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Take-Two Interactive Software Inc (NASDAQ:TTWO)

BMO Capital Markets Technology & Digital Media Conference Call

December 11, 2013 1:15 PM ET

Executives

Karl Slatoff – President

Analysts

Edward S. Williams – BMO Capital Markets

Edward S. Williams – BMO Capital Markets

All right, good afternoon. We’ll go ahead and get started with the afternoon presentation. So thanks all for joining us. I’m Edward Williams, the Digital Entertainment and eCommerce analyst for BMO. And I’m pleased to have with us here today Karl Slatoff, who’s President of Take-Two Interactive. For those of you who do have questions feel free to ask for questions later on but you can also submit question via your app and I will see them up here. But Karl just go ahead and get started. Obviously, this has been a key fall for the interactive entertainment industry as a whole, for two – Take-Two specifically going back to the launch of GTA V. But if you look specifically at the launches of PlayStation 4 and Xbox One, how would you characterize how the launches have been relative to what you’re thinking off in relative to what you’ve seen in prior cycles?

Karl Slatoff

Okay. Well look – I mean we’re actually very pleased and excited about where the launches are right now. And this is our caveat in with the idea, this is still early days. And when you’re coming out with the console cycle when you have a holiday season, there is an underlying expectation that whatever product is this pent up demand and whatever product is in the market will typically sell out or close to being sold out. But this was a little bit different because there is a lot of noise around the gaming industry in general and a lot of question about whether this console cycle will have the same juice in this one that we’re going into, will have the same juice as the previous console cycle.

And there is a lot of doubters about whether or not the console – the console market in general is dead. And I think the successful launches for the PS4 and the Xbox One have proven that obviously console gaming is live and well and there’s some people who are very excited about these launches. And it’s 7 million units in the first day across – the both consoles do that. I feel – I think they both have now announced that they’ve sold over 2 million units each. That’s a pretty big, that’s a pretty quick uptake. I believe Sony, I don’t want to speak for Sony but Sony said that it took them I believe a month or – two weeks to sell a million units before, I can’t remember the specific thing, but it took a much longer time.

So the uptake was – has been very quick. And I think that’s a very positive sign for us. But again you really will learn more as things go out, but – and also as more content is available on the systems, you’re going to get a real sense for what the appetite is for the – for this generation coming up, but today we’re very pleased and very excited about it.

Edward S. Williams – BMO Capital Markets

From your perspective, we’re to look at NBA 2K, can you give us a little bit color as to the differences in costs associated with bringing games out on PS4 and Xbox One relative to prior console cycle. So my recollection is that with the launch of the 360 and the PS3, there is a massive increase in the development cost.

Karl Slatoff

Right.

Edward S. Williams – BMO Capital Markets

Are we looking at the same sort of function of an increasing cost or how would you characterize that?

Karl Slatoff

Yes, I would definitely characterize it as – look you can always spend more money and with more capabilities which these systems do have, you always have the ability to add more to the games which by definition should put pressure on costs and you have increased cost. But the magnitude of the increase is much, much smaller than it was going from the last generation to this generation. And primarily based on the fact they were already in the HD – in high definition mode with our current generation.

So you’re not going to see that size of leads that you had last time. But like I said before there is opportunity to do more and that should translate into higher costs. But importantly mitigating that higher cost, I think is the efficiencies that we’ve gained over the last generation in terms of the structure of our organization and then speaking specifically for Take-Two at this point, but it’s probably an industry-wide phenomenon. But we’ve got bigger teams now; we don’t have small teams, we’ve got bigger teams, the teams are gelled together. They’ve already been through big investments, so you pick up efficiencies there.

So we’re better at doing these big investment games than we were before. So that pick up in efficiency, is going to make a big difference. Also we have some development synergies that exist in this next-generation, which didn’t necessarily exist in the last generation. In other words, the development, the chipsets are much more similar between the PS4 and the Xbox One than they were before and that helps us to gain efficiencies when we’re developing across platform. So while there is an ability to add features and spend more money, it is mitigated by the efficiency that we’re picking up on the development side.

Edward S. Williams – BMO Capital Markets

Okay. And when do you think will get to an installed base for these consoles that will allow for you guys to have an material amount of your revenues on the next-gen systems. Is it something that happens kind of at some point during 2014? Or it’s got to get to holiday 2014?

