Take-Two Interactive Software Inc (TTWO) 2005 Q2 法說會逐字稿

Greetings, ladies and gentlemen and welcome to the Take-Two Interactive Software second quarter 2005 results conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to introduce your host, Miss Cindi Buckwalter, Executive Vice President of Take-Two Interactive Software.

Thank you.

Miss Buckwalter, you may begin.

Good afternoon, everyone.

Welcome to Take-Two's conference call for our second quarter ended April 30, 2005.

Thank you for joining us today.

Before we begin, I would first like to quickly review our Safe Harbor statement by reminding 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 at this time.

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 our 10-Q for the first quarter ended January 31, 2005, which may be obtained from our website or by contacting the SEC.

Today's call will consist of a presentation by our management team, followed by a question and answer period.

With me today from Take-Two are Paul Eibeler, our President and CEO, and Karl Winters, our CFO.

Let me quickly run through some of the highlights of the quarter before you hear from Paul and Karl.

We delivered on our guidance in Q2 with our results slightly better than expected.

Revenue of 222 million was ahead of our 200 to 210 million in guidance.

We came in at a loss of $0.12 per share, which reflects the three-for-two split ahead of our split adjusted guidance of a loss of $0.13 per share.

Our three-for-two stock split announced and completed during the quarter shows the confidence that both we as a management team and the Board have in our future and our on-going commitment to increase shareholder value.

Leading our publishing business this quarter, Rockstar shipped its highly-anticipated sequel Midnight Club 3: DUB Edition, which topped the game charts in April.

We were very pleased that Grand Theft Auto: San Andreas continued to be a significant contributor to the quarter's results. 2K Sports further expanded its sports portfolio with the launch of Major League Baseball: 2K5 and the announcement of a long term, non exclusive license with the National Basketball Association to develop and publish NBA-licensed basketball games.

We continued to execute on our product diversification strategy with a number of high profile game properties announced by 2K Games and 2K Sports.

Most recently, we had a great E3 with over 25 games shown by Rockstar, 2K Games, 2K Sports, and Global Star.

We are very excited about the opportunities ahead of us for next-gen products as well as new products for the large installed base of current generation hardware.

We've announced eight titles for Xbox 360 with more in development for the Xbox 360, the PlayStation 3, and the PSP.

Now let me turn the call over to Karl for more details on our results and guidance and then Paul will talk more about E3 and our pipeline.

Karl.

Thanks, Cindi, and good afternoon.

Net sales for the second quarter were 222.1 million, an increase of 45% compared to 153.4 million a year ago.

Our net loss for the quarter was 8.2 million or $0.12 per share compared to a net loss of $14.6 million or $0.22 per share in the second quarter of 2004.

Sales of Rockstar's Midnight Club 3: DUB Edition drove our second quarter results, representing 29% of quarter's total revenue.

We also realized strong performance from our other major new Q2 releases, Major League Baseball 2K5, Stronghold 2 and Close Combat: First to Fight.

The MLB titles represented about 6% of total sales with Stronghold 2 for PC contributing approximately 4% and Close Combat: First To Fight titles representing about 3%.

Notably, our 2K Sports portfolio in the aggregate contributed 9% of total sales in the quarter.

Additionally, Grand Theft Auto: San Andreas once again was a contributor in the quarter, representing about 9% of total Q2 sales.

Our Jack of All Games distribution business showed top-line growth in the quarter, driven by the release of Sony's new PSP hand-held system in March.

The increased availability of PS2 and Xbox hardware also contributed to revenue growth as well as incremental sales of hardware/software bundles and PSP accessories.

And just a quick update on our distribution warehouse in Ohio, Jack has been using its new facility on a phase-in basis and expects to complete the full integration by late June.

Our publishing distribution split in the quarter was in line with our expectations.

Publishing was about 66% of revenue with distribution representing the remaining 34% of our business compared to our publishing distribution split of 58% versus 42% last year.

Our gross profit margin for the quarter was approximately 32% compared to about 22% last year.

The primary reason for the increased margin was related to our business mix as our higher-margin publishing business represented a larger percentage of revenue compared to last year's second quarter.

And a significant percentage of our publishing business came from our internally-owned and developed Midnight Club and Grand Theft Auto franchises, compared to last year's second quarter when our publishing business was led by the console versions of Mafia, an externally-developed and externally-owned title.

Additionally, with the release of several new PC titles this quarter, our higher margin PC business was 11% of total publishing, compared to only 1% in Q2 last year.

Turning to the components of cost of goods sold, product costs increased due to the significant growth in revenue year-over-year, but declined as a percentage of revenue as our business mix was more heavily weighted toward publishing than last year.

The decrease in product costs as a percentage of revenue was partly offset by a greater percentage of lower margin hardware revenue in our distribution business this quarter.

Royalties increased on a dollar basis but remained about flat as a percentage of publishing revenue.

The dollar increase was primarily attributable to internal royalty expense associated with our publishing sales.

Additionally, royalty expenses increased as a result of royalty payments, and amortization of pre-paid royalties were externally developed and licensed products sold in the quarter.

Software development costs increased in dollars and as a percentage of publishing revenue.

A majority of the increase related to amortization of development of costs for Midnight Club 3: DUB Edition, which shipped in the quarter.

Our operating expenses in the second quarter increased as our business grew.

The increase in sales and marketing expenses compared with Q2 last year relates primarily to expanded advertising and promotional support for our products, led by our advertising campaigns, Midnight Club 3: DUB Edition and our MLB game.

