Take-Two Interactive Software, Inc. (TTWO) Q2 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to Take-Two Interactive's Second Quarter 2013 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Hank Diamond, Senior Vice President of Investor Relations and Corporate Communications for Take-Two Interactive. Thank you. Sir, you may begin.

Good afternoon. Welcome, and thank you for joining Take-Two's conference call to discuss its results for the second quarter of fiscal year 2013 ended September 30, 2012. Today's call will be led by Strauss Zelnick, Take-Two's Chairman and Chief Executive Officer; Karl Slatoff, our Chief Operating Officer; 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, 2012. These documents may be obtained from our website at www.take2games.com. And now, I'll turn the call over to Strauss.

Thanks, Hank. Before we get started, I'd just like to take a minute to acknowledge that those of us who are here in New York have witnessed and experienced a pretty tough couple of days with the storm that just came through here. Our team has been very fortunate. We are not unmindful of the fact there's been a significant loss of life in this tragedy, a great deal of loss of property and a great deal of displacement and dislocation. Our own headquarters have been displaced by the events. We're located downtown. And I think our team has done an extraordinary job of conducting business as usual despite that, for which I'm immensely grateful. I did want to acknowledge, in the light of that, what we're about to talk today is business. And our business is that of providing people with light entertainment. We take it very seriously but it is -- pales in comparison to the seriousness of these events and we want to acknowledge that. That said, it's our job to go on with things and we aim to do that. In that context, I'm pleased to report that Take-Two delivered exceedingly strong results for the second quarter of fiscal year 2013. Our revenue and our earnings beat guidance due to the success of 2K's Borderlands 2, along with robust demand for our catalog and our digitally delivered offerings. Borderlands 2 has become one of the most critically and commercially successful releases in 2K's history. The title received stellar reviews from the media and consumers alike, achieving an average Metacritic score of 90, including a perfect 100 from PlayStation: The Official Magazine, and a near-perfect 98 from Game Informer. It's already sold more than 5 million units worldwide and consumer demand for the title remains strong. Like…

Thanks, Strauss. I'd like to join Strauss in congratulating 2K and teams at Visual Concepts, Firaxis Games and Gearbox Software for delivering such an incredible array of titles over the past 6 weeks. I'll now turn to our upcoming releases. 2K will build on its success with Borderlands 2 by launching a series of downloadable add-on campaigns for the game. Our first Borderlands title redefined add-on content and, according to research from EEDAR, was able to achieve attach rates more than double the industry average. Earlier this month, 2K released a fifth playable character class, the Necromancer, as well as the first add-on campaign, Captain Scarlett and Her Pirate's Booty, which immerse players in an all-new storyline, expansive environment and hours of additional shooter-looter action. A second add-on campaign will be released soon and all 4 planned add-on campaigns will be available by June 2013 and can be purchased at a discounted price through the Borderlands 2 Season Pass. Today, 2K launched Borderlands Legends, an all-new action-packed Borderlands experience designed specifically for mobile devices. Legends is available for iPhone, iPad, and iPod touch, and 2K is exploring bringing the game to additional mobile devices. An action RPG-strategy hybrid with intuitive touch-based commands and a slick user interface, Borderlands Legends combines the inventory and skill tree management that gamers love about the franchise while adding a layer of strategy that resonates well on mobile devices. 2K is supporting XCOM: Enemy Unknown with 2 new downloadable add-on content packages available this year, along with additional content planned for 2013. The first of the 2 new packs, the Slingshot Content Pack, will be available soon and includes 3 linked council missions with new maps, a new playable squad character with a unique story and voice, and new character customization options. In addition, players…

