UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended March 31, 2004 |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period from to |
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Commission File Number 0-12699 |
ACTIVISION, INC.
(Exact name of registrant as specified in its charter)
Delaware |
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95-4803544 |
(State or other jurisdiction of |
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(I.R.S. Employer Identification No.) |
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3100 Ocean Park Blvd., Santa Monica, CA |
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90405 |
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Registrants telephone number, including area code: (310) 255-2000 |
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Securities registered pursuant to Section 12(b) of the Act: |
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None |
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Securities registered pursuant to Section 12(g) of the Act: |
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Preferred Stock Purchase Rights |
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Common Stock, par value $.000001 per share |
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(Title of Class) |
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 ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý No o
The aggregate market value of the Common Stock of the registrant held by non-affiliates of the registrant on September 30, 2003 was $1,035,877,616.
The number of shares of the registrants Common Stock outstanding as of May 26, 2004 was 137,981,025.
Documents Incorporated by Reference
Portions of the registrants definitive Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K, with respect to the 2004 Annual Meeting of Shareholders, are incorporated by reference into Part III of this Annual Report.
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Item 1. BUSINESS
Activision, Inc. (Activision or we) is 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 fiscal 2004 product portfolio included such best-selling products as Tony Hawks Underground, True Crime: Streets of L.A., Call of Duty and X2: Wolverines Revenge.
Our products cover game categories such as action/adventure, action sports, racing, role-playing, simulation, first-person action and strategy. Our target customer base ranges from game enthusiasts and children to mass-market consumers and 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) hand-held device and the personal computer (PC). The installed base for this current generation of hardware platforms is significant and growing. We believe recent price cuts in calendar 2004 on the Xbox and PS2 hardware should continue to drive the growth of the installed base of these two platforms. We also expect the installed base of the other current generation platforms to continue to grow. In addition, Sony announced that it would be entering the hand-held hardware market with the introduction of its hand-held gaming device, PlayStation Portable (PSP). PSP is currently expected to be released in the United States toward the end of the first quarter of calendar 2005. Nintendo has also announced that it plans to launch a new dual-screened, portable game system, Nintendo Dual Screen (NDS), before the end of calendar 2004. We are currently developing titles for the PSP and the NDS with the objective of having one or more titles at launch for each of these platforms. We are also planning to develop titles for the next generation console systems expected to be developed by Sony, Microsoft and Nintendo for release in the next two to three years.
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. Our distribution business consists of operations in Europe that provide logistical and sales services to third-party publishers of interactive entertainment software, our own publishing operations and manufacturers of interactive entertainment hardware.
We were originally incorporated in California in 1979. In December 1992, we reincorporated in Delaware. In June 2000, we reorganized into the current holding company organizational structure.
In April 2003, the Board of Directors approved a three-for-two split of our outstanding common shares effected in the form of a 50% stock dividend. The split was paid on June 6, 2003 to shareholders of record as of May 16, 2003. In February 2004, the Board of Directors approved a second 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. The par value of our common stock was maintained at the pre-split amount of $.000001. All share and per share data have been restated as if the stock splits had occurred as of the earliest period presented.
We have completed a number of acquisitions of both software development companies and interactive entertainment product distribution companies. The interactive entertainment industry has been consolidating and we intend to continue to expand our resources through acquisitions, strategic relationships and key license transactions. During fiscal 2004, we continued to enhance our internal product development capabilities with the acquisition of a privately held interactive software development company, Infinity Ward. See the Consolidated Financial Statements and Notes thereto included in Item 8 of this Annual Report on Form 10-K for additional information regarding this and prior acquisitions.
We have two reportable segments: publishing and distribution. Publishing relates to the development (both internally and externally), marketing and sale of DVD, CD and cartridge-based interactive entertainment software products owned or controlled by us directly, by license or through our affiliate label program with certain third-party
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publishers. Distribution primarily refers to logistical and sales services provided by our European distribution subsidiaries to third-party publishers of interactive entertainment software, our own publishing operations and manufacturers of interactive entertainment hardware. See the Consolidated Financial Statements and Notes thereto included in Item 8 of this Annual Report on Form 10-K for certain financial information required by Item 1.
Our objective is to be a worldwide leader in the development, publishing and distribution of quality interactive entertainment software products that deliver a highly satisfying consumer entertainment experience. Our business strategy, the key components of our business operations and the risk factors that could impact our business are detailed below.
Strategy
Create, Acquire and Maintain Strong Brands. We focus development and publishing activities principally on products that are, or have the potential to become, franchise properties with sustainable consumer appeal and brand recognition. It is our experience that these products can then serve as the basis for sequels, prequels and related new products that can be released over an extended period of time. We believe that the publishing and distribution of products based in large part on franchise properties enhances predictability of revenues and the probability of high unit volume sales and operating profits. We have entered into a series of strategic relationships with the owners of intellectual property pursuant to which we have acquired the rights to publish products based on franchises such as Marvel Comics properties including Spider-Man, X-MEN, Iron Man and Fantastic Four. We have additionally entered into exclusive licensing agreements to develop and publish video games based on the best-selling childrens book series Lemony Snickets A Series of Unfortunate Events, which is being developed into a feature film, as well as for DreamWorks SKGs recently released Shrek 2 and three other Dreamworks SKG upcoming computer-animated films, Shark Tale, Madagascar and Over the Hedge and their sequels. We also have a strategic relationship with professional skateboarder Tony Hawk through an exclusive multi-year agreement to develop video games using his name and likeness. Through fiscal 2004, we have released five successful titles in the Tony Hawk franchise. We also have created a select number of new intellectual properties, such as True Crime: Streets of L.A. and Call of Duty, that we believe have the potential to join this list of franchise properties.
Execute Disciplined Product Selection and Development Processes. The success of our publishing business depends, in significant part, on our ability to develop high quality games that will generate high unit volume sales. Our publishing units have implemented a formal control process for the selection, development, production and quality assurance of our products. We apply this process, which we refer to as the Greenlight Process, to all of our products, whether externally or internally developed. The Greenlight Process includes in-depth reviews of each project at six important stages of development by a team that includes many of our highest-ranking operating managers and coordination between our sales and marketing personnel and development staff at each step in the process.
We develop our products using a combination of our internal development resources and external development resources acting under contract with us. We are a capital investor in some of these external developers. We typically select our external developers based on their track record and expertise in producing products in the same category. One developer will often produce the same game for multiple platforms and will produce sequels to the original game. We believe that selecting and using development resources, in this manner allows us to strengthen and leverage the particular expertise of our internal and external development resources, which we believe will add to the quality of our products.
Create and Maintain Diversity in Product Mix, Platforms and Markets. We believe that maintaining a diversified mix of products can reduce our operating risks and enhance profitability. Therefore, we develop and publish products spanning a wide range of product categories, including action/adventure, action sports, racing, role-playing, simulation, first-person action and strategy. We also develop products designed for target audiences ranging from game enthusiasts and children to mass-market consumers and value buyers. Presently, we concentrate on developing, publishing and distributing products that operate on PS2, GameCube and Xbox console systems, GBA hand-held device and the PC. We typically offer our products for use on multiple platforms in order to reduce the risks associated with any single platform, leverage our costs over a larger installed hardware base and increase unit sales.
Continue to Improve Profitability. We continually strive to manage risk and increase our operating leverage and efficiency with the goal of increased profitability. We believe the key factor affecting our future profitability will
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be the success rate of our product releases. Therefore, our product selection and development process includes, as a significant component, periodic evaluations of the expected commercial success of products under development. Through this process, for titles that we determine to be less promising, corrections are made in the development process or, if necessary, they are discontinued before we incur additional development costs. In addition, we believe our focus on cross platform releases and branded products will contribute to improved profitability.
We continue to focus on increasing our margins. We have, for example, acquired certain experienced and specialized developers in instances where we can enhance profitability through the elimination of royalty obligations. Additionally, we often rely on independent third-party interactive entertainment software developers to develop some of our software products, thereby taking advantage of specialized independent developers without incurring the fixed overhead obligations associated with increased internally employed staff.
Our sales and marketing staff work with our studio resources to increase the visibility of new product launches and to coordinate the timing and promotion of product releases. Our finance and sales and marketing personnel work together to improve inventory management and receivables collections. We have instituted broad objective-based reward programs that provide incentives to management and staff throughout the organization to produce results that meet our financial objectives.
Grow Through Continued Strategic Acquisitions and Alliances. The interactive entertainment industry has been consolidating, and we believe that success in this industry will be driven in part by the ability to take advantage of scale. Specifically, smaller companies are more capital constrained, enjoy less predictability of revenues and cash flow, lack product diversity and must spread fixed costs over a smaller revenue base. Several industry leaders are emerging that combine the entrepreneurial and creative spirit of the industry with professional management, the ability to access the capital markets and the ability to maintain favorable relationships with developers, intellectual property owners and retailers. Through 15 completed acquisitions since 1997, we believe that we have successfully diversified our operations, our channels of distribution, our development talent pool and our library of titles, and have emerged as one of the industrys leaders. We intend to continue to evaluate the expansion of our resources through acquisitions, strategic relationships and key license transactions. We intend to continue expanding our intellectual property library through key license transactions and strategic relationships with intellectual property owners and to continue to evaluate opportunities to increase our development capacity through the acquisition of or investment in selected experienced software development firms.
Products
Historically we have been best known for our action/adventure, strategy and simulation products. With the successful introduction of the Tony Hawks Pro Skater brand, we have become a leader in the skateboarding category. We have also found success in the superheroes category with our release of titles based on the Spider-Man and X-MEN properties. We have also found recent success in the racing and first person action categories through two original intellectual properties, True Crime: Streets of L.A. and Call of Duty, both of which we hope to establish as successful long-term franchises. In addition, we have established ourselves as a leader in the value software publishing business with products under our Cabelas license, as well as with products distributed on behalf of our value affiliate label partners. Products published by us in this category are generally developed by third parties, often under contract with us, and are marketed under the Activision Value Publishing name. Value software is typically less sophisticated and less complex, both in terms of the development process and consumer gameplay.
Hardware Licenses. Our products currently are being developed or published primarily for PS2, Xbox and GameCube console systems, GBA hand-held device and PCs. In order to maintain general access to the console systems and hand-held device marketplace, we have maintained licenses for PS2, GameCube and Xbox console systems and GBA hand-held device with the owners of each such platform. Each license allows us to create multiple products for the applicable platform, subject to certain approval rights which are reserved by each licensor. Each license also requires that we pay the licensor a per unit royalty for each unit manufactured. In contrast, we are not required to obtain any license for the development and production of products for PCs.
Intellectual Property Rights. Many of our current and planned releases are based on intellectual property and other character or story rights licensed from third parties, as well as a combination of characters, worlds and concepts derived from our extensive library of titles, and original characters and concepts owned and created by us. When publishing products based on licensed intellectual property rights, we generally seek to capitalize on the name recognition, marketing efforts and goodwill associated with the underlying property. For Activision-owned intellectual property, we generally attempt to establish such properties as sustainable, long-term game franchises.
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In acquiring intellectual property rights from third parties, we seek to obtain rights to publish titles across a variety of platforms, to include the ability to produce multiple titles and to retain rights over an extended period of time. In past years, we have been able to enter into a series of long-term or multi-product agreements with owners of various intellectual properties that are well known throughout the world and to create products based on these recognizable characters, story lines or concepts. These agreements typically provide us with exclusive publishing rights for a specific period of time and, in some cases, for specified platforms. The scope of our licensing activities includes theatrical motion pictures, television shows, animated films and series, comic books, literary works, sports personalities and events and celebrities. We intend to continue expanding relationships with our existing intellectual property partners and to enter into agreements with other intellectual property owners for additional recognizable properties, characters, story lines and concepts. However, we may not be able to maintain or expand our existing relationships or to seek out and sustain new long-term relationships of similar caliber in the future.
Product Development and Support
We develop and produce titles using a model in which a core group of creative, production and technical professionals, in coordination with our marketing and finance departments, have responsibility for the entire development and production process including the supervision and coordination of internal and external resources. This team assembles the necessary creative elements to complete a title using, where appropriate, outside programmers, artists, animators, scriptwriters, musicians and songwriters, sound effects and special effects experts, and sound and video studios. We believe that this model allows us to supplement internal expertise with top quality external resources on an as-needed basis.