General and administrative expenses increased from last year as we have expanded our financial and operational infrastructure to support our continued growth.

We have also incurred higher business and professional fees related to Sarbanes-Oxley compliance and we have incurred higher rent and office expenses compared to Q2 last year as a result of the development studios we've acquired and the opening of a new office of our 2K Games publishing label.

R&D expenses increased from Q2 last year due to several development studio acquisitions.

We've also added additional staffing in our studios, reflecting our strategy of bringing more development in-house.

Our head count in R&D is increased more than 70% from April, 2004 to over 1100 people at the end of April, 2005.

Our tax rate for the quarter was approximately 25% as we had forecasted on our last call, due primarily to our geographic mix as we had a significant contribution of business from our international operations where we operate at lower effective tax rates.

Based on our projected mix of business for the balance of this year, we expect to continue to maintain this rate for fiscal 2005.

We used cash from operations of approximately 95 million in the second quarter.

Our main uses of cash in Q2 were the payment of crude expenses and changes in working capital positions following the peak holiday season.

We would expect to be operating cash flow neutral over the summer months.

At the end of the second quarter we had 210 million of cash as compared to 155 million at year end.

I'd like to briefly review some other key balance sheet items.

Net accounts receivable at the end of the second quarter were approximately 127 million compared to 286 million at year end and 69 million this time last year.

The majority of the receivable balance at the end of Q2 was for our publishing business.

Our DSOs were 52 days compared to 59 days in the fourth quarter, and 40 days in the second quarter last year.

Our business in Q2 was very back end loaded, similar to what we experienced in Q4 with over half of our Q2 sales in the month of April as we shipped Midnight Club in that month.

This led to a somewhat higher DSO level.

Our accounts receivable reserves stood at about 57 million at the end of the quarter, representing approximately 31% of gross receivables.

The decreased reserve level from Q4 and Q1 is due to the lower volume of business shipped in the second quarter.

Our Q2 reserves represented approximately 8% of trailing six months revenue and about 5% of trailing nine months revenue, similar to Q1 levels.

Inventories at end of the quarter were approximately 117 million, a decrease of about 38 million from year end and 18 million from last quarter.

About 70% of our inventory balance relates to our distribution business with over 85% of the domestic distribution of inventory consisting of products with cost of goods below 14.99.

Our software development costs totalled about 98 million at the end of the quarter, compared to about 64 million at the end of the year and about 88 million at the end of Q1.

The increase in software development costs since year end relates primarily to the significant ramp-up in new products that we have recently announced for our 2K Games label, including high-profile titles like Oblivion and Civilization.

Additionally, the increase in software development costs includes many of the sports titles being developed at our internal studios, this in line with the continued execution on our strategy of further expanding our portfolio breadth and depth.

The increase also includes titles that Rockstar's working on internally for near-term release, such as The Warriors and Bullitt.

We currently have over 140 SKUs in various stages of development, representing over 70 different brands of which approximately 40 SKUs are planned for the balance of fiscal 2005.

And just a quick housekeeping note: We've accelerated the contingent payment due to the original owner of the publishing rights for the Duke Nuke 'em titles.

When we originally acquired the publishing rights for Duke Nuke 'em from Atari, we were obligated to pay 6 million upon delivery of the final version of Duke Nuke 'em forever.

We agreed to pre-pay this contingent obligation to Atari for 4.25 million and we will pay an additional 0.5 million upon the commercial release of the Duke Nuke 'em product.

I would note that we have a strong relationship with 3D Realms, the developer of Duke Nuke 'em, as demonstrated by our recently announced collaborative efforts on Prey.

We remain confident in the Duke Nuke 'em franchise, and look forward to the release of the title in the future.

Moving on to guidance, we are reiterating our guidance for the full year of 1.3 to 1.35 billion in net sales and a split adjusted $1.40 to $1.47 in EPS.

Within the back half of our year, we are adjusting our guidance to reflect the following changes in our release schedule: We moved the launch of Grand Theft Auto Liberty City Stories for the PSP from Q3 to Q4 in order to do a simultaneous North American and European launch of the title following Sony's European launch of the PSP platform in September.

We moved Call of Ktulu for PS2 and Xbox as well as Top Spin for PS2 from Q3 to Q4 to provide for additional development time on these titles and a better launch window.

Our new Q3 guidance is 205 to 215 million in net sales and a loss per share of $0.05 to $0.10.

With regard to our guidance for the full-year, we assumed continued investment of additional resources and development, including current and next-generation console and hand-held products.

We are also strategically investing in several other areas.

We have been rapidly scaling up our 2K Games and 2K Sports organizations in anticipation of a robust portfolio in fiscal 2006.

In recognizing the increasingly competitive landscape, we have strengthened our marketing budgets for fiscal 2005 in conjunction with several key product launches.

With that said, even with this year's investment spending for our future, our full-year fiscal 2005 guidance represents double-digit top and bottom line growth from last year.

We look forward to speaking with you again in September when we report our third quarter results.

At this point, I'll turn the call over to Paul to cover our product lineup and E3 highlights.

Paul?

Thanks, Karl.

I will just add some comments to Karl's presentation, recapping the quarter, reviewing some product highlights and E3 updates.

As we have said, by moving some products from Q3 to Q4, we will take advantage of a pre-holiday launch window while maintaining our strong outlook for the second half of the year and full-year guidance.

