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Executives

Strauss Zelnick - CEO

Analysts

Stephen Ju - Credit Suisse

Take-Two Interactive Software, Inc. (TTWO) Credit Suisse Technology Conference December 3, 2013 1:00 PM ET

Question-And-Answer Session

Stephen Ju - Credit Suisse

I am Steven Jew from Credit Suisse Internet Equity Research Team. We’re joined by Strauss Zelnick, CEO of Take-Two Interactive. So welcome Strauss.

Strauss Zelnick

Thanks for having me.

Stephen Ju - Credit Suisse

Great. So let’s march right into it. So Take-Two and others in the industry move from having development teams to more of a cost of follow-up with additional downloadable content in between major releases. Do you feel like from a management perspective that you have to run harder to stay still or as you evaluate each franchise on its own merits, the return on invested capital has increased?

Strauss Zelnick

I think you always feel like you have to run harder but hopefully not stand still. We’re really pleased with the progress that we’ve made at this Company in the last six years. Most investors have pretty much left the company for dead in 2007. It was pretty rough state of affairs and despite big market events in 2008, we’ve been able to create a great deal of value and to delivering the promise, the promise being delivered, a diverse array of the highest quality interactive entertainment experiences to consumers all around the globe without regard to their platform or their business model or for their demographic. And we’ve been able to largely to do that while still maintaining the number one asset the company had to grab that [indiscernible].

So we didn’t lose anything in terms of what we had and we added a whole lot, specifically the introduction of at least one new intellectual property every year since 2007. Today we have nine franchises that have sold each at least 1 million to 5 million of release, which is extraordinary. I think we have the best collection of owned intellectual property and the business. We have I think put it now and it certainly wasn’t before the top worldwide marketing and distribution system. I think most people in the business would agree with that, if you look at our results pound-for-pound, and we have for sure the best creative teams in the business.

So those are the assets we have. Its cut into a platform transition, there is pressure placed on the business. I think you’re alluding to that and the companies that tend to survive and thrive are those with strong creative teams, strong owned intellectual properties, strong technology and a strong balance sheet and we think we fill the bill on all four of those things. So, are we always running harder? Yes, because this is very much of what have you done from your lately business, not just in rooms like this but with regard to consumers too. And we’re mindful of that. So we have a lot of great stuff to come.

Stephen Ju - Credit Suisse

So, on your earnings call you talked about acquisition opportunities as a potential use of cash. Would you be looking at content IP or technology or both? What are the right criteria to fit into the portfolio you’re building?

Strauss Zelnick

Well, first and foremost, it seems to me that you only do deals when they’re accretive, and it seems like that memo was lost by some of our peers in the business, but we only do accretive transactions. And by accretive I don’t mean high in the sky accretive, I mean like dollars and cents EPS accretive.

So, we’ve been really selective. Our acquisitions over the years have been very small, driven by intellectual property and talent simultaneously. We now are blessed with a very strong balance sheet and that gives us opportunity to spread our wings, but we remain highly disciplined value investors and I don’t think you should expect that to change.

In terms of use of capital, there are a number of opportunities. The first is we’ve built this thing on the shoestring and our organic growth has been nothing short of extraordinary. In 2007 the Company’s revenues, excluding the non-core division which was divested were about $700 million last year, last fiscal year. So also a non-GTA year. They were about $1.2 billion. That’s all organic growth. We’re proud of that record and we think that that’s what we get paid for; to deliver that. And it’s nice to have some capital, so that we can invest behind organic growth initiatives without having to couple together every single investment with third parties. So you should expect more organic growth. Certainly, we’re driven by a focus on that.

Secondarily, we have an opportunity to return capital to the shareholders. We just bought 16.2 million shares of stock. We deployed $270 million to do it. We’re a cash generating enterprise. We’ve said that we expect to be a cash generating enterprise going forward and we expect to be profitable and our profits to put to cash.

And then thirdly we could look at accretive M&As, but I want to emphasize that’s going to be both strategically and opportunistically driven; strategically in that it has to fit with our DNA, which is interactive entertainment and digital content and opportunistically in that the values have to work.

Stephen Ju - Credit Suisse

Got it. So on the last call you also talked about and then brought this up just now, the prospects for the company to be profitable for the foreseeable future, and I know you are reluctant to bring up the very specific game release plans, but would you share with us the underlying business plan that is driving that financial [indiscernible]?

