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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                             to                              .
Commission file number 001-34003
TAKE-TWO INTERACTIVE SOFTWARE, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
 
51-0350842
(I.R.S. Employer
Identification No.)
622 Broadway
New York, New York
 (Address of principal executive offices)
 
10012
(Zip Code)
Registrant's Telephone Number, Including Area Code: (646) 536-2842

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ý
Accelerated filer o
Non-accelerated filer o
 (Do not check if a
smaller reporting company)
Smaller reporting company o
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý

As of October 31, 2017, there were 114,053,077 shares of the Registrant's Common Stock outstanding, net of treasury stock.

 




Table of Contents

INDEX

 
 
 
 
 
 


(All other items in this report are inapplicable)


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Table of Contents

PART I. FINANCIAL INFORMATION
Item 1.    Financial Statements (Unaudited)
TAKE-TWO INTERACTIVE SOFTWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
 
September 30, 2017
 
March 31, 2017
 
(Unaudited)
 
 
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
749,626

 
$
943,396

Short-term investments
513,516

 
448,932

Restricted cash
469,101

 
337,818

Accounts receivable, net of allowances of $50,109 and $66,483 at September 30, 2017 and March 31, 2017, respectively
429,019

 
219,558

Inventory
36,431

 
16,323

Software development costs and licenses
41,983

 
41,721

Deferred cost of goods sold
115,135

 
127,901

Prepaid expenses and other
100,704

 
59,593

Total current assets
2,455,515

 
2,195,242

Fixed assets, net
86,689

 
67,300

Software development costs and licenses, net of current portion
595,076

 
381,910

Deferred cost of goods sold, net of current portion
10,820

 

Goodwill
381,359

 
359,115

Other intangibles, net
116,527

 
110,262

Other assets
50,394

 
35,325

Total assets
$
3,696,380

 
$
3,149,154

LIABILITIES AND STOCKHOLDERS' EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
75,810

 
$
31,892

Accrued expenses and other current liabilities
952,568

 
750,875

Deferred revenue
822,126

 
903,125

Total current liabilities
1,850,504

 
1,685,892

Long-term debt
52,369

 
251,929

Non-current deferred revenue
167,070

 
10,406

Other long-term liabilities
153,991

 
197,199

Total liabilities
$
2,223,934

 
$
2,145,426

Commitments and Contingencies (See Note 12)


 


Stockholders' equity:
 

 
 

Preferred stock, $.01 par value, 5,000 shares authorized; no shares issued and outstanding at September 30, 2017 and March 31, 2017

 

Common stock, $.01 par value, 200,000 shares authorized; 130,723 and 119,813 shares issued and 113,531 and 102,621 outstanding at September 30, 2017 and March 31, 2017, respectively
1,307

 
1,198

Additional paid-in capital
1,845,450

 
1,452,754

Treasury stock, at cost; 17,192 common shares at September 30, 2017 and March 31, 2017
(303,388
)
 
(303,388
)
Accumulated deficit
(42,451
)
 
(99,694
)
Accumulated other comprehensive loss
(28,472
)
 
(47,142
)
Total stockholders' equity
1,472,446

 
1,003,728

Total liabilities and stockholders' equity
$
3,696,380

 
$
3,149,154

   
See accompanying Notes.

2


Table of Contents

TAKE-TWO INTERACTIVE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share amounts)
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net revenue
$
443,562

 
$
420,167

 
$
861,778

 
$
731,719

Cost of goods sold
246,548

 
205,605

 
441,117

 
396,985

Gross profit
197,014

 
214,562

 
420,661

 
334,734

Selling and marketing
76,914

 
80,187

 
129,128

 
151,321

General and administrative
60,824

 
49,685

 
121,427

 
96,428

Research and development
49,999

 
30,005

 
92,268

 
63,905

Depreciation and amortization
18,883

 
7,491

 
26,626

 
14,869

Business reorganization
1,713

 

 
12,312

 

Total operating expenses
208,333

 
167,368

 
381,761

 
326,523

Income (loss) from operations
(11,319
)
 
47,194

 
38,900

 
8,211

Interest and other, net
(2,969
)
 
(7,078
)
 
(5,777
)
 
(11,584
)
Gain on long-term investments, net

 

 

 
1,350

Income (loss) before income taxes
(14,288
)
 
40,116

 
33,123

 
(2,023
)
(Benefit from) provision for income taxes
(11,552
)
 
3,684

 
(24,417
)
 
112

Net income (loss)
$
(2,736
)
 
$
36,432

 
$
57,540

 
$
(2,135
)
Earnings (loss) per share:
 

 
 

 
 

 
 

Basic earnings (loss) per share
$
(0.03
)
 
$
0.42

 
$
0.54

 
$
(0.03
)
Diluted earnings (loss) per share
$
(0.03
)
 
$
0.39

 
$
0.53

 
$
(0.03
)
 See accompanying Notes.

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Table of Contents

TAKE-TWO INTERACTIVE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
(in thousands)
 
Three Months Ended
September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)
$
(2,736
)
 
$
36,432

 
$
57,540

 
$
(2,135
)
Other comprehensive income (loss):
 

 
 

 
 

 
 

Foreign currency translation adjustment
14,297

 
(1,394
)
 
23,776

 
(5,027
)
Cash flow hedges:
 
 
 
 
 
 
 
Change in fair value of effective cash flow hedge
(5,217
)
 

 
(5,217
)
 

Available-for-sale securities:
 

 
 

 
 

 
 

Unrealized gain (loss), net on available-for-sale securities, net of taxes
27

 
(163
)
 
111

 
43

Reclassification to earnings for realized (gains) losses, net on available for sale securities, net of taxes

 
5

 

 
9

Change in fair value of available for sale securities
27

 
(158
)
 
111

 
52

Other comprehensive income (loss)
9,107

 
(1,552
)
 
18,670

 
(4,975
)
Comprehensive income (loss)
$
6,371

 
$
34,880

 
$
76,210

 
$
(7,110
)
   
See accompanying Notes.

4



TAKE-TWO INTERACTIVE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
 
Six Months Ended September 30,
 
2017
 
2016
Operating activities:
 

 
 

Net income (loss)
$
57,540

 
$
(2,135
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 

 
 

Amortization and impairment of software development costs and licenses
38,862

 
63,459

Depreciation
15,369

 
14,869

Amortization and impairment of intellectual property
17,286

 

Impairment of in-process research and development
11,257

 

Stock-based compensation
83,083

 
33,333

Amortization of discount on Convertible Notes
13,915

 
12,981

Gain on conversions of Convertible Notes
(4,141
)
 

Amortization of debt issuance costs
482

 
779

Other, net
1,194

 
(2,912
)
Changes in assets and liabilities:


 
 

Restricted cash
(131,283
)
 
(106,940
)
Accounts receivable
(209,198
)
 
(212,032
)
Inventory
(18,721
)
 
(62,555
)
Software development costs and licenses
(146,009
)
 
(148,512
)
Prepaid expenses and other assets
(45,089
)
 
(8,560
)
Deferred revenue
65,671

 
80,913

Deferred cost of goods sold
4,379

 
(17,287
)
Accounts payable, accrued expenses and other liabilities
246,472

 
303,790

Net cash provided by (used in) operating activities
1,069

 
(50,809
)
Investing activities:
 

 
 

Change in bank time deposits
(40,000
)
 
66,841

Proceeds from available-for-sale securities
111,480

 
72,387

Purchases of available-for-sale securities
(134,273
)
 
(74,552
)
Purchases of fixed assets
(32,717
)
 
(8,283
)
Asset acquisition
(25,965
)
 

Proceeds from sale of long-term investment

 
1,350

Purchase of long-term investments

 
(1,885
)
Net cash (used in) provided by investing activities
(121,475
)
 
55,858

Financing activities:
 

 
 

Excess tax benefit from stock-based compensation

 
1,143

Tax payment related to net share settlements on restricted stock awards
(86,125
)
 
(30,621
)
Net cash used in financing activities
(86,125
)
 
(29,478
)
Effects of foreign currency exchange rates on cash and cash equivalents
12,761

 
(4,310
)
Net change in cash and cash equivalents
(193,770
)
 
(28,739
)
Cash and cash equivalents, beginning of year
943,396

 
798,742

Cash and cash equivalents, end of period
$
749,626

 
$
770,003

   
See accompanying Notes.

