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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------
FORM 10-K
|X| Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended October 31, 2001
OR
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
0-29230
(Commission File No.)
TAKE-TWO INTERACTIVE SOFTWARE, INC.
(Exact name of Issuer as specified in its charter)
Delaware 51-0350842
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
575 Broadway, New York, New York 10012
(Address of principal executive offices including zip code)
Issuer's telephone number, including area code: (212) 334-6633
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Check whether the Registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file
such reports) and (2) has been subject to such filing requirements for the past
90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
The aggregate market value of the Registrant's common stock held by
non-affiliates as of January 22, 2002 was approximately $668,160,000. As of
January 22, 2002, there were 36,807,713 shares of the Registrant's common stock
outstanding.
Documents Incorporated by Reference:
Proxy Statement Relating to Annual Meeting
(incorporated into Part III)
================================================================================
PART I
Item 1. Business.
On December 17, 2001, Take-Two Interactive Software, Inc. announced its
intention to restate its financial statements for the fiscal year ended October
31, 2000 and the interim quarters of fiscal 2001. All financial data in this
Report reflects the effects of this restatement for fiscal 2000, each of the
quarters in such year and the interim quarters of fiscal 2001. See Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations for details regarding the restatement, Item 3. Legal Proceedings for
a discussion of a related investigation and Notes 2 and 20 of Notes to
Consolidated Financial Statements.
General
We develop, publish and distribute interactive software games
worldwide. Our software operates on personal computers and video game consoles
manufactured by Sony, Nintendo and Microsoft. We develop software internally and
engage third parties to develop games on our behalf. We publish our products
under our Rockstar Games, Gathering of Developers, Talonsoft and Take-Two
labels. We were ranked number three by NPDFunworld among all video game
publishers in North America for 2001.
Our Rockstar Games subsidiary recently released Grand Theft Auto 3 for
Sony's PlayStation(R)2. According to NPDFunworld, Grand Theft Auto 3 was ranked
the number one selling video game across all platforms in North America for
2001. We also recently released Max Payne for Microsoft's Xbox and Sony's
PlayStation(R)2, and we have a strong line-up of additional PlayStation 2
titles, including State of Emergency and a sequel to the popular Midnight Club.
Our Gathering of Developers subsidiary also expects to bring several PC games to
market, such as the highly anticipated Duke Nukem Forever.
Our Jack of All Games domestic distribution subsidiary sells our
software as well as third-party software, hardware and accessories to retail
outlets in the United States. Our customers in the United States include
Wal-Mart, Gamestop, Best Buy, Circuit City, Electronics Boutique, Toys "R" Us
and Blockbuster, as well as other leading national and regional drug store,
supermarket and discount store chains and specialty retailers.
We also have sales, marketing and publishing operations in the United
Kingdom, France, Germany, Austria, Denmark, Italy, Australia, Canada and Japan.
The Industry
A large and growing installed base of video game consoles and advanced
PCs combined with expanding gameplayer demographics have driven demand for
interactive entertainment software in recent years. The Interactive Digital
Software Association (IDSA) estimates that 60% of all Americans, or
approximately 145 million people, play video games on a regular basis. According
to Euromonitor, worldwide sales of consoles, console games and games for the PC
grew from $17 billion in 1996 to $27 billion in 2000.
Demand for interactive entertainment software is expected to increase
due to the increased penetration of PC and console platforms, the increased
installed base of next-generation platforms and broadening consumer
demographics. The International Data Corporation (IDC) estimates that
approximately 53% of all households in the United States will own a PC by 2002.
According to IDC, the household penetration rate for video game consoles today
is approximately 46%, and is expected to increase.
-2-
Historically, the interactive entertainment software industry has
experienced rapid and sustained periods of growth coinciding with the release of
successive generations of game console platforms. The industry has recently
transitioned to next-generation platforms, which began with the release of
Sony's PlayStation 2 in 2000 and continued with the recent release of Nintendo's
Game Boy Advance, Microsoft's Xbox and Nintendo's GameCube in 2001. Demand
for these new platforms is expected to be significant due to their ability to
offer one or more of the following features:
o More powerful and realistic graphics and game play through
128-bit technology;
o Backwards compatibility (the ability to play the platforms'
previous generation of games); and
o Broad entertainment capabilities, including Internet access and
the ability to watch DVD movies and play compact discs.
Interactive entertainment software has increasingly become a mainstream
entertainment choice for a maturing, technologically sophisticated audience.
According to IDSA, 58% of Americans who play video games are over the age of 18,
of which 43% are female. Additional catalysts for growth include mass market
penetration of budget titles and the emergence of non-traditional retail
channels such as drug stores and supermarkets.
Software Products
We publish titles with potential for broad consumer appeal. We plan to
deliver game content for both PC and console markets, particularly for
next-generation platforms with potential for significant market penetration,
including the following titles:
Title Platform Genre Description
- ----- -------- ----- -----------
State of Emergency PS2 Action Fight for freedom and justice.
Duke Nukem Forever PC, Xbox, GBA First-person shooter The return of video game's ultimate action
hero.
Mafia PC, Xbox Third-person role Chicago. The 1930's. Prohibition. The real
playing American underworld.
Serious Sam: PC, GameCube, First person shooter Sequel to the Gamesport game of the year.
Second Encounter GBA
Austin Powers GBA, PS2 Third-person The international man of mystery is back, baby,
action/adventure/ yeah!
comedy
Age of Wonder 2 PC Strategy Sequel to the popular fantasy/strategy game.
Hidden & Dangerous 2 PC, PS2 Military Tactics and intense action combine in
behind-enemy-lines thriller.
Midnight Club 2 PS2 Urban racing Sequel to the hit urban racing game.
Grand Theft Auto 3 PC Action The global mega hit makes its way to the PC.
Smuggler's Run 2 GameCube Adventure Racing The off-road franchise returns.
MTV's Celebrity PS2 Fighting MTV's smash hit goes interactive.
Deathmatch
Austin Powers Pin Ball PS Arcade Adventure with everyone's favorite psychedelic
superstar.
Spec Ops: PS Action The number one military franchise returns.
Airborne division
Family Feud GameCube Game Show The popular game show comes to GameCube.
-3-
Arrangements with Major Platform Manufacturers
We have entered into license agreements with Sony, Nintendo and
Microsoft to develop and publish software for the PlayStation, PlayStation 2,
Nintendo 64, Color Gameboy, Gameboy Advance, Nintendo GameCube and Xbox in North
America and Europe. We are not required to obtain any licenses to develop titles
for the PC.
We entered into a Licensed Publisher Agreement with Sony Computer
Entertainment America, Inc. in May 2000. Under the agreement, Sony granted us
the right and license to develop, market, publish and distribute software titles
for the PlayStation 2 in North America. The agreement requires us to submit
products to Sony for its approval. The agreement provides for Sony to be the
exclusive manufacturer of our products for the PlayStation 2 and for us to pay
royalties to Sony based on the number of units manufactured.
The agreement with Sony expires in March 2003 and is automatically
renewable for successive one-year terms, unless terminated by Sony in the event
of a breach by us or our bankruptcy or insolvency. Sony may also terminate the
agreement on a title-by-title basis. Upon expiration or termination of all of
our publishing agreements with Sony (including those discussed below), we have
certain rights to sell off existing inventories. We also entered into a similar
three-year agreement with Sony in March 2000 for PlayStation 2 covering European
territories.
We entered into a four-year Licensed Publisher Agreement with Sony in
March 1999 under which Sony granted us the right and license to develop, market,
publish and distribute software titles for the PlayStation in North America. We
also entered into a similar agreement with Sony for Playstation in February 1999
covering European territories.
We entered into a Publisher License Agreement with Microsoft in
December 2000. Under the agreement, Microsoft granted us the right and license
to develop, market, publish and distribute software titles for Microsoft's Xbox
in territories to be determined on a title-by-title basis. The agreement
requires us to submit products to Microsoft for its approval and for us to make
royalty payments to Microsoft based on the number of units manufactured.
Products for the Xbox must be manufactured by pre-approved manufacturers. The
agreement may be terminated by either party in the event of a material breach.
Microsoft may also terminate the agreement on a title-by-title basis. Upon
expiration or termination of the agreement, we have certain rights to sell-off
existing inventories.
We entered into a three-year Confidential License Agreement with
Nintendo in November 2001. Under the agreement, Nintendo granted us the right
and license to develop, market, publish and distribute software for Nintendo's
GameCube in the western hemisphere. The agreement requires us to submit products
to Nintendo for its approval. The agreement also provides for Nintendo to be the
exclusive manufacturer of our products and for us to make royalty payments to
Nintendo based on the number of units manufactured. The agreement may be
terminated by either party in the event of a breach and may be terminated by
Nintendo in the event of our bankruptcy. Upon termination of all of our
agreements with Nintendo (including those discussed below), we have certain
rights to sell off existing inventories. We also entered into a similar
three-year agreement with Nintendo in November 2001 for GameCube covering
European territories.
-4-
We entered into a three-year agreement with Nintendo in July 2001,
granting us the right and license to develop software for Nintendo's GameBoy
Advance in the Western Hemisphere. In October 2001, we entered into a similar
three-year agreement with Nintendo for European territories. In addition, in
March 1999 we entered into an agreement with Nintendo granting us the right and
license to develop software for the Nintendo GameBoy, GameBoy Color and GameBoy
Pocket handheld game systems. In February 1998, we entered into agreements with
Nintendo granting us the right and license to develop software for Nintendo 64
in the United States and Europe.
Software Development and Licensing
We develop software titles through our internal development studios,
Talonsoft, Rockstar Canada, DMA Design Limited, the developer of Grand Theft
Auto 3, and PopTop Software, the developer of Railroad Tycoon 2 and Tropico. We
also maintain a development studio focusing on games for the Nintendo GameBoy
Color platform in the United Kingdom under the name Tarantula, as well as a
recently acquired development studio in Austria under the name Neo. As of
October 31, 2001, our internal development studios and product development
department employed 214 personnel with the technical capabilities to develop and
localize (translate into foreign languages) software titles for all major game
platforms and territories.
For the years ended October 31, 2001, 2000 and 1999, we incurred costs
of $6,190,000, $5,668,000 and $5,263,000 on research and development relating to
our software titles. Additionally, for the years ended October 31, 2001, 2000
and 1999, we capitalized software development costs of $6,490,000, $8,837,000
and $1,901,000.
Many of our software titles are developed by third parties. As a result
of our acquisition of Gathering of Developers in fiscal 2000, we have
established relationships with software developers, including Apogee Software
a/k/a 3D Realms, the creator of the Duke Nukem' franchise, Ritual Entertainment,
Terminal Reality, Epic MegaGames and Remedy Entertainment. We have entered into
agreements with certain of these developers, as well as other developers such as
Angel Studios and Illusions Software, to develop software products on our
behalf.
Agreements with developers generally give us exclusive publishing and
marketing rights and require us to make advance royalty payments, pay royalties
based on product sales and satisfy other conditions. Royalty advances for
software titles are recoupable only against royalties otherwise due to
developers. Our agreements with developers generally provide us with the right
to monitor development efforts and to cease making advance payments if specified
development milestones are not satisfied. We monitor the level of advances in
light of expected sales for the related titles and write off unrecoverable
advances to cost of sales in the period in which we determine the advance will
not be fully recouped.
In May 1998, we entered into an agreement with Apogee Software to
develop two games based on the Max Payne character. The agreement grants us the
exclusive worldwide right to publish Max Payne and a sequel on PC platforms. The
agreement requires us to pay royalties and satisfy other conditions and grants
Apogee approval rights with respect to products under development. The agreement
may be terminated by either party in the event of a material breach or default.
-5-
In July 2001, we entered into a letter agreement with Apogee granting
us the exclusive right to develop and publish Max Payne for video game console
platforms. The agreement requires us to make recoupable royalty advances and pay
royalties to Apogee. We internally developed and released Max Payne for
Microsoft's Xbox and Sony's PlayStation 2 in December 2001.
We actively seek to acquire licenses for well-recognized properties. In
December 2000, we acquired the exclusive worldwide publishing rights to the
best-selling franchise of Duke Nukem' PC and video games, including the back
catalog rights to six products, as well as PC, console and sequel rights to Duke
Nukem' Forever, the sequel to the popular Duke Nukem' 3D developed by Apogee
Software.
We also acquired the exclusive worldwide rights from New Line
Productions to publish and distribute titles based on Austin Powers movies, the
exclusive rights from MTV to develop titles based on MTV's properties and
certain rights from Microsoft, including all of the rights to Oni and Myth and
the right to develop two products utilizing the Halo game engine. Among our
titles, we own all right, title and interest to all of the intellectual
properties associated with the Grand Theft Auto product franchise, and we
develop Grand Theft Auto products internally. We expect to launch another major
addition to the Grand Theft Auto franchise in 2002.
In 2000, we pursued an Internet strategy, which included our entry into
online gaming markets through the acquisition of assets consisting of broadband,
multiplayer and other online gaming technologies. We were unable to successfully
implement this strategy, and we sold or wrote off certain of these assets. We
are currently focusing on potential multiplayer opportunities for our publishing
content.
Sales and Marketing
We sell software titles to retail outlets in the United States and
Europe through direct relationships with large retail customers and third-party
distributors. Our customers in the United States include Wal-Mart, Gamestop,
BestBuy, Circuit City, Electronics Boutique, Toys "R" Us and Blockbuster as well
as other leading mass merchandisers; video, electronic and toy stores; national
and regional drug stores; supermarket and discount store chains; and specialty
retailers. Our European customers include Dixons, Electronics Boutique and
Karstadt. We have sales and marketing operations in the United Kingdom, France,
Germany, Austria, Denmark, Italy, Australia, Canada and Japan.
Our marketing and promotional efforts are intended to maximize exposure
and broaden distribution of our titles, promote brand name recognition, assist
retailers and properly position, package and merchandise our titles. We market
titles by implementing aggressive public relations campaigns, primarily using
print and on-line advertising and to a lesser extent television and radio spots.
Our Rockstar Games subsidiary actively pursues relationships with
participants in the music and entertainment industries. We believe that the
shared demographics between various media and some of the software titles
marketed by Rockstar Games provide excellent cross-promotional opportunities. We
have been working with popular recording artists to create sophisticated game
soundtracks, have entered into agreements to license high-profile names and
likenesses, and have arrangements for co-branding opportunities. Our goal is to
accelerate the acceptance of our titles, create brand awareness and develop a
greater number of franchise titles.
We also employ various other marketing methods designed to promote
consumer awareness, including in-store promotions and point-of-purchase
displays, direct mail, cooperative advertising, as well as attendance at trade
shows. As of October 31, 2001, we had a sales and marketing staff of 150
persons.
-6-
Distribution
We distribute our own titles, as well as third-party titles and
hardware through our subsidiaries. We distribute three major categories of
third-party console products, consisting principally of hardware; newly released
and popular software titles; and budget and catalog software titles. We seek to
maintain a balance among these product categories in order to maximize sales and
operating performance.
For the year ended October 31, 2001, the sale of third-party products
accounted for approximately 46.1% of our total revenues, with sales to our five
largest customers aggregating approximately 20.9% of our total revenues. No
single customer accounted for more than 10% of our total revenues during this
period.
We procure products from suppliers using standard purchase orders based
on our assessment of market demand, as well as pre-orders from retailers. We
generally do not have any long-term agreements with our suppliers, and carry
inventory quantities that we believe are necessary to provide rapid response
time to retailer orders. We utilize electronic data interchange, or EDI, with
many of our retailers to enhance the efficiency of placing and shipping orders.
Jack of All Games maintains warehouse facilities and sales offices in
Ohio, Illinois and New York. Products arrive at our warehouses where products
are picked, packed and shipped to customers. We generally ship products by
common carrier.
Manufacturing
Sony and Nintendo are the sole manufacturers of software products sold
for use on their respective hardware platforms. We begin the manufacturing
process for our published titles by placing a purchase order for the manufacture
of our products with Sony or Nintendo and opening either a letter of credit in
favor of the manufacturer or utilizing our line of credit with the manufacturer.
We then send software code and a prototype of the product to the manufacturer,
together with related artwork, user instructions, warranty information,
brochures and packaging designs for approval, defect testing and manufacture.
Games manufactured by Sony and Nintendo are generally shipped within two weeks
of receipt of our manufacturing order. Games for the Xbox must be manufactured
by pre-approved manufacturers.
Production of PC software includes CD-ROM pressing, assembly of
components, printing of packaging and user manuals and shipping of finished
goods, which is performed by third-party vendors in accordance with our
specifications. We believe that there are alternative sources for these services
that could be implemented without delay. We send software code and a prototype
of a title, together with related artwork, user instructions, warranty
information, brochures and packaging designs to manufacturers. Games are
generally shipped within two weeks of receipt of our manufacturing order.
To date, we have not experienced any material difficulties or delays in
the manufacture of our titles or material delays due to manufacturing defects.
Our software titles carry a 90-day limited warranty.
Competition
In our publishing business, we compete both for licenses to properties
and the sale of interactive entertainment software with Sony, Nintendo,
Microsoft and Sega, each of which is a large developer and marketer of software
for its platforms. Sony and Nintendo currently dominate the industry and have
the financial resources to withstand significant price competition and to
implement extensive advertising campaigns, particularly for prime-time
television spots. These companies may also increase their own software
development efforts or focus on developing software products for third-party
platforms.
-7-
We also compete with domestic companies such as Electronic Arts,
Activision, Acclaim Entertainment, THQ, Midway Games and international companies
such as Sega, Vivendi, Ubisoft, Infogrames, Eidos, Capcom, Konami and Namco. In
addition, we believe that large software companies and media companies are
increasing their focus on the interactive entertainment software market. Certain
of our competitors are developing on-line interactive games and interactive
networks that may compete with our products for consumer dollars. Many of our
competitors have far greater financial, technical, personnel and other resources
than we do, and many are able to carry larger inventories, adopt more aggressive
pricing policies and make higher offers to licensors and developers for
commercially desirable properties than we can.
Retailers have limited shelf space and promotional resources, and
competition is intense among an increasing number of newly introduced
entertainment software titles and hardware for adequate levels of shelf space
and promotional support. Competition for retail shelf space is expected to
increase, which may require us to increase our marketing expenditures just to
maintain current levels of sales of our titles. Competitors with more extensive
lines and popular titles frequently have greater bargaining power with
retailers. Accordingly, we may not be able to achieve the levels of support and
shelf space that such competitors receive. Similarly, as competition for popular
properties increases, our cost of acquiring licenses for such properties is
likely to increase, possibly resulting in reduced margins. Prolonged price
competition, increased licensing costs or reduced operating margins would cause
our profits to decrease significantly.
Competition for our titles is influenced by the timing of competitive
product releases and the similarity of such products to our titles and may
result in loss of shelf space or a reduction in sell-through of our titles at
retail stores. Our titles also compete with other forms of entertainment such as
motion pictures, television and audio and video products featuring similar
themes, on-line computer programs and other forms of entertainment which may be
less expensive or provide other advantages to consumers.
In our distribution business, we compete with large national companies
such as Ingram Entertainment, as well as smaller regional distributors. We also
compete with the efforts of the major entertainment software companies that
distribute directly to retailers or over the Internet. Some of our competitors
have far greater financial, technical, personnel and other resources than we do,
and many are able to carry larger inventories, adopt more aggressive pricing
policies and provide more comprehensive product selection than we can.
Intellectual Property
We develop proprietary software titles and have obtained the rights to
publish and distribute software titles developed by third parties. We attempt to
protect our software and production techniques under copyright, trademark and
trade secret laws as well as through contractual restrictions on disclosure,
copying and distribution. Although we generally do not hold any patents or
registered copyrights, we seek to obtain trademark registrations for our product
names.
Interactive entertainment software is susceptible to unauthorized
copying. Unauthorized third parties may be able to copy or to reverse engineer
our titles to obtain and use programming or production techniques that we regard
as proprietary. In addition, our competitors could independently develop
technologies substantially equivalent or superior to our technologies.
-8-
As the amount of interactive entertainment software in the market
increases and the functionality of this software further overlaps, we believe
that interactive entertainment software will increasingly become the subject of
claims that such software infringes the copyrights or patents of others. From
time to time, we receive notices from third parties alleging infringement of
their proprietary rights. Although we believe that our titles and the titles and
technologies of third-party developers and publishers with whom we have
contractual relationships do not and will not infringe or violate proprietary
rights of others, it is possible that infringement of proprietary rights of
others may occur. Any claims of infringement, with or without merit, could be
time-consuming, costly and difficult to defend.
Employees
As of December 31, 2001, we had 662 full-time employees. None of our
employees are subject to a collective bargaining agreement. We consider our
relations with employees to be good.
Item 2. Properties.
Executive Offices
Our principal executive offices are located at 575 Broadway, New
York, New York in approximately 13,300 square feet of space under a five-year
lease with 575 Broadway Corporation, a company controlled by the father of Ryan
A. Brant, our Chairman. The lease provides for an annual rent of approximately
$474,000 and expires in 2004. We believe that the terms of the lease are no less
favorable than could have been obtained from an unaffiliated third-party.
International Operations
Take-Two Interactive Software Europe Limited leases 12,500 square
feet of office space in Windsor, United Kingdom. The lease provides for a
current annual rent of approximately $400,000, plus taxes and utilities, and
expires in 2011. Take-Two Interactive Software Europe Limited also leases office
space in Lincoln, United Kingdom. The lease provides for a current annual rent
of approximately $17,000 and expires in 2007.
Subsidiaries of Take-Two Interactive Software Europe Limited lease
office space at locations in Paris, France, Munich, Germany and Tokyo, Japan for
current aggregate annual rent of approximately $173,000. Directsoft leases
office and warehouse space in Hornsby, Australia at an annual rent of
approximately $48,000. Joytech Europe Limited leases office space in Leighton
Buzzard Beds, United Kingdom at an annual rent of approximately $85,000. Funsoft
Nordic A.S. and its subsidiaries lease office and warehouse space at locations
in Oslo, Norway, Spanga, Sweden and Arthus, Denmark for current aggregate annual
rent of approximately $45,000. DMA Design Limited currently leases office space
in Dundee and Edinburgh, Scotland, at an annual rental of approximately
$400,000. CD Verte Italia Spa currently leases office and warehouse space in
Golarata, Italy at an annual rent of approximately $79,000.
Development Facilities
Rockstar Canada leases approximately 3,600 square feet of space in
Ontario, Canada at an annual rental of approximately $26,000 plus taxes and
insurance. Talonsoft leases approximately 10,800 square feet of office space in
Baltimore, Maryland. Talonsoft currently pays $162,000 per annum under the
lease. PopTop Software leases approximately 3,300 square feet of office space in
Fenton, Missouri and pays an annual rental of $37,000. Neo leases approximately
3,000 square feet of office space in Vienna, Austria.
-9-
North America Distribution Facilities
Jack of All Games leases approximately 13,000 square feet of office and
warehouse space in College Point, New York. The lease provides for annual rent
of $237,000, plus increases in real estate taxes, and expires in October 2006.
