Take-Two Interactive Software Inc (TTWO) 2006 Q4 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Take-Two Interactive fiscal 2006 results. [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 for Take-Two Interactive Software.

Thank you, Ms. Buckwalter, you may begin.

Thank you.

Good afternoon and thank you all for joining us today.

First, we would like to apologize for the short notice on this conference call.

Our top priority was to file our 10-K for fiscal 2006 and to issue our press release on our 2006 results and provide immediate access to this information and commentary for all investors.

For anyone who misses the call today, we will have the conference call replay available on our Web site later tonight and, as always, we are available to answer any questions after the call and later this week.

Before we begin, I would first like to quickly review our safe harbor statement by reminding everyone that the statements made during this call that are not historical facts are considered forward-looking statements under federal securities laws.

These forward-looking statements are based on the beliefs of our management, as well as assumptions made by and information currently available to us at this time.

Actual operating results may vary significantly from these forward-looking statements based on a variety of factors.

These important factors are described in our filings with the SEC, including our 10-K for the fiscal year ended October 31st, 2006, which may be obtained from our Web site 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 and thanks for joining us.

I'm glad to have this opportunity to speak with you today.

Take-Two is emerging from a challenging period.

Today we filed our 10-K for fiscal '06, a major step forward in closing the chapter on our stock option investigation.

Last month, the special committee submitted its report.

In summary, the committee found that incorrect measurement dates for certain historical stock option grants were used.

The investigation did not find any pattern or practice of back-dating option grants after August 2003 and also found no misconduct by the company's current executive officers.

We have completed a restatement to reflect stock-based compensation expenses, which is incorporated in the Form 10-K filed today.

As a result of this filing, we have now satisfied one of the key conditions for maintaining our NASDAQ listing and we look forward to completing the remainder of the requirements as quickly as possible.

Also today, we announced the appointment of Seth Krause as General Counsel.

Seth's impressive credentials and expertise will strengthen our legal and compliance efforts.

Our goal is to put these distractions behind us.

As we look to the future, we're encouraged about our prospects in '07 and the opportunities we'll be able to leverage against the installed base of next generation hardware, as it continues to grow.

I'll hand the call over to Karl, who will discuss our financials in detail, then I'll come back to discuss our '07 product lineup and outlook.

Thanks, Paul, and good afternoon.

I will be covering several topics today -- first, the restatement related to the stock option grant investigation; second, a review of the fourth quarter and full fiscal year 2006 results; and third, our outlook for both the first quarter fiscal 2007 and the full fiscal year.

Let me begin by summarizing the accounting impact of the investigation into the company's historical option practices.

As you know, the report of the special committee of the board determined that incorrect measurement dates were used for financial accounting purposes for certain stock-based compensation awards made in periods prior to September 2003.

As a result, the company has recorded additional non-cash stock-based compensation expense and tax effects for past stock-based compensation awards.

This led to the restatement of our previously filed financial statement, which is reflected in the Form 10-K we have just filed for fiscal 2006.

Based on the results of the investigation, the cumulative adjustment to net income, including tax effects, amounted to $42.1 million, after tax, for the period from the company's IPO in April 1997 through October 31st, 2005.

If you wish to discuss specific accounting methodology related to the restatement, I'll be happy to address your questions during Q&A.

Now let's turn our result-- let's turn our attention to our results for fiscal 2006.

Before we delve into the numbers, let me provide an overview of the four key factors that impacted our financial results -- first, lower average selling prices due to the console transition; secondly, our continued investment in sports and next gen products; thirdly, over $125 million of incremental charges related to several areas -- our cost savings initiatives and related write-offs we announced early last year, the recording of a valuation allowance for deferred taxes, an asset impairment to our Joytech business, and expenses from the option investigation and DA inquiries; and lastly, 2006 was our first year of expensing options under FAS-123.

We have highlighted the incremental charges and FAS-123 expenses in our press release so that you can see where these charges flow through the income statement.

Now let me provide a bit more color on the first two items impacting our 2006 performance and then I will cover the last two areas when I review our numbers in detail.

First, to the console transition, which has continued to be challenging for us.

While much of our holiday lineup and recent investments were focused on titles for next gen platforms, the market penetration of new hardware did not occur in line with our expectations and while we were pleased with the strength of legacy platforms -- particularly the PlayStation 2, the majority of our 2006 sales on these platforms were catalog products that sold at lower average prices.

As a result, our total PlayStation 2 revenue was significantly reduced.

Titles like Grand Theft Auto -- San Andreas, Grand Theft Auto -- Liberty City Stories, and Midnight Club 3 -- DUB Edition Remix, were all selling at greatest hit pricing levels of 1999 for much of the year, one third of the price of next gen games.

Just to give you an idea of the numbers, about 30% of our 2006 publishing sales were from PlayStation 2 titles at average wholesale prices of about $20.

This was close to 40-- a 40% decline in wholesale prices from last year, when titles like Grand Theft Auto -- San Andreas were still selling at retail price points of $49.99.

