31, 2015, our net loss was $279.5 million, as compared to net income of $361.6 million in the prior year. Diluted loss per share for the fiscal year ended March 31, 2015 was $3.48, as compared to diluted income per share of $3.20 for the fiscal year ended March 31, 2014. Our earnings decreased primarily because the prior year had benefitted from the release of Grand Theft Auto V on Sony's PS3 and Microsoft's Xbox 360 console gaming systems and due to the deferral of net revenue and cost of goods sold related to the sell-in of certain titles during the second half of our fiscal year ended March 31, 2015.
At March 31, 2015 we had $911.1 million of cash and cash equivalents, compared to $935.4 million at March 31, 2014. The decrease in cash and cash equivalents from March 31, 2014 was primarily due to cash used in investing activities partially offset by cash provided by operating activities. Net cash used in investing activities related to purchases of short-term investments and purchases of fixed assets, which were partially offset by the proceeds received from the sale of our long-term investments. Net cash provided by operations was primarily due to an increase in deferred revenue generated by the sale of Grand Theft Auto V on Sony's PS4 and Microsoft's Xbox One platforms, Evolve and virtual currency partially offset by investments in software development.
Discontinued operations
The financial results of our former distribution business, which was sold in February 2010, have been classified as discontinued operations in our Consolidated Statements of Operations for all periods presented. See Note 1 to our Consolidated Financial Statements for additional information regarding discontinued operations.
**Critical Accounting Policies and Estimates **
The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("U.S. GAAP") requires management to make estimates and assumptions about future events and apply judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net revenues and expenses during the reporting periods. We base our estimates, assumptions and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our Consolidated Financial Statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are fairly presented in accordance with U.S. GAAP. However, because future events and their effects cannot be determined with certainty, actual amounts could differ significantly from these estimates.
We have identified the policies below as critical to our business operations and the understanding of our financial results and they require management's most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. The effect and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 to the Consolidated Financial Statements. Management has reviewed these critical accounting estimates and related disclosures with the Audit Committee of our Board of Directors.
Revenue Recognition
We earn our revenue from the sale of internally developed interactive software titles and from the sale of titles developed by and/or licensed from third-party developers.
We recognize revenue on the sales of software products upon the transfer of title and risk of loss to our customers. Accordingly, we recognize revenue for software titles when there is (1) persuasive evidence that an arrangement with the customer exists, which is generally based on a customer purchase order, (2) the product is delivered, (3) the selling price is fixed or determinable and (4) collection of the customer receivable is deemed probable. Certain products are sold to customers with a street date (i.e., the earliest date these products may be sold by retailers). For these products we recognize revenue on the later of the street date or the sale date. In addition, some of our software products are sold as full game digital downloads and digital add-on content for which the consumer takes possession of the digital content for a fee. Revenue from product downloads is generally recognized when the download is made available (assuming all other recognition criteria are met).
In providing credit terms to our customers, our payment arrangements typically provide net 30 and 60 day terms. Advances received for licensing and exclusivity arrangements are reported on our Consolidated Balance Sheets as deferred revenue until we meet our performance obligations, at which point we recognize the revenue.
For some of our software products, we enter into multiple element revenue arrangements in which we may provide a combination of full game software, additional add-on content, hosting of gameplay, maintenance or support. When all other revenue recognition criteria are met, we determine the fair value of each delivered and undelivered element using vendor-specific objective evidence ("VSOE") of fair value and allocate the total price among the various elements. When we have not established VSOE for each element, revenue is deferred until the earlier of the point at which VSOE of fair value exists for any undelivered element or until all elements of the arrangement have been delivered. For arrangements that require the deferral of revenue, the cost of goods sold is deferred and recognized as the related net revenue is recognized. Deferred cost of goods sold includes product costs and licenses. We determine VSOE for each element based on historical stand-alone sales to third parties. In determining VSOE, we require that a substantial majority of the selling prices for a product or service fall within a reasonably narrow pricing range. Changes in assumptions or judgments or changes to the elements in a software arrangement could cause a material increase or decrease in the amount of revenue that we report in a particular period.
In identifying the deliverables within an arrangement we consider whether our software products contain more-than-inconsequential online functionality by evaluating the significance of the development effort, the nature of the online features, the extent of anticipated marketing focus on the online features, the significance of the online features to the consumers' anticipated overall gameplay experience, and the significance and length of time of our post sale obligations to consumers. Determining whether the online functionality for a particular game constitutes a more than inconsequential deliverable is subjective and requires management's judgment.
When our software products provide limited online functionality at no additional cost to the consumer, we generally consider such features to be incidental to the overall product offering and an inconsequential deliverable, and we recognize revenue when the four primary criteria described above have been met. When software products provide online functionality that represents a more-than-inconsequential deliverable, we recognize the software-related revenues and the related cost of goods sold ratably over the estimated service period of the title (assuming all other recognition criteria are met) as we have not established VSOE for that deliverable.
During the fiscal year ended March 31, 2015, the Company concluded that the updates being provided with Grand Theft Auto V were no longer considered an inconsequential deliverable because add-on content updates were expected to be provided beyond 12 months. As a result, the net revenue and cost of goods sold that have been deferred will be recognized ratably over the expected service period, which is equal to the estimated remaining life of the game which, for Grand Theft Auto V, we have projected to be 24 months from the time of release.
Certain of our games provide consumers with the option to purchase virtual currency to use in the game to acquire virtual goods. We recognize revenue from the sale of virtual currency, using the game-based model, ratably over the estimated remaining life of the game.
Certain of our software products include in-game advertising for third-party products. Advance payments received for in-game advertising are reported on our Consolidated Balance Sheet as deferred revenue until we meet our performance obligations, at which point we recognize the revenue, which is generally at the time of the initial release of the product.
Revenue is recognized after deducting estimated reserves for returns, price concessions and other allowances. In circumstances when we do not have a reliable basis to estimate returns and price concessions or are unable to determine that collection of a receivable is probable, we defer the revenue until such time as we can reliably estimate any related returns and allowances and determine that collection of the receivable is probable.
**Allowances for Returns, Price Concessions and Other Allowances **
We accept returns and grant price concessions in connection with our publishing arrangements. Following reductions in the price of our products, we grant price concessions to permit customers to take credits against amounts they owe us with respect to merchandise unsold by them. Our customers must satisfy certain conditions to entitle them to return products or receive price concessions, including compliance with applicable payment terms and confirmation of field inventory levels.
Generally our distribution arrangements with customers do not give them the right to return titles or to cancel firm orders. However, we occasionally accept returns from our customers for stock balancing and make accommodations to customers, which include credits and returns, when demand for specific titles falls below expectations.
We make estimates of future product returns and price concessions related to current period product revenue. We estimate the amount of future returns and price concessions for published titles based upon, among other factors, historical experience and performance of the titles in similar genres, historical performance of the hardware platform, customer inventory levels, analysis of sell-through rates, sales force and retail customer feedback, industry pricing, market conditions and changes in demand and acceptance of our products by consumers.
Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price concessions in any accounting period. We believe we can make reliable estimates of returns and price concessions. However, actual results may differ from initial estimates as a result of changes in circumstances, market conditions and assumptions. Adjustments to estimates are recorded in the period in which they become known.
**Software Development Costs and Licenses **
Capitalized software development costs include direct costs incurred for internally developed titles and payments made to third-party software developers under development agreements.
We capitalize internal software development costs (including stock-based compensation, specifically identifiable employee payroll expense and incentive compensation costs related to the completion and release of titles), third-party production and other content costs, subsequent to establishing technological feasibility of a software title. Technological feasibility of a product includes the completion of both technical design documentation and game design documentation. Significant management judgments and estimates are utilized in the assessment of when technological feasibility is established. For products where proven technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product by product basis.