Jack of All Games also leases approximately 206,000 square feet of office and
warehouse space in Cincinnati, Ohio. Jack of All Games pays $750,000 per annum,
plus taxes and insurance, under the lease, which expires in January 2006. Jack
of All Games Canada, Inc. (formerly Triad Distributors) currently leases
approximately 36,750 square feet of office and warehouse space in Ontario,
Canada at an annual rate of approximately $219,000 plus operating costs, under a
lease that expires September 2004. VLM Entertainment Group leases approximately
3,000 square feet of space in Northbrook, Illinois at an annual rental of
$33,000. VLM also leases approximately 56,200 square feet of office and
warehouse space in Ottawa, Illinois at an annual rent of $288,000. VLM leases
such space from its former stockholders and believes that the terms of the lease
are no less favorable than could have been obtained from an unaffiliated
third-party.
Item 3. Legal Proceedings.
In December 2001 and January 2002, six purported class action lawsuits
were filed in the United States District Court for the Southern District of New
York by Peter Fischbein; Drimal Ltd.; Corado Petruzzelli; Michael Lucas; Israel
M. Zacks; and Eliot Gertsen against Take-Two Interactive Software, Inc. and
certain of its officers or directors asserting damages on behalf of all persons
or entities who purchased or otherwise acquired Take-Two common stock in the
open market during the period commencing on February 24, 2000 through December
17, 2001. These complaints allege violations of Section 10 (b) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by Take-Two and the
individual defendants and violations of Section 20 (a) of the Exchange Act by
the individual defendants.
In the foregoing complaints, the plaintiffs allege that, among other
things, because Take-Two's financial statements issued during the class period
were not prepared in conformity with generally accepted accounting principles,
the defendants concealed adverse material information and made or participated
in the making of untrue statements of material facts and omitted to state
material facts concerning the business, financial condition, operations and
future prospects of Take-Two. The plaintiffs, in each of the complaints, seek
compensatory damages, including interest, against all of the defendants,
recovery of their reasonable litigation costs, and expenses. Take-Two intends to
defend vigorously the claims against it. Although we cannot predict the ultimate
outcome of these actions, an unfavorable resolution could have a material
adverse effect on our financial condition, cash flows and results of operations.
In connection with an informal and voluntary request from the SEC to
provide documents, we engaged the law firm of Blank Rome Tenzer Greenblatt LLP,
as counsel, to conduct an investigation into our accounting treatment of certain
transactions in fiscal 2000 and 2001. Blank Rome retained advisors to conduct a
forensic accounting investigation. In addition, our Board of Directors
authorized the Audit Committee (consisting of three independent members of the
Board), together with Morrison Foerster LLP, as independent counsel, to oversee
the investigation and advise the Audit Committee with respect to the
investigation. In February 2002, Blank Rome reported the results of the
investigation to the Audit Committee and the Board of Directors, which included
among other things, that we implement certain remedial procedures, controls and
systems.
-10-
As a result of the investigation and other reviews we performed, we
restated our previously issued consolidated financial statements for fiscal
2000, each of the quarters in such year, and the first three quarters of 2001.
The effect of the restatement is presented in Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations and in Notes 2 and
20 of the Notes to the Consolidated Financial Statements.
The Securities and Exchange Commission has issued a formal order of
investigation into, among other things, certain accounting matters relating to
our financial statements, periodic reporting and internal accounting control
provisions of the federal securities laws.
We are involved in routine litigation in the ordinary course of our
business, which in management's opinion will not have a material adverse effect
on our financial condition, cash flows or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
Not Applicable.
-11-
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Market Information. Our common stock has traded since September 23, 1998 on
the NASDAQ National Market under the symbol "TTWO." From April 14, 1997 to
September 22, 1998, our common stock traded on the NASDAQ SmallCap Market. On
January 22, 2002, trading in our common stock was halted by NASDAQ pending our
furnishing certain information relating to a restatement of our financial
statements. The following table sets forth, for the periods indicated, the range
of the high ask and low bid prices for the common stock as reported by NASDAQ.
Such prices reflect inter-dealer quotations, without retail mark-up, mark-down
or commission and may not necessarily represent actual transactions.
High Low
Fiscal Year Ended October 31, 2000
- ----------------------------------
First Quarter ...................................... 17.50 10.00
Second Quarter ..................................... 18.94 8.00
Third Quarter ...................................... 13.50 8.88
Fourth Quarter ..................................... 16.50 9.00
Fiscal Year Ended October 31, 2001
- ----------------------------------
First Quarter ...................................... 13.44 8.41
Second Quarter ..................................... 14.63 10.44
Third Quarter ...................................... 24.50 14.06
Fourth Quarter ..................................... 21.62 6.44
Fiscal Year Ending October 31, 2002
- -----------------------------------
First Quarter
(through January 22, 2002) ......................... 19.50 9.30
The last reported sale price for our common stock on January 22, 2002
was $18.56. The number of record holders of our common stock was approximately
157 as of January 22, 2002. We believe that there are in excess of 1,000
beneficial owners of our common stock.
Dividend Policy. To date, we have not declared or paid any cash
dividends. The payment of dividends, if any, in the future is within the
discretion of the board of directors and will depend upon future earnings,
capital requirements and other relevant factors. The payment of cash dividends
is restricted by the terms of our loan agreement. We presently intend to retain
all earnings to finance continued growth and development of our business and we
do not expect to declare or pay any cash dividends in the foreseeable future.
-12-
Item 6. Selected Financial Data.
Our consolidated financial statements for the fiscal year ended October
31, 2000, the related Management's Discussion and Analysis of Financial
Condition and Results of Operations for such year, each of the quarters in such
year and the interim quarters of fiscal 2001 have been restated. See
Management's Discussion and Analysis of Financial Condition and Results of
Operations and Consolidated Financial Statements contained elsewhere in this
Report.
(in thousands, except per share data)
Statement of Operations Data: Fiscal Year Ended October 31
-----------------------------------------------------------------------
2001(1) 2000(2) 1999 1998(3) 1997(3)
-------------- -------------- ----------- ------------ ---------
Net sales..................................... $451,056 $364,001 $304,714 $194,052 $97,341
Income (loss) from operations................. 25,841 33,309 27,381 10,690 (895)
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle..................................... (1,295) 6,417 16,332 7,181 (2,768)
Net income (loss)............................. (8,580) 6,417 16,332 7,181 (2,768)
Net income (loss) per share
Basic......................................... $(.25) $.23 $.79 $ .49 $(.25)
Diluted....................................... (.25) .23 .76 .42 (.25)
Net income (loss) per share attributable to
common stockholders - Diluted (4)............. (.25) .23 .76 .37 (.31)
Balance Sheet Data: As of October 31
----------------------------------------------------------------------
2001 2000(2) 1999 1998 1997
---- ------- ---- ---- ----
Cash and cash equivalents..................... $6,056 $5,245 $10,374 $2,763 $2,372
Working capital............................... 88,229 69,025 41,439 21,797 16,037
Total assets.................................. 354,997 330,257 231,712 109,385 56,395
Total debt.................................... 54,073 96,873 56,137 30,808 22,031
Total liabilities............................. 134,936 160,065 146,609 73,820 44,460
Stockholders' equity.......................... 220,061 170,192 85,103 35,566 11,935
(1) Includes approximately $27 million of net sales and $5.3 million of income,
net of taxes of $3.6 million, representing the effect of the adoption of
Staff Accounting Bulletin 101 "Revenue Recognition" (SAB 101) in the first
quarter of fiscal 2001. There was no impact on net income. See Note 3 of
Notes to Consolidated Financial Statements.
(2) As restated. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Restatement of Historical Financial
Statements."
(3) Net income in 1998 and 1997 includes acquired S corporation net income of
$1,233,000 and $1,347,000, respectively.
(4) Gives effect to distributions of $673,000 and $931,000 to S corporation
shareholders prior to acquisitions in 1998 and 1997, respectively.
-13-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Restatement of Historical Financial Statements
In connection with an informal and voluntary request from the SEC to
provide documents, we engaged counsel to conduct an investigation into our
accounting treatment of certain transactions in fiscal 200 and 2001. Counsel
retained advisors to perform a forensic accounting investigation. As a result of
the investigation, we restated our previously issued consolidated financial
statements for fiscal 2000 to eliminate $15,367,000 of net sales made to certain
independent third-party distributors and related cost of sales of $8,702,000,
which were improperly recognized as revenue and later returned or repurchased by
us.
In addition, we reviewed our revenue recognition policy, reserve
policies and our accounting for certain other transactions. As a result of this
review, we restated our previously issued consolidated financial statements for
fiscal 2000 for the following transactions:
o The elimination of $3,780,000 of net sales and related cost of
sales of $2,236,000 that were previously recognized for
products that had not been shipped within the period;
o A charge of $19,206,000 to record our portion of the losses
incurred by an affiliate accounted for under the equity method
in accordance with the provisions of EITF Issue No. 99-10, and
a net reduction for post acquisition amortization of $710,000
after we acquired the remaining 80% interest in this entity.
See note 5 of Notes to Consolidated Financial Statements; and
o The elimination of $2,563,000 of license revenue in connection
with a business combination.
Our financial statements for fiscal 2000 have been restated as follows
(and are presented in thousands, except per share data):
Year ended
October 31, 2000
--------------------------
As Reported As Restated
----------- -----------
Statement of Operations Data:
Net sales (1)........................... $387,006 $364,001
Cost of sales (1)....................... 247,796 235,978
Depreciation and amortization .......... 9,805 8,680
Income from operations ................. 45,061 33,309
Equity in loss of affiliate ............ 763 19,969
Income before provision for income taxes 38,229 8,961
Provision for income taxes ............. 13,266 2,544
Net income ............................. 24,963 6,417
Basic income per share ................. 0.91 0.23
Diluted income per share ............... 0.88 0.23
(1) Restated amounts give effect to reclassification of certain amounts to
conform to current year presentation, including the reduction in net sales
and costs of sales by approximately $1.3 million.
-14-
October 31, 2000
------------------------
As Reported As Restated
----------- -----------
Balance Sheet Data:
Accounts receivable* ......................... $134,877 $110,783
Inventories* ................................. 44,922 53,798
Prepaid royalties - current .................. 19,721 24,093
Deferred tax assets .......................... 666 9,243
Intangible assets ............................ 90,505 66,562
Other assets, net ............................ 1,565 2,558
Total assets ................................. 351,641 330,257
Accounts payable ............................. 47,972 46,566
Accrued expenses and other current
liabilities* ................................ 19,357 16,189
Total liabilities ............................ 164,639 160,065
Retained earnings ............................ 43,365 24,819
Total liabilities and stockholders' equity ... 351,641 330,257
* Restated amounts reflect a reclassification relating to the presentation of
allowance for returns.
We also restated the unaudited results of operations for each of the
quarters in fiscal 2000 for the matters described above.
Our unaudited results of operations for each of the three quarters in
the period ended July 31, 2001 were restated for the matters discussed above and
for the following:
o The cumulative effect in the first quarter of the change in
accounting related to the adoption of SAB 101. See Note 3 of Notes
to Consolidated Financial Statements;
o The recognition in the first quarter of net sales of $3,780,000
and related cost of sales of $2,237,000 for transactions that did
not qualify for revenue recognition in the fourth quarter of
fiscal 2000;
o An additional charge of $438,000, net of taxes of $292,000, in the
third quarter for an extraordinary loss on the early
extinguishment of debt; and
o An adjustment in the first two quarters for income related to the
reversal of revenue of $721,000 in the first quarter and $951,000
in the second quarter, net of expense reductions, and a
corresponding adjustment to the purchase price related to a
business acquired during the year.
Nine months
ended July 31, 2001
-------------------------------
As Reported As Restated
------------- -----------
Statement of Operations Data:
Net sales ......................... $ 309,048 $ 327,797
Cost of sales ..................... 201,609 210,226
Income from operations ............ 23,610 35,555
Net income (loss) ................. (3,765) (3,275)
Basic income per share ............ (.11) (.10)
Diluted income per share .......... (.11) (.10)
See Note 20 of Notes to Consolidated Financial Statements for financial
information relating to the restatement of the fiscal 2000 and fiscal 2001
quarters.
Significant Accounting Policies
Financial Reporting Release No. 60, which was recently released by the
Securities and Exchange Commission, requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. Note 3 of the Notes to the Consolidated Financial
Statements includes a summary of the significant accounting policies and methods
used in the preparation of our Consolidated Financial Statements. The following
is a brief discussion of the more significant accounting policies and methods
used by us.
In addition, Financial Reporting Release No. 61 was recently released
by the SEC to require all companies to include a discussion to address, among
other things, liquidity, off-balance sheet arrangements, contractual obligations
and commercial commitments.
General
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. The most significant estimates and assumptions relate to the
recoverability of prepaid royalties, capitalized software development costs and
other intangibles, inventories, realization of deferred income taxes and the
adequacy of allowances for returns, price protection and doubtful accounts.
Actual amounts could differ significantly from these estimates.
Revenue Recognition
Our principal sources of revenues are derived from publishing and
distribution operations. Publishing revenues are derived from the sale of
internally developed software titles or software titles licensed from third
parties. Distribution revenues are derived from the sale of third-party software
titles, accessories and hardware. Publishing activities generally generate
significantly higher margins than distribution activities, with sales of PC
software titles resulting in higher margins than sales of CDs or cartridges
designed for video game consoles. Effective November 1, 2000, we recognize
revenue net of allowances for returns and price protection when title and risk
of loss pass to customers (generally, upon receipt of products by customers).
Prior to that date, we recognized revenue upon shipment. In accordance with
Statement of Position 97-2 "Software Revenue Recognition" we recognize revenue
when the price is fixed and determinable, upon persuasive evidence of an
agreement, our fulfillment of our obligations under any such agreement and a
determination that collection is probable. Our payment arrangements with
customers provide primarily 60 day terms and to a limited extent with certain
customers 30, 90 or 120 day terms. We may not have a reliable basis to estimate
returns and allowances for certain customers or we may be unable to determine
that collection of receivables is probable. In such circumstances, we defer
revenues at the time of sale and recognize revenues when collection of the
related receivable becomes probable or cash is collected.
-15-
Returns and Reserves
Our arrangements with customers for published titles generally require
us to accept returns and provide price protection. We establish a reserve for
future returns of published titles and price protection based primarily on
historical return rates, return policies and price protection, and recognize
revenues net of allowances for returns and price protection. Our distribution
arrangements with customers generally do not give them the right to return
titles or to cancel firm orders. However, we sometimes accept returns for stock
balancing and negotiate accommodations to customers, which includes price
discounts, credits and returns, when demand for specific titles fall below
expectations. The historical product return rate for our distribution business
has been substantially less than for our publishing business. If future returns
significantly exceed our reserves, our operating results would be adversely
affected.
Prepaid Royalties
Our agreements with licensors and developers generally require us to
make advance royalty payments and pay royalties based on product sales. Prepaid
royalties are capitalized when technological feasibility of the related software
title is established, which generally occurs early in the development cycle.
Prepaid royalties are amortized as cost of sales based on the greater of the
proportion of current year sales to total of current and estimated future sales
on a product-by-product basis for that title or the contractual royalty rate
based on actual net product sales. We continually evaluate recoverability of
prepaid royalties on a product-by-product basis and we charge to cost of sales
any amount that management deems unlikely to be recoverable in the future.
Prepaid royalties are classified as current and non-current assets
based on estimated net product sales within the next year. Unrecoverable prepaid
royalties written down amounted to $975,000, $501,000 and $1,308,000 for the
years ended October 31, 2001, 2000 and 1999. Amortization of prepaid royalties
amounted to $17,598,000, $16,849,000 and $12,144,000 for the years ended October
31, 2001, 2000 and 1999.
Capitalized Software Development Costs
We capitalize internal software development costs subsequent to
establishing technological feasibility of a title. Amortization of such costs as
cost of sales is done on a product-by-product basis based on the greater of the
proportion of current year sales to total of current and estimated future sales
for that title or the straight-line method over the remaining estimated useful
life of the title. We continually evaluate the recoverability of capitalized
costs. Capitalized software costs were written down by $389,000 and $698,000 for
the years ended October 31, 2001 and 1999. No capitalized software costs were
written down for the year ended October 31, 2000. Amortization of capitalized
software costs amounted to $3,780,000, $1,451,000 and $1,136,000 for the years
ended October 31, 2001, 2000 and 1999.
-16-
Income Taxes
Income tax assets and liabilities are determined by taxable
jurisdiction. We do not provide taxes in undistributed earnings of our
subsidiaires. The total amount of undistributed earnings of foreign
susbsidiaries for income tax purposes was approximately $36 million and $10
million for the years ended October 31, 2001 and 2000, respectively. It is our
intention to reinvest undistributed earnings of our foreign subsidiaries and
thereby indefinitely postpone their remittance. Accordingly, no provision has
been made for foreign withholding taxes or United States income taxes which may
become payable if undistributed earnings of foreign subsidiaires are paid as
dividends to us.
Results of Operations
The following table sets forth for the periods indicated the percentage
of net sales represented by certain items reflected in our statement of
operations, and sets forth net sales by territory, platform and principal
product:
-17-
Years Ended October 31,
-------------------------
2001 2000 1999
-------------------------
(as restated)
OPERATING DATA:
Net sales .................... 100.0% 100.0% 100.0%
Cost of sales ................ 67.9 64.8 70.2
Selling and marketing ........ 12.2 11.8 9.9
General and administrative ... 9.9 10.0 8.3
Research and development ..... 1.4 1.6 1.7
Depreciation and amortization 2.8 2.4 0.9
Interest expenses ............ 1.9 1.7 1.0
Provision (benefit) for income
taxes ........................ (0.5) 0.7 2.7
Net income (loss) ............ (1.9) 1.8 5.4
NET SALES BY TERRITORY:
North America ............... 76.4% 71.6% 67.0%
International ............... 23.6 28.4 33.0
PLATFORM MIX (publishing):
Console ..................... 57.5% 50.6% 47.4%
PC .......................... 35.7 36.9 41.7
Hand-held ................... 1.9 7.3 5.7
Accessories ................. 4.9 5.2 5.2
PRINCIPAL PRODUCT SALES (2001)
Grand Theft Auto 3, PS2...... 7.4% -- --
Max Payne, PC................ 5.2 -- --
Midnight Club, PS2........... 4.1 2.7 --
Smugglers Run, PS2........... 3.0 3.3 --
Ten largest titles........... 31.3% 16.4% 33.5%
-18-
Business Acquisitions and Dispositions
In April 2000, we acquired the remaining 80.1% of the stock of
Gathering of Developers, Inc. that we did not already own for 1,060,000 shares
of common stock. Prior to the acquisition, we had a distribution and publishing
arrangement with Gathering under which we were entitled to receive a
distribution fee of 20% of net receipts derived from sales of PC products.
Products sold under this arrangement accounted for approximately 6.3% of our net
sales and 18.0% of our net income for the year ended October 31, 1999, and
approximately 9.7% of our net sales and 9.3% of our net income during fiscal
2000.
We also acquired PopTop Software, Inc., an independent software
developer, in July 2000 for 559,100 shares of common stock. PopTop's operations
did not contribute to our revenues and its loss did not significantly affect
our net income during fiscal 2000.
We purchased Toga Holdings BV, the parent of Pixel Broadband Studios
Ltd. in March 2000 as part of our Internet strategy for $4.5 million in cash and
2,561,000 shares of common stock. Pixel had developed leading-edge software
technology, which enables broadband carriers to deliver persistent online
gameplay via satellite, cable and wireless communications devices. We intended
to combine Pixel's business with the gaming content of our Rockstar video game
publishing subsidiary with a view toward obtaining financing to operate this
business independently. Due to unfavorable market conditions, we abandoned a
proposed financing in July 2000. We incurred a charge of $1,103,000 consisting
primarily of professional fees related to the abandoned offering.
We sold Toga to Gameplay.com plc in October 2000. During fiscal 2000,
Toga's operations did not contribute to our revenues and accounted for an
operating loss of approximately $1.5 million. We incurred a loss of $286,000 in
connection with the sale of Toga. In connection with the sale of Toga, we
entered into a Joint Exploitation Agreement with Gameplay pursuant to which we
acquired Neo Software Productions GMBH, a software developer based in Austria.
Neo developed Max Payne for Microsoft's Xbox.
In February 2000, we sold Falcon Ventures d/b/a DVDWave.com, an online
provider of music CDs, to eUniverse, Inc. and recorded a gain of $1,976,000.
Falcon Ventures accounted for an insignificant portion of our revenues and
accounted for an operating loss of approximately $1.1 million during fiscal
2000.
In November 2000, we acquired all of the capital stock of VLM
Entertainment Group Inc., a third-party video game distributor, for $2 million
in cash and 875,000 shares of common stock and assumed liabilities of
approximately $10.6 million. VLM accounted for 14.4% of our distribution
revenues in fiscal 2001.
In July 2001, we acquired all of the outstanding capital stock of
Techcorp Limited, a Hong Kong based design and engineering firm specializing in
video game accessories, for 30,000 shares of restricted common stock, $100,000
in cash and assumed liabilities of $2.9 million. The acquisition of Techcorp did
not have a significant effect on our 2001 operating results.
In July 2001, we sold all of the outstanding capital stock of Jack of
All Games UK, a video game distributor, to Jay Two Limited, an unaffiliated
third-party controlled by Freightmasters Ltd., for approximately $215,000. In
connection with the sale, the purchaser assumed net liabilities of $436,000. We
recorded a gain on this sale of $651,000. The sale of Jack of All Games UK is
not expected to have a significant effect on our future operating results.
-19-
Fiscal Year Ended October 31, 2001 and 2000
Net Sales. Net sales increased by $87,055,000, or 23.9%, to
$451,056,000 for fiscal 2001 from $364,001,000 for fiscal 2000. The increase was
attributable to growth in both publishing and distribution operations and
acquisitions. The adoption of SAB 101 effective November 2000 to recognize
revenue when both title and all risks of loss pass to customers resulted in an
increase in net sales of $27 million. Fiscal 2000 sales that were previously
recognized upon product shipment were effectively reversed with the adoption of
SAB 101 and reported upon receipt by the customer as sales in the first quarter
of fiscal 2001. In fiscal 2001, we implemented changes to our practices to
significantly reduce shipment time near quarter and year end. Accordingly, the
adoption of SAB 101 did not have a significant impact on previously reported
interim results for the first three quarters of fiscal 2001.
Publishing revenues increased by $56,795,000 or 30.5%, to $242,913,000
for fiscal 2001 from $186,118,000 for fiscal 2000. The increase was primarily
attributable to the release of Grand Theft Auto 3 for PlayStation 2 and Max
Payne for the PC, and included $21 million resulting from the adoption of SAB
101. Publishing activities accounted for approximately 53.9% of net sales in
fiscal 2001.
