Activision Blizzard, Inc.
ACTIVISION INC /NY (Form: 10-Q, Received: 08/04/2005 15:45:56)

 

UNITED STATES
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, 2005

 

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 Exchange Act). Yes ý   No o

 

The number of shares of the registrant’s Common Stock outstanding as of July 29, 2005 was 203,622,364.

 

 



 

ACTIVISION, INC. AND SUBSIDIARIES

 

INDEX

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Consolidated Balance Sheets as of June 30, 2005 (Unaudited) and March 31, 2005

 

 

 

 

 

Consolidated Statements of Operations for the three months ended June 30, 2005 and 2004 (Unaudited)

 

 

 

 

 

Consolidated Statements of Cash Flows for the three months ended June 30, 2005 and 2004 (Unaudited)

 

 

 

 

 

Consolidated Statement of Changes in Shareholders’ Equity for the three months ended June 30, 2005 (Unaudited)

 

 

 

 

 

Notes to Consolidated Financial Statements for the three months ended June 30, 2005 (Unaudited)

 

 

 

 

Item 2.

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

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

 

 

 

 

Item 4.

Controls and Procedures

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

 

 

 

 

Item 5.

Other Information

 

 

 

 

Item 6.

Exhibits

 

 

 

 

SIGNATURES

 

 

 

 

CERTIFICATIONS

 

 

2



 

Part I.  Financial Information .

Item 1.   Financial Statements.

ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

 

June 30, 2005

 

March 31, 2005

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

242,341

 

$

313,608

 

Short-term investments

 

543,558

 

527,256

 

Accounts receivable, net of allowances of $76,842 and $69,191 at June 30, 2005 and March 31, 2005, respectively

 

94,804

 

109,144

 

Inventories

 

45,136

 

48,018

 

Software development

 

97,825

 

73,096

 

Intellectual property licenses

 

14,336

 

21,572

 

Deferred income taxes

 

8,568

 

6,760

 

Other current assets

 

23,237

 

23,010

 

 

 

 

 

 

 

Total current assets

 

1,069,805

 

1,122,464

 

 

 

 

 

 

 

Software development

 

9,764

 

18,518

 

Intellectual property licenses

 

20,605

 

14,154

 

Property and equipment, net

 

31,911

 

30,490

 

Deferred income taxes

 

35,536

 

28,041

 

Other assets

 

1,299

 

1,635

 

Goodwill

 

98,527

 

91,661

 

 

 

 

 

 

 

Total assets

 

$

1,267,447

 

$

1,306,963

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

65,447

 

$

108,984

 

Accrued expenses

 

88,558

 

98,067

 

 

 

 

 

 

 

Total current liabilities

 

154,005

 

207,051

 

 

 

 

 

 

 

Other liabilities

 

93

 

 

 

 

 

 

 

 

Total liabilities

 

154,098

 

207,051

 

 

 

 

 

 

 

Commitments and contingencies (Note 14)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, $.000001 par value, 3,750,000 shares authorized, no shares issued at June 30, 2005 and March 31, 2005

 

 

 

Series A Junior Preferred stock, $.000001 par value, 1,250,000 shares authorized, no shares issued at June 30, 2005 and March 31, 2005

 

 

 

Common stock, $.000001 par value, 450,000,000 and 225,000,000 shares authorized, 203,042,745 and 201,030,623 shares issued and outstanding at June 30, 2005 and March 31, 2005, respectively

 

 

 

Additional paid-in capital

 

764,560

 

741,680

 

Retained earnings

 

343,029

 

346,614

 

Accumulated other comprehensive income

 

7,743

 

11,618

 

Unearned compensation

 

(1,983

)

 

 

 

 

 

 

 

Total shareholders’ equity

 

1,113,349

 

1,099,912

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

1,267,447

 

$

1,306,963

 

 

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,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Net revenues

 

$

241,093

 

$

211,276

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

Cost of sales – product costs

 

136,754

 

89,088

 

Cost of sales – software royalties and amortization

 

14,576

 

12,283

 

Cost of sales – intellectual property licenses

 

20,940

 

17,648

 

Product development

 

17,802

 

21,105

 

Sales and marketing

 

46,318

 

41,734

 

General and administrative

 

18,151

 

13,685

 

 

 

 

 

 

 

Total costs and expenses

 

254,541

 

195,543

 

 

 

 

 

 

 

Operating income (loss)

 

(13,448

)

15,733

 

 

 

 

 

 

 

Investment income, net

 

7,348

 

2,112

 

 

 

 

 

 

 

Income (loss) before income tax provision (benefit)

 

(6,100

)

17,845

 

 

 

 

 

 

 

Income tax provision (benefit)

 

(2,515

)

5,888

 

 

 

 

 

 

 

Net income (loss)

 

$

(3,585

)

$

11,957

 

 

 

 

 

 

 

Basic earnings (loss) per share

 

$

(0.02

)

$

0.07

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

201,856

 

183,686

 

 

 

 

 

 

 

Diluted earnings (loss) per share

 

$

(0.02

)

$

0.06

 

 

 

 

 

 

 

Weighted average common shares outstanding assuming dilution

 

201,856

 

204,539

 

 

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,

 

 

 

2005

 

2004

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

(3,585

)

$

11,957

 

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

 

 

 

 

 

Deferred income taxes

 

(9,304

)

5,028

 

Realized gain on sale of short term investments

 

(1,343

)

 

Depreciation and amortization

 

3,161

 

2,579

 

Amortization of capitalized software development costs and intellectual property licenses

 

21,815

 

31,750

 

Amortization of stock compensation expenses

 

17

 

 

Tax benefit of stock options

 

6,769

 

3,597

 

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

 

 

 

 

 

Accounts receivable

 

14,383

 

(60,471

)

Inventories

 

2,882

 

(13,208

)

Software development and intellectual property licenses

 

(37,005

)

(26,694

)

Other assets

 

943

 

(2,687

)

Accounts payable

 

(43,532

)

2,684

 

Accrued expenses and other liabilities

 

(9,676

)

(6,671

)

 

 

 

 

 

 

Net cash used in operating activities

 

(54,475

)

(52,136

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(5,231

)

(1,881

)

Cash payments to effect business combinations, net of cash acquired

 

(6,925

)

 

Increase in restricted cash

 

(7,500

)

 

Purchases of short-term investments

 

(73,756

)

 (186,167

)

Proceeds from sales and maturities of short-term investments

 

66,892

 

211,657

 

 

 

 

 

 

 

Net cash provided by (used in) investing activities

 

(26,520

)

23,609

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

13,169

 

8,034

 

 

 

 

 

 

 

Net cash provided by financing activities

 

13,169

 

8,034

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(3,441

)

(1,303

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(71,267

)

(21,796

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

313,608

 

165,120

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

242,341

 

$

143,324

 

 

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, 2005
(Unaudited)
(In thousands)

 

 

 

Common Stock

 

Additional
Paid-In Capital

 

Retained
Earnings

 