Thanks, Karl, and good afternoon, everyone. Today, I'll review our results for the second quarter and then discuss our updated outlook for the full year fiscal 2013 and our initial outlook for the third quarter. All of the numbers I'll be providing today are non-GAAP results from continuing operations, unless otherwise stated. Our press release provides a reconciliation of our GAAP to non-GAAP measurements. Starting with our results for the second quarter of fiscal 2013, we delivered net revenue of $288 million, up 169% from the prior year. This result exceeded our outlook range of $200 million to $250 million due to the breakout success of Borderlands 2, along with better-than-expected catalog and digital sales. Catalog sales accounted for 28% of net revenue, led by Grand Theft Auto IV and Red Dead Redemption. Revenue from digitally delivered content grew 108% year-over-year and accounted for 20% of net revenue, driven by offerings for the Borderlands franchise, in particular digital sales of Borderlands 2, as well as the Grand Theft Auto franchise, the Sid Meier's Civilization franchise and Max Payne 3. Gross margin increased to 43.7%, up 13.1 percentage points year-over-year, as this year's second quarter revenue mix was heavily weighted towards higher-priced new releases versus lower-priced catalog titles in last year's second quarter. Operating expenses were approximately $112 million, up about $44 million versus the prior year's second quarter, driven primarily by higher marketing expenses to support the release of Borderlands 2. Interest and other expense increased versus the prior year, primarily due to the convertible notes that we issued in November 2011. And non-GAAP net income was $10.2 million or $0.11 per share as compared to non-GAAP net loss of $39.4 million or $0.47 per share in fiscal second quarter 2012. This result is significantly better than our outlook range,…

Thanks, Karl and Lainie. Our recent results underscore that Take-Two possesses the key attributes necessary to succeed in today's challenging environment: world-class creative teams, the strongest intellectual property portfolio in the business, a measured strategy to invest in digitally delivered content for both traditional and emerging platforms, and a sound financial footing. We remain committed to delivering the highest quality entertainment experiences that translate into growth and profits for our shareholders. I'd like to thank our colleagues for their hard work and dedication, especially during these trying times. Everyone has come together as a team, working in some instances remotely, and making sure that the business continues without missing a beat. It's pretty extraordinary. And for that, the entire management team is immensely grateful. I'd also like to thank our shareholders for your continued support for joining us today, and I wish you all safety and soundness for yourselves, your homes, and your families. And with that, we'll take your questions. Operator?

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

I have just 2 questions on guidance. First, for the holiday quarter, could you tell us what NBA has sold in the past? And then maybe help us understand how you could hit the low end of guidance, I think it's 3 25, with NBA selling very strong, Borderlands presumably getting reorders and XCOM commercially successful. It seems pretty low. Maybe you could kind of -- what would have to happen to hit the low end? And then secondly, when you guided fiscal '13 originally, I think it was over 1.5 years ago, you were willing to guide $2 for that. I'm just kind of wondering, now the GTA has shifted out to fiscal '14, why you can't guide that year at this point?

It's Lainie. For the holiday quarter, we don't give out on a title-by-title basis how the revenue comes together. But I can tell you that it's based on our best estimates as of right now and how we're selling into the market and what our anticipating is going to be with the holiday season, which we think will be very strong. This is done by a title-by-title basis and rolled out. In terms of fiscal year '14, we're not at the stage right now to give out guidance for that year. So we're not doing so at this time.

Okay. And maybe a follow-up. Just to hit the low end though for the holiday quarter, like, would it have to be tough market conditions or would the catalog for NBA really have to fall off? Or what kind of scenario do you see for the low end?

We're not trying to parse it more specifically than that. As Lainie said, we aim with guidance to give our best estimate of where we'll land without too much conservatism or too much optimism. We try to hit what we think will be the case.

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

Wondered if you could sort of help us think about how we can start modeling in Asia and particularly with NBA now going live in China. And how you're looking at that business, I guess, I'm assuming from a royalty standpoint.

Eric, it's Lainie. For Asia, we haven't really shared the details on how the economics are going to work for us yet. So I can't really explain exactly how to model it in. For fiscal year '13, it's a pretty small part of our business, but we plan for it to be bigger in the future years.

Our next question comes from the line of James Hardiman with Longbow Research.

A couple questions here. I guess, this is a little bit of a follow-up to Justin's question. Can you break down to whatever level possible what's changed since the last earnings call in terms of your outlook? I mean, you touched on it a little bit in the prepared remarks, but you basically beat the second quarter by $0.33 at your midpoint. You're bringing down the full year by $1.70. So basic math would suggest you've basically shifted $2 out of this year and into next. Is it as simple as that? Or are there some other takes, some other things on the negative side of the ledger that I should be considering as I think about earnings power this year and next?