In addition, we often seek out and engage independent third-party developers to create products on our behalf. Such products are sometimes owned by us, and usually we have unlimited rights to commercially exploit these products. In other circumstances, the third-party developer may retain ownership of the intellectual property and/or technology included in the product and reserve certain exploitation rights. We typically select these independent third-party developers based on their expertise in developing products in a specific category and use the same developer to produce the same game for multiple platforms. Each of our third-party developers is under contract with us for specific or multiple titles. From time to time, we also acquire the license rights to publish and/or distribute software products that are or will be independently created by third-party developers. In such cases, the agreements with such developers provide us with exclusive publishing and/or distribution rights for a specific period of time, often for specified platforms and territories. In either case, we often have the ability to publish and/or distribute sequels, conversions, enhancements and add-ons to the product initially being produced by the independent developer and frequently have the right to engage the services of the original developer with regard to the development of such products.
In consideration for the services that the independent third-party developer provides, it receives a royalty generally based on net sales of the product that it has developed. Typically, the developer also receives an advance, which we recoup from the royalties otherwise payable to the developer. The advance generally is paid in milestone stages. The payment at each stage is tied to the completion and delivery of a detailed performance milestone. Working with an independent developer allows us to reduce our fixed development costs, share development risks with the third-party developer, take advantage of the third-party developers expertise in connection with certain categories of products or certain platforms, and gain access to proprietary development technologies.
From time to time, we may make a capital investment and hold a minority interest in a third-party developer in connection with interactive entertainment software products to be developed by such developer for us, which we believe helps to create a closer relationship between us and the developer. We account for those capital investments over which we have the ability to exercise significant influence using the equity method. For those investments over which we do not have the ability to exercise significant influence, we account for our investment using the cost method. There can be no assurance that we will realize long-term benefits from such investments or that we will continue to carry such investments at their current value.
Greenlight Process
We have adopted and implemented a rigorous procedure for the selection, development, production and quality assurance of our internally and externally produced interactive entertainment software titles. The process, known internally as the Greenlight Process, involves six phases throughout the development and production phases of a title, each of which includes a number of specific performance milestones. The six phases of the Greenlight Process are the concept, assessment, prototype, first playable, alpha and beta. This procedure is designed to enable
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us to manage and control production and development budgets and timetables, to identify and address production and technical issues at the earliest opportunity, and to coordinate marketing and quality control strategies throughout the production and development phases, all in an environment that fosters creativity. Checks and balances are intended to be provided through the structured interaction of the project team with our creative, technical, marketing and quality assurance/customer support personnel, as well as the legal, accounting and finance departments. In order to maintain the competitiveness of our products and to take advantage of increasingly sophisticated technology associated with hardware platforms, our development process includes a significant amount of time for play-testing new products and extensive product quality evaluations.
Product Support
We provide various forms of product support to both our internally and externally developed titles. Our quality assurance personnel are involved throughout the development and production of each title published by us. We subject all such products to extensive testing before release to ensure compatibility with all appropriate hardware systems and configurations and to minimize the number of bugs and other defects found in the products. To support our products after release, we provide online access to our customers on a 24-hour basis as well as operator help lines during regular business hours. The customer support group tracks customer inquiries, and we use this data to help improve the development and production processes.
Publishing Activities
Marketing
Our marketing efforts include online activities (such as the creation of World Wide Web pages to promote specific titles), public relations, print and broadcast advertising, coordinated in-store and industry promotions (including merchandising and point of purchase displays), participation in cooperative advertising programs, direct response vehicles, and product sampling through demonstration software distributed through the Internet or on compact discs. From time to time, we also receive marketing support from hardware manufacturers and retailers in connection with their own promotional efforts. In addition, certain of our products contain software that enables customers to electronically register their purchases with us online.
We believe that certain of our franchise properties have loyal and devoted audiences who purchase our sequels as a result of dedication to the property and satisfaction from previous product purchases. We therefore market these sequels both toward the established market as well as broader audiences. In addition, in marketing titles based on licensed properties, we believe that we derive benefits from the continued exploitation of these licensed properties and the marketing and promotional activities of the property owners.
Sales and Distribution
Domestic. Our products are available for sale or rental in thousands of retail outlets domestically. Our domestic customers include Best Buy, Blockbuster, Circuit City, Electronic Boutique, GameStop, Target, Toys R Us and Wal-Mart. Our largest customer, Wal-Mart, accounted for approximately 20% and 16% of our consolidated net revenues for fiscal 2004 and 2003, respectively.
In the United States and Canada, our products are sold primarily on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses and game specialty stores. We believe that a direct relationship with retail accounts results in more effective inventory management, merchandising and communications than would be possible through indirect relationships. We have implemented electronic data interchange linkages with many of our retailers to facilitate the placing and shipping of orders. We sell our products to a limited number of distributors.
International. 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. We conduct our international publishing activities through offices in the United Kingdom, Germany, France, Italy, Canada, Sweden, Australia, and Japan. Whenever practicable, we seek to maximize our worldwide revenues and profits by releasing high quality foreign language releases concurrently with English language releases and by continuing to expand the number of direct selling relationships we maintain with key retailers in major territories.
Affiliate Labels. In addition to our own products, we distribute a select number of interactive entertainment products that are developed and marketed by other third-party publishers through our affiliate label programs in
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North America and Europe. The distribution of other publishers products allows us to increase the efficiencies of our sales force and provides us with the ability to better ensure adequate shelf presence at retail stores for all of the products that we distribute. Distributing other publishers titles mitigates the risk associated with a particular title or titles published by us failing to achieve expectations. Services provided by us under our affiliate label program include order solicitation, in-store marketing, logistics and order fulfillment, sales channel management, as well as other accounting and general administrative functions. Our current affiliate label partners include LucasArts, as well several affiliate label partners in our value business. Each affiliate label relationship is unique and may pertain only to distribution in certain geographic territories such as the United States or Europe and may be further limited only to specific titles or titles for specific platforms.
Distribution
We distribute interactive entertainment hardware and software products in Europe through our European distribution subsidiaries, Centresoft in the United Kingdom, NBG in Germany and CD Contact in the Benelux countries. These subsidiaries act as wholesalers in the distribution of products and also provide packaging, logistical and sales services, and in some cases, product localization for certain vendors. They provide services to our publishing operations and to various third-party publishers, including Sony, Nintendo and Microsoft. Centresoft is Sonys exclusive distributor of PlayStation products to the independent channel in the United Kingdom. In the fiscal year ended March 31, 2004, sales for Sony, Nintendo and Microsoft accounted for approximately 23%, 5% and 4%, respectively, of our worldwide distribution net revenues.
We acquired Centresoft and NBG in 1997 and CD Contact in 1998. We entered into the distribution business to obtain distribution capacity in Europe for our own products, while supporting the distribution infrastructure with third-party sales, and to diversify our operations into the European market. Centresoft and our other distribution subsidiaries operate in accordance with strict confidentiality procedures in order to provide independent services to various third-party publishers.
Emerging Technologies
We are actively supporting emerging platforms (wireless devices, closed and open online networks, and interactive television) by publishing and licensing key brands, such as Shrek 2, Tony Hawks Underground, and Call of Duty for these emerging platforms. We also develop and optimize our titles for consoles that support online play, such as PS2 and Xbox. Currently, we have released versions of Tony Hawks Pro Skater titles and Tony Hawks Underground for the PS2s online service, as well as MTX: Mototrax, Jedi Knight: Jedi Academy, Return to Castle Wolfenstein, Soldier of Fortune 2 and Tenchu: Return from Darkness for Xbox Live, Microsofts online service. We have published and licensed rights to various brands, such as Spider-Man 2: The Movie, for various hand-held wireless devices, such as Nokias N-Gage wireless platform, as well as many traditional wireless handsets. We believe that more of our brands can be successfully published for wireless and online platforms, as well as exploited through other emerging technologies, as they continue to evolve.
Manufacturing
We prepare a set of master program copies, documentation and packaging materials for our products for each hardware platform on which the product will be released. Except with respect to products for use on the Sony, Nintendo and Microsoft systems, our disk duplication, packaging, printing, manufacturing, warehousing, assembly and shipping are performed by third-party subcontractors.
To maintain protection over their hardware technologies, Sony, Nintendo and Microsoft generally specify or control the manufacturing and assembly of finished products. We deliver the master materials to the licensor or its approved replicator, which then manufactures finished goods and delivers them to us for distribution under our label. At the time our product unit orders are filled by the manufacturer, we become responsible for the costs of manufacturing and the applicable per unit royalty on such units, even if the units do not ultimately sell.
To date, we have not experienced any material difficulties or delays in the manufacture and assembly of our products or material returns due to product defects.
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Competition
The interactive entertainment industry is extremely competitive. The availability of significant financial resources has become a major competitive factor in the industry primarily as a result of the escalating development, acquisition, production and marketing budgets required to publish quality titles. In addition, competitors with larger product lines and popular titles typically have greater leverage with retailers, distributors and other customers who may be willing to promote titles with less consumer appeal in return for access to such competitors most popular titles.
Employees
As of March 31, 2004, we had 1,324 employees, including 688 in product development, 129 in North American publishing, 104 in international publishing, 114 in operations, corporate finance and administration, and 289 in European distribution activities.
As of March 31, 2004, 178 of our full-time employees were subject to term employment agreements with us. These agreements generally commit such employees to employment terms of between one and five years from the commencement of their respective agreements. Most of the employees subject to such agreements are executive officers or key members of the product development, sales or marketing divisions. These individuals perform services for us as executives, directors, producers, associate producers, computer programmers, game designers, sales directors and marketing product managers. The execution by us of employment agreements with such employees, in our experience, reduces our turnover during the development, production and distribution phases of our entertainment software products and allows us to plan more effectively for future development and marketing activities.
None of our employees is subject to a collective bargaining agreement except for the employees of our German distribution subsidiary who are allowed by German law to belong to an organized labor council. To date, we have not experienced any labor-related work stoppages.
Factors Affecting Future Performance
In connection with the Private Securities Litigation Reform Act of 1995 (the Litigation Reform Act), we are hereby disclosing certain cautionary information to be used in connection with written materials (including this Annual Report on Form 10-K) and oral statements made by or on behalf of our employees and representatives that may contain forward-looking statements within the meaning of the Litigation Reform Act. Such statements consist of any statement other than a recitation of historical fact and can be identified by the use of forward-looking terminology such as may, expect, anticipate, estimate or continue or the negative thereof or other variations thereon or comparable terminology. You are cautioned that all forward-looking statements are necessarily speculative and there are numerous risks and uncertainties that could cause actual events or results to differ materially from those referred to in such forward-looking statements. These forward looking statements are subject to business and economic risk and reflect managements current expectations and are inherently uncertain and difficult to predict. The discussion below highlights some of the more important risks identified by management, but should not be assumed to be the only factors that could affect future performance. You are cautioned that we do not have a policy of updating or revising forward-looking statements, and thus you should not assume that silence by management over time means that actual events are bearing out as estimated in such forward-looking statements.
We depend on a relatively small number of brands for a significant portion of our revenues and profits.
A significant portion of our revenues is derived from products based on a relatively small number of popular brands each year, and these products are responsible for a disproportionate amount of our profits. In addition, many of these products have substantial production or acquisition costs and marketing budgets. In fiscal 2004, 31% of our consolidated net revenues (44% of worldwide publishing net revenues) was derived from two brands, one of which accounted for 17% and the other of which accounted for 14% of consolidated net revenues (24% and 20%, respectively, of worldwide publishing net revenues). In fiscal 2003, 38% of our consolidated net revenues (52% of worldwide publishing net revenues) was derived from two brands, one of which accounted for 20% and the other of which accounted for 18% of consolidated net revenues (27% and 25%, respectively, of worldwide publishing net revenues). In fiscal 2002, two brands accounted for 35% of our consolidated net revenues (50% of worldwide publishing net revenues), one of which accounted for 31% and the other of which accounted for 4% of consolidated net revenues (44% and 6%, respectively, of worldwide publishing net revenues). We expect that a limited number of popular brands will continue to produce a disproportionately large amount of our revenues and profits. Due to this
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dependence on a limited number of brands, the failure to achieve anticipated results by one or more products based on these brands may significantly harm our business and financial results.