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Table of Contents

TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Dollars in thousands, except share and per share amounts)
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Take-Two Interactive Software, Inc. (the "Company," "we," "us," or similar pronouns) was incorporated in the state of Delaware in 1993. We are a leading developer, publisher and marketer of interactive entertainment for consumers around the globe. We develop and publish products principally through our two wholly-owned labels Rockstar Games and 2K. Our products are designed for console systems and personal computers, including smart phones and tablets, and are delivered through physical retail, digital download, online platforms and cloud streaming services.
Basis of Presentation
The accompanying Condensed Consolidated Financial Statements are unaudited and include the accounts of the Company and its wholly-owned subsidiaries and, in the opinion of management, reflect all normal and recurring adjustments necessary for the fair presentation of our financial position, results of operations and cash flows. Interim results may not be indicative of the results that may be expected for the full fiscal year. All inter-company accounts and transactions have been eliminated in consolidation. The preparation of these Condensed Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in these Condensed Consolidated Financial Statements and accompanying notes. As permitted under generally accepted accounting principles in the United States, interim accounting for certain expenses, including income taxes, are based on full year assumptions when appropriate. Actual results could differ materially from those estimates.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission, although we believe that the disclosures are adequate to make the information presented not misleading. These Condensed Consolidated Financial Statements and accompanying notes should be read in conjunction with 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, 2017.
Certain immaterial reclassifications have been made to prior period amounts to conform to the current period presentation.
Revenue Recognition
As part of our on-going assessment of estimated service periods, in June 2017, we extended Grand Theft Auto V's estimated service period from 41 through 50 months, or through December 2018. We expect this change in estimated service period to have a material impact on our Consolidated Financial Statements for fiscal 2018. The impact of this change is shown in the table below.

 
Three Months Ended September 30,
Six Months Ended September 30,
 
2017
 
2017
Change in net revenue
$
(78,761
)
 
$
(104,445
)
Change in income from operations
(72,633
)
 
(96,364
)
Change in net income
(66,245
)
 
(88,154
)
Change in earnings per share, basic
$
(0.61
)
 
$
(0.82
)
Change in earnings per share, diluted
$
(0.59
)
 
$
(0.81
)

Impairment of In-process Research & Development ("IPR&D")

During the three months ended September 30, 2017, as a result of our decision not to proceed with further development of certain IPR&D from the Social Point, S.L. ("Social Point") acquisition, we recognized an impairment charge of $11,257 in Depreciation and amortization expense in our Condensed Consolidated Statements of Operations.

6



Recently Adopted Accounting Pronouncements
Accounting for Stock Compensation
In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-09, Compensation—Stock Compensation. This new guidance identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows.
We adopted this update effective April 1, 2017. Upon adoption, using the modified retrospective transition method, we recognized previously unrecognized excess tax benefits as a deferred tax asset, which was fully offset by a valuation allowance, resulting in no net impact to retained earnings. Without the valuation allowance, our deferred tax asset would have increased by $24,594. We elected to apply the change in presentation of excess tax benefits as an operating activity in the statement of cash flows prospectively and thus no prior periods were adjusted. We also elected to account for forfeitures as they occur using the modified retrospective transition method, which resulted in a cumulative effect adjustment of $323 to retained earnings (an increase in the accumulated deficit). The other aspects of the new guidance did not have a material effect on the Company’s consolidated financial statements.
Accounting for Acquisitions or Disposals
In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business, with the objective of providing additional guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this update provide new guidance to determine when an integrated set of assets and activities (collectively referred to as a “set”) is not a business. The new guidance requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. The new guidance is expected to reduce the number of transactions that need to be further evaluated. The new standard, as amended, will be effective prospectively for interim and annual reporting periods beginning on January 1, 2018 (April 1, 2018 for the Company), with early adoption permitted. We adopted this update as of April 1, 2017.
Recently Issued Accounting Pronouncements
Accounting for Goodwill
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350). This ASU eliminates Step 2 from the goodwill impairment test. Under the new guidance, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. Additionally, this ASU eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. The amendments in this ASU are effective for fiscal years beginning after December 15, 2019 (April 1, 2020 for the Company), including interim periods within those fiscal years, and is applied on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. While we are currently evaluating the impact of the adoption of this ASU, we do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements.
Accounting for Restricted Cash
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. This ASU amends the presentation of restricted cash within the statement of cash flows. The new guidance requires that changes in restricted cash and cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts on the statement of cash flows. This standard will be effective for fiscal years beginning after December 15, 2017 (April 1, 2018 for the Company), including interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of the adoption of this ASU.
Accounting for Leases
In February 2016, the FASB issued ASU 2016-02, Leases. This new guidance requires lessees to recognize a right-of-use asset and a lease liability for virtually all leases (other than leases that meet the definition of a short-term lease). The liability will be equal to the present value of lease payments. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Operating leases will result in straight-line expense (similar to current operating leases) while finance leases will result in a front-loaded expense pattern (similar to current capital leases). Classification will be based on criteria that are largely similar to those applied in current lease accounting. This update is effective for annual periods, and interim periods within

7



those years, beginning after December 15, 2018 (April 1, 2019 for the Company). This new guidance must be adopted using a modified retrospective approach whereby lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. Early adoption is permitted. We are currently evaluating the impact of adopting this update on our Consolidated Financial Statements, which will consist primarily of a balance sheet gross up of our operating leases, mostly for office space.
Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). Under the new standard, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB recently issued several amendments to the standard, including clarifications on disclosure of prior-period performance obligations and remaining performance obligations.

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method).

The new standard is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2017 (April 1, 2018 for the Company), with early adoption permitted for annual reporting periods beginning after December 15, 2016 (April 1, 2017 for the Company). The Company will adopt the new standard effective April 1, 2018 using the cumulative catch-up transition method.

We anticipate this standard will have a material impact on our Consolidated Financial Statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for on-line enabled games that benefit from meaningful post-contract customer support ("PCS") such as unspecified content updates for which we do not have vendor-specific objective evidence of fair value ("VSOE").

Under the current accounting standards, for titles that do not have VSOE, we recognize the entire sales price ratably over the title's estimated service period. The VSOE requirement will be eliminated under the new standard. Accordingly, we may be required to recognize as revenue a portion of the sales price upon delivery of the software, as compared to the current requirement of recognizing the entire sales price ratably over an estimated offering period.

It is possible that our evaluation of the expected impact of the new standard on certain transactions could change if there are additional interpretations of the new revenue guidance that are different from our preliminary conclusions.
2. MANAGEMENT AGREEMENT
In May 2011, we entered into an amended management services agreement, (the "2011 Management Agreement") with ZelnickMedia Corporation ("ZelnickMedia") pursuant to which ZelnickMedia provided us with certain management, consulting and executive level services. In March 2014, we entered into a new management agreement, (the "2014 Management Agreement"), with ZelnickMedia pursuant to which ZelnickMedia continues to provide financial and management consulting services to the Company through March 31, 2019. The 2014 Management Agreement became effective April 1, 2014 and supersedes and replaces the 2011 Management Agreement, except as otherwise contemplated by the 2014 Management Agreement. As part of the 2014 Management Agreement, Strauss Zelnick, the President of ZelnickMedia, continues to serve as Executive Chairman and Chief Executive Officer, and Karl Slatoff, a partner of ZelnickMedia, continues to serve as President of the Company. The 2014 Management Agreement provides for an annual management fee of $2,970 over the term of the agreement and a maximum annual bonus opportunity of $4,752 over the term of the agreement, based on the Company achieving certain performance thresholds. In consideration for ZelnickMedia's services, we recorded consulting expense (a component of general and administrative expenses) of $2,524 and $1,336 during the three months ended September 30, 2017 and 2016, respectively, and $3,861 and $2,673 during the six months ended September 30, 2017 and 2016, respectively. We recorded stock-based compensation expense for non-employee restricted stock units granted to ZelnickMedia, which is included in general and administrative expenses of $13,863 and $6,907 during the three months ended September 30, 2017 and 2016, respectively, and 19,877 and $10,796 during the six months ended September 30, 2017 and 2016, respectively.