James, this is Lainie. The difference between the 2 periods, there's a lot of missing -- there's a lot of pieces that go back and forth each quarter as we update our number. The biggest driver is obviously GTA V is now fiscal year '14, and we've announced that it's during spring 2013 release time period, not in this fiscal year. The revised estimates are mostly the updates on our currently released titles. Obviously strength from Borderlands and NBA and our catalog. But there's also other titles that will go up and down depending on how they're performing in the marketplace. And we also feel our -- we have continued strength in our catalog into Q3 and Q4 that's included in our numbers for this year.

Fair enough. Let's talk a little bit about the fourth quarter sort of implied guidance. Obviously, with BioShock Infinite coming out, you guys feel pretty good about how the fourth quarter is shaping up. If I sort of back into a sales number, I'm looking at about $286 million, which is pretty close to what you guys made in the second quarter. But the earnings power seems to be a lot better. How should I think about sort of the margin profile in the fourth quarter? Does that say anything about Borderlands versus BioShock? Or is it -- are there some other margin factors that allow you to generate a little bit more on a similar top line in the fourth quarter?

For the fourth quarter, which we're not giving guidance out for right now, I can tell you the big drivers will be BioShock Infinite, continued sales of NBA and Borderlands 2 and XCOM. There are some titles that we haven't announced yet. There's also going to be some significant marketing cost during the quarter for some titles for that quarter, as well as for future -- like, future periods right after that.

So should I take that to mean that given a spring release of Grand Theft Auto, that we're going to see some significant marketing spend this year for a next year release for GTA?

I'm not going to share that level of detail at this time, but it definitely includes marketing for some of our key titles that would be coming in the future.

Our next question comes from the line of Arvind Bhatia from Sterne Agee. Arvind Bhatia - Sterne Agee & Leach Inc., Research Division: A couple of things here. One, I wanted to see if you could give us a general idea of how many, say, AAA titles you might be thinking of in fiscal '14. I know you're not giving specific guidance. But just for all of us to be in the ballpark of how you're modeling outside of GTA V, of course you're going to have the annual titles, the NBA, et cetera. But could you at least, at a high level, give us that sense? And then on GTA V, what's the reason that you're not giving a specific date at this point? And logically, this is going to be in the first quarter of next fiscal. But is there any reason why you're not announcing a specific date today?

Thanks, Arvind, for your questions. We have announced, for fiscal '14, XCOM coming from 2K Marin. And obviously, Rockstar has announced GTA V. And we said before, our release schedule includes announced and unannounced titles. We're not giving more color on fiscal '14 right now, but obviously, we will in the future as we would in the normal course. And with regard to the date for Grand Theft Auto V, spring 2013, we make those announcements based on what we think is best to market the title. And that we think that, that's the right way to describe it and we're just thrilled with the way that is shaping up. Arvind Bhatia - Sterne Agee & Leach Inc., Research Division: Last question. On BioShock, you mentioned some of the reasons you're feeling stronger. Can you quantify the pre-order trends that you might be seeing with BioShock right now?

We're not giving out that information right now.

Our next question comes from the line of Douglas Creutz with Cowen and Company.

I was wondering if you could give any color on how the Borderlands 2 Season Pass is progressing. If you're willing to give an attach rate, that'd be great. And then if you could discuss how the accounting for the digital revenue is going to flow through your P&L. I assume it's going to be amortized out over several quarters. But if you could just talk about that, that'll be helpful.

Yes, like everything Borderlands and Borderlands-related, the Season Pass is phenomenally successful. Borderlands -- the first Borderlands really set the standard for how downloadable content could be released and how consumers would pay for it and enjoy it. And Borderlands 2 is seeing extraordinary success with its downloadable content, extraordinary success. So we feel just great about that. And Lainie will address the amortization issue.

Sure. For the past [indiscernible] free item. During this quarter, for GAAP purposes, it'll be recognized when it's delivered, which is in Q3. But for non-GAAP purposes, it's included in our numbers in this quarter.

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

I was wondering if you could help us just understand the potential for the online Asia games going into next year. If you think about how should we rank order them or maybe think about how you're allocating marketing spend or are you involved in those discussions? Are you involved in putting marketing dollars to work there? And then, separately on GTA V, how differently should we think about the online potential there versus the online revenue of the last generation?

