Take-Two Interactive Software, Inc. (TTWO) Earnings Call Transcript & Summary

All right. Good morning, everyone. Welcome to our next keynote, here on Thursday, day 4 of the TMT Conference. We are thrilled today to have Strauss Zelnick, the CEO of Take-Two with us. Strauss, thanks for coming.

Thanks for having me. Nice to be here. Pretty sparse room. Before we get started, I guess, everyone else's out there going to hold foods and buying up everything that's not nailed down.

Everyone's ordering online groceries, just to stay at home.

Yes. I know.

All right. So please note that all important disclosures, including first the holdings disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at www.morganstanley.com/researchdisclosures, and they're also available at the registration desk. Some of the statements made today by Take-Two maybe considered forward-looking. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. Any forward-looking statements that Take-Two makes are based on assumptions as of today and Take-Two undertakes no obligations to update them. Please refer to Take-Two's Form 10-K for discussion of the risk factors that may affect actual results. Strauss is the Chairman of Take-Two. He's been the Chairman since 2007, CEO since 2011. Thanks for coming along.

Pleasure. Thanks for having me.

There's always a lot of things going on in the video game industry. I always really appreciate sort of your perspective of the macro themes going on and what's happening and what's not happening. And so maybe let's sort of start there. Sort of stepping back in the video game industry, you have free-to-play, mobile, all these questions of what's changing. In your mind, over the last year to 2 years, what has changed for the better for leading publishers like yourselves? And what have proven to be new source of challenges that you need to address and make sure that you're investing appropriately for?

What changed for the better, I think, for all of us is just continued growth in the marketplace. We've got a cohort of people who still are average age 37, 38. People continue consuming the entertainment they fell in love with when they were 17 for the rest of their lives. So when they turn 38 or 39, they don't stop playing video games. The overall market is going to continue to expand. There's been expansions in different formats. In the last several years, we saw this enormous amount of activity around Fortnite and PUBG and more recently, Apex Legends. So this whole sort of mid-core, free-to-play market has developed. That's really exciting. So we now have a robust console market and massive growth in PC formats unexpectedly, actually, and continued scale and growth in various kinds of mobile entertainment. At the same time, there's new opportunities on the horizon, whether that's streaming services or eSports businesses, which is still nascent and relatively small and potential growth in geographies. So China is a bigger market for our firm and our industry than before. And right now, we, as an industry that's largely located in the U.S., haven't really penetrated India very much. There's opportunity there. We haven't penetrated Africa very much. There's opportunity there. The Middle East and the list goes on. So the opportunity set is fantastic. What's happened on the challenge side is in -- as entertainment businesses mature, demands for quality grow. And so we see fewer titles on the shelves because a B title will fail and lose money. And that just puts a finer point on our strategy, which has been the same for better or for worse. And I think for better for 12 years, which is a smaller number of the best releases in the business. And the result of that is not that we've had a perfect track record. Frankly, we've had a near-perfect track record. We've the highest hit ratio in the business. We allocate capital more effectively than everyone else's result, and our returns and the returns for our shareholders have reflected that success. So it's a challenge -- frankly, it's an ongoing challenge for us because we have to wake up every day and do it again. And many of my colleagues who develop games are listening and sometimes they do listen to these things. They'd be horribly shocked and disappointed by -- a sort of assumed way that activity. That's a really hard thing to do. It's hard every day. But we've always tried to do it. So less of a challenge for us because our DNA is focused on quality. It's still a challenge for us in terms of executing against that and a disappointment when we fall short, which does happen now and then.

And I guess, sort of now zooming a little more into Take-Two specifically. I would agree that the focus on quality, it really is unparalleled with a couple of your studios and kind of what they put out. When you talk to investors, when you read in the press, when you sort of interact with people externally, what aspect do you think is still most misunderstood, but what kind of goes on beneath the hood that Take-Two differentiate where you -- to your point, B titles are going to lose money, and so what do you do to ensure that the A titles keep coming out?

