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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 1999
OR
[ ] 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 94-2606438
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3100 OCEAN PARK BLVD., SANTA MONICA, CA 90405
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 255-2000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, par value $.000001 per share
------------------------------------------
(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 X No
----- -----
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 registrant's 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. [ ]
The aggregate market value of the Common Stock of the registrant held by
non-affiliates of the registrant on June 25, 1999 was $295,741,675.
The number of shares of the registrant's Common Stock outstanding as of June 25,
1999 was 22,982,248.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's 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 1999 Annual Meeting of
Shareholders, are incorporated by reference into Part III of this Annual Report.
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INDEX
Page No.
--------
PART I.
Item 1. Business ............................................................................. 3
Item 2. Properties ........................................................................... 14
Item 3. Legal Proceedings .................................................................... 14
Item 4. Submission of Matters to a Vote of Security Holders .................................. 14
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ................ 15
Item 6. Selected Consolidated Financial Data ................................................. 17
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................................ 18
Item 7A. Quantitative and Qualitative Disclosures about Market Risk............................ 26
Item 8. Consolidated Financial Statements and Supplementary Data ............................. 27
PART III.
Item 10. Directors and Executive Officers of the Registrant ................................... 28
Item 11. Executive Compensation ............................................................... 28
Item 12. Security Ownership of Certain Beneficial Owners and Management ....................... 28
Item 13. Certain Relationships and Related Transactions ....................................... 28
PART IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ..................... 29
SIGNATURES ............................................................................................... 32
2
PART I
Item 1. BUSINESS
(a) GENERAL
Activision, Inc. (together with its subsidiaries, "Activision"
or the "Company") is a leading international publisher, developer and
distributor of interactive entertainment and leisure products. The
Company was incorporated in California in 1979. In December 1992, the
Company reincorporated in Delaware.
The Company's products span a wide range of genres (including
action, adventure, strategy and simulation) and target markets
(including game enthusiasts, value buyers and children). In addition to
its genre and market diversity, the Company publishes, develops and
distributes products for a variety of game platforms, including
personal computers ("PCs"), the Sony Playstation console system and the
Nintendo 64 console system.
The Company completed the acquisition of Raven Software
Corporation ("Raven") on July 13, 1997, NBG EDV Handels- und Verlags
GmbH ("NBG") on November 26, 1997, S.B.F. Services, Limited dba Head
Games Publishing ("Head Games") on June 30, 1998, and CD Contact
Data GmbH ("CD Contact") on September 29, 1998. Each of the above
transactions originally had been accounted for by the Company as an
immaterial pooling of interests. The financial results for each such
acquired company and related cash flows had therefore been included
in the reported operations of the Company beginning only on the date
of acquisition. Based on a reevaluation of these transactions,
including the results of operations of each entity, statements by
the Securities and Exchange Commission (the "SEC") on materiality of
pooling transactions and requirements to evaluate the impact on each
line item in the financial statements and the impact on the
Company's trends, the Company has restated all financial information
reported in this Annual Report on Form 10-K for all periods prior to
the consummation of each transaction to include the financial
position, results of operations and cash flows of such acquired
companies.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company has two reportable segments: publishing
CD-based and cartridge based interactive entertainment and leisure
software; and distributing interactive entertainment and leisure
products. Publishing relates to the development (both internally and
externally), marketing and sale of products owned or controlled by
the Company, either directly or through its affiliate label program.
Distribution refers to the sale by the Company's European
distribution subsidiaries of other publishers' software and related
products to the marketplace. 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.
(c) NARRATIVE DESCRIPTION OF BUSINESS
FACTORS AFFECTING FUTURE PERFORMANCE
In connection with the Private Securities Litigation Reform
Act of 1995 (the "Litigation Reform Act"), the Company is 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 its employees and representatives
that may contain "forward-looking statements" within the meaning of the
Litigation Reform Act. Such statements consist of any statement other
than a recitation of historical fact and can be identified by the use
of forward-looking terminology such as "may," "expect," "anticipate,"
"estimate" or "continue" or the negative thereof or other variations
thereon or comparable terminology. The listener or reader is cautioned
that all forward-looking statements are necessarily speculative and
there are numerous risks and uncertainties that could cause actual
events or results to differ materially from those referred to in such
forward-looking statements. 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.
The reader or listener is cautioned that the Company does not have a
policy of updating or revising forward-looking statements and thus he
or she should not assume that silence by management over time means
that actual events are bearing out as estimated in such forward-looking
statements.
FLUCTUATIONS IN QUARTERLY RESULTS; FUTURE OPERATING RESULTS
UNCERTAIN; SEASONALITY. The Company's quarterly operating results have
varied significantly in the past and will likely vary significantly in
the future depending on numerous factors, several of which are not
under the Company's control. Such factors include, but are not limited
to, demand for products published or distributed by the Company, the
size and rate of growth of the interactive entertainment and leisure
markets, development and promotional expenses relating to the
introduction of new products, changes in computing platforms, product
returns, the timing of orders from major customers, delays in shipment,
the level of price competition, the timing of
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product introductions by the Company and its competitors, product
life cycles, product defects and other quality problems, the level
of the Company's international revenues, and personnel changes.
Products are generally shipped as orders are received, and
consequently, the Company operates with little or no backlog. Net
revenues in any quarter are, therefore, substantially dependent on
orders booked and shipped in that quarter.
The Company's expenses are based in part on the Company's
product development and marketing budgets. Many of the costs incurred
by the Company to produce and sell its products are expensed as such
costs are incurred, which often is before a product is released. In
addition, a significant portion of the Company's expenses are fixed. As
the Company increases its production and sales activities, current
expenses will increase and, if sales from previously released products
are below expectations, net income is likely to be disproportionately
affected.
Due to all of the foregoing, revenues and operating results
for any future quarter are not predictable with any significant degree
of accuracy. Accordingly, the Company believes that period-to-period
comparisons of its operating results are not necessarily meaningful and
should not be relied upon as indications of future performance.
The Company's business has experienced and is expected to
continue to experience significant seasonality, in part due to consumer
buying patterns. Net revenues typically are significantly higher during
the fourth calendar quarter, primarily due to the increased demand for
consumer software during the year-end holiday buying season. Net
revenues and net income in other quarters are generally lower and vary
significantly as a result of new product introductions and other
factors. For example, the Company's net revenues in its last five
quarters were $68.1 million for the quarter ended March 31, 1998, $61.5
million for the quarter ended June 30, 1998, $66.2 million for the
quarter ended September 30, 1998, $193.5 million for the quarter ended
December 31, 1998 and $115.2 million for the quarter ended March 31,
1999. The Company's net income (loss) for the last five quarters was
$689,000 for the quarter ended March 31, 1998, $(3.7) million for the
quarter ended June 30, 1998, $(2.2) million for the quarter ended
September 30, 1998, $16.0 million for the quarter ended December 31,
1998 and $5.2 million for the quarter ended March 31, 1999. The Company
expects its net revenues and operating results to continue to reflect
significant seasonality.
DEPENDENCE ON NEW PRODUCT DEVELOPMENT; PRODUCT DELAYS. The
Company's future success depends in part on the timely introduction of
successful new products to replace declining revenues from older
products. If, for any reason, revenues from new products were to fail
to replace declining revenues from older products, the Company's
business, operating results and financial condition would be materially
and adversely affected. In addition, the Company believes that the
competitive factors in the marketplace for premium-priced interactive
products create the need for higher quality, distinctive products that
incorporate increasingly sophisticated effects and the need to support
product releases with increased marketing, resulting in higher
development, acquisition and marketing costs. The lack of market
acceptance or significant delay in the introduction of, or the presence
of a defect in, one or more premium-priced products could have a
material adverse effect on the Company's business, operating results
and financial condition, particularly in view of the seasonality of the
Company's business. Further, because a large portion of a product's
revenue generally is associated with initial shipments, the delay of a
product introduction expected near the end of a fiscal quarter may have
a material adverse effect on operating results for that quarter.
The Company has, in the past, experienced significant delays
in the introduction of certain new products. The timing and success of
interactive entertainment products remain unpredictable due to the
complexity of product development, including the uncertainty associated
with technological developments. Although the Company has implemented
substantial development controls, there likely will be delays in
developing and introducing new products in the future. There can be no
assurance that new products will be introduced on schedule, or at all,
or that they will achieve market acceptance or generate significant
revenues.
RELIANCE ON THIRD PARTY DEVELOPERS AND INDEPENDENT
CONTRACTORS. The percentage of products published by the Company that
are developed by independent third party developers has increased over
the last several fiscal years. From time to time, the Company also
utilizes independent contractors for certain aspects of product
development and production. The Company has less control over the
scheduling and the quality of work by independent contractors and third
party developers than that of its own employees. A delay in the work
performed by independent contractors and third party developers or poor
quality of such work may result in product delays. Although the Company
intends to continue to rely in part on products that are developed
primarily by its own employees, the Company's ability to grow its
business and its future operating results will depend, in significant
part, on the Company's continued ability to maintain relationships with
skilled independent contractors and third party developers. There can
be no assurance that the Company will be able to maintain such
relationships.
4
UNCERTAINTY OF MARKET ACCEPTANCE; SHORT PRODUCT LIFE CYCLES.
The market for interactive entertainment and leisure systems and
interactive software has been characterized by shifts in consumer
preferences and short product life cycles. Consumer preferences for
entertainment and leisure software products are difficult to predict
and few products achieve sustained market acceptance. There can be no
assurance that new products introduced by the Company will achieve any
significant degree of market acceptance, that such acceptance will be
sustained for any significant period, or that product life cycles will
be sufficient to permit the Company to recoup development, marketing
and other associated costs. In addition, if market acceptance is not
achieved, the Company could be forced to accept substantial product
returns to maintain its relationships with retailers and its access to
distribution channels. Failure of new products to achieve or sustain
market acceptance or product returns in excess of the Company's
expectations would have a material adverse effect on the Company's
business, operating results and financial condition.
PRODUCT CONCENTRATION; DEPENDENCE ON HIT PRODUCTS. The Company
derives a significant portion of its revenues from a relatively small
number of products released each year, and many of these products have
substantial production or acquisition costs and marketing budgets.
During fiscal 1998, one product accounted for approximately 10.2% of
the Company's consolidated net revenues. All other products were
individually less than 10% of the Company's consolidated net revenues.
