Activision Blizzard, Inc.
ACTIVISION INC /NY (Form: 10-Q, Received: 08/04/2003 15:29:57)      

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark one)

 

 

 

 

 

ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

 

 

For the Quarterly Period Ended June 30, 2003

 

 

 

OR

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

For the transition period from               to              

   

Commission File Number 0-12699

 

ACTIVISION, INC.
(Exact name of registrant as specified in its charter)

Delaware

 

95-4803544

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

3100 Ocean Park Boulevard, Santa Monica, CA

 

90405

(Address of principal executive offices)

 

(Zip Code)

 

 

 

(310) 255-2000
(Registrant’s telephone number, including area code)

 

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 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 ý   No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes ý   No o

 

The number of shares of the registrant’s Common Stock outstanding as of July 25, 2003 was 88,102,997.

 

 



 

ACTIVISION, INC. AND SUBSIDIARIES

 

INDEX

 

PART I.

FINANCIAL INFORMATION

3

 

 

 

Item 1.

Financial Statements

3

 

 

 

 

Consolidated Balance Sheets as of June 30, 2003 (Unaudited) and March 31, 2003

3

 

 

 

 

Consolidated Statements of Operations for the three months ended June 30, 2003 and 2002 (Unaudited)

4

 

 

 

 

Consolidated Statements of Cash Flows for the three months ended June 30, 2003 and 2002 (Unaudited)

5

 

 

 

 

Consolidated Statement of Changes in Shareholders’ Equity for the three months ended June 30, 2003 (Unaudited)

6

 

 

 

 

Notes to Consolidated Financial Statements for the three months ended June 30, 2003 (Unaudited)

7

 

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

28

 

 

 

Item 4.

Controls and Procedures

29

 

 

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

29

Item 1.

Legal Proceedings

 

 

 

29

Item 6.

Exhibits and Reports on Form 8-K

 

 

 

30

 

 

 

SIGNATURES

32

 

2



 

Part I.  Financial Information .  

 

Item 1.  Financial Statements.

   

ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

 

June 30, 2003

 

March 31, 2003

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

290,833

 

$

285,554

 

Short-term investments

 

98,942

 

121,400

 

Accounts receivable, net of allowances of  $56,819 and $57,356 at June 30, 2003 and March 31, 2003, respectively

 

33,328

 

15,822

 

Inventories

 

25,107

 

19,577

 

Software development

 

25,768

 

26,791

 

Intellectual property licenses

 

19,229

 

8,906

 

Deferred income taxes

 

33,475

 

38,290

 

Other current assets

 

22,324

 

10,565

 

 

 

 

 

 

 

Total current assets

 

549,006

 

526,905

 

 

 

 

 

 

 

Software development

 

45,667

 

35,281

 

Intellectual property licenses

 

26,456

 

36,943

 

Property and equipment, net

 

26,358

 

22,265

 

Deferred income taxes

 

13,696

 

10,322

 

Other assets

 

1,902

 

5,081

 

Goodwill

 

67,672

 

68,019

 

 

 

 

 

 

 

Total assets

 

$

730,757

 

$

704,816

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term debt

 

$

 

$

147

 

Accounts payable

 

51,340

 

45,602

 

Accrued expenses

 

48,062

 

58,656

 

 

 

 

 

 

 

Total current liabilities

 

99,402

 

104,405

 

 

 

 

 

 

 

Long-term debt, less current portion

 

 

2,671

 

 

 

 

 

 

 

Total liabilities

 

99,402

 

107,076

 

 

 

 

 

 

 

Commitments and contingencies (Note 13)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, $.000001 par value, 3,750,000 shares authorized, no shares issued at June 30, 2003 and March 31, 2003

 

 

 

Series A Junior Preferred stock, $.000001 par value, 1,250,000 shares authorized, no shares issued at June 30, 2003 and March 31, 2003

 

 

 

Common stock, $.000001 par value, 125,000,000 shares authorized, 107,613,658 and 107,372,727 shares issued and 88,016,775 and 90,084,245 shares outstanding at June 30, 2003 and March 31, 2003, respectively

 

 

 

Additional paid-in capital

 

639,307

 

592,295

 

Retained earnings

 

134,727

 

130,564

 

Less:  Treasury stock, at cost, 19,596,883 and 17,288,482 shares at June 30, 2003 and March 31, 2003, respectively

 

(142,946

)

(121,685

)

Accumulated other comprehensive income (loss)

 

267

 

(3,434

)

 

 

 

 

 

 

Total shareholders’ equity

 

631,355

 

597,740

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

730,757

 

$

704,816

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3



   

ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

 

 

 

For the three months ended June 30,

 

 

 

2003

 

2002

 

 

 

 

 

 

 

Net revenues

 

$

158,725

 

$

191,258

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

Cost of sales – product costs

 

76,610

 

83,344

 

Cost of sales – software royalties and amortization

 

15,498

 

15,838

 

Cost of sales – intellectual property licenses

 

10,143

 

12,643

 

Product development

 

13,580

 

11,751

 

Sales and marketing

 

26,285

 

21,993

 

General and administrative

 

11,463

 

14,493

 

 

 

 

 

 

 

Total costs and expenses

 

153,579

 

160,062

 

 

 

 

 

 

 

Operating income

 

5,146

 

31,196

 

 

 

 

 

 

 

Investment income, net

 

1,257

 

1,156

 

 

 

 

 

 

 

Income before income tax provision

 

6,403

 

32,352

 

 

 

 

 

 

 

Income tax provision

 

2,240

 

11,648

 

 

 

 

 

 

 

Net income

 

$

4,163

 

$

20,704

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.05

 

$

0.23

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

88,046

 

90,059

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.04

 

$

0.21

 

 

 

 

 

 

 

Weighted average common shares outstanding assuming dilution

 

93,770

 

100,125

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4



   

ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)

 

 

 

For the three months ended June 30,

 

 

 

2003

 

2002

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

4,163

 

$

20,704

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

Deferred income taxes

 

1,441

 

(1,566

)

Depreciation and amortization

 

2,251

 

2,168

 

Amortization of capitalized software development costs and intellectual property licenses

 

19,045

 

18,527

 

Tax benefit of stock options and warrants exercised

 

512

 

12,753

 

Changes in operating assets and liabilities (net of effects of acquisitions):

 

 

 

 

 

Accounts receivable

 

(17,406

)

12,946

 

Inventories

 

(5,530

)

(4,703

)

Software development and intellectual property licenses

 

(28,244

)

(33,187

)

Other assets

 

(3,102

)

6,061

 

Accounts payable

 

5,738

 

(18,649

)

Accrued expenses and other liabilities

 

(2,566

)

2,994

 

 

 

 

 

 

 

Net cash provided by (used in) operating activities

 

(23,698

)

18,048

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(5,671

)

(1,860

)

Proceeds from disposal of property and equipment

 

 

408

 

Purchases of short-term investments

 

(24,500

)

 

Proceeds from sales and maturities of short-term investments

 

46,930

 

 

Cash payment to effect business combinations, net of cash acquired

 

 

(12,091

)

Minority capital investment

 

 

(1,500

)

 

 

 

 

 

 

Net cash provided by (used in) investing activities

 

16,759

 

(15,043

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

1,423

 

15,059

 

Other borrowings, net

 

(2,818

)

1,184

 

Proceeds from issuance of common stock pursuant to underwritten public offering, net of offering costs

 

 

248,102

 

Purchase of structured stock repurchase transactions

 

(36,420

)

 

Settlement of structured stock repurchase transactions

 

65,903

 

 

Purchase of treasury stock

 

(18,814

)

 

 

 

 

 

 

 

Net cash provided by financing activities

 

9,274

 

264,345

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

2,944

 

3,973

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

5,279

 

271,323

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

285,554

 

279,007

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

290,833

 

$

550,330

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5



   

ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
For the three months ended June 30, 2003
(Unaudited)
(In thousands)

 

 

 

 

 

Additional
Paid-In
Capital

 

Retained
Earnings

 

 

 

Accumulated
Other
Comprehensive
Income (Loss)

 

Shareholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

Common Stock

Treasury Stock

Shares

 

Amounts

Shares

 

Amounts

Balance, March 31, 2003

 

107,373

 

$

 

$

592,295

 

$

130,564

 

(17,288

)

$

(121,685

)

$

(3,434

)

$

597,740

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

4,163

 

 

 

 

4,163

 

Unrealized depreciation on short-term investments

 

 

 

 

 

 

 

(24

)

(24

)

Foreign currency translation adjustment

 

 

 

 

 

 

 

3,725

 

3,725

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7,864

 

Issuance of common stock pursuant to employee stock option and stock purchase plans and common stock warrants

 

241

 

 

1,423

 

 

 

 

 

1,423

 

Tax benefit attributable to employee stock options and common stock warrants

 

 

 

512

 

 

 

 

 

512

 

Structured stock repurchase transactions

 

 

 

(36,420

)

 

 

 

 

(36,420

)

Settlement of structured stock repurchase transactions

 

 

 

81,497

 

 

(1,144

)

(10,000

)

 

71,497

 

Purchase of treasury stock

 

 

 

 

 

(1,165

)

(11,261

)

 

(11,261

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2003

 

107,614

 

$

 

$

639,307

 

$

134,727

 

(19,597

)

$

(142,946

)

$

267

 

$

631,355

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6



 

ACTIVISION, INC. AND SUBSIDIARIES  

Notes to Consolidated Financial Statements (Unaudited)

For the three months ended June 30, 2003

 

1.               Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of Activision, Inc. and its subsidiaries (“Activision” or “we”).  The information furnished is unaudited and reflects all adjustments that, in the opinion of management, are necessary to provide a fair statement of the results for the interim periods presented.  The consolidated financial statements should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the year ended March 31, 2003 as filed with the Securities and Exchange Commission (“SEC”).

 

Software Development Costs and Intellectual Property Licenses

 

Software development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products.

 

We account for software development costs in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.”  Software development costs are capitalized once technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation.  For products where proven technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product basis.  Prior to a product’s release, we expense, as part of cost of sales – software royalties and amortization, capitalized costs when we believe such amounts are not recoverable.  Capitalized costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation.  Amounts related to software development which are not capitalized are charged immediately to product development expense.  We evaluate the future recoverability of capitalized amounts on a quarterly basis.  The recoverability of capitalized software development costs is evaluated based on the expected performance of the specific products for which the costs relate.  Criteria used to evaluate expected product performance include historical performance of comparable products using comparable technology; orders for the product prior to its release; and estimated performance of a sequel product based on the performance of the product on which the sequel is based.

 

Commencing upon product release, capitalized software development costs are amortized to cost of sales – software royalties and amortization based on the ratio of current revenues to total projected revenues, generally resulting in an amortization period of six months or less.  For products that have been released in prior periods, we evaluate the future recoverability of capitalized amounts on a quarterly basis.  The primary evaluation criterion is actual title performance.

 

Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks or copyrights in the development of our products.  Depending upon the agreement with the rights holder, we may obtain the rights to use acquired intellectual property in multiple products over multiple years, or alternatively, for a single product.

 

We evaluate the future recoverability of capitalized intellectual property licenses on a quarterly basis.  The recoverability of capitalized intellectual property license costs is evaluated based on the expected performance of the specific products in which the licensed trademark or copyright is to be used.  As many of our intellectual property licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized intellectual property license costs based on certain qualitative factors such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned theatrical releases or television series based on the intellectual property and the rights holder’s continued promotion and exploitation of the intellectual property.  Prior to the related product’s release, we expense, as part of cost of sales – intellectual property licenses, capitalized intellectual property costs when we believe such amounts are not recoverable.  Capitalized intellectual

 

7



 

property costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation.  Criteria used to evaluate expected product performance include historical performance of comparable products using comparable technology; orders for the product prior to its release; and estimated performance of a sequel product based on the performance of the product on which the sequel is based.

 

Commencing upon the related product’s release, capitalized intellectual property license costs are amortized to cost of sales – intellectual property licenses based on the ratio of current revenues for the specific product to total projected revenues for all products in which the licensed trademark or copyright will be utilized.  As intellectual property license contracts may extend for multiple years, the amortization of capitalized intellectual property license costs relating to such contracts may extend beyond one year.  For intellectual property included in products that have been released, we evaluate the future recoverability of capitalized amounts on a quarterly basis.  The primary evaluation criterion is actual title performance.

 

Revenue Recognition

 

We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers.  We may permit product returns from, or grant price protection to, our customers on unsold merchandise under certain conditions.  Price protection, when granted and applicable, allows customers a credit against amounts they owe us with respect to merchandise unsold by them.  With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery of such copies. Per copy royalties on sales that exceed the guarantee are recognized as earned.  In addition, in order to recognize revenue for both product sales and licensing transactions, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable.

