Take-Two Interactive Software Inc (TTWO) 2006 Q1 法說會逐字稿

Greetings, Ladies and Gentlemen, and welcome to the Take-Two Interactive Software 2006 first quarter fiscal 2006 financial results conference call. [OPERATOR INSTRUCTIONS].

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms. Cindi Buckwalter, Executive Vice President of Take-Two Interactive Software.

Thank you, Ms. Buckwalter.

You may begin.

Thank you.

Good afternoon, and 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 may 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-K for the year ended October 31, 2005, which may be obtained from our website at www.take2games.com, 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.

Today, Karl will first review our Q1 results, then Paul will talk about our recent releases in our product pipeline.

Karl?

Thanks, Cindy, and good afternoon.

Net sales for the first quarter were $265 million, compared to $502 million a year ago.

Our net loss for the quarter was $29 million, or $0.41 per share, compared to a net profit of $55 million or $0.79 per diluted share in the first quarter of 2005.

Revenue was down primarily due to the significant comparison we were up against from last year's strong holiday sales of Grand Theft Auto San Andreas for PlayStation 2, which accounted for $287 million, or about 57% of last year's first quarter total sales.

And as we said on our last call, both our fourth quarter fiscal 2005 and first quarter results this year were negatively impacted by the lighter than expected consumer purchases of video games and lower average selling prices as the industry transitions to next-gen hardware.

With that said, our revenue came in slightly ahead of the range we provided in early January, primarily due to the higher than expected distribution line.

This year in Q1, Grand Theft Auto Liberty City Stories for PSP was our top title, representing approximately 20% of the quarter's total revenue.

This was followed by Grand Theft Auto San Andreas for PlayStation 2, at approximately 6% of sales, and Civilization IV on PC at about 5% of sales.

Our sports business also performed quite well, representing close to 13% of total revenue, with XBox 360 titles at about 6% of revenue.

Our Jack of All Games business increased from Q4 to approximately $107 million in Q1, as they ramped up their hardware and software sales during the holiday season.

We have also additionally been closely monitoring Jack's inventory positions through the difficult holiday season, and have reduced total distribution of inventory by over 25 million year over year as of the end of Q1.

Jack continues to work to leverage their size and scale by securing more exclusive distribution arrangements for valued products, while at the same time providing full support to their customers by also supplying the new hardware platforms and the new frontline software titles that drive customer traffic.

We believe that Jack will have interesting opportunities this year as the hardware transition progresses.

Our gross profit margin for the quarter was approximately 21%, compared to 36% last year.

The primary reason for the decreased margin is related to our business mix, as our higher margin publishing sales represented a smaller percentage of revenue compared to last year's first quarter.

Our publishing distribution split in the quarter was roughly 60% publishing and 40% distribution, compared to our publishing distribution split of 71%, 29% last year.

Within our distribution business, a greater percentage of revenue this year came from hardware sales, which carry lower gross margins.

But most importantly, the significant percentage of Grand Theft Auto San Andreas from last year's first quarter was the major contributor to our higher gross margin last year.

Additionally, this year, we realized higher software amortization related to the greater number of our sports titles and other internally developed products that were released in the quarter.

Lastly, we experienced lower average retail pricing in the market this holiday season.

These factors were only partially offset by a reduction in royalty experiences and a greater percentage of a higher margin PC titles from the current period.

Our operating expenses in the first quarter were approximately $104 million, down about $3 million from last year's first quarter.

Our selling and marketing and R&D expenses declined year over year.

However, we saw growth over last year in G&A due to several factors.

G&A experiences this year included approximately $3 million in costs related to the expensing of stocks options which was required under FAS-123 beginning in our first quarter.

This year, we also incurred about 2 million more in IT and professional fees related to audit fees, SOX compliance and legal matters, and we have expanded our IT and the finance global headcount in the the past year to support these initiatives.

We also realized an additional two million for increased rent and new offices for the development studios we've acquired since last year's first quarter.

These increase were only partially offset by reduced incentive compensation this year.

We were cash flow positive in the first quarter, generating approximately 38 million, as we collected receivables for many of our big holiday releases.

At the end of Q1, we had about $143 million in cash, as compared to $107 million in cash at year-end.

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

Net accounts receivable at the end of the first quarter were approximately $84 million, compared to $198 million at the end of Q4, and $137 million at this time last year.

Out DSOs in Q1 were approximately 29 days, compared to 58 days in the fourth quarter, and 25 days in the first quarter of last year.

Our accounts receivable reserve stood at about 91 million at the end of the quarter, representing approximately 52% of gross receivables.

Our Q1 reserves were approximately 16% of trailing six months revenue, and about 12% of trailing nine months revenue, higher than last year's Q1 levels due to the mix of publishing products we sold during the holiday period.