During fiscal 1999, no single product accounted for greater than 10% of
the Company's consolidated net revenues. However, the Company
anticipates that a limited number of products will continue to produce
a disproportionate amount of revenues. Due to this dependence on a
limited number of products, the failure of one or more of these
products to achieve anticipated results may have a material adverse
effect on the Company's business, operating results and financial
results.
The Company's strategy also includes as a key component
publishing titles that have franchise value, such that sequels,
enhancements and add-on products can be released over time, thereby
extending the life of the property in the market. While the focus on
franchise properties, if successful, results in extending product life
cycles, it also results in the Company depending on a limited number of
titles for its revenues. There can be no assurance that the Company's
existing franchise titles can continue to be exploited as successfully
as in the past. In addition, new products that the Company believes
will have potential value as franchise properties may not achieve
market acceptance and therefore may not be a basis for future releases.
INDUSTRY COMPETITION; COMPETITION FOR SHELF SPACE. The
interactive entertainment and leisure industries are intensely
competitive. Competition in these industries is principally based on
product quality and features, the compatibility of products with
popular platforms, company or product line brand name recognition,
access to distribution channels, marketing effectiveness, reliability
and ease of use, price and technical support. Significant financial
resources also have become a competitive factor in these industries,
principally due to the substantial cost of product development and
marketing that is required to support best-selling titles. In addition,
competitors with broad product lines and popular titles typically have
greater leverage with distributors and other customers who may be
willing to promote titles with less consumer appeal in return for
access to such competitor's most popular titles.
The Company's competitors range from small companies with
limited resources to large companies with substantially greater
financial, technical and marketing resources than those of the Company.
The Company's competitors currently include Electronic Arts, LucasArts,
Microsoft, Sega, Nintendo, Sony, Havas, Infogrames, Hasbro, GT
Interactive and Eidos, among many others.
As competition increases, significant price competition,
increased production costs and reduced profit margins may result.
Prolonged price competition or reduced demand would have a material
adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that the Company will be
able to compete successfully against current or future competitors or
that competitive pressures faced by the Company will not have a
material adverse effect on its business, operating results and
financial condition.
Retailers typically have a limited amount of shelf space, and
there is intense competition among entertainment and leisure software
producers for adequate levels of shelf space and promotional support
from retailers. As the number of interactive entertainment and leisure
products increase, the competition for shelf space has intensified,
resulting in greater leverage for retailers and distributors in
negotiating terms of sale, including price discounts and product return
policies. The Company's products constitute a relatively small
percentage of a retailer's sales volume, and there can be no assurance
that retailers will continue to purchase the Company's products or
promote the Company's products with adequate levels of shelf space and
promotional support.
DEPENDENCE ON DISTRIBUTORS AND RETAILERS; RISK OF CUSTOMER
BUSINESS FAILURE; PRODUCT Returns. Certain mass market retailers have
established exclusive buying relationships under which such retailers
will buy consumer software only from one intermediary. In such
instances, the price or other terms on which the Company sells to such
retailers may be adversely effected by the terms imposed by such
intermediary, or the Company may be unable to sell to such retailers on
terms which the Company deems acceptable. The loss
5
of, or significant reduction in sales attributable to, any of the
Company's principal distributors or retailers could materially
adversely effect the Company's business, operating results and
financial condition.
Retailers in the computer industry have from time to time
experienced significant fluctuations in their businesses and there have
been a number of business failures among these entities. The insolvency
or business failure of any significant retailer or other wholesale
purchaser of the Company's products could have a material adverse
effect on the Company's business, operating results and financial
condition. Sales are typically made on credit, with terms that vary
depending upon the customer and the nature of the product. The Company
does not hold collateral to secure payment. Although the Company has
obtained insolvency risk insurance to protect against any bankruptcy,
insolvency, or liquidation that may occur to its customers, such
insurance contains a significant deductible as well as a co-payment
obligation, and the policy does not cover all instances of non-payment.
In addition, the Company maintains a reserve for uncollectible
receivables that it believes to be adequate, but the actual reserve
which is maintained may not be sufficient in every circumstance. As a
result of the foregoing, a payment default by a significant customer
could have a material adverse effect on the Company's business,
operating results and financial condition.
The Company also is exposed to the risk of product returns
from retailers and other wholesale purchasers. Although the Company
provides reserves for returns that it believes are adequate, and
although the Company's agreements with certain of its customers place
certain limits on product returns, the Company could be forced to
accept substantial product returns to maintain its relationships with
retailers and its access to distribution channels. Product returns that
exceed the Company's reserves could have a material adverse effect on
the Company's business, operating results and financial condition.
CHANGES IN TECHNOLOGY AND INDUSTRY STANDARDS. The consumer
software industry is undergoing rapid changes, including evolving
industry standards, frequent new platform introductions and changes in
consumer requirements and preferences. The introduction of new
technologies, including new console systems such as Sega's Dreamcast
and Sony's PlayStation 2, technologies that support multi-player games,
and new media formats such as on-line delivery and digital video disks
("DVD"), could render the Company's previously released products
obsolete or unmarketable. The development cycle for products utilizing
new operating and console systems, microprocessors or formats may be
significantly longer than the Company's current development cycle for
products on existing operating systems, microprocessors and formats and
may require the Company to invest resources in products that may not
become profitable. There can be no assurance that the mix of the
Company's future product offerings will keep pace with technological
changes or satisfy evolving consumer preferences, or that the Company
will be successful in developing and marketing products for any future
operating system or format. Failure to develop and introduce new
products and product enhancements in a timely fashion could result in
significant product returns and inventory obsolescence and could have a
material adverse effect on the Company's business, operating results
and financial condition.
RISKS ASSOCIATED WITH LEVERAGE. As of March 31, 1999, the
Company had outstanding $60,000,000 of subordinated convertible notes
due 2005. In June 1999, the Company obtained a term loan and
revolving credit facility composed of $25 million of term loans and
up to $100 million of revolving credit loans and letters of credit.
The proceeds of the term loan, which is due in June 2002, were used
to complete the acquisition of Expert Software, Inc. and to pay
expenses associated with the acquisition and the financing
transaction. The revolving credit facility will be used for working
capital and general corporate purposes.
The term loan and the revolving credit facility are secured
by a pledge of substantially all of the asset of the Company and of
its US subsidiaries. The facility contains various financial and
other covenants that the Company and its subsidiaries must comply
with. If the Company were to default under the terms of the credit
facility, either as a result of a failure to pay principal or
interest when due or as a result of a breach of a financial or other
covenant, the lenders could stop providing funds and letters of
credit to the Company and could declare an event of default and
foreclose on the collateral. This could also result in an
acceleration of the subordinated notes. A default by the Company
under the revolving credit and term loan facility would materially
adversely effect the Company's business and could result in the
Company declaring bankruptcy.
YEAR 2000. Like many other software companies, the year 2000
computer issue creates risk for the Company. If internal computer and
embedded systems do not correctly recognize date information when the
year changes to 2000, there could be an adverse impact on the Company's
operations. The Company has initiated a comprehensive plan to prepare
its internal computer and embedded systems for the year 2000 and is
currently implementing changes to alleviate year 2000 incapabilities.
As part of such plan, the Company has purchased software programs that
have been independently developed by third parties which will test year
2000 compliance for the majority of the Company's systems.
All of the entertainment and leisure software products
currently being shipped by the Company have been tested for year 2000
compliance and have passed these tests. In addition, all products
currently in development are being tested as part of the normal quality
assurance testing process and are scheduled to be released fully year
2000 compliant. The year 2000 computer issue could, however, still
affect the ability of consumers to use the PC products sold by the
Company. For example, if the computer system on which a consumer uses
the Company's products is not year 2000 compliant, such noncompliance
could affect the consumer's ability to use the products.
The Company has developed ontingency plans to address the most
material areas of exposure to the Company, such as adding network
operating systems to back-up the Company's current network server and
developing back-up plans for telecommunications with external offices
and customers. In addition, the Company has put in place a staffing
plan to handle orders manually should there be a failure of electronic
data interchange connections with its customers and suppliers.
Management believes that the items mentioned above constitute the
greatest risk of exposure to the Company and that the plans developed
by the Company will be adequate for handling these items.
The Company also has contacted critical suppliers of products
and services to determine that the suppliers' operations and the
products and services they provide are year 2000 compliant. To assist
suppliers (particularly trading partners using electronic data
interchange) in evaluating their year 2000 issues, the Company has
developed a questionnaire designed to asses the ability of each
supplier to address year 2000
6
incompatibilities. All critical suppliers and trading partners of
the Company have responded to the questionnaire and confirmed the
expectation that they will continue providing services and products
through the change to 2000.
Year 2000 compliance testing on substantially all of the
Company's critical systems have been completed, and corresponding
changes are anticipated to be made by July 1999. The costs incurred by
the Company to date related to this testing and modification process
are less than $100,000. The Company expects that the total cost of its
year 2000 compliance plan will not exceed $200,000. The total estimated
cost does not include potential costs related to any systems used by
the Company's customers, any third party claims, or the costs incurred
by the Company when it replaces internal software and hardware in the
normal course of its business. The overall cost of the Company's year
2000 compliance plan is a minor portion of the Company's total
information technology budget and is not expected to materially delay
the implementation of any other unrelated projects that are planned to
be undertaken by the Company. In some instances, the installation
schedule of new software and hardware in the normal course of business
has been accelerated to afford a solution to year 2000 compatibility
issues. The total cost estimate for the Company's year 2000 compliance
plan is based on management's current assessment of the projects
comprising the plan and is subject to change as the projects progress.
Based on currently available information, management does not
believe that the year 2000 issues discussed above related to the
Company's internal systems or its products sold to customers will have
a material adverse impact on the Company's financial condition or
results of operations; however, the specific extent to which the
Company may be affected by such matters is not certain. In addition,
there can be no assurance that the failure by a supplier or another
third party to ensure year 2000 compatibility would not have a material
adverse effect on the Company.
EURO CONVERSION. On January 1, 1999, eleven of the fifteen
member countries of the European Union adopted the "euro" as their
common currency. The sovereign currencies of the participating
countries are scheduled to remain legal tender as denominations of the
euro between January 1, 1999 and January 1, 2002. Beginning January 1,
2002, the participating countries will issue new euro-denominated bills
and coins for use in cash transactions. No later than July 1, 2002, the
participating countries will withdraw all bills and coins denominated
in the sovereign currencies, so that the sovereign currencies no longer
will be legal tender for any transactions, making conversion to the
euro complete. The Company has performed an internal analysis of the
possible implications of the euro conversion on the Company's business
and financial condition, and has determined that the impact of the
conversion will be immaterial to its overall operations. The Company's
wholly owned subsidiaries operating in participating countries
represented 24.1% and 22.1% of the Company's consolidated net revenues
for the fiscal year ended March 31, 1999 and 1998, respectively.