 

Revenue from product sales is reflected after deducting the estimated allowance for returns and price protection.  Management must make estimates of potential future product returns and price protection related to current period product revenue.  We estimate the amount of future returns and price protection based upon historical experience, customer inventory levels and changes in the demand and acceptance of our products by the end consumer.

 

Sales incentives or other consideration given by us to our customers is accounted for in accordance with Emerging Issues Task Force (“EITF”) Issue 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).”  In accordance with EITF Issue 01-9, sales incentives and other consideration that are considered adjustments of the selling price of our products, such as rebates and product placement fees, are reflected as reductions of revenue.  Sales incentives and other consideration that represent costs incurred by us for assets or services received, such as the appearance of our products in a customer’s national circular ad, are reflected as sales and marketing expenses.

 

Stock-Based Compensation and Pro Forma Information

 

Under SFAS No. 123, “Accounting for Stock-Based Compensation,” compensation expense is recorded for the issuance of stock options and other stock-based compensation based on the fair value of the stock options and other stock-based compensation on the date of grant or measurement date.  Alternatively, SFAS No. 123 allows companies to continue to account for the issuance of stock options and other stock-based compensation in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.”  Under APB No. 25, compensation expense is recorded for the issuance of stock options and other stock-based compensation based on the intrinsic value of the stock options and other stock-based compensation on the date of grant or measurement date.  Under the intrinsic value method, compensation expense is recorded on the date of grant or measurement date only if the current market price of the underlying stock exceeds the stock option or other stock-based compensation exercise price.  At June 30, 2003, we had several stock-based employee compensation plans, which are described more fully in Note 14 to the Notes to Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for the year ended March 31, 2003 filed with the SEC. We account for those

 

8



 

plans under the recognition and measurement principles of APB Opinion No. 25 and related Interpretations. No stock-based employee compensation cost is reflected in net income for any periods presented, as all options granted under those plans had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (amounts in thousands, except per share data):

 

 

 

 

Three months ended June 30,

 

 

 

2003

 

2002

 

Net income, as reported

 

$

4,163

 

$

20,704

 

Deduct:  Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

 

(5,535

)

(4,769

)

 

 

 

 

 

 

Pro forma net income (loss)

 

$

(1,372

)

$

15,935

 

 

 

 

 

 

 

Earnings (loss) per share

 

 

 

 

 

 

 

 

 

 

 

Basic - as reported

 

$

0.05

 

$

0.23

 

Basic - pro forma

 

$

(0.02

)

$

0.18

 

 

 

 

 

 

 

Diluted - as reported

 

$

0.04

 

$

0.21

 

Diluted - pro forma

 

$

(0.02

)

$

0.16

 

 

The fair value of options granted in the three months ended June 30, 2003 and 2002 has been estimated at the date of grant using the Black-Scholes option pricing model. The Black-Scholes option pricing model requires the input of highly subjective assumptions, including the expected stock price volatility.  We use the historical stock price volatility of our common stock over the most recent period that is generally commensurate with the expected option life as the basis for estimating expected stock price volatility.  In prior fiscal years, the historical stock price volatility used was based on the daily, low stock price of our common stock, which, in recent years, resulted in an expected volatility ranging from approximately 65% to 70%.  For options granted during the three months ended June 30, 2003, the historical stock price volatility used was based on a weekly stock price observation, using an average of the high and low stock prices of our common stock, which resulted in an expected stock price volatility of approximately 47%.  Management believes such amount is more representative of prospective trends.

 

2.               Stock Split

 

In April 2003, the Board of Directors approved a three-for-two split of our outstanding common shares effected in the form of a 50% stock dividend.  The split was paid on June 6, 2003 to shareholders of record as of May 16, 2003.  The par value of our common stock was maintained at the pre-split amount of $.000001.  The consolidated financial statements and Notes thereto, including all share and per share data, have been restated as if the stock split had occurred as of the earliest period presented.

 

3.     Cash, Cash Equivalents and Short-Term Investments

 

Short-term investments generally mature between three months and two years.  Investments with maturities beyond one year may be classified as short-term based on their liquid nature and because such securities represent the investment of cash that is available for current operations.  All of our short-term investments are classified as available-for-sale and are carried at fair market value with unrealized appreciation (depreciation) reported as a separate component of accumulated other comprehensive income (loss) in

 

9



 

shareholders’ equity.  The specific identification method is used to determine the cost of securities disposed with realized gains and losses reflected in investment income, net.

 

The following table summarizes our investments in securities as of June 30, 2003 (amounts in thousands):

 

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Cash and time deposits

 

$

98,024

 

$

 

$

 

$

98,024

 

Money market funds

 

39,206

 

 

 

39,206

 

Auction rate notes

 

153,603

 

 

 

153,603

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

290,833

 

 

 

290,833

 

 

 

 

 

 

 

 

 

 

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Corporate bonds

 

16,647

 

17

 

 

16,664

 

Taxable senior debt

 

2,253

 

 

 

2,253

 

U.S. agency issues

 

42,847

 

80

 

(132

)

42,795

 

Asset-backed securities

 

24,574

 

160

 

(15

)

24,719

 

Municipal bonds

 

12,511

 

 

 

12,511

 

 

 

 

 

 

 

 

 

 

 

Short-term investments

 

98,832

 

257

 

(147

)

98,942

 

 

 

 

 

 

 

 

 

 

 

Cash, cash equivalents and short-term investments

 

$

389,665

 

$

257

 

$

(147

)

$

389,775

 

 

The following table summarizes the maturities of our investments in debt securities as of June 30, 2003 (amounts in thousands):

 

 

 

 

Amortized
Cost

 

Fair
Value

 

Due in one year or less

 

$

199,301

 

$

199,268

 

Due after one year through two years

 

28,560

 

28,558

 

 

 

227,861

 

227,826

 

Asset-backed securities

 

24,574

 

24,719

 

 

 

 

 

 

 

Total

 

$

252,435

 

$

252,545

 

 

For the three months ended June 30, 2003, net realized gains on short-term investments consisted of no gross realized gains and $4,000 of gross realized losses.  There was no net realized gain (loss) for the three months ended June 30, 2002.

 

4.               Inventories

 

Inventories are valued at the lower of cost (first-in, first-out) or market.  Our inventories consist of the following (amounts in thousands):

 

 

 

 

June 30, 2003

 

March 31, 2003

 

Purchased parts and components

 

$

1,105

 

$

1,129

 

Finished goods

 

24,002

 

18,448

 

 

 

 

 

 

 

 

 

$

25,107

 

$

19,577

 

 

10



 

5.               Goodwill

 

The changes in the carrying amount of goodwill for the three months ended June 30, 2003 are as follows (amounts in thousands):

 

 

 

 

Publishing

 

Distribution

 

Total

 

 

 

 

 

 

 

 

 

Balance as of March 31, 2003

 

$

63,194

 

$

4,825

 

$

68,019

 

Adjustment to original purchase allocation

 

(575

)

 

(575

)

Effect of foreign currency exchange rates

 

 

228

 

228

 

 

 

 

 

 

 

 

 

Balance as of June 30, 2003

 

$

62,619

 

$

5,053

 

$

67,672

 

 

6.               Income Taxes

 

The income tax provision of $2.2 million for the three months ended June 30, 2003 reflects our effective income tax rate of approximately 35%.  State taxes, partially offset by research and development tax credits and the impact of foreign tax rate differentials, resulted in an effective income tax rate equal to our statutory rate of 35%.  The income tax provision of $11.6 million for the three months ended June 30, 2002 reflects our effective income tax rate of approximately 36%.  The significant item that generated the variance between our effective rate as of June 30, 2002 and our statutory rate of 35% was state taxes, partially offset by research and development tax credits.

 

7.               Software Development Costs and Intellectual Property Licenses

 

As of June 30, 2003, capitalized software development costs included $32.7 million of internally developed software costs and $38.7 million of payments made to third-party software developers.  As of March 31, 2003, capitalized software development costs included $26.0 million of internally developed software costs and $36.1 million of payments made to third-party software developers.  Capitalized intellectual property licenses were $45.7 million and $45.8 million as of June 30, 2003 and March 31, 2003, respectively.  Amortization and write-offs of capitalized software development costs and intellectual property licenses were $19.0 million and $18.5 million for the three months ended June 30, 2003 and 2002, respectively.

 

8.               Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss)

   

Comprehensive Income

 

The components of comprehensive income for the three months ended June 30, 2003 and 2002 were as follows (amounts in thousands):

 

 

 

Three months ended June 30,

 

 

 

2003

 

2002

 

 

 

 

 

 

 

Net income

 

$

4,163

 

$

20,704

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

 

 

 

 

Foreign currency translation adjustment

 

3,725

 

5,380

 

Unrealized depreciation on short-term investments

 

(24

)

 

 

 

 

 

 

 

Other comprehensive income

 

3,701

 

5,380

 

 

 

 

 

 

 

Comprehensive income

 

$

7,864

 

$

26,084

 

 

11



 

Accumulated Other Comprehensive Income (Loss)

 

For the three months ended June 30, 2002, accumulated other comprehensive loss primarily consisted of foreign currency translation adjustments.

 

For the three months ended June 30, 2003, the components of accumulated other comprehensive income were as follows (amounts in thousands):

 

 

 

 

Foreign
Currency

 

Unrealized
Appreciation
(Depreciation)
on Investments

 

Accumulated
Other
Comprehensive
Income (Loss)

 

Balance, March 31, 2003

 

$

(3,568

)

$

134

 

$

(3,434

)

Other comprehensive income (loss)

 

3,725

 

(24

)

3,701

 

 

 

 

 

 

 

 

 

Balance, June 30, 2003

 

$

157

 

$

110

 

$

267

 

 

The amounts above are shown net of taxes.  The income taxes related to other comprehensive income were not significant, as income taxes were not provided for foreign currency translation items as these are considered indefinite investments in non-U.S. subsidiaries.

 

9.               Investment Income, Net

 

Investment income, net is comprised of the following (amounts in thousands):

 

 

 

 

Three months ended June 30,

 

 

 

2003

 

2002

 

Interest expense

 

$

(195

)

$

(536

)

Interest income

 

1,456

 

1,692

 

Net realized loss on investments

 

(4

)

 

 

 

 

 

 

 

Investment income, net

 

$

1,257

 

$

1,156

 

 

10.        Supplemental Cash Flow Information

 

Non-cash investing and financing activities and supplemental cash flow information is as follows (amounts in thousands):

 

 

 

 

Three months ended June 30,

 

 

 

2003

 

2002

 

Non-cash investing and financing activities:

 

 

 

 

 

Subsidiaries acquired with common stock

 

$

 

$

8,193

 

Issuance of options and common stock warrants in exchange for licensing rights and other services

 

 

2,184

 

Stock offering costs

 

 

781

 

Change in unrealized appreciation on short-term investments

 

24

 

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

Cash paid for income taxes

 

$

3,349

 

$

1,314

 

Cash paid (received) for interest, net

 

(1,743

)

(1,546

)

 

12



 

11.  Operations by Reportable Segments and Geographic Area

 

Based upon our organizational structure, we operate two business segments: (i) publishing of interactive entertainment software and (ii) distribution of interactive entertainment software and hardware products.

 

Publishing refers to the development, marketing and sale of products, either directly, by license or through our affiliate label program with third-party publishers.  In the United States, our products are sold primarily on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses and office super-stores.  We conduct our international publishing activities through offices in the United Kingdom, Germany, France, Australia, Sweden, Canada and Japan.  Our products are sold internationally on a direct-to-retail basis, through third-party distribution and licensing arrangements and through our wholly-owned distribution subsidiaries located in the United Kingdom, the Netherlands and Germany.

 

Distribution refers to our European operations located in the United Kingdom, the Netherlands and Germany that provide logistical and sales services to third-party publishers of interactive entertainment software, our own publishing operations and manufacturers of interactive entertainment hardware.

 

Resources are allocated to each of these segments using information on their respective net revenues and operating profits before interest and taxes.

 

The accounting policies of these segments are the same as those described in the Summary of Significant Accounting Policies in our Annual Report on Form 10-K for the year ended March 31, 2003.  Revenue derived from sales between segments is eliminated in consolidation.

