Take-Two Interactive Software Inc (TTWO) 2002 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the Take-Two Interactive 2002 2nd quarter conference call.

All participants are in a listen-only mode.

A brief question and answer session will follow the formal presentation.

If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad.

As a reminder, this conference is being recorded.

I would like to turn the call over to your host, Miss Cindi Buckwalter.

Thank you, Miss Buckwalter, you may begin.

Thank you.

Good afternoon, ladies and gentlemen.

Welcome to the conference call for Take-Two Interactive 2nd quarter, fiscal 2002. And thank you for joining us today.

You should all have a copy of our press release, distributed this afternoon.

If you don't have a copy, call Wolf Axlerod at 212-370-4500 to request a copy.

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 fact are considered forward-looking statements under Federal Security's 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 the forward-looking statements based on a variety of factors.

These important factors are described in our filings with the sec, including our annual report on form 10-K as amended for the fiscal year ended October 31st, 2001 and our form 10-Q for the first quarter ended January 31st, 2002.

We have no obligation to update such forward-looking statements.

Before we begin the call, I would also like to mention that our current relationship with the SEC precludes us from discussing and answering questions regarding the status of the SEC investigation, beyond what is disclose made our SEC filing.

Today's call will consist of a presentation by our management team, followed by a question and answer period.

With us today from Take-Two are Kelly Sumner, our CEO, Paul Eibeler, our President and Karl Winters, our CFO.

At this time, I'm pleased to introduce Kelly Sumner.

Kelly?

Thank you, Cindi and thanks for joining us today on Take-Two's 2nd quarter 2002 earnings conference call.

I'm pleased to say we had a strong quarter and first six months on many fronts.

Let me share some high points from our perspective.

First, take-two's titles have continued to enjoy great acceptance in the marketplace, setting new sales records and winning accolades in the industry, the media and gamers.

Second, for the second consecutive quarter, we've produced the kind of solid earnings performance that our shareholders deserve.

A major contributor to our performance is the fact that much of our publishing revenue comes from the intellectual property that we own outright.

I will be talking more about that in a few moments.

Third, we've have made further progress in strengthening out balance sheet and improving our cashflow.

Fourth, we've continued our efforts to build the management team, board of directors and corporate infrastructure needed to support a growing, successful company.

And fifth, we have developed an exciting pipeline of titles to keep Take-Two's momentum strong.

As most of you know, we're just back from E3.

Paul Eibeler will recap some of the exciting announcements we made at the show as well as other product highlights in his segment of the call today.

Looking at the quarterly results, net sales for q2 were $170 million, up over 90% from the $88 million reported for the same period of fiscal 2001.

An exceeding revenue guidance of $145 million by $25 million.

Our interest share on a diluted basis for 25 cents versus a net loss of 35 cents per share last year.

Excluding the class action assessment charge and gain on internet investments, pro forma net income for Q2 was 27 cents per diluted share, which is exceeded our guidance of 25 cents.

Based on the outlook for industry fundamentals and a strong market performance of our published products, we've again raised our guidance for the remainder of fiscal year 2002.

We now believe fiscal 2002 net sales will be $733 million. Our guidance for earnings per share is now $1.68, including the charts with the class action lawsuits, which was 2 cents per share.

Without the charge, pro forma earnings per share are expected to be $1.70.

Our guidance for Q3 is $100 million in net sales with 7 cents of diluted EPS.

Now let me share some of the highlights in each of the five areas I touched on earlier.

In published products, Take-Two and Rockstar gains, in particular, held onto a leadership position.

According to industry analysts, NPD Funworld and CHART- track.

We were the number two publisher of PlayStation 2 software in the US for the first six months of the fiscal year and had a 17.7% dollar share of this market.

We were the number 2 publisher across all [INAUDIBLE] platforms, with a 10.6% dollar share.

Grand Theft Auto 3 for PlayStation 2 was a top selling video game against all platforms in the US and most of Europe for the 2nd quarter and the first six months of our fiscal year.

Since the launch of the PlayStation 2 platform, GTA 3 has been the number one selling PlayStation 2 title in North America and Europe, selling over 6 million units to date.

State of Emergency was the number one selling video game on any platform in the US and UK, during launch week.

We're pleased with the performance of State of Emergency, which has already achieved strong sales and is qualified as a greatest hits title.

As for the value-priced title that we made for the PlayStation 1, Take-Two was the number five publisher on PlayStation 1 software for the first half fiscal 2002, with a 7.8% unit share.

I've already spoken about our solid earnings performance and the outlook for the balance of fiscal 2002 and will be giving you more financial details in just a few moments.

