Take-Two Interactive Software, Inc.
Q1 2016 Earnings Call Transcript

Published: 11 Aug 2015

[Operator:]

Greetings and welcome to the Take-Two Interactive First Quarter Fiscal Year 2016 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Hank Diamond. Thank you, sir. You may begin.

[Henry A. Diamond:]

Good afternoon. Welcome and thank you for joining Take-Two's conference call to discuss its results for the first quarter of fiscal year 2016 ended June 30, 2015. Today's call will be led by Strauss Zelnick, Take-Two's Chairman and Chief Executive Officer; Karl Slatoff, our President; and Lainie Goldstein, our Chief Financial Officer. We will be available to answer your questions during the Q&A session following our prepared remarks. Before we begin, I'd like to remind everyone that the statements made during this call that are not historical facts are considered forward-looking statements under federal securities laws. These forward-looking statements are based on the beliefs of our management, as well as assumptions made by and information currently available to us. We have no obligation to update these forward-looking statements. Actual operating results may vary significantly from these forward-looking statements based on a variety of factors. These important factors are described in our filings with the SEC, including the company's Annual Report on Form 10-K for the fiscal year ended March 31, 2015, including the risks summarized in the section entitled Risk Factors. I'd also like to note that unless otherwise stated, all numbers we will be discussing today are non-GAAP. Please refer to our earnings release for a GAAP to non-GAAP reconciliation and further explanation. Our earnings release and filings with the SEC may be obtained from our website at www.take2games.com. And now, I'll turn the call over to Strauss.

[Strauss H. Zelnick:]

Thanks, Hank. Good afternoon and thank you for joining us today. I'm pleased to report that during the first quarter we delivered strong revenue and earnings growth, driven by robust demand for our recent releases in catalog as well as better than forecasted recurrent consumer spending. Our solid earnings converted into significant cash flow and at quarter-end, we had approximately $1.2 billion in cash and short-term investments. Nearly two years after its record-shattering launch, Grand Theft Auto V continues to outperform expectations. On April 14, Rockstar Games brought this groundbreaking title to PC with a number of enhancements, generating stellar reviews and strong digitally delivered sales. In addition, we benefited from ongoing demand for the console versions of Grand Theft Auto V, particularly as the installed bases of PlayStation 4 and Xbox One expand. To-date, Grand Theft Auto V has sold in more than 54 million units worldwide. And Rockstar Games is successfully driving engagement with the title and meaningful incremental profits through their release of new content for Grand Theft Auto Online, which I'll discuss shortly. NBA 2K15 continues to broaden its global audience and build on the franchise's trend of annual growth. Sell-in of the title has crossed the 7 million unit mark and surpassed NBA 2K14 during the same period after launch. And NBA 2K15 has generated substantial revenue growth over last year's release, driven in part by high-margin recurrent consumer spending. Our first quarter results were also enhanced by a diverse array of other recent releases and catalog titles. Standouts include the Borderlands series, particularly The Handsome Collection, WWE 2K15 and Evolve. We continue to capitalize on our industry's transition towards digital distribution. During the first quarter our digitally delivered revenue increased 139% to $254 million and represented 69% of our total net revenue. This result was driven by growth in full game downloads and recurrent consumer spending, both of which exceeded our outlook. Recurrent consumer spending represented a significant component of our overall business mix, accounting for 25% of our total net revenue in the first quarter. Grand Theft Auto Online was once again the single largest contributor, as Rockstar Games has driven sustained engagement through the ongoing release of free content updates, most recently The Ill-Gotten Gains updates Part One and Part Two, which were launched in June and July respectively. Roughly 70% of Internet-connected Grand Theft Auto V users have played Grand Theft Auto Online. And the active user base continues to grow with average monthly active users for calendar 2015 to-date up more than 40% versus calendar 2014. In addition virtual currency for NBA 2K was an important part of our digitally delivered success. Revenues grew by 54% year over year, benefiting both from online console play and strong engagement with the MyNBA2K15 companion app. Downloadable add-on content is also a key element of recurrent consumer spending. The leading contributors in the first quarter were offerings for the Borderlands series and Evolve. Finally, our results benefited from the enduring popularity of WWE SuperCard, which has been downloaded more than 7.5 million times, and sustained growth from NBA 2K Online in China, which now has 27 million registered users and continues to be the number one PC online sports title in China. Expanding our revenue from our current consumer spending is a key strategic focus for our organization and an important high margin growth opportunity. We now anticipate that revenue from our current consumer spending will grow in fiscal 2016 and represent an increased percentage of our total business mix versus last year. Fiscal 2016 is off to a solid start and promises to be another year of substantial non-GAAP earnings and positive cash flow for Take-Two. Our ability to project significant profits this year with a lighter release schedule reflect that our company is now structurally a higher-margin enterprise than at any time in our history. Today Take-Two is a global interactive entertainment leader with the industry's top creative talent, a diverse portfolio of critically acclaimed and commercially successful franchises and a solid financial foundation. We're better positioned than ever to deliver growth and margin expansion in future years and returns for our shareholders over the long term. I'll now turn the call over to Karl.