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Table of Contents

In connection with the 2014 Management Agreement, we granted restricted stock units as follows:
 
Six Months Ended September 30,
 
2017
 
2016
Time-based
66,122

 
107,551

Market-based(1)
122,370

 
199,038

Performance-based(1)
 

 
 

New IP
20,396

 
33,174

Major IP
20,394

 
33,172

Total—Performance-based
40,790

 
66,346

Total Restricted Stock Units
229,282

 
372,935

_______________________________________________________________________________

(1)
Represents the maximum number of shares eligible to vest.
Time-based restricted stock units granted in 2017 will vest on April 4, 2019, and those granted in 2016 will vest on April 1, 2018, in each case provided that the 2014 Management Agreement has not been terminated prior to such vesting date.
Market-based restricted stock units granted in 2017 are eligible to vest on April 4, 2019, and those granted in 2016 are eligible to vest on April 1, 2018, in each case provided that the 2014 Management Agreement has not been terminated prior to such vesting date. Market-based restricted stock units are eligible to vest based on the Company's Total Shareholder Return (as defined in the relevant grant agreement) relative to the Total Shareholder Return (as defined in the relevant grant agreement) of the companies that constitute the NASDAQ Composite Index as of the grant date measured over a two-year period. To earn the target number of market-based restricted stock units (which represents 50% of the number of the market-based restricted stock units set forth in the table above), the Company must perform at the 50th percentile, with the maximum number of market-based restricted stock units earned if the Company performs at the 75th percentile. Each reporting period we re-measure the fair value of the unvested shares of market-based restricted stock units granted to ZelnickMedia.
Performance-based restricted stock units granted in 2017 are eligible to vest on April 4, 2019, and those granted in 2016 are eligible to vest on April 1, 2018, in each case provided that the 2014 Management Agreement has not been terminated prior to such vesting date. Performance-based restricted stock units, of which 50% are tied to "New IP" and 50% to "Major IP" (as defined in the relevant grant agreement), are eligible to vest based on the Company's achievement of certain performance metrics (as defined in the relevant grant agreement) of individual product releases of "New IP" or "Major IP" measured over a two-year period. The target number of performance-based restricted stock units that may be earned pursuant to these grants is equal to 50% of the grant amounts set forth in the above table (the numbers in the table represent the maximum number of performance-based restricted stock units that may be earned). Each reporting period we assess the performance metric and upon achievement of certain thresholds record an expense for the unvested portion of the shares of performance-based restricted stock units. Certain performance metrics, based on unit sales, have been achieved as of September 30, 2017 for the "Major IP" performance-based restricted stock units granted in 2017 and 2016.
The unvested portion of time-based, market-based and performance-based restricted stock units held by ZelnickMedia were 602,217 and 898,526 as of September 30, 2017 and March 31, 2017, respectively. In addition to the restricted stock units granted to ZelnickMedia, 478,839 restricted stock units vested and 46,752 restricted stock units were forfeited during the six months ended September 30, 2017.
3. FAIR VALUE MEASUREMENTS
The carrying amounts of our financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued expenses and other current liabilities, approximate fair value because of their short maturities.
We follow a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of "observable inputs" and minimize the use of "unobservable inputs." The three levels of inputs used to measure fair value are as follows:
Level 1—Quoted prices in active markets for identical assets or liabilities.

Level 2—Observable inputs other than quoted prices included in Level 1, such as quoted prices for markets that are not active or other inputs that are observable or can be corroborated by observable market data.

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Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
The table below segregates all assets and liabilities that are measured at fair value on a recurring basis (which is measured at least annually) into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date.
 
September 30, 2017
 
Quoted prices
in active
markets for
identical
assets
(level 1)
 
Significant
other
observable
inputs
(level 2)
 
Significant
unobservable
inputs
(level 3)
 
Balance Sheet Classification
Money market funds
$
408,621

 
$
408,621

 
$

 
$

 
Cash and cash equivalents
Bank-time deposits
36,889

 
36,889

 

 

 
Cash and cash equivalents
Commercial paper
6,156

 

 
6,156

 

 
Cash and cash equivalents
Corporate bonds
6,311

 

 
6,311

 

 
Cash and cash equivalents
Bank-time deposits
216,545

 
216,545

 

 

 
Short-term investments
Corporate bonds
277,559

 

 
277,559

 

 
Short-term investments
Commercial paper
14,774

 

 
14,774

 

 
Short-term investments
Mutual funds
4,638

 

 
4,638

 

 
Short-term investments
Foreign currency forward contracts
5

 

 
5

 

 
Prepaid expenses and other
Foreign currency forward contracts
(50
)
 

 
(50
)
 

 
Accrued expense and other current liabilities
Cross-currency swap
(5,781
)
 

 
(5,781
)
 

 
Accrued expense and other current liabilities
Private equity
890

 

 

 
890

 
Other assets
Contingent consideration
(135
)
 

 

 
(135
)
 
Other long-term liabilities
Total recurring fair value measurements, net
$
966,422

 
$
662,055

 
$
303,612

 
$
755

 
 
 
 
March 31, 2017
 
Quoted prices
in active
markets for
identical
assets
(level 1)
 
Significant
other
observable
inputs
(level 2)
 
Significant
unobservable
inputs
(level 3)
 
Balance Sheet Classification
Money market funds
$
646,386

 
$
646,386

 
$

 
$

 
Cash and cash equivalents
Bank-time deposits
46,605

 
46,605

 

 

 
Cash and cash equivalents
Commercial paper
38,268

 

 
38,268

 

 
Cash and cash equivalents
Corporate bonds
243,019

 

 
243,019

 

 
Short-term investments
Bank-time deposits
175,745

 
175,745

 

 

 
Short-term investments
Commercial paper
25,936

 

 
25,936

 

 
Short-term investments
Mutual funds
4,232

 

 
4,232

 

 
Short-term investments
Foreign currency forward contracts
2

 

 
2

 

 
Prepaid expenses and other
Foreign currency forward contracts
(352
)
 

 
(352
)
 

 
Accrued and other current liabilities
Private equity
570

 

 

 
570

 
Other assets
Contingent consideration
(6,465
)
 

 

 
(6,465
)
 
Other long-term liabilities
Total recurring fair value measurements, net
$
1,173,946

 
$
868,736

 
$
311,105

 
$
(5,895
)
 
 
The fair value of contingent consideration was estimated using a Monte-Carlo simulation model, which included significant unobservable Level 3 inputs, such as projected financial performance over the earn-out period along with estimates for market volatility and the discount rate applicable to potential cash payouts. During the three months ended September 30,

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Table of Contents

2017, we recognized a reduction to general and administrative expense of $7,012 for the decrease in fair value of the contingent consideration liability associated with the Social Point acquisition, which reduced the fair value of the contingent consideration liability to $135 after the impact of foreign exchange. The reduction resulted from the lower probability of Social Point achieving certain performance measures in the 12 and 24-month periods following the acquisition.
We did not have any transfers between Level 1 and Level 2 fair value measurements, nor did we have any transfers into or out of Level 3 during the six months ended September 30, 2017.
Debt
As of September 30, 2017, the estimated fair value of our 1.00% Convertible Notes due 2018 (the "1.00% Convertible Notes") was $257,627. The fair value was determined using Level 2 inputs, observable market data, for the 1.00% Convertible Notes and their embedded option feature. See Note 9 for additional information regarding our 1.00% Convertible Notes.
4. SHORT-TERM INVESTMENTS
Our short-term investments consisted of the following:
 
September 30, 2017
 
 
 
Gross
Unrealized
 
 
 
Cost or
Amortized Cost
 
Gains
 
Losses
 
Fair Value
Short-term investments
 

 
 

 
 

 
 

Bank time deposits
$
216,545

 
$

 
$

 
$
216,545

Available-for-sale securities:
 

 
 

 
 

 
 

Corporate bonds
277,598

 
112

 
(151
)
 
277,559

Commercial paper
14,774

 

 

 
14,774

Mutual funds
4,489

 
162

 
(13
)
 
4,638

Total short-term investments
$
513,406

 
$
274

 
$
(164
)
 
$
513,516

 
 
 
March 31, 2017
 
 
 
Gross
Unrealized
 
 
 
Cost or
Amortized Cost
 
Gains
 
Losses
 
Fair Value
Short-term investments
 

 
 

 
 

 
 

Bank time deposits
$
175,745

 
$

 
$

 
$
175,745

Available-for-sale securities:
 

 
 

 
 

 
 

Corporate bonds
243,140

 
98

 
(219
)
 
243,019

Commercial paper
25,938

 
5

 
(7
)
 
25,936

Mutual funds
4,118

 
123

 
(9
)
 
4,232

Total short-term investments
$
448,941

 
$
226

 
$
(235
)
 
$
448,932

We consider various factors in the review of investments with an unrealized loss, including the credit quality of the issuer, the duration that the fair value has been less than the adjusted cost basis, the severity of the impairment, the reason for the decline in value and our intent to sell and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. Based on our review, we did not consider these investments to be other-than-temporarily impaired as of September 30, 2017 or March 31, 2017.

