Take-Two Interactive Software Inc (TTWO) 2004 Q1 法說會逐字稿

Welcome to the Take-Two Interactive first quarter 2004 earnings conference call.

At this time all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS).

As a reminder this conference is being recorded.

It is now my pleasure to introduce Cindi Buckwalter, Executive Vice President of Take-Two Interactive Software.

Thank you Ms. Buckwalter, you may begin.

Thank you.

Good morning ladies and gentlemen.

Welcome to the conference call for Take-Two's first quarter of fiscal 2004, and thank you for joining us today.

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

If you have not received a copy, please call Euro RSCG Middleburg (ph) at 212-699-2723 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 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, 2003.

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

With me today from Take-Two are Jeff Lapin, our CEO, and Karl Winters, our CFO.

At this time, I am pleased to introduce Jeff Lapin.

Jeff?

Thanks Cindi.

Good morning and thanks for joining us today.

We have quite a bit to cover this morning.

First off, I want to mention that we continue to be in discussions with the SEC; unfortunately we don't have anything else to share with you at this point, but we assure you that as soon as we can report anything substantive we will.

We believe 2004 represents an opportunity for Take-Two, and we are particularly excited about the release of Grand Theft Auto: San Andreas in October.

By design, details surrounding Grand Theft Auto: San Andreas are few; however, it is already generating a huge amount of excitement amongst consumers and we are extremely confident that Rockstar Games will deliver another unparalleled experience.

As you read in this morning's release, first quarter earnings were in line with our revised guidance of 70 cents per share, revenue for the quarter was $375.5 million, which came in slightly lower than we guided on February second as actual results for the second half of January came in below estimates.

We were particularly pleased with performance of the Grand Theft Auto Double Packs in the quarter, with the Xbox version experiencing very solid sell-through.

Based on NPD data through January, the Double Pack for Xbox is the fourth best-selling Xbox title to date.

And we are very pleased with the strong cash flow we generated this quarter.

Cash flow from operations was approximately $85 million, bringing our total cash position to over $254 million as of the end of January.

And Jack of All Games had another strong quarter with revenue of approximately $144 million, a 398 percent increase over the first quarter last year.

Moving on to guidance.

For fiscal 2004, we are reiterating 1.22 billion in net sales and $2.45 in earnings per share.

For the second quarter we are revising our earnings guidance downward to 33 cents, primarily because of the request by Capcom to move the release of Vice City on PS2 and PC in Japan to the first half of our third quarter.

Capcom convinced us that this shift would be beneficial because it would provide additional time to market these titles and maximize sales.

Jack of All Games is expected to cover the topline shortfall, which is allowing us to maintain our revenue guidance.

That being said, for the second quarter we anticipate $220 million in net sales and 33 cents in earnings per share.

We are also issuing initial guidance for our third quarter ending July 31st of net sales between 180 and 200 million and earnings per share of 12 to 17 cents.

I will now hand the call over to Karl Winters to discuss our financial results in more detail and to provide some additional visibility on guidance.

I will follow up with information on our product lineup, highlights from last week's Destination PlayStation event, and provide our industry outlook.

Karl?

Thanks Jeff, and good morning.

Net sales in the first quarter were 375.5 million compared to 411 million a year ago.

Net income for the quarter was 31.8 million, or 70 cents per share, compared to net income of 51.5 million, or $1.22 per share in the first quarter of 2003.

The primary reason for the decrease in revenue in earnings year-over-year was the contribution of Grand Theft Auto: Vice City for PlayStation 2 in the first quarter last year.

The title represented approximately 280 million of our Q1 sales last year, or about 68 percent of that quarter's revenue.

And because Vice City is an internally developed and internally owned title, the contribution to our bottom line was also significant last year.

Our Jack of All Games distribution business performed very well, achieving record sales for the first quarter.

For Q1, our publishing business was 62 percent of total revenue with distribution contributing the remaining 38 percent, compared to 75 percent publishing and 25 percent distribution in the first quarter of 2003.

The product mix in our publishing business continue to be more evenly balanced among our new products in catalog, indicating the further diversification of our product portfolio.

Our top 10 products were approximately 52 percent of total revenue for the quarter compared to 73 percent last year.

The Grand Theft Auto Double Pack for Xbox was about 13 percent of revenue for the quarter.

Max Payne 2 for PlayStation 2 was about 11 percent of revenue while the Xbox title was about 7 percent of revenue.

Manhunt was approximately 9 percent of revenue.

Mafia for PS2, least the last week of the quarter, was about 3 percent of revenue.