Accumulated
Other
Comprehensive Income (Loss)

 

Unearned
Compensation

 

Shareholders’
Equity

 

Shares

 

Amounts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, March 31, 2005

 

201,031

 

$

 

$

741,680

 

$

346,614

 

$

11,618

 

$

 

$

1,099,912

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

(3,585

)

 

 

(3,585

)

Unrealized appreciation on short-term investments

 

 

 

 

 

595

 

 

595

 

Foreign currency translation adjustment

 

 

 

 

 

(4,470

)

 

(4,470

)

Total comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

(7,460

)

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

 

1,952

 

 

13,169

 

 

 

 

13,169

 

Tax benefit attributable to employee stock options

 

 

 

6,769

 

 

 

 

6,769

 

Issuance of stock to effect business combination

 

60

 

 

942

 

 

 

 

942

 

Restricted stock grant

 

 

 

2,000

 

 

 

(2,000

)

 

Amortization of unearned compensation

 

 

 

 

 

 

17

 

17

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2005

 

203,043

 

$

 

$

764,560

 

$

343,029

 

$

7,743

 

$

(1,983

)

$

1,113,349

 

 

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, 2005

 

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 consists of only normal recurring 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, 2005 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 Standard (“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.

 

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.  In evaluating the recoverability of capitalized costs, the assessment of expected product performance utilizes forecasted sales amounts and estimates of additional costs to be incurred.  If revised forecasted or actual product sales are less than and/or revised forecasted or actual costs are greater than the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge.

 

Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks, copyrights, software, technology or other intellectual property or proprietary rights 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.

 

7



 

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 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 property 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 and unreleased products, 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.  In evaluating the recoverability of capitalized costs, the assessment of expected product performance utilizes forecasted sales amounts and estimates of additional costs to be incurred.  If revised forecasted or actual product sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge.  Additionally, as noted above, 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.  Material differences may result in the amount and timing of charges for any period if management makes different judgments or utilizes different estimates in evaluating these qualitative factors.

 

Revenue Recognition

 

We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers.  Certain products are sold to customers with a street date (the date that products are made widely available for sale by retailers).  For these products we recognize revenue no earlier than the street date.  Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection.  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.

 

8



 

Sales incentives or other consideration given by us to our customers is accounted for in accordance with the Financial Accounting Standards Board’s 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, 2005, 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, 2005 filed with the SEC. We account for those plans under the recognition and measurement principles of APB Opinion No. 25 and related Interpretations.  The following table illustrates the effect on net income (loss) and earnings (loss) per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation:

 

 

 

Three months ended June 30,

 

 

 

2005

 

2004

 

Net income (loss), as reported

 

$

(3,585

)

$

11,957

 

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

 

(2,971

)

(4,866

)

 

 

 

 

 

 

Pro forma net income (loss)

 

$

(6,556

)

$

7,091

 

 

 

 

 

 

 

Earnings (loss) per share

 

 

 

 

 

 

 

 

 

 

 

Basic - as reported

 

$

(0.02

)

$

0.07

 

Basic - pro forma

 

$

(0.03

)

$

0.04

 

 

 

 

 

 

 

Diluted - as reported

 

$

(0.02

)

$

0.06

 

Diluted - pro forma

 

$

(0.03

)

$

0.03

 

 

Prior to April 1, 2005, the fair value of options granted was estimated at the date of grant using the Black-Scholes option pricing model. As of April 1, 2005, we switched to a Binomial-Lattice model to estimate the fair value of options granted after that date.  Both models require 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.  For options granted during the three months ended June 30, 2005 and 2004, the historical stock price volatility used was based on a weekly stock price

 

9



 

observation , using an average of the high and low stock prices of our common stock, which resulted in an expected stock price volatility of 46% and 48%, respectively.  For purposes of the above pro forma disclosure, the fair value of options granted is amortized to stock-based employee compensation cost over the period(s) in which the related employee services are rendered.  Accordingly, the pro forma stock-based compensation cost for any period will typically relate to options granted in both the current period and prior periods.

 

Restricted Stock

 

In June 2005, we issued the rights to 116,822 shares of restricted stock to an employee.  These shares vest over a five-year period and remain subject to forfeiture if vesting conditions are not met.  In accordance with APB Opinion No. 25, we recognize unearned compensation in connection with the grant of restricted shares equal to the fair value of our common stock on the date of grant.  The fair value of these shares when issued was approximately $17.12 per share and resulted in an increase in “Additional paid-in capital” and “Unearned compensation” on the accompanying balance sheet of $2.0 million.  Over the vesting period, we reduce unearned compensation and recognize compensation expense.  For the first quarter of fiscal 2006, we recorded expense related to these shares of approximately $17,000 in “General and administrative” on the accompanying statements of operations.

 

Reclassifications

 

Certain amounts in the consolidated financial statements have been reclassified to conform with the current year’s presentation.

 

We have reclassified certain auction rate securities from cash and cash equivalents to short-term investments.  Auction rate securities are variable rate bonds tied to short-term interest rates with maturities on the face of the underlying security in excess of 90 days.  Auction rate securities have interest rate resets through a modified Dutch auction at predetermined short-term intervals, typically every 7, 28 or 35 days.  Interest paid during a given period is based upon the interest rate determined during the prior auction.

 

Although these securities are issued and rated as long-term bonds, they are priced and traded as short-term instruments because of the liquidity provided through the interest rate reset.  We had historically classified these instruments as cash and cash equivalents if the reset period between interest rate resets was 90 days or less, which was based on our ability to liquidate our holdings or roll our investment over to the next reset period.  Our re-evaluation of the maturity dates and other provisions associated with the underlying bonds resulted in a reclassification from cash and cash equivalents to short-term investments of approximately $196.4 million on the June 30, 2004 balance sheet.  As a result of this balance sheet reclassification, certain amounts were reclassified in the accompanying consolidated statement of cash flows for the quarter ended June 30, 2004 to reflect the gross purchases and sales of these securities as investing activities rather than as a component of cash and cash equivalents.  This change in classification does not affect previously reported cash flows from operating or from financing activities in the previously reported consolidated statements of cash flows or the previously reported consolidated statements of operations.  For the quarter ended June 30, 2004, as a result of these revisions in classification, net cash provided by investing activities related to these current investments increased $105.0 million.

 

2.               Stock Split

 

In February 2004, 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 March 15, 2004 to shareholders of record as of February 23, 2004.  In February 2005, the Board of Directors approved a four-for-three split of our outstanding common shares effected in the form of a 33-1/3% stock dividend.  The split was paid March 22, 2005 to shareholders of record as of March 7, 2005.  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 splits had occurred as of the earliest period presented.

 

10



 

On March 7, 2005, in connection with our stock split, all shares of common stock held as treasury stock were formally cancelled and restored to the status of authorized but unissued shares of common stock.

