Activision Blizzard, Inc.
ACTIVISION INC /NY (Form: 10-Q/A, Received: 06/07/2007 06:03:31)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

(Mark one)

 

x

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

 

For the Quarterly Period Ended June 30, 2006

 

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
(State or other jurisdiction of
incorporation or organization)

 

95-4803544
(I.R.S. Employer Identification No.)

3100 Ocean Park Boulevard, Santa Monica, CA
(Address of principal executive offices)

 

90405
(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 for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x   No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer  x

Accelerated Filer  o

Non-accelerated filer  o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  o   No   x

The number of shares of the registrant’s Common Stock outstanding as of June 1, 2007 was 283,310,734.

 




ACTIVISION, INC. AND SUBSIDIARIES

INDEX

 

 

 

 

 

 

Explanatory Note

 

 

PART I.

 

FINANCIAL INFORMATION

 

 

Item 1.

 

Financial Statements (Restated)

 

 

 

 

Consolidated Balance Sheets as of June 30, 2006 (Unaudited) and March 31, 2006

 

 

 

 

Consolidated Statements of Operations for the three months ended June 30, 2006 and 2005 (Unaudited)

 

 

 

 

Consolidated Statements of Cash Flows for the three months ended June 30, 2006 and 2005 (Unaudited)

 

 

 

 

Consolidated Statement of Changes in Shareholders’ Equity for the three months ended June 30, 2006 (Unaudited)

 

 

 

 

Notes to Consolidated Financial Statements for the three months ended June 30, 2006 (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 1A.

 

Risk Factors

 

 

Item 6.

 

Exhibits

 

 

SIGNATURES

 

 

CERTIFICATIONS

 

 

 

2




CAUTIONARY STATEMENT

This Amended Quarterly Report on Form 10-Q/A contains, or incorporates by reference, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to, (1) projections of revenues, expenses, income or loss, earnings or loss per share, cash flow projections or other financial items; (2) statements of our plans and objectives, including those relating to product releases; (3) statements of future economic performance; and (4) statements of assumptions underlying such statements. We generally use words such as “anticipate”, “believe”, “could”, “estimate”, “expect”, “forecast”, “future”, “intend”, “may”, “plan”, “positioned”, “potential”, “project”, “scheduled”, “set to”, “subject to”, “upcoming” and other similar expressions to help identify forward-looking statements. These forward-looking statements are subject to business and economic risk, reflect management’s current expectations, estimates and projections about our business, and are inherently uncertain and difficult to predict. Our actual results could differ materially. The forward-looking statements contained herein speak only as of the date on which they were made, and we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of this Quarterly Report. Risks and uncertainties that may affect our future results include, but are not limited to, those discussed under the heading “Risk Factors”, included in Part II Item 1A. All references to “we”, “us”, “our”, “Activision” or “the Company” in the following discussion and analysis mean Activision, Inc. and its subsidiaries.

EXPLANATORY NOTE

We are amending our Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2006 as filed with the Securities and Exchange Commission (the “SEC”) on August 8, 2006 (the “Original Filing”) to restate our consolidated financial statements as of June 30, 2006 and for the three months ended June 30, 2006 and 2005 and the related disclosures.  See Note 2, “Restatement of Unaudited Consolidated Financial Statements,” of the Notes to the Consolidated Financial Statements for a detailed discussion of the effect of the restatement.  The impacts of the restatement adjustments extend to periods from the fiscal year ended March 31, 1994 through the fiscal quarter ended June 30, 2006.  We have restated our consolidated financial statements for the year ended March 31, 2006 and we filed an Amended Annual Report on Form 10-K/A with the SEC on May 25, 2007.  In these restated consolidated financial statements, the cumulative compensation expense, including the related income tax impacts, as of March 31, 2003, is recognized as a net decrease to beginning retained earnings as of March 31, 2003. All share and per share information presented in this report has been adjusted to reflect splits and dividends of our common stock.

The restatement reflects the findings of a special subcommittee of independent members of our Board of Directors, which was established in July 2006 to review our historical stock option granting practices (the “Special Subcommittee”).  The Special Subcommittee conducted its investigation with the assistance of Munger Tolles & Olson LLP as its independent counsel and Deloitte & Touche USA LLP (“Deloitte”) as forensic accounting experts retained by counsel.  The Special Subcommittee found that 3,450 of the option grants reviewed, covering 148,747,202 shares, required measurement date corrections.  As a result, we recorded approximately $66.7 million in additional pre-tax $45.4 million after-tax non-cash stock-based compensation expense over the thirteen year period from April 1, 1993 through March 31, 2006 in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and $0.6 million in additional pre-tax non-cash stock-based compensation expense during the quarter ended June 30, 2006 in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment”.  More than 80% or $55.4 million of the $66.7 million relates to periods through March 31, 2003 and 4% or $2.6 million of the non-cash pre-tax expense relates to the fiscal year 2006. Separately, the restatement reflects an additional $1.7 million pre-tax charge ($1.1 million after-tax) related to recently identified insufficient payroll tax withholdings in fiscal 2005.

In connection with the restatement of stock-based compensation expense, we are also restating the pro forma disclosures for stock-based compensation expense required under SFAS No. 123, “Accounting for Stock—Based Compensation” included in Note 2 of the Notes to the Consolidated Financial Statements.

The Special Subcommittee reviewed 4,849 option grants covering 204,230,604 shares and found that 3,450 grants covering 148,747,202 shares required measurement date corrections. A majority of the grants requiring measurement date corrections (measured by number of shares) occurred on 16 dates over the 15-year period.  The need for these measurement date corrections arose from failure to understand and apply the correct accounting rules, failure to establish and maintain adequate procedures and controls, failure on certain occasions to appreciate the implications of available information, and insufficient finality and documentation.  As a result, the exercise prices

3




for certain options were affected by selection of grant dates with hindsight, which led to errors in the determination of measurement dates, and we did not correctly account for modifications and repricings after initial grant dates.

The Special Subcommittee found that four individuals — former heads of human resources, finance and legal, and a senior partner of our former outside corporate law firm who sat on and acted as secretary to our Board — bore significant responsibility, in varying degrees, for measurement date inaccuracies by virtue of their positions and/or involvement in the option granting process at varying times.  The Special Subcommittee made no finding as to intentional wrongdoing by these individuals.

The Special Subcommittee also determined that Robert A.  Kotick (chairman of the board and chief executive officer), Brian G.  Kelly (co-chairman of the board), Ronald Doornink (director and senior advisor), and George Rose (senior vice president, general counsel and secretary) did not engage in intentional wrongdoing with respect to our stock option granting practices.