Karl Slatoff

I think it really depends ultimately in the industry on the release schedule and your specific release schedule. As you mentioned before, we have our basketball game NBA 2K14 is currently out on next-gen consoles, it’s out on PS4 and it’s out on the Xbox One at this point. And we’re very pleased how that is going. The – our scores are incredibly high particularly for new generation release in this sports game, we’ve done very well. We’ve done much better in the competition in that regard. And that’s a positive thing.

And in general our NBA game as a whole, so if you look at the current generation and the next-generation together, we’ve actually sold in more units combined than we did last year on just the current generation. So you hear a lot in the industry right now about the problems that developers are having in the transition period and the risk that are associated with transition, which are all very true. But in our specific situations, we only have one game right now for next-gen. We’re not seeing that. We’re actually seeing because our product is a high-quality product. The current gen version, the PS3 and the 360 version and the PS4 and the Xbox One version are actually different games and with different development cycles behind them. So as a combined unit, we’re actually seeing an increase over last year in terms of selling at this point. So we’re not seeing the growing – we’re not seeing that that pain in transition.

I think it’s really about the product that you put out. If you just put a hot product out that’s a stray port, you don’t do anything with it then obviously you’re going to put yourself more at risk. You still may make money, but you’re not going to do as well as you otherwise what have with you, add content to it or do something that’s a little bit different. So in terms of when is it going to be a meaningful part of our revenue, again that depends release on release and I would say that where we are in the console cycle, where we’re going to know much more about how robust this is will be in the next holiday season whether it’s a meeting part of our revenue or anyone else’s revenue is really on a individual release by release basis.

Question-and-Answer Session

Edward S. Williams – BMO Capital Markets

Okay. There are a couple of questions coming in on the iPad out here. First of all, there is a question just kind of within these next-gen consoles about ultra HD capabilities. So are you seeing any ultra HD capabilities? Or are you working on any titles that are in ultra HD?

Karl Slatoff

Well, we haven’t really discussed what we’re working on in terms of that context. So I don’t really have anything to share with you on that.

Edward S. Williams – BMO Capital Markets

Okay. And then if we can shift gears a little bit, we – well I’ll start off with this one as a question here about the GTA online, the question is being how big can this get, there is a lot of debate out there around MMO model given where the work have declined. Can GTA bought this trend, what are monetization plans?

Karl Slatoff

All right, in terms of GTA online, I think like any property and this goes for whether it’s an online persistent world or whether it’s just a release. The success of whatever that release is going to be is going to be depending on the quality of the content and the depth that which the consumer engages with that content. And in terms of our expectations around GTA online and where we are today, it hasn’t been that long, obviously GTA online went live in October.

We started offering our cash pack sort of monetization on November 7th. So we’re about a month into it. So I don’t have any specifics to share with you in terms of how we monetize and how well that’s going at this point. But I can tell you that people are highly engaged and there were a lot of people playing and it’s going very, very well at this point. And it really is a matter how big is it, how good – how big could they get and how good they can get is really a question of the content. And Rockstar recently released some pretty robust information about what’s coming down the pike and it’s only – they’ve only really talked about what’s coming in December and some point in 2014.

There is a lot of user-generated content opportunities with the creator modes both the Deathmatch and the Race mode. There is also a capture mode which is sort of like a capture the flag mode, all of which is cooperative or competitive game play. And they’ve also announced some plans without any real specifics about incremental content associated with formal highs – the actual highs for online and also story mode content. So there is a lot of content planned out there for release. And I think how good can be is really depends on how much you continue to engage with the consumer. And at this obviously Rockstar is incredibly good at that and we expect them continue to do what they’re great at.

Edward S. Williams – BMO Capital Markets

Can you give us a little bit of colors with the massive launch of GTA V, can you give us a little bit of color as to the sustained usage of the product at this point, especially kind of post launches in next gen systems. Are you seeing any changes in playing patterns?

Karl Slatoff

Yes, we don’t have – I don’t know have any specifics to share with you, but needless to say the engagement with the game is incredibly high and I think that’s really reflected with this how well our sales have gone at this point. And they have gone well. I think we’ve announced that we have sold in 29 million units, but in terms of the actual, how people are engaging with the game. I don’t have any real specific status to share with you today, but it’s a GTA game and GTA games are very deep games with a lot of things to do, a lot of content and people tend to try to get their money’s worth, so I think things are going very well in that regard.

Edward S. Williams – BMO Capital Markets

Okay. And then you’ve got a number of initiatives in Asia partnering with Tencent, Nexon, XLGAMES. Can you characterize what the opportunity is in the Asian market as a whole or what you are looking to achieve out of those partnerships?