Our future success depends on our ability to release popular products.
The life of any one game product is relatively short, in many cases less than one year. It is therefore important for us to be able to continue to develop many high quality new products that are popularly received. We focus our development and publishing activities principally on products that are, or have the potential to become, franchise brand properties. If we are unable to do this, our business and financial results may be negatively affected.
If we are unable to maintain or acquire licenses to intellectual property, we may publish fewer hit titles and our revenue may decline.
Many of our products are based on intellectual property and other character or story rights acquired or licensed from third parties. These license and distribution agreements are limited in scope and time, and we may not be able to renew key licenses when they expire or to include new products in existing licenses. The loss of a significant number of our intellectual property licenses or of our relationships with licensors, or inability to obtain additional licenses of significant commercial value could have a material adverse effect on our ability to develop new products and therefore on our business and financial results. Additionally, the failure of intellectual property acquired by us to be popularly received could impact the market acceptance of our products in which the intellectual property is included. Such lack of market acceptance could result in the write-off of the unrecovered portion of acquired intellectual property assets, which could cause material harm to our business and financial results.
Transitions in console platforms could have a material impact on the market for interactive entertainment software.
When new console platforms are announced or introduced into the market, consumers typically reduce their purchases of game console entertainment software products for current console platforms in anticipation of new platforms becoming available. During these periods, sales of our game console entertainment software products may be expected to slow or even decline until new platforms are introduced and achieve wide consumer acceptance. Each of the three current principal hardware producers launched a new platform in recent years. In calendar 2003, Sony announced that it would be entering the hand-held hardware market with the introduction of its hand-held gaming device, PSP. PSP is currently expected to be released in the United States toward the end of the first quarter of calendar 2005. Most recently, Nintendo also announced that it plans to launch a new dual-screened, portable game system, NDS, before the end of calendar 2004. We are currently developing titles for the PSP and the NDS with the objective of having one or more titles at launch for each of these platforms. The introduction of PSP and NDS may have a negative effect on the sale of our GBA titles. We are also planning to develop titles for the next generation console systems expected to be developed by Sony, Microsoft and Nintendo for release in the next two to three years. We estimate that the next console hardware transition cycle will commence in late calendar 2005 or calendar 2006. Delays in the launch, shortages, technical problems or lack of consumer acceptance of the next generation platforms could adversely affect our sales of products for these platforms.
We must make significant expenditures to develop products for new platforms which may not be successful or released when anticipated.
The interactive entertainment software industry is subject to rapid technological change. New technologies could render our current products or products in development obsolete or unmarketable. We must continually anticipate and assess the emergence and market acceptance of new interactive entertainment hardware platforms well in advance of the time the platform is introduced to consumers. New platforms have historically required the development of new software and also have the effect of undermining demand for products based on older technologies. Because product development cycles are difficult to predict, we must make substantial product development and other investments in a particular platform well in advance of introduction of the platform. If the platforms for which we develop new software products or modify existing products are not released on a timely basis or do not attain significant market penetration, or if we develop products for a delayed or unsuccessful platform, we may not be able to recover in revenues our development costs, which could be significant, and our business and financial results could be significantly harmed.
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We are exposed to seasonality in the purchases of our products.
The interactive entertainment software industry is highly seasonal, with the highest levels of consumer demand occurring during the year-end holiday buying season. As a result, our net revenues, gross profits and operating income have historically been highest during the second half of the calendar year. Additionally, in a platform transition period, sales of game console software products can be significantly affected by the timeliness of introduction of game console platforms by the manufacturers of those platforms, such as Sony, Microsoft and Nintendo. The timing of hardware platform introduction is also often tied to holidays and is not within our control. If a hardware platform is released unexpectedly close to the holidays, this would result in a shortened holiday buying season and could negatively impact the sales of our products. Further, delays in development, licensor approvals or manufacturing can also affect the timing of the release of our products, causing us to miss key selling periods such as the year-end holiday buying season.
We depend on skilled personnel.
Our success depends to a significant extent on our ability to identify, hire and retain skilled personnel. The software industry is characterized by a high level of employee mobility and aggressive recruiting among competitors for personnel with technical, marketing, sales, product development and management skills. We may not be able to attract and retain skilled personnel or may incur significant costs in order to do so. If we are unable to attract additional qualified employees or retain the services of key personnel, our business and financial results could be negatively impacted.
Our platform licensors are our chief competitors and frequently control the manufacturing of and have broad approval rights over our video game products.
Generally, when we develop interactive entertainment software products for hardware platforms offered by Sony, Nintendo or Microsoft, the products are manufactured exclusively by that hardware manufacturer or their approved replicator.
Our agreements with these manufacturers include certain provisions, such as approval rights over all products and related promotional materials and the ability to change the fee they charge for the manufacturing of products, that allow them substantial influence over our costs and the release schedule of our products. In addition, since each of the manufacturers is also a publisher of games for its own hardware platforms and manufactures products for all of its other licensees, a manufacturer may give priority to its own products or those of our competitors in the event of insufficient manufacturing capacity. Accordingly, Sony, Nintendo or Microsoft could cause unanticipated delays in the release of our products as well as increases to our development, manufacturing, marketing or distribution costs, which could materially harm our business and financial results.
In addition, as online capabilities for video game platforms emerge, our platform licensors will control our ability to provide online game capabilities for our console platform products and will in large part establish the financial terms on which these services are offered to consumers. Currently, both Microsoft and Sony provide online capabilities for Xbox and PS2 products, respectively. In each case, compatibility code and the consent of the licensor are required for us to include online capabilities in our products. In addition, the business model for Microsofts and Sonys online businesses for their video game products may compete with our online business. As these capabilities become more significant, the failure or refusal of our licensors to approve our products, or the successful deployment by these licensors of services competitive to ours, may harm our business.
Our platform licensors set the royalty rates and other fees that we must pay to publish games for their platforms, and therefore have significant influence on our costs.
We pay a licensing fee to the hardware manufacturer for each copy of a product manufactured for that manufacturers game platform. In the next few years, we expect our platform licensors to introduce new hardware platforms into the market. In order to publish products for new hardware platforms, we must take a license from the platform licensor which gives the platform licensor the opportunity to set the fee structure that we must pay in order to publish games for that platform. Similarly, the platform licensors have retained the flexibility to change their fee structures for online gameplay and features for their consoles and the manufacturing of products. The control that platform licensors have over the fee structures for their future platforms and online access makes it difficult for us to predict our costs and profitability in the medium to long term. Because publishing products for console systems is the
11
largest portion of our business, any increase in fee structures would have a significant negative impact on our business model and profitability.
If our products contain defects, our business could be harmed significantly.
Software products as complex as the ones we publish may contain undetected errors when first introduced or when new versions are released. Despite extensive testing prior to release, we cannot be certain that errors will not be found in new products or releases after shipment, that could result in loss of or delay in market acceptance. This loss or delay could significantly harm our business and financial results.
Inadequate intellectual property protections could prevent us from enforcing or defending our proprietary technology.
We regard our software as proprietary and rely on a combination of copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements and other methods to protect our proprietary rights. We own or license various copyrights and trademarks. Although we provide shrinkwrap license agreements or limitations on use with our software, it is uncertain to what extent these agreements and limitations are enforceable. We are aware that some unauthorized copying occurs within the computer software industry, and if a significantly greater amount of unauthorized copying of our interactive entertainment software products were to occur, it could cause material harm to our business and financial results.
Policing unauthorized use of our products is difficult, and software piracy is a persistent problem, especially in some international markets. Further, the laws of some countries where our products are or may be distributed either do not protect our products and intellectual property rights to the same extent as the laws of the United States, or are poorly enforced. Legal protection of our rights may be ineffective in such countries. Moreover, as we leverage our software products using emerging technologies such as the Internet and online services, our ability to protect our intellectual property rights and to avoid infringing intellectual property rights of others may diminish. We cannot be certain that existing intellectual property laws will provide adequate protection for our products in connection with these emerging technologies.
We may be subject to intellectual property claims.
As the number of interactive entertainment software products increases and the features and content of these products continue to overlap, software developers increasingly may become subject to infringement claims. Many of our products are highly realistic and feature materials that are based on real world examples, which may inadvertently infringe upon the intellectual property rights of others. Our products often utilize complex, cutting edge technology that may become subject to the intellectual property rights of others. Although we believe that we make reasonable efforts to ensure that our products do not violate the intellectual property rights of others, it is possible that third parties still may claim infringement. From time to time, we receive communications from third parties regarding such claims. Existing or future infringement claims against us, whether valid or not, may be time consuming and expensive to defend.
Intellectual property litigation or claims could force us to do one or more of the following:
Cease selling, incorporating or using products or services that incorporate the challenged intellectual property;
Obtain a license from the holder of the infringed intellectual property, which if available at all, may not be available on commercially favorable terms; or
Redesign the effected interactive entertainment software products, which could cause us to incur additional costs, delay introduction and possibly reduce commercial appeal of our products.
Any of these actions may cause material harm to our business and financial results.
We rely on independent third parties to develop some of our software products.
We rely on independent third-party interactive entertainment software developers to develop some of our software products. Since we depend on these developers in the aggregate, we remain subject to the following risks:
12
Continuing strong demand for developers resources, combined with the recognition they receive in connection with their work, may cause developers who worked for us in the past either to work for our competitors in the future or to renegotiate our agreements with them on terms less favorable for us.
Limited financial resources and business expertise and inability to retain skilled personnel may force developers out of business prior to completing our products or require us to fund additional costs.
Our competitors may acquire the businesses of key developers or sign them to exclusive development arrangements. In either case, we would not be able to continue to engage such developers services for our products, except for those that they are contractually obligated to complete for us.
Increased competition for skilled third-party software developers also has compelled us to agree to make significant advance payments on royalties to game developers. If the products subject to these arrangements do not generate sufficient revenues to recover these royalty advances, we would have to write-off unrecovered portions of these payments, which could cause material harm to our business and financial results. Typically, we pay developers a royalty based on a percentage of net revenue, less agreed upon deductions, but in a few cases, we have agreed to pay developers fixed per unit product royalties after royalty advances are fully recouped. To the extent that sales prices of products on which we have agreed to pay a fixed per unit royalty are marked down, our profitability could be adversely affected.
We operate in a highly competitive industry.
The interactive entertainment software industry is intensely competitive and new interactive entertainment software products and platforms are regularly introduced. Our competitors vary in size from small companies with limited resources to very large corporations with significantly greater financial, marketing and product development resources than we have. Due to these greater resources, certain of our competitors can spend more money and time on developing and testing products, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, pay higher fees to licensors for desirable motion picture, television, sports and character properties and pay more to third-party software developers than we can. We believe that the main competitive factors in the interactive entertainment software industry include: product features and playability; brand name recognition; compatibility of products with popular platforms; access to distribution channels; quality of products; ease of use; price; marketing support; and quality of customer service.
We compete primarily with other publishers of personal computer and video game console interactive entertainment software. Significant third-party software competitors currently include, among others: Atari, Inc.; Capcom Co. Ltd.; Eidos PLC; Electronic Arts Inc.; Konami Company Ltd.; Namco Ltd.; Sega Enterprises, Ltd.; Take-Two Interactive Software, Inc.; THQ Inc.; Ubi Soft Entertainment and Vivendi Universal Publishing. In addition, integrated video game console hardware and software companies such as Sony Computer Entertainment, Nintendo Co. Ltd. and Microsoft Corporation compete directly with us in the development of software titles for their respective platforms.
We also compete with other forms of entertainment and leisure activities. For example, we believe that the overall growth in the use of the Internet and online services by consumers may pose a competitive threat if customers and potential customers spend less of their available time using interactive entertainment software and more using the Internet and online services.
We may face difficulty obtaining access to retail shelf space necessary to market and sell our products effectively.