LIMITED PROTECTION OF INTELLECTUAL PROPERTY AND PROPRIETARY
RIGHTS; RISK OF LITIGATION. The Company holds copyrights on the
products, manuals, advertising and other materials owned by it and
maintains trademark rights in the Company name, the ACTIVISION logo,
and the names of the products owned by the Company. The Company regards
its software as proprietary and relies primarily on a combination of
trademark, copyright and trade secret laws, employee and third-party
nondisclosure agreements, and other methods to protect its proprietary
rights. Unauthorized copying is common within the software industry,
and if a significant amount of unauthorized copying of the Company's
products were to occur, the Company's business, operating results and
financial condition could be adversely effected. There can be no
assurance that third parties will not assert infringement claims
against the Company in the future with respect to current or future
products. As is common in the industry, from time to time the Company
receives notices from third parties claiming infringement of
intellectual property rights of such parties. The Company investigates
these claims and responds as it deems appropriate. Any claims or
litigation, with or without merit, could be costly and could result in
a diversion of management's attention, which could have a material
adverse effect on the Company's business, operating results and
financial condition. Adverse determinations in such claims or
litigation could also have a material adverse effect on the Company's
business, operating results and financial condition.
Policing unauthorized use of the Company's products is
difficult, and while the Company is unable to determine the extent to
which piracy of its software products exists, software piracy can be
expected to be a persistent problem. In selling its products, the
Company relies primarily on "shrink wrap" licenses that are not signed
by licensees and, therefore, may be unenforceable under the laws of
certain jurisdictions. Further, the Company enters into transactions in
countries where intellectual property laws are not well developed or
are poorly enforced. Legal protections of the Company's rights may be
ineffective in such countries.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to
a significant extent on the performance and continued service of its
senior management and certain key employees. Competition for highly
skilled employees with technical, management, marketing, sales, product
development and other specialized training is intense, and there can be
no assurance that the Company will be successful in attracting and
retaining such personnel. Specifically, the Company may experience
increased costs in order
7
to attract and retain skilled employees. Although the Company enters
into term employment agreements with most of its skilled employees
and management personnel, there can be no assurance that such
employees will not leave the Company or compete against the Company.
The Company's failure to attract or retain qualified employees could
have a material adverse effect on the Company's business, operating
results and financial condition.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS: CURRENCY
FLUCTUATIONS. International sales and licensing accounted for 65%, 71%
and 66% of the Company's total revenues in the fiscal years 1997, 1998
and 1999, respectively. The Company intends to continue to expand its
direct and indirect sales, marketing and localization activities
worldwide. This expansion will require significant management time and
attention and financial resources in order to develop adequate
international sales and support channels. There can be no assurance,
however, that the Company will be able to maintain or increase
international market demand for its products. International sales are
subject to inherent risks, including the impact of possible
recessionary environments in economies outside the United States, the
costs of transferring and localizing products for foreign markets,
longer receivable collection periods and greater difficulty in accounts
receivable collection, unexpected changes in regulatory requirements,
difficulties and costs of staffing and managing foreign operations, and
political and economic instability. There can be no assurance that the
Company will be able to sustain or increase international revenues or
that the foregoing factors will not have a material adverse effect on
the Company's future international revenues and, consequently, on the
Company's business, operating results and financial condition. The
Company currently does not engage in currency hedging activities.
Although exposure to currency fluctuations to date has been
insignificant, fluctuations in currency exchange rates may in the
future have a material adverse impact on revenues from international
sales and licensing and thus the Company's business, operating results
and financial condition.
RISK OF DEFECTS. Products such as those offered by the Company
frequently contain errors or defects. Despite extensive product
testing, in the past the Company has released products with defects and
has discovered errors in certain of its product offerings after their
introduction. In particular, the PC hardware environment is
characterized by a wide variety of non-standard peripherals (such as
sound cards and graphics cards) and configurations that make
pre-release testing for programming or compatibility errors very
difficult and time-consuming. Despite testing by the Company, new
products or releases may contain errors after commencement of
commercial shipments, resulting in a loss of or delay in market
acceptance, which could have a material adverse effect on the Company's
business, operating results and financial condition.
RISKS ASSOCIATED WITH ACQUISITIONS. The Company is in the
process of integrating the operations of its recently acquired
subsidiaries, Head Games, CD Contact and Expert Software, Inc.
("Expert") with its previously existing operations. This process, as
well as the process of managing two significant new operations,
requires substantial management time and effort and diverts the
attention of management from other matters. In addition, there is a
risk of loss of key employees, customers and vendors of the recently
acquired operations as well as existing operations as this process is
implemented. The Company may not be successful in integrating these
operations.
Consistent with the Company's strategy of enhancing its
distribution and product development capabilities, the Company intends
to continue to pursue acquisitions of companies, intellectual property
rights and other assets that can be purchased or licensed on acceptable
terms and which the Company believes can be operated or exploited
profitably. Some of these transactions could be material in size and
scope. While the Company will continually be searching for appropriate
acquisition opportunities, the Company may not be successful in
identifying suitable acquisitions. If any potential acquisition
opportunities are identified, the Company may not be able to consummate
such acquisitions and if any such acquisition does occur, it may not be
successful in enhancing the Company's business or be accretive to the
Company's earnings. As the interactive entertainment and leisure
businesses continue to consolidate, the Company faces significant
competition in seeking acquisitions and may in the future face
increased competition for acquisition opportunities. This may inhibit
the Company's ability to complete suitable transactions. Future
acquisitions could also divert substantial management time, could
result in short term reductions in earnings or special transaction or
other charges and may be difficult to integrate with existing
operations or assets.
The Company may, in the future, issue additional shares of
common stock in connection with one or more acquisitions, which may
dilute its existing shareholders. The Company's shareholders will not
have an opportunity, with respect to most of its future acquisitions,
to review the financial statements of the entity being acquired or to
evaluate the benefits of the intellectual property rights being
purchased or licensed, or to vote on the acquisitions.
RISK OF DISTRIBUTION COMPANIES' VENDOR DEFECTIONS; VENDOR
CONCENTRATION. The Company's CD Contact subsidiary and CenterSoft
subsidiary perform software distribution services in the Benelux
territory and in the United Kingdom, respectively, and, via export, in
other European territories for a variety of entertainment software
publishers, many of which are competitors of the Company. These
services are
8
generally performed under limited term contracts, some of which
provide for cancellation in the event of a change of control. While
the Company expects to use reasonable efforts to retain these
vendors, the Company may not be successful in this regard. The
cancellation or non-renewal of one or more of these contracts could
have a material adverse effect on the Company's business, operating
results and financial condition. Three of CD Contact's vendors
accounted for 50%, 11% and 11%, respectively, of CD Contact's net
revenues in fiscal year 1999. The net revenues from these vendors
represents 6%, 1% and 1%, respectively, of consolidated net revenues
of the Company. Two of CentreSoft's vendors accounted for 30% and
11%, respectively, of CentreSoft's net revenues in fiscal year 1999.
The net revenues from these vendors represented 11% and 4%,
respectively, of consolidated net revenues of the Company. All other
vendors contributed less than 10% individually to the respective
subsidiary's net revenues.
STRATEGY
The Company's objective is to be a worldwide leader in the
development, publishing and distribution of quality interactive
entertainment and leisure products that deliver, at each point of the
value spectrum, a highly satisfying experience. The Company's strategy
includes the following elements:
CREATE AND MAINTAIN A BALANCED AND DIVERSIFIED PORTFOLIO OF
OPERATIONS. The Company has assembled a large diversified portfolio of
development, publishing and distribution operations and relationships
which are complementary and, at the same time, reduce the Company's
risk of concentration on any one developer, brand, platform, customer
or market. The Company has focused historically on the development and
publishing of premium games which provide the most sophisticated game
play and entertainment experience at the top price point. While the
Company will continue to take advantage of its expertise in this area,
it has recently diversified its business operations and product and
audience mix, and plans on continuing such diversification in the
future. For example, the Company acquired several separate companies in
the last two years in order to establish the distribution business.
Additionally, the Company believes that its recent acquisition of
Expert Software Inc., along with the Company's acquisition in June 1998
of Head Games, positions the Company as a leading publisher of "value"
products for the PC, which are characterized by less sophisticated game
play and lower price points. Further, the Company publishes and
distributes titles that run on a variety of platforms (PC, Sony
PlayStation and Nintendo 64). This diversification significantly
reduces the risk of downturn or underperformance in any of the
Company's individual operations.
CREATE AND MAINTAIN STRONG BRANDS. The Company focuses its
development and publishing activities principally on titles that are,
or have the potential to become, franchise properties with sustainable
consumer appeal and brand recognition. These titles can thereby serve
as the basis for sequels, prequels, mission packs and other add-ons and
related new titles that can be released over an extended period of
time. The Company believes that the publishing and distribution of
products based in large part on franchise properties enhances revenue
predictability and the probability of high unit volume sales and
operating profits. In addition, the Company has entered into a series
of strategic partnerships with the owners of intellectual property
pursuant to which the Company has acquired the rights to publish titles
based on franchises such as STAR TREK, various Disney films such as TOY
STORY 2, A BUG'S LIFE and TARZAN, and SPIDERMAN.
FOCUS ON ON-TIME DELIVERY. The success of the Company's
publishing business is dependent, in significant part, on its ability
to develop games that will generate high unit volume sales that can be
completed in accordance with planned budgets and schedules. In order to
increase its ability to achieve this objective, the Company's
publishing units have implemented a formal control process for the
development of the Company's products. This process includes three key
elements: (i) in-depth reviews are conducted for each project at five
intervals during the development process by a team that includes
several of the Company's highest ranking operating managers; (ii) each
project is led by a small team which is heavily incentivized to deliver
a high-quality product, on-schedule and within budget; and (iii)
day-to-day progress is monitored by a dedicated process manager in
order to insure that issues, if any, are promptly identified and
addressed in a timely manner.
