filings.toolsItem 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS
The statements contained herein, which are not historical facts including statements relating to our acquisition of Zynga Inc. (the "Zynga Acquisition"), are considered forward-looking statements under federal securities laws and may be identified by words such as "anticipates," "believes," "estimates," "expects," "intends," "plans," "potential," "predicts," "projects," "seeks," "should," "will," or words of similar meaning and include, but are not limited to, statements regarding the outlook for our future business and financial performance. Such forward-looking statements are based on the current beliefs of our management as well as assumptions made by and information currently available to them, which are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict. Actual outcomes and results may vary materially from these forward-looking statements based on a variety of risks and uncertainties including the uncertainty of the impact of the COVID-19 pandemic and measures taken in response thereto; the effect that measures taken to mitigate the COVID-19 pandemic have on our operations, including our ability to timely deliver our titles and other products, and on the operations of our counterparties, including retailers, including digital storefronts and platform partners, and distributors; the effects of the COVID-19 pandemic on consumer demand and the discretionary spending patterns of our customers as the situation with the pandemic continues to evolve; the impact of changes in interest rates by the Federal Reserve and other central banks, including on our short-term investment portfolio; the impact of inflation; volatility in foreign currency exchange rates; risks that the Zynga Acquisition disrupts our plans and operations; the ability company to retain key personnel subsequent to the Zynga Acquisition; the ability to realize the benefits of the Zynga Acquisition, including Net Bookings opportunities and cost synergies; the ability to successfully integrate Zynga’s business with Take-Two’s business or to integrate the businesses within the anticipated timeframe; the outcome of any legal proceedings that may be instituted against Take-Two, Zynga or others related to the acquisition; the amount of the costs, fees, expenses and charges related to the acquisition; other risks included herein; as well as, but not limited to, the risks and uncertainties discussed under the heading "Risk Factors" included in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended March 31, 2022; and our other periodic filings with the Securities and Exchange Commission. All forward-looking statements are qualified by these cautionary statements and speak only as of the date they are made. We undertake no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise.
Our Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is provided in addition to the accompanying Condensed Consolidated Financial Statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. The following discussion should be read in conjunction with the MD&A and our annual consolidated financial statements and the notes thereto, included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2022. All figures are in millions, except per share amounts or as otherwise noted.
Overview
Zynga Acquisition and Related Debt Transactions
We acquired Zynga on May 23, 2022, for consideration having an acquisition date fair value of $9,513.7, consisting of $3,992.4 in cash, the issuance of 46.3 shares of our common stock, and $143.6 of replacement equity awards attributable to the pre-acquisition service period. Refer to Note 14 - Acquisitions of our Condensed Consolidated Financial Statements. Zynga is a leading developer of mobile games with a mission to connect the world through games.
Also, in connection with the Zynga Acquisition, we entered into several debt transactions (refer to Note 9 - Debt).
On April 14, 2022, we completed our offering and sale of $2,700.0 aggregate principal amount of our senior notes, consisting of $1,000.0 principal amount of our 3.300% Senior Notes due 2024 (the “2024 Notes”), $600.0 principal amount of our 3.550% Senior Notes due 2025 (the “2025 Notes”), $600.0 principal amount of our 3.700% Senior Notes due 2027 (the “2027 Notes”), and $500.0 principal amount of our 4.000% Senior Notes due 2032 (the “2032 Notes” and, together with the 2024 Notes, the 2025 Notes and the 2027 Notes, the “Senior Notes”).The Senior Notes were issued under an indenture between the Company and The Bank of New York Mellon, as trustee (the “Trustee”).
The 2024 Notes mature on March 28, 2024, and bear interest at an annual rate of 3.300%. The 2025 Notes mature on April 14, 2025, and bear interest at an annual rate of 3.550%. The 2027 Notes mature on April 14, 2027, and bear interest at an annual rate of 3.700%. The 2032 Notes mature on April 14, 2032, and bear interest at an annual rate of 4.000%. We will pay interest on the 2024 Notes semiannually on March 28 and September 28 of each year, commencing September 28, 2022. During the three months ended September 30, 2022, we made interest payments of $15.0. We will pay interest on each of the 2025 Notes, 2027 Notes, and 2032 Notes semi-annually on April 14 and October 14 of each year, commencing October 14, 2022. The proceeds were used to finance our acquisition of Zynga.
On May 23, 2022, we entered into a new unsecured Credit Agreement (the "2022 Credit Agreement"), which replaced in its entirety the Company's prior Credit Agreement and provides for an unsecured five-year revolving credit facility with commitments of $500.0, including sublimits for (i) the issuance of letters of credit in an aggregate face amount of up to $100.0 and (ii) borrowings and letters of credit denominated in Pounds Sterling, Euros, and Canadian Dollars in an aggregate principal amount of up to $100.0. In addition, the 2022 Credit Agreement contains uncommitted incremental capacity permitting the incurrence of up to an additional amount not to exceed the greater of $250.0 and 35.0% of the Company's Consolidated Adjusted EBITDA (as defined in the 2022 Credit Agreement).
Loans under the 2022 Credit Agreement will bear interest at a rate of (a) 0.000% to 0.625% above an alternate base rate (6.25% at September 30, 2022) or (b) 1.000% to 1.625% above Secured Overnight Financing Rate ("SOFR"), approximately 3.04% at September 30, 2022, which rates are determined by the Company's credit rating. On June 22, 2022, we drew down approximately $200.0 at 3.28% from our facility under the 2022 Credit Agreement.
On June 22, 2022, we entered into an unsecured 364-Day Term Loan Credit Agreement ("Term Loan"). The Term Loan provides for an unsecured 364-day term loan credit facility in the aggregate principal amount of $350.0 and matures on June 21, 2023, and will bear interest at our election at a margin of (a) 0.000% to 0.375% above an alternate base rate (defined on the basis of prime rate) or (b) 0.750% to 1.375% above SOFR, which margins are determined by reference to our credit rating. We fully drew down on the Term Loan on June 22, 2022 at 3.6%.
The proceeds from our draw-downs of the 2022 Credit Agreement and Term Loan were used to finance a portion of the settlement of the Convertible Notes acquired from Zynga. In total, we paid $321.6 for the tendered or converted 2024 Convertible Notes, including interest, and $845.1 for the tendered 2026 Convertible Notes in cash, and we issued 3.7 shares of our common stock upon the conversion of the 2024 Convertible Notes. After settlement of all Convertible Notes tendered or surrendered for conversion, $21.4 aggregate principal amount of the 2024 Convertible Notes remained outstanding and $29.4 aggregate principal amount of the 2026 Convertible Notes remained outstanding at September 30, 2022.
Cybersecurity Incident
In September 2022, we experienced a network intrusion in which an unauthorized third party illegally accessed and downloaded confidential information from our systems, including early development footage for the next Grand Theft Auto. We immediately took steps to isolate and contain the incident. Rockstar Games did not experience and does not anticipate any disruption to its current services nor any long-term effect on its development timelines as a result of this incident. Subsequently, also in September 2022, we became aware that an unauthorized third party illegally accessed credentials for a vendor platform that 2K Games uses to provide help desk support to its customers. The unauthorized party sent a communication to certain players containing a malicious link. 2K Games immediately notified all affected users and took steps to restrict further unauthorized activity until service was restored. In connection with this activity (the “Cybersecurity Incident”), we have incurred certain immaterial incremental one-time costs related to consultants, experts and data recovery efforts and expect to incur additional costs related to cybersecurity protections in the future. We are in the process of implementing a variety of measures to further enhance our cybersecurity protections.
Our Business
We are a leading developer, publisher, and marketer of interactive entertainment for consumers around the globe. We develop and publish products principally through Rockstar Games, 2K, Private Division, and Zynga. Our products are currently designed for console gaming systems, PC, and Mobile 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 creating the highest-quality, most engaging interactive entertainment franchises in the business and delivering them across an array of platforms to captivate our global audience. We focus on building compelling entertainment franchises by publishing a select number of titles for which we can create sequels and incremental revenue opportunities through virtual currency, add-on content, in-game purchases, and in-game advertising. 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, role-playing, shooter, sports, and strategy, which we distribute worldwide. We believe that our commitment to creativity and innovation is a distinguishing strength, enabling us to differentiate our products in the marketplace by combining advanced technology with compelling storylines and characters that provide unique gameplay experiences for consumers. We have created, acquired, or licensed a group of highly recognizable brands to match the broad consumer demographics that we serve, ranging from adults to children and game enthusiasts to casual gamers. Another cornerstone of our strategy is to support the success of our products in the marketplace through innovative marketing programs and global distribution on platforms and through channels that are relevant to our target audience.