We also realized strong sales from our catalog titles which were approximately 20 percent of our publishing business in Q1.

Our platform mix was relatively comparable year-over-year.

In Q1 this year, our platform breakdown was about 94 percent console software, 2 percent PC products, 2 percent handheld, and 2 percent accessories, while last year's first quarter was 98 percent console, 1 percent PC and 1 percent accessories.

Jack of All Games revenue grew significantly in the first quarter.

The revenue increased 39 percent year-over-year and their business has continued to generate healthy gross margins.

We are pleased that our distribution gross margin has remained in the low teens, similar to the levels achieved in the back half of fiscal 2003.

Jack's business has continued to grow due to a variety of reasons -- the increase in the installed base of hardware, the greater breadth of products they carry for all platforms with a specific concentration on attractively priced budget products, and the efficient one-stop service they offer for retailers.

We anticipate continued strong growth for Jack in 2004 and beyond as we enter the later years of the console cycle.

In order to prepare for that growth and to run our distribution operations more efficiently, we have made arrangements to secure a larger distribution facility.

The new facility will be approximately 400,000 square feet, twice the size of our current warehouse, and will be located just a mile from our existing facility, which we will be exiting.

The new facility will include sophisticated automated material handling systems designed to handle our increasing volume and to speed order processing.

We are also investing in a Tier 1 best-of-breed warehouse management system that is intended to increase the accuracy, efficiency and visibility of the operation.

We hope to move into our new facility by late summer.

Our gross profit margin for the quarter was about 34 percent compared to about 40 percent last year.

The primary reason for the decreased margin was that our business mix was more heavily weighted toward distribution compared to last year, when we had a greater percentage of higher margin publishing business.

Moving to the individual components of cost of goods sold.

Our product costs increased in absolute dollars and a percentage of revenue in Q1 because of the significantly higher contribution of the distribution business in the quarter, which carries higher product costs than our publishing business.

In addition, the percentage of publishing revenue coming from our entire Grand Theft Auto franchise was significantly less than the first quarter of this year compared to last year -- approximately 22 percent this year versus 70 percent last year - which also adversely impacted our gross margins in Q1.

And as a reminder, our product costs in Q1 last year included approximately 7.9 million of expenses related to the impairment of several products.

However, this was offset by the amortization of intellectual property in Q1 this year, primarily related to the launch of Max Payne 2.

Royalties decreased on both a dollar basis and as a percentage of publishing revenue due to a variety of factors.

Most significantly, our internal royalty payments were much higher last year compared to this year due to the volume of publishing sales.

In addition, last year we wrote down approximately 6.6 million of prepaid royalties while we had 1.3 million of write-offs this year.

These factors were somewhat offset by increased amortization of prepaid royalty expense related to several of our licensed properties.

Our product mix this holiday season contained a larger percentage of licensed products compared to last year.

Software development costs remained relatively constant as a percentage of publishing revenue.

Our operating expenses decreased but were slightly higher as a percentage of revenue compared to last year.

Sales and marketing expenses increased in dollars and as a percentage of revenue due to the higher level of advertising and promotional support we provided for our new product launches and catalog titles.

We had more product releases this holiday season than last year, when our product release schedule was concentrated among fewer titles.

General and administrative expenses decreased in both dollars and as a percentage of revenue.

This was primarily due to the 3.1 million in charges we incurred last year related to the consolidation of our distribution business.

R&D expenses increased compared to last year due to several factors -- the acquisitions of Angel Studios, Frog City and Cat Daddy last year, as well as an additional general staffing in our development area.

Our headcount in R&D has increased 40 percent from this time last year to about 620 people currently, which is consistent with our strategy to bring more of our development in-house.

Depreciation and amortization expense decreased significantly year over year due primarily to a $4.4 million impairment charge related to the consolidation of our distribution facilities last year.

As we guided on our year end call, our effective tax rate has decreased.

For the quarter, our effective rate was approximately 37 percent.

This reduced rate was achieved as the result of a comprehensive tax study we completed last year and the implementation of a new tax structure for our worldwide operations.

We expect our effective tax rate to remain at approximately 37 percent going forward.

We are pleased to report strong cash flow for the quarter.

Our cash flow from operations was approximately 85 million compared to about 82 million in the first quarter of last year.

At the end of the first quarter, we had about 254 million in cash compared to 183 million in cash last year.

I'd like now to reviews some of the other key balance sheet items.

Net accounts receivable at the end of the first quarter were approximately 145 million compared to 167 million in receivables at the end of last year.

Nearly 65 percent of the receivable balance was for our distribution business.