For more information on these matters, please refer to Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; Item 4, “Controls and Procedures”; and Note 2 of the Notes to the Consolidated Financial Statements.

We have not amended, and we do not intend to amend, any of our other previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the periods affected by the restatement other than our Annual Report on Form 10-K/A for the year ended March 31, 2006 and our Quarterly Report on Form 10-Q/A for the quarter ended June 30, 2006 originally filed with the SEC on August 8, 2006.  For this reason, the Consolidated Financial Statements and related financial information contained in any related previously filed financial reports should no longer be relied upon.

For the convenience of the reader, this Form 10-Q/A sets forth the Original Filing in its entirety, as amended by, and to reflect, the restatement.  This Form 10-Q/A also reflects certain corrections to the exhibit index of the Original Filing that came to our attention in the course of preparing this Form 10-Q/A and other pending filings.  The following sections of this Form 10-Q/A have been amended to reflect the restatement and exhibit index corrections.

Part I — Item 1 — Financial Statements (Restated);

Part I — Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations, as to matters related to the restatement;

 Part I — Item 4 — Controls and Procedures;

Part II — Item 1A — Risk Factors as to matters related to the restatement; and

 Part II — Item 6 — Exhibits.

In addition, in accordance with applicable rules and regulations promulgated by the SEC, this Form 10-Q/A includes updated certifications from our Chief Executive Officers and Chief Financial Officer as Exhibits 31.1, 31.2, 31.3, 32.1, 32.2, and 32.3.

Other than as stated above, this Form 10-Q/A continues to speak as of June 30, 2006 or (where applicable) as of the date of the Original Filing, and the information in this Form 10-Q/A does not modify or update any other item or disclosure in the Original Filing or reflect any other events occurring after the Original Filing.

This Amended Quarterly Report on Form 10-Q/A should be read in conjunction with our Amended Annual Report on Form 10-K/A for the year ended March 31, 2006, filed with the SEC on May 25, 2007, and our current reports on Form 8-K that have been filed subsequent to the date of the Original Filing.

 

4




FINANCIAL INFORMATION.

Item 1.  Financial Statements.

ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

June 30, 2006

 

 

 

 

 

(Unaudited)

 

March 31, 2006

 

 

 

As restated(1)

 

As restated(1)

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

245,023

 

$

354,331

 

Short-term investments

 

547,553

 

590,629

 

Accounts receivable, net of allowances of $87,155 and $98,253 at June 30, 2006 and March 31, 2006, respectively

 

65,361

 

28,782

 

Inventories

 

64,095

 

61,483

 

Software development

 

65,650

 

40,260

 

Intellectual property licenses

 

23,844

 

4,973

 

Deferred income taxes

 

12,245

 

9,664

 

Other current assets

 

40,229

 

25,933

 

 

 

 

 

 

 

Total current assets

 

1,064,000

 

1,116,055

 

 

 

 

 

 

 

Software development

 

12,982

 

20,359

 

Intellectual property licenses

 

73,100

 

82,073

 

Property and equipment, net

 

43,986

 

45,368

 

Deferred income taxes

 

57,349

 

52,545

 

Other assets

 

4,113

 

1,409

 

Goodwill

 

180,646

 

100,446

 

 

 

 

 

 

 

Total assets

 

$

1,436,176

 

$

1,418,255

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

73,344

 

$

88,994

 

Accrued expenses

 

87,142

 

104,862

 

 

 

 

 

 

 

Total current liabilities

 

160,486

 

193,856

 

 

 

 

 

 

 

Other liabilities

 

40,960

 

1,776

 

 

 

 

 

 

 

Total liabilities

 

201,446

 

195,632

 

 

 

 

 

 

 

Commitments and contingencies (Note 15)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, $.000001 par value, 3,750,000 shares authorized, no shares issued at June 30, 2006 and March 31, 2006

 

 

 

Series A Junior Preferred stock, $.000001 par value, 1,250,000 shares authorized, no shares issued at June 30, 2006 and March 31, 2006

 

 

 

Common stock, $.000001 par value, 450,000,000 shares authorized, 280,315,487 and 277,020,898 shares issued and outstanding at June 30, 2006 and March 31, 2006, respectively

 

 

 

Additional paid-in capital

 

909,584

 

867,297

 

Retained earnings

 

323,681

 

341,990

 

Accumulated other comprehensive income

 

1,465

 

16,369

 

Unearned compensation

 

 

(3,033

)

 

 

 

 

 

 

Total shareholders’ equity

 

1,234,730

 

1,222,623

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

1,436,176

 

$

1,418,255

 


(1) See Note 2 “Restatement of Unaudited Consolidated Financial Statements.”

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

5




ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)

 

 

For the three months ended June 30,

 

 

 

2006

 

2005

 

 

 

As restated(1)

 

As restated(1)

 

Net revenues

 

$

188,069

 

$

241,093

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

Cost of sales — product costs

 

108,623

 

136,754

 

Cost of sales — software royalties and amortization

 

19,261

 

14,576

 

Cost of sales — intellectual property licenses

 

9,916

 

20,940

 

Product development

 

25,625

 

18,078

 

Sales and marketing

 

36,179

 

46,367

 

General and administrative

 

21,914

 

18,697

 

 

 

 

 

 

 

Total costs and expenses

 

221,518

 

255,412

 

 

 

 

 

 

 

Operating loss

 

(33,449

)

(14,319

)

 

 

 

 

 

 

Investment income, net

 

8,275

 

7,348

 

 

 

 

 

 

 

Loss before income tax benefit

 

(25,174

)

(6,971

)

 

 

 

 

 

 

Income tax benefit

 

(6,865

)

(2,724

)

 

 

 

 

 

 

Net loss

 

$

(18,309

)

$

(4,247

)

 

 

 

 

 

 

Basic loss per share

 

$

(0.07

)

$

(0.02

)

 

 

 

 

 

 

Weighted average common shares outstanding

 

278,335

 

269,141

 

 

 

 

 

 

 

Diluted loss per share

 

$

(0.07

)

$

(0.02

)

 

 

 

 

 

 

Weighted average common shares outstanding assuming dilution

 

278,335

 

269,141

 


(1) See Note 2 “Restatement of Unaudited Consolidated Financial Statements.”

