Take-Two Interactive Software Inc (TTWO) 2006 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Take-Two Interactive Software second quarter fiscal 2006 financial results conference call.

At this time all participants are in a listen-only mode.

A brief question-and-answer session will follow the formal presentation. [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 all for joining us today.

Before we begin, we'd 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, 2006, 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.

At this time, I am pleased to introduce Paul Eibeler.

Paul?

Good afternoon.

Thanks for joining us.

I'd like to first summarize a few highlights that we'll be discussing today.

We made strides in streamlining our global organization.

Karl will provide more detail shortly but the reductions we've already made, including those during the current quarter, will result in over $28 million in annual savings.

These actions, including closing some development studios, were difficult, but were necessary steps as we continue to manage our business through this tough console transition.

We're fortunate to have the industry's best development talent, the cornerstone of our plans, from Rockstar's Table Tennis to 2K's BioShock we showcase the innovation and quality of our product development teams at E3 last month.

This continued focus on creating compelling content will enable Take-Two to grow and gain market share.

Finally, we're pleased to announce that the Federal Trade Commission inquiry is closed.

There were no fines nor penalties.

As always, we are committed to supporting the ESRB, educate parents and consumers about the rating system.

Let me hand the call over to Karl.

Thanks, Paul, and good afternoon.

Before we review our operating results for the quarter, I'd like to provide some insight into the cost cutting and other initiatives we implemented in Q2 and Q3 and provide details regarding the financial impact on our results.

As we mentioned in our Q1 earnings call, the console transition has proven to be more difficult than we and others in the industry had expected and as a result we determined it was necessary to streamline our business so that we are better prepared for the opportunities we see ahead of us next year and beyond.

We took a hard look at our global operations across all functional areas and closely examined our product release schedule for both current and NextGen platforms, including reevaluating sales expectations for our titles.

Based on that analysis, we made some very difficult decisions including the decision to close three of our development studios.

Indy Build, Rockstar Vienna and Frog City, along with consolidating some of our smaller PC studios into our premier Firaxis Studio.

While these decisions were very difficult, since they involved lost jobs along with the short-term financial cost to the Company, we believe they are the right long-term decisions given the current market conditions.

These are just our most visible cost savings initiatives.

There have been other expense reductions as well.

We believe these actions will lead to over $28 million in annual savings going forward.

As mentioned in the press release today, the total charge in the second quarter from our asset write-offs and studio closings was approximately $26 million, of which $24 million are non-cash items.

When I review the quarter's results in a minute I'll provide details on how these charges impacted our income statement.

In addition to the second quarter charges we expect to incur approximately $3 million of charges in Q3 when the balance of our planned initiatives are completed.

We are also in the process of relocating our international publishing headquarters to Geneva from the U.K.

This move is not only a cost savings measure, but it should also benefit us in several other ways.

Switzerland provides a more central location to support our growth in Europe, it offers a favorable business environment, and it is in close geographic proximity to attractive emerging markets.

We expect this relocation to result in approximately $3 million in charges in fiscal 2006 spread over the third and fourth quarters.

Now moving on to our Q2 operating results.

Net sales for the second quarter were $265 million compared to $222 million a year ago.

Our net loss poor the quarter was $50 million or $0.71 per share, compared to a net loss of $8 million or $0.12 per share in the second quarter of 2005.

Total revenue in the second quarter was up about 19% compared to Q2 last year due to a 36% increase in our publishing business.

Publishing revenue was led by the sales of The Elder Scrolls IV--Oblivion for Xbox 360 and PC, which together represented about 40% of publishing revenue.

This was followed by Major League Baseball 2k6 on multiple platforms which was approximately 14% of publishing revenue in the quarter.

Other leading Q2 titles were Grand Theft Auto, Liberty City Stories for PSP, Top Spin 2 for Xbox 360, Grand Theft Auto: San Andreas, and Midnight Club 3: DUB Edition REMIX, both for PS2.

Our sports business was once again a strong contributor to revenue.

Sports titles represented over 30% of our publishing revenue in the second quarter.

Jack of All Games' second quarter revenue declined year-over-year, due primarily to reduced sales of current generation hardware and software, and a decrease in average selling prices as the industry transitions to NextGen platforms.

On a positive note, Jack's hardware and accessory business picked up due to the introduction and increased availability of Xbox 360 hardware.

Additionally, even with a significant contribution from hardware which carries lower margins than software products, Jack achieved gross margins in the double digits as a result of the continued focus on margin expansion.

In looking at our consolidated results our total gross profit margin for the quarter was significantly impacted by our product mix which was heavily weighted toward lower margin licensed titles in our publishing business.

Our internally-owned, internally-developed titles, which typically provide much higher margins, represented less than 20% of our publishing revenue in the quarter, while our sports business contributed over 30% of the quarter's publishing revenue and our licensed external products were 50%.

The bulk of our licensed product revenue came from The Elder Scrolls which was co-published with Bethesda Softworks.

