TTWO

Business Context and Reporting Period

Company: Take-Two Interactive Software, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: January 31, 2003
Business Overview: The Company develops, publishes, and distributes interactive software games for PCs and video game console platforms. Operations are centralized in the United States with global distribution.

Key Financial Metrics

Note: The Company had no outstanding borrowings under its $40 million revolving line of credit as of January 31, 2003.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 44.5% to $408.8 million, driven primarily by a 59.0% increase in publishing revenues. This was largely attributable to the strong performance of Grand Theft Auto: Vice City (PS2), which accounted for 68.4% of total revenues.
• Profitability: Net income rose 44.9% to $50.5 million. Operating income increased 46.2% to $85.1 million.
• Cost Structure: Cost of sales increased 36.1% but decreased as a percentage of sales (59.9% vs. 63.6%) due to a higher mix of high-margin publishing revenue. However, this included a $7.9 million charge for impairment of intangibles related to Duke Nukem Forever and a sequel.
• Operating Expenses: Selling and marketing expenses rose 56.6% due to advertising for new titles. General and administrative expenses increased 65.1%, partly due to a $3.1 million charge for consolidating distribution operations. R&D expenses surged 187.4% following the acquisition of Angel Studios and Barking Dog Studios.
• Cash Flow: Operating cash flow increased to $81.6 million. Investing activities used $31.0 million, primarily for the acquisition of Angel Studios ($27.2 million net cash paid).

Guidance, Outlook, Risks, and Unusual Items

Management Commentary and Outlook

• Seasonality: The Company notes that sales are seasonal, with peak shipments typically occurring in the fourth calendar quarter (holiday season).
• Distribution Consolidation: The Company consolidated its distribution business in January 2003, closing warehouses in Illinois and New York. Management estimates this will reduce distribution net sales by approximately $30 million for fiscal 2003.
• Stock Repurchase: In January 2003, the Board authorized a $25 million stock repurchase program. No shares had been repurchased as of March 11, 2003.

Risks and Contingencies

• SEC Investigation: The SEC has issued a formal order of investigation into certain accounting matters, periodic reporting, and internal accounting controls. Management believes routine litigation will not have a material adverse effect.
• Product Concentration: The top 10 titles accounted for 73.0% of revenues in Q1 2003, with Grand Theft Auto: Vice City alone representing 68.4%. Future results depend heavily on the success of new titles.
• Development Delays: Significant write-downs ($7.9 million) were recorded for Duke Nukem Forever due to continued development delays and market assessment.
• Contingent Liabilities: The Company has obligations to pay up to $8 million for Max Payne 2 and $6 million for Duke Nukem Forever upon meeting specific delivery and sales targets.

Investor Verification Checklist

• Revenue Concentration: Verify the sustainability of revenue streams given that Grand Theft Auto: Vice City drove nearly 70% of Q1 sales.
• Asset Impairments: Review the status and projected release dates for Duke Nukem Forever to assess the risk of further write-downs.
• Regulatory Status: Monitor the progress and potential outcome of the SEC investigation into accounting matters.
• Acquisition Integration: Assess the financial impact and integration progress of the Angel Studios and Barking Dog Studios acquisitions.
• Customer Concentration: Note that three retail customers accounted for 47.2% of accounts receivable, creating credit risk exposure.