Inventories at the end of the quarter were approximately 107 million, down significantly from 136 million at year end, and 134 million at Q1 last year, due to our reduced business this holiday season.

Our software development costs and licenses totalled about 129 million at the end of the quarter, compared to about 118 million at year-end, and about 96 million at this time last year.

The increase in these costs relates primarily to our diversification strategy, which is in line with the continued execution on our plans to further expand our portfolio breadth and depth.

We've also signed up a significant number of new products for our 2K games and 2K sports labels, and are putting significant development resources between Rock Star's current and next generation products so that we are well positioned in 2007 and beyond.

We currently have over 120 SKUs in various stages of development, representing over 40 different brands.

Approximately 70 SKUs are planned for fiscal 2006, including the titles we have already released this year.

Now a few comments about the present and future.

We are assuming a continued cautious retail environment due to the ongoing console transition.

We also assume that 360 hardware availabilities will remain constrained, and that the pricing pressure we are seeing now in current gen software will continue through 2006.

Having said that, we believe that our Q2 lineup looks very promising. 2K's Major League Baseball and Oblivion titles are both highly anticipated, and we expect strong consumer demand for Grand Theft Auto Liberty City Stories on console, which is currently planned for release late in the quarter.

We are continuing to manage our business for the opportunities that we see in 2007 and beyond.

At this point, I will turn the call over to Paul to provide more detail on our recent releases and our product lineup for the remainder of 2006, as well as an early glimpse into 2007.

Paul?

Thanks, Karl.

Good afternoon, and thanks for joining us today.

Our results for the first quarter of fiscal '06 were disappointing, and reflected the challenging conditions in our market during the past holiday season.

The video game industry is in the midst of a difficult transition, which presents us with a number of near-term market uncertainties.

As a result, we are taking steps to streamline our business, re-examining our product line, and closely evaluating our release schedule for both current gen and next gen platforms; but any steps we take will not be at the expense of the quality of our products and brands.

It's important to emphasize that the transition will create new opportunities, with hardware platforms that allow our developers to express the full range of their talents in creating compelling new content.

In the meantime, it is crucial that we manage through the transition as effectively as possible, while insuring that Take-Two is in a strong competitive position for the upturn that we believe begins in '07.

Our plan to achieve these goals has three basic elements: One, continue to support our high quality product lineup for fiscal '06.

We believe great content remain the driving factor for growth, and we are very excited about the quality of our release schedule over the next year.

Two, improve the efficiency of our operations.

We are streamlining our business and controlling costs, while at the same time continuing to support the creative talent that will produce our next wave of hit products.

Three, maintain our investment in diverse development resources.

As the industry moves beyond the current transition, we will be well positioned to leverage the opportunities of next gen platforms, thanks to our talented internal development studios, our growing portfolio of brands, and our expansion into new genres, such as sports.

Now I would like to spend a few moments discussing these initiatives.

The '06 lineup is one of the strongest in our history, with a broad range of products that are winning praise from gamers and critics alike.

Our strategy is to continue to develop quality games for current generation hardware, while introducing new games for next gen platforms, such as the XBox 360 and PSP.

For example, Grand Theft Auto Liberty City Stories for PSP was our top title in the quarter and has been the number one PSP title in the U.S. every month since its launch in October.

We anticipate strong sales throughout '06 as the hardware base continues to build.

The strong contribution of Grand Theft Auto San Andreas in the quarter demonstrates the longevity of our Grand Theft Auto brand.

In late January, Grand Theft Auto San Andreas joined our growing roster of Greatest Hits titles for PS2 and Platinum Hits for XBox.

We are extremely proud of the continued strong performance of Rock Star products.

Rock Star is clearly the dominant video game publishing label in this cycle, with five original franchises selling over 1 million units during the current generation.

On top of those five proprietary brands, Rock Star created the blockbuster Grand Theft Auto series, which generated unprecedented demand.

This brand has sold more than 40 million units during the current console cycle alone.

This is a testament to the hard work, talent and creative storytelling of the Rock Star organization, now over 700 individuals.

We have a long term agreement that will enable Rock Star to continue to make great products under its current management team for many years to come, with terms that align the interest of all parties to drive the product sales and company performance.

Moving on to 2K.

We continued to see strong sales momentum from Civilization IV, which shipped late in Q4.

Civilization IV enjoyed the high game rankings and was named '05 PC Game of the Year, Best Online Game and Best Strategy Game by IGN.

NBA 2K6, NHL 2K6 and Amped 3 for the XBox 360 all shipped during the first quarter in conjunction with the hardware launch.

NBA 2K6 outsold EA's title in head to head competition in December and January according to the NPD data.

Also in the first quarter, we shipped College Hoops 2K6 for PlayStation 2 and XBox, featuring a variety of new features for the franchise And Torino '06 shipped for Playstation 2, XBox and PC in January in advance of the Winter Olympics.

