UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities
Exchange Act of 1934
For the fiscal year ended October 31, 2004
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 of Incorporation or Organization) |
(I.R.S. Employer 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
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
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 $1,283,000,000.
As of December 10, 2004, there were 46,091,024 shares of the Registrant’s common stock outstanding.
Documents Incorporated by Reference:
Proxy Statement Relating to Annual Meeting to be held in Fiscal 2005
(Incorporated into Part III)
INDEX
| PAGE | |||
| PART I | |||
| Item 1. | 1 | ||
| Item 2. | 9 | ||
| Item 3. | 10 | ||
| Item 4. | 10 | ||
| PART II | |||
| Item 5. | 11 | ||
| Item 6. | 12 | ||
| Item 7. | 13 | ||
| Item 7A. | 33 | ||
| Item 8. | 33 | ||
| Item 9. | 33 | ||
| Item 9A. | 34 | ||
| Item 9B. | 34 | ||
| PART III | |||
| Item 10. | 35 | ||
| Item 11. | 35 | ||
| Item 12. | 35 | ||
| Item 13. | 35 | ||
| Item 14. | 35 | ||
PART IV |
|||
| Item 15. | 36 | ||
| 39 | |||
| 66 | |||
PART I
| Item 1. | Business |
Safe Harbor Statement under the Securities Litigation Reform Act of 1995: We make forward-looking statements in this report that are based on the beliefs of management and assumptions made by and information currently available to them. The words “expect,” “anticipate,” “believe,” “may,” “estimate,” “intend” and similar expressions are intended to identify such forward-looking statements. Forward-looking statements involve risks, uncertainties and assumptions described in “Management’s Discussion and Analysis of Financial Condition and Result of Operations – Risk Factors,” which could cause our actual results to be materially different from results expressed or implied by such forward-looking statements.
Overview
We are a leading global publisher of interactive software games designed for personal computers, and video game consoles and handheld platforms manufactured by Sony, Microsoft and Nintendo. Through our Rockstar Games® subsidiary, we have pursued a growth strategy by capitalizing on the widespread market acceptance of video game consoles, as well as the growing popularity of innovative action games that appeal to mature audiences. We are also seeking to diversify our product offerings through our Globalstar™ subsidiary by capitalizing on perceived growth opportunities in the market for sports and other licensed action and strategy titles.
Our Rockstar publishing subsidiary continues to successfully create new, proprietary brands and sequels to existing brands with broad consumer appeal. Rockstar recently released Grand Theft Auto: San Andreas, the highly anticipated next installment to the blockbuster Grand Theft Auto® franchise, for the PlayStation®2. Grand Theft Auto: San Andreas was the top selling video game for the PlayStation 2 in the United States for the one-month period ended November 27, 2004, with approximately 3.6 million units sold according to NPDFunworldSM. Rockstar plans to release Grand Theft Auto: San Andreas for the Xbox® and PC in fiscal 2005. Rockstar also expects to release Midnight Club 3: DUB Edition for the PlayStation 2 and Xbox, and The Warriors, a new title based on the Paramount Pictures’ classic 1979 gang drama, for the PlayStation 2.
Our Globalstar subsidiary has recently focused on publishing sports games under an agreement with SEGA Corporation. Following the July 2004 launch of ESPN NFL 2K5 (professional football) for the PlayStation 2 and Xbox at a $19.99 suggested retail price, we released ESPN NHL 2K5 (professional hockey), ESPN NBA 2K5 (professional basketball) and ESPN College Hoops 2K5 (college basketball) for the PlayStation 2 and Xbox. As of November 27, 2004, we sold 3.4 million units of these four sports titles according to NPDFunworld. Globalstar is also concentrating on publishing titles incorporating popular licensed properties, including a title based on Charlie and The Chocolate Factory.
We also distribute our products as well as third-party software, hardware and accessories to retail outlets in North America through our Jack of All Games subsidiary. Our customers in North America include Best Buy, Blockbuster, Circuit City, Electronics Boutique, GameStop, Target, Toys “R” Us, Wal-Mart, 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 Australia, Austria, Canada, France, Germany, Holland, Italy, New Zealand, Spain and the United Kingdom.