11



The following table summarizes the contracted maturities of our short-term investments at September 30, 2017:
 
September 30, 2017
 
Amortized
Cost
 
Fair
Value
Short-term investments
 

 
 

Due in 1 year or less
$
363,960

 
$
364,085

Due in 1 - 2 years
149,446

 
149,431

Total short-term investments
$
513,406

 
$
513,516

5. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Our risk management strategy includes the use of derivative financial instruments to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange rates. We do not enter into derivative financial contracts for speculative or trading purposes. We recognize derivative instruments as either assets or liabilities on our Condensed Consolidated Balance Sheets, and we measure those instruments at fair value. We classify cash flows from derivative transactions as cash flows from operating activities in our Condensed Consolidated Statements of Cash Flows.
Foreign currency forward contracts
The following table shows the gross notional amounts of foreign currency forward contracts:
 
September 30, 2017
 
March 31, 2017
Forward contracts to sell foreign currencies
$
113,762

 
$
177,549

Forward contracts to purchase foreign currencies
3,319

 
9,170

For the three months ended September 30, 2017 and 2016, we recorded a loss of $6,102 and $225, respectively, and for the six months ended September 30, 2017 and 2016, we recorded a loss of $14,705 and a gain $573, respectively, related to foreign currency forward contracts in Interest and other, net in our Condensed Consolidated Statements of Operations. Our foreign currency exchange forward contracts are not designated as hedging instruments under hedge accounting and are used to reduce the impact of foreign currency on certain balance sheet exposures and certain revenue and expense. These instruments are generally short term in nature, with typical maturities of less than one year, and are subject to fluctuations in foreign exchange rates.
Cross-currency swaps
We entered into a cross-currency swap agreement during the three months ended September 30, 2017 related to an intercompany loan that has been designated and accounted for as a cash flow hedge of foreign currency exchange risk. The intercompany loan is related to the acquisition of Social Point. As of September 30, 2017, the notional amount of the cross-currency swap is $129 million. This cross-currency swap mitigates the exposure to fluctuations in the U.S. dollar-euro exchange rate related to the intercompany loan. The critical terms of the cross-currency swap agreement correspond to the intercompany loan and both mature at the same time in 2027; as such there was no ineffectiveness during the period.
Changes in the fair value of this cross-currency swap are recorded in Accumulated other comprehensive income (loss) and offset the change in value of interest and principal payment as a result of changes in foreign exchange rates. Resulting gains or losses from the cross-currency swap are reclassified from Accumulated other comprehensive income (loss) to earnings to completely offset foreign currency transaction gains and losses recognized on the intercompany loan. We recognize the difference between the U.S. dollar interest payments received from the swap counterparty and the U.S. dollar equivalent of the euro interest payments made to the swap counterparty in interest and other, net on our Condensed Consolidated Statement of Operations. There are no credit-risk related contingent features associated with these swaps.
6. INVENTORY
Inventory balances by category are as follows:
 
September 30, 2017
 
March 31, 2017
Finished products
$
27,647

 
$
15,530

Parts and supplies
8,784

 
793

Inventory
$
36,431

 
$
16,323


12



Estimated product returns included in inventory at September 30, 2017 and March 31, 2017 were $234 and $529, respectively.
7. SOFTWARE DEVELOPMENT COSTS AND LICENSES
Details of our capitalized software development costs and licenses are as follows:
 
September 30, 2017
 
March 31, 2017
 
Current
 
Non-current
 
Current
 
Non-current
Software development costs, internally developed
$
33,017

 
$
491,057

 
$
28,959

 
$
310,229

Software development costs, externally developed
2,614

 
103,499

 
5,455

 
71,407

Licenses
6,352

 
520

 
7,307

 
274

Software development costs and licenses
$
41,983

 
$
595,076

 
$
41,721

 
$
381,910

During the three months ended September 30, 2017 and 2016, we recorded $276 and $2,526, respectively, and during the six months ended September 30, 2017 and 2016, we recorded $960 and $11,594, respectively, of software development impairment charges (a component of cost of goods sold).
Liability Awards
During the three months ended September 30, 2017, we reclassified 5,550,000 time and performance based restricted stock units as equity awards. These awards were granted in prior periods and historically accounted for as liability awards as they previously could be settled only in cash and based on a contractually stipulated cash settlement value. However, in September 2017 at our Annual Meeting of Stockholders, we received stockholder approval to increase the number of shares of Common Stock for which awards may be granted and therefore now have the ability and intent to settle these awards in stock. As a result, we reclassified $74,707 from Other long-term liabilities to Additional paid-in capital within Stockholders' equity. Additionally, we recognized incremental cost of $112,789 to reflect the difference between the share price at the time of the modification and the contractually stipulated cash settlement value. Of these incremental costs, $84,176 was capitalized within Software development costs and licenses, net of current portion; $23,251 was recorded within Software development costs and royalties (a component of cost of goods sold); and $5,361 was recorded within Research and development costs. These awards are expected to vest between fiscal 2019 and fiscal 2022. As of September 30, 2017, the unrecognized compensation cost for these awards is $364,993.
8. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of the following:
 
September 30, 2017
 
March 31, 2017
 
 
 
 
Software development royalties
$
660,453

 
$
492,133

Business reorganization
70,937

 
65,935

Licenses
57,241

 
37,019

Compensation and benefits
44,668

 
44,843

Deferred acquisition payments
25,000

 
25,000

Marketing and promotions
20,124

 
21,030

Other
74,145

 
64,915

Accrued expenses and other current liabilities
$
952,568

 
$
750,875

9. DEBT
Credit Agreement
In April 2016, we entered into a Sixth Amendment to our Second Amended and Restated Credit Agreement (as amended, the "Credit Agreement"). The Credit Agreement provides for borrowings of up to $100,000 which may be increased by up to $100,000 pursuant to the terms of the Credit Agreement and which 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) 0.25% to 0.75% above a certain base rate (4.25% at September 30, 2017) or (b) 1.25% to 1.75% above the LIBOR Rate (approximately 1.24% at September 30, 2017), 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 September 30, 2017 and March 31, 2017.

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Table of Contents

Availability under the Credit Agreement is unrestricted when liquidity, as defined in the Credit Agreement, is at least $300,000. When liquidity is below $300,000 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 $5,000.
Information related to availability on our Credit Agreement is as follows:
 
September 30, 2017
 
March 31, 2017
Available borrowings
$
98,306

 
$
98,320

Outstanding letters of credit
1,664

 
1,664

We recorded interest expense and fees related to the Credit Agreement of $111 and $111, respectively for the three months ended September 30, 2017 and 2016 and $221 and $221 for the six months ended September 30, 2017 and 2016, respectively. 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 our 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 $30,000.
1.00% Convertible Notes Due 2018
On June 18, 2013, we issued $250,000 aggregate principal amount of 1.00% Convertible Notes due 2018. The 1.00% Convertible Notes were issued at 98.5% of par value for proceeds of $246,250. 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. We do not have the right to redeem the 1.00% Convertible Notes prior to maturity. We also granted the underwriters a 30-day option to purchase up to an additional $37,500 principal amount of 1.00% Convertible Notes to cover overallotments, if any. On July 17, 2013, we closed our public offering of $37,500 principal amount of our 1.00% Convertible Notes as a result of the underwriters exercising their overallotment option in full on July 12, 2013, bringing the total proceeds to $283,188.
The 1.00% Convertible Notes are convertible at an initial conversion rate of 46.4727 shares of our common stock per $1 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 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 our 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 September 30, 2017. Accordingly, as of October 1, 2017, the 1.00% Convertible Notes may be converted at the holder's option through December 31, 2017. During the three and six months ended September 30, 2017, 1.00% Convertible Notes with an aggregate principal amount of $169,436 and $213,898 were settled, and an additional $2,104 were tendered for conversion with October 2017 settlement dates. We elected to settle in shares of our common stock. Our intent and ability, given our option, would be to settle future conversions in shares of our common stock. As such, we have continued to classify these 1.00% Convertible Notes as long-term debt.
Upon the occurrence of certain fundamental changes involving the Company, holders of the 1.00% Convertible Notes may require us to purchase all or a portion of their 1.00% Convertible Notes for cash at a price equal to 100% of the principal amount

14


Table of Contents

of the notes to be purchased, plus accrued and unpaid interest (including additional interest, if any) to, but excluding, the fundamental change purchase date.
The indenture governing the 1.00% Convertible Notes contains customary terms and covenants and events of default. If an event of default (as defined therein) occurs and is continuing, the Trustee by notice to the Company, or the holders of at least 25% in aggregate principal amount of the 1.00% Convertible Notes then outstanding by notice to the Company and the Trustee, may, and the Trustee at the request of such holders shall, declare 100% of the principal of and accrued and unpaid interest (including additional interest, if any) on all the 1.00% Convertible Notes to be due and payable. In the case of an event of default arising out of certain bankruptcy events, 100% of the principal of and accrued and unpaid interest (including additional interest, if any), on the 1.00% Convertible Notes will automatically become due and payable immediately.
The 1.00% Convertible Notes are senior unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the 1.00% Convertible Notes; equal in right of payment to our existing and future indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness incurred by our subsidiaries.
We separately account for the liability and equity components of the 1.00% Convertible Notes in a manner that reflects our nonconvertible debt borrowing rate. We estimated the fair value of the 1.00% Convertible Notes to be $225,567 upon issuance of our 1.00% Convertible Notes, assuming a 6.15% non-convertible borrowing rate. The carrying amount of the equity component was determined to be approximately $57,621 by deducting the fair value of the liability component from the net proceeds of the 1.00% Convertible Notes. The excess of the principal amount of the liability component over its carrying amount is amortized to interest and other, net over the term of the 1.00% Convertible Notes using the effective interest method. The equity component is not remeasured as long as it continues to meet the conditions for equity classification. In accounting for the $2,815 of banking, legal and accounting fees related to the issuance of the 1.00% Convertible Notes, we allocated $2,209 to the liability component and $606 to the equity component. Debt issuance costs attributable to the liability component are being amortized to interest and other, net over the term of the 1.00% Convertible Notes, and issuance costs attributable to the equity component were netted with the equity component in additional paid-in capital.
As of September 30, 2017 and March 31, 2017, the if-converted value of our 1.00% Convertible Notes exceeded the principal amount of $54,252 and $268,149, respectively by $203,376 and $470,456, respectively.
The following table provides additional information related to our 1.00% Convertible Notes:
 
