Take-Two Interactive Software, Inc.
Q1 2014 Earnings Call Transcript

Published: 31 Jul 2013

[Operator:]

Greetings, and welcome to Take-Two Interactive's First Quarter Fiscal Year 2014 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Hank Diamond, Senior Vice President of Investor Relations and Corporate Communications for Take-Two Interactive. Thank you, Mr. Diamond, you may now begin.

[Henry 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 2014 ended June 30, 2013. 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, 2013 and the company's registration statement on Form S-3 dated June 12, 2013. These documents may be obtained from our website at www.take2games.com.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, which is posted at www.take2games.com for a GAAP to non-GAAP reconciliation and further explanation. And now, I'll turn the call over to Strauss.

[Strauss H. Zelnick:]

Thanks, Hank. Good afternoon, and thanks for joining us today. During our fiscal first quarter, we continued to benefit from robust demand for our recent releases, Evergreen catalog titles and expanding portfolio of unique digitally delivered offerings. This enabled our company to deliver results that exceeded our outlook, marking the fourth consecutive quarter in which we've outperformed expectations. These results confirm that the market for the highest-quality current generation titles remain strong even as anticipation builds for upcoming launches of next-generation consoles later this year. Accordingly, we've increased our revenue and earnings outlook for fiscal year 2014.Turning to the key drivers of our first quarter results, the enduring popularity of Borderlands 2 has enabled the title to sell in nearly 7 million units and remains on track to become the highest selling release in the history of 2K. During the first quarter, we launched 3 critically acclaimed and highly successful downloadable add-on packs for the title, including the Ultimate Vault Hunter Upgrade Pack, Psycho Pack and Tiny Tina's Assault on Dragon Keep. Add-on content for Borderlands 2, including its season pass, was the single-largest contributor to our first quarter results. Our add-on content provides incremental revenue and profits, while also helping to deepen the engagement of existing fans and attract new ones. NBA 2K13 continues to grow its audience around the world and contribute significantly to our results. The title is now both the highest-selling and most-profitable sports release in the history of 2K, with more than 6 million units sold in worldwide. In addition to being the industry standard bearer, the success of NBA 2K13 has been enhanced by record digital sales for the franchise, including virtual goods, while our NBA 2K Everywhere offerings bring the brand to every screen where consumers want to experience the very best in basketball. BioShock Infinite is North America's best-selling multiplatform release so far this year, according to NPD. The title has crossed the 4 million unit selling mark, and we expect it to become the top-selling release in the BioShock franchise. It's being supported with downloadable add-on content, which Karl will discuss shortly. We had no tentpole releases during the first quarter, and therefore our industry-leading catalog was particularly integral to our results. In addition to Borderlands, catalog sales were led by Rockstar Games' iconic Grand Theft Auto franchise and Red Dead Redemption, which continue to attract new fans years after launch. Our strong catalog remains an important competitive advantage and provides a relatively stable and predictable profit stream to complement our new release schedule. Revenue from digitally delivered content grew 128% in the first quarter and accounted for a record 52% of our total non-GAAP net revenue. The primary drivers were add-on content and full-game downloads of new and existing catalog titles. We also benefited from in-game purchases of virtual goods and our growing portfolio of mobile offerings. On June 20, we released XCOM

[Karl Slatoff:]

Thanks, Strauss. Today I'll give an update on the recent releases and development pipeline. Earlier this month, 2K successfully launched Sid Meier's Civilization V

[Lainie Goldstein:]

Thanks, Karl, and good afternoon, everyone. I'll review our results for the fiscal first quarter and then discuss our updated outlook for fiscal year 2014 and our initial outlook for this fiscal second quarter. All of the numbers I'll be providing today are non-GAAP results from continuing operations and all comparisons are year-over-year unless otherwise stated. Our press release provides reconciliation of our GAAP to non-GAAP measurements. Starting with our results for the fiscal first quarter, net revenue decreased 36% to $144.3 million, as last year's first quarter benefited from the releases of Max Payne 3 and Spec Ops

[Strauss H. Zelnick:]

Thanks, Karl and Lainie. On behalf of the entire management team, I'd like to thank our colleagues for their effort in delivering a solid start to what we believe will be a fantastic year for the company. To our shareholders, I want to express our appreciation for your continued interest and support. We'll now take your questions. Operator?