Our revenue is primarily derived from the sale of internally developed software titles and software titles developed by third parties. Operating margins are dependent in part upon our ability to release new, commercially successful software products and to manage effectively their development and marketing costs. We have internal development studios located in Australia, Canada, China, Czech Republic, Finland, Germany, Hungary, India, Serbia, South Korea, Spain, Turkey, the United Kingdom (U.K.), and the United States (U.S.).
Software titles published by our Rockstar Games label are primarily internally developed. We expect Rockstar Games, our wholly-owned publisher of the Grand Theft Auto, Max Payne, Midnight Club, Red Dead Redemption, and other popular franchises, to continue to be a leader in the action/adventure product category and to create groundbreaking entertainment. We believe that Rockstar Games has established a uniquely original, popular cultural phenomenon with its Grand Theft Auto series, which is the interactive entertainment industry's most iconic and critically acclaimed brand and has sold-in over 385 million units. Our most recent installment, Grand Theft Auto V, which was released in 2013, has sold-in more than 170 million units worldwide and includes access to Grand Theft Auto Online. Red Dead Redemption 2, which has been a critical and commercial success that set numerous entertainment industry records, has sold-in more than 45 million units worldwide. Rockstar Games is also well known for developing brands in other genres, including the L.A. Noire, Bully, and Manhunt franchises. Rockstar Games continues to expand on our established franchises by developing sequels, offering downloadable episodes, and additional content. Rockstar Game's titles are published across all key platforms, including mobile. In February 2022, Rockstar Games announced that active development of the next entry in the Grand Theft Auto series is well underway.
Our 2K label has published a variety of popular entertainment properties across all key platforms and across a range of genres including shooter, action, role-playing, strategy, sports and family/casual entertainment. We expect 2K to continue to develop new, successful franchises in the future. 2K's internally owned and developed franchises include the critically acclaimed, multi-million unit selling BioShock, Mafia, Sid Meier's Civilization, and XCOM series. 2K also publishes successful externally developed brands, such as Borderlands and Tiny Tina's Wonderlands. 2K's realistic sports simulation titles include our flagship NBA 2K series, which continues to be the top-ranked NBA basketball video game, the WWE 2K professional wrestling series, and PGA TOUR 2K. In March 2020, 2K announced a multi-year partnership with the National Football League encompassing multiple future video games that will be non-simulation football game experiences. 2K also publishes mobile titles, such as WWE SuperCard.
Our Private Division label is dedicated to bringing titles from the industry's leading creative talent to market and is the publisher and owner of Kerbal Space Program and OlliOlli World. Kerbal Space Program 2 is planned for early access release in fiscal year 2023. Private Division also previously released The Outer Worlds and Ancestors: The Humankind Odyssey.
Our Zynga label, which includes our former T2 Mobile Games label (which included Socialpoint, Playdots, and Nordeus), publishes popular free-to-play mobile games that deliver high quality, deeply engaging entertainment experiences and generates revenue from in-game sales and in-game advertising. Zynga's diverse portfolio of popular game franchises has been downloaded more than 6 billion times on mobile, including CSR Racing, Dragon City, Empires & Puzzles, FarmVille, Golf Rival, Harry Potter: Puzzles & Spells, Merge Dragons, Merge Magic, Monster Legends, Toon Blast, Top Eleven, Toy Blast, Two Dots, Words With Friends, Zynga Poker, and a high volume of hyper-casual titles, including Hair Challenge and High Heels, published by Rollic. Zynga is also an industry-leading next-generation platform with the ability to acquire new users, cross-promote games, apply live services content updates, and optimize programmatic advertising and yields at scale through Chartboost, its leading mobile advertising and monetization platform.
We are continuing our strategy in Asia to broaden the distribution of our existing products and expand our online gaming presence, especially in China and South Korea. 2K has a multi-year license from the NBA to offer an online version of the NBA simulation game in China, Taiwan, South Korea, and Southeast Asia. NBA 2K Online, our free-to-play NBA simulation game that is based on the console edition of NBA 2K, which was co-developed by 2K and Tencent, is the top online PC sports game in China with more than 55 million registered users. We have released two iterations of NBA 2K Online and continue to enhance the title with new features. Additionally, we see a long-term opportunity to expand our mobile efforts across various emerging markets, particularly throughout Asia.
We have expanded our relationship with the NBA through the NBA 2K League. This groundbreaking competitive gaming league is jointly owned by us and the NBA and consists of teams operated by actual NBA franchises and several international partners. The NBA 2K League follows a professional sports league format: head-to-head competition throughout a regular season, followed by a bracketed playoff system and a finals match-up. The NBA 2K League is currently gearing up for its sixth season.
Trends and Factors Affecting our Business
Product Release Schedule. Our financial results are affected by the timing of our product releases and the commercial success of those titles. Our Grand Theft Auto products in particular have historically accounted for a significant portion of our revenue. Sales of Grand Theft Auto products generated 15.8% of our net revenue for the six months ended
September 30, 2022. The timing of our Grand Theft Auto product releases may affect our financial performance on a quarterly and annual basis.
Economic Environment and Retailer Performance. We continue to monitor economic conditions, including the impact of various macroeconomic and geopolitical factors, including inflation and the COVID-19 pandemic, that may affect our business, by affecting areas such as consumer demand, pricing pressure on our products, credit quality of our receivables, and foreign currency exchange rates. The COVID-19 pandemic has affected and may continue to affect our business operations, including our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued effects over time. During fiscal year 2021, as in the final quarter of fiscal year 2020, we noted a positive impact to our results that we believe was partly due to increased consumer engagement with our products because of the COVID-19 related business closures and movement restrictions, such as "shelter in place" and "lockdown" orders, implemented around the world, as well as the online accessibility and social nature of our products. As expected, during fiscal year 2022 and the first two quarters of fiscal year 2023, we experienced a moderation in engagement from the all-time highs experienced in fiscal year 2021, but overall engagement continued to be notably higher than it was pre-pandemic.
Based on our concern for the health and safety of our teams, we transitioned the vast majority of our teams to working from home throughout fiscal years 2021 and 2022; however, the majority of our offices either have reopened or are scheduled to reopen in the coming months. Given the evolving dynamics of the COVID-19 pandemic, we continue to adhere to safety standards in the planning and implementation of our return to office. To date, our plans have resulted in minimal disruption. However, despite largely positive outcomes to date, these efforts may ultimately not be effective, and a protracted economic downturn may limit the effectiveness of our mitigation efforts. Any of these considerations described above could cause or contribute to the risks described under the heading "Risk Factors" included in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended March 31, 2022, and could materially adversely affect our business, financial condition, results of operations, or stock price. Therefore, the effects of the COVID-19 pandemic will not be fully reflected in our financial results until future periods, and, at this time, we are not able to predict its ultimate impact on our business.
Additionally, our business is dependent upon a limited number of customers that account for a significant portion of our revenue. Our five largest customers accounted for 79.9% and 79.8% of net revenue during the six months ended September 30, 2022 and 2021, respectively. As of September 30, 2022, and March 31, 2022, five customers comprised 68.9% and 72.8% 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 51.0% and 63.8% of such balance at September 30, 2022, and March 31, 2022, respectively. We had two customers who accounted for 32.4% and 18.6% of our gross accounts receivable as of September 30, 2022, and two customers who accounted for 43.5% and 20.3% of our gross accounts receivable as of March 31, 2022. We did not have any additional customers that exceeded 10% of our gross accounts receivable as of September 30, 2022, and March 31, 2022. The economic environment has affected our customers in the past, and may do so in the future, including as a result of the COVID-19 pandemic. Bankruptcies or consolidations of our large retail customers could seriously hurt our business, due to uncollectible accounts receivables and the concentration of purchasing power among the remaining large retailers. There has been increased consolidation in our industry, as larger, better capitalized competitors will be in a stronger position to withstand prolonged periods of economic downturn and sustain their business through financial volatility.