September 30, 2017
 
March 31, 2017
Additional paid-in capital
$
35,784

 
$
35,784

Principal amount of 1.00% Convertible Notes
$
54,252

 
$
268,149

Unamortized discount of the liability component
1,837

 
15,751

Carrying amount of debt issuance costs
46

 
469

Net carrying amount of 1.00% Convertible Notes
$
52,369

 
$
251,929

The following table provides the components of interest expense related to our 1.00% Convertible Notes:
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Cash interest expense (coupon interest expense)
$
130

 
$
698

 
$
579

 
$
1,417

Non-cash amortization of discount on 1.00% Convertible Notes
8,678

 
3,869

 
13,915

 
7,004

Amortization of debt issuance costs
263

 
127

 
423

 
234

Total interest expense related to 1.00% Convertible Notes
$
9,071

 
$
4,694

 
$
14,917

 
$
8,655


15



10. EARNINGS (LOSS) PER SHARE ("EPS")
The following table sets forth the computation of basic and diluted earnings (loss) per share (shares in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Computation of Basic earnings (loss) per share:
 

 
 

 
 

 
 

Net income (loss)
$
(2,736
)
 
$
36,432

 
$
57,540

 
$
(2,135
)
Less: net income allocated to participating securities

 
(745
)
 
(487
)
 

Net income (loss) for basic earnings (loss) per share calculation
$
(2,736
)
 
$
35,687

 
$
57,053

 
$
(2,135
)
 
 
 
 
 
 
 
 
Total weighted average shares outstanding—basic
109,430

 
87,176

 
107,232

 
84,990

Less: weighted average participating shares outstanding

 
(1,783
)
 
(908
)
 

Weighted average common shares outstanding—basic
109,430

 
85,393

 
106,324

 
84,990

 
 
 
 
 
 
 
 
Basic earnings (loss) per share
$
(0.03
)
 
$
0.42

 
$
0.54

 
$
(0.03
)
 
 
 
 
 
 
 
 
Computation of Diluted earnings (loss) per share:
 
 
 
 
 
 
 
Net income (loss)
$
(2,736
)
 
$
36,432

 
$
57,540

 
$
(2,135
)
Less: net income allocated to participating securities

 
(564
)
 
(478
)
 

Add: interest expense, net of tax, on Convertible Notes

 
8,669

 

 

Net income (loss) for diluted earnings (loss) per share calculation          
$
(2,736
)
 
$
44,537

 
$
57,062

 
$
(2,135
)
 
 
 
 
 
 
 
 
Weighted average common shares outstanding—basic
109,430

 
85,393

 
106,324

 
84,990

Add: dilutive effect of common stock equivalents

 
29,809

 
3,032

 

Weighted average common shares outstanding—diluted
109,430

 
115,202

 
109,356

 
84,990

Less: weighted average participating shares outstanding

 
(1,783
)
 
(908
)
 

Weighted average common shares outstanding- diluted
109,430

 
113,419

 
108,448

 
$
84,990

 
 
 
 
 
 
 
 
Diluted earnings (loss) per share
$
(0.03
)
 
$
0.39

 
$
0.53

 
$
(0.03
)
Certain of our unvested restricted stock awards (including restricted stock units and time-based and market-based restricted stock awards) are considered participating securities since these securities have non-forfeitable rights to dividends or dividend equivalents during the contractual period of the award, and thus require the two-class method of computing EPS.
The calculation of EPS for common stock under the two-class method shown above for the six months ended September 30, 2017 excludes income attributable to the participating securities from the numerator and excludes the dilutive effect of those awards from the denominator.
We incurred a net loss for the three months ended September 30, 2017 and the six months ended September 30, 2016; therefore, the basic and diluted weighted average shares outstanding for those periods exclude the effect of the unvested share-based awards that are considered participating securities and all common stock equivalents because their effect would be antidilutive. For the three months ended September 30, 2017 and the six months ended September 30, 2016, we had 2,145,000 and 5,172,000, respectively, of unvested share-based awards that are excluded from the EPS calculation due to the net loss for those periods.
We define common stock equivalents as restricted stock awards and common stock related to the Convertible Notes (see Note 9) outstanding during the period. Common stock equivalents are measured using the treasury stock method, except for the Convertible Notes, which are assessed for their effect on diluted EPS using the more dilutive of the treasury stock method or the if-converted method. Under the provisions of the if-converted method, the Convertible Notes are assumed to be converted and included in the denominator of the EPS calculation and the interest expense, net of tax, recorded in connection with the Convertible Notes is added back to the numerator.

16



During the six months ended September 30, 2017, 2,700,000 restricted stock awards vested, we granted 600,000 unvested restricted stock awards, and 14,000 unvested restricted stock awards were forfeited.
11. ACCUMULATED OTHER COMPREHENSIVE LOSS
The following table provides the components of accumulated other comprehensive loss:
 
Six Months Ended September 30, 2017
 
Foreign
currency
translation
adjustments
 
Unrealized
gain (loss) on
forward contracts
 
Unrealized
gain (loss) on
cross-currency swap
 
Unrealized
gain (loss) on
available-for-
sales
securities(1)
 
Total
Balance at March 31, 2017
$
(47,666
)
 
$
600

 
$

 
$
(76
)
 
$
(47,142
)
Other comprehensive income before reclassifications
23,776

 

 
(5,781
)
 
111

 
18,106

Amounts reclassified from accumulated other comprehensive loss

 

 
564

 

 
564

Balance at September 30, 2017
$
(23,890
)
 
$
600

 
$
(5,217
)
 
$
35

 
$
(28,472
)

 
Six Months Ended September 30, 2016
 
Foreign
currency
translation
adjustments
 
Unrealized
gain (loss) on
derivative
instruments
 
Unrealized
gain (loss) on
available-for-
sales
securities
 
Total
Balance at March 31, 2016
$
(38,580
)
 
$
600

 
$
84

 
$
(37,896
)
Other comprehensive income (loss) before reclassifications
(5,027
)
 

 
43

 
(4,984
)
Amounts reclassified from accumulated other comprehensive loss

 

 
9

 
9

Balance at September 30, 2016
$
(43,607
)
 
$
600

 
$
136

 
$
(42,871
)

12. COMMITMENTS AND CONTINGENCIES
We have entered into various agreements in the ordinary course of business that require substantial cash commitments over the next several years. Other than agreements entered into in the ordinary course of business and in addition to the agreements requiring known cash commitments as reported in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended March 31, 2017, we did not have any significant changes to our commitments since March 31, 2017.
Legal and Other Proceedings
We are, or may become, subject to demands and claims (including intellectual property claims) and are involved in routine litigation in the ordinary course of business, which we do not believe to be material to our business or financial statements. We have appropriately accrued amounts related to certain of these claims and legal and other proceedings. While it is reasonably possible that a loss may be incurred in excess of the amounts accrued in our financial statements, we believe that such losses, unless otherwise disclosed, would not be material.
On April 11, 2016, we filed a declaratory judgment action in the United States District Court for the Southern District of New York seeking, among other things, a judicial declaration that Leslie Benzies, the former president of one of our subsidiaries with whom we had been in ongoing discussions regarding his separation of employment, is not entitled to any minimum allocation or financial parity with any other person under the applicable royalty plan. We believe we will prevail in this matter, although there can be no assurance of the outcome. On April 12, 2016, Mr. Benzies filed a complaint in the Supreme Court of the State of New York, New York County against us, and certain of our subsidiaries and employees. We removed this case to the United States District Court for the Southern District of New York, but the case was subsequently remanded to state court. The complaint claims damages of at least $150,000 and contains allegations of breach of fiduciary duty; fraudulent inducement and fraudulent concealment; aiding and abetting breach of fiduciary duty; breach of various contracts; breach of implied duty of good faith and fair dealing; tortious interference with contract; unjust enrichment; reformation; constructive trust; declaration of rights; constructive discharge; defamation and fraud. Motion practice in both the federal and state actions is ongoing. While we believe that we have meritorious defenses to these claims, and we intend to vigorously defend against them and to pursue any counterclaims, we have accrued what we believe to be an adequate amount for this matter, which amounts are classified as Business reorganization within Accrued expenses and other current liabilities in our Condensed Consolidated Balance Sheet (see Note 8). We do not believe

