Take-Two Lower on SEC Notice

The company also posts solid earnings but lowers first-quarter guidance.
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Updated from 1:04 p.m. EST.

Take-Two Interactive

(TTWO) - Get Report

shares sank Thursday after the video game maker said the

Securities and Exchange Commission

was on the verge of bringing a civil action against it.

As of 1:30 p.m. EST, the company's shares were down $1.88, or 6.2%, to $28.44.

The maker of the blockbuster hit

Grand Theft Auto

video game said a previously reported SEC investigation into its accounting has been escalated with a so-called "Wells Notice," in which the agency informs a company it plans a civil action unless it can be talked out of it. Take-Two's 31-year-old chairman and founder Ryan Bryant, an unidentified current employee and two former officers also got the notices.

If the company is not able to resolve its issues with the SEC -- which are believed to involve revenue recognition and product returns -- it would result in a change in the timing of the recording of revenue in past, current and future financial statements, Take-Two said in its press release Thursday.

"The only thing we can say is the process is moving along and we'll have to see where it proceeds," CEO Jeffrey Lapin, who came to Take-Two last year, said in a conference call. "We are in active discussions with the SEC."

Lapin could not offer any timeline on the investigation or civil action.

The potential civil action comes nearly two years after the SEC launched a formal investigation of Take-Two in February 2002. In December 2001, New York-based Take-Two shocked investors when it announced it would restate financial results for the past seven quarters.

"At least now

the investigation is sort of on the road to resolution," said James Lin, founder of video game industry consultancy The SIMBA Group and a former sell-side analyst. "We've finally heard something from the SEC after 20 months of hearing nothing."

But Lin acknowledged that with a civil action, "who knows how long this can drag on." Lin does not own any shares of Take-Two, and the company is not a client.

News of the potential civil suit came as Take-Two reported higher earnings and revenue in its latest fourth quarter compared with last year, but lowered earnings targets for the first quarter and fiscal year 2004.

For the fourth quarter ended Oct. 31, Take-Two earned $26.6 million, or 59 cents a share, on revenue of $278.5 million, compared with earnings of $22.3 million, or 54 cents a share, on revenue of $218.4 million. Analysts had been forecasting earnings of 59 cents a share on revenue of $257.6 million.

For the first quarter ending Jan. 31, 2004, Take-Two now expects to earn $1.10 a share on revenue of $412 million, down from its previous earnings target of $1.21 a share. Analysts were forecasting earnings of $1.20 a share on revenue of $414.8 million. For all of next year the company expects to earn $2.60 a share on revenue of $1.18 billion, down from the previous estimate of $2.68 a share. Analysts were forecasting earnings of $2.68 a share on revenue of $1.17 billion, according to Thomson First Call.

The lower earnings guidance reflects a greater focus on distribution than publishing, and with it significantly lower margins, as well as more shares outstanding than previously anticipated, said Karl Winters, Take-Two's CFO.

Take-Two noted its current guidance could change if it is fined by the SEC and that it could be forced to restate its results if its revenue-recognition practices are found to violate accounting rules.

However, Mark Haefele, CFO and COO of Sonic Capital and co-manager for a Boston-based hedge fund, suggested restatements in recent periods seem unlikely. "For the recent quarters to be restated, you'd have to be in a situation where new people came to the company and cooked the books knowing the SEC was looking over their shoulder," said Haefele, also a columnist at

Street Insight.com

. "That seems illogical."

Haefele is long Take-Two shares and notes that the company is trading at a significant discount to the industry, with a price-to-earnings ratio of 11, based on the company's new guidance.