We enter into agreements with third-party developers that require us to make payments for game development and production services. In exchange for our payments, we receive the exclusive publishing and distribution rights to the finished game title as well as, in some cases, the underlying intellectual property rights. Such agreements typically allow us to fully recover these payments to the developers at an agreed upon royalty rate earned on the subsequent retail sales of such software, net of any agreed upon costs. Prior to establishing technological feasibility of a product we record any costs incurred by third-party developers as research and development expenses. Subsequent to establishing technological feasibility of a product we capitalize all development and production service payments to third-party developers as software development costs and licenses. We typically enter into agreements with third-party developers after completing the technical design documentation for our products and therefore record the design costs leading up to a signed development contract as research and development expense. When we contract with third-party developers, we generally select those that have proven technology and experience in the genre of the software being developed, which often allows for the establishment of technological feasibility early in the development cycle. In instances where the documentation of the design and technology are not in place prior to an executed contract, we monitor the software development process and require our third-party developers to adhere to the same technological feasibility standards that apply to our internally developed products.
Licenses consist of payments and guarantees made to holders of intellectual property rights for use of their trademarks, copyrights or other intellectual property rights in the development of our products. Agreements with license holders generally provide for guaranteed minimum payments for use of their intellectual property.
Certain licenses, especially those related to our sports products, extend over multi-year periods and encompass multiple game titles. In addition to guaranteed minimum payments, these licenses frequently contain provisions that could require us to pay royalties to the license holder based on pre-agreed unit sales thresholds.
Amortization of capitalized software development costs and licenses commences when a product is released and is recorded on a title-by-title basis in cost of goods sold. For capitalized software development costs, amortization is calculated using (1) the proportion of current year revenues to the total revenues expected to be recorded over the life of the title or (2) the straight-line method over the remaining estimated useful life of the title, whichever is greater. For capitalized licenses, amortization is calculated as a ratio of (1) current period revenues to the total revenues expected to be recorded over the remaining life of the title or (2) the contractual royalty rate based on actual net product sales as defined in the licensing agreement, whichever is greater.
We evaluate the future recoverability of capitalized software development costs and licenses on a quarterly basis. Recoverability is primarily assessed based on the actual title's performance. For products that are scheduled to be released in the future, recoverability is evaluated based on the expected performance of the specific products to which the cost or license relates. We utilize a number of criteria in evaluating expected product performance, including: historical performance of comparable products developed with comparable technology; market performance of comparable titles; orders for the product prior to its release; general market conditions; and, past performance of the franchise. When management determines that the value of the title is unlikely to be recovered by product sales, capitalized costs are charged to cost of goods sold in the period in which such determination is made.
We have established profit and unit sales based internal royalty programs that allow selected employees to each participate in the success of software titles that they assist in developing. Royalties earned by employees under this program are recorded as a component of cost of goods sold in the period earned.
Fair Value Estimates
The preparation of financial statements in conformity with U.S. GAAP often requires us to determine the fair value of a particular item to fairly present our Consolidated Financial Statements. Without an independent market or another representative transaction, determining the fair value of a particular item requires us to make several assumptions that are inherently difficult to predict and can have a material influence on the conclusion of the appropriate accounting.
Various valuation techniques are used to estimate fair value. These include (1) the market approach where market transactions for identical or comparable assets or liabilities are used to determine the fair value, (2) the income approach, which uses valuation techniques to convert future amounts (for example, future cash flows or future earnings) to a single present amount, and (3) the cost approach, which is based on the amount that would be required to replace an asset. For many of our fair value estimates, including our estimates of the fair value of acquired intangible assets, we use the income approach. Using the income approach requires the use of financial models, which require us to make various estimates including, but not limited to (1) the potential future cash flows for the asset, liability or equity instrument being measured, (2) the timing of receipt or payment of those future cash flows, (3) the time value of money associated with the delayed receipt or payment of such cash flows, and (4) the inherent risk associated with the cash flows (risk premium). Developing these cash flow estimates is inherently difficult and subjective, and, if any of the estimates used to determine the fair value using the income approach turn out to be inaccurate, our financial results may be negatively affected. Furthermore, relatively small changes in many of these estimates can have a significant influence on the estimated fair value resulting from the financial models or the related accounting conclusion reached. For example, a relatively small change in the estimated fair value of an asset may change a conclusion as to whether an asset is impaired. While we are required to make certain fair value assessments associated with the accounting for several types of transactions, the following areas are the most sensitive to the assessments:
Business Combinations—Goodwill and Intangible Assets. We must estimate the fair value of assets acquired and liabilities assumed in a business combination. Our assessment of the estimated fair value of each of these can have a material effect on our reported results as intangible assets are amortized over various lives. Goodwill represents the excess of purchase price over the fair value of the net tangible assets and intangible assets acquired in a business combination. A change in the estimated fair value of an acquired asset or liability assumed often has a direct influence on the amount recognized as goodwill, which is an asset that is not amortized. Often determining the fair value of these acquired assets and liabilities assumed requires an assessment of expected use of the asset, the expected cost to extinguish the liability or our expectations related to the timing and the successful completion of development of an acquired in-process technology. Such estimates are inherently difficult and subjective and can have a material influence on our financial statements.
We use either the income, cost or market approach to aid in our conclusions of such fair values and asset lives. The income approach presumes that the value of an asset can be estimated by the net economic benefit to be received over the life of the asset, discounted to present value. The cost approach presumes that an investor would pay no more for an asset than its replacement or reproduction cost. The market approach estimates value based on what other participants in the market have paid for reasonably similar assets. Although each valuation approach is considered in valuing the assets acquired, the approach ultimately selected is based on the characteristics of the asset and the availability of information.
We test our goodwill for impairment annually, in our second fiscal quarter, or more frequently if events and circumstances indicate the fair value of a reporting unit may be below its carrying amount. A reporting unit is defined as an operating segment or one level below an operating segment. We have determined that we operate in one reporting unit which is our operating segment. The determination of whether or not goodwill has become impaired involves a significant
level of judgment in the assumptions underlying the approach used to determine the value of our reporting units. Changes in our strategy and/or market conditions could significantly affect these judgments and require reductions to recorded intangible asset balances. The Company has the option to first perform a qualitative assessment to determine if the fair value of its reporting unit is more likely than not (i.e., a likelihood of more than 50%) less than its carrying value before performing the two-step impairment test. If the two-step impairment test for goodwill is utilized, step one compares the fair value of the reporting unit to its carrying value. If the carrying value exceeds the fair value, there is a potential impairment and step two must be performed. Step two compares the carrying value of the reporting unit's goodwill to its implied fair value (i.e., fair value of reporting unit less the fair value of the unit's assets and liabilities, including identifiable intangible assets). If the implied fair value of goodwill is less than the carrying amount of goodwill, an impairment is recognized. Based on our annual impairment assessment process for goodwill, no impairments were recorded during the fiscal year ended March 31, 2015 or 2014.
Long-lived assets. We review long-lived assets for impairment whenever events or changes in circumstances indicate that the related carrying amount of an asset or asset group may not be recoverable. Determining whether impairment has occurred typically requires various estimates and assumptions, including determining which cash flows are directly related to the potentially impaired asset, the useful life over which cash flows will occur, their amount and the asset's residual value, if any. In turn, measurement of an impairment loss requires a determination of fair value, which is based on the best information available. We use internal discounted cash flow estimates, quoted market prices when available and independent appraisals, as appropriate, to determine fair value. We derive the required cash flow estimates from our historical experience and our internal business plans and apply an appropriate discount rate. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset with future undiscounted cash flows expected to be generated from the use and eventual disposition of the asset. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset.