A do want to emphasize a point that I mentioned earlier, regarding the intellectual property we own.

In fiscal 2001, for example, about 2/3 of our publishing revenue was generated by titles for which we currently own the I.P.

This has a significant positive impact on Take-Two because we have the ultimate control of our brands in that regard, we recently announced that acquired ownership of Max Payne brands, and all the related intellectual property. The $10 million in cash plus approximately $1 million restricted shares of common stock as well as certain development incentives.

This puts us in an excellent position to benefit financially from the release of Max Payne 2, scheduled for calendar 2003, and from future expansions of this successful franchise, which has already sold 2 3/4 million units worldwide.

Turning now to our cashflow and balance sheet progress, cashflow from operations was $30 million for 2nd quarter.

Days outstanding were 34 days as of april 30th, 2002, as compared to 96 days at the same time last year.

We are in a cash position of $17 million at the end of the 2nd quarter and no barrings under our bank lines.

During the 2nd quarter, we continue to enhance our corporate infrastructure, to support our future growth, making key additions to management and the board of directors.

Early last month we announced the appointment of the prominent film producer and Oscar winner, Steve [inaudible], to our board.

We also further strengthened our financial management team by hiring two experienced manager in key functional areas.

Karl will have more in a few moments.

At this point, I also want to comment on the announcement that we have settled the securities class action lawsuit filed against Take-Two and certain offices, directors and former officers.

We are pleased to have settled the litigation and to be focusing our attention to producing the kind of solid, financial and operational results you've seen in the last six months.

We've recognize the pre-tax charge of $1.5 million in the 2nd quarter for the portion of settlement costs and legal fees not covered by insurance.

The final area we want to highlight is Take-Two's strong product pipeline.

Which [INAUDIBLE] plan for the proven brand franchises as well as launches of exciting new brands, we believe Take-Two has the best product line in its history.

In just a moment, Paul will give you a product update, including some of the incentives we announced at E3.

But first, Karl will take you through the quarter numbers in more detail.

Let me conclude my remarks by saying that our team is focused on continuing the positive track record we've demonstrated thus far in 2002.

Thank you again for joining us and for your continued interest and support of Take-Two.

I now turn the call over to Karl Winters.

Thanks, Kelly and good afternoon.

Our operating results produced net sales of $170 million and earnings per share of 25 cents.

Excluding the $1.5 million charge related to the settlement of our class action lawsuit and a $32,000 gain on internet investments, our pro forma earnings per share was 27 cents for the quarter.

Net sales increased over 90%, compared to net sales of $88 million for the 2nd quarter of last year.

Our publishing revenue represented 79% of our business, while our distribution business was 21% of revenue.

Compared to 55% publishing and 45% distribution in the 2nd quarter of last year.

The increase in our publishing business as a percentage of total revenue reflects the success of our new products that Paul will discuss later in the call, as well as the continued strength of our catalogued titles.

The platform mix for the publishing business was 94% from console software, 5% from pc software and 1% from accessories.

Our gross profit margin for the 2nd quarter was 37%, compared to 35% in the 2nd quarter of last year.

The increased margin resulted from two primary factors.

The shift in our business mix for publishing verses distribution, a goal that we have stated in our prior calls, as well as the continued strong sales of Grand Theft Auto 3, an internally developed and owned title.

Double operating expenses were very comparable on a basis to the 2nd quarter of last year.

General and administrative expense on a dollar basis for 2nd quarter was approximately equal to that of this year's 1st quarter.

During the 1st quarter of this year, we incurred professional fees related principally to the audit [inaudible] of the company's financial statements.

During the 2nd quarter, we continued to incur professional fees related to the principally to the [inaudible], PricewaterhouseCoopers' quarterly review

and the ongoing SEC investigation.

In addition, we have added personnel expense to the enhancements we made to our organizational infrastructure, for instance, in our finance and it departments.

Selling and marketing expenses from a dollar basis for the 2nd quarter was just below the 1st quarter expense, with a principal focus on the advertising and promotional support for the new product launches and existing catalog titles.

R&D expense increased this year over last year due principally to head count.

It increased during the 2nd quarter comparison with the 1st quarter this year due to bonus compensation and added headcount.

Based on the strength of our publishing business, we produced significant cash flow during the quarter, generating approximately $30 million in cash from operations.

At the end of the quarter, we had approximately $70 million in cash with no borrowings on our line of credit, as compared to $7 million in cash and outstanding borrowings of about $90 million at the end of the 2nd quarter, last year.

Debt accounts receivable at the end of the 2nd quarter were approximately $65 million, compared to $95 million receivables at our fiscal year end.

