Cost of Sales Years ended October 31, % of % of 2003 Sales 2002 Sales $ Increase % Inc Product costs $537,257 52.0 $411,518 51.8 $125,739 30.6 Royalties 89,294 8.6 80,442 10.1 8,852 11.0 Software development costs 11,003 1.1 8,124 1.0 2,879 35.4 Total cost of sales $637,554 61.7 $500,084 62.9 $137,470 27.5 Royalties. The increase in royalties was primarily due to expense under a royalty program based on product sales for certain of our internal development personnel, partly offset by lower royalties payable to third parties and lower write-downs and amortization of prepaid royalties. Our internal royalty program may continue to be a significant expense in future periods. Cost of Sales. The increase in product costs is primarily attributa- ble to higher costs associated with our expanded distribution opera- tions. These costs were partly offset by lower product pricing from suppliers and lower manufacturing costs (principally attributable to volume purchase discounts and rebates) and lower cost PC titles. Product costs for fiscal 2003 included a charge of $7,892 relating to the impairment of intangibles related to certain products in develop- ment, including  Duke Nukem Forever and its sequel. The impairment was based on continued product development delays and our assessment of current market acceptance and projected cash flows for these products. Product costs for fiscal 2002 included $3,064 of litigation settlement costs relating to a distribution agreement. Software Development Costs. Software development costs increased due to the release of a greater number of internally devel- oped titles during this period resulting in higher amortization in the current period. These software development costs relate to our internally developed titles. In future periods, cost of sales may be adversely affected by man- ufacturing and other costs, price competition and by changes in prod- uct and sales mix and distribution channels.  Selling and marketing.  The increase in selling and marketing expense was attributable to increased levels of advertising and pro- motional support for existing and new titles as well as higher person- nel expenses and is consistent with the growth of our business. General and administrative. The general and administrative expense increase in absolute dollars was principally attributable to costs associated with the consolidation of our distribution operations, as well as increased personnel expenses (including bonuses, severance pay- ments and the issuance of restricted stock), higher rent and bad debt expenses. Higher costs were partly offset by lower professional fees, including the reimbursement of $1,100 of legal fees from insurance proceeds in fiscal 2003 relating to costs recorded in the prior year.  Fiscal 2002 costs reflected litigation settlement costs of $1,190 relating to a distribution arrangement. The fiscal 2003 net consolidation charge of $2,621 consisted of: lease termination costs, representing the fair value of remaining lease payments, net of estimated sublease rent; dis- position of fixed assets, representing the net book value of fixed assets and leasehold improvements; and other exit costs. Bad debt expense Income from Operations. Income from operations increased  by $40,306, or 32.8%, to $163,011 for fiscal 2003 from $122,705 for fiscal 2002, due to the changes referred to above. Depreciation and amortization. Depreciation and amortization expense increase includes $4,407 related to the impairment of a cus- tomer list from a previous acquisition as a result of the consolidation of our distribution operations, higher amortization of intangible assets as a result of acquisitions and higher depreciation related to the implementation of accounting software systems. Research and development. Research and development costs increased primarily due to the acquisitions of development studios, as well as increased personnel costs. Once software development projects reach technological feasibility, which is relatively early in the development process, a substantial portion of our research and development costs are capitalized and subsequently amortized as cost of goods sold. increased as a result of customer bankruptcies not covered by insur- ance during the current year. Years ended October 31, % of % of 2003 Sales 2002 Sales $ Increase % Inc Selling and marketing $103,015 10.0 $ 77,990 9.8 $25,025 32.1 General and administrative 88,083 8.5 71,544 9.0 16,539 23.1 Research and development 25,107 2.4 11,524 1.5 13,583 117.9 Depreciation and amortization 16,923 1.6 10,829 1.4 6,094 56.3 Total operating expenses $233,128 22.6 $171,887 21.6 $61,241 35.6 Operating Expenses 16 TAKE-TWO INTERACTIVE SOFTWARE, INC. AND SUBSIDIARIES Management’s Discussion and Analysis of Financial  Condition and Results of Operations  (continued) (Dollars in thousands, except per share amounts)