[Operator:]

[Operator Instructions] Our first question comes from the line of Justin Post with Merrill Lynch.

[A. Justin Post:]

I guess just 2 questions. You're raising revenues, it's still very early in the year, just what gives you most confidence that you can achieve the higher revenue forecast for the year? What's kind of going right, right now? And then secondly, any thoughts on potentially keeping the share count in check now that you've kind of done all the convertible activity? And are there ways the company can actually start thinking about reducing the share count?

[Strauss H. Zelnick:]

Thanks, Justin. We're increasing the financial outlook based on our better-than-expected results for the first quarter and our strong release schedule for the remainder of the year, including obviously Grand Theft Auto V, our NBA title, our WWE title and our catalog titles and the rest of our release schedule, so it's looking very sound. In terms of our share count, remember our share count is driven by cap accounting, that means we have to include things like unvested options. It also varies depending on whether we're in a profit or a loss quarter. It also varies with regard to the accounting for our converts. And the answer is based on this most recent financing, our share count really hasn't changed very much at all, and we feel the small change is actually swamped by the reduction in the interest cost and the benefit of the incremental capital in our balance sheet. In terms of other steps to reduce the share count, I think the real question is, what steps are we taking to increase value per share and the value of the company overall? And those steps, we outlined them some years ago and we've been trying to execute against. Primarily, what we've tried to do is diversify the product offerings of the company, be a market leader in terms of the quality of our intellectual property and the quality of our individual leases for those franchises. Every year since 2007, we've released a multimillion unit, new intellectual property, we'd like to keep doing that. We've expanded our offerings around the world. We've gotten into mobile business and other businesses, including the MMO business in Asia. And we've really been a leader in innovating for product offerings, whether that's in-game payments or free-to-play games in Asia with partners. We need to keep doing more of that. The fact is, today, we reported over $600 million of cash on our balance sheet and an outlook of -- for making $2.25 to $2.50 a share in non-GAAP earnings. And we've also said, importantly, that we expect the following fiscal year to be profitable and to be profitable for the foreseeable future. If we're able to achieve that and we have a good deal of confidence that we can, then the value of the company and of all those shares will -- should increase. And that's certainly our hope and expectations.

[A. Justin Post:]

Great. Maybe a follow-up on the first point. Are you seeing a little bit better preorder activity than you saw maybe a couple of months ago? Or are you seeing just more demand from retailers for some of your big releases? Any update on how you're looking at the slate right now?

[Strauss H. Zelnick:]

We don't talk about specific preorders, but I will tell you that the outlook is great and the feedback directly from retail is terrific. And obviously, the release that this whole company is focused on worldwide is Grand Theft Auto V. And we're very proud of the fact that we are one company, even though we have a relatively far-flung group of employees in multiple locations all over the world. We all pull together to get behind all of our tentpole releases. And retail's our most important partner, it still represents the bulk of our revenues. Feedback, including the feedback driven by preorders, has been nothing short of extraordinary. However, we don't discuss the specific numbers.

[Operator:]

Our next question comes from the line of Arvind Bhatia with Sterne Agee.

[Arvind Bhatia:]

I know you don't want to get into any kind of numbers on GTA V, but I thought maybe we could talk about GTA IV and if you could just remind us what that title in its first year and life to date, as you continue to see success of that product. And then also in terms of the digital strategy for GTA V, obviously huge opportunity there. You're doing some of that right at the start. It will be helpful to maybe understand how frequently you'll be introducing additional digital content.