Our accounts receivable reserves currently stands at about $26 million, representing approximately 29% of total receivables.

Our DSOs were 34 days at the end of the 2nd quarter.

This compares to 39 days at the end of the 1st quarter and 69 days at year-end.

Our success in reducing DSOs was heavily influenced by the significant demand for our published products early in the quarter, such as Grand Theft Auto 3 and Max Payne.

In addition, we've launched state of emergency within the first few weeks of the quarter.

As a result, we realized almost 50% of our revenue in the 1st month of the quarter.

This provided additional time to collect the related receivables, which positively impacted the DSO level for the second quarter.

As is customary in the industry, payment terms for the majority of our customers typically range from 30 to 60 days.

As a result, we expect our dsos will trend higher.

I would also like to give you an update on the additional improvements we've made on our financial infrastructure.

As mentioned our last call, we plan to add additional middle management resources to the finance team.

As a result, we've added two new members to the team.

Bob [inaudible] has joined us as Director of Financial Reporting and Manny Rivero has joined as Treasurer.

These are newly-created positions at Take-Two and I believe theses experienced individuals will provide the management support needed in these key areas of our business.

We've also brought in Deloitte & Touche as consultants to further review and assess financial and operating procedures throughout our organization, so that continued improvements may be made where necessary.

They are focusing on such areas as procurement, cash management and dispersement, sales management, warehouse operations and other key functional areas.

In summary, we are pleased with our operating results this quarter and our current financial position as well as the additions we've need our staff and the further improvements we've made to our organization.

We look forward to speaking with you again after Labor Day when Take-Two reports 3rd quarter results.

At this point, I'd like to turn the call over to Paul Eibeler, our President, who will review Take-Two's business for the quarter in more detail.

Paul?

Thanks, Karl.

The strong financial performance you've heard about for the 2nd quarter and 1st half, year to date, was driven by the continued demand for our products.

I'd like to share product highlights and talk about our pipeline.

Grand Theft Auto 3 continues to perform extremely well.

Since the launch of the PlayStation 2 in october, 2000, Grand Theft Auto 3 has been the best-selling console title in North America and Europe.

Recently, Grand Theft Auto 3 won the Sony Publisher's Choice Award as Game of the Year.

We also announce that future console versions of the Grand Theft Auto brand franchise will be developed exclusively for the PlayStation 2 through October, 2004.

Grand Theft Auto 3 for PC, which shipped in the third fiscal quarter of 2002, has been well-received.

The PC format provides enhanced graphics and sound and we've also given players additional options to customize the game.

Initial sell-through is meeting our expectations and early indications from the international retailers are that Grand Theft Auto 3 for PC, is currently the number one PC title in several European markets.

Our release schedule during the fiscal 2nd quarter was highlighted by State of Emergency for PlayStation 2.

We also introduced additional products under the Serious Sam and Tropical PC franchises, as well as multi-[INAUDIBLE] for PC.

And we shipped Max Payne for the Xbox launch in Europe.

In the third fiscal quarter, in addition to Grand Theft Auto 3 for PC, we have shipped two additional PlayStation 1 value titles, the Italian Job and Big Bass Fishing.

In May, Midnight Club and Smuggler's Run were relaunched as part of Sony's PlayStation 2 Greatest Hits program.

Later in the 3rd quarter, we plan to ship Major Wonders 2 and Tropical Gold for PC.

Austin Powers pinball will ship as a value PlayStation 1 title.

Also in Q3, we anticipate shipping our first GameCube product, Smuggler's Run War Zones, for the GameCube is an extension of our propriety brand to an additional platform.

We are planning to keep this momentum going with a full calendar of releases. Here is a recap of the highlights we announced at E3.

Our next extension in the Grand Theft Auto franchise will be Grand Theft Auto Vice City, shipping on October 22nd for the PlayStation 2.

The Rockstar team is committed to taking Grand Theft Auto Vice City to a whole new level with additional game play, graphics and audio.

Further details will be announced in July.

Conflict Desert Storm is a fall, 2002 release that we previewed at E3.

Gamers will play as part of an elite special forces squad on missions behind enemy lines during the Gulf War.

To add to this realism, the game is being developed under the direction of a special forces SAS veteran.

Conflict Desert Storm will be available for the PlayStation 2, Xbox, GameCube and PC.

Also, we will extend our brand franchise Serious Sam, the action-packed, first-person shooter, for the Xbox platform in the 4th calendar quarter of 2002.

Max Payne 2 is currently in development for calendar 2003.

Since its introduction in July of 2001, Max Payne has been an award winner an top-selling product for the PC, PlayStation 2 and Xbox.

To date, local shipments of the Max Payne franchise are approaching 2.8 million units.

