UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
20549
FORM 10-Q
(Mark one)
ý |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
|
|
|
For the Quarterly Period Ended June 30, 2004 |
||
|
|
|
OR |
||
|
|
|
o |
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-12699
ACTIVISION,
INC.
(Exact name of registrant as specified in its charter)
Delaware |
|
95-4803544 |
(State or other jurisdiction of |
|
(I.R.S. Employer Identification No.) |
|
|
|
3100 Ocean Park Boulevard, Santa Monica, CA |
|
90405 |
(Address of principal executive offices) |
|
(Zip Code) |
(310) 255-2000
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o
The number of shares of the registrants Common Stock outstanding as of July 26, 2004 was 138,392,458.
ACTIVISION, INC. AND SUBSIDIARIES
INDEX
2
ACTIVISION, INC. AND
SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
|
|
June 30, 2004 |
|
March 31, 2004 |
|
||
Assets |
|
(Unaudited) |
|
|
|
||
Current assets: |
|
|
|
|
|
||
Cash and cash equivalents |
|
$ |
339,735 |
|
$ |
466,552 |
|
Short-term investments |
|
199,411 |
|
121,097 |
|
||
Accounts receivable, net of allowances of $48,279 and $47,028 at June 30, 2004 and March 31, 2004, respectively |
|
123,048 |
|
62,577 |
|
||
Inventories |
|
39,635 |
|
26,427 |
|
||
Software development |
|
75,696 |
|
58,320 |
|
||
Intellectual property licenses |
|
15,159 |
|
32,115 |
|
||
Deferred income taxes |
|
23,497 |
|
26,127 |
|
||
Other current assets |
|
21,184 |
|
18,660 |
|
||
|
|
|
|
|
|
||
Total current assets |
|
837,365 |
|
811,875 |
|
||
|
|
|
|
|
|
||
Software development |
|
21,660 |
|
28,386 |
|
||
Intellectual property licenses |
|
17,630 |
|
16,380 |
|
||
Property and equipment, net |
|
24,841 |
|
25,539 |
|
||
Deferred income taxes |
|
6,666 |
|
9,064 |
|
||
Other assets |
|
1,243 |
|
1,080 |
|
||
Goodwill |
|
76,436 |
|
76,493 |
|
||
|
|
|
|
|
|
||
Total assets |
|
$ |
985,841 |
|
$ |
968,817 |
|
|
|
|
|
|
|
||
Liabilities and Shareholders Equity |
|
|
|
|
|
||
Current liabilities: |
|
|
|
|
|
||
Accounts payable |
|
$ |
75,558 |
|
$ |
72,874 |
|
Accrued expenses |
|
56,534 |
|
63,205 |
|
||
|
|
|
|
|
|
||
Total current liabilities |
|
132,092 |
|
136,079 |
|
||
|
|
|
|
|
|
||
Commitments and contingencies (Note 14) |
|
|
|
|
|
||
|
|
|
|
|
|
||
Shareholders equity: |
|
|
|
|
|
||
Preferred stock, $.000001 par value, 3,750,000 shares authorized, no shares issued at June 30, 2004 and March 31, 2004 |
|
|
|
|
|
||
Series A Junior Preferred stock, $.000001 par value, 1,250,000 shares authorized, no shares issued at June 30, 2004 and March 31, 2004 |
|
|
|
|
|
||
Common stock, $.000001 par value, 225,000,000 shares authorized, 167,809,185 and 166,876,567 shares issued and 138,263,860 and 137,331,242 shares outstanding at June 30, 2004 and March 31, 2004, respectively |
|
|
|
|
|
||
Additional paid-in capital |
|
770,257 |
|
758,626 |
|
||
Retained earnings |
|
220,236 |
|
208,279 |
|
||
Less: Treasury stock, at cost, 29,545,325 shares at June 30, 2004 and March 31, 2004 |
|
(144,128 |
) |
(144,128 |
) |
||
Accumulated other comprehensive income |
|
7,384 |
|
9,961 |
|
||
|
|
|
|
|
|
||
Total shareholders equity |
|
853,749 |
|
832,738 |
|
||
|
|
|
|
|
|
||
Total liabilities and shareholders equity |
|
$ |
985,841 |
|
$ |
968,817 |
|
The accompanying notes are an integral part of these consolidated financial statements.
3
ACTIVISION,
INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
OPERATIONS
(Unaudited)
(In thousands, except per share data)
|
|
For the three months ended June 30, |
|
||||
|
|
2004 |
|
2003 |
|
||
|
|
|
|
|
|
||
Net revenues |
|
$ |
211,276 |
|
$ |
158,725 |
|
|
|
|
|
|
|
||
Costs and expenses: |
|
|
|
|
|
||
Cost of sales product costs |
|
89,088 |
|
76,610 |
|
||
Cost of sales software royalties and amortization |
|
12,283 |
|
15,498 |
|
||
Cost of sales intellectual property licenses |
|
17,648 |
|
10,143 |
|
||
Product development |
|
21,105 |
|
13,580 |
|
||
Sales and marketing |
|
41,734 |
|
26,285 |
|
||
General and administrative |
|
13,685 |
|
11,463 |
|
||
|
|
|
|
|
|
||
Total costs and expenses |
|
195,543 |
|
153,579 |
|
||
|
|
|
|
|
|
||
Operating income |
|
15,733 |
|
5,146 |
|
||
|
|
|
|
|
|
||
Investment income, net |
|
2,112 |
|
1,257 |
|
||
|
|
|
|
|
|
||
Income before income tax provision |
|
17,845 |
|
6,403 |
|
||
|
|
|
|
|
|
||
Income tax provision |
|
5,888 |
|
2,240 |
|
||
|
|
|
|
|
|
||
Net income |
|
$ |
11,957 |
|
$ |
4,163 |
|
|
|
|
|
|
|
||
Basic earnings per share |
|
$ |
0.09 |
|
$ |
0.03 |
|
|
|
|
|
|
|
||
Weighted average common shares outstanding |
|
137,765 |
|
132,069 |
|
||
|
|
|
|
|
|
||
Diluted earnings per share |
|
$ |
0.08 |
|
$ |
0.03 |
|
|
|
|
|
|
|
||
Weighted average common shares outstanding assuming dilution |
|
153,407 |
|
140,655 |
|
The accompanying notes are an integral part of these consolidated financial statements.