Looking at Q2, we are adding to our strong lineup. 24 The Game for PlayStation 2 shipped in North America last week.

It was developed in conjunction with Fox TV, and the television series creators.

Kiefer Sutherland and other actors from the show are featured in the game.

Global Star shipped Sukoko Fever for Gameboy Advance, based on the popular puzzle game.

From Rock Star, we leveraged the success of the multi-million unit selling Midnight Club franchise with Midnight Club 3 Dub Edition Remix shipping next week.

Remix adds a new city, Tokyo, along with new music, new races and new cars, and will retail for $19.99 for the Playstation 2 Greatest Hits program and XBox Platinum Hits collection.

Both fans and new players will be drawn by the speed and style that defines this series and the great value proposition at under $20.

Shipping in just a few weeks from 2K Elder Scrolls IV Oblivion for PC and 360, one of the most highly anticipated games this year.

We are pleased with the next gen look and feel of the title, and are proud to be working with the Bethesda team on such a platform defining title.

The game is in production is now and will ship on March 20th.

Building on the tremendous reception that Liberty City Stories received for the PSP, we plan to ship the PlayStation 2 version late in the second quarter.

We are confident that extending this game to the console market will allow more gamers to experience this unique compelling content.

We're also continuing to expand our sports franchises in the second quarter.

College Hoops 2K6 for XBox 360 is in stores this week, in advance of March Madness.

It is the only next generation college basketball title available on the system; and like our NBA 2K6 XBox 360 title, the game has the pace of play, an entire feature set found in the current gen game.

Plus, 2K Sports added more schools and enhancements that only the power of the XBox 360 can offer, like high-definition realism, and the excitement and passion of a college crowd.

Also in Q2, we'll introduce the first products under our exclusive partnership with Major League Baseball.

MLB 2K6 for Playstation 2 and XBox will ship in early April, and the XBox 360, PSP and Game Cube versions ship in late April.

We are taking this time to make the extra investments, giving gamers the high quality they expect.

As we proved with the NBA 2K6 on the XBox 360, details such as realistic crowd movement and true true television broadcast camera angles complement great game play and resonate with gamers.

The enhanced, more comprehensive batting, pitching, fielding and coaching controls, combined with the inside edge intelligence, adds an unprecedented element of realism to the baseball video game genre.

We're also featuring a number of major advertisers in MLB 2K6 who are attracted to the audience of sports games.

As for our other sports titles, World Poker Tour for PSP is planned for release in April, Top Spin 2, the next installment of this critically-acclaimed top selling tennis brand, is also coming to the XBox 360, DS, and Gameboy Advance in April.

We're equally enthusiastic about the products planned for the second half of '06, which include a strong roster of offerings from Rock Star and 2K.

Yesterday, Rock Star announced Table Tennis for XBox 360 for release in the third quarter.

Rock Star San Diego designed this title, used the full power of the 360 hardware, taking advantage of high resolution graphics and high speed animation to create a fun and addictive game.

We believe they will capture the passion of the highly popular sport in a way that only Rock Star can.

Later this year, Rock Star will bring Bully to PlayStation 2 and XBox.

Additional titles include a sequel of Rock Star's brands for console, along with two PSP titles, including one based on the Grand Theft Auto franchise.

And from 2K, we have the Da Vinci Code for current gen console in PC planned for the release in conjunction with the Columbia Pictures Feature Film.

In the summer, 2K will introduce Prey for PC and XBox 360, a highly anticipated game from Human Head Studios in 3D realms.

In the fall, we have Stronghold Legends for PC, a sequel to the popular Stronghold brand.

Family Guy, based on the Emmy Award winning hit Fox television series for the current generation console systems, also in the fall.

And later this year, 2K Sports will sequel its popular license titles with the NBA, NHL, College Hoop, and additional titles based on our Major League Baseball license.

Looking forward to '07, we already have a solid lineup of titles in development; bold next generation line up Rock Star, including sequels to several best selling Rock Star franchises; the 2K Sports lineup of titles based on our multi-year licenses with MLB, NBA, [INAUDIBLE] and NHL; the 2K Sports non-licensed title lineup from the development team that created Tennis, Snowboarding, Boxing, and other sports games; the next gen console game, Bioshock, from 2K's recently acquired Rational Games Development Studio; a new product, The Darkness, the next gen platform, based on the popular comic book series.

And also in '07, 2K is planning to leverage a number of its premier original franchises into the mobile game arena, including Top Spin and Civilization.

I noted earlier that cost discipline is also a key part of our strategy for managing through the uncertainties of the current transition.

In this regard, we have consolidated two of our development studios -- Top Top and the recently acquired Firaxis Studio.

This will allow us to combine the strong creative talents of these studios into a single entity under the development headed by Sid Meier.