[Strauss H. Zelnick:]

Yes. We've -- for Grand Theft Auto IV, we've sold in about 25 million units inception to date. I don't have the first-year numbers at the tip of my tongue. Although, I guess, the answer is that -- Hank does. So we sold through about 8.5 million units the first month, that's about 11 million units within the first month of launch in 2008, just putting in context. But the more important point is that we've sold in 25 million units of GTA IV inception to date and still selling now, this many years later, and the entire franchise has sold in about 125 million units, over 125 million units. So -- and it's also worth noting that the install base today of the platforms for which we're releasing is roughly triple it was when we launched GTA IV. That isn't to say that we'll see a straight line to results, but this massive install base at the time when we think consumers are hungry for Grand Theft Auto V is very good news indeed. In terms of digital content, we're going to let Rockstar Games talk about digital plans for the title. That's the appropriate place for us to talk about to what we're doing for the product and what we're doing for marketing. But suffice it to say that we've been a leader in digital add-on content in the quarter that we just released. Our biggest contributor revenue was downloadable add-on content for Borderlands 2, and we think we really do have a point of view about how best to delight consumers not just at the time of the initial release, but also on an ongoing basis. And what we've learned is that downloadable content does not work for every title in the market, it doesn't even work for all of our titles. It works when we put out something really great and then we put out more stuff that people really, really like. And once again, it comes back to delighting consumers. That is Rockstar Games' specialty. That is what Grand Theft Auto V is all about, a delightful consumer experience that we think is going to amaze everyone who plays it. And you'll stay tuned, but we feel really good about it.

[Operator:]

Our next question comes from the line of Mike Olson with Piper Jaffray.

[Michael J. Olson:]

You mentioned just now a BBB install base today versus when GTA IV shipped, and is there anything you can say about kind of what your expectations are for GTA V attach rates in the current environment and with the much larger addressable market? And maybe if not specifics on attach rate, just kind of maybe how you're thinking about why attach rates could be different from -- when GTA IV shipped?

[Strauss H. Zelnick:]

Well, we're at a different point in the console cycle, Mike, and there's no doubt that attach rates are lower at the tail end of the console cycle, in general. Because if they weren't, then I'd be telling you that we're going to -- I mean, I guess, I'd extrapolate and so that we expect we'd sell 75 million units of GTA V, which will be lovely, but we're not saying that today and are -- obviously, our financial outlook does not reflect that number. Why do attach rates decline? Because this is a sine-curve business. And when people get new hardware, they overconsume as they get used to having a hardware they underconsume. It's always been the nature of the business for nearly 30 years, and I don't really expect it to change. That said, we're putting out an extraordinary experience, and we do think that avid players and even casual players who own these consoles and some who currently who don't own the consoles will own this title, and we'll be there to serve and meet their needs.

[Michael J. Olson:]

All right. And then can you just talk about the new day and date release features of the next-gen consoles? Is that something that you guys are excited about or more neutral on? And I guess could you share what percent of your front-line titles tend to be downloaded directly today? I'm assuming it's near 0%.

[Strauss H. Zelnick:]

Oh no, it's not near 0. We definitely have full-game digital downloads, and they're meaningful to us. And obviously, we'll let the console companies talk about their own policies. They set them and we adhere to them, because they're our partners and that's the business that they're in. But our own view is that meeting consumers where they are is the best way to run the business. And then you want to make sure that your policies reflect the way people like to consume product. We've always been ecumenical about platforms, channels, geographies and business models. We are not a rule-based company. Our goal is to delight consumers. And the way we do that this by being flexible, bringing them the best products wherever they are on whatever platform they want to consume it. So we are -- we try to be good partners with the console makers, they are our bread and butter. We support them as they do us. We recognize that they set these policies, and we encourage the policies to be as open-minded as possible. But you can rest assure that we will always be, in our view, a leader in being flexible and consumer-friendly within the purview of the policies that the console makers set.

[Operator:]

Our next question comes from the line of Eric Handler with MKM Partners.

[Eric O. Handler:]

Two digital items for you. One, can you give us a sense of how much of your digital business was mobile? And then secondly, maybe you could give us a sense, for the digital business, how much came from Asia?

[Strauss H. Zelnick:]

We don't really break it out, but we did say that the biggest drivers were full-game downloads and downloadable content. But apart from that, we don't break it out with more specificity.