Thanks, Ben. We are involved with all the key decisions on all of our titles. These are partnerships with the strongest local partners in the various local markets in which we operate. And they are real partnerships. So we're involved with every part of the decision-making. We wouldn't normally give details on how much we're spending on any given title. What is nice about online titles is that consumers are involved with the development in a way because you go to beta and you begin to see metrics from the title, and the online titles can be living entities -- living, breathing entities where what the consumers are doing can influence exactly what we're delivering to consumers before we actually go live. And then when we're actually live -- for example, we're now live in China as of the 24th -- we can still further iterate the title to meet consumers' needs and expectations to drive results. So how much we spend on marketing will reflect in no small measure consumer uptake of the title on an ongoing basis. So our expectations prior to launch wouldn't really be that valuable except to say the resources are there to support these titles as they roll out. And the initial indications from China are excellent and very encouraging. And we feel quite encouraged about what we're seeing coming out of Korea as well, and how that might translate to the rest of Asia. I think the second question was about the potential for digital content for Grand Theft Auto V, and it's way too early to discuss those plans. And of course, those discussions would come from Rockstar in the normal course. I think you can safely assume Rockstar, as the label that led the charge in downloadable content with Grand Theft Auto IV, I think you have every reason to believe, particularly because of the groundbreaking nature of the title itself and the multiplayer in the title, that there's going to be a lot of interesting stuff. But I'll leave that to Rockstar to announce.

Our next question comes from the line of Brian Fitzgerald with Jefferies. Brian Patrick Fitzgerald - Jefferies & Company, Inc., Research Division: Maybe a little drill down on -- to follow up to Doug's question in terms of the Borderlands pass, is it safe to assume that you're encouraged enough to say, "Hey, we ought to do other pass type of programs with some of our other titles." And then, second question. Initial takes on your thoughts -- with the upcoming Wii U and the Microsoft SmartGlass products, how are you thinking about those and their impacts on the industry?

Yes, we have actually had other season passes. Rockstar has had season passes, and we've been involved with them before and with varying degrees of success. It falls in the category of give consumers what they want at a fair price, and they'll come out for it. In the case of all of our downloadable contents across all of our labels, our goal is always to give consumers more than they pay for, so that when they show up -- when they keep the title as opposed to turning it in, and when they stay involved with the title, we're going to make that really worth their while. And that's true across our entire company. And I think Borderlands is a great example but certainly not the only example of that. Turning to your question about Wii U, we are supporting Wii U. We have NBA 2K coming out for Wii U on the 16th of November, and we're very excited about that. We'll see how it does. In terms of particular devices, I'm a huge believer in tablets. We've been very supportive of all things tablet and mobile-related and we think the world of Microsoft. So we assume they're going to figure it out. They always seem to.

Our next question comes from the line of Atul Bagga with Lazard Capital Markets.

A couple of questions on China and Asia business. Can you give us some more color on NBA in China? How big -- what's the user base now? And what kind of monetization you're seeing in China? And second, based on your initiative in China, any plans for bringing NBA free-to-play in the Western market? And lastly, 2, 3 years from now, how do you see -- what could be the scale of this business in China, Korea, Asia?

Thanks, Atul, for your questions. I can't really help you out. We don't typically give that level of detail and it would be premature to do so anyhow. Obviously, the China market is very, very significant in scale and free-to-play massive multiplayer games can do very well. At any given time, 10 or 20 of them are performing quite well in that marketplace, which creates a business opportunity vastly larger than anywhere else in the world. We have no -- we haven't discussed any plans to bring NBA online elsewhere. We have a great relationship with the NBA and we aim to delight consumers. I think whatever we do will be market-specific. I don't think you'd see a simple port of a title from one market to another. We would tailor anything we do to the needs of the particular market. And in terms of the scale, again, we haven't contemplated, and I think part of that is our approach in general to projections. This is a volatile business. We've said it before. In many instances, we've done better than expectations. In certain sad instances, we've missed our expectations. And we seem to be in a very good period right now and we like that. What we try not to do is -- we try to talk about what we're up to in a way that provides transparency, but not claim success until we actually deliver it. That's typically our approach. So the potential scale for any business in China that's successful is obviously enormous. The potential scale for our businesses there, it remains too early to say. We are trying very hard. We have great partners. We have great intellectual property. I am really proud of what we've been able to do from a standing start. I'm particularly proud because we did it with such limited risk. And that's very important as stewards of other people's capital and our own capital as well, since we're all shareholders here on the phone today. That's a crucial way to look at it and it is the way we look at it. But we try to do the best job we can and success will take care of itself.