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 with the SEC under applicable law as soon as reasonably practicable after we file such material. The information on our website is not part of this report.
New Developments
Effective May 2004, we entered into a three-year agreement with SEGA Corporation, whereby we co-publish and exclusively distribute SEGA’s sports titles. Pursuant to an option agreement with SEGA, we have the right to acquire Visual Concepts Entertainment, Inc. (“Visual Concepts”) and its subsidiary Kush Games (“Kush”), California-based developers of SEGA’s sports titles, and the intellectual property rights associated with the realistic sports simulation games developed and/or produced by Visual Concepts and Kush. We recently acquired certain assets from Microsoft Corporation, including Indie Built (“Indie”), the developer of the successful Top Spin (tennis), Amped and Amped 2 (snowboarding) and Links (golf) sports games, and the intellectual property rights associated with these products. In addition, we acquired Venom Games Limited (“Venom”), a UK-based developer of the boxing games Rocky and Rocky Legends. See “Co-publishing and Distribution Agreement with SEGA,” “Management’s Discussion and Analysis of Financial Corporations Results of Operations – Business Acquisitions” and Note 3 to Consolidated Financial Statements.
Industry Overview
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 International Development Group (“IDG”), 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 IDG, sales of video game hardware and software and PC games reached $11.2 billion in the United States, and $8.2 billion in Europe, 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 launch the PlayStation Portable™ (“PSP”), a multipurpose handheld platform for games, movies and music, which is expected to become available in North America in March 2005. We recently acquired Mobius Entertainment Limited (“Mobius”), a UK-based developer of games designed to operate on handheld devices, such as Sony’s PSP. Nintendo recently introduced the DS, a dual screen handheld gaming device, featuring a touch screen, wireless gameplay and text messaging capabilities. Also, Microsoft is expected to launch its next-generation platform, the Xbox 2, for the 2005 holiday season, and Sony is expected to launch its next-generation platform, the PlayStation 3, in 2006. These platforms are expected to accelerate the fusion of music, movies, video gameplay and online computer entertainment.
We have devoted our principal efforts and resources toward developing highly successful cutting edge proprietary intellectual properties; establishing well-known product brands with significant potential for sequels; and focusing our creative efforts on delivering games that are attractive to a broad demographic. We continue to diversify our publishing operations, and 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 we are positioned for future growth as the interactive entertainment industry continues to expand and evolve.
Fiscal 2004 Product Launches
We publish products in the action, racing, strategy, sports and simulation genres. During fiscal 2004, we published 9 new internally developed titles and 33 new titles developed by third parties. Of these titles, 3 internally developed titles and 4 externally developed titles sold more than one million units across all platforms, and 7 externally developed titles sold more than 500,000 units across all platforms.
Grand Theft Auto products accounted for approximately 34.3% of our revenues for fiscal 2004, with Grand Theft Auto: San Andreas for the PlayStation 2; Grand Theft Auto Double Pack for the Xbox; and Grand Theft Auto: Vice City for the PlayStation 2 accounting for 20.9%, 5.7% and 3.6%, respectively, of our revenues for this year. No other product accounted for more than 10% of our revenues for this year.
Our frontline products sell at retail for $49.95 in North America. Products that are designated Sony’s Greatest Hits and Microsoft’s Platinum Hits sell for $19.99. We currently offer our sports titles at $19.99, and we position other value-priced product offerings at $9.99. We include online capability features in certain of our PC, PlayStation 2 and Xbox titles, which permits users to play against one another on the Internet.