Karl Slatoff

Sure, so our original theory about going to Asia and this is, I’m talking about everywhere except Japan because Japan is a little bit of a different market versus some of the other markets in Asia. And the Asian market is large, I think into the synergy of $11 billion or so of value created in videogames and most of that is online free-to-play. So the best way to go after those markets is obviously to go and attack that business model. We decided to go out in a little different way rather than invest a substantial amount of money hence you are going into a market that we didn’t know much about. The best of approach for us was to go and partner with the best of breed, folks who’ve actually been doing free-to-play for quite a while, understand the market better and actually really need content, they need franchises which we bring to the table.

So for China specifically, we did a deal with Tencent with our NBA game which launched in October of 2012 or so we’re about a year into there. We also launched a game with Nexon in Korea around a baseball game which we did a launch in May of this year. And we have a deal with XLGAMES for a release of Civilization online which is going to be a very robust undertaking around our Civilization franchise initially for the Korean market. So those are the three initiatives that we’ve gone after. And the idea here is partner with the best of breed, partner with folks who have done it before, bringing your content to there, build franchise value in brand in those markets and mitigate your downside and be in a position to take advantage of the upside. So that’s been our approach in Asia. Now should these be successful on a still early days. Obviously these are online properties and they have a very consistent earnings flow. So that should help us, again it’s successful through that our earnings curve over time.

Edward S. Williams – BMO Capital Markets

Okay. Do you see the roll free-to-play becoming more significant in the western markets?

Karl Slatoff

Yes, I think it can be I think it’s a – there are very few examples of where that’s worth on the massive scale, there are some, but I do think its something that consumer seem to like and it looks there are opportunities to achieve strong business models in that regard. So I think with the new technology in the connected environments both the PCs, it’s a no-brainer, but also a new counsel systems where connectivity, it seems to be a heavy focus for the next-generation. You are going to have more opportunity to experiment with business models and we don’t necessarily think of it in very rigid terms of free-to-play versus pay content.

For us it’s really more about post release monetization and what’s the best way toconsumers continually engaged in your content. Post release, whether it’s a big Tenco release or whether it’s an initial data release in an online context. Keeping the consumer engaged and monetizing them in the most appropriate way, and you can do that through one-time payments, you can do through DLC, you can do it through free-to-play, you can experiment, but the good news is we’ll have the opportunities to do that. And I think that for sure is a – will be a change in the industry. You’ll see more experimentation. What will ultimately be the prevalent – the prevailing business model remains to be same.

Edward S. Williams – BMO Capital Markets

Okay, there a couple more. This is – this is a prolific crowd and so a lots of questions coming through here. The – there is another question from the audience which is about mobile gaming market. What are your thoughts about the mobile gaming market?

Karl Slatoff

Well, right now the mobile gaming market and again that we should be clear – I should be clear about how we tend to think of the industry. We don’t really think of it in the context of platforms whether its PC console or mobile platforms. We think really more in the context of core versus casual experiences. And while we do dabble on casual experiences, most of what we do is for the core gamer. We do highly – high quality in-depth entertainment experiences and that’s our bread and butter. And that will continue to be our bread and butter for quite sometime not to say we won’t experiment with casual, but we definitely are a core company at our heart. So that’s an important lens that we look through first.

As it turns out most of the mobile experiences to date have been more casual and that’s just based on the limitations of platform themselves. That being said, we’re highly active in the mobile space. We’ve take our core franchises and we brought them to mobile tablets or to phones and to tablets, GTA 3 the 10 year anniversary edition is a good example of that. We’ve recently announced that San Andreas is coming out. We’ve done Civilization titles, XCOM titles. So we and our NBA title, not just catalog, our NBA title.

There is a full version of the simulation game that’s available on – in a tablet form. So we do bring our core experiences and that will continue to be – we’ll push – we’ll keep pushing that platform as long as the core customer wants to engage in that platform. So that’s one thing that we’re doing. We see a lot of opportunity there. And it’s a no-brainer. It doesn’t cost a huge amount of money for us to do it and it’s easy for us to monetize. The second piece of it that we find very attractive is coming up with companion applications where side by side content that you can use to help to encourage people to engage with your core franchises in five minutes, 10 minute bites on the road. These are things like NBAs.