Hardware Platforms. We derive most of our revenue from the sale of products made for video game consoles manufactured by third parties, which comprised 46.4% of our net revenue by product platform for the six months ended September 30, 2022. 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, such as those released in November 2020 by Sony and Microsoft, demand for interactive entertainment used on older platforms typically declines, which may negatively affect our business during the market transition to the new consoles. The new Sony and Microsoft consoles provide "backwards compatibility" (i.e., the ability to play games for the previous generation of consoles), which could mitigate the risk of such a decline. However, we cannot be certain how backwards compatibility will affect demand for our products. Further, events beyond our control may impact the availability of these new consoles, which may also affect demand. We manage our product delivery on each current and future platform in a manner we believe to be most effective to maximize our revenue opportunities and achieve the desired return on our investments in product development. Accordingly, our strategy for these platforms is to focus our development efforts on a select number of the highest quality titles.
Online Content and Digital Distribution. The interactive entertainment software industry is delivering a growing amount of content through digital online delivery methods. We provide a variety of online delivered products and offerings. Virtually all of our titles that are available through retailers as packaged goods products are also available through direct digital download (from digital storefronts we own and others owned by third parties) as well as a large selection of our catalog titles. In addition, we aim to drive ongoing engagement and incremental revenue from recurrent consumer spending on our titles through virtual currency, add-on content, in-game purchases, and in-game advertising. As disclosed in our "Results of
Operations," below, net revenue from digital online channels comprised 94.4% of our net revenue for the six months ended September 30, 2022. We expect online delivery of games and game offerings to continue to continue to be the primary part of our business over the long term.
We also publish an expanding variety of titles for Mobile, which are delivered to consumers through digital download, and are primarily distributed, marketed, and promoted through third parties, primarily Apple’s App Store and the Google Play Store. Virtual items for our Mobile games are purchased through the payment processing systems of these platform providers. We generate a significant portion of our net revenue through the Apple and Google platforms and expect to continue to do so for the foreseeable future as we launch more games for Mobile. Apple and Google generally have the discretion to set the amounts of their platform fees and change their platforms’ terms of service and other policies with respect to us or other developers at their sole discretion, and those changes may be unfavorable to us. These platform fees are recorded as cost of revenue as incurred. Further, as a result of the platform fees associated with online game sales, our Mobile Net revenue generally generates lower gross margin percentage than our Console or PC revenue. Accordingly, the overall product mix between Mobile and other game sales may impact our gross margins.
Player acquisition costs. Principally for our Mobile titles, we use advertising and other forms of player acquisition and retention to grow and retain our player audience. These expenditures, which are recorded within Sales and marketing in our Consolidated Statements of Operations, generally relate to the promotion of new game launches and ongoing performance-based programs to drive new player acquisition and lapsed player reactivation. Over time, these acquisition and retention-related programs may become either less effective or costlier, negatively impacting our operating results.
Content Release Highlights
During fiscal year 2023, Private Division released Rollerdrome, and 2K released The Quarry, NBA 2K23, PGA TOUR 2K23, and New Tales from the Borderlands.
To date we have announced that, during the remainder of fiscal year 2023, 2K will release Marvel's Midnight Suns and WWE 2K23, and Private Division will release Kerbal Space Program 2 early access on PC.
In addition, throughout the year, we expect to continue to deliver new content for our franchises. We will also continue to invest in opportunities that we believe will enhance and scale our business and have the potential to drive growth over the long-term.
Critical Accounting Policies and Estimates
Our most critical accounting policies, which are those that require significant judgment, include revenue recognition; price protection and allowances for returns; capitalization and recognition of software development costs and licenses; fair value estimates including valuation of goodwill, intangible assets, and long-lived assets; valuation and recognition of stock-based compensation; and income taxes. We are reiterating our significant accounting policy on revenue recognition, which is included in Note 1 - Basis of Presentation, including certain revenue policies applied upon close of the Zynga Acquisition. In-depth descriptions of our other critical accounting policies and estimates can be found in our Annual Report on Form 10-K for the fiscal year ended March 31, 2022.
Recently Adopted and Recently Issued Accounting Pronouncements
See Note 1 - Basis of Presentation and Significant Accounting Policies for further discussion.
Operating Metric
Net Bookings
We monitor Net Bookings as a key operating metric in evaluating the performance of our business. Net Bookings is defined as the net amount of products and services sold digitally or sold-in physically during the period and includes licensing fees, merchandise, in-game advertising, strategy guides, and publisher incentives. Net Bookings were as follows:
| Three Months Ended September 30, | Six Months Ended September 30, | |||||||||||||||||||||||||||||||||||||||||||||||||
| 2022 | 2021 | Increase/ (decrease) | % Increase/ (decrease) | 2022 | 2021 | Increase/ (decrease) | % Increase/ (decrease) | |||||||||||||||||||||||||||||||||||||||||||
| Net Bookings | $ | 1,504.8 | $ | 984.9 | $ | 519.9 | 52.8 | % | $ | 2,507.3 | $ | 1,696.3 | $ | 811.0 | 47.8 | % |
For the three months ended September 30, 2022, Net Bookings increased by $519.9 as compared to the prior year period. The increase was primarily due to Net Bookings from Zynga, which we acquired in May 2022 (refer to Note 14 - Acquisitions), including top contributors Rollic's hyper-casual portfolio, Empires & Puzzles, Toon Blast, Words With Friends, and Merge Dragons!, as well as an increase in Net Bookings from Tiny Tina’s Wonderlands, which released in March 2022. These increases were partially offset by a decrease in Net Bookings from our Grand Theft Auto, Borderlands, and Red Dead Redemption franchises.
For the six months ended September 30, 2022, Net Bookings increased by $811.0 as compared to the prior year period. The increase was primarily due to Net Bookings from Zynga, which we acquired in May 2022 (refer to Note 14 - Acquisitions), including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Words With Friends, and Merge Dragons!, as well as an increase in Net Bookings from (i) Tiny Tina’s Wonderlands; (ii) The Quarry, which released in June 2022; (iii) our WWE 2K franchise, including our March 2022 release of WWE 2K22; and (iv) Top Eleven, which was part of our June 2021 Nordeus acquisition. These increases were partially offset by a decrease in Net Bookings from our Grand Theft Auto, Borderlands, and Red Dead Redemption franchises.
Results of Operations
The following tables set forth, for the periods indicated, our Condensed Consolidated Statements of Operations, net revenue by geographic region, net revenue by platform, net revenue by distribution channel, and net revenue by content type:
| Three Months Ended September 30, | Six Months Ended September 30, | ||||||||||||||||||||||||||||||||||||||||||||||
| (millions of dollars) | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||||||||||||||||||||||
| Net revenue | $ | 1,393.5 | 100.0 | % | $ | 858.2 | 100.0 | % | $ | 2,495.9 | 100.0 | % | $ | 1,671.5 | 100.0 | % | |||||||||||||||||||||||||||||||
| Cost of revenue | 713.9 | 51.2 | % | 456.7 | 53.2 | % | 1,149.7 | 46.1 | % | 786.4 | 47.0 | % | |||||||||||||||||||||||||||||||||||
| Gross profit | 679.6 | 48.8 | % | 401.5 | 46.8 | % | 1,346.2 | 53.9 | % | 885.1 | 53.0 | % | |||||||||||||||||||||||||||||||||||
| Selling and marketing | 444.4 | 31.9 | % | 136.0 | 15.8 | % | 716.4 | 28.7 | % | 239.9 | 14.4 | % | |||||||||||||||||||||||||||||||||||