4
ACTIVISION,
INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
|
|
For the three months ended June 30, |
|
||||
|
|
2004 |
|
2003 |
|
||
Cash flows from operating activities: |
|
|
|
|
|
||
Net income |
|
$ |
11,957 |
|
$ |
4,163 |
|
Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
|
|
|
|
|
||
Deferred income taxes |
|
5,028 |
|
1,441 |
|
||
Depreciation and amortization |
|
2,579 |
|
2,251 |
|
||
Amortization of capitalized software development costs and intellectual property licenses |
|
31,750 |
|
19,045 |
|
||
Tax benefit of stock options |
|
3,597 |
|
512 |
|
||
Changes in operating assets and liabilities (net of effects of acquisitions): |
|
|
|
|
|
||
Accounts receivable |
|
(60,471 |
) |
(17,406 |
) |
||
Inventories |
|
(13,208 |
) |
(5,530 |
) |
||
Software development and intellectual property licenses |
|
(26,694 |
) |
(28,244 |
) |
||
Other assets |
|
(2,687 |
) |
(3,102 |
) |
||
Accounts payable |
|
2,684 |
|
5,738 |
|
||
Accrued expenses and other liabilities |
|
(6,671 |
) |
(2,566 |
) |
||
|
|
|
|
|
|
||
Net cash (used in) operating activities |
|
(52,136 |
) |
(23,698 |
) |
||
|
|
|
|
|
|
||
Cash flows from investing activities: |
|
|
|
|
|
||
Capital expenditures |
|
(1,881 |
) |
(5,671 |
) |
||
Purchases of short-term investments |
|
(95,493 |
) |
(24,500 |
) |
||
Proceeds from sales and maturities of short-term investments |
|
15,962 |
|
46,930 |
|
||
|
|
|
|
|
|
||
Net cash provided by (used in) investing activities |
|
(81,412 |
) |
16,759 |
|
||
|
|
|
|
|
|
||
Cash flows from financing activities: |
|
|
|
|
|
||
Proceeds from issuance of common stock to employees |
|
8,034 |
|
1,423 |
|
||
Other borrowings, net |
|
|
|
(2,818 |
) |
||
Purchase of structured stock repurchase transactions |
|
|
|
(36,420 |
) |
||
Settlement of structured stock repurchase transactions |
|
|
|
65,903 |
|
||
Purchase of treasury stock |
|
|
|
(18,814 |
) |
||
|
|
|
|
|
|
||
Net cash provided by financing activities |
|
8,034 |
|
9,274 |
|
||
|
|
|
|
|
|
||
Effect of exchange rate changes on cash |
|
(1,303 |
) |
2,944 |
|
||
|
|
|
|
|
|
||
Net increase (decrease) in cash and cash equivalents |
|
(126,817 |
) |
5,279 |
|
||
|
|
|
|
|
|
||
Cash and cash equivalents at beginning of period |
|
466,552 |
|
285,554 |
|
||
|
|
|
|
|
|
||
Cash and cash equivalents at end of period |
|
$ |
339,735 |
|
$ |
290,833 |
|
The accompanying notes are an integral part of these consolidated financial statements.
5
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF
CHANGES IN SHAREHOLDERS EQUITY
For the three months
ended June 30, 2004
(Unaudited)
(In thousands)
|
|
Common Stock |
|
Additional |
|
Retained |
|
Treasury Stock |
|
Accumulated |
|
Shareholders |
|
||||||||||
|
|
Shares |
|
Amounts |
|
Capital |
|
Earnings |
|
Shares |
|
Amounts |
|
Income (Loss) |
|
Equity |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Balance, March 31, 2004 |
|
166,877 |
|
$ |
|
|
$ |
758,626 |
|
$ |
208,279 |
|
(29,546 |
) |
$ |
(144,128 |
) |
$ |
9,961 |
|
$ |
832,738 |
|
Components of comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Net income |
|
|
|
|
|
|
|
11,957 |
|
|
|
|
|
|
|
11,957 |
|
||||||
Unrealized depreciation on short-term investments |
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,217 |
) |
(1,217 |
) |
||||||
Foreign currency translation adjustment |
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,360 |
) |
(1,360 |
) |
||||||
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,380 |
|
||||||
Issuance of common stock pursuant to employee stock option and stock purchase plans |
|
933 |
|
|
|
8,034 |
|
|
|
|
|
|
|
|
|
8,034 |
|
||||||
Tax benefit attributable to employee stock options |
|
|
|
|
|
3,597 |
|
|
|
|
|
|
|
|
|
3,597 |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Balance, June 30, 2004 |
|
167,810 |
|
$ |
|
|
$ |
770,257 |
|
$ |
220,236 |
|
(29,546 |
) |
$ |
(144,128 |
) |
$ |
7,384 |
|
$ |
853,749 |
|
The accompanying notes are an integral part of these consolidated financial statements.
6
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
For the three months ended June 30, 2004
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements include the accounts of Activision, Inc. and its subsidiaries (Activision or we). The information furnished is unaudited and consists of only normal recurring adjustments that, in the opinion of management, are necessary to provide a fair statement of the results for the interim periods presented. The Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended March 31, 2004 as filed with the Securities and Exchange Commission (SEC).
Software Development Costs and Intellectual Property Licenses
Software development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products.
We account for software development costs in accordance with 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 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 license costs represent license fees paid to intellectual property rights holders for use of their trademarks, copyrights, software, technology or other intellectual property or proprietary rights in the development of our products. Depending upon the agreement with the rights holder, we may obtain the rights to use acquired intellectual property in multiple products over multiple years, or alternatively, for a single product.
7
We evaluate the future recoverability of capitalized intellectual property licenses on a quarterly basis. The recoverability of capitalized intellectual property license costs is evaluated based on the expected performance of the specific products in which the licensed trademark or copyright is to be used. As many of our intellectual property licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized intellectual property license costs based on certain qualitative factors such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned theatrical releases or television series based on the intellectual property and the rights 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.
