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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, 2003
OR
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
0-29230
(Commission File No.)
TAKE-TWO INTERACTIVE SOFTWARE, INC.
(Exact name of Registrant as specified in its charter)
Delaware 51-0350842
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
622 Broadway, New York, New York 10012
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (646) 536-2842
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
Indicate by check mark whether the Registrant (1) has 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. |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes |X| No |_|
The aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold, or the average bid and asked price of such common equity, as of the
last business day of the Registrant's most recently completed second fiscal
quarter was approximately $910,000,000.
As of January 30, 2004, there were 44,578,611 shares of the Registrant's common
stock outstanding.
Documents Incorporated by Reference:
Proxy Statement Relating to 2004 Annual Meeting
(Incorporated into Part III)
INDEX
PAGE
----
PART I.
Item 1. Business 3
Item 2. Properties 11
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 12
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 13
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 38
Item 8. Financial Statements and Supplementary Data 38
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 38
Item 9A. Controls and Procedures 38
PART III.
Item 10. Directors and Executive Officers of the Registrant 39
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners and Management 39
Item 13. Certain Relationships and Related Transactions 39
Item 14. Principal Accountant Fees and Services 39
PART IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 40
Index to Financial Statements 43
Signatures 87
2
PART I
Item 1. Business
We restated our previously issued financial statements for the fiscal years
ended October 31, 1999, 2000, 2001 and 2002, the interim quarters of 2002 and
the first three quarters of 2003. All financial data in this report reflects the
effects of the restatement. See Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations and Notes 2 and 19 to Consolidated
Financial Statements for details relating to the restatement.
General
We are a leading global publisher of interactive software games designed for
personal computers, video game consoles and handheld platforms manufactured by
Sony, Microsoft and Nintendo. Our business has grown rapidly, with net sales
increasing from $795 million in fiscal 2002 to $1 billion in fiscal 2003, and
with net income increasing from $72 million to $98 million for these periods.
Our Rockstar Games(R) publishing label continues to successfully create new,
proprietary brands, as well as sequels to existing brands, with broad consumer
appeal. Rockstar recently released Max Payne 2: The Fall of Max Payne, the
sequel to the hit franchise Max Payne(R) that debuted in 2001, for the PC,
Sony's PlayStation(R) 2 and Microsoft's Xbox; a Grand Theft Auto(R) Double Pack
(consisting of Grand Theft Auto 3 and Grand Theft Auto: Vice City) for the
PlayStation 2 and Xbox; Manhunt for the PlayStation 2; and Max Payne for the
Game Boy(R) Advance. Rockstar plans to release a sequel to its most popular
franchise, Grand Theft Auto, as well as new brands, Red Dead Revolver and The
Warriors, a game based on the Paramount Pictures' classic 1979 gang drama, in
fiscal 2004.
We also recently released Conflict: Desert Storm II: Back to Baghdad and
Starsky & Hutch for the PC, PlayStation 2 and Xbox; Ford Racing 2 for the
PlayStation 2 and Xbox; and MTV's Celebrity Deathmatch for the PlayStation 2,
PlayStation, Xbox and PC. Our Gathering publishing label released Space Colony,
Hidden & Dangerous 2, Railroad Tycoon 3 for the PC and Mafia for the PlayStation
2, and intends to release Mafia for Xbox in March 2004. We also launched the
PlayStation 2 Greatest Hits and Xbox Platinum Hits versions of Conflict: Desert
Storm, bringing our catalog of Greatest Hits products for the PlayStation 2 to
six titles and our catalog of Microsoft's Platinum Hits to two titles.
We distribute our products as well as third-party products, hardware and
accessories to retail outlets in North America through our Jack of All Games
subsidiary. Our customers in North America include Wal-Mart, Best Buy,
Electronics Boutique, Target, GameStop, Toys "R" Us, Blockbuster and Circuit
City, and 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, Holland, Austria,
Italy, Australia, New Zealand and Canada.
In December 2003, we completed the acquisition of TDK Mediactive, Inc., a
California based publisher of video games based on popular licensed properties,
including The Haunted Mansion, Pirates of the Caribbean, Robotech, The Muppets,
Corvette and Star Trek.
We were incorporated under the laws of the State of Delaware in 1993. Our
Internet address is www.take2games.com. We make available free of charge on our
website our periodic reports filed under applicable law as soon as reasonably
practicable after we file such material. The information on our website is not
part of this report.
3
The Industry
Expanding gamer demographics has driven demand for interactive entertainment
software in recent years. Video games have increasingly become a mainstream
entertainment choice for a maturing, technologically sophisticated audience.
According to the Entertainment Software Association, the average age of
Americans who play video and PC games is 29, with an estimated 60% of all
Americans, or approximately 145 million people, playing video games on a regular
basis.
According to NPDFunworld, sales of video game hardware and software and PC
games reached $11.2 billion in the United States in 2003. Strong demand for
interactive software games is expected to continue as a result of increasing
penetration of video game console platforms. Video game hardware manufacturers
offer platforms with more powerful and realistic graphics, backwards
compatibility (the ability to play the platforms' previous generation of games),
broadband connectivity and media convergence features. Sony has announced plans
to release two new game systems: the PSP, a handheld game platform expected to
be launched in North America in fall 2004; and the PSX, an entertainment system
incorporating a hard disk drive, a DVD recorder to record movies and television
programs, a high speed internet connection and a PlayStation 2 game machine. The
PSX was released in Japan in December 2003 and is expected to be launched in
North America in 2004.
We have pursued a growth strategy by capitalizing on the widespread market
acceptance of video game consoles and the growing popularity of innovative
gaming experiences that appeal to more mature audiences. We have devoted our
principal efforts and resources toward developing cutting edge proprietary
intellectual properties; establishing well-known product franchises with
significant potential for sequels; building leading development studios with
multi-platform development capabilities; and focusing our creative efforts on
delivering games that are attractive to a broad demographic. Our Jack of All
Games distribution subsidiary continues to capitalize on the growing installed
base of hardware and the proliferation of software titles and outlets to
purchase software. We believe that the combination of these factors positions us
for future growth as the interactive entertainment industry continues to expand
and evolve.
Publishing
We have consolidated our publishing operations into the following three
labels: Rockstar Games, Gathering and Global Star. Rockstar will continue to
focus on the creation of premium priced, groundbreaking entertainment. Our
Gathering label, which has historically focused on PC titles, will publish all
mid-priced and non-Rockstar premium priced products on the PC, console and
handheld platforms. Global Star will publish PC, console and handheld titles
that retail for $19.99 and below. Our Gotham Games label has been phased out.
Gotham's and TDK's product portfolios will be published by either Gathering or
Global Star depending on price point.
4
Since November 2002, we have released the following titles:
- ---------------------------------------------------------------------------------------------------------
Title Platform Release Date Label
- ---------------------------------------------------------------------------------------------------------
Mafia PS2 January 2004 Gathering
- ---------------------------------------------------------------------------------------------------------
Max Payne 2: The Fall of Max Payne PC; Xbox; PS2 October, Rockstar
November,
December 2003
- ---------------------------------------------------------------------------------------------------------
Manhunt PS2 November 2003 Rockstar
- ---------------------------------------------------------------------------------------------------------
Grand Theft Auto Double Pack PS2; Xbox October, Rockstar
November 2003
- ---------------------------------------------------------------------------------------------------------
MTV's Celebrity Deathmatch PC; PS2; Xbox; October 2003 Gotham
PS1
- ---------------------------------------------------------------------------------------------------------
Conflict: Desert Storm II: Back to Baghdad PS2; Xbox; PC October 2003 Gotham
- ---------------------------------------------------------------------------------------------------------
Starsky & Hutch PS2; Xbox; PC September 2003 Gotham
- ---------------------------------------------------------------------------------------------------------
Space Colony PC October 2003 Gathering
- ---------------------------------------------------------------------------------------------------------
Hidden & Dangerous 2 PC October 2003 Gathering
- ---------------------------------------------------------------------------------------------------------
Railroad Tycoon 3 PC October 2003 Gathering
- ---------------------------------------------------------------------------------------------------------
Piglet's Big Game PS2, March 2003 Gotham
GameCube
- ---------------------------------------------------------------------------------------------------------
Vietcong PC March 2003 Gathering
- ---------------------------------------------------------------------------------------------------------
The Great Escape PS2; Xbox; PC July 2003 Gotham
- ---------------------------------------------------------------------------------------------------------
Midnight Club 2 PS2; Xbox; PC April, June, Rockstar
July 2003
- ---------------------------------------------------------------------------------------------------------
State of Emergency Xbox March 2003 Rockstar
- ---------------------------------------------------------------------------------------------------------
Tropico 2: Pirate Cove PC April 2003 Gathering
- ---------------------------------------------------------------------------------------------------------
Grand Theft Auto: Vice City PS2, PC October, Nov. Rockstar
2002; May 2003
- ---------------------------------------------------------------------------------------------------------
Going forward in fiscal 2004, Rockstar plans to release Red Dead Revolver, a
western-themed shooter from Rockstar San Diego, the developer of Midnight Club
and Smuggler's Run, for the PlayStation 2 and Xbox. Rockstar also expects to
release The Warriors, a new title based on the Paramount Pictures film, and the
next installment in the Grand Theft Auto franchise. Rockstar anticipates the
release of Grand Theft Auto: Vice City for PlayStation 2 and PC in Japan under a
license agreement with Capcom Co. Ltd. Rockstar previously released Grand Theft
Auto 3 for PlayStation 2 and PC in Japan under this agreement, which was one of
the most successful debuts of a Western title in Japan.
5
Gathering's lineup includes Vietcong: Fist Alpha, an add-on to the popular
Vietcong, and Vietcong: Purple Haze, which will include Vietcong and Fist Alpha
together; Destruction Derby Arenas on PlayStation 2, the next generation
installment of the successful PlayStation franchise, Destruction Derby, complete
with online capabilities; a sequel to the Hidden & Dangerous franchise; and
several new titles under Gathering's distribution arrangement with Destineer
Publishing. Titles planned for release under the Gathering label from TDK's
portfolio include Robotech and Spy vs Spy.
Global Star is focusing on building value-priced game franchises primarily
for console platforms across popular genres, such as racing, sports and action
games. Global Star's lineup includes Carve, a personal watercraft racing game
with online capabilities for the Xbox; Motocross Mania 3, the latest addition to
the Motocross Mania franchise; a new console release in the Virtual Pool
franchise; an extension of the Army Men franchise, Army Men: Sarge's War for
PlayStation 2 and Xbox; and sports and racing console products from TDK's
portfolio, including Corvette and UFC: Sudden Impact.
Software Content and Licensing
We have established a portfolio of successful proprietary software content.
We own all of the intellectual property rights associated with our brands: Grand
Theft Auto; Max Payne; Midnight Club; Manhunt; Smuggler's Run; Oni; Myth; Spec
Ops; Railroad Tycoon; Tropico; Red Dead Revolver; Army Men; and School Tycoon.
We believe that content ownership facilitates our internal product development
efforts and maximizes profit potential.
In May 2002, we acquired all of the intellectual properties associated with
the game Max Payne, as well as a royalty-free perpetual license to use the Max
Payne game engine technologies. In August 2003, we acquired all of the
intellectual properties associated with Red Dead Revolver (subject to a
distribution license in Asia) in consideration of a royalty on future product
sales and, in September 2003, we acquired all the ownership rights associated
with the Army Men brand.
We also actively seek to acquire licenses for well-recognized properties. We
acquired the exclusive worldwide rights to create video games based on the
theatrical motion picture entitled "The Warriors." We also acquired the
exclusive worldwide publishing rights to the best-selling franchise of Duke
Nukem PC and video games, including the right to publish PC and console versions
of Duke Nukem Forever. In December 2003, we acquired exclusive rights to certain
properties owned by the Cartoon Network. We expect to continue to pursue
selective acquisitions of property rights that we believe will enhance our
prospects. See Note 6 to Consolidated Financial Statements.
Software Development
We develop most of our front-line software titles through our internal
development studios: Rockstar San Diego (formerly Angel Studios), the developer
of Midnight Club and Smuggler's Run; Rockstar North (formerly DMA Design), the
developer of the Grand Theft Auto series and Manhunt; Rockstar Toronto (a/k/a
Alternative Realities Technologies), the developer of the PlayStation 2 versions
of Max Payne and Max Payne 2: The Fall of Max Payne; Rockstar Vancouver (a/k/a
Barking Dog Studios); Rockstar Vienna (a/k/a Neo Software), the developer of the
Xbox versions of Max Payne and Max Payne 2: The Fall of Max Payne; PopTop
Software, the developer of the Railroad Tycoon series and Tropico; Frog City,
the developer of Tropico: Pirates Cove; and Cat Daddy Games.
As of December 31, 2003, our internal development studios and product
development department had 625 employees with the technical capabilities to
develop and localize (translate into foreign languages and make other changes
appropriate to the territory) software titles for all major hardware platforms,
the PC and in all major territories. Currently, most of our Rockstar label
products are developed internally.
For the fiscal years ended October 31, 2003, 2002 and 2001, we incurred
costs of $25,107,000, $11,524,000 and $6,190,000, respectively, on research and
development relating to our software titles. Additionally, for these years, we
capitalized software development costs of $15,923,000, $9,645,000 and
$6,293,000, respectively.
6
Certain of our software titles are developed by third parties. 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 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.
The development cycle for new console and PC titles ranges from twelve to
twenty-four months. After initial development of a product, it may take between
nine to twelve months to develop the product for other hardware platforms. The
cost to develop a front line product ranges from $3 million to $7 million.
In connection with the acquisition of the publishing rights associated with
Duke Nukem, we entered into an agreement with Apogee Software to develop Duke
Nukem Forever for the PC. This agreement does not require us to make advances to
Apogee in connection with the development of the product. See Note 6 to
Consolidated Financial Statements.
Other Third-Party Arrangements
In April 2003, we acquired exclusive distribution rights to eight PC games
and two console ports to be published by Destineer Publishing. For these rights,
we agreed to make recoupable advances and pay royalties to Destineer. Destineer
also granted us an immediately exercisable option to purchase an equity interest
in Destineer. The results of Destineer's operations have been consolidated in
our financial statements. See Note 4 to Consolidated Financial Statements.
In May 2003, we granted Capcom the exclusive right to publish localized
versions of Grand Theft Auto 3 and Grand Theft Auto: Vice City in Japan. We are
entitled to receive royalties from Capcom based on product sales.
In September 2003, we entered into a distribution agreement with TDK
Mediactive. The agreement granted us the exclusive right to distribute certain
games published by TDK. In December 2003, we acquired all of the outstanding
capital stock of TDK. See Note 23 to Consolidated Financial Statements.
Arrangements with Platform Manufacturers
We have entered into license agreements with Sony, Microsoft and Nintendo to
develop and publish software in North America and Europe for the PlayStation,
PlayStation 2, Xbox, Game Boy Advance and GameCube. 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 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 agreement with Sony in
March 2000 for PlayStation 2 covering European territories and Australia.
7
We entered into a four-year Licensed Publisher Agreement with Sony in
November 2002 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 in October 2000 for
PlayStation covering European territories and Australia.
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 and expires in
November 2004. Microsoft also has the right to terminate 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.
We entered into a three-year agreement with Nintendo in July 2001, granting
us the right and license to develop software for Nintendo's Game Boy Advance in
the Western Hemisphere. In October 2001, we entered into a similar three-year
agreement with Nintendo for European territories.
Sales and Marketing
We sell software titles to retail outlets in North America and Europe
through direct relationships with large retail customers and third-party
distributors. Our customers in North America include Wal-Mart, Best Buy,
Electronics Boutique, Target, GameStop, Toys "R" Us, Blockbuster and Circuit
City and 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, Game Group (formerly
Electronics Boutique), Karstadt, Carrefour and Media Saturn. We have sales and
marketing operations in the United Kingdom, France, Germany, Holland, Austria,
Italy, Australia, New Zealand and Canada.
For the fiscal year ended October 31, 2003, sales to our five largest
customers accounted for approximately 38.6% of our net sales. Wal-Mart accounted
for 11.4% of our net sales for the year ended October 31, 2003. No other
customer accounted for more than 10% of our net sales for this year.
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 public relations campaigns, using print and on-line
advertising, television, radio spots and outdoor advertising. For fiscal 2003,
we incurred selling and marketing costs of $103,015,000. We label and market our
products in accordance with Entertainment Software Rating Board (ESRB)
principles and guidelines.
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 expand our
portfolio of franchise brands.
8
To date, Max Payne, Midnight Club, Conflict: Desert Storm, Smuggler's Run,
Grand Theft Auto 3 and State of Emergency have been designated Sony's Greatest
Hits Program titles, and Max Payne and Conflict: Desert Storm have been
designated Microsoft's Platinum Hits Program titles. To qualify for these
programs under our agreements with hardware manufacturers, our products had to
satisfy certain shelf life and sales requirements. In connection with these
programs, we receive a manufacturing discount from Sony and Microsoft. Nintendo
has also established a Player's Choice Program for the Nintendo GameCube.
We seek to stimulate continued sales and maximize profit potential by
reducing the wholesale prices of our products to retailers at various times
during the life of a product. Price concessions may occur at any time in a
product's life cycle, but typically occur six to nine months after a product's
initial launch. A significant amount of our price concessions to retailers
relates to products designated as a Greatest or Platinum Hits Program title
offered by Sony and Microsoft. Price concessions in fiscal 2003 and 2002
amounted to $33,429,000 and $29,267,000, respectively. In certain international
markets, we provide volume rebates to stimulate continued product sales.
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. We employ
separate sales forces for our publishing and distribution operations. As of
December 31, 2003, we had a sales and marketing staff of 224 persons.
Distribution
We distribute our own titles as well as third-party titles, hardware and
accessories through our subsidiaries. We distribute three major categories of
third-party console and handheld products, consisting principally of newly
released and popular software titles, budget and catalog software titles, and
hardware.
We procure products from suppliers principally using standard purchase
orders based on our assessment of market demand, as well as pre-orders from
retailers. We periodically enter into agreements with our suppliers that provide
exclusive distribution rights to certain products. We carry inventory quantities
that we believe are necessary to provide rapid response time to retailer orders.
We utilize electronic data interchange ("EDI") with many of our retailers to
enhance the efficiency of placing and shipping orders and receiving payments.
Our Jack of All Games subsidiary maintains warehouse facilities and sales
offices in Ohio and Toronto, Canada. Products arrive at our warehouses where
products are picked, packed and shipped to customers. We generally ship products
by common carrier. Because we generally ship products within seven days of
receipt of orders, backlog is not material to our business.
Jack of All Games continues to capitalize on the growing installed base of
hardware and the proliferation of software titles and outlets to purchase
software. It has established a strong presence in the budget segment of the
business due to its expanding portfolio of value-priced products and its
expertise in selling these titles. Jack of All Games continues to leverage this
strategy by serving as the exclusive distributor of our value-priced published
products, including Starsky & Hutch, MTV's Celebrity Deathmatch, Ford Racing 2
and Ford Mania. Global Star's products are sold exclusively through Jack of All
Games, which we believe further strengthens its position in the value-priced
product business. We are consolidating Jack of All Games' United States and
Canadian distribution businesses on an operational basis, which we believe will
extend the reach of our domestic value console business into Canada.
9
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. The same procedure applies to games for the
Xbox. Xbox games must be manufactured by pre-approved manufacturers and are
generally shipped within two weeks of receipt of our manufacturing order.
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, and, to
a limited extent, by us. We believe that there are alternative sources for these
services that could be obtained 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 the 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, Microsoft and
Nintendo, each of which is a large developer and marketer of software for its
own platforms. Each of these competitors has 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 also compete with domestic companies such as Electronic Arts, Activision,
THQ, Acclaim Entertainment, Midway Games and Atari and international companies
such as Sega, Vivendi, Ubi Soft, 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. Some of our competitors
have greater financial, technical, personnel and other resources than we do, and
are able to carry larger inventories 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.
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.
10
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 greater financial, technical, personnel and other resources than we do, and
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, we seek
to obtain trademark and copyright registrations for our products.
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.
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.
International Operations
Sales in international markets, principally in the United Kingdom and other
countries in Europe, have accounted for a significant portion of our net sales.
For the fiscal years October 31, 2003 and 2002, sales in international markets
accounted for approximately 27.9% and 20.0%, respectively, of our net sales. 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. See Note 21 to Consolidated Financial Statements.
Employees
As of December 31, 2003, we had 1,226 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
In September 2002, we relocated our principal executive offices to 622
Broadway, New York, New York in approximately 50,000 square feet of space under
a ten-year lease which provides for annual rent of approximately $1,500,000. In
July 2003, we entered into a sublease for an additional 15,000 square feet at
this location for an annual rent of approximately $368,000.
We also maintain offices at 575 Broadway, New York, New York in
approximately 13,300 square feet of space under a 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 $513,000 and expires in
March 2004. We believe that the terms of the lease are no less favorable than
could have been obtained from an unaffiliated third-party. We intend to relocate
our 575 Broadway operations to 622 Broadway.
11
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 $572,000, plus taxes and utilities, and expires in 2011.