[Operator:]

Our next question comes from the line of Daniel Ernst with Hudson Square Research.

[Daniel Ernst:]

Two questions, if I might. First, on the console cycle. Can you talk about what your expectations are for the size of the install base cycle-on-cycle and what your expectations are for the initial sell in? I think there's some expectations that the console makers will not repeat past mistakes. And how supply -- if you have any view on that within the industry and whether the early part of the console cycle could be bigger than the early part of the last one, and whether this new console cycle could be as large or be smaller than the last one? And then on digital, your commentary around the relative success that you had with a $20 tablet game. I wonder if you could opine to the future, Strauss, as to when we think we could have a tablet game that is as immersive as a console game, and what that point you'd be able to support console-type prices? Can you get the $60 game when you deliver a game that's as immersive on a tablet as it is on a console or PC?

[Strauss H. Zelnick:]

Yes. I mean, the second question first. The console -- the tablets still aren't powerful enough to run our console titles in their full experiences and the way they want. But that we think that's just a moment in time. We think that if you believe in Moore's Law, and we do, it's a matter of just a couple of years before tablet will be a terrific entertainment platform. It already is a great entertainment platform for watching a TV show or watching a movie. We do need an outboard controller that becomes sort of an industry standard that works for consumers. But I have every reason to believe that a tablet will be a great game platform, and we'll be right there. I do think we're a couple of years away. To your point about pricing, we don't tend to spend a lot of time talking about pricing. The truth is that consumers pay for what's of value to them. And obviously, we create a product that's very expensive to make in market, and its price point reflects the intersection of those 2 things. If -- there really is no reason why if you deliver great experience on tablet, we should be price limited. But if we were, we'd have to figure out a different business model, and we're pretty flexible people and we -- I'm sure we'd be able to do that. So we'll listen to consumers and we'll give them what they want. And obviously, the experience that we currently deliver to consoles has a certain price, and it also has a certain cost. And if consumers push back on the individual bite size of a price because it's on a tablet, that wouldn't make very much sense. But if that happened, we could work within those parameters as well by altering and tailoring our product offering. In terms of the console cycle, we're quite optimistic. We don't share our projections or expectations, and we've only announced one title so far, which is the NBA title for next-gen. So we really haven't talked a whole lot about it but, yes, we are pretty optimistic and we're going to leave projections to the analysts.

[Operator:]

Our next question comes from the line of Ben Schachter with Macquarie.

[Benjamin A. Schachter:]

A couple of questions on GTA and then one for Lainie. Strauss, can you talk about the marketing plan, how it's going to differ versus what was for GTA IV? Any changes notably between international and domestic? And then also, I know you can't talk about the digital content plans, you'll have Rockstar do that, but can you just talk about from a pure financial point of view, what does the ARPU look like? Or what is the lifetime value of a GTA V consumer look like versus a GTA IV consumer? And then Lainie, could you just let us know what you think the net cash will be by the end of the fiscal year?

[Karl Slatoff:]

Ben, it's Karl. In terms of GTA marketing, again, this is really something that Rockstar is better first to talk about than we are. But look, we have a lot more of arcane tools at our at disposal than we did back when GTA IV launched. I mean, online is a much bigger component of most marketing budgets, not just ours, but across the industry. There's also other outlets there's -- that we use. I mean, we're very heavy in retail, preorders are a big part of our marketing strategy. So there are some differences. But rest assured, the Rockstar folks have put together an incredibly comprehensive marketing program that ties in all of our marketing partners, including third-party media sources and retail as well. In terms of the digital content plays, that is something that we're just -- we're ultimately impressing [ph] lifetime value of consumers, et cetera, that's something that we just don't discuss.

[Lainie Goldstein:]

And for the cash at the end of the year, we don't provide cash flow projections, but we are going to be cash flow positive for the remainder of this fiscal year.

[Operator:]

Our next question comes from the line of Doug Creutz with Cowen & Company.