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The following are certain of our products released in fiscal 2004:
| Title | Platform | Release Date |
| Grand Theft Auto: San Andreas | PS2 | October 2004 |
| Conflict: Vietnam | PS2; Xbox; PC | October 2004 |
| Outlaw Golf 2 | Xbox | October 2004 |
| Codename: Kids Next Door – Operation S.O.D.A | GBA | October 2004 |
| Robotech Invasion | PS2; Xbox | October 2004 |
| Scaler | PS2; Xbox | October 2004 |
| ESPN NBA 2K5 | PS2; Xbox | September 2004 |
| Kohan II: Kings of War | PC | September 2004 |
| Vietcong: Purple Haze | PS2; Xbox | September 2004 |
| ESPN NHL 2K5 | PS2; Xbox | August 2004 |
| The Guy Game | PS2; Xbox | August 2004 |
| ESPN NFL 2K5 | PS2; Xbox | July 2004 |
| Army Men: Sarge’s War | Xbox; PC; GameCube | July 2004 |
| Manhunt | Xbox; PC PS2 |
April 2004 November 2003 |
| Red Dead Revolver | PS2; Xbox | April 2004 |
| Serious Sam: Next Encounter | PS2; GameCube; GBA | April 2004 |
| Destruction Derby Arenas | PS2 | March 2004 |
| Corvette | PS2 Xbox |
March 2004 December 2003 |
| Mafia | Xbox PS2 |
March 2004 January 2004 |
| Star Trek: Shattered Universe | PS2; Xbox | January 2004 |
| Max Payne 2: The Fall of Max Payne | PS2 Xbox |
December 2003 November 2003 |
| Grand Theft Auto Double Pack | Xbox | November 2003 |
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Publishing
We conduct publishing operations through our Rockstar and Globalstar subsidiaries.
Rockstar Games
Our Rockstar label continues to focus on the creation of premium priced, groundbreaking entertainment. We believe that Rockstar’s Grand Theft Auto product franchise is a uniquely original popular culture phenomenon. Rockstar released Grand Theft Auto: San Andreas for the PlayStation 2 in October 2004.
For fiscal 2005, Rockstar plans to release Grand Theft Auto: San Andreas for the Xbox and PC, and anticipates that it will also ship this product for the PlayStation 2 in Japan under a license agreement. Rockstar also plans to release Midnight Club 3: DUB Edition for the PlayStation 2 and Xbox, and The Warriors, a new title based on the Paramount Pictures film, for the PlayStation 2. Rockstar currently anticipates that it will release a new console title based on a proven brand and titles based on two of Rockstar’s premier brands for Sony’s PSP platform.
Globalstar
Globalstar is focusing on building brands for video game consoles, handheld platforms and the PC across popular genres, such as sports, action and strategy games. Globalstar recently launched four high quality sports titles at a value price of $19.99 under an agreement with SEGA. While we believe that this value pricing may have provided a catalyst for consumers to purchase these titles, the highly favorable game rankings of the titles developed by Visual Concepts and Kush is expected to help build long-term brand loyalty. We currently anticipate that we will ship ESPN MLB 2K5 (major league baseball) in fiscal 2005.
Globalstar is also concentrating on the growing market for video games incorporating popular licensed entertainment properties.
Co-publishing and Distribution Arrangement with SEGA
Effective May 2004, we entered into a three-year agreement with SEGA Corporation, whereby we co-publish and exclusively distribute SEGA’s sports titles. Under our current arrangement, we are entitled to receive all of the revenue and profit, if any, from the sale of the sports titles developed by Visual Concepts and Kush, and we are obligated to pay for development and marketing costs of the sports titles. The agreement may be terminated by us under certain circumstances, including as a result of SEGA’s failure to obtain licenses from the major sports leagues and players associations.
Pursuant to an option agreement with SEGA, we have the right to purchase all of the outstanding capital stock of Visual Concepts and Kush. The option is exercisable until the earlier of (1) March 31, 2006 or (2) the termination of our distribution agreement with SEGA. We are currently negotiating the option price, and we are continuing to evaluate potential opportunities in the market for sports titles.
Software Content and Licensing
We have established a portfolio of successful proprietary software content. We own all of the intellectual property rights associated with the following brands: Grand Theft Auto; Max Payne; Midnight Club; Manhunt; Red Dead Revolver; Smuggler’s Run; Oni; Myth; Spec Ops; Railroad Tycoon; Tropico; Army Men; and School Tycoon. We believe that content ownership facilitates our internal product development efforts and maximizes profit potential.
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. 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.