Revenue Recognition
We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers. Certain products are sold to customers with a street date (the date that products are made widely available by retailers). For these products we recognize revenue on the street date. Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection. With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery of such copies. Per copy royalties on sales that exceed the guarantee are recognized as earned. In addition, in order to recognize revenue for both product sales and licensing transactions, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable. Revenue recognition also determines the timing of certain expenses, including cost of sales intellectual property licenses and cost of sales software royalties and amortization.
Sales incentives or other consideration given by us to our customers is accounted for in accordance with the Financial Accounting Standards Boards Emerging Issues Task Force (EITF) Issue 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products). In accordance with EITF Issue 01-9, sales incentives and other consideration that are considered adjustments
8
of the selling price of our products, such as rebates and product placement fees, are reflected as reductions of revenue. Sales incentives and other consideration that represent costs incurred by us for assets or services received, such as the appearance of our products in a customers national circular ad, are reflected as sales and marketing expenses.
Stock-Based Compensation and Pro Forma Information
Under SFAS No. 123 Accounting for Stock-Based Compensation, compensation expense is recorded for the issuance of stock options and other stock-based compensation based on the fair value of the stock options and other stock-based compensation on the date of grant or measurement date. Alternatively, SFAS No. 123 allows companies to continue to account for the issuance of stock options and other stock-based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Under APB No. 25, compensation expense is recorded for the issuance of stock options and other stock-based compensation based on the intrinsic value of the stock options and other stock-based compensation on the date of grant or measurement date. Under the intrinsic value method, compensation expense is recorded on the date of grant or measurement date only if the current market price of the underlying stock exceeds the stock option or other stock-based compensation exercise price. At June 30, 2004, we had several stock-based employee compensation plans, which are described more fully in Note 15 to the Notes to Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for the year ended March 31, 2004 filed with the SEC. We account for those plans under the recognition and measurement principles of APB Opinion No. 25 and related Interpretations. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (amounts in thousands, except per share data):
|
|
Three months ended June 30, |
|
||||
|
|
2004 |
|
2003 |
|
||
Net income, as reported |
|
$ |
11,957 |
|
$ |
4,163 |
|
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
|
(4,866 |
) |
(5,535 |
) |
||
|
|
|
|
|
|
||
Pro forma net income (loss) |
|
$ |
7,091 |
|
$ |
(1,372 |
) |
|
|
|
|
|
|
||
Earnings (loss) per share |
|
|
|
|
|
||
Basic - as reported |
|
$ |
0.09 |
|
$ |
0.03 |
|
Basic - pro forma |
|
$ |
0.05 |
|
$ |
(0.01 |
) |
|
|
|
|
|
|
||
Diluted - as reported |
|
$ |
0.08 |
|
$ |
0.03 |
|
Diluted - pro forma |
|
$ |
0.05 |
|
$ |
(0.01 |
) |
The fair value of options granted is estimated at the date of grant using the Black-Scholes option pricing model. The Black-Scholes option pricing model requires the input of highly subjective assumptions, including the expected stock price volatility. We use the historical stock price volatility of our common stock over the most recent period that is generally commensurate with the expected option life as the basis for estimating expected stock price volatility. For options granted during the three months ended June 30, 2004 and 2003, the historical stock price volatility used was based on a weekly stock price observation, using an average of the high and low stock prices of our common stock, which resulted in an expected stock price volatility of 48%. For purposes of the above pro forma disclosure, the fair value of options granted is amortized to stock-based employee compensation cost over the period(s) in which the related
9
employee services are rendered. Accordingly, the pro forma stock-based compensation cost for any period will typically relate to options granted in both the current period and prior periods.
2. Stock Split
In April 2003, the Board of Directors approved a three-for-two split of our outstanding common shares effected in the form of a 50% stock dividend. The split was paid on June 6, 2003 to shareholders of record as of May 16, 2003. 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. The Consolidated Financial Statements and Notes thereto, including all share and per share data, have been restated as if the stock splits had occurred as of the earliest period presented.
3. Acquisitions
In May 2002, we acquired a 30% interest in the outstanding capital stock of Infinity Ward, Inc. (Infinity Ward), a privately held interactive software development company, as well as an option to purchase the remaining 70% of outstanding capital stock. In October 2003, we exercised our option to acquire the remaining 70% of the outstanding capital stock of Infinity Ward for cash of approximately $3.5 million. This acquisition further enables us to implement our multi-platform development strategy by augmenting our internal product development capabilities for the PC.
A significant portion of the purchase price for this acquisition was assigned to goodwill as the primary asset we acquired in the transaction was an assembled workforce with proven technical and design talent with a history of high quality product creation. Goodwill has been included in the publishing segment of our business and is non-deductible for tax purposes. The results of operations of Infinity Ward are included in our consolidated statement of operations beginning October 24, 2003. Pro forma consolidated statements of operations are not shown, as they would not differ materially from reported results.
4. Cash, Cash Equivalents and Short-Term Investments
Short-term investments generally mature between three months and two years. Investments with maturities beyond one year may be classified as short-term based on their liquid nature and because such securities represent the investment of cash that is available for current operations. All of our short-term investments are classified as available-for-sale and are carried at fair market value with unrealized appreciation (depreciation) reported as a separate component of accumulated other comprehensive income (loss) in shareholders equity. The specific identification method is used to determine the cost of securities disposed with realized gains and losses reflected in investment income, net.
