Take-Two Interactive Software Inc (TTWO) 2003 Q1 法說會逐字稿

Good morning, ladies and gentlemen.

And welcome to the Take-Two Interactive first quarter 2003 earnings conference call.

At this time 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 zero on your telephone keypad.

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms. Cindi Buckwalter, vice president of finance of Take-Two Interactive.

Thank you, Ms. Buckwalter, you may begin.

Thank you.

Good morning, ladies and gentlemen.

Welcome to the conference call for Take-Two Interactive's first quarter of fiscal 2003 and thank you for joining us today.

You should have a copy of our press release which was distributed earlier this morning.

If you haven't received a copy, please call Wolf Axelrod (ph) at 212-370-4500.

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 annual report on Form 10-K for the fiscal year ended October 31st, 2002.

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 disclosed in our SEC filings.

At this time I'm pleased to introduce Mr. Jeff Lapin.

Jeff?

I'm pleased to welcome you to Take-Two's first quarter 2003 earnings conference call and my first opportunity to address you as CEO of the company.

I'm even more confident than ever about my decision to join this creative and innovative company and to be part of its exciting future.

With me today are Paul Eibeler, our president, Karl Winters, our CFO, and of course, Cindi Buckwalter, our vice president of finance.

Before Karl and Paul discuss the details, financial and operational aspects of the quarter, I'd like to share my perspective on the marketplace and some summary thoughts on the quarter.

During 2002, demand for video games remained strong, growing by approximately 20%.

However, at the latter part of the year, the industry wide supply of games grew at a faster pace than demand.

As a result, there was excess inventory and increased pricing pressures on B and C titles.

A titles like Grand Theft Auto: Vice City continue to sell at full price.

This short-term supply demand imbalance will dissipate over the next several months.

Many of our competitors who recently announced reductions in the quantity of future games to be published and the excess inventories currently moving through the channels.

Assuming pre E3 price cuts from the three hardware manufacturers, we believe the industry will grow by a healthy 15 to 20% in 2003.

Take-Two has been largely insulated from the adverse effects of the current supply demand imbalance due to the phenomenal success of Grand Theft Auto: Vice City and our disciplined approach in publishing a select number of high quality games.

Our publishing inventory is at predictive levels and we have experienced little pricing pressure on our titles.

We again enjoyed strong financial results in the first quarter.

Revenue of 409 million exceeded guidance and surpassed last year's record first quarter results.

Earnings per share of $1.20 exceeded guidance and increased over 30% from last year.

For the ninth consecutive quarter we've been cash flow positive, generating 80 million dollars of operating cash flow in the first quarter.

We ended the quarter with over 160 million dollars in cash and the strongest balance sheet in the company's history.

Our impressive results are driven by the unprecedented success of Grand Theft Auto: Vice City, which accounted for 68% of revenue in the first quarter.

Worldwide sales of Vice City have reached in excess of 8.5 million units, far surpassing Grand Theft Auto III in the same time frame.

The first quarter results do include approximately 7.5 million of charges related to costs associated with the closure of two distribution facilities which were part of the Jack of All Games distribution division and whose operations were consolidated into our primary distribution facility in Cincinnati, Ohio.

In addition, results include 6.6 million of write down and 7.9 million dollars of impairment costs related to specific projects.

While we don't usually discuss the details of specific property charges, I will mention that approximately $5 million of these charges relate to a write down of Duke Nuke 'Em (ph).

While the team is vigorously working on the game, the risks associated with the extended development time caused us to re-evaluate the carrying value of this property.

Karl will give further details on these and other charges.

We have raised fiscal year 2003 guidance to 970 million dollars in net sales and $2.26 in net earnings per share and reiterated second quarter guidance of 190 million in net sales and 34 cents in net earnings per share.

Our three publishing labels continue to focusing on creating great products for their respective marketing segments.

Rock Star accomplished numerous milestones with the Grand Theft Auto franchise and look forward to the highly anticipated launch of Midnight Club 2 this quarter.

Rock Star has over ten new brands in development at its five studios, including Manhunt and The Warriors, which are scheduled to be relieved in the next 12 months.

Gotham Games, our recently launched market label, achieved brand recognition quickly with its timely introduction of Conflict Desert Storm in the fall.

Gotham is now establishing a presence in the children's market with the pending launch of Piglet's Big Game from Disney in conjunction with the movie release in March.

We'll continue to expand Gotham with both original and licensed products.

Moxie and Stronghold Crusader from the PC division gathering have remained solid performance for us.

We'll be launching (inaudible) Pirate Cove extension of our popular stimulation brand.