In 2005, our PlayStation 2 publishing business was approximately 60% of our publishing revenue or roughly $500 million, compared to $225 million in 2006.

So year-over-year, our PlayStation 2 business dropped by nearly $300 million.

On a positive note, we're pleased that we've increased sales of our Xbox 360 titles, where our average wholesale pricing was in the mid-$40s in 2006.

However, given the smaller install base of next gen platforms, the increase in our Xbox 360 and handheld business wasn't large enough to offset the reduction in PlayStation 2 revenue.

Next to sports.

The other factor that has impacted our recent results is the financial investment we've made in 2K Sports, with a focus on next gen platforms.

We've achieved major progress in sports with our critically acclaimed titles and sales are more than double last year.

Our next gen sports titles are an increasing percentage of our total sports business.

However, the install base of next gen platforms has not yet reached the critical mass necessary to provide a return on the high development and licensing costs of the sports business so, as expected, our sports business in 2006 was not yet profitable.

With that said, we remain confident in our strategic initiatives to expand our next gen development efforts and sports business and expect to begin to see the return on these investments this year.

Moving on to our numbers, please note that all comparative results discussed today reflect the restatements for 2005.

For the full year of 2006, net revenue was $1.04 billion compared with $1.2 billion in 2005.

Our net loss, including a number of incremental charges that totaled $125 million, was $185 million or $2.60 per share, versus net income in 2005 of $35 million or $0.50 per share.

And, as I will explain later, our loss included a $63.5 million valuation allowance against deferred tax assets and caused us to realize no tax benefit from our loss.

Approximately $111 million of the $125 million in incremental charges in 2006 were non-cash items.

For the 2006 fourth quarter, net revenues were $267 million compared to $307 million a year ago.

Our net loss of $14 million or $0.20 per share for the fourth quarter compared to net income of approximately $19 million or $0.27 per share in the fourth quarter of fiscal 2005.

Excluding the incremental charges of $14.7 million, Q4 was slightly profitable.

Now looking at the full year operating results in more detail, net revenue decreased about 14% due primarily to comparison against the strong contribution of Grand Theft Auto -- San Andreas in fiscal 2005, as well as the impact of lower selling prices in 2006.

Grand Theft Auto -- San Andreas was launched right at the end of fiscal 2004 and represented about 45% of our publishing business last year, compared to 7% this year.

Looking at the breakdown of our business, publishing revenue represented 73% of the 2006 total, with distribution revenue at 27%, about the same as 2005.

In fiscal 2006, Grand Theft Auto -- Liberty City Stories for the PSP and PlayStation 2 accounted for 10% and 6%, respectively, of our publishing revenue and Grand Theft Auto -- Vice City Stories for the PSP accounted for 6% of our publishing revenue.

Oblivion for Xbox 360 and PC were 8% and 6% of publishing revenue, respectively.

Our sports business was about 20% of our publishing revenue in 2006.

At close to $150 million for the year, sports revenue more than doubled compared to 2005.

Sales of next gen titles were over $300 million, a significant percentage of our business at 41% of publishing revenue, but still a relatively small dollar number compared to where we see this business going in 2007 and beyond.

Distribution revenue declined year-over-year, due primarily to a decrease in volume and average selling prices of software.

However, we realized a roughly 25% increase in hardware sales, mostly as a result of the Xbox 360 launch in our first quarter of fiscal 2006.

And our continued focus on the distribution business has led to a reduction in working capital requirements.

In fact, Jack's inventory levels at year end were at their lowest levels in years.

Despite their decrease in revenue year-over-year, along with more hardware sales this year, our emphasis on improving Jack's business mix resulted in gross margins that were fairly comparable to last year at about 9%.

Our overall gross profit margin for 2006 was 20.5% versus 34.5% in 2005.

Looking at the major drivers of the margin decline, excluding the write-down of several titles in 2006, gross profit from our publishing business declined by over 45%, due principally to a $400 million reduction in PlayStation 2 and Xbox publishing business year-over-year.

Product costs rose as a percentage of net revenue as product costs remained relatively stable in dollar terms, while average pricing on our current generation software declined.

We also had a greater volume of lower-margin Jack hardware sales.

Royalties increased on a percentage basis, due primarily to the rise in external royalty costs from third-party-licensed titles like Oblivion, Prey and the Da Vinci Code.

Oblivion was the biggest factor in our royalty expense increase due to the co-publishing arrangement for the title.

As we said on our Q2 call, the gross margin from this title is about 20%.

In addition, higher royalty expense in 2006 reflected the first full year of a long-term third party exclusive licensing arrangement with Major League Baseball.

The increase in software development costs as a percentage of net revenue largely reflected an increase in sales of our internally developed games in 2006 compared to last year and the generally rising costs of development of those titles, many of which were next gen products.

Software development costs were also higher this year due to our previously reported $17 million in write-offs for several titles, resulting from our cost-savings initiatives earlier in the year that led to the closure of 3 studios and our reassessment of sales expectations for various titles.

