Take-Two Interactive Software Inc (TTWO) 2004 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Take-Two Interactive conference call. (OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms. Cindy Buckwalter, Executive Vice President of Take-Two Interactive Software.

Thank you, Ms. Buckwalter.

You may begin.

Good afternoon, ladies and gentlemen.

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

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

If you have not received a copy, please visit our website at www.take2games.com.

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 31, 2003, and on Form 10-Q for the quarter ended April 30, 2004.

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 Richard Roedel, our CEO;

Paul Eibeler, our President; and Karl Winters, our CFO.

At this time I am pleased to introduce Richard Roedel.

Good afternoon and thank you for joining us today.

As you read in today's release we reported revenue of 160.9 million and a loss of 32 cents per share in the third quarter.

The key drivers in the quarter were Rockstar's successful introduction of their new Red Dead Revolver brand and the well-received launch of ESPN NFL 2K5 in late July.

Our Jack of All Games distribution business remains strong, and they continue to maintain solid gross profit margin.

Before going further, I want to express to you how much opportunity we believe Take-Two represents.

Take-Two is an outstanding Company that has experienced unprecedented success over the year.

Success we can and will build on.

Take-Two is about content.

We're focused on expanding the depth and breadth of our product line.

Take-Two is about distribution, and we will continue to grow and leverage our distribution footprint.

Take-Two it is about our employees.

We'll continue to build on the most creative, innovative talent in the industry.

And we have strong teams in operations and finance to support the Company's growth.

And we're about using our market position and our financial strength to create value for shareholders.

Take-Two is participating in a growing market, a market that we believe will present many opportunities for us to further develop our internal brand.

We're in a position to recognize and capture additional opportunities and leverage our experience.

We are updating our expectations for our current fiscal year, anticipating revenue in the range of 1,145,000,000 to 1,160,000,000, and earnings per share in the range of $1.60 to $1.62.

For fiscal 2005 we're providing initial revenue guidance in the range of 1,200,000,000 to 1,300,000,000, and initial earnings per share guidance in the range of $2 to $2.20.

At the midpoint of our guidance for each year this represents top line growth of approximately 8 percent reflecting a strong global product pipeline and significant contributions from our distribution business.

Our expected bottom line growth of over 30 percent is being driven by higher revenue volume and operating margin leverage, partially offset by the investment of additional resources in development, including current and Next Generation console and handheld product.

For the first quarter we're providing initial guidance in the range of 420 to 460 million in net sales and $1 to $1.10 in diluted net income per share.

We're confident that this forecast is based on a solid financial and business plan.

Paul Eibeler, Gary Lewis, Karl Winters and I, along with the entire Take-Two finance team, have worked very hard to set achievable financial and operational goals for fiscal 2005.

The entire management team is firmly committed to accountability at all levels in our organization.

We have refined our process toward detailed reviews of the performance of individual business units, and are developing plans to more closely correlate compensation to the performance of those units.

To help us with this and other improvements to our personnel strategies we recently hired David Messenger in the new position of Senior Vice President of Human Resources.

Before David joined Take-Two he was in charge of the Towers Perrin's change management practice in New York.

He brings extensive experience implementing new HR strategies, including compensation performance management, employee integration during mergers and acquisitions, organizational design and leadership development.

David has a deep understanding of most effective ways to compensate and motivate our employees throughout the Company.

Sam Judd has joined Take-Two in the new role of Senior Vice President of Planning and Administration.

Sam spent the last 11 years at Viacom in various capacities, most recently leading the finance, consumer service, warehouse, manufacturing and supply chain functions for the Simon & Schuster Global Publishing business.

Sam is focused on business planning, strategy development and IP, and is already proven invaluable during the fiscal 2005 budgeting process.

And in July we announced that Barbara Kaczynski, former CFO of the National Football League, joined our Board of Directors, increasing the number of board members to eight.

Barbara chairs the Take-Two audit committee.

These additions further round out and solidify our management team and Board.

Take-Two truly represents a fantastic opportunity.

We are ready in a very solid financial position and are getting only stronger.

With another banner season in front of us, we're fortunate to have the industry's top creative talent and one of the strongest portfolios of proprietary brands.

The global interactive entertainment industry is a growth business.

With Take-Two tremendous depth of resources and synergy between our publishing, development and distribution capabilities we believe the company's positioned to grow organically and also leverage external opportunities as they arise.

During 2005 you should expect us -- to see us actively exploring opportunities to further expand and diversify our product portfolio.

Together with a powerful product pipeline, full distribution capability, a growing market and an opportunistic business approach Take-Two is poised to show growth next year.

We're very excited about our prospect for the remainder of this year and throughout 2005.

I would like turn the call over to Karl who will walk you through our third quarter results and guidance in more detail.

Good afternoon.

Net sales in the third quarter were 160.9 million compared to 152 million a year ago.

Net loss for the quarter was 14.4 million or 32 cents per share compared to net income of 5.7 million or 13 cents per share in the third quarter of 2003.

Before we analyze our year over year results, let's briefly compare our results for the guidance we issued in early June.

We had expected revenue of 130 to 140 million, and a net loss per share of 28 to 33 cents.

Our actual revenue was higher than guidance primarily due to the release of the ESPN NFL 2K5 during the quarter, which was not included in our prior guidance.

Now that we have signed a binding agreement with Sega to co-publish and exclusively distribute the ESPN titles, our guidance includes the impact of this incremental business.