Rockstar North Limited (formerly DMA Design Limited) currently leases 14,600
square feet of office space in Edinburgh, Scotland, at an annual rent of
approximately $540,000, which expires in June 2009. Jack of All Games, Inc.
leases approximately 206,000 square feet of office and warehouse space in
Cincinnati, Ohio. Jack of All Games, Inc. pays $750,000 per annum, plus taxes
and insurance, under the lease, which expires in January 2006.
In addition, our other subsidiaries lease office space in Ontario and
Vancouver, Canada; Paris, France; Munich, Germany; Sydney, Australia; Aukland,
New Zealand; Amsterdam, Holland; Milan, Italy; Vienna, Austria; London, Lincoln
and Leighton Buzzard, UK and in Baltimore, Maryland; San Diego, San Francisco
and Los Angeles, California; Fenton, Missouri; Austin, Texas and Bellevue,
Washington for an aggregate annual rent of approximately $2,329,000.
Item 3. Legal Proceedings
We received a Wells Notice from the Staff of the Securities and Exchange
Commission stating the Staff's intention to recommend that the SEC bring a civil
action seeking an injunction and monetary damages against us alleging that we
violated certain provisions of the federal securities laws. The proposed
allegations stem from the previously disclosed SEC investigation into certain
accounting matters related to our financial statements, periodic reporting and
internal accounting controls. Our Chairman, an employee and two former officers
also received Wells Notices. The SEC's Staff also raised issues with respect to
our revenue recognition policies and its impact on our current and historical
financial statements. We have entered into discussions with the Staff to address
the issues raised in the Wells Notice. See Note 2 to Consolidated Financial
Statements.
On October 22, 2003, the action that had been filed on October 20, 2003 in
the Fourth Judicial District for the State of Tennessee Circuit Court of Cocke
County entitled Hamel vs. Take-Two Interactive Software, Inc., seeking
compensatory and punitive damages of $246,000,000 arising from the use of one of
our video games, was removed by us to the US District Court for the Eastern
District of Tennessee. On October 24, 2003, that action was voluntarily
dismissed by the plaintiffs without prejudice.
We are also 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
On November 17, 2003, at a special meeting, our stockholders voted to amend
our certificate of incorporation to increase our authorized shares of common
stock from 50,000,000 to 100,000,000. At the meeting, 32,869,810 shares voted
for the amendment, 2,663,909 shares voted against and 6,564 shares abstained.
12
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. The
following table sets forth, for the periods indicated, the range of the high and
low sales prices for the common stock as reported by NASDAQ.
Fiscal Year Ended October 31, 2002 High Low
---------------------------------- ---- ---
First Quarter .......................................... $19.50 $ 9.30
Second Quarter ......................................... 26.90 14.00
Third Quarter .......................................... 27.05 16.09
Fourth Quarter ......................................... 30.78 19.36
Fiscal Year Ended October 31, 2003
----------------------------------
First Quarter .......................................... $31.48 $19.83
Second Quarter ......................................... 24.19 18.30
Third Quarter .......................................... 31.40 21.66
Fourth Quarter ......................................... 41.67 24.35
Fiscal Year Ending October 31, 2004
-----------------------------------
First Quarter .......................................... $40.91 $27.42
The last reported sale price for our common stock on January 30, 2004 was
$29.00. The number of record holders of our common stock was approximately 123
as of January 30, 2004. 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. Our loan agreement with the bank prohibits us from
paying cash dividends. 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.
Changes in Securities. During the three months ended October 31, 2003, we
issued 10,000 shares of restricted common stock to an employee under our
Incentive Stock Plan. In connection with the above securities issuance, we
relied on Section 4(2) promulgated under the Securities Act of 1933, as amended.
Securities Authorized for Issuance under Equity Compensation Plans. The
table setting forth this information is included in Part III - Item 12. Security
Ownership of Certain Beneficial Owners and Management.
13
Item 6. Selected Financial Data
Our consolidated financial information should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and Consolidated Financial Statements (including the notes thereto)
contained elsewhere in this report.
We restated our previously issued financial statements for the fiscal years
ended October 31, 1999, 2000, 2001 and 2002, the interim quarters of 2002 and
the first three quarters of 2003 to reflect our revised revenue recognition
policy. Under this policy, we recognize as a reduction of net sales a reserve
for estimated future price concessions in the period in which the sale is
recorded. Measurement of the reserve is based on, among other factors, an
historical analysis of price concessions, an assessment of field inventory
levels and sell-through for each product, current industry conditions and other
factors affecting the estimated timing and amount of concessions management
believes will be granted. We previously recognized price concession reserves in
the period in which we communicated the price concessions to our customers. We
also restated our financial statements for the fiscal years ended October 31,
2000 and 2001 to increase our provision for returns at October 31, 2000 by
approximately $4.9 million for certain sales transactions primarily to retail
customers in fiscal 2000, and to reflect the fiscal 2001 returns as a reduction
of the revised October 31, 2000 reserve for returns rather than the previously
reported reduction of sales in fiscal 2001. Additionally, fiscal 2000 and 2001
revenues were restated for approximately $0.2 million to adjust for sales
cut-off transactions at the end of fiscal 2000. See Notes 2 and 19 to
Consolidated Financial Statements for details relating to the restatement.
(In thousands, except per share data)
Years Ended October 31
--------------------------------------------------------------------------
2003 2002 2001(1) 2000 1999
---- ---- ------- ---- ----
(Restated) (Restated) (Restated) (Restated)
Statement of Operations Data:
Net sales ......................................... $1,033,693 $ 794,676 $ 451,396 $ 358,918 $ 303,715
Income from operations ............................ 163,011 122,705 28,377 30,250 26,627
Income (loss) before cumulative effect
of change in accounting principle ............... 98,118 71,563 (1,674) 4,555 15,871
Net income (loss) ................................. 98,118 71,563 (6,918) 4,555 15,871
Net income (loss) per share
Basic ........................................... $ 2.34 $ 1.88 $ (0.20) $ 0.17 $ 0.77
Diluted ......................................... 2.27 1.81 (0.20) 0.16 0.74
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(Restated) (Restated) (Restated) (Restated)
Balance Sheet Data:
Cash and cash equivalents ......................... $ 183,477 $ 108,369 $ 6,056 $ 5,245 $ 10,374
Working capital ................................... 348,155 196,555 91,794 65,663 40,743
Total assets ...................................... 707,298 491,440 354,305 326,173 231,016
Total debt ........................................ -- -- 54,073 96,873 56,137
Total liabilities ................................. 173,806 135,896 135,140 158,538 146,609
Stockholders' equity .............................. 533,492 355,544 219,165 167,634 84,407
- ---------------
(1) Includes approximately $23.8 million of net sales, $8.7 million of income
from operations and $5.2 million of income included in loss before
cumulative effect of change in accounting principle, 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 loss.
As required by Statement of Financial Accounting Standards No. 145,
"Rescission of FASB Statements No. 4, 44 and 64, Amendment to FASB Statement
No. 13, and Technical Corrections", the $1,948 net loss on extinguishment of
debt for the year ended October 31, 2001 previously classified as an
extraordinary item has been reclassified as follows: $3,165 of loss on
extinguishment to non-operating expenses (included within loss before
cumulative effect of change in accounting principle) and $1,217 of tax
benefit to benefit for income taxes in the above table.
14
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
(Dollars in thousands, except per share amounts)
Restatement of Historical Financial Statements
We restated our previously issued financial statements for the fiscal years
ended October 31, 1999, 2000, 2001, 2002, the interim quarters of 2002 and the
first three quarters of 2003 to reflect our revised revenue recognition policy.
Under this policy, we recognize as a reduction of net sales a reserve for
estimated future price concessions in the period in which the sale is recorded.
Measurement of the reserve is based on, among other factors, an historical
analysis of price concessions, an assessment of field inventory levels and
sell-through for each product, current industry conditions and other factors
affecting the estimated timing and amount of concessions management believes
will be granted. We previously recognized price concession reserves in the
period in which we communicated the price concessions to our customers. We also
restated our financial statements for the fiscal years ended October 31, 2000
and 2001 to increase our provision for returns at October 31, 2000 by
approximately $4.9 million for certain sales transactions primarily to retail
customers in fiscal 2000, and to reflect the fiscal 2001 returns as a reduction
of the revised October 31, 2000 reserve for returns rather than the previously
reported reduction of sales in fiscal 2001. Additionally, fiscal 2000 and 2001
revenues were restated for approximately $0.2 million to adjust for sales
cut-off transactions at the end of fiscal 2000. See Notes 2 and 19 to
Consolidated Financial Statements for details relating to the restatement.
Our 2002 financial statements have been restated as follows:
Year Ended
October 31, 2002
-------------------------
As Reported As Restated
-------------------------
Statement of Operations Data:
Net sales $793,976 $794,676
Product costs $410,118 $411,518
Royalties $ 80,774 $ 80,442
Cost of sales $499,016 $500,084
Gross Profit $294,960 $294,592
Depreciation and amortization $ 11,187 $ 10,829
Income from operations $122,715 $122,705
Income before provision for income taxes $120,948 $120,938
Provision for income taxes $ 49,383 $ 49,375
Net income $ 71,565 $ 71,563
Basic net income per share $ 1.88 $ 1.88
Diluted net income per share $ 1.81 $ 1.81
October 31, 2002
-------------------------
As Reported As Restated
-------------------------
Balance Sheet Data:
Accounts receivable, net $107,188 $105,576
Prepaid royalties, current $ 13,723 $ 14,215
Deferred tax asset $ 5,392 $ 6,245
Total current assets $328,632 $328,365
Total assets $491,707 $491,440
Accrued expenses and other current liabilities $ 49,821 $ 50,698
Income taxes payable $ 1,603 $ 1,357
Total current liabilities $131,179 $131,810
Retained earnings $ 87,804 $ 86,906
Total liabilities and stockholders' equity $491,707 $491,440
All applicable amounts relating to the aforementioned restatements have been
reflected in these consolidated financial statements and notes thereto.
15
Our Consolidated Statement of Operations for the year ended October 31, 2001 has
been restated as follows:
Year Ended
October 31, 2001
-------------------------
As Reported As Restated
-------------------------
Statement of Operations Data:
Net sales $448,801 $451,396
Product costs $283,522 $282,279
Royalties $ 18,573 $ 19,875
Cost of sales $306,264 $306,323
Gross Profit $142,537 $145,073
Income from operations $ 25,841 $ 28,377
Loss before benefit for income taxes and
cumulative change in accounting principle * $ (6,660) $ (4,124)
Benefit for income taxes * $ (3,417) $ (2,450)
Net loss before cumulative change in accounting
principle $ (3,243) $ (1,674)
Cumulative change in accounting principle $ (5,337) $ (5,244)
Net loss $ (8,580) $ (6,918)
Basic net loss per share $ (0.25) $ (0.20)
Diluted net loss per share $ (0.25) $ (0.20)
- ---------------
* As required by Statement of Financial Accounting Standards No. 145,
"Rescission of FASB Statements No. 4, 44 and 64, Amendment to FASB Statement No.
13, and Technical Corrections" ("SFAS 145"), the $1,948 net loss on
extinguishment of debt for the year ended October 31, 2001 previously classified
as an extraordinary item has been reclassified in the As Reported column as
follows: $3,165 of loss on extinguishment to non-operating expenses and $1,217
of tax benefit to benefit for income taxes in the above table.
Overview
We are a leading global publisher of interactive software games designed for
personal computers, video game consoles and handheld platforms manufactured by
Sony, Microsoft and Nintendo. We also distribute our products as well as
third-party products, hardware and accessories to retail outlets in North
America through our Jack of Games subsidiary, and we have sales, marketing and
publishing operations in the United Kingdom, France, Germany, Holland, Austria,
Italy, Australia, New Zealand and Canada.
Our principal sources of revenue 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. Operating margins in our publishing business are dependent upon our
ability to continually release new, commercially successful products. We develop
most of our front-line products internally, and we own all of our major
intellectual properties, which we believe permits us to maximize profitability.
Our distribution revenues are derived from the sale of third-party software
titles, accessories and hardware. Operating margins in our distribution business
are dependent on the mix of software and hardware sales, with software
generating higher margins than hardware. Publishing activities generate
significantly higher margins than distribution activities, with sales of PC
software titles resulting in higher margins than sales of products designed for
video game consoles.
We have pursued a growth strategy by capitalizing on the widespread market
acceptance of video game consoles and the growing popularity of innovative
gaming experiences that appeal to more mature audiences. We have established a
portfolio of successful proprietary software content, including our premier
brands: Grand Theft Auto, Max Payne and Midnight Club, for the major hardware
platforms. We expect to continue to be the leader in the mature, action product
category by leveraging our existing franchises and developing new brands, such
as Manhunt.
16
We currently anticipate that the release of new brands in fiscal 2004,
including The Warriors and Red Dead Revolver, along with the launch of the next
installment of Grand Theft Auto, will generate significant cash flow from our
publishing business. We also believe that we will be able to continue to grow
our distribution business through a combination of our retail relationships and
our value product offerings.
Historically, each generation of video game consoles and handheld platforms
experiences a gradual decrease in retail pricing over the life of the system,
with retail pricing for software titles following a similar trend. The
PlayStation 2 and Xbox were introduced several years ago, and have been reduced
in price since their launch, with additional price reductions anticipated to
occur in 2004. Reduced pricing for our titles could result in lower margins for
our published products and reduced growth rates in our publishing business.
However, as retail prices for interactive entertainment hardware and software
decline, our distribution business benefits from the wider availability of
higher margin, value priced software titles.
Estimates
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 net sales 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 concessions and doubtful accounts.
Actual amounts could differ significantly from these estimates.
Revenue Recognition
We recognize revenue upon the transfer of title and risk of loss to our
customers. We apply the provisions of Statement of Position 97-2, "Software
Revenue Recognition" in conjunction with the applicable provisions of Staff
Accounting Bulletin No. 101, "Revenue Recognition." Accordingly, we recognize
revenue for software when there is (1) persuasive evidence that an arrangement
with our customer exists, which is generally a customer purchase order, (2) the
software is delivered, (3) the selling price is fixed or determinable and (4)
collection of the customer receivable is deemed probable. Our payment
arrangements with customers typically provide net 30 and 60-day terms.
Revenue is recognized after deducting estimated reserves for returns and
price concessions. In specific circumstances when we do not have a reliable
basis to estimate returns and price concessions or are unable to determine that
collection of receivables is probable, we defer the sale until such time as we
can reliably estimate any related returns and allowances and determine that
collection of the receivables is probable.
Allowances for Returns and Price Concessions
We accept returns and grant price concessions in connection with our
publishing arrangements. Following reductions in the price of our products, we
grant price concessions to permit customers to take credits against amounts they
owe us with respect to merchandise unsold by them. Our customers must satisfy
certain conditions to entitle them to return products or receive price
concessions, including compliance with applicable payment terms and confirmation
of field inventory levels.
Our distribution arrangements with customers do not give them the right to
return titles or to cancel firm orders. However, we sometimes accept returns
from our distribution customers for stock balancing and make accommodations to
customers, which includes credits and returns, when demand for specific titles
falls below expectations.
We make estimates of future product returns and price concessions related to
current period product revenue. We estimate the amount of future returns and
price concessions for published titles based upon, among other factors,
historical experience, customer inventory levels, analysis of sell-through rates
and changes in demand and acceptance of our products by consumers.
17
Significant management judgments and estimates must be made and used in
connection with establishing the allowance for returns and price concessions in
any accounting period. We believe we can make reliable estimates of returns and
price concessions. However, actual results may differ from initial estimates as
a result of changes in circumstances, market conditions and assumptions.
Adjustments to estimates are recorded in the period in which they become known.
Prepaid Royalties
Our agreements with licensors and developers generally provide us with
exclusive publishing rights and require us to make advance royalty payments that
are recouped against royalties due to the licensor or developer based on product
sales. Prepaid royalties are amortized as cost of sales on a title by title
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 contractual royalty
rate based on actual net product sales. We continually evaluate the
recoverability of prepaid royalties and charge 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 or if we
determine that we will cancel a development project. Prepaid royalties are
classified as current and non-current assets based upon estimated net product
sales within the next year. See Note 3 to Consolidated Financial Statements.
Capitalized Software Development Costs
We capitalize internal software development costs subsequent to establishing
technological feasibility of a title. Capitalized software development costs
represent the costs associated with the internal development of our publishing
products. Amortization of such costs as a component of cost of sales is recorded
on a title-by-title basis based on the greater of the proportion of current year
sales to total of current and estimated future sales for the title or the
straight-line method over the remaining estimated useful life of the title. We
continually evaluate the recoverability of capitalized software costs and will
charge to cost of sales any amounts that are deemed unrecoverable or for
projects that we will abandon. See Note 3 to Consolidated Financial Statements.
Income Taxes
Income tax assets and liabilities are determined by taxable jurisdiction. We
do not provide taxes on undistributed earnings of our international
subsidiaries. The total amount of undistributed earnings of foreign subsidiaries
was approximately $60,700 and $41,900 for the years ended October 31, 2003 and
2002, 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 subsidiaries are paid as dividends to us. The realization of deferred
tax assets depends on whether the Company generates future taxable income of the
appropriate type. In addition, we may adopt tax planning strategies to realize
these assets. If future taxable income does not materialize or tax planning
strategies are not effective, we may be required to record a valuation
allowance.
Recently Adopted Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards 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 provisions of SFAS 143 are
effective for financial statements issued for fiscal years beginning after June
15, 2002. The adoption of SFAS 143 in fiscal 2003 did not have an impact on our
financial condition, cash flows and results of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment to FASB
Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 eliminates
the requirement (in SFAS No. 4) that gains and losses from the extinguishments
of debt be aggregated and classified as extraordinary items, net of the related
income tax. As a result of the adoption of this pronouncement, the $1,948 net
loss on extinguishment of debt for the year ended October 31, 2001 classified as
an extraordinary item was reclassified as follows: $3,165 of loss on
extinguishment to non-operating expenses and $1,217 of tax benefit to provision
for income taxes. The adoption of SFAS 145 in fiscal 2003 did not have any
impact on our financial condition, cash flows and results of operations, other
than the reclassification referred to above.
18
In January 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS 146"). SFAS 146 requires the recognition of such costs when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
The provisions of SFAS 146 are to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The adoption of SFAS 146 in the
first quarter of fiscal 2003 did not have a material impact on our financial
condition and results of operations.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure" ("SFAS 148"). SFAS 148 amends the transition provisions of FASB No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123"), for entities that
voluntarily change to the fair value method of accounting for stock-based
employee compensation. We do not currently intend to change our accounting to
the fair value method. SFAS 148 also amends the disclosure provisions of SFAS
123 to require prominent disclosure about the effects on reported net income of
an entity's accounting policy decisions with respect to stock-based employee
compensation and amends APB Opinion No. 28, "Interim Financial Reporting" ("APB
28") to require disclosures about such effects in interim financial information.
The disclosure provisions of the amendments to FASB 123 were adopted by us in
the second quarter of fiscal 2003.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 expands previously
issued accounting guidance and disclosure requirements for certain guarantees
and requires recognition of an initial liability for the fair value of an
obligation assumed by issuing a guarantee. The provision for initial recognition
and measurement of liability will be applied on a prospective basis to
guarantees issued or modified after December 31, 2002. The adoption of FIN 45 in
the first quarter of fiscal 2003 did not have any impact on our financial
condition or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 requires a variable interest
entity to be consolidated by a company if that company is subject to a majority
of the risk of loss from the variable interest entity's activities or is
entitled to receive a majority of the entity's residual return or both. FIN 46
also provides criteria for determining whether an entity is a variable interest
entity subject to consolidation. FIN 46 requires immediate consolidation of
variable interest entities created after January 31, 2003. For variable interest
entities created prior to February 1, 2003, consolidation is required on July 1,
2003. The adoption of FIN 46 in the third quarter of fiscal 2003 did not have a
material impact on our financial condition or results of operations (see Note 4
to Consolidated Financial Statements).
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS No. 149 amends
and clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." In general, SFAS No. 149 is effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The adoption of SFAS 149 did not have any impact
on our financial condition or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures in its
statement of financial position certain financial instruments with
characteristics of both liabilities and equity. In accordance with SFAS 150,
financial instruments that embody obligations for the issuer are required to be
classified as liabilities. SFAS 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise shall be effective at
the beginning of the first interim period beginning after June 15, 2003, except
for the provisions relating to mandatorily redeemable financial instruments
which have been deferred indefinitely. The adoption of SFAS 150 did not have any
impact on our financial condition.