In fiscal 2001, software titles designed for PC platforms accounted for
approximately 35.7% of publishing revenues as compared to 36.9% in the prior
year. Software titles designed for video game console platforms accounted for
57.5% of publishing revenues as compared to 50.6% in the prior year. We expect
that sales of video game console titles will continue to account for an
increasing portion of our publishing revenues.
Distribution revenues increased by $30,260,000, or 17.0%, to
$208,143,000 for fiscal 2001 from $177,883,000 for fiscal 2000. The increase was
attributable to the continued rollout of Sony's PlayStation 2, and included $6
million relating to the adoption of SAB 101. VLM Entertainment Group, which was
acquired in November 2000, accounted for 14.4% of our distribution revenues in
fiscal 2001. In fiscal 2001, distribution activities accounted for approximately
46.1% of net sales, with video game hardware and peripherals accounting for
16.0% of net sales.
International operations accounted for approximately $106,564,000 or
23.6% of net sales in fiscal 2001 compared to $103,315,000 or 28.4% in fiscal
2000. The percentage decrease was attributable to the growth in our North
American operations. In recent periods, we placed increasing emphasis on
expanding publishing activities in Europe, and we sold our Jack of All Games UK
distribution subsidiary in July 2001. We expect that international sales will
continue to account for a significant portion of our future revenues.
Cost of Sales. Cost of sales increased by $70,286,000 or 29.8%, to
$306,264,000 for fiscal 2001 from $235,978,000 for fiscal 2000. The increase was
commensurate with increased net sales and included $18 million resulting from
the adoption of SAB 101. Cost of sales primarily represents royalties paid to
our manufacturers, amortization of prepaid royalties to third-party developers,
amortization of capitalized software related to internally developed titles and
the cost of third-party products for our distribution business. Included in cost
of sales is a non-cash impairment charge of $3,786,000 taken in the quarter
ended April 30, 2001 relating to a reduction in the value of certain Internet
gaming assets. Cost of sales as a percentage of net sales increased to 67.9% for
fiscal 2001 from 64.8% for fiscal 2000 as a result of higher production costs
associated with the development of next-generation software titles and the
aforementioned impairment charge. We estimate that cost of sales as a percentage
of net sales in our publishing business is generally 60%, while cost of sales as
a percentage of net sales in our distribution business is generally 90%.
Selling and Marketing. Selling and marketing expenses increased by
$12,399,000, or 28.9%, to $55,253,000 for fiscal 2001 from $42,854,000 for
fiscal 2000. The increase was primarily attributable to increased advertising
activities relating to our new releases in 2001. Selling and marketing expenses
as a percentage of net sales remained relatively constant from year to year.
-20-
General and Administrative. General and administrative expenses
increased by $8,458,000, or 23.2%, to $44,867,000 for fiscal 2001 from
$36,409,000 for fiscal 2000. General and administrative expenses as a percentage
of net sales remained relatively constant from year to year at 10.0%. The
increase in absolute dollars was attributable to increased salaries and rent
necessary to support our expanded operations and increased bad debt expenses.
Research and Development. Research and development costs increased by
$522,000, or 9.2%, to $6,190,000 for fiscal 2001 from $5,668,000 for fiscal
2000. Research and development costs as a percentage of net sales remained
relatively constant from year to year. Once software development projects reach
technological feasibility, a substantial portion of our research and development
costs are capitalized and subsequently amortized as cost of goods sold. These
capitalized software development costs relate to our internally developed
publishing titles.
Depreciation and Amortization. Depreciation and amortization expense
increased by $3,961,000, or 45.6%, to $12,641,000 for fiscal 2001 from
$8,680,000 for fiscal 2000. Depreciation and amortization expense as a
percentage of net sales increased to 2.8% for fiscal 2001 from 2.4% for fiscal
2000. The increases were attributable to amortization of intangible assets as a
result of business acquisitions offset by the impact of sales of businesses made
in fiscal 2000 and fiscal 2001.
Income from Operations. Income from operations decreased by $7,468,000,
or 22.4%, to $25,841,000 for fiscal 2001 from $33,309,000 for fiscal 2000
primarily due to the increase in our cost of sales discussed above.
Interest Expenses. Interest expenses increased by $2,441,000,
or 40.2% to $8,510,000 for fiscal 2001 from $6,069,000 for fiscal 2000. The
increase was attributable to higher levels of borrowings during 2001. Interest
expenses as a percentage of net sales remained constant.
Gain on Sale of Subsidiary. We sold Jack of All Games UK in July 2001
and recorded a gain on sale of $651,000.
Loss on Available-For-Sale Internet Securities. We incurred non-cash
impairment charges of $21,477,000 during fiscal 2001 relating to our Internet
related investments to reflect other than temporary declines in the value of
such investments.
Income Taxes. Income tax expenses decreased by $4,744,000 for fiscal
2001 from fiscal 2000. The decrease was attributable to tax losses in fiscal
2001 compared to taxable income in fiscal 2000. We recorded an income tax
benefit of $2,200,000 for fiscal 2001 compared to an income tax provision of
$2,544,000 for fiscal 2000. The effective tax rate in 2001 and 2000 of (62.9%)
and 28.4%, respectively, are the result of state and foreign tax rate
differentials partially offset by non deductible items. We believe that it is
more likely than not that we will generate sufficient levels of taxable income
in the future to realize $21,765,000 of reported net deferred tax assets,
approximately $7 million of which is a capital loss carryforward. The amount of
the deferred tax asset considered realizable, however, could be reduced in the
near term if estimates of future taxable income during the carryforward period
are reduced. Failure to achieve sufficient levels of taxable income from capital
transactions might affect the ultimate realization of the capital loss
carryforwards. If this were to occur, management is committed to implementing
tax planning strategies, such as the sale of net appreciated assets to the
extent required (if any) to generate sufficient taxable income prior to the
expiration of the capital loss carryforwards.
Extraordinary Item. We incurred an extraordinary charge of $1,948,000,
net of taxes of $1,217,000, upon the early extinguishment of debt of $15,000,000
in July 2001.
Cumulative Effect of Change in Accounting Principle. In connection
with our adoption of SAB 101, we recognized a cumulative effect of $5.3 million,
net of taxes of $3,558,000.
Net (loss) Income. As a result of the foregoing, for fiscal 2001, we
incurred a net loss of $8,580,000 as compared to net income of $6,417,000 for
fiscal 2000.
-21-
Fiscal Years Ended October 31, 2000 and 1999
Net Sales. Net sales increased by $59,287,000, or 19.5%, to
$364,001,000 for fiscal 2000 from $304,714,000 for fiscal 1999. Substantially
all of the increase in net sales in fiscal 2000 was attributable to internal
growth of our publishing and distribution operations.
Publishing revenues increased by $27,001,000, or 17.0%, to
$186,118,000 for fiscal 2000 from $159,117,000 for fiscal 1999. The increase was
primarily attributable to the release of Midnight Club and Smuggler's Run at the
launch of PlayStation 2. In fiscal 2000, publishing activities accounted for
approximately 51.1% of our net sales.
In fiscal 2000, software products designed for PC platforms accounted
for approximately 36.9% of our publishing revenues as compared to 41.7% in
fiscal 1999. The decrease was primarily attributable to our emphasis on
developing and releasing titles for next-generation video game console
platforms. Software titles developed for video game console platforms accounted
for 50.6% of publishing revenues compared to 47.4% in the prior year. The
increase was primarily attributable to the release of several new products with
the launch of PlayStation 2 in October 2000.
Distribution revenues increased by $32,286,000, or 22.2%, to
$177,883,000 for fiscal 2000 from $145,597,000 for fiscal 1999. The increase was
primarily attributable to continued strong sales of PlayStation hardware and
software, and the launch of PlayStation 2. In fiscal 2000, distribution
activities accounted for approximately 48.9% of our net sales, with video game
hardware and peripherals accounting for 20.4% of net sales.
International operations accounted for approximately $103,315,000 or
28.4% of our net sales for fiscal 2000 compared to $100,520,000 or 33.0% for
fiscal 1999. The percentage decrease was primarily attributable to the growth in
our North American operations.
Cost of Sales. Cost of sales increased by $22,074,000, or 10.3%, to
$235,978,000 for fiscal 2000 from $213,904,000 for fiscal 1999. The increase was
primarily a result of the expanded scope of our operations and was consistent
with revenue growth. Cost of sales as a percentage of net sales decreased to
64.8% for fiscal 2000 from 70.2% for fiscal 1999. This decrease was primarily
due to an increase in our higher margin publishing activities.
Selling and Marketing. Selling and marketing expenses increased by
$12,746,000, or 42.3%, to $42,854,000 for fiscal 2000 from $30,108,000 for
fiscal 1999. Selling and marketing expenses as a percentage of net sales
increased to 11.8% for fiscal 2000 from 9.9% for fiscal 1999. The increases were
due to increased marketing costs associated with establishing our publishing
programs and brand names.
General and Administrative. General and administrative expenses
increased by $11,173,000 or 44.3%, to $36,409,000 for fiscal 2000 from
$25,236,000 for fiscal 1999. General and administrative expenses as a percentage
of net sales increased to 10.0% for fiscal 2000 from 8.3% for fiscal 1999. The
increases were due to additional salaries, rent, insurance premiums and
professional fees in connection with our expanded operations and from our
acquisitions offset by our dispositions.
Research and Development. Research and development costs increased by
$405,000, or 7.7%, to $5,668,000 for fiscal 2000 from $5,263,000 for fiscal
1999. Research and development costs as a percentage of sales decreased to 1.6%
for fiscal 2000 from 1.7% for fiscal 1999.
Depreciation and Amortization. Depreciation and amortization expense
increased by $5,858,000 to $8,680,000 for fiscal 2000 from $2,822,000 for fiscal
1999. Depreciation and amortization expense as a percentage of net sales
increased to 2.4% for fiscal 2000 from 0.9% for fiscal 1999. The increases were
attributable to the amortization of goodwill associated with the acquisitions of
Toga Holdings, Gathering of Developers and DMA Design Limited. We sold Toga
Holdings in October 2000.
-22-
Abandoned Offering Costs. We incurred a charge of $1,103,000 relating
to an abandoned offering in fiscal 2000.
Income from Operations. Income from operations increased by $5,928,000,
or 21.7%, to $33,309,000 for fiscal 2000 from $27,381,000 for fiscal 1999. The
increase was commensurate with our growth in net sales offset by the changes
referred to above.
Interest Expenses. Interest expenses increased by $3,159,000, or
108.6%, to $6,069,000 for fiscal 2000 from $2,910,000 for fiscal 1999. The
increase was primarily a result of increased borrowings and the amortized
portion of the expenses relating to a subordinated loan.
Gain on Sale of Subsidiary - Net. Includes a gain on sale of $1,976,000
relating to the sale of Falcon Ventures and offset by a loss of $286,000
relating to the sale of Toga Holdings.
Equity in Loss of Affiliate. In fiscal 2000, in accordance with EITF
99-10, we incurred a charge of $19,969,000 for our share of losses incurred by
Gathering of Developers prior to our acquisition of the then remaining interest
in Gathering of Developers. The increase over fiscal 1999 is the result of
increased losses at Gathering of Developers coupled with the implementation of
EITF 99-10.
Income Taxes. Income taxes decreased by $5,550,000 or 68.6% to
$2,554,000 as a result of a reduced taxable income for fiscal 2000 as compared
to a tax provision of $8,094,000 for fiscal 1999. The reduction in the effective
tax rate of 28.4% in fiscal 2000 from 33.1% in fiscal 1999 is primarily
attributable to the foreign tax rate differential.
Net Income. As a result of the foregoing, we recorded net income of
$6,417,000 in fiscal 2000, as compared to net income of $16,332,000 in fiscal
1999.
Liquidity and Capital Resources
Our primary cash requirements have been and will continue to be to fund
developing, publishing and distributing our products. We have historically
financed our operations through cash flows from operations, the issuance of debt
and equity securities and bank borrowings. At October 31, 2001, we had working
capital of $88,229,000 as compared to working capital of $69,025,000 at October
31, 2000. At October 31, 2001, we had cash and cash equivalents of $6,056,000.
Net cash provided by operating activities for fiscal 2001 was
$27,319,000 as compared to net cash used in operating activities of $54,230,000
for fiscal 2000 and $16,023,000 for fiscal 1999. The increase in 2001 was
primarily attributable to our increased focus on working capital management.
In fiscal 2000 and 1999, we invested substantial funds in our next-generation
entertainment software publishing subsidiaries. We believe that such investments
will continue to be reflected in future cash flow from operations. Fiscal 1999
cash flows were also impacted by an increase in accounts receivable offset in
part by an increase in accounts payable.
Net cash used in investing activities for fiscal 2001 was $13,479,000
as compared to $12,906,000 for fiscal 2000 and $21,540,000 for fiscal 1999. Net
cash used in investing activities in 2001 related primarily to the purchase of
fixed assets and to a lesser extent acquisitions. Net cash used in investing
activities in 2000 and 1999 related primarily to acquisitions.
Net cash used in financing activities for fiscal 2001 was $11,790,000
as compared to net cash provided by financing activities of $70,535,000 for
fiscal 2000 and $46,055,000 for fiscal l999. Net cash used in fiscal 2001
related primarily to the repayment of indebtedness offset by proceeds from
equity offerings and the exercise of stock options and warrants. Net cash
provided by operations in fiscal 2000 and 1999 was primarily due to proceeds
from borrowings and equity offerings.
-23-
In December 1999, we entered into a credit agreement with a group of
lenders led by Bank of America, N.A., as agent. The agreement was amended in
February 2002 to provide for borrowings of up to $15,000,000 through February
20, 2002; $22,500,000 through February 28, 2002; $30,000,000 through April 13,
2002; and $50,000,000 through the remaining term of the agreement. Generally,
advances under the line of credit are based on a borrowing formula equal to the
lesser of (1) the borrowing limit or (2) 70% of eligible accounts receivable,
plus 25% of eligible inventory. Interest accrues on such advances at the bank's
prime rate plus 0.5%, or at LIBOR plus 2.5%. Borrowings under the line of credit
are collateralized by our accounts receivable, inventory, equipment, general
intangibles, securities and other personal property, including the capital stock
of our domestic subsidiaries. The loan agreement contains certain financial and
other covenants, which were amended retroactively. Accordingly, as of October
31, 2001, we were in compliance with such covenants, as amended. The loan
agreement limits or prohibits us from declaring or paying cash dividends,
merging or consolidating with another corporation, selling assets (other than in
the ordinary course of business), creating liens and incurring additional
indebtedness. The line of credit expires on December 7, 2002. As of October 31,
2001, $48,701,000 was outstanding under the line of credit.
In January 2001, our United Kingdom subsidiary entered into a credit
facility agreement, as amended, with Lloyds TSB Bank plc under which Lloyds
agreed to make available borrowings of up to $19,000,000. Advances under the
credit facility bear interest at the rate of 1.25% per annum over the bank's
base rate, and are guaranteed by us. The credit facility expires in March 2002.
As of October 31, 2001, $5,372,000 was outstanding under the credit facility.
During the year ended October 31, 2001, we received proceeds of
$22,614,000 from the exercise of stock options and warrants.
In July 2001, we sold 1,300,000 shares of common stock in a private
placement and received net proceeds of approximately $20.9 million. We used the
proceeds to repay in full the subordinated indebtedness described below, and
other indebtedness.
In July 2000, we entered into a subordinated loan agreement with Finova
Mezzanine Capital under which we borrowed $15,000,000 evidenced by a five-year
promissory note bearing interest at the rate of 12.5% per annum, payable
monthly. In connection with the loan, we issued to Finova warrants to purchase
451,747 shares of common stock at an exercise price of $11.875 per share. We
incurred an extraordinary charge of $1,948,000, net of taxes, upon the early
repayment of this indebtedness.
In connection with our acquisition of the franchise of Duke Nukem' PC
and video games in December 2000, we are obligated to pay $6 million in cash
upon delivery of the final PC version of Duke Nukem' Forever.
-24-
Our accounts receivable, less an allowance for doubtful accounts,
returns and price protection and other discounts at October 31, 2001 were
$94,950,000. Of such receivables, approximately $11,033,000 or 11.7% was due
from one customer. Most of our receivables are covered by insurance and
generally have been collected in the ordinary course of business. Our sales are
typically made on credit, with terms that vary depending upon the customer and
the demand for the particular title being sold. We do not hold any collateral to
secure payment by our customers. As a result, we are subject to credit risks,
particularly in the event that any of our receivables represent sales to a
limited number of retailers or are concentrated in foreign markets. If we are
unable to collect our accounts receivable as they become due and such accounts
are not covered by insurance, our liquidity and working capital position would
be adversely affected. We had accounts receivable days outstanding of 69 at
October 31, 2001, as compared to 92 days at October 31, 2000.
Our offices and warehouse facilities are occupied under noncancelable
operating leases expiring at various times from July 2001 to October 2011.
Additionally, we have leased certain furniture, equipment and automobiles under
noncancelable operating leases expiring through July 2005. Our future minimum
rental payments for the year ending October 31, 2002 are $3,879,000, and
aggregate minumum rental payments through applicable lease expirations is
$16,756,000.
We have no material commitments for capital expenditures. We anticipate
incurring significant additional legal, accounting and other professional
expenses in connection with pending litigation and regulatory matters.
Recently Issued Accounting Pronouncements
In July 2001, the FASB issued Statement of Financial Accounting
Standard No. 141, "Business Combinations" ("SFAS 141") and Statement of
Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142").
SFAS 141 establishes accounting and reporting for business combinations
by requiring that all business combinations be accounted for under the purchase
method. Use of the pooling-of-interests method is no longer permitted. SFAS 141
also provides guidance on purchase accounting related to the recognition of
intangible assets and accounting for negative goodwill. SFAS 141 requires that
the purchase method be used for business combinations initiated after June 30,
2001. SFAS 142 changes the accounting for goodwill from an amortization method
to an impairment-only approach. Upon adoption of SFAS 142, amortization of
goodwill recorded for business combinations consummated prior to July 1, 2001
will cease, and intangible assets acquired prior to July 1, 2001 that do not
meet the criteria for recognition under SFAS 141 will be reclassified to
goodwill. Goodwill will be subject to an annual impairment test, including a
transitional impairment test required upon adoption of SFAS 142, which
companies have six months to complete.
The provisions of SFAS 142 will be effective for fiscal years beginning
after December 15, 2001; however, early adoption is permitted. We anticipate the
early adoption of SFAS 142 as of the beginning of fiscal 2002. We are still in
the process of reallocating previously identifiable intangibles that do not meet
the criteria of SFAS 141 into goodwill and evaluating the useful lives of our
remaining identifiable intangibles. However, we currently estimate that
unaudited pro forma income before extraordinary item and cumulative effect of
change in accounting principle and the respective diluted EPS would have been
approximately $2.9 million and $0.08, respectively for the year ended October
31, 2001 had the provisions of the new standards been applied in that year. We
are in the process of completing the step one transitional assessment of
goodwill. We do not currently anticipate having to record a transition
impairment of goodwill or other intangible assets as a cumulative effect as a
result of these new standards.
In August 2001, the FASB issued Statement of Financial Accounting
Standard No.143, "Accounting for Obligations Associated with the Retirement of
Long-Lived Assets" ("SFAS 143"). The objective of SFAS 143 is to provide
accounting guidance for legal obligations associated with the retirement of
long-lived assets. The retirement obligations included within the scope of this
project are those that an entity cannot avoid as a result of either the
acquisition, construction or normal operation of a long-lived asset. Components
of larger systems also fall under this project, as well as tangible long-lived
assets with indeterminable lives. The provisions of SFAS 143 are effective for
financial statements issued for fiscal years beginning after June 15, 2002. We
are currently evaluating the expected impact of the adoption of SFAS 143 on our
financial condition, cash flows and results of operations and will adopt SFAS
143 in fiscal 2003.
In October 2001, the FASB issued Statement of Financial Accounting
Standard No.144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"). The objectives of SFAS 144 are to address significant
issues relating to the implementation of SFAS 121 and to develop a single
accounting model, based on the framework established in SFAS 121, for long-lived
assets to be disposed of by sale, whether previously held and used or newly
acquired. The provisions of SFAS 144 are effective for financial statements
issued for fiscal years beginning after December 15, 2001. We are currently
evaluating the expected impact of the adoption of SFAS 144 on our financial
condition and results of operations and will be adopting SFAS 144 in the first
quarter of fiscal 2003.
-25-
Cautionary Statement and Risk Factors
Safe Harbor Statement under the Securities Litigation Reform Act of
1995: We make statements in this report that are considered forward-looking
statements under federal securities laws. Such forward-looking statements are
based on the beliefs of management as well as assumptions made by and
information currently available to them. The words "expect," "anticipate,"
"believe," "may," "estimate," "intend" and similar expressions are intended to
identify such forward looking statements. Forward- looking statements involve
risks, uncertainties and assumptions including, but not limited to, the
following:
The market for interactive entertainment software titles is
characterized by short product life cycles. The interactive entertainment
software market is characterized by short product life cycles and frequent
introduction of new products. New products introduced by us may not achieve
significant market acceptance or achieve sufficient sales to permit us to
recover development, manufacturing and associated costs. Historically, few
interactive entertainment software products have achieved sustained market
acceptance. Even the most successful titles remain popular for only limited
periods of time, often less than six months. The life cycle of a game generally
consists of a relatively high level of sales during the first few months after
introduction followed by a decline in sales. Because revenues associated with
the initial shipments of a new product generally constitute a high percentage of
the total revenues associated with the life of a product, any delay in the
introduction of one or more new products could harm our operating results.
Additionally, because we introduce a relatively limited number of new products
in a given period, the failure of one or more of our products to achieve market
acceptance could result in losses.
A significant portion of our revenues are derived from a limited number
of titles. Our ten best selling titles accounted for approximately 31.3% of our
revenues for the year ended October 31, 2001. For this period, Grand Theft Auto
3 for the PlayStation 2 accounted for 7.4% of our revenues; Midnight Club for
the PlayStation 2 accounted for 4.1% of our revenues; Smuggler's Run for the
PlayStation 2 accounted for 3.0% of our revenues; and Max Payne for the PC
accounted for 5.2% of our revenues, with each of the next three titles
accounting for between 1.9% and 3.0% of our revenues. Our ten best selling
titles accounted for 16.4% of our revenues for the year ended October 31, 2000.
Each of Grand Theft Auto and the Smuggler's Run titles accounted for
approximately 3.0% of our revenues for the year ended October 31, 2000, with
each of the next four titles accounting for between 1.2% and 2.3% of our
revenues. For the year ended October 31, 1999, our ten best selling titles
accounted for approximately 33.5% of our revenues, with Grand Theft Auto
products accounting for approximately 18.7% of our revenues. Our future titles
may not be commercially viable. We also may not be able to release new titles
within scheduled release times or at all. If we fail to continue to develop and
sell new, commercially successful titles, our revenues and profits may decrease
substantially and we may incur losses.