And while we continue to expect the ESPN business to have minimal bottom line impact on our current fiscal year, we did realize a small bottom line contribution from the NFL title in Q3 as a result of the sales volume we achieved.

It is also important to note that we realized a recent reduction in EPS in Q3 as a result of our change in our income tax provision relating to tax reserve requirements.

Turning now to our Q3 year-over-year results.

The primary reason for the increase in revenue from last year is the release of ESPN NFL 2K5.

And with the inclusion of the NFL title in our third quarter results, our publishing business was a greater percentage of total revenue than where we had guided due to the inclusion of the ESPN publishing business in the quarter.

For Q3 our publishing distribution split was 61 percent, 39 percent, which is comparable last year's third quarter numbers of 59 percent versus 41 percent.

Leading our publishing businesses this quarter was Rockstar's new title, Red Dead Revolver, which represented approximately 22 percent of total Q3 revenue.

ESPN NFL 2K5 generated approximately 13 percent of revenue.

And Grand Theft Auto Vice City for PlayStation 2 continued to be a strong performer, generating about 7 percent of revenue in the quarter.

Our platform mix differed considerably from last year's third quarter.

We had significantly more PC business last year due primarily to the release of Grand Theft Auto Vice City for PC, which was our single biggest title in Q3 last year.

This year our platform break down was dominated by console software, which was 90 percent of our publishing business, but only 6 percent of sales from PC products, 2 percent from handheld and 2 percent from accessories.

In contrast, last year's third quarter consisted of 58 percent console products, 41 percent PC products and 1 percent accessories.

Turning now to Jack of All Games.

Year-over-year Jack's business was flat.

But we're pleased that our distribution gross margin has remained in the low teens.

We anticipate modest growth for the Jack in the fourth and first quarters as a result of the strong slate of new software releases coming from Take-Two and other publishers this holiday season.

The work on our new distribution warehouse facility is progressing very well, and we anticipate moving in early next year.

Our gross profit margin for the quarter was about 27 percent compared to about 39 percent last year.

The primary reason for the decreased margin related to the platform mix in our publishing business.

As I mentioned earlier, last year we had a significant percentage of higher margin PC business, primarily related to the release of Grand Theft Auto Vice City for PC, which was about 18 percent of total revenue in that quarter.

Also, our top five products last year were all internally owned, internally developed products which generally carry higher margins than external products.

Additionally, the percentage of revenue coming from our internally owned and developed Grand Theft Auto franchise was approximately 12 percent this year versus 32 percent last year, which also adversely impacted our gross margins in Q3.

Royalties increased on both a dollar basis and as a percentage of publishing revenue due to the higher percentage of licensed external properties this year, most significantly the ESPN title.

However, this is partially offset by the elimination of $3.7 million of third quarter incentive compensation due to the Company's performance this year.

Software development costs increased modestly in dollars and as a percentage of publishing revenue due primarily to capitalized software amortization related to Red Dead Revolver.

Our operating expenses increased in dollars and as a percentage of revenue compared to last year, as did selling and marketing expenses.

The increase in sales and marketing expenses compared with Q3 last year and Q2 this year relates primarily to expanded advertising and promotional support for our products, led by our advertising campaign for the launch of the ESPN NFL 2K5.

General and administrative expenses increased in both dollars and as a percentage of revenue from last year.

Our D&A expenses have increased as we've expanded our financial and operational infrastructure to support our continued growth but were comparable to the levels we incurred in Q1 and Q2 this year.

R&D expenses increased in dollars and as a percentage of revenue compared to last year due to the acquisition this year of TDK, now part of Global Star, and Mobius Entertainment, now Rockstar Leeds.

We have also added additional staffing in our development studios reflecting our strategy of bringing more development in-house.

Our headcount in R&D has increased 25 percent from July last year to about 650 people at the end of Q3.

Depreciation and amortization expenses increased over last year due principally to the continued rollout of our J.D.

Edwards system and the build out of office space earlier this year for Rockstar.

However, depreciation and amortization expenses increased only modestly from Q2.

We reported negative operating cash flow for the quarter of approximately 60 million compared to positive cash flow of about 20 million in the third quarter last year.

This was driven by our third quarter loss as well as our significant investment in developing new products during the quarter, including licensed properties.

This is in line with our strategy that Paul will elaborate on later in the call to further expand the portfolio breadth and depth of our Global Star publishing label.

At the end of the third quarter we had about 198 million in cash compared to 182 million in cash at year end.

With the launch of San Andreas occurring late in Q4, we expect operating cash flow to be negative again in Q4, but we expect to return to positive operating cash flow in Q1.

I would like to briefly review some of the other key balance sheet items.

Net accounts receivable at the end of the third quarter were approximately 79 million compared to 167 million in receivables at year end.

The majority of the receivable balance was for our distribution business.

Our DSOs are 44 days compared to 54 days in the fourth quarter, 36 days in the third quarter last year.

Our accounts receivable reserves stood at about 52 million at the end of the quarter, representing approximately 40 percent of gross receivables.

Our reserves are approximately 17 percent of trailing six-month revenue and about 8 percent of trailing nine-month revenue, relatively consistent with last quarter's levels.

Inventories at the end of the quarter were approximately 97 million, down from about 100 million last quarter and 102 million at year end.

About 65 percent relates to our distribution business, with about 85 percent of the domestic distribution inventory consisting of products with costs below 1499.

Turning now to our prepaid royalties and software development costs.