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that the ultimate outcome of such litigation, even if in excess of our current accrual, will have a material adverse effect on our business, financial condition or results of operations.
13. BUSINESS REORGANIZATION
In the first quarter of fiscal 2018, we announced and initiated actions to implement a strategic reorganization at one of our labels (the "2018 Plan"). In connection with this initiative, we incurred business reorganization expenses of $1,713 during the three months ended September 30, 2017 due to true-up of estimates for employee separation costs and $12,312 during the six months ended September 30, 2017 due primarily to employee separation costs. Through September 30, 2017, we paid $2,547 related to these reorganization activities. As of September 30, 2017, $5,002 remained accrued for in Accrued expenses and other current liabilities and $4,763 in Other non-current liabilities. Although we may record additional expense or benefit in future periods to true-up estimates, we do not expect to incur additional reorganization costs in connection with the 2018 Plan.
14. INCOME TAXES
The benefit from income taxes for the three months ended September 30, 2017 is based on our projected annual effective tax rate for fiscal year 2018, adjusted for specific items that are required to be recognized in the period in which they are incurred. The benefit from income taxes was $11.6 million for the three months ended September 30, 2017 as compared to a provision of $3.7 million for the prior year period.
When compared to the statutory rate of 35%, the effective tax rate of 80.9% for the three months ended September 30, 2017, was primarily due to the adoption of ASU 2016-09, Compensation - Stock Compensation, as of April 1, 2017, which required us to recognize $8.0 million of excess tax benefits from employee stock compensation as a component of the benefit from income taxes (previously excess tax benefit and tax deficiencies were recognized in additional paid-in-capital), as well as $2.5 million of tax benefits related to the reduction in a contingent consideration liability associated with the Social Point acquisition, partially offset by a $5.0 million decrease in the projected benefit related to tax credits.
The benefit from income taxes reported for the six months ended September 30, 2017 is based on our projected annual effective tax rate for fiscal year 2018, adjusted for specific items that are required to be recognized in the period in which they are incurred. The benefit from income taxes was $24.4 million for the six months ended September 30, 2017, as compared to a provision of $0.1 million for the prior year period.
When compared to the statutory rate of 35%, the effective tax rate of (73.7)% for the six months ended September 30, 2017 was primarily due to the adoption of ASU 2016-09, Compensation - Stock Compensation, as of April 1, 2017, which required us to recognize $24.5 million of excess tax benefits from employee stock compensation as a component of the benefit from income taxes (previously excess tax benefit and tax deficiencies were recognized in additional paid-in-capital), $5.5 million of tax benefits from tax credits, and $5.4 million of tax benefits due to changes in our valuation allowance, as well as the mix of projected pre-tax income.
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 may impact our effective tax rate in future periods.

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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 are considered forward-looking statements under federal securities laws and may be identified by words such as "anticipates," "believes," "estimates," "expects," "intends," "plans," "potential," "predicts," "projects," "seeks," "should" "will," or words of similar meaning and include, but are not limited to, statements regarding the outlook for the Company's future business and financial performance. Such forward-looking statements are based on the current beliefs of our management as well as assumptions made by and information currently available to them, which are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. Actual outcomes and results may vary materially from these forward-looking statements based on a variety of risks and uncertainties including those contained herein, in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2017, in the section entitled "Risk Factors," and the Company's other periodic filings with the Securities and Exchange Commission. All forward-looking statements are qualified by these cautionary statements and speak only as of the date they are made. The Company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.
Our Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is provided in addition to the accompanying Condensed Consolidated Financial Statements and notes to assist readers in understanding our results of operations, financial condition and cash flows. The following discussion should be read in conjunction with the MD&A and our annual consolidated financial statements and the notes thereto, included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2017.
Overview
Our Business
We are a leading developer, publisher and marketer of interactive entertainment for consumers around the globe. We develop and publish products principally through our two wholly-owned labels Rockstar Games and 2K. Our products are currently designed for console gaming systems such as Sony's PlayStation®4 ("PS4") and PlayStation®3 ("PS3"), Microsoft's Xbox One® ("Xbox One") and Xbox 360® ("Xbox 360"), Nintendo's Switch, and personal computers ("PC"), including smartphones and tablets. We deliver our products through physical retail, digital download, online platforms and cloud streaming services.
We endeavor to be the most creative, innovative and efficient company in our industry. Our core strategy is to capitalize on the popularity of video games by developing and publishing high-quality interactive entertainment experiences across a range of genres. We focus on building compelling entertainment franchises by publishing a select number of titles for which we can create sequels and incremental revenue opportunities through 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 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 costs. We have internal development studios located in Canada, China, Czech Republic, Spain, the United Kingdom and the United States.
Software titles published by our Rockstar Games label are primarily internally developed. We expect Rockstar Games, our wholly-owned publisher of the Grand Theft Auto, Max Payne, Midnight Club, Red Dead 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 270 million units. The latest installment, Grand Theft Auto V, was released on Sony's PS3 and Microsoft's Xbox 360 in September 2013, on Sony'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 Games is also well known for developing brands in other genres, including the L.A. Noire, Bully and Manhunt franchises. Rockstar Games continues to

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expand on our established franchises by developing sequels, offering downloadable episodes, content and virtual currency, and releasing titles for smartphones and tablets.
Our 2K label has published a variety of popular entertainment properties across all key platforms and across a range of genres including shooter, action, role-playing, strategy, sports and family/casual entertainment. We expect 2K to continue to develop new, successful franchises in the future. 2K's internally owned and developed franchises include the critically acclaimed, multi-million unit selling BioShock, Mafia, Sid Meier's Civilization and XCOM series. 2K also publishes externally developed brands, such as Battleborn, Borderlands and Evolve. 2K's realistic sports simulation titles include our flagship NBA 2K series, which continues to be the top-ranked NBA basketball video game, and the WWE 2K professional wrestling series.
On January 31, 2017, we acquired privately-held Social Point S.L. ("Social Point") for $175 million in cash and the issuance of 1,480,168 shares of our common stock, plus potential earn-out consideration of up to an aggregate of $25.9 million in cash and shares of our common stock. Founded in 2008 and headquartered in Barcelona, Spain, Social Point is a developer of popular free-to-play mobile games that focuses on delivering high-quality, deeply-engaging entertainment experiences. Social Point currently has multiple profitable titles in the market, including its two most successful games, Dragon City and Monster Legends. In addition, Social Point has a robust development pipeline with a number of exciting games planned for launch over the next two years.
We are continuing to execute on our growth initiatives in Asia, where our strategy is to broaden the distribution of our existing products and expand our online gaming presence, especially in China and South Korea. 2K has secured a multi-year license from the NBA to develop an online version of the NBA simulation game in China, Taiwan, South Korea and Southeast Asia. In October 2012, NBA 2K Online, our free-to-play NBA simulation game, which was co-developed by 2K and Tencent, launched commercially on the Tencent Games portal in China.
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 37.4% of our net revenue for the six months ended September 30, 2017. 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 that may unfavorably affect our businesses, such as deteriorating consumer demand, pricing pressure on our products, credit quality of our receivables, and foreign currency exchange rates. Our business is dependent upon a limited number of customers that account for a significant portion of our revenue. Our five largest customers accounted for 71.7% and 69.4% of net revenue during the six months ended September 30, 2017 and 2016, respectively. As of September 30, 2017 and March 31, 2017, our five largest customers comprised 70.2% and 69.9% 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 63.5% and 57.6% of such balance at September 30, 2017 and March 31, 2017, respectively. We had three customers who accounted for 29.9%, 17.2%, and 16.4% of our gross accounts receivable as of September 30, 2017 and two customers who accounted for 40.2% and 17.4% of our gross accounts receivable as of March 31, 2017. 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 consoles manufactured by third parties, such as Sony's PS4 and PS3 and Microsoft's Xbox One and Xbox 360, which comprised 81.9% of our net revenue by product platform for the six months ended September 30, 2017. The success of our business is dependent upon the consumer acceptance of these consoles and continued growth in the installed base of these platforms. When new hardware platforms are introduced, demand for software used on older platforms typically declines, which may negatively affect our business during the market transition to the new consoles. 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. Accordingly, our strategy is to focus our development efforts on a select number of the highest quality titles for these platforms, while also expanding our offerings for emerging platforms such as tablets, smartphones and online games.
Online Content and Digital Distribution.    The interactive entertainment software industry is delivering a growing amount of content through digital online delivery methods. We provide a variety of online delivered products and offerings. Most of our titles that are available through retailers as packaged goods products are also available through direct digital download (from websites we own and others owned by third parties). In addition, we aim to drive ongoing engagement and incremental revenue