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

6




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

 

 

For the three months ended June 30,

 

 

 

2006

 

2005

 

 

 

As restated(1)

 

As restated(1)

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(18,309

)

$

(4,247

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Deferred income taxes

 

(6,797

)

(8,615

)

Realized gain on sale of short term investments

 

(2

)

(1,343

)

Depreciation and amortization

 

4,421

 

3,161

 

Amortization of capitalized software development costs and intellectual property licenses

 

21,116

 

21,815

 

Stock-based compensation expense

 

5,849

 

866

 

Tax benefit of stock option exercises

 

2,763

 

5,871

 

Excess tax benefit from stock option exercises

 

(2,005

)

 

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

 

 

 

 

 

Accounts receivable

 

(25,469

)

14,383

 

Inventories

 

1,012

 

2,882

 

Software development and intellectual property licenses

 

(44,862

)

(37,005

)

Other assets

 

637

 

943

 

Accounts payable

 

(22,058

)

(43,532

)

Accrued expenses and other liabilities

 

(19,969

)

(9,654

)

Net cash used in operating activities

 

(103,673

)

(54,475

)

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(2,631

)

(5,231

)

Cash payments to effect business combinations, net of cash acquired

 

(30,500

)

(6,925

)

Increase in restricted cash

 

 

(7,500

)

Purchases of short-term investments

 

(63,455

)

(73,756

)

Proceeds from sales and maturities of short-term investments

 

80,967

 

66,892

 

Net cash used in investing activities

 

(15,619

)

(26,520

)

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

4,837

 

13,169

 

Excess tax benefit from stock option exercises

 

2,005

 

 

 

 

 

 

 

 

Net cash provided by financing activities

 

6,842

 

13,169

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

3,142

 

(3,441

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(109,308

)

(71,267

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

354,331

 

313,608

 

Cash and cash equivalents at end of period

 

$

245,023

 

$

242,341

 


(1) See Note 2 “Restatement of Unaudited Consolidated Financial Statements.”

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

7




ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
For the three months ended June 30, 2006
(Unaudited)
(In thousands)

 

 

 

Common Stock

 

Additional
Paid-In

 

Retained 

 

Accumulated
Other
Comprehensive 

 

Unearned

 

Shareholders’

 

 

 

Shares

 

Amounts

 

Capital

 

Earnings

 

Income (Loss)

 

Compensation

 

Equity

 

Balance, March 31, 2006, as restated(1)

 

277,021

 

$

 

$

867,297

 

$

341,990

 

$

16,369

 

$

(3,033

)

$

1,222,623

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss, as restated(1)

 

 

 

 

(18,309

)

 

 

(18,309

)

Unrealized depreciation on short-term investments (net of tax benefit of $7.1 million)

 

 

 

 

 

(18,482

)

 

(18,482

)

Foreign currency translation adjustment, as restated(1)

 

 

 

 

 

3,578

 

 

3,578

 

Total comprehensive loss, as restated(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

(33,213

)

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

 

912

 

 

4,837

 

 

 

 

4,837

 

Issuance of stock to effect business combination

 

2,382

 

 

30,000

 

 

 

 

30,000

 

Stock based compensation expense related to employee stock options, restricted stock, and employee stock purchases, as restated(1)

 

 

 

7,720

 

 

 

 

7,720

 

Tax benefit attributable to employee stock options and common stock warrants, as restated(1)

 

 

 

2,763

 

 

 

 

2,763

 

Reclassification of unearned compensation

 

 

 

(3,033

)

 

 

3,033

 

 

Balance, June 30, 2006, as restated(1)

 

280,315

 

$

 

$

909,584

 

$

323,681

 

$

1,465

 

$

 

$

1,234,730

 


(1) See Note 2 “Restatement of Unaudited Consolidated Financial Statements

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

8




ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
For the three months ended June 30, 2006

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 Amended Annual Report on Form 10-K/A for the fiscal year ended March 31, 2006 as filed with the Securities and Exchange Commission (“SEC”) on May 25, 2007.

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 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.

9




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, 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 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

10




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 our revenue for any period if factors or market conditions change or if management makes different judgments or utilizes different estimates in determining the allowances for returns and price protection.  For example, a 1% change in our June 30, 2006 allowance for returns and price protection would impact net revenues by $0.8 million.

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.

11




Stock-Based Compensation Expense

On April 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS No. 123R”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan (“employee stock purchases”) based on estimated fair values. SFAS No. 123R supersedes our previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”).  In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS No. 123R. We have applied the provisions of SAB 107 in our adoption of SFAS No. 123R.

We adopted SFAS No. 123R using the modified prospective transition method, which requires the application of the accounting standard as of April 1, 2006, the first day of our fiscal year 2007. The Company’s Consolidated Financial Statements as of and for the three months ended June 30, 2006 reflect the impact of SFAS No. 123R. In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123R.  Stock-based compensation expense recognized under SFAS No. 123R for the three months ended June 30, 2006 was $5.8 million.  See Note 16 for additional information.

SFAS No. 123R requires companies to estimate the fair value of share-based payment awards on the measurement date using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Consolidated Statement of Operations. Prior to the adoption of SFAS No. 123R, the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB No. 25 as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). Under APB No. 25, compensation expense was 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 measurement date.  Under the intrinsic value method, compensation expense was recorded on the date of grant or measurement date only if the current market price of the underlying stock exceeded the stock option or other stock-based award’s exercise price.  For the three months ended June 30, 2005, we recognized $0.9 million of stock-based compensation expense related to employee stock options, restricted stock, and employee stock purchases under APB No. 25.  See Notes 2 and 16 for additional information.

Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in our Consolidated Statement of Operations for the first quarter of fiscal 2007 included compensation expense for share-based payment awards granted prior to, but not yet vested as of April 1, 2006, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and compensation expense for the share-based payment awards granted subsequent to April 1, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. As stock-based compensation expense recognized in the Consolidated Statement of Operations for the first quarter of fiscal 2007 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

As of April 1, 2005, we changed our method of valuation for share-based awards to a binomial-lattice model from the Black-Scholes option-pricing model (“Black-Scholes model”) which was used for options granted prior to April 1, 2005.  For additional information, see Note 16.  Our determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to our expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.

12




Restricted Stock

In June 2005, we issued the rights to 155,763 shares of restricted stock to an employee.  Additionally, in October 2005 we issued the rights to 96,712 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 No. 25, we recognized 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 $12.84 and $15.51 per share, respectively, and resulted in increases in “Additional paid-in capital” and “Unearned compensation” of $2.0 million and $1.5 million on the respective balance sheets at the times of grant.  Prior to the adoption of SFAS No. 123R, we reduced unearned compensation and recognized compensation expense over the vesting periods.  Upon adoption of SFAS No. 123R, unearned compensation was reclassified against additional paid in capital and we will increase additional paid in capital and recognize compensation expense over the respective remaining vesting periods.  For the first quarter of fiscal 2007, we recorded expense related to these shares of approximately $175,000, which was included as a component of stock-based compensation expense within “General and administrative” on the accompanying statements of operations.  Since issuance, we have recognized $642,000 of the $3.5 million of unearned compensation with the remainder to be recognized over a weighted-average period of 4.1 years.