| General and administrative | 214.6 | 15.4 | % | 127.8 | 14.9 | % | 451.7 | 18.1 | % | 232.2 | 13.9 | % | |||||||||||||||||||||||||||||||||||
| Research and development | 243.2 | 17.5 | % | 101.5 | 11.8 | % | 417.0 | 16.7 | % | 193.8 | 11.6 | % | |||||||||||||||||||||||||||||||||||
| Depreciation and amortization | 29.9 | 2.1 | % | 16.1 | 1.9 | % | 51.0 | 2.0 | % | 28.6 | 1.7 | % | |||||||||||||||||||||||||||||||||||
| Total operating expenses | 932.1 | 66.9 | % | 381.4 | 44.4 | % | 1,636.1 | 65.6 | % | 694.5 | 41.5 | % | |||||||||||||||||||||||||||||||||||
| (Loss) income from operations | (252.5) | (18.1) | % | 20.1 | 2.3 | % | (289.9) | (11.6) | % | 190.6 | 11.4 | % | |||||||||||||||||||||||||||||||||||
| Interest and other, net | (50.5) | (3.6) | % | (0.6) | (0.1) | % | (79.8) | (3.2) | % | (1.6) | (0.1) | % | |||||||||||||||||||||||||||||||||||
| Gain (loss) on fair value adjustments, net | 1.9 | 0.1 | % | 0.4 | — | % | (37.7) | (1.5) | % | 2.4 | 0.1 | % | |||||||||||||||||||||||||||||||||||
| (Loss) income before income taxes | (301.1) | (21.6) | % | 19.9 | 2.3 | % | (407.4) | (16.3) | % | 191.4 | 11.5 | % | |||||||||||||||||||||||||||||||||||
| (Benefit from) provision for income taxes | (44.1) | (3.2) | % | 9.7 | 1.1 | % | (46.4) | (1.9) | % | 28.9 | 1.7 | % | |||||||||||||||||||||||||||||||||||
| Net (loss) income | $ | (257.0) | (18.4) | % | $ | 10.2 | 1.2 | % | $ | (361.0) | (14.5) | % | $ | 162.5 | 9.7 | % |
| Three Months Ended September 30, | Six Months Ended September 30, | ||||||||||||||||||||||||||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||||||||||||||||||||||||||
| Net revenue by geographic region: | |||||||||||||||||||||||||||||||||||||||||||||||
| United States | $ | 842.9 | 60.5 | % | $ | 514.9 | 60.0 | % | $ | 1,525.8 | 61.1 | % | $ | 1,008.1 | 60.3 | % | |||||||||||||||||||||||||||||||
| International | 550.6 | 39.5 | % | 343.3 | 40.0 | % | 970.1 | 38.9 | % | 663.4 | 39.7 | % | |||||||||||||||||||||||||||||||||||
| Net revenue by platform: | |||||||||||||||||||||||||||||||||||||||||||||||
| Console | $ | 551.9 | 39.6 | % | $ | 596.1 | 69.5 | % | $ | 1,159.1 | 46.4 | % | $ | 1,198.5 | 71.7 | % | |||||||||||||||||||||||||||||||
| Mobile | 730.1 | 52.4 | % | 115.1 | 13.4 | % | 1,099.7 | 44.1 | % | 197.4 | 11.8 | % | |||||||||||||||||||||||||||||||||||
| PC and other | 111.5 | 8.0 | % | 147.0 | 17.1 | % | 237.1 | 9.5 | % | 275.6 | 16.5 | % | |||||||||||||||||||||||||||||||||||
| Net revenue by distribution channel: | |||||||||||||||||||||||||||||||||||||||||||||||
| Digital online | $ | 1,319.2 | 94.7 | % | $ | 779.1 | 90.8 | % | $ | 2,357.0 | 94.4 | % | $ | 1,519.9 | 90.9 | % | |||||||||||||||||||||||||||||||
| Physical retail and other | 74.3 | 5.3 | % | 79.1 | 9.2 | % | 138.9 | 5.6 | % | 151.6 | 9.1 | % | |||||||||||||||||||||||||||||||||||
| Net revenue by content: | |||||||||||||||||||||||||||||||||||||||||||||||
| Recurrent consumer spending | $ | 1,101.8 | 79.1 | % | $ | 563.6 | 65.7 | % | $ | 1,927.4 | 77.2 | % | $ | 1,135.9 | 68.0 | % | |||||||||||||||||||||||||||||||
| Full game and other | 291.7 | 20.9 | % | 294.6 | 34.3 | % | 568.5 | 22.8 | % | 535.6 | 32.0 | % |
Three Months Ended September 30, 2022 Compared to September 30, 2021
| (millions of dollars) | 2022 | % | 2021 | % | Increase/ (decrease) | % Increase/ (decrease) | |||||||||||||||||||||||||||||
| Total net revenue | $ | 1,393.5 | 100.0 | % | $ | 858.2 | 100.0 | % | $ | 535.3 | 62.4 | % | |||||||||||||||||||||||
| Software development costs and royalties (1) | 289.9 | 20.8 | % | 144.9 | 16.9 | % | 145.0 | 100.1 | % | ||||||||||||||||||||||||||
| Product costs | 204.5 | 14.7 | % | 66.1 | 7.7 | % | 138.4 | 209.4 | % | ||||||||||||||||||||||||||
| Internal royalties | 124.3 | 8.9 | % | 159.6 | 18.6 | % | (35.3) | (22.1) | % | ||||||||||||||||||||||||||
| Licenses | 95.2 | 6.8 | % | 86.1 | 10.0 | % | 9.1 | 10.6 | % | ||||||||||||||||||||||||||
| Cost of revenue | 713.9 | 51.2 | % | 456.7 | 53.2 | % | 257.2 | 56.3 | % | ||||||||||||||||||||||||||
| Gross profit | $ | 679.6 | 48.8 | % | $ | 401.5 | 46.8 | % | $ | 278.1 | 69.3 | % |
(1) Includes $8.0 and $10.3 of stock-based compensation expense in 2022 and 2021, respectively, in software development costs and royalties.
For the three months ended September 30, 2022, net revenue increased by $535.3 as compared to the prior year period. The increase was primarily due to net revenue of $639.3 from Zynga, which we acquired in May 2022 (refer to Note 14- Acquisitions), including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Words With Friends, and Merge Dragons!, as well as an increase in net revenue of $20.0 from Tiny Tina's Wonderlands, which released in March 2022. These increases were partially offset by a decrease in net revenue of (i) $54.5 from our Grand Theft Auto franchise and (ii) $42.0 from our Borderlands franchise.
Net revenue from console games decreased by $44.2 and accounted for 39.6% of our total net revenue for the three months ended September 30, 2022, as compared to 69.5% for the prior year period. The decrease in net revenue from console games was due to a decrease in net revenue from our Grand Theft Auto, Red Dead Redemption, and Borderlands franchises and Hades, which released in August 2021*.* These decreases in net revenue from console games were partially offset by an increase in net revenue from our WWE 2K franchise, Tiny Tina's Wonderlands, and The Quarry. Net revenue from PC and other decreased by $35.5 and accounted for 8.0% of our total net revenue for the three months ended September 30, 2022, as compared to 17.1% for the prior year period. The decrease was primarily due to a decrease in net revenue from Tiny Tina's Wonderlands. Net revenue from mobile increased by $615.0 and accounted for 52.4% of our total net revenue for three months ended September 30, 2022, as compared to 13.4% for the prior year period. The increase was primarily due to net revenue of $630.3 from our May 2022 acquisition of Zynga, including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Words With Friends,and Merge Dragons!, as well as an increase in net revenue from Top Eleven.
Net revenue from digital online channels increased by $540.1 and accounted for 94.7% of our total net revenue for the three months ended September 30, 2022, as compared to 90.8% for the prior year period. The increase was primarily due to net revenue of $638.8 from our May 2022 acquisition of Zynga, including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Words With Friends, and Merge Dragons!. This increase was partially offset by a decrease in net revenue from our Grand Theft Auto and Borderlands franchises*.* Net revenue from physical retail and other channels decreased by $4.8 and accounted for 5.3% of our total net revenue for the three months ended September 30, 2022, as compared to 9.2% for the same period in the prior year period. The decrease in net revenue from physical retail and other channels was due primarily to a decrease in net revenue from Hades.
Recurrent consumer spending is generated from ongoing consumer engagement and includes revenue from virtual currency, add-on content, in-game purchases, and in-game advertising. Net revenue from recurrent consumer spending increased by $538.2 and accounted for 79.1% of net revenue for the three months ended September 30, 2022, as compared to 65.7% of net revenue for the prior year period. The increase in net revenue from recurrent consumer spending was primarily due to net revenue of $628.9 from our May 2022 acquisition of Zynga, including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Words With Friends, and Merge Dragons!. These increases were partially offset by a decrease in net revenue from our Grand Theft Auto franchise*.* Net revenue from full game and other decreased by $2.9 and accounted for 20.9% of net revenue for the three months ended September 30, 2022 as compared to 34.3% of net revenue for the prior year period. The decrease in net revenue from full game and other was due primarily to a decrease in net revenue from our Borderlands franchise. This decrease was partially offset by an increase in net revenue from Tiny Tina's Wonderlands, our NBA 2K franchise and The Quarry.
Gross profit as a percentage of net revenue for the three months ended September 30, 2022 was 48.8% as compared to 46.8% for the prior year period. The increase in gross profit as a percentage of net revenue was due to (i) lower internal royalties due to the timing of when royalties are earned and (ii) lower capitalized software amortization due to impairments recognized in the prior year period, partially offset by (i) higher amortization related to intangible assets related to our Zynga acquisition and (ii) higher product costs for fees paid to platform partners due to an increase in Mobile revenues as a result of the Zynga acquisition.