Strauss Zelnick

We’re being more forthcoming than we’ve ever been before. We’ve said – I’m known to be pretty conservative, with not much of the stock tower and we’ve said we expect to be profitable next year and for the foreseeable future. Those are not words I use lightly. And I have yet to be wrong when I’ve said things like that. So that’s good little guidance. We’ve also said we’ve more than 10 projects in development for next gen, both current franchise, sequels and new intellectual property. That’s a lot of color on our upcoming release schedule and a great deal of color.

And beyond that I’m frankly not sure what color would benefit. If I said we have a title called Stephen's Life in Elementary School next October and I told you it was going to sell 20 million units, what credibility could that possibly have? New intellectual property is a risky business. So I think the news is we are pretty proud of the fact that we timed the completion of the current gen releases so well.

We're really proud of the fact that our last several releases have been very successful in an exceedingly challenged market, and not just the massive success of GTA V but also the success of BioShock and Borderlands 2, NBA, WWE. The fact that NBA is one of the most highly rated titles across the board for next-gen is extraordinary with us, a sports title fitting the bill there.

So we seem to be firing on all cylinders. I understand the market would like as much clarity as possible. In a pure-play entertainment business, what I just said is an awful lot of clarity. Can you really imagine how more clarity could help someone because I would just be puffing. And I know that is not unlike some of our competitors but it’s just not what we do. We haven't done it for six years. Lord knows we’re not going to start now from -- I didn't do when I was in the position of weakness. Why on earth would I do it from a position of strength?

Stephen Ju - Credit Suisse

Got you. So you brought up the prospect of a stock repurchase earlier, but with Grand Theft Auto performing so well, you will be pretty flush with cash after this holiday season also even with the repurchase. But even after the repurchase of shares held by Mr. Icon [ph], the stock has not really reacted. So does this color your stance on returning even more value to shareholders?

Strauss Zelnick

We didn't do the buyback in order to move the stock. I have been on the record about buybacks. Typically buybacks don't create shareholder value, unless they are done when the stock is trading at a deep discount to underlying value, and on the record of saying it at conferences like these, I’m a big believer that don't look at what someone says, look at what they do and I just voted with $270 million of our capital that I feel this buyback fits the bill. That's just one man's opinion and I defy you to find me any CEO who thinks his stock is overvalued. But it is our view that this was an opportune moment, and it was the right thing to do. And it's very simple, all you need to do is little tiny bit of balance sheet analysis and you can take a look at what our enterprise is trading for.

Stephen Ju - Credit Suisse

So as a content creator you obviously want to be where the consumers are, but the package goods model does not work in all geographies. So Take-Two's footprint is probably not as wide as it could be and I’m a demise [ph] to think that good content should be able to travel anywhere. So what are your thoughts on alternative revenue models in other regions to be able to address those users who are waiting for your content?

Strauss Zelnick

It’s a great point. Asia for example, China specifically is a free to play market and that's why we entered China with a partner, with Tencent and NBA 2K Online is a free to play game that we monetize with in-game payments and that's been viable for over a year and continues to do well. It’s one of the top 10 games according to QQ Games in China. We have our free to play model in Korea as well with our baseball title. We have done a number of free to play titles over there.

We have also experimented with mobile games, built just for mobile in Japan quite successfully. So we have expanded into Asia with a mindset that's driven locally and says okay what do the Asian markets want, not what do we want but what do the Asian markets and consumers want. And we're equally flexible here, where we have put out some free to play titles, we do have in-game payments available for our NBA title and also for GTA. We’re pleased with the progress that we’re making on both. So we intend to be very, very flexible.

That said our D&A remains in these very high end AAA immensely immersive experiences and I don't really see us deviating from that. So we'll be flexible on the business model as much as possible, certainly be flexible on channels of distribution, be very flexible on the platforms that we support, but I think where we probably are not going to deviate is quality and immersion. That is what we’re known for.

Stephen Ju - Credit Suisse

I think at this point we'll open up the floor for some questions from the audience. But while we're waiting I'll log in a few more. So the first the time ever in a console cycle, the new boxes are not shipping with backwards compatibility, which pretty much forces consumers to re-acquire some of the content that they have already purchased for their library. So do you think this move will be a hindrance against more rapid adoption of this cycle?