 

3.               Acquisitions

 

During the quarter ended June 30, 2005, we completed the acquisitions of two privately held interactive software development companies.  We accounted for these acquisitions in accordance with SFAS No. 141, “Business Combinations.”  SFAS No. 141 addresses financial accounting and reporting for business combinations, requiring that the purchase method be used to account and report for all business combinations.  These acquisitions have further enabled us to implement our multi-platform development strategy by bolstering our internal product development capabilities for console systems and personal computers and strengthening our position in the first-person action, action and action sports game categories.  A significant portion of the purchase price for these acquisitions was assigned to goodwill as the primary asset we acquired in each of the transactions was an assembled workforce with proven technical and design talent with a history of high quality product creation.  Pro forma consolidated statements of operations for these acquisitions are not shown, as they would not differ materially from reported results.  During the quarter ended June 30, 2004, we did not complete any acquisitions.

 

4.               Cash, Cash Equivalents and Short-Term Investments

 

Short-term investments generally mature between three and thirty months.  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 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.

 

Restricted Cash – Compensating Balances

 

As of June 30, 2005, we maintained a $7.5 million irrevocable standby letter of credit.  Under the terms of this arrangement, we are required to maintain on deposit with the bank a compensating balance, restricted as to use, not less than the sum of the available amount of the letter of credit plus the aggregate amount of any drawings under the letter of credit that have been honored thereunder but not reimbursed.   At June 30, 2005, the $7.5 million deposit is included in short-term investments as restricted cash.

 

11



 

The following table summarizes our investments in securities as of June 30, 2005 (amounts in thousands):

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Cash and time deposits

 

$

122,974

 

$

 

$

 

$

122,974

 

Commercial paper

 

2,493

 

 

(1

)

2,492

 

U.S. agency issues

 

4,983

 

 

(1

)

4,982

 

Money market funds

 

111,893

 

 

 

111,893

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

242,343

 

 

(2

)

242,341

 

 

 

 

 

 

 

 

 

 

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Commercial paper

 

9,290

 

 

(3

)

9,287

 

Restricted cash

 

7,500

 

 

 

7,500

 

Corporate bonds

 

169,348

 

12

 

(1,144

)

168,216

 

U.S. agency issues

 

276,784

 

41

 

(1,027

)

275,798

 

Mortgage-backed securities

 

75,161

 

 

(498

)

74,663

 

Asset-backed securities

 

7,251

 

 

(7

)

7,244

 

Common stock

 

31

 

3

 

 

34

 

Municipal bonds

 

816

 

 

 

816

 

 

 

 

 

 

 

 

 

 

 

Short-term investments

 

546,181

 

56

 

(2,679

)

543,558

 

 

 

 

 

 

 

 

 

 

 

Cash, cash equivalents, restricted cash and short-term investments

 

$

788,524

 

$

56

 

$

(2,681

)

$

785,899

 

 

Auction rate securities are securities that are structured with short-term reset dates of generally less than 90 days but with maturities in excess of 90 days.  At the end of the reset period, investors can sell or continue to hold the securities at par.  These securities are classified in the table below based on their legal stated maturity dates.

 

The following table summarizes the maturities of our investments in debt securities as of June 30, 2005 (amounts in thousands):

 

 

 

Amortized
Cost

 

Fair
Value

 

Due in one year or less

 

$

151,377

 

$

150,658

 

Due after one year through two years

 

192,682

 

191,470

 

Due after two years through three years

 

99,586

 

99,495

 

Due in three years or more

 

95,230

 

94,631

 

 

 

 

 

 

 

 

 

538,875

 

536,254

 

Asset-backed securities

 

7,251

 

7,244

 

 

 

 

 

 

 

Total

 

$

546,126

 

$

543,498

 

 

12



 

For the three months ended June 30, 2005, there were $1.3 million of gross realized gains and no gross realized losses.   For the three months ended June 30, 2004, there were no gross realized gains and no gross realized losses.

 

 In accordance with EITF 03-1, “ The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” the fair value of investments in an unrealized loss position for which an other-than-temporary impairment has not been recognized was $478.4 million at June 30, 2005 with related gross unrealized losses of $2.7 million.  At June 30, 2005, the gross unrealized losses were comprised mostly of unrealized losses on corporate bonds, U.S. agency issues, and mortgage-backed securities with $0.4 million of unrealized loss being in a continuous unrealized loss position for twelve months or greater.

 

Our investment portfolio consists of government and corporate securities with effective maturities less than 30 months.  The longer the term of the securities, the more susceptible they are to changes in market rates of interest and yields on bonds.  Investments are reviewed periodically to identify possible impairment.  When evaluating the investments, we review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer, and our ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery in market value.  We have the intent and ability to hold these securities for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the initial cost of the investment.  We expect to realize the full value of all of these investments upon maturity or sale.

 

5.               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, 2005

 

March 31, 2005

 

Finished goods

 

$

41,419

 

$

45,926

 

Purchased parts and components

 

3,717

 

2,092

 

 

 

 

 

 

 

 

 

$

45,136

 

$

48,018

 

 

6.               Goodwill

 

The changes in the carrying amount of goodwill for the three months ended June 30, 2005 are as follows (amounts in thousands):

 

 

 

Publishing

 

Distribution

 

Total

 

 

 

 

 

 

 

 

 

Balance as of March 31, 2005

 

$

85,899

 

$

5,762

 

$

91,661

 

Goodwill acquired during the period

 

6,260

 

 

6,260

 

Issuance of contingent consideration

 

942

 

 

942

 

Adjustment-prior period purchase allocation

 

(155

)

 

(155

)

Effect of foreign currency exchange rates

 

52

 

(233

)

(181

)

 

 

 

 

 

 

 

 

Balance as of June 30, 2005

 

$

92,998

 

$

5,529

 

$

98,527

 

 

7.               Income Taxes

 

The income tax benefit of $2.5 million for the three months ended June 30, 2005 reflects our effective income tax rate for the quarter of 41.2% which differs from our anticipated effective tax rate for the year of 34.5% due to a one-time international tax benefit for the release of certain tax reserves due to the expiration of a tax statute of limitations.  The significant items that generated the variance between our effective rate and our statutory rate of 35% were research and development tax credits and the impact of foreign tax rate

 

13



 

differentials , partially offset by state taxes.  The income tax provision of $5.9 million for the three months ended June 30, 2004 reflects our effective income tax rate of approximately 33%.  The significant items that generated variances between our effective rate and our statutory rate of 35% were research and development tax credits and the impact of foreign tax rate differentials, partially offset by state taxes.

 

8.               Software Development Costs and Intellectual Property Licenses

 

As of June 30, 2005, capitalized software development costs included $84.0 million of internally developed software costs and $23.6 million of payments made to third-party software developers.  As of March 31, 2005, capitalized software development costs included $61.3 million of internally developed software costs and $30.3 million of payments made to third-party software developers.  Capitalized intellectual property licenses were $34.9 million and $35.7 million as of June 30, 2005 and March 31, 2005, respectively.  Amortization and write-offs of capitalized software development costs and intellectual property licenses were $21.8 million and $31.8 million for the three months ended June 30, 2005 and 2004, respectively.