Net revenue earned outside of the United States increased by $207.3 and accounted for 39.5% of our total net revenue for the three months ended September 30, 2022, as compared to 40.0% in the prior year period. The increase in net revenue outside of the United States was primarily due to net revenue of $255.5 from our May 2022 acquisition of Zynga, including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Zynga Poker, and Merge Dragons!. Thin increase was partially offset by a decrease in net revenue from our Grand Theft Auto and Borderlands franchises. Changes in foreign currency exchange rates decreased net revenue by $8.3 and decreased gross profit by $4.4 for the three months ended September 30, 2022 as compared to the prior year period.
Operating Expenses
| (millions of dollars) | 2022 | % of net revenue | 2021 | % of net revenue | Increase/ (decrease) | % Increase/ (decrease) | |||||||||||||||||||||||||||||
| Selling and marketing | $ | 444.4 | 31.9 | % | $ | 136.0 | 15.8 | % | $ | 308.4 | 226.8 | % | |||||||||||||||||||||||
| General and administrative | 214.6 | 15.4 | % | 127.8 | 14.9 | % | 86.8 | 67.9 | % | ||||||||||||||||||||||||||
| Research and development | 243.2 | 17.5 | % | 101.5 | 11.8 | % | 141.7 | 139.6 | % | ||||||||||||||||||||||||||
| Depreciation and amortization | 29.9 | 2.1 | % | 16.1 | 1.9 | % | 13.8 | 85.7 | % | ||||||||||||||||||||||||||
| Total operating expenses**(1)** | $ | 932.1 | 66.9 | % | $ | 381.4 | 44.4 | % | $ | 550.7 | 144.4 | % |
(1) Includes stock-based compensation expense, which was allocated as follows:
| 2022 | 2021 | ||||||||||
| Selling and marketing | $ | 17.5 | $ | 7.1 | |||||||
| General and administrative | 44.2 | 16.7 | |||||||||
| Research and development | 38.2 | 13.0 | |||||||||
Changes in foreign currency exchange rates decreased total operating expenses by $19.8 for the three months ended September 30, 2022, as compared to the prior year period.
Selling and marketing
Selling and marketing expenses increased by $308.4 for the three months ended September 30, 2022, as compared to the prior year period, due primarily to (i) marketing expense for titles from our Zynga acquisition, including Rollic's hyper-casual portfolio, Toon Blast, Merge Dragons!, Empires & Puzzles, and Toy Blast, (ii) higher amortization related to intangible assets related to our Zynga acquisition, and (iii) higher personnel expenses for additional headcount, including related to our acquisition of Zynga.
General and administrative
General and administrative expenses increased by $86.8 for the three months ended September 30, 2022, as compared to the prior year period, due primarily to increases in (i) personnel expenses for additional headcount, including our acquisition of Zynga and (ii) professional fees related to our acquisition and integration of Zynga.
General and administrative expenses for the three months ended September 30, 2022 and 2021 included occupancy expense (primarily rent, utilities and office expenses) of $16.6 and $8.4, respectively, related to our development studios.
Research and development
Research and development expenses increased by $141.7 for the three months ended September 30, 2022, as compared to the prior year period, due primarily to increases in personnel expenses due to increased headcount, including related to our acquisition of Zynga.
Depreciation and Amortization
Depreciation and amortization expenses increased by $13.8 for the three months ended September 30, 2022 as compared to the prior year period, due primarily to acquired intangible assets and depreciation expense related to Zynga.
Interest and other, net
Interest and other, net was expense of $50.5 for the three months ended September 30, 2022, as compared to $0.6 for the prior year period. The increase was due primarily to interest expense related to our Senior Notes, Term Loan, 2022 Credit Agreement, and Bridge Loan commitment, including the amortization of related deferred costs, in connection with our acquisition of Zynga (refer to Note 9 - Debt and Note 14 - Acquisitions) and foreign currency losses.
Gain (loss) on fair value adjustments, net
Gain (loss) on fair value adjustments, net was a gain of $1.9 for the three months ended September 30, 2022 as compared to $0.4 for the prior year period. The change was due primarily to changes in fair value based on the observable price changes of our long-term investments.
Benefit from Income Taxes
The benefit from income taxes for the three months ended September 30, 2022 is based on our projected annual effective tax rate for fiscal year 2023, adjusted for specific items that are required to be recognized in the period in which they are incurred. The benefit from income taxes was $44.1 for the three months ended September 30, 2022 as compared to the provision for income taxes of $9.7 for the prior year period.
When compared to the statutory rate of 21.0%, the effective tax rate of 14.6% for the three months ended September 30, 2022 was due primarily to tax benefits of $8.5 from tax credits, tax benefits of $3.4 from employee stock-based compensation, and tax expense of $12.8 related to geographic mix of earnings.
In the prior year period, when compared to our statutory rate of 21%, the effective tax rate of 48.4% for the three months ended September 30, 2021 was due primarily to a tax expense of $2.4 related to a nondeductible increase in fair value of the contingent consideration liability associated with the acquisition of Nordeus, tax expense of $5.4 from a shortfall on employee stock-based compensation offset by $2.6 from the geographic mix of earnings.
The change in the effective tax rate, when compared to the prior year period's effective tax rate, is due primarily to increased tax benefits from tax credits, increased tax benefits from employee stock-based compensation in the current period, and by the geographic mix of earnings.
The accounting for share-based compensation will increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return, which depends on the stock price at the time of the employee award vesting.
We anticipate that additional excess tax benefits or shortfalls from employee stock compensation, tax credits, and changes in our geographic mix of earnings could have a significant impact on our effective tax rate in the future. In addition, we are regularly examined by domestic and foreign taxing authorities. Examinations may result in tax assessments in excess of amounts claimed and the payment of additional taxes. We believe our tax positions comply with applicable tax law, and that we have adequately provided for reasonably foreseeable tax assessments. It is possible that settlement of audits or the expiration of the statute of limitations could have an impact on our effective tax rate in future periods.
The Tax Cuts and Jobs Act of 2017 (“TCJA”) requires taxpayers to capitalize and amortize research and development costs pursuant to Internal Revenue Code ("IRC") Section 174. Although Congress is considering legislation that would defer the capitalization and amortization requirement to later years, we have no assurance that the requirement will be repealed or otherwise modified. The requirement was effective for the Company beginning April 1, 2022. The actual impact of Section 174 capitalization and amortization on the income tax payable and deferred tax asset will depend on multiple factors, including the amount of research and development expenses we will incur and whether we conduct our research and development activities inside or outside the United States. If legislation is not passed to defer, repeal, or otherwise modify the capitalization and amortization requirement we expect our cash taxes payable and deferred tax assets to increase in the future.
On March 11, 2021, the American Rescue Plan Act of 2021 (the “ARPA”) was enacted. The ARPA, among other things, includes provisions to expand the IRC Section 162(m) disallowance for deduction of certain compensation paid by publicly held corporations. Effective for tax years starting after December 31, 2026 (April 1, 2027 for the Company), the ARPA expands the limitation to cover the next five most highly compensated employees. The ARPA did not have a material impact on our Consolidated Financial Statements for the three months ended September 30, 2022. We continue to evaluate the potential impact the ARPA may have on our operations and Consolidated Financial Statements in future periods.
In August 2022, President Biden signed into law the Inflation Reduction Act of 2022 (the “Inflation Reduction Act”), which includes a 15% book-income alternative minimum tax on corporations with average applicable financial statement income over $1 billion for any 3-year period ending with 2022 or later and a 1% excise tax on the fair market value of stock that is repurchased by publicly traded U.S. corporations or their specified affiliates. The alternative minimum tax and the excise tax are effective in taxable years beginning after December 31, 2022. We will continue to evaluate the potential impact of the Inflation Reduction Act may have on our operations and Consolidated Financial Statements in future periods.
Net (loss) income and (loss) earnings per share
For the three months ended September 30, 2022, net loss was $257.0, as compared to income of $10.2 in the prior year period. Diluted loss per share for the three months ended September 30, 2022 was $1.54, as compared to diluted earnings per share of $0.09 in the prior year period. Basic weighted average shares of 166.9 were 50.1 shares higher as compared to the prior year period diluted weighted average shares, due to stock issued as consideration for the Zynga Acquisition and for the conversion of Convertible Notes. See Note 10 - (Loss) Earnings Per Share to our Condensed Consolidated Financial Statements for additional information.