Our short and long-term prepaid royalties and capitalized software stood at about 70 million at the end of the quarter, roughly a $33 million increase compared to our year-end balance, and a $19 million increase from Q2.

Only two of our key brands individually represent more than 5 percent of this 70 million total across all SKUs.

We currently have about 95 products in development of which approximately 25 are planned for the balance of fiscal 2004 and about 55 for fiscal 2005.

In addition to the 65 capitalized SKUs for fiscal 2005, we expect to ship an additional 10 to 15 products next year, although we had no capitalized balances for these products as of the end of Q3.

The primary reason for the increase in our prepaid royalties this quarter relates to the new licensed properties we have signed, such as the ESPN game, the Warner Bros. properties, and a variety of Global Star titles.

Also, both our prepaid royalties and our cap software balances generally increase at this time of year as we have a very light release schedule during the seasonally quiet summer months and are working on a variety of products to be shipped over the holiday season.

Moving onto guidance.

As Rich mentioned earlier, we are updating our fiscal 2004 guidance.

The increased revenue guidance reflects the addition of the ESPN business for both Q3 and Q4, which was not in our previous guidance.

I would also note that you can expect to see a shift in our business mix in Q4 between publishing and distribution.

Our typical publishing distribution mix has been about 60, 65 percent publishing and 35 to 40 percent distribution on both a quarterly and annual basis.

However, with the launch of Grand Theft Auto San Andreas in Q4 we would expect to see our publishing business move up a bit to about 70 to 75 percent of revenue in that quarter.

In our last call, we said we expected Grand Theft Auto San Andreas to be north of 15 percent of our 2004 publishing revenue.

With consumer and retail demand for the title continuing to build, we have increased our expectations to approximately 25 percent of our 2004 publishing revenue for the title.

And for fiscal 2004, we continue to expect full year tax rate of about 34 percent.

Now I would like to provide a bit more color on our fiscal 2005 guidance.

We expect our publishing business to represent about 60 to 65 percent of our total revenue on both a quarterly and annual basis; the distribution accounting for the remainder.

Within our publishing business we expect about 70 percent of revenue to come from our Rockstar label, and the remaining 30 percent to come from our Global Star label.

Of our total publishing revenue from both labels, about 70 percent will come from sequels and extensions of proven brands as well as catalog products.

And about 30 percent of publishing revenue will come from new brands.

Within our new brand mix we have assumed that three new brands will contribute the majority of this revenue ranging by way of individual contribution from 4 to 10 percent of publishing revenue.

These three new brands are The Warriors, the ESPN titles which we consider one brand, and Charlie and the Chocolate Factory.

We have assumed that 7 of our franchises will have a sequel or an extension.

For instance, this includes Midnight Club 3 DUB Edition, and two other unannounced titles based on significant Rockstar brands.

For the purposes of our model, these three Rockstar titles are projected to contribute in the aggregate about 25 percent of total publishing revenue.

Grand Theft Auto San Andreas, PlayStation 2, PC and distribution in Japan is expected to contribute in excess of 30 percent of our fiscal 2005 publishing revenue.

In total, we would expect about 50 percent of our publishing revenue from sequel releases and extensions.

Our fiscal 2005 guidance assumes minimal contributions from TSP products, but no revenue from next gen console products.

We believe that it in fiscal 2005 our gross profit margins will be relatively comparable to those expected for this year.

This is due to a variety of factors.

Our business mix will include a greater number of licensed externally developed properties, higher royalties and continued narrow gross margins in our ESPN line.

Although these factors will impact our gross margins, we believe our strategy to expand Global Star's product portfolio for sports, licensed and budget properties is a wise strategic move for Take-Two to capture increasing margins market share longer-term.

We expect continued sales growth from our distribution business next year, and have assumed consistent gross margins in this business.

For fiscal 2005 we expect our quarterly operating expenses to range from about 20 percent in high sales volume periods to just over 30 percent during the seasonally slowest months of the year, and average out in the low 20 percent area for the entire year.

Within our operating expenses, G&A expense should show minimal growth due to our cost-cutting focus.

For sales and marketing we expect to support our current portfolio and invest in supporting new launches at levels modestly higher than fiscal 2004.

R&D expense will increase given our recent acquisitions of studios and the continued expansion of our staff.

Lastly, moving onto our tax addition.

We recently said that we had implemented a new tax structure for our worldwide operations that would result in a reduced tax rate going forward.

We believe we can realize further tax efficiencies next year when we expect to have fully implement our new tax structure.

So we're now expecting our corporate tax rate to actually decline even further in fiscal 2005 to approximately 33 percent.

Although we're not currently providing 2005 quarterly guidance beyond the first quarter, we would expect the quarterly breakdown of fiscal 2005 to be roughly comparable to the relative breakdown we experienced back in fiscal 2003.

We look forward to speaking with you again in December when we report our fourth quarter and year-end results.

At this point I will turn the call over to Paul to cover our product lineup and additional corporate development.

I would like to quickly review Q3, update you on Q4 and fiscal '05.

The third quarter featured Red Dead Revolver and the launch of ESPN NFL 2K5.

Red Dead Revolver as an internally developed Rockstar brand and a new genre in the video game industry has performed well beating our expectations.

According to NTD data for May Red Dead Revolver was the number one title on all platforms and continues to be a top ten title on PlayStation 2 and Xbox in both June and July.

With Red Dead Revolver Rockstar Games again delivered an innovative, high-quality product and firmly established a new brand.