Our DSOs were 35 days compared to 54 days in the fourth quarter and 25 days in the first quarter of last year.

Our DSO level reflects the timing of our product releases.

Our first quarter releases shipped more evenly throughout the quarter in contrast to the back-end weighting of products we experienced in our fourth quarter.

Our accounts receivable reserve stood at about 83 million at the end of the quarter, representing approximately 36 percent of total receivables.

Our reserves are approximately 13 percent of trailing 6 months revenue and about 10 percent of trailing 9 months revenue, relatively consistent with last quarter's levels.

Inventories at the end of the quarter were approximately 111 million, up from about 102 million at year end.

We had expected inventory levels to trend down by the end of Q1; however, Jack of All Games business has continued to grow at record levels and their margins have remained solid.

As a result, we have allowed our distribution inventory levels to move beyond our initial targets to capture some of the additional opportunities we have seen in the business.

With that said, we will be monitoring inventory levels much more closely over the coming months, and you can expect to see them trend downward through the seasonally slower quarters ahead.

Just to give you a better feel for the (indiscernible) of our inventory, about 62 percent of our inventory relates to our distribution business with about 46 percent of the distribution of inventory consisting of products with cost of goods below $10, and about 85 percent of the distribution of inventory consisting of products with costs below 14.99.

Just to give you an idea of the composition of our distribution inventory by platform, at the end of the first quarter, approximately 34 percent of PlayStation 2 products, 21 percent Game Boy, 16 percent Xbox, 14 percent PlayStation 1, 13 percent GameCube, and 2 percent other products.

This platform breakdown correlates closely to the sales trends we've been seeing in Jack's business.

Turning now to our prepaid royalties and software development costs.

Our short and long-term prepaid royalties and cap software stood at about 40 million at the end of the quarter, roughly a $3 million increased compared to our year end balance, representing over 60 products in development.

The increase from year end was primarily attributable to the acquisition of TDK and the inclusion of their products in our prepaid royalty balances.

We expect to ship approximately 40 of the products in development during the remainder of fiscal 2004.

Our SKU count is trending higher than it has historically due to Global Star's strategy of publishing smaller, value priced titles.

Let me point out a couple of other line items on our balance sheet where there was some meaningful change since year end 2003.

Prepaid expenses and other current assets decreased due primarily to the utilization of prepaid estimated U.S. taxes, as well as the elimination of some prepaid inventory and distribution advances to TDK that were consolidated upon the closing of the TDK acquisition this quarter.

Goodwill increased, also as a result of the TDK acquisition.

Our intangibles balance decreased primarily due to the amortization of a portion of the Max Payne intellectual property.

Accrued expenses and other current liabilities increased due principally to royalties payable to internal and external developers for products that shipped in the first quarter.

Moving on to guidance.

As Jeff discussed earlier, we are reiterating our fiscal 2004 guidance for net sales of 1.22 billion and EPS of $2.45, and are reiterating our second quarter sales guidance of 220 million by reducing our second quarter EPS guidance to 33 cents, primarily to reflect the shift to the Japanese release of Vice City out of Q2 and into Q3.

The shortfall in revenue form the shift to the product was offset by the strength in our distribution business.

We are also providing initial guidance for the third quarter ending July 31st of net sales between 180 and 200 million and EPS of between 12 and 17 cents.

Also, we continue to expect our publishing business to represent about 60 to 65 percent of our revenue on both a quarterly and annual basis, with distribution accounting for the remaining 35 to 40 percent.

Of course there may be some quarters where the business split trends slightly outside this range.

With regard to our consolidated 2004 guidance, the composition of our publishing revenue has changed since we last provided detailed guidance.

This is due to a realignment of our expectations based on recent events and analysis of market demand for our products.

We had previously said that we expected the next installment of Grand Theft Auto and Max Payne 2 on console to each contribute modestly in excess of 10 percent of our publishing revenue for fiscal 2004, meaning 10 percent for Grand Theft Auto;

San Andreas and 10 percent of the aggregate for PlayStation 2 to and Xbox versions of Max Payne 2.

Based on the continued strength of the Grand Theft Auto franchise and our early indications of demand for Grand Theft Auto;

San Andreas, we believe this number is closer to 15 percent of our 2004 publishing revenue.

And with the sell-through to date of Max Payne 2 on console, we believe the full year contribution from these two products will be less than 10 percent of publishing revenue.

For new brands such as Manhunt, Red Dead Revolver and The Warriors, we continue to expect that no new brand will represent more than 8 percent of our publishing revenue for the year across the entire franchise.