19
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, sales mix, platform and principal
products:
Years Ended October 31,
--------------------------------
2003 2002 2001
--------------------------------
(Restated) (Restated)
Operating data:
Net sales..................................................... 100.0% 100.0% 100.0%
Cost of sales
Product costs............................................. 52.0 51.8 62.5
Royalties................................................. 8.6 10.1 4.4
Software development costs................................ 1.1 1.0 0.9
Total cost of sales......................................... 61.7 62.9 67.9
Selling and marketing......................................... 10.0 9.8 11.7
General and administrative.................................... 8.5 9.0 9.9
Research and development...................................... 2.4 1.5 1.4
Depreciation and amortization................................. 1.6 1.4 2.8
Interest (income) expense, net................................ (0.2) 0.1 1.9
Loss on Internet securities................................... -- -- 4.8
Provision (benefit) for income taxes.......................... 6.5 6.2 (0.5)
Net income (loss)............................................. 9.5 9.0 (1.5)
Net Sales by Territory:
North America............................................... 72.1% 80.0% 76.4%
International............................................... 27.9 20.0 23.6
Net Sales Mix:
Publishing.................................................. 65.0% 71.5% 54.1%
Distribution................................................ 35.0 28.5 45.9
Platform Mix (publishing):
Console..................................................... 81.2% 83.9% 57.6%
PC.......................................................... 17.2 14.3 35.6
Accessories and Handheld ................................... 1.6 1.8 6.8
Principal Products:
Grand Theft Auto: Vice City, PS2
(released October - November 2002)........................ 33.6% 7.5% --%
Grand Theft Auto: Vice City, PC (released May 2003)......... 2.6 -- --
Grand Theft Auto 3, PS2 (released October 2001)............. 2.4 29.8 7.3
Grand Theft Auto 3, PC (released May 2002).................. 0.4 3.1 --
Max Payne, PS2 (released December 2001) ................... 0.9 6.6 --
Max Payne, Xbox (released December 2001).................... 0.2 3.0 --
Max Payne, PC (released July 2001).......................... -- 0.4 5.1
State of Emergency, PS2 (released February 2002)............ -- 4.4 --
Midnight Club 2, PS2 (released April 2003).................. 4.1 -- --
Midnight Club, PS2 (released October 2000).................. 0.7 1.1 4.1
Smuggler's Run, PS2 (released October 2000)................. -- 0.3 3.0
Ten largest titles.......................................... 50.5 59.5 30.8
20
Business Acquisitions
During fiscal 2003, we acquired the assets of Frog City, Inc. ("Frog City"),
the developer of Tropico 2: Pirate Cove, and all of the outstanding membership
interests of Cat Daddy Games LLC ("Cat Daddy"), another development studio. The
total purchase price for both studios consisted of $757 in cash and $319 of
prepaid royalties previously advanced to Frog City. We also agreed to make
additional payments of up to $2,500 to the former owners of Cat Daddy, based on
a percentage of Cat Daddy's profits for the first three years after acquisition,
which will be recorded as compensation expense if the targets are met. In
connection with the acquisitions, we recorded goodwill of $1,267 and net
liabilities of $191.
In November 2002, we acquired all of the outstanding capital stock of Angel
Studios, Inc. ("Angel"), the developer of the Midnight Club and Smuggler's Run
franchises. The purchase price consisted of 235,679 shares of restricted common
stock (valued at $6,557), $28,512 in cash and $5,931 (net of $801 of royalties
payable to Angel) of prepaid royalties previously advanced to Angel. In
connection with the acquisition, we recorded identifiable intangibles of $4,720
(comprised of intellectual property of $2,810, technology of $1,600 and
non-competition agreements of $310), goodwill of $37,425 and net liabilities of
$1,145.
In August 2002, we acquired all of the outstanding capital stock of Barking
Dog Studios Ltd. ("Barking Dog"), a Canadian-based development studio. The
purchase price consisted of 242,450 shares of restricted common stock (valued at
$3,801), $3,000 in cash, $825 of prepaid royalties previously advanced to
Barking Dog and assumed net liabilities of $70. In connection with the
acquisition, we recorded identifiable intangibles of $2,200, comprised of
non-competition agreements of $2,000 and intellectual property of $200, and
goodwill of $6,372.
In November 2000, we acquired all of the capital stock of VLM Entertainment
Group Inc., a third-party video game distributor, for $2,000 in cash and 875,000
shares of common stock (valued at $8,039). VLM accounted for 14.5% of our
distribution net sales in fiscal 2001.
The acquisitions have been accounted for as purchase transactions and,
accordingly, the results of operations and financial position of the acquired
businesses are included in our consolidated financial statements from the
respective dates of acquisition.
In December 2003, we acquired all of the outstanding capital stock and paid
certain liabilities of TDK Mediactive, Inc. ("TDK"). The purchase price of
approximately $14,276 consisted of $17,116 in cash and issuance of 163,641
restricted shares of our common stock (valued at $5,160), reduced by
approximately $8,000 due to TDK under a distribution agreement. We are in the
process of completing the purchase price allocation. TDK's results will be
included in our operating results beginning in the first quarter of fiscal 2004.
21
Fiscal Years Ended October 31, 2003 and 2002
Net Sales
Years ended October 31,
-----------------------------------------------------------
$ %
2003 % 2002 % Increase Inc
------------------------------------------------------------
Publishing $ 671,892 65.0 $568,492 71.5 $103,400 18.2
Distribution 361,801 35.0 226,184 28.5 135,617 60.0
------------------------------------------------------------
Net sales $1,033,693 100.0 $794,676 100.0 $239,017 30.1
============================================================
Net Sales. The increase in net sales was attributable to growth in our
publishing and distribution operations.
The increase in publishing revenues was primarily attributable to sales of
Grand Theft Auto: Vice City for PlayStation 2, which was released in October
2002 in North America and in November 2002 internationally and reflected the
growth of our publishing operations in Europe. We expect continued growth in our
publishing business in fiscal 2004. Publishing revenues in fiscal 2003 and 2002
include licensing revenues of $25,002 and $13,873, respectively.
Products designed for video game console platforms accounted for 81.2% of
fiscal 2003 publishing revenues as compared to 83.9% for fiscal 2002. Products
designed for PC platforms accounted for 17.2% of fiscal 2003 publishing revenues
as compared to 14.3% for fiscal 2002. We anticipate our product mix will remain
relatively constant for the foreseeable future but may fluctuate from period to
period.
Distribution revenues are derived from the sale of third-party software
titles, accessories and hardware. The increase in distribution revenues was
primarily attributable to our increasing market share for budget titles in North
American retail channels. We expect continued growth in our distribution
business in fiscal 2004, and that distribution revenues may increase as a
percentage of net sales during this period.
International operations accounted for approximately $288,753, or 27.9% of
net sales for fiscal 2003 compared to $159,245, or 20.0% of net sales for fiscal
2002. The increases were primarily attributable to expanded publishing
operations in Europe, which benefited from the November 2002 release of Grand
Theft Auto: Vice City for PlayStation 2, and significantly higher average
foreign exchange rates. We expect international sales to continue to account for
a significant portion of our revenues.
22
Cost of Sales
Years ended October 31,
-----------------------------------------------------------
% of % of $ %
2003 sales 2002 sales Increase Inc
-----------------------------------------------------------
Product costs $537,257 52.0 $411,518 51.8 $125,739 30.6
Royalties 89,294 8.6 80,442 10.1 8,852 11.0
Software development costs 11,003 1.1 8,124 1.0 2,879 35.4
-----------------------------------------------------------
Total cost of sales $637,554 61.7 $500,084 62.9 $137,470 27.5
===========================================================
Cost of Sales. The increase in product costs is primarily attributable to
higher costs associated with our expanded distribution operations. These costs
were partly offset by lower product pricing from suppliers and lower
manufacturing costs (principally attributable to volume purchase discounts and
rebates) and lower cost PC titles. Product costs for fiscal 2003 included a
charge of $7,892 relating to the impairment of intangibles related to certain
products in development, including Duke Nukem Forever and its sequel. The
impairment was based on continued product development delays and our assessment
of current market acceptance and projected cash flows for these products.
Product costs for fiscal 2002 included $3,064 of litigation settlement costs
relating to a distribution agreement.
23
Royalties. The increase in royalties was primarily due to expense under a
royalty program based on product sales for certain of our internal development
personnel, partly offset by lower royalties payable to third parties and lower
write-downs and amortization of prepaid royalties. Our internal royalty program
may continue to be a significant expense in future periods.
Software Development Costs. Software development costs increased due to the
release of a greater number of internally developed titles during this period
resulting in higher amortization in the current period. These software
development costs relate to our internally developed titles.
In future periods, cost of sales may be adversely affected by manufacturing
and other costs, price competition and by changes in product and sales mix and
distribution channels.
Operating Expenses
Years ended October 31,
-----------------------------------------------------------
% of % of $ %
2003 sales 2002 sales Increase Inc
-----------------------------------------------------------
Selling and marketing $103,015 10.0 $ 77,990 9.8 $25,025 32.1
General and administrative 88,083 8.5 71,544 9.0 16,539 23.1
Research and development 25,107 2.4 11,524 1.5 13,583 117.9
Depreciation and amortization 16,923 1.6 10,829 1.4 6,094 56.3
-----------------------------------------------------------
Total operating expenses $233,128 22.6 $171,887 21.6 $61,241 35.6
===========================================================
Selling and marketing. The increase in selling and marketing expense was
attributable to increased levels of advertising and promotional support for
existing and new titles as well as higher personnel expenses and is consistent
with the growth of our business.
General and administrative. The general and administrative expense increase
in absolute dollars was principally attributable to costs associated with the
consolidation of our distribution operations, as well as increased personnel
expenses (including bonuses, severance payments and the issuance of restricted
stock), higher rent and bad debt expenses. Higher costs were partly offset by
lower professional fees, including the reimbursement of $1,100 of legal fees
from insurance proceeds in fiscal 2003 relating to costs recorded in the prior
year. Fiscal 2002 costs reflected litigation settlement costs of $1,190 relating
to a distribution arrangement. The fiscal 2003 net consolidation charge of
$7,028 consisted of: lease termination costs, representing the fair value of
remaining lease payments, net of estimated sublease rent; disposition of fixed
assets, representing the net book value of fixed assets and leasehold
improvements; and other exit costs. Bad debt expense increased as a result of
customer bankruptcies not covered by insurance during the current year.
Research and development. Research and development costs increased primarily
due to the acquisitions of development studios, as well as increased personnel
costs. Once software development projects reach technological feasibility, which
is relatively early in the development process, a substantial portion of our
research and development costs are capitalized and subsequently amortized as
cost of goods sold.
Depreciation and amortization. Depreciation and amortization expense
increase includes $4,407 related to the impairment of a customer list from a
previous acquisition as a result of the consolidation of our distribution
operations, higher amortization of intangible assets as a result of acquisitions
and higher depreciation related to the implementation of accounting software
systems.
Income from Operations. Income from operations increased by $40,306, or
32.8%, to $163,011 for fiscal 2003 from $122,705 for fiscal 2002, due to the
changes referred to above.
Interest (Income) Expense, net. Interest income of $2,265 for fiscal 2003
was attributable to interest earned on the invested cash. Interest expense of
$480 for fiscal 2002 reflected borrowings from our credit facilities, which were
repaid in early fiscal 2002.
24
Class Action Settlement Costs. During fiscal 2002, we recorded $1,468 of
class action settlement costs, which represents a settlement of $7,500 and
related legal fees, net of $6,145 of insurance proceeds.
Provision for Income Taxes. Income tax expense was $67,197 for fiscal 2003
as compared to $49,375 for fiscal 2002. The increase was primarily attributable
to increased taxable income. The effective tax rate was 40.6% for fiscal 2003,
as compared to an effective tax rate of 40.8% for fiscal 2002. The effective
income tax rate differs from the statutory rate primarily as a result of
non-taxable foreign income, non-deductible expenses, valuation allowances for
deferred tax assets and the mix of foreign and domestic taxes as applied to the
income. The valuation allowances relate to capital loss and state net operating
loss carryforwards.
At October 31, 2003 and October 31, 2002, we had capital loss carryforwards
totaling approximately $21,000. The capital loss carryforwards will expire in
the periods fiscal 2006 through fiscal 2008. Failure to achieve sufficient
levels of taxable income from capital transactions might affect the ultimate
realization of the capital loss carryforwards. At October 31, 2002 management
had a strategy of selling net appreciated assets of the company, to the extent
required to generate sufficient taxable income prior to the expiration of these
benefits. At October 31, 2003, based on management's future plans, this strategy
was no longer viable, and accordingly a valuation allowance has been recorded
for this asset. At October 31, 2003, we had foreign net operating losses of
$9,800 expiring between 2005 and 2010, and state net operating losses of $41,700
expiring between 2021 and 2023. Limitations on the utilization of these losses
may apply, and accordingly valuation allowances have been recorded for these
assets.
Net Income. Net income increased $26,555 or 37.1%, to $98,118 for fiscal
2003 from $71,563 for fiscal 2002, due to the changes referred to above.
Diluted Net Income per Share. Diluted net income per share increased $0.46,
or 25.4%, to $2.27 for fiscal 2003 from $1.81 for fiscal 2002. The increase in
net income was partly offset by the higher weighted average shares outstanding.
The increase in weighted shares outstanding resulted from the issuance of shares
underlying stock options and to the acquisitions of the Max Payne intellectual
property and the development studios.
Fiscal Years Ended October 31, 2002 and 2001
Net Sales
Years ended October 31,
-----------------------------------------------------------
$ %
2002 % 2001 % Increase Inc
------------------------------------------------------------
Publishing $568,492 71.5 $244,071 54.1 $324,421 132.9
Distribution 226,184 28.5 207,325 45.9 18,859 9.1
------------------------------------------------------------
Net sales $794,676 100.0 $451,396 100.0 $343,280 76.0
============================================================
Net Sales. The increase in revenues was primarily attributable to growth
in publishing operations. Included in net sales for fiscal 2001 was $23,846
attributable to the adoption of SAB 101. See Note 3 to Consolidated Financial
Statements.
The increase in publishing revenues was primarily attributable to the
continued strong sales of Grand Theft Auto 3 for PlayStation 2 and the release
of Grand Theft Auto: Vice City for the PlayStation 2, Max Payne for the
PlayStation 2 and Xbox, State of Emergency for the PlayStation 2 and Grand Theft
Auto 3 for the PC. Fiscal 2001 included $17,248 of net sales attributable to the
adoption of SAB 101.
25
Products designed for video game console platforms accounted for 83.9% of
fiscal 2002 publishing revenues as compared to 57.6% for fiscal 2001. The
increase was primarily attributable to continued sales of Grand Theft Auto 3 for
PlayStation 2 and the release of Grand Theft Auto: Vice City for the PlayStation
2, Max Payne for PlayStation 2 and Xbox and State of Emergency for PlayStation
2. Products designed for the PC accounted for approximately 14.3% of fiscal 2002
publishing net sales as compared to 35.6% for fiscal 2001. The decrease is a
result of fewer PC titles released during fiscal 2002.
The increase in distribution revenues was primarily attributable to the
commercial introduction of Xbox and GameCube and the continued rollout of
PlayStation 2 and the sale of software for these console platforms. Distribution
revenue represented 28.5% and 45.9% of net sales for fiscal 2002 and 2001,
respectively. Fiscal 2001 included $6,598 attributable to the adoption of SAB
101.
International operations accounted for approximately $159,245, or 20.0% of
net sales for fiscal 2002 compared to $106,565 or 23.6% for fiscal 2001. The
increase in absolute dollars was primarily attributable to expanded publishing
operations in Europe, including the release of Max Payne and State of Emergency
for PlayStation 2, Grand Theft Auto 3 for the PC and continued sales of Grand
Theft Auto 3 for PlayStation 2.
Cost of Sales
Years ended October 31,
-----------------------------------------------------------
% of % of $ %
2002 sales 2001 sales Increase Inc
-----------------------------------------------------------
Product costs $411,518 51.8 $282,279 62.5 $129,239 45.8
Royalties 80,442 10.1 19,875 4.4 60,567 304.7
Software development costs 8,124 1.0 4,169 0.9 3,955 94.9
-----------------------------------------------------------
Total cost of sales $500,084 62.9 $306,323 67.9 $193,761 63.3
===========================================================
Cost of Sales. The decrease in product costs as a percentage of net sales
was due to the higher proportion of publishing net sales which have lower
product costs than distribution net sales, partly offset by the shift in
publishing product mix to higher cost console titles from lower cost PC titles.
Fiscal 2002 includes $3,064 of litigation settlement costs relating to a
distribution agreement, while fiscal 2001 includes an impairment charge of
$3,397 relating to a reduction in the value of certain acquired Internet assets.
Product costs in fiscal 2001 included $15,106 related to the adoption of SAB
101.
The increase in royalties were due to higher royalty payments and increased
amortization of prepaid royalties as a result of increased product sales,
principally for State of Emergency, Max Payne, Midnight Club and Smuggler's Run.
In addition, we wrote off $14,122 of prepaid royalties, principally due to the
termination of several projects in 2002. We also implemented a royalty program
for certain of our development personnel based on product sales.
The increase in software development costs in absolute dollars reflects
higher amortization principally related to the Grand Theft Auto titles. These
software development costs relate to our internally developed titles.
Operating Expenses
Years ended October 31,
-----------------------------------------------------------
$ %
% of % of Increase Inc
2002 sales 2001 sales (Decrease) (Dec)
-----------------------------------------------------------
Selling and marketing $ 77,990 9.8 $ 52,998 11.7 $24,992 47.2
General and administrative 71,544 9.0 44,867 9.9 26,677 59.5
Research and development 11,524 1.5 6,190 1.4 5,334 86.2
Depreciation and amortization 10,829 1.4 12,641 2.8 (1,812) (14.3)
-----------------------------------------------------------
Total operating expenses $171,887 21.6 $116,696 25.9 $55,191 47.3
===========================================================
26
Selling and marketing. The increase in selling and marketing expense was
attributable to television and other advertising expenses relating to Grand
Theft Auto 3, Max Payne, Grand Theft Auto: Vice City and Conflict Desert Storm
during fiscal 2002.
General and administrative. The increase in general and administrative
expense was attributable to increased personnel expenses primarily relating to
salaries of additional executive, financial, accounting and information
technology personnel and legal and professional fees incurred in connection with
legal proceedings and regulatory matters as well as litigation settlement costs
relating to a distribution arrangement.
Research and development. The increase in research and development costs was
attributable to bonus compensation, increased staffing levels and the
acquisition of Barking Dog Studios. Once software development projects reach
technological feasibility, which is relatively early in the development process,
a substantial portion of our research and development costs are capitalized and
subsequently amortized as cost of goods sold.
Depreciation and amortization. The depreciation and amortization expense
decrease was due to our adoption of SFAS 142, and was partly offset by increased
depreciation related to the implementation of a new accounting software system
and amortization related to the Max Payne acquisition.
Income from Operations. Income from operations increased by $94,328, or
332.4%, to $122,705 for fiscal 2002 from $28,377 for fiscal 2001, due to the
changes referred to above.
Interest (Income) Expense, net. Interest expense decreased by $8,030, or
94.4%, to $480 for fiscal 2002 from $8,510 for fiscal 2001. The decrease was
attributable to substantially lower levels of borrowing from our credit
facilities and interest income earned on invested cash.
Gain on Sale of Subsidiary. We recorded a non-operating gain of $651 on the
sale of our Jack of All Games UK subsidiary during fiscal 2001.
(Gain) Loss on Internet Investments. For fiscal 2002, we recognized a gain
of $181 from the sale of marketable securities. During fiscal 2001, we incurred
an impairment charge of $21,477 relating primarily to our investments in
Gameplay and eUniverse to reflect other than temporary declines in the value of
these investments.
Class Action Settlement Costs. During fiscal 2002, we recorded $1,468 of
class action settlement costs, which represents a settlement of $7,500 and
related legal fees, net of $6,145 of insurance proceeds.
Loss on Early Extinguishment of Debt. During fiscal 2001, we incurred a
charge of $3,165 upon the early repayment of $15,000 of subordinated
indebtedness.
Provision for Income Taxes. We incurred income tax expense of $49,375 for
fiscal 2002 as compared to a benefit of $2,450 for fiscal 2001. The increase was
primarily attributable to increased taxable income. The difference between the
statutory rate and the effective rates of 40.8% and (59.4%) for fiscal 2002 and
2001, respectively, primarily is the result of state and foreign tax rate
differentials and non-deductible items, such as amortization of intangibles.
Cumulative Effect of Change in Accounting Principle. In connection with the
adoption of SAB 101, we recognized a cumulative effect of $5,244, net of taxes
of $3,496, in fiscal 2001.
Net Income. For fiscal 2002, we achieved net income of $71,563, as compared
to net loss of $6,918 for fiscal 2001.
27
Liquidity and Capital Resources
Our primary cash requirements are to fund the development and marketing of
our products. We satisfy our working capital requirements primarily through cash
flow from operations. At October 31, 2003, we had working capital of $348,155 as
compared to working capital of $196,555 at October 31, 2002.
Our cash and cash equivalents increased $75,108 to $183,477 at October 31,
2003, from $108,369 at October 31, 2002. The increase is primarily attributable
to $80,628 of cash provided by operating activities and by $44,562 provided by
financing activities, partly offset by $45,881 used in investing activities.
Net cash provided by operating activities for fiscal 2003 was $80,628
compared to $144,998 for fiscal 2002 and $27,319 for fiscal 2001. The decrease
in fiscal 2003 was primarily attributable to cash used to finance significantly
increased levels of accounts receivables and inventories, increases in prepaid
expenses and software development costs, partly offset by an increase in net
income, higher non-cash adjustments principally relating to the consolidation of
our distribution facilities and increased tax benefit from stock options. The
increase in cash provided by operating activities in fiscal 2002 was primarily
attributable to increased net income and our focus on working capital management
in both fiscal 2002 and 2001. The increase in cash provided from operations for
fiscal 2002 was also attributable to increases in accounts payable and accrued
expenses, partly offset by increased levels of inventories, prepaid expenses and
accounts receivable.