Our quarterly operating results may vary significantly, which could
cause our stock price to decline. We have experienced and may continue to
experience wide fluctuations in quarterly operating results. The interactive
entertainment industry is highly seasonal, with sales typically higher during
the fourth and first calendar quarters, due primarily to the increased demand
for games during and immediately following the holiday buying season. Our
failure or inability to introduce products on a timely basis to meet seasonal
fluctuations in demand will harm our business and operating results. These
fluctuations could also cause our stock price to decline. Other factors that
cause fluctuations include delays in the introduction of new titles; the size
and timing of product and corporate acquisitions; variations in sales of titles
designed to operate on particular platforms; development and promotional
expenses relating to the introduction of new titles, sequels or enhancements of
existing titles; availability of hardware platforms; the timing and success of
title introductions by our competitors; product returns; the accuracy of
retailers' forecasts of consumer demand; and the timing of orders from major
customers.
-26-
Our expense levels are based, in part, on our expectations regarding
future sales and therefore our operating results would be harmed by a decrease
in sales or a failure to meet our sales expectations. The uncertainties
associated with interactive entertainment software development, lengthy
manufacturing lead times, production delays and the approval process for
products by hardware manufacturers and other licensors make it difficult to
predict the quarter in which our products will ship and therefore may cause us
to fail to meet financial expectations. In future quarters our operating results
may fall below the expectations of securities analysts and investors. In this
event, the trading price of our common stock could significantly decline.
The interactive entertainment software industry is cyclical, and we may
fail to anticipate changing consumer preferences. Our business is subject to all
of the risks generally associated with the interactive entertainment software
industry, which has been cyclical in nature and has been characterized by
periods of significant growth followed by rapid declines. Our future operating
results will depend on numerous factors beyond our control, including the
popularity, price and timing of new software and hardware platforms being
released and distributed by us and our competitors; international, national and
regional economic conditions, particularly economic conditions adversely
affecting discretionary consumer spending; changes in consumer demographics; the
availability of other forms of entertainment; and critical reviews and public
tastes and preferences, all of which change rapidly and cannot be predicted. In
order to plan for acquisition and promotional activities, we must anticipate and
respond to rapid changes in consumer tastes and preferences. A decline in the
popularity of interactive entertainment software or particular platforms could
cause sales of our titles to decline dramatically. The period of time necessary
to develop new game titles, obtain approvals of manufacturers and produce
CD-ROMs or game cartridges is unpredictable. During this period, consumer appeal
of a particular title may decrease, causing sales to decline.
Rapidly changing technology and platform shifts could hurt our
operating results. The interactive entertainment industry in general is
associated with rapidly changing technology, which often leads to software and
platform obsolescence and significant price erosion over the life of a product.
The introduction of new platforms and technologies can render existing software
titles obsolete or unmarketable. We expect that as more advanced platforms
achieve market acceptance, consumer demand for software for older platforms will
decline. Obsolescence of software or platforms could leave us with increased
inventories of unsold titles and limited amounts of new titles to sell to
consumers, which would have a material adverse effect on our operating results.
A number of software publishers who compete with us have developed or are
currently developing software for use by consumers over the Internet. Future
increases in the availability of such software or technological advances in such
software or the Internet could result in a decline in platform-based software
and impact our sales. Direct sales of software by major manufacturers over the
Internet would materially adversely affect our distribution business.
Next-generation hardware platforms on which we have based our business
strategy may not achieve significant market acceptance. Our software development
efforts with respect to new hardware platforms may not lead to marketable titles
or titles that generate sufficient revenues to recover their development,
manufacturing and marketing costs, especially if a new hardware platform does
not reach a significant level of market acceptance. This risk may increase in
the future, as continuing increases in development costs require corresponding
increases in revenues in order to maintain profitability.
-27-
We have devoted and will continue to devote significant development and
marketing resources on products designed for next-generation video game systems
that have not yet achieved large installed bases. We released several titles for
the PlayStation 2 and have additional titles under development for this
platform. If PlayStation 2 does not continue to achieve wide acceptance by
consumers or Sony is unable to ship a significant number of PlayStation 2 units
in a timely fashion, or if the sale of our titles fails to meet our
expectations, we will have spent substantial amounts for developing products for
this platform without corresponding revenues, which could result in losses. We
are also devoting development resources on products designed for Microsoft's
Xbox and Nintendo's GameCube. If fewer than expected units of a new hardware
platform are produced or shipped, or if such platforms do not achieve commercial
success, we may experience lower than expected sales or losses for these
platforms.
Our business is dependent on licensing and publishing arrangements with
third parties. Our success depends on our ability to identify and develop new
titles on a timely basis. We have entered into agreements with third parties to
acquire the rights to publish and distribute interactive entertainment software.
These agreements typically require us to make advance payments, pay royalties
and satisfy other conditions. Our advance payments may not be sufficient to
permit developers to develop new software successfully. In addition, software
development costs, promotion and marketing expenses and royalties payable to
software developers have increased significantly in recent years and reduce the
potential profits derived from sales of our software. Future sales of our titles
may not be sufficient to recover advances to software developers, and we may not
have adequate financial and other resources to satisfy our contractual
commitments. If we fail to satisfy our obligations under these license
agreements, the agreements may be terminated or modified in ways that may be
burdensome to us.
Returns of our published titles and markdown allowances may adversely
affect our operating results. We are exposed to the risk of product returns and
markdown allowances with respect to our customers. Although our distribution
arrangements with retailers generally do not give them the right to return
titles to us or to cancel firm orders, our arrangements with retailers for
published titles require us to accept returns. We sometimes negotiate
accommodations to retailers, including price discounts, credits and returns,
when demand for specific titles falls below expectations. We establish a reserve
for future returns and markdown allowances for published titles at the time of
sales, based primarily on these return policies and historical return rates, and
we report our revenues net of returns.
Decreased demand for products compatible with older hardware platforms
may result in a higher level of markdown allowances. In addition, if new
platforms or products do not achieve market acceptance, we may be required to
grant markdown allowances to maintain our relationships with retailers and
access to distribution channels. If return rates and markdown allowances for our
published titles significantly exceed our reserves, our revenues will decline
and we could incur losses.
The interactive entertainment software industry is highly competitive.
We compete for both licenses to properties and the sale of interactive
entertainment software with Sony, Nintendo, Microsoft and Sega, each of which is
a large developer and marketer of software for its platforms. Sony and Nintendo
currently dominate the industry and have the financial resources to withstand
significant price competition and to implement extensive advertising campaigns,
particularly for prime-time television spots. These companies may also increase
their own software development efforts or focus on developing software products
for third-party platforms.
We compete with domestic and international companies, large software
companies and media companies. Many of our competitors have far greater
financial, technical, personnel and other resources than we do, and many are
able to carry larger inventories, adopt more aggressive pricing policies and
make higher offers to licensors and developers for commercially desirable
properties than we can. Competition in the entertainment software industry is
based on product quality and features; brand name recognition; access to
distribution channels; effectiveness of marketing; and price. Our titles also
compete with other forms of entertainment such as motion pictures, television
and audio and video cassettes featuring similar themes, online computer programs
and forms of entertainment which may be less expensive or provide other
advantages to consumers.
-28-
Increased competition for limited shelf space and promotional support
from retailers could affect the success of our business and require us to incur
greater expenses to market our titles. Retailers have limited shelf space and
promotional resources, and competition is intense among an increasing number of
newly introduced interactive entertainment software titles for adequate levels
of shelf space and promotional support. Competition for retail shelf space is
expected to increase, which may require us to increase our marketing
expenditures just to maintain current levels of sales of our titles. Competitors
with more extensive lines and popular titles frequently have greater bargaining
power with retailers. Accordingly, we may not be able to achieve the levels of
promotional support and shelf space that such competitors receive.
Rating systems for interactive entertainment software, potential
legislation and consumer opposition could inhibit sales of our products. Trade
organizations within the video game industry require interactive entertainment
software publishers to provide consumers with information relating to graphic
violence, profanity or sexually explicit material contained in software titles.
Certain countries have also established similar rating systems as prerequisites
for sales of interactive entertainment software in such countries. In some
instances, we may be required to modify our products to comply with the
requirements of such governmental entities, which could delay the release of
those products in such countries. We recently discontinued making sales of Grand
Theft Auto 3 in Australia for several weeks while we made certain content
changes to this title to comply with applicable rating systems. We believe that
we comply with such rating systems and display the ratings received for our
titles.
Historically, our software titles received a rating of "G" (all ages)
or "T" (age 13 and over), although most of our newer titles (including Grand
Theft Auto 3, Max Payne and State of Emergency) have received a rating of "M"
(age 18 and over). Certain retailers may decline to sell interactive
entertainment software containing graphic violence or sexually explicit
material, which may limit the potential market for our "M" rated products.
Several proposals have been made for federal legislation to regulate
the interactive entertainment software, motion picture and recording industries,
including a proposal to adopt a common rating system for interactive
entertainment software, television and music containing violence and sexually
explicit material and the Federal Trade Commission has adopted rules with
respect to the marketing of such material to minors. Consumer advocacy groups
have also opposed sales of interactive entertainment software containing graphic
violence and sexually explicit material by pressing for legislation in these
areas and by engaging in public demonstrations and media campaigns. If any
groups were to target our "M" rated titles, we might be required to
significantly change or discontinue a particular title, which in the case of our
best selling titles could hurt our business. Additionally, in light of the
events in September 2001, we revised content in certain of our products that we
deemed inappropriate. Delays in the release of products as a result of
inappropriate content could result in lost revenues.
We cannot publish our console titles without the approval of hardware
manufacturers. We are required to obtain a license to develop and publish titles
for each hardware console platform for which we develop and publish titles. Our
existing hardware console platform licenses require that we obtain approval for
the publication of new titles on a title-by-title basis. As a result, the number
of titles we are able to publish for these hardware platforms, along with our
ability to time the release of these titles and, accordingly, our revenues from
titles for these hardware platforms, may be limited. If any manufacturer chooses
not to renew or extend our license agreement at the end of its current term, or
if the manufacturer were to terminate our license for any reason, we would be
unable to publish additional titles for that manufacturer's hardware platform.
-29-
License agreements relating to these rights generally extend for a term
of three years. The agreements are terminable upon the occurrence of a number of
factors, including: (1) breach of the agreement by us; (2) our bankruptcy or
insolvency; or (3) our entry into a relationship with, or acquisition by, a
competitor of the manufacturer. We cannot assure you that we will be able to
obtain new or maintain existing licenses on acceptable terms, or at all.
We are dependent upon a license agreement with Sony to publish titles
for PlayStation 2. The term of the license agreement expires in March 2003 and
is automatically extended, unless terminated by one of the parties, for
additional successive one-year terms. Termination of such agreement would
seriously hurt our business.
Sony and Nintendo are the sole manufacturers of the titles we publish
under license from them. Games for the Xbox must be manufactured by pre-approved
manufacturers. Each platform license provides that the manufacturer may raise
prices for the titles at any time and grants the manufacturer substantial
control over the release of new titles. Each of these manufacturers also
publishes software for its own platforms and manufactures titles for all of its
other licensees and may choose to give priority to its own titles or those of
other publishers if it has insufficient manufacturing capacity or if there is
increased demand.
In addition, these manufacturers may not have sufficient production
capacity to satisfy our scheduling requirements during any period of sustained
demand. If manufacturers do not supply us with finished titles on favorable
terms without delays, our operations would be materially interrupted, and we
would be unable to obtain sufficient amounts of our product to sell to our
customers. If we cannot obtain sufficient product amounts, our revenues will
decline and we could incur losses.
We may not be able to protect our proprietary rights or avoid claims
that we infringe on the proprietary rights of others. We develop proprietary
software and have obtained the rights to publish and distribute software
developed by third parties. We attempt to protect our software and production
techniques under copyright, trademark and trade secret laws as well as through
contractual restrictions on disclosure, copying and distribution. Interactive
entertainment software is susceptible to unauthorized copying. Unauthorized
third parties may be able to copy or to reverse engineer our software to obtain
and use programming or production techniques that we regard as proprietary.
As the amount of interactive entertainment software titles in the
market increases and the functionality of this software further overlaps, we
believe that interactive entertainment software will increasingly become the
subject of claims that such software infringes the copyrights or patents of
others. From time to time, we receive notices from third parties alleging
infringement of their proprietary rights. Although we believe that our software
and technologies and the software and technologies of third-party developers and
publishers with whom we have contractual relations do not and will not infringe
or violate proprietary rights of others, it is possible that infringement of
proprietary rights of others has or may occur. Any claims of infringement, with
or without merit, could be time-consuming, costly and difficult to defend.
We are dependent on third-party software developers to complete many of
our titles. We rely on third-party software developers for the development of a
significant number of our titles. Quality third-party developers are continually
in high demand. Software developers who have developed titles for us in the past
may not be available to develop software for us in the future. Due to the
limited number of third-party software developers and the limited control that
we exercise over them, these developers may not be able to complete titles for
us on a timely basis or within acceptable quality standards, if at all.
-30-
We depend on third-party software developers and our internal
development studios to develop new interactive entertainment software within
anticipated release schedules and cost projections. In addition, the development
cycle for new titles is long, typically ranging from twelve to twenty-four
months. After development of a product, it may take between six to twelve
additional months to develop the product for other hardware platforms. If
developers experience financial difficulties, additional costs or unanticipated
development delays, we will not be able to release titles according to our
schedule.
Our software is susceptible to errors, which can harm our financial
results and reputation. The technological advancements of new hardware platforms
allow more complex software products. As software products become more complex,
the risk of undetected errors in products when first introduced increases. If,
despite testing, errors are found in new products or releases after shipments
have been made, we could experience a loss of or delay in timely market
acceptance, product returns, loss of revenues and damage to our reputation.
The costs of developing and marketing products for new interactive
entertainment hardware platforms may be substantial and could harm our operating
results. We anticipate that it will be more costly to develop titles for new
hardware platforms and believe the costs of developing and publishing titles for
these hardware platforms will require greater financial and technical resources
than prior development and publishing efforts. Additionally, during periods of
new technology and platform introductions, forecasting our revenues and earnings
is more difficult than in more stable or rising product markets.
Our distribution business is subject to intense competition. Our
distribution business operates in a highly competitive environment. The intense
competition that characterizes our industry is based primarily on breadth,
availability and quality of product lines; price; terms and conditions of sale;
credit terms and availability; speed and accuracy of delivery; and effectiveness
of sales and marketing programs. Our competitors include regional, national and
international distributors, as well as hardware manufacturers and software
publishers. We may lose market share or be forced in the future to reduce our
prices in response to the actions of our competitors, and thereby experience a
reduction in our gross margins.
Gross margins relating to our distribution business have been
historically narrow which increases the impact of variations in costs on our
operating results. As a result of intense price competition in the console
hardware and software distribution industry, our gross margins in our
distribution business have historically been narrow and we expect them to
continue to be narrow in the future. We receive purchase discounts from
suppliers based on various factors, including volume purchases. These purchase
discounts directly affect our gross margins. It may become more difficult for us
to achieve the percentage growth in sales required to continue to receive volume
purchase discounts.
A significant percentage of our revenues relates to products sold to us
by relatively few manufacturers or publishers. They each have the ability to
make rapid and significantly adverse changes in their sales terms and
conditions, such as reducing the amount of price protection and return rights as
well as reducing the level of purchase discounts they make available to us. Our
inability to pass through to our customers the impact of these changes could
have a negative impact on our gross margins. A decline in gross margins could
have a material adverse effect on our business and could result in losses.
We may not be able to adequately adjust our cost structure in a timely
fashion in response to a sudden decrease in demand. A significant portion of our
selling and general and administrative expense is comprised of personnel,
facilities and costs of invested capital. In the event of a significant decline
in revenues, we may not be able to exit facilities, reduce personnel, or make
other significant changes to our cost structure without significant disruption
to our operations or without significant termination and exit costs. Management
may not be able to implement such actions, if at all, in a timely manner to
offset an immediate shortfall in revenues and gross profit.
-31-
Our distribution business is dependent on suppliers to maintain an
adequate supply of products to fulfill customer orders on a timely basis. Our
ability to obtain particular products in required quantities and to fulfill
customer orders on a timely basis is critical to our success. In most cases, we
have no guaranteed price or delivery agreements with suppliers. In certain
product categories, limited price protection or return rights offered by
manufacturers may have a bearing on the amount of product we may be willing to
purchase. The console hardware industry experiences significant product supply
shortages from time to time due to the inability of certain manufacturers to
supply certain products on a timely basis. As a result, we have experienced, and
may in the future continue to experience, short-term hardware inventory
shortages. In addition, manufacturers who currently distribute their products
through us may decide to distribute, or to substantially increase their existing
distribution, through other distributors, or directly to retailers. In the case
of software, alternative means of distribution have emerged, such as electronic
distribution. We cannot assure you that suppliers will be able to maintain an
adequate supply of products to fulfill our customer orders on a timely basis or
that we will be able to obtain particular products or that products currently
offered by suppliers will continue to be available.
We are subject to the risk that our inventory values may decline and
protective terms under supplier arrangements may not adequately cover the
decline in values. The interactive entertainment software and hardware industry
is subject to rapid technological change, new and enhanced generations of
products, and evolving industry standards. These changes may cause inventory to
decline substantially in value or to become obsolete. We are also exposed to
inventory risk to the extent that supplier price protections are not available
on all products or quantities and are subject to time restrictions. In addition,
suppliers may become insolvent and unable to fulfill price protection
obligations.
We rely on arrangements with independent shipping companies for the
delivery of our products. The termination of our arrangements with one or more
of these independent shipping companies, or the failure or inability of one or
more of these independent shipping companies to deliver products from suppliers
to us or products from us to our customers on a timely basis could adversely
affect our results of operations.
Our rapid expansion and acquisitions may strain our operations. We have
expanded through internal growth and acquisitions, which have placed and may
continue to place a significant strain on our management, administrative,
operational, financial and other resources. We have released a significant
number of titles on new platforms, expanded our publishing and distribution
operations, increased our advances to developers and payments to manufacturers,
enlarged our work force and expanded our presence in international markets. To
successfully manage this growth, we must continue to implement and improve our
operating systems as well as hire, train and manage a substantial and increasing
number of management, technical, marketing, administrative and other personnel.
We may be unable to effectively manage expanded operations that are
geographically dispersed.
A limited number of customers may account for a significant portion of
our sales. Sales to our five largest customers accounted for approximately,
20.9% of our revenues for the year ended October 31, 2001, 22.7% of our revenues
for the year ended October 31, 2000 and 24.6% of our revenues for the year ended
October 31, 1999. Our customers may terminate their relationship with us at any
time. The loss of our relationships with principal customers or a decline in
sales to principal customers could harm our operating results. Bankruptcies or
consolidations of certain large retail customers could also hurt our business.
-32-
We have significant debt obligations. We have historically incurred
substantial indebtedness in order to finance our operations. As of October 31,
2001, $48,701,000 was outstanding under a line of credit agreement entered into
with a group of lenders led by Bank of America, N.A., as agent. This line of
credit was recently amended to provide for borrowings of up to $15,000,000
through February 20, 2002; $22,500,000 through February 28, 2002; $30,000,000
through April 13, 2002; and $50,000,000 through December 7, 2002. Borrowings
under the line of credit are collateralized by our accounts receivable,
inventory, equipment, general intangibles, securities and other personal
property, including the capital stock of our domestic subsidiaries. The loan
agreement contains certain financial and other covenants, which were
retroactively amended. Accordingly, we are in compliance with such covenants as
amended. The loan agreement limits or prohibits us, subject to certain
exceptions, from declaring or paying cash dividends, merging or consolidating
with another corporation, selling assets (other than in the ordinary course of
business), creating liens and incurring additional indebtedness. If we default
on our obligations, the banks could elect to declare our indebtedness to be due
and payable and foreclose on our assets. Our UK subsidiary also had outstanding
indebtedness of $5,372,000 at October 31, 2001.
We are subject to credit and collection risks. Our sales are typically
made on credit, with terms that vary depending upon the customer and the demand
for the particular title being sold. We do not hold any collateral to secure
payment by our customers. As a result, we are subject to credit risks,
particularly in the event that any of our receivables represent sales to a
limited number of retailers or are concentrated in foreign markets. If we are
unable to collect on accounts receivable as they become due and such accounts
are not covered by insurance, it could adversely affect our financial condition.
Our accounts receivable, less an allowance for doubtful accounts and product
returns, at October 31, 2001 were $94,950,000.
We are subject to risks and uncertainties of international trade. Sales
in international markets, primarily in the United Kingdom and other countries in
Europe and the Pacific Rim, have accounted for a significant portion of our
revenues. Sales in international markets accounted for approximately 23.6% of
our revenues for the year ended October 31, 2001, 28.4% of our revenues for the
year ended October 31, 2000 and 33.0% of our revenues for the year ended October
31, 1999. We are subject to risks inherent in foreign trade, including increased
credit risks; tariffs and duties; fluctuations in foreign currency exchange
rates; shipping delays; and international political, regulatory and economic
developments, all of which can have a significant impact on our operating
results. All of our international sales are made in local currencies. For the
year ended October 31, 2001, our foreign currency translation adjustment loss
was $767,000. We purchase currency forward contracts to a limited extent to seek
to minimize our exposure to fluctuations in foreign currency exchange rates.
Litigation. Several class action lawsuits have been filed against us.
These lawsuits can be costly to defend and can distract management's time from
our operations. An unfavorable resolution of these actions could have a material
adverse effect on our financial condition and results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are subject to market risks in the ordinary course of our business,
primarily risks associated with interest rate and foreign currency fluctuations.
Historically, fluctuations in interest rates have not had a significant impact
on our operating results. At October 31, 2001, we had $54,073,000 in outstanding
variable rate indebtedness. A hypothetical 1% increase in the interest rate of
our variable rate debt would increase annual interest expense by approximately
$541,000 as of October 31, 2001.
-33-
We transact business in foreign currencies and are exposed to risk
resulting from fluctuations in foreign currency exchange rates. Accounts
relating to foreign operations are translated into United States dollars using
prevailing exchange rates at the relevant fiscal quarter or year end.
Translation adjustments are included within accumulated other comprehensive
income as a separate component of stockholders' equity. For the year ended
October 31, 2001, our foreign currency translation loss was $767,000. A
hypothetical 10% change in applicable currency exchange rates at October 31,
2001 would result in a material translation adjustment. We purchase currency
forward contracts to a limited extent to seek to minimize our exposure to
fluctuations in foreign currency exchange rates. We had no outstanding contracts
as of October 31, 2001.
In addition, we may be exposed to risk of loss associated with
fluctuations in the value of our investments. Our investments are stated at fair
value, with net unrealized appreciation and loss included within accumulated
other comprehensive income as a separate component of stockholders' equity. We
regularly review the carrying values of our investments to identify and record
impairment losses when events or circumstances indicate that such investments
may be other than temporarily impaired.