Our next question comes from the line of Colin Sebastian with Robert W. Baird. Colin A. Sebastian - Robert W. Baird & Co. Incorporated, Research Division: As we're now looking ahead to the big launch next fiscal year, it brings up a question more generally, I think, whether there's any added pressure at the developer level to deliver key titles in advance of next-gen console launches, or even if that plays a part in how you're determining launch windows. And related to that, I wonder how we should think about the ramp-up in operating expenses over the next year on new platforms, if that might mitigate some of the shift in EPS that we see moving out of fiscal '13.

Yes, in terms of timing. I think we are very mindful of the potential console transition. Of course, we rely on the information we receive from our hardware partners, as does the market, and we typically don't comment on it. We are very mindful of an upcoming transition. And the consumer behavior puts a fine point on that because as we head into the maturation of the cycle, we see tie ratios come down and you've seen what happens when that happens. It fits very well with our stated strategy, which is we try really hard to do only the highest-quality titles, the titles that consumers will show up for without regard to where you are in the hardware cycle. In that way, we can really benefit from a large installed base, which we already have and which will grow larger through the holidays for today's hardware. And we are -- while not immune, we are less at risk for the lower tie ratios because we're putting out must-have product. If we don't put out must-have product, we too will be hurt by the fact that people are more selective in their purchases as you head into the end of the cycle. Everyone in our company is mindful of that, not the least our creative teams. So we're all very, very mindful of that. In terms of your second question, we don't have a ramp-up of operating expenses for next generation. Like everyone else in the business, except one of our competitors, once we reach technical feasibility, we capitalize our software development. And at that point, it no longer hits our P&L until we release the title, at which point we amortize it in accordance with GAAP, as you know. So we wouldn't expect our operating expenses to increase. And I think I'll answer a question you didn't necessarily pose, which is -- has been posed, which is, do we believe the titles to be a whole lot more expensive to make for next gen? And the answer is, we do not. In many instances, we believe that it may be somewhat easier to make titles for next-gen, depending on how the technology comes together.

[Operator Instructions] Our next question comes from the line of Mike Olson with Piper Jaffray.

Just a question about the kind of general pipeline, not necessarily games-specific, but any color that you could provide as far as recurring seasonal strategy for your games? Obviously, you've got NBA 2K, and should we think about May as always including a major Rockstar title like L.A. Noire or Red Dead, or just in general how you're thinking about kind of the annual strategy for some of those games?

Well, as those of us -- those of you who have followed us for the last 5 years know, we aim to diversify the products of the company and to build up and diversify the release schedule, while staying true to the company's DNA of focusing on owned intellectual property and only the highest quality interactive entertainment. And the company has been extraordinarily successful at diversifying its release schedule. Since 2007, we've released at least one multimillion unit selling title, new intellectual property every year, sometimes more. At the same time, we do not have a strategy of annualizing our titles apart from our sports titles, which are naturally annualized. And the reason is that -- really several-fold. The first is, we want to put out the highest-quality titles and we think it's tough to do that annually, although one of our competitors in particular does a very good job of it. The second is that we think you preserve the lifespan of the intellectual property by limiting the releases to less than annually. And the third is that primarily, we're focused on quality and we put out a title when it's really great and really ready to go. That said, the release schedule is much more robust than it used to be and I expect that to continue to be the case. With regard to our label strategy, first of all, probably better that our labels should talk about it and they do. That said, again, we have -- the commonality we have across the company is to try to be the most creative shop, the most efficient shop, the most innovative shop. And I feel that while we can always do better, we're making strong progress across all 3 of those dimensions.

Mr. Zelnick, it appears we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Once again, I'd like to thank all of our colleagues at Take-Two for stepping up at this very difficult time. I'd like to thank our shareholders for joining us and we wish you well.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.