These write-offs were reflected in our Q2 results.

Full-year 2006 operating expenses were approximately $400 million compared with $377 million or 31% for the prior year.

The major area of operating expense increase was in G&A, primarily for the fees related to the option investigation and the DA inquiries, as well as impairment charges of $15.6 million.

Let me just recap the major items.

For G&A, legal and other professional expenses for the option investigation and responses to the SEC and Manhattan DA amounted to about $7 million.

Expenses for relocating our international publishing headquarters to Geneva were about $2.3 million.

Incremental G&A expenses related to our cost reduction effort totaled about $2 million, including severance costs and lease termination costs.

Stock-based compensation expenses under FAS-123 were, in total, $12.1 million, most of which fell into G&A.

Just for your reference, the stock-based compensation expense broke out as follows among the operating expense line items -- $6.9 million of G&A, $4.1 million in R&D and $1.1 million in selling and marketing.

For impairment, our $15.6 million of impairment expenses were in two main areas.

About $8.1 million was due to the write-down of goodwill and fixed assets for our Joytech subsidiary, a small manufacturer of video game accessories.

The majority of the remaining $7.5 million of impairment charges related to our studio closures in Q2 and Q3 and the write-off of various intangibles, trademarks and other assets.

Absent these $39 million of incremental charges and FAS-123 option expenses that we did not experience last year, our operating expenses actually declined by about $16 million, year-over-year.

The last area of discussion on our income statement relates to taxes.

You will see that our effective income tax rate for fiscal 2006 is 0.2%, a significant reduction from our 15% effective tax rate in fiscal 2005 and 32% rate in fiscal 2004.

In light of our domestic cumulative losses for the past 3 years, we are required under FAS-109 to record a valuation allowance to reduce our deferred tax assets.

Basically, what this means is that in fiscal 2006, despite our book loss, we are not recognizing the tax benefit of this loss, which would have reduced our net loss.

Instead, we effectively incurred a non-cash income tax expense of $63.5 million or roughly $0.89 per share as a result of the write-off of our previously recorded deferred tax assets and our inability to record a benefit for the 2006 U.S. losses.

It is important to note that as we generate taxable income in the U.S., we will realize the benefit of the reversal of the valuation allowance to offset the tax expense in future periods, resulting in a reduced tax expense for the period of profitability and greater net income than would otherwise be reported.

To quickly recap our fourth quarter, the major contributors to publishing revenue were Grand Theft Auto -- Vice City Stories on PSP, Bully on PS2 and NBA 2K7 on Xbox 360.

These 3 titles represented about 40% of our publishing revenue.

Our Grand Theft Auto franchise contributed about 36% of publishing revenue and the sports business was about 19% of publishing revenue.

Distribution revenue declined compared with Q4 last year, due primarily to reduced sales of value-priced software and a decrease in average selling prices as the industry transitions to the next generation platforms.

However, hardware sales were up, driven primarily by sales of the Xbox 360, which was launched late in 2005.

Our overall gross profit margin for the fourth quarter was 30.7% versus 37.4% in Q4 of 2005.

Product costs, royalties and software development costs all increased as a percentage of net revenue due to the same factors that impacted full-year numbers.

Additionally, in comparing our results to 2005, we had a greater percentage of high-margin PC product last year when we launched Civilization IV.

Operating expenses of approximately $96 million in the fourth quarter included $5.5 million in legal fees related to the option investigation and SEC and DA inquiries, $2.6 million in FAS-123 option expense, $1.4 million for our Geneva relocation and $1.2 million in asset write-offs and other studio closure expenses.

Excluding these incremental charges of $10.7 million, operating expenses actually declined year-over-year in Q4 by about $7.5 million.

And, as I discussed for our full-year results, we realized a $4 million charge in Q4 for valuation allowances on our deferred tax assets.

Turning to the balance sheet, at the end of 2006 we had about $132 million in cash as compared to $107 million in cash at year end 2005.

Net accounts receivable at year end were approximately $143 million compared to $198 million at the end of 2005.

Our DSOs in Q4 were about 48 days compared to 58 days in the fourth last year.

Our accounts receivable reserve stood at about $92 million at year end, representing approximately 39% of gross receivables.

Our Q4 reserves were about 18% of trailing 6 months revenue and about 12% of trailing 9 months revenue, slightly higher than last year's Q4 levels, due to the mix of publishing product we sold this year and the general pricing trends we've seen in the marketplace for current gen titles.

Inventories at year end were approximately $96 million, reduced significantly from $136 million at year end 2005 due to our lower sales levels and our continued focus on better management of Jack inventory levels.

Our capitalized software development costs and licenses totaled about $117 million at the end of the year, about the same as last year.

As of year end, we had about 40 titles in various stages of development on current and next gen platforms.

We are being very selective in the new projects we are signing in order to focus our development and marketing efforts on fewer titles that we believe have a greater potential in the marketplace.