As we've said in prior calls, co-publishing gross margins can range anywhere from 20% to 40%, and in this case tipped toward the lower end of that range.

Major League Baseball 2k6 was always big driver of revenue and carries fairly high royalty costs.

These two titles were the leading factors in our increased Q2 royalty expense compared to last year.

In comparison, our publishing business in Q2 last year was led by Midnight Club 3: DUB Edition and Grand Theft Auto: San Andreas, both higher margin internally-owned and internally-developed titles.

Also impacting gross margins in Q2 this year were approximately $18 million in write-offs of software development costs for several titles resulting primarily from our reassessment of sales expectations.

Our software development costs were also higher this year due to the larger number of internally-developed titles that were released compared to Q2 last year.

In the second quarter, our product costs increased because of our higher volume of business, but decreased as a percentage of revenue due to our mix of publishing and distribution business.

Our revenue split in the quarter was roughly 75% publishing, and 25% distribution, compared to our publishing/distribution split of 66% versus 34% in Q2 last year.

Our operating expenses in the second quarter were approximately $95 million, up about $11 million from last year's second quarter, primarily driven by nearly $8 million of charges related to our write-offs and cost cutting initiatives.

However, our selling and marketing expenses declined year-over-year due primarily to a reduction in marketing and co-op expenses.

Additionally, our marketing expenses were higher last year as we heavily supported the launch of our 2K Sports and 2K Games publishing labels which were established in fiscal 2005.

G&A expenses rose this year as a result of additional rent and new offices for the development studios we've acquired since last year's second quarter, increases in IT expenses for system improvements, along with higher professional and legal fees.

R&D expenses increased due to the additional employees from studio acquisitions, as well as $2 million in severance and other costs related to the closure of our Indy Built and Frog City studios during the quarter.

Depreciation and amortization expenses increased, primarily due to about $6 million in write-offs of intangibles and trademarks related to our cost cutting initiatives.

The increases in our operating expenses were partially offset by reduced incentive compensation this year due to the Company's performance.

At the end of Q2 we had about $141 million in cash as compared to $107 million in cash at year end.

Net accounts receivable at the end of the second quarter were approximately $130 million compared to $198 million at the end of Q4 and $127 million at this time last year.

Our DSOs in Q2 were approximately 44 days compared to 58 days in the fourth quarter and 52 days in the second quarter last year.

Our accounts receivable reserve stood at about $88 million at the end of the quarter, representing approximately 40% of gross receivables.

Our Q2 reserves were approximately 17% of trailing six months revenue, and about 11% of trailing nine months revenue, higher than last year's Q the 2 levels due to the mix of publishing product we sold this year.

Inventories were approximately $92 million, down significantly from $136 million at year end at $117 million at Q2 last year due to our continued focus on managing Jack's inventory levels.

Our software and development costs in licenses totaled about $106 million at the end of the quarter compared to approximately $118 million at the end of year end at about the same level at this time last year.

We currently have over 45 titles in various stages of development on current and NextGen platforms.

While we've talked in prior earnings calls about the number of SKUs in development, which represent all the different platforms and titles being developed for, we think it is more meaningful to talk about titles than SKUs.

While we are discussing the balance sheet I want to give a heads up that beginning with July 31st financial statements you will see deferred revenue broken out on our balance sheet relating to agreements for online content, in-game advertising and licensing of our intellectual property.

Most recently, we've received approximately $35 million of payments in our third quarter and we expect to receive additional payments this year.

To the extent we have not performed the obligations required under these agreements we will report such payments as deferred revenue on our balance sheet.

Now a few comments about the future.

We are assuming a continued cautious retail environment in 2006 due to the ongoing console transition.

While we still don't have the visibility to provide detailed financial guidance, given the short-term uncertainty, we can provide some data points that should be helpful in updating your models.

First, to address the balance of 2006.

As we said in the press release we expect to return to profitability in Q4, driven primarily by our release schedule and also by the anticipated ramp-up in consumer spending as we approach the holiday season.

For fiscal 2007, we expect to be profitable for the year although we anticipate the normal seasonality of the business to lead to significant variability in our quarterly results.

Additionally, to provide some more color around our expectations for our three key publishing labels next year we would expect the relative break down of our publishing revenue to be roughly 50% from Rockstar and the remaining 50% from 2k Sports, 2k Games and Global Star.

I'd also like to provide some more details about our sports business, both the present and future, to demonstrate why we are excited about this business and why we've committed significant capital to it, both from a development and marketing standpoint.

We've invested about $60 million in development studio acquisitions, $40 million in software development since acquiring the studios, and another $80 million on licenses and IP for products delivered to date.

We have assembled nine top quality development teams with about 300 people working on our sports titles.

We've already made some major traction in the category with close to $100 million in sports business in just the first six months of fiscal 2006, compared to about $65 million for all of fiscal 2005.