Our publishing strategy is clear.

To focus primarily on the introduction and successful extension of our proprietary brands and to selectively round out our product portfolio with license properties.

We also look forward to pursuing additional opportunities to extend our brand sizes through avenues of music and wireless games.

We're encouraged by Take-Two's continued progress and future prospects and express our confidence by authorizing the repurchase of 25 million dollars in stock.

Today we have not made any purchases because of the short period of time between that announcement and the information given today.

I'm extremely optimistic about Take-Two's leading position in the industry and the opportunities that lie ahead.

We will continue to expand our U.S. and international publishing businesses by creating new cutting edge brands and when appropriate licensing intellectual property to third parties including family and children's properties.

We will continue to focus on the profitability on our distribution business.

We will deploy our growing capital base through acquisition when we believe shareholder value will be increased.

We will continue to enhance our systems and infrastructure to support the rapid growth of Take-Two.

The opportunities are many and we intend to capitalize them to the best of our ability.

Before I conclude I have two personal comments about our management team.

I want to thank Kelly Sumner (ph), my predecessor, for the great job he is currently doing as president of our gathering division.

Second, Paul Eibeler will be taking a leave of absence starting in April to have hip replacement surgery.

I'm sure many of you have seen Paul limp around recently.

He's done a stellar job and will be missed for several months while he recovers.

Cindi and I will fill in for Paul with analyst and shareholder relations during this time.

Now let me turn the call over to Karl Winters, who will review our financial performance in greater detail, then on to Paul who will discuss our project pipeline distribution business and other development

Thanks, Jeff, and good morning.

We're very pleased with our operating results for the first quarter.

Net sales were 409 million, an increase of 45% compared to 283 million a year ago.

Net income for the quarter was 50 million or $1.20, compared to net income 35 million or 92 cents per share in the first quarter of 2002.

Primary reason for the upside in our revenue and EPS relative to our guidance is from the better than expected performance of our publishing business.

This was led primarily by the strength of Grand Theft Auto Vice City, which launched domestically at the very end of fiscal 2002 and shipped in the first week of Q1.

Vice City contributed approximately 68% of our total revenue for the quarter.

We also experienced solid sell through, through Conflict Desert Storm for X Box, and titles for (inaudible) Max Payne was a solid performer in the quarter.

Platform mix for our publishing business was similar to the first quarter of last year.

We had an excess of 95% console software, one percent from PC products and one percent from accessories and hand-held products.

Our gross profit margin for the quarter was 40% compared to about 36% in the first quarter of last year.

The gross profit margin improvement over last year as a result of two primary factors.

First, our publishing business contributed a greater percentage of revenue this quarter compared to last year.

For the quarter, our publishing business represented 75% of our revenue, with distribution accounting for the remaining 25%, compared to 68% publishing and 32% distribution in the first quarter of last year.

The strength of our publishing business was primarily a result of the very significant contribution of revenue from Vice City and internally developed and owned franchise, which resulted in better margins.

This is partially offset with 6.6 million of expense due to the write down in value of several projects in development and 7.9 million of product costs related to the impairment of several additional products.

Approximately 5.5 million of the impairment is the write down value of Duke Nuke 'Em.

Development continues on Duke Nuke 'Em , however the continued delays in the release have caused us to adopt a more cautious view in the carrying value of this intangible asset.

With regard to write downs we continue to exercise a prudent view in light of past and current industry experience for commercial success of the title.

Additionally, based on the more competitive market conditions in our industry during this past holiday season we believed it was necessary to establish an even higher level of performance standards through our products and development.

We are very comfortable with our pipeline of future titles, but we will continue to apply stringent level of performance expectations as we deploy funds in developing new products.

In terms of the individual components of cost of goods sold, our product costs increased in absolute dollars but decreased as percentage of revenue because of the significantly higher percentage of Grand Theft Auto products shipped in the quarter.

Revenues increased on both a dollar basis and as a percentage of revenue due primarily to the write downs of certain products and development which I mentioned earlier.

The increase in this number reflects a royalty program we have established for our internal development teams as a result of the tremendous success of our products.

Our software development costs are relatively flat and related primarily to the amortization of capitalized software for Vice City.

Our operating expenses increased to support our significantly expanded business.

However, we also incurred some unusual expenses that I'll explain in detail in a moment which further increased our operating expenses.

Selling and marketing expenses came in about where we expected relative to our sales levels reflecting continued advertising and promotional support for our current portfolio of products, as well as some initial marketing for upcoming products, including Midnight Club 2.