In fiscal 2001, we recorded a loss of $19,171,000 to reflect an other
than temporary impairment of our investment relating to Gameplay. At October 31,
2001, we held 6,869,000 shares of common stock of Gameplay.com plc with a fair
value of approximately $75,000 which was recorded as non-current.
In fiscal 2001, we recorded a loss of $2,000,000 to reflect an other
than temporary impairment of our investment relating to eUniverse Inc. At
October 31, 2001, we held 2,269,333 shares of eUniverse with fair value of
approximately $6,241,000, all of which was recorded as current. We recorded an
unrealized gain of $157,000, net of tax of $96,000, within accumulated other
comprehensive income (loss) as a separate component of stockholders' equity.
Item 8. Financial Statements.
The financial statements appear in a separate section of this report
following Part III.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
-34-
PART III
Item 10. Directors and Executive Officers.
The information required by this Item is incorporated by reference to
the section of the Company's definitive Proxy Statement for its Annual Meeting
of Stockholders to be held in 2002, entitled "Election of Directors" to be filed
with the Securities and Exchange Commission within 120 days after the end of the
fiscal year covered by this Report.
Item 11. Executive Compensation.
The information required by this Item is incorporated by reference to
the section of the Company's definitive Proxy Statement for its Annual Meeting
of Stockholders to be held in 2002, entitled "Executive Compensation" to be
filed with the Securities and Exchange Commission within 120 days after the end
of the fiscal year covered by this Report.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this Item is incorporated by reference to
the section of the Company's definitive Proxy Statement for its Annual Meeting
of Stockholders to be held in 2002, entitled "Security Ownership of Certain
Beneficial Owners and Management" to be filed with the Securities and Exchange
Commission within 120 days after the end of the fiscal year covered by this
Report.
Item 13. Certain Relationships and Related Transactions.
The information required by this Item is incorporated by reference to
the section of the Company's definitive Proxy Statement for its Annual Meeting
of Stockholders to be held in 2002, entitled "Certain Relationships and Related
Transactions" to be filed with the Securities and Exchange Commission within 120
days after the end of the fiscal year covered by this Report.
-35-
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Exhibits
3.1 Form of Restated Certificate of Incorporation of the
Company.(1)
3.2 Amendment to Restated Certificate of Incorporation.(1)
3.3 By-Laws of the Company.(1)
10.1 1997 Stock Option Plan of the Company.(1)
10.2 Credit Agreement (the "Credit Agreement"), dated December 7,
1999, by and among the Company, certain of its subsidiaries,
certain lenders and Bank of America, N.A., as Agent.(2)
10.3 Amendment to Credit Agreement.
10.4 Loan Agreement with Lloyds TBS Commercial and Take-Two
Interactive Software Europe Ltd.
10.5 Employment Agreement, dated July 21, 2000, as amended, by and
between the Company and Paul Eibeler.
10.6 Employment Agreement dated February 15, 2001 by and between
the Company and Kelly Sumner.
10.7 Licensed Publishing Agreement dated April 1, 2000 between Sony
Computer Entertainment America, Inc. and the Company.(3)*
10.8 Publishing Agreement dated May 8, 1998 between Gathering of
Developers I, Ltd. and Apogee Software, Ltd/ 3D Realms.(3)*
10.9 Xbox Publisher License Agreement dated December 14, 2000
between Microsoft Corporation and the Company. *
10.10 Confidential License Agreement for Nintendo GameCube dated
September 24, 2001 between Nintendo of America Inc. and the
Company. *
21.1 Subsidiaries of the Company.
23.1 Consent of PricewaterhouseCoopers LLP.
* Portions hereof have been omitted and filed separately with
the Securities and Exchange Commission pursuant to a request
for confidential treatment in accordance with Exchange Act
Rule 24b-2
-36-
- --------------------
(1) Incorporated by reference to the applicable exhibit contained in
the Company's Registration Statement on Form SB-2 (File no. 333-6414).
(2) Incorporated by reference to the applicable exhibit contained in
the Company's Annual Report on Form 10-K for the year ended October 31, 1999.
(3) Incorporated by reference to the applicable exhibit contained in
the Company's Registration Statement on Form S-3 (File No. 333-66748).
(b) Financial Statement Schedules: Schedule II-Valuation and Qualifying
Accounts.
(c) Reports on Form 8-K filed during the quarter ended October 31,
2001: None
-37-
TAKE-TWO INTERACTIVE SOFTWARE, INC.
YEAR ENDED OCTOBER 31, 2001
INDEX TO FINANCIAL STATEMENTS
Report of Independent Accountants F-1
Consolidated Balance Sheets - At October 31, 2001 and October 31, 2000
(restated) F-2
Consolidated Statements of Operations - For the years ended October 31, 2001,
2000 (restated) and 1999 F-3
Consolidated Statements of Cash Flows - For the years ended October 31, 2001,
2000 (restated) and 1999 F-4
Consolidated Statements of Stockholders' Equity - For the years ended October
31, 1999, 2000 (restated) and 2001 F-5
Notes to Consolidated Financial Statements F-7
Report of Independent Accountants
To the Board of Directors and
Shareholders of Take-Two Interactive Software, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flows and stockholders' equity
listed in the accompanying index present fairly, in all material respects, the
financial position of Take Two Interactive Software, Inc. and its subsidiaries
("the Company") at October 31, 2001 and October 31, 2000, and the results of
their operations and their cash flows for each of the three years in the period
ended October 31, 2001 in conformity with accounting principles generally
accepted in the United States of America. In addition, in our opinion, the
financial statement schedule listed in the accompanying index present fairly, in
all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and financial statement schedule are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, the Company
restated its financial statements for the year ended October 31, 2000.
As discussed in Note 3 to the consolidated financial statements, effective
November 1, 2000, the Company changed its method of accounting for revenue
recognition to conform to the requirements of SEC Staff Accounting Bulletin
No. 101 Revenue Recognition.
/s/ PricewaterhouseCoopers LLP
New York, New York
February 11, 2002
F-1
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share data)
- --------------------------------------------------------------------------------
October 31, 2001 October 31, 2000
ASSETS: Restated
---------------- ----------------
Current assets:
Cash and cash equivalents $ 6,056 $ 5,245
Accounts receivable, net of provision for doubtful
accounts and sales allowances of $26,106 and $11,615 at
October 31, 2001 and 2000, respectively 94,950 110,783
Inventories, net 61,937 53,798
Prepaid royalties 21,892 24,093
Prepaid expenses and other current assets 17,925 10,386
Investments 6,241 2,926
Deferred tax asset 13,873 9,243
--------- ---------
Total current assets 222,874 216,474
Property and equipment, net 11,033 5,260
Prepaid royalties 11,097 1,303
Capitalized software development costs, net 11,934 9,613
Investments 75 28,487
Intangibles, net 88,175 66,562
Deferred tax asset 7,892 --
Other assets 1,917 2,558
--------- ---------
Total assets $ 354,997 $ 330,257
========= =========
LIABILITIES and STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $ 60,223 $ 46,566
Accrued expenses and other current liabilities 20,250 16,189
Lines of credit 54,073 84,605
Current portion of capital lease obligation 99 89
--------- ---------
Total current liabilities 134,645 147,449
Capital lease obligation, net of current portion 291 348
Loan payable, net of unamortized discount of $2,732 at October 31, 2000 -- 12,268
--------- ---------
Total liabilities 134,936 160,065
--------- ---------
Commitments and contingencies (See Note 14)
Stockholders' equity
Common stock, par value $.01 per share; 50,000,000 shares authorized;
36,640,972, and 31,172,866 shares issued and outstanding
at October 31, 2001 and 2000, respectively 366 312
Additional paid-in capital 213,908 157,738
Deferred compensation -- (5)
Retained earnings 16,239 24,819
Accumulated other comprehensive loss (10,452) (12,672)
--------- ---------
Total stockholders' equity 220,061 170,192
--------- ---------
Total liabilities and stockholders' equity $ 354,997 $ 330,257
========= =========
The accompanying notes are an integral part of these
consolidated financial statements
F-2
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Consolidated Statements of Operations
(In thousands, except per share data)
Years Ended October 31,
-----------------------------------
2000
2001 Restated 1999
--------- --------- ---------
Net sales $ 451,056 $ 364,001 $ 304,714
Cost of sales (includes impairment charge on Internet gaming assets of $3,786 306,264 235,978 213,904
for the year ended October 31, 2001)
--------- --------- ---------
Gross profit 144,792 128,023 90,810
--------- --------- ---------
Operating expenses:
Selling and marketing (includes impairment charge on Internet
gaming assets of $401 for the year ended October 31, 2001) 55,253 42,854 30,108
General and administrative 44,867 36,409 25,236
Research and development costs 6,190 5,668 5,263
Depreciation and amortization 12,641 8,680 2,822
Abandoned offering costs -- 1,103 --
--------- --------- ---------
Total operating expenses 118,951 94,714 63,429
--------- --------- ---------
Income from operations 25,841 33,309 27,381
Non-operating expense (income):
Interest expenses, net 8,510 6,069 2,910
Gain on sale of subsidiary (651) (1,690) --
Loss on available-for-sale Internet securities 21,477 -- --
Equity in loss of affiliate -- 19,969 45
--------- --------- ---------
Total non-operating expense 29,336 24,348 2,955
(Loss) income before income taxes, extraordinary item and cumulative
effect of change in accounting principle (3,495) 8,961 24,426
(Benefit) provision for income taxes (2,200) 2,544 8,094
--------- --------- ---------
(Loss) income before extraordinary item and cumulative effect of change
in accounting principle (1,295) 6,417 16,332
Extraordinary item, loss on early extinguishment of debt, net of taxes of $1,217 1,948 -- --
Cumulative effect of change in accounting principle, net of taxes of $3,558 5,337 -- --
--------- --------- ---------
Net (loss) income $ (8,580) $ 6,417 $ 16,332
========= ========= =========
Share data:
Basic:
Weighted average common shares outstanding 33,961 27,307 20,690
========= ========= =========
(Loss) income before extraordinary item and cumulative effect of change
in accounting per share $ (0.04) $ 0.23 $ 0.79
Extraordinary item per share (0.06) -- --
Cumulative effect of change in accounting principle per share (0.16) -- --
--------- --------- ---------
Net (loss) income - Basic $ (0.25) $ 0.23 $ 0.79
========= ========= =========
Diluted:
Weighted average common shares outstanding 33,961 28,330 21,515
========= ========= =========
(Loss) income before extraordinary item and cumulative effect of change
in accounting per share $ (0.04) $ 0.23 $ 0.76
Extraordinary item per share (0.06) -- --
Cumulative effect of change in accounting principle per share (0.16) -- --
--------- --------- ---------
Net (loss) income - Diluted $ (0.25) $ 0.23 $ 0.76
========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------
(In thousands) Year ended October 31,
--------------------------------
2000
2001 Restated 1999
--------- --------- ---------
Cash flows from operating activities:
Net (loss) income $ (8,580) $ 6,417 $ 16,332
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization 12,641 8,680 2,822
Loss on disposal of fixed assets 219 239 124
Gain on sale of subsidiary (651) (1,690) --
Loss on available-for-sale Internet securities 21,477 -- --
Impairment charge on Internet assets 4,187 -- --
Stock received in consideration of license revenues -- (1,710) --
Equity in loss of affiliate -- 19,969 45
Extraordinary loss on early extinguishment of debt, net of taxes 1,948 -- --
(Benefit) provision for deferred taxes (8,307) (1,301) 70
Provision for doubtful accounts and sales allowances 14,491 3,722 3,843
Provision for Inventory obsolescence 108 9 319
Amortization of various expenses and discounts 2,134 439 485
Forfeiture of compensatory stock options in connection with AIM acquisition -- -- (146)
Issuance of compensatory stock -- 55 831
Changes in assets and liabilities, net of acquisitions and disposals:
Decrease (increase) in accounts receivable 7,325 (6,467) (51,970)
Increase in inventories, net (4,034) (12,507) (10,835)
Increase in prepaid royalties (8,279) (16,914) (12,119)
Decrease in advances to developers -- -- 4,320
Increase in prepaid expenses and other current assets (5,470) (4,009) (6,361)
(Increase) decrease in capitalized software development costs (2,710) (7,386) 33
(Increase) decrease in other non-current assets (455) (1,428) 618
Increase (decrease) in accounts payable 1,511 (28,680) 30,181
(Decrease) increase in accrued expenses and other current liabilities (236) (11,668) 9,366
Decrease in other liabilities -- -- (3,981)
-------- -------- --------
Net cash provided by (used in) operating activities 27,319 (54,230) (16,023)
-------- -------- --------
Cash flows from investing activities:
Purchases of fixed assets (8,568) (2,881) (2,180)
Investment in affiliates -- -- (4,100)
Other investment -- (4,122) --
Acquisitions, net of cash acquired (1,769) (4,294) (15,260)
Acquisitions of intangible assets (3,105)
Proceeds from disposal of a business 215 -- --
Additional cash paid for prior acquisition (252) (1,609) --
-------- -------- --------
Net cash used in investing activities (13,479) (12,906) (21,540)
-------- -------- --------
Cash flows from financing activities:
Issuance of stock in connection with the secondary public offering,
net of issuance costs of $2,187 -- -- 21,852
Proceeds from private placements 20,892 21,285 --
Net (repayments) borrowings under lines of credit (40,545) 28,557 22,869
Financing costs (1,029) (725)
(Repayment) proceeds from loan payable (15,000) 15,000 --
Repayments of note payable -- (89) (460)
Proceeds from exercise of stock options and warrants 22,931 6,921 2,609
Repayments of capital lease obligation (68) (110) (90)
-------- -------- --------
Net cash (used in) provided by financing activities (11,790) 70,535 46,055
-------- -------- --------
Effect of foreign exchange rates on cash (1,239) (8,528) (881)
-------- -------- --------
Net increase (decrease) in cash for the period 811 (5,129) 7,611
Cash and cash equivalents, beginning of the period 5,245 10,374 2,763
-------- -------- --------
Cash and cash equivalents, end of the period $ 6,056 $ 5,245 $ 10,374
======== ======== ========
Supplemental disclosure of non-cash investing activities:
Issuance of common stock in connection with acquisitions $ 13,981 $ 55,261 $ 7,364
======== ======== ========
Equipment acquired under capital lease $ 21 $ 140 $ --
======== ======== ========
F-4
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------
(In thousands) Year ended October 31,
--------------------------------
2000
2001 Restated 1999
-------- ------------- --------
Supplemental information on businesses acquired:
Fair value of assets acquired
Cash $ 331 $ 164 $ 329
Current assets 10,417 241 12,316
Non current assets 770 138 1,245
Investment (including prepaid purchase price for Neo) -- 48,385 --
Intangible assets 25,168 22,910 24,097
Less, liabilities assumed
Current Liabilities (25,809) (3,171) (15,909)
Stock and warrants issued (8,611) (54,816) (6,096)
Options issued -- (1,750) --
Disposal adjustment -- (3,279) --
Direct transaction costs (166) (400) (393)
Investment interest and purchase option -- (3,964) --
-------- -------- --------
Cash paid 2,100 4,458 15,589
Less, cash acquired (331) (164) (329)
-------- -------- --------
Net cash paid $ 1,769 $ 4,294 $ 15,260
======== ======== ========
Supplemental information on businesses disposed:
Current assets $ (318) $ (457)
Non current assets -- (553)
Current liabilities 754 235
-------- --------
Net liabilities (assets) disposed 436 (775)
Consideration received for business disposed:
Stock -- 2,751
Cash 215 --
-------- ---------
Gain on sale $ (651) $ (1,976)
======== ========
Cash paid during the year for interest $ 8,284 $ 5,944 $ 2,670
======== ======== ========
Cash paid during the year for taxes $ 9,793 $ 4,030 $ 829
======== ======== ========
The supplemental information on business acquired and disposed for the year
ended October 31, 2000 are net of the Toga acquisition and disposal.
(See Note 4)
The accompanying notes are an integral part of the
consolidated financial statements.
F-5
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the years ended October 31, 1999, October 31, 2000 (restated) and
October 31, 2001
(In thousands)
Common Stock Additional
---------------------- Paid-in Deferred
Shares Amount Capital Compensation
--------- --------- --------- ---------
Balance, November 1, 1998 18,072 $ 181 $ 33,546 $ (224)
Issuance of compensatory stock options and warrants 537 5 831 (5)
Proceeds from exercise of stock options and warrants 654 6 2,602 --
Amortization of deferred compensation -- -- -- 181
Forfeiture of compensatory stock options in connection with AIM acquisition -- -- (146) --
Issuance of common stock in connection with acquisitions 763 8 7,364 --
Issuance of common stock in connection with a public offering,
net of issuance costs 3,005 30 21,822 --
Issuance of common stock in lieu of royalty payments 55 1 332 --
Tax benefit in connection with the exercise of stock options -- -- 994 --
Foreign currency translation adjustment -- -- -- --
Net income -- -- -- --
--------- --------- --------- ---------
Balance, October 31, 1999 23,086 231 67,345 (48)
Proceeds from exercise of stock options and warrants 1,373 13 6,963 --
Amortization of deferred compensation -- -- -- 43
Issuance of common stock in connection with acquisitions 4,222 43 55,218 --
Issuance of common stock in connection with private placements,
net of issuance costs 2,422 24 21,261 --
Issuance of warrant in connection with a debt financing 2,927 --
Issuance of common stock in lieu of repayment of debt assumed from Pixel 168 2 2,528
Retirement of common stock (98) (1) (1,249) --
Tax benefit in connection with the exercise of stock options -- -- 2,745 --
Foreign currency translation adjustment -- -- -- --
Net unrealized loss on investments net of taxes of $1,736 -- -- -- --
Net income - Restated -- -- -- --
--------- --------- --------- ---------
Balance, October 31, 2000 (restated) 31,173 312 157,738 (5)
Proceeds from exercise of stock options and warrants 3,266 32 22,582 --
Amortization of deferred compensation -- -- -- 5
Issuance of common stock in connection with acquisitions 1,466 14 13,967 --
Issuance of common stock in connection with private placements,
net of issuance costs 1,300 13 20,879 --
Retirement of common stock (564) (5) (7,305) --
Tax benefit in connection with the exercise of stock options -- -- 6,047 --
Foreign currency translation adjustment -- -- -- --
Net unrealized gain on investments net of taxes of $1,640 -- -- -- --
Net loss -- -- -- --
--------- --------- --------- ---------
Balance, October 31, 2001 36,641 $ 366 $ 213,908 $ --
========= ========= ========= =========
(In thousands)
Accumulated
Other
Retained Comprehensive Comprehensive
Earnings Income Income
(Deficit) (Loss) Total (Loss)
--------- --------- --------- ---------
Balance, November 1, 1998 $ 2,070 $ (7) $ 35,566 $ 7,304
Issuance of compensatory stock options and warrants -- -- 831
Proceeds from exercise of stock options and warrants -- -- 2,608
Amortization of deferred compensation -- -- 181
Forfeiture of compensatory stock options in connection with AIM acquisition -- -- (146)
Issuance of common stock in connection with acquisitions -- -- 7,372
Issuance of common stock in connection with a public offering,
net of issuance costs -- -- 21,852
Issuance of common stock in lieu of royalty payments -- -- 333
Tax benefit in connection with the exercise of stock options -- -- 994
Foreign currency translation adjustment -- (820) (820) (820)
Net income 16,332 -- 16,332 16,332
--------- --------- --------- ---------
Balance, October 31, 1999 18,402 (827) 85,103 15,512
Proceeds from exercise of stock options and warrants -- -- 6,976
Amortization of deferred compensation -- -- 43
Issuance of common stock in connection with acquisitions -- -- 55,261
Issuance of common stock in connection with private placements,
net of issuance costs -- -- 21,285
Issuance of warrant in connection with a debt financing -- -- 2,927
Issuance of common stock in lieu of repayment of debt assumed from Pixel 2,530
Retirement of common stock -- -- (1,250)
Tax benefit in connection with the exercise of stock options -- -- 2,745
Foreign currency translation adjustment -- (9,014) (9,014) (9,014)
Net unrealized loss on investments net of taxes of $1,736 -- (2,831) (2,831) (2,831)
Net income - Restated 6,417 -- 6,417 6,417
--------- --------- --------- ---------
Balance, October 31, 2000 (restated) 24,819 (12,672) 170,192 (5,428)
Proceeds from exercise of stock options and warrants -- -- 22,614
Amortization of deferred compensation -- -- 5
Issuance of common stock in connection with acquisitions -- -- 13,981
Issuance of common stock in connection with private placements,
net of issuance costs -- -- 20,892
Retirement of common stock -- -- (7,310)
Tax benefit in connection with the exercise of stock options -- -- 6,047
Foreign currency translation adjustment -- (767) (767) (767)
Net unrealized gain on investments net of taxes of $1,640 -- 2,987 2,987 2,987
Net loss (8,580) -- (8,580) (8,580)
--------- --------- --------- ---------
Balance, October 31, 2001 $ 16,239 $ (10,452) $ 220,061 $ (6,360)
========= ========= ========= =========
The accompanying notes are an integral part of these
consolidated condensed financial statements.
F-6
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
1. Description of the Business
Take-Two Interactive Software, Inc. (the "Company") was incorporated in
the State of Delaware in September 1993. The Company develops
interactive software games designed for PCs and video game console
platforms and publishes games it and other parties develop. It also
distributes games for PC's and video game consoles published by third
parties.
2. Restatement of Financial Statements
The Company engaged outside Counsel to conduct an investigation into
the Company's accounting treatment of certain transactions in fiscal
2000 and 2001. Counsel was assisted in its investigation by forensic
accountants.
As a result of the investigation, the Company restated its previously
issued consolidated financial statements for fiscal 2000 to eliminate
$15,367,000 of net sales made to independent third party distributors
and the related cost of sales of $8,702,000, which were improperly
recognized as revenue since the products were later returned or
repurchased by the Company.
In addition, the Company reviewed its revenue recognition policy,
reserve policies and its accounting for certain other transactions. As
a result of this review, the Company restated its previously issued
consolidated financial statements for fiscal 2000 for the following
transactions:
o The elimination of $3,780,000 of sales and related cost of
sales of $2,236,000 that were previously recognized for
products that had not been shipped within the period.
o A non-cash charge of $19,206,000 to record the Company's
portion of the losses incurred by an affiliate accounted for
under the equity method in accordance with the provisions of
EITF Issue No. 99-10 (see Note 7), and a relating net
reduction for post acquisition amortization of $710,000 after
the Company acquired the remaining 80% interest in this entity
(see Note 4).
o The elimination of $2,563,000 of license revenue in connection
with a business combination (see Note 5).