We've secured long-term license agreements with the NBA, NHL, NCAA, and an exclusive third-party deal with Major League Baseball.

Our NBA Xbox 360 title has been selling well against the competing product at comparable retail pricing.

We are clearly executing on the strategy that we outlined to you when we entered the sports business.

The next critical step in leveraging our sports investment is capturing the opportunity of NextGen, which we always said was our sweet spot in sports, when we expect to leverage the benefits of both premium software pricing and increased hardware penetration.

To give you an idea of the leverage provided by higher software pricing and higher unit sales let me walk through a few numbers from NPD for our U.S. sales.

In fiscal 2005, if you exclude the NFL title which we no longer offer, in the U.S. alone we sold just under 3 million units of sports titles at an average retail price of about $20.

Year-to-date in fiscal 2006, we've sold close to 2 million units at an average retail price of about $35, as estimated by NPD.

Based on our current model and expected release schedule, we expect to sell more than 5 million units of sports titles in the U.S. in 2007 at an average retail price of $45.

Assuming these levels of sales in the U.S. and additional international sales our sports business should become profitable and a much more meaningful business for us next year.

In addition to higher pricing and greater hardware penetration we expect to see increasing levels of in-game advertising in our sports titles.

We already have advertising in several of our sports games and given the attractive demographics of sports video game players and the amount of time they spend playing video games, we expect advertising within our sports titles to increase significantly.

Online game play should also become a valuable revenue source for us as we believe sports fans are very interested in subscription services and other downloadable content to keep their stats up to date and game play experience fresh.

So while the sports business is a long-term commitment for Take-Two, it's one we think is clearly well worth the effort.

For our overall business we see multiple drivers for operating margin expansion longer term.

The cost cutting initiatives announced today, with anticipated annual savings of over $28 million, will have a positive impact on our margins going forward.

As the installed base of new hardware platforms ramps up in 2007 we will realize higher unit sales for our NextGen titles which should translate into a faster recoupment of our development costs.

We expect to continue to see higher average retail pricing on new releases for the NextGen hardware platforms.

In addition to higher software pricing we are beginning to see incremental revenue from in-game advertising, as well as licensing our IP for mobile platforms and other products.

With the continued consumer adoption of online game play as the NextGen platforms roll out, we will also begin to capture high margin sales from micro transactions and subscription revenue and as we announced at E3 from the delivery of episodic content for our games.

And lastly, the recent opening of our 2K office in Shanghai provides the opportunity to both reduce development costs for our titles and generate incremental revenue streams for the sale of localized content in international markets.

Taking these factors together, we believe we can show meaningful improvement in our operating margins in 2007 and 2008.

At this point, I'll turn the call back to Paul.

Thanks, Karl.

FTC.

I want to revisit the news announced by the Federal Trade Commission today.

As you can imagine, we are pleased that the FTC has concluded its very thorough investigation and the matter has been resolved.

We recognize the importance of the FTC investigation and the necessity of maintaining public confidence in the ESRB rating system and helping the ESRB educate parents and consumers about the rating system.

We look forward to putting this behind us and focusing on what we do best, creating interactive entertainment.

Our outlook for the industry is unchanged.

Beyond the short-term challenges and uncertainty, we continue to have great confidence in our long-term prospects for '07 and beyond.

We are driven by the exciting technological capabilities of the NextGen systems, the growing installed base of hardware with the increasing online adoption rates, the consumer appetite for compelling content, and, most importantly, the talent of our product development organization.

Our job now is to prepare for the next wave of growth by continuing to manage through the transition and focus on three strategic priorities.

First, continuing to support our high quality diverse product lineup for '06.

Second, improving the efficiency of our operations and leveraging our strengths as a top-tier publisher.

And third, maintaining our investment in strong development resources.

Content.

The Take-Two story is and always will be about exciting, quality product.

We're continuing to create an increasingly diverse lineup based on strong, established brands and compelling new titles.

Our product strength was evident in the quarter.

Elder Scrolls IV--Oblivion and Major League Baseball 2k6 were among the top 10 titles for April in the NPD rankings.

Grand Theft Auto: San Andreas was the top title for February, according to NPD with sales spurred by the Greatest Hits pricing.

Rockstar's other Greatest Hit title for the quarter was Midnight Club 3: DUB Edition REMIX.

Also during the quarter, 2k released 24--The Game for PS2 and Top Spin 2 for Xbox 360, Gameboy, and DS.

We finished the quarter as the number two publisher in the U.S. for April, and had over a 30% increase in both dollars and units compared to April '05.

What we saw at E3 strengthens our optimism for the long-term.

We're pleased that Sony and Nintendo have announced November ship dates for PlayStation 3 and Wii.

For PS3, we have a number of projects underway and expect to have several titles available in the launch period.

Nintendo's Wii should provide additional opportunities for our sports and mass market family titles.

The Xbox 360 has shown the strong consumer demand in both their appetite for NextGen content and acceptance of higher price points for these products.