[Douglas Creutz:]

It looks like you beat your OpEx guidance in the quarter by about $10 million. You lowered your full year OpEx guidance by about $30 million, and I was wondering if you could kind of talk about what's going on there? And then separately, the game that you took the write-down on, is that a game that was canceled or one that remains in development?

[Lainie Goldstein:]

So for the OpEx, specifically to this quarter, the beat over last quarter was due to the onetime write-off that we -- or the onetime contractual obligation that we had last year. And then for the full year, it's just an overall mix of where we're seeing the business, in bottoms up, we forecasting for the remainder of the year.

[Strauss H. Zelnick:]

Yes. And in terms of the write-down for software cost, capitalized software cost, we're not providing more clarity on that.

[Operator:]

Our next question comes from the line of Edward Williams from BMO Capital Markets.

[San Phan:]

This is San Phan for Edward Williams. Just 2 questions. One, can you tell us a bit more about what your plans for the growing cash balance is, particularly after 2K is released? And then 2, if you can share any thoughts on how you're allocating development dollars across legacy consoles or current chain consoles versus next-gen?

[Lainie Goldstein:]

I'll take the first part of the question on the cash balance. We did mention that we don't provide cash flow projections, but we plan to be cash flow positive for the remainder of the year.

[Karl Slatoff:]

In terms of allocating dev across current-gen, next-gen, we're obviously not going to tell you that specifically. But we can tell you that we're supporting both next-gen and current-gen consoles significantly.

[Operator:]

[Operator Instructions] Our next question comes from the line of Mike Hickey with The Benchmark Company.

[Mike Hickey:]

Just curious, Strauss, on kind of your philosophy if some of your bigger games over next-gen platforms, if you expect any sort of change into how you kind of pace the orations [ph]. I know, historically, you've always kind of left it up to your developers, but with new tech and maybe some more new synergy in terms of less difficulty in terms of competing platforms, you can keep it up at air, at least differently?

[Strauss H. Zelnick:]

Look, it's possible that we are going to find that developing for this next-gen will be more efficient. It's possible to find that it's easier to develop for multiple platforms simultaneously, it remains to be seen. The bulk of our timing of releases though has been driven by making sure that we put out really great titles and making sure that we don't overwhelm audiences and burn out our franchises. Our goal is to try to create permanent franchises, that's the unique goal in the industry. Our competitors do not see it that way. Our competitors' view is that our franchise will have a certain life, and at the end of that life, you move onto the next thing, so you better make hay while the sun shines. Our view is to the contrary. The best franchises are permanent franchises. Outside of our business you can look at James Bond, for example. And it's been our goal not just to preserve and grow the Grand Theft Auto franchise, but also to build other franchises that we think can be permanent, whether that's the Red Dead franchise or the Borderlands franchise or the BioShock franchise or others, Civilization, for example. So I don't -- I think in certain instances, we'd like to see releases paced a little more closely together. I don't really think next-gen is going to change the production approach sufficiently that, that will be the difference that makes the difference.

[Mike Hickey:]

And I was just curious on your kind of view on your competitive profile. Obviously, at E3 this year, there seems to be a lot more representation within the open-world experiences. And of course, we're on the front end here of an emerging console cycle where there can be a big share shift. So just curious how you see the competition.

[Strauss H. Zelnick:]

We have a healthy respect for our competition. We don't take anything for granted. We're fond of saying that we think arrogance is the enemy of continued success. We're always looking over our shoulders and not because we are worried about someone eating our lunch, but because we're worried about making sure that we always provide the best experience to consumers, that we're always known as the standard bearer for what is the very best in interactive entertainment. And to do that, we have to be mindful of what our competitors are doing and what our consumers want, and always give them what they want and then some and to do so at a fair price. So we have the highest weighted average Metacritic ratings in the business, and yet we know we can always do more. Our basketball title, for example, is the highest-rated sports title in the business. It has been for 12 years the #1 basketball title, and yet we still want to do more. We're very self-critical, we're always trying to push the envelope. So are we worried about our competition? Yes. But what are we focused on? We focus on our own knitting, making sure that we do is the very best.