 

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

 

Comprehensive Income (Loss)

 

The components of comprehensive income (loss) for the three months ended June 30, 2005 and 2004 were as follows (amounts in thousands):

 

 

 

Three months ended June 30,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Net income (loss)

 

$

(3,585

)

$

11,957

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

 

 

 

 

Foreign currency translation adjustment

 

(4,470

)

(1,360

)

 

 

 

 

 

 

Unrealized appreciation (depreciation) on short-term investments

 

595

 

(1,217

)

 

 

 

 

 

 

Other comprehensive income (loss)

 

(3,875

)

(2,577

)

 

 

 

 

 

 

Comprehensive income (loss)

 

$

(7,460

)

$

9,380

 

 

Accumulated Other Comprehensive Income (Loss)

 

For the three months ended June 30, 2005, the components of accumulated other comprehensive income (loss) were as follows (amounts in thousands):

 

 

 

Foreign
Currency

 

Unrealized
Appreciation
(Depreciation)
on Investments

 

Accumulated
Other
Comprehensive
Income (Loss)

 

 

 

 

 

 

 

 

 

Balance, March 31, 2005

 

$

14,838

 

$

(3,220

)

$

11,618

 

Other comprehensive income (loss)

 

(4,470

)

595

 

(3,875

)

 

 

 

 

 

 

 

 

Balance, June 30, 2005

 

$

10,368

 

$

(2,625

)

$

7,743

 

 

14



 

The income taxes related 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.

 

10.        Investment Income, Net

 

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

 

 

 

Three months ended June 30,

 

 

 

2005

 

2004

 

Interest income

 

$

6,067

 

$

2,200

 

Interest expense

 

(62

)

(88

)

Net realized gain on investments

 

1,343

 

 

 

 

 

 

 

 

Investment income, net

 

$

7,348

 

$

2,112

 

 

11.        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,

 

 

 

2005

 

2004

 

Non-cash investing and financing activities:

 

 

 

 

 

Change in unrealized appreciation (depreciation) on short-term investments

 

$

595

 

$

(1,217

)

Subsidiaries acquired with common stock

 

942

 

 

Adjustment-prior period purchase allocation

 

155

 

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

Cash paid for income taxes

 

$

382

 

$

2,621

 

Cash received for interest, net

 

4,877

 

2,015

 

 

12.        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 certain third-party publishers.  In the United States and Canada, we primarily sell our products on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses and game specialty stores.  We conduct our international publishing activities through offices in the United Kingdom, Germany, France, Italy, Spain, Australia, Sweden, Canada and Japan.  Our products are sold internationally on a direct-to-retail basis and through third-party distribution and licensing arrangements and through our wholly-owned distribution subsidiaries.

 

Distribution refers to our operations 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.

 

15



 

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, 2005.  Revenue derived from sales between segments is eliminated in consolidation.

 

Information on the reportable segments for the three months ended June 30, 2005 and 2004 is as follows (amounts in thousands):

 

 

 

Three months ended June 30, 2005

 

 

 

Publishing

 

Distribution

 

Total

 

 

 

 

 

 

 

 

 

Total segment revenues

 

$

193,551

 

$

47,542

 

$

241,093

 

Revenues from sales between segments

 

(22,451

)

22,451

 

 

 

 

 

 

 

 

 

 

Revenues from external customers

 

$

171,100

 

$

69,993

 

$

241,093

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

$

(13,909

)

$

461

 

$

(13,448

)

 

 

 

 

 

 

 

 

Total assets

 

$

1,164,521

 

$

102,926

 

$

1,267,447

 

 

 

 

Three months ended June 30, 2004

 

 

 

Publishing

 

Distribution

 

Total

 

 

 

 

 

 

 

 

 

Total segment revenues

 

$

161,652

 

$

49,624

 

$

211,276

 

Revenues from sales between segments

 

(8,324

)

8,324

 

 

 

 

 

 

 

 

 

 

Revenues from external customers

 

$

153,328

 

$

57,948

 

$

211,276

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

$

15,894

 

$

(161

)

$

15,733

 

 

 

 

 

 

 

 

 

Total assets

 

$

880,041

 

$

105,800

 

$

985,841

 

 

Geographic information for the three months ended June 30, 2005 and 2004 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,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

North America

 

$

112,320

 

$

125,191

 

Europe

 

119,981

 

78,101

 

Other

 

8,792

 

7,984

 

 

 

 

 

 

 

Total

 

$

241,093

 

$

211,276

 

 

16



 

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

 

 

 

Three months ended June 30,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Console

 

$

180,450

 

$

158,321

 

Hand-held

 

29,239

 

22,085

 

PC

 

31,404

 

30,870

 

 

 

 

 

 

 

Total

 

$

241,093

 

$

211,276

 

 

As of and for the three months ended June 30, 2005, we had one customer that accounted for 19% of consolidated net revenues and 32% of consolidated accounts receivable, net.  As of and for the three months ended June 30, 2004 we had one customer that accounted for 26% of consolidated net revenues and 33% 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.

 

13.  Computation of Earnings (Loss) 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,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

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

 

$

(3,585

)

$

11,957

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Denominator for basic earnings per share - weighted average common shares outstanding

 

201,856

 

183,686

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

Employee stock options and stock purchase plan

 

 

19,915

 

Warrants to purchase common stock

 

 

938

 

 

 

 

 

 

 

Potential dilutive common shares

 

 

20,853

 

 

 

 

 

 

 

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

 

201,856

 

204,539

 

 

 

 

 

 

 

Basic earnings (loss) per share

 

$

(0.02

)

$

0.07

 

 

 

 

 

 

 

Diluted earnings (loss) per share

 

$

(0.02

)

$

0.06

 

 

Options to purchase 16,234,195 shares of common stock at exercise prices ranging from $1.33 to $17.85 and options to purchase 84,933 shares of common stock at exercise prices ranging from $11.65 to $12.50 were outstanding for the three months ended June 30, 2005 and 2004, respectively, but were not included in the calculation of diluted earnings (loss) per share because their effect would be antidilutive.

 

17



 

14.  Commitments and Contingencies

 

Credit Facilities

 

We have revolving credit facilities with our Centresoft subsidiary located in the UK (the “UK Facility”) and our NBG subsidiary located in Germany (the “German Facility”).  The UK Facility provided Centresoft with the ability to borrow up to Great British Pounds (“GBP”) 8.0 million ($14.4 million), including issuing letters of credit, on a revolving basis as of June 30, 2005.  Furthermore, under the UK Facility, Centresoft provided a GBP 0.6 million ($1.1 million) guarantee for the benefit of our CD Contact subsidiary as of June 30, 2005.  The UK Facility bore interest at LIBOR plus 2.0% as of June 30, 2005, is collateralized by substantially all of the assets of the subsidiary and expires in January 2006.  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, 2005, we were in compliance with these covenants.  No borrowings were outstanding against the UK Facility as of June 30, 2005.  The German Facility provided for revolving loans up to EUR 0.5 million ($0.6 million) as of June 30, 2005, bore interest at a Eurocurrency rate plus 2.5%, is collateralized by certain of the subsidiary’s property and equipment and has no expiration date.  No borrowings were outstanding against the German Facility as of June 30, 2005.