So 2 questions there. What do I think is -- I love that question for a CEO because I've never met a CEO who didn't think his or her stock was grossly undervalued. And so then -- and then they feel pain like, "Oh, my God, it's terrible. We're so horribly misunderstood." So first of all, it's a great luxury and pleasure to sit in the seat that I sit in. Secondly, when you're followed by 25 -- roughly 25 analysts, all of whom are incredibly smart and diligent and hardworking, we're not misunderstood in the least. And finally, at the end of the day, we trade on fundamentals. If we deliver, we perform well. If we don't deliver, we fall short, we perform badly. And so our focus is always just keep delivering. When we were doing the turnaround, we really were misunderstood because the turnaround took longer than I would've liked, but we got there. And we started having good results 2, 2.5 years in and the market did not pick up on that at all, which created a great buying opportunity for some of you in the room. But even then, I was asked, what does the market misunderstand? I was like, "Market doesn't really misunderstand much usually." There are moments of time when the market misunderstands because if there weren't, then none of you could be doing what you do for a living. But at that time, the market was sort of stuck on. Yes, yes, yes. We know there's some new guy doing this, but this company was a bad actor and had bad results, and we think that will probably continue. So the market can have a long memory for certain things, both good and bad. But at this point, I think we're fully understood. Now do I think there are embedded call options in our security that maybe aren't being reflected at any given time? I do, but I talk about them pretty openly. And unlike many others who do what I do in business and public companies, we tend to spend precious little time painting beautiful visions of the future. We talk more about what are we doing? What's our strategy? What are actual results? What are things that have gone well? What are the disappointments? We're transparent about it. You make your own decisions about what that means. So I have no complaints. Now, what was the second part of the question?

Second part is sort of the way in which you manage the company or allow the individual studios to be managed so that you ensure that the title stay As. You're not having any of the B titles where, to your point, it's hard to make money with the B title in the new world?

Well, I'm not shy. And I'm a player coach. We don't have an -- I'm not an autocrat. And I'm not the -- do not perceive myself to be pulling the levers in the enterprise. Our enterprise is driven by our creative talent and the people who market and distribute our properties every day. And I see myself as a person who's in service of the overall goals, personal and professional, which hopefully are totally aligned with the interest of the shareholders. Our goal is to be the most creative, the most innovative, the most efficient entertainment company that exists. Our goal is to make the best entertainment of any sort that anyone makes. Our goal is to be of service and so doing to our consumers. And we all feel exactly the same way. So -- and we agree, as a team, that the only way you really succeed in entertainment over long periods of time is by putting out the best quality products. That's just a fact. The entertainment -- the electronic entertainment business is 120 years old. Like I've studied it my whole life. I've run every kind of entertainment business there is. Any entertainment company that does not define itself through the lens of quality, ultimately fails or swallowed up by someone else. So it's not hard to get people on the same page, particularly because if you hire the best and brightest, and that's our goal. The best and brightest always wants to do the best work. So I don't have to motherhood an apple pie for us to talk about quality. Where it gets challenged is in the execution and when we hit bumps in the road. And then we're all in it together, and we try to solve those problems together.

I want to sort of drill into a couple of those bumps as well as the call options after the next question. But sort of given the near-term sort of the unfortunate situation around coronavirus and everything that's going on from a macro perspective. I know predicting the future is impossible in the scenario, but I guess the question is, number one, what can you tell us as sort of what you've seen to date on your players and your engagement, et cetera? And then how do you think about sort of the long-term impact on behavior modification or gamers or players after we get through the corona situation, hopefully, soon?