During the quarter Rockstar's Grand Theft Auto Vice City also shipped in Japan under a license agreement with Capcom.

This title topped the Japanese charts for the launch.

With sales of over 400,000 units, Vice City is one of the most successful Western titles in the Japanese market.

In late July we launched ESPN NFL 2K5, the first product under our co-publishing agreement with Sega.

This title shipped to both PlayStation 2 and Xbox and featured unsurpassed product quality matched with an aggressive marketing campaign and full distribution at value pricing.

We are very pleased with the inroads we have made in the lucrative sport segment.

And we recognize that the sports business represents a significant annual recurring revenue opportunity for Take-Two.

We plan on continuing to build on this success.

Digital Concepts, the developer of the ESPN product, has consistently delivered the best sports media games in the business, and we commend the entire development team.

ESPN video games has an incredible loyal base of core customers, which we will continue to build on while we expand the ESPN lines to new fans.

The significant part of this strategy for rebuilding brand awareness is to focus on the quality of the ESPN titles.

Quality resonated extremely well with gamers, retailers and the gaining press.

Moving onto the fourth quarter.

We recently shipped ESPN NHL 2K5 for PlayStation 2 and Xbox.

And later in the quarter we will be shipping ESPN NBA 2K5 for both platforms.

Our NHL game has received great early press with many of the editors ranking this game as the best hockey product in the market.

In late October Rockstar will be launching an extension of Grand Theft Auto for the Game Boy Advance, a game specifically designed for the portable market.

In the quarter we will also ship Vietcong: Purple Haze, a narrative based first person shooter for PlayStation 2 and Xbox.

And we will ship Conflict: Vietnam, an extension of our successful Conflict series for PlayStation 2, Xbox and PC.

We will be publishing Robotech: Invasion based on the popular toy line, extending our Outlaw franchise with Outlaw Golf 2 for PlayStation 2 and Xbox.

Shipping the PC sequel, Kohan II: Kings of War, and our first product based for the Cartoon Network licensed, CodeName Kids Next Door for Game Boy Advance.

And we're extremely proud that the fourth quarter features one of the most anticipated titles in the history of interactive software, the launch of Grand Theft Auto San Andreas.

We have moved the ship date of Grand Theft Auto San Andreas by one week to better accommodate testing and production schedules.

We're confident we will deliver the product in North America on October 26 and in the European market on October 29.

Grand Theft Auto San Andreas is set in a fictional state on the West Coast and draws heavily upon the music, fashion and films of the early '90s.

Rockstar North and Rockstar Games have faithfully recreated this time period capturing every conceivable aspect of the style and environments of this era, from the cars, lighting, architecture, hairstyles, clothing, vernacular to the contradictory obsessions with fast food and working out.

Also, as the gamers have come to expect, this product will feature an expensive soundtrack covering everything they might hope to hear as they scan their FM radio dial.

With entire state to explore, an astounding number of player customization options, the signature open ended game play is synonymous with this franchise, combined with a powerful driving narrative, we believe that Grand Theft Auto San Andreas is poised to capture and captivate gamers for years to come.

Anticipation for Grand Theft Auto San Andreas is unprecedented and is continuing to increase as we approach the launch.

News of Grand Theft Auto San Andreas is dominating the specialty magazines every month as well as being heavily featured on all the online gaming sites.

The gaining press is eagerly anticipating the release of the game and are already applauding what they have seen.

I would like to take a moment and recite a few examples of their comments.

Game Informer wrote in August, "it is clear that San Andreas is set to be another major milestone in gaining history".

PSM's August issue, "after seeing Grand Theft Auto San Andreas in action, we now know what love at first sight is like".

To give you an idea of the level of enthusiasm online, IGM.com praised Grand Theft Auto San Andreas by simply stating, "so far beyond what people are anticipating.

It will literally blow people away."

Grand Theft Auto San Andreas will be unlike anything gamers than ever seen before with its unprecedented size, depth and scope.

Now moving to Q1.

Q1 will feature Rockstar's Midnight Club 3 DUB Edition for PlayStation 2 and Xbox in January.

The Midnight Club brand has represented innovative, open-ended driving, open-ended street racing since its launch in 2000.

Midnight Club 3 promises to deliver even more style and depth of game play as the Rockstar San Diego team has expanded on the open-ended city environment incorporating signature elements of Atlantic, San Diego and Detroit.

Rockstar San Diego has managed to truly capture the thrill of street racing.

For the first time in the series, the game will feature over 50 real world licensed vehicles, from Cadillacs to Hummers to Mercedes.

And there's a whole spectrum of car and motorcycle customization to explore with the gamer getting to choose and personalize their vehicle to their individual tastes.

With significant input from DUB Magazine, the source on automotive lifestyles, Rockstar has secured the most respected licensees of vehicles and aftermarket automotive parts.

The players can now create the ride of their dreams.

We have moved the Warriors to April.

Our Rockstar Toronto studio is excited about this cult classic property.

In addition to the Warriors and Midnight Club 3, fiscal 2005 will feature two other front-line Rockstar console products for release in Q3 and Q4.

Under the Rockstar label we will also support the Sony PSC with two products planned for release at or near the launch.

Additional products planned for release by Rockstar in fiscal 2005 include a PC version of Grand Theft Auto San Andreas in Q3, and a console version for the Japanese market.

In the first quarter of fiscal 2005 we will be publishing the Xbox and PC game Close Combat First to Fight, developed with the U.S.

Marine Corps.