Net cash used in investing activities for fiscal 2003 was $45,881 as
compared to $18,084 for 2002 and $13,479 for fiscal 2001. The increase in fiscal
2003 is primarily attributable to higher expenditures for the acquisition of
development studios and lower proceeds from sale of investments, partly offset
by fewer intangible assets acquisitions. The increase in fiscal 2002 is
primarily attributable to the acquisition of the Max Payne intangible assets and
the Barking Dog development studio and increased expenditures for fixed assets.
Net cash used in investing activities for fiscal 2001 related primarily to the
purchase of fixed assets and to a lesser extent acquisitions.
Net cash provided by financing activities for fiscal 2003 was $44,562 as
compared to net cash used in financing activities for fiscal 2002 of $31,988 and
$11,790 for fiscal 2001. The increase in fiscal 2003 was primarily attributable
to the absence of repayment of indebtedness and higher proceeds from the
exercise of stock options. The increase in net cash used in financing activities
for fiscal 2002 was primarily attributable to the absence of private placement
proceeds in fiscal 2002 and the repayment of indebtedness. 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.
In December 1999, we entered into a credit agreement, as amended and
restated in August 2002, with a group of lenders led by Bank of America, N.A.,
as agent. The agreement provides for borrowings of up to $40,000 through the
expiration of the line of credit on August 28, 2005. Generally, advances under
the line of credit are based on a borrowing formula equal to 75% of eligible
accounts receivable plus 35% of eligible inventory. Interest accrues on such
advances at the bank's prime rate plus 0.25% to 1.25%, or at LIBOR plus 2.25% to
2.75% depending on our consolidated leverage ratio (as defined). We are required
to pay a commitment fee to the bank equal to 0.5% of the unused loan balance.
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.
Available borrowings under the agreement are reduced by the amount of
outstanding letters of credit, which were $9,290 at October 31, 2003. The loan
agreement contains certain financial and other covenants, including the
maintenance of consolidated net worth, consolidated leverage ratio and
consolidated fixed charge coverage ratio. As of October 31, 2003, we were in
compliance with such covenants. 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. We had no outstanding
borrowings under the revolving line of credit as of October 31, 2003.
In February 2001, our United Kingdom subsidiary entered into a credit
facility agreement, as amended in March 2002, with Lloyds TSB Bank plc
("Lloyds") under which Lloyds agreed to make available borrowings of up to
approximately $22,200. 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.
Available borrowings under the agreement are reduced by the amount of
outstanding guarantees. The facility expires on March 31, 2004. We had no
outstanding guarantees or borrowings under this facility as of October 31, 2003.
28
For fiscal 2003, 2002 and 2001, we received proceeds of $44,865, $23,308 and
$22,931, respectively, relating to the exercise of stock options and warrants.
In December 2003, we acquired all of the outstanding capital stock and paid
certain liabilities of TDK Mediactive. The purchase price of approximately
$14,276 consisted of $17,116 in cash and issuance of 163,641 restricted shares
of our common stock (valued at $5,160), reduced by approximately $8,000 due to
TDK under a distribution agreement.
Our accounts receivable, less allowances, which includes doubtful accounts,
returns, price concessions, rebates and other sales allowances, at October 31,
2003 was $166,536 as compared to $105,576 at October 31, 2002.
The increase of $92,971 in gross accounts receivable at October 31, 2003
principally reflects increased product releases at year end as well as cash
received in advance of products shipped at the end of fiscal 2002. Two retail
customers each accounted for more than 10% of the receivable balance (28.3% in
aggregate) at October 31, 2003. As of October 31, 2003, most of our receivables
had been covered by insurance, with certain limits and deductibles, in the event
of a customer's bankruptcy or insolvency. In November 2003, we terminated our
receivables insurance. Generally, we have been able to collect our receivables
in the ordinary course of business. We do not hold any collateral to secure
payment from customers. As a result, we are subject to credit risks,
particularly in the event that any of the receivables represent a limited number
of retailers or are concentrated in foreign markets. If we are unable to collect
our accounts receivable as they become due, we could be required to increase our
allowance for doubtful accounts, which could adversely affect our liquidity and
working capital position.
Our allowances increased from $30,806 at October 31, 2002 to $62,817 at
October 31, 2003 and increased as a percentage of gross receivables from 22.6%
at October 31, 2002 to 27.4% at October 31, 2003. The increase was due to
additional price concessions and returns for our published products and
additional bad debts, net of deductibles and insurance proceeds, related to the
bankruptcy of two customers, the losses from which were not entirely covered by
insurance. We had accounts receivable days outstanding of 56 days for the three
months ended October 31, 2003, as compared to 45 days for the three months ended
October 31, 2002. Receivable days outstanding increased primarily as a result of
increased product releases at year end. Our receivable days outstanding
fluctuate from period to period depending on the timing of product releases.
Inventories of $101,748 at October 31, 2003 increased $27,357 from October
31, 2002, reflecting higher levels of distribution products to support the
growth of this business. Accounts payable of $106,172 at October 31, 2003
increased $26,512 primarily due to the increase in inventory levels.
In September 2002, we relocated our principal executive offices to 622
Broadway, New York, New York. We have recently leased additional space at 622
Broadway to accommodate our expanded operations. We estimate that as of October
31, 2003 we will incur an additional $1,200 in capital expenditures for
continuing renovations and leasehold improvements for this space. In connection
with signing a ten year lease, we provided a standby letter of credit of $1,560,
expiring December 31, 2003. As a result of the relocation, we recorded expenses
of $363 and $514 in fiscal 2003 and 2002, respectively, related to lease costs
with regard to our former executive offices. In addition, we expect to spend an
additional $4,000 in connection with the implementation of accounting software
systems for our international operations and the upgrade for our domestic
operations. We are considering expanding our distribution facilities in
Cincinnati, Ohio, which would require additional capital expenditures for
leasehold improvements and equipment. As of the date of this report, we have no
other material commitments for capital expenditures.
Our Board of Directors authorized a stock repurchase program under which we
may repurchase up to $25,000 of our common stock from time to time in the open
market or in privately negotiated transactions. We have not repurchased any
shares under this program.
We have incurred and may continue to incur significant legal, accounting and
other professional fees and expenses in connection with pending regulatory
matters.
Based on our currently proposed operating plans and assumptions, we believe
that projected cash flow from operations and available cash resources will be
sufficient to satisfy our cash requirements for the reasonably foreseeable
future.
29
Contractual Obligations and Contingent Liabilities and Commitments
Our offices and warehouse facilities are occupied under non-cancelable
operating leases expiring at various times from December 2003 to October 2013.
We also lease certain furniture, equipment and automobiles under non- cancelable
leases expiring through October 2007. Our future minimum rental payments for the
year ending October 31, 2004 are $7,268 and aggregate minimum rental payments
through applicable lease expirations are $37,865.
We have entered into distribution agreements under which we purchase various
software games. These agreements, which expire between June 2004 and March 2005,
require remaining aggregate minimum guaranteed payments of $14,330 at October
31, 2003, including $3,491 of payments due pursuant to an agreement with TDK
Mediactive. These agreements are collateralized by a standby letter of credit of
$3,600 at October 31, 2003. Additionally, assuming performance by third-party
developers, we have outstanding commitments under various software development
agreements to pay developers an aggregate of $27,224 over the fiscal year ending
October 31, 2004.
In connection with our acquisition of the publishing rights to the Duke
Nukem franchise for PC and video games in December 2000, we are obligated to pay
$6,000 contingent upon delivery of the final version of Duke Nukem Forever for
the PC. In May 2003, we agreed to pay up to $6,000 upon the achievement of
certain sales targets for Max Payne 2. We also agreed to make additional
payments of up to $2,500 to the former owners of Cat Daddy based on a percentage
of Cat Daddy's profits for the first three years after acquisition. The payables
will be recorded when the conditions requiring their payment are met.
The following table summarizes our minimum contractual obligations and
commercial commitments as of October 31, 2003:
- ---------------------------------------------------------------------------------------------------
Payments due by periods ended October 31,
- ---------------------------------------------------------------------------------------------------
2009 and
Contractual Obligations Total 2004 2005 to 2006 2007 to 2008 thereafter
- ---------------------------------------------------------------------------------------------------
Capital Lease Obligations $ 176 $ 103 $ 73 -- --
- ---------------------------------------------------------------------------------------------------
Operating Lease Obligations 38,086 7,268 10,497 $8,289 $12,032
- ---------------------------------------------------------------------------------------------------
Letters of Credit 9,290 9,290 -- -- --
- ---------------------------------------------------------------------------------------------------
Publishing Arrangements 36,555 27,224 8,822 509 --
- ---------------------------------------------------------------------------------------------------
Distribution Arrangements 14,330 14,330 -- -- --
- ---------------------------------------------------------------------------------------------------
Total $98,437 $58,215 $19,392 $8,798 $12,032
- ---------------------------------------------------------------------------------------------------
Fluctuations in Operating Results and Seasonality
We have experienced fluctuations in quarterly operating results as a result
of the timing of the introduction of new titles; variations in sales of titles
developed for particular platforms; market acceptance of our titles; development
and promotional expenses relating to the introduction of new titles, sequels or
enhancements of existing titles; projected and actual changes in platforms; the
timing and success of title introductions by our competitors; product returns;
changes in pricing policies by us and our competitors; the size and timing of
acquisitions; the timing of orders from major customers; and order cancellations
and delays in product shipment. Sales of our titles are also seasonal, with peak
shipments typically occurring in the fourth calendar quarter (our fourth and
first fiscal quarters) as a result of increased demand for titles during the
holiday season. Quarterly comparisons of operating results are not necessarily
indicative of future operating results.
30
International Operations
Sales in international markets, principally in the United Kingdom and other
countries in Europe, have accounted for a significant portion of our net sales.
For fiscal 2003 and 2002, sales in international markets accounted for
approximately 27.9% and 20.0%, respectively, of our net sales. 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.
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 which
could cause our actual results, performance or achievements to be materially
different from results, performance or achievements, expressed or implied by
such forward-looking statements:
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 introductions 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 marketing 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 nine months, although sales of certain products may extend for significant
periods of time, including through our election to participate in Sony's
Greatest Hits and Microsoft's Platinum Hits programs.
The life cycle of a game generally involves a relatively high level of sales
during the first few months after introduction followed by a decline in sales.
Because net sales associated with the initial shipments of a new product
generally constitute a high percentage of the total net sales associated with
the life of a product, any delay in the introduction of one or more new products
could adversely affect our operating results. Additionally, because we introduce
a relatively limited number of new products in any period, the failure of one or
more of our products to achieve market acceptance could adversely affect our
operating results.
A significant portion of our net sales is derived from a limited number of
titles. For the year ended October 31, 2003, our ten best selling titles
accounted for approximately 50.5% of our net sales, with Grand Theft Auto: Vice
City for PlayStation 2 accounting for 33.6% of our net sales, Midnight Club 2
for PlayStation 2 accounting for 4.1% of our net sales and Grand Theft Auto:
Vice City for PC accounting for 2.6% of our net sales. Our ten best selling
titles accounted for approximately 59.5% of our net sales for the year ended
October 31, 2002. For this period, Grand Theft Auto 3 for PlayStation 2
accounted for 29.8% of our net sales, Grand Theft Auto: Vice City for the
PlayStation 2 accounted for 7.5% of our net sales and Max Payne for PlayStation
2 accounted for 6.6% of our net sales. Our ten best selling titles accounted for
approximately 30.8% of our net sales for the fiscal year ended October 31, 2001.
Our future titles may not be commercially viable. If we fail to continue to
develop and sell new, commercially successful titles, our net sales and profits
may decrease substantially and we may incur losses.
31
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
calendar quarter (our fourth and first fiscal quarters), due primarily to the
increased demand for games during 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:
o delays in the introduction of new titles;
o the size and timing of product and business acquisitions;
o variations in sales of titles designed to operate on particular
platforms;
o development and promotional expenses relating to the introduction of new
titles;
o availability of hardware platforms;
o the timing and success of title introductions by our competitors;
o product returns and price concessions;
o the timing of orders from major customers.
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, 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 market
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:
o the popularity, price and timing of new software and hardware platforms
being released and distributed by us and our competitors;
o international, national and regional economic conditions, particularly
economic conditions adversely affecting discretionary consumer spending;
o war, acts of terrorism and military action, which could adversely affect
consumer preferences in entertainment;
o changes in consumer demographics;
o the availability and popularity of other forms of entertainment; and
o 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 finished products is unpredictable. During this period, consumer appeal
of a particular title may decrease, causing product sales to fall short of
expectations.
32
Rapidly changing technology and platform shifts could hurt our operating
results. The interactive entertainment industry in general is associated with
rapidly changing technology. As more advanced platforms achieve market
acceptance, consumer demand for software for older platforms declines.
We are devoting significant development resources primarily on products
designed for Sony's PlayStation 2 and Microsoft's Xbox. If consumer demand for
these platforms declines generally or as a result of the next hardware
transition cycle, we may experience lower than expected sales or losses from
products designed for these platforms.
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 publishers over the
Internet would materially adversely affect our distribution business.
It is difficult to anticipate hardware development cycles and we must make
substantial development and investment decisions well in advance of the
introduction of new hardware products. If new hardware products are delayed or
do not meet our expectations for consumer acceptance we may not be able to
recover our investment and our business and financial results could be adversely
affected.
Our business is dependent on 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 price concessions may adversely affect
our operating results. We are exposed to the risk of product returns and price
concessions with respect to our customers. Our distribution arrangements with
customers do not give them the right to return titles to us or to cancel firm
orders. However, we sometimes accept product returns from our distribution
customers for stock balancing and negotiate accommodations to customers which
include credits and returns, when demand for specific products falls below
expectations. We accept returns and grant price concessions in connection with
our publishing arrangements. Revenue is recognized after deducting estimated
reserves for returns and price concessions. We believe that we can reliably
estimate future returns and price concessions. However, if return rates and
price concessions for our published titles exceed our reserves, our net sales
will decline.
The interactive entertainment software industry is highly competitive. We
compete for both licenses to properties and the sale of interactive
entertainment software with Sony, Microsoft and Nintendo, each of which is a
large developer and marketer of software for its own platforms. Each of these
competitors has 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 also compete with domestic companies such as
Electronic Arts, Activision, THQ, Midway Games, Acclaim Entertainment and Atari
and international companies such as Sega, Vivendi, Ubi Soft, Eidos, Capcom,
Konami and Namco. Some of our competitors have greater financial, technical,
personnel and other resources than we do, and are able to carry larger
inventories and make higher offers to licensors and developers for commercially
desirable properties than we can. Our titles also compete with other forms of
entertainment such as motion pictures, television and audio and video products
featuring similar themes, online computer programs and forms of entertainment
which may be less expensive or provide other advantages to consumers.
33
Our distribution business also 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.
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.
A limited number of customers may account for a significant portion of our
sales. Sales to our five largest customers accounted for approximately 38.6%,
31.4% and 20.8%, respectively, of our net sales for the years ended October 31,
2003, 2002 and 2001. For the year ended October 31, 2003, sales of our products
to Wal-Mart accounted for 11.4% of our net sales. Our sales are made primarily
pursuant to purchase orders without long-term agreements or other commitments.
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 seriously hurt our business.
We are subject to credit and collection risks. Our sales are typically made
on credit. 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. We recently terminated our receivables
insurance. Although we continually assess the creditworthiness of our
customers, which are principally large, national retailers, if we are unable to
collect our accounts receivable as they become due, it could adversely affect
our financial condition.
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, and impose
penalties for noncompliance. 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 rating systems, which could delay the
release of those products in such countries. Our software titles receive a
rating of "E" (age 6 and older), "T" (age 13 and over) or "M" (age 17 and over).
Most of our new titles (including Grand Theft Auto 3, Grand Theft Auto: Vice
City, Max Payne 2: The Fall of Max Payne, Manhunt and Mafia) have received an M
rating. We believe that we comply with such rating systems and properly display
the ratings and content descriptions received for our titles.
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 or sexually
explicit material, and the Federal Trade Commission has issued reports with
respect to the marketing of such material to minors. Consumer advocacy groups
have also opposed sales of interactive entertainment software containing graphic
violence or sexually explicit material by pressing for legislation in these
areas (including legislation prohibiting the sale of certain "M" rated video
games to minors) and by engaging in public demonstrations and media campaigns.
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, and adversely affect our operating results.
If any groups (including international, national and local political and
regulatory bodies) 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 seriously hurt our business. Although lawsuits seeking
damages for injuries allegedly suffered by third parties as a result of video
games have been unsuccessful, a claim of this kind has been asserted against us.
See Item 3 "Legal Proceedings."
34
We cannot publish our console titles without the approval of hardware
manufacturers. We are required to obtain a license from Sony, Microsoft and
Nintendo, our principal competitors, to develop and publish titles for their
respective hardware platforms. 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 net sales 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. Termination of any such
agreements would seriously hurt our business.
License agreements relating to these rights generally extend for a term of
three or four 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.
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 for its or other publishers' products.
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 supplies, our net sales 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 or are named in lawsuits by
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. Moreover, intellectual property litigation or claims
could require us to discontinue the distribution of products, obtain a license
or redesign our products, which could result in additional substantial costs and
material delays.
We are dependent on third-party software developers to complete certain of
our titles. We rely on third-party software developers for the development of
certain 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.
35
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. The development cycle for new titles
ranges from twelve to twenty-four months. After development of a product, it may
take between nine 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 net sales and damage to our reputation.
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, 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.
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 and
facilities. In the event of a significant decline in net sales, 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 in a timely manner, if at all, to offset an immediate shortfall in
net sales and gross profit.
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 concessions or return rights offered by publishers may
have a bearing on the amount of product we may be willing to purchase. Our
industry may experience significant hardware 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 or publishers 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.
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 characterized by the introduction of 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 in our distribution business to the extent that supplier price concessions
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 concession obligations.
We are subject to risks and uncertainties of international trade. Sales in
international markets, primarily in the United Kingdom and other countries in
Europe, have accounted for a significant portion of our net sales. Sales in
international markets accounted for approximately 27.9%, 20.0% and 23.6%,
respectively, of our net sales for the year ended October 31, 2003, 2002 and
2001. 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.
36
The market price for our common stock may be highly volatile. The market
price of our common stock has been and may continue to be highly volatile.
Factors such as our operating results, announcements by us or our competitors
and various factors affecting the interactive entertainment software industry
may have a significant impact on the market price of our common stock.
We are subject to rapidly evolving regulation affecting financial reporting,
accounting and corporate governance matters. In response to recent corporate
events, legislators and government agencies have focused on the integrity of
financial reporting, and regulatory accounting bodies have recently announced
their intention to issue several new accounting standards, including accounting
for stock options as compensation expense, certain of which are significantly
different from current accounting standards. We cannot predict the impact of the
adoption of any such proposals on our future financial results. Additionally,
recently enacted legislation focused on corporate governance, auditing and
internal accounting controls imposes compliance burdens on us, and will require
us to devote significant financial, technical and personnel resources to address
compliance issues.
We are subject to SEC proceedings that may result in sanctions and monetary
penalties. We received a Wells Notice from the Staff of the SEC stating the
Staff's intention to recommend that the SEC bring an enforcement action seeking
an injunction and monetary damages against us alleging that we violated certain
provisions of the federal securities laws. The proposed allegations stem from
the previously disclosed SEC investigation into certain accounting matters
related to our financial statements, periodic reporting and internal accounting
controls. The investigation is continuing and we expect to receive additional
requests for information.
Restatements of our financial statements could result in lawsuits. The Staff
of the SEC has raised issues with respect to our revenue recognition policies
and certain sales transactions and its impact on our current and historical
financial statements. After a detailed review, we restated our previously issued
financial statements to reflect our revised revenue recognition policy with
respect to establishing reserves for price concessions for our published
products, as well as to increase our provision for returns at October 31, 2000
with respect to certain sales transactions primarily to retail customers with a
corresponding reduction in the returns provision in 2001. Although we have
entered into discussions with the Staff to address the issues raised in the
Wells Notice, we are unable to predict the outcome of these discussions. We may
be subject to class action lawsuits seeking damages as a result of the
restatements. See Note 2 to Consolidated Financial Statements.
We are uncertain about the future of our management and key personnel. Our
Chairman has received a Wells Notice from the Staff of the SEC. Our Chairman
founded the company and we depend on this individual for our strategic and
operating decisions. The loss of the services of this individual could have a
material adverse effect on our business and prospects. Additionally, pursuant to
the terms of his amended employment contract, our Chief Executive Officer has
the right to elect to voluntarily terminate his agreement and resign at any time
after March 31, 2004 and receive his full salary and bonus during the
eighteen-month period following such resignation. Furthermore, we are dependent
upon the expertise and skills of certain of our Rockstar employees responsible
for content creation and product development and marketing. Although we have
employment agreements with each of these creative, development and marketing
personnel, and we have granted them incentives in the form of an internal
royalty program based on sales of Rockstar published products, there can be no
assurance that we will be able to continue to retain these personnel at current
compensation levels, or at all. Failure to continue to attract and retain
qualified management, creative, development, financial, marketing, sales and
technical personnel could materially adversely affect our business and
prospects.