Well, I mean first of all, any time people are sicker or tragically lost their lives that's a much more important topic than anything we're covering today. So I just want to sort of put a fine point on that. In terms of business continuity, we're not concerned. In terms of our consumer, we're not concerned. And we have the ability to work remotely if it comes down to that. And I don't believe it will. So I mean I do think there's going to be a whole lot more cases of coronavirus than we've seen so far because it's more transmissible than a regular flu. I think it's terribly unfortunate that -- and I'm in the media business, I can't really be super critical, but I think it's really unfortunate that the press is not seemingly aware that we have currently, right now, in America 25 million cases of the flu. And in any given flu season in America, somewhere between 30,000 and 60,000 people typically pass away from the flu. That seems to be lost in the shuffle. And this is a flu virus. And I think there be a whole lot of it. I think there'll be -- it seems to have a slightly higher fatality rate. I actually think when we understand what the denominator is, not going to be much higher, I could be wrong, I'm not a doctor, but assure I do talk to a lot of doctors. I think it's going to be very unpleasant. I think the market may take a real hit, actually. I think things will slow down. So with all -- with that said, it also will pass, this flu virus, and we'll develop herd immunity and vaccines will be developed, and we have been through this before. So I think given that we've been through flu pandemics many times before, pretty good idea of how it's going to pencil out. But I think people were mindful of what the flu does every year around the world, particularly in developing countries, they might be a little less concerned. We've had really significant flood problems. As recently as 2009 and 2010, where, I think, 800,000 people died in '09 and '10 from the flu. So all that said, as it happens, our business is not particularly exposed to it.

I guess in those past flu pandemics or even sort of what you see in other regions of the globe, it sounds like there are instances where there's actually more gaming consumption. Have you seen that in past flu pandemics as well?

I have never looked at it. I mean just -- this is the first time it got called out. But I mean we're obviously not doing victory laps of any sort under those circumstances, I would just -- I don't -- we're not an industry that is likely to be meaningfully affected. We have delayed 1 SKU the Twitch SKU of the Outer Worlds because the studio is located in China, and there was an inability to get to work for a period of time. The rest of our worldwide enterprise can work remotely effectively.

That last point, this has been coming up in a lot of the video game and the publisher discussions this past week. The extent to which there is sort of a month or a prolonged period where more people are working from home. Given the fact that Rockstar is in California, could you see that potentially impacting the productivity of those game developers. There was a prolonged sort of work at home period or are they just as productive at home as they are in the studio?

They're going to have to find a way to be just as productive at home. We have access technology. Actually, I think, one of the things that may come out of this, if it's as widespread as I believe it'll be is, one unexpected consequence is, a lot of us who were skeptical about remote work and -- are going to be less skeptical about it. I'm one of them, by the way, I don't really -- I'm not a big believer in remote work. But, I think, I may be surprised. I think you are going to see a significant change, maybe a long-lasting change in business travel. I think there are a lot of people who may say, "Well, I really can be effective through a Zoom video conference, I really, really can. We're just one of -- there was a meeting that was scheduled and now that meeting is occurring on a Zoom meeting. Is it as effective as being face-to-face? I actually don't think so. But you also -- every one of you had lost productivity getting here, returning from here and the time that is less productive here. I'm not sure. I think we may be very surprised coming out of this that a lot of companies say, "You know what, let's do more video conferences, let's travel less, let's have more meetings on Zoom."

I'm onboard. I love fewer miles. That would be great. I want to ask a few questions about some of the individual franchises. Red Dead Redemption online sort of seems like it's finally starting to really bud through. Maybe talk to us about the individual drivers of success you've seen early. What's really sort of driven the engagement and the monetization that you've seen to date? And then as you sort of look ahead, what -- are there any unique challenges to the Red Dead ecosystem that are not -- that are different than what you see at GTA, where it should not be a good parallel?

Well, they're very different titles. So they're not necessarily parallel. I'm just starting with the fact that in great success, Grand Theft Auto has sold in 120 million units and Red Dead has sold in 29 million. So they're different scale of success, both massive, but different. And they're different formats. One is a period piece into western and it's thoughtful and emotional and the other is more current day and action-oriented and gritty and involves a criminal underculture. So completely different titles. And -- but for the fact that they are both interactive entertainment experiences brought to by Rockstar, there's not much more that you could say that would be -- and they're both open world, there's not much more that you could say that would express similarity. We've had great success with Red Dead Online of late. In the third quarter, we announced that our results were tripled, both sequentially and year-over-year, what we previously enjoyed. And we're incredibly excited about the momentum of Red Dead online, something I've said for a while. And what's driving that? Content. Content to content drop, Moonshiners' content drop. More content is coming and that's also driving the ongoing success of Grand Theft Auto Online, which you didn't ask about but I'll mention it anyhow. We've been saying for years, we expect Grand Theft Auto Online to moderate. Not only is that not happening this year, not only are we going to be up sequentially, we're actually going to set a new record for Grand Theft Auto Online this fiscal year. It's just amazing in so many ways. And what's driving that? People love Grand Theft Online. They love the new content. The Diamond Casino & Resort pack has been incredibly successful. There's a big community of people who enjoy being inside that world. And as long as we give them more things to do and more ways to engage, they stay engaged.