Also planned for Q1 is Spy vs.

Spy based on the popular license for PlayStation 2 and Xbox, and Dora the Explorer for Game Boy Advance.

For the first half of 2005 we will be publishing ESPN College Hoops in Q1 and ESPN Major League Baseball in Q2.

In the back half of fiscal 2005 we will start this sport cycle again.

In the second quarter we will be introducing several sequel products to our popular brands.

First Stronghold 2, the sequel to the million plus unit PC franchise.

We're also planning a sequel to the successful Serious Sam brand for both PC and Xbox.

Additionally we will be publishing another extension to the popular irreverent Outlaw series, Outlaw Tennis, for PlayStation 2 and Xbox.

In fiscal 2005 you will see additional licensed titles as we further broaden and diversify our product portfolio.

The first of such high-profile licensed properties was announced last week with Warner Brothers.

Take-Two will publish products based on Charlie and the Chocolate Factory to ship with the feature film directed by Tim Burton, starring Johnny Depp, scheduled for release next summer.

We're also working on additional console versions of games based on Cartoons Network's, CodeName Kids Next Door, and the popular Nickelodeon property, Dora the Explorer.

For fiscal 2005 we're also planning value priced titles based on licenses from GM featuring Hummer, and from Ford the classic Mustang and also Motocross Mania 3.

These licensed titles will be introduced under our Global Star label, which is important to note is publishing beyond value priced products.

The Global Star portfolio products will be expanded to include all of our licensed properties, as well as additional titles formally under the Gathering label.

By focusing more of our resources on the Global Star label, we believe we will have greater impact at both retail and the consumer level.

In an effort to further strengthen and support our distribution capabilities, our new North American distribution facility will become fully operational after the upcoming holiday selling season.

This new facility will increase the efficiency of our product film and operations to better serve our customers.

The Jack of All Games distribution business is positioned to remain opportunistic and capture additional revenue opportunities, especially after the holidays.

This strategy has worked well and our experienced Jack management team is committed to delivering future growth.

Statistically Take-Two is well positioned to leverage its strength as a top tier publisher.

Propelled by the strongest holiday lineup ever, we expect to be in the best financial position in the Company's history as we enter calendar 2005.

And as others have noted, we believe that the post holiday period will present many opportunities.

Take-Two will be actively exploring acquisitions and other product deals that leverage our publishing and distribution capabilities, our size and our depth to continue expanding our diverse product portfolio.

We presented you with an exciting and achievable plan for 2005.

We're quite enthusiastic about the industry's growth potential and very optimistic about our ability to capture market share and maintain our leadership position going forward.

Now we will open up to the Q&A session.

(OPERATOR INSTRUCTIONS).

Heath Terry with Credit Suisse First Boston.

I was wondering if you could give us an idea of what you expect operating cash flow to look like next year as for the full year, given the increase in capitalized software development spending that you are expecting as we go into the next hardware cycle and you start kind of ramping your development spending for next cycle?

And relative to where you are this year, how much of an increase do you think we are going to see in the amount of development spending total?

Not just the -- I am talking about the cash flow side of it, not just what is going to be reported on the income statement, that you'll need to do to get to where you want to be for next cycle?

Let's see if we can break that down a little bit.

On the one hand it is a cash flow statement.

We obviously would expect to build our cash position significantly throughout the year with the lineup that we have in the earnings per share.

And while we do have a late San Andreas -- Grand Theft Auto San Andreas launch this year, we think year-over-year that will balance out.

With regard to have the Cap software and monies that we really spend to develop products, Paul, do you want to add any color in terms of what we see in the trend there?

What we're benefiting from is that we have a lot of sequels in production.

That we have a varied product line with different lengths or different types of products.

Obviously the licensed products aren't as costly on a development side to produce.

And we're seeing some benefit from the control factor we have with our internal studio.

So we feel good going forward with the product line.

And as we approach Next Generation, we feel we're very well positioned to take advantage and to grow our position.

And maybe another way to look at this as well is our R&D expenses as we look into the future we expect to be somewhat stable.

We do talk about adding development talent.

If we do significantly add on an internal basis that obviously would move some.

But we don't see for the immediate future the costs increasing all that much on a game by game basis.

Ed Williams with Harris Nesbitt Gerard.

A couple of questions.

Unfortunately I got cut off in the middle of Karl's comments, so forgive me if I'm asking stuff you already answered, Karl.

But looking at San Andreas can you give us an idea as to what the retail price point will be for the game?

And also looking at your fourth quarter and first quarter what are you looking as far as kind of a distribution revenue as a percentage of the total sales in those two quarters?

And to kind of break it down, how do you expect San Andreas to perform relative to, say, Vice City?

I will address the retail pricing, because that has been somewhat of a topic or a tough issued internally and externally.

Long term we wanted to do what was right for the brand.

And it is all about delivering a compelling game experience.

When we looked at premium pricing, the premium today being 49.99, is what the price will be at the launch.

We are committed to opening ourselves up to higher pricing, but only if we could deliver something that added significant incremental value.

And we have some thoughts about that going forward.

But for the launch it will be 49.95, which we think is the right thing for the brand and the long-term positioning of the brand.

Similar to when Grand Theft Auto 3 was introduced, it exceeded everyone's expectations in terms of the product itself.

And Vice City, the feedback was that that exceeded expectations in terms of product.

So Grand Theft Auto franchise is all about delivering a great game experience.

Your question about the distribution mix versus publishing, in the fourth quarter we said that we expected to be in about a 75 percent publishing, 25 percentage division range.