At this point, I will turn the call back over to Jeff to cover our product lineup and additional corporate developments.

Jeff?

Thanks Karl.

The second quarter's premier title from Rockstar will be Red Dead Revolver for the PlayStation 2 and Xbox.

Red Dead Revolver was shown to a very receptive retail audience at Destination PlayStation last week.

The game's multilayered storyline and breathtaking graphics authentically recreate the look and feel of the wild west.

Hopefully you have had a chance to see some of the screen shots from the gaming press.

Marketing and PR have already begun, and the full promotion will highlight Red Dead Revolver's fast-paced arcade style game play and cinematic visuals.

The print advertising, television commercials, and national outdoor campaign will support the product in the run-up to the launch and beyond.

The title will be in stores at the end of April.

We also plan to ship the Xbox and PC versions of Manhunt on April 30 in North America, with the title in stores in Europe on April 23rd.

Manhunt on the PS2 has been very well received at retail and its performance is in line with our expectations for a new franchise.

We are pleased to bring this game to these new platforms.

Also in the quarter, Max Payne for the Game Boy Advance will ship to European retailers in late March.

In the third quarter from Rockstar we have The Warriors, based on the cult film by the same name, and Grand Theft Auto for the Game Boy Advance.

In the fourth quarter, Rockstar Games' most anticipated title for 2004, Grand Theft Auto: San Andreas from Rockstar North will debut exclusively on PlayStation 2.

From Gathering, Mafia for the Xbox will be shipping next week in North America and be in stores in Europe a few weeks later.

We are pleased with the initial reception to Mafia for PlayStation 2 and continue to support the product in North America with an ongoing national TV advertising campaign.

On March 29th, Gathering will ship Destruction Derby Arena in North America for PlayStation 2, which features full online capability.

And as we announced last month, Gathering has secured the North American publishing rights for the next installment in the successful Conflict series, Conflict: Vietnam, which is targeted for a multiplatform release this fall.

Gathering continues to work with Destineer on a variety of PC titles and 2-console ports.

We'll have more to say about these titles on our next call.

Global Star's lineup was greeted with strong enthusiasm by retailers at Destination PlayStation last week.

This was the first industry event since the announcement of our strategy to focus Global Star on both console and PC value publishing.

Retail seemed particularly enthusiastic about the compelling value proposition of attractively priced games with strong license or brands names.

Global Star has been aggressively building its portfolio of licensed products.

For instance, we recently acquired the rights to the Army Men franchise, and Global Star will be introducing Army Men: Sarge's War on multiple platforms in the third quarter.

We also acquired the exclusive license to the popular Outlaw Sports franchise from MTV, and our upcoming plans include the holiday release of Outlaw Golf 2, the successor to Outlaw Golf.

The multiplayer title Corvette for PlayStation 2 will hit stores early next week and be available internationally the first week of April.

Serious Sam: Next Encounter will be released for PlayStation 2, GameCube and Game Boy Advance in mid April.

The PlayStation 2 title will include online support, which we think will be a very strong selling point as one of the few PlayStation 2 releases to ship at a value price with online playability.

UFC: Sudden Impact for PlayStation 2 was slated for release in late April.

On the Xbox, the international version of Carve is slated for late March.

Carve, an Xbox exclusive, was released in North America two weeks ago and has been doing well.

Carve is a personal watercraft simulator game that supports Xbox Live for up to 8 players; again, online support being a compelling selling point with a value priced title.

Global Star's PC slate for the second quarter includes Virtual Pool 3, Ultimate Tycoon Pack, Tropico Masters Edition, Haunted Mansion, and The Muppets.

And as we recently announced, we signed a deal with Cartoon Network for the exclusive first-look rights to develop games for new shows aimed at Cartoon Network's key 6 to 11 year-old demographic.

The first title will be based on the cartoon Codename: Kids Next Door.

I want to point out that while we're providing much more information about our product lineup, the product mentions today are not an exclusive list.

There will be some products introduced during the fiscal year that we have not yet announced.

We will give more detail as the year progresses.

In other publishing developments, we recently opened a sales and marketing office in Spain to take advantage of the increasing demand for interactive entertainment in this market.

Spain is one of the fastest-growing markets for hardware and software in Europe.

At Destination PlayStation last week, Sony made a strong case for the PS2 having a ten-year lifecycle, which may be one of the reasons behind the lower-than-expected downward movement of PS2 hardware prices.

We feel our mass-market initiative, the focus of Global Star and Jack of All Games, are well timed as Sony and Microsoft look to expand the life of their current generation hardware.