To reiterate, our '05 guidance represents top line growth of about 12 -- of about 15 to 20% over fiscal '04 and bottom line growth 31 to 38%.

Moving to Q2 results, we are pleased with the reception of Midnight Club 3: DUB Edition that was released in April.

Midnight Club 3: DUB Edition was the number one title across all platforms in April, according to MPD.

Grand Theft Auto: San Andreas sales remained strong, contributing meaningfully to Q2 results and next week, Rockstar is releasing Grand Theft Auto: San Andreas for PC and Xbox.

Both retail and the gaming press have been extremely receptive to the look and feel of the product on these platforms.

Rockstar is very excited to have PC and Xbox gamers get their hands on this most anticipated title.

From 2K Sports we released major league baseball 2K5 for PS2 and Xbox featuring Derek Jeter on the cover.

This year's title received an excellent reception by fans, gamers, and the press.

I want to commend Kush Games, the 2K Sports studio that took over baseball development for taking a healthy step forward for the franchise. 2K Games also launched Stronghold 2 for PC at the end of the quarter.

Sales are strong in both U.S. and Europe.

Our Jack of All Games distribution business benefited from the PSP launch as well as increased availability of console hardware.

Moving onto the E3 industry trade show last month, we had a very successful show, highlighted by an extensive Rockstar and 2K product lineup and enthusiastic gamer, retail, and media responses to our product line.

Rockstar showed four titles starting with Midnight Club 3: DUB Edition for PSP, shipping in North America in late June.

The product has amazing graphics and will be the fastest, deepest racing game for the PSP with all the speed and adrenaline of a console game.

This product showcases the PSP's potential and will raise the bar in Rockstar tradition.

Grand Theft Auto: Liberty City Stories for PSP was announced for simultaneous launch in North America and Europe in Q4 in conjunction with Sony, Europe.

Returning to Liberty City the setting of Grand Theft Auto 3, this title has an entirely original story line with all new missions and the freedom, production value, and depth of play that fans expect from a Grand Theft Auto title.

Look for some exciting gaming press coverage in the next few weeks that will continue to build the anticipation for this must-have game.

Rockstar also showed the much-anticipated multi-platform game, The Warriors, based on the 70's cult classic Paramount film.

Rockstar has recreated and re-expanded on the story line of the film to create a deep and compelling game play experience.

Both retail and gaming press feedback from E3 was very positive.

And Rockstar showed the new, original titled Bully, planned for late October for PS2 and Xbox.

Set a fictitious reform school, Bulworth Academy, this debut title from Rockstar Vancouver takes the Rockstar tradition of groundbreaking, innovative, original game-play, and humorous tongue-in-cheek story telling to an entirely new setting, the school yard.

Rockstar will be revealing more information on Bully over the coming months.

To recap Rockstar's plan for the second half of the year, we're shipping Grand Theft Auto: San Andreas for Xbox and PC next week and Midnight Club 3: DUB Edition for PSP at the end of this month.

In Q4, Rockstar will introduce Grand Theft Auto: Liberty City Stories on PSP as well as two additional console products, The Warriors and Bully.

In Q4, Rockstar will also shift Grand Theft Auto: San Andreas to the Japanese market under a co-publishing partnership with Capcom and Midnight Club 3: DUB Edition for PSP in Europe.

Moving onto 2K Games.

Our 2K group showcased their diverse lineup of products on every platform at E3 with over 20 new titles from 2K Games and 2K Sports.

Although there was much focus on next-generation at the show, we have a lot of business for PS2, Xbox, and PC.

Planned for Q3 on multiple platforms, we showed Charlie and the Chocolate Factory, based on the film directed by Tim Burton and starring Johnny Depp.

As part of our extended partnership with Sid Meier and Firaxis we showed Pirates for Xbox, an extension of the Pirates PC game, the successful Pirates PC game planned for Q3.

We also showed Call of Ktulu, based on the work of classic science fiction author H.P.

Lovecraft and Top Spin, the best-selling Xbox tennis game which we are extending to PS2.

Both of these titles will ship in Q4.

In Q4 from 2K Games, we have Shattered Union from our internal development studio, Pop Top.

Also slated for the fourth quarter, 2K has sequels to two established franchises, Serious Sam 2 and Viet Kong 2.

For North America, 2K Games will release 24 the game, based on the hit FOX TV show and Conflict Global Terror, the next release from the popular conflict series created by FCI. 2K Sports Q4 releases include World Poker Tour games for multiple platforms based on the Travel channel's hit show, with real-life players and extensive multi-player mode.

From Visual Concepts and Kush Games we will release NBA and NHL games for console in Q4.

Under Global Star, our value and kids label, we will extend Code Name Kids Next Door and Dora the Explorer to console.

As we look out to fiscal '06, we are excited about the response to the relationships 2K Games has established with world class developers Firaxis, Bethesda Softworks, 3-D Realms, and Human Head Studios.

Civilization IV from Firaxis and Elder Scroll IV Oblivion from Bethesda Softworks are certainly some of the most anticipated sequels slated for '06.

And Prey from 3-D Realms and Human Head Studios, combines the story line, graphics, and game play that the teams at ATI used at E3 to showcase their latest technology.

The magazine covers from PC Gamer and Game Informer are endorsements of the quality and anticipation for these up-coming products.

E3 also presented a great opportunity to showcase our product development resources for next-generation.

We are excited by what our hardware companies and our hardware partners showed and we continue to work closely with them.

Take-Two was well represented.