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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.” During fiscal 2004, we acquired exclusive rights to certain properties owned by the Cartoon Network, as well as exclusive rights to, among other things, certain properties associated with Charlie and The Chocolate Factory. We expect to continue to actively pursue selective acquisitions of property rights that we believe will enhance our prospects.
Software Development
We develop most of our frontline software titles for our Rockstar label through our internal development studios: Rockstar San Diego, the developer of Midnight Club and Smuggler’s Run; Rockstar North, the developer of the Grand Theft Auto and Manhunt series; Rockstar Toronto, the developer of the PlayStation 2 versions of Max Payne and Max Payne 2: The Fall of Max Payne; Rockstar Vancouver; and Rockstar Vienna, the developer of the Xbox versions of Max Payne and Max Payne 2: The Fall of Max Payne.
In March 2004, we acquired Mobius (Rockstar Leeds), a UK-based studio that specializes in developing titles for handheld platforms such as Sony’s PSP. It is currently anticipated that Rockstar Leeds will develop Rockstar titles for the PSP based on two of Rockstar’s premier brands.
We also develop products for the PC through our internal development studios: PopTop Software, the developer of the Railroad Tycoon series and Tropico 2; Frog City, the developer of Tropico: Pirate Cove; and Cat Daddy Games.
We recently acquired Venom, a UK-based studio and the developer of the successful boxing game Rocky. We also recently acquired Indie, best known for developing Top Spin, the award-winning tennis game, Amped and Amped 2, snowboarding games, and Links, a golf game.
As of October 31, 2004, our internal development studios and product development department had 755 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 and the PC in all major territories.
For fiscal 2004, 2003 and 2002, research and development expenses relating to our software titles were $43.3 million, $25.1 million and $11.5 million, respectively. Additionally, for these years, we capitalized software development costs of $26.0 million, $15.9 million and $9.6 million, respectively.
Certain of our 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, handheld 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 frontline product generally ranges from $3 million to $10 million. We expect that development costs will increase for next-generation platforms.
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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, PSP, Xbox, Game Boy Advance and GameCube. We are not required to obtain any licenses to develop titles for the PC.
Sony. 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 this agreement, we have certain rights to sell off existing inventories. We also entered into a similar agreement with Sony for PlayStation 2 covering European territories and Australia.
In September 2004, we entered into a three-year agreement with Sony pursuant to which Sony granted us the right and license to develop, market, publish and distribute software titles for the PSP in North America. We entered into a four-year Licensed Publisher Agreement with Sony in April 2004 under which Sony granted us the right and license to develop, market, publish and distribute software titles for the PlayStation in North America. We also entered into a similar agreement with Sony for PlayStation covering European territories and Australia.
Microsoft. 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 March 2005. 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.
Nintendo. We entered into a Confidential License Agreement with Nintendo that expires in December 2007. 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, we have certain rights to sell off existing inventories. We also entered into a similar three-year agreement with Nintendo for GameCube covering European territories.
We also entered into an agreement with Nintendo that expires in July 2007, granting us the right and license to develop software for Nintendo’s Game Boy Advance in the western hemisphere. We entered into a similar 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 Best Buy, Blockbuster, Circuit City, Electronics Boutique, GameStop, Target, Toys “R” Us, Wal-Mart 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 Carrefour, Dixons, Game Group (formerly Electronics Boutique), Karstadt, and Media Saturn. We have sales and marketing operations in Australia, Austria, Canada, France, Germany, Holland, Italy, New Zealand, Spain and the United Kingdom.
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For fiscal 2004, sales to our five largest customers accounted for approximately 38.9% of our revenues, with Wal-Mart accounting for 10.4% of our revenues. No other customer accounted for more than 10% of our revenues 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 2004, we incurred selling and marketing costs of $117.6 million. We label and market our products in strict 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. Rockstar, in collaboration with Interscope Records, an affiliate of Universal Music Group, also released an eight-CD box set soundtrack to Grand Theft Auto: San Andreas with more than 80 tracks, including in-game radio stations featuring a mix of rap, rock, country and R&B.