Retailers of our products typically have a limited amount of shelf space and promotional resources, and there is intense competition among consumer interactive entertainment software products for high quality retail shelf space and promotional support from retailers. To the extent that the number of products and platforms increases, competition for shelf space may intensify and may require us to increase our marketing expenditures. Retailers with limited shelf space typically devote the most and highest quality shelf space to those products expected to be best sellers. We cannot be certain that our new products will consistently achieve such best seller status. Due to increased competition for limited shelf space, retailers and distributors are in an increasingly better position to negotiate favorable terms of sale, including price discounts, price protection, marketing and display fees and product return policies. Our products constitute a relatively small percentage of any retailers sales volume, and we cannot be certain that retailers will continue to purchase our products or to provide our products with adequate levels of shelf
13
space and promotional support on acceptable terms. A prolonged failure in this regard may significantly harm our business and financial results.
Our sales may decline substantially without warning and in a brief period of time because we do not have long-term contracts for the sale of our products.
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. 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 sales are made primarily on a purchase order basis without long-term agreements or other forms of commitments. Our largest customer, Wal-Mart, accounted for approximately 20% and 16% of our consolidated net revenues for fiscal 2004 and 2003, respectively. The loss of, or significant reduction in sales to, any of our principal retail customers or distributors could significantly harm our business and financial results.
We may permit our customers to return our products and to receive pricing concessions which could reduce our net revenues and results of operations.
We are exposed to the risk of product returns and price protection with respect to our distributors and retailers. Return policies allow distributors and retailers to return defective, shelf-worn and damaged products in accordance with terms granted. Price protection, when granted and applicable, allows customers a credit against amounts they owe us with respect to merchandise unsold by them. We may permit product returns from, or grant price protection to, our customers under certain conditions. The conditions our customers must meet to be granted the right to return products or price protection are, among other things, compliance with applicable payment terms, delivery to us of weekly inventory and sell-through reports, and consistent participation in the launches of our premium title releases. We may also consider other factors, including the facilitation of slow-moving inventory and other market factors. When we offer price protection, we offer it with respect to a particular product to all of our retail customers; however, only those customers who meet the conditions detailed above can avail themselves of such price protection. We also offer a 90-day limited warranty to our end users that our products will be free from manufacturing defects. Although we maintain a reserve for returns and price protection, and although we may place limits on product returns and price protection, we could be forced to accept substantial product returns and provide substantial price protection to maintain our relationships with retailers and our access to distribution channels. Product returns and price protection that exceed our reserves could significantly harm our business and financial results.
We may be burdened with payment defaults and uncollectible accounts if our distributors or retailers cannot honor their credit arrangement with us.
Distributors and retailers in the interactive entertainment software industry have from time to time experienced significant fluctuations in their businesses, and a number of them have failed. The insolvency or business failure of any significant retailer or distributor of our products could materially harm our business and financial results. We typically make sales to most of our retailers and some distributors on unsecured credit, with terms that vary depending upon the customers credit history, solvency, credit limits and sales history, as well as whether we can obtain sufficient credit insurance. Although, as in the case with most of our customers, we have insolvency risk insurance to protect against our customers bankruptcy, insolvency or liquidation, this insurance contains a significant deductible and a co-payment obligation, and the policy does not cover all instances of non-payment. In addition, although we maintain a reserve for uncollectible receivables, the reserve may not be sufficient in every circumstance. As a result, a payment default by a significant customer could significantly harm our business and financial results.
We may not be able to maintain our distribution relationships with key vendors.
Our CD Contact, NBG and Centresoft subsidiaries distribute interactive entertainment software and hardware products and provide related services in the Benelux countries, Germany and the United Kingdom, respectively, and via export in other European countries for a variety of entertainment software publishers, many of which are our competitors, and hardware manufacturers. These services are generally performed under limited term contracts. Although we expect to use reasonable efforts to retain these vendors, we may not be successful in this regard. The cancellation or non-renewal of one or more of these contracts could significantly harm our business and financial results. Sony, Nintendo and Microsoft products accounted for approximately 23%, 5% and 4%, respectively, of our worldwide distribution net revenues for fiscal 2004.
14
Our international revenues may be subject to regulatory requirements as well as currency fluctuations.
Our international revenues have accounted for a significant portion of our total revenues. International sales and licensing accounted for 53%, 50% and 49% of our consolidated net revenues in fiscal 2004, 2003 and 2002, respectively. We expect that international revenues will continue to account for a significant portion of our total revenues in the future. International sales may be subject to unexpected regulatory requirements, tariffs and other barriers. Additionally, foreign sales that are made in local currencies may fluctuate. We have and may continue to engage in limited currency hedging activities. Currency exchange rates fluctuations may in the future have a material positive or negative impact on revenues from international sales and licensing and thus our business and financial results.
Our business, our products and our distribution are subject to increasing regulation in key territories of content, consumer piracy and online delivery. If we do not successfully respond to these regulations, our business may suffer.
Legislation is continually being introduced that may affect both the content of our products and their distribution. For example, privacy laws in the United States and Europe impose various restrictions on our web sites. Those rules vary by territory although the Internet recognizes no geographical boundaries. In addition, many foreign countries have laws that permit governmental entities to censor the content and advertising of interactive entertainment software. Other countries, such as Germany, have adopted laws regulating content both in packaged goods and those transmitted over the Internet that are stricter than current United States laws. In the United States, federal and several state governments are considering content restrictions on products such as ours, as well as restrictions on distribution of such products. We may be required to modify our products or alter our marketing strategies to comply with new regulations, which could delay the release of our products in those countries. Due to the uncertainties regarding such regulations, confusion in the marketplace may occur, and we are unable to predict what effect, if any, such regulations would have on our business.
In addition to such regulations, certain retailers have in the past declined to stock some of our products because they believed that the content of the packaging artwork or the products would be offensive to the retailers customer base. Although to date these actions have not caused material harm to our business, we cannot assure you that similar actions by our distributors or retailers in the future would not cause material harm to our business.
Our products may be subject to legal claims.
In prior fiscal years, two lawsuits, Linda Sanders, et al. v. Meow Media, Inc., et al., United States District Court for the District of Colorado, and Joe James, et al. v. Meow Media, Inc., et al., United States District Court for the Western District of Kentucky, Paducah Division, have been filed against numerous video game companies, including us, by the families of victims who were shot and killed by teenage gunmen in attacks perpetrated at schools. These lawsuits alleged that the video game companies manufactured and/or supplied these teenagers with violent video games, teaching them how to use a gun and causing them to act out in a violent manner. These lawsuits have been dismissed. Similar additional lawsuits may be filed in the future. Although our general liability insurance carrier agreed to defend us in such lawsuits in the past, it is uncertain whether the insurance carrier would do so in the future, or if it would cover all or any amounts which we might be liable for if such future lawsuits are not decided in our favor. If such future lawsuits are filed and ultimately decided against us and our insurance carrier does not cover the amounts we are liable for, it could have a material adverse effect on our business and financial results. Payment of significant claims by insurance carriers may make such insurance coverage materially more expensive or unavailable in the future, thereby exposing our business to additional risk.
We may face limitations on our ability to find suitable acquisition opportunities or to integrate additional acquired businesses.
We intend to pursue additional acquisitions of companies, properties and other assets that can be purchased or licensed on acceptable terms and which we believe can be operated or exploited profitably. Some of these transactions could be material in size and scope. Although we continue to search for additional acquisition opportunities, we may not be successful in identifying suitable acquisitions. As the interactive entertainment software industry continues to consolidate, we face significant competition in seeking and consummating acquisition opportunities. We may not be able to consummate potential acquisitions or an acquisition may not enhance our business or may decrease rather than increase our earnings. In the future, we may issue additional shares of our common stock in connection with one or more acquisitions, which may dilute our existing shareholders. Future acquisitions could also divert substantial management time and result in short-term reductions in earnings or special transaction or other charges. In addition,
15
we cannot guarantee that we will be able to successfully integrate the businesses that we may acquire into our existing business. Our shareholders may not have the opportunity to review, vote on or evaluate future acquisitions.
Our shareholder rights plan, charter documents and other agreements may make it more difficult to acquire us without the approval of our Board of Directors.
We have adopted a shareholder rights plan under which one right entitling the holder to purchase one one-hundredths (1/100) of a share of our Series A Junior Preferred Stock price at an exercise price of $40 per share (subject to adjustment) is attached to each outstanding share of common stock. Such shareholder rights plan makes an acquisition of control in a transaction not approved by our Board of Directors more difficult. Our Amended and Restated By-laws have advance notice provisions for nominations for election of nominees to the Board of Directors which may make it more difficult to acquire control of us. Our long-term incentive plans provide, in the discretion of a committee, for acceleration of stock options following a change in control under certain circumstances, which has the effect of making an acquisition of control more expensive. In addition, some of our officers have severance compensation agreements that provide for substantial cash payments and accelerations of other benefits in the event of a change in control. These agreements and arrangements may also inhibit a change in control.
Our reported financial results could be affected if significant changes in current accounting principles are adopted.
Recent actions and public comments from the Securities and Exchange Commission have focused on the integrity of financial reporting generally. Similarly, Congress has considered a variety of bills that could affect certain accounting principles. The Financial Accounting Standards Board and other regulatory accounting agencies have recently introduced several new or proposed accounting standards, such as accounting for stock options, some of which represent a significant change from current practices. Changes in our accounting for stock options could materially increase our reported expenses.
Our stock price is highly volatile.
The trading price of our common stock has been and could continue to be subject to wide fluctuations in response to many factors, including:
Quarter to quarter variations in results of operations
Our announcements of new products
Our competitors announcements of new products
Our product development or release schedule
General conditions in the computer, software, entertainment, media or electronics industries and in the economy
Timing of the introduction of new platforms and delays in the actual release of new platforms
Hardware manufacturers announcements of price reductions in hardware platforms
Changes in earnings estimates or buy/sell recommendations by analysts
Investor perceptions and expectations regarding our products, plans and strategic position and those of our competitors and customers
In addition, the public stock markets experience extreme price and trading volume volatility, particularly in high technology sectors of the market. This volatility has significantly affected the market prices of securities of many technology companies for reasons often unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.
16
We seek to manage our business with a view to achieving long-term results, and this could have a negative effect on short-term trading.
We focus on creation of shareholder value over time, and we intend to make decisions that will be consistent with this long-term view. As a result, some of our decisions, such as whether to make or discontinue operating investments, manage our balance sheet and capital structure, or pursue or discontinue strategic initiatives, may be in conflict with the objectives of short-term traders. Further, this could adversely affect our quarterly or other short-term results of operations.
We do not pay cash dividends on our common stock.
We have not paid any cash dividends on our common stock nor do we anticipate paying cash dividends in the near future.
Financial Information about Foreign and Domestic Operations and Export Sales
See Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 10 of Notes to Consolidated Financial Statements included in Item 8.
Available Information
You can obtain additional information about Activision from our website at http://www.activision.com. Furthermore, our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge and through our website.