2.               Restatement of Unaudited Consolidated Financial Statements

The restatement reflects the findings of the Special Subcommittee of independent members of our Board of Directors, which was established in July 2006 to review our historical stock option granting practices.

Background of Review :  In June 2006, two investment companies published reports analyzing companies in the video game publishing industry (including the Company) for potentially problematic option grants. In response to these reports, we directed Bryan Cave LLP, which was then our outside counsel, to review historic stock option grants to our senior executive officers, including grants identified in the published investment company reports, and to compile materials relating to such grants.  In July 2006, two stockholder derivative lawsuits were filed against certain of our current and former officers and directors alleging improprieties in our issuance of stock options.  On July 25, 2006, the Board approved the appointment of a Special Subcommittee of independent directors to conduct a comprehensive independent review of our practices and policies relating to the granting of stock options (the “Special Subcommittee”).

Scope of Review :  On or about August 4, 2006, the Special Subcommittee retained the law firm of Munger Tolles & Olson LLP to serve as counsel to the Special Subcommittee and to assist the Special Subcommittee in conducting its review.  Counsel to the Special Subcommittee thereafter retained Deloitte & Touche USA LLP (“Deloitte”), an independent registered public accounting firm, to assist in a review of facts and circumstances regarding our historical stock option grants and to advise Special Subcommittee counsel on accounting issues with respect to the stock option grants.

Findings :  The Special Subcommittee reviewed 4,849 option grants covering 204,230,604 shares, or about 86% of the 237,756,486 options granted in the period covering from fiscal year 1992 through fiscal year 2006 and the first five months of fiscal year 2007 (including the quarterly period covered by this Amended Quarterly Report on Form 10-Q/A), and found that 3,450 grants covering 148,747,202 shares required measurement date corrections.  Of the options found to require measurement date corrections, a majority — covering approximately 88,250,000 shares, were granted to non-officer employees or former officers of the Company, while options covering approximately 60,500,000 shares were granted to current officers and directors.

A majority of the grants requiring measurement date corrections (measured by number of shares) occurred on 16 dates over the 15-year period reviewed by the Special Subcommittee.  Twelve annual grants, covering 29,423,701 shares, were found to require measurement date corrections, including almost 100% of the options included in the annual grants made in the 10 calendar years 1996 through 2005 and approximately 5.9% of the annual grants made in calendar year 2006 (covering 24.3% of the shares covered by the 2006 annual grants).  In addition, acquisition grants covering 4,656,491 million shares were found to require measurement date corrections.  The remaining grants requiring measurement date corrections

13




(covering 114,667,010 shares), consisted of various employment service related grants over the 15-year period reviewed by the Special Subcommittee, which included employment contract related grants (new contracts or the renewal of existing contracts), new hire grants, promotion grants, merit and bonus grants, and retention incentive grants.

The need for these measurement date corrections arose from failure to understand and apply the correct accounting rules, failure to establish and maintain adequate procedures and controls, failure on certain occasions to appreciate the implications of available information, and insufficient finality and documentation.  As a result, the exercise prices for certain options were affected by selection of grant dates with hindsight, which led to errors in the determination of measurement dates, and we did not correctly account for modifications and repricings after initial grant dates.

Determination of Measurement Dates :  According to APB No. 25, the measurement date is the first date on which proper approval is obtained and all of the following are known: (1) the individual employee who is entitled to receive the option grant, (2) the number of options that an individual employee is entitled to receive, and (3) the option’s exercise price.  To correct the measurement date inaccuracies, we re-determined the measurement date based on the date when all APB No. 25 criteria were satisfied. Effective April 1, 2006, the determination of the measurement date in accordance with SFAS No. 123R additionally includes the requirement to communicate the terms of the option award to the grantee.  In re-determining the most appropriate measurement date of an option grant, we considered meeting minutes and other documents of our Board of Directors, including minutes of the Compensation Committee, in addition to the following data:

·       reports on Form 4 filed with the SEC;

·       personnel files;

·       payroll records;

·                   information obtained in interviews with various current and former Company employees and members of our Board of Directors;

·       various records maintained by our human resources department;

·       contemporaneous emails; and

·                   the date on which such grants were entered into the Company’s stock option system (“option entry date”) and thereby constructively communicated to each recipient via each recipient’s individual stock option account as administered by a third-party on-line broker.

For grants where there was not sufficient evidence and documentation to support the original measurement date or to determine the precise date when the number of options and exercise price were finalized, we used all available relevant information to form a reasonable conclusion as to the most likely measurement date for such option grants.

Over the 15 year review period covering from fiscal year 1992 through fiscal year 2006 and the first five months of fiscal 2007 (including the quarterly period covered by this Amended Quarterly Report on Form 10-Q/A), over 80% of all grants, representing over 90% of all shares, were either individually reviewed (such as an employment contract grant) or were reviewed as a separate block of grants (such as annual grants or acquisition related grants) or as an identifiable category of grants with common characteristics.  The remaining 1,489 grants, representing less than 8% of all shares, were not individually reviewed and did not appear to have any unusual pricing or other characteristics indicating a need for full individual review.  Sampling and other analysis indicated that these remaining grants consisted of grants to “rank-and-file” employees, largely in the categories of employment contract, bonus, and other miscellaneous grants.  These remaining grants, for the 5 year period from fiscal year 2002 through fiscal year 2006, represented 4,953,230 shares and 2% of all the shares granted during the entire 15 year review period.  Various analytics and sensitivities were performed to determine whether these remaining grants had any unique pricing or other characteristics.  None were identified.  For perspective as a sensitivity

14




analysis, if the high market price between the option grant date and the option entry date (the date on which such grants were entered into the Company’s stock option system and available to employees) was used as an alternative measurement date price for a sampling of grants based on distribution patterns and price ranges, the total additional non-cash pre-tax stock-based compensation expense would be approximately $2.5 million spread over a period from fiscal year 1994 through fiscal year 2006, and approximately $1.3 million of non-cash pre-tax stock-based compensation expense would impact the five fiscal years from 2002 through 2006.  Given the immaterial number of shares and limited potential income statement impact, along with the absence of unique pricing or other characteristics, additional review procedures were not deemed necessary for these remaining grants and were therefore not applied, and no change was made to the original grant date as the measurement date.

The following is a summary of the primary stock-option accounting errors underlying this restatement and their impact in key categories of option grants.