This was further confirmed as Sony commented on how well the PlayStation 1 continues to sell and how the system has demonstrated its long life, reaching nine years this holiday season.

For the PlayStation 2, Sony said there are currently 220 new titles planned for release in calendar 2004, bringing the total number of available PS2 titles to 851.

They expect to sell in 100 million units of software and between 5 and 7.5 million units of hardware in calendar 2004.

The big news that filtered out of Destination PlayStation last week was the later than expected launch of the PSP.

Although Sony did not announce a specific launch date, they guided that rather than launching the system at this holiday season, it would launch by the end of their fiscal year, which indicates the product is likely to be introduced in the first quarter of 2005.

Take-Two is now seriously exploring developing content for the PSP, and we expect to have software available near or just after launch.

I anticipate a PS2 price cut sometime before the summer, but after what we learned at Destination PlayStation I believe we'll first see a $149 price point and then a $129 price point by the holiday.

We believe that the movement of the PSP launch into 2005 is a pretty clear indication that the PS3 will launch in 2006.

The fundamentals of our business and those of the interactive industry remain strong.

We are quite optimistic about Take-Two's and the industry's prospectus for the remainder of 2004.

We continue to expect U.S. software growth rates of about 10 percent this year.

And while it's a little early to talk about the expectations for industry growth in 2005, we believe the launch of the PSP in 2005 certainly provides an additional catalyst for growth in that year.

Now we will be pleased to take your questions.

I'd like to point out -- excuse me, one point of clarification.

The launch of Manhunt for Xbox in PC is planned for shipment in North America on April 20th.

I think Jeff said April 30th, but it is planned for April 20th.

My mistake.

Operator, now we will open the call to questions, please.

(OPERATOR INSTRUCTIONS).

Heath Terry, Credit Suisse First Boston.

Jeff, can you talk a little bit more how what Sony said at Destination PlayStation fit in with Take-Two's planning for this year?

If I heard you right, the 5 to 7.5 million units of hardware seems to be a bit below what we saw last year, and if that -- particularly if we see actually $129 by the holidays.

If you could just address how that fits in with your planning for the year.

I think -- yes.

We were somewhat disappointed but not surprised by those numbers.

As far as our planning for the year, I think we are planning for a price cut some time in the E3 timeframe.

I'm not sure we've taken into account a full $129 price point at the end of the year, I think we've been a little more conservative than that.

So I think we've taken into account 149 but not the 129 yet.

But it's still my feeling that we're going to get there by the end of the year.

When you take all of that into account, obviously, Sony is going to do what they're going to do.

What do you see happening to the overall demand for hardware this year as it impacts your business?

Again, I was pretty optimistic with what happened with GameCube at Christmas when they came down to 99 and they got the tremendous boost.

And if Sony gets down to that or Xbox gets down to that 129 area, I think there's a lot of elasticity at that point and you're going to see a big boost in demand for hardware and also software.

So does that change make you -- what we saw with GameCube this past fall make you more likely --obviously none of your big front-line games are planned for GameCube.

Is that a change we might see happen?

We never exclude the possibility of porting our games over to other platforms, and that's always a possibility.

Edward Williams, Harris Nesbitt.

First of all, given the performance of some of your key titles in the January quarter like Manhunt and Max Payne 2, what is that you think you would do differently going forward with some of the key releases such as Warriors and Red Dead Revolver, if anything?

I think our marketing and product development team at Rockstar, as we all do in this company -- we're a bunch of very smart people and always are looking at ways to do things better.

I'm not necessarily saying that we didn't do things the right way, but clearly this business is evolving, that everything is bigger, better, more complicated, probably more hit-driven than it's been in the past.

And we are constantly looking at ways on how to improve what we do, what we make, and as a result, to maximize sales.

So it's an ongoing process of doing it better.

What about the economics of Global Star?

Can you give us a little bit of color as to what you're spending on R&D for those games and marketing, and what you're looking for for kind of the average game to generate on revenue?

In general -- and again, this is the generality -- it's in the 3 to $700,000 range for product development, and that may include 1 or 2 SKUs depending on which SKUs and how complicated the games are.

The retail price point will generally be 19.99.

And obviously there's a lower product cost from the manufacturers at that price point, so the gross margin is in line with our other gross margins on our higher end properties.

And we expect those properties to sell in the hundreds of thousands, especially since they will be all distributed and sold through Jack of All Games as opposed to our front-line sales force, using the Jack of All Games distribution power, which they specialize at that price point.

The final question is, looking at R&D headcount.

What are you expecting it to do as the year progresses?

And Karl, maybe you can provide some color as to what you're looking for from the R&D line on your income statement going forward?