LEVERAGE INFRASTRUCTURE AND ORGANIZATION. The Company is
continually striving to reduce its risk and increase its operating
leverage and efficiency through the variabilization of expenses. For
example, the Company has significantly increased its product making
capabilities by allocating a larger portion of its product development
investments to experienced independent development companies. These
companies generally are small firms focused on a particular product
type, run and owned by individuals willing to take development risk by
accepting payments based on the completion of fixed performance
milestones in exchange for a royalty on the revenue stream of the game
after the Company recoups its development costs. The Company has also
broadly instituted objective-based reward programs that provide
incentives to management and staff to produce results that meet the
Company's financial objectives.
GROW THROUGH CONTINUED STRATEGIC ACQUISITIONS. The interactive
entertainment and leisure industries are consolidating, and the Company
believes that success in these industries will be driven in part
9
by the ability to take advantage of scale. Specifically, smaller
companies are more capital constrained, enjoy less predictability of
revenues and cashflow, 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
industries with professional management, the ability to access the
capital markets and the ability to maintain favorable relationships
with strategic developers, property owners, and retailers. Through
seven completed acquisitions since 1997, the Company believes that
it has successfully diversified its operations, its channels of
distribution and its library of titles and has emerged as one of the
industry's leaders.
PRODUCTS
The Company currently is best known for its action, adventure,
strategy and simulation products, although the Company also distributes
products in other categories such as sports, leisure and role playing.
The Company may in the future expand its product offerings into new
categories.
The Company's current and upcoming releases are based on a
combination of characters, worlds and concepts derived from the
Company's extensive library of titles, original characters and concepts
owned and created by the Company, and intellectual property or other
character or story rights licensed from third parties. In publishing
products based on licensed intellectual property rights, the Company
generally seeks to capitalize on the name recognition, marketing
efforts and goodwill associated with the underlying property.
In the past year, the Company has entered into a series of
long term or multi-product agreements with the owners of intellectual
property that is well known throughout the world. In addition to the
strategic relationships established by the Company with Disney
Interactive for several animated film properties and with Viacom
Consumer Products for STAR TREK, the Company also has entered into an
exclusive distribution agreement with LucasArts Entertainment which
gives the Company the right during the term of the agreement to
distribute all past and future LucasArts PC and PlayStation products in
the United Kingdom and over 40 other international countries, including
titles based on STAR WARS: EPISODE ONE and INDIANA JONES.
In addition to its own internally developed products, the
Company publishes and distributes software products for other
independent developers and publishers such as id Software, Nihilistic
Software, Ritual Entertainment and Kalisto Entertainment. As the
Company seeks to associate the "ACTIVISION" mark only with the highest
quality interactive entertainment products, the Company attempts to be
selective in acquiring publishing and distribution rights from third
party developers. Such products typically are marketed under the
Company's name as well as the name of the original developer. The
Company believes that these efforts enable the Company to leverage its
investment in worldwide sales and marketing and add a new source of
products while balancing the risks inherent in internal product
development and production. This activity also allows the Company to
enter new product genres more quickly and provide consumers with a
wider variety of products.
In addition, during the last year, the Company entered the
"value priced" software publishing business through its acquisition
of Head Games Publishing in June 1998 and of Expert Software Inc. in
June 1999. Products published by the Company in this category are
generally developed by third parties, often under contract with the
Company, and are marketed under the Head Games and Expert Software
names.
PRODUCT DEVELOPMENT AND SUPPORT
The Company uses both internal and external resources to
develop products. The Company also acquires rights to products through
publishing and distribution arrangements with other interactive
entertainment and leisure companies.
INTERNAL DEVELOPMENT
The Company's internal development and production groups are
located at the Company's headquarters in Santa Monica, California and
at the Company's Raven Software subsidiary located in Madison,
Wisconsin.
Activision internally develops and produces titles using a
model in which a core group of creative, production and technical
professionals on staff at the Company, in cooperation with the
Company's marketing and finance departments, have overall
responsibility for the entire development and production process and
for 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, musicians and songwriters, sound effects and special effects
experts, and sound and video studios. The Company believes that this
model allows the Company to supplement internal expertise with top
quality external resources on an as needed basis.
The Company has adopted and implemented a rigorous procedure
for the selection, development, production and quality assurance of its
internally produced entertainment software titles. The process involves
one or more pre-development, development and production phases, each of
which includes a number of specific performance milestones. This
procedure is designed to enable the Company to manage and control
production and development budgets and timetables, to identify and
address production and
10
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 the Company's
creative, technical, marketing and quality assurance/customer
support personnel, as well as the legal, accounting and finance
departments.
EXTERNAL DEVELOPMENT
The Company licenses or acquires software products from
independent developers for publishing or distribution by the Company.
Acquired titles generally are marketed under the Company's name as well
as the name of the original developer. The agreements with developers
provide the Company with exclusive publishing or distribution rights
for a specific period of time for specified platforms and territories.
These agreements often grant to the Company the right to publish or
distribute sequels, enhancements and add-ons to the product originally
being developed and produced by the developer. In consideration for its
services, the developer receives a royalty based on sales of the
product that it has developed. Typically, the developer also receives a
nonrefundable advance which is recoupable by the Company from the
royalties otherwise required to be paid to the developer. The royalty
generally is paid in stages, with the payment of each stage tied to the
completion of a detailed performance milestone.
The Company acquires titles from developers during various
phases of the development and production processes for such titles. To
the extent the Company acquires rights early in the development
process, the Company generally will cause the independent developer to
comply with the requirements of the pre-development, development and
production processes applicable to titles internally produced by
Activision. The Company will assign a game producer to each title who
will serve as the principal liaison to the independent developer and
help insure that performance milestones are timely met. The Company
generally has the right to cease making payments to an independent
developer if the developer fails to complete its performance milestones
in a timely fashion.
The Company may make, from time to time, an investment and
hold a minority equity interest in the third party developer in order
to create a closer relationship between the Company and the developer.
In this regard, the Company recently acquired a minority equity
interest in each of Pandemic Studios, Savage Entertainment and
Hammerhead Studios in connection with several new entertainment
software products to be developed by each of these developers for the
Company. There can be no assurance that the Company will realize long
term benefits from any of these investments or that it will continue to
carry such investments at its current value.
PRODUCT SUPPORT
The Company provides various forms of product support to both
its internally and externally developed titles. The Company's quality
assurance personnel are involved throughout the development and
production processes for each title published by the Company. All such
products are subjected to extensive testing before release in order to
insure compatibility with the widest possible array of hardware
configurations and to minimize the number of bugs and other defects
found in the products. To support its products after release, the
Company provides on-line support to its customers on a 24-hour basis as
well as operator help lines during regular business hours. The customer
support group tracks customer inquiries and this data is used to help
improve the development and production processes.
PUBLISHING AND DISTRIBUTION ACTIVITIES
MARKETING
The Company's marketing efforts include on-line activities
(such as the creation of World Wide Web pages to promote specific
Company 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. In addition, the Company's products contain software
that enables customers to "electronically register" their purchases
with the Company via modem. Through this process, the Company captures
electronic mail addresses for its customers as well as a variety of
additional market research data.
The Company believes that certain of its franchise properties
have loyal and devoted audiences who purchase the Company's sequels as
a result of dedication to the property and satisfaction from previous
product purchases. Marketing of these sequels is therefore directed
both toward the established market as well as broader audiences. In
marketing titles based on licensed properties, the Company believes
that it derives marketing synergies and related benefits from the
marketing and promotional activities of the property owners. In
marketing titles owned by third party developers, the Company believes
that it derives
11
marketing synergies and related benefits from the previously
established reputation of the properties owned by the developer.
SALES AND DISTRIBUTION
DOMESTIC SALES AND DISTRIBUTION. The Company's products are
available for sale or rental in thousands of retail outlets
domestically. The Company's domestic customers include Best Buy,
CompUSA, Computer City, Electronic Boutique, Babbages, WalMart,
K-Mart, Target and Toys "R" Us. During fiscal 1999, no single
domestic customer accounted for more than 10% of consolidated net
revenues.
In the United States, the Company's products are sold
primarily on a direct basis to major computer and software retailing
organizations, mass market retailers, consumer electronic stores and
discount warehouses and mail order companies. The Company believes that
a direct relationship with retail accounts results in more effective
inventory management, merchandising and communications than would be
possible through indirect relationships. The Company has implemented
electronic data interchange ("EDI") linkage with many of its retailers
to facilitate the placing and shipment of orders. The Company seeks to
continue to increase the number of retail outlets reached directly
through its internal sales force. To a lesser extent, the Company sells
its products through wholesale distributors, such as Ingram Micro and
Merisel.
INTERNATIONAL SALES AND DISTRIBUTION. The Company conducts its
international publishing and distribution activities through offices in
the United Kingdom, Germany, France, Australia and Japan. The Company
seeks to maximize its worldwide revenues and profits by releasing high
quality foreign language localizations concurrently with the English
language releases, whenever practicable, and by continuing to expand
the number of direct selling relationships it maintains with key
retailers in major territories.
In November 1997, the Company commenced its European
distribution operations through the acquisitions of NBG in Germany and
CentreSoft in the United Kingdom. CentreSoft is Sony's exclusive
distributor of PlayStation products to the independent channel in the
United Kingdom and employs approximately 150 people, including one of
the largest entertainment software sales and marketing organizations in
that country. In September 1998, the Company acquired CD Contact, a
company specializing in the localization and marketing of entertainment
software products in the Benelux territories. The assets and personnel
of CD Contact currently are being combined with the Company's other
distribution operations to form the core of Activision's international
distribution operations and a base for further expansion into European
territories. The Company will emphasize the expansion of CentreSoft's,
NBG's and CD Contact's channel relations and intends to leverage the
management expertise of these companies into other territories.
AFFILIATE LABELS. In addition to its own products, the Company
distributes interactive entertainment products that are developed and
marketed by other third party publishers through its "affiliate label"
programs. The distribution of other publishers' products allows the
Company to maximize the efficiencies of its sales force and provides
the Company with the ability to better insure adequate shelf presence
at retail stores for all of the products that it distributes. It also
mitigates the risk associated with a particular title or titles
published by Activision failing to achieve expectations. Services
provided by the Company under its affiliate label program include order
solicitation, in-store marketing, logistics and order fulfillment, and
sales channel management.