Grant Dates and Exercise Prices Based on Employment Service Related “Business Events” Insufficient to Support Reported Measurement Date

A large number of the grants requiring measurement date corrections were made in connection with employment service related “business events” (including employment contracts for both new hires and contract renewals for existing employees).  In many instances, the Special Subcommittee determined that the lowest price was chosen from among several alternative dates, on the theory that it was permissible to use a date that was tied to a “business event,” such as the date negotiations commenced, the date of a handshake agreement, the date that an employee began working for the Company, or the date that the contract was signed by the employee.  These grants account for approximately $34.5 million, or about 52% of the total of approximately $66.7 million in additional pre-tax stock-based compensation expense recorded by the Company in the restated financial statements reported in the Company’s Amended Annual Report on Form 10-K/A for the fiscal year ended March 31, 2006.

Annual Grants Affected by Insufficient Finality and Documentation and Selection of Dates with Hindsight

Annual grants were issued to a large number of employees each year (typically in April) and were made at the lowest or second-lowest price of the month in which they were granted from calendar year 1997 through calendar year 2003.  The Special Subcommittee found evidence that the dates of some or all of these grants were chosen in late April or early May and were therefore affected by selection of dates with hindsight, and that required details of various annual grants did not have the required level of finality, including completion of allocations of options to individual employees, or were not supported by sufficient documentation until after the reported grant date.  In total, twelve annual grants, covering 29,423,701 shares, were found to require measurement date corrections, including almost 100% of the options included in the annual grants made for the 10 calendar years 1996 through 2005 and approximately 5.9% of the annual grants made for calendar year 2006 (covering 24.3% of the shares covered by the calendar year 2006 annual grants).  Annual grants account for approximately $18.7 million or approximately 28% of the approximately $66.7 million in additional pre-tax stock-based compensation expense recorded by the Company in the restated financial statements reported in the Company’s Amended Annual Report on Form 10-K/A for the fiscal year ended March 31, 2006.

Grants Affected by Modifications after Initial Grant Date

Certain grants were modified after the initial grant date, but the Company did not account correctly for the modification in accordance with APB No. 25.  The modifications included the acceleration of vesting, the continuation of the vesting period of options of terminated employees or the extension of the post-service exercise period for vested stock options of terminated employees.  Modifications were made to 337 option grants that were not accounted for in accordance with APB No. 25. We recorded approximately $10.0 million additional pre-tax stock-based compensation expense to properly account for these modifications, or about 15% of the approximately $66.7 million in additional pre-tax stock-based compensation expense recorded by the Company in the restated financial statements reported in the Company’s Amended Annual Report on Form 10-K/A for the fiscal year ended March 31, 2006.

15




Grants Affected by Repricings after Initial Grant Date

Certain grants (mostly relating to employment service related grants on three dates) were repriced after the initial grant date, but the Company did not account correctly for the repricing.  Such repricings are considered a modification of an award and require the application of variable accounting.  In accordance with the provisions of Financial Accounting Standard Board Interpretation 44, “Accounting for Certain Transactions involving Stock Compensation,” we determined that we should have recorded an additional $3.5 million in stock-based compensation expense related to these grants, or approximately 5% of the approximately $66.7 million in additional pre-tax stock-based compensation expense recorded by the Company in the restated financial statements reported in the Company’s Amended Annual Report on Form 10-K/A for the fiscal year ended March 31, 2006.

Impact .  We have recorded approximately $66.7 million in additional pre-tax stock-based compensation expense for the thirteen year period from April 1, 1993 through March 31, 2006 in accordance with APB No. 25.  The additional stock-based compensation expense is amortizable over the service period relating to each option, typically three to five years, with approximately two-thirds of the total expense being recorded in or before fiscal 2002.  Separately, the restatement reflects an additional $1.7 million pre-tax change ($1.1 million after-tax) related to recently identified insufficient payroll tax withholdings in fiscal 2005.  The additional pre-tax stock-based compensation expense and payroll tax withholdings change are included in the table below.  Additionally, approximately $0.6 million in additional pre-tax stock-based compensation expense was recorded to correct measurement date inaccuracies, pursuant to the provisions of SFAS No. 123R, during the three months ended June 30, 2006, for the period specifically covered by this Amended Quarterly Report on Form 10-Q/A. For the three months ended June 30, 2005, approximately $0.9 million in additional pre-tax stock-based compensation expense was recorded to correct measurement date inaccuracies, in accordance with APB No. 25 and has been included in the approximately $66.7 million in additional pre-tax stock-based compensation expense for the thirteen year period from April 1, 1993 through March 31, 2006.

Years ended
March 31,

 

 

 

Total
additional
compensation
expense

 

2006

 

2005

 

2004

 

Cumulative
effect at
April 1,
2003

 

2003

 

2002

 

 

Net income, as previously reported

 

 

 

$

41,899

 

$

138,335

 

$

77,715

 

 

 

 

 

 

 

 

Additional compensation expense resulting from improper measurement dates for stock option grants (1)

 

$

68,351

 

2,731

 

4,963

(1)

5,280

 

$

55,377

 

$

10,156

 

$

22,017

 

 

Tax related effects

 

(21,828

)

(1,083

)

(1,685

)

(1,663

)

(17,397

)

(2,979

)

(6,732

)

 

Total effect on net income

 

$

46,523

 

1,648

 

3,278

 

3,617

 

$

37,980

 

$

7,177

 

$

15,285

 

 

Net income, as restated

 

 

 

$

40,251

 

$

135,057

 

$

74,098

 

 

 

 

 

 

 

 


(1)              Also includes $1.7 million charge for insufficient payroll tax withholdings in fiscal 2005.

16




 

Years ended March 31,

 

 

 

2001

 

2000

 

1999

 

1998

 

1997

 

1996

 

1995

 

1994

 

Additional compensation expense resulting from improper measurement dates for stock option grants

 

$

3,816

 

$

5,267

 

$

2,384

 

$

3,884

 

$

4,785

 

$

2,919

 

$

110

 

$

39

 

Tax related effects

 

(1,281

)

(1,598

)

(746

)

(1,392

)

(1,879

)

(740

)

(37

)

(13

)

 Total effect on net income

 

$

2,535

 

$

3,669

 

$

1,638

 

$

2,492

 

$

2,906

 

$

2,179

 

$

73

 

$

26

 

 

The cumulative effect of all the restatement adjustments to our Consolidated Balance Sheet as of March 31, 2003 resulted in a decrease in retained earnings of $38.0 million, an increase in additional paid-in capital of $36.2 million, and a decrease in deferred tax assets of $1.8 million.