Our general and administrative expenses were higher than expected, due primarily to several factors.

First, as detailed in our press release, we consolidated our distribution business by closing our warehouse operations in Ottawa, Illinois and New York.

We moved this business into our main Jack of All Games distribution facility in Cincinnati, Ohio.

This consolidation will produce cost savings in the distribution business, but results in a charge of three million for lease termination costs, disposition of fixed assets and relocation expenses.

We also took a 4.4 million dollar impairment charge to write down the intangible value of the customer list associated with the Illinois operations, with this expense flowing through depreciation and amortization expense.

Of the 7.4 million in total charges for the distribution business consolidations, approximately 5.4 million were non-cash items.

Our G and A expenses also included 2.8 million in bad debt expense related to the bankruptcy of two customers.

And finally, G and A expense for the quarter included discretionary bonus compensation due to the company's strong performance.

As is expected, R&D expenses increased significantly over last year due to the acquisition of Angel Studios in November and Barking Dog in August, as well as additional staffing in our development area.

Now I would like to move to the balance sheet, which I'm pleased to report is the strongest in our company's history.

We continue to operate on a cash flow positive basis, generating approximately 80 million in operating cash flow.

At the end of the quarter we had approximately 164 million dollars in cash, with no borrowings on our lines of credit, as compared to 31 million dollars in cash and no outstanding borrowings at this time last year.

Net accounts receivable at the end of the year were approximately 121 million, compared to 108 million in receivables at the end of the fourth quarter.

Our DSOs were 27 days in the first quarter, compared with 45 days in the fourth quarter, and 39 days in the first quarter of last year.

Our DSOs were low this quarter due to the timing of product shipments, which were heavily front end weighted.

We expect that our DSOs will fluctuate going forward, primarily depending on the timing of our product release schedule.

Our accounts receivable reserve currently stands at about 46 million, representing approximately 27% of total receivables.

Our reserves in both dollar and percentage basis increased significantly year-over-year as compared to year-end levels.

This increase reflects additional price protection for our published products to reflect the present retail environment.

Inventories at the end of the quarter were approximately 77 million, up slightly from 74 million at the end of the year.

The significant majority of our inventory relates to our distribution business.

Jack of All Games has historically been very successful in taking advantage of opportunities presented when there's excess supply of product on the market, which we saw this past holiday season.

We expect inventory levels to come down significantly by the end of the second quarter.

Turning now to our prepaid royalties and capitalized software development costs.

Our short and long-term prepaid royalties and capitalized software together stood at about 45 million at the end of the first quarter representing about 70 products in development.

We expect to ship about 40 of the products in development during fiscal 2003.

Four of which (inaudible) this year.

Our capitalized software has remained relatively flat, but our prepaid royalties have declined since year-end.

The decline in prepaid royalties is primarily related to the adjustment of carrying value of products we mentioned earlier.

In addition, approximately seven million of prepaid royalties were recharacterized in connection with acquisition of Angel Studios and is principally recorded as intangibles.

Going forward, we would expect capitalized software and prepaid royalties to increase as newly acquired internal studios continue to work on Rock Star products and as we sign up new license properties and external development teams to work on our Gotham Games and gathering titles.

Overall, intangibles increased due to the adjustment of carrying value of Duke Nuke 'Em and lists related to our consolidation that I discussed earlier.

Moving on to guidance.

Our guidance in fiscal 2003 has been increased to 970 million in net revenue from $2.26 in earnings per share.

We are reiterating our guidance for the second quarter and April 30th of 190 million in net revenue and 34 cents in earnings per share.

In summary, we are pleased with our operating results for the first quarter of fiscal 2003 and our current financial position.

Our revenue increased 45% and we realize a 25 million dollar increase in operating income year-over-year.

Our operating margin of 28.4% for the first quarter is a record achievement for us.

We generated an operating cash flow of approximately 80 million in the quarter.

We have over 160 million in cash and no debt.

And we are projecting top line growth of 22% and bottom line growth of 25% for fiscal 2003.

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

Paul?

Thanks, Karl.

Today I'll recap Q1, review the product highlights for Q2 and give a quick overview of the balance of fiscal 2003 and the drivers for fiscal '04.

Our Q1 was driven by the unprecedented strength of internally developed wholly owned Grand Theft Auto franchise from our Rock Star label.

Our domestic business was highlighted by the reorders for Grand Theft Auto Vice City which was launched in North America in late fiscal 2002 and held the number one ranking for most of our first quarter in the key holiday selling season.

The international launch of Vice City on November 7th was equally as strong as we captured all international shipments in Q1.