We believe the NextGen technology plays to our strengths as game developers as we continue to make compelling and ground breaking products.

The investments we have made during this cycle in building our strong product development resources of over 1,100 people ensure our ability to create compelling content.

We are pleased with the improvements we've been able to make in both game play and graphics as our developers have become more confident with the 360.

Rockstar's Table Tennis is an excellent example of this.

Released worldwide last week and shown at E3, this title has created a lot of buzz, receiving Team Xbox and Gamespot nods as the best sports game of E3.

And our NextGen lineup continues to grow.

The announcement of Grand Theft Auto 4, which will launch simultaneously on PlayStation 3 and Xbox 360 in October '07, was the most anticipated news event at E3.

Additionally, we announced a Rockstar-Microsoft strategic alliance where Rockstar will provide exclusive, downloadable, episodic content for Xbox live.

This is a new area of opportunity for us with the potential to drive incremental sales and extend the product lifecycle.

Downloadable, episodic content is one of several ways we'll maximize the value of our key brands to create additional revenue streams.

Also at E3, Rockstar announced Grand Theft Auto: Vice City Stories for PSP shipping on October 17, 2006, further extending the Grand Theft Auto brand, an all new story set in Vice City.

This game promises to be an exciting hardware driver for the holiday season.

And as announced yesterday, Grand Theft Auto: Liberty City Stories, the best-selling PSP title is now available in North America on PS2.

The game will be on the European retail shelves on June 23.

2K also showed a strong and diverse range of titles.

BioShock was named game of the show by IGN, Game Spot, and others.

The title received more than 14 awards and multiple nominations.

The Darkness, based on the popular comic book series, also created lots of buzz for its great story line and game play, receiving numerous critical mentions and nominations.

Da Vinci Code premiered at E3 and was available worldwide on PS2, Xbox and PC in coordination with the blockbuster Columbia Pictures film on May 19.

2K and Microsoft demonstrated the multi-player function of Prey live on the floor at each booth.

The game received high praise with MTV highlighting Prey as the multi-player game of choice.

Prey is coming to PC and Xbox 360 next month.

The 2K PC lineup is built around five properties.

First, Sid Meier's Civilization IV: Warlords, the first expansion for this critically acclaimed title.

Second, Sid Meier's Railroads!

Third, CivCity: Rome.

Four, Stronghold Legends, and five, Dungeon Siege II: Broken World Expansion Pack.

And the PSP title, Dungeon Siege: Throne of Agony.

Sid Meier has taken an active role in helping manage our premier 2K development studios.

Sid's experience and intuitive knowledge of the industry are a true asset for the entire organization.

Licensed product from 2K included The Family Guy from Fox, The Darkness, based on the successful comic book series and developed by critically acclaimed Starbreeze developer, as well as Ghost Rider, a popular Marvel comic book franchise that will be released in coordination with a feature film starring Nicholas Cage scheduled for February.

And we provided a first look at part of our broad sports lineup: NHL 2K7, NBA 2K7 and College Hoops 2K7.

We demonstrated the features of MLB 2K6 on Xbox 360, 2K Sports E3 titles were nominated for more than eight awards, and NBA 2K7 was both IGN's and Game Daily's best sports game, with BET calling it the hottest game around.

I'm pleased to say that we recently signed a multi-year, non-exclusive license with the NHL and NHLPA.

We now have a sports lineup built around solid, long-term licenses with the four major leagues.

Operating efficiency.

We've taken decisive steps to streamline operations making our internal development studio resources more productive.

Investing in development resources.

While we pursue cost efficiencies, we believe it is also important to strike a balance between the need to manage expenses and to invest in creative resources to capture the opportunities of the next cycle.

Along these lines we established 2K Shanghai both as a development studio and as a center for sales and marketing.

This presence will allow us to tap into the growing China game market and provide access to that country's development talent.

The first title from 2K Shanghai, due out this summer, will be the localized Chinese version of Sid Meier's Civilization IV for PC.

As a result, we continue to have one of the most diverse and talented development organizations in the industry with over 1,100 employees in seven countries.

For comparison, we entered the cycle in 2000 with approximately 100 people in product development.

Since that time, we've added studios like Angel, now Rockstar San Diego;

Mobius, now Rockstar Leeds;

Visual Concepts;

CUSH Games;

Irrational, and Firaxis.

Looking to the future, we are increasingly confident in our prospects in '07 and beyond.

Here are a few of the factors that we believe will contribute to stronger results.

We expect to see operating margin expansion in both '07 and '08 as we benefit from a stronger mix of internal, wholly-owned IP, higher price points, and additional revenue streams like episodic content and in-game advertising.

We expect our investment in the sports portfolio to begin showing profitability in the fiscal '07 timeframe, as we capture sales at premium pricing.

And we're excited about our entire product lineup for '07.

We plan a strong slate to take advantage of the greater installed base of NextGen systems, including Grand Theft Auto IV, BioShock, The Darkness, the complete sports 2K lineup.