Six Months Ended September 30, 2022 Compared to September 30, 2021
| (millions of dollars) | 2022 | % | 2021 | % | Increase/ (decrease) | % Increase/ (decrease) | |||||||||||||||||||||||||||||
| Total net revenue | $ | 2,495.9 | 100.0 | % | $ | 1,671.5 | 100.0 | % | $ | 824.4 | 49.3 | % | |||||||||||||||||||||||
| Internal royalties | 217.7 | 8.7 | % | 305.0 | 18.2 | % | (87.3) | (28.6) | % | ||||||||||||||||||||||||||
| Software development costs and royalties (1) | 455.0 | 18.2 | % | 231.9 | 13.9 | % | 223.1 | 96.2 | % | ||||||||||||||||||||||||||
| Licenses | 155.6 | 6.2 | % | 136.5 | 8.2 | % | 19.1 | 14.0 | % | ||||||||||||||||||||||||||
| Product costs | 321.4 | 12.9 | % | 113.0 | 6.8 | % | 208.4 | 184.4 | % | ||||||||||||||||||||||||||
| Cost of revenue | 1,149.7 | 46.1 | % | 786.4 | 47.0 | % | 363.3 | 46.2 | % | ||||||||||||||||||||||||||
| Gross profit | $ | 1,346.2 | 53.9 | % | $ | 885.1 | 53.0 | % | $ | 461.1 | 52.1 | % |
(1) Includes $(25.4) and $22.4 of stock-based compensation expense in 2022 and 2021, respectively, in software development costs and royalties.
For the six months ended September 30, 2022, net revenue increased by $824.4 million as compared to the prior year period. The increase was primarily due to net revenue of $916.1 from Zynga, which we acquired in May 2022 (refer to Note 14- Acquisitions), including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Words With Friends, and Merge Dragons!, as well an increase in net revenue of $61.3 million from Tiny Tina's Wonderlands, which released in March 2022. These increases were partially offset by a decrease in net revenue of (i) $127.1 million from our Grand Theft Auto franchise and (ii) $63.3 million from our Borderlands franchise.
Net revenue from console games decreased by $39.4 million and accounted for 46.4% of our total net revenue for the six months ended September 30, 2022, as compared to 71.7% for the prior year period. The decrease was due to a decrease in net revenue from our Grand Theft Auto, Red Dead Redemption, and Borderlands franchises, partially offset by an increase in net revenue from Tiny Tina's Wonderlands, our WWE 2K franchise, and The Quarry. Net revenue from PC and other decreased by $38.5 million and accounted for 9.5% of our total net revenue for the six months ended September 30, 2022, as compared to 16.5% for the prior year period. The decrease was due to a decrease in net revenue from our Borderlands and Grand Theft Auto franchises, partially offset by an increase in net revenue from Tiny Tina's Wonderlands. Net revenue from mobile increased by $902.3 million and accounted for 44.1% of our total net revenue for six months ended September 30, 2022, as compared to 11.8% for the prior year period. The increase was primarily due to net revenue of $903.2 from our May 2022 acquisition of Zynga, including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Words With Friends, and Merge Dragons!, as well as an increase in net revenue from Top Eleven.
Net revenue from digital online channels increased by $837.1 million and accounted for 94.4% of our total net revenue for the six months ended September 30, 2022, as compared to 90.9% for the prior year period. The increase was primarily due to net revenue of $915.5 from our May 2022 acquisition of Zynga, including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Words With Friends, and Merge Dragons!, as well as an increase in net revenue from Tiny Tina's Wonderlands. These increases in net revenue from digital online channels were partially offset by a decrease in net revenue from our Grand Theft Auto and Borderlands franchises. Net revenue from physical retail and other channels decreased by $12.7 million and accounted for 5.6% of our total net revenue for the six months ended September 30, 2022, as compared to 9.1% for the prior year period. The decrease was due to a decrease in net revenue from our NBA 2K franchise, partially offset by an increase in net revenue from The Quarry.
Recurrent consumer spending is generated from ongoing consumer engagement and includes revenue from virtual currency, add-on content, in-game purchases, and in-game advertising. Net revenue from recurrent consumer spending increased by $791.5 million and accounted for 77.2% of net revenue for the six months ended September 30, 2022, as compared to 68.0% of net revenue for the prior year period. The increase was primarily due to net revenue of $902.4 from our May 2022 acquisition of Zynga, including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Words With Friends, and Merge Dragons!, as well as an increase in net revenue from Top Eleven. The increase in net revenue from recurrent consumer spending was partially offset by a decrease in net revenue from our Grand Theft Auto franchise. Net revenue from full game and other increased by $32.9 million and accounted for 22.8% of net revenue for the six months ended
September 30, 2022 as compared to 32.0% of net revenue for the prior year period. The increase was due to an increase in net revenue from The Quarry, Tiny Tina's Wonderlands, and our NBA 2K and WWE 2K franchises, partially offset by a decrease in net revenue from our Borderlands, Grand Theft Auto, and Red Dead Redemption franchises*.*
Gross profit as a percentage of net revenue for the six months ended September 30, 2022 was 53.9% as compared to 53.0% for the prior year period. The increase in gross profit as a percentage of net revenue was due to lower internal royalties due to the timing of when royalties are earned and (ii) lower capitalized software amortization due to impairments recognized in the prior year period, partially offset by (i) higher amortization related to intangible assets related to our Zynga acquisition and (ii) higher product costs for fees paid to platform partners due to an increase in Mobile revenues as a result of the Zynga acquisition.
Net revenue earned outside of the United States increased by $306.7 million and accounted for 38.9% of our total net revenue for the six months ended September 30, 2022, as compared to 39.7% in the prior year period. The increase in net revenue outside of the United States was primarily due to net revenue of $346.5 from our May 2022 acquisition of Zynga, including top contributors Empires & Puzzles, Rollic's hyper-casual portfolio, Toon Blast, Zynga Poker, and Merge Dragons!, as well as an increase in net revenue from Top Eleven, partially offset by a decrease in net revenue from our Grand Theft Auto and Borderlands franchises. Changes in foreign currency exchange rates decreased net revenue by $20.8 million and decreased gross profit by $8.8 million for the six months ended September 30, 2022 as compared to the prior year period.
Operating Expenses
| (millions of dollars) | 2022 | % of net revenue | 2021 | % of net revenue | Increase/ (decrease) | % Increase/ (decrease) | |||||||||||||||||||||||||||||
| Selling and marketing | $ | 716.4 | 28.7 | % | $ | 239.9 | 14.4 | % | $ | 476.5 | 198.6 | % | |||||||||||||||||||||||
| General and administrative | 451.7 | 18.1 | % | 232.2 | 13.9 | % | 219.5 | 94.5 | % | ||||||||||||||||||||||||||
| Research and development | 417.0 | 16.7 | % | 193.8 | 11.6 | % | 223.2 | 115.2 | % | ||||||||||||||||||||||||||
| Depreciation and amortization | 51.0 | 2.0 | % | 28.6 | 1.7 | % | 22.4 | 78.3 | % | ||||||||||||||||||||||||||
| Total operating expenses (1) | $ | 1,636.1 | 65.6 | % | $ | 694.5 | 41.5 | % | $ | 941.6 | 135.6 | % |
(1) Includes stock-based compensation expense, which was allocated as follows (in millions):
| 2022 | 2021 | ||||||||||
| Selling and marketing | 53.2 | $ | 15.2 | ||||||||
| General and administrative | 64.7 | 33.9 | |||||||||
| Research and development | 59.3 | 24.8 | |||||||||
Changes in foreign currency exchange rates decreased total operating expenses by $35.8 million for the six months ended September 30, 2022, as compared to the prior year period.
Selling and marketing
Selling and marketing expenses increased by $476.5 million for the six months ended September 30, 2022, as compared to the prior year period, due primarily to (i) marketing expense for titles from our Zynga acquisition, including Rollic's hyper-casual portfolio, Toon Blast, Merge Dragons!, Empires & Puzzles, and Toy Blast, (ii) higher amortization related to intangible assets related to our Zynga acquisition, and (iii) higher personnel expenses for additional headcount, including related to our acquisition of Zynga.
General and administrative
General and administrative expenses increased by $219.5 million for the six months ended September 30, 2022, as compared to the prior year period, due to increases in (i) professional fees related to our acquisition and integration of Zynga and (ii) personnel expenses for additional headcount, including our acquisition of Zynga.
General and administrative expenses for the six months ended September 30, 2022 and 2021 included occupancy expense (primarily rent, utilities and office expenses) of $29.5 million and $15.9 million, respectively, related to our development studios.