17
Item 2. PROPERTIES
Our principal corporate and administrative offices are located in approximately 114,700 square feet of leased space in a building located at 3100 Ocean Park Boulevard, Santa Monica, California 90405. The following is a listing of the principal offices maintained by us on May 26, 2004:
PROPERTY |
|
LOCATION |
|
SQ FT |
|
OWNERSHIP |
|
LEASE EXPIRATION |
|
|
|
|
|
|
|
|
|
Corporate Offices |
|
Santa Monica, CA, USA |
|
114,700 |
|
Lease |
|
April 2007 |
|
|
|
|
|
|
|
|
|
Product Development Facilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gray Matter Interactive Studios, Inc. |
|
Los Angeles, CA, USA |
|
10,000 |
|
Lease |
|
May 2005 |
Infinity Ward, Inc. |
|
Encino, CA, USA |
|
11,200 |
|
Lease |
|
February 2006 |
Luxoflux, Inc. |
|
Santa Monica, CA, USA |
|
12,400 |
|
Lease |
|
January 2005 |
Neversoft Entertainment, Inc. |
|
Woodland Hills, CA, USA |
|
27,400 |
|
Lease |
|
July 2005 |
Raven Studios |
|
Madison, WI, USA |
|
25,900 |
|
Lease |
|
December 2005 |
Shaba Games, Inc. |
|
San Francisco, CA, USA |
|
15,800 |
|
Lease |
|
February 2008 |
Treyarch Corporation |
|
Santa Monica, CA, USA |
|
37,000 |
|
Lease |
|
November 2009 |
Z-Axis, Ltd. |
|
Hayward, CA, USA |
|
18,500 |
|
Lease |
|
June 2005 |
|
|
|
|
|
|
|
|
|
Publishing Facilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Australia Publishing |
|
Sydney, Australia |
|
7,300 |
|
Lease |
|
July 2006 |
France Publishing |
|
Bezons, France |
|
3,800 |
|
Lease |
|
October 2006 |
German Publishing |
|
Burglengenfeld, Germany |
|
2,200 |
|
Own |
|
N/A |
Japan Publishing |
|
Tokyo, Japan |
|
2,300 |
|
Lease |
|
March 2006 |
United Kingdom Publishing |
|
Slough, UK |
|
8,200 |
|
Lease |
|
September 2010 |
Value Publishing |
|
Eden Prairie, MN, USA |
|
14,000 |
|
Lease |
|
May 2008 |
Italy Publishing |
|
Legnano, Italy |
|
2,700 |
|
Lease |
|
October 2008 |
|
|
|
|
|
|
|
|
|
Distribution Facilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
German Distribution |
|
Burglengenfeld, Germany |
|
55,700 |
|
Own |
|
N/A |
Netherlands Distribution-offices |
|
Breda, the Netherlands |
|
4,200 |
|
Lease |
|
January 2007 |
Netherlands Distribution-warehouse |
|
Venlo, the Netherlands |
|
44,600 |
|
Own |
|
N/A |
United Kingdom Distribution |
|
Birmingham, UK |
|
182,089 |
|
Lease |
|
May 2011-2018 |
Our publishing operations additionally lease facilities in Canada, Minnesota, New York, Texas and Sweden for purposes of sales and branch offices.
Item 3. LEGAL 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 have subsequently been filed by Gianni Angeloni, Christopher Hinton, Stephen Anish, the Alaska Electrical Pension Fund, and Joseph A. Romans asserting the same claims. Five of the six actions have been transferred to the same court where the first-filed complaint was pending. In addition, on March 12, 2004, a shareholder derivative lawsuit 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 Superior Court for the County of Los Angeles. We strongly deny these allegations and will vigorously defend these cases.
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 appears to be focused on certain accounting practices common to the interactive entertainment industry, with specific emphasis on revenue recognition. In connection with this inquiry, the Securities and Exchange Commission submitted to us a request for information. We responded to this
18
inquiry on September 2, 2003. To date, we have not received a request from the Securities and Exchange Commission for any additional information. 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 has advised us 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 have cooperated and intend to continue to cooperate fully with the Securities and Exchange Commission in the conduct of this inquiry.
On June 30, 2003, we terminated our Star Trek Merchandising License Agreement with Viacom Consumer Products, Inc. and filed a complaint in the Superior Court of the State of California for breach of contract and constructive trust against Viacom Consumer Products and Viacom International, Inc. (Viacom). On August 15, 2003, Viacom filed its response to our complaint as well as a cross-complaint alleging, among other matters, a breach of contract by Activision and seeking claimed damages in excess of $50 million. We strongly dispute the claims by Viacom, consider the damages alleged by Viacom to be speculative and without merit, and intend to defend vigorously and aggressively against the cross-complaint.
In addition, w e 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.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
19
Item 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is quoted on the Nasdaq National Market under the symbol ATVI.
The following table sets forth for the periods indicated the high and low reported sale prices for our common stock. As of May 26, 2004, there were approximately 2,840 holders of record of our common stock.
|
|
High |
|
Low |
|
||
Fiscal 2003 |
|
|
|
|
|
||
First Quarter ended June 30, 2002 |
|
$ |
15.60 |
|
$ |
11.70 |
|
Second Quarter ended September 30, 2002 |
|
14.02 |
|
9.91 |
|
||
Third Quarter ended December 31, 2002 |
|
10.61 |
|
5.42 |
|
||
Fourth Quarter ended March 31, 2003 |
|
7.00 |
|
5.79 |
|
||
|
|
|
|
|
|
||
Fiscal 2004 |
|
|
|
|
|
||
First Quarter ended June 30, 2003 |
|
$ |
8.99 |
|
$ |
6.01 |
|
Second Quarter ended September 30, 2003 |
|
9.58 |
|
7.23 |
|
||
Third Quarter ended December 31, 2003 |
|
12.73 |
|
7.71 |
|
||
Fourth Quarter ended March 31, 2004 |
|
16.17 |
|
11.38 |
|
On May 26, 2004, the last reported sales price of our common stock was $15.88.
Dividends
We paid no cash dividends in 2004 or 2003 nor do we anticipate paying any cash dividends at any time in the foreseeable future. We expect that earnings will be retained for the continued growth and development of the business. Future dividends, if any, will depend upon our earnings, financial condition, cash requirements, future prospects and other factors deemed relevant by our Board of Directors.
Stock Splits
In April 2003, the Board of Directors approved a three-for-two split of our outstanding common shares effected in the form of a 50% stock dividend. The split was paid on June 6, 2003 to shareholders of record as of May 16, 2003. In February 2004, the Board of Directors approved a second 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.
Buyback Program
During fiscal 2003, our Board of Directors authorized a buyback program under which we can repurchase up to $350.0 million of our common stock. Under the program, shares may be purchased as determined by management, from time to time and within certain guidelines, in the open market or in privately negotiated transactions, including privately negotiated structured stock repurchase 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.
Under the buyback program, we repurchased approximately 1.9 million shares of our common stock for $12.4 million and 16.2 million shares of our common stock for $101.4 million, in the years ended March 31, 2004 and 2003, respectively. In addition, approximately 1.7 million shares of common stock were acquired in the year ended March 31, 2004 as a result of the settlement of $10.0 million of structured stock repurchase transactions entered into in fiscal 2003. As of March 31, 2004, we had no outstanding structured stock repurchase transactions. These transactions are settled in cash or stock based on the market price of our common stock on the date of the settlement.
20
Upon settlement, we either have our capital investment returned with a premium or receive shares of our common stock, depending, respectively, on whether the market price of our common stock is above or below a pre-determined price agreed in connection with each such transaction.
Shareholders Rights Plan
On April 18, 2000, our Board of Directors approved a shareholders rights plan (the Rights Plan). Under the Rights Plan, each common shareholder at the close of business on April 19, 2000 received a dividend of one right for each share of common stock held. Each right represents the right to purchase one one-hundredths (1/100) of a share of our Series A Junior Preferred Stock at an exercise price of $40.00. Initially, the rights are represented by our common stock certificates and are neither exercisable nor traded separately from our common stock. The rights will only become exercisable if a person or group acquires 15% or more of the common stock of Activision, or announces or commences a tender or exchange offer which would result in the bidders beneficial ownership of 15% or more of our common stock.
In the event that any person or group acquires 15% or more of our outstanding common stock, each holder of a right (other than such person or members of such group) will thereafter have the right to receive upon exercise of such right, in lieu of shares of Series A Junior Preferred Stock, the number of shares of common stock of Activision having a value equal to two times the then current exercise price of the right. If we are acquired in a merger or other business combination transaction after a person has acquired 15% or more of our common stock, each holder of a right will thereafter have the right to receive upon exercise of such right a number of the acquiring companys common shares having a market value equal to two times the then current exercise price of the right. For persons who, as of the close of business on April 18, 2000, beneficially own 15% or more of the common stock of Activision, the Rights Plan grandfathers their current level of ownership, so long as they do not purchase additional shares in excess of certain limitations.
We may redeem the rights for $.01 per right at any time until the first public announcement of the acquisition of beneficial ownership of 15% of our common stock. At any time after a person has acquired 15% or more (but before any person has acquired more than 50%) of our common stock, we may exchange all or part of the rights for shares of common stock at an exchange ratio of one share of common stock per right. The rights expire on April 18, 2010.
21
Securities Authorized for Issuance Under Equity Compensation Plans
Information for our equity compensation plans in effect as of March 31, 2004 is as follows (amounts in thousands, except per share amounts):
|
|
(a) |
|
(b) |
|
(c) |
|
Plan Category |
|
Number of
securities |
|
Weighted-average |
|
Number of
securities |
|
Equity compensation plans approved by security holders |
|
13,301 |
|
$7.88 |
|
360 |
|
Equity compensation plans not approved by security holders |
|
24,876 |
|
$6.09 |
|
15,499 |
|
Total |
|
38,177 |
|
$6.71 |
|
15,859 |
|
See Note 15 of the Notes to Consolidated Financial Statements included in Item 8 for the material features of each equity compensation plan that was adopted without security holder approval.
22
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table summarizes certain selected consolidated financial data, which should be read in conjunction with our Consolidated Financial Statements and Notes thereto and with Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein. The selected consolidated financial data presented below as of and for each of the fiscal years in the five-year period ended March 31, 2004 are derived from our audited consolidated financial statements. The Consolidated Balance Sheets as of March 31, 2004 and 2003 and the Consolidated Statements of Operations and Consolidated Statements of Cash Flows for each of the fiscal years in the three-year period ended March 31, 2004, and the reports thereon, are included elsewhere in this Form 10-K.
(In thousands, except per share data)
|
|
Year ended March 31, |
|
|||||||||||||
|
|
|
|
Restated (1) |
|
|||||||||||
|
|
2004 (2) |
|
2003 (2) |
|
2002 (2) |
|
2001 |
|
2000 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Statement of Operations Data: |
|
|
|
|
|
|
|
|
|
|
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Net revenues |
|
$ |
947,656 |
|
$ |
864,116 |
|
$ |
786,434 |
|
$ |
620,183 |
|
$ |
572,205 |
|
Cost of sales product costs |
|
475,541 |
|
440,977 |
|
435,725 |
|
324,907 |
|
319,422 |
|
|||||
Cost of sales intellectual property licenses and software royalties and amortization |
|
91,606 |
|
124,196 |
|
99,006 |
|
89,702 |
|
91,238 |
|
|||||
Income (loss) from operations |
|
109,817 |
|
94,847 |
|
80,574 |
|
39,807 |
|
(30,325 |
) |
|||||
Income (loss) before income tax provision (benefit) |
|
115,992 |
|
103,407 |
|
83,120 |
|
32,544 |
|
(38,736 |
) |
|||||
Net income (loss) |
|
77,715 |
|
66,180 |
|
52,238 |
|
20,507 |
|
(34,088 |
) |
|||||
Basic earnings (loss) per share |
|
0.58 |
|
0.46 |
|
0.46 |
|
0.24 |
|
(0.41 |
) |
|||||
Diluted earnings (loss) per share |
|
0.54 |
|
0.43 |
|
0.39 |
|
0.22 |
|
(0.41 |
) |
|||||
Basic weighted average common shares outstanding |
|
133,249 |
|
144,359 |
|
113,966 |
|
83,921 |
|
83,334 |
|
|||||
Diluted weighted average common shares outstanding |
|
144,893 |
|
155,483 |
|
133,775 |
|
92,475 |
|
83,334 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Cash Provided By (Used In): |
|
|
|
|
|
|
|
|
|
|
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Operating activities |
|
67,403 |
|
90,975 |
|
111,792 |
|
81,565 |
|
2,883 |
|
|||||
Investing activities |
|
(15,169 |
) |
(155,101 |
) |
(8,701 |
) |
(8,631 |
) |
(25,041 |
) |
|||||
Financing activities |
|
117,569 |
|
64,090 |
|
50,402 |
|
2,547 |
|
42,028 |
|
|||||
|
|
As of March 31, |
|
|||||||||||||
|
|
2004 (2) |
|
2003 (2) |
|
2002 (2) |
|
2001 |
|
2000 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Balance Sheet Data: |
|
|
|
|
|
|
|
|
|
|
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Working capital |
|
$ |
675,796 |
|
$ |
422,500 |
|
$ |
333,199 |
|
$ |
182,980 |
|
$ |
158,225 |
|
Cash, cash equivalents and short-term investments |
|
587,649 |
|
406,954 |
|
279,007 |
|
125,550 |
|
49,985 |
|
|||||
Capitalized software development and intellectual property licenses |
|
135,201 |
|
107,921 |
|
56,742 |
|
42,205 |
|
40,808 |
|
|||||
Goodwill |
|
76,493 |
|
68,019 |
|
35,992 |
|
10,316 |
|
12,347 |
|
|||||
Total assets |
|
968,817 |
|
704,816 |
|
556,887 |
|
359,957 |
|
309,737 |
|
|||||
Long-term debt |
|
|
|
2,671 |
|
3,122 |
|
63,401 |
|
73,778 |
|
|||||
Shareholders equity |
|
832,738 |
|
597,740 |
|
430,091 |
|
181,306 |
|
132,009 |
|
|||||
(1) Consolidated financial information for fiscal years 2003-2000 has been restated for the effect of our three-for-two stock split effected in the form of a 50% stock dividend to shareholders of record as of February 23, 2004, paid March 15, 2004.