As we mentioned earlier, our decision to acquire the brand and intellectual property rights will yield significant benefits as we further grow the Max Payne franchise.

The purchase of the Max Payne IP is consist with the Take-Two strategy of building an extensive portfolio of propriety brands.

Take-Two will continue to leverage theses brands by the development of sequels, as well as to extend these brands to other platforms and other forms of entertainment.

Additional releases for the Fall/Winter schedule include two new brands, MAFIA, an action driving game with breath-taking graphics, initially for PC,

and Celebrity Death Match, based on the popular MTV show, for PlayStation 2.

Also for PlayStation 2, we will have the much-anticipated Midnight Club 2, the sequel to Midnight Club 1, which was one of the top-selling games at, and since the launch of, PlayStation 2 in October, 2000.

We will be extending the brand franchise, State of Emergency to the Xbox platform with additional features and game play.

Rounding out the PC lineup will be Serious Sam Gold, another extension of this brand, and Stronghold Crusader, the next installment of the successful Stronghold brand.

One additional comment is that the original Stronghold game was number one on the charts for eight weeks in Germany.

Remember, Germany is the biggest PC strategy market in the world.

We will also introduce Duke Nukem for the Game Boy Advance and Spec Ops: Airborne Division, another valuable product for the PlayStation 1.

As you see from the schedule, we're building Take-Two's publishing business on a broad foundation of popular brand franchises.

Our distribution businesses, Jacker of All Games, remains a steady, predictable component of our revenue model.

We are ahead of our stated goal of 60/40 publishing versus distribution.

Our distribution business will be less than 40% of our revenue with the first half of our fiscal year running at 28%.

Management focus in the distribution business remains on the bottom line with a varied customer-base and a healthy mix of software and hardware.

Going forward, Take-Two will continue to generate profitable growth from our core strengths, which include powerful Take-Two owned brands, an exciting pipeline of products, a leading market share, and a strong financial position.

We look forward to sharing the results of these efforts with you.

Now we're ready to respond to any questions.

Due to the large number of participants and in an effort to respond to all of you, we request that each of you limit your questions to one.

Thank you very much.

Ladies and gentlemen, at this time we will be conducting our question and answer session. If you would like to ask a question, please press star 1 on your touch-tone keypad. To remove your question from the queue, you may press star 2.

And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.

Again, to ask a question, press star 1 on your touch-tone keypad and if you're using speaker phone, please pick up your handset before pressing the star keys.

I will pause for a brief moment.

Our first question is from Edward Williams of Gerard Klauer Madison.

Please state your question.

Good afternoon.

Just a couple of quick questions.

Karl, what was the amortization of capitalized software in the quarter?

And if you could just comment on a number of games, there was a long list, but just a total number of games you currently have in development?

The amortization, Ed, we will get that out in the Q, so, I think rather than deal with that at this point, the number of titles, Kelly?

Yeah, as far as the number of titles, Ed, we have in excess of 60 titles under development currently.

Can you comment on how they breakdown?

I think they take roughly the -- I mean we -- roughly the same percent as you've seen of releases so far. We're obviously fairly dominant on the PlayStation 2, but we have a very healthy mix of GameCube, Xbox, Advanced Color Game Boy and obviously PC.

Okay.

Thank you.

Ed, the best news on our product release schedule is the past two quarters we've been able to move titles around.

So, we feel very good about that ability based on the large number of titles that we've been developing.

Okay, great, thank you.

Our next question comes from Shawn Milne of Morgan Keegan.

Please state your question.

This is Bob Dulene with Morgan Keegan.

Is my line open?

Yes, your line is open, Bob.

I don't think Shawn took my place yet, but..

[ laughter ]

Real quick, with respect to the class action lawsuit, at one time there, were five or six lawsuits, were those rolled up into one?

And does this solve all of them or are there more coming?

Yes, with regards to the securities actions, they were effectively rolled into one and this deals with them all.

And secondly, Karl, with respect to FAS-142 and any impairment tests you've done relative to the goodwill balance, has that been completed and do you anticipate any kind of write down on the goodwill?

No, we're comfortable at this point, and yes, it has been completed.

Thank you

Our next question is from Shawn Milne of SoundView Technology.

Please state your question.

Thanks a lot.

Yes, I haven't changed firms yet today!

Just on the outlook for Q3. Can you give us a sense, Karl, what you think the mix will be?

You're running higher on publishing than distribution and maybe just a little bit more, Paul, if you can in terms of the results of Jack of All Games in the 2nd quarter and, you know, profit or loss from that division in the quarter.

Thanks.