 

Commitments

 

In the normal course of business, we enter into contractual arrangements with third parties for non-cancelable operating lease agreements for our offices, 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 lessor, developer or intellectual property holder, based upon contractual arrangements.  Typically, the payments to third-party developers are conditioned upon the achievement by the developers of contractually specified development milestones.  These payments to third-party developers and intellectual property holders typically are deemed to be advances and are recoupable against future royalties earned by the developer or intellectual property holder based on the sale of the related game. Additionally, in connection with certain intellectual property right acquisitions and development agreements, we will commit to spend specified amounts for marketing support for the related game(s) which is to be developed or in which the intellectual property will be utilized.  Additionally, we lease certain of our facilities under non-cancelable operating lease agreements.  Assuming all contractual provisions are met, the total future minimum commitments for these and other contractual arrangements in place as of June 30, 2005, are scheduled to be paid as follows (amounts in thousands):

 

 

 

Contractual Obligations

 

 

 

Facility

 

Developer

 

 

 

 

 

 

 

Leases

 

and IP

 

Marketing

 

Total

 

Fiscal year ending March 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

$

8,466

 

$

29,674

 

$

10,780

 

$

48,920

 

2007

 

11,190

 

8,875

 

3,535

 

23,600

 

2008

 

7,775

 

6,275

 

8,375

 

22,425

 

2009

 

6,622

 

2,900

 

 

9,522

 

2010

 

5,820

 

 

 

5,820

 

Thereafter

 

23,957

 

 

 

23,957

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

63,830

 

$

47,724

 

$

22,690

 

$

134,244

 

 

18



 

Compensation Guarantee

 

In June 2005, we entered into an employment agreement with the President and Chief Executive Officer of Activision Publishing containing a guarantee related to total compensation.  The agreement guarantees that in the event that on May 15, 2010 total compensation has not exceeded $20.0 million, we will make a payment for the amount of the shortfall.  The $20.0 million guarantee will be recognized as compensation expense evenly over the term of the employment agreement comprising of salary payments, bonus payments, restricted stock expense, stock option expense and an accrual for any anticipated remaining portion of the guarantee.  The remaining portion of the guarantee is accrued over the term of the agreement in “Other liabilities” and will remain accrued until the end of the employment agreement at which point it will be used to make a payment for any shortfall or reclassified into shareholders’ equity.

 

Legal and Regulatory Proceedings

 

On March 5, 2004, a class action lawsuit was filed against us and certain of our current and former officers and directors.  The complaint, which asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 based on allegations that our revenues and assets were overstated during the period between February 1, 2001 and December 17, 2002, was filed in the United States District Court, Central District of California by the Construction Industry and Carpenters Joint Pension Trust for Southern Nevada purporting to represent a class of purchasers of Activision stock.  Five additional purported class actions were subsequently filed by Gianni Angeloni, Christopher Hinton, Stephen Anish, the Alaska Electrical Pension Fund and Joseph A. Romans asserting the same claims.  Consistent with the Private Securities Litigation Reform Act (“PSLRA”), the court appointed lead plaintiffs consolidating the six putative securities class actions into a single case.  In an Order dated May 16, 2005, the court dismissed the consolidated complaint because the plaintiffs failed to satisfy the heightened pleading standards of the PSLRA.  The court did, however, give the lead plaintiffs leave to file an amended consolidated complaint within 30 days of the order.  Rather than file a new complaint, the Plaintiff agreed to dismiss the entire case with prejudice.  The Order dismissing the action with prejudice was entered on June 17, 2005.

 

In addition, on March 12, 2004, a shareholder derivative lawsuit captioned Frank Capovilla, Derivatively on Behalf of Activision, Inc. v. Robert Kotick, et al. was filed, purportedly on behalf of Activision, which in large measure asserts the identical claims set forth in the federal class action lawsuit.  That complaint was filed in California Superior Court for the County of Los Angeles. Also, on March 22, 2005, a new derivative lawsuit captioned Ramalingham Balamohan, Derivatively on Behalf of Nominal Defendant Activision, Inc. v. Robert Kotick, et al. was filed in the Federal Court in Los Angeles.  This complaint makes the same allegations as the previous complaints, but it names all the current directors as defendants.  In the California state derivative case, in light of the ruling dismissing the complaint in the federal class action, plaintiff’s counsel has requested additional time to consider whether to dismiss the case or file an amended complaint that attempts to distinguish this derivative action from the now dismissed federal class action. Currently, all proceedings in the California state derivative case are stayed pending plaintiff’s decision. In the federal derivative case, plaintiff voluntarily filed a notice of dismissal of the action, without prejudice, pending resolution of the federal class action and an order dismissing this action was entered on June 3, 2005. Given the result in the federal class action, we do not anticipate that plaintiff’s counsel will attempt to file a new complaint in the federal derivative case.

 

On July 11, 2003, we were informed by the staff of the Securities and Exchange Commission that the Securities and Exchange Commission has commenced a non-public formal investigation captioned “In the Matter of Certain Video Game Manufacturers and Distributors.” The investigation appeared 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 Securities and Exchange Commission submitted to us a request for information.  We responded to this inquiry on September 2, 2003.  The Securities and Exchange Commission staff also informed us that other companies in the video game industry received similar requests for information. The Securities and Exchange Commission advised us

 

19



 

that this request for information should not be construed as an indication from the Securities and Exchange Commission or its staff that any violation of the law has occurred, nor should it reflect negatively on any person, entity or security. We cooperated fully with the Securities and Exchange Commission in the conduct of this inquiry.  In July 2005, Activision was advised by the staff of the Securities and Exchange Commission that Activision is no longer the subject of this investigation and the matter is closed with regard to Activision.

 

In addition, we are party to other 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, after consultation with legal counsel, the outcome of such routine claims will not have a material adverse effect on our business, financial condition, results of operations or liquidity.

 

15.  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 of which we had approximately $226.2 million available for utilization at June 30, 2005. 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, 2005 and June 30, 2004, we did not repurchase any of our common stock or enter into any structured stock repurchase transactions.  As of June 30, 2005 and 2004, we had no outstanding structured stock repurchase transactions.

 

16.  Recently Issued Accounting Standards and Laws

 

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”), which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation (“ SFAS 123”).  SFAS No. 123R supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees , and amends FASB Statement No. 95, Statement of Cash Flows .  Generally, the approach in SFAS No. 123R is similar to the approach described in SFAS 123.  However, SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values.  Pro forma disclosure is no longer an alternative.

 

SFAS No. 123R must be adopted by us no later than April 1, 2006. Early adoption will be permitted in periods in which financial statements have not yet been issued.  We expect to adopt SFAS No. 123R on April 1, 2006.