Research and development
Research and development expenses increased by $223.2 million for the six months ended September 30, 2022, as compared to the prior year period, due primarily to increases in personnel expenses due to increased headcount, including related to our acquisition of Zynga.
Depreciation and Amortization
Depreciation and amortization expenses for the six months ended September 30, 2022 increased by $22.4 million, as compared to the prior year period, due primarily to acquired intangible assets and depreciation expense related to Zynga.
Interest and other, net
Interest and other, net was expense of $79.8 million for the six months ended September 30, 2022, as compared to $1.6 million for the prior year period. The increase was due primarily to interest expense related to our Senior Notes, Term Loan, 2022 Credit Agreement, and Bridge Loan commitment, including the amortization of related deferred costs, in connection with our acquisition of Zynga (refer to Note 9 - Debt and Note 14 - Acquisitions) and foreign currency losses.
Gain (loss) on fair value adjustments, net
Gain (loss) on fair value adjustments, net was a loss of $37.7 for the six months ended September 30, 2022 as compared to a gain of $2.4 for the prior year period. The change was due primarily to a loss relating to our Convertible Notes, partially offset by a gain related to our Capped Calls, both as result of our Zynga Acquisition (refer to Note 9 - Debt and Note 14 - Acquisitions).
Benefit from Income Taxes
The benefit from income taxes for the six months ended September 30, 2022 is based on our projected annual effective tax rate for fiscal year 2023, adjusted for specific items that are required to be recognized in the period in which they are incurred. The benefit for income taxes was $46.4 for the six months ended September 30, 2022 as compared to a provision for income taxes of $28.9 for the prior year period.
When compared to the statutory rate of 21.0%, the effective tax rate of 11.4% for the six months ended September 30, 2022 was due primarily to a tax expense of $22.6 related to the geographic mix of earnings, nondeductible expense of $8.2 related to the settlement of convertible debt, tax expense of $6.0 from employee stock-based compensation, offset by benefits of $30.9 from tax credits.
In the prior year period, when compared to the statutory rate of 21.0%, the effective tax rate of 15.1% for the six months ended September 30, 2021 was due primarily to a tax benefit of $11.4 as a result of tax credits anticipated to be utilized and excess tax benefits of $4.0 from employee stock-based compensation offset by a tax expense of $2.4 related to a nondeductible increase in fair value of the contingent consideration liability associated with the acquisition of Nordeus and by the geographic mix of earnings.
The change in the effective tax rate, when compared to the prior year period's effective tax rate, is due primarily to increased tax benefits from tax credits in the current period, increased expense from employee stock-based compensation, nondeductible expense related to the settlement of convertible debt and by the geographic mix of earnings.
The accounting for share-based compensation will increase or decrease our effective tax rate based on the difference between our share-based compensation expense and the deductions taken on our tax return, which depends on the stock price at the time of the employee award vesting. Since we recognize excess tax benefits on a discrete basis, we anticipate that our effective tax rate will vary from quarter to quarter depending on our stock price in each period.
We anticipate that additional excess tax benefits or shortfalls from employee stock compensation, tax credits, and changes in our geographic mix of earnings could have a significant impact on our effective tax rate in the future. In addition, we are regularly examined by domestic and foreign taxing authorities. Examinations may result in tax assessments in excess of amounts claimed and the payment of additional taxes. We believe our tax positions comply with applicable tax law, and that we have adequately provided for reasonably foreseeable tax assessments. It is possible that settlement of audits and/or the expiration of the statute of limitations could have an impact on our effective tax rate in future periods.
The Tax Cuts and Jobs Act of 2017 (“TCJA”) requires taxpayers to capitalize and amortize research and development costs pursuant to Internal Revenue Code ("IRC") Section 174. Although Congress is considering legislation that would defer the capitalization and amortization requirement to later years, we have no assurance that the requirement will be repealed or otherwise modified. The requirement was effective for the Company beginning April 1, 2022. For the six months ended September 30, 2022, we recorded an estimated increase to income tax payable and deferred tax assets of approximately $70.0 due to Section 174 capitalization. The actual impact of Section 174 capitalization and amortization on the income tax payable and deferred tax asset will depend on multiple factors, including the amount of research and development expenses we will incur and whether we conduct our research and development activities inside or outside the United States. If legislation is not
passed to defer, repeal, or otherwise modify the capitalization and amortization requirement we expect our cash taxes payable and deferred tax assets to increase in the future.
On March 11, 2021, the American Rescue Plan Act of 2021 (the “ARPA”) was enacted. The ARPA, among other things, includes provisions to expand the IRC Section 162(m) disallowance for deduction of certain compensation paid by publicly held corporations. Effective for tax years starting after December 31, 2026 (April 1, 2027 for the Company), the ARPA expands the limitation to cover the next five most highly compensated employees. The ARPA did not have a material impact on our Consolidated Financial Statements for the six months ended September 30, 2022. We continue to evaluate the potential impact the ARPA may have on our operations and Consolidated Financial Statements in future periods.
In August 2022, President Biden signed into law the Inflation Reduction Act of 2022 (the “Inflation Reduction Act”), which includes a 15% book-income alternative minimum tax on corporations with average applicable financial statement income over $1 billion for any 3-year period ending with 2022 or later and a 1% excise tax on the fair market value of stock that is repurchased by publicly traded U.S. corporations or their specified affiliates. The alternative minimum tax and the excise tax are effective in taxable years beginning after December 31, 2022. We will continue to evaluate the potential impact of the Inflation Reduction Act may have on our operations and Consolidated Financial Statements in future periods.
Net (loss) income and (loss) earnings per share
For the six months ended September 30, 2022, net loss was $361.0 million, as compared to income of $162.5 million in the prior year period. For the six months ended September 30, 2022, diluted loss per share was $2.38 as compared to diluted earnings per share of $1.39 in the prior year period. Basic weighted average shares of 151.8 million were 34.9 million shares higher as compared to the prior year period, due to stock issued as consideration for the Zynga Acquisition and for the conversion of Convertible Notes. See Note 10 - (Loss) Earnings Per Share to our Condensed Consolidated Financial Statements for additional information regarding earnings per share.
Liquidity and Capital Resources
Our primary cash requirements are to fund (i) the development, manufacturing, and marketing of our published products, (ii) working capital, (iii) capital expenditures, (iv) debt and interest payments, (v) acquisitions, and (vi) tax payments. We expect to rely on cash and cash equivalents as well as on short-term investments, funds provided by our operating activities, and our 2022 Credit Agreement to satisfy our working capital needs. Refer to Note 9 - Debt for additional discussion of our outstanding debt obligations.
Short-term Investments
As of September 30, 2022, we had $348.0 of short-term investments, which are highly liquid in nature and represent an investment of cash that is available for current operations. From time to time, we may purchase additional short-term investments depending on future market conditions and liquidity needs. As of September 30, 2022, based on the composition of our investment portfolio and actions taken in recent months by central banks around the world, including the U.S. Federal Reserve, in response to rising inflation and related adverse economic conditions, we anticipate our investment yields may increase, which could increase our future interest income. Such impact is not expected to be material to our liquidity.
Senior Notes
On April 14, 2022, we completed our offering and sale of $2,700.0 aggregate principal amount of our senior notes, consisting of $1,000.0 principal amount of our 3.300% Senior Notes due 2024 (the “2024 Notes”), $600.0 principal amount of our 3.550% Senior Notes due 2025 (the “2025 Notes”), $600.0 principal amount of our 3.700% Senior Notes due 2027 (the “2027 Notes”), and $500.0 principal amount of our 4.000% Senior Notes due 2032 (the “2032 Notes” and, together with the 2024 Notes, the 2025 Notes and the 2027 Notes, the “Senior Notes”).The Senior Notes were issued under an indenture between the Company and The Bank of New York Mellon, as trustee.
The Senior Notes are the Company’s senior unsecured obligations and rank equally with all of our other existing and future unsubordinated obligations. The 2024 Notes mature on March 28, 2024 and bear interest at an annual rate of 3.300%. The 2025 Notes mature on April 14, 2025 and bear interest at an annual rate of 3.550%. The 2027 Notes mature on April 14, 2027 and bear interest at an annual rate of 3.700%. The 2032 Notes mature on April 14, 2032 and bear interest at an annual rate of 4.000%. We will pay interest on the 2024 Notes semi-annually on March 28 and September 28 of each year, commencing September 28, 2022. During the three months ended September 30, 2022, we made interest payments of $15.0. We will pay interest on each of the 2025 Notes, 2027 Notes, and 2032 Notes semi-annually on April 14 and October 14 of each year, commencing October 14, 2022. The proceeds were used to finance our acquisition of Zynga.