(2) Effective April 1, 2001, we adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangibles. SFAS No. 142 addresses financial accounting and reporting requirements for acquired goodwill and other intangible assets. Under SFAS No. 142, goodwill is deemed to have an indefinite useful life and should not be amortized but rather tested at least annually for
23
impairment. In accordance with SFAS No. 142, we have not amortized goodwill during the years ended March 31, 2004, 2003 and 2002.
24
Item 7. MANAGEMENTS 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 products cover game categories such as action/adventure, action sports, racing, role-playing, simulation, first-person action and strategy. Our target customer base ranges from game enthusiasts and children to mass-market consumers and 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) hand-held device and the personal computer (PC). The installed base for this current generation of hardware platforms is significant and growing. We believe recent price cuts in calendar 2004 on the Xbox and PS2 hardware should continue to drive the growth of the installed base of these two platforms. We also expect the installed base of the other current generation platforms to continue to grow. In addition, Sony announced that it would be entering the hand-held hardware market with the introduction of its hand-held gaming device, PlayStation Portable (PSP). PSP is currently expected to be released in the United States toward the end of the first quarter of calendar 2005. Nintendo has also announced that it plans to launch a new dual-screened, portable game system, Nintendo Dual Screen (NDS), before the end of calendar 2004. We are currently developing titles for the PSP and the NDS with the objective of having one or more titles at launch for each of these platforms. We are also planning to develop titles for the next generation console systems expected to be developed by Sony, Microsoft and Nintendo for release in the next two to three years. 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 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, 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, 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.
A number of our fiscal 2005 big propositions will include well-established brands, which are backed by high-profile intellectual property and/or highly anticipated motion picture releases. Examples of these brands are our superheroes and skateboarding brands. We have a long-term relationship with Marvel Enterprises through an exclusive licensing agreement that expires in 2009. This agreement grants us the exclusive rights to develop and publish video games based on Marvels comic book franchises Spider-Man, X-MEN, Fantastic Four and Iron Man. Through our long-term relationship with Spider-Man Merchandising, LLP, we have completed the development of the video game Spider-Man 2: The Movie, the sequel to the highly successful Spider-Man: The Movie, a key fiscal 2003 title release that has continued to perform strongly into fiscal 2004. The video game release of Spider-Man 2: The
25
Movie is scheduled to coincide with the Spider-Man 2 theatrical release in June 2004. We also recently announced that 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. In addition, we have an exclusive licensing agreement with professional skateboarder Tony Hawk that continues until 2015. The agreement grants us exclusive rights to develop and publish video games using Tony Hawks name and his likeness. Through fiscal 2004, we have released five successful titles in the Tony Hawk franchise with cumulative net revenues of over $800.0 million, including the most recent, Tony Hawks Underground, which was released in the third quarter of fiscal 2004. We will continue to promote our skateboarding franchise with the release in fiscal 2005 of the sequel to the very successful Tony Hawks Underground.
We will also continue to develop new intellectual properties such as True Crime: Streets of L.A. and Call of Duty, which were originally released in the third quarter of fiscal 2004. These highly successful titles were both ranked by third-party sales tracking agencies as among the top-five selling games for the holiday season. We expect to develop a variety of games on multiple platforms based on these two new original properties and hope to establish them as a source of recurring revenues. For example, in fiscal 2005, we are scheduled to release Call of Duty: Finest Hour which will be released on multiple console platforms.
We will also continue to evaluate 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 SKG that grants us the exclusive rights to publish video games based on DreamWorks SKGs theatrical release Shrek 2, as well as upcoming computer-animated films, Shark Tale, Madagascar and Over the Hedge, and their sequels. We also have an exclusive licensing agreement to develop and publish video games for the best-selling childrens book series, Lemony Snickets A Series of Unfortunate Events which is being developed for a feature film by Paramount Pictures, Nickelodeon Movies and DreamWorks SKG.
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 in prior fiscal years of a number of talented and experienced development companies. Most recently, in October 2003, we exercised our option to acquire the remaining 70% of the outstanding capital of Infinity Ward, the developer of our PC title, Call of Duty. We had acquired the initial 30% of Infinity Wards outstanding capital stock in May 2002. We also have development agreements with other top-level, third-party developers such as id Software, Valve Corporation, Spark Unlimited, Lionhead Studios and The Creative Assembly.
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 Managements Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 to the Notes to the Consolidated Financial Statements included in Item 8. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition. We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers. Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection. 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.
26
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 Activision 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 lifecycle, Activision sales force and retail customer feedback, industry pricing, weeks of on-hand retail channel inventory, absolute quantity of on-hand retail channel inventory, Activision warehouse on-hand inventory levels, the titles 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. Historically, total actual returns and price protection have not exceeded our allowance estimates. 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 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 credit worthiness, current economic trends and changes in our customers payment terms and their economic condition, as well as whether we can obtain sufficient credit insurance. Any significant changes in any of these criteria would impact managements 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 managements 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 products 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
27
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 development 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 actual impairment charge may be larger than originally estimated in any given quarter.
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.
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 holders continued promotion and exploitation of the intellectual property. Prior to the related products 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 products 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 development 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 actual impairment charge may be larger than originally estimated in any given quarter. 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 holders 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.
28
Selected Consolidated Statements of Operations Data
The following table sets forth certain consolidated statements of operations data for the periods indicated as a percentage of consolidated net revenues and also breaks down net revenues by territory and platform, as well as operating income by business segment:
|
|
Year ended March 31, |
|
|||||||||||||
|
|
(In thousands) |
|
|||||||||||||
|
|
2004 |
|
2003 |
|
2002 |
|
|||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Net revenues |
|
$ |
947,656 |
|
100 |
% |
$ |
864,116 |
|
100 |
% |
$ |
786,434 |
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Cost of sales product costs |
|
475,541 |
|
50 |
|
440,977 |
|
51 |
|
435,725 |
|
56 |
|
|||
Cost of sales software royalties and amortization |
|
59,744 |
|
6 |
|
79,194 |
|
9 |
|
58,892 |
|
7 |
|
|||
Cost of sales intellectual property licenses |
|
31,862 |
|
3 |
|
45,002 |
|
5 |
|
40,114 |
|
5 |
|
|||
Product development |
|
97,859 |
|
10 |
|
56,971 |
|
7 |
|
40,960 |
|
5 |
|
|||
Sales and marketing |
|
128,221 |
|
14 |
|
100,646 |
|
12 |
|
86,161 |
|
11 |
|
|||
General and administrative |
|
44,612 |
|
5 |
|
46,479 |
|
5 |
|
44,008 |
|
6 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total costs and expenses |
|
837,839 |
|
88 |
|
769,269 |
|
89 |
|
705,860 |
|
90 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Income from operations |
|
109,817 |
|
12 |
|
94,847 |
|
11 |
|
80,574 |
|
10 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Investment income, net |
|
6,175 |
|
|
|
8,560 |
|
1 |
|
2,546 |
|
1 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Income before income tax provision |
|
115,992 |
|
12 |
|
103,407 |
|
12 |
|
83,120 |
|
11 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Income tax provision |
|
38,277 |
|
4 |
|
37,227 |
|
4 |
|
30,882 |
|
4 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Net income |
|
$ |
77,715 |
|
8 |
% |
$ |
66,180 |
|
8 |
% |
$ |
52,238 |
|
7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Net Revenues by Territory: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
United States |
|
$ |
446,812 |
|
47 |
% |
$ |
432,261 |
|
50 |
% |
$ |
404,905 |
|
51 |
% |
Europe |
|
479,224 |
|
51 |
|
413,125 |
|
48 |
|
368,799 |
|
47 |
|
|||
Other |
|
21,620 |
|
2 |
|
18,730 |
|
2 |
|
12,730 |
|
2 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total net revenues |
|
$ |
947,656 |
|
100 |
% |
$ |
864,116 |
|
100 |
% |
$ |
786,434 |
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Net Revenues by Segment/Platform Mix: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Publishing: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Console |
|
$ |
508,418 |
|
76 |
% |
$ |
466,116 |
|
76 |
% |
$ |
312,986 |
|
57 |
% |
Hand-held |
|
24,945 |
|
4 |
|
49,966 |
|
8 |
|
119,177 |
|
22 |
|
|||
PC |
|
132,369 |
|
20 |
|
99,893 |
|
16 |
|
117,345 |
|
21 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total publishing net revenues |
|
665,732 |
|
70 |
|
615,975 |
|
71 |
|
549,508 |
|
70 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Distribution: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Console |
|
223,802 |
|
79 |
|
208,505 |
|
84 |
|
167,709 |
|
71 |
|
|||
Hand-held |
|
18,361 |
|
7 |
|
14,103 |
|
6 |
|
39,865 |
|
17 |
|
|||
PC |
|
39,761 |
|
14 |
|
25,533 |
|
10 |
|
29,352 |
|
12 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total distribution net revenues |
|
281,924 |
|
30 |
|
248,141 |
|
29 |
|
236,926 |
|
30 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total net revenues |
|
$ |
947,656 |
|
100 |
% |
$ |
864,116 |
|
100 |
% |
$ |
786,434 |
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Operating Income by Segment: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Publishing |
|
$ |
93,223 |
|
10 |
% |
$ |
79,139 |
|
9 |
% |
$ |
68,675 |
|
9 |
% |
Distribution |
|
16,594 |
|
2 |
|
15,708 |
|
2 |
|
11,899 |
|
1 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total operating income |
|
$ |
109,817 |
|
12 |
% |
$ |
94,847 |
|
11 |
% |
$ |
80,574 |
|
10 |
% |
29
Results of Operations Fiscal Years Ended March 31, 2004 and 2003
Net income for the year ended March 31, 2004 was $77.7 million or $0.54 per diluted share, as compared to $66.2 million or $0.43 per diluted share for the year ended March 31, 2003.
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). 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 years ended March 31, 2004 and 2003 (in thousands):
|
|
Year ended March 31, |
|
Increase/ |
|
Percent |
|
|||||
|
|
2004 |
|
2003 |
|
|
|
|||||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
|
|||
North America |
|
$ |
446,812 |
|
$ |
432,261 |
|
$ |
14,551 |
|
3 |
% |
Europe |
|
197,300 |
|
164,984 |
|
32,316 |
|
20 |
% |
|||
Other |
|
21,620 |
|
18,730 |
|
2,890 |
|
15 |
% |
|||
Total International |
|
218,920 |
|
183,714 |
|
35,206 |
|
19 |
% |
|||
Total Publishing Net Revenues |
|
665,732 |
|
615,975 |
|
49,757 |
|
8 |
% |
|||
Distribution Net Revenues |
|
281,924 |
|
248,141 |
|
33,783 |
|
14 |
% |
|||
Consolidated Net Revenues |
|
$ |
947,656 |
|
$ |
864,116 |
|
$ |
83,540 |
|
10 |
% |
Consolidated net revenues increased 10% from $864.1 million for the year ended March 31, 2003 to $947.7 million for the year ended March 31, 2004. This increase was generated by both our publishing and distribution businesses. The increase in consolidated net revenue was driven by the following:
Strong performance of our fiscal 2004 third quarter releases of True Crime: Streets of L.A. and Tony Hawks Underground for the PS2, Xbox and GameCube and Call of Duty for the PC. We continued to see strong sales of these titles through March 2004. In addition, we had strong results from several other titles released during fiscal 2004 including, Return to Castle Wolfenstein, X2: Wolverines Revenge, Cabelas Dangerous Hunts, Cabelas Deer Hunt 2004 Season, and in select European markets, Jedi Knight: Jedi Academy. We also had strong catalog sales from a number of our franchises, including Spider-Man. Catalog sales are sales of titles released prior to the current fiscal year.