 

Information on the reportable segments for the three months ended June 30, 2003 and 2002 is as follows (amounts in thousands):

 

 

 

 

Three months ended June 30, 2003

 

 

 

Publishing

 

Distribution

 

Total

 

 

 

 

 

 

 

 

 

Total segment revenues

 

$

114,405

 

$

44,320

 

$

158,725

 

Revenues from sales between segments

 

(9,670

)

9,670

 

 

 

 

 

 

 

 

 

 

Revenues from external customers

 

$

104,735

 

$

53,990

 

$

158,725

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

$

5,170

 

$

(24

)

$

5,146

 

 

 

 

 

 

 

 

 

Total assets

 

$

643,200

 

$

87,557

 

$

730,757

 

 

 

 

Three months ended June 30, 2002

 

 

 

Publishing

 

Distribution

 

Total

 

 

 

 

 

 

 

 

 

Total segment revenues

 

$

153,145

 

$

38,113

 

$

191,258

 

Revenues from sales between segments

 

(15,651

)

15,651

 

 

 

 

 

 

 

 

 

 

Revenues from external customers

 

$

137,494

 

$

53,764

 

$

191,258

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

$

32,461

 

$

(1,265

)

$

31,196

 

 

 

 

 

 

 

 

 

Total assets

 

$

770,187

 

$

84,566

 

$

854,753

 

 

13



 

Geographic information for the three months ended June 30, 2003 and 2002 is based on the location of the selling entity.  Revenues from external customers by geographic region were as follows (amounts in thousands):

 

 

 

 

Three months ended June 30,

 

 

 

2003

 

2002

 

 

 

 

 

 

 

United States

 

$

82,739

 

$

107,104

 

Europe

 

72,740

 

79,992

 

Other

 

3,246

 

4,162

 

 

 

 

 

 

 

Total

 

$

158,725

 

$

191,258

 

 

Revenues by platform were as follows (amounts in thousands):

 

 

 

 

Three months ended June 30,

 

 

 

2003

 

2002

 

 

 

 

 

 

 

Console

 

$

123,826

 

$

144,266

 

Hand-held

 

7,508

 

13,289

 

PC

 

27,391

 

33,703

 

 

 

 

 

 

 

Total

 

$

158,725

 

$

191,258

 

 

As of and for the three months ended June 30, 2003, we had one customer that accounted for 16% of consolidated net revenues and 29% of consolidated accounts receivable, net.  As of and for the three months ended June 30, 2002 we had one customer that accounted for 17% of consolidated net revenues and 27% of consolidated accounts receivable, net.  This customer was the same customer in both periods and was a customer of both our publishing and distribution businesses.

 

14



 

12.  Computation of Earnings Per Share

 

The following table sets forth the computations of basic and diluted earnings per share (amounts in thousands, except per share data):

 

 

 

 

Three months ended June 30,

 

 

 

2003

 

2002

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

Numerator for basic and diluted earnings per share - income available to common shareholders

 

$

4,163

 

$

20,704

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Denominator for basic earnings per share weighted average common shares outstanding

 

88,046

 

90,059

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

Employee stock options and stock purchase plan

 

5,426

 

9,645

 

Warrants to purchase common stock

 

298

 

421

 

 

 

 

 

 

 

Potential dilutive common shares

 

5,724

 

10,066

 

 

 

 

 

 

 

Denominator for diluted earnings per share - weighted average common shares outstanding plus assumed conversions

 

93,770

 

100,125

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.05

 

$

0.23

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.04

 

$

0. 21

 

 

Options to purchase 8,642,016 shares of common stock at exercise prices ranging from $10.85 to $22.16 and options to purchase 23,030 shares of common stock at exercise prices ranging from $18.89 to $22.16 were outstanding for the three months ended June 30, 2003 and 2002, respectively, but were not included in the calculation of diluted earnings per share because their effect would be antidilutive.

 

13.  Commitments

 

Credit Facilities

 

We have revolving credit facilities with our Centresoft subsidiary located in the United Kingdom (the “UK Facility”) and our NBG subsidiary located in Germany (the “German Facility”).  As of June 30, 2003, the UK Facility provided Centresoft with the ability to borrow up to Great British Pounds (“GBP”) 8.6 million ($14.2 million), including issuing letters of credit, on a revolving basis. Furthermore, as of June 30, 2003, under the UK Facility, Centresoft provided a GBP 0.6 million ($1.0 million) guarantee for the benefit of our CD Contact subsidiary.  The UK Facility bears interest at LIBOR plus 1.5%, is collateralized by substantially all of the assets of the subsidiary and expires in October 2003.  The UK Facility also contains various covenants that require the subsidiary to maintain specified financial ratios related to, among others, fixed charges.  As of June 30, 2003, we were in compliance with these covenants.  No borrowings were outstanding against the UK Facility as of June 30, 2003.  The German Facility provided for revolving loans up to EUR 0.8 million ($0.9 million) as of June 30, 2003, bears interest at a Eurocurrency rate plus 2.5%, is collateralized by the subsidiary’s accounts receivable, inventory and certain property and equipment and

 

15



 

has no expiration date.  No borrowings were outstanding against the German Facility as of June 30, 2003.  Effective July 1, 2003, the German Facility was reduced to EUR 0.5 million ($0.6 million).

 

Developer and Intellectual Property Contracts

 

In the normal course of business, we enter into contractual arrangements with third parties for the development of products, as well as for the rights to intellectual property.  Under these agreements, we commit to provide specified payments to a developer or intellectual property holder, based upon contractual arrangements.  Assuming all contractual provisions are met, the total future minimum contract commitment for contracts in place as of June 30, 2003 is approximately $121.9 million and is scheduled to be paid as follows (amounts in thousands):

 

 

Fiscal year ending March 31,

 

 

 

 

 

 

 

2004

 

$

68,046

 

2005

 

34,522

 

2006

 

11,050

 

2007

 

3,950

 

2008 and thereafter

 

4,376

 

 

 

 

 

Total

 

$

121,944

 

 

The commitment schedule above excludes approximately $9.3 million of commitments originally scheduled to be paid between fiscal 2004 through fiscal 2007 relating to an intellectual property rights agreement with a third party.  Effective June 30, 2003, we terminated the agreement and filed a breach of contract suit against the third party.

 

Legal and Regulatory Proceedings

 

We are party to routine claims and suits brought by us and against us in the ordinary course of business, including disputes arising over the ownership of intellectual property rights, contractual claims and collection matters.  In the opinion of management, the outcome of such routine claims will not have a material adverse effect on our business, financial condition, results of operations or liquidity.

 

On July 11, 2003, we were informed by the staff of the SEC that the SEC has commenced a non-public formal investigation captioned “In the Matter of Certain Video Game Manufacturers and Distributors.” The investigation appears to be focused on certain accounting practices common to the interactive entertainment industry, with specific emphasis on revenue recognition. In connection with this inquiry, the SEC submitted to us a request for information. The SEC staff also informed us that other companies in the video game industry received similar requests for information. The SEC has advised us that this request for information should not be construed as an indication from the SEC or its staff that any violation of the law has occurred, nor should it reflect negatively on any person, entity or security. We intend to cooperate fully with the SEC in the conduct of this inquiry.

 

14.  Capital Transactions

 

During fiscal 2003, our Board of Directors authorized a buyback program under which we can repurchase up to $350.0 million of our common stock. Under the program, shares may be purchased as determined by management and within certain guidelines, from time to time, in the open market or in privately negotiated transactions, including privately negotiated structured option transactions, and through transactions in the options markets. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time to time without prior notice.

 

During the three months ended June 30, 2003, we repurchased approximately 1.2 million shares of our common stock for $11.3 million.  In addition, approximately 1.1 million shares of common stock were

 

16



 

acquired in the three months ended June 30, 2003 as a result of the settlement of a structured stock repurchase transaction entered into in fiscal 2003.  As of June 30, 2003, we had outstanding structured stock repurchase transactions in the aggregate amount of approximately $71.4 million. These transactions may be settled in cash or stock based on the market price of our common stock on the date of the settlement. Upon settlement, we will either have our capital investment returned with a premium or receive up to approximately 7.9 million shares of our common stock, depending, respectively, on whether the market price of our common stock is above or below a pre-determined price agreed in connection with each such transaction.  These transactions are recorded in shareholders’ equity in the accompanying consolidated balance sheet as of June 30, 2003.  In any period, cash used in financing activities related to common stock repurchased may differ from the comparable change in shareholders’ equity, reflecting timing differences between the recognition of share repurchase transactions and their settlement for cash.

 

15.  Related Parties

 

In August 2001, we elected to our Board of Directors an individual who is a partner in a law firm that has provided legal services to Activision for more than ten years.  For the three months ended June 30, 2003 and 2002, the fees we paid to the law firm account for less than 1% of the firm’s total revenues.  The rates charged to us were at arm’s length, and we believe that the fees are competitive with the fees charged by other law firms.

 

16.  Recently Issued Accounting Standards

 

In April 2003, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”  SFAS No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.”  SFAS No. 149 is effective for all contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003.  The guidance is to be applied prospectively.  We are currently assessing the impact SFAS No. 149 will have upon our financial position and 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 No. 150 changes the accounting guidance for certain financial instruments that, under previous guidance, could be classified as equity or “mezzanine” equity by now requiring those instruments to be classified as liabilities (or assets in some circumstances) in the statement of financial position.  Further, SFAS No. 150 requires disclosure regarding the terms of those instruments and settlement alternatives.  SFAS No. 150 is generally effective for all financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003.  The adoption of SFAS No. 150 will not have a material impact on our financial position or results of operations.

 

17



 

 

Item 2 .  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

We are a leading international publisher of interactive entertainment software products.  We have built a company with a diverse portfolio of products that spans a wide range of categories and target markets and that is used on a variety of game hardware platforms and operating systems.  We have created, licensed and acquired a group of highly recognizable brands, which we market to a growing variety of consumer demographics.

 

Our products cover game categories such as action/adventure, action sports, racing, role-playing, simulation, first-person action and strategy.  We currently offer our products in versions that operate on the Sony PlayStation 2 (“PS2”), Sony PlayStation (“PS1”), Nintendo GameCube (“GameCube”) and Microsoft Xbox (“Xbox”) console systems, Nintendo Game Boy Advance (“GBA”) hand-held device and the personal computer (“PC”).  In prior years, we have also offered our products on the Nintendo 64 (“N64”) and Sega Dreamcast (“Dreamcast”) console systems and Nintendo Game Boy Color (“GBC”) hand-held device.  Sony recently announced that it would be re-entering the hand-held hardware market with the introduction of its hand-held gaming device, PlayStation Portable (“PSP”).  PSP is currently expected to be released in the fourth quarter of calendar 2004.  We expect that we will develop titles for this new platform.

 

Our publishing business involves the development, marketing and sale of products, either directly, by license or through our affiliate label program with third-party publishers.  In the United States, we primarily sell our products on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses and office super-stores.  We conduct our international publishing activities through offices in the United Kingdom (“UK”), Germany, France, Australia, Sweden, Canada and Japan.  Our products are sold internationally on a direct-to-retail basis, through third-party distribution and licensing arrangements and through our wholly-owned European distribution subsidiaries.  Our distribution business consists of operations located in the United Kingdom, the Netherlands and Germany that provide logistical and sales services to third-party publishers of interactive entertainment software, our own publishing operations and manufacturers of interactive entertainment hardware.

 

Our profitability is directly affected by the mix of revenues from our publishing and distribution businesses. Operating margins realized from our publishing business are substantially higher than margins realized from our distribution business.  Operating margins in our publishing business are affected by our ability to release highly successful or “hit” titles.  Though many of these titles have substantial production or acquisition costs and marketing budgets, once a title recoups these costs, incremental net revenues directly and positively impact our operating margin. Operating margins in our distribution business are affected by the mix of hardware and software sales, with software producing higher margins than hardware.

 

Our focus with respect to future game development will be on big, well-established brands that we believe we can build into successful game franchises such as our superheroes and action sports brands.  With regard to our superheroes brands, in August 2002, we exercised an option to develop and publish the video game based on the sequel to the “Spider-Man” movie, which is expected to be theatrically released in the summer of 2004.  Spider-Man: The Movie was a key release for the first quarter of fiscal 2003 and performed strongly throughout fiscal 2003.  In December 2002, we expanded our long-term alliance with Marvel Enterprises through an exclusive, multi-year, licensing agreement that expires in 2009.  The agreement extends our exclusive rights to develop and publish video games based on Marvel’s comic book franchises Spider-Man, X-MEN, Fantastic Four and Iron Man.  The agreement additionally provides us the rights to develop video games in conjunction with motion pictures and television series involving X-MEN, Fantastic Four and Iron Man.  Further, another of our key strategies is to continue to be a leader in the action sports category.  We will continue to promote our action sports franchises with the release of titles for existing franchises such as Tony Hawk’s Underground , as well as new action sports titles related to motor cross and snowboarding.  We will also continue to develop new intellectual properties, such as the upcoming titles True Crime: Streets of L.A. and Call of Duty , which we hope to establish as franchise properties.

 

We will also continue to evaluate emerging brands that we believe have potential to become successful game franchises.  For example, in August 2002, we entered into an exclusive licensing agreement to develop and publish video games for the best-selling children’s book series, Lemony Snicket’s “A Series of Unfortunate Events” which is being developed for a feature film by Paramount Pictures and Nickelodeon Movies.  In

 

18



 

December 2002, we entered into a multi-year, multi-property, publishing agreement with DreamWorks SKG that grants us the exclusive rights to publish video games based on DreamWorks SKG’s upcoming computer-animated films, “Sharkslayer,” “Madagascar” and “Over the Hedge,” as well as their sequels.  In fiscal 2003, we additionally entered into an agreement to license the rights to publish video games based on the upcoming movie, “Shrek 2.”