Turning now to Q1, while we would like to provide more detail regarding our Q1 results, as you can imagine, we have been intently focused on the work required to get our restatements completed and our financials filed, which has been our top priority.

As a result, at this point we are providing a range of expected results for Q1.

We currently anticipate net revenue in the range of $265 million to $275 million, with a net loss in the range of $23 million to $25 million or $0.33 to $0.35 cents per share.

It is important to note that our net loss estimates do not reflect any tax benefit, as we will not be recording any tax benefits until our deferred tax assets are expected to be realized.

Our Q1 results reflected the same general business trends and product mix we discussed earlier and included $6.4 million in legal and accounting fees for the option investigation and responses to the SEC and Manhattan DA and approximately $2.1 million in FAS-123 stock option expenses.

To give some highlights for the first quarter, our business mix was about 60% publishing and 40% distribution, about the same as Q1 last year.

Distribution revenue was up slightly, driven primarily by holiday bundles.

Our leading publishing titles were Grand Theft Auto -- Vice City Stories and Grand Theft Auto -- Liberty City Stories, both for PSP, and Grand Theft Auto -- San Andreas and Bully -- both for PlayStation 2.

NBA 2K7 on Xbox 360 and PlayStation 3 led 2K's sales and we ended the first quarter with approximately $138 million in cash.

We expect to file financial results for the first quarter in mid-March and will issue our regular earnings release detailing the quarterly results at that time.

Since we are providing this comprehensive business update today, we do not plan to hold a separate conference call for Q1.

Now to address the balance of 2007.

Looking out into the full fiscal year 2007, we currently anticipate revenue in the range of $1.2 billion to $1.25 billion.

We expect to return to profitability in the fourth quarter and breakeven for the full fiscal year.

Our assumptions to return to profitability in Q4 are driven primarily by our release schedule, which includes the launch of Grand Theft Auto 4 and BioShock in Q4.

Let me provide some additional data points on our 2007 outlook.

We expect our total revenue mix to be split about 75% publishing and 25% distribution, consistent with recent annual levels.

Within publishing, we expect the relative breakdown for our 3 key publishing labels to be roughly 45% from Rockstar, 25% from 2K Sports, 25% from 2K Games and about 5% from Global Star and Joytech.

This is fairly comparable to what we experienced in 2006, however, the projected mix of business within the labels is more favorable from a margin standpoint.

On a blended basis for publishing and distribution, we expect gross margins for fiscal 2007 to be in line with the levels we achieved in Q4 2006.

A significant portion of Rockstar's revenue will come from our premium priced Grand Theft Auto IV on the next gen platforms compared to 2006 when a large part of Rockstar's business was lower-priced catalog products on current gen platforms.

For 2K Games, we expect a greater percentage of sales to come from our higher-margin internally developed and owned titled, led by BioShock.

Regarding 2K Sports, you may remember that in our last earnings call we provided some detailed assumptions regarding our sports business.

I'd like to update these numbers to remind you why we are excited about this business and why we've committed significant capital to it, both from a development and marketing standpoint.

To date, we've invested about $200 million in sports since 2004 -- over $60 million in development studio acquisitions, $50 million in software development since acquiring the studios and another $80 million-plus in licenses and IP for products delivered to date.

We've assembled 7 top-quality development teams with over 300 people working on our sports titles.

We've already made some major traction in the sports category with revenue close to $150 million in fiscal 2006 compared to about $65 million for fiscal 2005.

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

NBA 2K7 for the Xbox 360 has been outselling the competing product at comparable retail pricing and we've just shipped Major League Baseball 2K7.

The title was right on time and it looks great.

We've taken many questions on how our sports division can become profitable, so let me explain how we get there.

We are continuing to execute on the next gen strategy that we outlined to you when we established 2K Sports.

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

To give you an idea of the leverage provided by higher software pricing and higher unit sales, let me walk you through some numbers.

In our last call, we gave you NPD retail numbers, but we think it would be more helpful to provide insight into our actual wholesale numbers.

In fiscal 2006, we sold about 5.5 million units of sports titles at an average wholesale price in the mid-$20s.

Based on our current model and expected release schedule, we expect to sell approximately 8 million units of sports titles in the U.S. in 2007 at an average wholesale price approaching $30.

The roughly $5 of higher wholesale price assumption is based on the continuing penetration of next gen systems, where software is generally priced at premium levels, along with some opportunities from in-game advertising and micro transactions.

The additional units we are forecasting reflect several factors -- our confidence in better performance this year from our Major League Baseball title, based on the on-time release and improved game quality and the launch of our second MLB title, The Bigs, this summer; continued market share gains relative to our competitors in our NBA, NHL and college basketball titles, where we compete head to head against lower-rated titles; and the introduction of All Pro Football 2K8, a new football title shipping this summer.

And there are several other points worth noting about sports.

Many people seem to assume that the licenses we have with the sports leagues have significant escalating costs going forward.

That is not true.