The Company's 2000 financial statements have been restated as follows
(presented in thousands, except per share data):
Year ended
October 31, 2000
---------------------------
As Reported As Restated
----------- -----------
Statement of Operations Data:
Net sales * $ 387,006 $ 364,001
Cost of sales * $ 247,796 $ 235,978
Depreciation and amortization $ 9,805 $ 8,680
Income from operations $ 45,061 $ 33,309
Equity in loss of affiliate $ 763 $ 19,969
Income before provision for income taxes $ 38,229 $ 8,961
Provision for income taxes $ 13,266 $ 2,544
Net income $ 24,963 $ 6,417
Basic income per share $ 0.91 $ 0.23
Diluted income per share $ 0.88 $ 0.23
* Restated amounts give effect to reclassification of certain amounts to
conform to current year presentation including the reduction in net sales
and costs of sales by approximately $1.3 million.
F-7
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
October 31, 2000
-----------------------
As Reported As Restated
----------- -----------
Balance Sheet Data
Accounts receivable* $134,877 $110,783
Inventories* $ 44,922 $ 53,798
Prepaid royalties - current $ 19,721 $ 24,093
Deferred tax assets $ 666 $ 9,243
Intangible assets $ 90,505 $ 66,562
Other assets, net $ 1,565 $ 2,558
Total assets $351,641 $330,257
Accounts payable $ 47,972 $ 46,566
Accrued expenses and other current liabilities* $ 19,357 $ 16,189
Total liabilities $164,639 $160,065
Retained earnings $ 43,365 $ 24,819
Total liabilities and stockholders equity $351,641 $330,257
* Restated amounts reflect a reclassification relating to the presentation of
allowance for returns.
All applicable amounts relating to the aforementioned restatements have
been reflected in these consolidated financial statements and notes
thereto.
3. Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the financial statements
of the Company and its wholly owned subsidiaries. All intercompany
balances and transactions have been eliminated in consolidation.
Certain amounts in the financial statements of the prior years have
been reclassified to conform to the current year presentation for
comparative purposes.
Risks and Uncertainties
Substantially all of the Company's net sales are derived from software
publishing and distribution activities, which are subject to increasing
competition, rapid technological change and evolving consumer
preferences, often resulting in the frequent introduction of new
products and short product lifecycles. Accordingly, the Company's
profitability and growth prospects depend upon its ability to
continually acquire, develop and market new, commercially successful
software products and obtain adequate financing, if required. If the
Company fails to continue to acquire, develop and market commercially
successful software products, its operating results, cash flows and
financial condition could be materially adversely affected in the
near future.
F-8
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at
the dates of the financial statements and the reported amounts of
revenues and expenses during the reporting periods. The most
significant estimates and assumptions relate to the recoverability of
prepaid royalties, capitalized software development costs and other
intangibles, inventories, realization of deferred income taxes and the
adequacy of allowances for returns, price protection and doubtful
accounts. Actual amounts could differ significantly from these
estimates.
Concentration of Credit Risk
A significant portion of the Company's cash balance is maintained with
several major financial institutions with satisfactory standing and,
while attempting to limit credit exposure with any single institution,
there are times that balances will exceed insurable amounts.
If the financial condition and operations of the Company's customers
deteriorate, the risk of collection could increase substantially. As of
October 31, 2001 and 2000, the receivable balances from the Company's
largest customer amounted to approximately 11.7% and 10.1% of the
Company's net receivable balance, respectively. For the years ended
October 2001, 2000, and 1999, the Company's five largest customers
accounted for 20.9%, 22.7%, and 24.6% of net sales, respectively.
Except for the largest customer noted above, all receivable balances
from the remaining customers were less than 10%. The Company maintains
insurance, to the extent available, on the receivable balances.
Revenue Recognition
Publishing revenue is derived from the sale of internally developed
interactive software titles or from the sale of titles licensed from
a third party developer. Publishing revenue amounted to $242,913,000
$186,118,000 and $159,117,000 in 2001, 2000 and 1999, respectively.
Distribution revenue is derived from the sale of third-party
interactive software titles and hardware. Distribution revenue amounted
to $208,143,000, $177,883,000 and $145,597,000 for 2001, 2000 and 1999,
respectively.
The Company recognizes revenue in accordance with Statement of Position
("SOP") 97-2 "Software Revenue Recognition", as amended by SOP 98-9
"Modification of SOP 97-2 Software Revenue Recognition with respect to
Certain Transactions." SOP 97-2 provides guidance on applying generally
accepted accounting principles in recognizing revenue on software
transactions. SOP 98-9 deals with the determination of vendor specific
objective evidence of fair value in multiple element arrangements, such
as maintenance agreements sold in conjunction with software packages.
The Company's transactions generally include only one element, the
interactive software game. The Company recognizes revenue, when the
price is fixed and determinable, there is persuasive evidence of an
arrangement, the fulfillment of its obligations under any such
arrangement and determination that collection is probable. Accordingly,
revenue is recognized when title and all risks of loss are transferred
to the customer, which is generally upon receipt. The Company's payment
arrangements with its customers provide primarily 60 day terms and to a
limited extent with certain customers 30, 90 or 120 day terms.
The Company's distribution arrangements with customers generally do not
give customers the right to return products; however, the Company at
its discretion may accept product returns for stock balancing or
defective products. In addition, the Company sometimes negotiates
accommodations to customers, including price discounts, credits and
product returns, when demand for specific products falls below
expectations. The Company's publishing arrangements require the Company
to accept product returns. The Company establishes a reserve for future
returns and other allowances based primarily on its return policies,
price protection and historical return rates. The Company may not have
a reliable basis to estimate returns and allowances for certain
customers or it may be unable to determine that collection of the
receivable is probable. In such circumstances, the Company defers the
revenues at the time of the sale and recognizes them when collection of
the related receivable becomes probable or cash is received.
F-9
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
Effective November 1, 2000, the Company adopted Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements". Consistent with the guidelines provided in SAB No. 101,
the Company changed its revenue recognition policy to recognize revenue
as noted above. Prior to the adoption of SAB 101, the Company
recognized revenue upon shipment. As a result of adopting SAB 101, net
sales and cost of sales of approximately $27.2 million and $18.3
million, respectively, which were originally recognized in the year
ended October 31, 2000 were also recognized in the year ended October
31, 2001. The cumulative effect of the application of the revenue
recognition policies set forth in SAB 101 for the year ended October
31, 2001 was approximately $5.3 million net of tax benefit of
approximately $3.6 million or $0.16 per share. Had the Company adopted
SAB 101 as of the beginning of fiscal 2000, the unaudited pro forma net
sales, net income and diluted earnings per share for the year ended
October 31, 2000 would have been approximately $345 million, $4.6
million and $0.16, respectively. It is impracticable for the Company to
present proforma information for periods prior to fiscal 2000.
Advertising
The Company expenses advertising costs as incurred. The Company shares
portions of certain customers' advertising expenses through co-op
advertising arrangements. Co-op advertising allowances provided to
customers are recognized at the time the revenue is recognized.
Advertising expense for the years ended October 31, 2001, 2000, and
1999 amounted to $22,983,000, $16,769,000 and $11,986,000,
respectively.
Cash and Cash Equivalents
The Company considers all highly liquid instruments purchased with
original maturities of three months or less to be cash equivalents.
Inventory
Inventories are stated at the lower of average cost or market. The
Company periodically evaluates the carrying value of its inventories
and makes adjustments as necessary. Reserves for product returns are
included in the inventory balance.
Prepaid Royalties
The Company's agreements with licensors and developers generally
provide it with exclusive publishing rights and require it to make
advance royalty payments that are recouped against royalties due to the
developer based on product sales. Prepaid royalties are amortized as
cost of sales based on the greater of the proportion of current year
sales to total of current and estimated future sales on a title by
title basis for that title or the contractual royalty rate based on
actual net product sales. The Company continually evaluates the
recoverability of prepaid royalties and charges to cost of sales the
amount that management determines is probable that will not be recouped
at the contractual royalty rate in the period in which such
determination is made. Included in prepaid royalties at October 31,
2001 and 2000, respectively are $13,811,000 and $9,029,000 related to
titles that have not been released yet. Prepaid royalties are
classified as current and non-current assets based upon estimated net
product sales within the next year. Prepaid royalties were written down
by $975,000 $501,000 and $1,308,000 for the years ended October 31,
2001, 2000 and 1999, respectively, to estimated net realizable value.
Amortization of prepaid royalties amounted to $17,598,000, $16,849,000
and $12,144,000 during fiscal years 2001, 2000, and 1999, respectively.
Capitalized Software Development Costs (Including Film Production
Costs)
The Company capitalizes internal software development costs subsequent
to establishing technological feasibility of a title. Amortization of
such costs as a component of cost of sales is recorded on a
product-by-product basis upon product release based on the greater of
the proportion of current year sales to total of current and estimated
future sales for that title or the straight-line method over the
remaining estimated useful life of the product. The Company continually
evaluates the recoverability of capitalized software costs. Capitalized
Software Development Costs represent the costs associated with the
internal development of the Company's publishing products. Capitalized
software costs were written down by $389,000 and $698,000 to estimated
net realizable value for the years ended October 31, 2001 and 1999,
respectively. No capitalized software costs were written down for the
year ended October 31, 2000. Amortization of capitalized software costs
amounted to $3,780,000, $1,451,000 and $1,136,000 during 2001, 2000,
and 1999, respectively.
F-10
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
Property and Equipment
Office equipment, furniture and fixtures and automobiles are
depreciated using the straight-line method over their estimated lives
ranging from five to seven years. Computer equipment and software are
depreciated using the straight-line method over three years. Leasehold
improvements are amortized over the lesser of the term of the related
lease or estimated useful lives. Accumulated amortization includes the
amortization of assets recorded under capital leases, which amounted to
approximately $202,000 and $73,000 at October 31, 2001 and 2000,
respectively. The cost of additions and betterments are capitalized,
and repairs and maintenance costs are charged to operations in the
periods incurred. When depreciable assets are retired or sold, the cost
and related allowances for depreciation are removed from the accounts
and the gain or loss is recognized. The carrying values of these assets
are recorded at historical cost. The cost of major additions and
betterments is capitalized.
Intangible Assets
Intangible assets consist of identifiable intangibles and the remaining
excess purchase price paid over identified intangible and tangible net
assets of acquired companies (goodwill). Intangible assets are
amortized under the straight-line method over the period of expected
benefit of seven years for the acquisition of development studios and
ten years for the acquisition of distribution operations. The Company
assesses the recoverability of its intangible assets by determining
whether the carrying value can be recovered through estimated future
undiscounted cash flows over its remaining life. If estimated future
cash flows indicate that the unamortized balance will not be recovered,
an adjustment will be made to reduce the carrying value to an amount
consistent with estimated future cash flows discounted at the Company's
incremental borrowing rate. Cash flow estimates are based on trends of
historical performance and management's estimate of future performance,
giving consideration to existing and anticipated competitive and
economic conditions.
Impairment of Long-Lived Assets
The Company accounts for long-lived assets in accordance with the
provisions of Statement of Financial Accounting Standards No. 121,
"Accounting for Impairment of Long-Lived Assets and Long Lived Assets
to be Disposed Of" ("SFAS 121"). SFAS 121 requires that long-lived
assets be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. The Company compares the carrying amount of the asset to
the estimated undiscounted future cash flows expected to result from
the use of the asset. If the carrying amount of the asset exceeds
estimated expected undiscounted future cash flows, the Company records
an impairment charge for the difference between the carrying amount of
the asset its fair value. The estimation of fair value is generally
measured by discounting expected future cash flows at the Company's
incremental borrowing rate or fair value if available.
Stock-Based Compensation
The Company accounts for its employee stock option plans in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25"). Under APB 25, generally no
compensation expense is recorded when the terms of the award are fixed
and the exercise price of the employee stock option equals or exceeds
the fair value of the underlying stock on the date of grant. The
Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123").
Net (Loss) Income per Share
Basic earnings per share ("EPS") is computed by dividing the net (loss)
income applicable to common stockholders for the year by the
weighted-average number of common shares outstanding during the year.
Diluted EPS is computed by dividing the net (loss) income applicable to
common stockholders for the year by the weighted-average number of
common and common stock equivalents, which include common shares
issuable upon the exercise of stock options and warrants outstanding
during the year. Common stock equivalents are excluded from the
computation if their effect is antidilutive.
F-11
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
Comprehensive Income (Loss)
Comprehensive income (loss) represents the change in net assets of a
business enterprise during a period from transactions and other events
and circumstances from non-owner sources. Comprehensive income (loss)
of the Company includes net income adjusted for the change in foreign
currency translation adjustments and the change in net unrealized gain
(loss) from investments.
Income Taxes
The Company recognizes deferred taxes under the asset and liability
method of accounting for income taxes. Under the asset and liability
method, deferred income taxes are recognized for differences between
the financial statement and tax bases of assets and liabilities at
currently enacted statutory tax rates for the years in which the
differences are expected to reverse. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes
the enactment date. In addition, valuation allowances are established
when necessary to reduce deferred tax assets to the amounts expected to
be realized.
Foreign Currency Translation
The functional currency for the Company's foreign operations is the
applicable local currency. Accounts of foreign operations are
translated into U.S. dollars using quarter or year-end exchange rates
for assets and liabilities at the balance sheet date and average
prevailing exchange rates for the period for revenue and expense
accounts. Adjustments resulting from translation are included in other
comprehensive income (loss).
Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments, including
cash and cash equivalents, accounts receivable, accounts payable and
accrued liabilities, approximate fair value because of their short
maturities. The carrying amount of prepaid royalties and investments
approximate fair value based upon the recoverability of these assets.
The carrying amount of the Company's lines of credit approximates fair
value because the interest rates of the lines of credit are based on
floating rates identified by reference to market rates. The carrying
amounts of the Company's loan payable and capital lease obligations
approximate the fair value of such instruments based upon management's
best estimate of interest rates that would be available to the Company
for similar debt obligations at October 31, 2001.
The Company enters into forward foreign exchange contracts to a limited
extent to manage the risk associated with currency fluctuations on
certain sales and purchase commitments denominated in foreign
currencies. The Company's forward foreign exchange contracts are
primarily denominated in certain European currencies and are for
periods consistent with the terms of the underlying transactions, which
is less than one year. Gains and losses resulting from the impact of
currency exchange rate movements on contracts that qualify, as
effective hedges are not recognized in operations until the underlying
hedged transactions are recognized. Upon recognition, such gains and
losses are recorded in operations as an adjustment to the carrying
amount of the underlying transactions in the period in which these
transactions are recognized. As of October 31, 2001, there are no
forward foreign exchange contracts outstanding. As of October 31, 2000,
the contract amount of forward foreign exchange contracts outstanding
was approximately $678,000.
Recently Issued Accounting Pronouncements
In July 2001, the FASB issued Statement of Financial Accounting
Standard No. 141, "Business Combinations" ("SFAS 141") and Statement of
Financial Accounting Standard No. 142, "Goodwill and Other Intangible
Assets" ("SFAS 142").
SFAS 141 establishes accounting and reporting for business combinations
by requiring that all business combinations be accounted for under the
purchase method. Use of the pooling-of-interests method is no longer
permitted. SFAS 141 also provides guidance on purchase accounting
related to the recognition of intangible assets and accounting for
negative goodwill. SFAS 141 requires that the purchase method be used
for business combinations initiated after June 30, 2001.
F-12
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
SFAS 142 changes the accounting for goodwill from an amortization
method to an impairment-only approach. Upon adoption of SFAS 142,
amortization of goodwill recorded for business combinations consummated
prior to July 1, 2001 will cease, and intangible assets acquired prior
to July 1, 2001 that do not meet the criteria for recognition under
SFAS 141 will be reclassified to goodwill. Goodwill will be subject to
an annual impairment test, including a transitional impairment test
required upon adoption of SFAS 142 for which companies have six months
to complete. The provisions of SFAS 142 will be effective for fiscal
years beginning after December 15, 2001; however, early adoption is
permitted. The Company anticipates the early adoption of SFAS 142 as of
the beginning of fiscal 2002. The Company is still in the process of
reallocating previously identifiable intangibles that do not meet the
criteria of SFAS 141 into Goodwill and evaluating the useful lives of
its remaining identifiable intangibles. However, the Company currently
estimates that unaudited pro forma income (loss) before extraordinary
item and cumulative effect of change in accounting principle and the
respective diluted EPS and net income and diluted EPS would have been
approximately $2.9 million and $0.08 and ($4.4 million) and ($0.13),
respectively for the year ended October 31, 2001 had the provisions of
the new standards been applied in that year. The Company is in the
process of completing its step one transition assessment of goodwill.
However, it does not currently anticipate having to record transition
impairment of goodwill or other intangible assets as a cumulative
effect as a result of these new standards.
In August 2001, the FASB issued Statement of Financial Accounting
Standard No.143, "Accounting for Obligations Associated with the
Retirement of Long-Lived Assets" ("SFAS 143"). The objective of SFAS
143 is to provide accounting guidance for legal obligations associated
with the retirement of long-lived assets. The retirement obligations
included within the scope of this pronouncement are those that an
entity cannot avoid as a result of either the acquisition, construction
or normal operation of a long-lived asset. Components of larger systems
also fall under this pronouncement, as well as tangible long-lived
assets with indeterminable lives. The provisions of SFAS 143 are
effective for financial statements issued for fiscal years beginning
after June 15, 2002. The Company is currently evaluating the expected
impact of the adoption of SFAS 143 on the Company's financial
condition, cash flows and results of operations. The Company will adopt
the standard in the first quarter of fiscal 2003.
In October 2001, the FASB issued Statement of Financial Accounting
Standard No.144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS 144"). The objectives of SFAS 144 are to
address significant issues relating to the implementation of SFAS 121
and to develop a single accounting model, based on the framework
established in SFAS 121, for long-lived assets to be disposed of by
sale, whether previously held and used or newly acquired. The
provisions of SFAS 144 are effective for financial statements issued
for fiscal years beginning after December 15, 2001. The Company is
currently evaluating the expected impact of the adoption of SFAS 144 on
the Company's financial condition and results of operations. The
Company will adopt the standard at the first quarter of fiscal 2003.
4. Business Acquisitions (See Note 5)
The Company acquired a number of companies that develop, publish or
distribute interactive software games during the three-year period
ended October 31, 2001. The aggregate purchase price, including cash
payments and issuance of its common stock was $28.1 million, $65.4
million, and $9.7 million in 2001, 2000 and, 1999, respectively. The
value of the Company's common stock issued in connection with these
acquisitions has been based on the market price of the Company's common
stock at the time such proposed transactions were agreed and announced.
The aggregate purchase price excludes the value of stock issued for
acquisitions accounted for as pooling of interests.
In 1999, 1,033,000 shares of the Company's common stock were issued for
the acquisition of Talonsoft, Inc. ("Talonsoft") accounted for as
pooling of interests. The Company's consolidated financial statements
including the related notes had been restated as of the earliest period
presented to include the results of operations, financial position and
cash flows of Talonsoft.
The acquisitions described below have been accounted for as purchase
transactions in accordance with APB No. 16 and SFAS 141 (for
transactions after July 1, 2001) and, accordingly, the results of
operations and financial position of the acquired businesses are
included in the Company's consolidated financial statements from the
respective dates of acquisition.
2001 transactions
In July 2001, the Company acquired all of the outstanding capital stock
of Techcorp Limited ("Techcorp"), a Hong Kong based design and
engineering firm specializing in video game accessories. In
consideration, the Company issued 30,000 shares of the Company's
restricted common stock (valued at $572,000), paid $100,000 in cash and
assumed net liabilities of approximately $2.9 million. In connection
with the acquisition, the Company recorded goodwill of $3,558,000 on a
preliminary basis. The Company is in the process of obtaining an
independent third party valuation in support of its preliminary
purchase price allocation. The Company will make the required
adjustments, if any, upon completion of such valuation. In accordance
with SFAS 141, the Company is not amortizing the goodwill recorded in
connection with this acquisition.
F-13
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
In November 2000, the Company acquired all of the outstanding capital
stock of VLM Entertainment Group, Inc. ("VLM"), a company engaged in
the distribution of third-party software products. In connection with
this transaction, the Company paid the former stockholders of VLM $2
million in cash and issued 875,000 shares of the Company's common stock
(valued at $8.0 million) and assumed net liabilities of approximately
$10.6 million. In connection with this transaction, the Company
recorded intangible assets of approximately $20.7 million on a
preliminary basis. The Company is in the process of obtaining an
independent third party valuation in support of its preliminary
purchase price allocation. The Company will make the required
adjustments, if any, upon completion of such valuation.
In connection with the sale of Toga to Gameplay in October 2000, the
Company agreed to acquire Gameplay's game software development and
publishing business - Neo Software Produktions GMBH ("Neo"). Such
acquisition was completed in January of 2001. See Note 5 for further
discussion of this transaction.
The following table sets forth the components of the purchase price of
the 2001 acquisitions (in thousands):
Neo VLM Techcorp Total
-------- -------- -------- --------
Cost of the acquisition:
Value of business sold
(Prepaid purchase price-Neo)
or stock issued $ 17,266 $ 8,039 $ 572 $ 25,877
Cash -- 2,000 100 2,100
Transaction Costs 109 27 30 166
-------- -------- -------- --------
Total $ 17,375 $ 10,066 $ 702 $ 28,143
======== ======== ======== ========
Allocation of purchase price:
Current Assets $ 2 $ 9,852 $ 894 $ 10,748
Non-Current Assets 71 201 498 770
Liabilities (881) (20,680) (4,248) (25,809)
Goodwill 7,282 12,362 3,558 23,202
Customer Lists -- 8,331 -- 8,331
Technology 8,037 -- -- 8,037
Trademarks 1,939 -- 1,939
Workforce 925 -- -- 925
-------- -------- -------- --------
Total $ 17,375 $ 10,066 $ 702 $ 28,143
======== ======== ======== ========
Certain of Neo's internet-related technology assets were determined to
be impaired in April 2001. Accordingly, the Company recorded as cost of
sales a non-cash impairment charge of $3,786,000 consisting of
$2,350,000 relating to server maintenance technologies and $1,047,000
relating to multiplayer technologies developed by Neo's development
studio in connection with Online Pirates and $389,000 of capitalized
software relating to other products to be developed by Neo. In
addition, the Company recorded as selling and marketing expenses an
impairment charge of $401,000 related to online sales promotions.
F-14
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
2000 Transactions
In August 2000, the Company acquired all of the outstanding capital
stock of PopTop Software, Inc. ("PopTop") for 559,100 shares of its
Common Stock (valued at $5.8 million) and assumed net liabilities of
approximately $88,000.
In April 2000, the Company acquired the remaining 80.1% of the equity
interest of Gathering of Developers, Ltd ("Gathering") for 1,060,000
shares of its Common Stock (valued at $10.4 million) and assumed
liabilities of approximately $3 million. In accordance with the
provisions of EITF 99-10, the Company recorded an additional charge of
$19,206,000 (see Notes 2 and 7) which effectively reduced the cost of
the acquisition of Gathering by the same amount. The result was a net
reduction for post acquisition amortization of $710,000 comprised of a
$1,125,000 reduction of the amortization of intangible assets offset by
an increase of $415,000 in the amortization of prepaid royalties.