 

In addition to acquiring or creating high profile intellectual property, we will also continue our focus on establishing and maintaining relationships with talented and experienced software development teams.  During fiscal 2003, we bolstered our internal development capabilities with the acquisitions of two privately-held interactive software development companies, Z-Axis and Luxoflux, as well as a 30% capital investment in a third, Infinity Ward.  We have also recently entered into development agreements with other top-level, third-party developers such as id Software, Valve L.L.C., Stainless Steel Studios, Inc., Spark Unlimited and Lionhead Studios.

 

We are utilizing these developer relationships, new intellectual property acquisitions, and our existing library of intellectual property to further focus our game development on big, well-established brands that we believe have the potential to become franchise properties with sustainable consumer appeal and brand recognition.  We are also creating a number of new intellectual properties that we believe have the potential to join this list of franchise properties.  Additionally, to maintain the competitiveness of our products and to take advantage of increasingly sophisticated technology associated with new hardware platforms, we are increasing the amount of time spent play-testing new products, conducting more extensive product quality evaluations and lengthening product development schedules to allow time to make the improvements indicated by our testing and evaluations.  We are focusing on improved game quality, and in many cases, this will result in an increase in future product development costs.

 

Critical Accounting Policies

 

We have identified the policies below as critical to our business operations and the understanding of our financial results.  The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results.  For a detailed discussion on the application of these and other accounting policies, see Note 1 to the Notes to the Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for the year ended March 31, 2003 as filed with the SEC.  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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

Revenue Recognition. We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers.  Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection.  We may permit product returns from, or grant price protection to, our customers on unsold merchandise under certain conditions.  Price protection, when granted and applicable, allows customers a credit against amounts they owe us with respect to merchandise unsold by them.  With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery of such copies. Per copy royalties on sales that exceed the guarantee are recognized as earned.  In addition, in order to recognize revenue for both product sales and licensing transactions, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable.  Revenue recognition also determines the timing of certain expenses, including cost of sales – intellectual property licenses and cost of sales – software royalties and amortization.

 

Allowances for Returns, Price Protection, Doubtful Accounts and Inventory Obsolescence.  We may permit product returns from, or grant price protection to, our customers under certain conditions.  The conditions our customers must meet to be granted the right to return products or price protection are, among other things, compliance with applicable payment terms, delivery to us of weekly inventory and sell-through reports, and consistent participation in the launches of our premium title releases.  We may also consider other factors, including the facilitation of slow-moving inventory and other market factors. Management must make estimates of potential future product returns and price protection related to current period product revenue.  We estimate

 

19



 

the amount of future returns and price protection based upon historical experience, customer inventory levels and changes in the demand and acceptance of our products by the end consumer.  Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price protection in any accounting period.  Material differences may result in the amount and timing of our revenue for any period if management makes different judgments or utilizes different estimates.

 

Similarly, management must make estimates of the uncollectibility of our accounts receivable.  In estimating the allowance for doubtful accounts, we analyze the age of current outstanding account balances, historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in our customers’ payment terms and their economic condition, as well as whether we can obtain sufficient credit insurance.  Any significant changes in any of these criteria would impact management’s estimates in establishing our allowance for doubtful accounts.

 

We value inventory at the lower of cost or market.  We regularly review inventory quantities on hand and in the retail channel and record a provision for excess or obsolete inventory based on the future expected demand for our products. Significant changes in demand for our products would impact management’s estimates in establishing our inventory provision.

 

Software Development Costs.  Software development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products.

 

We account for software development costs in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.”  Software development costs are capitalized once technological feasibility of a product is established and such costs are determined to be recoverable.  Technological feasibility of a product encompasses both technical design documentation and game design documentation.  For products where proven technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product basis.  Prior to a product’s release, we expense, as part of cost of sales – software royalties and amortization, capitalized costs when we believe such amounts are not recoverable.  Capitalized costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation.  Amounts related to software development which are not capitalized are charged immediately to product development expense.  We evaluate the future recoverability of capitalized amounts on a quarterly basis.  The recoverability of capitalized software development costs is evaluated based on the expected performance of the specific products for which the costs relate.  Criteria used to evaluate expected product performance included historical performance of comparable products using comparable technology; orders for the product prior to its release; and estimated performance of a sequel product based on the performance of the product on which the sequel is based.

 

Commencing upon product release, capitalized software development costs are amortized to cost of sales – software royalties and amortization based on the ratio of current revenues to total projected revenues, generally resulting in an amortization period of six months or less.  For products that have been released in prior periods, we evaluate the future recoverability of capitalized amounts on a quarterly basis.  The primary evaluation criterion is actual title performance.

 

Significant management judgments and estimates are utilized in the assessment of when technological feasibility is established, as well as in the ongoing assessment of the recoverability of capitalized costs.

 

Intellectual Property Licenses.   Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks or copyrights in the development of our products.  Depending upon the agreement with the rights holder, we may obtain the rights to use acquired intellectual property in multiple products over multiple years, or alternatively, for a single product.

 

We evaluate the future recoverability of capitalized intellectual property licenses on a quarterly basis.  The recoverability of capitalized intellectual property license costs is evaluated based on the expected performance of the specific products in which the licensed trademark or copyright is to be used.  As many of our intellectual property licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized intellectual property license costs based on certain qualitative factors such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned

 

20



 

theatrical releases or television series based on the intellectual property and the rights holder’s continued promotion and exploitation of the intellectual property.  Prior to the related product’s release, we expense, as part of cost of sales – intellectual property licenses, capitalized intellectual property costs when we believe such amounts are not recoverable.  Capitalized intellectual property costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation.  Criteria used to evaluate expected product performance include historical performance of comparable products using comparable technology; orders for the product prior to its release; and estimated performance of a sequel product based on the performance of the product on which the sequel is based.

 

Commencing upon the related product’s release, capitalized intellectual property license costs are amortized to cost of sales – intellectual property licenses based on the ratio of current revenues for the specific product to total projected revenues for all products in which the licensed trademark or copyright will be utilized.  As intellectual property license contracts may extend for multiple years, the amortization of capitalized intellectual property license costs relating to such contracts may extend beyond one year.  For intellectual property included in products that have been released, we evaluate the future recoverability of capitalized amounts on a quarterly basis.  The primary evaluation criterion is actual title performance.

 

Significant management judgments and estimates are utilized in the assessment of the recoverability of capitalized costs.

 

21



 

The following table sets forth certain consolidated statements of operations data for the periods indicated as a percentage of total net revenues and also breaks down net revenues by territory, business segment and platform, as well as operating income (loss) by business segment (amounts in thousands):

 

 

 

 

Three months ended June 30,

 

 

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

158,725

 

100

%

$

191,258

 

100

%

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of sales – product costs

 

76,610

 

48

 

83,344

 

44

 

Cost of sales – software royalties and amortization

 

15,498

 

10

 

15,838

 

8

 

Cost of sales – intellectual property licenses

 

10,143

 

6

 

12,643

 

7

 

Product development

 

13,580

 

9

 

11,751

 

6

 

Sales and marketing

 

26,285

 

17

 

21,993

 

11

 

General and administrative

 

11,463

 

7

 

14,493

 

8

 

 

 

 

 

 

 

 

 

 

 

Total costs and expenses

 

153,579

 

97

 

160,062

 

84

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

5,146

 

3

 

31,196

 

16

 

 

 

 

 

 

 

 

 

 

 

Investment income, net

 

1,257

 

1

 

1,156

 

1

 

 

 

 

 

 

 

 

 

 

 

Income before income tax provision

 

6,403

 

4

 

32,352

 

17

 

 

 

 

 

 

 

 

 

 

 

Income tax provision

 

2,240

 

1

 

11,648

 

6

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

4,163

 

3

%

$

20,704

 

11

%

 

 

 

 

 

 

 

 

 

 

Net Revenues by Territory:

 

 

 

 

 

 

 

 

 

United States

 

$

82,739

 

52

%

$

107,104

 

56

%

Europe

 

72,740

 

46

 

79,992

 

42

 

Other

 

3,246

 

2

 

4,162

 

2

 

 

 

 

 

 

 

 

 

 

 

Total net revenues

 

$

158,725

 

100

%

$

191,258

 

100

%

 

 

 

 

 

 

 

 

 

 

Net Revenues by Segment/Platform Mix:

 

 

 

 

 

 

 

 

 

Publishing:

 

 

 

 

 

 

 

 

 

Console

 

$

88,484

 

77

%

$

114,160

 

75

%

Hand-held

 

4,596

 

4

 

10,690

 

7

 

PC

 

21,325

 

19

 

28,295

 

18

 

 

 

 

 

 

 

 

 

 

 

Total publishing net revenues

 

114,405

 

72

 

153,145

 

80

 

 

 

 

 

 

 

 

 

 

 

Distribution:

 

 

 

 

 

 

 

 

 

Console

 

35,342

 

80

 

30,106

 

79

 

Hand-held

 

2,912

 

6

 

2,599

 

7

 

PC

 

6,066

 

14

 

5,408

 

14

 

 

 

 

 

 

 

 

 

 

 

Total distribution net revenues

 

44,320

 

28

 

38,113

 

20

 

 

 

 

 

 

 

 

 

 

 

Total net revenues

 

$

158,725

 

100

%

$

191,258

 

100

%

 

 

 

 

 

 

 

 

 

 

Operating Income (Loss) by Segment:

 

 

 

 

 

 

 

 

 

Publishing

 

$

5,170

 

3

%

$

32,461

 

17

%

Distribution

 

(24

)

 

(1,265

)

(1

)

 

 

 

 

 

 

 

 

 

 

Total operating income

 

$

5,146

 

3

%

$

31,196

 

16

%

 

22



 

Results of Operations – Three Months Ended June 30, 2003 and 2002

 

Net Revenues

 

Net revenues for the three months ended June 30, 2003 decreased 17% from the same period last year, from $191.3 million to $158.7 million.  This decrease was incurred in our publishing business.

 

The following table details our publishing net revenues by platform as a percentage of total publishing net revenues for the three months ended June 30, 2003 and 2002:

 

 

 

 

Three months ended June 30,

 

 

 

2003

 

2002

 

Publishing Net Revenues

 

 

 

 

 

PC

 

19

%

18

%

 

 

 

 

 

 

Console

 

77

%

75

%

PlayStation 2

 

37

 

35

 

Microsoft Xbox

 

31

 

12

 

Nintendo GameCube

 

5

 

23

 

PlayStation

 

4

 

5

 

 

 

 

 

 

 

Hand-held

 

4

%

7

%

Game Boy Advance

 

4

 

6

 

Game Boy Color

 

 

1

 

Total publishing net revenues

 

100

%

100

%

 

Publishing net revenues for the three months ended June 30, 2003 decreased 25% from the same period last year, from $153.1 million to $114.4 million.  This decline was experienced in both our domestic and international publishing businesses and is due to the fact that publishing net revenues for the three months ended June 30, 2002, reflect the simultaneous cross-platform, multi-national release of Spider-Man: The Movie which was one of our top performing titles of fiscal 2003. Though there were no individual titles that performed comparably to Spider-Man: The Movie , publishing net revenues for the three months ended June 30, 2003 reflect solid sales of releases such as X2 Wolverine’s Revenge for PS2, Xbox, GameCube, GBA and PC, Return to Castle Wolfenstein and Wakeboarding Unleashed for PS2 and Xbox, Soldier of Fortune II: Double Helix for Xbox and Medieval Total War: Viking Invasion for PC.

 

Platform mix of publishing net revenues between PC, console and hand-held for the three months ended June 30, 2003 remained relatively consistent with the same period last year. Platform mix of our future publishing net revenues will likely be impacted by a number of factors, including the ability of hardware manufacturers to continue to increase their installed hardware bases, the introduction of new hardware platforms, as well as the timing of key product releases from our own product release schedule.  We expect that net revenues from console titles will continue to represent the largest component of our publishing net revenues with PS2 having the largest percentage of that business due to its larger installed hardware base.  We expect net revenues from hand-held titles to remain the smallest component of our publishing net revenues.  However, if PSP is introduced in fiscal 2005, we may see an increase in our hand-held business in comparison to prior periods.  Our net revenues from PC titles will be primarily driven by our product release schedule.

 

A significant portion of our revenues and profits are derived from a relatively small number of popular titles and brands each year as revenues and profits are significantly affected by our ability to release highly successful or “hit” titles.  For example, for the three months ended June 30, 2003, 21% of our consolidated net revenues and 29% of worldwide publishing net revenues were derived from net revenues from X2 Wolverine’s Revenge .  Though many of these titles have substantial production or acquisition costs and marketing budgets, once a title recoups these costs, incremental net revenues directly and positively impact our operating profits resulting in a disproportionate amount of operating income being derived from these select titles.  We expect that a limited

 

23



 

number of titles and brands will continue to produce a disproportionately large amount of our net revenues and profits.