Certain Tax Consequences :  Certain stock options were granted with an exercise price lower than the fair market value on the actual measurement dates, with vesting occurring after December 31, 2004, which resulted in nonqualified deferred compensation for purposes of Section 409A of the Internal Revenue Code.  Section 409A subjects the option holders to additional income tax, penalties and interest on the value of the options deferred and, in certain cases, exercised each year.  We do not have any tax liability associated with Section 409A. For options that have already been exercised by non-executive officer employees, that are subject to Section 409A consequences, the Company has elected to  participate in the Internal Revenue Service program described in IRS Announcement 2007-18 pursuant to which the Company was able to pay the Section 409A taxes on behalf of its non-executive officer employees, and has incurred $7.3 million in additional pre-tax compensation expense in the fiscal quarter ended March 31, 2007, in absorbing these related costs on behalf of these employees. With respect to unexercised options subject to Section 409A held by such current and former non-executive officer employees, the Company on or about June 7, 2007 is commencing an offer to amend the exercise price of these options to eliminate their Section 409A tax liability consistent with Internal Revenue Service guidance.  Pursuant to the offer, the Company will also make a cash payment in January 2008 to employees who accept the offer, in an amount equal to the difference between the original exercise price of each amended option and the amended exercise price of each amended option. This will likely result in additional future compensation expense to the Company once these actions occur.

The following tables reflect the impact of the additional non-cash charges for stock-based compensation expense and related tax effects on:

·                   the consolidated statements of operations for the quarters ended June 30, 2006 and 2005 (Unaudited).

·                   the consolidated balance sheets as of June 30, 2006 (Unaudited) and March 31, 2006.

·                   the consolidated statements of cash flows for the quarters ended June 30, 2006 and 2005 (Unaudited).

·                   the pro forma information required by SFAS No. 123 for the quarter ended June 30, 2005 (Unaudited).

17




Consolidated Statement of Operations (Unaudited)

 

 

For the three months ended June 30, 2006

 

(in thousands, except per share data)

 

As previously
reported

 

Adjustments

 

As restated

 

 

 

 

 

 

 

 

 

Net revenues

 

$

188,069

 

$

 

$

188,069

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

Cost of sales — product costs

 

108,623

 

 

108,623

 

Cost of sales — software royalties and amortization

 

19,250

 

11

 

19,261

 

Cost of sales — intellectual property licenses

 

9,916

 

 

9,916

 

Product development

 

25,422

 

203

 

25,625

 

Sales and marketing

 

36,194

 

(15

)

36,179

 

General and administrative

 

21,450

 

464

 

21,914

 

 

 

 

 

 

 

 

 

Total costs and expenses

 

220,855

 

663

 

221,518

 

 

 

 

 

 

 

 

 

Operating loss

 

(32,786

)

(663

)

(33,449

)

 

 

 

 

 

 

 

 

Investment income, net

 

8,275

 

 

8,275

 

 

 

 

 

 

 

 

 

Loss before income tax benefit

 

(24,511

)

(663

)

(25,174

)

 

 

 

 

 

 

 

 

Income tax benefit

 

(6,685

)

(180

)

(6,865

)

 

 

 

 

 

 

 

 

Net loss

 

$

(17,826

)

$

(483

)

$

(18,309

)

 

 

 

 

 

 

 

 

Basic loss per share

 

$

(0.06

)

$

(0.01

)

$

(0.07

)

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

278,335

 

 

278,335

 

 

 

 

 

 

 

 

 

Diluted loss per share

 

$

(0.06

)

$

(0.01

)

$

(0.07

)

 

 

 

 

 

 

 

 

Weighted average common shares outstanding assuming dilution

 

278,335

 

 

278,335

 

 

18




Consolidated Statement of Operations (Unaudited)

 

 

For the three months ended June 30, 2005

 

(in thousands, except per share data)

 

As previously
reported

 

Adjustments

 

As restated

 

Net revenues

 

$

241,093

 

$

 

$

241,093

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

Cost of sales — product costs

 

136,754

 

 

136,754

 

Cost of sales — software royalties and amortization

 

14,576

 

 

14,576

 

Cost of sales — intellectual property licenses

 

20,940

 

 

20,940

 

Product development

 

17,802

 

276

 

18,078

 

Sales and marketing

 

46,318

 

49

 

46,367

 

General and administrative

 

18,151

 

546

 

18,697

 

 

 

 

 

 

 

 

 

Total costs and expenses

 

254,541

 

871

 

255,412

 

 

 

 

 

 

 

 

 

Operating loss

 

(13,448

)

(871

)

(14,319

)

 

 

 

 

 

 

 

 

Investment income, net

 

7,348

 

 

7,348

 

 

 

 

 

 

 

 

 

Loss before income tax benefit

 

(6,100

)

(871

)

(6,971

)

 

 

 

 

 

 

 

 

Income tax benefit

 

(2,515

)

(209

)

(2,724

)

 

 

 

 

 

 

 

 

Net loss

 

$

(3,585

)

(662

)

$

(4,247

)

 

 

 

 

 

 

 

 

Basic loss per share

 

$

(0.01

)

$

(0.01

)

$

(0.02

)

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

269,141

 

$

 

269,141

 

 

 

 

 

 

 

 

 

Diluted loss per share

 

$

(0.01

)

$

(0.01

)

$

(0.02

)

 

 

 

 

 

 

 

 

Weighted average common shares outstanding assuming dilution

 

269,141

 

$

 

269,141

 

 

 

 

 

 

 

 

 

 

19




Consolidated Balance Sheet (Unaudited)

 

 

As of June 30, 2006

 

(in thousands, except per share data)

 

As previously
reported

 

Adjustments

 

As restated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

245,023

 

$

 

$

245,023

 

Short-term investments

 

547,553

 

 

547,553

 

Accounts receivable, net of allowances of $87,155

 

65,361

 

 

65,361

 

Inventories

 

64,095

 

 

64,095

 

Software development

 

65,631

 

19

 

65,650

 

Intellectual property licenses

 

23,844

 

 

23,844

 

Deferred income taxes

 

12,245

 

 

12,245

 

Other current assets

 

40,229

 

 

40,229

 

Total current assets

 

1,063,981

 

19

 

1,064,000

 

 

 

 

 

 

 

 

 

Software development

 

13,072

 

(90

)

12,982

 

Intellectual property licenses

 

73,100

 

 

73,100

 

Property and equipment, net

 

43,986

 

 

43,986

 

Deferred income taxes

 

58,504

 

(1,155

)

57,349

 

Other assets

 

4,113

 

 

4,113

 

Goodwill

 

180,646

 

 

180,646

 

Total assets

 

$

1,437,402

 

$

(1,226

)

$

1,436,176

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

73,344

 

$

 

$

73,344

 

Accrued expenses

 

88,264

 

(1,122

)

87,142

 

Total current liabilities

 

161,608

 