In addition to traditional sports titles, including games based on the league licenses, you'll see sports products from the internal development teams that have created great boxing and tennis titles.

In summary, we're highly focused on the future, continuing to develop compelling content and building our diverse product line, streamlining operations to manage through the transition, and investing in the innovations that will drive improved margins in '07 and beyond.

Again, thanks for your time today.

Operator, we will now open up the call to questions.

Thank you.

Ladies and gentlemen, we will now be conducting a question-and-answer session. [OPERATOR INSTRUCTIONS] One moment, please, while we poll for questions.

Our first question comes from Mr. Heath Terry of Credit Suisse.

Please proceed with your question.

Great, thanks.

Karl, could you give us a little bit more detail on the decision to break out deferred revenue?

How much of that is directly tied to the Microsoft deal in terms of you providing online content to that versus being tied to the in-game advertising deals that you've put together?

Heath, you know, we're excited to be in a variety of agreements that cover the online content, the in-game advertising, the licensing of IP.

We think this has shown a material trend for us for the future and, you know, we've chatted about this at E3, we've chatted about it in recent past, and we think we're at a point where it's becoming meaningful and significant in terms of revenue capabilities for this Company and really leveraging that IP in a variety of new ways.

We talked about the sports titles included therein.

So I think in respect to, you know, some of the confidentiality and the competitive nature of the business, where we're not going to break out details player-by-player, but there are a number of players involved in those revenue streams, and you can imagine from sports to other pieces of IP that we have that people would find that interesting.

So I'm afraid we can't give you much more color than that.

Is there an anticipated life of that $35 million in deferred revenue that you can talk about?

I think other than to say that we'll appropriately match it in the future when we've provided services for the agreements represented by that number, and, you know, we certainly are talking about fiscal '07 and, you know, things like that in terms of time frames.

Okay.

And then, Paul, the $18 million charge for writing off products in development, can you talk about how many products that represents?

Are there any of those that you all have put a name to before?

And then one change that we're -- I think we're noticing in the product lineup is previously you had talked about an unnamed Rockstar sequel coming out for the current generation this year.

Was that one of the titles that was written off or has that simply been pushed to fiscal '07?

I think the titles we're talking about in terms of write-offs were about a half dozen and then, Paul, with regard to the release schedule for the future?

Going back to the cost savings, the cuts that we made was part of a long process.

It was very difficult because of the growth path that we have been on.

We continue to be extremely prudent, and we're examining every cost and every expense as we go through this transition period.

In terms of the Rockstar lineup, you know, we traditionally play that lineup fairly close to the vest as we've evaluated the marketplace we have made some decisions and are in the process of making decisions with some products of whether they belong on existing Gen or whether we can use those assets and move them to NextGen.

We're real pleased with the table tennis.

We've clearly identified the Vice City Stories for the back half of the year, and identified Bully and additional products from Rockstar, we'll give more color as we go through the year.

And that one title, though, specifically, the one that on previous calls you had talked about coming out this year, was that one moved or --

That one was planned for existing Gen and we'll have to follow-up with you depending on what happens in the near future with the marketplace and some things we are doing in product development.

But it's definitely off the table for this year?

Correct.

Okay.

Thank you.

Thank you.

Our next question comes from the line of Mr. P.J.

McNealy with American Technology Research.

Please proceed with your question.

Hi, good afternoon.

I think there's a little bit of frustration over the lack of guidance.

I mean the [3DPS] for this quarter wasn't anywhere near where you guys came in, and when you look out to, can see that fiscal year '07 has some profitability in the sports line, and fiscal year '08 titles, why not give guidance for the current quarter and for the fiscal year and set expectations at this point?

P. J., as you know, yes, we have not been providing guidance in the recent past, and we are trying to provide meaningful, you know, data points or mile posts for the future, but the analyst estimates are, obviously, a product of everyone's individual research and there's a pretty big range of estimates out there even for the current quarter that we just concluded.

So, you know, the results, you know, last quarter included over $26 million worth of charges for our right sizing the portfolio and addressing the strategic interests that we want to pursue for the business at hand.

So we continue to really try to work to improve the financial performance.

We do have that optimism for the future, and when we feel comfortable that we understand, you know, the installed base and the hardware launches and consumer behavior at a tighter level, we'll get back into that in a more meaningful way.

We do share your frustration, but there are a lot of uncertain factors or uncertainty in the marketplace right now.

We're very excited.

We just shipped Liberty City Stories which got some very, very good, you know, reviews and ratings for a game that was the number one title on the PSP and we moved it to the console, and we think it's going to be a big seller but we don't have the confidence right now to actually put a number out there for you.

So we're taking a small break from the guidance, and as we get into some more normalized business factors and conditions, we'll make that decision to go back and give guidance.

We also have an October year that presents an additional problem in terms of the guidance that's different for some of our competitors.