We are pleased that Sid will be honored next week with a star on the Walk of Game in San Francisco.

We're also evaluates plans to reduce overhead in several key area.

We're working to bring costs down to the greatest extent possible, while recognizing that we need to be well positioned for '07.

In our Jack of All Games distribution business, the management team remains focused on bottom line results.

With their inventory down significantly, Jack can be flexible in taking advantage of opportunities that arise.

Their focus is on providing valuated services as they leverage their strength in the overall retail market place and capitalize on hardware transition opportunities.

While we are absolutely determined to exercise strict cost discipline, we know that no company ever cut its way to growth.

That's why we believe it is essential to continue to invest in the future by building our development resources, supporting or products with appropriate marketing, and expanding our ability to offer a more diversified product line.

We have made investments which will be important building blocks for growth.

For example, Firaxis, which gives us the extraordinary development and management talent;

Irrational Games, with their critically acclaimed development teams in Boston and Australia;

Rock Star [INAUDIBLE], which gives us an exceptional entree into the portable games market; and our Sports Development Studios, which diversify our revenue stream.

In summary, while the console transition is challenging, we are dealing with the current industry conditions and working hard to position Take-Two for future opportunities.

We're continuing to create great products that will cement our strong following among gamers, and seeking a balance of managing our expenses while investing in creative resources to build a diversified business base.

We look forward to the results of these efforts in the future.

Again, thanks for your time today.

Operator, we'll now open up the call to questions.

Thank you. [OPERATOR INSTRUCTIONS].

Our first question is coming from Heath Terry with Credit Swiss First Boston.

Please state your question.

Great, thanks.

Karl, could you -- could you -- just one kind of housekeeping thing.

Could you tell what the 123R charge was for this quarter?

The charge in total is about $4.5 million.

Okay.

Thanks.

And then Paul, can you talk about the pricing strategy for Grand Theft Auto Liberty City Stories?

Hot a lot has been holding premium prices lately.

Do you feel like this is one that you can maybe reach for, given that -- the Grand Theft Auto brand?

We've been very successful with Liberty City Stories at the higher price line, full price on the PSP, which is a different type of consumer, and we've delivered a new game for the PSP, and that's a $249 purchase.

And we're looking at lower pricing on Liberty City Stories for the console, which is a $149 or below purchase.

We are very, very protective of the Grand Theft Auto brand.

We've delivered, you know, unprecedented, and, you know, a tremendous value to the consumer; and in terms of the size of the game and the scope, and we think Liberty City Stories is a great product, and we look forward to bringing it to the console.

But it's also at a different time in the transition, and it -- you know, it ties the products, you know, together, because it does tie back into the original Grand Theft Auto 3 storyline.

It's very engaging for the consumer.

So we're excited about it, but it will be at lower pricing.

Got you..

The cost cutting, or cost containment focus, I guess, Karl mentioned that there are going to be 70 SKUs in '06.

I guess -- I guess first, how does that compare with what you released in '05?

And then, you know, looking at -- looking at '06, how much of the focus on cost containment is going to come from rationalizing your SKU count down to your most profitable, maybe focusing on your most profitable franchises?

Heath, I think the SKU count of about 70 for '06 is, you know, comparable to '05.

Having said that, you know, we've certain added a number of internal resources by way of studio development, and, you know, the buildout of the Sports business, and some significant titles that we're involved with, for instance, with Sid, and Firaxis, and, you know, all in addition to the great lineup coming from Rock Star.

So the cost, you know, exercised that we try to undertake on a regular basis, but certainly with an intensity, you know -- most recently given the holiday season -- focuses on not only the pipeline, and the imbedded, you know, people supporting those products, but on every cost within the business.

So we're keenly sensitive to the G&A levels, as well as the margin performance, for instance.

So I don't foresee in the immediate future that we would suddenly have a significant dent in the pipeline by the way of the products that we would walk away from, but more perhaps of a right sizing of timing of that product in the market place, and just being very cost conscious about how we're spending elsewhere with those businesses.

In this past -- this is Paul.

The past holiday season was, you know, different than we expected.

There is uncertainty in the market in terms of flow of hardware, hardware price reductions, introductions of the next -- you know, of the next gen -- you know, the timing.

So we are just taking that all into account.

We do believe there is a lot of opportunity on this existing gen, and we're showing several products in the release schedule, and we'll take advantage of that; but given the uncertainty in the market, we're just reacting accordingly.

We have tremendous leverage in the retail marketplace, we have tremendous leverage with the consumer; and we just want to maximize that leverage going forward.

Okay.

And then the long term employment contracts that you mentioned for the Rock Star team, can you give us an idea of what exactly was done to align -- better align their interests with that of the overall Company?

To what ex-tent was maybe their performance tied to the performance of the Company's equity a part of this longer term deal?