Our NBA Everywhere concept, where we have the MyPLAYER app or you can do things that very separate from the core console game but they’ve set your experience either through virtual currency or earning training points things like that. It will affect your experience in the core console. So for us that’s also been a significant focus is this use the mobile device sort of as a second screen experience to make the – to encourage the consumers to engage more deeply with our core product. And the third component of it is for us is we do experiment with some more casual things. And it’s a little bit more adventure oriented. The risks aren’t very big and you tend to have to do a lot of them to kind of find the next Angry Birds, but it is something that we’ve done. We’ve experimented with it, but again it’s not really our focus but it’s something that we obviously are interested in looking at.

Edward S. Williams – BMO Capital Markets

Okay. Just staying with my iPad here for questions for a moment, the – there is another one. Given the success of GTA, which was held as a cultural event by the media, is there anyway speed up development of those kinds of blockbuster releases?

Karl Slatoff

If we – there is a question, the answer to that is always yes. There is always a way to speed up development. And then you have to ask your question of do you want to, is it the right business decision to make. And if you could speed up development and not sacrifice quality and every time you come out with whether its GTA or different product, every time you came out with it, if you could do it and take video gaming to the next level which is what happens, every time GTA comes out, it sets a new standard for video gaming. If you could do that every year and if you could do that without tiring out your franchise then that would be a really good thing.

Now we don’t fundamentally believe that that is – that’s not possible certainly without sacrificing investing in other IT. And for us specifically, it’s very important to invest in other products because we don’t want to be ever in a situation where a product sort of runs its lifecycle and then there is nothing there to replace it. So we’re very focused on new IP. So there is always an opportunity cost, so they’re dedicating all of your resources or the vast majority of your resources towards any one franchise. It may work really well in the short-term, but it’s very dangerous maybe doing a long-term and that is not something that we’re interested in doing.

That being said, there is always room for us to improve. And it’s not necessarily just about coming out with GTA every two years versus three years, four years and five years, it’s finding a way to keep the consumer engaged with the franchise in between tent-pole releases whenever they happen. And I think that we’ve seen before and Rockstar is one of the original innovators on DLC content with GTA 4. We have more tools in our disposal and the GTA online is another example of that where we can keep the consumer engaged with their franchise in between these tent-pole tempo releases, so it doesn’t matter quiet as much when they come out. And that’s obviously a path that we can choose to take if that’s the right business decision for us.

Edward S. Williams – BMO Capital Markets

Just to kind of follow up on that for a little bit, what’s your thought on the number kind of major releases that Take-Two can bring out or maybe should bring out on an annual basis if we should look at it that way. Well, whether you should or you shouldn’t that’s the way you’re going to look at it. And I think – I think history is a decent barometer in general. And the question is what is the major release?

So every release we do at this point in time, at this point given our focus unless there are different business models we go after smaller bets. But as a whole everything that we do on a go forward basis, the intension is to create a real franchise is to create a major release. So we as a company given where we sit right now, where we’re going to be doing 10, 12, 15 major releases a year that’s just not who we are. But on average, when you’re doing – doing 5, 4, 3, 6 it depends on the year, but I think that you’re sort of in that vicinity of 2 to 7, but other than that it’s kind of hard to give you anymore detail because it will vary year-to-year.

Karl Slatoff

Are there any questions from the audience? All right, they’re preferring to email then I guess than to use their voices. Let’s go to look at the balance sheet a little bit and so you got a lot of cash. Can you talk about your capital allocation thoughts and you obviously just did a substantial buyback of the blocker stock. What can you look for from along those lines staying within that context can we also look at what are your thoughts around M&A possibilities?

Karl Slatoff

Right, so in terms of capital allocation obviously, we allocate our capital with growth in mind. And we did – obviously we did – just do a share buyback, so that’s always – to returning cash to shareholders as we’ve said before, it’s always an option that we consider – excuse me, but putting that aside, there is first and foremost the best use of our capital is to invest in what we do best. And what we do best is to engage and developing core games that we think that could become hit product and ultimately long-term values franchises. And we strongly believe that the value that – to create value in entertainment business, the best way to do that is to create franchises.

And to create franchises each of these games is a significant investment. And we want to make sure they were always well capitalized to deploy that that investment into what we do and what we do is we develop games. So that’s first and foremost. And so vast majority of our capital should and always be allocated into – investing into our core business. In addition to that, our M&A is something that we’ve been looking at for the past 7 years and we’ve done some of it and we’ve bought studios, we’ve bought individual IPs and what we look for specifically is we look for content, we look for IP value, we look for technology and we look for teams.