Yeah, we've, you know, stated as a goal of doing 60% of better with regard to publishing.

I think we can see, you know, similar types of success as we move forward here in terms of back growing part of our business.

With regard to -- Paul, you want to take on the Jack business?

The business remains strong.

There is a good, growing customer base, we just had the whole management team focused on the bottom line.

Not on top line revenue.

And, you know, that's very important with the mix of product, where hardware versus software.

And they were a contributor to our profitability this quarter.

Okay.

I guess I'm just trying to understand, I mean the top line is much better than expected, but the bottom line was sort of in line I'm trying to understand where the shift was here.

I think overall, you know, the margin performed well.

We expected it to continue to perform well.

We definitely had some added G&A spending for items I addressed during the call.

And, you know, with regard to the ongoing, you know, PricewaterhouseCoopers, we're doing a more extensive review with them quarterly, with the ongoing SEC investigation.

So, we had an added G&A expense that we definitely incurred this quarter.

Okay.

So that's why you're talking about 7 cents for the 3rd quarter, I was a little higher than that.

Maybe other people were higher than that.

You know, without going through the P&L, line by line, I don't think we can take the time this afternoon to do that type of analysis, but clearly that's what we had during the 2nd quarter.

I think if you look at the 3rd and 4th quarters combined it probably adds up to what generally the consensus of the analysts had out there, somewhat higher in the 4rd quarter but lower in the 3rd quarter and vice versa.

Thank you.

Thank you, Shawn.

Our next question is from Mike Wallace of UBS Warburg.

Please state your question.

Hi, publishing is a percentage of business seems like -- I don't know if it an all-time high, but it was very high but the gross margins aren't that much different.

I'm wondering how come the gross margins weren't higher with the high publishing mix?

And is that why earnings for Q3 are going to be below consensus?

Certainly is an all-time high as far as publishing.

We, traditionally at Q3, because it's -- forms, you know, the basis of the summer months and doesn't really have any high-selling times in that, has always been traditionally the company's weakest quarter.

And that's what we're anticipated for the 3rd quarter.

And the gross margins in the quarter weren't that much different from prior periods where the mix of publishing was much lower as a percentage of revenues.

During the quarter we shipped in terms of a total revenue, you know, percentage,

Grand Theft Auto 3 was about 35% of our overall revenue and State of Emergency was approximately 22%.

And, you know, without getting into a product by-product discussion, we don't experience, you know, similar levels of profitability from State of Emergency, which is not owned outright internally.

So, overall we're very pleased with the margin.

It is continuing to perform at our, you know, desired expectation level.

Definitely some of that type of expense coming through the numbers.

Okay.

Had you given previous guidance, I think the street estimate is 12 cents for Q3.

Well, there was no guidance for Q3 or Q4 given.

The last guidance we -- last guidance we gave was for this quarter, that we're announcing today.

Okay.

And is there an update on Duke Nukem, the PC, forever?

I think we've said in previous calls, as soon as we know that we have a confirmed ship date and that basically means pretty much having the gold monster in our hands, we're not going to announce anything, but suffice to say that Duke Nukem isn't in any of the numbers that we've talked about going forward.

Okay.

Thanks.

Our next question is from Arvin Batia of SWS Securities.

Please state your question.

Good afternoon, guys.

Quick question on the 3rd quarter, was there any product that also shifted from the 3rd quarter into the 4th quarter that might have caused some of this shifting between the two quarters. For example, I think the Duke Nukem product on Game Boy, if I recall correctly that, was supposed to be a Q3 product, but can you help us there?

Well, the thing is, to be fair, that, you know, it was your -- the analysts idea of how big Q3 should be rather than the company's idea.

Obviously we gave you -- gave everybody the year and updates on that year, but we never, ever commented.

We, as a company, never expected, if you look at our historical results of Q3 as I said before, is always traditionally a fairly, is our weakest quarter.

So, we never commented on the number that we going to do in the Q3.

And, you know, we continue to move products in and out of quarters, particularly trying to move products into the first month of a quarter to strengthen our cash position, our DSO levels.

So, you're suggesting that there were maybe some products towards the end of the quarter that might have not -- that you no longer want them to be shifting that late in the quarter, is that how we should look at it?

I think what I'm saying is that we try to manage our portfolio of products in line with the goals that we've set ourselves and if we have the ability to move products, then we clearly will move products.

We've moved products from Q1 to -- I'm sorry, from one to two, from two to three and we may well move products from three to four and four to one.

Got it.

And last question, Desert Storm, that product is beginning to reasonable a lot of buzz.

Can you talk a little bit about that, as to what the potential of that product is going to mean.