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from recurrent consumer spending on our titles through virtual currency, add-on content, and microtransactions. We also publish an expanding variety of titles for tablets and smartphones, which are delivered to consumers through digital download via the Internet. Our "Results of Operations" discloses that net revenue from digital online channels comprised 66.3% of our net revenue by distribution channel for the six months ended September 30, 2017. We expect online delivery of games and game offerings to continue to grow and to become an increasing part of our business over the long-term.
Product Releases
We released the following key titles during the six months ended September 30, 2017:
Title
Publishing
Label
 
Internal or External
Development
 
Platform(s)
 
Date Released
NBA 2K18
2K
 
Internal
 
Xbox 360, Xbox One, PS3, PS4, PC, Switch (digital)
 
September 19, 2017
Product Pipeline
We have announced the following future key titles to date (this list does not represent all titles currently in development):
Title
Publishing
Label
 
Internal or External
Development
 
Platform(s)
 
Expected Release Date
WWE 2K18
2K
 
Internal/External
 
PS4, Xbox One
 
October 13, 2017 (released)
NBA 2K18
2K
 
Internal
 
Switch (physical)
 
October 17, 2017 (released)
L.A. Noire
Rockstar Games
 
Internal
 
PS4, Xbox One, Switch
 
November 14, 2017
L.A. Noire: The VR Case Files
Rockstar Games
 
Internal
 
HTC Vive
 
December 2017
WWE 2K18
2K
 
Internal/External
 
Switch
 
Fall 2017
Red Dead Redemption 2
Rockstar Games
 
Internal
 
PS4, Xbox One
 
Spring 2018

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 inventory obsolescence, and valuation of goodwill, intangible assets and long-lived assets; valuation and recognition of stock-based compensation; and income taxes. In-depth descriptions of these can be found in our Annual Report on Form 10-K for the fiscal year ended March 31, 2017.
Revenue Recognition
As part of our on-going assessment of estimated service periods, during the three months ended June 30, 2017, we extended Grand Theft Auto V's estimated service period from 41 to 50 months, or through December 2018. We expect this change in estimated service period to have a material impact on our Consolidated Financial Statements for fiscal 2018. The impact of this change in estimate is further discussed in Note 1 - Basis of Presentation and Significant Accounting Policies in the Notes to our Condensed Consolidated Financial Statements.
Recently Adopted and Recently Issued Accounting Pronouncements
See Note 1 - Basis of Presentation and Significant Accounting Policies in the Notes to our Condensed Consolidated Financial Statements for further discussion.

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Results of Operations
The following table sets forth, for the periods indicated, our Condensed Consolidated Statements of Operations, net revenue by geographic region, net revenue by product platform and net revenue by distribution channel:
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(thousands of dollars)
2017
 
2016
 
2017
 
2016
Net revenue
$
443,562

 
100.0
 %
 
$
420,167

 
100.0
 %
 
$
861,778

 
100.0
 %
 
$
731,719

 
100.0
 %
Cost of goods sold
246,548

 
55.6
 %
 
205,605

 
48.9
 %
 
441,117

 
51.2
 %
 
396,985

 
54.3
 %
Gross profit
197,014

 
44.4
 %
 
214,562

 
51.1
 %
 
420,661

 
48.8
 %
 
334,734

 
45.7
 %
Selling and marketing
76,914

 
17.3
 %
 
80,187

 
19.1
 %
 
129,128

 
15.0
 %
 
151,321

 
20.7
 %
General and administrative
60,824

 
13.7
 %
 
49,685

 
11.8
 %
 
121,427

 
14.1
 %
 
96,428

 
13.2
 %
Research and development
49,999

 
11.3
 %
 
30,005

 
7.2
 %
 
92,268

 
10.7
 %
 
63,905

 
8.7
 %
Depreciation and amortization
18,883

 
4.3
 %
 
7,491

 
1.8
 %
 
26,626

 
3.1
 %
 
14,869

 
2.0
 %
Business reorganization
1,713

 
0.4
 %
 

 
 %
 
12,312

 
1.4
 %
 

 
 %
Total operating expenses
208,333

 
47.0
 %
 
167,368

 
39.9
 %
 
381,761

 
44.3
 %
 
326,523

 
44.6
 %
Income (loss) from operations
(11,319
)
 
(2.6
)%
 
47,194

 
11.2
 %
 
38,900

 
4.5
 %
 
8,211

 
1.1
 %
Interest and other, net
(2,969
)
 
(0.7
)%
 
(7,078
)
 
(1.7
)%
 
(5,777
)
 
(0.7
)%
 
(11,584
)
 
(1.6
)%
Gain on long-term investments, net

 

 

 
 %
 

 
 %
 
1,350

 
0.2
 %
Income (loss) before income taxes
(14,288
)
 
(3.2
)%
 
40,116

 
9.5
 %
 
33,123

 
3.8
 %
 
(2,023
)
 
(0.3
)%
(Benefit from) provision for income taxes
(11,552
)
 
(2.6
)%
 
3,684

 
0.8
 %
 
(24,417
)
 
(2.8
)%
 
112

 
 %
Net income (loss)
$
(2,736
)
 
(0.6
)%
 
$
36,432

 
8.7
 %
 
$
57,540

 
6.7
 %
 
$
(2,135
)
 
(0.3
)%
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net revenue by geographic region:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

United States
$
276,005

 
62.2
%
 
$
252,483

 
60.1
%
 
$
534,265

 
62.0
%
 
$
445,584

 
60.9
%
International
167,557

 
37.8
%
 
167,684

 
39.9
%
 
327,513

 
38.0
%
 
286,135

 
39.1
%
Net revenue by product platform:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Console
$
360,465

 
81.3
%
 
$
353,038

 
84.0
%
 
$
705,382

 
81.9
%
 
$
607,064

 
83.0
%
PC and other
83,097

 
18.7
%
 
67,129

 
16.0
%
 
156,396

 
18.1
%
 
124,655

 
17.0
%
Net revenue by distribution channel:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Digital online
$
302,886

 
68.3
%
 
$
230,759

 
54.9
%
 
$
571,122

 
66.3
%
 
$
402,837

 
55.1
%
Physical retail and other
140,676

 
31.7
%
 
189,408

 
45.1
%
 
290,656

 
33.7
%
 
328,882

 
44.9
%
Three Months Ended September 30, 2017 Compared to September 30, 2016
(thousands of dollars)
2017
 
%
 
2016
 
%
 
Increase/
(decrease)
 
% Increase/
(decrease)
Net revenue
$
443,562

 
100.0
%
 
$
420,167

 
100.0
%
 
$
23,395

 
5.6
 %
Internal royalties
104,049

 
23.5
%
 
77,425

 
18.4
%
 
26,624

 
34.4
 %
Product costs
42,563

 
9.6
%
 
55,059

 
13.1
%
 
(12,496
)
 
(22.7
)%
Software development costs and royalties(1)
66,782

 
15.1
%
 
45,194

 
10.8
%
 
21,588

 
47.8
 %
Licenses
33,154

 
7.5
%
 
27,927

 
6.6
%
 
5,227

 
18.7
 %
Cost of goods sold
246,548

 
55.6
%
 
205,605

 
48.9
%
 
40,943

 
19.9
 %
Gross profit
$
197,014

 
44.4
%
 
$
214,562

 
51.1
%
 
$
(17,548
)
 
(8.2
)%
_______________________________________________________________________________

(1)
Includes $28,065 and $5,566 of stock-based compensation expense in 2017 and 2016, respectively, in software development costs and royalties.
For the three months ended September 30, 2017, net revenue increased by $23.4 million as compared to the prior year period. This increase was due primarily to an aggregate increase of $47.0 million from our NBA 2K franchise and an increase of $9.1 million from Social Point titles with no comparable revenues in prior year period as it was acquired in January 2017, partially offset by a