NBA 2K is a game that, unfortunately, had a little misstep this year. So maybe talk to us about what went wrong there? And what steps have you put in place to ensure that the next iteration of the game can hopefully be more successful than this year's?

So the first is, I mean I'll take issue with the description. Sometimes I think we get burned for transparency. NBA 2K is a massive, massive hit and contributes extraordinarily, both creatively and financially, to our company's success. And 2K20 is no exception. We have great engagement. We sold in over 8 million units, continuing to sell, engagement continues to grow. And the MyTeam mode is way up. I think we announced it was up something like 38%. We had one -- in an effort to be transparent, we said, "Look, we had originally expected NBA 2K20 to be -- set a lifetime record, and we no longer expect that it will set a lifetime record and that's a reflection that one part of the game is generating somewhat less recurrent consumer spending than we expected. When we said it would set a record, that's just being transparent. That's not a reflection of a problem. A problem is like, wow, this thing didn't sell we have -- that's a problem. This thing is a huge massive success. Now what did happen is our developers are constantly trying to innovate, and they make changes in trying to innovate. And that's how things like The Neighborhood came along. And we've said over and over again and repeat it here, that our goal first is to entertain and engage and only second do we think about monetization. And there are times when we make an innovation that has different monetization characteristics, sometimes better, sometimes worse. In this case, somewhat less effective than we had expected. So we had to change our outlook about setting a record. That's all that happened. It's an enormous success.

Got it. Got it.

Now what do we do about that? We keep innovating, and we add to the innovation, a focus on data, and we try to have a result that's great from a creative point of view and great from a business point of view. But sometimes, when you're focused on being the most creative, the most innovative and the most efficient, you don't get every part of the equation right. The good news is, it's an amazing title and consumers love it.

I want to ask you about pipeline a little bit. One of the topics that often comes up with investors is sort of the franchise concentration and it's not unique to Take-Two. It comes up with all publishers around GTA, NBA 2K and Red Dead. I know in the past couple of years, you've really been focused on increasing the cadence of releases and sort of having more titles and more breadth. Where are you now in that journey? And sort of talk to us how you think about sort of diversifying the company's overall portfolio across more franchises?

So we said that we have the -- we're making the biggest investment we've ever made in our pipeline. That will be expressed over the next 5 years. We've also said that our goal year in, year out is not only to have this basis of great catalog and great live games but also to have, in addition to our annual releases, new frontline releases every year. Sometimes we're able to do it, sometimes we're not. We're investing more and more so that we will get to a point where pretty reliably we'll have a great frontline release schedule in addition to a catalog, in addition to live ops, in addition to annualized releases. Equally, we're focused on building up our mobile business, where we're still a relatively small player and we're focused on doing that, both through social point, which now has 5 successful games in the market, up from 2 as well as 2K that has 2 mobile games in the market quite successfully, particularly SuperCard, which has been downloaded over 20 million times. So where would I like to see us go and sort of a proposed embedded call options? I'd like to see us develop that -- those -- that pipeline and have it come to fruition in a really high-quality way. And that pipeline is a diverse pipeline. We're going to talk more about in the coming months.

Got it. Got it. And part of that, maybe one of the engines driving that is the Private Division. So maybe just for everyone in the room, explain to them what the Private Division is? How is it different than the other studios? And what is the difference in the offering coming out of the Private Division versus the other studios? Is there a different gamer you're trying to reach? Is there a different use case you're trying to reach? Like how is the private studio different in your mind?