10
The following table summarizes our investments in securities as of June 30, 2004 (amounts in thousands):
|
|
Amortized |
|
Gross |
|
Gross |
|
Fair |
|
||||
Cash and cash equivalents: |
|
|
|
|
|
|
|
|
|
||||
Cash and time deposits |
|
$ |
93,570 |
|
$ |
|
|
$ |
|
|
$ |
93,570 |
|
Money market funds |
|
49,754 |
|
|
|
|
|
49,754 |
|
||||
Auction rate notes |
|
196,411 |
|
|
|
|
|
196,411 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Cash and cash equivalents |
|
339,735 |
|
|
|
|
|
339,735 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Short-term investments: |
|
|
|
|
|
|
|
|
|
||||
Corporate bonds |
|
21,147 |
|
|
|
(108 |
) |
21,039 |
|
||||
Taxable senior debt |
|
17,019 |
|
2 |
|
|
|
17,021 |
|
||||
U.S. agency issues |
|
141,652 |
|
1 |
|
(996 |
) |
140,657 |
|
||||
Asset-backed securities |
|
17,712 |
|
30 |
|
(49 |
) |
17,693 |
|
||||
Municipal bonds |
|
3,001 |
|
|
|
|
|
3,001 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Short-term investments |
|
200,531 |
|
33 |
|
(1,153 |
) |
199,411 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Cash, cash equivalents and short-term investments |
|
$ |
540,266 |
|
$ |
33 |
|
$ |
(1,153 |
) |
$ |
539,146 |
|
The following table summarizes the maturities of our investments in debt securities as of June 30, 2004 (amounts in thousands):
|
|
Amortized |
|
Fair |
|
||
Due in one year or less |
|
$ |
292,277 |
|
$ |
291,933 |
|
Due after one year through two years |
|
86,953 |
|
86,196 |
|
||
|
|
379,230 |
|
378,129 |
|
||
Asset-backed securities |
|
17,712 |
|
17,693 |
|
||
|
|
|
|
|
|
||
Total |
|
$ |
396,942 |
|
$ |
395,822 |
|
For the three months ended June 30, 2004, there were no gross realized gains and no gross realized losses. For the three months ended June 30, 2003, net realized gains on short-term investments consisted of no gross realized gains and $4,000 of gross realized losses.
5. Inventories
Inventories are valued at the lower of cost (first-in, first-out) or market. Our inventories consist of the following (amounts in thousands):
|
|
June 30, 2004 |
|
March 31, 2004 |
|
||
Purchased parts and components |
|
$ |
4,073 |
|
$ |
392 |
|
Finished goods |
|
35,562 |
|
26,035 |
|
||
|
|
|
|
|
|
||
|
|
$ |
39,635 |
|
$ |
26,427 |
|
11
6. Goodwill
The changes in the carrying amount of goodwill for the three months ended June 30, 2004 are as follows (amounts in thousands):
|
|
Publishing |
|
Distribution |
|
Total |
|
|||
|
|
|
|
|
|
|
|
|||
Balance as of March 31, 2004 |
|
$ |
70,898 |
|
$ |
5,595 |
|
$ |
76,493 |
|
Effect of foreign currency exchange rates |
|
|
|
(57 |
) |
(57 |
) |
|||
|
|
|
|
|
|
|
|
|||
Balance as of June 30, 2004 |
|
$ |
70,898 |
|
$ |
5,538 |
|
$ |
76,436 |
|
7. Income Taxes
The income tax provision of $5.9 million for the three months ended June 30, 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 state taxes. The income tax provision of $2.2 million for the three months ended June 30, 2003 reflects our effective income tax rate of approximately 35%. State taxes, offset by research and development tax credits and the impact of foreign tax rate differentials, resulted in an effective income tax rate equal to our statutory rate of 35% for the three months ended June 30, 2003.
8. Software Development Costs and Intellectual Property Licenses
As of June 30, 2004, capitalized software development costs included $37.2 million of internally developed software costs and $60.2 million of payments made to third-party software developers. As of March 31, 2004, capitalized software development costs included $35.3 million of internally developed software costs and $51.5 million of payments made to third-party software developers. Capitalized intellectual property licenses were $32.8 million and $48.5 million as of June 30, 2004 and March 31, 2004, respectively. Amortization and write-offs of capitalized software development costs and intellectual property licenses were $31.8 million and $19.0 million for the three months ended June 30, 2004 and 2003, respectively.
9. Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss)
Comprehensive Income
The components of comprehensive income for the three months ended June 30, 2004 and 2003 were as follows (amounts in thousands):
|
|
Three months ended June 30, |
|
||||
|
|
2004 |
|
2003 |
|
||
|
|
|
|
|
|
||
Net income |
|
$ |
11,957 |
|
$ |
4,163 |
|
|
|
|
|
|
|
||
Other comprehensive income (loss) |
|
|
|
|
|
||
Foreign currency translation adjustment |
|
(1,360 |
) |
3,725 |
|
||
Unrealized depreciation on short-term investments |
|
(1,217 |
) |
(24 |
) |
||
|
|
|
|
|
|
||
Other comprehensive income (loss) |
|
(2,577 |
) |
3,701 |
|
||
|
|
|
|
|
|
||
Comprehensive income |
|
$ |
9,380 |
|
$ |
7,864 |
|
12
Accumulated Other Comprehensive Income (Loss)
For the three months ended June 30, 2004, the components of accumulated other comprehensive income were as follows (amounts in thousands):
|
|
Foreign |
|
Unrealized |
|
Accumulated |
|
|||
|
|
|
|
|
|
|
|
|||
Balance, March 31, 2004 |
|
$ |
9,864 |
|
$ |
97 |
|
$ |
9,961 |
|
Other comprehensive loss |
|
(1,360 |
) |
(1,217 |
) |
(2,577 |
) |
|||
|
|
|
|
|
|
|
|
|||
Balance, June 30, 2004 |
|
$ |
8,504 |
|
$ |
(1,120 |
) |
$ |
7,384 |
|
The income tax benefit related to other comprehensive loss was not significant.
10. Investment Income, Net
Investment income, net is comprised of the following (amounts in thousands):
|
|
Three months ended June 30, |
|
||||
|
|
2004 |
|
2003 |
|
||
Interest expense |
|
$ |
(88 |
) |
$ |
(195 |
) |
Interest income |
|
2,200 |
|
1,456 |
|
||
Net realized loss on investments |
|
|
|
(4 |
) |
||
|
|
|
|
|
|
||
Investment income, net |
|
$ |
2,112 |
|
$ |
1,257 |
|
11. Supplemental Cash Flow Information
Non-cash investing and financing activities and supplemental cash flow information is as follows (amounts in thousands):
|
|
Three months ended June 30, |
|
||||
|
|
2004 |
|
2003 |
|
||
Non-cash investing and financing activities: |
|
|
|
|
|
||
Change in unrealized depreciation on short-term investments |
|
$ |
1,217 |
|
$ |
24 |
|
|
|
|
|
|
|
||
Supplemental cash flow information: |
|
|
|
|
|
||
Cash paid for income taxes |
|
$ |
2,621 |
|
$ |
3,349 |
|
Cash paid (received) for interest, net |
|
(2,015 |
) |
(1,743 |
) |
12. Operations by Reportable Segments and Geographic Area
Based upon our organizational structure, we operate two business segments: (i) publishing of interactive entertainment software and (ii) distribution of interactive entertainment software and hardware products.