Sony's impressive preview event included a Rockstar PlayStation 3 demo and comments from our Sam Houser President of Rockstar Games.

As Sam said, each time Sony launches a console, the video game business moves to the next level.

And Microsoft's presentation showcased our 2K work, including the incredible game play of NBA 2K6 for Xbox 360, featuring Lebron James.

Our Top Spin 2 game for Xbox 360, one of the few Xbox 360 games playable on the show floor, highlighted the power of their new system.

To date, we have announced eight titles in development for Xbox 360 to ship near or at launch, including six sports titles.

Our investment in the past year clearly has established 2K Sports and we now look forward to building on the incredible resources of our world-class internal sports development studios, Visual Concepts, Kush Games, and Indie Built.

Over the last few years our goal has been to diversify our product line and invest in building the groundwork for future growth.

We have continued to work toward that goal this year and we are proud of our accomplishments.

For the balance of '05 and into '06 we are intently focused on maximizing the opportunities from our Rockstar label with new and established brands on both existing and next-gen platforms as well as delivering on the potential of the 2K games and 2K Sports business.

Thank you for listening to our presentation and now I'll open it up to question and answers.

[OPERATOR INSTRUCTIONS] Our first question is coming from Heath Terry about Credit Suisse First Boston.

Great, thanks.

Can you just talk to us about what your view on the competitive environment is going to be like this holiday season?

There's obviously been a lot of talk about the difference that games like Halo and Half Life and obviously GTA made for publishers last Christmas, after having seen the lineup at E3, what's your view on the impact the competition's going to have on your lineup for this holiday season, particularly given that you're introducing new franchises like Bully and The Warriors?

And then if you could also talk a little bit about what your expectations are for pricing in the -- during the transition and on current-generation as well as next-generation?

Thanks.

Thanks, Heath.

I'll take the first shot at it And Karl and Cindi can add.

We're very excited about the back half of the year.

We think that based on the success we had last year with the Rockstar Grand Theft Auto that it really sets the stage for two new brands like Warriors and Bully, so we're excited from that standpoint.

We think that the work that we've done in the past year to build the 2K lineup, the market is certainly ready for their lineup of products.

We're excited about what we think we can establish on the PSP, similar to what the Rockstar brand did at the launch of PlayStation 2.

We are bringing two very, very solid titles to the PSP market.

We'll have a number of titles for the 360 launch, so we're excited about that.

We think the back half of the year is very good.

Just to add to what Paul said, the sports lineup that we have this holiday season is very strong.

We've only been in the sports business less than a year, but really have had an impact through the quality games that Visual Concepts and Kush have developed that we look forward to extending those brands this holiday season and really believe they stack up very well relative to our competition.

We also have a slant on our product line to some of the casual gamers with properties like Charlie and the Chocolate Factory, that buy into that, we're bringing some of our Mass brands, Dora the Explorer, Code Name Kids Next Door, to console.

We think the casual gamers will have more of an effect this year on the existing platforms.

In terms of pricing, we think that our business, we're in the entertainment business and we continue to deliver a great, great value when it's compared to other forms of entertainment.

We think that we have some titles that certainly command triple A pricing, and as we've been the leader in different types of pricing strategies.

As we look to the casual market, we can use some pricing at times to differentiate the product.

Thank you.

Our next question is coming from Tony Gikas with Piper Jaffrey.

Great job on the quarter guys.

A couple questions, post-E3, and I'm assuming that your product development people have had a chance to look a little closer at some of the new technologies coming and you've had some time to work on some of the new product, is there any thoughts on research and development spend on next-gen products?

I mean, does it look like the 360 may be a little less expensive than you thought or the PSP might be a little bit more expensive?

Maybe just a quick update there.

Second question in terms of launching the The Warriors and Bully, could you characterize the marketing spend to launch these new brands?

And then third question looking at the October quarter, are the product shipments pretty balanced throughout the quarter or are they late in the quarter?

And how does the environment, the August, September, October time frame look for launching product in terms of competition?

Tony, on the R&D question in terms of spending next-gen versus current-gen, I think you've seen that we've currently ramped up internally.

We've got a 1,100 people actively employed, we've got 145 SKUs in development, 70 different types of games.

We're taking our commitment to the next-gen very seriously.

We've already announced eight games, for release at or near the 360.

Without getting carried away on the exact costing of each and every game, they all behave somewhat differently and you know as well as others that you can build a very expensive game on current-gen and I'm certain we could build a very expensive game on on next-gen.

But I would suggest that while we see some increase in the cost, we don't look at it as a doubling, tripling type of factor, but it's early and we'll continue to invest as we see appropriately.

We're very excited about what these platforms bring to the marketplace and what the games can do.

The marketing spend and the holiday season for launches of Bully and Warrior, we expect those to be significant campaigns, the marketplace is competitive.

I think we've certainly understood that over our recent holiday season or two and we've been I'd say as a trend spending money in advance of launch, spending money at launch, and spending money after launch and we would continue to expect to do that.

And finally, the balance within Q4 we think is a little bit more even this year perhaps than say last when we had one major title launched at the end of the quarter.

The PSP games coming out in September in both the U.S. and Europe should provide a little bit more balance into the quarter than just the second half of October balance.

We certainly will see more in the way of September, October releases than say August, the first month of the quarter.

One comment on our marketing spend.

We get a tremendous advantage of bringing products out under the Rockstar label.