In March 2000, the Company acquired all of the outstanding capital
stock of Toga, the parent company of Pixel Broadband Studios, Ltd.
("Pixel"). In connection with this acquisition, the Company paid $4.5
million in cash, issued 2,561,000 shares of its Common Stock (valued at
$38.6 million), issued a warrant to purchase the stock of Pixel to the
founder of Pixel (valued at $1.75 million based on the Black-Scholes
pricing model) and assumed net liabilities of approximately $3.3
million. Toga was sold in October 2000 to Gameplay.com PLC
("Gameplay") (See Note 5).
The following table sets forth the components of the purchase prices of
the 2000 acquisitions (net of the disposition of Toga) (in thousands):
Gathering Pop Top Toga Total
-------- -------- -------- --------
Cost of the acquisition:
Value of stock issued $ 10,402 $ 5,836 $ 38,578 $ 54,816
Value of warrants issued -- -- 1,750 1,750
Cash -- -- 4,458 4,458
Investments and advances at
time of acquisition 3,964 -- -- 3,964
Transaction Costs 48 32 320 400
-------- -------- -------- --------
Total $ 14,414 $ 5,868 $ 45,106 $ 65,388
Allocation of purchase price:
Current Assets $ 4,063 $ -- $ -- $ 4,063
Non-Current Assets 72 66 -- 138
Liabilities (6,675) (154) (3,279) (10,108)
Goodwill 8,128 $ 5,110 $ -- 13,238
Trademarks 8,826 846 -- 9,672
Prepaid purchase price - Neo -- -- 17,266 17,266
Gameplay Investment -- -- 31,119 31,119
-------- -------- -------- --------
Total $ 14,414 $ 5,868 $ 45,106 $ 65,388
F-15
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
Unaudited proforma information
The unaudited pro forma data below for the years ended October 31, 2001
and 2000 is presented as if purchase acquisitions for fiscal 2000 and
2001 had been made as of November 1, 1999. The unaudited pro forma
financial information is based on management's estimates and
assumptions and does not purport to represent the results that actually
would have occurred if the acquisitions had, in fact, been completed on
the dates assumed, or which may result in the future. The unaudited pro
forma financial information includes purchase acquisitions that are
significant to the Company's operations.
Unaudited Pro forma
(in thousands, except for per share data)
October 31, 2001 October 31, 2000
---------------------- -------------------------
Total Revenues $ 458,665 $ 424,809
Income before extraordinary item and
cumulative effect of change in
accounting: $ (4,079) $ 1,187
Net income per share - Basic $ (0.12) $ 0.03
Net income per share - Diluted $ (0.12) $ 0.03
Included in the unaudited pro forma information is amortization of
goodwill of approximately $7,320,000 and $7,744,000 net of taxes of
$2,799,000 and $3,081,000 for the years ended October 31, 2001 and
2000, respectively.
1999 transactions
In 1999, the Company paid $1.2 million in cash, issued 638,000 shares
of its common stock (valued at $6.1 million), incurred direct
transaction costs of approximately $400,000 and assumed liabilities
of approximately $15.9 million for all acquisitions accounted for as
purchases. These acquisitions were LDA Distribution Limited, Joytech
Europe Limited, DVDWave.com, Funsoft Nordic A.S., Triad Distributors,
Inc., Global Star Software Ltd., DMA Design Holdings Limited, DMA
Design Limited and CD Verte, S.p.A. ("CD Verte") and a minority
interest in Bungie Software. In addition, for CD Verte, the Company
paid $800,000 on December 1, 1999 and will pay an additional $1.2
million, subject to a potential downward adjustment based on net income
of the acquired entity, over a three-year period.
5. Disposition of Assets
In July 2001, the Company sold all of the outstanding capital stock of
Jack of All Games UK, a video game distributor, to Jay Two Limited, an
unaffiliated third-party controlled by Freightmasters Ltd., for
approximately $215,000. In connection with the sale, the purchaser
assumed net liabilities of $436,000. The Company recorded a
non-operating gain of $651,000 net of taxes relating to the sale.
In October 2000, the Company sold all of the outstanding shares of Toga
to Gameplay and simultaneously entered into a license agreement with
Gameplay for the online distribution of certain of the Company's PC
games. Toga had been purchased in March 2000 (see Note 4). The Company
received (i) 15,371,698 shares of Gameplay's common stock (valued at
approximately $31.1 million); (ii) a warrant to purchase 1,000,000
shares of Gameplay stock (the Company assigned no value to the
warrant); and (iii) a joint exploitation agreement with Gameplay under
which the Company acquired rights to the software development business
of Neo - a subsidiary of Gameplay (valued at approximately $17.3
million). The value of such right was recorded as prepaid purchase
price at the time of Toga's sale and has been included in intangible
assets at October 31, 2000.
F-16
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
The Company recognized a loss of $286,000 on the sale of Toga, which
was recorded as a component of "gain on sale of subsidiary, net" on the
2000 Consolidated Statement of Operations. The Company obtained an
independent third party valuation in support of the value assigned to
its right to acquire Neo. In January 2001, the Company completed the
acquisition of Neo and assumed net liabilities of approximately
$808,000, in addition to the prepaid purchase price of $17.3 million
noted above.
In June 2000, the Company sold its 19.9% equity interest in Bungie
Software ("Bungie") to Microsoft Corporation for approximately $5
million in cash. The Company did not realize any gain or loss on this
transaction. Separately, the Company sold its exclusive Halo publishing
and distribution rights to Bungie for $4 million in cash, a royalty
free license to Bungie's Halo technology in connection with the
development of two original products and all right, title and interest
to the Myth franchise and the PC and Playstation(R) 2 game, Oni. The
Company recorded this transaction as net sales of $5.5 million after
giving effect to the receipt of $9 million in cash and $5.8 million of
assets (consisting of $2.8 million relating to Oni, $1.5 million
relating to Myth and $1.5 million relating to the license to use Halo
game engine technology for two original products), net of $9.3 million
of assets sold. The Company obtained independent third party valuations
in support of the transaction.
In February 2000, the Company sold all of its interest in Falcon
Ventures Corporation d/b/a DVDWave.com to eUniverse, Inc. ("eUniverse")
in exchange for 310,000 shares of eUniverse's common stock. The Company
recognized a gain of $1,976,000 and recorded such gain as a component
of "Gain on sale of subsidiary, net" on the Consolidated Statement of
Operations.
6. Intangible Assets
Intangible assets consist of trademarks, intellectual property,
customer lists, acquired technology and the excess purchase price paid
over identified intangible and tangible net assets of acquired
companies (goodwill).
In December 2000, the Company acquired the exclusive worldwide
publishing rights to the franchise of Duke Nukem PC and video games,
including the PC, console and sequel rights to Duke Nukem Forever. In
connection with the transaction, the Company paid $2.3 million in cash
and issued 557,103 shares of its common stock (valued at approximately
$5.4 million). In addition, the Company is contingently liable to make
a further payment of $6 million upon delivery of the gold master of
Duke Nukem Forever. The Company recorded an intangible asset of $7.7
million related to the intellectual property purchased in this
transaction on a preliminary basis. The Company is in the process of
obtaining an independent third party valuation in support of its
preliminary valuation. The Company will make the required adjustments,
if any, upon completion of such valuation. The additional $6 million
will be recorded as an additional intangible asset upon resolution of
the contingency.
F-17
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
The following table sets forth the components of the intantgible
assets as of October 31, 2001 and 2000 (in thousands):
October October
31, 2001 31, 2000
-------- --------
Goodwill $ 70,191 $ 45,183
Prepaid purchase price -Neo (Note 5) -- 17,266
Trademarks 13,922 11,983
Customer lists 9,081 803
Intellectual property 8,527 --
Technology 4,640 --
Workforce 925 --
-------- --------
107,286 75,235
Less - accumulated amortization 19,111 8,673
-------- --------
$ 88,175 $ 66,562
-------- --------
Amortization expense for the years ended October 31, 2001, 2000, and
1999, amounted to $9,309,000, $6,919,000, and $1,662,000, respectively.
7. Investment in Affiliate
In May 1998, the Company entered into a distribution agreement with
Gathering, a publisher of PC and video games. Pursuant to the
agreement, the Company agreed to pay Gathering advance royalty payments
of up to $7.5 million for the rights to distribute certain PC titles.
In February 1999, the Company amended the May 1998 distribution
agreement under which the Company agreed to pay Gathering advance
royalty payments of up to $12.5 million (inclusive of the payments
under the May 1998 agreement). The Company's advance royalty payments
under the February 1999 agreement were to be recouped from royalties
due to Gathering under the distribution agreement after payment of the
Company's distribution fee. The Company also made advance royalty
payments to Gathering in a similar arrangement under various publishing
agreements for video games.
In February 1999, the Company purchased a 19.9% equity interest in
Gathering for approximately $4 million. The investment was accounted
for by the equity method due to the Company having significant
influence over Gathering. The difference between the carrying value of
the investment and the underlying equity in the net assets of
approximately $4,377,000, was attributed to goodwill and was
amortized using the straight-line method over the period of expected
benefit of seven years. Such amortization has been included in the
equity in loss of affiliate.
In addition, the equity holders of Gathering granted the Company an
option to purchase all of their interests, exercisable on two separate
occasions during the six-month periods ending April 30, 2001 and 2002
based on a fixed formula. In consideration of the option grant, the
Company issued to Gathering's equity holders 125,000 shares of common
stock, valued at $1,275,000, which was amortized over the term of the
purchase option, which expired unexercised in April 2000 upon
acquisition of the remaining 80% equity interest in Gathering (see
Note 4).
Until October 31, 1999, the Company recognized its proportionate share
of the losses in Gathering using the equity method of accounting.
Effective November 1, 1999, the Company recognized its share of losses
in accordance with the provisions of EITF 99-10, "Percentage Used to
Determine the Amount of Equity Method Losses." This resulted in an
additional charge of $19,206,000 (See Note 2).
F-18
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
8. Investments
Investments are comprised of marketable equity securities and are
classified as current and non-current assets. The investments are
accounted for under the cost method as "available-for-sale" in
accordance with Statement of Financial Standards No. 115 "Accounting
for Certain Investments in Debt and Equity Securities". The investments
are stated at fair value, with unrealized appreciation reported as a
separate component of accumulated other comprehensive income (loss) in
stockholders' equity.
During 2001, the Company recorded an impairment charge of $21,477,000,
consisting of approximately $19,171,000 relating to its investment in
Gameplay, $2,000,000 relating to its investment in eUniverse, Inc.
based on the quoted market prices and $306,000 relating to its
investment in a privately-held company, which is included in other
non-current assets. All of these investments were deemed to be other
than temporarily impaired. In addition, the Company recorded unrealized
gains and losses on its remaining investments through other
comprehensive income (loss).
As of October 31, 2001 and 2000, investments consist of (in thousands):
2001 2000
----------------------- -----------------------
Current Non Current Current Non Current
-------- -------- -------- --------
Average cost $ 5,988 $ 75 $ 2,896 $ 33,084
Unrealized gains (losses) $ 253 $ -- 30 (4,597)
-------- -------- -------- --------
Fair value $ 6,241 $ 75 $ 2,926 $ 28,487
======== ======== ======== ========
For the fiscal years ended October 31, 2001 and 2000, the gross
proceeds from the sale of investments were $11,000 and $639,000,
respectively. The gross realized losses from these sales totaled
$69,000 and $180,000, respectively. The loss on sale of securities is
based on the average cost of the individual securities sold.
9. Inventories
As of October 31, 2001 and 2000, inventories consist of (in thousands):
2001 2000
------- -------
Parts and supplies $ 1,468 $ 496
Finished products 60,469 53,302
------- -------
$61,937 $53,798
------- -------
10. Fixed Assets
As of October 31, 2001 and 2000, fixed assets consist of (in
thousands):
2001 2000
-------- --------
Computer equipment $ 5,705 $ 3,737
Office equipment 1,583 816
Computer software 4,357 537
Furniture and fixtures 1,876 1,710
Automobiles 438 305
Leasehold improvements 2,209 1,086
Capital leases 398 348
-------- --------
16,566 8,539
Less: accumulated depreciation and
Amortization (5,533) (3,279)
-------- --------
$ 11,033 $ 5,260
======== ========
F-19
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
In 2001, the Company capitalized costs of approximately $2.8 million
associated with software and hardware upgrades to its accounting
systems.
Depreciation expense for the years ended October 31, 2001, 2000, and
1999, amounted to $3,731,000, $1,761,000, and $1,160,000, respectively.
11. Lines of Credit
As of October 31, 2001 and 2000, lines of credit consist of (in
thousands):
2001 2000
------- -------
Line of credit with Bank of America -
4.94% to 6.01% (8.38 to 9.23% in 2000) $48,701 $70,599
Line of credit with Barclays' Bank -
5.25% to 5.75% (7.4% in 2000) -- 14,006
Line of credit with Lloyds TSB Bank plc - 4.5% to 5.75%
5,372 --
------- -------
$54,073 $84,605
======= =======
In February 2001, five of the Company's European subsidiaries entered
into a credit facility agreement with Lloyds TSB Bank plc ("Lloyds")
under which Lloyds agreed to make available borrowings of up to $19
million linked to the British Pound Sterling. Borrowings under the line
of credit are collaterized by: (i) a guarantee by the Company for
approximately $23 million, plus interest and other costs, as defined;
(ii) an unlimited debenture by the European subsidiaries and (iii) an
assignment of the proceeds of the insurance policies, as defined, taken
out in respect of the Europeans subsidiaries accounts receivables. The
outstanding balance and available credit under the revolving line of
credit were $5,372,000 and $15,076,000 respectively, as of October 31,
2001. Advances under the credit facility bear interest at the rate of
1.25% per annum over the bank's base rate. The credit facility
originally expired in December 2001 but has been extended through March
31, 2002.
In December 1999, the Company entered into a credit agreement with a
group of lenders led by Bank of America, N.A., as agent, which provides
for borrowings of up to $75,000,000. The Company may increase the
credit line up to $85,000,000 subject to certain conditions. Interest
accrues on such advances at the bank's prime rate plus 0.5% or at LIBOR
plus 2.5%. Borrowings under the line of credit are collaterized by all
of the Company's accounts receivable, inventory, equipment, general
intangibles, securities and other personal property, including the
capital stock of the Company's domestic subsidiaries. The outstanding
balance and available credit under this facility were $48,701,000 and
$26,299,000, respectively at October 31, 2001. The line of credit
expires on December 7, 2002. Under the terms of the credit agreement,
the Company is required to comply with certain financial, affirmative
and negative covenants, including consolidated net worth, consolidated
leverage ratio and consolidated fixed charge ratio. In addition, the
credit agreement limits or prohibits the Company from
declaring or paying cash dividends, merging or consolidating with
another corporation, selling assets (other than in the ordinary course
of business), creating liens and incurring additional indebtedness.
The agreement was amended in February 2002 to provide for borrowings of
up to $15,000,000 through February 20, 2002; $22,500,000 through
February 28, 2002; $30,000,000 through April 13, 2002; and $50,000,000
through the remaining term of the agreement. Generally, advances under
the line of credit are based on a borrowing formula equal to the lesser
of (1) the borrowing limit or (2) 70% of eligible accounts receivable,
plus 25% of eligible inventory. In addition, certain financial
covenants and several other covenants were amended retroactively.
Accordingly, as of October 31, 2001, the Company was in compliance with
the covenants, as amended.
F-20
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
In December 1999, Take-Two Interactive Software Europe Limited entered
into a line of credit agreement with Barclays' Bank. The line of credit
provided for borrowings of up to approximately $25,000,000. Advances
under the line of credit bore interest at the rate of 1.4% over the
bank's base rate per annum, payable quarterly. Borrowings were
collateralized by receivables of the Company's European subsidiaries,
and guaranteed by the Company. The available credit under this facility
expired in February 2001.
12. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities as of October 31, 2001
and 2000 consist of (in thousands):
2001 2000
------- -------
Accrued co-op advertising and product rebates $ 4,514 $ 1,801
Accrued VAT and payroll taxes 5,214 539
Income taxes payable -- 5,410
Royalties payable 3,829 4,866
Deferred revenue 748 --
Other 5,945 3,573
------- -------
Total $20,250 $16,189
======= =======
13. Extraordinary Loss on Early Extinguishment of Debt
In July 2000, the Company entered into a subordinated loan agreement
with Finova Mezzanine Capital Inc. ("Finova") in the principal amount
of $15 million. The loan was payable in full in July 2005, and bore
interest at the rate of 12.5% per annum, payable monthly. In connection
with the loan, the Company issued to Finova a five year warrant to
purchase approximately 452,000 shares of common stock exercisable at a
price of $11.875 per share. The warrant was valued at approximately
$2.9 million, using the Black-Scholes pricing model with the following
weighted average assumptions: expected volatility of 55.0%; a risk-free
interest rate of 6.1%; dividend rate of 0.0% and an expected term of
5.2 years. Subject to the outstanding loan balance, the warrant
entitled Finova to receive additional shares of the Company's Common
Stock for three consecutive years commencing July 2003, and contained
certain anti-dilution provisions. The Company had recorded the loan net
of a discount of approximately $2.9 million to reflect an allocation of
the proceeds to the estimated value of the warrant. The discount was
amortized using the "interest method" over the term of the financing.
In July 2001, the Company prepaid the outstanding subordinated loan and
recorded an extraordinary loss of $1,948,000, net of $1,217,000 of
income taxes, related to the deferred financing costs and the
unamortized discount associated with the loan. In accordance with its
terms, the contingent warrant for additional shares of the Company's
Common Stock was terminated.
F-21
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
14. Commitments and Contingencies
Capital Leases
The Company leases equipment under capital lease agreements, which
extend through fiscal year 2006. Future minimum lease payments under
these capital leases, and the present value of such payments as of
October 31, 2001 is as follows:
Year ending October 31: (in thousands)
-----------------------
2002 $ 120
2003 117
2004 117
2005 67
2006 1
Thereafter --
----------------
Total minimum lease payments 422
Less: amounts representing interest (32)
----------------
Present value of minimum obligations under capital leases $ 390
================
Lease Commitments
The Company leases 28 office and warehouse facilities. The corporate
headquarters are leased under a noncancelable operating lease with a
company controlled by the father of the chairman of the board and
expires in March 2004. Rent expense and certain utility expenses under
this lease amounted to $474,000, $419,000, and $302,000, for the years
ended October 31, 2001, 2000, and 1999, respectively. The other offices
are under noncancelable operating leases expiring at various times from
July 2001 to October 2011. In addition, the Company has leased certain
equipment, furniture and auto leases under noncancelable operating
leases, which expire through July 2005.
Future minimum rentals required as of October 31, 2001 are as follows:
Year ending October 31: (in thousands)
-----------------------
2002 $ 3,879
2003 3,363
2004 2,662
2005 1,998
2006 1,282
Thereafter 3,572
------------------
Total minimum lease payments $ 16,756
==================
Rent expense (including the corporate headquarters) amounted to
$3,553,000, $2,303,000, and $1,544,000, for the years ended October 31,
2001, 2000, and 1999, respectively.
F-22
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
Legal and Other Proceedings
The Company is involved in routine litigation arising in the ordinary
course of its business. In the opinion of the Company's management,
none of the pending litigation will have a material adverse effect on
the Company's consolidated financial condition, cash flows or results
of operations.
In December 2001 and January 2002, six purported class action lawsuits
have been filed in the United States District Court for the Southern
District of New York by Peter Fischbein, Drimal Ltd., Corado
Petruzzelli, Michael Lucas, Israel M. Zacks and Eliot Gersten against
the Company and certain of its officers or directors asserting damages
on behalf of all persons or entities who purchased or otherwise
acquired the Company's common stock in the open market during the
period commencing on February 24, 2000 through December 17, 2001. These
complaints allege violations of Section 10 (b) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by the
Company and the individual defendants and violations of Section 20 (a)
of the Exchange Act by the individual defendants.
In the foregoing complaints, the plaintiffs allege that, among other
things, because the Company's financial statements issued during the
class period were not prepared in conformity with generally accepted
accounting principles, the defendants concealed adverse material
information and made or participated in the making of untrue statements
of material facts and omitted to state material facts concerning the
business, financial condition, operations and future prospects of the
Company. The plaintiffs, in each of the complaints, seek compensatory
damages, including interest, against all of the defendants, recovery of
their reasonable litigation costs, and expenses. The Company intends to
vigorously defend the claims against it. Although it cannot predict the
ultimate outcome of these actions, an unfavorable resolution could have
a material adverse effect on the Company's financial condition, cash
flows and results of operations.
The Securities and Exchange Commission issued a formal order of
investigation into, among other things, certain accounting matters
relating to the Company's financial statements, periodic reporting and
internal accounting control provisions of the federal securities laws.
15. Employee Savings Plans
The Company maintains a 401(k) profit sharing plan and trust (the
"401(k) Plan"). The 401(k) Plan is offered to all eligible employees
and participants may make voluntary contributions up to 15% of their
salary. The Company does not match employee contributions.
16. Income Taxes
The Company is subject to foreign withholding taxes in certain
countries where it does business. Domestic and foreign (loss) income
before income taxes, extraordinary loss and cumulative effect of change
in accounting principle is as follows (in thousands):
Years ended October 31,
---------------------------------------------------------
2001 2000 1999
---------------- ----------------- -----------------
Domestic $ (29,322) $ (5,507) $ 228
Foreign 25,827 14,468 24,198
---------------- ----------------- -----------------
Total $ (3,495) $ 8,961 $ 24,426
================ ================= =================
Income tax expense (benefit) is as follows (in thousands):
Years ended October 31,
---------------------------------------------------------
2001 2000 1999
----------------- ----------------- ----------------
Current:
Federal $ - $ - $ -
State and local 500 500 22
Foreign 5,607 3,345 8,002
Deferred (8,307) (1,301) 70
----------------- ----------------- ----------------
Total $ (2,200) $ 2,544 $ 8,094
================= ================= ================
F-23
The differences between the provision for income taxes and the income
tax computed using the U.S. statutory federal income tax rate to pretax
income are as follows:
(in thousands) Years ended October 31,
--------------------------------------------------------------
2001 2000 1999
------------------- ------------------- ------------------
Statutory federal tax expense (benefit) $ (1,223) $ 3,136 $ 8,305
Changes in expenses resulting from:
State taxes, net of federal benefit (652) 369 1,539
Foreign tax expense differential (3,433) (1,359) (1,807)
Goodwill amortization 1,656 592 244
Other permanent items 123 (194) (187)
Impairment of intangibles 1,329 -
----------------- ------------------- --------------------
Income tax expense (benefit) $ (2,200) $ 2,544 $ 8,094
================= =================== ====================
The components of the net deferred tax asset as of October 31, 2001 and
2000 consists of the following:
(in thousands) 2001 2000
------------------ -----------------
Current:
Deferred tax asset:
Bad debt allowance $ 4,356 $ 3,329
Sales and inventory reserves 1,539 1,404
Unrealized (gains) losses (96) 1,736
Tax credit carryforward 552 552
Depreciation and amortization 745 (149)
Net operating loss carryforward 11,598 6,025
------------------ -----------------
Total current deferred tax assets 18,694 12,897
Deferred tax liability -
Capitalized software (4,821) (3,654)
------------------ -----------------
Total net current deferred tax assets 13,873 9,243
------------------ -----------------
Non-current deferred tax asset -
Capital Loss carryforward 7,892 -
------------------ -----------------
Net deferred tax asset $ 21,765 $ 9,243
================== =================
Management believes that it is more likely than not that the Company
will generate sufficient levels of taxable income in the future to
realize the $21,765,000 of reported net deferred tax assets. The amount
of the deferred tax asset considered realizable, however, could be
reduced in the near term if estimates of future taxable income during
the carryforward period are reduced. Failure to achieve sufficient
levels of taxable income from capital transactions might affect the
ultimate realization of the capital loss carryforwards. If this were to
occur, management is committed to implementing tax planning strategies,
such as the sale of net appreciated assets of the Company to the extent
required (if any) to generate sufficient taxable income prior to the
expiration of these benefits.