[Karl Slatoff:]

Thanks, Strauss. Today I'll discuss our pipeline for the remainder of fiscal 2016 and beyond. On September 29 2K will continue their illustrious basketball legacy with the launch of NBA 2K16. This year's release will define the ultimate intersection of sports and pop culture with three unique game covers featuring NBA All-Stars Stephen Curry, James Harden and Anthony Davis, as well as an all new MyCareer mode, written and directed by acclaimed filmmaker Spike Lee. NBA 2K16 will also feature the most extensive sound track in NBA 2K history, including more than 50 tracks by notable artists such as The Ramones, Nas, Jay Z, M.I.A, Calvin Harris and Drake. On October 27 2K will release WWE 2K16, which will further leverage the development expertise of Visual Concepts and promises to take this beloved sports entertainment franchise to exciting new heights. Stone Cold Steve Austin, a 2009 WWE Hall of Fame inductee and winner of 21 championships throughout his career, will be the cover superstar. In addition 2K recently announced that action-movie icon and WWE Hall of Fame inductee Arnold Schwarzenegger, will make his series debut in WWE 2K16. Consumers who pre-order the title at participating retailers will receive his two famous characters from the films The Terminator and Terminator 2

[Lainie Goldstein:]

Thanks, Karl, and good afternoon, everyone. Now I'll review our results for the fiscal first quarter and then discuss our outlook for the second quarter and fiscal year 2016. All of the numbers I'll be providing today are non-GAAP and all comparisons are year-over-year unless otherwise stated. Our press release provides a reconciliation of our GAAP to non-GAAP measurements. Starting with our results for the fiscal first quarter, our revenue grew 142% to $366.4 million. This result exceeded our outlook range of $325 million to $350 million due to stronger than expected revenues from Grand Theft Auto V and Grand Theft Auto Online, as well as upside from a number of other titles, especially Borderlands

[Strauss H. Zelnick:]

Thanks, Karl and Lainie. On behalf of our entire management team, I'd like to thank our colleagues for their hard work and a solid start to the year. And to our shareholders, I'd like to express our appreciation for your continued support. We'll now take your questions. Operator?

[Operator:]

Thank you. We will now be conducting a question-and-answer session. Our first question comes from the line of Eric Handler with MKM Partners. Please go ahead with your question.

[Eric O. Handler:]

Yes. Thanks for taking my question. Just looking at your income statement, it looks like the internal royalties have been paid, and are being paid in arrears as you see the profitability of the Rockstar Studio, I'm assuming. And I'm just curious now that we're seeing, we're beyond the GTA V release with PC, should internal royalties start coming down? I'm just trying to get a sense of how we should be modeling that line item.

[Lainie Goldstein:]

Eric, are you looking at the GAAP financials or the non-GAAP financials?

[Eric O. Handler:]

Well, you only give GAAP for internal royalties. I don't know if you have a non-GAAP for internal royalties.

[Lainie Goldstein:]

We probably – we don't show that. But the GAAP, the way the internal royalties is calculated is a little different than what we're doing with the non-GAAP where the non-GAAP financials and the EPS associated with that is going to follow along with the overall profitability of the business. And the internal royalties will be calculated based on the overall profitability of the business and that profit share at that point in time.

[Eric O. Handler:]

Okay. Thank you very much.

[Operator:]

Thank you. Our next comes from the line of Brian Fitzgerald with Jefferies. Please go ahead with your question.

[Brian P. Fitzgerald:]

Thanks, guys. When considering GTA, NBA, Borderlands, WWE and Evolve, across those games, can you give us any more color on how they vary in terms of leverage to digital download versus digital recurrent consumer spend? I know you highlighted GTA, NBA and Borderlands specifically in this quarter drove a lot of the recurrent spend. Are there any variances to call out in terms of which franchises are more leveraged to digital download versus recurrent digital spend? Thanks.