 

As discussed in the “Overview” section of Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in connection with our focus of future game development on big, well-established brands that we believe have the potential to become game franchise properties with sustainable consumer appeal, we have chosen to eliminate certain smaller and non-core projects from our development plan,  reducing the number of titles to be released in fiscal 2004.  Further, as a result of the increase in the length of product development schedules, the release dates of certain fiscal 2004 titles have shifted to fiscal 2005.  Because of these and other factors, we currently expect fiscal 2004 net revenues to be less than those of fiscal 2003, but we currently expect that we will resume net revenue growth in fiscal 2005.

 

Another factor that could affect fiscal 2004 net revenue performance is software pricing.  While we expect console launch pricing for most genres to hold at $49.99 through the holidays, we believe that we could see additional price declines thereafter.

 

Distribution net revenues for the three months ended June 30, 2003 increased 16% from the same period last year, from $38.1 million to $44.3 million.  The increase reflects the distribution of two very successful third-party publishers’ titles, as well as the positive impact of the year-over-year strengthening of the Euro and the GBP in relation to the U.S. dollar.  For the three months ended June 30, 2003, hardware sales represented approximately 12% of total distribution sales, compared to approximately 28% for the same period last year.  The decrease in hardware sales as a percentage of total distribution net revenues reflects the benefit received during the three months ended June 30, 2002 from the hardware launch of the GameCube during that quarter. The decrease also reflects the impact on sales during the three months ended June 30, 2003 of the lower price points of the PS2, GameCube and Xbox hardware in calendar 2003 versus the prior year.  For the three months ended June 30, 2003, software sales as a percentage of total distribution net revenues increased over the same period last year.  This increase reflects the distribution of two very successful third-party publishers’ titles, an increase in the hardware installed base and the acquisition by our UK distribution subsidiary of the distribution rights of a significant new customer.  The mix of future distribution net revenues between hardware and software will be driven by a number of factors including hardware price reductions instituted by hardware manufacturers, the introduction of new hardware platforms and our ability to establish and maintain distribution agreements with hardware manufacturers and third-party software publishers.  We continue to expect software sales as a percentage of total distribution net revenues in fiscal 2004 to increase slightly from fiscal 2003.

 

Geographically, our domestic operations include our North American publishing business and our international operations include our European and Asian/Australian publishing businesses and our European distribution business.  Domestic net revenues decreased 23% from $107.1 million for the three months ended June 30, 2002, to $82.7 million for the three months ended June 30, 2003 for the reason detailed above in the discussion of our publishing business net revenues.  International net revenues decreased by 10% from $84.2 million for the three months ended June 30, 2002, to $76.0 million for the three months ended June 30, 2003 primarily for the reason detailed above in the discussion of our publishing business.

 

Costs and Expenses

 

Cost of sales – product costs represented 48% and 44% of consolidated net revenues for the three months ended June 30, 2003 and 2002, respectively.  The primary factor that affected cost of sales – product costs as a percentage of consolidated net revenues was that distribution net revenues as a percentage of consolidated net revenues increased from 20% for the three months ended June 30, 2002 to 28% for the three months ended June 30, 2003.  Distribution net revenues have a higher per unit cost as compared to publishing net revenues.

 

Cost of sales – software royalties and amortization for the three months ended June 30, 2003 increased as a percentage of publishing net revenues from the same period last year, from 10% to 14%.  In absolute dollars, cost of sales – software royalties and amortization for the three months ended June 30, 2003 was consistent with the same period last year at approximately $15.5 million.  Though there was a higher volume of new title releases during the three months ended June 30, 2003, resulting in a comparable absolute dollar amount, those titles did not achieve the same success as our top selling title in the first quarter of fiscal 2003, Spider-Man: The Movie .  The strong net revenue performance of Spider-Man: The Movie resulted in a lower percentage for the

 

24



 

three months ended June 30, 2002 of cost of sales – software royalties and amortization as a percentage of publishing net revenues as compared to the percentage for the three months ended June 30, 2003.

 

Cost of sales – intellectual property licenses for the three months ended June 30, 2003 increased slightly as a percentage of publishing net revenues from the same period last year, from 8% to 9%.  In absolute dollars, cost of sales – intellectual property licenses for the three months ended June 30, 2003 decreased from the same period last year, from $12.6 million to $10.1 million.  The increase in the percentage reflects that one of our top performing titles released in the first quarter of fiscal 2004 had a higher intellectual property royalty rate structure than the majority of the top performing titles released in the first quarter of fiscal 2003.  The decrease in cost of sales – intellectual property licenses in absolute dollars reflects the decrease in net revenues.

 

Product development expenses for the three months ended June 30, 2003 increased as a percentage of publishing net revenues from the same period last year, from 8% to 12%. In absolute dollars, product development expense for the three months ended June 30, 2003 also increased from the same period last year, from $11.8 million to $13.6 million.  The increase in the percentage and in absolute dollars reflects, as previously discussed, our increasing emphasis on product quality and the lengthening of product development schedules.

 

Sales and marketing expenses of $26.3 million and $22.0 million represented 17% and 11% of consolidated net revenues for the three months ended June 30, 2003 and 2002, respectively.  The increase in absolute dollars for the three months ended June 30, 2003 from the same period last year primarily was the result of increased costs in our publishing business.  The increase in sales and marketing expense dollars in our publishing business was due to the fact that in the first quarter of fiscal 2004, we had a higher number of new title releases, including X2 Wolverine’s Revenge, Wakeboarding Unleashed, and Return to Castle Wolfenstein for the PS2 and Xbox, for which we had significant promotional programs.  In the first quarter of fiscal 2003, we had one new title release, Spider-Man: The Movie , for which we had significant promotional programs.  The success of this title contributed to the decrease in sales and marketing expenses as a percentage of consolidated net revenues for the three months ended June 30, 2002 as compared to the three months ended June 30, 2003.  The increase in the percentage and absolute dollars also reflects approximately $2.7 million of costs recorded during the three months ended June 30, 2003 relating to the domestic industry tradeshow that occurs annually in May.  Prior to fiscal 2004, costs relating to our annual domestic tradeshow were amortized over the entire fiscal year.

 

General and administrative expenses for the three months ended June 30, 2003 decreased $3.0 million from the same period last year, from $14.5 million to $11.5 million.  As a percentage of consolidated net revenues, general and administrative expenses remained relatively constant year-over-year at approximately 7% to 8%.  The decrease in absolute dollars was primarily due to the incurrence in the first quarter of fiscal 2003 of an approximate $2.0 million charge for the relocation of our UK distribution facility due to the increased growth of our UK distribution and UK publishing businesses.

 

Operating Income

 

Operating income for the three months ended June 30, 2003 was $5.1 million, compared to $31.2 million in the same period last year.  The decrease was incurred in our publishing business, reflecting the effects of the first quarter fiscal 2003 release of Spider-Man: The Movie, which was one of our top performing titles of fiscal 2003.  Distribution operating loss for the three months ended June 30, 2003 decreased as compared to the same period last year, from  $1.3 million to $24,000. This change includes the incurrence in the first quarter of fiscal 2003 of an approximate $2.0 million charge for the relocation of our UK distribution facility.

 

Investment Income, Net

 

Investment income, net for the three months ended June 30, 2003 of $1.3 million was consistent with the same period last year.

 

Provision for Income Taxes

 

The income tax provision of $2.2 million for the three months ended June 30, 2003, reflects our effective income tax rate of approximately 35%.  State taxes, partially offset by research and development tax credits and

 

25



 

the impact of foreign tax rate differentials, resulted in an effective income tax rate equal to our statutory rate of 35%.  The realization of deferred tax assets is dependent on the generation of future taxable income.  We believe that it is more likely than not that we will generate sufficient taxable income to realize the benefit of net deferred tax assets recognized.

 

Liquidity and Capital Resources

 

As of June 30, 2003, our primary source of liquidity was comprised of $290.8 million of cash and cash equivalents and $98.9 million of short-term investments.  We believe that we have sufficient working capital ($449.6 million at June 30, 2003), as well as proceeds available from our international credit facilities (described below), to finance our operational requirements for at least the next twelve months, including purchases of inventory and equipment, the funding of the development, production, marketing and sale of new products and the acquisition of intellectual property rights for future products from third parties.

 

We actively manage our capital structure and balance sheet as a component of our overall business strategy.  When we determine that market conditions are appropriate, we may seek to achieve long-term value for the shareholders through, among other things, new debt or equity financings or refinancings, share repurchases and other transactions involving our equity or debt securities.

 

Cash Flows

 

Our cash and cash equivalents were $290.8 million at June 30, 2003 compared to $285.6 million at March 31, 2003.  Activity in cash and cash equivalents for the three months ended June 30, 2003, included $23.7 million used in operating activities, offset by $16.8 million and $9.3 million provided by investing and financing activities, respectively.  The principal components comprising cash flows used in operating activities included an increase in accounts receivable and our continued investment in software development and intellectual property licenses.  Accounts receivable increased as a result of an increase in the number of first quarter title releases and the timing of their release dates.  In the three months ended June 30, 2003, we spent approximately $28.2 million in connection with the acquisition of publishing or distribution rights for products being developed by third parties, the execution of new license agreements granting us long-term rights to intellectual property of third parties, as well as the capitalization of product development costs relating to internally developed products.  We expect that we will continue to make significant expenditures relating to our investment in software development and intellectual property licenses.

 

The cash provided by investing activities primarily was the result of the maturity or sale of short-term investment vehicles.  The goal of our short-term investments is to maximize return while minimizing risk, maintaining liquidity, coordinating with anticipated working capital needs and providing for prudent investment diversification.

 

The cash provided by financing activities primarily is the result of the maturity of structured stock repurchase transactions, partially offset by cash used to purchase treasury stock and enter into additional structured stock repurchase transactions.  During fiscal 2003, our Board of Directors authorized a buyback program under which we can repurchase up to $350.0 million of our common stock. Under the program, shares may be purchased as determined by management and within certain guidelines, from time to time, in the open market or in privately negotiated transactions, including privately negotiated structured option transactions and through transactions in the options markets. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time to time without prior notice.  As of June 30, 2003, we had outstanding structured stock repurchase transactions in the aggregate amount of approximately $71.4 million. These transactions may be settled in cash or stock based on the market price of our common stock on the date of the settlement. Upon settlement, we will either have our capital investment returned with a premium or receive up to approximately 7.9 million shares of our common stock, depending, respectively, on whether the market price of our common stock is above or below a pre-determined price agreed in connection with each such transaction. 

 

26



 

Credit Facilities

 

We have revolving credit facilities with our Centresoft subsidiary located in the United Kingdom (the “UK Facility”) and our NBG subsidiary located in Germany (the “German Facility”).  As of June 30, 2003, the UK Facility provided Centresoft with the ability to borrow up to Great British Pounds (“GBP”) 8.6 million ($14.2 million), including issuing letters of credit, on a revolving basis. Furthermore, as of June 30, 2003, under the UK Facility, Centresoft provided a GBP 0.6 million ($1.0 million) guarantee for the benefit of our CD Contact subsidiary.  The UK Facility bears interest at LIBOR plus 1.5%, is collateralized by substantially all of the assets of the subsidiary and expires in October 2003.  The UK Facility also contains various covenants that require the subsidiary to maintain specified financial ratios related to, among others, fixed charges.  As of June 30, 2003, we were in compliance with these covenants.  No borrowings were outstanding against the UK Facility as of June 30, 2003.  The German Facility provided for revolving loans up to EUR 0.8 million ($0.9 million) as of June 30, 2003, bears interest at a Eurocurrency rate plus 2.5%, is collateralized by the subsidiary’s accounts receivable, inventory and certain property and equipment and has no expiration date.  No borrowings were outstanding against the German Facility as of June 30, 2003.  Effective July 1, 2003, the German Facility was reduced to EUR 0.5 million ($0.6 million).

 

Commitments

 

In the normal course of business, we enter into contractual arrangements with third parties for the development of products, as well as for the rights to intellectual property.  Under these agreements, we commit to provide specified payments to a developer or intellectual property holder, based upon contractual arrangements.  Assuming all contractual provisions are met, the total future minimum contract commitment for contracts in place as of June 30, 2003 is approximately $121.9 million and is scheduled to be paid as follows (amounts in thousands):

 

 

Fiscal year ending March 31,

 

 

 

 

 

 

 

2004

 

$

68,046

 

2005

 

34,522

 

2006

 

11,050

 

2007

 

3,950

 

2008 and thereafter

 

4,376

 

 

 

 

 

Total

 

$

121,944

 

 

The commitment schedule above excludes approximately $9.3 million of commitments originally scheduled to be paid between fiscal 2004 through fiscal 2007 relating to an intellectual property rights agreement with a third party.  Effective June 30, 2003, we terminated the agreement and filed a breach of contract suit against the third party.