We continue to see strong demand for Vice City as we move into Q2.

The strength of this brand is clearly evident from the fact that Grand Theft Auto 3 continued to sell at the original full retail price of 49.99 for 15 months after its release, including several months following the launch of Vice City.

In February, we created additional excitement by moving Grand Theft Auto 3 to a 29.99 retail price point.

Another driver for our business is our expanding list of PlayStation 2 titles which have qualified for the Sony greatest hits program.

In Q1 we shipped Max Payne as a Sony PlayStation 2 credit hits product.

Enjoyed sales of Midnight Club greatest hits titles.

We also realized revenues from our catalog products under Gotham Games.

Conflict Desert Storm continues to capture the market with its content and both the PlayStation 2 and X-Box titles showed strong sales during Q1.

Also shipping in Q1 was Gotham's extension of the serious (inaudible) brand to X-Box.

For PlayStation 1, Rock Star shipped the compilation pack consisting of Grand Theft Auto including in London.

The PC business in Q1 was comprised of catalogue sales, highlighted by reorders for Gatherings, Mafia and Stronghold Crusader and Grand Theft Auto 3.

Jack of All Games distribution business had a record quarter of over 100 million dollars in revenue and represented 25% of our Q1 business.

Today, Jack of All Games is firmly positioned as the leading full line console distributor focused on value-added services.

In January, we streamlined our distribution operations by closing two satellite warehouses in Ottawa, Washington Illinois and consolidated them into Ohio.

This will result in cost savings.

During Q1 Jack of All Games has been able to take advantage of several key opportunity buys for excess console software as a result of the older supply of product in the channel from the holiday season.

We're confident our inventory represents a very strong mix of attractively priced products that can easily move through the retail channels.

As we move to Q2, we are very excited about the highly anticipated Midnight Club 2 from our Rock Star label.

Midnight Club was an original property that shipped to the launch of PlayStation 2 and achieved worldwide sales of over one million units.

The sequel Midnight Club 2 has already received critical acclaim from the gaming press with its breath taking graphics and revolutionary game play.

Set in three cities, LA, Paris, Tokyo, Midnight Club 2 features include eight player on line multi player racing action combining both cars and motorcycles.

Our Rock Star team will again raise the bar for compelling content and build on the successful Midnight Club franchise.

In the second quarter Rock Star has moved State of Emergency to the Sony PlayStation 2 greatest hits program and Rockstar's Max Payne is our first title to be added to the X-Box platinum hits program.

We will also be bringing State of Emergency to X-Box in Q2 and price this product in line with the PlayStation 2 greatest hits products.

Conflict Desert Storm from Gotham Games will be extended to the Nintendo GameCube in this quarter.

Gotham also recently announced the licensing agreement with Disney for Piglet's Big Game for PlayStation 2 and GameCube.

This game is based on the successful Winnie the Pooh franchise.

The game will ship in early March to support Disney's feature film release Piglet's Big Movie that opens on March 17th.

Our entry into the children's market is an example of our ability to broaden the Take-Two portfolio through licensed properties.

Gotham will also ship several PlayStation 1 titles in Q2 including Patriarch Pinball and Bowling.

We're pricing these at 9.99.

Midnight Club will be extended to X-Box and PC, representing another example of our ability to bring these key brands to other platforms.

For the PC market, Gathering looks forward to the Q2 launch of Viet Cong.

Viet Cong combines jungle warfare in a action shooter.

We're building on this new brand.

Gathering will also build on its successful Tropico (ph) franchise with the sequel Tropico 2: Pirate's Coffee.

Now I'll highlight the fiscal 2003 second half.

First up for the domestic market is The Great Escape from Gotham Games based on the classic World War II action movie.

The game follows the Steve McQueen character in the role of the Allied Forces to escape artist -- The Great Escape will be available on multiple platforms, PlayStation 2, PC and X-Box.

Also from Gotham, the much anticipated Celebrity Death Match based on the popular TV show is now planned for the second half of '03.

This new positioning will allow us to capture additional sales as we approach the key 2003 holiday selling season.

Full Death Match will be available on multiple systems also including PlayStation 1, PS 2, PC X-Box and GameCube.

Gotham's extension of Mafia to PlayStation 2 and X-Box are planned for late fiscal 2003.

We will also ship several additional PlayStation 1 value titles in the second half of fiscal '03, including Motocross Mania 2 and ATV Mania.

Now turning to the PC business.

Rock Star's Grand Theft Auto Vice City will be available on PC in May.