In most cases, our royalty and marketing commitments are relatively fixed.

To illustrate, in 2006 league royalties represented approximately 30% of our $150 million sales of sports titles.

Even with the anticipated continued growth in our sports business in 2007, the absolute dollar amount of league commitments will remain fairly constant, so the league royalties as a percentage of our total sales, will trend down closer to 20%.

In fact, our sports revenue could double from 2006 levels before our league royalty commitments become variable.

The variable rate at that point is only modestly higher than for high-profile Hollywood-licensed IP.

This relatively fixed royalty structure provides further opportunities for leverage in sports as our average selling prices and the unit volume increase.

Based on these assumptions, our sports division is expected to be a much more meaningful revenue contributor this fiscal year and should be profitable in calendar 2007 before allocation of corporate overhead.

Given the continued ramp in the next gen install base going forward and our greater percentage of sales at higher software price points, we expect the sports division to be marginally profitable by year end and increasingly profitable in 2008.

Moving back to our overall business, let me give you an idea of where we see our operating expenses trending.

We're obviously coming off a recent period of high G&A spend based on some of the regulatory challenges we've had.

We see Q1 levels about comparable to Q4 based on the amount of professional time required to wrap up the option investigation and restatement and continue to provide the DA with their requested information.

Beginning in Q2, we expect quarterly G&A levels to trend down to the mid-30s for a net 10% to 15% annual reduction.

And just to provide more insight into Q2, given our relatively light release schedule and the pricing trends we've mentioned earlier, we would expect net revenue to be down about 20% from last year's Q2.

Sales and marketing is closely tied to our product releases, so you can expect a larger marketing spend overall in 2007, about in line with the percentage growth we are expecting in sales.

R&D will fluctuate from quarter to quarter based on what products our teams are working on, but on an annual basis, we would expect R&D to be about comparable to 2006.

Depreciation and amortization should grow at about the same rate as last year.

As for taxes, you can expect any immediate U.S. losses to be recorded without tax benefit, while future profits will benefit from the reversal of the valuation allowance on our deferred tax assets.

As a result, our losses in the short term are magnified, while our profitable periods will reflect lower effective tax rates.

Income earned in all jurisdictions outside the U.S. should result in tax expense.

Taking these factors together, we believe we can show a meaningful improvement in our financial performance in 2007 and profitability in the fourth quarter.

Looking into 2008, we see additional opportunities to capitalize on the strength of our core franchises and our sports business.

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

Thank you.

Thanks, Karl.

We always anticipated that '06 would be an investment year as we positioned Take-Two for next gen opportunities.

However, the fact remains that the performance of our portfolio during '06 was below plan.

Even with $125 million in incremental charges for the year and $14.7 million for Q4, the level of the '06 loss is unacceptable.

Our '06 results reflect the continuing transition in the video game industry, the impact on average selling prices for our current generation software and the small but growing base for next gen.

Also, despite our success in selling titles for the PSP platform, overall software sales for the PSP were less than we expected.

As we review '06, it's important to point out the tremendous impact of Grand Theft Auto -- San Andreas in fiscal '05.

If we exclude the sales of Grand Theft Auto -- San Andreas from both years, our sales would have been up 21% year-over-year and if you look at the publishing sales alone, excluding San Andreas, publishing sales would have been up 50% year-over-year.

On a positive note, as Karl outlined, Take-Two ended fiscal '06 with over $132 million in cash, an increase of more than $25 million from the year-ago period.

In terms of the product portfolio, we continued to receive positive critical response to many of our products in '06, reflecting our efforts to broaden and diversify the portfolio.

Our best sellers included, from Rockstar, extensions of established franchises such as Grand Theft Auto -- Liberty City Stories, Grand Theft Auto -- Vice City Stories and Midnight Club 3 -- DUB Edition Remix and two new brands -- the innovative games Table Tennis and Bully.

At 2K a major focus in '06 was on building and strengthening the label's infrastructure by investing in new franchises and integrating the 6 2K internal development studios.

Successful products included recently acquired franchises from Sid Meier, such as Civilization IV and Railroads!, third party titles like Oblivion and Prey and a broad range of titles from 2K Sports, including our Major League Baseball, NBA, NHL and college hoop titles.

2K Sports increased its market share of next generation titles, especially NBA 2K7 for Xbox 360 and, in our first quarter, for PlayStation 3.

The strong January NPD data showed NBA 2K7 as the number one basketball game on both Xbox 360 and PlayStation 3 for the month.

We have always viewed 2K Sports as a next gen investments and were especially pleased that NBA 2K7 and College Hoops 2K7 are the best-selling next generation basketball titles with NHL 2K7 holding its own on both platforms.

We enjoyed good consumer responses to both Bully and Grand Theft Auto -- Liberty City Stories for PlayStation 2 and will continue to publish and support titles for the PlayStation 2 system.

Critically, we received several award nominations for the upcoming Game Developers Conference, including nominations for Bully, Table Tennis and Oblivion as best game.