Publishing refers to the development, marketing and sale of products, either directly, by license or through our affiliate label program with certain third-party publishers. In the United States, 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
13
Kingdom, Germany, France, Italy, Australia, Sweden, Canada and Japan. Our products are sold internationally on a direct-to-retail basis and through third-party distribution and licensing arrangements and through our wholly-owned distribution subsidiaries.
Distribution refers to our operations in the United Kingdom, the Netherlands and Germany that provide logistical and sales services to third-party publishers of interactive entertainment software, our own publishing operations and manufacturers of interactive entertainment hardware.
Resources are allocated to each of these segments using information on their respective net revenues and operating profits before interest and taxes.
The accounting policies of these segments are the same as those described in the Summary of Significant Accounting Policies in our Annual Report on Form 10-K for the year ended March 31, 2004. Revenue derived from sales between segments is eliminated in consolidation.
Information on the reportable segments for the three months ended June 30, 2004 and 2003 is as follows (amounts in thousands):
|
|
Three months ended June 30, 2004 |
|
|||||||
|
|
Publishing |
|
Distribution |
|
Total |
|
|||
|
|
|
|
|
|
|
|
|||
Total segment revenues |
|
$ |
161,652 |
|
$ |
49,624 |
|
$ |
211,276 |
|
Revenues from sales between segments |
|
(8,324 |
) |
8,324 |
|
|
|
|||
|
|
|
|
|
|
|
|
|||
Revenues from external customers |
|
$ |
153,328 |
|
$ |
57,948 |
|
$ |
211,276 |
|
|
|
|
|
|
|
|
|
|||
Operating income (loss) |
|
$ |
15,894 |
|
$ |
(161 |
) |
$ |
15,733 |
|
|
|
|
|
|
|
|
|
|||
Total assets |
|
$ |
880,041 |
|
$ |
105,800 |
|
$ |
985,841 |
|
|
|
Three months ended June 30, 2003 |
|
|||||||
|
|
Publishing |
|
Distribution |
|
Total |
|
|||
|
|
|
|
|
|
|
|
|||
Total segment revenues |
|
$ |
114,405 |
|
$ |
44,320 |
|
$ |
158,725 |
|
Revenues from sales between segments |
|
(9,670 |
) |
9,670 |
|
|
|
|||
|
|
|
|
|
|
|
|
|||
Revenues from external customers |
|
$ |
104,735 |
|
$ |
53,990 |
|
$ |
158,725 |
|
|
|
|
|
|
|
|
|
|||
Operating income (loss) |
|
$ |
5,170 |
|
$ |
(24 |
) |
$ |
5,146 |
|
|
|
|
|
|
|
|
|
|||
Total assets |
|
$ |
643,200 |
|
$ |
87,557 |
|
$ |
730,757 |
|
14
Geographic information for the three months ended June 30, 2004 and 2003 is based on the location of the selling entity. Revenues from external customers by geographic region were as follows (amounts in thousands):
|
|
Three months ended June 30, |
|
||||
|
|
2004 |
|
2003 |
|
||
|
|
|
|
|
|
||
United States |
|
$ |
125,191 |
|
$ |
82,739 |
|
Europe |
|
78,101 |
|
72,740 |
|
||
Other |
|
7,984 |
|
3,246 |
|
||
|
|
|
|
|
|
||
Total |
|
$ |
211,276 |
|
$ |
158,725 |
|
Revenues by platform were as follows (amounts in thousands):
|
|
Three months ended June 30, |
|
||||
|
|
2004 |
|
2003 |
|
||
|
|
|
|
|
|
||
Console |
|
$ |
158,321 |
|
$ |
123,826 |
|
Hand-held |
|
22,085 |
|
7,508 |
|
||
PC |
|
30,870 |
|
27,391 |
|
||
|
|
|
|
|
|
||
Total |
|
$ |
211,276 |
|
$ |
158,725 |
|
As of and for the three months ended June 30, 2004, we had one customer that accounted for 26% of consolidated net revenues and 33% of consolidated accounts receivable, net. As of and for the three months ended June 30, 2003 we had one customer that accounted for 16% of consolidated net revenues and 29% of consolidated accounts receivable, net. This customer was the same customer in both periods and was a customer of both our publishing and distribution businesses.
15
13. Computation of Earnings Per Share
The following table sets forth the computations of basic and diluted earnings per share (amounts in thousands, except per share data):
|
|
Three months ended June 30, |
|
||||
|
|
2004 |
|
2003 |
|
||
|
|
|
|
|
|
||
Numerator: |
|
|
|
|
|
||
Numerator for basic and diluted earnings per share - income available to common shareholders |
|
$ |
11,957 |
|
$ |
4,163 |
|
|
|
|
|
|
|
||
Denominator: |
|
|
|
|
|
||
Denominator for basic earnings per share-weighted average common shares outstanding |
|
137,765 |
|
132,069 |
|
||
|
|
|
|
|
|
||
Effect of dilutive securities: |
|
|
|
|
|
||
Employee stock options and stock purchase plan |
|
14,939 |
|
8,139 |
|
||
Warrants to purchase common stock |
|
703 |
|
447 |
|
||
|
|
|
|
|
|
||
Potential dilutive common shares |
|
15,642 |
|
8,586 |
|
||
|
|
|
|
|
|
||
Denominator for diluted earnings per share - weighted average common shares outstanding plus assumed conversions |
|
153,407 |
|
140,655 |
|
||
|
|
|
|
|
|
||
Basic earnings per share |
|
$ |
0.09 |
|
$ |
0.03 |
|
|
|
|
|
|
|
||
Diluted earnings per share |
|
$ |
0.08 |
|
$ |
0.03 |
|
Options to purchase 63,700 shares of common stock at exercise prices ranging from $15.53 to $16.66 and options to purchase 12,963,024 shares of common stock at exercise prices ranging from $7.23 to $14.77 were outstanding for the three months ended June 30, 2004 and 2003, respectively, but were not included in the calculation of diluted earnings per share because their effect would be antidilutive.