Inventory Obsolescence. We regularly review inventory quantities on-hand and in the retail channels and record an inventory provision for excess or obsolete inventory based on the future expected demand for our products. Significant changes in demand for our products would affect management's estimates in establishing our inventory provision. We write down inventory based on excess or obsolete inventories determined primarily by future anticipated demand for our products. Inventory write-downs are measured as the difference between the cost of the inventory and market value, based upon assumptions about future demand that are inherently difficult to assess.
Stock-based Compensation
Stock-based compensation expense is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. Determining the fair value of stock-based awards at the grant date requires judgment in estimating expected stock volatility and the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially affected.
We have also granted time, performance-based and market-based restricted stock and restricted stock unit awards, to employees and non-employees. Time-based and market-based awards to non-employees are subject to variable accounting. For the time-based restricted stock awards to non-employees, we cumulatively remeasure the fair value at the end of every period based on the month end closing price of our common stock. Market-based restricted stock awards vest based on the relative performance of our common stock to a composite index. We calculate the fair value of market-based restricted stock awards
using a Monte Carlo Simulation method, which requires a substantial number of inputs and estimates of future market conditions and considers the range of various vesting probabilities. As a result, expense recorded for our non-employee awards can fluctuate substantially from period to period.
Income Taxes
We record a tax provision for the anticipated tax consequences of the reported results of operations. The provision for income taxes is computed using the asset and liability method, under which deferred income taxes are recognized for differences between the financial statement and tax bases of assets and liabilities at currently enacted statutory tax rates for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment.
We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Our history of pre-tax losses represents sufficient evidence for us to determine that the establishment of a valuation allowance against the deferred tax asset is appropriate. This valuation allowance offsets deferred tax assets associated with future tax deductions as well as carryforward items.
Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws or interpretations thereof. In addition, our filed tax returns are subject to examination by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.
We recognize and measure uncertain tax positions and record tax benefits when it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.
At each period end, it is necessary for us to make certain estimates and assumptions to compute the provision for income taxes including allocations of certain transactions to different tax jurisdictions, amounts of permanent and temporary differences, the likelihood of deferred tax assets being recovered and the outcome of contingent tax risks. These estimates and assumptions are revised as new events occur, more experience is acquired and additional information is obtained. The effect of these revisions is recorded in income tax expense or benefit in the period in which they become known.
**Recently Issued Accounting Pronouncements **
Presentation of Debt Issuance Costs
In April 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-03, "Simplifying the Presentation of Debt Issuance Costs." This new guidance requires the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability. This update will be applied retrospectively and is effective for annual periods, and interim periods within those years, beginning after December 15, 2015 (April 1, 2016 for the Company). Early adoption is permitted. The adoption of this new guidance is not expected to have a material effect on our Consolidated Financial Statements.
Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, as a new Topic, Accounting Standards Codification Topic 606. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a
company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU is effective for the annual and interim periods beginning after December 15, 2016 (April 1, 2017 for the Company) and shall be applied retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. On April 1, 2015, the FASB proposed deferring the effective date by one year to annual and interim years beginning after December 15, 2017. The proposal permits early adoption, but no earlier than the original effective date of annual and interim periods beginning after December 15, 2016. The Company is currently determining its implementation approach and evaluating the impact of adopting this update on our Consolidated Financial Statements.
Requirements for Reporting Discontinued Operations
In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This new guidance raises the threshold for a disposal to qualify as discontinued operations and requires new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. Under the new standard, companies report discontinued operations when they have a disposal that represents a strategic shift that has or will have a major impact on operations or financial results. This update will be applied prospectively and is effective for annual periods, and interim periods within those years, beginning after December 15, 2014 (April 1, 2015 for the Company). Early adoption is permitted provided the disposal was not previously disclosed. The adoption of this new guidance is not expected to have a material effect on our Consolidated Financial Statements.
Presentation of Unrecognized Tax Benefits
In July 2013, new guidance was issued requiring that entities that have an unrecognized tax benefit and a net operating loss carryforward or similar tax loss or tax credit carryforward in the same jurisdiction as the uncertain tax position present the unrecognized tax benefit as a reduction of the deferred tax asset for the loss or tax credit carryforward rather than as a liability when the uncertain tax position would reduce the loss or tax credit carryforward under the tax law. The disclosure requirements became effective for annual periods (and interim periods within those annual periods) beginning after December 15, 2013 (April 1, 2014 for the Company), and are applied prospectively. The adoption of this guidance had no material effect on our Consolidated Financial Statements.
**Fluctuations in 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 size and timing of acquisitions; the timing of orders from major customers; 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 titles during the holiday season. Quarterly and annual comparisons of operating results are not necessarily indicative of future operating results.
**Results of Operations **
The following table sets forth, for the periods indicated, the percentage of net revenue represented by certain line items in our statements of operations, net revenue by geographic region, net revenue by platform and net revenue by distribution channel:
| Fiscal Year Ended March 31, | ||||||||||
| 2015 | 2014 | 2013 | ||||||||
| Net revenue | 100.0 | % | 100.0 | % | 100.0 | % | ||||
| Cost of goods sold | 73.4 | % | 60.2 | % | 58.9 | % | ||||
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| Gross profit | 26.6 | % | 39.8 | % | 41.1 | % | ||||
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| Selling and marketing | 21.7 | % | 10.2 | % | 21.2 | % | ||||
| General and administrative | 16.2 | % | 6.9 | % | 12.1 | % | ||||
| Research and development | 10.6 | % | 4.5 | % | 6.4 | % | ||||
| Depreciation and amortization | 2.0 | % | 0.6 | % | 1.0 | % | ||||
| | | | | | | | | | | |
| Total operating expenses | 50.5 | % | 22.2 | % | 40.7 | % | ||||
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| Income (loss) from operations | (23.9 | )% | 17.7 | % | 0.4 | % | ||||
| Interest and other, net | (2.9 | )% | (1.4 | )% | (2.6 | )% | ||||
| Gain on long-term investments, net | 1.6 | % | 0.0 | % | 0.0 | % | ||||
| Loss on extinguishment of debt | 0.0 | % | (0.4 | )% | 0.0 | % | ||||
| Gain on convertible note hedge and warrants, net | 0.0 | % | 0.1 | % | 0.0 | % | ||||
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| Income (loss) from continuing operations before income taxes | (25.2 | )% | 16.0 | % | (2.2 | )% | ||||
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| Provision for income taxes | 0.6 | % | 0.6 | % | 0.4 | % | ||||
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| Income (loss) from continuing operations | (25.8 | )% | 15.4 | % | (2.6 | )% | ||||
| (Loss) income from discontinued operations, net of taxes | 0.0 | % | 0.0 | % | 0.2 | % | ||||
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| Net income (loss) | (25.8 | )% | 15.4 | % | (2.4 | )% | ||||
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| Net revenue by geographic region: | ||||||||||
| United States | 57.5 | % | 46.5 | % | 58.5 | % | ||||
| International | 42.5 | % | 53.5 | % | 41.5 | % | ||||
| Net revenue by platform: | ||||||||||
| Console | 81.4 | % | 91.4 | % | 80.4 | % | ||||
| PC and other | 18.6 | % | 8.6 | % | 19.6 | % | ||||
| Net revenue by distribution channel: | ||||||||||
| Physical retail and other | 58.0 | % | 84.2 | % | 78.9 | % | ||||
| Digital online | 42.0 | % | 15.8 | % | 21.1 | % |
**Fiscal Years ended March 31, 2015 and 2014 **
| (thousands of dollars) | 2015 | % | 2014 | % | Increase/ (decrease) | % Increase/ (decrease) | |||||||||||||
| Net revenue | $ | 1,082,938 | 100.0 | % | $ | 2,350,568 | 100.0 | % | $ | (1,267,630 | ) | (53.9 | )% | ||||||
| Software development costs and royalties(1) | 231,615 | 21.4 | % | 333,450 | 14.2 | % | (101,835 | ) | (30.5 | )% | |||||||||
| Product costs | 178,810 | 16.5 | % | 477,861 | 20.3 | % | (299,051 | ) | (62.6 | )% | |||||||||
| Licenses | 77,725 | 7.2 | % | 64,412 | 2.8 | % | 13,313 | 20.7 | % | ||||||||||
| Internal royalties | 306,717 | 28.3 | % | 538,604 | 22.9 | % | (231,887 | ) | (43.1 | )% | |||||||||
| Cost of goods sold | 794,867 | 73.4 | % | 1,414,327 | 60.2 | % | (619,460 | ) | (43.8 | )% | |||||||||
| Gross profit | $ | 288,071 | 26.6 | % | $ | 936,241 | 39.8 | % | $ | (648,170 | ) | (69.2 | )% | ||||||
(1)
Includes $17,121 and $30,124 of stock-based compensation expense in 2015 and 2014, respectively.