There's such an anticipation for the next Rockstar title and both Warriors and Bully seem to be generating a tremendous amount of interest because of the creativity of Rockstar and how the market use -- how they will bring those properties out, the great game experience that they can deliver on that.

We made a significant investment last year in the 2K Sports, so I think that this year we will have a similar spend and we probably can benefit from a growing market this year and establishment of that brand last year, and then the other products under 2K all have -- if you look at some of the sequels that are in there they have had some real investment.

So there is a built-in anticipation.

Our next question is coming from Edward Williams with Harris Nesbitt.

Good afternoon.

A couple questions.

First of all, Karl, can you just remind us what the percentage of revenues was in the April quarter that came from the internal studios?

Our internal studios have generally -- I know year-to-date it's been we'll call it a 70/30, 80/20 type mix of the larger number in internal versus external.

And do you see that number basically holding flat as we look at it over the next 12 to 24 months or is that number likely to materially change?

I think that's one way of getting into '06 which we are certainly excited about, Edward.

We certainly do count on our Rockstar internal resources and the 2K Games within the sports line, internal resource contribute in a very significant way.

I think it's a little early for us to basically be looking out let's say to holiday, '06.

Certainly for the near-term, we continue to expect our internal resources to develop a majority of what we do.

As we get into '06, Edward, we will see the effect of three pretty big ramps with Oblivion, Prey And Civilization IV.

We didn't have that last year, so you'll probably see it SKU a little bit differently depending on the release of those titles.

And when in '06 might those ship, are any of those holiday '06 releases or --?

We're probably going to ask you to stay tuned for a couple months, Edward, and when we get around to the next call, we'll try to put more daylight on that.

And as far as the head count is concerned, you have 1,100 currently.

What's in your budget as far as expanding the head count in development say for the balance of this year?

For the studios we have in-house, I would say we have some modest plans for expansion, but nothing that would move that number materially.

As you know, we've certainly been acquisitive in the past and we're not bashful about when we recognize a good team of people that fit if we're excited about them and/or product that they bring with them.

So the short answer would be for the studios we have, it is what it is and we'll grow it as necessary, but we're not against taking a good opportunistic position.

Then, what's the philosophy, if you will, about the development efforts going into next several years?

Is that a number that we could see expand again relatively materially?

Looking at it in a more philosophical approach rather than the economics of that?

We've had double-digit growth this year over last.

Whether you're top line or bottom line oriented.

We've certainly taken the resources internal with things that we believe are worthy of that support and I don't think you should expect it to just flatten out any time in the near future, but to go several years out, I think we're up against the transition on the hardware platforms, we're excited about what we've seen.

We've got a very good portfolio of internal and external product coming into the marketplace in the near-term.

We would like to continue to grow that.

And then just one last question, the eight Xbox 360 titles that you said would be at or near the launch, is that something we can interpret as being within three months, within six months?

Three to six months is a safe bet.

Thank you very much.

Thanks, Edward.

Our next question is coming from Colin Sebastian with Thomas Weisel Partners.

Thanks.

I have a couple of quick questions.

I know you don't want to divert too much attention from your up-coming Rockstar titles, but I was hoping you could talk a little bit about your plans for the GTA franchise and the next-generation.

It would seem the arrangement you have with Sony has worked out quite well, but does the release timing of the 360 perhaps change that relationship?

I have of couple follow-ups.

Thanks.

No, right now we still have a lot of growth left in Grand Theft Auto: San Andreas with the PC or extension to PC and Xbox and the move to the Japanese market where the Grand Theft Auto franchise has been very successful.

We're very excited about bringing that title to PSP with a new story line and certainly anyone that is a Grand Theft Auto fan will gravitate or move towards this product, especially if they are excited about, as excited as we are in the industry about the PSP.

We have a great relationship with Sony and at the same time, I'll also say we have a very, very strong relationship with Microsoft.

So regarding that brand and other products we have, we're in a good position, but we haven't announced or made any decisions yet.

Okay, in terms of the sports titles, can you comment on is there any change in the pricing strategy there for this fall?

And you had mentioned previously about extending the Baseball Franchise a bit with the MLB license.

Just curious if there are any new baseball franchises or games planned for the fall or the winter time period?

Well, I think from the standpoint of the Sports business, I think it's fair to say we've done a really good job in a short period of time in terms of the quality of our games, the favorable press we've received from the trade press, of course the fans of the game.

We've done a great job, had a great impact.

We've been supporting the sports business very heavily in terms of marketing, we continue to do so, and as you can tell by the bringing the Visual Concepts, Kush, Indie in-house, we're pretty committed to sports.

I think it's a little early to talk about pricing longer-term.

I mean we'll look at each product on a product by product basis, we'll look at the competitive marketplace and hardware pricing, but we feel really good about the quality of the games and believe that they can certainly support premium pricing, but we'll have more to say as we get to the holiday period.

Certainly with the MLB franchise, we're excited about our exclusives that will begin next spring and we have a lot of plans to extend this brand and really build this brand from a video game business and look forward to doing that.

It's just a little early to talk specifically about that, but again, when we talk to you on our next call and talk a little bit more about '06.

We can shed some further daylight on that.

Okay, fair enough.

One last question.

On the R&D line, spending was down about 10 million sequentially, and I know you mentioned on last call that there is some personnel-related expenses in the Q1 number.

Is that what accounts for the difference for those one-time in nature?

Thank you.

Yes.