While we don't give specifics, what we can say is that the Rock Star group is extremely, you know, committed, passionate, dedicated group of, you know, of developers.

With that, they entered the last cycle with about 100 people.

Today, they're 700 plus, so it's a big organization, and we had to adjust, you know, how we compensate that organization to fit all the different development teams that they have.

We have aligned them with management.

We've communicated with them, you know, on a regular basis, in terms of, you know, obstacles in the business today, and challenges in the business, and we're just excited that we, you know, have this behind us, and we can move forward.

And the alignment in terms of, you know, we'll call it stakeholder interests, we certainly used equity compensation programs in the past with regard to the development talent and leadership, and we would expect to have more of the same in the future.

Great.

All right.

I'll hand it off to somebody else.

Thank you.

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

Please state your question.

Hi, guys, it's Tom standing in for Edward.

On your internal development, can you tell us where you stand with a number of developers in total, including the 700 of Rock Star, and how many you expect that go to by the end of the year?

Tom, I think the answer to that question is we have approximately 1300 people in development; and then in terms of trending it for the year, you know, we've obviously made a number of acquisitions, we've been acquisitive over time.

I think, you know, where we stand right at this moment is, you know, nicely aimed with the portfolio for '06 and '07.

You haven't seen anything, you know, from us in recent -- well, several months by way of new announcements or things like that of acquiring additional internal talent.

But we've had a watchful eye on the marketplace -- if something extraordinary comes along, we're not going to just pass it by, but we feel very good about the line of product and resources standing behind it on an internal footing for the near term future.

Okay.

And of the total SKUs that you have in development, can you give us a -- give us a rough idea of how that breaks down on current gen versus next gen?

Yes, the current gen is about -- let's call it 70 or so of the 120 that we have under way, and next gen, including -- we consider PSP to be part of the next gen, of about 50 SKUs.

50, okay.

And lastly, if I could, you had mentioned mobile games.

Can you talk about what your plan or strategy is there, or are you thinking about partnering with somebody, or do you think you might try to build that up on your own?

Tom, this is Cindi.

We would expect to probably work with other parties.

This is obviously an area that has tremendous growth opportunity, and we think that there's quite a bit of content that we now have in our portfolio in terms of this 2K Sports lineup -- as Paul mentioned, Top Spin, and with 2K Games, titles like Civilization that lend themselves very well to mobile gaming.

So you will see us do more of that going forward, but I would say that we would generally work with third parties to achieve that objective.

Okay.

Great.

I'm all set.

Thank you.

Thank you.

Our next question is coming from Elizabeth Osur with Citigroup.

Please state your question.

Thanks.

A couple of just quick questions.

But first, you talked about an efficiency initiative.

I'm not quite clear what kind of initiatives you guys are planning.

Could you be a little bit more specific on where we might be seeing costs come out of the system?

One example we gave was combining the two studios of Top Top and Firaxis.

We think there's a lot of synergies between the studios that we can take advantage of.

We think there's a lot of cost efficiencies in just managing the business in terms of we brought our sales organizations together, we think there's buying opportunities on the media side, things like that that we could be doing more efficiently as we get through this transition.

Could you maybe quantify that?

Liz, I think at this point, you know, rather than try to pencil the all into into one, you know, bite size number, our commitment is to continue to work this, you know, certainly over the near term, and if there's something more meaningful that we get to by way of a specific announcement, we would certainly try to get that into the marketplace at that point.

Okay.

And then just totally separate topic, could you talk about what kind of changes you're still making to the Bully game, or when we might expect to see that, or why -- you know, are we just holding off until the holiday season, or is there something else going on?

Given the climate, we just went back and evaluated the game.

We think that, you know, Bully has a tremendous opportunity because it's based on the great storytelling of the Rock Star, it's, you know, a fictional [INAUDIBLE] academy and school yard antics.

We do follow all of the SRV guidelines and the plan is for us to release that in the back half of '05.

Okay.

Thanks a lot.

Thank you.

Our next question is coming from with Anthony Gikas with Piper Jaffray.

Please state your question.

Hi, good afternoon guys, a couple of question.

Could you elaborate a little bit more on the operating costs in the quarter?

I think you talked about the G&A.

I might have missed your comments on why sales and marketing were so high, and maybe what the trend could be over the course of the next couple of quarters, the tax rate we should use for the remainder of the year, and then maybe just the third question, just a general, your thoughts on why we're seeing such a slow down the industry -- and this is not specific to Take-Two -- but is this a quality or innovation issue that we're seeing with current gen products, or are the consumers just purely holding off in anticipation of getting the new hardware platforms?

With regard to the first couple of points, Tony, the tax rate is obviously sensitive to the, you know, pretax levels that we generate in different jurisdictions, and we've had some discussion and, you know, I usually keep these comments fairly brief about where we operate.