At the Academy of Interactive Arts and Science awards, Bully, Table Tennis, Railroads!, NBA 2K7, Prey and Oblivion were nominated in several categories.

The strength of our creative output is clearly a competitive advantage and we're pleased with the recognition of our games.

Turning to '07, we started off with a broad range of products based on established franchises and new concepts.

Grand Theft Auto San Andreas in Japan for PS2 led the Japanese charts the week it was released in late January and had the strongest launch of any western title in the difficult Japanese market.

Capcom, our marketing and publishing partner in Japan, says Grand Theft Auto -- San Andreas has already outsold Grand Theft Auto 3 and Grand Theft Auto Vice City.

The Japanese service company, Media Create, estimated that San Andreas sold over 220,000 units in its first weekend.

Other titles that have shipped so far this year include -- The Warriors, extended for PSP;

Sid Meier's Pirates! for PSP;

College Hoops 2K7 for Xbox 360, Xbox and PS2;

Ghost Rider on PS2, PSP and Game Boy Advance, which has had some strong early results based on the success of the movie;

Jade Empire Special Edition on PC, a co-publishing deal with BioWare; and we're pleased to announce a full console launch for Major League Baseball 2K7, which is in stores now for Xbox 360, Xbox, PS3, PS2 and PSP.

MLB 2K7 features a completely revamped next gen baseball experience.

The first reviews are coming in with Game Informer giving our 360 title an 8.5, reflecting the focus our development teams have put into improving this franchise.

We are excited about our lineup for the remainder of this year and '08.

From Rockstar -- Grand Theft Auto -- Vice City Stories for PS2 in March, the PS2 version of last year's best-selling PSP title;

Manhunt 2 for PS2, PSP and Wii this summer, a sequel to Rockstar's million-unit-selling franchise; and the much-anticipated Grand Theft Auto IV, which will be available simultaneously on Xbox 360 and PS3 in October '07.

Starting in '08, Rockstar will introduce exclusive episodic content downloads for Grand Theft Auto IV on Xbox Live.

Additionally, we already announced the exciting new Rockstar-owned IP, L.A.

Noire, developed by Team Bondi, a next generation game for an '08 release.

And you should expect further announcements soon regarding Rockstar's lineup of multi-platform next gen titles based on proven franchises from the Rockstar catalog for fiscal '08 and beyond.

The Rockstar catalog is the strongest in the business and includes hit franchises like Grand Theft Auto, Midnight Club, Red Dead Revolver, Bully, Manhunt, Table Tennis and more.

From 2K Games -- the Elder Scrolls IV, Shivering Isles PC expansion for this top-selling title; the Darkness for PS3 and Xbox 360, based on the hit comic book series from Top Cow Productions, developed by the world-renowned studio, Star Breeze; the licensed game, Fantastic Four -- Rise of the Silver Surfer, for multiple platforms, including Wii, available in June, along with Marvel's Fantastic Four feature film from 20th Century Fox.

From 2K Irrational Studio -- the much-anticipated BioShock for Xbox 360 and PC, which was the E3 Game of the Show, now slated for August.

From 2K Sports -- All Pro Football 2K8 for next gen platforms this summer, a highly anticipated title from the team at Visual Concepts that created the successful NFL 2K series.

We're excited about the fully licensed MLB game, The Bigs, on multiple platforms, including Wii.

Reflecting our efforts to maximize the potential of our MLB license, The Bigs is a fun, arcade-style game that complements the MLB 2K7 simulation experience and expands this market to a wider audience.

The Bigs will be available this summer.

College Hoops 2K7 for PS3 in March, the only NCAA game available for the next gen system;

NBA 2K8 and NHL 2K8 for multiple platforms.

Starting in '08, 2K Sports will be publishing its traditional lineup of licensed sports franchises and extending of those licenses, along with games based on its tennis and other proprietary sports franchises.

Profitability -- I want to reiterate that we expect to return to profitability in the fourth quarter and breakeven for the full fiscal year '07.

Our drive to profitability includes a more-significant bottom line contribution from Rockstar games, especially from the strength of Grand Theft Auto IV.

Additionally, as Karl stated, we anticipate that our 2K Sports division will become profitable in calendar '07.

We will achieve this by delivering the quality games 2K Sports is known for, expanding our 2K Sports lineup with titles like All Pro Football 2K8 and The Bigs, and leveraging the larger next gen install base and higher price points.

Our confidence comes from the fact that 2K Sports more than doubled its revenue in '06 by generating close to $150 million in revenue.

We have always viewed 2K Sports as a next gen investment and as the install base continues to grow, 2K Sports is capturing a greater share of the next gen market.

This is happening for one distinct reason -- product quality.

2K Sports continues to make great strikes in capturing market share, especially on next gen titles.

NPD for January was very strong for all our next gen 2K Sports titles.

We're confident this trend will continue with the positive reviews coming in for Major League Baseball 2K7.