And for Q1, and really for the balance of fiscal 2005, we expect to see that 65, 35 roughly percent relationship throughout the year.

What about the relative performance of San Andreas to Vice City?

I think at this point drawing comparisons is interesting.

We obviously expect a significant contribution here given some of the percentages and the contribution to the business that we expect in the fourth quarter and for fiscal '05 from Grand Theft Auto San Andreas.

So far the reviews and the feedback from the consumer and marketplace in terms of the magazines and things that we have all seen certainly lead us to think it will be compelling.

And we do know that the market is substantially bigger in terms of hardware that is in the marketplace.

We are out from a marketing standpoint way in front of what was done in the marketing of Vice City.

And the press feedback has been more positive than what was written about the Vice City product.

So with all those indicators, we feel good.

We think the launch will be very, very large, bigger than Vice City.

And we think that the quality of the game and the hours of game play that this game will deliver will probably be similar to Vice City.

A little bit different than Grand Theft Auto 3 that was the number one title, unprecedented for 11, 12 months.

Do you have any sense as to what the pre orders are like relative to where Vice City was?

Significantly higher.

Anthony Gikas with Piper Jaffray.

I want to say terrific job with the starts of the ESPN products.

I will start there.

Quick question.

How many units of the NFL 2K5 have sold through, or have you shipped to date?

And do you think that these sales are cutting into any of your competition unit sales, or do you think you're really expanding the market?

The second question, can you tell us is the exclusive with Sony on GTA exactly the same as it was with the previous version?

And I have a follow-up.

The NFL title, we are not going to go right down to the last dollar on the NFL contribution to the quarter.

We did say there it was the principal reason for us over achieving on our revenue guidance.

And I think it would give you some idea how well we did then within the third quarter.

And obviously the game I think is performing very well and it has been well-received in the consumer marketplace.

In terms of numbers, we don't comment on individual titles, but you saw that the July MTD sales have remained strong.

We do believe that the price point has made the avid football fan buy two games or plan on buying two games.

And we also believe that at this point in the cycle we have opened up, particularly to football market today to the more casual sports gamer that would pick a product upon more of a casual purchase.

And with regard to Grand Theft Auto San Andreas what we said in the past and what we will say again today is that it is exclusive on launch.

And that is about as far as we can take that.

A quick follow-up then.

What will the rating be on the GTA product for the Game Boy Advance that you are playing out?

And then I missed some of the stats you were giving about the quarterly breakdown.

Did you give us enough information to back into how many units of Grand Theft Auto you will be shipping in the month of October?

I think we probably -- we probably laid it out I think fairly boldly.

If there were some things you couldn't hear, perhaps after the call we could make sure that you could hear everything clearly.

With regard to the GameBoy version --?

It has a M rating.

There are a few other (inaudible) advanced titles that have M ratings.

Stewart Halpern with RBC Capital Markets.

First, if I can get a clarification from Karl, I think when you were talking about the cap software developments did you refer to 55 SKUs on which you were capitalizing software development that are to be released in fiscal '05 and then another 10 to 15 for fiscal '05 which are aren't yet being capitalized.

Did I hear that right?

That's right.

The count is somewhat higher than what we have historically had, and we would attribute that principally to Global Star brands that we are building up.

So if that sort of 65 to 70 could you give us some sense of how many of those are front-line versus value?

They range in price points from the Willy Wonka title for instance as a more premium priced product and on down from there.

So there's really no way to generalize it fairly.

It depends upon a game by game basis.

I'm sorry.

I meant in terms of if you take the total of 70, whatever it is.

Underlying the guidance you gave presumably you know some number of those are going to be full price titles, some are going to be less than full price.

Do you have some sense of that breakdown?

I think the comments that we gave on the guidance where we sort of laid out which of the principal drivers behind the new part of our business versus the sequel business would lead you to conclude that we have several Rockstar titles, Grand Theft Auto San Andreas on top of that.

And we've got a couple of new brands and we laid those out as Warriors and the ESPN and Charlie and the Chocolate Factory.

Once you get past those principal drivers behind the numbers they decline from there.

So the guidance doesn't assume any other front-line titles other than those you've alluded to in one fashion or another?

I think in terms of significant distributors to the P&L overall we've laid out the principal drivers.

I can't tell you that there is not another full price product in there, but with a lesser unit type assumption behind it.

Right, okay.

And then on the Grand Theft Auto San Andreas when you make reference to over 30 percent of the fiscal '05 publishing, obviously over 35 percent could be 30.01 all the way up to 99.9 percent.

Is it fair to say that when you say over 30 percent you mean thirty something percent as opposed to 40, 50, 60, 70 percent?

Yes.

For intellectual integrity we are trying to live somewhat close to the number, but we didn't want to the nail it to the last decimal point.

And then just finally, previously you had made -- you talked a lot about how the prospect of having Midnight Club 3 for the holiday season was something that you thought would advantage the product because of foot traffic in the stores for the holiday season.

Can you talk about the decision to move away from that?

We just think this time January is a better spot for the game based on a number of variables.

We wrestled over that decision.

Okay.

Thanks.

In terms of going back to the SKUs count, there are more Game Boy products in the plan.

There are more of the I would say value licensed products under the Global Star name and some of products that Jack is doing.

That is also a function of this time or this timing in the market.

We have a lot of more casual gamers in the Jack business that they control some sections of value priced products.