We've seen numbers like a million unit plus type numbers and what the relationship of the developer there is?

Well, we're very pleased with the amounts of buzz that's happening around Desert Storm.

As Paul said, it was previewed at E3.

I'd like to comment that the million units didn't actually come from Take-Two.

It came from someone in Europe.

We think that it's one of our premiere titles for the quarter.

It's on four platforms and we think it's going to do very well.

It's obviously highly topical at the moment and we're obviously going to put some real focus on this title.

As far as our relationship with the developer, we're already talking about potentially extensions to this franchise, but it's too early to give you any real lead on that.

Are the margins in this product very similar to most of your deals like this?

Yes, it is a third party development, third party license, so, it will be a typical margins that you expect from us or any of our competitors.

Okay, thank you.

Thanks.

Our next question is from Tony Gigas of US Bancorp.

Please state your question.

Hi, guys, a couple of quick questions for you.

Reserves during the quarter grew to about 29% of gross receivables.

Is that a little too conservative, are you overly reserved?

Or are there any concerns from that perspective.

And the second question is how is wholesale pricing holding up on Grand Theft Auto 3?

In the first question, with regard to the reserves, I try to avoid adjectives with regard to reserves.

We think we've been prudent about the level of reserves required to the business activity within the business.

You know, we do know that the percentage is higher, you know, the variability of the business on a cyclical basis is a thing that we can study for each quarter, but 29% in terms of reserve relationship we're comfortable with, we think it's appropriate and, you know we really believe, you know, the mix of the business is a little bit more skewed toward publishing at this time of the year.

So as a result, we'll have a a little higher mix in that reserve for publishing verses distribution, which historically carries much lower reserves.

As far as Grand Theft Auto 3 for the PlayStation, we've seen no erosion of our margins or the wholesale price.

It is selling at the same price as its debut in October of last year.

The product is -- was the number two product last quarter -- I'm sorry, last month, behind [INAUDIBLE], selling, I think 175,000 units, which we were very happy with.

And we have seen, obviously, some sort of increase since the price decreased by Sony, but obviously it's too early to tell whether that will really impact this quarter or not.

Okay.

That's great.

Thanks.

Thank you.

Our next question comes from John Taylor with Acadia.

Please state your question.

Hi.

I had got a couple of questions.

Could you segment your receivables in inventory for us by publishing and distribution?

That's the first question.

John, we typically have not done that and we view the business as really integrated, front end to back end distribution to publishing.

As you know, our distribution arm really handles our publishing servicing as well.

Okay.

Okay, let me try this, then, State of Emergency, you say you did about 22% of revenue.

Is that total revenue or published revenue?

That's total revenue.

Total revenue.

So, how do you feel about channel inventories of that given sell-through and do you have any of that left in the barn?

We're very pleased with how State of Emergency has performed and, you know, in terms of how it sold-through in the trade world, we're delighted with the overall performance of the product.

And we have no inventory to speak of here, so...

Okay.

The -- I guess the other thing is -- is there anything else you can kind of tell us on the gross margin line?

Because, you know, with the strong contribution from GTA 3 and the publishing side, I think you know, some of us are a little perplexed as to when why more of that didn't show up in gross margin.

Is there any other color you can add to that for us?

The GTA 3, for instance, in the 1st quarter, I think was at a 40% or better relationship in terms of 1st quarter, you know, revenues.

So, this quarter is definitely at a lesser level in terms of the overall mix.

State of Emergency does not perform, obviously, at that same level.

So, I don't know how much more color I can really provide there, other than the overall blend came in at our levels that we were happy with from experience.

Okay.

And then I gather some of the revenue outside was absorbed by operating expense.

Can you give us any sense as to how much of the operating expense increase, whether you're looking at, you know, the R&D line, which was up a decent amount, or the G&A line, you know, how much of that is sort of a temporary nature, versus how much of that will be around this time next year?

I think generally with regard to R&D, we expect that to be a lower amount, by material percentage for R&D, okay, which is not a large dollar amount on our income statement, as we move forward because there was additional bonus compensation with regard to success of the product shipped earlier this year and late last year.

With regard to the, you know, G&A area that I addressed earlier, we're experiencing some incremental level of spending there.

It is difficult for us to give a precise level of how much that would come down in the future.

I think it's fair to say we would expect it to come down at some point in time and we've taken that into consideration with regard to the guidance.

If you look at the delta, is there any way you can give us a sense of how much of that is head count-related, is truly, sort of full-time FTE, as opposed to outside consultants and kind of temporary things?

At this point, at the end of the quarter we have approximately 700 employees in business and I think somewhat earlier this year we in the mid-600s, without being overly precise.