Strauss Zelnick

Well they don't have to repurchase, as long as they keep their old box, as long as it's still working and with a switcher, which is no big deal. So I don't see it as a problem at all and there maybe, you certainly, if we have the physical ability to port, so that's not and wouldn't be particularly costly. The question is there an economic opportunity for us to do so. I don't think backwards compatibility affects consumers at all.

Unidentified Analyst

Just two questions. First vis-à-vis your outlook for next fiscal year, I know you are not giving too much detail. But is there any context you could give in terms of how much of that profit expectation is due to an expected contribution from GTA V revenue versus the entirely non GTA?

Strauss Zelnick

No we haven't given our outlook yet obviously for the year and we also haven't really talked too much about GTA V beyond what we done already, which is the release of the game itself, both physically and digitally and the release of GTA online and certainly we've announced that we have in-game payments. We haven't given a lot more clarity than that, and you can certainly expect some clarity over the coming months. So it would be premature to talk about that. But look GTA IV is still a revenue generator for us. GTA is a master franchise for the company and the frontline release is doing great and the catalogue would be expected to do great minimally, and that's without any other information.

Unidentified analyst

And I know you're not providing a lot of information in terms of the online strategy of monetization, but from a high level, could you just talk to, given the genre of the game and so forth, if there's any reason from a digital standpoint that should monetize better or worse than other AAA titles out there that have big digital presence, I think -- FIFA or a Battlefield or a Call of Duty, so forth.

Strauss Zelnick

Well remember there are titles that have a big digital distribution presence through both frontline releases and downloadable content that don’t have the ability to do in game payments. So FIFA does, NBA does, GTA online does. So that's a big distinction right there. But we haven't yet described what's going on, it's pretty early. We only switched on in game payments pretty recently.

Unidentified analyst

There's no reason it should be able to monetize better or worse than other large titles? I mean is there anything that sets it apart or makes it different when we each think about the overarching monetization ability backing in digital versus other large….

Strauss Zelnick

Yes I guess GTA, I mean that's the biggest performer.

Unidentified analyst

Which means it should be more monetizable or….

Strauss Zelnick

I think it could be. It depends on how we do it. I have to tell you that we're really, we've announced we sold over 29 million of the title. I feel like we’ve got well paid for our efforts. Our focus with GTA Online is to delight consumers, while the goods that we're selling in the game are intended to enhance the experience first and foremost. We are charging money for them but the way we do business at Take Two is first and foremost driven by this desire to delight consumers. That's why we have the highest metacritic ratings in the business for the past five years, and not just because we're altruistic and we love doing it -- by the way we really do love doing it and we’re passionate about it, but because I really have always been a believer in every entertainment business I've been in, that if you start by making consumers really, really happy there's always an option to make money on that basis.

Many of our competitors really do think about monetization and second about what they supply, we think first about what we're supplying and second about monetization. So it's not that I'm being coy about what's going on. We're really focused on making GTA Online an extraordinary experience and we’re new to this business. Not unlike some of our competitors, we are unafraid to be honest about that. We didn't build a massive infrastructure in advance of GTA Online. We had some glitches along the way as a result. As a result we kept the cost extraordinarily low as we explored this new marketplace. But it really is too soon. Could I imagine a world in which in-game monetization is very special because the GTA absolutely could. Are we ready to say that now? We’re certainly not.

Unidentified analyst

In just one separate somewhat unrelated question. When it comes to full game digital downloads, it seems like from a straight economic standpoint, it’s neutral for yourself in the sense that you're either paying Best Buy or Games Hub, also margin you're paying it to Xbox or PlayStation Network for their game store fee. But the benefit of digital is that you have infinite abilities to merchandize and price and experiment around pricing and promoting your product, which you can't do in a physical world per se. So it seems like you have a benefit from that regard if more is shipping digitally. What’s your expectation in terms of two years, out how much of full game downloads are digital and what kind of benefit could that bring into your business.

Strauss Zelnick

Well first of all, we do get some margin benefit although as you point out it’s not massive, some of our competitors seem to think it’s massive but I'd love to figure out why they think that. We said repeatedly we do get a modest margin benefit and exactly the math you just referred to gives us a small benefit and we're happy to have it.