[Operator:]

Our next question comes from the line of Brian Fitzgerald with Jefferies.

[Brian Patrick Fitzgerald:]

Catalog was a key driver for the quarter at 60% of the net rev, and digital is also growing nicely up 130%-ish. How much of the digital is catalog? Have you broken by that, or how do you think about that? Or is it more shift around based on the release lineup? And then maybe one follow-on after that.

[Strauss H. Zelnick:]

Brian, we don't break it out specifically, but we did say that Borderlands 2 downloadable add-on packs was a big driver in the quarter. So it isn't all just catalog. It's good that our catalog is doing so well, it's also good that digital is doing well. It's a mixture of both. You had another question?

[Brian Patrick Fitzgerald:]

Yes, another quick one. So free-to-play, how do you think free-to-play is driving digital also? Are the conversions trending better or how do you think about that in terms of driving your digital side?

[Strauss H. Zelnick:]

We don't -- our free-to-play business is largely limited to Asia, and that business is developing nicely, as Karl mentioned. We expect it to be a meaningful contributor going forward, but it's already turning into a profit contributor, which is also nice. That business has really unfolded exactly as expected. We mitigated our risk and the risk didn't materialize, and we're being unique to see the reward. But outside of Asia, we basically have business for which people pay for, and that's through pretty much across the board for us. We're open-minded about business models. Free-to-play is a business model, in the states, has been pretty checkered. If you take a look at how some of our competitors have done that have tried to play in that space, there was a brief moment in the sun and that moment has clearly passed. We were highly skeptical that, that business, had been said so publicly. And in any case, it was not an area which we had great expertise. So we continue to play in the mobile space, the bulk of those games are sold. And we continue to be open-minded about business models as they develop.

[Operator:]

Our next question comes from the line of Colin Sebastian with Robert W. Baird & Co.

[Colin A. Sebastian:]

Just a couple of follow-ups, I think. On NBA 2K14, wondering if there will be any shipments included in the September quarter? And related to that, can you talk about your expectations for that franchise or that title relative to last year's version? And then secondly, does the pending investment in Activision from Tencent have any impact in your relationship there?

[Karl Slatoff:]

I'll take the Activision piece first. I think there's been any affect at all in our relationship with Tencent based on their investment in Activision. So that's a pretty easy one. In terms of NBA 2K14, can you repeat that question again? I think I missed it.

[Colin A. Sebastian:]

Sure. Will there be any shipments of that title included in the September quarter? And then also, your expectations for the game relative to last year's version?

[Karl Slatoff:]

Okay. In terms of September quarter, there wouldn't be, because the game isn't released in September. And in terms of our expectations versus the last one, obviously, we're very excited about -- the great thing about 2K is that the NBA, that VC team of it, every single release, they're pushing themselves. Strauss talked about competition and always looking over our shoulder just to see who's behind us. And in fact, the team in Visual Concepts has always been doing competition against themselves. And every iteration they try to take the game to the next level. And this NBA 2K14 is no exception. So obviously, we're very excited about the release. We've got a great marketing plan around it. We've got a great deal with LeBron, so we think we're going to generate product consumer buzz, and we have very high expectations for the title. In terms of specifics, can't give you those.

[Operator:]

Our next question comes from the line of Arvind Bhatia with Sterne Agee.

[Arvind Bhatia:]

Just clarification question, guys. The full year guidance, does that include the impairment charge or does not?

[Lainie Goldstein:]

Yes, it does include the impairment charge, Arvind.

[Operator:]

There are no further questions at this time. I would like to turn the floor back over to management for any closing comments you may have.

[Strauss H. Zelnick:]

Just we'd like to thank our shareholders and everyone else for attending the call today. We appreciate the support. We feel like we're off to a good start. We have a lot of wood to chop for the remainder of the year, but things are looking very positive and promising. So thank you very much.

[Operator:]

Ladies and gentlemen, this does conclude today's conference. You may disconnect your lines at this time. And we thank you, all, for your participation. Good day.