Conclusion -- I want to wrap up my remarks by thanking all of you for continued support during what can be described as a challenging time.

We are committed to moving the company forward by introducing exciting products by the most creative minds in the industry, continuing to diversify our revenue stream and focus on the most profitable parts of our business, making tough decisions to benefit our cost structure, while continuing our investments in the next generation and maintaining a high standard for corporate governance.

Thank you for your time today and we'll open the call for questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from the line of John Taylor with Arcadia Investment Group-- Corporation.

Please proceed with your question.

Hi.

I have a couple of questions, if I can.

The first one, may be margin related for next year.

As-- when you guys get to sort of running speed on 2K and get it to the point where you're sort of absorbing the minimum royalty costs and all that sort of thing and-- on the one hand, and given the participation on the Rockstar side, I wonder if, say, in '08 -- I know this is looking out a ways, but I wonder if you could give us a sense of what the contribution margin of each of the labels might look like in kind of a normalized world?

And if you won't give us anything specific on that, maybe rank them for us?

And then a historic one is could you break gross margin down between publishing and distribution in fiscal '06, the year you just closed, and also what the inventory breakdown was?

Thank you.

John, it's Karl.

With regard to-- Let me take a shot at ranking.

I think, consistent with our experience in past years, internally owned titles will typically hold the highest margin opportunity for us, because you really, in that world, have limited exposure in terms of payments to third parties.

When we move into the 2K Games and Sports end, we also, on the Games side, have internally owned titles and with the acquisition of Irrational and Firaxis, we're excited about those and we think the opportunity to be fully involved with those teams and those products should prove very beneficial for us in the future.

With regard to third party or licensed IP-related titles, obviously the margins become a little bit more challenged, however, for instance, with Sports, the attractiveness of being in the marketplace year-in, year-out and proving, as we have, with the quality of the games and continuing to show that we can-- we can really deliver quality offerings there, makes those added costs worthwhile, in our opinion.

So the margins definitely become somewhat more compressed as we move into, we'll call it, third party IP or development-related products.

You're, I think, correct to note that the absorption within 2K Sports, which we tried to illustrate during the prepared comments, is very important and it provides the opportunity for us, I think, into the future to get the gross margins for that business into a very respectable publishing-type segment versus in the recent past this has really been an investment for us as we prepared to get into the next gen cycle here on the diversified platform.

And I think Paul's comments also illustrated the fact that we've been very successful in growing publishing revenues year-over-year ex Grand Theft Auto -- San Andreas, for instance.

So that's absolutely following through on what we committed to do standing here several years ago.

With regard to gross margin percentage opportunities in 2008, I think you can only-- you'll have to take our comments from '07 and extrapolate for '08, but as the install base ramps, I mean, we're sitting here discussing having average prices in the $20s headed for $30, price declines by 50% from prior periods, we would expect to have those types of, we'll call it negatives, show up more handily as positives for 2008, because the install base should be there and we've been very pleased with the 360 and our handheld penetration to date.

We expected something a little bit more in the handheld areas, but it's been very successful for us in diversifying the portfolio.

So if-- can I play back what you just said and see if I can do it this way?

So in terms of ranking the gross margin, is it fair to say that Rockstar is going to be top, 2K Games will be second, 2K Sports will be third and Global Star will be fourth in terms of contribution after royalties?

I don't know that I would group numbers two and three, which was 2K Games and Sports just flat-out in that order, because it depends at what point in time we're talking about.

And 2K Games, I think, does follow Rockstar, because there is an orientation within 2K Games for third party-- whether licensed IP or development deals that we do there.

Okay.

Okay, good.

And then-- I'm sorry, and then maybe that historic question?

I'm sorry, what was it?

Could you repeat that?

Yes, the breakdown-- the gross margin on the segments and then the inventory on the segments?

Oh, the margins.

Yes, I think if you don't mind, John, within the footnotes to the financial statement we've got a lot of information on segments--

Okay, good.

--and we do lay out publishing versus distribution.

J.T., it's Paul.

The past year has been very challenging for us.

This transition we've taken a number of hits on the chin with some of our products, but we feel it's a lot about leverage and we gave a lot of information on the call that shows that the leverage that we have going forward, we've had tremendous success on next gen.

We gave a lot of color on the sports business and that is going to be driven by the product quality from our studios, as well as expanding those product lines.

We're very excited about what happened today, shipping 5-- the MLB sim game on 5 platforms and then following up with The Bigs in arcade style.

So we'll continue to support the Major League Baseball license with multiple products and the leverage that we have there from a product development standpoint.

And then, particularly like the high anticipations coming from the 2K studios on our football product.

It's one of the most highly anticipated games in the fall.

We think we can have some fun there and the investment that we've made in the past 18 months in Rockstar product development on next gen is going to be a very, very important part of our '08 and part of our positioning.

It all starts with Grand Theft Auto IV, which is the most highly anticipated product for next year, and then we sell that going into a growing install base.

So we feel about our business today, but the past year has been very challenging.