In any given quarter, our digitally distributed revenues which is obviously frontline and catalogue and DLC and, and, and, represents 20% to 30% of our business depending on what our business looks like. That's up from zero, just a few short years ago. Hard to know what percentage of the business becomes digitally distributed. It seems to me if history is any guide, we're moving very much in that direction, but we’re ecumenical, Retail's an important partner for us. We're happy to support retail. It is the bulk of our business now. And we're not voting, we’re saying, wherever the consumer us that's where we want to be and we want to be a leader or whatever that is, but if I had to guess I don’t know, maybe it goes from 20% or 30% to 40% or 50% in a pretty short time.

Unidentified analyst

[indiscernible]

Strauss Zelnick

Depends on the quarter. Yes, it really does depend on the quarter.

Unidentified analyst

Just similar to that question, how should we think about margins in terms of GTA monetization and things like that with in-game payments versus what you just spoke about in terms of full game downloads?

Strauss Zelnick

Let me not talk specifically about GTA, but obviously we have to amortize the development cost. We write off our marketing costs. At a certain point in time when those are amortized, everything else is gravy after you cut in your distributor. So you could imagine your margins go up over time with big hits and that’s true for all entertainment businesses. Sorry not to be more specific, but we’re not giving much more color than that.

Unidentified Analyst

And then just in terms of OpEx, as we’re thinking going forward supporting both current gen and next gen, would there be any reason to think that there would be pick up in that in terms of R&D cost supporting both generations’ of consoles?

Strauss Zelnick

You mean that it will get more expensive?

Unidentified Analyst

Yes.

Strauss Zelnick

No. That doesn’t appear to be the case.

Stephen Ju - Credit Suisse

There is someone who is in front now.

Unidentified Analyst

When you look at the next generation of tablets that are coming out, especially the new iPad has got 64-bit, the ability for those tablets to actually for a gamer, whatever, to use high performance videogames on those tablets, is that something that could be a pretty big growth drive in terms of the amount of people that have the accessibility to your products versus selling that has to either have a high performance computer or an Xbox or whatever going forward?

Strauss Zelnick

The short question is yes, but let’s try this way. Two years ago how many people in this room owned a tablet? Two years ago? Now how many people in this room own a tablet? Two years ago how many people in this room were taking notes on a tablet? I mean like how many of you were taking notes on tablet versus paper, let’s say paper, two years ago? You guys have pretty forward thinking. Today how many of you are taking notes on paper? How many of you are taking – maybe case enough to take notes? But anyway, you need a tablet. The answer is look tablets -- I’ve saying this for years, I stated before the iPad was launched, and we bet the high ended tablets will be ubiquitous. They will be used for interpersonal communication. They will be used for business. They will be used for entertainment purposes.

Let me try another Q&A. How many of you believe in Moore’s Law? Yes, most of us believe. It’s not -- by the way, not everyone does believe Moore’s Law. Moore’s Law will come to an end at some point in my opinion. But it’s still alive and kicking. By the way Moore’s Law was a tongue-in-cheek law when it was proved. That’s what I love about it. Actually, it’s sort of Peter Principle, also tongue-in-cheek when it was first expressed, but of course turned out to be true.

So if you believe that tablets would be ubiquitous, which I do and Moore’s Law on the other hand which I do, then that tells you tablets will be a perfectly fine entertainment platform for high end immersive videogames. If you view is that we ought to be everywhere, without regard to business module or business partner and that is our view, then we’ll be making our titles available for tablets and we do it through our own website and through Steam and Valve. We’ll do it through Sony and Microsoft, export it and anyone else who is legitimate and supports it and protects our intellectual property, and I think it’s going to be a great system for videogames and will vastly expand our marketplace.

Unidentified Analyst

And like over the next five years, do you see guys transitioning yourselves to a gaming-as-a-service business model, where for example like you’ve seen it with some of these lower performance games that are done online where you buy weapons or whatever; you buy tools or is that something that you guys can move toward like in terms of like; let’s use Grand Theft Auto as an example, might be like a new car or something like that and then users go on, download the new car and they’ll pay some sort of fee?

Strauss Zelnick

Well, you can do that in Grand Theft Auto Online.

Unidentified Analyst

Okay.