37
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
(Dollars in thousands)
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, 2003, we had no outstanding
variable rate indebtedness.
We transact business in foreign currencies and are exposed to risks
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 as a separate component of stockholders'
equity. For the year ended October 31, 2003, our foreign currency translation
adjustment gain was $4,119. Foreign exchange transaction gain for the year ended
October 31, 2003 was $2,015. A hypothetical 10% change in applicable currency
exchange rates at October 31, 2003 would result in a material translation
adjustment.
Item 8. Financial Statements and Supplementary Data
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.
Item 9A. Controls and Procedures
Based on their evaluation of the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this report, our Chief
Executive Officer and Chief Financial Officer have concluded that our disclosure
controls and procedures are effective at the reasonable assurance level for
recording, processing, summarizing and reporting the information we are required
to disclose in our reports filed under the Securities Exchange Act of 1934.
There were no changes in our internal controls over financial reporting during
the fiscal quarter ended October 31, 2003 that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting.
38
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this Item is incorporated by reference to the
section of our definitive Proxy Statement for our Annual Meeting of Stockholders
to be held in 2004, 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 our definitive Proxy Statement for our Annual Meeting of Stockholders
to be held in 2004, 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 our definitive Proxy Statement for our Annual Meeting of Stockholders
to be held in 2004, 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 our definitive Proxy Statement for our Annual Meeting of Stockholders
to be held in 2004, 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.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated by reference to the
section of our definitive Proxy Statement for our Annual Meeting of Stockholders
to be held in 2004, entitled "Principal Accountant Fees and Services" to be
filed with the Securities and Exchange Commission within 120 days after the end
of the fiscal year covered by this Report.
39
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this Report:
(i) Financial Statements. See Index to Financial Statements
on page 43 of this Report.
(ii) Financial Statement Schedule. See page 88 of this Report.
(iii) Exhibits
3.1 Restated Certificate of Incorporation
3.1.1 Certificate of Designation, dated March 11, 1998
3.1.2 Certificate of Amendment of Restated Certificate
of Incorporation, dated April 30, 1998
3.1.3 Certificate of Amendment of Restated Certificate
of Incorporation, dated November 17, 2003
3.2 By-Laws (1)
10.1 1997 Stock Option Plan (1) +
10.2 2002 Stock Option Plan (2) +
10.3 Incentive Stock Plan adopted by the Board of
Directors on June 12, 2003. (3) +
10.4 Amended and Restated Credit Agreement, dated
August 28, 2002, by and among the Company,
certain of its subsidiaries, certain lenders and
Bank of America, N.A., as agent. (4)
10.5 Loan Agreement with Lloyds TBS Commercial and
Take-Two Interactive Software Europe Ltd. (5)
10.6 Employment Agreement, dated February 15, 2002,
by and between the Company and Karl H. Winters.
(6) +
10.7 Employment Agreement, dated August 1, l998, as
amended, by and between the Company and Ryan A.
Brant. (7) +
10.8 Amendment to Employment Agreement with Ryan A.
Brant, dated November 18, 2002. (8) +
10.9 Employment Agreement dated as of November 18,
2002, by and between the Company and Jeffrey C.
Lapin. (8) +
10.10 Amendment to Employment Agreement with, Jeffrey
C. Lapin dated December 9, 2003. +
10.11 Licensed Publishing Agreement dated April 1,
2000 between Sony Computer Entertainment
America, Inc. and the Company. (9) *
10.12 Publishing Agreement dated May 8, 1998 between
Gathering of Developers I, Ltd. and Apogee
Software, Ltd/ 3D Realms. (10) *
10.13 Xbox Publisher License Agreement dated December
14, 2000 between Microsoft Corporation and the
Company. (5) *
40
10.14 Confidential License Agreement for Nintendo Game
Cube dated September 24, 2001 between Nintendo
of America, Inc. and the Company. (5) *
10.15 Letter Agreement dated July 21, 2001 between
Apogee Software, Ltd and the Company. (9)
10.16 Development and Publishing Agreement dated
February 10, 2000 by and between the Company and
VIS International plc. (11)
10.17 Lease Agreement between the Company and Moklam
Enterprises, Inc. dated July 1, 2002. (4)
10.18 Asset Purchase Agreement between Apogee
Software, Ltd., Remedy Entertainment and the
Company. (12)
10.19 Stock Purchase Agreement, dated November 19,
2002, by and between the Company and Angel
Studios, Inc. (13)
21.1 Subsidiaries of the Company.
23.1 Consent of PricewaterhouseCoopers LLP.
31.1 Chief Executive Officer Certification Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer Certification Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer Certification pursuant to
18 U.S.C. Section 1350, as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer Certification pursuant to
18 U.S.C. Section 1350, as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
* 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.
+ Represents a management contract or compensatory plan or
arrangement.
(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 Company's Proxy
Statement dated May 10, 2002.
(3) Incorporated by reference to the applicable exhibit
contained in the Company's Quarterly Report on Form 10-Q
for the three months ended July 31, 2003.
(4) Incorporated by reference to the applicable exhibit
contained in the Company's Quarterly Report on Form 10-Q
for the three months ended July 31, 2002.
(5) Incorporated by reference to the applicable exhibit
contained in the Company's Annual Report on Form 10-K for
the year ended October 31, 2001.
(6) Incorporated by reference to the applicable exhibit
contained in the Company's Annual Report on Form 10-K/A
in the year ended October 31, 2001.
(7) Incorporated by reference to the applicable exhibit
contained in the Company's Registration Statement on Form
S-1 (File No. 333-748851).
41
(8) Incorporated by reference to the applicable exhibit
contained in the Company's Annual Report on Form 10-K for
the year ended October 31, 2002.
(9) Incorporated by reference to the applicable exhibit
contained in the Company's Current Report on Form 8-K
dated May 7, 2002.
(10) Incorporated by reference to the applicable exhibit
contained in the Company's Registration Statement on Form
S-3/A dated September 14, 2001 (File no. 333- 66748).
(11) Incorporated by reference to the applicable exhibit
contained in the Company's Quarterly Report on Form 10-Q
for the three months ended April 30, 2002.
(12) Incorporated by reference to the applicable exhibit
contained in the Company's Current Report on Form 8-K
dated June 5, 2002.
(13) Incorporated by reference to the applicable exhibit
contained in the Company's Current Report on Form 8-K
dated November 22, 2002.
(b) Reports on Form 8-K filed during the quarter ended October 31,
2003:
On September 3, 2003, the Company furnished a Current Report on Form 8-K to
report the Press Release dated September 3, 2003 relating to the Company's
financial results for the third fiscal quarter ended July 31, 2003. (Items 7, 9
and 12)
On October 22, 2003, the Company filed a Current Report on Form 8-K to
report a legal proceeding filed in the Fourth Judicial District for the State of
Tennessee Circuit Court of Cocke County entitled Hamel et al vs. Sony Computer
Entertainment America, Inc., Take-Two Interactive Software, Inc.,
Rockstar Games Inc., and Walmart, Inc. (Item 5)
42
TAKE-TWO INTERACTIVE SOFTWARE, INC.
YEAR ENDED OCTOBER 31, 2003
INDEX TO FINANCIAL STATEMENTS
Report of Independent Auditors 44
Consolidated Balance Sheets - At October 31, 2003 and 2002
(Restated) 45
Consolidated Statements of Operations - For the years ended
October 31, 2003, 2002 (Restated) and 2001 (Restated) 46
Consolidated Statements of Cash Flows - For the years ended
October 31, 2003, 2002 (Restated) and 2001 (Restated) 48
Consolidated Statements of Stockholders' Equity - For the
years ended October 31, 2001 (Restated), 2002 (Restated) and
2003 50
Notes to Consolidated Financial Statements 52
Financial Statement Schedule:
II - Valuation and Qualifying Accounts - For the years ended
October 31, 2003, 2002 (Restated) and 2001 (Restated) 88
43
Report of Independent Auditors
To the Board of Directors and
Shareholders of Take-Two Interactive Software, Inc.
In our opinion, the consolidated financial statements 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, 2003 and October 31, 2002, and the results of their operations and
their cash flows for each of the three years in the period ended October 31,
2003 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, presents 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 Consolidated Financial Statements, the Company has
restated its financial statements for the years ended October 31, 2002 and 2001.
As discussed in Note 3, effective November 1, 2001, the Company adopted the
provisions of Statement of Financial Accounting Standards No. 141, "Business
Combinations" and Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets". Accordingly, the Company discontinued the
amortization of goodwill as of that date. Also, as discussed in Note 3,
effective November 1, 2000, the Company changed its method of accounting for
revenue recognition to conform to the requirements of SEC Staff Bulletin No.
101, "Revenue Recognition".
/s/ PricewaterhouseCoopers LLP
New York, New York
February 12, 2004
44
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share data)
- --------------------------------------------------------------------------------
October 31,
2003 2002
------------- --------------
(Restated)
ASSETS
Current assets
Cash and cash equivalents $ 183,477 $ 108,369
Accounts receivable, net of allowances
of $62,817 and $30,806 at October 31,
2003 and 2002, respectively 166,536 105,576
Inventories 101,748 74,391
Prepaid royalties 12,196 14,215
Prepaid expenses and other current assets 41,112 19,569
Deferred tax asset 8,333 6,245
------------- -------------
Total current assets 513,402 328,365
------------- -------------
Fixed assets, net 22,260 15,319
Prepaid royalties 8,439 12,203
Capitalized software development costs, net 16,336 10,385
Investments -- 97
Goodwill, net 101,498 61,529
Intangibles, net 44,836 55,293
Deferred tax asset -- 7,983
Other assets, net 527 266
------------- -------------
Total assets $ 707,298 $ 491,440
============= =============
LIABILITIES and STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 106,172 $ 79,660
Accrued expenses and other current
liabilities 56,707 50,698
Income taxes payable 2,265 1,357
Current portion of capital lease obligation 103 95
------------- -------------
Total current liabilities 165,247 131,810
Capital lease obligation, net of current
portion 73 201
Deferred tax liability 8,486 3,885
------------- -------------
Total liabilities 173,806 135,896
------------- -------------
Stockholders' equity
Common stock, par value $.01 per share;
50,000,000 shares authorized (100,000,000
as of November 17, 2003); 44,227,215 and
40,361,739 shares issued and outstanding at
October 31, 2003 and 2002, respectively 442 404
Additional paid-in capital 350,852 273,502
Deferred compensation (1,890) (227)
Retained earnings 185,024 86,906
Accumulated other comprehensive loss (936) (5,041)
------------- -------------
Total Stockholders' Equity 533,492 355,544
------------- -------------
Total Liabilities and Stockholders' Equity $ 707,298 $ 491,440
============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
45
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except share data)
- -------------------------------------------------------------------------------
Years Ended October 31,
-------------------------------------
2003 2002 2001
---------- ---------- ----------
(Restated) (Restated)
Net sales $1,033,693 $794,676 $451,396
---------- -------- --------
Cost of sales
Product costs 537,257 411,518 282,279
Royalties 89,294 80,442 19,875
Software development costs 11,003 8,124 4,169
---------- -------- --------
Total cost of sales 637,554 500,084 306,323
---------- -------- --------
Gross profit 396,139 294,592 145,073
---------- -------- --------
Operating expenses
Selling and marketing 103,015 77,990 52,998
General and administrative 88,083 71,544 44,867
Research and development 25,107 11,524 6,190
Depreciation and amortization 16,923 10,829 12,641
---------- -------- --------
Total operating expenses 233,128 171,887 116,696
---------- -------- --------
Income from operations 163,011 122,705 28,377
---------- -------- --------
Interest (income) expense, net (2,265) 480 8,510
Gain on sale of subsidiary -- -- (651)
(Gain) loss on Internet investments (39) (181) 21,477
Class action settlement costs -- 1,468 --
Loss on early extinguishment of debt -- -- 3,165
---------- -------- --------
Total non-operating (income) expenses (2,304) 1,767 32,501
---------- -------- --------
Income (loss) before income taxes and cumulative effect of change in
accounting principle 165,315 120,938 (4,124)
Provision (benefit) for income taxes 67,197 49,375 (2,450)
---------- -------- --------
Income (loss) before cumulative effect of change in accounting principle 98,118 71,563 (1,674)
Cumulative effect of change in accounting principle, net of taxes of $3,496 -- -- 5,244
---------- -------- --------
Net income (loss) $ 98,118 $ 71,563 $ (6,918)
========== ======== ========
The accompanying notes are an integral part of these consolidated
financial statements.
46
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Statements of Operations (continued)
(In thousands, except share data)
- -------------------------------------------------------------------------------
Years Ended October 31,
----------------------------------
2003 2002 2001
------- ---------- ----------
(Restated) (Restated)
Per share data:
Basic:
Weighted average common shares outstanding 41,965 38,030 33,961
======= ======== =======
Income (loss) before cumulative effect of change in accounting principle per share $ 2.34 $ 1.88 $ (0.05)
Cumulative effect of change in accounting principle per share -- -- (0.15)
------- -------- -------
Net income (loss) per share - Basic $ 2.34 $ 1.88 $ (0.20)
======= ======== =======
Diluted:
Weighted average common shares outstanding 43,297 39,570 33,961
======= ======== =======
Income (loss) before cumulative effect of change in accounting principle per share $ 2.27 $ 1.81 $ (0.05)
Cumulative effect of change in accounting principle per share -- -- (0.15)
------- -------- -------
Net income (loss) per share - Diluted $ 2.27 $ 1.81 $ (0.20)
======= ======== =======
The accompanying notes are an integral part of these consolidated
financial statements.
47
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands, except share data)
- -------------------------------------------------------------------------------
Years Ended October 31,
------------------------------------------------
2003 2002 2001
------------- ------------- -------------
(Restated) (Restated)
Cash flows from operating activities:
Net income (loss) $ 98,118 $ 71,563 $ (6,918)
Adjustment to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation and amortization 12,516 10,829 12,641
(Gain) loss on disposal of fixed assets (31) 126 219
Gain on sale of subsidiary -- -- (651)
(Gain) loss on Internet investments (39) (181) 21,477
Impairment charge on Internet assets -- -- 4,187
Impairment of intellectual property and technology 7,892 -- --
Non-cash charges for consolidation of distribution facilities 5,474 -- --
Loss on early extinguishment of debt -- -- 3,165
Provision (benefit) for deferred taxes 8,203 6,726 (9,422)
Provision for returns 47,342 28,350 40,543
Provision for price concessions 45,919 29,513 25,757
Provision for doubtful accounts and sales allowances 31,390 16,638 5,528
Amortization of various expenses and discounts 9,301 6,262 1,168
Write off of prepaid royalties and capitalized software 9,588 15,616 1,585
Tax benefit from exercise of stock options 20,858 10,700 --
Compensatory stock and stock options 3,445 3,052 5
Other (2,190) (840) 108
Changes in operating assets and liabilities, net of effects of acquisitions:
Increase in accounts receivable (185,611) (87,100) (51,505)
Increase in inventories (25,146) (12,852) (2,821)
Increase in prepaid royalties (10,764) (8,157) (8,174)
Increase in prepaid expenses and other current assets (15,597) (3,034) (4,509)
Increase in capitalized software development costs (5,152) (895) (3,099)
Decrease (increase) in other non-current assets -- 257 (455)
Increase in accounts payable 20,148 23,019 1,511
Increase (decrease) in accrued expenses and other current liabilities 4,445 33,835 (3,021)
Increase in income taxes payable 519 1,571 --
------------- ------------- -------------
Net cash provided by operating activities 80,628 144,998 27,319
------------- ------------- -------------
Cash flows from investing activities:
Purchase of fixed assets (15,464) (10,466) (8,568)
Sale of investments 114 6,170 --
Acquisitions, net of cash acquired (27,973) (3,788) (1,769)
Acquisition of intangible assets (2,075) (10,000) (3,105)
Proceeds from disposal of business -- -- 215
Other investing activities (483) -- (252)
------------- ------------- -------------
Net cash used in investing activities (45,881) (18,084) (13,479)
------------- ------------- -------------
Cash flows from financing activities:
Proceeds from private placements -- -- 20,892
Net repayments under lines of credit -- (54,284) (40,545)
Repayment of loan payable -- -- (15,000)
Proceeds from exercise of stock options and warrants 44,865 23,308 22,931
Other financing activities (303) (1,012) (68)
------------- ------------- -------------
Net cash provided by (used in) financing activities 44,562 (31,988) (11,790)
------------- ------------- -------------
Effect of foreign exchange rates (4,201) 7,387 (1,239)
------------- ------------- -------------
Net increase in cash for the period 75,108 102,313 811
Cash and cash equivalents, beginning of the period 108,369 6,056 5,245
------------- ------------- -------------
Cash and cash equivalents, end of the period $ 183,477 $ 108,369 $ 6,056
============= ============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
48
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Statements of Cash Flows (continued)
(In thousands, except share data)
- -------------------------------------------------------------------------------
Years Ended October 31,
---------------------------------------------
2003 2002 2001
------------- ------------- -------------
(Restated) (Restated)
Supplemental disclosure of non-cash investing activities:
Issuance of common stock in connection with acquisitions $ 6,557 $ 22,344 $ 13,981
============= ============= =============
Supplemental information on intangible assets and businesses acquired:
Fair value of assets acquired
Cash $ 1,284 $ 37 $ 331
Current assets 437 36 10,417
Non-current assets 507 67 770
Intangible assets 6,842 31,479 25,975
Goodwill 38,692 4,866 25,386
Less, liabilities assumed
Current liabilities (3,612) (210) (26,210)
Stock, warrants and other consideration (12,807) (22,344) (31,219)
Direct transaction costs (11) (106) (245)
------------- ------------- -------------
Cash paid 31,322 13,825 5,205
Less cash acquired (1,284) (37) (331)
------------- ------------- -------------
Net cash paid $ 30,048 $ 13,788 $ 4,874
============= ============= =============
Supplemental information on businesses disposed:
Current assets -- -- $ (318)
Current liabilities -- -- 754
------------- ------------- -------------
Net liabilities (assets) disposed -- -- 436
Consideration received for businesses disposed:
Cash -- -- 215
------------- ------------- -------------
Gain on sale -- -- $ (651)
============= ============= =============
Cash paid during the year for interest $ 110 $ 1,513 $ 8,284
============= ============= =============
Cash paid during the year for taxes $ 48,361 $ 30,045 $ 9,973
============= ============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
49
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the Years Ended October 31, 2001 (Restated), 2002 (Restated) and 2003
(In thousands)
- -------------------------------------------------------------------------------
Accumulated
Common Stock Additional Deferred Other
------------------------ Paid-in Compen- Retained Comprehensive
Shares Amount Capital sation Earnings Income (Loss) Total
-----------------------------------------------------------------------------------------------
(Restated) (Restated)
Balance, November 1, 2000 31,173 $ 312 $ 157,738 $ (5) $ 22,261 $ (12,672) $ 167,634
Foreign currency translation
adjustment -- -- -- -- -- (767) (767)
Net unrealized income on
investments, net of taxes of
$1,832 -- -- -- -- -- 2,987 2,987
Net loss -- -- -- -- (6,918) -- (6,918)
----------
Comprehensive (loss) (4,698)
----------
Proceeds from exercise of stock
options and warrants 3,266 32 22,582 -- -- -- 22,614
Amortization of deferred
compensation -- -- -- 5 -- -- 5
Issuance of common stock in
connection with acquisitions 1,466 14 13,967 -- -- -- 13,981
Issuance of common stock in
connection with private
placements, net of issuance
costs 1,300 13 20,879 -- -- -- 20,892
Retirement of common stock (564) (5) (7,305) -- -- -- (7,310)
Tax benefit in connection with
the exercise of stock options -- -- 6,047 -- -- -- 6,047
-----------------------------------------------------------------------------------------------
Balance, October 31, 2001 36,641 366 213,908 -- 15,343 (10,452) 219,165
Foreign currency translation
adjustment -- -- -- -- -- 5,553 5,553
Net unrealized income on
investments, net of taxes of
$87 -- -- -- -- -- (142) (142)
Net income -- -- -- -- 71,563 -- 71,563
----------
Comprehensive income 76,974
----------
Proceeds from exercise of stock
options and warrants 2,434 25 23,283 -- -- -- 23,308
Amortization of deferred
compensation -- -- -- 682 -- -- 682
Deferred compensation in
connection with restricted
stock issued 50 1 908 (909) -- -- --
Issuance of common stock in
connection with acquisitions 1,212 12 22,332 -- -- -- 22,344
Issuance of compensatory stock
and stock options 25 -- 2,371 -- -- -- 2,371
Tax benefit in connection with
the exercise of stock options -- -- 10,700 -- -- -- 10,700
-----------------------------------------------------------------------------------------------
Balance, October 31, 2002 40,362 $ 404 $ 273,502 $ (227) $ 86,906 $ (5,041) $ 355,544
========== ========== ========== =========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
50
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Consolidated Statements of Stockholders' Equity (continued)
For the Years Ended October 31, 2001 (Restated), 2002 (Restated) and 2003
(In thousands)
- -------------------------------------------------------------------------------
Accumulated
Common Stock Additional Other
--------------- Paid-in Deferred Retained Comprehensive
Shares Amount Capital Compensation Earnings Income (Loss) Total
------------------------------------------------------------------------------------
(Restated) (Restated)
Balance, October 31, 2002 40,362 $404 $273,502 $ (227) $ 86,906 $(5,041) $355,544
Foreign currency translation adjustment -- -- -- -- -- 4,119 4,119
Net unrealized loss on investment, net of
taxes of $9 -- -- -- -- -- (14) (14)
Net income -- -- -- -- 98,118 -- 98,118
--------
Comprehensive income 102,223
--------
Proceeds from exercise of stock options and
warrants 3,404 34 44,831 -- -- -- 44,865
Amortization of deferred compensation -- -- -- 3,427 -- -- 3,427
Issuance of common stock in
connection with acquisition 236 2 6,555 -- -- -- 6,557
Issuance of compensatory stock and stock
options 225 2 5,106 (5,090) -- -- 18
Tax benefit in connection with the exercise
of stock options -- -- 20,858 -- -- -- 20,858
------ ---- -------- ------- -------- ------- --------
Balance, October 31, 2003 44,227 $442 $350,852 $(1,890) $185,024 $ (936) $533,492
====== ==== ======== ======= ======== ======= ========
The accompanying notes are an integral part of these consolidated
financial statements.