14. Commitments and Contingencies
Credit Facilities
We have revolving credit facilities with our Centresoft subsidiary located in the United Kingdom (the UK Facility) and our NBG subsidiary located in Germany (the German Facility). The UK Facility provides Centresoft with the ability to borrow up to Great Britain Pounds (GBP) 8.0 million ($14.5 million), including issuing letters of credit, on a revolving basis as of June 30, 2004. Furthermore, under the UK Facility, Centresoft provided a GBP 0.6 million ($1.1 million) guarantee for the benefit of our CD Contact subsidiary as of June 30, 2004. The UK Facility bore interest at LIBOR plus 2.0% as of June 30, 2004, is collateralized by substantially all of the assets of the subsidiary and expires in November 2005. The UK Facility also contains various covenants that require the subsidiary to maintain specified financial ratios related to, among others, fixed charges. As of June 30, 2004, we were in compliance with these covenants. No borrowings were outstanding against the UK Facility as of June 30, 2004. The German Facility provided for revolving loans up to EUR 0.5 million ($0.6 million) as of June 30, 2004, bore interest at a
16
Eurocurrency rate plus 2.5%, is collateralized by certain of the subsidiarys property and equipment and has no expiration date. No borrowings were outstanding under the German Facility as of June 30, 2004.
Developer and Intellectual Property Contracts
In the normal course of business, we enter into contractual arrangements with third parties for the development of products, as well as for the rights to intellectual property. Under these agreements, we commit to provide specified payments to a developer or intellectual property holder based upon contractual arrangements. Assuming all contractual provisions are met, the total future minimum contract commitment for contracts in place as of June 30, 2004 is approximately $85.9 million and is scheduled to be paid as follows (amounts in thousands):
Fiscal year ending March 31, |
|
|
|
|
|
|
|
|
|
2005 |
|
$ |
54,652 |
|
2006 |
|
17,752 |
|
|
2007 |
|
8,595 |
|
|
2008 |
|
1,895 |
|
|
2009 and thereafter |
|
3,020 |
|
|
|
|
|
|
|
Total |
|
$ |
85,914 |
|
The commitment schedule above excludes approximately $9.3 million of commitments originally scheduled to be paid between fiscal 2004 through fiscal 2007 relating to an intellectual property rights agreement with a third party. Effective June 30, 2003, we terminated the agreement and filed a breach of contract suit against the third party.
Marketing Commitments
In connection with certain intellectual property right acquisitions and development agreements, we will commit to spend specified amounts for marketing support for the related game(s) which is to be developed or in which the intellectual property will be utilized. Assuming all contractual provisions are met, the total future minimum marketing commitment for contracts in place as of June 30, 2004 is approximately $49.9 million, which is scheduled to be paid as follows (amounts in thousands):
Fiscal Year ending March 31, |
|
|
|
|
|
|
|
|
|
2005 |
|
$ |
23,350 |
|
2006 |
|
11,500 |
|
|
2007 |
|
10,000 |
|
|
2008 |
|
5,000 |
|
|
|
|
|
|
|
Total |
|
$ |
49,850 |
|
17
Lease Obligations
We lease certain of our facilities under non-cancelable operating lease agreements. Total future minimum lease commitments as of June 30, 2004 are as follows (amounts in thousands):
Fiscal Year ending March 31, |
|
|
|
|
|
|
|
|
|
2005 |
|
$ |
7,353 |
|
2006 |
|
8,561 |
|
|
2007 |
|
8,013 |
|
|
2008 |
|
4,748 |
|
|
2009 |
|
3,701 |
|
|
Thereafter |
|
16,547 |
|
|
|
|
|
|
|
Total |
|
$ |
48,923 |
|
Legal and Regulatory Proceedings
On March 5, 2004, a class action lawsuit was filed against us and certain of our current and former officers and directors. The complaint, which asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 based on allegations that our revenues and assets were overstated during the period between February 1, 2001 and December 17, 2002, was filed in the United States District Court, Central District of California by the Construction Industry and Carpenters Joint Pension Trust for Southern Nevada purporting to represent a class of purchasers of Activision stock. Five additional purported class actions have subsequently been filed by Gianni Angeloni, Christopher Hinton, Stephen Anish, the Alaska Electrical Pension Fund, and Joseph A. Romans asserting similar 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 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.
18
In addition, we are party to other routine claims and suits brought by us and against us in the ordinary course of business, including disputes arising over the ownership of intellectual property rights, contractual claims and collection matters. In the opinion of management, after consultation with legal counsel, the outcome of such routine claims will not have a material adverse effect on our business, financial condition, results of operations or liquidity.
15. Capital Transactions
During fiscal 2003, our Board of Directors authorized a buyback program under which we can repurchase up to $350.0 million of our common stock. Under the program, shares may be purchased as determined by management and within certain guidelines, from time to time, in the open market or in privately negotiated transactions, including privately negotiated structured option transactions, and through transactions in the options markets. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time to time without prior notice.
During the three months ended June 30, 2004, we did not repurchase any of our common stock or enter into any structured stock repurchase transactions. As of June 30, 2004, we had no outstanding structured stock repurchase transactions.
16. Related Parties
In August 2001, we elected to our Board of Directors an individual who is a partner in a law firm that has provided legal services to Activision for more than ten years. For the three months ended June 30, 2004 and 2003, the fees we paid to the law firm were an insignificant portion of the firms total revenues. We believe that the fees charged to us by the law firm are competitive with the fees charged by other law firms.
19
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 within the next one 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
20
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, in the first quarter of fiscal 2005 we released the video game Spider-Man 2, the sequel to the highly successful Spider-Man: The Movie. The video game release of Spider-Man 2 coincided with the Spider-Man 2 theatrical release in June 2004. Also, under 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 released five successful titles in the Tony Hawk franchise with cumulative net revenues of over $800 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 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, which was released in the first quarter of fiscal 2005, as well as upcoming computer-animated films, Shark Tale, which is scheduled to be released in the second quarter of fiscal 2005, 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 as 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 development companies with talented and experienced teams. We 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 of our Annual Report on Form 10-K for the year ended March 31, 2004 filed with the SEC. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition. We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers. Certain products are sold to customers with a street date (the date that products are made widely available for sale by retailers). For these products we recognize revenue on the street date.