 

Recently Issued Accounting Standards

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”  SFAS No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.”  SFAS No. 149 is effective for all contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003.  The guidance is to be applied prospectively.  We are currently assessing the impact SFAS No. 149 will have upon our financial position and results of operations.

 

27



 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  SFAS No. 150 changes the accounting guidance for certain financial instruments that, under previous guidance, could be classified as equity or “mezzanine” equity by now requiring those instruments to be classified as liabilities (or assets in some circumstances) in the statement of financial position.  Further, SFAS No. 150 requires disclosure regarding the terms of those instruments and settlement alternatives.  SFAS No. 150 is generally effective for all financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003.  The adoption of SFAS No. 150 will not have a material impact on our financial position or results of operations.

 

Factors Affecting Future Performance

 

In connection with the Private Securities Litigation Reform Act of 1995 (the “Litigation Reform Act”), we have disclosed certain cautionary information to be used in connection with written materials (including this Quarterly Report on Form 10-Q) and oral statements made by or on behalf of our employees and representatives that may contain “forward-looking statements” within the meaning of the Litigation Reform Act.  Such statements consist of any statement other than a recitation of historical fact and can be identified by the use of forward-looking terminology such as “may,” “expect,” “anticipate,” “estimate” or “continue” or the negative thereof or other variations thereon or comparable terminology.  The listener or reader is cautioned that all forward-looking statements are necessarily speculative and there are numerous risks and uncertainties that could cause actual events or results to differ materially from those referred to in such forward-looking statements.  For a discussion that highlights some of the more important risks identified by management, but which should not be assumed to be the only factors that could affect future performance, see our Annual Report on Form 10-K for the fiscal year ended March 31, 2003 which is incorporated herein by reference.  The reader or listener is cautioned that we do not have a policy of updating or revising forward-looking statements and thus he or she should not assume that silence by management over time means that actual events are bearing out as estimated in such forward-looking statements.

 

 

Item 3 .  Quantitative and Qualitative Disclosures about Market Risk

 

Market risk is the potential loss arising from fluctuations in market rates and prices.  Our market risk exposures primarily include fluctuations in interest rates and foreign currency exchange rates.  Our market risk sensitive instruments are classified as “other than trading.”  Our exposure to market risk as discussed below includes “forward-looking statements” and represents an estimate of possible changes in fair value or future earnings that would occur assuming hypothetical future movements in interest rates or foreign currency exchange rates.  Our views on market risk are not necessarily indicative of actual results that may occur and do not represent the maximum possible gains and losses that may occur, since actual gains and losses will differ from those estimated, based upon actual fluctuations in foreign currency exchange rates, interest rates and the timing of transactions.

 

Interest Rate Risk

 

Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio.  We do not use derivative financial instruments in our investment portfolio.  We manage our interest rate risk by maintaining an investment portfolio consisting primarily of debt instruments with high credit quality and relatively short average maturities.  We also manage our interest rate risk by maintaining sufficient cash and cash equivalent balances such that we are typically able to hold our investments to maturity.  As of June 30, 2003, our cash equivalents and short-term investments included debt securities of $252.5 million.

 

The following table presents the amounts and related weighted average interest rates of our investment portfolio as of June 30, 2003 (amounts in thousands):

 

28



 

 

 

 

Average
Interest Rate

 

Amortized
Cost

 

Fair
Value

 

Cash equivalents:

 

 

 

 

 

 

 

Fixed rate

 

1.23

%

$

153,603

 

$

153,603

 

Variable rate

 

1.12

 

39,206

 

39,206

 

 

 

 

 

 

 

 

 

Short-term investments:

 

 

 

 

 

 

 

Fixed rate

 

1.97

%

$

98,832

 

$

98,942

 

 

Our short-term investments generally mature between three months and two years.

 

Foreign Currency Exchange Rate Risk

 

We transact business in many different foreign currencies and may be exposed to financial market risk resulting from fluctuations in foreign currency exchange rates, particularly GBP and EUR. The volatility of GBP and EUR (and all other applicable currencies) will be monitored frequently throughout the coming year.  When appropriate, we enter into hedging transactions in order to mitigate our risk from foreign currency fluctuations. We will continue to use hedging programs in the future and may use currency forward contracts, currency options and/or other derivative financial instruments commonly utilized to reduce financial market risks if it is determined that such hedging activities are appropriate to reduce risk.  We do not hold or purchase any foreign currency contracts for trading purposes.  As of June 30, 2003, assuming a change in currency rates of 10% of period end rates, the potential gain or loss on outstanding hedging contracts would be approximately $207,400.  However any such gain or loss would in turn be offset by the potential gain or loss on the hedged receivable and/or payable.

 

Market Price Risk

 

With regard to the structured stock repurchase transactions described in Note 14 in the Notes to the Consolidated Financial Statements, it is possible that at settlement we could take delivery of shares at an effective repurchase price higher than the then market price.

 

 

Item 4 .  Controls and Procedures

 

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports filed with the Securities and Exchange Commission.  In addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect those internal controls subsequent to the date we carried out our last evaluation.

 

 

Part II.  OTHER INFORMATION  

Item 1.  Legal Proceedings

 

We are party to routine claims and suits brought by us and against us in the ordinary course of business including disputes arising over the ownership of intellectual property rights, contractual claims and collection matters.  In the opinion of management, the outcome of such routine claims will not have a material adverse effect on our business, financial condition, results of operations or liquidity.

 

On July 11, 2003, we were informed by the staff of the SEC that the SEC has commenced a non-public formal investigation captioned “In the Matter of Certain Video Game Manufacturers and Distributors.” The investigation appears to be focused on certain accounting practices common to the interactive entertainment industry, with specific emphasis on revenue recognition. In connection with this inquiry, the SEC submitted to us a request for information. The SEC staff also informed us that other companies in the video game industry received similar requests for information. The SEC has advised us that this request for information should not be construed as an indication from the SEC or its staff that any violation of the law has occurred, nor should it

 

29



 

reflect negatively on any person, entity or security. We intend to cooperate fully with the SEC in the conduct of this inquiry.

 

 

Item 6.  Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 

 

1.1

 

Underwriting agreement between Activision and Goldman, Sachs & Co. dated June 4, 2002 (incorporated by reference to Exhibit 1.1 of Activision’s 8-K, filed June 6, 2002).

 

 

 

3.1

 

Amended and Restated Certificate of Incorporation, dated June 1, 2000 (incorporated by reference to Exhibit 2.5 of our Current Report on Form 8-K, filed on June 16, 2000).

 

 

 

3.2

 

Certificate of Amendment of Amended and Restated Certificate of Incorporation, dated June 9, 2000 (incorporated by reference to Exhibit 2.7 of our Current Report on Form 8-K, filed on June 16, 2000).

 

 

 

3.3

 

Certificate of Amendment of Amended and Restated Certificate of Incorporation, dated August 23, 2001 (incorporated by reference to Exhibit 3.3 of Amendment No. 1 to our Registration Statement on Form S-3, Registration No. 333-66280, filed on August 31, 2001).

 

 

 

3.4

 

Certificate of Designation of Series A Junior Preferred Stock, dated December 27, 2001 (incorporated by reference to Exhibit 3.4 of our Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2001).

 

 

 

3.5

 

Amended and Restated By-laws dated August 1, 2000 (incorporated by reference to Exhibit 3.2 of our Current Report on Form 8-K, filed July 11, 2001).

 

 

 

4.1

 

Rights Agreement dated as of April 18, 2000, between us and Continental Stock Transfer & Trust Company, which includes as exhibits the form of Right Certificates as Exhibit A, the Summary of Rights to Purchase Series A Junior Preferred Stock as Exhibit B and the form of Certificate of Designation of Series A Junior Preferred Stock of Activision as Exhibit C (incorporated by reference to our Registration Statement on Form 8-A, Registration No. 001-15839, filed April 19, 2000).

 

 

 

10.1

 

Activision, Inc. 2002 Incentive Plan, as amended.

 

 

 

10.2

 

Activision, Inc. 2003 Incentive Plan.

 

 

 

31.1

 

Certification of Robert A. Kotick pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification of Ronald Doornink pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.3

 

Certification of William J. Chardavoyne pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

30



 

 

32.1

 

Certification of Robert A. Kotick pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

 

Certification of Ronald Doornink pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.3

 

Certification of William J. Chardavoyne pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)   Reports on Form 8-K

 

 

1.1

 

We filed a Form 8-K on April 22, 2003, reporting under “Item 7.  Financial Statements, Pro Forma Financial Statements and Exhibits” and “Item 9.  Regulation FD Disclosure” issuing a press release announcing revised revenues and earnings guidance for the fourth quarter of fiscal 2003 and for the full 2003 fiscal year, and reiterated our fiscal year 2004 outlook.

 

 

 

1.2

 

We filed a Form 8-K on May 5, 2003, reporting under “Item 5. Other Events and Regulation FD Disclosure,” “Item 7.  Financial Statements, Pro Forma Financial Statements and Exhibits” and “Item 9. Regulation FD Disclosure” issuing press releases announcing that our Board of Directors increased the number of directors from six to seven members and appointed Ron Doornink to fill the newly-created vacancy, and announcing a three-for-two split of our outstanding common shares.

 

 

 

1.3

 

We filed a Form 8-K on May 8, 2003, reporting under “Item 7. Financial Statements, Pro Forma Financial Statements and Exhibits” and “Item 9.  Regulation FD Disclosure” issuing a press release announcing our fourth quarter and fiscal 2003 year end results.

 

31



 

 

SIGNATURES

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

Date:   August 4, 2003

 

ACTIVISION, INC.

 

 

/s/ William J. Chardavoyne

 

William J. Chardavoyne

Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

 

32


 

 

Exhibit 10.1

 

As Adopted by the Board of Directors

on April 4, 2002, and amended on

July 22, 2002 and amended on

April 10, 2003

 

ACTIVISION, INC.

 

2002 INCENTIVE PLAN

 

ACTIVISION, INC., a corporation formed under the laws of the State of Delaware (the “Company”), hereby establishes and adopts the following 2002 Incentive Plan (the “Plan”).

 

RECITALS

 

WHEREAS, the Company desires to encourage high levels of performance by those individuals who are key to the success of the Company, to attract new individuals who are highly motivated and who will contribute to the success of the Company and to encourage such individuals to remain as employees of the Company and its subsidiaries by increasing their proprietary interest in the Company’s growth and success.

 

WHEREAS, to attain these ends, the Company has formulated the Plan embodied herein to authorize the granting of incentive awards through grants of share options (“Options”), grants of share appreciation rights, grants of Share Purchase Awards (hereafter defined), grants of Restricted Share Awards (hereafter defined), grants of Performance-Based Awards (hereafter defined), or any other award made under the Plan to those persons (each such person, a “Participant”) whose judgment, initiative and efforts are or have been or will be responsible for the success of the Company.

 

NOW, THEREFORE, the Company hereby constitutes, establishes and adopts the following Plan and agrees to the following provisions:

 

ARTICLE 1.

 

PURPOSE OF THE PLAN

 

1.1.                             Purpose .  The purpose of the Plan is to assist the Company and its subsidiaries in attracting and retaining selected individuals to serve as officers (other than executive officers), consultants, advisors and other key employees of the Company and its subsidiaries who will contribute to the Company’s success and to achieve long-term objectives which will inure to the benefit of all shareholders of the Company through the additional incentive inherent in the ownership or increased ownership of the Company’s shares of common stock (“Shares”).  Options granted under the Plan will be either “incentive share options,” intended to qualify as such under the provisions of Section 422 of the Internal Revenue Code of 1986, as amended from time to time (the “Code”), or “nonqualified share options.”  For purposes of the Plan, the term “subsidiary” shall mean “subsidiary corporation,” as such term is defined in Section 424(f) of the Code, and “affiliate” shall have the meaning set forth in Rule 12b-2 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  For purposes of the Plan, the term “Award” shall mean a grant of an Option, a grant of a share appreciation right, a grant of a Share Purchase Award, a grant of a Restricted Share Award, or any other award made under the terms of the Plan.

 



 

ARTICLE 2.

 

SHARES SUBJECT TO AWARDS

 

2.1.                             Number of Shares .  Subject to the adjustment provisions of Section 10.9 hereof, the aggregate number of Shares which may be issued under Awards under the Plan, whether pursuant to Options, share appreciation rights, Share Purchase Awards, Restricted Share Awards or Performance-Based Awards shall not exceed 4,350,000.  No Options to purchase fractional Shares shall be granted or issued under the Plan.  For purposes of this Section 2.1, the Shares that shall be counted toward such limitation shall include all Shares:

 

(1)  issued or issuable pursuant to Options that have been or may be exercised;

 

(2)  issued or issuable pursuant to Share Purchase Awards;

 

(3)  issued as, or subject to issuance as a Restricted Share Award; and

 

(4)  issued or issuable under any other Award granted under the terms of the Plan.