Those are the things that are very valuable to us from an M&A perspective. We don’t look to invest in headlines, we don’t deploy hundreds of millions of dollars into social gaming because that’s what everybody wants to talk about or into a mobile gaming company that has one product that’s not what we do, you know that’s not something that is for us, is it an investment that makes a lot of sense that you might get lucky, but it’s a wing in appearance not necessarily good investment strategy. We look for investments that are going to be immediately or very soon accretive to earnings and that includes the actual purchase price as well.

We don’t just look at it, if you buy an entity that is creating net income then obviously it’s accretive. But you want to make sure you are actually buying at the right valuation because we actually value our balance sheet, and if we issue stock, we recognize that there is dilution. So fundamentally it has to be a company that we believe is going to derive significant value to us in the future. We are not just looking to put money into work, we are looking for the right opportunity. So if we do see, every M&A deal which has been done on the videogame space, we’ve seen it before it came and we’ve been excited for the most part not to take the bait on some of these things and we’ve gotten pressure to do so. But in general what we are looking for again, is we are looking for a content, we are looking for tech and we are looking for teams that will help us grow our core business.

Edward S. Williams – BMO Capital Markets

Okay. And then Take-Two has a history of peaks in values with regards to its earnings kind of coming – especially coming out of non-GTA years. You guys have made comments of late that your expectations that you’ll be able to sustain a profitable business in the non-GTA release here. Can you give us a little bit of colors to what gives you the confidence and your ability to achieve that and maybe some of the steps that have changed, or…

Karl Slatoff

Right.

Edward S. Williams – BMO Capital Markets

Systems have changed with the course of our seven years since you guys have been there?

Karl Slatoff

So since I’ve been with the company we’ve done that twice, we’ve had profitability and substantial profitability in certain circumstances without a major release of GTA. So we know we can do it and now the question is why can we say now that we’ve got confidence that we’ll be profitable every year for the foreseeable future and I think it really boils down to two things and one of them is when you look at our IP what we have now, what is different from us, where we sit today versus where we sit at the – in the previous transition from the last gen to the current gen.

The biggest difference we have is we have much more IP, we’ve got better IP than we did before. We’re very reliant on Grand Theft Auto. Now the beauty of Grand Theft Auto is we are always going to have peaks with Grand Theft Auto because it is such – every time Grand Theft Auto comes back you are going to have a great year and that’s luxury and that’s something that we embarrass. I’d rather have those years and not. I’ll take those peaks over having a smooth curve without those peaks because it’s very valuable and obviously these are watershed events for us.

But now we’ve got a much broader set of IP which we invested in over the last generation. We have nine franchises that have sold 5 million units or more in a single release. So nine franchises with 5 million unit sellers and one single release which puts us in a very different position than it did from the last transition. And the other aspect, so we’ve got more to choose from and there is no question about. We’ve got more proven success and that helps us to have a little bit more visibility into our opportunity going forward versus where we started last time around.

The second piece is in the cost structure. We spent the better part of the last seven years, managing our cost structure and we also don’t have the MLB license anymore, which I think we said before, Hank, that it was a $30 million loss in fiscal 2012, or it was the last time we spoke about that. But that was a pretty big albatross hanging around our necks and that’s gone at this point. So our cost structure is much better than it used to be and our revenue outlook is much better than it used to be. So that’s what gives us our confidence.

Edward S. Williams – BMO Capital Markets

Okay. I got one more question on the iPad and if there is any questions from the audience? All right. Let me go to this one which is – can you take this content to be monetized, in other ways outside the videogame space i.e. GTA movie or television series or unlocking value by selling away since for such ventures?

Karl Slatoff

Yes, the answer to that is it can without question and there is and we’ve had interest coming in and not just for Grand Theft Auto, but for a bunch of our properties. Most of our major properties we’ve had interest either from television or film or otherwise. We do sell merchandise at this point, but it’s not material. So there is some monetization there. But the answer is of course that is and then you just have to do the math and what the risks are associated with it. And unless you are really willing to take a significant risk in investing in entertainment properties, it’s very different, for example, movies.

If you’re going to invest in a movie, you can make a lot of money on movies, but as a licensor, you’ve got to look at what the success rate is, what the movie have to do for you to generate substantial economics that are worth taking the risk on whatever that – the franchise risk. So if it’s a bad movie, does that hurt your franchise or not, so there is always a balance that has to be struck there. But obviously, we consider those inbound requests. We take those inbound requests. There are circumstances where we’ve actually done this, where we’ve optioned our content for film. So it’s something we consider at this point, but again its not core to what we do.

Edward S. Williams – BMO Capital Markets

Okay, thank you very much, Karl.

Karl Slatoff

Okay, thanks Ed.

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