Okay, thank you.

Thank you.

Our next question comes from the line of Todd Greenwald from Nollenberger.

Please proceed with your question.

Hi, thank you.

Mostly housekeeping.

I'm just wondering, on your 2007 guidance for breakeven earnings, I'm assume that's on a GAAP basis and, if so, could you break out what the stock-based comp is that you expect from that and any other non-cash charges?

Todd, the stock-based comp for 2006 was approximately $12 million.

It's a little early to pin that down with a lot of certainty, but we would expect it, certainly, to be somewhat in that neighborhood.

And then with regard to 2007--

Your question about the-- was that on a GAAP basis, that was on a GAAP basis in terms of our breakeven forecast.

Okay and the same question on the 1, '07 January quarter?

Yes, we were referring to GAAP measures and I think we had indicated, for instance, in Q4 we had about $2 million of FAS-123 expense.

And we said it would expect to be about $2 million, also, in Q1 and that was included in the net loss numbers we provided.

Okay.

And on your-- for 2007, what are you expecting for publishing growth versus distribution?

We've, obviously, expected, I think the entire portfolio to increase.

We gave the split as roughly 75-25, so we see added opportunities, as well, for distribution as the install base comes up on next gen.

That provides additional software product.

The 360 by Holiday '07 will have been in the marketplace now for 2 years.

That type of-- older products on the 360 becomes more of an opportunity for Jack and we would expect to see its performance increase somewhat year-over-year.

Okay, thanks.

Thank you.

Our next question comes from the line of Mike Hickey with Janco Partners.

Please proceed with your question.

Hi, guys.

Congrats on getting your K filed.

Thank you, Mike.

Can you give us an update on your cash position?

Mike, I mentioned at the end of Q1 that it was approximately $138 million.

Thank you.

And then for your GTA IV release, how do you think the economics of that title will fall out between your fiscal '07 and your fiscal '08 period?

We would expect to have a significant launch of that product.

It's highly anticipated.

It's the must-have title in terms of next gen and we would expect to see continued sales of that product well into 2008 and perhaps even beyond.

We still, as you can still from our historical disclosures, often times have significant numbers posting 2 years later coming from the Grand Theft Auto releases.

So this title will continue to track, we believe, with the increase in the install base.

When-- when we look back -- this is Paul -- to Grand Theft Auto 3, that was launched at a similar timeframe in the PlayStation 2, Xbox cycle.

It was just available on the PlayStation 2 initially.

That title sold very well.

It was the number one title for, I think, 11 of the 12 months.

We believe from what we've seen that Grand Theft Auto IV, coming from the most creative, dynamic group, the Rockstar group in the industry.

They've had a lot of time and they're working very, very hard on delivering an extremely compelling piece of content.

We think Grand Theft Auto IV has that same type of potential.

So we're excited.

We're shipping it in late October.

Our fiscal year ends the end of October and we believe that it will have sales that will roll forward throughout our fiscal '08.

Okay.

And then you guys, certainly, I think broke new ground in terms of content by putting Manhunt on to the Wii.

Can we expect other Rockstar titles to also extend over into the Wii and is GTA IV a game that you guys-- do you believe that's something that could be playable on the Wii?

Well, let's talk about the Wii.

We view the Wii as an incremental revenue opportunity and we announced The Bigs product for Wii, which is an arcade-style baseball game that we think fits perfectly.

We announced the Fantastic Four, tying in with a key Marvel property, 40 million comic books and highly anticipated movie that I don't know if anyone has seen the clips.

It looks spectacular.

So we're excited about that.

So we have 2 titles.

And we view some of the Rockstar, similar to other mature content that has done well on Nintendo systems in the past, and we will look, depending on the type of product, what our development teams feel they can do in terms of making it a very fun experience that fits in with the Wii experience.

So you'll see future titles from both 2K, 2K Sports, and Rockstar on the Wii platform.

And I think it's important to note, Mike, that, for instance, even with handheld, in the last 2 years the company has-- in 2006 we did about-- just short, I think, of $200 million on the handheld platform.

If you look back on our results 2 years earlier, that number is virtually not there.

The Wii-- we can't project exactly what the future will bring, but we're very excited to have added platforms to further diversify our mix.

And we look forward to the future.

Okay.

And just to clarify from a prior question, are there any other charges in your breakeven number, your GAAP breakeven for fiscal '07 beyond the option expense?

There's no other sort of unusual charges that we anticipate at this point.

We continue, obviously, to try to be prudent about business units that-- and we made a number of tough decisions on that, back in 2006.

So we really expect at this point to maximize the portfolio we're working with, to get those 40 titles into the marketplace in the next year or two and we expect to see good returns.

Thanks, guys.

Thank you.

Ladies and gentlemen, given how late it is, we are going to end the call now, but as I mentioned earlier, our Webcast will be available later this evening for replay and we would be happy to answer any additional questions.

Thank you very much for joining us today.

Ladies and gentlemen, this does conclude today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.