It's at about 620 people, we've added modestly to that, although the year-to-year increase is somewhat larger.

That's principally (indiscernible) the acquisition of three studios during fiscal 2003.

So we've maintained as a matter of philosophy that we are always on the lookout for talent that fits within the culture of the company.

We wouldn't be bashful about adding more, but we think we're well staffed at this point to handle what's in our pipeline.

And all I can say is stay tuned and we'll see what the future brings as we continue to focus on things like PSP and some of the Global Star products.

Any color as to what we should be looking for for a run rate?

I think you've seen probably pretty close to the maximum in terms of the run rate for the year.

We have a little bit more weighting in the first quarter for so-called incentive type compensation for people performing with the holiday orientation.

But I will say that we are always and will be looking for talented development studios.

And if we find one, obviously, that will increase that line item.

My comment is purely on the run rate.

Last question with regards to what sort of turnover do you have in your R&D studios at this point?

Very low.

Any percentage terms relative to (multiple speakers)

I don't have a percentage.

I do see employee headcount changes, and I would tell you it's very low.

Stuart Halpern, RBC Capital Markets.

Given everything you've said in terms of guidance for the fiscal year, my math says that that would imply GTA: San Andreas unit volume on the high side of publishing in relation to sales as something less than 3 million units.

Without making a specific prediction, would you say that that math is order of magnitude?

You're in the ballpark.

You're in the ballpark.

On the Q3 guidance, if you could elaborate a little bit -- it seems like the EPS guidance you've given seems to imply quite a low margin, especially if you've got an implied expense of EPS from shifting GTA Japan into that quarter.

Is there anything you can tell us to help us understand why it seems (indiscernible) have such a low margin in that quarter?

I think the margin in the business at that point is weighted fairly heavily.

With fixed spending within our business, the overall operating margin is going to feel the full bore of that since it's our lightest quarter in terms of revenue contribution.

It's a slow time of year.

We don't try to bring a lot of product into the marketplace.

The distribution business does continue to truck along reasonably well with a fairly even performance Q2 to Q3 in terms of revenue contribution, but we are going to feel that effect most strongly in Q3.

So the fact that you did higher EPS last year on lower revenues than your guiding, that doesn't imply that there are going to be some expenses related to that (multiple speakers) facilities change or anything like that?

I think we had a little bit more PC contribution in last year's mix at that point in time, including Vice City if I recall.

Those products are highly profitable, very low manufacturing costs.

And we don't really have that type of orientation in the numbers this time around.

Finally, you've got a few products in Q2 which are scheduled to ship really pretty close to the end of the quarter.

Could you comment on risk that one or more of these things might actually slip?

I think at this point we've given you our best estimates of what we think we can achieve.

Obviously, we would like to take as much time as necessary to bring out the best product.

But given the fact that we have been showing Red Dead Revolver at PlayStation Destination and things like that, we obviously feel pretty strongly that we're in the running to bring it out this quarter.

John Taylor, Arcadia Investment Corporation.

It sounds like you took an accelerated amortization charge for Max Payne.

I'm wondering if you can talk a little bit more about -- specify what that number was, how much is still on the balance sheet, and kind of what your amortization expectation changes are due to the fact that got out of the gate a little slower than expected?

That is the first question.

Second is -- I wonder if you could give us any closer or more specific guidance on your publishing gross margin expectations for Q2 and Q3?

Third question is -- it sounds like you're moving a little closer to PSP than maybe we have heard you talk about before.

Give us an update on whether kits are available, what pieces of kits might be available, and what you're expectation of development costs are.

Then finally, if I may -- last year about this time we were flooded with closeout product.

I wonder if you could characterize the closeout situation post-holiday you're seeing at Jacks this year versus last year.

Thanks.

We will to try to take them in the order you gave them John.

The first comment was with regard to Max Payne and some of the amortization costs.

We do break out the acquisition costs for Max Payne into various categories.

There's, obviously, the overall story and the characters; there are individual games that are expected, and we have amortized a very significant percentage of that overall purchase price (indiscernible) to date.

We clearly do estimate the number of units that we expect to ship on a given product, and we correlate the amortization of the allocated purchase price that we did back over a year ago when we acquired the property to this particular game.

So we take a same dollar amount of cost, and whether it's more or less units it gets divided by the correct estimated number of units to drive to that per-unit amortization.

So I think to your point about product performance, we are very cognizant of how that behaves and we take the appropriate costs.

With regard to the gross margin in Q2 and Q3, I think we've typically lived in the high 30s.