In Q1 we had some we'll call it incentive-oriented compensation that ran through the numbers at that point in time given the holiday season and the successful launches of products.

So the base line that you're looking at for Q2 is where we would expect it to be over the near-term, maybe a little bump upward as we go forward in time.

Great, thanks, guys.

Thank you.

Our next question is coming from Arvind Bhatia with Southwest Securities.

Couple of questions.

First one is on GTA.

Can you provide any color as to what is the total percentage you might expect from that franchise overall this year and the reservations that you're seeing so far on the Xbox side, the first one?

Arvind, in terms of our expectations for Grand Theft Auto: San Andreas, really consistent with what we've said over the past few calls.

We're still looking for the San Andreas brand to generate about 40% of our publishing revenue this year, so we're still looking at that number.

That's of the publishing revenue, and the indication from -- particularly the mall stores today has been very, very positive on the Xbox of version that's shipping this week, Grand Theft Auto: San Andreas.

Okay, and then you talked about 140 SKUs in development.

I think you have 40 more coming up the balance of the year.

Two questions: For the balance of the year, the 40 SKUs represent how many brands?

And then how many SKUs do you plan for 2006?

Arvind, just looking quickly, I don't have that sorted by brand, but I would say that you're talking probably about 15 brands, if you will, for the balance of the year, across those 40 SKUs in terms of next year, again, we're building out our model for next year.

We are pretty excited about a lot of the products that we signed and we've announced over the past six months, but it's a little early to talk about specifics in terms of SKU count, but we'll again, address that on our next conference call.

Two quick ones.

Catalog sales for the quarter and again, I don't know -- you don't seem to want to talk about '06, but any general idea in your -- from your perspective market growth for software, console software next year?

Arvind, in terms of catalog sales, and I'll just make a note that we define catalog as a product that is in its third quarter of release, so something that's shipped in one quarter, the first and second quarter of its life it becomes a catalog in the third quarter of its release.

So just so we're clear.

And in Q2 it was about 30% of our business was catalog.

Got it.

Then final question on operating margins for I guess going forward.

Can you guys talk about the key drivers for your operating margins, going forward?

Do you think you can expand that further from this point on or should we expect flattish trends?

Arvind, I think we can -- when we get into next year, depending on which part of the business we're looking at, we can expand on it because this year we've laid a lot of the ground work and infrastructures.

Paul addressed a moment ago, for instance even with advertising on the 2K lineup, which is principally sports-driven this year.

The operating margin by the time we get down to that level is fairly small.

So next year with the possibility of added expansion of volume in those products, the added volume, the bigger games that are coming into the marketplace, we don't require a lot of additional infrastructure support to handle that level of business.

So we think expansion is certainly possible and what we're looking for.

Got it.

Arvind, going to your comment about industry growth, we're excited about a new driver with the PSP.

We're excited about our release schedule which addresses all different segments of the market.

We'll have some more PC products going forward that we haven't had in the past year.

We'll have some more mass titles of the casual gamers that we're excited about.

We're hesitant to just talk about just general industry growth because we've really focused on our release schedule and growth that comes out of that release schedule, but we do feel very, very good with the business going into this Christmas.

Okay, thank you.

Our next question comes from Elizabeth Osur with Citigroup.

Thanks.

I just had two quick questions.

First one is sort of a follow-up to Arvind's.

With regard to industry growth, could you give us some idea of how to think about the distribution business and the growth rate of that business, both for the remainder of this year and then also next year?

Our distribution business has been more steady, more predictable.

We think that they have a big opportunity in the back half of this year for the casual gaming market with some of the opportunity buys and some of the mass-type products that they have.

With the new systems being introduced to the market it presents an opportunity for them, particularly with a lot of retailers to manage certain segments of their business, particularly their lower-priced products and differing promotions in and out to those retailers, so I think it will be steady, up a small -- in the 5 to 10% range, and that will depend upon hardware availability and depend upon some of the opportunity buys for that are in the market.

Thanks.

Then my last question, just wanted to know on the sports business, whether you have any plans to get into the hand-held market?

We like the PSP very much.

Our development people are very, very excited about it.

We will look in, we are looking and taking our 2K line and in '06 you'll see more PSP products out of 2K and then you'll naturally see the extension of our sports brands to that system.

Okay, great, thanks.

Our next question is comes from P.J.

McNealy with American Technology Research.

Hi there, good afternoon.

Couple questions on games.

One was, any update on what's happening with the football assets from the 2K line?

Are they still under development or is that something that's been closed off?

Second is, you touched on a western game at E3 from Rockstar.

Any other color around what that title looks like?

Then just a clarification on pricing.

Is it still safe to assume that the $49 price point in your mind is going to hold up for triple A titles in the second half and games like Liberty City and Bully, and The Warriors are all $49 titles or should be thinking about those as coming in at a lower price point?

Thanks.

First in terms of football.

Football is a big market.

We have a great development team.

We're looking at all the opportunities revolving around the sport of football and we haven't made any announcements, but we believe that if anyone can put a football product on the market without a license, it's us based on our past history and we'll give more information as we firm up our plans.

With regard to pricing, for the holiday season, P.J., I mean, we haven't gone game by game in terms of announcing a price, it's still a little early for that, but as Paul mentioned I think earlier in the call, quality product at this point we believe supports full price and I think it's well and commonly understood $49.99 stands for full price and there's been price points higher than that with extra consumer value built into the product in a variety of ways.

So we're not bashful or backing off of our belief that we think we can continue to carry those prices.