 

SFAS No. 123R permits public companies to adopt its requirements using one of two methods:

 

      A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date.

 

      A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

 

20



 

As permitted by SFAS 123, we currently account for share-based payments to employees using Opinion 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options.  Accordingly, the adoption of SFAS No. 123R’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position.  The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future.

 

On November 24, 2004, the FASB issued Statement No. 151, Inventory Costs, an Amendment of ARB No. 43, Chapter 4 (“SFAS No. 151”). The standard requires that abnormal amounts of idle capacity and spoilage costs within inventory should be excluded from the cost of inventory and expensed when incurred.  The provisions of SFAS No. 151 are applicable to inventory costs incurred during fiscal years beginning after June 15, 2005.  We expect the adoption of SFAS No. 151 will not have a material impact on our financial position or results of operations.

 

On December 15, 2004 the FASB issued Statement No. 153 (“SFAS No. 153”), Exchanges of Nonmonetary Assets an Amendment of Accounting Principles Board Opinion No. 29 .   This standard requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis, unless (1) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial substance. The new standard is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005.  We expect the adoption of SFAS No. 153 will not have a material impact on our financial position or results of operations.

 

On October 22, 2004, the President of the United States signed the American Jobs Creation Act of 2004 (the “Act”). The Act raises a number of issues with respect to accounting for income taxes.  For companies that pay U.S. income taxes on manufacturing activities in the U.S., the Act provides a deduction from taxable income equal to a stipulated percentage of qualified income from domestic production activities.  The manufacturing deduction provided by the Act replaces the extraterritorial income (“ETI”) deduction currently in place.  We currently derive benefits from the ETI exclusion which was repealed by the Act.  Our exclusion for fiscal 2006 and 2007 will be limited to 75% and 45% of the otherwise allowable exclusion and no exclusion will be available in fiscal 2008 and thereafter.  The Act also creates a temporary incentive for U.S. multinationals to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations. The Act also provides for other changes in tax law that will affect a variety of taxpayers.  On December 21, 2004, the Financial Accounting Standards Board (“FASB”) issued two FASB Staff Positions (“FSP”) regarding the accounting implications of the Act related to (1) the deduction for qualified domestic production activities and (2) the one-time tax benefit for the repatriation of foreign earnings. The FASB determined that the deduction for qualified domestic production activities should be accounted for as a special deduction under FASB Statement No. 109, Accounting for Income Taxes .  The FASB also confirmed, that upon deciding that some amount of earnings will be repatriated, a company must record in that period the associated tax liability.  The guidance in the FSPs applies to financial statements for periods ending after the date the Act was enacted.  We are evaluating the Act at this time and have not yet determined whether we will avail ourselves of the opportunity of the one-time tax benefit for the repatriation of foreign earnings.  We plan to complete our assessment before the end of fiscal 2006 and are not currently in a position to estimate a range of possible repatriation amounts.

 

21



 

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

 

Overview

 

Our Business

 

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 variety of consumer demographics. Our product portfolio includes such best-selling franchises as Spider-Man, Tony Hawk, Call of Duty, True Crime, X-Men and Shrek.

 

Our products cover diverse game categories including action/adventure, action sports, racing, role-playing, simulation, first-person action and strategy.  Our target customer base ranges from casual players to game enthusiasts, children to adults and mass-market consumers to “value” buyers.  We currently offer our products primarily in versions that operate on the Sony PlayStation 2 (“PS2”), Nintendo GameCube (“GameCube”) and Microsoft Xbox (“Xbox”) console systems, Nintendo Game Boy Advance (“GBA”), Sony PlayStation Portable (“PSP”) and Nintendo Dual Screen (“NDS”) hand-held devices and the personal computer (“PC”).  The installed base for this current generation of hardware platforms is significant and growing and the fiscal 2005 release of two new handheld devices, NDS, which was released worldwide, and PSP, which was released in North America, will also help expand the software market.

 

We also intend to develop titles for the next-generation console systems which are being developed by Sony, Nintendo and Microsoft.  Microsoft recently unveiled their next-generation console, the Xbox 360, which is expected to be released in November 2005.  We are currently developing four titles for release on the Xbox 360, Tony Hawk’s American Wasteland, Call of Duty 2, Quake IV and GUN.   Sony and Nintendo recently unveiled their next-generation consoles, the PlayStation 3 and Revolution, respectively, and both are expected to be released in calendar 2006.  Though there are still many unknowns relating to these new platforms, our aim is to have a significant presence at the launch of each new platform while being careful not to move away too quickly from the current generation platforms given their large and still growing installed base.

 

Our publishing business involves the development, marketing and sale of products directly, by license or through our affiliate label program with certain third-party publishers.  In the United States and Canada, we primarily sell our products on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses and game specialty stores.  We conduct our international publishing activities through offices in the United Kingdom (“UK”), Germany, France, Italy, Spain, the Netherlands, 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 UK, 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, we will continue to focus on our “big propositions,” products that are backed by strong brands and high quality development, for which we will provide significant marketing support.

 

22



 

Our fiscal 2006 “big propositions” include well-established brands, which are backed by high-profile intellectual property and/or highly anticipated motion picture releases.  We have a long-term relationship with Marvel Enterprises through an exclusive licensing agreement.  This agreement grants us the exclusive rights to develop and publish video games based on Marvel’s comic book franchises Spider-Man, X-Men, Fantastic 4 and Iron Man.  Through our long-term relationship with Marvel Enterprises, our fiscal 2006 releases include titles based on Marvel’s Spider-Man, Fantastic 4 and X-Men.  In the first quarter of fiscal 2006 we released the video game, Fantastic 4 , just prior to the theatrical release of “Fantastic 4.”  We will also be developing and publishing video games based on New Line Cinema’s future feature film “Iron Man.”  In addition, through our licensing agreement with Spider-Man Merchandising, LLP, we will be developing and publishing video games based on Columbia Pictures/Marvel Enterprises, Inc.’s upcoming feature film “Spider-Man 3,” which is expected to be released in May 2007.   We also have an exclusive licensing agreement with professional skateboarder Tony Hawk.  The agreement grants us exclusive rights to develop and publish video games using Tony Hawk’s name and likeness.  Through the first quarter of fiscal 2006, we have released six successful titles in the Tony Hawk franchise with cumulative net revenues of $960.8 million, including the most recent, THUG 2 , which was released in the third quarter of fiscal 2005.  We will continue to promote our skateboarding franchise with the release in fiscal 2006 of Tony Hawk’s American Wasteland .