Credit Agreement
On May 23, 2022, we entered into a new unsecured Credit Agreement (the "2022 Credit Agreement"), which replaced in its entirety the Company's prior Credit Agreement, dated as of February 8, 2019, which was paid off in full and terminated. The 2022 Credit Agreement provides for an unsecured five-year revolving credit facility with commitments of $500.0, including sublimits for (i) the issuance of letters of credit in an aggregate face amount of up to $100.0 and (ii) borrowings and letters of credit denominated in Pounds Sterling, Euros, and Canadian Dollars in an aggregate principal amount of up to $100.0. In addition, the 2022 Credit Agreement contains uncommitted incremental capacity permitting the incurrence of up to an additional amount not to exceed the greater of $250.0 and 35.0% of the Company's Consolidated Adjusted EBITDA (as defined in the 2022 Credit Agreement).
Loans under the 2022 Credit Agreement will bear interest at a rate of (a) 0.000% to 0.625% above an alternate base rate (6.25% at September 30, 2022) or (b) 1.000% to 1.625% above Secured Overnight Financing Rate ("SOFR"), approximately 3.04% at September 30, 2022, which rates are determined by the Company's credit rating.
On June 22, 2022, we drew down $200.0 at approximately 3.28% from our facility under the 2022 Credit Agreement. The proceeds were used to finance a portion of the repurchase of the Convertible Notes. After giving effect to this borrowing, we had approximately $299.5 available for additional borrowings as of September 30, 2022. On September 22, 2022, we repriced our outstanding borrowing at approximately 4.84%.
Term Loan
On June 22, 2022, we entered into an unsecured 364-Day Term Loan Credit Agreement ("Term Loan"). The Term Loan provides for an unsecured 364-day term loan credit facility in the aggregate principal amount of $350.0 and matures on June 21, 2023, and will bear interest at our election at a margin of (a) 0.000% to 0.375% above an alternate base rate (defined on the basis of prime rate) or (b) 0.750% to 1.375% above SOFR, which margins are determined by reference to our credit rating.
We fully drew down on the Term Loan on June 22, 2022 at approximately 3.60%. The proceeds were used to finance a portion of the repurchase of the Convertible Notes (refer to Note 9 - Debt).
Financial Condition
We are subject to credit risks, particularly if any of our receivables represent a limited number of customers or are concentrated in foreign markets. If we are unable to collect our accounts receivable as they become due, it could adversely affect our liquidity and working capital position.
Generally, we have been able to collect our accounts receivable in the ordinary course of business. We do not hold any collateral to secure payment from customers. We have trade credit insurance on the majority of our customers to mitigate accounts receivable risk.
A majority of our trade receivables are derived from sales to major retailers, including digital storefronts and platform partners, and distributors. Our five largest customers accounted for 79.9% and 79.8% of net revenue during the six months ended September 30, 2022 and 2021, respectively. As of September 30, 2022 and March 31, 2022, five customers accounted for 68.9% and 72.8% of our gross accounts receivable, respectively. Customers that individually accounted for more than 10% of
our gross accounts receivable balance comprised 51.0% and 63.8% of such balances at September 30, 2022 and March 31, 2022, respectively. We had two customers who accounted for 32.4% and 18.6% of our gross accounts receivable as of September 30, 2022, respectively, and two customers who accounted for 43.5% and 20.3% of our gross accounts receivable as of March 31, 2022, respectively. Based upon performing ongoing credit evaluations, maintaining trade credit insurance on a majority of our customers and our past collection experience, we believe that the receivable balances from these largest customers do not represent a significant credit risk, although we actively monitor each customer's credit worthiness and economic conditions that may affect our customers' business and access to capital. We are monitoring the current global economic conditions, including credit markets and other factors as it relates to our customers in order to manage the risk of uncollectible accounts receivable, including as a result of the COVID-19 pandemic.
We believe our current cash and cash equivalents, short-term investments, and projected cash flows from operations, along with availability under our 2022 Credit Agreement, will provide us with sufficient liquidity to satisfy our cash requirements for working capital, capital expenditures, and commitments on both a short-term and long-term basis. Our liquidity and capital resources were not materially affected by the COVID-19 pandemic and related volatility and slowdown in the global financial markets to date. For further discussion regarding the potential future impacts of the COVID-19 pandemic and related economic conditions on our business, refer to Item 1A, Risk Factors of our Annual Report on Form 10-K for the fiscal year ended March 31, 2022.
As of September 30, 2022, the amount of cash and cash equivalents held outside of the U.S. by our foreign subsidiaries was $772.7. 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.
Our Board of Directors has authorized the repurchase of up to 21.7 shares of our common stock. Under this program, we may purchase shares from time to time through a variety of methods, including in the open market or through privately negotiated transactions, in accordance with applicable securities laws. Repurchases are subject to the availability of stock, prevailing market conditions, the trading price of the stock, our financial performance, and other conditions. The program does not require us to repurchase shares and may be suspended or discontinued at any time for any reason.
During the three months ended September 30, 2022, we did not repurchase shares of our common stock in the open market, as part of the program. We have repurchased a total of 11.7 shares of our common stock under the program, and as of September 30, 2022, 10.0 shares of our common stock remained available for repurchase under the share repurchase program.
Our changes in cash flows were as follows:
| Six Months Ended September 30, | |||||||||||
| (millions of dollars) | 2022 | 2021 | |||||||||
| Net cash provided by operating activities | $ | 155.4 | $ | 283.7 | |||||||
| Net cash used in investing activities | (2,790.6) | (384.1) | |||||||||
| Net cash provided by (used in) financing activities | 2,133.5 | (244.4) | |||||||||
| Effects of foreign currency exchange rates on cash, cash equivalents, and restricted cash and cash equivalents | (36.2) | (0.7) | |||||||||
| Net change in cash, cash equivalents, and restricted cash and cash equivalents | $ | (537.9) | $ | (345.5) |
At September 30, 2022, we had $1,657.4 of cash and cash equivalents and restricted cash and cash equivalents, compared to $2,195.3 at March 31, 2022. The decrease was due to Net cash used in investing activities primarily related to our Zynga Acquisition (refer to Note 14 - Acquisitions). This net decrease was partially offset by Net cash provided by financing activities (refer to Note 9 - Debt), primarily related to proceeds from the issuance of Senior Notes and draw-downs on our 2022 Credit Agreement and Term Loan, which were partially offset by payments for Convertible Notes that were part of our Zynga Acquisition. To a lesser extent, the net decrease was also partially offset by Net cash provided by operating activities from sales of our products, partially offset by the timing of payments, including for transaction related costs related to our Zynga Acquisition.
Commitments
Refer to Note 12 - Commitments and Contingencies for disclosures regarding our commitments.
Capital Expenditures
In fiscal year 2023, we anticipate capital expenditures to be approximately $150.0. During the six months ended September 30, 2022, capital expenditures were $99.4.
International Operations
Net revenue earned outside of the United States is principally generated by our operations in Europe, Asia, Australia, Canada, and Latin America. For the three months ended September 30, 2022 and 2021, 39.5% and 40.0%, respectively, of our net revenue was earned outside of the United States. We are subject to risks inherent in foreign trade, including increased credit risks, tariffs and duties, fluctuations in foreign currency exchange rates, shipping delays, and international political, regulatory and economic developments, all of which can have a significant effect on our operating results.
Fluctuations in Quarterly Operating Results and Seasonality
We have experienced fluctuations in quarterly and annual operating results as a result of the timing of the introduction of new titles; variations in sales of titles developed for particular platforms; market acceptance of our titles; development and promotional expenses relating to the introduction of new titles; sequels or enhancements of existing titles; projected and actual changes in platforms; the timing and success of title introductions by our competitors; product returns; changes in pricing policies by us and our competitors; the accuracy of retailers' forecasts of consumer demand; the size and timing of acquisitions; the timing of orders from major customers; and order cancellations and delays in product shipment. Sales of our full game products are also seasonal, with peak demand typically occurring in the fourth calendar quarter during the holiday season. For certain of our software products with multiple performance obligations, we defer the recognition of our net revenue over an estimated service period, which generally ranges from six to fifteen months. As a result, the quarter in which we generate the highest net bookings may be different from the quarter in which we recognize the highest amount of net revenue. Quarterly comparisons of operating results are not necessarily indicative of future operating results.
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