(1,122

)

160,486

 

 

 

 

 

 

 

 

 

Other liabilities

 

40,960

 

 

40,960

 

 

 

 

 

 

 

 

 

Total liabilities

 

202,568

 

(1,122

)

201,446

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 15)

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

Preferred stock, $.000001 par value, 3,750,000 shares authorized, no shares issued at June 30, 2006

 

 

 

 

Series A Junior Preferred stock, $.000001 par value, 1,250,000 shares authorized, no shares issued at June 30, 2006

 

 

 

 

Common stock, $.000001 par value, 450,000,000 shares authorized, 280,315,487 shares issued and outstanding at June 30, 2006

 

 

 

 

Additional paid-in capital

 

862,678

 

46,906

 

909,584

 

Retained earnings

 

370,687

 

(47,006

)

323,681

 

Accumulated other comprehensive income

 

1,469

 

(4

)

1,465

 

Unearned compensation

 

 

 

 

Total shareholders’ equity

 

1,234,834

 

(104

)

1,234,730

 

Total liabilities and shareholders’ equity

 

$

1,437,402

 

$

(1,226

)

$

1,436,176

 

 

20




Consolidated Balance Sheet
(in thousands, except per share data)

 

 

As of March 31, 2006

 

 

 

As previously
reported

 

Adjustments

 

As restated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

354,331

 

$

 

$

354,331

 

Short-term investments

 

590,629

 

 

590,629

 

Accounts receivable, net of allowances of $98,253

 

28,782

 

 

28,782

 

Inventories

 

61,483

 

 

61,483

 

Software development

 

40,260

 

 

40,260

 

Intellectual property licenses

 

4,973

 

 

4,973

 

Deferred income taxes

 

9,664

 

 

9,664

 

Other current assets

 

25,933

 

 

25,933

 

Total current assets

 

1,116,055

 

 

1,116,055

 

 

 

 

 

 

 

 

 

Software development

 

20,359

 

 

20,359

 

Intellectual property licenses

 

82,073

 

 

82,073

 

Property and equipment, net

 

45,368

 

 

45,368

 

Deferred income taxes

 

53,813

 

(1,268

)

52,545

 

Other assets

 

1,409

 

 

1,409

 

Goodwill

 

100,446

 

 

100,446

 

Total assets

 

$

1,419,523

 

$

(1,268

)

$

1,418,255

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

88,994

 

$

 

$

88,994

 

Accrued expenses

 

103,169

 

1,693

 

104,862

 

Total current liabilities

 

192,163

 

1,693

 

193,856

 

 

 

 

 

 

 

 

 

Other liabilities

 

1,776

 

 

1,776

 

 

 

 

 

 

 

 

 

Total liabilities

 

193,939

 

1,693

 

195,632

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 15)

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

Preferred stock, $.000001 par value, 3,750,000 shares authorized, no shares issued at March 31, 2006

 

 

 

 

Series A Junior Preferred stock, $.000001 par value, 1,250,000 shares authorized, no shares issued at March 31, 2006

 

 

 

 

Common stock, $.000001 par value, 450,000,000 shares authorized, 277,020,898 shares issued and outstanding at March 31, 2006

 

 

 

 

Additional paid-in capital

 

823,735

 

43,562

 

867,297

 

Retained earnings

 

388,513

 

(46,523

)

341,990

 

Accumulated other comprehensive income

 

16,369

 

 

16,369

 

Unearned compensation

 

(3,033

)

 

(3,033

)

Total shareholders’ equity

 

1,225,584

 

(2,961

)

1,222,623

 

Total liabilities and shareholders’ equity

 

$

1,419,523

 

$

(1,268

)

$

1,418,255

 

 

21




Consolidated Statement of Cash Flows (Unaudited)
(in thousands)

 

 

For the three months ended June 30, 2006

 

 

 

As previously
reported

 

Adjustments

 

As restated

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net loss

 

$

(17,826

)

$

(483

)

$

(18,309

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

Deferred income taxes

 

(6,684

)

(113

)

(6,797

)

Realized gain on sale of short term investments

 

(2

)

 

(2

)

Depreciation and amortization

 

4,421

 

 

4,421

 

Amortization of capitalized software development costs and intellectual property licenses

 

21,140

 

(24

)

21,116

 

Stock-based compensation expense

 

5,203

 

646

 

5,849

 

Tax benefit of stock option exercises

 

 

2,763

 

2,763

 

Excess tax benefit from stock option exercises

 

 

(2,005

)

(2,005

)

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

 

 

 

 

 

 

 

Accounts receivable

 

(25,469

)

 

(25,469

)

Inventories

 

1,012

 

 

1,012

 

Software development and intellectual property licenses

 

(44,892

)

30

 

(44,862

)

Other assets

 

637

 

 

637

 

Accounts payable

 

(22,058

)

 

(22,058

)

Accrued expenses and other liabilities

 

(17,154

)

(2,815

)

(19,969

)

Net cash used in operating activities

 

(101,672

)

(2,001

)

(103,673

)

Cash flows from investing activities:

 

 

 

 

 

 

 

Capital expenditures

 

(2,631

)

 

(2,631

)

Cash payments to effect business combinations, net of cash acquired

 

(30,500

)

 

(30,500

)

Purchases of short-term investments

 

(63,455

)

 

(63,455

)

Proceeds from sales and maturities of short-term investments

 

80,967

 

 

80,967

 

Net cash used in investing activities

 

(15,619

)

 

(15,619

)

Cash flows from financing activities:

 

 

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

4,837

 

 

4,837

 

Excess tax benefit from stock option exercises

 

 

2,005

 

2,005

 

Net cash provided by financing activities

 

4,837

 

2,005

 

6,842

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

3,146

 

(4

)

3,142

 

 

 

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(109,308

)

 

(109,308

)

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

354,331

 

 

354,331

 

Cash and cash equivalents at end of period

 

$

245,023

 

$

 

$

245,023

 

 

22




Consolidated Statement of Cash Flows (Unaudited)
(in thousands)

 

 

For the three months ended June 30, 2005

 

 

 

As previously
reported

 

Adjustments

 

As restated

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net loss

 

$

(3,585

)

(662

)

$

(4,247

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

Deferred income taxes

 

(9,304

)

689

 

(8,615

)

Realized gain on sale of short term investments

 

(1,343

)

 

(1,343

)

Depreciation and amortization

 

3,161

 

 

3,161

 

Amortization of capitalized software development costs and intellectual property licenses

 

21,815

 

 

21,815

 

Stock-based compensation expense

 

17

 

849

 

866

 

Tax benefit of stock option exercises

 

6,769

 

(898

)

5,871

 