Publishing console net revenues increased by 9% from $466.1 million for the year ended March 31, 2003 to $508.4 million for the year ended March 31, 2004. As expected, within the mix of specific consoles, net revenues from the sale of software for the prior generation console hardware systems, such as PS1, continued to decline while the net revenues from the sale of software for the current generation of console hardware systems continued to grow.
Net revenues were positively impacted from titles selling at higher average retail prices throughout fiscal 2004 as compared to fiscal 2003. As a result of the strong performance of our key fiscal 2004 releases, we were able to maintain the original price points for those titles for an extended period of time.
International net revenues benefited from the strong year-over-year strengthening of the Euro (EUR) and Great British Pound (GBP) in relation to the U.S. dollar. We estimate that foreign exchange rates increased reported net revenue by approximately $52.1 million. Excluding the impact of changing foreign currency rates, our international net revenue increased 4% year-over-year.
The increase in publishing net revenues was offset by fewer titles released in fiscal 2004 as compared to fiscal 2003.
30
North America Publishing Net Revenue (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
446,812 |
|
47 |
% |
$ |
432,261 |
|
50 |
% |
$ |
14,551 |
|
3 |
% |
Domestic publishing net revenues increased 3% from $432.3 million for the year ended March 31, 2003, to $446.8 million for the year ended March 31, 2004. The increase reflects the strong performance of our fiscal 2004 third quarter releases of True Crime: Streets of L.A. and Tony Hawks Underground for the PS2, Xbox and GameCube and Call of Duty for the PC. We continued to see strong sales of these titles through March 2004. The increase in net revenues was offset by fewer titles released in fiscal 2004 as compared to fiscal 2003.
International Publishing Net Revenue (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
218,920 |
|
23 |
% |
$ |
183,714 |
|
21 |
% |
$ |
35,206 |
|
19 |
% |
International publishing net revenues increased by 19% from $183.7 million for the year ended March 31, 2003, to $218.9 million for the year ended March 31, 2004. International publishing also saw strong results from our 2004 releases of True Crime: Streets of L.A. and Tony Hawks Underground for the PS2, Xbox and GameCube and Call of Duty for the PC. We also had strong results from several other titles released during fiscal 2004 including, Return to Castle Wolfenstein, X2: Wolverines Revenge and Jedi Knight: Jedi Academy. In addition, we had strong catalog sales from a number of our franchises, including Spider-Man. There also was a positive strengthening of the EUR and the GBP in relation to the U.S. dollar of approximately $22.2 million. Excluding the impact of changing foreign currency rates, our international publishing net revenue increased 7% year-over-year. The increase in net revenues was offset by fewer titles released in fiscal 2004 as compared to fiscal 2003.
31
Publishing Net Revenue by Product Line
Publishing net revenues increased 8% from $616.0 million for the year ended March 31, 2003 to $665.7 million for the year ended March 31, 2004. The following table details our publishing net revenues by platform and as a percentage of total publishing net revenues for the years ended March 31, 2004 and 2003 (in thousands):
|
|
Year Ended |
|
% of |
|
Year Ended |
|
% of |
|
Increase/ |
|
Percent |
|
|||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
PC |
|
$ |
132,369 |
|
20 |
% |
$ |
99,893 |
|
16 |
% |
$ |
32,476 |
|
33 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Console |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
PlayStation 2 |
|
289,048 |
|
43 |
% |
260,307 |
|
42 |
% |
28,741 |
|
11 |
% |
|||
Microsoft Xbox |
|
145,111 |
|
22 |
% |
75,329 |
|
12 |
% |
69,782 |
|
93 |
% |
|||
Nintendo GameCube |
|
52,909 |
|
8 |
% |
74,694 |
|
12 |
% |
(21,785 |
) |
(29 |
)% |
|||
PlayStation |
|
20,843 |
|
3 |
% |
52,722 |
|
9 |
% |
(31,879 |
) |
(60 |
)% |
|||
Other |
|
507 |
|
|
% |
3,064 |
|
1 |
% |
(2,557 |
) |
(83 |
)% |
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total Console |
|
508,418 |
|
76 |
% |
466,116 |
|
76 |
% |
42,302 |
|
9 |
% |
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Hand-held |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Game Boy Advance |
|
24,621 |
|
4 |
% |
44,060 |
|
7 |
% |
(19,439 |
) |
(44 |
)% |
|||
Game Boy Color |
|
324 |
|
|
% |
5,906 |
|
1 |
% |
(5,582 |
) |
(95 |
)% |
|||
Total Hand-held |
|
24,945 |
|
4 |
% |
49,966 |
|
8 |
% |
(25,021 |
) |
(50 |
)% |
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total Publishing Net Revenues |
|
$ |
665,732 |
|
100 |
% |
$ |
615,975 |
|
100 |
% |
$ |
49,757 |
|
8 |
% |
Personal Computer Net Revenue (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
132,369 |
|
20 |
% |
$ |
99,893 |
|
16 |
% |
$ |
32,476 |
|
33 |
% |
Net revenue from sales of titles for the PC increased 33% from $99.9 million for the year ended March 31, 2003 to $132.4 million for the year ended March 31, 2004. Though the number of premium PC titles released in fiscal 2004 remained relatively consistent with fiscal 2003, certain of our fiscal 2004 releases, Call of Duty, Empires: Dawn of the Modern World and, in select European markets, Jedi Knight: Jedi Academy, performed very well in both the domestic and international markets. According to NPD Group, a third-party sales tracking agency, Call of Duty was the number one selling PC title in North America during the quarter of its release, our third quarter of fiscal 2004. We expect fiscal 2005 PC publishing net revenues to increase as a percentage of total publishing net revenues over fiscal 2004 reflecting the release of more PC titles in fiscal 2005, including the highly anticipated Doom 3.
32
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
289,048 |
|
43 |
% |
$ |
260,307 |
|
42 |
% |
$ |
28,741 |
|
11 |
% |
Net revenue from sales of titles for the PS2 increased 11% from $260.3 million for the year ended March 31, 2003 to $289.0 million for the year ended March 31, 2004. Though the number of new PS2 titles reduced in fiscal 2004 to 10 from 13 in fiscal 2003, we were able to increase our PS2 sales in both the domestic and international markets. The increase is primarily due to strong, worldwide sales of several of our PS2 titles including True Crime: Streets of L.A., Tony Hawks Underground, X2: Wolverines Revenge, Return to Castle Wolfenstein, Cabelas Dangerous Hunts and Cabelas Deer Hunt 2004 Season. We expect the growth of the installed base of PS2 hardware to be driven by the recent price cut announced by Sony in May 2004.
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
145,111 |
|
22 |
% |
$ |
75,329 |
|
12 |
% |
$ |
69,782 |
|
93 |
% |
Net revenue from sales of titles for the Xbox increased 93% from $75.3 million for the year ended March 31, 2003 to $145.1 million for the year ended March 31, 2004. Though the number of new Xbox titles remained relatively consistent from fiscal 2003 to fiscal 2004, we were able to increase our Xbox sales in both the domestic and international markets. The increase is primarily due to strong worldwide sales of several of our Xbox titles including True Crime: Streets of L.A., Tony Hawks Underground, Return to Castle Wolfenstein, Soldier of Fortune 2, X2: Wolverines Revenge, Tenchu: Return from Darkness and, in select European markets, Jedi Knight: Jedi Academy. The increase was also due to an increased installed base of the Xbox. We expect the growth of the installed base of Xbox hardware to be driven by the recent price cut announced by Microsoft in March 2004.
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
52,909 |
|
8 |
% |
$ |
74,694 |
|
12 |
% |
$ |
(21,785 |
) |
(29 |
)% |
Net revenue from sales of titles for the Nintendo GameCube decreased 29% from $74.7 million for the year ended March 31, 2003 to $52.9 million for the year ended March 31, 2004. The decrease is primarily due to a reduction in the number of GameCube new title releases from 9 in fiscal 2003 to 5 in fiscal 2004. The titles that were released for GameCube performed strongly, including Tony Hawks Underground and True Crime: Streets of L.A. We expect the installed base of GameCube hardware to continue to grow at its current low price point.
33
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
20,843 |
|
3 |
% |
$ |
52,722 |
|
9 |
% |
$ |
(31,879 |
) |
(60 |
)% |
Net revenue from sales of titles for the Sony PlayStation console system (PS1) for the year ended March 31, 2004 decreased 60% from the prior fiscal year, from $52.7 million to $20.8 million. The decrease was expected due to the market transition away from the prior generation of hardware platforms, such as PS1, to the current generation console systems. We expect sales of PS1 products to continue to decline in fiscal 2005.
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
24,621 |
|
4 |
% |
$ |
44,060 |
|
7 |
% |
$ |
(19,439 |
) |
(44 |
)% |
Net revenue from sales of titles for the GBA for the year ended March 31, 2004 decreased 44% from the prior fiscal year, from $44.1 million to $24.6 million. This is due to a decrease in the number of GBA games released year-over-year. In fiscal 2003, we released 11 GBA titles, whereas in fiscal 2004 we released 4 GBA titles. We expect the hand-held installed base to grow with the release of the NDS and PSP which are expected to launch in late calendar year 2004 and early calendar year 2005, respectively. In addition, in fiscal 2005, as the GBA hardware approaches the peak of its life cycle, we expect to increase our focus on developing GBA games for mass-market consumers.
The platform mix of our future publishing net revenues will likely be impacted by a number of factors, including the ability of hardware manufacturers to continue to increase their installed hardware base, the introduction of new hardware platforms, as well as the timing of key product releases from our product release schedule. We expect that net revenues from console titles will continue to represent the largest component of our publishing net revenues with PS2 having the largest percentage of that business due to its larger installed hardware base. We expect net revenues from hand-held titles to remain the smallest component of our publishing net revenues. However, if the PSP and/or the NDS hand-held devices are introduced in fiscal 2005, we may see an increase in our hand-held business in comparison to prior periods. Our net revenues from PC titles will be primarily driven by our product release schedule.
A significant portion of our revenues and profits are derived from a relatively small number of popular titles and brands each year as revenues and profits are significantly affected by our ability to release highly successful or hit titles. For example, for the year ended March 31, 2004, 28% of our consolidated net revenues and 40% of worldwide publishing net revenues were derived from net revenues from our Tony Hawks Underground and True Crime: Streets of L.A. 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 operating profits resulting in a disproportionate amount of operating income being derived from these select titles. We expect that a limited number of titles and brands will continue to produce a disproportionately large amount of our net revenues and profits.
Two factors that could affect future publishing and distribution net revenue performance are console hardware pricing and software pricing. As console hardware moves through its life cycle, hardware manufacturers typically enact price reductions. Reductions in the price of console hardware typically result in an increase in the installed base of hardware owned by consumers. Price cuts on Xbox and PS2 hardware were announced in March and May 2004, respectively. Historically, we have also seen that lower console hardware prices put downward pressure
34
on software pricing. While we expect console software launch pricing for most genres to hold at $49.99 through the calendar 2004 holidays, we believe we could see additional software price declines thereafter.
Distribution Net Revenue (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
281,924 |
|
30 |
% |
$ |
248,141 |
|
29 |
% |
$ |
33,783 |
|
14 |
% |
Distribution net revenues for the year ended March 31, 2004 increased 14% from the prior fiscal year, from $248.1 million to $281.9 million. The increase was primarily due to the positive impact of the year-over-year strengthening of the EUR and the GBP in relation to the U.S. dollar. Excluding the impact of the changing foreign currency rates, our distribution net revenue was in line with our prior fiscal year, with a slight increase of 2% year-over-year. The mix of distribution net revenues between hardware and software sales varied year-over-year with approximately 28% hardware in the year ended March 31, 2004 as compared to 38% hardware in the prior fiscal year. This is mainly attributed to an increase in business with large, mass-market customers that generate a higher percentage of sales from software. In both fiscal years, hardware sales were principally comprised of sales of console hardware. The mix of future distribution net revenues will be driven by a number of factors including the occurrence of further hardware price reductions instituted by hardware manufacturers, the introduction of new hardware platforms and our ability to establish and maintain distribution agreements with hardware manufacturers and third-party software publishers. We are expecting our fiscal 2005 distribution results to be in line with fiscal 2004.