We see that type of percentage overall for those quarters.

Publishing versus distribution -- I think we're on record that the distribution business lives pretty well in the low teens.

We do expect to see that continue for the immediate future, so you can probably back into the publishing number with some amount of precision.

And then with regard to -- I will just comment on the closeout product from Jack, and then Jeff on PlayStation PSP.

With regard to closeout, I think we saw more last year than we saw this year by way of buying opportunity.

Having said that, Jack's business has continued to really accelerate and grow, and we have permitted it to carry a wide assortment.

That appears to be very successful in the sales pitch, of being able to do immediate replenishment, quick turnaround on orders, sometimes within 24 hours depending on our customers.

So we are very comfortable that we are carrying a solid assortment but we haven't quite seen the level of opportunistic buying that we had last year.

Jeff, on PSP?

With PSP, I think this is the first time we have made a fairly aggressive statement that we are seriously looking at it, and in fact, beginning the development process on games.

As far as pricing goes, I'm not sure yet -- somewhere in the, again, 4 to $800,000 range, something like that.

And we expect to be there at or near launch.

So yes, this is the first time that we are making the statement that we are getting into this business.

Are you guys assuming a $40 retail price for PSP, or where are you on the ASP there?

So far we are assuming a $40 price.

Arvind Bhatia, Southwest Securities.

Jeff, I don't mean to put you on the spot, but I've had questions from investors about the amendment to your employment agreement as mentioned in your last 10-K.

Is it possible for you to make any comments on why that amendment was needed?

That's my first question.

Then I have some operational questions as well.

Arvind, I will tell you what I have told others, which is the agreement speaks for itself.

It's pretty self-explanatory.

I'm not going to comment on the facts and circumstances that surrounded it and lead to it.

It's my hope to stay here.

As everybody knows, I moved my family to New York a year ago.

And that's all I'm going to say about it at this point.

Okay.

One question for Karl.

The new guidance -- we are assuming that the new guidance takes into account the new recognition, revenue recognition policy whereby you were taking allowances up-front as opposed to as you communicate.

Is that appropriate?

That's correct, Arvind.

And then on PlayStation 3, Jeff, you mentioned 2006 on Xbox 2.

However, there continues to be chatter about a 2005 launch and rumors about development kits have been sent, etc.

Can you make any comments relating to that and how that affects your strategy for 2004 and 2005.

I know you talked a little bit about your R&D spending, but are you incorporating or are you beginning to prepare for Xbox 2 in particular for a 2005 launch?

I can't give you a lot of color on that, Arvind.

I can tell you that our development people have met several times with Microsoft and have attended various development conferences.

I can't give you any color on release date other than I have heard the chatter also, the same chatter you have.

And obviously, if that's going to come out a little earlier we will be there at launch also.

But that wouldn't surprise you if Xbox 2 launched in 2005, then?

No, it wouldn't surprise me, but I can't confirm it at all.

On Grand Theft Auto and the percentages that you gave for that, and Max Payne and Manhunt, etc. -- just want to make sure, those are percentages of total revenue, correct?

Publishing revenue.

And then on Grand Theft Auto, the 15 percent.

Is that just the new version or that includes everything, all Grand Theft Auto?

That's the new version.

New version only.

Thank you.

Bill Lennan, WR Hambrecht.

First a clarification.

Jeff, the commentary on Destination PlayStation numbers.

The 220 million units that Sony is talking about in 2004 -- is that a worldwide number or a U.S. and European number?

You know what?

I'm going to have to get back to you on that, I really do not know the answer.

Okay.

Second question, you said you think we'll see $149 by summer on PS2, and then perhaps 129 by Christmas.

Wrapping that up with your earlier comments about the 10 year life cycle, I'm not sure I find that consistent.

So we went to 179 last year, and then it will probably be a year before we go to 149.

What is it that makes you think we'll get an additional price cut after 149, if in fact that does happen, in 2004?

I'm giving you my best on what I know today, and I'm not sure 149 is going to move enough units.

I don't know this, but I'm not sure 149 is going to move enough units.

And that's why I'm hoping we get to 120.

If it does, we won't.

Okay.

One more on Microsoft, not so much on the timing of Xbox 2 which has been covered.

Do you think Microsoft's behavior in terms of pricing remains reactive?

In other words, if Sony didn't do anything would Microsoft also not do anything, or do you think they ever take an active first cut price cut role?

They very well may take an active role, and I can come up with all kinds of theories to support that.

If you're hearing a high-pitched whistle in the background, unfortunately there is a test probably underway in our building for the fire alarm system.

So we may have to cut the call a little short.