51
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
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, video game consoles and handheld platforms
and publishes games developed internally and by third-parties. The Company
also distributes games for video game consoles and handheld platforms
published internally and by third-parties, as well as hardware and
accessories manufactured by third-parties.
2. RESTATEMENT OF FINANCIAL STATEMENTS
The Company restated its previously issued financial statements for the
fiscal years ended October 31, 2000 (not presented herein), 2001 and 2002, to
reflect its revised revenue recognition policy. Under this policy, the
Company recognizes as a reduction of net sales a reserve for estimated future
price concessions in the period in which the sale is recorded. Measurement of
the reserve is based on, among other factors, an historical analysis of price
concessions, an assessment of field inventory levels and sell-through for
each product, current industry conditions and other factors affecting the
estimated timing and amount of concessions management believes will be
granted. The Company previously recognized price concession reserves in the
period in which it communicated the price concessions to its customers. The
Company also restated its financial statements for the fiscal years ended
October 31, 2000 and 2001 to increase its provision for returns at October
31, 2000 by approximately $4.9 million for certain sales transactions
primarily to retail customers in fiscal 2000, and to reflect the fiscal 2001
returns as a reduction of the revised October 31, 2000 reserve for returns
rather than the previously reported reduction of sales in fiscal 2001.
Additionally, fiscal 2000 and 2001 revenues were restated for approximately
$0.2 million to adjust for sales cut-off transactions at the end of fiscal
2000. The impact of these changes on opening retained earnings as of November
1, 2000 was $2.6 million. See Note 19.
The Company's 2002 financial statements have been restated as follows:
Year Ended
October 31, 2002
-------------------------
As Reported As Restated
-------------------------
Statement of Operations Data:
Net sales $793,976 $794,676
Product costs $410,118 $411,518
Royalties $ 80,774 $ 80,442
Cost of sales $499,016 $500,084
Gross Profit $294,960 $294,592
Depreciation and amortization $ 11,187 $ 10,829
Income from operations $122,715 $122,705
Income before provision for income taxes $120,948 $120,938
Provision for income taxes $ 49,383 $ 49,375
Net income $ 71,565 $ 71,563
Basic net income per share $ 1.88 $ 1.88
Diluted net income per share $ 1.81 $ 1.81
52
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
October 31, 2002
-------------------------
As Reported As Restated
----------- -----------
Balance Sheet Data:
Accounts receivable, net * $107,188 $105,576
Prepaid royalties, current $ 13,723 $ 14,215
Deferred tax asset $ 5,392 $ 6,245
Total current assets $328,632 $328,365
Total assets $491,707 $491,440
Accrued expenses and other current
liabilities * $ 49,821 $ 50,698
Income taxes payable $ 1,603 $ 1,357
Total current liabilities $131,179 $131,810
Retained earnings $ 87,804 $ 86,906
Total liabilities and stockholders' equity $491,707 $491,440
* Restated amounts reflect a reclassification relating to the presentation of
allowances.
The Company's Consolidated Statement of Operations for the year ended
October 31, 2001 has been restated as follows:
Year Ended
October 31, 2001
-------------------------
As Reported As Restated
-------------------------
Statement of Operations Data:
Net sales $448,801 $451,396
Product costs $283,522 $282,279
Royalties $ 18,573 $ 19,875
Cost of sales $306,264 $306,323
Gross Profit $142,537 $145,073
Income from operations $ 25,841 $ 28,377
Loss before benefit for income taxes and
cumulative change in accounting principle * $ (6,660) $ (4,124)
Benefit for income taxes * $ (3,417) $ (2,450)
Net loss before cumulative change in
accounting principle $ (3,243) $ (1,674)
Cumulative change in accounting principle $ (5,337) $ (5,244)
Net loss $ (8,580) $ (6,918)
Basic net loss per share $ (0.25) $ (0.20)
Diluted net loss per share $ (0.25) $ (0.20)
* As required by Statement of Financial Accounting Standards No. 145,
"Rescission of FASB Statements No. 4, 44 and 64, Amendment to FASB Statement
No. 13, and Technical Corrections" ("SFAS 145"), the $1,948 net loss on
extinguishment of debt for the year ended October 31, 2001 previously
classified as an extraordinary item has been reclassified in the As Reported
column as follows: $3,165 of loss on extinguishment to non-operating expenses
and $1,217 of tax benefit to benefit for income taxes in the above table.
All applicable amounts relating to the aforementioned restatements have been
reflected in these consolidated financial statements and notes thereto.
53
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
3. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the financial statements of the
Company and its wholly owned subsidiaries and for entities for which the
Company is deemed to be the primary beneficiary as defined in FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities". All
material inter-company 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.
Estimates
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 net sales 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, valuation of inventories, realization of deferred
income taxes and the adequacy of allowances for returns, price concessions
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. While the Company attempts 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, 2003 and 2002, the receivable balances from the Company's five
largest customers amounted to approximately 54.6% and 43.6% of the Company's
net receivable balance, respectively, with two customers accounting for 16.6%
and 11.7% at October 31, 2003 and with two customers representing 14.1% and
10.3% at October 31, 2002. For each of the three years in the period ended
October 31, 2003, the Company's five largest customers accounted for 38.6%,
31.4%, and 20.8% of net sales, respectively. For the year ended October 31,
2003, one customer accounted for $117,636, or 11.4%, of net sales. Except for
the largest customers noted above, all receivable balances from the remaining
individual customers were less than 10% of the Company's net receivable
balance. The Company maintained insurance, to the extent available, on the
receivable balances, with certain limits, in the event of a customer's
bankruptcy or insolvency. In November 2003, the Company terminated this
insurance.
Revenue Recognition
Publishing revenue is derived from the sale of internally developed
interactive software titles or from the sale of titles licensed from
third-party developers. Publishing revenue amounted to $671,892, $568,492,
and $244,071 in 2003, 2002 and 2001, respectively.
Distribution revenue is derived from the sale of third-party interactive
software titles, hardware and accessories. Distribution revenue amounted to
$361,801, $226,184 and $207,325 in 2003, 2002 and 2001, respectively.
54
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
The Company recognizes revenue upon the transfer of title and risk of loss to
its customers. The Company applies the provisions of Statement of Position
97-2, "Software Revenue Recognition" in conjunction with the applicable
provisions of Staff Accounting Bulletin No. 101, "Revenue Recognition."
Accordingly, the Company recognizes revenue for software when there is (1)
persuasive evidence that an arrangement with our customer exists, which is
generally a customer purchase order, (2) the software is delivered, (3) the
selling price is fixed or determinable and (4) collection of the customer
receivable is deemed probable. The Company's payment arrangements with
customers typically provide net 30 and 60-day terms.
Revenue is recognized after deducting estimated reserves for returns and
price concessions. In specific circumstances when the Company does not have a
reliable basis to estimate returns and price concessions or is unable to
determine that collection of receivables is probable, it defers the sale
until such time as it can reliably estimate any related returns and
allowances and determine that collection of the receivables is probable.
The Company accepts returns and grants price concessions in connection with
its publishing arrangements. Following reductions in the price of the
Company's products, it grants price concessions to permit customers to take
credits against amounts they owe the Company with respect to merchandise
unsold by them. The Company's customers must satisfy certain conditions to
entitle them to return products or receive price concessions, including
compliance with applicable payment terms and confirmation of field inventory
levels.
The Company's distribution arrangements with customers do not give them the
right to return titles or to cancel firm orders. However, the Company
sometimes accepts returns from its distribution customers for stock balancing
and makes accommodations to customers, which includes credits and returns,
when demand for specific titles falls below expectations.
The Company makes estimates of future product returns and price concessions
related to current period product revenue. The Company estimates the amount
of future returns and price concessions for published titles based upon,
among other factors, historical experience, customer inventory levels,
analysis of sell-through rates and changes in demand and acceptance of its
products by consumers.
Significant management judgments and estimates must be made and used in
connection with establishing the allowance for returns and price concessions
in any accounting period. The Company believes it can make reliable estimates
of returns and price concessions. However, actual results may differ from
initial estimates as a result of changes in circumstances, market conditions
and assumptions. Adjustments to estimates are recorded in the period in which
they become known.
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 $23.8 million
and $15.1 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, as
restated, was approximately $5.2 million net of tax benefit of approximately
$3.5 million, or $0.15 per share.
55
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
Advertising
The Company expenses advertising costs as incurred. Advertising expense for
the years ended October 31, 2003, 2002, and 2001 amounted to $55,795, $39,909
and $22,983, 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. Estimated product returns are included in the
inventory balance at their cost. Estimated product returns at October 31,
2003 and 2002 were $8,706 and $5,015, respectively.
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 on a
title-by-title 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
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 or if the Company determines that it will cancel a
development project. Included in prepaid royalties at October 31, 2003 and
2002, respectively, are $14,241 and $22,561 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.
The following table provides the details of total prepaid royalties:
Years Ended October 31,
-----------------------------------
2003 2002 2001
-------- ---------- ----------
(Restated) (Restated)
Beginning balance $ 26,418 $ 33,149 $ 24,718
Additions 30,034 28,555 25,423
Amortization (19,065) (21,238) (15,798)
Reclassification (7,251) 1,419 --
Write down (9,525) (15,126) (1,196)
Foreign exchange 24 (341) 2
-------- -------- --------
Ending balance 20,635 26,418 33,149
Less current balance 12,196 14,215 22,052
-------- -------- --------
Non-current balance $ 8,439 $ 12,203 $ 11,097
======== ======== ========
The reclassification for the year ended October 31, 2003 principally reflects
the transfer of prepaid royalties paid to Angel Studios, Inc. and Frog City,
Inc. prior to their acquisition by the Company as a component of the purchase
price of the acquisitions.
56
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
Capitalized Software Development Costs
The Company capitalizes internal software development costs, as well as film
production and other content costs, subsequent to establishing technological
feasibility of a title. Capitalized software development costs represent the
costs associated with the internal development of the Company's publishing
products. Amortization of such costs as a component of cost of sales is
recorded on a title-by-title basis based on the greater of the proportion of
current year sales to total of current and estimated future sales for the
title or the straight-line method over the remaining estimated useful life of
the title. The Company continually evaluates the recoverability of
capitalized software costs and will charge to cost of sales any amounts that
are deemed unrecoverable or for projects that it will abandon.
The following table provides the details of capitalized software development
costs:
Years Ended October 31,
-----------------------------
2003 2002 2001
-------- ------- -------
Opening balance $ 10,385 $ 9,739 $ 7,668
Additions 15,923 9,645 6,293
Amortization (10,940) (7,633) (3,780)
Reclassification -- (1,419) --
Write down (63) (490) (389)
Foreign exchange 1,031 543 (53)
-------- ------- -------
Balance, October 31 $ 16,336 $10,385 $ 9,739
======== ======= =======
For the year ended October 31, 2001, capitalized software development costs
of $389 were written off as cost of sales - software development costs, as
part of the impairment charge as described in Note 4.
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 $88 and $92 at October 31,
2003 and 2002, 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 amounts of these assets are recorded
at historical cost.
57
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
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). Effective November 1, 2001, the Company
adopted the provisions of Statement of Financial Accounting Standards No.
141, "Business Combinations" ("SFAS 141") in its entirety and Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"). SFAS 141 requires all business combinations be
accounted for using the purchase method of accounting and that certain
intangible assets acquired in a business combination shall be recognized as
assets apart from goodwill. SFAS 142 addresses the recognition and
measurement of goodwill and other intangible assets subsequent to their
acquisition. SFAS 142 provides that intangible assets with finite useful
lives be amortized and that intangible assets with indefinite lives and
goodwill not be amortized. The Company discontinued the amortization of
goodwill as of November 1, 2001. Identifiable intangibles are amortized under
the straight-line method over the period of expected benefit ranging from
three to ten years, except for intellectual property, which is amortized
based on the shorter of the useful life or expected revenue stream. Prior to
November 1, 2001, intangible assets were 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. Upon completion of the transitional impairment test, the fair
value for each of our reporting units exceeded the reporting unit's carrying
amount and no impairment was indicated.
SFAS 142 requires an annual test for impairment of goodwill, and between
annual tests if events occur or circumstances change that would more likely
than not reduce the fair value of a reporting unit below its carrying amount.
In assessing potential impairment of goodwill, the Company determines the
implied fair value of each reporting unit using discounted cash flow analysis
and compares such values to the respective reporting unit's carrying amount.
The Company performs its annual test for indication of goodwill impairment in
the fourth quarter of each fiscal year. At October 31, 2003 and 2002, the
fair value of the Company's reporting units exceeded the carrying amounts and
no impairment was indicated.
Impairment of Long-Lived Assets
The Company accounts for long-lived assets in accordance with the provisions
of Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which was adopted
in the first quarter of fiscal 2003 with no material effect on the Company's
financial condition and results of operations. SFAS 144 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, including assets to be disposed of by sale, whether previously
held and used or newly acquired. 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
and 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.
58
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
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 No. 123,
"Accounting for Stock- Based Compensation" ("SFAS 123").
Had compensation cost for the Company's stock option plans been determined
based on the fair value at the grant date for awards 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.
Years ended October 31,
------------------------------------------------
2003 2002 2001
------------- ------------- -------------
(Restated) (Restated)
Net income (loss), as reported $ 98,118 $ 71,563 $ (6,918)
Add: Stock-based employee compensation expense included in reported net
income, net of related tax effects 2,133 1,878 3
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax effects (18,194) (16,415) (11,713)
-------------- -------------- --------------
Pro forma net income (loss) $ 82,057 $ 57,026 $ (18,628)
============== ============== ==============
Earnings (loss) per share:
Basic - as reported $ 2.34 $ 1.88 $ (0.20)
============== ============== ==============
Basic - pro forma $ 1.96 $ 1.50 $ (0.55)
============== ============== ==============
Diluted - as reported $ 2.27 $ 1.81 $ (0.20)
============== ============== ==============
Diluted - pro forma $ 1.90 $ 1.44 $ (0.55)
============== ============== ==============
The pro forma disclosures shown are not representative of the effects on net
income and the net income per share in future periods.
Pro forma net income (loss) and net income (loss) per share for the years
ended October 31, 2002 and 2001 also differ from amounts previously reported
as a result of adjustments made to correct computational errors.
59
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
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
weighted average fair values of options granted were $15.05, $9.13 and $5.76
for the years ended October 31, 2003, 2002 and 2001, respectively. The
following weighted average assumptions for 2003 were used to value grants:
expected volatility of 78%; a risk-free interest rate of 2.60%; and an
expected holding period of 4.2 years. The following weighted average
assumptions for 2002 were used to value grants: expected volatility of 74%; a
risk-free interest rate of 1.77%; and an expected holding period of 4.1
years. 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. Dividends were assumed to be
zero for years ended October 31, 2003, 2002 and 2001.
Net Income (Loss) per Share
Basic earnings per share ("EPS") is computed by dividing the net income
(loss) 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 income (loss) 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,
restricted stock (for fiscal 2003) and warrants outstanding during the year.
Common stock equivalents are excluded from the computation if their effect is
antidilutive.
Comprehensive Income (Loss)
Comprehensive income (loss) 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. Valuation allowances are
established when necessary to reduce deferred tax assets to the amounts
expected to be realized after considering tax planning strategies, if
applicable. No income taxes have been provided on the undistributed earnings
of foreign subsidiaries, as such earnings are expected to be permanently
reinvested in those companies.
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). Realized and
unrealized transaction gains and losses are included in income in the period
in which they occur. Foreign exchange transaction gains (loss) included in
net income for fiscal years ended October 31, 2003, 2002 and 2001 amounted to
$2,015, $840 and $(108), respectively.
60
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
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.
Investments are reported at fair value. The carrying amount of prepaid
royalties 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.
Consideration Given to Customers or Resellers
In November 2001, the Financial Accounting Standards Board ("FASB") Emerging
Issues Task Force (EITF) reached a consensus on EITF Issue 01-09, Accounting
for Consideration Given by a Vendor to a Customer or Reseller of the Vendor's
Products, which is a codification of EITF 00-14, 00-22 and 00-25. This EITF
presumes that consideration from a vendor to a customer or reseller of the
vendor's products to be a reduction of the selling prices of the vendor's
products and, therefore, should be characterized as a reduction of revenue
when recognized in the vendor's income statement and could lead to negative
revenue under certain circumstances. Revenue reduction is required unless
consideration relates to a separate identifiable benefit and the benefit's
fair value can be established. The Company has early adopted EITF 01-09
effective November 1, 2001. The adoption of the new standard did not have a
material impact on the consolidated financial statements. The prior period
financial statements have been reclassified in accordance with this statement
and as a result, net sales and selling and marketing expenses have been
reduced by $2,255 for the year ended October 31, 2001, with no impact on
reported net loss.
Recently Adopted Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards 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
provisions of SFAS 143 are effective for financial statements issued for
fiscal years beginning after June 15, 2002. The adoption of SFAS 143 in the
first quarter of fiscal 2003 did not have an impact on the Company's
financial condition, cash flows and results of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment to FASB
Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145
eliminates the requirement (in SFAS 4) that gains and losses from the
extinguishments of debt be aggregated and classified as extraordinary items,
net of the related income tax. Under this pronouncement, the $1,948 net loss
on extinguishment of debt for the year ended October 31, 2001 previously
classified as an extraordinary item has been reclassified as follows: $3,165
of loss on extinguishment to non-operating expenses and $1,217 of tax benefit
to provision for income taxes. The adoption of SFAS 145 in fiscal 2003 did
not have any impact on the Company's financial condition, cash flows and
results of operations, other than the reclassification referred to above.
61
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
In January 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS 146"). SFAS 146 requires the recognition of such costs when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
The provisions of SFAS 146 are to be applied prospectively to exit or
disposal activities initiated after December 31, 2002. The adoption of SFAS
146 in the first quarter of fiscal 2003 did not have a material impact on the
Company's financial condition and results of operations.
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure" ("SFAS 148"). SFAS 148 amends the transition provisions of FASB
No. 123, "Accounting for Stock-Based Compensation", for entities that
voluntarily change to the fair value method of accounting for stock-based
employee compensation. The Company does not currently intend to change its
accounting to the fair value method. SFAS 148 also amends the disclosure
provisions of SFAS 123 to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with respect
to stock-based employee compensation and amends APB Opinion No. 28, "Interim
Financial Reporting" ("APB 28") to require disclosures about such effects in
interim financial information. The disclosure provisions of the amendments to
FASB 123 were adopted by the Company in the second quarter of fiscal 2003.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 expands previously
issued accounting guidance and disclosure requirements for certain guarantees
and requires recognition of an initial liability for the fair value of an
obligation assumed by issuing a guarantee. The provision for initial
recognition and measurement of liability will be applied on a prospective
basis to guarantees issued or modified after December 31, 2002. The adoption
of FIN 45 in the first quarter of fiscal 2003 did not have any impact on the
Company's financial condition or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 requires a variable interest
entity to be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's activities
or is entitled to receive a majority of the entity's residual return or both.
FIN 46 also provides criteria for determining whether an entity is a variable
interest entity subject to consolidation. FIN 46 requires immediate
consolidation of variable interest entities created after January 31, 2003.
For variable interest entities created prior to February 1, 2003,
consolidation is required on July 1, 2003. The adoption of FIN 46 in the
third quarter of fiscal 2003 did not have a material impact on the Company's
financial condition or results of operations (see Note 4).
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS No. 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." In general, SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. The adoption of SFAS
149 did not have any impact on the Company's financial condition or results
of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS
150"). SFAS 150 establishes standards for how an issuer classifies and
measures in its statement of financial position certain financial instruments
with characteristics of both liabilities and equity. In accordance with SFAS
150, financial instruments that embody obligations for the issuer are
required to be classified as liabilities. SFAS 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise shall
be effective at the beginning of the first interim period beginning after
June 15, 2003, except for the provisions relating to mandatorily redeemable
financial instruments which have been deferred indefinitely. The adoption of
SFAS 150 in the fourth quarter of fiscal 2003 did not have any impact on the
Company's financial condition.