Are you concerned with the market conditions with hardware units in the second half of the year with the Xbox 360?

We feel long-term the market conditions are great, but short-term, just availability, ship dates, launch quantities, present some real issues for us in terms of giving short-term guidance.

Okay.

Thank you.

Thank you.

Our next question comes from the line of Mr. Edward Williams with Harris Nesbitt.

Please proceed with your question.

Good afternoon.

Karl, can you give us some color on the $28 million savings?

Where exactly is it going to -- where will we see it on the income statement?

And also if you could just talk about the 2K sports product in '07, just to make sure that I'm clear with this, the $45 number that you gave out that is the retail price you're looking for, on average?

Yes, answering the last one first, the 45 was the average retail price that we would expect based on the mix of product and, you know, Paul alluded to some additional expansion in our sports area of, you know, more titles to come and, you know, including those, as well.

With regard to the break down of the charge, again, it was approximately $18 million running to the gross margin and $8 million running through the operating expenses, with approximately $6 million of that running through depreciation and amortization, $2 million through G&A.

I was actually looking more for the savings.

Where will we see it?

Oh, the savings.

I'm sorry.

The savings would show up in -- principally show up in the G&A and the R&D and to the extent that we are no longer building products that are obviously -- we don't have the payroll to run.

So you're going to see it really through the operating expense lines.

And along the lines with the R&D, what do you have right now in Shanghai as far as headcount is concerned, or looking at headcount in general?

Is the 1,100 a number that we're likely to see constant through the end of the current fiscal year or is that a number that could fluctuate some more?

It might trend upward just, you know, a bit from the 1,100.

We currently have about 20, 30 people on the ground in Shanghai and we have plans to expand that somewhat modestly, but this is really sort of our initial entry into that part of the world and we're going to be prudent about how we approach that, but we believe we have the right balance of internal resources and external relationships to really run the portfolio for the near term here.

Okay, and what are your plans as far as the Nintendo Wii?

Paul, you alluded to how you could take some of your sports properties or some of your more, I guess, family-oriented games towards it.

What level of support do you think Take-Two can provide for Wii, or how significant can the Nintendo console really be for you, say, in fiscal '07 or is this something we're going to have to look out to '08 or beyond?

The positive for us is that we have not been a big player in the Nintendo platform.

And the reception at this platform received at the E-3 show, you know, is one that makes us take a real strong look at it, and as we grow our sports business, there are opportunities with our sports games to extend them to the Wii system, particularly if you look at baseball where we have exclusive arrangement, as well as, you know, some of the other sports games which would play extremely well on the Wii product, the non-licensed league ones.

And then some of the 2K products will be, you know, have an opportunity on the Wii.

It's really probably a late '07 and '08 opportunity for us.

But it presents an additional revenue stream that we didn't have before.

Okay.

And then final question is, looking at inventory levels in general, you indicated that Jack's had gone down, but what was Jack's in the quarter and where should we see inventory as the year progresses?

The inventory split, distribution versus publishing, was about 50/50.

So right around the $45 million range.

Okay, and where should that number be as we look toward the end of the year?

We would expect to maintain it although, we would grow it somewhat in anticipation of the holiday season given our October 31st year end.

But, you know, that normally is a balanced working capital position that we can maintain.

In terms of the inventory, with the distribution business, that presents a real opportunity for us because that inventory is, you know, all quality product.

We're selling that and turning that in the marketplace but there have been opportunity buys, you know that we can take advantage of for the Jack business.

But we are running that business very cautiously and really watching all the expenses and really focusing on value-added services to the retail marketplace.

Okay, great.

Thank you.

Thanks, Ed.

Thank you.

Our next question comes from the line of Mr. Tony Gikas with Piper Jaffray.

Please proceed with your question.

Hi.

Thanks, guys.

Just as it relates to the charges in the quarter, what was the change in the headcount of the production staff, number one.

Could you identify what the cash flows were during the quarter?

I'm sorry, I missed that if you mentioned it.

And were there any changes to management that we should be aware of relative to the restructure?

We'll take them in the order you laid it out, Tony.

It was about 200 people.

We were marginally cash flow positive for the quarter.

We haven't announced any -- call it executive or senior level changes in management.

Okay.

And could you just give us a quick update on how sales of "The Da Vinci Code" have been in the last few weeks?

You know, we shipped to the make the launch of the movie, and we have product in full distribution, and it's a little bit early to tell, but we're a little bit cautious right now.

Okay.

Thanks, guys.

Thank you.

Our next question comes from the line of Ms. Elizabeth Osur with Citigroup.

Please proceed with your question.

Thanks.

Just a couple questions.

Karl, you mentioned other opportunities in the sports business like advertising and online transactions.

Are those critical to your getting profitable in the sports business in fiscal 2007?

Liz, I don't think they're critical.

We tried to, I think, portray the picture for sports that we're confident that given the number of units we've been able to ship to date and the units that we would foresee in the future for profitable performance.