Well, the idea between -- in the formation of Private Division was that there are a whole bunch of high-quality independent developers who aren't interested in being embedded within a major label inside a big diversified entertainment company that they want to stay very independent, they want to own their intellectual property, but they still need capital and they still need publishing. And that was the thesis, and Michael Worosz and the team have done a great job, going out into the market and saying, "Look, we're -- while we may be part of this big company, our way of doing business is totally different. We have capital to invest behind you. We're going to support your creative vision." And we did that because we thought that would be a more effective and efficient way to invest largely, if not entirely, behind new AAA IP. And equally, we've also been willing to acquire properties through Private Division. So Kerbal Space Program was acquired. That already was successful title, sold in over 4 million units, and we've announced that Kerbal Space Program 2 is coming, and we've started a studio to support that. And then we've already released Ancestors and The Outer Worlds and The Outer Worlds has been a massive success at 175 awards, it's sold in over 2 million units. So it's a very successful title. Best case scenario, Private Division grows up. And over time, by working with the best and the brightest who are outside of the main interactive entertainment system, we'll have our social point label, which is mobile; Rockstar, which is the highest quality console type titles; 2K, which is diversified, high-quality entertainment company that also is exposed to the sports business and Private Division -- 4, which is 4 powerful entities. And that should go back to the goal of having big frontline release schedule, that's diverse and powerful every season.

I have a couple more before we turn it over to...

We're getting into a speed round according to the clock in front of me.

Yes, we're down to 5 minutes. So I have a couple more before we turn it to the audience for Q&A. If the mic runners want to stretch out. Couple of higher level ones. In the past, you have been a very smart acquirer of your stock. You're well timed buybacks, in my opinion. Talk to us about sort of the priorities on capital allocation, as you sit here with all the changes going on in the ecosystem with cloud and distribution and everything else?

So we continue to have 3 priorities for our capital. First, to support organic growth. This company is an organic growth story. It will -- we have to continue to invest in ourselves. We are investing in the biggest pipeline in our history, and we hope that will be a smart investment. The second is through inorganic growth, and we bought Social Point off our balance sheet, then we have enough balance sheet capital and the capacity to do pretty significant transactions. I'm burdened by actually having an HP 12C app on my phone. And so we like to use it, and we're only interested in accretive deals that separates us from a lot of other people. Most corporate -- you guys follow a lot of businesses in more than 1 industry, so you know most corporate M&A fails. You also know that most -- and getting to third topic, returning capital to shareholders, most standardized buyback programs fail, they do not create value. So we don't do those. What we do instead is opportunistically enter the market because we have loads of capital. And when we think there's a market dislocation, we buy back stock. And so far, we've been right 100% of the time. I don't imagine I'll be right 100% of the time. But we've tethered -- we've tempered one's natural optimism about one's company to say, "Look, when there's truly a dislocation, we'll act." And last time we bought back stock, we did so at $0.99 a share. And I think -- I don't know what we're trading at today, but still looks like a reasonably intelligent decision. So those are the 3 uses of our capital. My druthers would be to find something strategically powerful. But again, we're looking for something strategically aligned and financially accretive, and we're disciplined.

Yes. I like the calculator app reference. The way that the ecosystem is changing for new distribution options like cloud, I think, is a really interesting sort of topic when you think about what the video game industry could look like in 4 or 5 years. To your point, you have years and years of media experience. It seems like there's an argument to be made that if the publishers -- leading publishers like yourself really wanted to, they can put together a package that will go direct-to-consumer, you can sort of get to the way Disney+ is now and maybe even bypass with the cloud players. What's your reaction to that? And how do you think about the industry structure evolving, where ultimately, you have the IP and the IP is the most valuable piece of the ecosystem?

We're already there. We have the IP, and it's most valuable part of the ecosystem. We get paid accordingly. A direct-to-consumer offering is only exciting if it's valuable for the consumer. The problem with a lot of people's focus on direct-to-consumer is what's driving them? What's driving them is Netflix's market cap. That's what's driving them. That's irrelevant, right? I would love to have Netflix's market cap. But I like many things, actually. Like I don't have any chocolate here right now, for example.

You can get that.