So, there's definitely some increase in head count expense that's coming through the numbers.

And I think that can perhaps can be helpful with regard to G&A.

Okay, thank you

Our next question is from Richard Zimmerman of Commerce Capital Mortgage.

Please state your question.

We're offering low rates right now!

Commerce Capital Markets!

No free publicity.

Just a couple of follow-ups I don't want to dig too much into this.

If I look at the gross margins year-over-year and back out the impairment charge last year, your gross margin would have been a little bit more.

I want to make a statement if you can attest to that.

Is it fair to say that the products were a strong piece of your revenue and you had to pay a higher royalty rate, which is included in your cost to do business, and that's why the gross margins were basically down year-over-year, if you take out that internet gain?

Without having studied the internet gain, we clearly do have some products, for instance, Max Payne, had a royalty associated with it which we've obviously made the investment decision to eliminate and properly, we think, control the property going forward.

That, we think, you know, will be beneficial in the future and as I mentioned, State of Emergency, while is not a pure, internally-owned product, also has some margin impact, as well.

Grand Theft Auto, we're obviously delighted with.

It continues to sell-through, although, you know, a somewhat lesser rate in terms of percentage of revenue for this quarter versus last.

I've not taken the time to look at the margin you're referring to with regard to last year, but that's where we stand currently.

And if you look at the SG&A line, the costs around 18, $19 million, you mentioned that, you know, you expect that will be an incremental level.

Is that expected for the remainder of the year that you'll see those kind of levels or do you expect that to start to dip and when do you expect that to happen, if so?

I think it's probably premature to say that starting tomorrow, you know, with expect a multi-million dollar dip, but we clearly do not expect to continue at the spending levels for the foreseeable future.

With the remainder of guidance for the previous year, we expect spending levels will be down.

And one of the criticisms of the company has been R&D and I wonder if you can talk about the head count R&D and where you see that headed?

R&D during the early part of this year we added about 20 additional professionals into that area and that was on a basis of about 200 people.

So, at this point we're 220 folks in total.

We think that's an important area, obviously for us to invest in and, you know, we think that's part of why you're seeing some bump up in R&D expense in the quarter.

And we will continue to invest in that area.

It is a matter of finding the right people.

We have vacancies and opportunities throughout the company.

This is our advert, actually!

So, it will continue to increase as we find the right personnel.

Okay, a last question on the cash position, the strong cash position, you look like you're still showing some, you know, your RCS and working capital tied up in the weaker 3rd quarter.

Where do you expect the year to end up in cash and is there any potential acquisition play along with that?

As far as the cash position, you know, we're very happy at the performance in the first six months.

We expect to have a -- be in a cash position as a group at the end of the year, we're not expected draw down on our lines this year.

And, you know, we're obviously in a situation now that we've got a very strong balance sheet and we have a healthy stock price that we have the ability to look at companies but we haven't got anything that we can divulge there.

Thank you, Kelly.

Thanks

Our next question comes from Gary Cooper of Banc of America Securities.

Please state your question.

Hi, couple of questions on GTA 3.

Karl, I think you mentioned that it's some of the full $40 price.

So, I was wondering if you could give us some idea of what percentage of the 6 million units that you shipped, sold last year's fiscal year versus this year?

Actually I'm -- I haven't got those percentages and what we said is that -- I think was I said, Gary, is that it's still selling at the same price as we were wholesaling it as of the release of the product, which is absolutely correct.

It isn't at a $40 price outside of North America.

The price is within Europe and other territories, wholesale prices are traditionally, significantly lower.

But it is at the same price in all the territories as we were selling in October.

Okay.

Is it fair to assume $40 in North America?

Well, approximately.

Okay.

And then, really what was I getting at is, I mean that's a very significant amount of money, I guess somewhere between 1 and 2 million units were shipped last year, so, you've had a huge bump this year and know you've got Vice coming out later this year.

So, can you talk about how, I guess your expectations for Vice, which some portion of vice will go out at 32 bucks, presumably, will perform against GTA 3 and whether you think in terms of dollar terms, you know, it will be enough to replace the GTA 3 revenue and/or growth on that point.

I'm sorry -- sorry, why would Vice go after $32?

Well, I guess I had made the assumption that obviously not in October, but after the holiday season there's some sort of prevailing belief, I guess, or at least a belief amongst some that most software titles will, or at least I would guess all software titles, will be at the $39.99 price point, which would make the assumption be $32 wholesale.

I understand what you're saying. I think it's fair to say that our sales and our competitors, EA, Activision, et cetera, have said that they're AAA block box of hot releases will remain at $49.99 or the $40 wholesale price for this selling season.