Three additional PC requests are planned for Gathering for the back half of 2003 -- Hidden and Dangerous 2, Railroad Tycoon 3, and Serious Sam 2.

All these franchises have achieved worldwide sales of over 500,000 units.

Rounding out fiscal '03 we're excited about Manhunt.

Manhunt is being developed by our Scotland based studio Rock Star North, who developed our blockbuster Grand Theft Auto franchise.

More updates to come as the momentum builds on this exciting Rock Star title.

As we firm our plans for fiscal 2004, we will continue to build on our catalogue of brands with sequels and extensions, create new brands and selectively license outside properties.

One of next year's most anticipated games is Warriors for PlayStation 2 based on the 1979 cult film.

This is developed by our internally owned Rock Star studio in Toronto.

Warriors will recreate the gang drama of this unique film property.

Also in 2004 is Rockstar's Max Payne 2.

The franchise has sold over three and a half million units achieving over 100 million dollars in retail sales since its launch.

Max Payne is an industry phenomena and a must have product for gamers.

In fiscal '04 we'll also launch the next extension to our Grand Theft Auto franchise to satisfy the enormous demand for this blockbuster brand in the marketplace.

Gotham's sequel to the hit game Conflict Desert Storm has moved to early '04.

Additional '04 we see extensions including Spec Ops, Viet Cong, State of Emergency, Hidden and Dangerous and Serious Sam.

This past week we attended Destination PlayStation in Florida, an event in which Sony invites all the key retailers and publishers to preview the upcoming year.

After several major retail meetings it became evident to us that Take-Two is firmly established as a market leader.

Our catalogue of proven brands and our ability to create new brands separates us from the competition.

Retailers clearly look to us for exciting products and promotions.

As we look forward to 2004, we anticipate over 32 million of next generation hardware systems that will ship to the worldwide market.

This sets the stage for Take-Two as we have solidly positioned to take advantage of this dynamic opportunity.

We will continue to introduce new brands, extend our existing brands and benefit from growing catalogue sales.

Now we can move and respond to your questions.

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

Thank you very much.

First question comes from Stewart Halpern with RBC Capital Markets.

On the Duke write down, I presume that you're still anticipating the release of the product at some point in time.

If so, will the write down that you're taking here mean that it will just enhance the profitability of the title for the period, when it is released?

I think with regard to the write down, our concern there was just with regard to the delays in the product were up for a number of years here now that the product has been underway.

We're looking further into the future based on our most recent assessment.

So I think the risk in our mind is warranted the write down at this point in time.

Stewart, there's been no change in our relationship with 3-D.

They have over 25 people working to finish the game.

We'll continue with our plan 90 days prior to shipping.

We'll go forward with that.

Having said that, obviously the point is we have reduced on our basis in this asset.

When we do ship it at some point in the future it will go at the lower cost as a result.

That was my point.

So on the assumption it does go out.

You won't be writing off the expenses that you've just written down so it will be much more profitable when it's released?

Right.

Thanks.

Your next question comes from Heath Terry with Credit Suisse First Boston.

Please state your question.

Thanks.

On the issue of the other product write down, can you give us an idea of what type of products those were, if there was any kind of product bias there?

Now the distribution business the 25% of revenue you're closing a couple of DCs or consolidating DCs.

Can you talk to us about what the plans are for growth in that business going forward and how important that is as kind of a strategic asset?

With regard to the write down, there's really no particular platform that we're focused on.

I think with regard to these products, we, in particular, have been mindful of the marketplace in the recent past.

And I would note obviously these are not really what we would consider to be the pure internal type products that we work on through the Rock Star division.

So we have just been I think prudent at this point with regard to some of the things we had underway.

Looking into the future, raising the bar somewhat for what we consider to be the commercial success of the product, and just felt more at this point what we learned in the holiday season to take these charges.

Heath, this company is the leader in creating innovative products.

And if we're going to continue to be the leader in creating innovative products we're going to go down some paths that don't work.

So I don't think we need to apologize for the write down.

Frankly, if we keep that position there will be more in the future.

And that balances out to are the great hits that we have on the distribution.

Heath, it was a strategic move after studying the business.

We feel we don't, that we can streamline the operation and still fulfill the majority of our customers' orders in a timely fashion and we don't lose a step by closing down just two satellite shipping points and our Jack of All Games facility in Ohio can definitely handle that business.

Heath, I think we saw the charge, particularly the cash portion of it, which was approximately $2 million, that the potential cost savings certainly were interesting with regard to that number.