[Karl Slatoff:]

Hi, Brian. It's Karl. Obviously, all of those titles are significant contributors to our digital sales, both our digital downloads and in recurrent consumer spending. We don't have any details to provide you specifically across game-to-game, but we can tell you in general, it's growing across all of our franchises.

[Brian P. Fitzgerald:]

Great. Thanks, Karl.

[Operator:]

Thank you. Our next question comes from the line of Ben Schachter with Macquarie. Please go ahead with your question. Ben Schachter - Macquarie Capital (USA), Inc. Hey, guys, a few questions. One, Lainie, you said that you accelerated some capitalized expenses in the quarter. Can you talk about how much and why? And then, Strauss, couple of things, M&A environment, anything notably different or changing now versus, say, the last couple of years? And then anything you can add on the cash and what we can expect going forward for uses of cash and potentially returns to shareholders? Thanks.

[Lainie Goldstein:]

So for the accelerated amortization of the capitalized development expenses that we talked about, the amount is about half of what the margin effect was in the quarter. So we're not talking about what specific title that is for, but that's the amount. And what's driving that is on each quarter, we'll look at the estimates of lifetime titles of our sales, and it will adjust the capitalized development cost, the amortization for it based on what those estimates are, whether it's up or down.

[Strauss H. Zelnick:]

And Ben, regarding the M&A environment, I think, we see that as unchanged. As you know, market prices are robust for certain companies in our space, and I think that reflects the fact that this is a growth area in the entertainment business and certain companies are doing very well indeed. We tend to be very disciplined. We're looking for accretive opportunities and we're very focused on value, but we don't really see any changes there. From our point of view in terms of cash, we increased our cash balance this quarter, because operations generated free cash flow. That's certainly good news. We're reporting roughly $1.2 billion in cash. We account for our converts as though they'll be satisfied with equity. So on that basis effectively it's all net cash as well. So our view on that is that cash in our business can be a strategic asset. It allows one to be opportunistic and it supports a company that operates within a business that does offer some risk. So we do see it as a strategic asset that will allow us to avail ourselves of both internal and external growth opportunities as they come about. In terms of use of cash we've said there will be three potential uses, first, to support organic growth. This company's story is an organic growth story largely. Second, to avail ourselves of inorganic opportunities. I just addressed that. And third, to return capital judiciously to shareholders. And we do have an open authorization for a buyback from our board. So I think it'll fall within those three buckets. But this is obviously a high-class problem to have.

[Operator:]

Thank you. Our next question comes from the line of Mike Olson with Piper Jaffray. Please go ahead with your question.

[Michael J. Olson:]

Hey. Good afternoon. So you've had a lot of success with recurrent consumer spending in your major titles. Are you kind of now going into development of every game with a focus on finding ways to drive recurrent consumer spending? I guess somebody already asked about specific titles that may be higher in recurrent consumer spending, but what about genres? Are there certain genres that are better suited for recurrent spend? Or do you think the opportunity is similar across all genres?

[Karl Slatoff:]

Hi, Mike. It's Karl. I think first and foremost the intention of all the labels in our studios is to create product that people really want to enjoy and that will delight consumers. So that's first and foremost. Whenever we're thinking about development pipeline, it's how can we create franchises. The best way to create a franchise is to create great product. That being said I would say pretty much across the board, every one of our releases on a go-forward basis should have some kind of recurrent consumer spending opportunity. There may be some titles where it doesn't make sense. But again that's a creative decision as much as it is a business decision. But there is no – I don't think there are any specific genres where it doesn't play well. If you look at some of the titles today that we're – from which we're generating recurrent consumer spending, they couldn't be more diverse. So I think it's fair to say that that's a focus for us across all of our titles. And I don't think that there's any set rules in terms of genres, et cetera.

[Michael J. Olson:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Drew Crum with Stifel. Please go ahead with your question.

[Drew E. Crum:]

Okay. Thanks. Good afternoon everyone. Karl, maybe you can talk about the decision to put Battleborn in the February release window. Why not tuck it in in front of the holiday? And then separately any update you guys can provide in terms of DLC for Grand Theft Auto V? Thanks.