62
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
4. BUSINESS ACQUISITIONS AND CONSOLIDATION
The Company acquired seven companies that develop, publish or distribute
interactive software games during the three-year period ended October 31,
2003. The aggregate purchase price, including cash payments and issuance of
its common stock was $42,075, $7,626 and $28,143 in 2003, 2002 and 2001,
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 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.
2003 Transactions
During the quarter ended July 31, 2003, the Company acquired the assets of
Frog City, Inc. ("Frog City"), the developer of Tropico 2: Pirate Cove, and
the outstanding membership interests of Cat Daddy Games LLC ("Cat Daddy"),
another development studio. The total purchase price for both studios
consisted of $757 in cash and $319 of prepaid royalties previously advanced
to Frog City. The Company also agreed to make additional payments of up to
$2,500 to the former owners of Cat Daddy, based on a percentage of Cat
Daddy's profits for the first three years after acquisition, which will be
recorded as compensation expense if the targets are met. In connection with
the acquisitions, the Company recorded goodwill of $1,267 and net liabilities
of $191.
In November 2002, the Company acquired all of the outstanding capital stock
of Angel Studios, Inc. ("Angel"), the developer of the Midnight Club and
Smuggler's Run franchises. The purchase price consisted of 235,679 shares of
restricted common stock (valued at $6,557), $28,512 in cash and $5,931 (net
of $801 of royalties payable to Angel) of prepaid royalties previously
advanced to Angel. In connection with the acquisition, the Company recorded
identifiable intangibles of $4,720 (comprised of intellectual property of
$2,810, technology of $1,600 and non-competition agreements of $310),
goodwill of $37,425 and net liabilities of $1,145.
In April 2003, the Company entered into an agreement with Destineer
Publishing Corp. ("Destineer"), a publisher of PC games, under which
Destineer granted the Company exclusive distribution rights to eight PC games
and two console ports to be published by Destineer. The Company agreed to
make recoupable advances to Destineer of approximately $6,700 and to pay
Destineer with respect to product sales under the distribution agreement. In
addition, the Company agreed to make a loan to Destineer of $1,000. Destineer
granted the Company an immediately exercisable option to purchase a 19.9%
interest in Destineer and a second option to purchase the remaining interest
for a price equal to a multiple of Destineer's EBIT, exercisable during a
period following April 2005. The fair value of these options was not
significant. Pursuant to the requirements of FIN 46, since Destineer is a
variable interest entity and the Company is considered to be the primary
beneficiary (as defined in FIN 46), the results of Destineer's operations
have been consolidated in the accompanying financial statements.
The 2003 acquisitions did not have a material effect on the Company's fiscal
2003 results of operations.
63
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
2002 Transaction
In August 2002, the Company acquired all of the outstanding capital stock of
Barking Dog Studios Ltd. ("Barking Dog"), a Canadian-based development
studio. The purchase price consisted of 242,450 shares of restricted common
stock (valued at $3,801), $3,000 in cash, $825 of prepaid royalties
previously advanced to Barking Dog and assumed net liabilities of $70. In
connection with the acquisition, the Company recorded identifiable
intangibles of $1,800, comprised of non-competition agreements of $1,600 and
intellectual property of $200, and goodwill of $6,772. The acquisition of
Barking Dog did not have a significant effect on the Company's fiscal 2002
results of operations.
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), paid
$100 in cash and assumed net liabilities of approximately $2,856. In
connection with the acquisition, the Company recorded goodwill of $3,558.
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 $2,000 in cash
and issued 875,000 shares of the Company's common stock (valued at $8,039)
and assumed net liabilities of approximately $10,627. In connection with this
transaction, the Company recorded intangible assets of approximately $20,693.
In connection with the sale of a subsidiary to Gameplay.com plc ("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 and the Company assumed net
liabilities of $808, in addition to the prepaid purchase price of $17,266. In
connection with the acquisition, the Company recorded goodwill and
intangibles of $18,183.
64
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
The following table sets forth the components of the purchase price of the
2001 acquisitions:
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 8,207 12,416 3,558 24,181
Customer lists -- 8,277 -- 8,277
Technology 8,037 -- -- 8,037
Trademarks 1,939 -- -- 1,939
------- -------- -------- --------
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 an
impairment charge of $3,786, consisting of $2,350 relating to server
maintenance technologies and $1,047 relating to multiplayer technologies
developed by Neo's development studio in connection with Online Pirates and
$389 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 related to online sales promotions.
Pro forma financial information for fiscal 2003 and 2002 acquisitions are not
presented since the impact is not material. The unaudited pro forma data
below for the year ended October 31, 2001 is presented as if purchase
acquisitions for fiscal 2001 had been made as of November 1, 2000. 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.
Unaudited
Pro Forma
October 31, 2001
----------------
(Restated)
Net sales $459,006
Loss before cumulative effect of change in accounting
principle $ (4,458)
Net Loss $ (9,702)
Net loss per share - Basic $ (0.28)
Net loss per share - Diluted $ (0.28)
Included in the unaudited pro forma information is amortization of goodwill
of approximately $7,320, net of taxes of $2,799, for the year ended
October 31, 2001.
65
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
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. In connection with the sale, the purchaser assumed net liabilities of
$436. The Company recorded a non-operating gain of $651. There were no income
taxes payable on this gain.
6. INTANGIBLE ASSETS AND GOODWILL
As a result of the adoption of SFAS 142, the Company discontinued the
amortization of goodwill effective November 1, 2001. Identifiable intangible
assets are amortized under the straight-line method over the period of
expected benefit ranging from three to ten years, except for intellectual
property, which is amortized based on the shorter of the useful life or
expected revenue stream. The Company re-characterized acquired workforce of
$925, which is not defined as an acquired intangible asset under SFAS 141, as
goodwill. Additionally, the estimated useful lives of certain identifiable
intangible assets were adjusted in conjunction with the adoption of SFAS 142.
The adjustment to the useful lives did not have a material effect on the
results of operations.
Intangible assets consist of trademarks, intellectual property, customer
lists and acquired technology. The excess purchase price paid over identified
intangible and tangible net assets of acquired companies are reported
separately as goodwill.
During the year ended October 31, 2003, the Company acquired all the
intellectual property rights associated with Army Men and School Tycoon for
an aggregate cost of $1,075.
In May 2002, the Company acquired all right, title and interest to the Max
Payne product franchise, including all of the intellectual property rights
associated with the brand, and a perpetual, royalty-free license to use the
Max Payne game engine and related technology. The purchase price consisted of
$10,000 in cash and 969,932 shares of restricted common stock (valued at
$18,543). In October 2003, the Company recorded an additional intangible of
$8,000, of which $1,000 related to the delivery of the final version of Max
Payne 2 for the PC and $7,000 based on the determination that the sales
targets for the PC and console versions of Max Payne would be achieved. The
Max Payne assets acquired have been recorded as intellectual property and
included in intangible assets.
In December 2000, the Company acquired the exclusive worldwide publishing
rights to the franchise of Duke Nukem PC and video games. In connection with
the transaction, the Company paid $2,300 in cash and issued 557,103 shares of
its common stock (valued at approximately $5,400). In addition, the Company
is required to make a further payment of $6,000 contingent upon delivery of
the final version of Duke Nukem Forever for the PC. The Company recorded an
intangible asset of $7,700 related to the intellectual property purchased in
this transaction. The additional $6,000 will be recorded as an additional
intangible asset upon resolution of the contingency.
In 2003, the Company recorded a charge of $4,407 related to the impairment of
a customer list, which was included in depreciation and amortization (see
Note 20.). In addition, cost of sales - product costs include $7,892 of
intellectual property and technology written off in 2003, of which $5,499
related to Duke Nukem Forever and its sequel, reflecting the continued
development delays for these products.
66
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
The following table sets forth the components of the intangible assets
subject to amortization as of October 31, 2003 and 2002:
As of October 31, 2003 As of October 31, 2002
---------------------------------- ----------------------------------
Gross Gross
Range of Carrying Accumulated Carrying Accumulated
Useful Life Amount Amortization Net Amount Amortization Net
----------- -------- ------------ ------- -------- ------------ -------
Trademarks 7-10 years $23,667 $ (5,998) $17,669 $23,342 $ (4,515) $18,827
Customer lists and relationships 5-10 years 4,673 (2,733) 1,940 9,081 (2,352) 6,729
Intellectual property 2-6 years 31,487 (10,907) 20,580 25,771 (2,869) 22,902
Non-competition agreements 3-6 years 4,838 (2,105) 2,733 4,880 (906) 3,974
Technology 3 years 4,192 (2,278) 1,914 4,640 (1,779) 2,861
------- --------- ------- ------- --------- -------
$68,857 $(24,021) $44,836 $67,714 $(12,421) $55,293
======= ========= ======= ======= ========= =======
Amortization expense (including goodwill for 2001) for the years ended
October 31, 2003, 2002 and 2001 amounted to $11,600, $9,893 and $9,309,
respectively.
Estimated amortization expense for the fiscal years ending October 31, are as
follows:
2004 $16,726
2005 4,657
2006 5,962
2007 2,709
2008 1,628
-------
Total $31,682
=======
The change in goodwill for the fiscal year ended October 31, 2003 is as
follows:
Balance October 31, 2002 $ 61,529
Acquisitions in fiscal 2003
Angel 37,425
Frog City and Cat Daddy 1,267
Adjustments for 2002 acquisition 1,277
--------
Balance October 31, 2003 $101,498
========
The addition to goodwill in 2002 was the $5,496 related to the Barking Dog
acquisition.
67
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
The following table provides a reconciliation of net income for exclusion of
goodwill amortization:
Years Ended October 31,
----------------------------------
2003 2002 2001
------- ---------- ----------
(Restated) (Restated)
Net income (loss) - as reported $98,118 $71,563 $(6,918)
Add: Goodwill amortization, net of taxes -- -- 4,116
------- ------- -------
Net income (loss) - as adjusted 98,118 71,563 (2,802)
Add: Cumulative effect of change in accounting principle, net of taxes -- -- (5,244)
------- ------- -------
Income (loss) before cumulative effect of change in accounting principle - as adjusted $98,118 $71,563 $ 2,442
======= ======= =======
Income (loss) before cumulative effect of
change in accounting principle- as reported $98,118 $71,563 $(1,706)
======= ======= =======
Earnings (loss) per share:
Reported earnings (loss) per share - basic $ 2.34 $ 1.88 $ (0.20)
Add: Goodwill amortization, net of taxes -- -- 0.12
------- ------- -------
Adjusted earnings (loss) per share - basic 2.34 1.88 (0.08)
Add: Cumulative effect of change in accounting principle -- -- (0.15)
------- ------- -------
Adjusted income (loss) before cumulative effect of change in accounting principle per
share - basic $ 2.34 $ 1.88 $ 0.07
======= ======= =======
Reported income (loss) before cumulative effect of change in accounting principle per
share - basic $ 2.27 $ 1.88 $ (0.05)
======= ======= =======
Reported earnings (loss) per share - diluted $ 2.27 $ 1.81 $ (0.20)
Add: Goodwill amortization, net of taxes -- -- 0.12
------- ------- -------
Adjusted earnings (loss) per share - diluted 2.27 1.81 (0.08)
Add: Cumulative effect of change in accounting principle -- -- (0.15)
------- ------- -------
Adjusted income (loss) before cumulative effect of change in accounting principle per
share - diluted $ 2.27 $ 1.81 $ 0.07
======= ======= =======
Reported income (loss) before cumulative effect of
change in accounting principle per share - diluted $ 2.27 $ 1.81 $ (0.05)
======= ======= =======
68
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
7. 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 (loss) reported as a separate component of accumulated other
comprehensive income (loss) in stockholders' equity.
For the fiscal years ended October 31, 2003 and 2002, the gross proceeds from
the sale of investments were $114 and $6,170, respectively. The gross
realized gain from these sales totaled $39 and $181, respectively. The
gain/loss on sale of securities is based on the average cost of the
individual securities sold.
During 2001, the Company recorded an impairment charge of $21,477, consisting
of approximately $19,171 relating to its investment in Gameplay, $2,000
relating to its investment in eUniverse, Inc. based on the quoted market
prices and $306 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.
8. INVENTORIES
As of October 31, 2003 and 2002, inventories consist of:
2003 2002
------------- -------------
Parts and supplies $ 4,793 $ 3,221
Finished products 96,955 71,170
------------- -------------
$ 101,748 $ 74,391
============= =============
69
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
9. FIXED ASSETS
As of October 31, 2003 and 2002, fixed assets consist of:
2003 2002
------------- -------------
Computer equipment $ 12,963 $ 8,004
Office equipment 5,096 3,811
Computer software 11,529 8,981
Furniture and fixtures 3,157 1,850
Automobiles -- 219
Leasehold improvements 6,047 3,265
Capital leases 398 398
------------- -------------
39,190 26,528
Less: accumulated depreciation and
amortization 16,930 11,209
------------- -------------
$ 22,260 $ 15,319
============= =============
In 2003 and 2002, the Company capitalized costs of approximately $2,923 and
$4,113, respectively, associated with software and hardware upgrades to its
accounting systems.
Depreciation expense for the years ended October 31, 2003, 2002, and 2001,
amounted to $9,510, $6,457 and $3,731, respectively.
10. LINES OF CREDIT
In December 1999, the Company entered into a credit agreement, as amended
and restated in August 2002, with a group of lenders led by Bank of America,
N.A., as agent. The agreement provides for borrowings of up to $40,000
through the expiration of the line of credit on August 28, 2005. Generally,
advances under the line of credit are based on a borrowing formula equal to
75% of eligible accounts receivable plus 35% of eligible inventory. Interest
accrues on such advances at the bank's prime rate plus 0.25% to 1.25%, or at
LIBOR plus 2.25% to 2.75% depending on the Company's consolidated leverage
ratio (as defined). The Company is required to pay a commitment fee to the
bank equal to 0.5% of the unused loan balance. Borrowings under the line of
credit are collateralized by the Company's accounts receivable, inventory,
equipment, general intangibles, securities and other personal property,
including the capital stock of the Company's domestic subsidiaries.
Available borrowings under the agreement are reduced by the amount of
outstanding letters of credit, which were $9,290 at October 31, 2003. The
loan agreement contains certain financial and other covenants, including the
maintenance of consolidated net worth, consolidated leverage ratio and
consolidated fixed charge coverage ratio. As of October 31, 2003, the
Company was in compliance with such covenants. The loan 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 Company had no outstanding borrowings under the revolving
line of credit as of October 31, 2003 and 2002.
In February 2001, the Company's United Kingdom subsidiary entered into a
credit facility agreement, as amended in March 2002, with Lloyds TSB Bank
plc ("Lloyds") under which Lloyds agreed to make available borrowings of up
to approximately $22,200. 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 the Company. Available borrowings under the agreement are reduced by the
amount of outstanding guarantees. The facility expires on March 31, 2004.
The Company had no outstanding guarantees or borrowings under this facility
as of October 31, 2003 and 2002.
70
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
11. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities as of October 31, 2003 and
2002 consist of:
2003 2002
------------- -------------
(Restated)
Accrued co-op advertising and product
rebates $ 3,985 $ 3,318
Accrued VAT and payroll taxes 11,593 10,249
Royalties payable 8,521 14,784
Deferred revenue 2,358 10,596
Sales commissions 10,381 6,248
Other 19,869 5,503
------------- -------------
Total $ 56,707 $ 50,698
============= =============
12. 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. In July 2001, the Company prepaid the outstanding
subordinated loan and recorded a loss of $3,165 related to the deferred
financing costs and the unamortized discount associated with the loan.
13. 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, 2003 is as
follows:
Year ending October 31:
-----------------------
2004 $ 117
2005 74
2006 1
-------------
Total minimum lease payments 192
Less: amounts representing interest (16)
-------------
Present value of minimum obligations under capital leases $ 176
=============
71
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
Lease Commitments
The Company leases 33 office and warehouse facilities. The former corporate
headquarters are leased under a non-cancelable 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 $444, $403 and $474, for the years ended October 31, 2003, 2002,
and 2001, respectively. The other offices are under non-cancelable operating
leases expiring at various times from December 2003 to October 2013. In
addition, the Company has leased certain equipment, furniture and auto
leases under non- cancelable operating leases, which expire through October
2007.
In September 2002, the Company relocated its principal executive offices to
622 Broadway, New York, New York. The Company has recently leased additional
space at 622 Broadway to accommodate its expanded operations. The Company
estimates that as of October 31, 2003 it will incur an additional $1,200 in
capital expenditures for continuing renovations and leasehold improvements
for this space. In connection with signing a ten year lease, the Company
provided a standby letter of credit of $1,560, expiring December 31, 2003.
As a result of the relocation, the Company recorded expenses of $363 and
$514 in fiscal 2003 and 2002, respectively, related to lease costs with
regard to the Company's former executive offices.
Future minimum rentals required as of October 31, 2003 are as follows:
Year ending October 31:
-----------------------
2004 $ 7,268
2005 5,657
2006 4,840
2007 4,221
2008 4,068
Thereafter 12,032
--------------
Total minimum lease payments 38,086
Less minimum rentals to be received under subleases (221)
--------------
$ 37,865
==============
Rent expense amounted to $7,445, $5,090 and $3,353, for the years ended
October 31, 2003, 2002, and 2001, respectively.
72
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
Legal and Other Proceedings
The Company received a Wells Notice from the Staff of the Securities and
Exchange Commission stating the Staff's intention to recommend that the SEC
bring a civil action seeking an injunction and monetary damages against the
Company alleging that it violated certain provisions of the federal
securities laws. The proposed allegations stem from the previously disclosed
SEC investigation into certain accounting matters related to the Company's
financial statements, periodic reporting and internal accounting controls.
The Company's Chairman, an employee and two former officers also received
Wells Notices. The Company has entered into discussions with the Staff to
address the issues raised in the Wells Notice. The SEC's Staff also raised
issues with respect to the Company's revenue recognition policies and its
impact on its current and historical financial statements. The Company is
unable to predict the outcome of these matters.
The Company is involved in routine litigation in the ordinary course of its
business, which in management's opinion will not have a material adverse
effect on the Company's financial condition, cash flows or results of
operations.
Other
The Company periodically enters into distribution agreements to purchase
various software games that require the Company to make minimum guaranteed
payments. These agreements, which expire between June 2, 2004 and March 22,
2005, require remaining aggregate minimum guaranteed payments of $14,330 at
October 31, 2003, including $3,491 of payments due pursuant to an agreement
with TDK Mediactive, Inc. ("TDK"). These agreements are collateralized by a
standby letter of credit of $3,600 at October 31, 2003. Additionally,
assuming performance by third-party developers, the Company has outstanding
commitments under various software development agreements to pay developers
an aggregate of $27,224 during fiscal 2004. The Company also expects to
spend an additional $4,000 in connection with the implementation of
accounting software systems for its international operations and the upgrade
for its domestic operations.
Additionally, in connection with the Company's acquisition of the publishing
rights to the franchise of Duke Nukem PC and video games in December 2000,
the Company is contingently obligated to pay $6,000 in cash upon delivery of
the final version of Duke Nukem Forever for the PC. In May 2003, the Company
agreed to make payments of up to $6,000 in cash upon the achievement of
certain sales targets for Max Payne 2. The Company also agreed to make
additional payments of up to $2,500 to the former owners of Cat Daddy based
on a percentage of Cat Daddy's future profits for the first three years
after acquisition. See Note 4. The payables will be recorded when the
conditions requiring their payment are met.
14. EMPLOYEE SAVINGS PLAN
The Company maintains a 401(k) retirement savings plan and trust (the
"401(k) Plan"). The 401(k) Plan is offered to all eligible employees and
participants may make voluntary contributions. The Company did not match
employee contributions during the year ended October 31, 2001. The Company
began matching contributions in July 2002. The matching contribution expense
incurred by the Company during the years ended October 31, 2003 and 2002 was
$384 and $95, respectively.