One question, as you take these kind of write downs on the product development side, you suggest that we may see more of these down the road, do you get more inclined to go back to your auditors and talk to them about moving to kind of the EA model for product development expenses where you expense all of it or most of it at the time that it's (inaudible) as opposed to capitalizing.

I understand EA has a different policy with regard to a certain portion of our portfolio.

I think GAAP requires us, with the history of the company, to capitalize our projects at the appropriate time.

Having said that, I think we're trying to be very prudent of when that point in time occurs and when we decide to continue to carry on with the project.

There's no point, I'm sure as Jeff and Paul would elaborate, in continuing to pour money into something that we don't feel strongly about.

And the company has been extremely successful in developing an internal portfolio of product and acquiring other product more recently.

We think that's paid off handsomely.

The business has done over a billion three in the last year and a half in two holiday selling seasons.

And the significant drivers of that come from the internally developed products.

One last question.

You touched on this a little bit but just having just come back from destination play station, can you give us a feel for what Sony's position is right now as far as pricing and volume on PlayStation 2 and did anything as far as your outlook for PlayStation and how aggressive (inaudible) going to be changed as a result of the conference?

The overall mood was very positive.

Sony's presentation, they remained extremely bullish in maintaining their leadership position and their ability to keep both PlayStation 2 and PlayStation 1 flowing to the consumer this year.

They didn't talk about any price decrease on hardware, but they were very pleased with January and February sales on hardware.

Retailers in general were extremely optimistic.

That so-called excess supply that we are opportunistically in gaining an advantage on our Jack of All Games, that overhang is really not at -- retail mood was very positive.

Thanks a lot.

Next question comes from Tony Gikas from U.S.

Bancorp Piper Jaffray.

This is Tony Gikas.

Just a follow-up on Heath's question to the Jack of All Games business.

How can we drive margins.

You've been working on that business for a while.

What type of gross and net margin expansion do you think you recognize to date and where do you think you can take that looking forward?

And then just a housekeeping question.

Are you disclosing how many units of Vice City units you've shipped life to date?

The last answer is life to date over five million.

Regards to distribution business.

We don't break it out Tony but we are approaching that business or looking at that business from every aspect.

First it looks, have you to go the customers and look at the mix of products that we're selling the customers.

We're dropping any expenses, moving expenses away, streamlining it from the satellite warehouses to one shipping point.

We've looked at increasing the opportunity buys that we can capture because of the growing customer base that we have.

So we're looking at it from all aspects.

Without disclosing the actual margins then could you maybe just give us a feel for how the margins have expanded?

I know the net margin is pretty thin.

Have we seen a 25 basis point, 50 basis point expansion there?

Tony, we've been particularly successful in the past year.

Part of Paul's focus since I've been here in really keying the business on the gross margin.

I would say a year two ago earlier in the cycle we were doing a lot March hardware sales out of necessity I but out of the customer base in that business.

It's shifted dramatically towards the budget title portion, which is exactly the inventory component that we're carrying a fair amount of but we think very opportunistically and very profitably in the future.

So the margin improvement generally that I think we've seen over the last year is in the range of two to 300 basis points and we're very pleased with that result.

But notwithstanding all that, Tony it's clearly one of my focuses because I think there are several more points of improvement.

I can't tell you when it's going to occur but it's one we'll continue to work on.

Thanks, guys.

Your next question comes from Ed Williams with Gerard Klauer Mattison.

Please state your question.

Paul, you said significant reduction in inventory levels at the end of the second quarter.

Can you quantify that at all relative to a year ago or something along those lines?

We'll come down a material percentage.

I don't think at this point that it's worth getting into exactly how much that is.

But I would note that a large majority of our inventories in the distribution business, it's about 80% of the overall number and we're very comfortable with the price points that we have within that inventory position and the Jack of All Games is an extensive customer base but it deals with regard to the budget mix very successfully.

Can you elaborate more on your comments with regard to the sell through of hardware in 2003, what you're looking for in each console in North America and Europe?

We just feel very good about the hardware market.

We think that -- I don't want to go into a breakdown but we're driving PlayStation 1 sales that helps news our value line.

I think Microsoft financially and they've captured the market they'll continue to expand and grow.

Sony did say at the meeting that they were looking at 10 million plus on the domestic market.

Next question comes from Arvind Bhatia from Southwest Securities.

Congratulations on a good quarter.

As you look at the future years, Jeff and Paul, can you provide some color on what sort of sustainable growth you're expecting particularly in fiscal '04 as you all know with your success of Grand Theft Auto, that will make your comparison somewhat difficult at least the first half of next year.