 

2.2.                             Shares Subject to Terminated Awards .  The Shares covered by any unexercised portions of terminated Options granted under Articles 4 and 6, Shares forfeited as provided in Section 8.2(a) and Shares subject to any Awards which are otherwise surrendered by the Participant without receiving any payment or other benefit with respect thereto may again be subject to new Awards under the Plan, other than grants of Options intended to qualify as incentive share options.  In the event the purchase price of an Option is paid in whole or in part through the delivery of Shares, the number of Shares issuable in connection with the exercise of the Option shall not again be available for the grant of Awards under the Plan.  Shares subject to Options, or portions thereof, which have been surrendered in connection with the exercise of share appreciation rights shall not again be available for the grant of Awards under the Plan.

 

2.3.                             Character of Shares .  Shares delivered under the Plan may be authorized and unissued Shares or Shares acquired by the Company, or both.

 

2.4.                             Limitations on Grants to Individual Participant .  Subject to adjustments pursuant to the provisions of Section 10.9 hereof, the maximum number of Shares with respect to which Options or stock appreciation rights may be granted hereunder to any employee during any fiscal year of the Company shall be 500,000 Shares (the “Limitation”).  If an Option is cancelled, the cancelled Option shall continue to be counted toward the Limitation for the year granted.  An Option (or a stock appreciation right) that is repriced during any fiscal year is treated as the cancellation of the Option (or stock appreciation right) and a grant of a new Option (or stock appreciation right) for purposes of the Limitation for that fiscal year.

 

ARTICLE 3.

 

ELIGIBILITY AND ADMINISTRATION

 

3.1.                             Awards to Employees and Others (a)   Participants who receive (i) Options under Articles 4 and 6 hereof or share appreciation rights under Article 5 (“Optionees”), and (ii) Share Purchase Awards under Article 7, Restricted Share Awards under Article 8, Deferred Share Awards (as defined herein) under Article 9, Performance-Based Awards under Article 11, or any other Award granted under the Plan shall consist of such officers (other than executive officers), key employees, consultants and

 

2



 

advisors of the Company or any of its subsidiaries or affiliates as the Committee (as defined in Section 3.2 below) shall select from time to time.  Executive officers and Directors (as defined in Section 3.2 below) of the Company shall not be eligible to receive Awards under the Plan. The Committee’s designation of an Optionee or Participant in any year shall not require the Committee to designate such person to receive Awards or grants in any other year.  The designation of an Optionee or Participant to receive Awards or grants under one portion of the Plan shall not require the Committee to include such Optionee or Participant under other portions of the Plan.

 

(b)                                   No Option that is intended to qualify as an “incentive share option” may be granted (x) to any individual that is not an employee of the Company or any subsidiary thereof, or (y) to any employee who, at the time of such grant, owns, directly or indirectly (within the meaning of Sections 422(b)(6) and 424(d) of the Code), shares possessing more than 10% of the total combined voting power of all classes of shares of the Company or any of its subsidiaries or affiliates, unless at the time of such grant, (i) the option price is fixed at not less than 110% of the Fair Market Value (as defined  in Section 10.2 below) of the Shares subject to such Option, determined on the date of the grant, and (ii) the exercise of such Option is prohibited by its terms after the expiration of five years from the date such Option is granted.

 

3.2.                             Administration (a)   The Plan shall be administered by a committee (the “Committee”) consisting of not fewer than two Directors of the Company (the directors of the Company being hereinafter referred to as the “Directors”), as designated by the Directors.  The Directors may remove from, add members to, or fill vacancies in the Committee.  Unless otherwise determined by the Directors, each member of the Committee will be a “non-employee director” within the meaning of Rule 16b-3 (or any successor rule) of the Exchange Act and an “outside director” within the meaning of Section 162(m)(4)(C)(i) of the Code and the regulations thereunder.

 

(b)                                   The Committee is authorized, subject to the provisions of the Plan, to establish such rules and regulations as it may deem appropriate for the conduct of meetings and proper administration of the Plan.  All actions of the Committee shall be taken by majority vote of its members.

 

(c)                                   Subject to the provisions of the Plan, the Committee shall have authority, in its sole discretion, to grant Awards under the Plan, to interpret the provisions of the Plan and, subject to the requirements of applicable law, including Rule 16b-3 of the Exchange Act, to prescribe, amend, and rescind rules and regulations relating to the Plan or any Award thereunder as it may deem necessary or advisable.  The Committee shall have no authority to reduce the exercise price of any Options or share appreciation rights granted under the Plan (except in connection with adjustments pursuant to Section 10.9 below).  All decisions made by the Committee pursuant to the provisions of the Plan shall be final, conclusive and binding on all persons, including the Company, its shareholders, Directors and employees, and other Plan participants.

 

ARTICLE 4.

 

OPTIONS

 

4.1.                             Grant of Options .  The Committee shall determine, within the limitations of the Plan, those officers (other than executive officers), key employees, consultants and advisors of the Company and its subsidiaries and affiliates to whom Options are to be granted under the Plan, the number of Shares that may be purchased under each such Option and the option price, and shall designate such Options at the time of the grant as either “incentive share options” or “nonqualified share options”;

 

3



 

provided, however , that Options granted to employees of an affiliate (that is not also a subsidiary) or to non-employees of the Company may only be “nonqualified share options.”

 

4.2.                             Share Option Agreements; etc.   All Options granted pursuant to Article 4 and Article 6 herein (a) shall be authorized by the Committee and (b) shall be evidenced in writing by share option agreements (“Share Option Agreements”) in such form and containing such terms and conditions as the Committee shall determine that are not inconsistent with the provisions of the Plan, and, with respect to any Share Option Agreement granting Options that are intended to qualify as “incentive share options,” are not inconsistent with Section 422 of the Code.  Granting of an Option pursuant to the Plan shall impose no obligation on the recipient to exercise such Option.  Any individual who is granted an Option pursuant to this Article 4 and Article 6 herein may hold more than one Option granted pursuant to such Articles at the same time and may hold both “incentive share options” and “nonqualified share options” at the same time.  To the extent that any Option does not qualify as an “incentive share option” (whether because of its provisions, the time or manner of its exercise or otherwise) such Option or the portion thereof which does not so qualify shall constitute a separate “nonqualified share option.”

 

4.3.                             Option Price .  Subject to Section 3.1(b), the option exercise price per each Share purchasable under any “incentive share option” granted pursuant to this Article 4, any “nonqualified share option” granted pursuant to Article 6, and Options intended to be performance-based under Section 162(m) of the Code shall not be less than 100% of the Fair Market Value of such Share on the date of the grant of such Option.  The option exercise price per share of each Share purchasable under any “nonqualified share option” that is not intended to be performance-based under Section 162(m) of the Code and is granted pursuant to this Article 4 shall be determined by the Committee at the time of the grant of such Option, but shall not be less than 85% of the Fair Market Value of such Share on the date of the grant of such Option.

 

4.4.                             Other Provisions .  Options granted pursuant to this Article 4 shall be made in accordance with the terms and provisions of Article 10 hereof and any other applicable terms and provisions of the Plan.

 

ARTICLE 5.

 

SHARE APPRECIATION RIGHTS

 

5.1.                             Grant and Exercise .  Share appreciation rights may be granted in conjunction with all or part of any Option granted under the Plan, as follows: (i) in the case of a nonqualified share option, such rights may be granted either at the time of the grant of such option or at any subsequent time during the term of the option; and (ii) in the case of an incentive share option, such rights may be granted only at the time of the grant of such option.  A “share appreciation right” is a right to receive cash or whole Shares, as provided in this Article 5, in lieu of the purchase of a Share under a related Option.  A share appreciation right or applicable portion thereof shall terminate and no longer be exercisable upon the termination or exercise of the related Option, and a share appreciation right granted with respect to less than the full number of Shares covered by a related Option shall not be reduced until, and then only to the extent that, the exercise or termination of the related Option exceeds the number of Shares not covered by the share appreciation right.  A share appreciation right may be exercised by the holder thereof (the “Holder”), in accordance with Section 5.2 of this Article 5, by giving written notice thereof to the Company and surrendering the applicable portion of the related Option.  Upon giving such notice and surrender, the Holder shall be entitled to receive an amount determined in the manner prescribed in Section 5.2 of this Article 5.  Options which have been so surrendered, in whole or in part, shall no longer be exercisable to the extent the related share appreciation rights have been exercised.

 

4



 

5.2.                          Terms and Conditions .  Share appreciation rights shall be subject to such terms and conditions, not inconsistent with the provisions of the Plan, as shall be determined from time to time by the Committee, including the following:

 

(a)                                   Share appreciation rights shall be exercisable only at such time or times and to the extent that the Options to which they relate shall be exercisable in accordance with the provisions of the Plan.

 

(b)                                   Upon the exercise of a share appreciation right, a Holder shall be entitled to receive up to, but no more than, an amount in cash or whole Shares as determined by the Committee in its sole discretion equal to the excess of the then Fair Market Value of one Share over the option exercise price per Share specified in the related Option multiplied by the number of Shares in respect of which the share appreciation right shall have been exercised.  The Holder shall specify in his written notice of exercise, whether payment shall be made in cash or in whole Shares.  Each share appreciation right may be exercised only at the time and so long as a related Option, if any, would be exercisable or as otherwise permitted by applicable law.

 

(c)                                   Upon the exercise of a share appreciation right, the Option or part thereof to which such share appreciation right is related shall be deemed to have been exercised for the purpose of the limitation of the number of Shares to be issued under the Plan, as set forth in Section 2.1 of the Plan.

 

(d)                                   With respect to share appreciation rights granted in connection with an Option that is intended to be an “incentive share option,” the following shall apply:

 

(i)                         No share appreciation right shall be transferable by a Holder otherwise than by will or by the laws of descent and distribution, and share appreciation rights shall be exercisable, during the Holder’s lifetime, only by the Holder.

 

(ii)                      Share appreciation rights granted in connection with an Option may be exercised only when the Fair Market Value of the Shares subject to the Option exceeds the option exercise price at which Shares can be acquired pursuant to the Option.

 

ARTICLE 6.

 

RELOAD OPTIONS

 

6.1.                             Authorization of Reload Options .  Concurrently with the award of any Option (such Option hereinafter referred to as the “Underlying Option”) to any Participant in the Plan, the Committee may grant one or more reload options (each, a “Reload Option”) to such Participant to purchase for cash or Shares (held for at least six months or such other period to avoid accounting charges against the Company’s earnings) a number of Shares as specified below.  A Reload Option shall be exercisable for an amount of Shares equal to (i) the number of Shares delivered by the Optionee to the Company to exercise the Underlying Option, and (ii) to the extent authorized by the Committee, the number of Shares used to satisfy any tax withholding requirement incident to the exercise of the Underlying Option, subject to the availability of Shares under the Plan at the time of such exercise.  Any Reload Option may provide for the grant, when exercised, of subsequent Reload Options to the extent and upon such terms and conditions consistent with this Article 6, as the Committee in its sole discretion shall specify at or after the time of grant of such Reload Option.  Except as otherwise determined by the Committee, a Reload Option will vest and become exercisable six months after the exercise of an Underlying Option or Reload Option by the Participant delivering to the Company Shares owned by the Optionee for at least six months in payment of the exercise price and/or tax withholding obligations.  Notwithstanding the fact that the

 

5



 

Underlying Option may be an “incentive share option,” a Reload Option is not intended to qualify as an “incentive share option” under Section 422 of the Code.

 

6.2.                             Reload Option Amendment .  Each Share Option Agreement shall state whether the Committee has authorized Reload Options with respect to the Underlying Option.  Upon the exercise of an Underlying Option or other Reload Option, the Reload Option will be evidenced by an amendment to the underlying Share Option Agreement.

 

6.3.                             Reload Option Price .  The option exercise price per Share payable upon the exercise of a Reload Option shall be the Fair Market Value of a Share on the date the corresponding Underlying Option is exercised.

 

6.4.                             Term and Exercise .  Except as otherwise determined by the Committee, each Reload Option vests and is fully exercisable six months after its grant (i.e., six months after the corresponding Underlying Option is exercised).  The term of each Reload Option shall be equal to the remaining option term of the Underlying Option.

 

6.5.                             Termination of Employment .  No additional Reload Options shall be granted to Optionees when Options and/or Reload Options are exercised pursuant to the terms of this Plan following termination of the Optionee’s employment unless the Committee, in its sole discretion, shall determine otherwise.

 

6.6.                             Applicability of Other Sections .  Except as otherwise provided in this Article 6, the provisions of Article 10 applicable to Options shall apply equally to Reload Options.

 

ARTICLE 7.

 

SHARE PURCHASE AWARDS

 

7.1.                             Grant of Share Purchase Award .  The term “Share Purchase Award” means the right to purchase Shares of the Company and to pay for such Shares through a loan made by the Company to the Participant (a “Purchase Loan”) as set forth in this Article 7.