The Company's affiliate label partners include LucasArts, as
described above, Psygnosis, with respect to all of its PC and
PlayStation products in North America, and Fox Interactive, with
respect to all Fox Sports branded interactive products in Europe,
Africa and Asia, excluding Japan.
OEM SALES AND DISTRIBUTION. The Company seeks to enhance the
distribution of its products through licensing arrangements with
original equipment manufacturers ("OEMs"). Under these arrangements,
one or more of the Company's titles are "bundled" with hardware or
peripheral devices sold and distributed by the OEM so that the
purchaser of the hardware or device obtains the Company's software as
part of the purchase or on a discounted basis. Although it is customary
for the Company to receive a lower per unit price on sales through OEM
bundle arrangements, the OEM customer makes a high unit volume
commitment to the Company with little associated marketing costs. In
addition, the Company from time to time receives substantial advance
payments from the OEM customer. The Company also believes that such
arrangements can substantially expand the distribution of its titles to
a broader audience. Recent OEM partners include Diamond Multimedia,
Gateway, Philips, Epson and Toshiba.
12
LICENSING AND MERCHANDISING
The Company believes that a number of its products have the
potential to be exploited in ancillary markets and media, such as
product merchandising and traditional entertainment media. The Company
seeks opportunities for the exploitation of these ancillary rights
directly and through third party agents. Potential opportunities
include the publication of strategy guides for selected titles, the
adaptation of titles into comic books, novels, television series or
motion pictures, and the licensing of product merchandising rights. The
Company believes that these types of licensing activities can provide
additional sources of revenue and increase the visibility of the title,
thereby leading to additional unit sales and greater potential for
additional sequels. There can be no assurance that the Company will be
successful in exploiting its properties in ancillary markets or media.
Similarly, the Company believes that there are opportunities
for further exploitation of its titles through the Internet, on-line
services such as America Online and the Microsoft Network, and through
recently created on-line gaming services such as Heat and WON. The
Company has established "900" telephone numbers as hint lines for
certain of its titles, and has realized revenues from the calls made to
these numbers. The Company also is actively exploring the establishment
of on-line game playing opportunities, on-line hint sites, and Internet
services as a method for realizing additional revenues from its
products. There can be no assurance that the Company will be successful
in exploiting these opportunities.
HARDWARE LICENSES
The Company's console products currently are being developed
or published primarily for the Sony PlayStation and Nintendo 64. In
order to maintain general access to the console systems marketplace,
the Company has obtained licenses for the PlayStation, Nintendo 64,
Nintendo Game Boy and other console systems. Each license allows the
Company to create one or more products for the applicable system,
subject to certain approval rights as to quality which are reserved by
each licensor. Each license also requires that the Company pay the
licensor a per unit license fee from product sales.
In contrast, the Company currently is not required to obtain
any license for the development and production of PC-CD products.
Accordingly, the Company's per unit manufacturing cost for PC-CD
products is less than the per unit manufacturing cost for console
products.
MANUFACTURING
The Company prepares a set of master program copies,
documentation and packaging materials for its products for each
respective hardware platform on which the product will be released.
Except with respect to products for use on the Sony and Nintendo
systems, the Company's disk duplication, packaging, printing,
manufacturing, warehousing, assembly and shipping are performed by
third party subcontractors.
In the case of products for the Sony and Nintendo systems, in
order to maintain protection over their hardware technologies, such
hardware producers generally specify and/or control the manufacturing
and assembly of finished products. The Company delivers the master
materials to the licensor or its approved replicator which then
manufactures finished goods and delivers them to the Company for
distribution under the Company's label. At the time the Company's
product unit orders are filled by the manufacturer, the Company becomes
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, the Company has not experienced any material
difficulties or delays in the manufacture and assembly of its products
or material returns due to product defects.
COMPETITION
The interactive entertainment and leisure industries are
intensely competitive and are in the process of substantial
consolidation. The availability of significant financial resources has
become a major competitive factor in these industries primarily as a
result of the increasing development, acquisition, production and
marketing budgets required to publish quality titles. In addition,
competitors with large product lines and popular titles typically have
greater leverage with distributors and other customers who may be
willing to promote titles with less consumer appeal in return for
access to such competitor's most popular titles. See "Factors Affecting
Future Performance".
The Company seeks to compete by publishing high quality titles
and by supporting these titles with substantial marketing efforts; by
focusing on properties with sustainable consumer appeal; by working to
strengthen its relationships with retailers and other resellers and
otherwise expanding its channels of distribution; and by pursuing
opportunities for strategic acquisitions. See "Strategy."
13
EMPLOYEES
As of March 31, 1999, the Company had 634 employees, including
207 in product development, 71 in North American publishing, 55 in
corporate finance, operations and administration, 67 in international
publishing, and 234 in European distribution activities.
As of March 31, 1999, approximately 120 of the Company's
full-time employees were subject to term employment agreements with the
Company. These agreements commit such employees to employment terms of
between one and three years from the commencement of their respective
agreements. Most of the employees subject to such agreements are senior
executives of the Company or members of the product development, sales
or marketing divisions. These individuals perform services to the
Company as executives, directors, producers, associate producers,
computer programmers, game designers, sales directors and marketing
product managers. The execution by the Company of employment agreements
with such employees, in the Company's experience, significantly reduces
the Company's turnover during the development and production of its
entertainment software products and allows the Company to plan more
effectively for future development activities.
None of the Company's employees are subject to a collective
bargaining agreement, and the Company has experienced no labor-related
work stoppages.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS
AND EXPORT SALES
See Item 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Note 6 of Notes to
Consolidated Financial Statements included in Item 8.
Item 2. PROPERTIES
The Company's principal corporate, administrative, and product
development offices are located in approximately 98,000 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 the Company at June 25, 1999:
Location of
Principal Facilities Square Feet Lease Expiration Date
-------------------------------------- ----------------- ------------------------------
Santa Monica, California 98,000 April 30, 2007
Birmingham, United Kingdom 82,000 March 25, 2011 - June 1, 2012
Burglengenfeld, Germany 35,000 Owned
Coral Gables, Florida 12,994 August 29, 2000
Berchem, Belgium 10,659 April 1, 2001
London, United Kingdom 10,625 July 23, 2005
Venlo, the Netherlands 7,778 February 15, 2000
Madison, Wisconsin 6,660 December 31, 2000
Sydney, Australia 3,400 Month-to-Month
Eden Prairie, Minnesota 3,193 September 30, 2003
Eemnes, The Netherlands 2,000 January 1, 2001
Munich, Germany 4,311 November 30, 2001
New York, New York 1,200 April 30, 2001
Tokyo, Japan 531 August 31, 2000
Item 3. LEGAL PROCEEDINGS
The Company is party to routine claims and suits brought
against it in the ordinary course of business including disputes
arising over the ownership of intellectual property rights and
collection matters. In the opinion of management, the outcome of such
routine claims will not have a material adverse effect on the Company's
business, financial condition, results of operations or liquidity.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
14
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's 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 closing sale prices for the Company's Common
Stock.
High Low
----------- -----------
Fiscal 1998
-------------
First Quarter ended June 30, 1997 $ 14.75 $ 9.87
Second Quarter ended September 30, 1997 $ 15.50 $ 11.00
Third Quarter ended December 31, 1997 $ 18.62 $ 13.00
Fourth Quarter ended March 31, 1998 $ 17.87 $ 9.50
Fiscal 1999
-------------
First Quarter ended June 30, 1998 $ 11.62 $ 9.37
Second Quarter ended September 30, 1998 $ 13.75 $ 9.37
Third Quarter ended December 31, 1998 $ 14.87 $ 8.75
Fourth Quarter ended March 31, 1999 $ 13.81 $ 9.75
Fiscal 2000
-------------
First Quarter through June 25, 1999 $ 14.25 $ 10.12
On June 25, 1999, the reported last sales price for the Common
Stock was $13.69. As of March 31, 1999, the Company had approximately
5,000 stockholders of record, excluding banks, brokers and depository
companies that are the stockholders of record for the account of
beneficial owners.
The Company paid no cash dividends in 1999 and does not intend
to pay any cash dividends at any time in the foreseeable future. The
Company expects that earnings will be retained for the continued growth
and development of the Company's business. Future dividends, if any,
will depend upon the Company's earnings, financial condition, cash
requirements, future prospects and other factors deemed relevant by the
Company's Board of Directors.
In July 1998, the Company granted warrants to purchase 250,000
shares of the Company's common stock to Disney Enterprises, Inc.
("Disney") in connection with a license agreement between the Company
and Disney's affiliate, Disney Interactive. The warrants have an
exercise price of $12.70 per share, vest in full on July 2, 1999 and
expire on July 2, 2008.
In September 1998, the Company granted warrants to purchase
750,000 shares of the Company's common stock to Viacom Consumer
Products, Inc. ("Viacom") in connection with a license agreement.
500,000 of the warrants have an exercise price of $10.27 per share,
vest ratably over five years, beginning on the date of issuance, and
expire on September 16, 2008. The warrant to purchase the remaining
250,000 shares also expires on September 16, 2008. These 250,000
warrants are exercisable ratably over five years beginning September
16, 2003 and have an exercise price equal to the average closing price
of the Company's common stock on the NASDAQ National Market for the
thirty days immediately preceding September 16, 2003.
In June 1998, the Company issued a total of 1,000,000
shares of the Company's common stock in connection with the
acquisition of Head Games. The Company also granted options to
purchase 295,000 shares of common stock to certain employees and
consultants and at the time of the acquisition.
In September 1998, the Company issued a total of 1,900,000
shares of the Company's common stock in connection with the acquisition
of CD Contact.
On March 23, 1999, options to purchase 1,000,000 shares of
the Company's common stock were granted to each of Robert A.
Kotick, the Company's Co-Chairman and Chief Executive Officer, and
Brian G. Kelly, the Company's Co-Chairman. The options were granted
in connection with employment agreements between the Company and
each of Mr. Kotick and Mr. Kelly, dated January 12, 1999. The
options vest in five equal
15
annual installments beginning on the date of issuance, have an
exercise price of $10.50 per share, and expire on January 12, 2009.
None of the shares, warrants, options or shares into which
the warrants or options are exercisable were registered under the
Securities Act of 1933, as amended (the "Securities Act"), by reason
of the exemption under Section 4(2) of the Securities Act. The
Company subsequently registered the shares, as well as the shares
issuable to the former shareholders of Head Games upon the exercise
of options, issued in connection with the Head Games and CD Contact
transactions for resale by the holders thereof.