Net revenue decreased $1,267.6 million for the fiscal year ended March 31, 2015 as compared to the prior year. This decrease was primarily due to a decrease of approximately $1,315.3 million in sales from our Grand Theft Auto franchise, as the prior year's results included the release of Grand Theft Auto V on Sony's PS3 and Microsoft's Xbox 360 console gaming systems, which was partially offset this year by the November 2014 release of Grand Theft Auto V on Sony's PS4 and Microsoft's Xbox One console gaming systems and the growth from Grand Theft Auto Online. The decrease in net revenue from Grand Theft Auto was partially offset by a $186.3 million increase in net sales due to the October 2014 release of Borderlands: The Pre-Sequel, higher sales from our WWE 2K franchise, the release of Sid Meier's Civilization: Beyond Earth in October 2014, higher sales from our NBA 2K franchise and sales from our release of Evolve in February 2015.
Net revenue on consoles decreased to 81.4% of our total net revenue for the fiscal year ended March 31, 2015 as compared to 91.4% for the same period in the prior year primarily because last year's results included the release of Grand Theft Auto V on Microsoft's Xbox 360 and Sony's PS3 console gaming systems. PC and other sales increased to 18.6% of our total net revenue for the year ended March 31, 2015 as compared to 8.6% for the year ended March 31, 2014, primarily due to the release of Sid Meier's Civilization: Beyond Earth for the PC in October 2014. Net revenue from physical retail and other channels decreased to 58.0% of our total net revenue for the fiscal year ended March 31, 2015 as compared to 84.2% for the same period in the prior year primarily due to last year's net revenue from physical retail benefitting from the release of Grand Theft Auto V on Sony's PS3 and Microsoft's Xbox 360 console gaming systems. Net revenue from digital online channels increased to 42.0% of our total net revenue for the fiscal year ended March 31, 2015 as compared to 15.8% in the prior fiscal year. Recurrent consumer spending (including add-on content, microtransactions and online play) represented 49.4% and 40.4% of net revenue from digital online channels for the fiscal years ended March 31, 2015 and 2014, respectively.
Gross profit as a percentage of net revenue was 26.6% for the fiscal year ended March 31, 2015, a decrease of 13.2 percentage points as compared to the prior year, primarily due to higher software development costs and royalties as a percentage of net revenue and the deferral of net revenue and cost of goods sold related to sell-in of certain titles during the second half of our fiscal year 2015. In addition, internal royalties were higher as a percentage of net revenues due to the timing of when internal royalties are earned.
Net revenue earned outside of the United States accounted for 42.5% of our total net revenue for the fiscal year ended March 31, 2015, as compared to 53.5% in the prior year. The year-over-year percentage decrease was primarily due to Grand Theft Auto V, which generated higher sales outside of the United States during the fiscal year ended March 31, 2014. Foreign currency exchange rates decreased net revenue by $14.4 million and decreased gross profit by $8.2 million for the fiscal year ended March 31, 2015.
Operating Expenses
| (thousands of dollars) | 2015 | % of net revenue | 2014 | % of net revenue | Increase/ (decrease) | % Increase/ (decrease) | |||||||||||||
| Selling and marketing | $ | 235,341 | 21.7 | % | $ | 240,996 | 10.2 | % | $ | (5,655 | ) | (2.3 | )% | ||||||
| General and administrative | 175,093 | 16.2 | % | 161,374 | 6.9 | % | 13,719 | 8.5 | % | ||||||||||
| Research and development | 115,043 | 10.6 | % | 105,256 | 4.5 | % | 9,787 | 9.3 | % | ||||||||||
| Depreciation and amortization | 21,057 | 2.0 | % | 13,359 | 0.6 | % | 7,698 | 57.6 | % | ||||||||||
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| Total operating expenses(1) | $ | 546,534 | 50.5 | % | $ | 520,985 | 22.2 | % | $ | 25,549 | 4.9 | % | |||||||
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(1)
Includes stock-based compensation expense, which was allocated as follows (in thousands):
| 2015 | 2014 | ||||||||||||||||||
| Selling and marketing | $ 8,798 | $10,136 | |||||||||||||||||
| General and administrative | $33,636 | $28,991 | |||||||||||||||||
| Research and development | $ 5,691 | $ 8,867 |
Foreign currency exchange rates decreased total operating expenses by approximately $4.3 million in the fiscal year ended March 31, 2015 as compared to the prior year.
Selling and marketing
Selling and marketing expenses decreased by $5.7 million for the fiscal year ended March 31, 2015, as compared to the prior year, primarily due to $20.7 million in higher advertising expenses incurred in the prior year for the releases of Grand Theft Auto V on Sony's PS3 and Microsoft's Xbox 360 gaming consoles in September 2013, and The Bureau: XCOM: Declassified in August 2013, which were partially offset by advertising expenses incurred in the current year for the releases of Grand Theft Auto V on Sony's PS4 and Microsoft's Xbox One gaming consoles in November 2014, and Borderlands: The Pre-Sequel and Sid Meier's Civilization: Beyond Earth in October 2014. Partially offsetting the overall decrease in selling and marketing expenses was $8.2 million in higher customer service costs and $6.0 million of higher incentive compensation based on label performance.
General and administrative
General and administrative expenses increased $13.7 million for the fiscal year ended March 31, 2015, as compared to the prior year primarily due to $9.0 million of higher expense related to our compensation of Zelnick Media which was predominantly stock based compensation expense resulting from the Company's relative stock price performance during fiscal year 2015 as well as $2.6 million of higher rent expense.
General and administrative expenses for the fiscal years ended March 31, 2015 and 2014 include occupancy expense (primarily rent, utilities and office expenses) of $17.9 million and $16.4 million, respectively, related to our development studios.
Research and development
Research and development expenses increased $9.8 million for the fiscal year ended March 31, 2015, as compared to the prior year primarily due to an increase of $3.9 million in IT spend on equipment at our development studios, higher personnel costs of $1.4 million, higher studio support costs of $1.4 million and higher occupancy related costs of $1.3 million.
Depreciation and amortization
Depreciation and amortization expenses increased $7.7 million for the fiscal year ended March 31, 2015, as compared to the prior year, primarily due to higher purchases of fixed assets for studio build-outs and information technology infrastructure.
Interest and other, net
| (thousands of dollars) | 2015 | % of net revenue | 2014 | % of net revenue | (Increase)/ decrease | % Increase/ (decrease) | |||||||||||||
| Interest income (expense), net | $ | (29,901 | ) | (2.7 | )% | $ | (33,961 | ) | (1.4 | )% | $ | 4,060 | (12.0 | )% | |||||
| Foreign exchange loss | (2,068 | ) | (0.2 | )% | 209 | 0.0 | % | (2,277 | ) | (1089.5 | )% | ||||||||
| Other | 76 | 0.0 | % | 199 | 0.0 | % | (123 | ) | (61.8 | )% | |||||||||
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| Interest and other, net | $ | (31,893 | ) | (2.9 | )% | $ | (33,553 | ) | (1.4 | )% | $ | 1,660 | (4.9 | )% | |||||
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Interest and other, net was an expense of $31.9 million for the fiscal year ended March 31, 2015, as compared to an expense of $33.6 million for the fiscal year ended March 31, 2014. The decrease of $1.7 million in interest and other, net was primarily related to a net decrease of $4.1 million in interest expense primarily due to the redemption of our 4.375% Convertible Notes in August 2013, partially offset by interest on the 1.00% Convertible Notes issued in June 2013. This decrease was partially offset by an increase of $2.3 million due to greater foreign currency exchange losses recorded during the fiscal year ended March 31, 2015.