 

7.2.                             Terms of Purchase Loans (a)   Purchase Loan .  Each Purchase Loan shall be evidenced by a promissory note.  The term of the Purchase Loan shall be for a period of years, as determined by the Committee, and the proceeds of the Purchase Loan shall be used exclusively by the Participant for purchase of Shares from the Company at a purchase price equal to the Fair Market Value on the date of the Share Purchase Award.

 

(b)                                   Interest on Purchase Loan .  A Purchase Loan shall be non-interest bearing or shall bear interest at whatever rate the Committee shall determine (but not in excess of the maximum rate permissible under applicable law), payable in a manner and at such times as the Committee shall determine.  Those terms and provisions as the Committee shall determine shall be incorporated into the promissory note evidencing the Purchase Loan.

 

(c)                                   Forgiveness of Purchase Loan .  Subject to Section 7.4 hereof, the Company may forgive the repayment of up to 100% of the principal amount of the Purchase Loan, subject to such terms and conditions as the Committee shall determine and set forth in the promissory note evidencing the Purchase Loan.   A Participant’s Purchase Loan can be prepaid at any time, and from time to time, without penalty.

 

6



 

7.3.                             Security for Loans (a)   Stock Power and Pledge .  Purchase Loans granted to Participants shall be secured by a pledge of the Shares acquired pursuant to the Share Purchase Award.  Such pledge shall be evidenced by a pledge agreement (the “Pledge Agreement”) containing such terms and conditions as the Committee shall determine.  Purchase Loans shall be recourse or non-recourse with respect to a Participant, as determined from time to time by the Committee.  The share certificates for the Shares purchased by a Participant pursuant to a Share Purchase Award shall be issued in the Participant’s name, but shall be held by the Company as security for repayment of the Participant’s Purchase Loan together with a stock power executed in blank by the Participant (the execution and delivery of which by the Participant shall be a condition to the issuance of the Share Purchase Award).  Unless otherwise determined by the Committee, the Participant shall be entitled to exercise all rights applicable to such Shares, including, but not limited to, the right to vote such Shares and the right to receive dividends and other distributions made with respect to such Shares.  When the Purchase Loan and any accrued but unpaid interest thereon has been repaid or otherwise satisfied in full, the Company shall deliver to the Participant the share certificates for the Shares purchased by a Participant under the Share Purchase Award.

 

(b)                                   Release and Delivery of Share Certificates During the Term of the Purchase Loan .  The Company shall release and deliver to each Participant certificates for Shares purchased by a Participant pursuant to a Share Purchase Award, in such amounts and on such terms and conditions as the Committee shall determine, which shall be set forth in the Pledge Agreement.

 

(c)                                   Release and Delivery of Share Certificates Upon Repayment of the Purchase Loan .  The Company shall release and deliver to each Participant certificates for the Shares purchased by the Participant under the Share Purchase Award and then held by the Company, provided the Participant has paid or otherwise satisfied in full the balance of the Purchase Loan and any accrued but unpaid interest thereon.  In the event the balance of the Purchase Loan is not repaid, forgiven or otherwise satisfied within 90 days after (i) the date repayment of the Purchase Loan is due (whether in accordance with its term, by reason of acceleration or otherwise), or (ii) such longer time as the Committee, in its discretion, shall provide for repayment or satisfaction, the Company shall retain those Shares then held by the Company in accordance with the Pledge Agreement.

 

(d)                                   Recourse Purchase Loans .  Notwithstanding Sections 7.3(a), (b) and (c) above, in the case of a recourse Purchase Loan, the Committee may make a Purchase Loan on such terms as it determines, including without limitation, not requiring a pledge of the acquired Shares.

 

7.4.                             Termination of Employment (a)   Termination of Employment by Death, Disability or by the Company Without Cause; Change of Control .  In the event of a Participant’s termination of employment or separation from service by reason of death, “disability” or by the Company without “cause,” or in the event of a “change of control,” the Committee shall have the right (but shall not be required) to forgive the remaining unpaid amount (principal and interest) of the Purchase Loan in whole or in part as of the date of such occurrence.  “Change of Control,” “disability” and “cause” shall have the respective meanings as set forth in the promissory note evidencing the Purchase Loan.

 

(b)                                   Other Termination of Employment .  Subject to Section 7.4(a) above, in the event of a Participant’s termination of employment or separation from service for any reason, the Participant shall repay to the Company the entire balance of the Purchase Loan and any accrued but unpaid interest thereon, which amounts shall become immediately due and payable, unless otherwise determined by the Committee.

 

7.5.                             Restrictions on Transfer .  No Share Purchase Award or Shares purchased through such an Award and pledged to the Company as collateral security for the Participant’s Purchase Loan

 

7



 

(and accrued and unpaid interest thereon) may be otherwise pledged, sold, assigned or transferred (other than by will or by the laws of descent and distribution).

 

ARTICLE 8.

 

RESTRICTED SHARE AWARDS

 

8.1.                             Restricted Share Awards (a)   Grant .  A grant of Shares made pursuant to this Article 8 is referred to as a “Restricted Share Award.”  The Committee may grant to any Participant an amount of Shares in such manner, and subject to such terms and conditions relating to vesting, forfeitability and restrictions on delivery and transfer (whether based on performance standards, periods of service or otherwise) as the Committee shall establish (such Shares, “Restricted Shares”).  The terms of any Restricted Share Award granted under this Plan shall be set forth in a written agreement (a “Restricted Share Agreement”) which shall contain provisions determined by the Committee and not inconsistent with this Plan.  The provisions of Restricted Share Awards need not be the same for each Participant receiving such Awards.

 

(b)                                   Issuance of Restricted Shares .  As soon as practicable after the date of grant of a Restricted Share Award by the Committee, the Company shall cause to be transferred on the books of the Company, Shares registered in the name of the Company, as nominee for the Participant, evidencing the Restricted Shares covered by the Award; provided, however, such Shares shall be subject to forfeiture to the Company retroactive to the date of grant, if a Restricted Share Agreement delivered to the Participant by the Company with respect to the Restricted Shares covered by the Award is not duly executed by the Participant and timely returned to the Company.  All Restricted Shares covered by Awards under this Article 8 shall be subject to the restrictions, terms and conditions contained in the Plan and the Restricted Share Agreement entered into by and between the Company and the Participant.  Until the lapse or release of all restrictions applicable to an Award of Restricted Shares, the share certificates representing such Restricted Shares shall be held in custody by the Company or its designee.

 

(c)                                   Shareholder Rights .  Beginning on the date of grant of the Restricted Share Award and subject to execution of the Restricted Share Agreement as provided in Sections 8.1(a) and (b), the Participant shall become a shareholder of the Company with respect to all Shares subject to the Restricted Share Agreement and shall have all of the rights of a shareholder, including, but not limited to, the right to vote such Shares and the right to receive distributions made with respect to such Shares; provided, however , that any Shares or any other property (other than cash) distributed as a dividend or otherwise with respect to any Restricted Shares as to which the restrictions have not yet lapsed shall be subject to the same restrictions as such Restricted Shares and shall be represented by book entry and held as prescribed in Section 8.1(b).

 

(d)                                   Restriction on Transferability .  None of the Restricted Shares may be assigned or transferred (other than by will or the laws of descent and distribution), pledged or sold prior to lapse or release of the restrictions applicable thereto.

 

(e)                                   Delivery of Shares Upon Release of Restrictions .  Upon expiration or earlier termination of the forfeiture period without a forfeiture and the satisfaction of or release from any other conditions prescribed by the Committee, the restrictions applicable to the Restricted Shares shall lapse.  As promptly as administratively feasible thereafter, subject to the requirements of Section 12.1, the Company shall deliver to the Participant or, in case of the Participant’s death, to the Participant’s beneficiary, one or more stock certificates for the appropriate number of Shares, free of all such restrictions, except for any restrictions that may be imposed by law.

 

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8.2.                             Terms of Restricted Shares (a)   Forfeiture of Restricted Shares .  Subject to Section 8.2(b), all Restricted Shares shall be forfeited and returned to the Company and all rights of the Participant with respect to such Restricted Shares shall terminate unless the Participant continues in the service of the Company as an employee until the expiration of the forfeiture period for such Restricted Shares and satisfies any and all other conditions set forth in the Restricted Share Agreement.  The Committee in its sole discretion, shall determine the forfeiture period (which may, but need not, lapse in installments) and any other terms and conditions applicable with respect to any Restricted Share Award and the Committee has the discretion to modify the terms and conditions of a Restricted Share award as long as the rights of the Participant are not impaired.

 

(b)                                   Waiver of Forfeiture Period . Notwithstanding anything contained in this Article 8 to the contrary, the Committee may, in its sole discretion and subject to the limitations imposed under Section 162(m) of the Code and the Treasury Regulations thereunder in the case of a Restricted Share Award intended to comply with the performance-based exception under Code Section 162(m), waive the forfeiture period and any other conditions set forth in any Restricted Share Agreement under appropriate circumstances (including the death, disability or retirement of the Participant or a material change in circumstances arising after the date of an Award) and subject to such terms and conditions (including forfeiture of a proportionate number of the Restricted Shares) as the Committee shall deem appropriate.

 

ARTICLE 9.

 

DEFERRED SHARE AWARDS

 

9.1.                             Shares and Administration .  Awards of the right to receive Shares that are not to be distributed to the Participant until after a specified deferral period (such Award and the deferred Shares delivered thereunder hereinafter as the context shall require, the “Deferred Shares”) may be made either alone or in addition to share Options, share appreciation rights, or Restricted Share Awards, or Other Share-based Awards (hereafter defined) granted under the Plan.  The Committee shall determine the officers (other than executive officers), employees, consultants and advisors of the Company and its subsidiaries to whom and the time or times at which Deferred Shares shall be awarded, the number of Deferred Shares to be awarded to any Participant, the duration of the period (the “Deferral Period”) during which, and the conditions under which, receipt of the Shares will be deferred, and the terms and conditions of the award in addition to those contained in Section 9.2.  In its sole discretion, the Committee may provide for a minimum payment at the end of the applicable Deferral Period based on a stated percentage of the Fair Market Value on the date of grant of the number of Shares covered by a Deferred Share award.  The Committee may also provide for the grant of Deferred Shares upon the completion of a specified performance period.  The provisions of Deferred Share awards need not be the same with respect to each recipient.

 

9.2.                             Terms and Conditions .  Deferred Share awards made pursuant to this Article 9 shall be subject to the following terms and conditions:

 

(a)                                   Subject to the provisions of the Plan, the Shares to be issued pursuant to a Deferred Share award may not be sold, assigned, transferred, pledged or otherwise encumbered during the Deferral Period or Elective Deferral Period (defined below), where applicable, and may be subject to a risk of forfeiture during all or such portion of the Deferral Period as shall be specified by the Committee.  At the expiration of the Deferral Period and Elective Deferral Period, share certificates shall be delivered to the

 

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Participant, or the Participant’s legal representative, in a number equal to the number of shares covered by the Deferred Share award.

 

(b)                                   Amounts equal to any dividends declared during the Deferral Period with respect to the number of Shares covered by a Deferred Share award will be paid to the Participant currently, or deferred and deemed to be reinvested in additional deferred Shares or otherwise reinvested, as determined at the time of the Award by the Committee, in its sole discretion.

 

(c)                                   Subject to the provisions of paragraph 9.2(d) of this Article 9, upon termination of employment for any reason during the Deferral Period for a  given Award, the Deferred Shares in question shall be forfeited by the Participant.

 

(d)                                   In the event of the Participant’s death or permanent disability during the Deferral Period (or Elective Deferral Period, where applicable), or in cases of special circumstances, the Committee may, in its sole discretion, when it finds that a waiver would be in the best interests of the Company, waive in whole or in part any or all of the remaining deferral limitations imposed hereunder with respect to any or all of the Participant’s Deferred Shares.

 

(e)                                   Prior to completion of the Deferral Period, a Participant may elect to further defer receipt of the Award for a specified period or until a specified event (the “Elective Deferral Period”), subject in each case to the approval of the Committee and under such terms as are determined by the Committee, all in its sole discretion.

 

(f)                                     Each Award shall be confirmed by a Deferred Share agreement or other instrument executed by the Company and the Participant.

 

ARTICLE 10.

 

GENERALLY APPLICABLE PROVISIONS

 

10.1.                      Option Period .  Subject to Section 3.1(b), the period for which an Option is exercisable shall be set by the Committee and shall not exceed ten years from the date such Option is granted, provided, however , in the case of an Option that is not intended to be an “incentive share option,” the Committee may prescribe a period in excess of ten years.  After the Option is granted, the option period may not be reduced, subject to expiration due to termination of employment or otherwise.

 

10.2.                      Fair Market Value .  The “Fair Market Value” of a Share shall be determined in good faith by the Committee in its sole discretion from time to time. In no case shall Fair Market Value be less than the par value of a Share.  An Option shall be c