 

We also continue to develop a number of original intellectual properties which are developed and owned by Activision.  For example, in the third quarter of fiscal 2005 we released Call of Duty: Finest Hour , on multiple console platforms.  This title was ranked by NPD Funworld (“NPD”) as one of the top-five best selling games in December 2004 and was the third game based upon this original property following the Call of Duty and Call of Duty: United Offensive titles for the PC.  The title True Crime: Streets of L.A., released in the third quarter of fiscal 2004, is another title based upon original intellectual property.  We expect to develop a variety of games on multiple platforms based on these two original properties including the upcoming fiscal 2006 releases of Call of Duty 2, Call of Duty 2: Big Red One, and True Crime: New York City .  We also expect to establish our fiscal 2006 release, GUN, as a source of recurring revenues.

 

We will also continue to evaluate and exploit emerging brands that we believe have potential to become successful game franchises.  For example, we have a multi-year, multi-property, publishing agreement with DreamWorks LLC that grants us the exclusive rights to publish video games based on DreamWorks Animation SKG’s theatrical release “Shrek 2,” which was released in the first quarter of fiscal 2005, “Shark Tale,” which was released in the second quarter of fiscal 2005, “Madagascar,” which was released in the first quarter of fiscal 2006, as well as upcoming computer-animated films “Over the Hedge,” and all of their respective sequels, including “Shrek 3.”   Additionally we have a strategic alliance with Harrah’s Entertainment, Inc. that grants us the exclusive, worldwide interactive rights to develop and publish “World Series of Poker” video games based on the widely popular World Series of Poker Tournament.

 

In addition to acquiring or creating high profile intellectual property, we have also continued our focus on establishing and maintaining relationships with talented and experienced software development teams.  We have strengthened our internal development capabilities through the acquisition of several development companies with talented and experienced teams including, most recently, the acquisitions of Vicarious Visions Inc. in January 2005, Toys For Bob, Inc. in April 2005 and Beenox, Inc. in May 2005.  We have development agreements with other top-level, third-party developers such as id Software and Lionhead Studios.

 

We are utilizing these developer relationships, new intellectual property acquisitions, new original intellectual property creations and our existing library of intellectual property to further focus our game development on product lines that will deliver significant, lasting and recurring revenues and operating profits.

 

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 Consolidated Financial Statements included in Item 1.  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

 

23



 

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.  Certain products are sold to customers with a street date (the date that products are made widely available for sale by retailers).  For these products we recognize revenue no earlier than the street date.  Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection.  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.

 

Sales incentives or other consideration given by us to our customers is accounted for in accordance with the Financial Accounting Standards Board’s 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.

 

Allowances for Returns, Price Protection, Doubtful Accounts and Inventory Obsolescence.   In determining the appropriate unit shipments to our customers, we benchmark our titles using historical and industry data.  We closely monitor and analyze the historical performance of our various titles, the performance of products released by other publishers and the anticipated timing of other releases in order to assess future demands of current and upcoming titles.  Initial volumes shipped upon title launch and subsequent reorders are evaluated to ensure that quantities are sufficient to meet the demands from the retail markets but at the same time, are controlled to prevent excess inventory in the channel.

 

We may permit product returns from, or grant price protection to, our customers under certain conditions.  In general, price protection refers to the circumstances when we elect to decrease the wholesale price of a product by a certain amount and, when granted and applicable, allows customers a credit against amounts owed by such customers to us with respect to open and/or future invoices.  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 the amount of future returns and price protection for current period product revenue utilizing historical experience and information regarding inventory levels and the demand and acceptance of our products by the end consumer.  The following factors are used to estimate the amount of future returns and price protection for a particular title:  historical performance of titles in similar genres, historical performance of the hardware platform, historical performance of the brand, console hardware life cycle, Activision sales force and retail customer feedback, industry pricing, weeks of on-hand retail channel inventory, absolute quantity of on-hand retail channel inventory, our warehouse on-hand inventory levels, the title’s recent sell-through history (if available), marketing trade programs and competing titles.  The relative importance of these factors varies among titles depending upon, among other items, genre, platform, seasonality and sales strategy.  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.  Based upon historical experience we believe our estimates are reasonable.  However, actual returns and price protection could vary materially from our allowance estimates due to a number of reasons including, among others, a lack of consumer acceptance of a title, the release in the same period of a similarly themed title by a competitor, or technological obsolescence due to the emergence of new hardware platforms.  Material differences may result in the amount and timing of

 

24



 

our revenue for any period if management makes different judgments or utilizes different estimates in determining the allowances for returns and price protection.

 

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 creditworthiness, 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 affect 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 Statement of Financial Accounting Standard (“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.

 

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.  In evaluating the recoverability of capitalized costs, the assessment of expected product performance utilizes forecasted sales amounts and estimates of additional costs to be incurred.  If revised forecasted or actual product sales are less than and/or revised forecasted or actual costs are greater than the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge.

 

Intellectual Property Licenses.   Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks, copyrights, software, technology or other intellectual property or proprietary rights 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.

 

25



 

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 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 property 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 and unreleased products, 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.  In evaluating the recoverability of capitalized costs, the assessment of expected product performance utilizes forecasted sales amounts and estimates of additional costs to be incurred.  If revised forecasted or actual product sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge.  Additionally, as noted above, 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.  Material differences may result in the amount and timing of charges for any period if management makes different judgments or utilizes different estimates in evaluating these qualitative factors.

 

26



 

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,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

241,093

 

100

%

$

211,276

 

100

%

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of sales – product costs

 

136,754

 

57

 

89,088

 

42

 

Cost of sales – software royalties and amortization

 

14,576

 

6

 

12,283

 

6

 

Cost of sales – intellectual property licenses

 

20,940

 

9

 

17,648

 

8

 

Product development

 

17,802

 

7

 

21,105

 

10

 

Sales and marketing

 

46,318

 

19

 

41,734

 

20

 

General and administrative

 

18,151

 

8

 

13,685

 

7

 

 

 

 

 

 

 

 

 

 

 

Total costs and expenses

 

254,541

 

106

 

195,543

 

93

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

(13,448

)

(6

)

15,733

 

7

 

 

 

 

 

 

 

 

 

 

 

Investment income, net

 

7,348

 

3

 

2,112

 

1

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income tax provision (benefit)

 

(6,100

)

(3

)

17,845

 

8

 

 

 

 

 

 

 

 

 

 

 

Income tax provision (benefit)

 

(2,515

)

(1

)

5,888

 

2

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(3,585

)

(2

)%

$

11,957

 

6

%

 

 

 

 

 

 

 

 

 

 

Net Revenues by Territory:

 

 

 

 

 

 

 

 

 

North America

 

$

112,320

 

46

%

$

125,191

 

59

%

Europe

 

119,981

 

50

 

78,101

 

37

 

Other

 

8,792

 

4

 

7,984

 

4

 

 

 

 

 

 

 

 

 

 

 

Total net revenues

 

$

241,093

 

100

%

$

211,276

 

100

%

 

 

 

 

 

 

 

 

 

 

Net Revenues by Segment/Platform Mix:

 

 

 

 

 

 

 

 

 

Publishing:

 

 

 

 

 

 

 

 

 

Console

 

$

142,362

 

59

%

$

119,127

 

56

%

Hand-held

 

25,331

 