Having said that, prices are very fluid when you get into the holiday season, depending on how products perform.

So.

Would you assume that that pricing would be softer if Sony were to cut the hardware price on the PS2?

I think for some titles it would.

I don't think that applies to some of the triple A titles that we have and other companies have in the marketplace because the core gamer is still there.

They're lowering the price to gain more market share and capture a more casual part of the market, but the core gamer will still pay for play value and if you just look at some of the Rockstar titles, as a form of entertainment you can't compare that value.

It's a great value.

Thanks.

And just the western?

And regarding the western, that was a demo that we had done some work on and Sam Houser had highlighted at the Sony meeting.

It's an unnamed title.

That came from one of our internal studios that has created some buzz and we haven't disclosed the title yet.

All right.

Thank you.

Our next question is coming from Gary Cooper with Banc of America Securities.

Couple questions here.

On the co-published games, 24, ,Elder Scrolls, Civilization, could you give us some idea of the profitability to Take-Two for these products and I understand if you might be reluctant to throw out a number, but if you put it on a spectrum with your own IP at one end and your distribution at the other, could you give us an idea of where it falls?

And I got a couple others.

Gary, if falls, you set it up beautifully.

It falls somewhere in the middle, although I think we would admit it would probably tip just a little bit more towards the distribution end of the margin spectrum when you understand that PC products for instance can live up in the 80, 85% end of the world.

So you know, I think it's pretty well understood industry-wide that when you're in a co-publishing relationship you're sharing by nature and 20 to 40% certainly wouldn't be out of the ballpark.

Okay.

The PC titles, Elder Scrolls, Prey, Civilization, are any of those scheduled for consoles and if not, is that a possibility?

And then my last question, Karl, maybe you could update us your capitalized software.

Could you give a rough breakdown as to what percentage of that is current-gen versus next-gen?

In terms of the PC titles, I think we were pretty clear that Elder Scrolls would also be coming for next-gen, for Xbox 360 in fact, Microsoft at E3 I think was showing it actually, the video in their booth.

We've also indicated that Prey in addition to being on PC would be on Xbox 360.

So I think two of those three at least so far, we've talked about console versions.

Certainly Prey has tremendous potential on console.

I don't know if you saw the demo that ATI did, but it was very, very exciting.

And then Civilization has had a long-established successful history on console, but with next-gen being connected, I think there's a big opportunity for those type of games to extend to the console market.

And Gary, your last question was the breakdown of our $98 million balance and our capitalized software monies that we've put out.

At this point, I would suggest to you as I mentioned earlier, we've got eight titles at or near launch of 360.

We've taken a very strong attitude with regard to having product available at the launch of these platforms.

I'm uncomfortable at this point for competitive reasons, really sort of breaking down strategically what that number consists of, but I think you can see that we're at it in a very meaningful way with eight products, six coming from sports, with the 360 upon us over the holiday season in front of us here.

We will continue to do that and we've obviously for instance, even on PSP, committed two of our large, successful Rockstar brands into that platform.

So we take these opportunities as significant and we're going to be on it.

Thanks.

Our next question is coming from John Taylor with Arcadia.

I got a couple of questions too.

So, can you -- do you feel like giving us a guess as to how important San Andreas on Xbox is likely to be in the July quarter?

That's the first one.

The second one, could you give us a breakdown of accounts receivable by publishing versus distribution?

Third question is, how much of Jack's business is being made up by hardware these days, particularly with the launches and with the improved supply of PS2?

I'm kind of wondering what that mix shift looks like.

And then I'm a little curious about your motivation to pre-pay the Duke thing.

I mean, as I recall, last year you guys took a haircut on the capitalized something you had on that particular product and now more cash is going into it in a different line.

So did you guys get a substantial discount for pre-paying?

I'm not sure I heard that clearly.

So that's five.

How about that?

That's a mouthful.

Let's see.

Let's start with the first question, the GTA, Grand Theft Auto: San Andreas contribution for Q3.

I would suggest to you that we've looked very carefully at the marketplace.

Obviously, this is the first large title into the marketplace for Xbox, which has a very healthy installed base.

Vice City performed very well in Xbox, so we're very excited about the title and the possibility in the marketplace.

I'm going to be coy for the moment in terms of the exact percentage for the quarter because we have every reason to support and believe in the product and think it will do very well.

Having said that, you've heard us basically dollarize for the year what we expect the title to do and you can draw all your conclusions perhaps from that in a certain way.

With regard to the Jack's business, certainly during Q2, tips a little bit more towards hardware.

That obviously brings the margin down just a little bit, but overall, we are very pleased with the opportunity that Jack had in the marketplace with the PSP in particular, and it's a little bit quieter time of year, so we don't expect a particularly robust performance from Jack during late spring and the summer, but overall, we were satisfied with the volume in the marketplace and the quality of the effort there, and --.

Let me follow up on that, if I can.

So if you just look at the software business in distribution, was it up or flat or down a little bit for the quarter?

I would say hardware, if you compare against let's say last year or similar quarters, hardware was up just a little bit by nature with the PSP available, just a little bit of a natural shift in that direction.

That takes away by definition from front line and value product that we put into the marketplace just as a percentage of the pie.

And in the past two quarters, Q1 and Q4 our percentage of software was higher than in past years because there was a lack of some of the hardware availability.

So hardware availability is -- at one point we were getting it down up to a third or below, 33 to 25, 20% and it floats in that general area.

Okay.