To date, Max Payne, Midnight Club, Midnight Club 2, Conflict: Desert Storm, Smuggler’s Run, Grand Theft Auto 3, Grand Theft Auto: Vice City, Manhunt and State of Emergency have been designated Sony’s Greatest Hits Program titles. Max Payne, Midnight Club 2, 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 manufacturing discounts 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 related to these Programs in fiscal 2004 and 2003 amounted to $5.5 million and $33.4 million, 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, co-operative advertising, as well as attendance at trade shows. We employ separate sales forces for our publishing and distribution operations. As of October 31, 2004, we had a sales and marketing staff of 237 persons.
Distribution
We distribute our own titles as well as third-party software, hardware and accessories in North America through our Jack of All Games subsidiary. 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 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 to be 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.
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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 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, although Xbox games must be manufactured by pre-approved manufacturers.
Production of PC software includes CD-ROM pressing, assembly of components, printing of packaging and user manuals and shipping of finished goods, which is performed by third-party vendors in accordance with our specifications, 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, 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 online 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 to maintain current levels of sales of our titles. Competitors with more extensive lines and popular titles may 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.
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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, online computer programs and other forms of entertainment which may be less expensive or provide other advantages to consumers.
In our distribution business, we compete with large national companies such as Ingram Entertainment, as well as smaller regional distributors. We also compete with the efforts of the major entertainment software companies that distribute directly to retailers or over the Internet. Some of our competitors have 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 obtain trademark and copyright registrations for our products.
Interactive entertainment software is susceptible to piracy and 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. Well organized piracy operations have proliferated in recent years as a result of the ability to download pirated copies of our software over the Internet. Although we attempt to incorporate protective measures into our software, piracy of our products could negatively impact our future profitability. 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 or are named in lawsuits by 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 revenues. For fiscal 2004 and 2003, sales in international markets accounted for approximately 27.5% and 27.9%, respectively, of our revenues. 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 19 to Consolidated Financial Statements.
Employees
As of October 31, 2004, we had 1,435 full-time employees. None of our employees is subject to a collective bargaining agreement. We consider our relations with employees to be good.
| Item 2. | Properties |
Our principal executive offices are located at 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 $1,488,000. We also sublease an additional 15,000 square feet at this location for an annual rent of approximately $368,000.
Take-Two Interactive Software Europe leases 12,500 square feet of office space in Windsor, United Kingdom. The lease provides for a current annual rent of approximately $634,000 plus taxes and utilities, and expires in 2011. Rockstar North currently leases 14,600 square feet of office space in Edinburgh, Scotland, at an annual rent of approximately $993,000, which expires in 2014.
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Jack of All Games leases approximately 206,000 square feet of office and warehouse space in Cincinnati, Ohio. Jack of All Games pays $1,100,000 per annum, plus taxes and insurance, under the lease, which expires in May 2006. Effective September 2004, Jack of All Games entered into a ten-year lease for 400,000 square feet of new office and state-of-the-art warehouse space. Jack of All Games pays approximately $1,000,000 per annum under the lease, plus taxes and insurance. Jack of All Games is entitled to a rent reduction in connection with its former warehouse space and will seek to sublease this space in April 2005. The transition to the new facility is planned to be completed by the end of May 2005.
In addition, our other subsidiaries lease office space in Sydney, Australia; Vienna, Austria; Ontario, Toronto and Vancouver, Canada; Paris, France; Munich, Germany; Breda, Holland; Madrid, Spain; Geneva, Switzerland; Milan, Italy; Auckland, New Zealand; London, Lincoln and Leighton Buzzard, Newcastle-upon-Tyne, UK; and in San Diego, San Francisco and Los Angeles, California; Baltimore, Maryland; Fenton, Missouri; Austin, Texas; Salt Lake City, Utah; and Bellevue, Washington; for an aggregate annual rent of approximately $3,657,000.
| Item 3. | Legal Proceedings |
In November 2004, we submitted an offer of settlement of the previously announced investigation by the Enforcement Division of the Securities and Exchange Commission to the Staff of the Commission. The Staff has agreed to recommend the offer of settlement to the Commission. If approved by the Commission, the proposed settlement, under which we would neither admit nor deny the allegations of a Complaint, would fully resolve all claims relating to the investigation that commenced in December 2001. Pursuant to the offer of settlement, we would pay a civil penalty of $7.5 million, which has been accrued in the accompanying financial statements, and would be enjoined from future violations of the federal securities laws.