Yes. So the fact that we want to have someone's market cap is not a reason to create a consumer offering. The reason to create a consumer offering is because you're going to benefit consumers and therefore, they'll pay you. So we are pursuing direct-to-consumer because we think we better be smart about it. But you can only expect direct-to-consumer offerings to work when they benefit consumers. Why did Netflix benefit consumers? Because American households consume about 150 hours of linear programming a month. That's typically over 100 properties. And if you offer them that for $15 and a broad array of products, well, that's a pretty good deal. That's not -- that doesn't speak to interactive entertainment. Consumers consume about 45 hours a month, and it's typically clustered around 3 titles, and you got to wonder then as subscription, for example, going to be a great model. And typically, when people talk about direct-to-consumer, they're talking about subscription. It doesn't have to be [ per head. ] So we have a direct-to-consumer offering. Rockstar has a big direct-to-consumer offering. You can buy any Take-Two title you want direct. But we are the last company on earth that's going to say, "We're not worried about what you want. We're not worried about what's good for you. Instead, let us talk to you about what's good for us." What's good for us? The Take-Two store. Why is it good for us? Because it's cheaper to run the Take-Two store than to have other distributors. Is it difficult for you? Is it an inconvenient for you? You prefer to shop on Amazon? I'm really sorry. We're not doing that. Well, we won't be doing that. We want to be where the consumer is. And consumer propositions that succeed are the intersection of what's great for the consumer and what works for the provider. That works in the Netflix scenario. I haven't seen it yet with regard to direct-to-consumer really for the interactive entertainment business. Unless and until we see it, don't expect it to be an important part of anyone's business.

All right. Question #2 for Strauss before we get the Lindt -- the Lindt bars.

Speed round. No. Ghirardelli.

You've recently lost one of the Houser brothers within Rockstar. Could you just comment on, yes, let's say, what that means for Rockstar and the future of the franchise?

Well, we're grateful to Dan Houser for his contribution. He was VP of Creative for Rockstar. He took a sabbatical, so he hasn't been involved with the business for about a year. During that year, of course, Rockstar has had extraordinary success. We expect to have a record year for Grand Theft Auto Online. There's more than 2,000 incredibly talented people working at Rockstar. Sam Houser is the founder of Rockstar and Head of the label. And he and his team do an amazing job, and we have enormous confidence in the label's success and growth going forward.

Given your experience in traditional media as well, we've obviously seen a ton of consolidation in that space. I'm curious, do you see a wave of consolidation happening in interactive entertainment in a similar way like how would you compare and contrast the scale benefits?

The consolidation that you've seen in linear entertainment has been lately largely driven by challenges more than success. Businesses that consolidate, either are challenged as you're seeking to find cost synergies typically, or where there's a massive benefit to scale. Entertainment businesses -- pure-play entertainment businesses don't uniquely benefit from scale. Once you're big enough to have a competitive operating margin, scale is not going to do much for you. We'd like to have more scale because our operating margins are still burdened by the fact that we're smaller than our -- some of our -- 2 of our competitors, but we'd only benefit from scale if we maintained our gross margins, of course. And if you get diseconomies of scale because you're running a worst business or you're running a fine business worse, either one will do, and you hurt your gross margins and so doing, obviously you're not going to benefit from operating margins. So what I think could drive this business towards consolidation would be sector challenges that I really don't expect, for the reasons I said earlier or if the business became heavily catalog-driven because if you have a heavy catalog business, the property has already been made, it's clicking the way, it's making money and you could strip out any overhead related to operating it, then a strategic combination could make good sense. There's not a lot of that going on here because our business isn't really that mature. So I think that's one of the reasons our consolidation really hasn't occurred. You have to find a real business case for it to occur. That said, you haven't asked it, but I'll answer it. In the event of consolidation, we see ourselves as an or rather than an E. We think that our results and our talent and our balance sheet allow us to pursue that. And we would like to gain scale, and we intend to try to continue to gain scale successfully, which is to say, preserving our success rate, preserving our hit ratio, preserving our gross margin, but through scale, having highly competitive operating margins. Right now, we have highly competitive gross margins. And sometimes, we have highly competitive operating margins, but not all the time.

Great. All right. We're against the clock. Strauss thank you so much.

Great. Thank you. Thanks all.