If you have any remaining thoughts we'll try to finish --

I'm finished.

If you guys want to run out in the street, that's fine.

They just shut it off; timing is everything.

Tony Gikas, Piper Jaffray.

Could you review for us the number of products in development, both on the PC and the console side of the business?

And then the Jack of All Games business seems to be doing pretty well these days.

Could you characterize the market share gains that they are making within that business?

You talked about margins being relatively flat for the remainder of the year.

Is there an opportunity for some margin expansion with that business a little longer term?

Then I have a quick follow-up.

I will take them in reverse order.

The Jack of All Games business, we mentioned, grew 39 percent on a year-over-year basis.

That's obviously a material percentage gain for the business.

We've given some comments in the past that the business clearly benefits, particularly in the value-oriented end of its product lineup, which we think of as products that can sell in the 9.99 to 19.99 band.

We believe that that is in part due to the increased installed hardware base for PlayStation 2 in particular, and the availability of attractive PlayStation product that has wide consumer recognition even if it's a year or two or three year old at this point.

So overall, we think the business will continue to expand at a reasonable rate.

I don't think we'll see a lot of movement in the margin in that business because at this point product availability is fairly good.

I don't think we'll see a lot of added buying opportunity.

And the price points that Jack's work out of are fairly predictable, particularly within the mass merchant marketplace.

And then with regard to products in development?

The number of products in development?

We had said on the call that we had about -- in terms of cap software and prepaid, about 60 products in development of which we expect to ship about 40 this year, in the balance of this year.

I would say that in terms of the relative breakdown between the different platforms, pretty similar to what you see overall in our portfolio in terms of our SKUs, most heavily weighted towards PlayStation 2, followed up by Xbox and PC.

For example, in the 40 SKUs roughly that we said for the balance of this year, about 40 percent for PlayStation 2, about 25 percent for Xbox, 25 percent for PC, and the balance -- 5 percent Game Boy Advance, 5 percent GameCube, just in terms of the SKUs.

So that gives you a rough idea for what (multiple speakers)

A couple of quick follow-ups.

On the PlayStation 3 product (technical difficulty)

We lost you, Tony.

Mr. Gikas, your line is still live.

Did you take yourself of off mute, please?

Operator, maybe we'll take another question.

(OPERATOR INSTRUCTIONS).

Paul Tryon, First Albany Capital.

Just a quick question on Grand Theft Auto.

With the expectation moving higher for Q4, what then does that say for Q1 '05 for your expectations for the overall sales from the group?

I noted that I think Vice City did 90 million in the Q4 and then went on to do 280 in the next quarter like you said.

Would that be -- if that's the right overall number, would it be right to think that if you increase this for Q4 that then that Q1 is probably likely to be lower?

When it comes to looking into the future and the success of this franchise, which has really been unparalleled in the industry, we would like to think the past is an indicator for the future.

But at this point it's a little early to get into the mix of how many pieces of that particular game or any other game for the holiday season that we can look at.

We have given some indication of what we think we can roll out in Q4 to launch the product, but we will just have to see in terms of how the product is perceived and how it comes along.

So the near-term indications of that, obviously, are positive, and you're up 30 -- it would be up 30 percent kind of comping over VC (ph), just on quarter -- just on that Q4, so --

I think the word positive may be modest.

Stewart Halpern, RBC Capital Markets.

Just as the call has been going on I've been getting e-mails from people asking about -- the year, in effect, is even more back weighted to Q4.

In addition to the change in the Grand Theft Auto: San Andreas guidance, is there anything else that's new in Q4 that might give comfort for that quarter being even more significant in terms of the overall contribution to the year?

Stuart, I don't think we have anything else of a material nature we could address.

Obviously, we think the business is performing well.

To reiterate guidance for the overall year of 1.22 billion is a strong performance, and the EPS is $2.45.

We've got a lot of confidence as we roll into the holiday season coming up later this year.

But there's nothing really knew that we could add to the mix at this point, of a material nature.

(indiscernible) just for example, with the push of the GTA: Vice city in Japan into Q3 -- is that going to come at a point in time in Q3 where you might expect some contribution in Q4 as well?

We'll just have to see how that works.

We're pleased with, obviously, the GTA 3 performance.

We have strong beliefs on how we will perform for the launch of Vice.

But at this point we're trying to be somewhat prudent about what our expectations could be for Q3.

At this point we will end the call.

We want to thank everybody for joining us today.

Hopefully we will see some of you next at E3.

Thank you very much.

Ladies and gentlemen, thank you for your participation.

This does conclude today's teleconference.