Gain on long-term investments, net
During the fiscal year ended March 31, 2015 the Company recognized a $17.5 million net gain on long-term investments, which was primarily comprised of the Company's sale of its investment in Twitch Interactive, Inc.'s ("Twitch") Class C Preferred stock, which was accounted for under the cost method of accounting. In September 2014, the Company recognized a pretax gain of $19.0 million in connection with the sale of Twitch.
Loss on extinguishment of debt
Loss on extinguishment of debt was $9.0 million for the fiscal year ended March 31, 2014 due to the conversion and redemption of our 4.375% Convertible Notes in August 2013. See "Liquidity and Capital Resources" for additional information regarding loss on extinguishment of debt.
Gain on convertible note hedge and warrants, net
Gain on convertible note hedge and warrants, net was $3.5 million for the fiscal year ended March 31, 2014 due to the increase in the Company's share price during the period from June 2013 to the date of the net settlement of the hedge and warrants in August 2013. See "Liquidity and Capital Resources" for additional information regarding settlement and related net gain on the convertible note hedge and warrant transactions.
Provision for income taxes
Income tax expense was $6.6 million for the fiscal year ended March 31, 2015, as compared to $14.5 million for the fiscal year ended March 31, 2014. The decrease in income tax expense is primarily attributable to a decrease in net income. Our effective tax rate differed from the federal statutory rate primarily due to changes in valuation allowances related to tax losses and tax credit carryforwards and due to the mix of earnings in our foreign entities, which are taxed at a rate other than the U.S. statutory rate of 35%. Our valuation allowances increased by $92.7 million during the fiscal year ended March 31, 2015 and decreased by $92.1 million during the fiscal year ended March 31, 2014 due to changes in net operating loss and tax credit carryforwards.
As of March 31, 2015, we had gross unrecognized tax benefits, including interest and penalties, of $42.7 million, of which $29.2 million would affect our effective tax rate if realized. For the fiscal year ended
March 31, 2015, gross unrecognized tax benefits increased by $17.8 million, which primarily relates to an increase in uncertain tax position for certain tax credits in domestic jurisdictions.
We generally are no longer subject to audit for U.S. federal income tax returns for periods prior to our fiscal year ended March 31, 2011 and state income tax returns for periods prior to the fiscal year ended October 31, 2010. With few exceptions, we are no longer subject to income tax examinations in non-U.S. jurisdictions for years prior to fiscal year ended October 31, 2010. U.S. federal taxing authorities have completed their audit through the fiscal years ended October 31, 2009. Certain U.S. state taxing authorities are currently examining our income tax returns from fiscal years ended March 31, 2011 through March 31, 2013. The determination as to further adjustments to our gross unrecognized tax benefits during the next 12 months is not practicable.
We are regularly audited by domestic and foreign taxing authorities. Audits may result in tax assessments in excess of amounts claimed and the payment of additional taxes. We believe that our tax positions comply with applicable tax law, and that we have adequately provided for reasonably foreseeable tax assessments.
Net income (loss) and earnings (loss) per share
For the fiscal year ended March 31, 2015, our net loss was $279.5 million, as compared to net income of $361.6 million in the prior year. Basic and diluted loss per share for the fiscal year ended March 31, 2015 was $3.48, as compared to basic earnings per share of $3.79 and diluted earnings per share of $3.20 for the fiscal year ended March 31, 2014. Basic and diluted weighted average shares outstanding were lower compared to the prior fiscal year primarily due to the repurchase of 16.2 million shares during the fiscal year ended March 31, 2014 and due to Convertible Notes shares being anti-dilutive in the current period, partially offset by vesting of restricted stock awards. See Note 1 to our consolidated financial statements for additional information regarding earnings (loss) per share.
**Fiscal Years Ended March 31, 2014 and 2013 **
| (thousands of dollars) | 2014 | % | 2013 | % | Increase/ (decrease) | % Increase/ (decrease) | |||||||||||||
| Net revenue | $ | 2,350,568 | 100.0 | % | $ | 1,214,483 | 100.0 | % | $ | 1,136,085 | 93.5 | % | |||||||
| Internal royalties | 538,604 | 22.9 | % | 24,724 | 2.0 | % | 513,880 | 2078.5 | % | ||||||||||
| Product costs | 477,861 | 20.3 | % | 316,072 | 26.0 | % | 161,789 | 51.2 | % | ||||||||||
| Software development costs and royalties(1) | 333,450 | 14.2 | % | 317,756 | 26.2 | % | 15,694 | 4.9 | % | ||||||||||
| Licenses | 64,412 | 2.8 | % | 57,285 | 4.7 | % | 7,127 | 12.4 | % | ||||||||||
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| Cost of goods sold | 1,414,327 | 60.2 | % | 715,837 | 58.9 | % | 698,490 | 97.6 | % | ||||||||||
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| Gross profit | $ | 936,241 | 39.8 | % | $ | 498,646 | 41.1 | % | $ | 437,595 | 87.8 | % | |||||||
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(1)
Includes $30,124 and $10,060 of stock-based compensation expense in 2014 and 2013, respectively.
Net revenue increased $1,136.1 million for the fiscal year ended March 31, 2014 as compared to the prior year. This increase was primarily due to an increase of approximately $1,481.5 million in sales from our Grand Theft Auto franchise, primarily related to the releases of Grand Theft Auto V on Sony's PS3 and Microsoft's Xbox 360, and higher sales of $139.5 million mainly driven by the October 2013 release of WWE 2K14 and higher sales of our NBA 2K franchise. These increases were partially offset by a $446.0 million decrease in net sales, as the prior year benefitted from the releases of Borderlands 2, Max Payne 3, BioShock Infinite, XCOM: Enemy Unknown and Spec Ops: The Line.
Net revenue on consoles increased to 91.4% of our total net revenue for the fiscal year ended March 31, 2014 as compared to 80.4% for the same period in the prior year primarily due to the current year release of Grand Theft Auto V on Microsoft's Xbox 360 and Sony's PS3 console gaming systems. PC and other sales decreased to $192.4 million or 8.2% of our total net revenue for the fiscal year ended March 31, 2014 as compared to $216.3 million or 17.8% for the prior year. The decrease was primarily due to the prior year PC release of Borderlands 2. Handheld sales decreased to $9.7 million or 0.4% of our total net revenue for the fiscal year ended March 31, 2014 as compared to $22.2 million, or 1.8% for the prior year primarily due to the prior year releases of various Nick Jr. titles.
Net revenue from physical retail and other channels increased to 84.2% of our total net revenue for the fiscal year ended March 31, 2014 as compared to 78.9% for the same period in the prior year, primarily due to the current year release of Grand Theft Auto V on Microsoft's Xbox 360 and Sony's PS3 console gaming systems. Net revenue from digital online channels of $372.0 million for the fiscal year ended March 31, 2014 increased $115.8 million, or 45.2%, as compared to the same period in the prior year. The increase was mainly driven by digital offerings from our Grand Theft Auto and NBA 2K franchises as well as Bioshock Infinite.