[Karl Slatoff:]

Hey, Drew. In terms of Battleborn again whenever we pick a release window for any of our titles, it's two specific things. It's when the title is ready, when is the best time for us to optimize it from a creative perspective, and then when do we think the right window is for that title, given what's in the market and also given the natural consumer patterns of – purchasing patterns over the years? I would say that it's really more the former. The most important decision that we make is, is the title ready? Is it the best creative – are we putting our best creative foot forward when we're releasing a title? That's always primary. And then we'll look at it and we'll say is there an open window? Given that, is there an open window that we can utilize? And I think pretty much across the board there aren't many months in the year where we feel uncomfortable releasing a title. Most of our titles stand amongst themselves. We don't necessarily need a holiday to drive our spending, because these are very high quality, AAA titles that are tent-pole releases in and of themselves. And then in terms of DLC for GTA V, we really don't have anything to say about that today.

[Drew E. Crum:]

Okay. Thanks, guys.

[Operator:]

Thank you. Our next question comes from the line of Doug Creutz with Cowen and Company. Please go ahead with your question.

[Douglas L. Creutz:]

Thanks. A relatively simple question. You mentioned that GTA Online I think is the largest sports PC online title in China. I just wondered if that's based on users or monetization or both?

[Strauss H. Zelnick:]

That's NBA 2K Online in China, and it's based on 27 million users.

[Douglas L. Creutz:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Neil Doshi with Mizuho. Please go ahead with your question.

[Neil A. Doshi:]

Thanks, guys. With the digital now becoming a significant portion of your business, any reason not to think why gross margins can't over time get into the 50% or 60% or 70% range, and then any thoughts on digital downloads? I think last quarter you were at 20% for full game download. How should we think about that kind of as we progress into the second quarter and the second half of the fiscal year as you have more console games to be released? Thanks.

[Lainie Goldstein:]

Yeah, on your first question on the digital business, we do expect the margins to continue to grow as we continue to get our digital business getting bigger and bigger, but what percentage that's going to be, it's a little early to say, but we expect it to continue to grow over the long term.

[Strauss H. Zelnick:]

And in terms of the percentage of our business reflected by digital downloads as opposed to physical sales, we do see that growing over time. The first quarter was disproportionately high because of the release of Grand Theft Auto V for PC, which tends to be a heavily downloaded format, but we also see the percentage growing for consoles over time. I don't think we're quoting a specific figure.

[Neil A. Doshi:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Mike Hickey with Benchmark Company. Please go ahead with your question.

[Mike Hickey:]

Hey, guys. Nice quarter. Thanks for taking my questions. Curious on Mafia III; it looks like it's had a pretty strong reveal at Gamescom last week. And I'm certainly not, but others are sort of making comparison to, sort of, a Rockstar Open World experience. And obviously, Mafia is a franchise, but curious if the development of Mafia III has been able to leverage some of the tech or expertise from your Rockstar team? Maybe less specifically, if you can't answer that question, have you been able to drive a sharing environment across your development studios? Thank you.

[Strauss H. Zelnick:]

We're blessed that we have two distinct labels at this company and multiplicity of studios with a lot of talent. We do not have a tech sharing environment. A very congenial company, but we don't think that's the best way to get the best out of our development folks. It's not the way it works around here. Mafia III is a completely different experience. I wouldn't compare it to anything else out there. The reveal was great, but it stands alone. And no, we don't use any other game in the same sentence as Grand Theft Auto. It is the industry's standard bearer. It's not up for comparison. So, no, I think, it's flattering to even think that may be the case, but it's not.

[Mike Hickey:]

Fair enough. The last question from me, just curious on – it looks like for the quarter, obviously, digital spend was better, reoccurring spend was better, at least versus your expectations. Now it seems you're more optimistic on recurrent digital spend in 2016, now looking for growth and a large percentage of that bucket to your total sales. So why wouldn't that drive upside to your original 2015 – or excuse me, fiscal 2016 profitability range? I guess basically just curious of the offset. Thank you.

[Strauss H. Zelnick:]

It's early in the year. We're very happy with the way the first quarter penciled out. We have a lot of other cards to turn over. We've got obviously a big release in the second quarter with NBA 2K16. We're really excited about that, but it is early days yet. But thanks. It's a really good start and we continue to believe we have a lot of work to do. We also have a great deal of opportunity.

[Mike Hickey:]

Thanks, Strauss. Good luck.

[Operator:]

Thank you. Ladies and gentlemen, we have no further questions at this time. I would like to turn the floor back over to management for closing remarks.

[Strauss H. Zelnick:]

We'd like to thank everyone who attended the call today for their attention, for their great questions, and we do appreciate your continued support. Thanks so much.

[Operator:]

Thank you, ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.