10

 

18,430

 

9

 

PC

 

25,858

 

11

 

24,095

 

12

 

 

 

 

 

 

 

 

 

 

 

Total publishing net revenues

 

193,551

 

80

 

161,652

 

77

 

 

 

 

 

 

 

 

 

 

 

Distribution:

 

 

 

 

 

 

 

 

 

Console

 

38,088

 

16

 

39,194

 

18

 

Hand-held

 

3,908

 

2

 

3,655

 

2

 

PC

 

5,546

 

2

 

6,775

 

3

 

Total distribution net revenues

 

47,542

 

20

 

49,624

 

23

 

 

 

 

 

 

 

 

 

 

 

Total net revenues

 

$

241,093

 

100

%

$

211,276

 

100

%

 

 

 

 

 

 

 

 

 

 

Operating Income (Loss) by Segment:

 

 

 

 

 

 

 

 

 

Publishing

 

$

(13,909

)

(6

)%

$

15,894

 

7

%

Distribution

 

461

 

 

(161

)

 

 

 

 

 

 

 

 

 

 

 

Total operating income (loss)

 

$

(13,448

)

(6

)%

$

15,733

 

7

%

 

27



 

Results of Operations – Three Months Ended June 30, 2005 and 2004

 

Net loss for the three months ended June 30, 2005 was $3.6 million or loss per share of $0.02, as compared to net income of $12.0 million or $0.06 per diluted share for the three months ended June 30, 2004.

 

Net Revenues

 

We primarily derive revenue from sales of packaged interactive software games designed for play on video game consoles (such as the PS2, Xbox and GameCube), PCs and hand-held game devices (such as the GBA, NDS and PSP).  We also derive revenue from our distribution business in Europe that provides logistical and sales services to third-party publishers of interactive entertainment software, our own publishing operations and third-party manufacturers of interactive entertainment hardware.

 

The following table details our consolidated net revenues by business segment and our publishing net revenues by territory for the three months ended June 30, 2005 and 2004 (in thousands):

 

 

 

Three Months Ended June 30,

 

Increase/

 

Percent

 

 

 

2005

 

2004

 

(Decrease)

 

Change

 

Publishing Net Revenues

 

 

 

 

 

 

 

 

 

North America

 

$

112,320

 

$

125,191

 

$

(12,871

)

(10

)%

Europe

 

72,439

 

28,477

 

43,962

 

154

%

Other

 

8,792

 

7,984

 

808

 

10

%

Total International

 

81,231

 

36,461

 

44,770

 

123

%

Total Publishing Net Revenues

 

193,551

 

161,652

 

31,899

 

20

%

Distribution Net Revenues

 

47,542

 

49,624

 

(2,082

)

(4

)%

Consolidated Net Revenues

 

$

241,093

 

$

211,276

 

$

29,817

 

14

%

 

Consolidated net revenues increased 14% from $211.3 million for the three months ended June 30, 2004 to $241.1 million for the three months ended June 30, 2005.  This increase was generated by our publishing business.  Our performance was driven by the following:

 

                  In Europe, our affiliate business exceeded the prior year results due to the launch of LucasArts’ Star Wars: Episode III Revenge of the Sith.  Other drivers of net revenue related to strong performance of our fiscal 2006 first quarter releases of Madagascar, Doom 3 for the Xbox, Doom 3: Resurrection of Evil for the PC , and the North American release of Fantastic Four.  According to NPD, Doom 3 collector’s edition was the #1 best-selling video game in the U.S. on the Xbox platform for the month of April.  Additionally, Madagascar was the #1 best-selling children’s title and the #2 selling game across all platforms for the month of June.  This compares to only two releases in the first quarter of fiscal 2005: Spider-Man 2 and Shrek 2 for PS2, Xbox, GameCube, GBA and PC.  The increase in revenues was partially offset by decreased pricing per unit driven by a lower initial pricing for Madagascar versus Shrek 2 in the prior year and price reductions on catalog titles.

 

                  International net revenues benefited from the year-over-year strengthening of the Euro (“EUR”), Great Britain Pound (“GBP”) and Australian Dollar (“AUD”) in relation to the U.S. Dollar.  We estimate that foreign exchange rates increased reported net revenue by approximately $4.7 million.   Excluding the impact of changing foreign currency rates, our international net revenue increased 110% year-over-year.

 

28



 

North America Publishing Net Revenue (in thousands)

 

Three Months
Ended
June 30,

 

% of
Consolidated

 

Three Months
Ended
June 30,

 

% of
Consolidated

 

Increase/

 

Percent

 

2005

 

Net Revenue

 

2004

 

Net Revenue

 

(Decrease)

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

$

112,320

 

46

%

$

125,191

 

59

%

$

(12,871

)

(10

)%

 

 

Domestic publishing net revenues decreased 10% from $125.2 million for the three months ended June 30, 2004, to $112.3 million for the three months ended June 30, 2005.  Despite strong North American sales of our fiscal 2006 first quarter releases of Doom 3 for the Xbox , Doom 3: Resurrection of Evil for the PC, Madagascar and Fantastic Four, the decrease reflects a $10 lower wholesale pricing difference on Madagascar as well as price reductions on catalog titles.  This compares with strong North American sales of Spider -Man 2 and Shrek 2 for the PS2, Xbox, Gamecube, GBA and PC in the first quarter of fiscal 2005.

 

International Publishing Net Revenue (in thousands)

 

Three Months
Ended
June 30,

 

% of
Consolidated

 

Three Months
Ended
June 30,

 

% of
Consolidated

 

Increase/

 

Percent

 

2005

 

Net Revenue

 

2004

 

Net Revenue

 

(Decrease)

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

$

81,231

 

34

%

$

36,461

 

17

%

$

44,770

 

123

%

 

International publishing net revenues increased by 123% from $36.5 million for the three months ended June 30, 2004, to $81.2 million for the three months ended June 30, 2005.  The increase in international publishing revenues was driven largely by the release of LucasArts’ Star Wars: Episode III Revenge of the Sith, which we shipped exclusively in Europe.  This compares to our fiscal 2005 first quarter releases of Shrek 2 and, on a limited territorial release schedule, Spider-Man 2 for PS2, Xbox, GameCube, GBA and PC.  There also was a positive strengthening of the EUR, GBP and AUD in relation to the U.S. dollar of approximately $3.2 million.  Excluding the impact of changing foreign currency rates, our international publishing net revenue increased 114% year-over-year.

 

29



 

Publishing Net Revenue by Platform (in thousands)

 

 

 

Three Months Ended

 

% of

 

Three Months Ended

 

% of

 

 

 

 

 

 

 

June 30,

 

Publishing

 

June 30,

 

Publishing

 

Increase/

 

Percent

 

 

 

2005

 

Net Revs.

 

2004

 

Net Revs.

 

(Decrease)

 

Change

 

Publishing Net Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PC

 

$

25,858

 

14

%

$

24,095

 

15

%

$

1,763

 

7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Console