16
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table summarizes certain selected consolidated
financial data, which should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto and with
Management's Discussion and Analysis of Financial Condition and Results
of Operations included elsewhere herein. Selected Consolidated
Financial Data as of and for each the fiscal years in the four year
period ended March 31, 1998 have been retroactively restated to reflect
the effect of pooling of interests transactions as discussed in Item 1
of this Report. The selected consolidated financial data presented
below as of and for each of the fiscal years in the five-year period
ended March 31, 1999 are derived from the audited consolidated
financial statements of the Company. The Consolidated Balance Sheets as
of March 31, 1999 and 1998 and the Consolidated Statements of
Operations and Statements of Cash Flows for each of the fiscal years in
the three-year period ended March 31, 1999, and the report thereon, are
included elsewhere in this Form 10-K.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Fiscal Years ended March 31,
------------------------------------------------------------------------
Restated
--------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- -------
STATEMENT OF OPERATIONS DATA:
Net revenues $436,485 $312,058 $189,239 $ 86,591 $57,750
Cost of sales - product costs 260,041 176,188 103,124 34,034 31,731
Cost of sales - royalties and software
amortization 37,825 29,840 13,108 7,333 1,794
Operating income (loss) 27,245 9,486 11,531 3,233 (3,275)
Income (loss) before income taxes 24,215 8,374 11,612 4,841 (1,776)
Net income (loss) 15,254 5,139 7,631 5,895 (1,875)
Preferred dividends paid and/or accumulated - (116) (151) - -
Basic net income (loss) per common share $ 0.69 $ 0.24 $ 0.37 $ 0.34 $ (0.11)
Diluted net income (loss) per common share $ 0.66 $ 0.23 $ 0.36 $ 0.32 $ (0.11)
Weighted average number of shares used in
computing basic net income (loss) per
common share (1) 22,162 21,339 20,262 17,232 17,404
Weighted average number of shares used in
computing diluted net income (loss) per
common share (1) 23,233 22,210 20,951 18,294 17,404
SELECTED OPERATING DATA:
EBITDA (2) $ 56,665 $ 42,760 $ 23,878 $ 13,727 $(1,333)
CASH (USED IN) PROVIDED BY:
Operating activities $ 18,078 $ 31,180 $ 4,956 $ 3,807 $ (393)
Investing activities $(64,331) (43,371) (19,588) (11,455) (61)
Financing activities 7,220 62,862 11,981 (4,378) 1,055
As of March 31,
------------------------------------------------------------------------
Restated
--------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- -------
BALANCE SHEET DATA:
Working capital $141,314 $115,773 $ 51,997 $39,871 $39,606
Cash and cash equivalents 32,847 74,241 23,320 25,792 38,013
Intangible assets 21,647 23,473 23,756 19,583 20,865
Total assets 283,612 229,280 131,952 84,442 71,672
Long-term debt 61,150 61,780 5,907 1,222 986
Redeemable and convertible preferred stock - - 1,500 - -
Shareholders' equity 127,475 97,397 81,634 62,439 61,693
(1) The Company has presented basic and diluted net income (loss) per share for
all periods in accordance with Statement of Financial Accounting Standards
No. 128 "Earnings per Share."
(2) EBITDA represents income (loss) before interest, income taxes, depreciation
and amortization. The Company believes that EBITDA provides useful
information regarding the Company's ability to service its debt; however,
EBITDA does not represent cash flow from operations as defined by generally
accepted accounting principles and should not be considered a substitute
for net income, as an indicator of the Company's operating performance or
cash flow, as a measure of liquidity.
17
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS CONTAINS FORWARD LOOKING
STATEMENTS REGARDING FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE
COMPANY THAT INVOLVE CERTAIN RISKS AND UNCERTAINTIES DISCUSSED IN THIS
CURRENT REPORT ON FORM 10-K UNDER "FACTORS AFFECTING FUTURE PERFORMANCE."
ACTUAL EVENTS OR THE ACTUAL FUTURE RESULTS OF THE COMPANY MAY DIFFER
MATERIALLY FROM ANY FORWARD LOOKING STATEMENT DUE TO SUCH RISKS AND
UNCERTAINTIES.
OVERVIEW
The Company is a leading international publisher, developer and
distributor of interactive entertainment and leisure products. The Company
currently focuses its publishing, development and distribution efforts on
products designed for personal computers ("PCs") as well as the Sony
PlayStation and the Nintendo 64 console systems. The Company's products span
a wide range of genres and target markets.
Activision distributes its products worldwide through its direct
sales forces, through its distribution subsidiaries, and through its third
party distributors and licensees. In addition, in September 1998 the Company
acquired CD Contact, significantly increasing its European distribution
capabilities.
The Company's financial information as of and for the year ended
March 31, 1999, 1998 and 1997, have been restated to reflect the effect of
pooling of interests transactions as discussed in Item 1 of this Report.
The Company recognizes revenue from the sale of its products upon
shipment. Subject to certain limitations, the Company permits customers to
obtain exchanges and returns within certain specified periods and provides
price protection on certain unsold merchandise. Revenues from product sales
are reflected after deducting the estimated allowance for returns and price
protection. With respect to license agreements which provide customers the
right to multiple copies in exchange for guaranteed amounts, revenue is
recognized upon delivery of the product master or the first copy. Per copy
royalties on sales which exceed the guarantee are recognized as earned. The
American Institute of Certified Public Accountants Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2"), provides guidance on applying
generally accepted accounting principles in recognizing revenue on software
transactions. SOP 97-2 was effective for all transactions entered into
subsequent to March 31, 1998. The Company has adopted SOP 97-2 and such
adoption did not have a material impact on the Company's financial position,
results of operations or liquidity. Effective December 15, 1998, the American
Institute of Certified Public Accountants Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition with Respect to
Certain Transactions" ("SOP 98-9"), was issued and is effective for
transactions entered into after March 15, 1999. SOP 98-9 deals with the
determination of vendor specific objective evidence of fair value in multiple
element arrangements such as maintenance agreements sold in conjunction with
software packages. The Company does not believe this will have a material
impact on the Company's financial position, results of operations or
liquidity.
Cost of sales-product costs represents the cost to purchase,
manufacture and distribute PC and console product units. Manufacturers of the
Company's PC software are located worldwide and are readily available.
Console CDs and cartridges are manufactured by the respective video game
console manufacturers, Sony, Nintendo and Sega, who often require significant
lead time to fulfill the Company's orders.
Cost of sales-royalties and software amortization represents amounts
due developers, product owners and other royalty participants as a result of
product sales, as well as amortization of capitalized software development
costs. The costs incurred by the Company to develop products are accounted
for in accordance with accounting standards which provide for the
capitalization of certain software development costs once technological
feasibility is established and such costs are determined to be recoverable.
Various contracts are maintained with developers, product owners or other
royalty participants which state a royalty rate, territory and term of
agreement, among other items. Upon a product's release, prepaid royalties and
license fees are charged to royalty expense based on the contractual royalty
rate. The capitalized software costs are then amortized to cost of
sales-royalties and software amortization on a straight-line basis over the
estimated product life commencing upon product release or on the ratio of
current revenues to total projected revenues, whichever amortization amount
is greater.
For products that have been released, management evaluates the
future recoverability of prepaid royalties and capitalized software costs on
a quarterly basis. Prior to a product's release, the Company expenses, as
part of product development costs, capitalized costs when, in management's
estimate, such amounts are not recoverable. The following criteria is used to
evaluate recoverability: historical performance of comparable products; the
commercial acceptance of prior products released on a given game engine;
orders for the product prior to its release; estimated performance of a
sequel product based on the performance of the product on which the sequel is
based; and actual development costs of a product as compared to the Company's
budgeted amount.
18
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, platform and channel:
Fiscal Years Ended March 31,
--------------------------------------------------------------------
(In thousands)
--------------------------------------------------------------------
1999 1998 1997
------------------- ------------------- ------------------
Restated Restated
------------------- ------------------
STATEMENT OF OPERATIONS DATA:
Net revenues: $436,485 100.0% $312,058 100.0% $189,239 100.0%
Costs and expenses:
Cost of sales - product costs 260,041 59.6% 176,188 56.5% 103,124 54.5%
Cost of sales - royalties and
software amortization 37,825 8.7% 29,840 9.6% 13,108 6.9%
Product development 21,422 4.9% 27,393 8.8% 20,470 10.8%
Sales and marketing 66,419 15.2% 47,714 15.3% 31,178 16.5%
General and administrative 21,348 4.9% 18,401 5.9% 8,284 4.4%
Amortization of intangible assets 1,585 0.4% 1,562 0.5% 1,505 0.8%
Merger expenses 600 0.1% 1,474 0.4% 39 -
-------- ------ -------- ------ -------- ------
Total costs and expenses 409,240 93.8% 302,572 97.0% 177,708 93.9%
-------- ------ -------- ------ -------- ------
Income from operations 27,245 6.2% 9,486 3.0% 11,531 6.1%
Interest income (expense), net (3,030) (0.7%) (1,112) (0.3%) 81 -
-------- ------ -------- ------ -------- ------
Net income before provision for income
taxes 24,215 5.5% 8,374 2.7% 11,612 6.1%
Income tax provision 8,961 2.0% 3,235 1.1% 3,981 2.1%
-------- ------ -------- ------ -------- ------
Net income $ 15,254 3.5% $ 5,139 1.6% $ 7,631 4.0%
======== ====== ======== ====== ======== =======
NET REVENUES BY TERRITORY:
United States $149,664 34.3% $ 89,936 28.8% $ 65,695 34.7%
Europe 278,032 63.7% 208,817 66.9% 113,456 60.0%
Other 8,789 2.0% 13,305 4.3% 10,088 5.3%
-------- ------ -------- ------ -------- ------
Total net revenues $436,485 100.0% $312,058 100.0% $189,239 100.0%
======== ====== ======== ====== ======== =======
NET REVENUES BY CHANNEL:
Retailer/Reseller $417,447 95.6% $286,953 92.0% $168,190 88.9%
OEM, Licensing, on-line and other 19,038 4.4% 25,105 8.0% 21,049 11.1%
-------- ------ -------- ------ -------- ------
Total net revenues $436,485 100.0% $312,058 100.0% $189,239 100.0%
======== ====== ======== ====== ======== =======
ACTIVITY/PLATFORM MIX:
Publishing:
Console $111,621 54.3% $ 26,302 19.8% $ 18,182 20.7%
PC 93,880 45.7% 106,524 80.2% 69,812 79.3%
-------- ------ -------- ------ -------- ------
Total publishing net revenues $205,501 47.1% $132,826 42.6% $ 87,994 46.5%
-------- ------ -------- ------ -------- ------
Distribution:
Console $156,584 67.8% $105,588 58.9% $ 50,298 49.7%
PC 74,400 32.2% 73,644 41.1% 50,947 50.3%
-------- ------ -------- ------ -------- ------
Total distribution net revenues $230,984 52.9% $179,232 57.4% 101,245 53.5%
-------- ------ -------- ------ -------- ------
Total net revenues $436,485 100.0% $312,058 100.0% $189,239 100.0%
======== ====== ======== ====== ======== =======
19
RESULTS OF OPERATIONS - FISCAL YEARS ENDED MARCH 31, 1998 AND 1999
NET REVENUES
Net revenues for the fiscal year ended March 31, 1999 increased
39.9%, from $312.1 million to $436.5 million, over the prior year. The United
States and international net revenues increased 66.5%, from $89.9 million to
$149.7 million, and 29.1%, from $222.1 million to $286.8 million,
respectively, over the prior year. The increase in overall net revenues was
composed of a 103.3% increase in console net revenues, from $131.9 million to
$268.2 million, and a 6.6% decrease in PC net revenues, from $180.2 million
to $168.3 million, respectively, over the prior year.