21
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.
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 life cycle, Activision sales force and retail customer feedback, industry pricing, weeks of on-hand retail channel inventory, absolute quantity of on-hand retail channel inventory, 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 creditworthiness, current economic trends and changes in our customers payment terms and their economic condition, as well as whether we can obtain sufficient credit insurance. Any significant changes in any of these criteria would 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.
22
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 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
23
property license costs relating to such contracts may extend beyond one year. For intellectual property 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.
24
The following table sets forth certain consolidated statements of operations data for the periods indicated as a percentage of total net revenues and also breaks down net revenues by territory, business segment and platform, as well as operating income (loss) by business segment (amounts in thousands):
|
|
Three months ended June 30, |
|
||||||||
|
|
2004 |
|
2003 |
|
||||||
|
|
|
|
|
|
|
|
|
|
||
Net revenues |
|
$ |
211,276 |
|
100 |
% |
$ |
158,725 |
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
||
Costs and expenses: |
|
|
|
|
|
|
|
|
|
||
Cost of sales product costs |
|
89,088 |
|
42 |
|
76,610 |
|
48 |
|
||
Cost of sales software royalties and amortization |
|
12,283 |
|
6 |
|
15,498 |
|
10 |
|
||
Cost of sales intellectual property licenses |
|
17,648 |
|
8 |
|
10,143 |
|
6 |
|
||
Product development |
|
21,105 |
|
10 |
|
13,580 |
|
9 |
|
||
Sales and marketing |
|
41,734 |
|
20 |
|
26,285 |
|
17 |
|
||
General and administrative |
|
13,685 |
|
7 |
|
11,463 |
|
7 |
|
||
|
|
|
|
|
|
|
|
|
|
||
Total costs and expenses |
|
195,543 |
|
93 |
|
153,579 |
|
97 |
|
||
|
|
|
|
|
|
|
|
|
|
||
Operating income |
|
15,733 |
|
7 |
|
5,146 |
|
3 |
|
||
|
|
|
|
|
|
|
|
|
|
||
Investment income, net |
|
2,112 |
|
1 |
|
1,257 |
|
1 |
|
||
|
|
|
|
|
|
|
|
|
|
||
Income before income tax provision |
|
17,845 |
|
8 |
|
6,403 |
|
4 |
|
||
|
|
|
|
|
|
|
|
|
|
||
Income tax provision |
|
5,888 |
|
2 |
|
2,240 |
|
1 |
|
||
|
|
|
|
|
|
|
|
|
|
||
Net income |
|
$ |
11,957 |
|
6 |
% |
$ |
4,163 |
|
3 |
% |
|
|
|
|
|
|
|
|
|
|
||
Net Revenues by Territory: |
|
|
|
|
|
|
|
|
|
||
United States |
|
$ |
125,191 |
|
59 |
% |
$ |
82,739 |
|
52 |
% |
Europe |
|
78,101 |
|
37 |
|
72,740 |
|
46 |
|
||
Other |
|
7,984 |
|
4 |
|
3,246 |
|
2 |
|
||
|
|
|
|
|
|
|
|
|
|
||
Total net revenues |
|
$ |
211,276 |
|
100 |
% |
$ |
158,725 |
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
||
Net Revenues by Segment/Platform Mix: |
|
|
|
|
|
|
|
|
|
||
Publishing: |
|
|
|
|
|
|
|
|
|
||
Console |
|
$ |
119,127 |
|
56 |
% |
$ |
88,484 |
|
56 |
% |
Hand-held |
|
18,430 |
|
9 |
|
4,596 |
|
3 |
|
||
PC |
|
24,095 |
|
12 |
|
21,325 |
|
13 |
|
||
Total publishing net revenues |
|
161,652 |
|
77 |
|
114,405 |
|
72 |
|
||
|
|
|
|
|
|
|
|
|
|
||
Distribution: |
|
|
|
|
|
|
|
|
|
||
Console |
|
39,194 |
|
18 |
|
35,342 |
|
22 |
|
||
Hand-held |
|
3,655 |
|
2 |
|
2,912 |
|
2 |
|
||
PC |
|
6,775 |
|
3 |
|
6,066 |
|
4 |
|
||
Total distribution net revenues |
|
49,624 |
|
23 |
|
44,320 |
|
28 |
|
||
|
|
|
|
|
|
|
|
|
|
||
Total net revenues |
|
$ |
211,276 |
|
100 |
% |
$ |
158,725 |
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
||
Operating Income (Loss) by Segment: |
|
|
|
|
|
|
|
|
|
||
Publishing |
|
$ |
15,894 |
|
7 |
% |
$ |
5,170 |
|
3 |
% |
Distribution |
|
(161 |
) |
|
|
(24 |
) |
|
|
||
|
|
|
|
|
|
|
|
|
|
||
Total operating income |
|
$ |
15,733 |
|
7 |
% |
$ |
5,146 |
|
3 |
% |
25
Net income for the three months ended June 30, 2004 was $12.0 million or $0.08 per diluted share, as compared to $4.2 million or $0.03 per diluted share for the three months ended June 30, 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 three months ended June 30, 2004 and 2003 (in thousands):
|
|
Three Months ended June 30, |
|
Increase/ |
|
Percent |
|
|||||
|
|
2004 |
|
2003 |
|
|
|
|||||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
|
|||
North America |
|
$ |
125,191 |
|
$ |
82,739 |
|
$ |
42,452 |
|
51 |
% |
Europe |
|
28,477 |
|
28,420 |
|
57 |
|
|
% |
|||
Other |
|
7,984 |
|
3,246 |
|
4,738 |
|
146 |
% |
|||
Total International |
|
36,461 |
|
31,666 |
|
4,795 |
|
15 |
% |
|||
Total Publishing Net Revenues |
|
161,652 |
|
114,405 |
|
47,247 |
|
41 |
% |
|||
Distribution Net Revenues |
|
49,624 |
|
44,320 |
|
5,304 |
|
12 |
% |
|||
Consolidated Net Revenues |
|
$ |
211,276 |
|
$ |
158,725 |
|
$ |
52,551 |
|
33 |
% |
Consolidated net revenues increased 33% from $158.7 million for the three months ended June 30, 2003 to $211.3 million for the three months ended June 30, 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 2005 first quarter releases of Spider-Man 2 and Shrek 2 for PS2, Xbox, GameCube, GBA and PC. In June 2004, according to the NPD Group, a third-party sales tracking agency, Spider-Man 2 and Shrek 2 were the number one and two best selling titles in North America across all platforms.