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 |
Not Applicable.
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PART II
| Item 5. | Market for Registrant’s Common Equity and Related Stockholder Matterss |
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 sale prices for the common stock as reported by NASDAQ.
| Year Ended October 31, 2003 | |||||||
| High | Low | ||||||
| First Quarter | $ | 31.48 | $ | 19.83 | |||
| Second Quarter | 24.19 | 18.30 | |||||
| Third Quarter | 31.40 | 21.66 | |||||
| Fourth Quarter | 41.67 | 24.35 | |||||
| Year Ended October 31, 2004 | |||||||
| First Quarter | 40.91 | 27.42 | |||||
| Second Quarter | 37.50 | 26.90 | |||||
| Third Quarter | 31.93 | 27.40 | |||||
| Fourth Quarter | 35.55 | 30.40 | |||||
| Year Ending October 31, 2005 | |||||||
| First Quarter (through December 10, 2004) | 36.64 | 31.80 | |||||
The last reported sale price for our common stock on December 10, 2004 was $33.71. The number of record holders of our common stock was approximately 122 as of December 10, 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, 2004, we issued an aggregate of 34,446 shares of restricted stock to nine employees under our Incentive Stock Plan. In connection with the above securities issuances, 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.
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| 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.
| (In thousands, except per share data) | |||||||||||||||
| Years Ended October 31, | |||||||||||||||
| 2004 | 2003 | 2002 | 2001(1)(2) | 2000(2) | |||||||||||
| Statement of Operations Data: | |||||||||||||||
| Net sales | $ | 1,127,751 | $ | 1,033,693 | $ | 794,676 | $ | 451,396 | $ | 358,918 | |||||
| Income from operations | 102,134 | 163,011 | 122,705 | 28,377 | 30,250 | ||||||||||
Income (loss) before cumulative effect
of change in accounting principle |
65,378 | 98,118 | 71,563 | (1,674 | ) | 4,555 | |||||||||
| Net income (loss) | $ | 65,378 | $ | 98,118 | $ | 71,563 | $ | (6,918 | ) | $ | 4,555 | ||||
| Net income (loss) per share | |||||||||||||||
| Basic | $ | 1.46 | $ | 2.34 | $ | 1.88 | $ | (0.20 | ) | $ | 0.17 | ||||
| Diluted | $ | 1.43 | $ | 2.27 | $ | 1.81 | $ | (0.20 | ) | $ | 0.16 | ||||
| As of October 31, | |||||||||||||||
| 2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||
| Balance Sheet Data: | |||||||||||||||
| Cash and cash equivalents | $ | 155,095 | $ | 183,477 | $ | 108,369 | $ | 6,056 | $ | 5,245 | |||||
| Working capital | 395,131 | 347,922 | 196,555 | 91,794 | 65,663 | ||||||||||
| Total assets | 950,513 | 707,298 | 491,440 | 354,305 | 326,173 | ||||||||||
| Total debt | — | — | — | 54,073 | 96,873 | ||||||||||
| Total liabilities | 315,043 | 173,806 | 135,896 | 135,140 | 158,538 | ||||||||||
| Stockholders’ equity | 635,470 | 533,492 | 355,544 | 219,165 | 167,634 | ||||||||||
| (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. | ||
| (2) | Fiscal 2001 and 2000 includes amortization of goodwill of $4,116 and $2,123 prior to our adoption of SFAS 142, “Goodwill and Intangible Assets” in 2002. | |
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| Item 7. | Management’s Discussion and Analysis of
Financial Condition and Results of Operations (Dollars in thousands, except per share amounts) |
Overview
We are a leading global publisher of interactive software games designed for personal computers, and video game consoles and handheld platforms manufactured by Sony, Microsoft and Nintendo. We also distribute our products as well as third-party software, hardware and accessories to retail outlets in North America through our Jack of All Games subsidiary, and we have sales, marketing and publishing operations in Australia, Austria, Canada, France, Germany, Holland, Italy, New Zealand, Spain and the United Kingdom.