Generally speaking, we operate a very favorable rate overseas and les favorable domestically.

So the tax rate is going follow where the income is really produced.

Having said that, you know, the rate -- the benefit that we have here is this higher than the absolute rates we've seen in the recent past, and that would tell you that we are generating pretax levels certainly in higher tax rate jurisdictions.

For the future, we'll have to see how the mix goes; but that would probably be the best clue I could leave you with in terms of -- you know, model the mix in terms of your expectations and take it from there.

With regard to sales and marketing, we obviously had a fairly large offering of products just in terms of absolute SKU count for the holiday season.

We tried to support those products sensibly, given what was happening in the market place.

We weren't bashful, for instance, about trying to get behind the Sports business, which was a new initiative, really, for us this year, and sort of going head to head in the marketplace.

And, you know, we're pleased with certain results that came from that.

But that absolutely kept the absolute dollars worth of marketing expense up in comparison to our prior year, which was a year -- you know, heavily dependent on one title, doesn't require the same committed amount of marketing expense over time.

Tony, in regards to your question about the consumer, we did, you know, see the effect of this transition.

We believe some consumers were looking forward to next gen.

We're very pleased with the appetite for the consumer, particularly for our games on PSP and on 360 in terms of the quantity of games, via tax rate.

I just got back, I was with a number of retail customers out at the Destination Meeting in Florida, and retailers were starting to be much more optimistic than in the past.

They were see something real excitement created at retail.

Some of it is just about managing expectations.

We're excited about the response to some of our titles, but we think a title like Oblivion could really drive a lot of business.

We just shipped 24 to a -- you know, a good start, a good launch -- just shipped it last week.

So we think that we're working through this, and you know, we remain, you know, optimistic going into the back half of '06 and '07.

And then I guess a quick follow-up.

What are your expectations for industry sales in calendar '06 and '07?

That's why we haven't given guidance, because we're, you know, uncertain right now about hardware numbers.

You know, we see a lot of positive indicators in the business, but we're just being very cautious right now, given the marketplace.

Thanks.

Thank you.

Our next question is coming from Mike Wallace with UBS.

Please state your question.

Hi.

A couple of things.

Paul, let me just address it directly.

You know, people have been saying the Housers are leaving.

Could you specifically address them?

Are they staying, or are they looked up?

Second, could you just address some of the [FTC] things, timing, City of L.A., what are you thinking about these lawsuits that have popped up?

Okay.

I mean, we don't like commenting on individuals, but, you know, Sam Houser in particular, and his brother Dan and Terry and Les, you know, are all key parts of the Rock Star organization.

They were the founders of the Rock Star label and the Rock Star brand.

You know, as you can imagine, they're very, very busy working on next gen, they're very excited about the resources they have.

It's a different type of business today than it was at the start of the last cycle, where they had 100 people, and they were introducing their first products for PlayStation 2.

Now they're -- you know, as you can see by their release schedule, they have the number one game on the PSP, excited about bringing a different type of offering to the XBox 360, and they have still, you know, some real opportunities for this gen, with several titles that they're bringing out.

You know, we -- we're very excited about working with them and, you know, they're under contract for us for the, you know, long term, so, you know, all of the rumors and everything that was out there, I don't give a lot of credence to it.

In terms of the FTC, we really don't have an update.

We have complied with all of the requests.

We are following and continue and have followed all of the guidelines and rules of the SRB and support the rating systems.

We are committed to building awareness of the SRB in the ratings, and educating everyone in the business about the huge diversity of entertainment products and the diverse audience for interactive games.

So part of it is just an education process.

But we really don't have any specific updates.

And just of the City of L.A. lawsuits, you know, we don't specifically comment on litigation, but we obviously believe that [INAUDIBLE] don't have any merit, and we'll continue to defend ourselves against them.

Okay.

And then just one more.

Any current thinking on, you know, the next console version of GTA?

I know you're not going to say if it's Sony or Microsoft, but what is your stance?

Are you going to wait to see what the install base is before you make any decisions, or, you know, are you leaning towards a partner with one or the other?

What's your thought process on that?

Right now, we're very excited about the plans for, you know, the GTA franchise.

We were pretty unique in approaching the PSP market with, you know, new content, and now we're excited about bringing that content -- you know, Liberty City Stories -- to the console market.

We have another PSP game planned on the Grand Theft Auto franchise in the back half of the year, and I think we're in a very envious position, because we have the biggest brand in the industry, and we are working very, very hard, you know, to bring that product out the way we have in the past, where we beat expectations, and our guys are very, very excited about the opportunity that, you know, the next gen hardware presents.

I think we're in the driver's seat, you know, in terms bringing that product to market.

Is it possible you'd do one for the 360, and a different version for the PS3?

Anything is possible, but, you know, it will be what you would expect in a great Grand Theft Auto product.