Strauss Zelnick

[Indiscernible]. So what I think you’re eluding to is a free-to-play system, where it costs nothing to enter and then you pay in game, and that is somewhat interesting model in Asia for example. It’s only choice in China. We have to be flexible about it. In the U.S., it’s not a very powerful model, certainly for us because I’m not psyched about a business that 3% of your customers pay you, which is where you dealing with, but again we’re flexible on it. That’s the way the business evolves. As long as we can get paid and make a profit doing it, we will be happy to contemplate it. I'm skeptical that for very high end products, that’s the way the business goes. I think you will continue to sell those high end products as the entry point and then you will have game monetization for certain sold items and free items.

Unidentified Analyst

Just two quick ones. You mentioned NBA 2K Online in China, you mentioned [ph] game rankings, but any other metrics you’ve given out in terms of the revenue run rate of that property? Obviously China is a big market. Basketball is a huge sport there. Anything additionally?

Strauss Zelnick

We have said it’s not huge for us yet. We have said that it is profitable and that contributes but it is not massive yet and beyond that we haven’t given more color.

Unidentified Analyst

What’s the inhibitor to that being bigger than it is?

Strauss Zelnick

The real inhibitor is when we embarked on that project four and half years ago, our company was much, much, much smaller. So for it to represent a meaningful part of our revenues, that has to be much, much, much bigger.

Unidentified Analyst

Understood.

Strauss Zelnick

But it’s doing fine in China. It’s not the number one game and the sport games in general not number one games over there. So it is like all entertainment businesses; the very top titles do very, very, very well. So the inhibitor for it being huge would be, it would have to a sort of top 1, 2, or 3 and it isn’t there right now.

Unidentified Analyst

But is the even -- I mean as a percentage of your digital revenue, is it even, I’m looking at what your digital revenue is, is it even over 10% you digital?

Strauss Zelnick

Yes, we’re not, I don’t want to parse it here. We haven’t done that yet.

Unidentified Analyst

And then just one second quick question. How is the perception -- any view on how the perception of the video game industry, software industry has changed for the media companies. It seemed like years ago there was a lot of interest by media companies getting the videos games, Then that kind of seemed to fade a little bit. All the focus has been on online gaming, free-to-play, so forth, not so much console. Now we have a new console cycle in market. It’s doing well so forth. So have you seen any change in this perception by the traditional media companies in terms of console video game software segment?

Strauss Zelnick

I have not. I mean there are couples that focus on it. Warner Brothers Interactive has done a great job building a business, really a phenomenal job. Disney continues to focus on it. Then there are others who really exited the business, like [indiscernible] and then there are ones that are sort in between Fox. It does not seem to be a massive area of interest for traditional content companies, not sure why because it’s the only growth industry in entertainment content and has been for some time. But probably question better to ask them.

Stephen Ju - Credit Suisse

So with GTA you probably have the largest user base of any console publisher out there. Is there any mechanism by which you can get that user base to register their information with you so that you can think about cross marketing some of the other Rockstar or even the 2K products?

Strauss Zelnick

We have a lot of information because we have the Rockstar Social Club and we know a lot about our consumers already.

Stephen Ju - Credit Suisse

So, let’s look into the [indiscernible] crystal ball. So five years from now do you think the install base for the PS4, plus the Xbox One globally is greater than the PS3 and the Xbox 360 today?

Strauss Zelnick

Yes I do but I don’t think you should put any stock in that whatsoever, because it’s just too early to know. The supply has been so tightly controlled, and someone we met with earlier said this is a supply story, not a demand story so far. It’s just too early to say. I think the good news is that consumers like the platforms and I feel very, very good about them. I need to stress where ecumenical and whether these new platforms succeed or fail we’re bound and determined to succeed by giving people fantastic interactive entertainment experiences and making them available for whatever platform they consume them on. If these platforms don’t succeed they’ll be consuming them on other platforms and they already do.

But yes, as a betting person I’d say yes and I’d specifically say yes because it appears that and this is largely anecdotal but tablets are a good example. All these new iterations of more and more exciting hardware seem to pick up in velocity generationally compared to five or 10 years ago. But if we had big market meltdown for example, repeat of ’08 and ’09 in three years or two years or two minutes, that would influence certainly. If this economy says on this track, yes, I feel pretty good about it.

Stephen Ju - Credit Suisse

And with that we’re out of time.

Strauss Zelnick

Thank you very much.

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