73
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
15. INCOME TAXES
The Company is subject to foreign income taxes in certain countries where it
does business. Domestic and foreign (loss) income before income taxes and
cumulative effect of change in accounting principle is as follows:
Years Ended October 31,
------------------------------------------------
2003 2002 2001
------------- ------------- -------------
(Restated) (Restated)
Domestic $ 134,746 $ 115,142 $ (29,594)
Foreign 30,569 5,796 25,470
------------- ------------- -------------
Total $ 165,315 $ 120,938 $ (4,124)
============= ============= =============
Income tax expense (benefit) is as follows:
Years Ended October 31,
------------------------------------------------
2003 2002 2001
------------- ------------- -------------
(Restated) (Restated)
Current:
Federal $ 33,167 $ 35,275 $ --
State and local 6,287 4,381 500
Foreign 14,703 2,993 5,450
Deferred 13,040 6,726 (8,400)
------------- ------------- -------------
Total $ 67,197 $ 49,375 $ (2,450)
============= ============= =============
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:
Years ended October 31,
------------------------------------------------
2003 2002 2001
------------- ------------- -------------
(Restated) (Restated)
Statutory federal tax expense (benefit) $ 57,860 $ 42,324 $ (1,442)
Changes in expenses resulting from:
State taxes, net of federal benefit 4,035 2,995 (1,729)
Foreign tax expense differential 2,191 568 (3,355)
Goodwill and intangible amortization 363 513 1,656
Other permanent items 1,482 1,874 123
Foreign income exclusion (9,163) -- --
Valuation allowances 10,429 1,101 968
Impairment of intangibles -- -- 1,329
------------- ------------- -------------
Income tax expense (benefit) $ 67,197 $ 49,375 $ (2,450)
============= ============= =============
74
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
The components of the net deferred tax asset as of October 31, 2003 and 2002
consists of the following:
2003 2002
------------- -------------
(Restated)
Current:
Deferred tax asset:
Sales and related allowances $ 8,173 $ 5,861
Depreciation and amortization 160 384
------------- -------------
Total current deferred tax assets 8,333 6,245
Non-current deferred tax assets -
Foreign net operating losses 3,240 2,016
State net operating losses 3,311 2,069
Capital loss carryforward 7,963 7,983
------------- -------------
14,514 12,068
Less: Valuation allowances (14,514) (4,085)
------------- -------------
Total non-current deferred tax assets -- 7,983
Non-current deferred tax liability -
Capitalized software (8,486) (3,885)
------------- -------------
Net deferred tax (liability) asset $ (153) $ 10,343
============= =============
At October 31, 2003 and October 31, 2002, the Company had capital loss
carryforwards totaling approximately $21,000. The capital loss carryforwards
will expire in the periods fiscal 2006 through fiscal 2008. Failure to
achieve sufficient levels of taxable income from capital transactions will
affect the ultimate realization of the capital loss carryforwards. At
October 31, 2002 management had a strategy of selling net appreciated assets
of the Company, to the extent required to generate sufficient taxable income
prior to the expiration of these benefits. At October 31, 2003, based on
management's future plans, this strategy was no longer viable, and
accordingly a valuation allowance has been recorded for this asset as it is
more likely than not that the deferred tax asset related to these
carryforwards will not be realized. At October 31, 2003, the Company had
foreign net operating losses of $9,800 expiring between 2005 and 2010, and
state net operating losses of $41,700 expiring between 2021 and 2023.
Limitations on the utilization of these losses may apply, and accordingly
valuation allowances have been recorded for these assets.
The total amount of undistributed earnings of foreign subsidiaries was
approximately $60,700 and $41,900 for the years ended October 31, 2003 and
2002, 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.
75
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
16. STOCKHOLDERS' EQUITY
In July 2001, the Company issued 1,300,000 shares of common stock in a
private placement to institutional investors and received proceeds of
$20,892, net of $1,400 of selling commissions and offering expenses.
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) for shares of Gameplay having an equal value.
In February 2002, the Company issued 20,000 shares of restricted common
stock to a former employee in connection with a separation agreement.
In January 2003, the Board of Directors authorized a stock repurchase
program under which the Company may repurchase up to $25,000 of its common
stock from time to time in the open market or in privately negotiated
transactions. The Company has not repurchased any shares under this program.
In November 2003, at a special meeting, the Company's stockholders voted to
amend the certificate of incorporation to increase the Company's authorized
shares of common stock from 50,000,000 to 100,000,000.
17. COMPREHENSIVE INCOME
The components of and changes in accumulated other comprehensive income
(loss) are:
Foreign
Currency Net Unrealized Accumulated Other
Translation Gain (Loss) on Comprehensive
Adjustments Investments Income (Loss)
----------------------- ----------------------- -----------------------
Balance at November 1, 2000 $ (9,841) $ (2,831) $ (12,672)
Comprehensive income changes during the
year, net of taxes of $1,832 (767) 2,987 2,220
----------------------- ----------------------- -----------------------
Balance at October 31, 2001 (10,608) 156 (10,452)
Comprehensive income changes during the
year, net of taxes of $87 5,553 (142) 5,411
----------------------- ----------------------- -----------------------
Balance at October 31, 2002 (5,055) 14 $ (5,041)
Comprehensive income changes during the
year, net of taxes of $9 4,119 (14) 4,105
----------------------- ----------------------- -----------------------
Balance at October 31, 2003 $ (936) $ -- $ (936)
======================= ======================= =======================
The taxes in the above table relate to the changes in the net unrealized
gain (loss) on investments. The foreign currency adjustments are not
adjusted for income taxes as they relate to indefinite investments in
non-U.S. subsidiaries.
76
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
18. INCENTIVE PLANS
Incentive Stock Plan
The Incentive Stock Plan ("Incentive Plan"), adopted by the Board of
Directors on June 12, 2003, allows the granting of restricted stock,
deferred stock and other stock-based awards of the Company's common stock to
directors, officers and other employees of the Company. A maximum of 500,000
shares are available for distribution under the Incentive Plan. As of
October 31, 2003, 285,000 shares of restricted common stock have been
granted under the Incentive Plan. The cost of the restricted shares granted
is expensed over the vesting period. The Incentive Plan is administered by
the Compensation Committee of the Board of Directors.
Stock Option Plans
In June 2002, the stockholders of the Company approved the Company's 2002
Stock Option Plan, as previously adopted by the Company's Board of Directors
(the "2002 Plan"), pursuant to which officers, directors, employees and
consultants of the Company may receive stock options to purchase up to an
aggregate of 3,000,000 shares of Common Stock. In April 2003, the
stockholders approved an increase in the aggregate amount of shares to
4,000,000 shares.
In January 1997, the stockholders of the Company approved the Company's 1997
Stock Option Plan, as amended, as previously adopted by the Company's Board
of Directors (the "1997 Plan"), pursuant to which officers, directors,
employees and consultants of the Company may receive options to purchase up
to an aggregate of 6,500,000 shares of the Company's Common Stock.
Subject to the provisions of the plans, 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 April 30, 2002, there were no options available for grant
under the 1997 Plan.
As of October 31, 2003 and 2002, the plans had outstanding stock options for
an aggregate of 3,066,000 and 2,764,000 shares of the Company's Common
Stock, respectively, vesting at various times from 1998 to 2006 and expiring
at various times from 2002 to 2007. Options granted generally vest over a
period of three to five years.
77
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
Non-Plan Stock Options
As of October 31, 2003 and 2002, there are non-plan stock options
outstanding for an aggregate of 1,503,000 and 2,931,000 shares of the
Company's Common Stock, respectively, vesting from 1999 to 2006 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, 2003, 2002, and 2001 was
approximately $26, $1,976 and $5, respectively.
The following table summarizes the activity in options under the plans
inclusive of non-plan options:
Weighted
Average
Shares Exercise
(in thousands) Price
-------------- --------
Options outstanding - November 1, 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
Granted-exercise price equal to fair value 3,950 $16.40
Granted-exercise price less than fair value 30 $ 0.01
Exercised (2,494) $10.43
Forfeited (270) $12.31
------ ------
Options outstanding - October 31, 2002 5,695 $13.96
Granted-exercise price equal to fair value 2,442 $25.26
Exercised (3,438) $13.53
Forfeited (130) $17.13
------ ------
Options outstanding - October 31, 2003 4,569 $20.23
====== ======
78
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
At October 31, 2003 and 2002 the number of options exercisable are 1,389,000
and 3,014,000, respectively, and their related weighted average exercise
prices are $15.09 and $12.56, respectively.
The following summarizes information about stock options outstanding and
exercisable at October 31, 2003:
Weighted Average
Shares Average Remaining
(in Exercise Contractual
Range of Exercise Prices thousands) Price Life (years)
------------------------ ---------- -------- ------------
$5.50 - $13.91 986 $10.43 2.42
$14.86 - $19.55 1,365 $18.37 3.61
$20.10 - $25.31 963 $21.98 4.33
$25.78 - $35.71 1,255 $28.63 4.20
-----
Options outstanding - October 31, 2003 4,569 $20.23 3.67
=====
$5.50 - $13.91 675 $10.42 2.16
$14.86 - $19.55 523 $17.98 3.53
$20.10 - $25.31 114 $21.88 4.10
$25.78 - $35.71 77 $26.43 3.98
-----
Options exercisable- October 31, 2003 1,389 $15.09 2.93
=====
79
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
19. RESULTS BY QUARTER (UNAUDITED)
The following tables set forth restated quarterly supplementary data for
each of the years in the two-year period ended October 31, 2003.
The unaudited quarterly results of operations for each of the quarters in the
fiscal year ended October 31, 2002 and for each of the three quarters in the
period ended July 31, 2003 have been restated for the revised revenue
recognition policy related to the change in the method of accounting for
price concessions identified in Note 2.
1st 2nd 3rd 4th
2003 Quarter Quarter Quarter Quarter
---- --------- --------- --------- --------
(Restated) (Restated) (Restated)
Net sales $411,008 $193,023 $152,055 $277,607
Gross profit 165,947 71,483 58,519 100,190
Net income $ 51,535 $ 14,623 $ 5,696 $ 26,264
Per share data:
Basic - EPS $ 1.26 $ 0.35 $ 0.13 $ 0.60
Diluted - EPS $ 1.22 $ 0.35 $ 0.13 $ 0.58
2002 As Restated
---- ---------------------------------------------
Net sales $286,945 $167,286 $123,117 $217,328
Gross profit 106,242 60,642 45,997 81,711
Net income $ 36,752 $ 8,010 $ 5,049 $ 21,752
Per share data:
Basic - EPS $ 1.00 $ 0.22 $ 0.13 $ 0.55
Diluted - EPS $ 0.97 $ 0.21 $ 0.13 $ 0.53
80
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
The following table summarizes the increase (decrease) in the results of
operations for the reported 2003 and 2002 fiscal quarters as a result of the
restatement discussed above:
As As
Reported Restatement Restated
-------- ----------- --------
Quarter ended January 31, 2003:
Net Sales $408,794 $ 2,214 $411,008
Gross Profit 164,127 1,820 165,947
Net income $ 50,462 $ 1,073 $ 51,535
Per share data:
Basic - EPS $ 1.24 $ 0.02 $ 1.26
Diluted - EPS $ 1.20 $ 0.02 $ 1.22
Quarter ended April 30, 2003:
Net Sales $194,213 $(1,190) $193,023
Gross Profit 72,474 (991) 71,483
Net income $ 15,239 $ (616) $ 14,623
Per share data:
Basic - EPS $ 0.37 $ (0.02) $ 0.35
Diluted - EPS $ 0.36 $ (0.01) $ 0.35
Quarter ended July 31, 2003:
Net Sales $155,587 $(3,532) $152,055
Gross Profit 61,669 (3,150) 58,519
Net income $ 7,649 $(1,953) $ 5,696
Per share data:
Basic - EPS $ 0.18 $ (0.05) $ 0.13
Diluted - EPS $ 0.18 $ (0.05) $ 0.13
81
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
As Reclassifications As
Reported Restatement (1) Restated
-------- ----------- ----------------- --------
Quarter ended January 31, 2002:
Net Sales $282,926 $ 3,425 $ 594 $286,945
Gross Profit 103,103 3,139 -- 106,242
Net income $ 34,829 $ 1,923 -- $ 36,752
Per share data:
Basic - EPS $ 0.95 $ 0.05 -- $ 1.00
Diluted - EPS $ 0.92 $ 0.05 -- $ 0.97
Quarter ended April 30, 2002:
Net Sales $170,330 $(3,218) $ 174 $167,286
Gross Profit 63,297 (2,655) -- 60,642
Net income $ 9,637 $(1,627) -- $ 8,010
Per share data:
Basic - EPS $ 0.26 $ (0.04) -- $ 0.22
Diluted - EPS $ 0.25 $ (0.04) -- $ 0.21
Quarter ended July 31, 2002:
Net Sales $122,461 $ 537 $ 119 $123,117
Gross Profit 45,524 473 -- 45,997
Net income $ 4,766 $ 283 -- $ 5,049
Per share data:
Basic - EPS $ 0.12 $ 0.01 -- $ 0.13
Diluted - EPS $ 0.12 $ 0.01 -- $ 0.13
Quarter ended October 31, 2002:
Net Sales $218,259 $(1,086) $ 155 $217,328
Gross Profit 83,036 (967) (358) 81,711
Net income $ 22,333 $ (581) -- $ 21,752
Per share data:
Basic - EPS $ 0.56 $ (0.01) -- $ 0.55
Diluted - EPS $ 0.54 $ (0.01) -- $ 0.53
(1) The net sales reclassification represents freight income previously recorded
as a reduction to product costs. The quarter ended October 31, 2002 also
reflects a reclassification of $358 from depreciation and amortization to
product costs.
82
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
20. CONSOLIDATION OF DISTRIBUTION FACILITIES
In January 2003, based on management's strategy to consolidate the Company's
distribution business, and after taking into account the relative cost
savings involved, the Company closed its warehouse operations in Ottawa,
Illinois and College Point, New York. Operations at these warehouses ceased
by January 31 and the business conducted there was consolidated with the
operations of the Company's Jack of All Games' distribution facility in
Ohio.
As a result of the closures, the Company recorded a charge of $7,028. The
charge consisted of: (1) lease termination costs, representing the fair
value of remaining lease payments, net of estimated sublease rent; (2)
disposition of fixed assets, representing the net book value of fixed assets
and leasehold improvements; (3) other exit costs; and (4) an impairment
charge with respect to an intangible asset, representing a customer list
relating to the business conducted at the Illinois facility.
These costs are included in general and administrative expense for the year
ended October 31, 2003, except for the intangibles impairment which is
included in depreciation and amortization expense, and are summarized in the
table below:
Lease Fixed Other
Termination Asset Intangibles Exit
Costs Dispositions Impairment Costs Total
----------- ------------ ----------- ----- -------
Provisions during the year ended October 31, 2003 $ 1,607 $ 999 $ 4,407 $ 15 $ 7,028
Asset write-offs (65) (999) (4,407) (3) (5,474)
Cash payments (1,542) -- -- (12) (1,554)
------- ----- ------- ---- -------
Remaining obligations at October 31, 2003 $ -- $ -- $ -- $ -- $ --
======= ===== ======= ==== =======
83
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
21. SEGMENT INFORMATION
The Company has adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
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 and types of 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 131.
For the years ended October 31, 2003, 2002, and 2001, the Company's net
sales in domestic markets accounted for approximately 72.1%, 80.0% and
76.4%, respectively, and net sales in international markets accounted for
27.9%, 20.0% and 23.6%, respectively.
As of October 31, 2003 and 2002, the Company's net property, plant and
equipment in domestic markets accounted for approximately $13,789 and
$11,222, respectively, and net property, plant and equipment in
international markets accounted for $8,471 and $4,097, respectively.
Information about the Company's total non-current assets in the United
States and international areas as of October 31, 2003 and 2002 are presented
below:
2003 2002
-------- --------
Total non-current assets:
United States $118,523 $ 98,849
International
United Kingdom 25,739 20,505
All other Europe 19,275 17,685
Other 30,359 26,036
-------- --------
$193,896 $163,075
======== ========
84
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
Information about the Company's net sales in the United States and
international areas for the years ended October 31, 2003, 2002 and 2001 are
presented below (net sales are attributed to geographic areas based on
product destination):
2003 2002 2001
---------- ---------- ----------
(Restated) (Restated)
Net Sales:
United States $ 667,580 $606,467 $324,750
Canada 77,360 28,965 20,080
International
United Kingdom 88,381 47,021 32,227
All other Europe 175,717 98,490 61,187
Asia Pacific 22,885 12,593 12,478
Other 1,770 1,140 674
---------- -------- --------
$1,033,693 $794,676 $451,396
========== ======== ========
Information about the Company's net sales by product platforms for the years
ended October 31, 2003, 2002 and 2001 are presented below:
2003 2002 2001
---------- ---------- ----------
(Restated) (Restated)
Platforms:
Sony PlayStation 2 $ 591,205 $473,214 $130,691
Sony PlayStation 58,334 58,718 75,084
Microsoft Xbox 84,112 54,144 2,428
PC 147,275 102,734 103,849
Nintendo Game Boy Color, Game Boy
Advance and 64 48,547 20,348 37,595
Nintendo GameCube 29,085 17,761 --
Sega Dreamcast 109 1,602 11,347
Accessories 20,165 31,734 31,536
Hardware 54,861 34,421 58,866
---------- -------- --------
$1,033,693 $794,676 $451,396
========== ======== ========
85
TAKE-TWO INTERACTIVE SOFTWARE, INC. and SUBSIDIARIES
Notes to Consolidated Financial Statements (concluded)
(Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
22. NET INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
PER SHARE
The following table provides a reconciliation of basic (loss) earnings per
share to diluted earnings per share for the years ended October 31, 2003,
2002, and 2001.
Income (loss) before
cumulative effect of Shares
change in (in Per Share
accounting principle thousands) Amount
-------------------- ---------- ---------
Year Ended October 31, 2003
Basic $ 98,118 41,965 $ 2.34
Effect of dilutive securities- Stock options, restricted stock and
warrants -- 1,332
-------- ------
Diluted $ 98,118 43,297 $ 2.27
======== ====== =======
Year Ended October 31, 2002 (Restated)
Basic $ 71,563 38,030 $ 1.88
Effect of dilutive securities- Stock options and warrants -- 1,540
-------- ------
Diluted $ 71,563 39,570 $ 1.81
======== ====== =======
Year Ended October 31, 2001 (Restated)
Basic and Diluted $(1,674) 33,961 $(0.05)
======== ====== =======
The computation for diluted number of shares excludes those unexercised
stock options and warrants which are antidilutive. The number of such shares
was 1,000,000, 143,000 and 222,000 for the years ended October 31, 2003,
2002, 2001, respectively.
23. SUBSEQUENT EVENT
In December 2003, the Company acquired all of the outstanding capital stock
and paid certain liabilities of TDK Mediactive. The purchase price of
approximately $14,276 consisted of $17,116 in cash and issuance of 163,641
restricted shares of the Company's common stock (valued at $5,160), reduced
by approximately $8,000 due to TDK Mediactive under a distribution
agreement. The Company is in the process of completing the purchase price
allocation. TDK's results will be included in the Company's operating
results beginning in the first quarter of fiscal 2004.
In September 2003, the Company and TDK entered into an agreement providing
the Company with the exclusive North American distribution rights for
certain TDK titles, including The Haunted Mansion, Star Trek: Shattered
Universe and Corvette. During the three months ended October 31, 2003, the
Company recorded $9,225 of net sales related to this agreement. At October
31, 2003, the Company owed $5,945 to TDK for purchases made under the
agreement, which was included in accounts payable, and remaining guarantee
payments of $3,491 under the contract.
86
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934 the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
TAKE-TWO INTERACTIVE SOFTWARE, INC.
By: /s/ Jeffrey C. Lapin
------------------------------
Jeffrey C. Lapin
Chief Executive Officer
Date: February 12, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the date indicated.
Signature Title Date
--------- ----- ----
/s/ Ryan A. Brant Chairman of the Board February 12, 2004
- ---------------------------------
Ryan A. Brant
/s/ Jeffrey C. Lapin Chief Executive Officer (Principal February 12, 2004
- --------------------------------- Executive Officer) and Director
Jeffrey C. Lapin
/s/ Karl H. Winters Chief Financial Officer (Principal February 12, 2004
- --------------------------------- Financial and Accounting Officer)
Karl H. Winters
/s/ Robert Flug Director February 12, 2004
- ---------------------------------
Robert Flug
/s/ Steven Tisch Director February 12, 2004
- ---------------------------------
Steven Tisch
/s/ Oliver R. Grace, Jr. Director February 12, 2004
- ---------------------------------
Oliver R. Grace, Jr.
/s/ Todd Emmel Director February 12, 2004
- ---------------------------------
Todd Emmel
/s/ Mark Lewis Director February 12, 2004
- ---------------------------------
Mark Lewis
/s/ Richard Roedel Director February 12, 2004
- ---------------------------------
Richard Roedel
87
SCHEDULE II
Take-Two Interactive Software, Inc. and Subsidiaries
Valuation and Qualifying Accounts
(In thousands)
Additions (A)
-----------------------------------------------
Balance at Balance at
Beginning Sales and returns Provision for End of
Description of Period allowance (D) bad debts (D) Deductions (B) Other (C) Period
---------- ----------------- ------------- -------------- --------- ----------
Year Ended October 31, 2003
Allowances $30,806 $120,329 $4,322 $94,937 $2,297 $62,817
Year Ended October 31, 2002
(Restated)
Allowances $32,350 $ 72,096 $2,405 $76,714 $ 669 $30,806
Year Ended October 31, 2001
(Restated)
Allowances $14,286 $ 69,570 $2,258 $57,302 $3,538 $32,350
(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 in
2001 and $2,297 related to foreign exchange in 2003 and $669 in 2002.
(D) Includes price concessions of $45,919, $29,513 and $25,757; returns of
$47,342, $28,350 and $40,543; other sales allowances including rebates,
discounts, co-op advertising and bad debts of $31,390, $16,638 and
$5,528 for year ended October 31, 2003, 2002 and 2001, respectively.
88