And then on Duke Nuke 'em, J.T., I think a little over two years ago we did adjust the basis that we were carrying our investment in that property.

Within that investment, we would have always had this contingent payment in mind, even though it's contingent upon the ultimate delivery of the product.

The opportunity presented itself to pay this at a discount, the discount was -- the original amount was 6 million and we paid it for 4.25, plus another 0.5 million upon delivery.

Oh there was 0.5 million.

Yes, so the discount was attractive to us and we took advantage of that.

Okay, and with the shape that it's in, let's say worst-case scenario emerges and there's no Duke Nuke 'em ever, do you have any asset or anything, security for this advanced payment?

No, we own the publishing rights at this point, and in conjunction with 3-D Realms, the developer of the product, we continue to be supportive of the franchise and believe in its ability to be in the marketplace and perform very well.

Obviously, we don't feel that that is a possibility that we think Duke Nuke 'em will ship.

We're anxiously waiting, but we feel very, very good about the product.

In the PC Gamer May issue, the cover story was on Prey and they actually gave a look to the editor from PC Gamer and there was a small clip about how excited he was and that there's more information to come on Duke Nuke 'em.

Okay, did we have anything else on that list?

I think we covered it J.T.

I'm not sure I wrote everything down but --.

Oh, the mix of accounts receivable between distribution publishing?

Majority in publishing J.T.

Vast majority?

I'd say a majority.

Okay.

Remember, we shipped Midnight Club late in the quarter.

Yes.

Yes.

Our quarter was certainly very back-end weighted in terms of our publishing business.

Okay.

Let me ask kind of a philosophical question.

Last year during the fall you guys were establishing the 2K brand, particularly in sports and we've talked about that today a little bit.

How are you thinking about the contribution margin from that label?

Either this fall or -- give us maybe a view into '06.

Does that become -- can you give us, like Gary's question, on a continuum of operating margins between distribution and publishing, where would the 2K Games fit in?

J.T., without getting carried away, we're at the lower end of that range sitting here today with the fall sports pricing that we've had in the marketplace recently.

We've been holding our comments with regard to the holiday season immediately in front of us for the pricing of the sports line because I think as Cindi said a moment ago, we're going to look at the marketplace right up to the last possible moment and make our best intelligent choice.

When we get into next year and we've said with regard to the sports line, the other big titles within 2K, the Rockstar big titles, and next-gen, there's no reason why these won't be at a premium level and then the margins increase accordingly.

So I think it's an increasing slope and we've invested in the people.

We've put some money to work in terms of marketing.

So the math should improve as time goes by.

And remember this year, J.T., we have tennis that will be brought to PlayStation 2, and then we have the opportunity on next next-gen with games like Amped and the Top Spin tennis game, as well as the establishment of the 2K Sports, those early purchasers of next-gen hardware definitely want the best product on the marketplace, and the way our product has been reviewed and previewed in the market stands with the best product.

I guess the point people are getting at is that maybe there's a chance you can grow profits there faster than you're growing revenues and help pad things out a little different next year.

Thank you for the questions, J.T.

We're going to have to move onto the next questioner though.

Okay, then.

Operator, I'm sorry, we'll take one more question.

Thank you.

Our last question is coming from Mike Wallace with UBS.

Hi.

There's a good chance these were asked already.

My head is swimming from all the questions so far.

I'll try them again.

I apologize if somebody went through these.

Number one, the distribution versus publishing.

Has that range changed I know you said, Paul, it would pick up in the fall.

With both quarters down a little bit year-over-year so far.

Does that imply that the fourth quarter you're going to see distribution up year-over-year?

Still expect 70/30 overall.

Okay.

As a percentage of the next business.

Okay.

So that would imply the next two quarters we're going to see it bump up then?

We think we have that opportunity given the marketplace and hardware availability.

Our focus in distribution is really on the bottom line.

We've hit the mass or the critical mass in terms of size, we're the biggest distributor in the marketplace.

Now we just have to maximize the profit opportunity.

Okay.

Second question, looking at the fourth quarter, the publishing business is there any particular game that's going to be a meaningful contributor 15 to 20% from one title?

In other words, what do you think your best game's going to be in the fourth quarter?

We're not going to handicap which one is best, Mike.

Why not?

Well, we've got of couple of things that we think are obviously very exciting.

We go from the PSP Grand Theft Auto versions to Warriors to Bully, and --.

Sports titles.

Japanese launch of GTA: San Andreas.

So there's a lot of things in the pre-holiday period that we think are very significant and that's just the beginning of the holiday period.

So don't put us in the corner and Cindi might have a different answer than Paul.

All right.

Last question, any update on the SEC?

Well, Mike, as we previously said back in November, we had made an offer to the staff of the SEC.

We said at the time that we accrued $7.5 million based on the settlement offer and the staff of the commission said they would recommend that offer to the SEC.

Have they done that?

Beyond that, what we've said in our public filings, we really don't have anything further to add on that at this time.

Okay.

So we don't know if they've accepted it or declined or asked for more or anything like that?

We really can't provide any further comment at this time, Mike.

Okay, any idea when it will finally get wrapped up?

You're still trying, Mike.

I'm sorry, that's about as far as we can take that particular topic.

Okay.

All right.

I'll stop there.

Thanks.

Thank you for the questions.

Thank you very much everyone for joining us today.

We look forward to speaking with you soon.

Bye.

Thank you.

This concludes today's teleconference.

Thank you all for your participation.