And, Mike, I think just as important to refer back to our press release where we said that we have a strong lineup of next gen products from Rock Star in 2007, including some of their biggest franchises.

Uh-huh.

Okay.

Thanks.

Thank you.

Our next question coming from Mike Hickey with Janco Partners.

Please state your question.

Hey guys, thinking about your new Rock Star Table Tennis game, is this just fast tennis?

I mean, can you give us a little bit of an idea of how good the game play is going to be here?

And then can you quantity maybe a little bit of the development effort in terms of capital outlay?

And then, can we expect this to extend to the PlayStation portable or the DS, or maybe a mobile application?

And then lastly, on the distribution side, is this something that -- it's a casual game, could we see this being downloaded through XBox live?

Right now, we just showed the Table Tennis game to all of the key retailers the last week, and it received, you know, a great, great response from them.

It's fun, it's addictive.

It takes advantage of the 360, you know, and of the next gen hardware capabilities.

It's a different product than you would expect from the Rock Star, but once you play it and get hooked, I think you'll be a fan of the game.

We think it has all of those opportunities that you described in terms of, you know, spreading that brand out to other systems, and, you know, downloads, and online play; but right now, we're just focused on getting this game out.

The plan is to ship it in May, and we'll give you more information as it unfolds.

Great.

And the last question, for your Q4, you talked about returning to profitability.

Originally, think you were modeling in for a PlayStation 3 launch, maybe 5% of core sales for your original fiscal '06 guidance.

Are you still anticipating the PlayStation 3 launch potentially, or at least modeled in for your Q4, and can you give us any sense if it was released in October, if you would have titles currently available for release at launch?

Mike, I'm going to go underneath your question and go at terms of, you know, when is PlayStation 3 really going to launch; and then, you know, our crystal ball really doesn't address that, and we certainly look at Sony in terms of, you know, further information there.

I think you can read plenty about, you know, holiday expectations, and for us us with October 31st, that's a very interesting time frame, as a fiscal year-end, so we'll just have to stay tuned on that point.

I don't think we can really give you any further insights in terms of what they're thinking.

Thanks, guys.

Thank you.

Our next question coming from John Taylor with Arcadia Investment Corporation.

Please state your question.

Hi, I've got a couple of questions, too.

Let me just follow up on that for a second, Karl, if I could.

So let's assume that Sony is in November or December with PS3, how much of your fourth quarter guidance and getting back into profitability depends on their being able to ship in October or earlier?

John, we're not in the guidance business if that time frame, you know, at a specific level.

I can recall that I think if we had any comment on this, we did not expect any, you know, significant percentage performance that was directly related to our '06 business, but not going back, I think, at least 6 months in terms of that commentary; so I wouldn't read too much into that, but that's certainly what we said at that point in time.

Okay, great.

And thanks for that refresher.

And then in terms of inventory, could you give -- you mentioned you burned off a bunch of Jack's inventory.

Could you give us a split of what the inventory was between distribution and publishing?

Inventory breaks down about 50/50 on publishing versus distribution.

Okay.

Great.

And then the -- in the past, you've given us kind of an average acquisition cost on the Jack side.

Can you give us an update on that?

In terms of the average cost of inventory?

Yes.

It's still living in about the same neighborhood.

About 80% of the SKUs that we carry have an acquired cost of $14.99 or less.

Okay.

Great.

And then in your amortization of [INAUDIBLE] costs, et cetera, recorded in the first quarter, did you burn off anything on an accelerated basis that you could call out, or was that a pretty normal sort of amortization rate?

We clearly are sensitive to the amortization of our costs in terms of what we expect for the product overall; so I mean, if volumes had come up, you could look at the -- you know, call it unit average of that cost and see if it would be something less, so I don't quite know how to answer your question.

I don't think we took anything by way of an acceleration where we looked at something of any size and walked away from it and just wrote it off a day before we would have otherwise released it.

So we didn't abandon anything of significance, and the rest of the math is directly related to what we expect for the product overall.

Okay, all right.

Great.

And then as you look sort of -- as you look at the product line for '06 and '07, could you give us a sense of which games kind of have the most robust and unique online feature set, particularly as it might relate to XBox Live?

Kind of which games really have -- you know, have had a loft effort and focus put on developing those features?

Well, our Sports games have, you know, been significant in terms of the online features, particularly with XBox live, and that is one area where I can tell you on our Rock Star side we're spending a lot of time, because we think there is tremendous potential as a feature set, and then tremendous earning opportunities down the road with the online potential.

And then when we look at the 2K games business, you'll see a lot of great online capabilities and components in the 360 products as we build them going forward.

In terms of specifics --

At the risk of having you send us to Sony for this answer, let me try this one.

Have you gotten much detail on kind of how Sony is approaching the mind business model as it relates to PS3?

At the risk of not --

You took the same risk, John.