Publishing net revenues for the year ended March 31, 1999 increased
54.7%, from $132.8 million to $205.5 million, over the prior year. Distribution
net revenues for the year ended March 31, 1999 increased 28.9%, from
$179.2 million to $231.0 million, over the prior year. These increases were
primarily attributable to the increases in publishing and distribution
console net revenues.
Publishing console net revenues for the year ended March 31, 1999
increased 324.3%, from $26.3 million to $111.6 million, over the prior year.
This increase was primarily attributable to the initial release of Tenchu
(PlayStation), Apocalypse (PlayStation), Vigilante 8 (PlayStation and N64),
Asteroids (PlayStation), Nightmare Creatures (PlayStation and N64) and
Activision Classics (PlayStation). Publishing PC net revenues for the year
ended March 31, 1999 decreased 11.8%, from $106.5 million to $93.9 million,
over the prior year. This decrease was primarily due to the release of Quake II
(Windows 95) in the prior year. Publishing PC initial releases during the
year ended March 31, 1999 included Civilization: Call to Power, Cabela's Big
Game Hunter, Cabela's Big Game Hunter 2, Asteroids and Sin.
Distribution console net revenues increased 48.3%, from $105.6 million
to $156.6 million, over the prior year. This increase was primarily
attributable to an increase in the number of products released for
PlayStation and Nintendo N64 and an increase in the Playstation and N64
hardware installed base. Distribution PC net revenues increased 1.1%, from
$73.6 million to $74.4 million, over the prior year. Distribution PC net
revenues remained relatively constant during this period as the number of new
PC titles released by the publishers utilizing the Company's distribution
services in each year were approximately the same.
Net OEM, licensing, on-line and other revenues for the fiscal year
ended March 31, 1999 decreased 24.3% to $19.0 million from $25 million in the
prior year. This decrease was due to the release of fewer PC titles during
the fiscal year that were compatible with OEM customers' products.
COSTS AND EXPENSES
Cost of sales - product costs represented 59.6% and 56.5% of net
revenues for the years ended March 31, 1999 and 1998, respectively. The
increase in cost of sales - product costs as a percentage of net revenues was
due to the increase in the sales mix related to console products. Console
products have a higher per unit product cost than PC products.
Cost of sales - royalties and software amortization expense
represented 8.7% and 9.6% of net revenues for the years ended March 31, 1999
and 1998, respectively. The decrease in cost of sales - royalties and
software amortization expense as a percentage of net revenues was due to
changes in the Company's product mix, with an increase in products with lower
royalty obligations as compared to the prior year.
Product development expenses for the year ended March 31, 1999
decreased 21.9% from the prior year, from $27.4 million to $21.4 million. The
decrease in the amount of product development expenses for the year ended
March 31, 1999 was primarily due to an increase in capitalizable development
costs relating to sequel products being developed on proven engine
technologies which have been capitalized in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased, or otherwise Marketed".
As a percentage of net revenues, total product creation costs
(i.e., royalties and software amortization expenses plus product development
expenses) for the year ended March 31, 1999, decreased to 13.6% from 18.4% in
the prior year. This decrease was attributable to decrease in the effective
royalty rate, as discussed above, and an increase in development costs
capitalized under SFAS 86, also as discussed above.
20
Sales and marketing expenses for the year ended March 31, 1999
increased 39.2% from the same period last year, from $47.7 million to
$66.4 million. As a percentage of net revenues, sales and marketing expenses
decreased slightly from 15.3% to 15.2%. The increase in the amount of sales
and marketing expenses for the year ended March 31, 1999 was primarily due to
a significant increase in television advertising and an increase in the
number of products released during the current year. However, as a percentage
of net revenues, such expenses have remained relatively constant.
General and administrative expense for the year ended March 31, 1999
increased 15.8% from the same period last year, from $18.4 million to
$21.3 million. As a percentage of net revenues, general and administrative
expenses decreased from 5.9% to 4.9%. The period over period increase in the
amount of general and administrative expenses primarily was due to an
increase in worldwide administrative support needs and headcount related
expenses. The decrease as a percentage of net revenues relates primarily to
efficiencies gained in controlling fixed costs and the increase in net
revenues.
OTHER INCOME (EXPENSE)
Interest expense, net of interest income, increased to $3.0 million
for the year ended March 31, 1999, from $1.1 million for the year ended
March 31, 1998. This increase primarily was the result of interest costs
associated with the Company's convertible subordinated notes issued in
December 1997 and short term borrowings under bank line of credit agreements
which had a greater average outstanding balance in the fiscal year ended
March 31, 1999.
PROVISION FOR INCOME TAXES
The income tax provision of $9.0 million for the year ended March 31,
1999, reflects the Company's effective income tax rate of approximately 37%.
The realization of deferred tax assets primarily is dependent on the
generation of future taxable income. Management believes that it is more
likely than not that the company will generate taxable income sufficient to
realize the benefit of deferred tax assets recognized.
RESULTS OF OPERATIONS - FISCAL YEARS ENDED MARCH 31, 1997 AND 1998
NET REVENUES
Net revenues for the year ended March 31, 1998 increased 65.0%, from
$189.2 million to $312.1 million over the prior year. Net revenues in the
United States and internationally increased 36.8%, from $65.7 million to
$89.9 million and 79.8%, from $123.5 million to $222.1 million, respectively,
over the prior year. The increase in overall net revenues was comprised of a
92.6% increase in console net revenues, from $68.5 million to $131.9 million,
and a 49.2% increase in PC net revenues, from $120.8 million to $180.2
million, respectively, over the prior year.
Publishing net revenues for the year ended March 31, 1998 increased
50.9%, from $88.0 million to $132.8 million, over the prior year.
Distribution net revenues for the year ended March 31, 1998 increased 77.1%,
from $101.2 million to $179.2 million, over the prior year. These increases
primarily were attributable to the increases in publishing PC net revenues
and distribution console net revenues.
Publishing console net revenues for the year ended March 31, 1998
increased 44.5%, from $18.2 million to $26.3 million, over the prior year.
This increase primarily was attributable to the initial release of Pitfall 3D
(PlayStation), Nightmare Creatures (PlayStation) and Car and Driver's Grand
Tour Racing (PlayStation.) Publishing PC net revenues for the year ended
March 31, 1998 increased 52.6%, from $69.8 million to $106.5 million, over
the prior year. This increase was primarily due to the release of Quake II
(Windows 95), Dark Reign: The Future of War (Windows 95), Hexen II (Windows
95), Battlezone (Windows 95) and Heavy Gear (Windows 95).
Distribution console net revenues increased 109.9%, from $50.3 million
to $105.6 million, over the prior year. This increase was primarily
attributable to an increase in the number of products released for PlayStation
and N64 and an increase in the PlayStation and N64 hardware installed base.
Distribution PC net revenues increased 44.6%, from $50.9 million to
$73.6 million, over the prior year. Additionally, distribution net revenues
increased over the prior fiscal year due to the fact that CentreSoft, which
began operations in June 1996, contributed only ten months of revenue for the
year ended March 31, 1997, as opposed to twelve months for the year ended
March 31, 1998.
21
Net OEM, licensing, on-line and other revenue, increased 19.5% to
$25.1 million from $21.0 million over the prior year. This increase was due
to an increase in the number of titles made available during the year to
OEMs, including enhanced 3-D versions of various products.
COSTS AND EXPENSES
Cost of sales - product costs represented 56.5% and 54.5% of net
revenues for the years ended March 31, 1998 and 1997, respectively. The
increase in cost of sales - product costs as a percentage of net revenues was
due to the increase in the sales mix of console net revenues versus PC net
revenues.
Cost of sales - royalties and software amortization expense
represented 9.6% and 6.9% of net revenues for the years ended March 31, 1998
and 1997, respectively. The increase in cost of sales - royalties and
software amortization expense as a percentage of net revenues was due to
changes in the Company's product mix and primarily was due to royalties
related to Quake II.
Product development expenses for the year ended March 31, 1998
increased 33.7% from the prior year, from $20.5 million to $27.4 million. As
a percentage of net revenues, product development expenses decreased from
10.8% to 8.8%. The increase in the amount of product development expenses for
the year ended March 31, 1998 was primarily due to the increased number of
new products in development and the increased costs associated with the
enhanced content and new technologies incorporated into such products. In
addition, product development expense as a percentage of net revenues
decreased primarily as a result of an increase in net revenues and an
increase in costs capitalized in accordance with SFAS No. 86.
As a percentage of net revenues, total product creation costs
(i.e., royalties and software amortization expense plus product development
expense) for the year ended March 31, 1998, increased to 18.4% from 17.7% in
the prior year. This increase was attributable to increase in the effective
royalty rate, as discussed above.