I'm sure that companies with weaker BCD, whatever, however you want to kind of put them, titled, would have to go down to a $30 price.

Certainly something such as the follow-up from Grand Theft Auto 3, we don't see it selling at $32 and we're, at the way that the Grand Theft Auto 3 is still performing at retail, having been the number two selling product last month and potentially the number one or two selling product again this month, we have no reason to believe we're going to reduce the price of Grand Theft Auto 3 at Christmas, either.

Okay.

So--

The reason being is you've got a lot more people coming into the market and new owners, particularly with the new price points, and Grand Theft Auto 3 has almost become a de facto standard piece of software that you would buy when you buy a new piece of hardware, given that you're over 17 years of age.

Okay, so this holiday season you're going to have both the Grand Theft Auto titles out at $49.99 at retail.

Is that correct?

That's entirely possible.

Okay.

And then to get back to what my point was on the earlier question was, just trying to gauge your expectations for Vice and really gauge, I know you haven't talked about next year, if you report somewhere in the neighborhood of $1.70 this year, you have a very significant amount of GTA 3 revenue.

It's been so successful, to replace and then grow from there.

So, can you talk a little about how you plan to grow the business in fiscal '03 over '02.

Yes, I think we have got a significant cash flow of titles in developments, I think I , at Williams' question I think we have something like 60 titles in development and so we're not totally reliant on Vice City to make the numbers and beat the numbers that we put forward this year.

We've taken a very conservative approach on Vice City.

We think the numbers compared to what we shipped on GTA are very, very achievable and hopefully we will have a surprise as we did on Grand Theft Auto 3 and those numbers will be more than we actually forecast originally.

Okay, just two quick ones.

One, you said that State of Emergency qualified for the Greatest Hits program?

Correct.

Does the title still have to be out for nine months before it goes to Greatest Hits or can you just sell 400 grand and put it out?

No, there are two qualifiers. The real qualifier is the number of units it sells at retail.

And then there's a time period.

It's qualified for the number of units, the time period, obviously; just a matter of time and the clock ticking.

Okay.

Thank you.

Thank you.

Our last question comes from Andrew Thomas of Credit Suisse First Boston, please state your question.

Hi, actually it's actually Heath Terry.

Just wondering if you could -- one, just kind of a clarification, the 60 titles under development; that titles or SKUs.

That's SKUs, sorry.

60 SKUs under development.

Correct.

Of the 700 employees, how many of those are on the distribution side of the business versus the -- the publishing side?

Would you say?

Approximately 175 to 200 depending on the time of year.

Okay.

And so then of the remaining say 500 or so that are -- that are in on the publishing side, how many of those are actually -- would you say talent developers?

About 50% of the balance is in development and the other 50% is obviously sales and marketing offices throughout the world and accounts teams, et cetera.

Okay.

And then can you -- can you give us any kind of update on the situation with Ubi Soft in Europe?

Well, as you know, Heath, we don't comment on litigation but we feel very comfortable with the situation, and you know, we will continue to spend our stocks on this.

Okay.

And I guess kind of the last at least question that I've got, you know, you've talked a lot about the differences between the internal products that you've got and the external products that you've got and the variability that has on your margin.

Can you talk about the things that you're doing to build up -- or what your priorities are in terms of building up your internal development and where you think the perfect balance for Take-Two is and the split on internal versus external development?

Yep, I mean we clearly are building up our internal developments as Karl, I think mentioned, we've taken 20 new people, which is pretty much a team of new people, this quarter.

We will continue to acquire or bring on people as we find the talent available.

It is our intention to develop, certainly our own brands of which we have significant ones, such as Max Payne and Grand Theft Auto, Midnight Club, et cetera, as much as we can internally.

If there is opportunities to acquire third party development, we will certainly look at that.

As far as mix is concerned, we would obviously like to have as much as our revenue generated by internal development because that obviously shows a much better profit margin but we will always have external opportunities such as working with people like Remedy and 3D Realms, which are excellent developers.

So, it's never going to be 100%, but something like 50% would be acceptable to us.

Okay.

And I guess just back to that one point of clarification, so, if it's 60 SKUs, how many titles does that work out into?

Actually I haven't got the number here, but I would -- I would guess something in the region of 35 -- something like that.

Okay.

All right, thank you.

Thank you.

In the interest of time, we will end the call at this point.

If anybody has further questions, feel free to call Paul Eibeler, Dawn Berry or me and we look forward speaking with all of you again after Labor Day when we report our 3rd quarter results.

Thank you very much for joining us today and thanks for your continued support.

Ladies and gentlemen, this does conclude your conference call for today.

You may disconnect now.