That gives us the ability to make such a statement.

Those added revenue streams can only advance the ball further, no pun intended.

And I know you're not looking to give guidance for future years, but is it possible for you to give us some sense of the number of titles that might come out in this year and the next two years?

I think I would prefer that we defer that until the next call.

We usually do more of an update in -- since our fiscal year touches two holiday seasons at the same time, in the September time frame, but we wanted to address the marketplace the best we could see it today.

Okay, and just final question, on the charge in the second quarter with regard to where that was allocated and the different cost of sales lines could you just provide a little more detail there?

The charge really ran through the software development costs.

All of it?

Yes.

Okay.

Thank you very much.

Thank you.

Our next question comes from Mr. John Taylor with Arcadia Investment Corporation.

Please proceed with your question.

Hi.

I've got a couple questions, too.

So you're going to put some deferred revenue on the balance sheet awaiting, you know, your fulfillment of certain things.

I'm wondering how should we think about the margin contribution as that starts to come into revenue as you book that?

Do you expect there to be much variability over time?

Maybe talk around some of those issues?

I got a couple after that, thanks.

J.T., for all the different people that are on the call we would be disappointed if you didn't have at least four or five questions.

We'll take a deep breath after this one.

Obviously, depending on when we're talking about online content, which implies development costs and monies to be spent, versus the placement of in-game advertising, or just the sheer licensing of IP, we'll get to different margin assumptions, but I think it's fair to note that all would be expected to be very high margin opportunities.

And, therefore, you know, we wouldn't foresee unusual variability, you know, in that one period it would suddenly dip to a low end of the publishing margin returns versus the high end in the next quarter.

But they are going to be specifically related to, you know, the shipment of individual games or delivery of content in the future as we approach each unique piece of IP.

I don't know that I can break that down for you neatly in terms of this group is in that percentage, but as you can imagine there's not a lot to be done with certain segments of that by way of added costs.

Can we assume that the -- if you were to work some of that off on a sports product because there's some participation from the leagues, the contribution from that particular segment would be less than what you might be able to get out of one of your own IP's?

I think, you know, to the extent that you certainly have the possibility for sharing and certain arrangements, you should expect that.

Yes.

Okay.

And then second question is, you're moving international to Geneva and closing a couple of studios and so on.

Are there any other kind of big strategic things that have yet to be addressed, or is that pretty much the heavy lifting that you're going to be doing this time around to get positioned for the next cycle?

That's the majority of the heavy lifting right now.

We're mindful of the current burn rates and where we're putting our investments but we've really taken a good hard look recently.

We'll still be opportunistic if anything strikes us as such.

Yes, okay.

And then the studios that you closed, were there any titles, in particular, that those studios are famous for?

There were half a dozen pieces of IP that we had in various stages of development.

Some are more significant perhaps than others, but, you know, for the ones that we think have unique value by way of franchise association we certainly reserve the right to bring them into the marketplace with alternative development resources whether internal or external, and as we have more color on that in the future we'll let you know.

Okay.

Last question.

You gave us the split between Jack and publishing on inventory.

Could you give us the same thing on receivables, please?

The receivables tip a little heavier towards Jack.

It's business ramps up a little bit more in the second half of the second quarter with the spring break holiday, Easter season, and the publishing business was shipped a little bit more evenly throughout the quarter.

So there's a higher weighting?

Higher weighting of receivables towards distribution and publishing.

It's really just the timing on what they ship versus what publishing shipped.

Thank you very much.

Thank you.

Our next question comes from Mr. Daniel Ernst of Hudson Square Research.

Please proceed with your question.

Yes.

Good afternoon.

Thanks for taking the call.

Two questions, if I might.

Just looking at margins, if I back out the charge allocated to COGS there, margins of 13%, still markedly lower than where you've been historically, but can you talk about what else happened in the quarter?

I realize there was certainly a large percentage of co-published games which, as you said, was trending towards bottom end of your range of 20% to 40% margin, but still that's well above the normalized margin we're calculating here at 13%, so maybe talk a little about what else happened in the quarter and what your expectations are in the near term, you know, not giving guidance on the bottom line, but at least give us some sense where you think margins are trending in the near term, and then I have a follow-up?

Thanks.

Daniel, that's a reasonable question.

We tried to provide a few points in the prepared comments.

Really what occurred during the quarter if you start with the various segments of the publishing business, about 20% of our publishing business came from wholly-owned, internally-developed IP.

Having said that, that 20% was really catalog sales from products released in holiday '05 or earlier.

So while that is still a nice margin business that is not as robust as launch quantities on big titles that we might be bringing out, for instance, in the holiday season or with our premier pieces of IP franchises.

So margin, you know, somewhat compressed within that segment.

The sports business, I think, as you observed and others have observed, do not -- does not behave at the same level given the licenses and the royalties that are involved there.