Publishing console net revenues increased by 35% from $88.5 million for the three months ended June 30, 2003 to $119.1 million for the three months ended June 30, 2004. The increase was driven by our top two releases published on four console platforms.
International net revenues benefited from the strong year-over-year strengthening of the Euro (EUR) and Great Britain Pound (GBP) in relation to the U.S. dollar. We estimate that foreign exchange rates increased reported net revenue by approximately $7.2 million. Excluding the impact of changing foreign currency rates, our international net revenue increased 4% year-over-year.
26
North America Publishing Net Revenue (in thousands)
June 30, |
|
% of |
|
June 30, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
125,191 |
|
59 |
% |
$ |
82,739 |
|
52 |
% |
$ |
42,452 |
|
51 |
% |
Domestic publishing net revenues increased 51% from $82.7 million for the three months ended June 30, 2003, to $125.2 million for the three months ended June 30, 2004. The increase reflects the strong performance of our fiscal 2005 first quarter releases of Spider-Man 2 and Shrek 2 for the PS2, Xbox, Gamecube, GBA and PC. We also had solid catalog sales from a number of our franchises, including Spider-Man and Call of Duty.
International Publishing Net Revenue (in thousands)
June 30, |
|
% of |
|
June 30, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
36,461 |
|
17 |
% |
$ |
31,666 |
|
20 |
% |
$ |
4,795 |
|
15 |
% |
International publishing net revenues increased by 15% from $31.7 million for the three months ended June 30, 2003, to $36.5 million for the three months ended June 30, 2004. International publishing also saw strong results from our fiscal 2005 first quarter releases of Shrek 2 and, on a limited territorial release schedule, Spider-Man 2 for PS2, Xbox, GameCube, GBA and PC. There also was a positive strengthening of the EUR and the GBP in relation to the U.S. dollar of approximately $2.4 million. Excluding the impact of changing foreign currency rates, our international publishing net revenue increased 8% year-over-year.
27
Publishing Net Revenue by Platform
Publishing net revenues increased 41% from $114.4 million for the three months ended June 30, 2003 to $161.7 million for the three months ended June 30, 2004. The following table details our publishing net revenues by platform and as a percentage of total publishing net revenues for the three months ended June 30, 2004 and 2003 (in thousands):
|
|
Quarter Ended |
|
% of |
|
Quarter Ended |
|
% of |
|
Increase/ |
|
Percent |
|
|||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
PC |
|
$ |
24,095 |
|
15 |
% |
$ |
21,325 |
|
19 |
% |
$ |
2,770 |
|
13 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Console |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
PlayStation 2 |
|
68,704 |
|
42 |
% |
42,453 |
|
37 |
% |
26,251 |
|
62 |
% |
|||
Microsoft Xbox |
|
25,836 |
|
16 |
% |
35,148 |
|
31 |
% |
(9,312 |
) |
(26 |
)% |
|||
Nintendo GameCube |
|
23,752 |
|
15 |
% |
6,226 |
|
5 |
% |
17,526 |
|
281 |
% |
|||
Other |
|
835 |
|
1 |
% |
4,657 |
|
4 |
% |
(3,822 |
) |
(82 |
)% |
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total Console |
|
119,127 |
|
74 |
% |
88,484 |
|
77 |
% |
30,643 |
|
35 |
% |
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Hand-held |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Game Boy Advance |
|
18,430 |
|
11 |
% |
4,596 |
|
4 |
% |
13,834 |
|
301 |
% |
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total Publishing Net Revenues |
|
$ |
161,652 |
|
100 |
% |
$ |
114,405 |
|
100 |
% |
$ |
47,247 |
|
41 |
% |
Personal Computer Net Revenue (in thousands)
June 30, |
|
% of |
|
June 30, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
24,095 |
|
15 |
% |
$ |
21,325 |
|
19 |
% |
$ |
2,770 |
|
13 |
% |
Net revenue from sales of titles for the PC increased 13% from $21.3 million for the three months ended June 30, 2003 to $24.1 million for the three months ended June 30, 2004. Our new release titles performed very well in both the domestic and international markets. In addition, the number of premium PC titles released in the first quarter of fiscal 2005 increased to 3 titles from 1 PC title released in the first quarter of fiscal 2004. We expect fiscal 2005 PC publishing net revenues to continue 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 and Rome: Total War.
28
June 30, |
|
% of |
|
June 30, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
68,704 |
|
42 |
% |
$ |
42,453 |
|
37 |
% |
$ |
26,251 |
|
62 |
% |
Net revenue from sales of titles for the PS2 increased 62% from $42.5 million for the three months ended June 30, 2003 to $68.7 million for the three months ended June 30, 2004. Though the number of new PS2 titles decreased in the first quarter of fiscal 2005 to 2 from 4 in fiscal 2004, 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 our PS2 titles including Spider-Man 2 and Shrek 2.
Microsoft Xbox Net Revenue (in thousands)
June 30, |
|
% of |
|
June 30, |
|
% of |
|
Increase/ |
|
Percent |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||
$ |
25,836 |
|
16 |
% |
$ |
35,148 |
|
31 |
% |
$ |
(9,312 |
) |
(26 |
)% |
Net revenue from sales of titles for the Xbox decreased 26% from $35.1 million for the three months ended June 30, 2003 to $25.8 million for the three months ended June 30, 2004. The decrease is due to a reduction in the number of Xbox titles released in the first quarter of fiscal 2005 to 2 from 5 in the first quarter of fiscal 2004. Though the titles released on the Xbox, Spider-Man 2 and Shrek 2, reflect solid sales both in the domestic and international markets, these titles did not perform as well on the Xbox as they did on other platforms as these titles were not as focused toward the demographic of the Xbox audience as compared to the titles released in the three months ended June 30, 2003, X2: Wolverines Revenge, Return to Castle Wolfenstein, Wakeboarding Unleashed and Soldier of Fortune II: Double Helix.
June 30, |
|