Okay, never mind.

I would prefer to just not comment on that.

Okay.

All right.

Thank you.

Thank you.

Our next question is coming from Chris Kwak with SIG.

Please state your question.

Great.

Thank you.

Just a few questions.

You know, you guys were able to generate positive cash flows despite what was obviously a tough quarter, given the timing of the working capital changes.

But when we look forward into the April and the July quarters, any sense for cash flows there and the timing of working capital, and how that might affect the cash flows the next two quarters?

Chris, you know, we obviously have a number of significant releases that we think will be, you know, in the positive performers; so in terms of the near-term, you know, whether it's titles of a baseball game, or Elder Scrolls, or Liberty City Stories, or Prey, you know, there's a lot of stuff going on for us in the springtime, so we feel good about our line up in the near term and the resulting impact on cash.

So you know, we ended rather nicely for the quarter, with cash up over October 31st, and you know, we continue to monitor it and be sensitive to where we are and what we're burning.

Well, I -- let me rephrase that.

Would it be safe to say your objective over the next couple of quarters, prior to the Q4 profitability, would be to try to at least, you know, get to a cash flow number that isn't -- you know, that's close to flat, or break even, or is there some kind of target that you're reaching for for the April and July quarters?

As I said, that's a difficult question, again, to answer, and, you know, in the zone of no guidance, because it's yet another number on the balance sheet that reflects, you know, what's going on within the business.

Uh-huh.

But, you know, we have done rather well over recent years in living on organic cash flows.

This is a transition; you know, we had a good war chest entering at the early -- beginning part of that transition.

We're going to be very careful with that as we move forward.

We'll have to see, you know, where the business is, and we think we have a number of titles that on the one hand could have some upside beyond our own expectations, but we'll just have to see how the consumers behave.

Two quick final questions.

GTA, the next GTA on the PSP, would it be safe to assume that would come out at $49.99?

At this point, it would be safe, yes.

And then lastly, the profitability, in terms of profitability in Q4, would that be driven mostly by exposure to next gen, current gen, portables, a combination of all three?

Is there anything that you're pressing on in particular in that quarter in terms of your expectations?

I think it would be driven by a combination of all three.

Certainly, the PSP opportunity big when you bring a brand like Grand Theft Auto.

But then it -- you know, we just have that window there that, you know, we think business will pick up significantly.

Great.

Thank you.

Thank you.

Our next question is coming from Glen Reid with Bear Stearns.

Please state your question.

Hi, thanks.

Three quick ones.

Could you sort of give us a sense for the profitability of your Sports business, you know, how that's been sort of year to date, and how you think that's trending, you know, over the next several quarters?

Secondly, pricing on AAA titles, current gen, you know, other than, you know, you just mentioned, you know, the PSP title going out at $50; but on the console, can we expect to see, you know, lower pricing there?

And on next gen, do you expect to see $60 on all of your next gen releases?

And then third, could you also give us a sense on the mix of publishing versus distribution this year, and perhaps next year?

Thanks.

I think with regard to the first question, which was profitability in Sports, I mean, given the current period that we just ended, you know, where the business operated at an overall loss, that question is a difficult one in terms of identifying which part of our overhead structures would you identify against any particular margin contribution coming from, you know, any of our divisions.

Having said that, I think we were pleased with the Sports business; the basketball game did very well, you know, in the first quarter, and, you know, we're encouraged by what we see for that business in the future.

But, quite frankly, given consumer behavior of the holiday season, it's a difficult period to sort of benchmark against, and we certainly expect to see, you know, more positive consumer behavior as we get further into the transition and on to the next gen opportunities.

The AAA pricing of current gen?

We have built in the $39.99, given the market conditions on the majority of our existing gen, and we're very pleased with the $59 price point and how that has held up for a number of titles on next gen.

But we think that that consumer is excited who buys next gen and wants quality product; and we think on the existing gen prices, you know, $39 and $49 for quality products will hold up when we move some of our more mass titles to the 39 range on existing gen.

You had that third part of the question?

And then the last question was, you know, a rough split on publishing versus distribution.

All I can observe really is that historically we've worked on the development of, you know, 70% publishing, and maybe 60% publishing.

While we're not, again, in the guidance mode for the foreseeable future, we are certainly encouraged by the trend that Jack showed Q1 over Q4 of last year, where their volume did pick up, and we were hopeful of that occurring, and it did.

The opportunities for Jack in the future certainly we think will continue, because it has always played successfully in between the middle of a current gen to a next gen strategy as the next gen product starts to become available to it for distribution at lower prices.

So we'll just have to see where that business goes.

Okay.

Thanks.

With that, we would like to thank you all for joining us today, and we look forward to seeing some of you out of E3 in May.

Thank you very much.

Thank you.

This concludes today's conference.

Thank you all for your participation.