So without getting specific, there are more low-end type products in the plan.

Mike Wallace with UBS.

I wanted to ask you more about the ESPN stuff.

Football has been hugely successful.

I think it is over 2 billion into retail.

What is the plan long-term?

Could you talk more about -- I know you don't want to get into a specific royalty structure, but is there a threshold in terms of units that you need to reach profitability?

And as we look out a year or two, will you continue to sell sports games for $20 or is the plan to hopefully take price up down the road?

And along those lines, I understand that you have an option to buy this sports franchise, does Visual Concepts come with that, and what is your thinking along those lines?

First, the value pricing was just one part of the strategy and it was a long-term strategy.

We are in this for the long haul.

We think that the sports segment is so inviting and it is the natural place for us to move to given the resources and the strengths of this Company.

And our commitment, I would add, to diversify our product portfolio.

We think this fits very nicely into that longer term strategy.

So the NFL game came out and performed very well.

I look back and focus that it was on product first we delivered -- the Visual Concept people delivered a great game on football.

We just shipped a hockey game.

They're delivering another outstanding product in hockey.

We're working very closely with them.

We have a great partnership with them.

We will bring out basketball also at the value price of 19.99.

We have not made decisions regarding next year's pricing.

For at least this gen we're considering the value pricing, whatever value could be in the market at that time.

In terms of the end, this is a long-term partnership.

We do have the ability at the end of this long-term agreement to take more of a position in terms of the assets.

And we will give you more information as we progress.

Is that the right to buy the brand or does Visual Concepts come with that?

The rights to buy all the assets.

The rights to participate greater in ownership of the assets.

Are the developers part of the assets?

I would think they are the key.

Okay.

Alright.

So what about the profit structure?

Could you talk about that?

Is there a unit threshold to make meaningful dollars?

How exactly should we look at that?

Also, with 19.99 products for this year, meaningful dollars are very difficult because you just don't have a lot of dollars.

And we've taken a lot off the table to drive this product into consumers' hands which we think is the right thing long-term to re-establish the brand.

All I can say on that is that we feel very good about the launch of the two games, both the hockey and the football game.

We are continuing to reinvest back in the advertising.

So this is part of the long-term strategies, so any dollars that could be picked up, we will turn back and put into the marketing of the product, again, part of the long-term strategy.

Do get free air time from ESPN?

We have a partnership with ESPN where -- they are a good partner and obviously there's some relationship in terms of the placement of advertising with them.

And I would add just one other thing, Mike, that the strategy that we laid out a couple of months ago with respect to this part of our business is that we think at this stage working exceptionally well.

And we really could not be more pleased with what we have been able to accomplish in a relatively short period of time.

And we think this is really good for our business and again plays to the commitment that we have made to broaden our product line.

And then just one more for fiscal '05.

It is the Duke Nukem in the plan?

No, it is not in any of the guidance that we've given.

Okay.

And should we just completely forget about this product by now or --?

Absolutely not.

Although it has been frustrating in terms of committing to a ship date.

But the 3-D realm guys continue to work.

They are using the Doom 3 technology, which is finished.

They are a premier developer but they certainly believe in no line before it's time.

So they want to deliver a great game and we are anxiously waiting for updates from them.

John Cara (ph) with Arcadia.

I have got a couple of questions.

Could you give us, without being specific on total, but the percentage mix between PS/2 and Xbox on the football game?

How much has been shipped in and sold through?

And on the Xbox piece in particular are you getting any feedback from Microsoft regarding how many people have shown up to use it on live and so on?

So that is the first question.

Second question, Karl, maybe for you, I think reference was made to consolidating the studios under two labels.

And I'm wondering was there -- are there going to be any G&A costs nonrecurring to sort of get that done?

And was any of that in the July quarter?

And then the third question on the distribution side, I wonder if you could characterize the mix of revenues a little bit?

It seems to me when you reported your second quarter numbers, distribution was down a little bit, partly because of the windfall availability of closeout stuff that was there the previous year.

And I'm wondering what the mix looks like between close out, repub, the other key segments in that line and how you're looking at that going into the holidays?

Thank you.

Working it backwards, the distribution mix, we still continue to see opportunity in the marketplace on value pricing, and that is where Jack is really focused.

And at this point in the cycle it remains very profitable for them, and they are doing a great job in procuring product and putting them in the marketplace.

On the G&A costs for the Global Star there really no incremental costs per se in accomplishing that.

It was more of an internal reorganization than anything that we had to get into actively moving people and things like that.

And lastly, in terms, Paul, of any color in terms of PlayStation 2 or the Xbox versions of the football game?

The initial launch, the Xbox sales were surprisingly stronger based on the installed base, but now it has somewhat leveled off a little bit to a more traditional type of ratio.

And the Xbox, the Microsoft people are very pleased with the online component to it.

I can't give specific numbers but they're just very pleased with it.

Operator, we will continue to take calls.

(OPERATOR INSTRUCTIONS).

Jennifer Jordan.

I believe that the majority of my questions have been answered.

I'm just curious you mentioned that you'd be designing some games for the Sony PSP and I'm wondering if you have any assessment of what you think that -- how you think that market will perform in the next year and how many SKUs do you tend to bring for it?

For planning purposes for '05 we have minimal numbers in there because we're not confirmed yet on terms of the ship date or the quantities.

But in particular our Rockstar guys are very excited about it and think it is just a great opportunity to extend some of their brands and offer some creativity to that system.