Gross profit as a percentage of net revenue was 39.8% for the fiscal year ended March 31, 2014, a decrease of 1.3 percentage points as compared to the prior year, primarily due to higher internal royalties mainly due to higher income generated from our Grand Theft Auto franchise, partially offset by (i) lower product costs in the current year as a percentage of net revenue as a result of a greater share of net revenue in the current year being generated from a product mix with higher average selling price points and (ii) lower software development costs and royalties as a percentage of net revenue for the fiscal year ended March 31, 2014, primarily due to the prior year release of Borderlands 2, which was externally developed.
Net revenue earned outside of the United States accounted for 53.5% of our total net revenue for the fiscal year ended March 31, 2014, as compared to 41.5% in the prior year. The year-over-year percentage increase was primarily due to the global release of Grand Theft Auto V, which generated higher sales outside the United States during the fiscal year ended March 31, 2014. Foreign currency exchange rates decreased net revenue and decreased gross profit by $5.7 million and $2.3 million, respectively, for the fiscal year ended March 31, 2014 as compared to the prior year.
Operating Expenses
| (thousands of dollars) | 2014 | % of net revenue | 2013 | % of net revenue | Increase/ (decrease) | % Increase/ (decrease) | |||||||||||||
| Selling and marketing | $ | 240,996 | 10.2 | % | $ | 257,329 | 21.2 | % | $ | (16,333 | ) | (6.3 | )% | ||||||
| General and administrative | 161,374 | 6.9 | % | 147,260 | 12.1 | % | 14,114 | 9.6 | % | ||||||||||
| Research and development | 105,256 | 4.5 | % | 78,184 | 6.4 | % | 27,072 | 34.6 | % | ||||||||||
| Depreciation and amortization | 13,359 | 0.6 | % | 10,634 | 1.0 | % | 2,725 | 25.6 | % | ||||||||||
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| Total operating expenses(1) | $ | 520,985 | 22.2 | % | $ | 493,407 | 40.7 | % | $ | 27,578 | 5.6 | % | |||||||
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(1)
Includes stock-based compensation expense, as follows:
| 2014 | 2013 | ||||||||||||||||||
| Selling and marketing | $10,136 | $ 5,562 | |||||||||||||||||
| General and administrative | $28,991 | $17,824 | |||||||||||||||||
| Research and development | $ 8,867 | $ 2,319 |
Foreign currency exchange rates increased total operating expenses by approximately $0.4 million in the fiscal year ended March 31, 2014 as compared to the prior year.
Selling and marketing
Selling and marketing expenses decreased $16.3 million for the fiscal year ended March 31, 2014, as compared to the prior year, primarily due to a decrease in advertising expenses of $31.5 million. In the prior year, advertising expenses had increased due to the releases of Borderlands 2 in September 2012, Max Payne 3 in May 2012 and BioShock Infinite in March 2013, as compared to expenses incurred for the September 2013 release of Grand Theft Auto V. This net decrease was partially offset by a $14.0 million increase primarily due to higher personnel costs related to stock-based compensation expense and headcount, and higher third-party commissions.
General and administrative
General and administrative expenses increased $14.1 million for the fiscal year ended March 31, 2014, as compared to the prior year, primarily due to an increase of $12.1 million in personnel costs primarily due to higher headcount and higher severance costs related to current year restructuring activities, $11.2 million of higher stock-based compensation expense primarily for previously granted stock-based awards to ZelnickMedia and $5.3 million of higher legal fees and IT-related costs, which were partially offset by the absence of a $15.0 million contractual provision that was triggered in June 2012.
General and administrative expenses for the fiscal years ended March 31, 2014 and 2013 include occupancy expense (primarily rent, utilities and office expenses) of $16.4 million and $15.9 million, respectively, related to our development studios.
Research and development
Research and development expenses increased $27.1 million for the fiscal year ended March 31, 2014, as compared to the prior year, primarily due to an increase of $20.9 million in personnel costs due mainly to higher stock-based compensation related to the current year issuance of restricted stock awards to certain employees and lower capitalization rates at our development studios due mainly to resources being transitioned to new projects following the September 2013 release of Grand Theft Auto V and an increase of $6.6 million in production expenses primarily due to work on titles that have not reached technological feasibility.
Depreciation and amortization
Depreciation and amortization expenses increased $2.7 million for the fiscal year ended March 31, 2014, as compared to the prior year primarily due to higher purchases of fixed assets during recent years.
Interest and other, net
| (thousands of dollars) | 2014 | % of net revenue | 2013 | % of net revenue | (Increase)/ decrease | % Increase/ (decrease) | |||||||||||||
| Interest expense, net | $ | (33,961 | ) | (1.4 | )% | $ | (30,763 | ) | (2.5 | )% | $ | (3,198 | ) | 10.4 | % | ||||
| Foreign currency exchange gain (loss) | 209 | 0.0 | % | (778 | ) | (0.1 | )% | 987 | (126.9 | )% | |||||||||
| Other | 199 | 0.0 | % | 190 | 0.0 | % | 9 | 4.7 | % | ||||||||||
| Interest and other, net | $ | (33,553 | ) | (1.4 | )% | $ | (31,351 | ) | (2.6 | )% | $ | (2,202 | ) | 7.0 | % | ||||
Interest and other, net was an expense of $33.6 million for the fiscal year ended March 31, 2014, as compared to an expense of $31.4 million for the fiscal year ended March 31, 2013. The increase of $2.2 million in interest and other, net was primarily related to an increase in our long-term debt associated with our June 2013 issuance of $287.5 million of 1.00% Convertible Notes partially offset by the August 29,
2013 redemption of our 4.375% Convertible Notes which had an aggregate principal amount of $138.0 million.
Loss on extinguishment of debt
Loss on extinguishment of debt was $9.0 million for the fiscal year ended March 31, 2014 due to the conversion and redemption of our 4.375% Convertible Notes. See "Liquidity and Capital Resources" for additional information regarding loss on extinguishment of debt.
Gain on convertible note hedge and warrants, net
Gain on convertible note hedge and warrants, net was $3.5 million for the fiscal year ended March 31, 2014 due to the increase in the Company's share price during the period from June 2013 to the date of the net settlement of the hedge and warrants in August 2013. See "Liquidity and Capital Resources" for additional information regarding settlement and related net gain on the convertible note hedge and warrant transactions.
Provision for income taxes
Income tax expense was $14.5 million for the fiscal year ended March 31, 2014, as compared to $5.1 million for the fiscal year ended March 31, 2013. The increase in tax expense was primarily attributable to an increase in pre-tax income from operations in excess of remaining net operating losses available in the fiscal year ended March 31, 2014. Our effective tax rate differed from the federal statutory rate primarily due to changes in valuation allowances during the period. Our valuation allowances decreased by $92.1 million and $1.3 million during fiscal years ended March 31, 2014 and 2013, respectively, due to the utilization of net operating loss carryforwards from prior years against income earned during each year.
As of March 31, 2014, we had gross unrecognized tax benefits, including interest and penalties, of $24.9 million, of which $24.9 million would affect our effective tax rate if realized. For the fiscal year ended March 31, 2014, gross unrecognized tax benefits increased by $3.2 million. We are generally no longer subject to audit for U.S. federal income tax returns for periods prior to our fiscal year ended October 31, 2010 and state income tax returns for periods prior to our fiscal year ended October 31, 2007. With few exceptions, we are no longer subject to income tax examinations in non-U.S. jurisdictions for years prior to our fiscal year ended October 31, 2010. U.S. federal taxing authorities have completed their audit through the fiscal years ended October 31, 2009. Certain U.S. state taxing authorities are currently examining our income tax returns from the fiscal years ended October 31, 2007 through October 31, 2010. The determination as to further adjustments to our gross unrecognized tax benefits during the next 12 months is not practicable.
