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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,
- -----------------------------------------------------