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decrease of $25.4 million from our BioShock franchise due to BioShock: The Collection releasing in September 2016 and a decrease of $7.2 million from Battleborn, which released in May 2016.
Net revenue from console games was relatively flat as compared to the prior year period and increased by $7.4 million, accounting for 81.3% of our total net revenue for the three months ended September 30, 2017, as compared to 84.0% for the prior year period. The increase in net revenue from console games was due primarily to higher net revenues from our NBA 2K franchise, and to a lesser extent higher net revenues from Grand Theft Auto Online and Grand Theft Auto V and revenues from Mafia III, which released in October 2016. These increases were offset by lower net revenues from our BioShock and XCOM franchises and a number of our other titles, none of which was individually significant. Net revenue from PC and other increased by $16.0 million and accounted for 18.7% of our total net revenue for the three months ended September 30, 2017, as compared to 16.0% for the prior year period. The increase in net revenue from PC and other was due primarily to higher net revenues from Social Point titles with no comparable revenues in the prior year period as it was acquired in January 2017, XCOM 2 driven by the release of an expansion pack in August 2017, and WWE SuperCard. These increases were partially offset by lower net revenues from Grand Theft Auto V.
Net revenue from digital online channels increased by $72.1 million and accounted for 68.3% of our total net revenue for the three months ended September 30, 2017, as compared to 54.9% for the prior year period. The increase in net revenue from digital online channels was due to higher net revenue from our NBA 2K franchise, Grand Theft Auto V and Grand Theft Auto Online, our XCOM and WWE 2K franchises, partially offset by lower net revenues from our BioShock franchise. Net revenue from physical retail and other channels decreased by $48.7 million and accounted for 31.7% of our total net revenues for the three months ended September 30, 2017, as compared to 45.1% for the same period in the prior year period. The decrease in net revenue from physical retail and other channels was due primarily to our BioShock franchise and Grand Theft Auto V.
Revenues from recurrent consumer spending on our titles through virtual currency, add-on content, and microtransactions increased by $85.5 million and accounted for 48.3% of net revenue for the three months ended September 30, 2017, as compared to 30.7% of net revenue for the prior year period. The increase in revenues from recurrent consumer spending was primarily due to higher net revenues from our NBA 2K franchise, Grand Theft Auto Online, XCOM, and WWE SuperCard.
Gross profit as a percentage of net revenue for the three months ended September 30, 2017 was 44.4% as compared to 51.1% for the prior year period. The decrease was due primarily to higher internal royalties as a percentage of net revenue due to the timing of when royalties are earned. Additionally, we recognized incremental stock compensation costs of $23.3 million within cost of goods sold. The incremental costs resulted from previously issued share based awards, which were historically classified as liability awards, being modified to equity awards during the period. This modification reflects the impact of differences between the share price at the time of the modification and contractually stipulated cash settlement values of the awards prior to the modification.
Net revenue earned outside of the United States was relatively flat compared to the prior year period and decreased by $0.1 million, accounting for 37.8% of our total net revenue for the three months ended September 30, 2017, as compared to 39.9% in the prior year period. Changes in foreign currency exchange rates increased net revenue by $1.2 million and increased gross profit by $0.4 million for the three months ended September 30, 2017 as compared to the prior year period.
Operating Expenses
(thousands of dollars)
2017
 
% of net
revenue
 
2016
 
% of net
revenue
 
Increase/
(decrease)
 
% Increase/
(decrease)
Selling and marketing
$
76,914

 
17.3
%
 
$
80,187

 
19.1
%
 
$
(3,273
)
 
(4.1
)%
General and administrative
60,824

 
13.7
%
 
49,685

 
11.8
%
 
11,139

 
22.4
 %
Research and development
49,999

 
11.3
%
 
30,005

 
7.2
%
 
19,994

 
66.6
 %
Depreciation and amortization
18,883

 
4.3
%
 
7,491

 
1.8
%
 
11,392

 
152.1
 %
Business reorganization
1,713

 
0.4
%
 

 
%
 
1,713

 
100.0
 %
Total operating expenses(1)
$
208,333

 
47.0
%
 
$
167,368

 
39.9
%
 
$
40,965

 
24.5
 %
_______________________________________________________________________________

(1)
Includes stock-based compensation expense, which was allocated as follows (in thousands):
 
2017
 
2016
Selling and marketing
$
3,187

 
$
2,279

General and administrative
$
19,458

 
$
9,774

Research and development
$
8,301

 
$
614


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Changes in foreign currency exchange rates increased total operating expenses by $1.5 million for the three months ended September 30, 2017, as compared to the prior year period.
Selling and marketing
Selling and marketing expenses decreased by $3.3 million for the three months ended September 30, 2017, as compared to the prior year period, due primarily to $8.5 million in lower advertising expenses. Advertising expenses were lower in the current year period due primarily to decreased spend for the releases of Mafia III and Civilization VI in October 2016 with no corresponding spend in the current year, partially offset by higher advertising expenses for Grand Theft Auto Online and Red Dead Redemption 2. The overall decrease was partially offset by higher personnel costs due primarily to higher headcount, including our acquisition of Social Point, and increased stock and incentive compensation.
General and administrative
General and administrative expenses increased by $11.1 million for the three months ended September 30, 2017, as compared to the prior year period, due primarily to increases in professional fees, including stock and incentive compensation expense related primarily to our management agreement with ZelnickMedia due to the increase in our share price and increases in personnel expenses, due to additional headcount, including our acquisition of Social Point. The overall increase was partially offset primarily by a $7.0 million reduction of expense related to the fair value as of September 30, 2017 of contingent consideration included in the Social Point acquisition.
General and administrative expenses for the three months ended September 30, 2017 and 2016 included occupancy expense (primarily rent, utilities and office expenses) of $4.4 million and $3.9 million, respectively, related to our development studios.
Research and development
Research and development expenses increased by $20.0 million for the three months ended September 30, 2017, as compared to the prior year period. The increase was primarily due to increases in personnel expenses, due to additional headcount, including our acquisition of Social Point and due to a $5.4 million stock compensation charge due to a share-based award modification. This was partially offset by lower development costs for titles that have not yet reached technological feasibility.
Depreciation and Amortization
Depreciation and amortization expenses increased by $11.4 million for the three months ended September 30, 2017, as compared to the prior year period, due primarily to the recognition of an $11.3 million impairment charge as a result of our decision not to proceed with further development of certain IPR&D from our acquisition of Social Point.
Business reorganization
During the three months ended September 30, 2017, we recognized $1.7 million of business reorganization expense related to the true-up of an estimate relating to employee separation costs in connection with the implementation of a strategic reorganization at one of our labels, with no corresponding costs in the prior year period.
Interest and other, net
Interest and other, net was an expense of $3.0 million for the three months ended September 30, 2017, as compared to $7.1 million for the prior year period. The decrease was due primarily to lower interest expense as a result of the settlement of our 1.75% Convertible Notes due 2016 (the "1.75% Convertible Notes") in December 2016 and higher gains on early conversions of our 1.00% Convertible Notes.
Benefit from Income Taxes
The benefit from income taxes for the three months ended September 30, 2017 is based on our projected annual effective tax rate for fiscal year 2018, adjusted for specific items that are required to be recognized in the period in which they are incurred. The benefit from income taxes was $11.6 million for the three months ended September 30, 2017 as compared to a provision of $3.7 million for the prior year period.
When compared to the statutory rate of 35%, the effective tax rate of 80.9% for the three months ended September 30, 2017, was primarily due to the adoption of ASU 2016-09, Compensation - Stock Compensation, as of April 1, 2017, which required us to recognize $8.0 million of excess tax benefits from employee stock-based compensation as a component of the benefit from income taxes (previously excess tax benefit and tax deficiencies were recognized in additional paid-in-capital), as well as $2.5 million of tax benefits related to a reduction in a contingent consideration liability associated with the Social Point acquisition, partially offset by a $5.0 million decrease in the projected benefit related to tax credits. We anticipate that additional excess tax benefits and tax credits may arise in future periods both of which could have a significant impact on our effective tax rate.

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In the prior year period, when compared to the statutory rate of 35%, the effective tax rate of 9.2% was primarily due to tax benefits of $5.0 million due to changes in valuation allowance and to a lesser extent tax credits and mix of earnings. 
The change in effective tax rate, when compared to the prior year period is primarily due to the adoption of ASU 2016-09, Compensation - Stock Compensation, as of April 1, 2017.
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 may impact our effective tax rate in future periods.
Net (loss) income and (loss) earnings per share
For the three months ended September 30, 2017, our net loss was $2.7 million, as compared to net income of $36.4 million in the prior year period. For the three months ended September 30, 2017, basic and diluted loss per share was $0.03 compared to basic earnings per share of $0.42 and diluted earnings per share of $0.39 in the prior year period. Basic weighted average shares of 109.4 million were 24.0 million shares higher as compared to the prior year period, due primarily to the vesting of restricted stock awards as well as the settlement of our 1.75% Convertible Notes by converting those notes to shares of our common stock using the stated conversion rate. See Note 10 to our Condensed Consolidated Financial Statements for additional information regarding earnings per share.
Six Months Ended September 30, 2017 Compared to September 30, 2016
(thousands of dollars)
2017
 
%
 
2016
 
%
 
Increase/
(decrease)
 
% Increase/
(decrease)
Net revenue
$
861,778

 
100.0
%
 
$
731,719

 
100.0
%
 
$
130,059

 
17.8
 %
Internal royalties
181,753

 
21.1
%
 
137,098

 
18.7
%
 
44,655

 
32.6
 %
Software development costs and royalties(1)
110,411

 
12.8
%
 
108,853

 
14.9
%
 
1,558

 
1.4
 %
Product costs
86,632

 
10.1
%
 
100,038

 
13.7
%
 
(13,406
)
 
(13.4
)%
Licenses
62,321

 
7.2
%
 
50,996

 
7.0
%
 
11,325

 
22.2
 %
Cost of goods sold
441,117

 
51.2
%
 
396,985

 
54.3
%
 
44,132

 
11.1
 %
Gross profit
$
420,661