So for instance during the quarter we had $82 million of royalties against $200 million, or thereabouts, of publishing business.

That's a significant percentage and the sports business will carry much lower gross margins as a result.

And finally of the 50%, or thereabouts, remaining of -- we'll call it licensed or externally developed product, about 80% of that number came to us by way of Oblivion, which we said on the call, tipped well towards the low end of the 20% to 40% range in gross margin.

When you add all that up we are somewhat absent this quarter of our higher margin opportunities with our bigger wholly-owned properties.

At this point in the cycle, you know that's probably appropriate, and we certainly believe that for holiday '06 and getting into '07 as we get more of NextGen materials, and return to premium pricing and an installed base that we can really sell to at a profitable level, that margin will expand.

And even in the near term, we have such titles as Liberty City Stories on PlayStation 2, limited development resources had to be expended to bring that product into the marketplace.

We have such things as Bully, Table Tennis.

These products carry much higher margins and will behave accordingly.

Agreed.

But if you look ahead to what you have lined up that's already come out this quarter, rest of this quarter, for the current quarter, based on everything you just said on where you are on internal versus external, where do you think margins should shake out in the current quarter?

We think margins will increase in the current quarter given the mix of product that we expect to have and the nature of it.

Okay.

And then second question, you know, if you look at your strategy for diversification and looking at sports and that's easily -- or more easily defined in terms of market and what the expectations are relative to your competition as you do new things, related titles, "The Da Vinci Code" and you have a Metacritic rating there in the 50s, what are you doing in terms of quality control in order to assure that as you diversify you're putting out those tier 1 titles that you're known for on the Rockstar side?

Is there something you can do strategically to alter that path rather than spin your wheels on developing titles that really don't have that attraction to marketplace really because, you know, or maybe in part because the quality isn't what you're known for?

I think you have to break the business components down a little bit, and when you look at our sports business, our sports games have always been highly rated and we've made significant improvements in any of the games that weren't highly rated.

We believe the Visual Concepts and CUSH and those studios are a great asset and make great products.

The "The Da Vinci Code," when you look at a licensed product, the key to that is making a good product that is shipped timely with the event, and the event in this case was the movie release.

We still think we put a pretty good product out in the marketplace for that, but you're going to get a different type of review from that gaming editor who likes different types of products.

I think Civilization, I think Elder Scrolls, Prey, BioShock, those products and the quality of those products are really evident in our commitment to delivering compelling content.

And, you know, I think if you examine the whole picture and break it out we do have some games like Family Guy from Fox which is a different type of audience, and we belive we'll put out a very good product, but that product might not get reviewed the same way a BioShock gets reviewed.

Our Rockstar guys have always put out tremendous Metacritic high ranking type games, and they'll continue to do that.

One thing we have done with the Rockstar development is give them all the resources during this cycle to continue that and to actually put out a stronger flow of product as we move into NextGen.

Also, Sid Meier, his association with not just Civilization, but with our 2K games area, is one of the industry greats, and, you know, he's a real strong asset for us to make compelling content.

Operator, at this point we'll take one more question.

Thank you.

Our final question comes from the line of Mr. Chris Kwak with SIG.

Please proceed with your question.

Can you hear me okay?

Go ahead, Chris.

Just a couple of questions.

On the deferred revenue, if we could revisit that and just ask is it going to be broken out into long-term or is everything short-term in terms of the deferred revenue, and should we assume that it's all -- the cash is going to be collected up-front?

If we have the deferred revenue on the books it's fair to assume we have the cash in hand.

In terms of the timing of, you know, [realizability] of the deferred revenues we'll address that appropriately with our disclosures and on the face of the balance sheet as necessary.

Okay.

And then turning to LCS on the PS2, we haven't really -- if you could just help us think about what you are expecting or what you think is a reasonable expectation for that relative to how it's done on the PSP, for example?

We're very excited about, you know, the launch extending the brand, especially at this point in the cycle.

We're pleased with some of the great reviews that we've received on the product, although it is a smaller product than traditionally we've put out on the console business.

We had a fairly large launch quantity.

Retailers are excited about it but it's only been out there a day or two in the market.

We think it will have a very long -- a long life, especially at the significant value pricing that it's at throughout the fall period.

We're just a little bit cautious given the uncertainty in the marketplace, but I certainly, you know, the response I heard from retail is that it is one of the must-have products and will be a great incremental sale to anyone shopping for video games for existing generation.

Just a follow-up on that, sorry, can you give us any guidance or any sense for is it significantly worse in terms of margins?

Is it it similar to the margin structure that you have either on the PSP or the PS2 in the prior iteration?

Thanks.

It's more similar than not.

At that price point it's somewhat compressed, but it is certainly on the healthy end of the publishing margin.

Great.

Thank you.

Great.

Thank you all for joining us today.

We look forward to speaking with you next quarter.

Good-bye.

Thank you, ladies and gentlemen, this concludes today's teleconference.

You may disconnect your lines at this time.