We also are excited about the Nintendo Game Boy market with the DS because we have some licenses that really lend itself to that going forward with the Cartoon Network property, Charlie and the Chocolate Factory, as well as the Dora license.

Shawn Milne with Friedman, Billings, Ramsey.

Karl, just a quick question about the guidance next year.

Can you just elaborate a little bit on the operating leverage?

You talked about the 8 percent growth on the top line and 30 percent growth on the bottom line?

Yet I think you were looking for roughly the same split in distribution next year.

And then you've got the incremental sales on ESPN, which really don't have a profit impact.

Can you just walk me through the bigger pickup on the bottom line?

Thanks.

We basically said that we expected our margins -- the gross margins remain relatively consistent through this year.

So that means in order to drive further bottom line contribution it has to come from somewhere else.

I think that comments I gave would lead you to believe that our G&A spending should remain, we think, very controlled.

We have made this a focus and a priority as making sure we invest appropriately for the future and that we not get ahead of ourselves.

We think we can get leverage on the sales and marketing, although it is getting later in the cycle and obviously a noisier marketplace.

But we think we have a couple of titles that help to drive right through that noise in a very significant way.

And as I already indicated, the R&D spending that we expect to see should be somewhat consistent with what we have seen in the past.

You really get down to sort of a spending assessment that, all right, the Company can drive additional volume margin business and see more of it fall to the bottom line.

And that's exactly what happened.

T. J. McNealy (ph) with American Technology.

One question for you on the ESPN clarification.

The original Sega deal for the ESPN relationship was a five-year deal, which is set to expire after next year.

Can you give us a status update on where you are with that part of the deal rather than the (indiscernible) concepts part?

I'm not sure about what the original deal was, but we have a longer-term deal.

And again ESPN we have done everything in very close partnership with them, and they are very pleased with the resurgence or the rebuilding of their games in the marketplace.

Defining longer-term means beyond next year?

Yes.

Arvind Bhatia with Southwest Securities.

My first question is regarding market forecasts for next year.

Do you guys care to provide any color on what you think the software market growth might be next year in your opinion?

And does your guidance for next year assume any new version of Grand Theft Auto?

I will answer your first question.

When we look at our planning process, when we do our planning process it really revolves around some conservative assumptions on the hardware side and in and around our release schedule.

So we think that there is market share to be taken in the marketplace and we have that product line that will do that.

In terms of Grand Theft Auto, it is too early to even talk about that.

We're really focused on San Andreas.

And we have given more color in terms of San Andreas, and then followed by Midnight Club, followed by Warriors and then two other Rockstar titles.

But it would be fair to say that right now there's nothing assumed in the numbers for '05?

I think Paul has reiterated what we have said so far this afternoon, which is we've got the Nightclub and we've got GTA San Andreas and two unannounced Rockstar titles that show up on the extension sequel end of the business, and is as far as we can go today.

Got you.

Was there any change in the number of units for Grand Theft Auto San Andreas for '05 that you might have been contemplating?

I know you didn't put out any guidance for '05, but internally as you were thinking about '05 and since you have upped the number of units based on demand for '04, did you keep the number of units for '05 the same that you were thinking before?

I think we have been working in a fairly consistent band of overall expectations for the products.

It has not been a significant percentage one way or the other.

Obviously, we are reading and looking and seeing -- I think that there are things that Rockstar has done very successfully in putting the brand out in front of the marketplace again and drawing attention to it and driving a lot of consumer interest.

And the preorders that Paul referenced a moment ago are at a very high level.

So all that leads to a very positive future look, but we will have to see.

But overall you're staying within the same range that you had before?

As you indicated, we didn't print such a range, but I think that that is a fair generalization.

Got it.

One last one quickly if I could.

The pricing on your NBA title, ESPN NBA Basketball, and I guess even on the College Hoops and NLB title, what will be the pricing?

Shouldn't it be -- is units to be 20 or is there any difference in pricing there?

No, for this year all the ESPN titles will be at 19.99.

Carolyn Furl (ph) with Merrill Lynch.

I know it is getting late.

I will try and keep this quick.

In terms of the -- after making a couple of management addition where do you think you guys are in terms of the management team that you have right now?

Do you expect to do any more hiring out there or do you think you guys are pretty set?

We're really very happy with the complement of our management team and our Board.

The two people that we have added to the management team, David and Sam, come with skills and experience that we think rounds out a very strong team that was in place.

And by adding Barbara Kaczynski on the Board we do that very same thing at the Board level.

We're really excited to have these three people as part of our team.

Operator, we will take one more question please.

Our final question comes from Bill Lennan of WR Hambrecht.

I wonder on the adjustable market question that Arvind asked, could you give us an update on what your latest thinking is of timing for next gen consoles?

Who comes out when?

And then a fast one.

Your '05 guidance, could you give us a U.S. vs. international mix estimate?

What we feel good about is that both companies are working on next gen systems.

We don't have any exposure in our plan, or our guidance to next gen.

And we don't have the final word yet nor would we be at liberty to say in terms of what is going on with the next gen.

But we feel good that both companies are moving towards that direction.

In terms of --.

(indiscernible) look for the '05 guidance international versus domestic, we typically live in about a 75 percent domestic, 25 percent international relationship on the total business.

It depends on which games we're bringing into the marketplace.

Certain games perform differently overseas than they do in the U.S.

Thank you very much for the call.

And Cindy and I will be around, and Richard and Karl for any additional questions today or tomorrow.

Thank you.

Thank you.