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

 

 

 

 

 

 

 

Accounts receivable

 

14,383

 

 

14,383

 

Inventories

 

2,882

 

 

2,882

 

Software development and intellectual property licenses

 

(37,005

)

 

(37,005

)

Other assets

 

943

 

 

943

 

Accounts payable

 

(43,532

)

 

(43,532

)

Accrued expenses and other liabilities

 

(9,676

)

22

 

(9,654

)

Net cash used in operating activities

 

(54,475

)

 

(54,475

)

Cash flows from investing activities:

 

 

 

 

 

 

 

Capital expenditures

 

(5,231

)

 

(5,231

)

Cash payments to effect business combinations, net of cash acquired

 

(6,925

)

 

(6,925

)

Increase in restricted cash

 

(7,500

)

 

(7,500

)

Purchases of short-term investments

 

(73,756

)

 

(73,756

)

Proceeds from sales and maturities of short-term investments

 

66,892

 

 

66,892

 

Net cash used in investing activities

 

(26,520

)

 

(26,520

)

Cash flows from financing activities:

 

 

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

13,169

 

 

13,169

 

Net cash provided by financing activities

 

13,169

 

 

13,169

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(3,441

)

 

(3,441

)

Net decrease in cash and cash equivalents

 

(71,267

)

 

(71,267

)

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

313,608

 

 

313,608

 

Cash and cash equivalents at end of period

 

$

242,341

 

$

 

$

242,341

 

 

23




Pro forma information regarding net income and net income per share is required by SFAS No. 123 and has been determined as if the Company had accounted for its employee stock purchase plan and employee stock option plans under the fair value method of SFAS No. 123. The impact of the restatements on the pro forma information is as follows (in thousands, except per share data):

Pro Forma Information (Unaudited)

 

For the three months ended June 30, 2005

 

 

 

As previously
reported

 

Adjustments

 

As restated

 

Net loss, as reported

 

$        (3,585

)

$           (662

)

$        (4,247

)

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects

 

 

649

 

649

 

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

 

(2,971

)

(655

)

(3,626

)

Pro forma net loss

 

$        (6,556

)

$           (668

)

$        (7,224

)

 

 

 

 

 

 

 

 

Loss per share

 

 

 

 

 

 

 

Basic — as reported

 

$          (0.01

)

$          (0.01

)

$          (0.02

)

Basic — pro forma

 

$          (0.02

)

$          (0.01

)

$          (0.03

)

 

 

 

 

 

 

 

 

Diluted — as reported

 

$          (0.01

)

$          (0.01

)

$          (0.02

)

Diluted — pro forma

 

$          (0.02

)

$          (0.01

)

$          (0.03

)

 

3.               Stock Split

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. In September 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 October 24, 2005 to shareholders of record as of October 10, 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.

4.               Acquisitions

RedOctane, Inc.

On June 6, 2006, we completed our acquisition of 100% of RedOctane, Inc. (“RedOctane”) for an aggregate accounting purchase price of $99.9 million including transaction costs, consisting of $30.9 million in cash and 2,382,077 shares of Activision common stock valued at approximately $30.0 million based upon prevailing market prices, and $39.0 million payable in Activision common stock within two years of the closing date, which is recorded in other liabilities. In addition, in the event the net income of the business over a certain period of time exceeds certain target levels by certain amounts, certain former shareholders of RedOctane will be entitled to an additional amount of up to $51.0 million payable in shares of Activision common stock. The contingent consideration will be recorded as an additional element of the purchase price if those contingencies are resolved. Based in Sunnyvale, California, RedOctane is a publisher, developer, and distributor of interactive entertainment software, hardware and accessories.

24




RedOctane offers its interactive entertainment products in versions that operate on the PS2, Xbox, and PC. RedOctane’s leading software product offering is Guitar Hero for the PS2. RedOctane also designs, manufactures, and markets high quality video game peripherals and accessories. This acquisition will provide Activision with an early leadership position in music-based gaming, which the company expects will be one of the fastest growing genres in the coming years.

The results of operations of RedOctane and the estimated fair market values of the acquired assets and liabilities have been included in the Consolidated Financial Statements since the date of acquisition. Pro forma consolidated statements of operations for this acquisition are not shown, as they would not differ materially from reported results. The acquired finite-lived intangible assets are being amortized over estimated lives ranging from 0.8 to 1.3 years. Goodwill has been included in the publishing segment of our business and is non-deductible for tax purposes.

Preliminary Purchase Price Allocation

We accounted for this acquisition 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. The purchase price for the RedOctane transaction was preliminarily allocated to assets acquired and liabilities assumed as set forth below (in thousands):

Current assets

 

$17,530

 

Property and equipment, net

 

207

 

Other assets

 

1,033

 

Goodwill

 

79,659

 

Trademark and other intangibles

 

16,700

 

Deferred tax liability

 

(6,496

)

Other liabilities

 

(8,733

)

 

 

 

 

Total consideration

 

$99,900

 

 

Purchased Intangible Assets

The following table presents details of the purchased finite-lived intangible assets acquired in the RedOctane acquisition (in thousands):

 

Estimated
Useful

 

 

 

 

 

Life

 

 

 

 

 

(in years)

 

Amount

 

Finite-lived intangibles:

 

 

 

 

 

Trademark

 

1.3

 

$1,000

 

Other intangibles

 

0.8-1.3

 

15,700

 

 

 

 

 

 

 

Total finite-lived intangibles

 

 

 

$16,700

 

 

25




The following tables present details of our total purchased finite-lived intangible assets as of June 30, 2006 (in thousands):

June 30, 2006

 

Gross

 

Accumulated
Amortization

 

Net

 

Trademark

 

$        1,000

 

$             10

 

$           990

 

Other intangibles

 

15,700

 

140

 

15,560

 

 

 

 

 

 

 

 

 

Total

 

$      16,700

 

$           150

 

$      16,550

 

 

The estimated future amortization expense of purchased finite-lived intangible assets as of June 30, 2006 is as follows (in thousands):

Fiscal year ending March 31,

 

Amount

 

2007 (remaining nine months)

 

$  9,486

 

2008

 

7,064

 

2009

 

 

2010

 

 

2011

 

 

Thereafter

 

 

Total

 

$ 16,550

 

 

5.               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.

26




The following table summarizes our investments in securities as of June 30, 2006 (amounts in thousands):

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Cash and time deposits

 

$   93,412

 

$         —

 

$         —

 

$   93,412

 

Money market funds

 

80,286

 

 

 

80,286

 

Commercial paper

 

60,700

 

 

(35

)

60,665

 

U.S. agency issues

 

10,662

 

 

(2

)

10,660