Would you care to give your initial thoughts of growth on that and are you including Duke Nuke 'Em in any of your future plans or is that still not in any of the plans?

Let me answer the questions in reverse.

Duke is not in any of our future plans at all.

So to the extent it happens, there's up side there.

To answer your first question, clearly it was one of my concerns when I came to the company, what's the pipeline.

And there is a much larger pipeline at this company than we talk about.

I alluded to it in my comments that Rock Star has over ten new brands in development.

Our model is not to advertise or publish or give any pre-advance notice on these brands because we're sensitive to people copying those, frankly, until close to the time where these brands are supposed to come out.

So there are several Rock Star properties for example scheduled for release which we haven't discussed yet.

So I'm confident about the pipeline for next year.

I'm confident in general about the pipeline.

When Jeff just said plans he meant our guidance.

I meant guidance.

I just wanted to clear that up.

You talk about fiscal '03.

I was focusing more on next year when you start against these strong numbers for Vice City and I don't doubt that the portfolio is strong to be able to show positive growth.

I just want to get your sense for what that growth level might be.

Are we talking about in fiscal '04 zero to 5%.

What sort of level do you think you can grow at top line and bottom line?

We have not given that guidance yet.

I don't think it's appropriate to give it until we conduct our forecast at the end of this year.

On the distribution side, you mentioned the 30 million decrease in guidance this year.

How does that spread out over the next few quarters?

Is that evenly spread out on the distribution side?

And what is the mix of publishing and distribution you expect overall for the year.

We'll lose some of the local customers the cash and carry type trade that also fits into our strategy, having a quality customer base and a quality mix of product and a lot of that is that local business is hardware and front line software which isn't as profitable as a full line mix of product.

Arvind, I don't want to sharpen the pencil too finely here but I would suggest that half of that 30 million we would expect not to see in the next two quarters and the remaining half in the fourth quarter which would pretty much weigh out how the distribution business does.

Then the mix for the year, distribution versus publishing?

Obviously 25 in the first quarter here.

That's about as strong as you'll see publishing for the year.

We wouldn't expect it return to historical levels of 60/40. 70/30 is not an unreasonable place to be.

Just a final question.

The timing of Manhunt.

Is that still going to be this year or are you is that next year's product?

Manhunt is currently scheduled for the fourth quarter of fiscal year.

Thanks.

Your next question comes from Mike Wallace with UBS Warburg.

Please state your question.

Thanks.

Couple questions first.

Vice City you said was 68% in the quarter.

What's your expectation for the year, the contribution?

I think Vice City is a significant driver in Q1.

We expect it to perform well going into the future and we think it will have a significant contribution in the balance of the year.

I mean a third, a half?

I'd love to try to ballpark that for you.

Obviously we have a pipeline of other products that are expected throughout the balance of the year.

And we'll look at Vice City the extent it comes out.

Potentially additive but we have good expectations for its performance based on everything that we've seen right through today.

Was GTA 3 a significant part of the January quarter?

GTA 3 contributed a modest percentage.

It was a good performer in light of the roll out of Vice City, we felt very strong about what it did.

It contributed approximately 2% to the business in terms of top line.

As far as the pipeline goes it sounds like Manhunt's Q4, Warriors and Max Payne early fiscal '04 then the next GTA late '04.

Do you have similar arrangements with man hunt that you have with GTA where it's Sony exclusive and even though you won't admit it you get a royalty break and a lot of advertising and that sort of thing.

Is Manhunt PS 2 only and what about Warriors and Max Payne, what are the platforms there?

I just want to address one thing you said.

You said that you made the assumption that Vice City was the end of the year.

We haven't announced that yet.

So I think the rest of your assumptions are correct.

That Max Payne and Warriors will be in the first half of the year.

We have not announced any further exclusivity deals with Sony on any other products thus far.

That's not to say that we didn't think it was in the best interests in the shareholders.

We wouldn't do it.

But we have not announced, made any arrangements thus far.

But the Manhunt for Q4, you said it's PS 2 only so far?

So far, yes.

And Mike I don't want to throw any cold water but I think you may be getting a little ahead of us in '04.

Our pipeline is fluid.

You see us moving products around from time to time.

But I think generally, on the comments, you're on the right track.

Thank you.

Your next question comes from Bob DeLean from Morgan Keegan.

Please state your question.

Just a quick comment.

In the press release today 11 original projects coming out of Rock Star now, how many of those have already been announced?

Three or four.

I can't remember the exact amount.

It's somewhere in that neighborhood.

So six or seven not announced.

What are the three or four?