The deferred tax asset relating to the Company's net operating loss
carryforwards includes tax assets of approximately $10.5 million
relating to cumulative tax deductions for dispositions of employees
incentive stock options, the benefit of which has been included in
additional paid in capital.
At October 31, 2001, the Company had net operating loss carryforwards
and capital loss carryforwards totaling approximately $30.5 million and
$20.8 million, respectively. The net operating loss carryforwards
expire at various times between fiscal 2012 and fiscal 2021 and the
capital loss carryforwards expire at fiscal 2006. In addition, at
October 31, 2001, the Company had a $552,000 tax credit carryforward,
which will expire at fiscal 2019.
F-24
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
The total amount of undistributed earnings of foreign subsidiaries for
income tax purposes was approximately $36 million and $10 million for
the years ended October 31, 2001 and 2000, respectively. It is the
Company's intention to reinvest undistributed earnings of its foreign
subsidiaries and thereby indefinitely postpone their remittance.
Accordingly, no provision has been made for foreign withholding taxes
or United States Income taxes which may become payable if undistributed
earnings of foreign subsidiaries were paid as dividends to the Company.
17. Stockholders' Equity
Private Placement
In July 2001, the Company issued 1,300,000 shares of common stock in a
private placement to institutional investors and received proceeds of
$20.9 million net of $1.4 million of selling commissions and offering
expenses.
In April and July 2000, the Company issued an aggregate 2,422,000
shares of the Company's Common Stock in private placements to
institutional investors and received proceeds of $21,285,000, net of
commissions and offering expenses of $2,432,000.
18. Public Offering
In July 2000, the Company incurred a charge of $1,103,000 relating to
an abandoned public offering of a subsidiary.
In May 1999, the Company consummated a secondary public offering of
3,005,000 shares of Common Stock, including 255,000 shares issued
pursuant to an over-allotment option. The proceeds from the offering
were $21,852,000, net of discounts and commissions and offering
expenses of $2,187,000.
Retirement of Common Stock
In February 2001, certain stockholders of the Company exchanged and
surrendered for cancellation 564,212 shares of the Company's Common
Stock (valued at $7,310,000) for shares of Gameplay having an equal
value.
In October 2000, a stockholder of the Company exchanged and surrendered
for cancellation 98,000 shares of the Company's common stock (valued
at $1,250,000) for shares of Gameplay having an equal value.
Warrants
As of October 31, 2001 and 2000, there are outstanding common stock
purchase warrants for an aggregate of 128,000 and 829,000 shares of the
Company's Common Stock, respectively, at prices ranging from $ 2.41 to
$11.85 and expiring from 2003 to 2005.
19. Incentive Plans
Stock Option Plan
In January 1997, the stockholders of the Company approved the Company's
1997 Stock Option Plan, as previously adopted by the Company's Board of
Directors (the "1997 Plan"), pursuant to which officers, directors, key
employees and consultants of the Company may receive incentive stock
options ("ISO") to purchase up to an aggregate of 6,500,000 shares of
the Company's Common Stock.
The 1997 Plan is administered by the Board of Directors. Subject to the
provisions of the 1997 Plan, the Board of Directors or any Committee
appointed by the Board of Directors, has the authority to determine the
individuals to whom the stock options are to be granted, the number of
shares to be covered by each option, the option price, the type of
option, the option period, restrictions, if any, on the exercise of the
option, the terms for the payment of the option price and other terms
and conditions.
As of October 31, 2001 and 2000, the 1997 Plan had outstanding stock
options for an aggregate of 2,631,000 and 1,973,000 shares of the
Company's Common Stock, respectively, vesting at various times from
1997 to 2004 and expiring at various times from 2002 to 2008. Options
granted generally vest over a period of three to five years.
F-25
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
Non-Plan Stock Options
As of October 31, 2001 and 2000, there are non-plan stock options
outstanding for an aggregate of 1,848,000 and 2,226,000 shares of the
Company's Common Stock, respectively, vesting from 1999 to 2004 and
expiring at various times from 2003 to 2007.
For those options with exercise prices less than fair value of the
underlying shares at the measurement date, the difference is recorded
as deferred compensation and is amortized over the vesting period.
Compensation expense for the years ended October 31, 2001, 2000, and
1999 was approximately $5,000, $43,000, and $181,000, respectively.
The following table summarizes the activity in options under the plans
inclusive of non-plan options:
Shares Weighted Average
(in thousands) Exercise Price
------------------ ---------------------
Options outstanding - November 1, 1998 2,631 $4.02
Granted-exercise price equal to fair value 2,506 $7.94
Exercised (1,101) $2.85
Forfeited (311) $5.07
------------------
Options outstanding - October 31, 1999 3,725 $6.96
Granted-exercise price equal to fair value 2,073 $10.14
Granted-exercise price less than fair value 14 $8.23
Exercised (1,270) $6.44
Forfeited (343) $5.89
------------------
Options outstanding - October 31, 2000 4,199 $8.72
Granted-exercise price equal to fair value 3,351 $9.94
Granted-exercise price less than fair value 500 $13.91
Exercised (3,327) $9.00
Forfeited (244) $10.09
==================
Options outstanding - October 31, 2001 4,479 $9.93
==================
At October 31, 2001 and 2000 the number of options exercisable are
2,113,000 and 2,119,000, respectively, and their related weighted
average exercise prices are $9.61 and $8.36, respectively.
F-26
The following summarizes information about stock options outstanding
and exercisable at October 31, 2001:
Average
Weighted Remaining
Shares Average Contractual
Exercise Price Shares (in thousands) Exercise Price Life
--------------------------------------------------- ------------------- ------------------- ----------------
$5.19 - $8.63 1,375 $ 7.38 3.65
$9.09 - $12.50 2,657 $ 10.59 4.19
$13.00 - $14.86 447 $ 13.91 3.58
------------------- -------------------- ---------------
Options outstanding - October 31, 2001 4,479 $ 9.93 3.97
=================== ==================== ===============
$5.19 - $8.63 814 $ 7.34 2.32
$9.09 - $12.50 1,148 $ 10.64 3.96
$13.00 - $14.86 151 $ 14.04 2.26
------------------- -------------------- ---------------
Options exercisable- October 31, 2001 2,113 $ 9.61 3.53
=================== ==================== ===============
Had compensation cost for the Company's stock option plan been
determined based on the fair value at the grant date for awards in
2001, 2000 and 1999 consistent with the provisions of SFAS No. 123, the
Company's net income and the net income per share would have been
reduced to the pro-forma amounts indicated below (in thousands).
2001 2000 1999
(As Restated)
----------------- ------------------ ----------------
Net (loss) income
As reported $ (8,580) $ 6,417 $ 16,332
Pro-forma $ (18,927) $ (4,714) $ 12,769
Net income per share
As reported-Basic $ (0.25) $ 0.23 $ 0.79
Pro-forma-Basic $ (0.56) $ (0.17) $ 0.62
As reported-Diluted $ (0.25) $ 0.23 $ 0.76
Pro-forma-Diluted $ (0.56) $ (0.17) $ 0.59
The pro-forma disclosures shown are not representative of the effects
on net income and the net income per share in future years.
The fair value of the Company's stock options used to compute pro-forma
net income and the net income per share disclosures is the estimated
present value at the grant date using the Black-Scholes option-pricing
model. The following weighted average assumptions for 2001 were used to
value grants: expected volatility of 85% for grants with a holding
period of 2 years, 79% for a holding period of 3 years and 75% for
holding periods of 4 to 5 years; a risk-free interest rate of generally
4.85% to 5.0%; and an expected holding period of two to five years. The
following weighted average assumptions were used to value grants for
2000 and 1999, respectively; expected volatility of 96% for grants with
a holding period of two years, and expected volatility of 60% for
grants with a holding period of three to four years and 65% for holding
periods of five years or more; a risk-free interest rate of generally
5.5% to 6.7% and 4% to 6%; and an expected holding period of two to
five and three to five years.
F-27
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
20. Results By Quarter (Unaudited)
The following tables set forth quarterly supplementary data for each of
the years in the two-year period ended October 31, 2001 (in thousands
except per share data).
The unaudited quarterly results of operations for each of the quarters
in the fiscal year ended October 31, 2000 and for each of the three
quarters in the period ended July 31, 2001 have been restated for the
matters identified in Note 2.
In addition, the unaudited quarterly results of operations for the
three quarters in the period ended July 31, 2001 have been restated as
follows:
o The cumulative effect in the first quarter of the change in
accounting related to the adoption of SAB 101 Revenue
Recognition" (see Note 3). In fiscal 2001, the Company
implemented changes to its practices to significantly reduce
shipment time near quarter and year end. Accordingly, the
adoption of SAB 101 did not have a significant impact on
previously reported interim results for the first three
quarters of 2001.
o The recognition in the first quarter of net sales of
$3,780,000 and related cost of sales of $2,236,000 for
transactions that did not qualify for revenue recognition in
the fourth quarter of fiscal 2000.
o Additional charge of $438,000, net of taxes of $292,000 in the
third quarter for an extraordinary loss on early
extinguishment of debt.
o Adjustment in the first two quarters for income related to the
reversal of revenue related to a business acquired during the
year and a corresponding adjustment to the purchase price. The
adjustment was a reduction of revenue of $721,000 in the first
quarter and $956,000 in the second quarter, net of expense
reductions of $29,000 and $44,000 in the first and second
quarters, respectively.
As Restated
---------------------------------------
1st 2nd 3rd 4th
2001 Quarter Quarter Quarter Quarter
------------------------ --------- --------- --------- ---------
Net sales $ 157,853 $ 88,617 $ 81,327 $ 123,259
Gross profit 53,593 30,940 33,038 27,221
Income (loss) before
extraordinary item and
cumulative effect of
adopting SAB 101 13,569 (11,636) 2,077 (5,305)
Extraordinary item, net
of taxes -- -- 1,948 --
Cumulative effect of adopting
SAB 101 (5,337) -- -- --
Net income $ 8,232 $ (11,636) $ 129 $ (5,305)
Per share data:
Basic EPS $ 0.25 $ (0.36) $ 0.00 $ (0.15)
Diluted EPS $ 0.25 $ (0.36) $ 0.00 $ (0.15)
As Restated
-----------------------------------------------------
1st 2nd 3rd 4th
2000 Quarter Quarter Quarter Quarter
------------------------ --------- --------- --------- ---------
Net sales $120,247 $ 69,519 $ 66,093 $108,142
Gross profit 35,292 29,107 28,829 34,795
Net income (a) $ 3,966 $ (8,460) $ 2,221 $ 8,690
Per share data:
Basic EPS $ 0.17 $ (0.33) $ 0.08 $ 0.28
Diluted EPS $ 0.16 $ (0.33) $ 0.07 $ 0.27
F-28
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
(a) Included in the third quarter of fiscal 2000 is an after-tax
loss of $695,000 ($.02 per diluted share) for the charge for
abandoned offering described in Note 17.
The following table summarizes the increase (decrease) in the results
of operations for the reported 2001 and 2000 fiscal quarters as a result of the
restatement discussed above (in thousands except per share data):
Effect of
As Adopting As
Reported Restatement SAB 101 Restated
--------- --------- ----------- ------------
Quarter ended January 31, 2001:
Net Sales $ 131,226 $ (603) $ 27,230 $ 157,853
Gross Profit 43,004 1,694 8,895 53,593
Income before cumulative effect 7,750 482 5,337 13,569
of adopting SAB 101
Cumulative effect of adopting -- -- (5,337) (5,337)
SAB 101, net of taxes
Net income $ 7,750 $ 482 $ -- $ 8,232
Per share data:
Basic -
Income per share before adoption $ 0.24 $ 0.01 $ 0.16 $ 0.41
of SAB 101
Cumulative effect of adopting $ -- $ -- $ (0.16) $ (0.16)
SAB 101, net of taxes
Net income per share $ 0.24 $ 0.01 $ -- $ 0.25
Diluted -
Income per share before adoption $ 0.24 $ 0.01 $ 0.16 $ 0.41
of SAB 101
Cumulative effect of adopting $ -- $ -- $ (0.16) $ (0.16)
SAB 101, net of taxes
Net income per share $ 0.24 $ 0.01 $ -- $ 0.25
Quarter ended April 30, 2001:
Net Sales $ 93,320 $ (4,703) $ -- $ 88,617
Gross Profit 31,162 (222) $ -- 30,940
Net income $ (11,924) $ 288 $ -- $ (11,636)
Per share data:
Basic - $ (0.37) $ 0.01 $ -- $ (0.36)
Diluted - $ (0.37) $ 0.01 $ -- $ (0.36)
F-29
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
As As
Reported Restatement Reclassifications Restated
--------- --------- ----------------- --------
Quarter ended July 31, 2001:
Net Sales $ 84,502 $ (3,175) -- $ 81,327
Gross Profit 33,273 (235) -- 33,038
Income before Extraordinary item 1,919 158 -- 2,077
Extraordinary item, net of taxes 1,510 438 -- 1,948
Net income $ 409 $ (280) -- $ 129
Per share data:
Basic -
Income before Extraordinary item $ 0.06 $ 0.00 -- $ 0.06
Extraordinary item, net of taxes $ (0.05) $ (0.01) -- $ (0.06)
Net income per share $ 0.01 $ (0.01) -- $ 0.00
Diluted -
Income before Extraordinary item $ 0.05 $ 0.00 -- $ 0.05
Extraordinary item, net of taxes $ (0.04) $ (0.01) -- $ (0.05)
Net income per share $ 0.01 $ (0.01) -- $ 0.00
Quarter ended January 31, 2000:
Net Sales $ 122,890 $ (2,195) (448) $ 120,247
Gross Profit 36,616 (1,324) -- 35,292
Net income $ 4,787 $ (821) -- $ 3,966
Per share data:
Basic - $ (0.21) $ (0.04) -- $ 0.17
Diluted - $ (0.20) $ (0.04) -- $ 0.16
Quarter ended April 30, 2000:
Net Sales $ 70,036 $ (286) (231) $ 69,519
Gross Profit 28,255 852 -- 29,107
Net income $ 3,354 $ (11,814) -- $ (8,460)
Per share data:
Basic - $ 0.13 $ (0.46) -- $ (0.33)
Diluted - $ 0.13 $ (0.46) -- $ (0.33)
Quarter ended July 31, 2000:
Net Sales $ 71,473 $ (5,330) (50) $ 66,093
Gross Profit 31,372 (2,543) -- 28,829
Net income $ 3,449 $ (1,228) -- $ 2,221
Per share data:
Basic - $ 0.12 $ (0.04) -- $ 0.08
Diluted - $ 0.12 $ (0.04) -- $ 0.08
Quarter ended October 31, 2000:
Net Sales $ 122,607 $ (13,899) (566) $ 108,142
Gross Profit 42,967 (8,172) -- 34,795
Net income $ 13,373 $ (4,683) -- $ 8,690
Per share data:
Basic - $ 0.43 $ (0.15) -- $ 0.28
Diluted - $ 0.42 $ (0.15) -- $ 0.27
F-30
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
21. Segment Information
The Company has adopted Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS No. 131"), which established standards for
reporting by public business enterprises of information about product
lines, geographical areas and major customers. The method for
determining what information to report is based on the way management
organizes the Company for making operational decisions and assessment
of financial performance. The Company's chief operating decision maker
is considered to be the Company's Chief Executive Officer ("CEO"). The
CEO reviews financial information presented on a consolidated basis
accompanied by disaggregated information about sales by geographic
region and by product platforms. The Company's Board of Directors
reviews consolidated financial information. The Company's operations
employ the same products, cost structures, margins and customers
worldwide. The Company's product development, publishing and marketing
activities are centralized in the United States under one management
team, with distribution activities managed geographically. Accordingly,
the Company's operations fall within one reportable segment as defined
in SFAS No. 131.
For the years ended October 31, 2001, 2000, and 1999, the Company's net
sales in domestic markets accounted for approximately 76.4%, 71.6% and
67.0% respectively, and net sales in international markets accounted
for 23.6%, 28.4%, and 33.0%, respectively.
As of October 31, 2001 and 2000, the Company's net property, plant and
equipment in domestic markets accounted for approximately $7,710,000
and $2,436,000, respectively, and net property, plant and equipment in
international markets accounted for $3,323,000 and $2,824,000,
respectively.
Information about the Company's non-current assets in the United States
and international areas as of October 31, 2001 and 2000 are presented
below (in thousands):
2001 2000
-----------------------------------------------
Total Non-current Assets:
United States $ 81,243 $ 82,904
International
United Kingdom 21,128 21,410
All other Europe 21,405 5,748
Other 8,347 3,721
-----------------------------------------------
$ 132,123 $ 113,783
-----------------------------------------------
Information about the Company's net sales in the United States and
international areas for the years ended October 31, 2001, 2000 and 1999
are presented below (net sales are attributed to geographic areas based
on product destination, (in thousands):
2001 2000 1999
----------------------------------------------------------------------
Net Sales:
United States $ 324,412 $ 250,278 $ 198,801
Canada 20,080 10,408 5,393
International
United Kingdom 32,225 25,968 53,101
All other Europe 61,187 60,814 37,304
Asia Pacific 12,478 15,505 9,366
Other 674 1,028 749
----------------------------------------------------------------------
$ 451,056 $ 364,001 $ 304,714
----------------------------------------------------------------------
F-31
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Notes to Consolidated Financial Statements
Information about the Company's net sales by product platforms for the
years ended October 31, 2001, 2000 and 1999 are presented below (in
thousands):
2001 2000 1999
--------------------------------------------------------------
Platforms:
PC.............................. $ 103,656 $ 89,927 $ 75,947
Sony PlayStation 2.............. 130,172 29,374 -
Sony PlayStation................ 75,044 76,353 103,543
Nintendo GameBoy
Color, GameBoy
Advance and 64.................. 37,703 58,919 61,033
Sega Dreamcast.................. 11,366 20,991 4,984
X Box 2,432 - -
Accessories..................... 31,648 29,178 22,187
Hardware........................ 59,035 59,259 37,020
--------------------------------------------------------------
$ 451,056 $ 364,001 $ 304,714
--------------------------------------------------------------
22. Net (Loss) Income Per Share
The computation for diluted number of shares excludes those unexercised
stock options and warrants which are antidilutive. The number of such
shares was 222,000, 73,000, and 470,000 for the years ended October 31,
2001, 2000, 1999, respectively.
The following table provides a reconciliation of basic earnings per
share to dilutive earnings per share for the years ended October 31,
2001, 2000, and 1999.
Per Share
(in thousands, except per share data) Net (Loss) Income Shares Amount
------------------ ------------ ----------------
Year Ended October 31, 2001
Basic and Diluted EPS $ (8,580) 33,961 $ (0.25)
================== ============ ==============
Year Ended October 31, 2000 (As Restated)
Basic EPS $ 6,417 27,307 $ 0.23
Effect of dilutive securities -
Stock options and warrants -- 1,023 --
------------------ ------------ --------------
Diluted EPS $ 6,417 28,330 $ 0.23
================== ============ ==============
Year Ended October 31, 1999
Basic EPS $ 16,332 20,690 $ 0.79
Effect of dilutive securities -
Stock options and warrants -- 825 (0.03)
------------------ ------------ --------------
Diluted EPS $ 16,332 21,515 $ 0.76
================== ============ ==============
F-32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly signed this report on its behalf
by the undersigned, thereunto duly authorized on the 11th day of February 2002.
TAKE-TWO INTERACTIVE SOFTWARE, INC.
By: /s/ Kelly Sumner
-------------------------------
Kelly Sumner,
Chief Executive Officer
In accordance with the requirements of the Securities Exchange Act of 1934, this
report was signed by the following persons in the capacities and on the dates
stated.
Signature Title Date
--------- ----- ----
/s/ Kelly Sumner
-----------------------------
Kelly Sumner Chief Executive Officer and Director February 11, 2002
(Principal Executive Officer)
/s/ Ryan A. Brant
-----------------------------
Ryan A. Brant Chairman and Director February 11, 2002
/s/ Paul Eibeler
-----------------------------
Paul Eibeler President and Director February 11, 2002
/s/ Patti Tay
-----------------------------
Patti Tay Chief Accounting Officer February 11, 2002
(Principal Financial and Accounting Officer)
/s/ Mark Lewis
-----------------------------
Mark Lewis Director February 11, 2002
/s/ Oliver R. Grace, Jr.
-----------------------------
Oliver R. Grace, Jr. Director February 11, 2002
/s/ Don Leeds
-----------------------------
Don Leeds Director February 11, 2002
/s/ Robert Flug
-----------------------------
Robert Flug Director February 11, 2002
-38-
SCHEDULE II
Take-Two Interactive Software, Inc.
Valuation and Qualifying Accounts
(In thousands)
Additions (A)
Balance at ------------------------------- Balance at
Beginning Sales and returns Provision for End of
Description of Period allowance bad debts Deductions (B) Other (C) Period
------------------------------------- ------------- ----------------- ------------- -------------- --------- -----------
Year Ended October 31, 2001
Allowance for doubtful accounts &
Returns.............................. $11,615 $71,481 $ 3,838 $64,366 $3,538 $26,106
Year Ended October 31, 2000
Allowance for doubtful accounts &
Returns.............................. $ 9,039 $41,159 $ 931 $39,514 -- $11,615
Year Ended October 31, 1999
Allowance for doubtful accounts &
Returns.............................. $ 1,473 $26,131 $ 1,272 $20,070 $ 233 $ 9,039
(A) Includes increases in allowance for sales returns and doubtful accounts due
to normal reserving terms.
(B) Includes actual write-offs of uncollectible accounts receivable or sales
returns and recoveries of previously written off receivables.
(C) Includes allowance accounts acquired in conjunction with acquisitions.
-39-