Costs and Expenses
Cost of Sales Product Costs (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
475,541 |
|
50 |
% |
$ |
440,977 |
|
51 |
% |
$ |
34,564 |
|
8 |
% |
Cost of sales product costs represented 50% and 51% of consolidated net revenues for the years ended March 31, 2004 and 2003, respectively. In absolute dollars, cost of sales product costs increased due to higher sales volume in fiscal 2004 as compared to fiscal 2003. There were two primary factors that affected cost of sales product costs as a percentage of consolidated net revenues:
The product mix of our publishing business for the year ended March 31, 2004 reflects a lower proportion of net revenues from titles for hand-held devices, as compared to the year ended March 31, 2003. Titles for hand-held devices generally have the highest manufacturing per unit cost of all platforms.
Due to the lower manufacturing costs for PC titles, we were able to benefit from the strong sales of Call of Duty for the year ended March 31, 2004.
We expect cost of sales product costs as a percentage of net revenue to decrease primarily due to a lower percentage of revenue generated from our distribution business in fiscal 2005, which is a lower margin business. We may also receive a benefit from changes in product mix in fiscal 2005 due to an increase in PC publishing net revenues as a percentage of total publishing net revenues and the focus on big proposition titles, for which we could benefit from volume discounts.
35
Cost of Sales Software Royalties and Amortization (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
59,744 |
|
9 |
% |
$ |
79,194 |
|
13 |
% |
$ |
(19,450 |
) |
(25 |
)% |
Cost of sales software royalties and amortization for the year ended March 31, 2004 decreased as a percentage of publishing net revenues from the prior fiscal year, from 13% to 9%. In absolute dollars, cost of sales software royalties and amortization for the year ended March 31, 2004 also decreased from the prior fiscal year, from $79.2 million to $59.7 million. The decrease in absolute dollars reflects that there were approximately fifteen major titles released in fiscal 2004 as compared to over twenty in fiscal 2003. The decrease in the percentage reflects the strong performance of our internally developed key fiscal 2004 third quarter releases.
Cost of Sales Intellectual Property Licenses (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
31,862 |
|
5 |
% |
$ |
45,002 |
|
7 |
% |
$ |
(13,140 |
) |
(29 |
)% |
Cost of sales intellectual property licenses for the year ended March 31, 2004 decreased in absolute dollars and as a percentage of publishing net revenues over the same period last year, from 7% to 5%. The decreases reflect the fact that two of our top performing titles in fiscal 2004, True Crime: Streets of L.A. and Call of Duty, were based on our wholly-owned original intellectual property. Additionally, during fiscal 2003, we recorded an approximate $7.0 million charge related to an assessment of the recoverability of certain of our investments in long-term licensing agreements. We expect cost of sales intellectual property licenses to increase in fiscal 2005 as compared to fiscal 2004, as we expect to have more titles releasing with licensed intellectual property.
Product Development (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
97,859 |
|
15 |
% |
$ |
56,971 |
|
9 |
% |
$ |
40,888 |
|
72 |
% |
Product development expenses for the year ended March 31, 2004 increased as a percentage of publishing net revenues from the prior fiscal year, from 9% to 15%. In absolute dollars, product development expenses for the year ended March 31, 2004 also increased from the prior fiscal year, from $57.0 million to $97.9 million. The increase in product development as a percentage of publishing net revenues and in absolute dollars resulted from:
A $21 million game cancellation charge recorded in the fiscal 2004 third quarter. We executed a realignment of our product portfolio driven by the evolution of the video game market, which is increasingly dominated by high quality products that are based on recognizable franchises and supported with big marketing programs. We completed a comprehensive review of our product portfolio in which we evaluated each product based on a number of criteria, including: the strength of the franchise, the projected product quality, the potential responsiveness of the product to aggressive marketing support and the financial risk in the event of product failure. As a result of this review, we believe that we have an extensive slate of high-potential properties in development. However, we found that certain projects had a lower likelihood of achieving acceptable levels of operating performance and that continued pursuit of these projects would create a substantial opportunity cost as it related to our slate of high-potential projects. Accordingly, in the three months ended December 31, 2003, we cancelled the development of ten products that we believed were
36
unlikely to produce an acceptable level of return on our investment. In connection with the cancellation of these products, we recorded a pre-tax charge of approximately $21 million.
Our increased emphasis on product quality and the lengthening of product development schedules. To maintain the competitiveness of our products and to take advantage of increasingly sophisticated technology associated with new hardware platforms, we have increased the amount of time spent play-testing new products, conducted more extensive product quality evaluations and lengthened product development schedules to allow time to make the improvements indicated by our testing and evaluations. We are focused on improved game quality, and in many cases, this has resulted in an increase in product development costs.
The increase in absolute dollars is also due to an increase in studio employee incentive compensation as a result of the strong performances of key fiscal 2004 title releases.
Sales and Marketing (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
128,221 |
|
14 |
% |
$ |
100,646 |
|
12 |
% |
$ |
27,575 |
|
27 |
% |
Sales and marketing expenses of $128.2 million and $100.6 million represented 14% and 12% of consolidated net revenues for the years ended March 31, 2004 and 2003, respectively. The increase in sales and marketing expense dollars and as a percentage of net revenues for the year ended March 31, 2004 from the prior fiscal year was primarily generated by our publishing business as a result of significant marketing programs, including television and in-theatre ad campaigns and in-store promotions, run in support of our three key fiscal 2004 third quarter title releases, Tony Hawks Underground, and our two new original properties, True Crime: Streets of L.A. and Call of Duty. We expect to continue to provide significant marketing support for our future big proposition titles. Accordingly, we expect fiscal 2005 sales and marketing costs to exceed fiscal 2004 spending levels.
General and Administrative (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
44,612 |
|
5 |
% |
$ |
46,479 |
|
5 |
% |
$ |
(1,867 |
) |
(4 |
)% |
General and administrative expenses for the year ended March 31, 2004 decreased $1.9 million over the same period last year, from $46.5 million to $44.6 million. As a percentage of consolidated net revenues, general and administrative expenses remained constant at 5%. The decrease in absolute dollars was primarily due to:
Lower bad debt expense of approximately $3.9 million.
The incurrence in the first quarter of fiscal 2003 of $1.0 million of merger related expenses by our publishing business.
An approximate $2.0 million charge incurred in fiscal 2003 by our distribution business for the relocation of our UK distribution facility.
Partially offset by a $5.2 million year-over-year increase in general and administrative employee related costs in both our publishing and distribution businesses.
37
Operating Income (in thousands)
|
|
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Publishing |
|
$ |
93,223 |
|
14 |
% |
$ |
79,139 |
|
13 |
% |
$ |
14,084 |
|
18 |
% |
Distribution |
|
16,594 |
|
6 |
|
15,708 |
|
6 |
|
886 |
|
6 |
|
|||
Consolidated |
|
$ |
109,817 |
|
12 |
% |
$ |
94,847 |
|
11 |
% |
$ |
14,970 |
|
16 |
% |
Publishing operating income for the year ended March 31, 2004 increased $14.1 million from the same period last year, from $79.1 million to $93.2 million. International publishing operating income for the year ended March 31, 2004 benefited from the positive impact of the year-over-year strengthening of the EUR and the GBP in relation to the U.S. dollar. Excluding the impact of changes in foreign currency rates, publishing operating income for the year ended March 31, 2004 increased approximately $7.8 million from the same period last year. This increase is primarily due to:
Strong performance in both the domestic and international markets of our fiscal 2004 third quarter title releases.
Partially offset by:
Increased sales and marketing spending.
The product development charge recorded in the fiscal 2004 third quarter in connection with the cancellation of ten products.
Distribution operating income for the year ended March 31, 2004 increased slightly over the same period last year, from $15.7 million to $16.6 million. Distribution operating income for the year ended March 31, 2004 benefited from the positive impact of the year-over-year strengthening of the EUR and the GBP in relation to the U.S. dollar. Excluding the impact of changes in foreign currency rates, distribution operating income for the year ended March 31, 2004 was down slightly by approximately $0.9 million from the same period last year. This decrease is primarily due to an increase in general and administrative employee related costs.
Investment Income, Net (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
6,175 |
|
|
% |
$ |
8,560 |
|
1 |
% |
$ |
(2,385 |
) |
(28 |
)% |
Investment income, net for the year ended March 31, 2004 was $6.2 million as compared to $8.6 million for the year ended March 31, 2003. The decrease was primarily due to interest rate reductions and the utilization of excess cash to enter into structured stock repurchase transactions and to purchase treasury stock during the year ended March 31, 2004. Premiums earned on structured stock repurchase transactions are recorded in additional paid-in-capital.
Provision for Income Taxes (in thousands)
March 31, |
|
% of |
|
March 31, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
38,277 |
|
33 |
% |
$ |
37,227 |
|
36 |
% |
$ |
1,050 |
|
3 |
% |
38
The income tax provision of $38.3 million for the year ended March 31, 2004 reflects our effective income tax rate of 33%. 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 differentials, partially offset by an increase in our deferred tax asset valuation allowance and state taxes. The realization of deferred tax assets depends primarily on the generation of future taxable income. We believe that it is more likely than not that we will generate taxable income sufficient to realize the benefit of net deferred tax assets recognized.
Results of Operations Fiscal Years Ended March 31, 2003 and 2002
Net income for the year ended March 31, 2003 was $66.2 million or $0.43 per diluted share, as compared to $52.2 million or $0.39 per diluted share for the year ended March 31, 2002.
Net Revenues
Net revenues for the year ended March 31, 2003 increased 10% from the prior fiscal year, from $786.4 million to $864.1 million. This increase was generated by our publishing business and, to a lesser degree, our distribution business.
The following table details our consolidated net revenues by business segment and our publishing net revenues by territory for the years ended March 31, 2003 and 2002 (in thousands):
|
|
Year ended March 31, |
|
Increase/ |
|
Percent |
|
|||||
|
|
2003 |
|
2002 |
|
(Decrease) |
|
Change |
|
|||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
|
|||
North America |
|
$ |
432,261 |
|
$ |
404,905 |
|
$ |
27,356 |
|
7 |
% |
Europe |
|
164,984 |
|
131,873 |
|
33,111 |
|
25 |
% |
|||
Other |
|
18,730 |
|
12,730 |
|
6,000 |
|
47 |
% |
|||
Total International |
|
183,714 |
|
144,603 |
|
39,111 |
|
27 |
% |
|||
Total Publishing Net Revenues |
|
615,975 |
|
549,508 |
|
66,467 |
|
12 |
% |
|||
Distribution Net Revenues |
|
248,141 |
|
236,926 |
|
11,215 |
|
5 |
% |
|||
Consolidated Net Revenues |
|
$ |
864,116 |
|
$ |
786,434 |
|
$ |
77,682 |
|
10 |
% |
39
Publishing net revenues for the year ended March 31, 2003 increased 12% from the prior fiscal year, from $549.5 million to $616.0 million. The following table details our publishing net revenues by platform as a percentage of total publishing net revenues for the years ended March 31, 2003 and 2002 (in thousands):
|
|
Year Ended |
|
% of |
|
Year Ended |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
PC |
|
$ |
99,893 |
|
16 |
% |
$ |
117,345 |
|
21 |
% |
$ |
(17,452 |
) |
(15 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Console |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
PlayStation 2 |
|
260,307 |
|
42 |
% |
110,120 |
|
20 |
% |
150,187 |
|
136 |
% |
|||
Microsoft Xbox |
|
75,329 |
|
12 |
% |
32,921 |
|
6 |
% |
42,408 |
|
129 |
% |
|||
Nintendo GameCube |
|
74,694 |
|
12 |
% |
16,773 |