Clearly the next Grand Theft Auto, Manhunt and The Warriors.

When you say the next Grand Theft Auto, because again it says original projects, I guess you're saying a sequel counts as an original project.

On that one I guess we included that.

I think that's all I have.

Everything else has been answered.

Thanks.

Your next question comes from Richard Zimmerman of Commerce Capital Markets.

Please state your question.

Congratulations on a nice quarter.

Can you talk about the uses of your cash related to, for example, stock buy back, what you've done, what you plan on doing, licensing, the opportunities there, and any other opportunities you see with that?

And also can you give us a projection given what you expect to do in earnings what you think your cash position would be at the end of the year?

Let me start with your first question and the last question, we're not going to project out our cash at this point.

We constantly are looking at how we should deploy our cash.

And that may include anything from further shareholder buy back to acquisitions, to content acquisitions, to keeping it in the bank.

And we look at it every day and we evaluate opportunities as they come.

So stay tuned.

But we look at all those opportunities every day and discuss them.

From that comment it sounds like you wouldn't rule out acquisitions?

Of course not.

Then a follow-up.

Can you talk about just overall give us a flavor, any major changes you see in the industry this year that are either surprises or that you see very impactful in how you're going to respond to those?

Richard, coming back from the Destination meeting, where I attended several presentations to the key customers, I would say that the biggest change for us is that we're clearly identified as a winner and that people look to us for our flow of product.

They look to us for the types of products that we create.

And it's just a very gratifying experience.

Thank you, good luck.

Next question comes from John Taylor (ph) with Arcadia Investment Corp.

Two questions.

One is real easy, I think.

Could you give us what the delta in legal and professional expense might have been so we can get a sense of kind of what the quarterly load has been to deal with all the, whatever stuff you've got going on with the SEC, et cetera, just that line item.

And a bigger question maybe for Paul, I guess: On the closeout front, you're kind of in an unusual position of being able to see kind of what's going on with supply and demand.

I think you mentioned that retail inventories feel pretty good but there might be some overhang in the publisher channel or on the publisher side.

Can you give us a sense of how quickly that seems to be getting absorbed, all this excess supply that came out last fall, and maybe when it might be cleaned up and what the implications for average selling price at retail are?

Thank you.

In answer to your first question with regard to professional fees, yes, last year we did have a significant amount of professional fees.

I would say the variance is in the range of several million dollars.

While I didn't put it in dollars in terms of what I mentioned earlier, we certainly had some bonuses in the first quarter of this year that were I'd say in direct correlation to the record performance of the business this recent past.

So those are probably offset in terms of fiscal variance.

JT, in terms of inventory, I think that if we are seeing a number of deals out there or excess buys that started in December, the quantities are manageable and represents a great opportunity for us to increase our margin in the distribution side because we make more money with the closeout opportunities.

Jack of All Games fulfills a great position in the industry, because they can orderly flow this product through.

What the management team of Jack of All Games came off this great quarter and past couple of years have done a great job, what they're real pleased about is that they have programs with a lot of customers out there for this excess product.

And I believe that the talk that there was a giant amount of product, it's not affecting retail and falls right into the Jack of All Games hands right now that they can manage it and move it through along with a couple of other people in the marketplace.

Can you give us a sense of how the closeout is impacting ASP as the mix gets worked in?

This product will be at $20 or less than the marketplace and it seems to be moving very well at that price point.

I don't know the forecast because it's still a very small part of the overall business.

Is there any particular concentration by platform?

I mean is anybody particularly heavy, PS 2, GameCube, whatever.

No it's spread out PlayStation 2, GameCube and Gameboy Advanced, X-Box.

It's spread out.

Thank you.

We'll take one more question.

Your next question comes from Paul Kaump with Dougherty & Company.

Can you comment a little bit on your licensed product strategy going forward, are you going to focus on movies, TV shows, other things?

We're going to focus on anything that we think will make a good game and sell.

And it could be any one of those categories and others that are available.

And we've already -- I've hired a licensing person.

We're already looking at several deals as we've said in those categories and others.

So we'll evaluate everything and try and do good deals which is the key to licensing.

Second question can you just real quick comment on what the G and A run rate should look like either going forward as a percentage of revenue or percentage growth basis or absolute dollar basis?

G&A, we would expect to be somewhere short of the 20 million dollars, 15 million, right in that range.

Thanks.

Congratulations.

Thank you.

Thank you.

That ends our conference call.

We'll all be around this afternoon for calls.

So please direct them to us.

And thank you very much for your support.

This concludes today's conference.

Thank you all for your participation.