We are regularly audited by domestic and foreign taxing authorities. Audits may result in tax assessments in excess of amounts claimed and the payment of additional taxes. We believe that our tax positions comply with applicable tax law, and that we have adequately provided for reasonably foreseeable tax assessments.
Discontinued operations
Income (loss) from discontinued operations, net of taxes, reflects the results of our former distribution business which was sold in February 2010. For the fiscal year ended March 31, 2014, there was an immaterial net loss from discontinued operations, net of taxes, compared to net income of $1.7 million for the prior year. The net income during the fiscal year ended March 31, 2013 was primarily due to the maturity of a remaining contract and changes in estimates of sublease income as a result of the Company entering into a new sublease.
Net income (loss) and earnings (loss) per share
For the fiscal year ended March 31, 2014, our net income was $361.6 million, as compared to a net loss of $29.5 million in the prior year. Earnings per share for the fiscal year ended March 31, 2014 were $3.79 for basic and $3.20 for diluted earnings per share as compared to a loss per share of $0.34 for basic and diluted earnings for the fiscal year ended March 31, 2013. Basic and diluted weighted average shares outstanding were lower compared to the prior year period primarily due to the repurchase of shares during the fiscal year ended March 31, 2014 partially offset by the vesting of restricted stock awards over the last twelve months and the issuance of shares upon the conversion of the 4.375% Convertible Notes. See Note 1 to our consolidated financial statements for additional information regarding earnings (loss) 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 funds provided by our operating activities, our Credit Agreement and our Convertible Notes to satisfy our working capital needs.
Short-term Investments
During the fiscal year ended March 31, 2015, the Company purchased $187.6 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, the Company may purchase additional short-term investments depending on future market conditions and liquidity needs.
Credit Agreement
In August 2014, we entered into a Third Amendment to our Credit Agreement. The Credit Agreement provides for borrowings of up to $100.0 million which may be increased by up to $40.0 million pursuant to the terms of the Credit Agreement, and is secured by substantially all of our assets and the equity of our subsidiaries. The Credit Agreement expires on August 18, 2019. Revolving loans under the Credit Agreement bear interest at our election of (a) 0.50% to 1.00% above a certain base rate (3.75% at March 31, 2015), or (b) 1.50% to 2.00% above the LIBOR Rate (approximately 1.76% at March 31, 2015), with the margin rate subject to the achievement of certain average liquidity levels. We are also required to pay a monthly fee on the unused available balance, ranging from 0.25% to 0.375% based on availability. We had no outstanding borrowings at March 31, 2015 and 2014.
Availability under the Credit Agreement is restricted by our United States and United Kingdom based accounts receivable and inventory balances. The Credit Agreement also allows for the issuance of letters of credit in an aggregate amount of up to $5.0 million.
As of March 31, 2015, there was $98.3 million available to borrow under the Credit Agreement. At March 31, 2015, we had no outstanding borrowings under the Credit Agreement and $1.7 million of letters of credit outstanding.
The Credit Agreement contains covenants that substantially limit us and our subsidiaries' ability to: create, incur, assume or be liable for indebtedness; dispose of assets outside the ordinary course of business; acquire, merge or consolidate with or into another person or entity; create, incur or allow any lien on any of their respective properties; make investments; or pay dividends or make distributions (each subject to certain limitations); or optionally prepay any indebtedness (subject to certain exceptions, including an exception permitting the redemption of the Company's unsecured convertible senior notes upon the meeting of certain minimum liquidity requirements). In addition, the Credit Agreement provides for certain events of default such as nonpayment of principal and interest, breaches of representations and warranties, noncompliance with covenants, acts of insolvency, default on indebtedness held by third parties
and default on certain material contracts (subject to certain limitations and cure periods). The Credit Agreement also contains a requirement that we maintain an interest coverage ratio of more than one to one for the trailing twelve month period, if certain average liquidity levels fall below $30.0 million. As of March 31, 2015, we were in compliance with all covenants and requirements outlined in the Credit Agreement.
1.75% Convertible Notes Due 2016
On November 16, 2011, we issued $250.0 million aggregate principal amount of 1.75% Convertible Notes due 2016 (the "1.75% Convertible Notes"). Interest on the 1.75% Convertible Notes is payable semi-annually in arrears on June 1st and December 1st of each year, commencing on June 1, 2012. The 1.75% Convertible Notes mature on December 1, 2016, unless earlier repurchased by the Company or converted. The Company does not have the right to redeem the 1.75% Convertible Notes prior to maturity.
The 1.75% Convertible Notes are convertible at an initial conversion rate of 52.3745 shares of our common stock per $1,000 principal amount of 1.75% Convertible Notes (representing an initial conversion price of approximately $19.093 per share of common stock for a total of approximately 13,094,000 underlying conversion shares) subject to adjustment in certain circumstances. Holders may convert the 1.75% Convertible Notes at their option prior to the close of business on the business day immediately preceding June 1, 2016 only under the following circumstances: (1) during any fiscal quarter commencing after March 31, 2012, if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter is greater than or equal to 130% of the applicable conversion price on each applicable trading day; (2) during the five business day period after any 10 consecutive trading day period (the "measurement period") in which the trading price per $1,000 principal amount of 1.75% Convertible Notes for each day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on each such day; or (3) upon the occurrence of specified corporate events. On and after June 1, 2016 until the close of business on the business day immediately preceding the maturity date, holders may convert their 1.75% Convertible Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 1.75% Convertible Notes may be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of the Company's common stock. Our common stock price exceeded 130% of the applicable conversion price per share for at least 20 trading days during the 30 consecutive trading days ended March 31, 2015. Accordingly, as of April 1, 2015 the 1.75% Convertible Notes may be converted at the holder's option through June 30, 2015. If the 1.75% Convertible Notes were to be converted during this period, our current intent and ability, given our option, would be to settle the conversion in shares of our common stock. As such, we have continued to classify these 1.75% Convertible Notes as long-term debt.
The indenture governing the 1.75% Convertible Notes contains customary terms and covenants and events of default. As of March 31, 2014, we were in compliance with all covenants and requirements outlined in the indenture governing the 1.75% Convertible Notes.
1.00% Convertible Notes Due 2018
On June 18, 2013, we issued $250.0 million aggregate principal amount of 1.00% Convertible Notes due 2018 (the "1.00% Convertible Notes" and together with the 1.75% Convertible Notes, the "Convertible Notes"). The 1.00% Convertible Notes were issued at 98.5% of par value for proceeds of $246.3 million. Interest on the 1.00% Convertible Notes is payable semi-annually in arrears on July 1st and January 1st of each year, commencing on January 1, 2014. The 1.00% Convertible Notes mature on July 1, 2018, unless earlier repurchased by the Company or converted. The Company does not have the right to redeem the 1.00% Convertible Notes prior to maturity. The Company also granted the underwriters a 30-day option to purchase up to an additional $37.5 million principal amount of 1.00% Convertible Notes to cover
overallotments, if any. On July 17, 2013, the Company closed its public offering of $37.5 million principal amount of the Company's 1.00% Convertible Notes as a result of the underwriters exercising their overallotment option in full on July 12, 2013, bringing the proceeds to $283.2 million.
The 1.00% Convertible Notes are convertible at an initial conversion rate of 46.4727 shares of our common stock per $1,000 principal amount of 1.00% Convertible Notes (representing an initial conversion price of approximately $21.52 per share of common stock for a total of approximately 13,361,000 underlying conversion shares) subject to adjustment in certain circumstances. Holders may convert the 1.00% Convertible Notes at their option prior to the close of business on the business day immediately preceding January 1, 2018 only under the following circumstances: (1) during any fiscal quarter commencing after September 30, 2013, if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter is greater than or equal to 130% of the applicable conversion price on each applicable trading day; (2) during the five business day period after any 10 consecutive trading day period (the "measurement period") in which the trading price per $1,000 principal amount of 1.00% Convertible Notes for each day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on each such day; or (3) upon the occurrence of specified corporate events. On and after January 1, 2018 until the close of business on the business day immediately preceding the maturity date, holders may convert their 1.00% Convertible Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 1.00% Convertible Notes may be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of the Company's common stock.