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 developed by 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 frontline products internally, and we own major intellectual properties, which we believe permits us to maximize profitability. Operating margins for titles based on licensed properties are affected by our costs to acquire licenses.
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 and handheld platforms.
Through our Rockstar Games subsidiary, we have pursued a growth strategy by capitalizing on the widespread market acceptance of video game consoles, as well as the growing popularity of innovative action games that appeal to mature audiences. We have established a portfolio of successful proprietary software content 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. We currently anticipate that the release of Grand Theft Auto: San Andreas for the Xbox and PC, Midnight Club 3: DUB Edition for the PlayStation 2 and Xbox and The Warriors for the PlayStation 2 will generate significant cash flow from our publishing business in fiscal 2005.
We are also seeking to diversify our product offerings through our Globalstar subsidiary by capitalizing on significant growth opportunities in the market for sports and other licensed action and strategy titles. We recently made strategic acquisitions of sports development studios, and we have the right to acquire Visual Concepts and Kush.
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 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. 104, “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.
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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, market conditions and changes in demand and acceptance of our products by consumers.
Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price concessions in any accounting period. 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 contractual amounts on product sales, adjusted for certain costs. 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 as defined in the respective agreements. At each balance sheet date, we 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 based on current and future sales 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 4 to Consolidated Financial Statements.
Capitalized Software Development Costs
We capitalize internal software development costs, as well as film production and other content costs subsequent to establishing technological feasibility of a title. Capitalized software development costs represent the costs associated with the internal development of 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. At each balance sheet date, we evaluate the recoverability of capitalized software costs based on undiscounted future cash flows and will charge to cost of sales any amounts that are deemed unrecoverable or for projects that we will abandon. See Note 7 to Consolidated Financial Statements.
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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 $89,700 for fiscal 2004. 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 we generate 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 December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” which revised Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”. This statement supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of operations. The revised statement is effective as of the first interim period beginning after June 15, 2005. The adoption of this standard, effective August 1, 2005, is expected to have a material impact on our consolidated financial statements.
In December 2003, The Financial Accounting Standards Board (“FASB”) revised Interpretation No. 46 “Consolidation of Variable Interest Entities” with certain clarifications and modifications. Revised Interpretation No. 46(R) provides guidance on the identification of variable interest entities, entities for which control is achieved through means other than through voting rights, and how to determine whether a variable interest holder should consolidate the variable interest entities. This Interpretation shall be applied to all entities subject to this Interpretation no later than the first reporting period that ends after March 15, 2004. The adoption of the revised Interpretation did not have a material impact on the consolidated financial statements.
In December 2003, the SEC issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which supercedes SAB No. 101, “Revenue Recognition in Financial Statements.” The primary purpose of SAB No. 104 is to rescind accounting guidance contained in SAB No. 101 related to multiple element revenue arrangements, superceded as a result of the issuance of Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Additionally, SAB No. 104 rescinds the SEC’s Revenue Recognition in Financial Statements Frequently Asked Questions and Answers (“FAQ”) issued with SAB No. 101. The adoption of SAB No. 104 in the first quarter of fiscal 2004 did not have a material impact on our consolidated financial statements.
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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 sales by territory, sales mix and platform:
| Years Ended October 31, | |||||||||
| 2004 | 2003 | 2002 | |||||||
| Operating Data: | |||||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | |||
| Cost of sales | |||||||||
| Product costs | 55.0 | 52.0 | 51.8 | ||||||
| Royalties | 10.1 | 8.6 | 10.1 | ||||||
| Software development costs | 1.4 | 1.1 | 1.0 | ||||||
| Total cost of sales | 66.5 | 61.7 | 62.9 | ||||||
| Selling and marketing | 10.4 | 10.0 | 9.8 | ||||||
| General and administrative | 8.7 | ||||||||