The indenture governing the 1.00% Convertible Notes contains customary terms and covenants and events of default. As of the fiscal year end March 31, 2014, we were in compliance with all covenants and requirements outlined in the indenture governing the 1.00% Convertible Notes.
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 64.6%, 39.4% and 52.5% of net revenue during the fiscal years ended March 31, 2015, 2014 and 2013, respectively. As of March 31, 2015 and 2014, five customers accounted for 63.9% and 68.3% of our gross accounts receivable, respectively. Customers that individually accounted for more than 10% of our gross accounts receivable balance comprised 54.5% and 59.8% of such balances at March 31, 2015 and 2014, respectively. We had three customers who accounted for approximately 18.5%, 18.4% and 17.6% of our gross accounts receivable as of March 31, 2015 and three customers who accounted for 22.6%, 22.3% and 14.9% of our gross accounts receivable as of March 31, 2014. We did not have any additional customers that exceeded 10% of our gross accounts receivable as of March 31, 2015 and 2014. 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 and projected cash flow 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 through at least the next 12 months.
As of March 31, 2015, the amount of cash and cash equivalents held outside of the U.S. by our foreign subsidiaries was approximately $291.0 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, the Company expects in the foreseeable future to have the ability to generate sufficient cash domestically to support ongoing operations. Consequently, it is the Company's intention to indefinitely reinvest undistributed earnings of its foreign subsidiaries. In the event the Company needed to repatriate funds outside of the U.S., such repatriation may be subject to local laws and tax consequences including foreign withholding taxes or U.S. income taxes. It is not practicable to estimate the tax liability and the Company would try to minimize the tax effect to the extent possible. However, any repatriation may not result in significant cash payments as the taxable event would likely be offset by the utilization of the then available tax credits.
In January 2013, our Board of Directors authorized the repurchase of up to 7,500,000 shares of our common stock. The authorization permits the Company to 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. It does not obligate the Company to make any purchases at any specific time or situation. Repurchases are subject to the availability of stock, prevailing market conditions, the trading price of the stock, the Company's financial performance and other conditions. The program may be suspended or discontinued at any time for any reason. The Company did not repurchase any shares during fiscal year ended March 31, 2015. During the fiscal year ended March 31, 2014, the Company repurchased approximately 4,217,000 shares of our common stock in the open market for approximately $73.3 million, including commissions of approximately $0.04 million, as part of the program. As of March 31, 2015, up to approximately 3,283,000 shares of our common stock remain available for repurchase under the Company's share repurchase authorization. On May 13, 2015, our Board of Directors approved an increase to the share repurchase authorization, increasing the total number of shares that the Company is permitted to repurchase to up to 10,000,000 shares of our common stock.
Our changes in cash flows were as follows:
| Fiscal Year Ended March 31, | ||||||||||
| (thousands of dollars) | 2015 | 2014 | 2013 | |||||||
| Net cash provided by operating activities | $ | 212,814 | $ | 700,262 | $ | (4,567 | ) | |||
| Net cash used in investing activities | (220,141 | ) | (30,813 | ) | (16,820 | ) | ||||
| Net cash provided by (used in) financing activities | 928 | (133,684 | ) | — | ||||||
| Effects of foreign currency exchange rates on cash and cash equivalents | (17,881 | ) | (2,867 | ) | 3,610 | |||||
| Net (decrease) increase in cash and cash equivalents | $ | (24,280 | ) | $ | 532,898 | $ | (17,777 | ) | ||
At March 31, 2015 we had $911.1 million of cash and cash equivalents, compared to $935.4 million at March 31, 2014. The decrease in cash and cash equivalents from March 31, 2014 was primarily due to cash being used in investing activities partially offset by cash provided by operating activities. Net cash used in investing activities related to purchases of short-term investments and purchases of fixed assets and was partially offset by the proceeds received from the sale of our long-term investment. Net cash provided by operations was primarily due to cash generated from the sale of Grand Theft Auto V on Sony's PS4 and Microsoft's Xbox One platforms, the sale of Evolve and the sale virtual currency partially offset by investments in software development and licenses.
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. Generally, these include:
Software Development and Licensing: We make payments to third-party software developers that include contractual payments to developers under several software development agreements that expire at various times through September 2019. Our aggregate outstanding software development commitments assume satisfactory performance by third-party software developers. We also have licensing commitments that primarily consist of obligations to holders of intellectual property rights for use of their trademarks, copyrights, technology or other intellectual property rights in the development of our products.
Marketing: We have certain minimum marketing support commitments where we commit to spend specified amounts related to marketing our products. Marketing commitments expire at various times through September 2019.
Operating Leases: Our offices are occupied under non-cancelable operating leases expiring at various times through June 2024. We also lease certain furniture, equipment and automobiles under non-cancelable leases expiring through fiscal year 2020. Some of the leases have fixed rent increases and also include inducements to enter into the lease. The effect of such amounts are deferred and recognized on a straight-line basis over the related lease term.
Purchase obligations primarily related to agreements to purchase services that are enforceable and legally binding on the Company that specifies all significant terms, including fixed, minimum or variable pricing provisions; and the approximate timing of the transactions, expiring at various times through March 2019.
A summary of annual minimum contractual obligations and commitments as of March 31, 2015 is as follows (in thousands of dollars):
| Fiscal Year Ending March 31, | Software Development and Licensing | Marketing | Operating Leases | Purchase Obligations | Convertible Notes Interest | Convertible Notes | Total | |||||||||||||||
| 2016 | $ | 81,612 | $ | 24,591 | $ | 19,558 | $ | 21,556 | $ | 7,250 | $ | — | $ | 154,567 | ||||||||
| 2017 | 62,320 | 5,675 | 17,007 | 12,207 | 7,250 | 250,000 | 354,459 | |||||||||||||||
| 2018 | 48,011 | 4,717 | 15,255 | 5,543 | 2,875 | — | 76,401 | |||||||||||||||
| 2019 | 27,204 | 43,423 | 15,452 | 1,593 | 1,438 | 287,500 | 376,610 | |||||||||||||||
| 2020 | 8,200 | 9,500 | 11,092 | — | — | — | 28,792 | |||||||||||||||
| Thereafter | — | — | 36,727 | — | — | — | 36,727 | |||||||||||||||
| Total | $ | 227,347 | $ | 87,906 | $ | 115,091 | $ | 40,899 | $ | 18,813 | $ | 537,500 | $ | 1,027,556 | ||||||||
In addition to the cash commitments above, we have also entered into acquisition agreements that contain provisions for us to pay contingent cash consideration, typically contingent on the acquired company achieving certain financial, unit sales, or performance conditions. The amount and timing of these payments are currently not fixed or determinable. See Note 11 to the Consolidated Financial Statements for a full discussion of our potential acquisition commitments.
Income Taxes. At March 31, 2015, the Company had recorded a liability for gross unrecognized tax benefits, including interest and penalties, of $29.2 million for which we are unable to make a reasonable and reliable estimate of the period in which these liabilities will be settled with the respective tax authorities, therefore, these liabilities have not been included in the contractual obligations table.
Off-Balance Sheet Arrangements
As of March 31, 2015 and 2014, 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 fiscal years ended March 31, 2015, 2014 and 2013, approximately 42.5%, 53.5% and 41.5%, respectively, of our net revenue was earned outside 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 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 titles are also seasonal, with peak shipments typically occurring in the fourth calendar quarter as a result of increased demand for titles during the holiday season. Quarterly comparisons of operating results are not necessarily indicative of future operating results.
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