Sales and marketing expenses for the year ended March 31, 1998
increased 52.9% from the period year, from $31.2 million to $47.7 million. As
a percentage of net revenues, sales and marketing expenses decreased slightly
from 16.5% to 15.3%. The increase in the amount of sales and marketing
expenses for the year ended March 31, 1998 was primarily due to increased
marketing and promotional activities necessary to release new titles in an
increasingly competitive environment and the Company's expansion of it's
European sales and marketing infrastructure. However, as a percentage of net
revenues, such expense has remained fairly consistent.
General and administrative expense for the year ended March 31, 1998
increased 121.7% from the same period last year, from $8.3 million to
$18.4 million. As a percentage of net revenues, general and administrative
expenses increased from 4.4% to 5.9%. The period over period increase in the
amount and as a percentage of net revenues of general and administrative
expenses for the year ended March 31, 1998 primarily was due to an increase
in worldwide administrative support needs and headcount related expenses.
OTHER INCOME (EXPENSE)
Interest expense, net of interest income, increased to $1.1 million
for the year ended March 31, 1998, from net interest income of $81,000 for
the year ended March 31, 1997. This increase primarily was the result of
interest costs associated with the Company's convertible subordinated notes
issued in December 1997 and short term borrowings under bank line of credit
agreements.
PROVISION FOR INCOME TAXES
The income tax provision of $3.2 million for the year ended March 31,
1998, reflects the Company's estimated effective income tax rate of
approximately 38.6%. The realization of deferred tax assets primarily is
dependent on the generation of future taxable income. Management believes
that it is more likely than not that the company will generate taxable income
sufficient to realize the benefit of deferred tax assets recognized.
QUARTERLY OPERATING RESULTS
The Company's quarterly operating results have in the past varied
significantly and will likely vary significantly in the future, depending on
numerous factors, several of which are not under the Company's control. See
Item 1. Business - "Certain Cautionary Information." Accordingly, the Company
believes that period-to-period comparisons of its operating results are not
necessarily meaningful and should not be relied upon as indications of future
performance.
22
The following table is a comparative breakdown of the Company's
quarterly results for the immediately preceding eight quarters (amounts in
thousands, except per share data):
Quarter ended
-------------------------------------------------------------------------------------------------
Restated
----------------------------------------------------------
March 31, Dec. 31, Sept. 30, June 30, March 31, Dec. 31, Sept. 30, June 30,
1999 1998 1998 1998 1998 1997 1997 1997
--------- -------- --------- -------- --------- -------- --------- --------
Net revenues $115,235 $193,537 $66,182 $61,531 $68,123 $139,587 $65,788 $38,560
Operating income (loss) 9,337 26,328 (2,783) (5,637) 1,536 13,742 3,591 (9,383)
Net income (loss) 5,210 16,022 (2,234) (3,744) 689 8,334 2,041 (5,925)
Net income (loss) per basic
share $ 0.23 $ 0.72 $ (0.10) $ (0.17) $ 0.03 $ 0.39 $ 0.09 $ (0.28)
Net income (loss) per diluted
share $ 0.22 $ 0.64 $ (0.10) $ (0.17) $ 0.03 $ 0.36 $ 0.09 $ (0.28)
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents decreased $41.4 million,
from $74.2 million at March 31, 1998 to $32.8 million at March 31, 1999.
Approximately $18.1 million in cash and cash equivalents was provided by
operating activities during the year ended March 31, 1999 versus $31.1
million provided by operating activities in fiscal 1998. This change was
primarily attributable to the increases during the year ended March 31, 1999
in accounts receivable, other current assets, inventories, and a decrease in
accounts payable resulting from the Company's overall growth during the
fiscal year ended March 31, 1999 partially offset by an increase in accrued
expenses.
Cash and cash equivalents used in investing activities was
approximately $64.3 million during the year ended March 31, 1999 versus $43.3
million used in investing activities during the year ended March 31, 1998.
The increase in cash used in investing activities was due to the significant
increase in prepaid royalties and capitalized software costs incurred by the
Company as a result of its execution of new license agreements granting the
Company long term rights to the intellectual property of third parties, as
well as the acquisition of publishing or distribution rights to products
being developed by third parties. Capital expenditures totaled approximately
$3.8 million for the year ended March 31, 1999 versus $9.3 million in the
prior year. The decrease in capital expenditures was due to the cost relating
to the Company moving its Los Angeles office to a new facility in Santa
Monica, California in the prior year.
Cash and cash equivalents provided by financing activities totaled
$7.2 million for the year ended March 31, 1999 versus $62.9 million in the
prior year. The decrease was due to the issuance of $60 million of
convertible subordinated debt in December 1997.
In connection with the Company's purchases of N64 hardware and
software cartridges for distribution in North America and Europe, Nintendo
requires the Company to provide irrevocable letters of credit prior to
accepting purchase orders from the Company for the purchase of these
cartridges. Furthermore, Nintendo maintains a policy of not accepting returns
of N64 hardware and software cartridges. Because of these and other factors,
the carrying of an inventory of N64 hardware and software cartridges entails
significant capital and risk.
As of March 31, 1999, the Company had a $40.0 million revolving
credit and letter of credit facility (the "Prior Facility") with a group of
banks. The Prior Facility currently provides the Company with the ability to
borrow funds and issue letters of credit against eligible accounts receivable
up to $40.0 million. The Prior Facility was scheduled to expire in October
2001. As of March 31, 1999, the Company had $22.4 million in letters of
credit outstanding and no borrowings against the Prior Facility (there were
no outstanding letters of credit or borrowings against the Prior Facility in
the fiscal year ended March 31, 1998). In addition, the Company had a
$2 million line of credit agreement (the "Asset Line") with a bank that expired
in September 1998. Approximately $1.1 million and $1.2 million was
outstanding on this line as of March 31, 1999 and 1998, respectively.
In June 1999, the Company replaced the Prior Facility with a
$125 million revolving credit facility and term loan (the "New Facility")
with a new group of banks that provides the Company with the ability to
borrow up to $100 million and issue letters of credit up to $80 million
against eligible accounts receivable and inventory. (See Note 13, "Subsequent
Events" in the footnotes to the Consolidated Financial Statements.) The
$25 million term loan portion of the New Facility was used to acquire Expert
and pay costs related to such acquisition and the securing of the New
Facility. The term loan has a three year term with principal amortization on
a straight line quarterly basis beginning December 31, 1999 and a borrowing
rate of the banks' base rate (which is generally equivalent to the published
prime rate) plus 2.0%, or the LIBOR rate 3.0%. The revolving portion of the
New Facility has a borrowing rate of the banks' base rate plus 1.75% or the
LIBOR rate of 2.75%. The Company pays a commitment fee of 1/2% based on the
unused portion of the line.
In addition, the Company's CentreSoft subsidiary has a revolving
credit facility (the "UK Facility") with its bank in the United Kingdom for
approximately $11.2 million. The UK Facility can be used for working capital
requirements and expires in June 2000. The Company had no borrowings
outstanding against the UK facility as of March 31, 1999. In the Netherlands,
the Company's CD Contact subsidiary has a credit facility ("the Netherlands
Facility") with a bank that permits borrowings against eligible accounts
receivable and inventory up to approximately $25 million. Borrowings under
the Netherlands Facility are due on demand and totaled $6.0 as of March 31,
1999. Letters of credit outstanding under the Netherlands Facility totaled
$6.9 million as of March 31, 1999.
The Company will use its working capital ($141.3 million at March 31,
1999), as well as the proceeds available from the New Facility, the UK
Facility and the Netherlands Facility, to finance the Company's operational
23
requirements for at least the next twelve months, including acquisitions of
inventory and equipment, the funding of development, production, marketing
and selling of new products, the acquisition of Expert, and the acquisition
of intellectual property rights for future products from third parties.
The Company's management currently believes that inflation has not
had a material impact on continuing operations.
YEAR 2000
Like many other software companies, the year 2000 computer issue
creates risk for the Company. If internal computer and embedded systems do
not correctly recognize date information when the year changes to 2000, there
could be an adverse impact on the Company's operations. The Company has
initiated a comprehensive plan to prepare its internal computer and embedded
systems for the year 2000 and is currently implementing changes to alleviate
any year 2000 incapabilities. As part of such plan, the Company has purchased
software programs that have been independently developed by third parties
which will test year 2000 compliance for the majority of the Company's
systems.
All of the entertainment and leisure software products currently
being shipped by the Company have been tested for year 2000 compliance and
have passed these tests. In addition, all such products currently in
development are being tested as part of the normal quality assurance testing
process and are scheduled to be released fully year 2000 compliant.
Notwithstanding the foregoing, the year 2000 computer issue could still
affect the ability of consumers to use the PC products sold by the Company.
For example, if the computer system on which a consumer uses the Company's
products is not year 2000 compliant, such noncompliance could affect the
consumer's ability to use such products.
Contingency plans currently have been developed to address the most
material areas of exposure to the Company, such as adding network operating
systems to back-up the Company's current network server and developing
back-up plans for telecommunications with external offices and customers. In
addition, a staffing plan has been developed to manually handle orders should
there be a failure of electronic data interchange connections with its
customers and suppliers. Management believes that the items mentioned above
constitute the greatest risk of exposure to the Company and that the plans
developed by the Company will be adequate for handling these items.
The Company has contacted critical suppliers of products and
services to determine that the suppliers' operations and the products and
services they provide are year 2000 compliant. To assist suppliers
(particularly trading partners using electronic data interchange) in
evaluating their year 2000 issues, the Company has developed a questionnaire
which indicates the ability of each supplier to address year 2000
incompatibilities. All critical suppliers and trading partners of the Company
have responded to the questionnaire and confirmed the expectation that they
will continue providing services and products through the change to 2000.
Year 2000 compliance testing on substantially all of the Company's
critical systems have been completed, and corresponding changes are expected
to be made by July 1999. The costs incurred by the Company to date related to
this testing and modification process are less than $100,000. The Company
expects that the total cost of its year 2000 compliance plan will not exceed
$200,000. The total estimated cost does not include potential costs related
to any systems used by the Company's customers, any third party claims, or
the costs incurred by the Company when it replaces internal software and
hardware in the normal course of its business. The overall cost of the
Company's year 2000 compliance plan is a minor portion of the Company's total
information technology budget and is not expected to materially delay the
implementation of any other unrelated projects that are planned to be
undertaken by the Company. In some instances, the installation schedule of
new software and hardware in the normal course of business has been
accelerated to also afford a solution to year 2000 compatibility issues. The
total cost estimate for the Company's year 2000 compliance plan is based on
management's current assessment of the projects comprising the plan and is
subject to change as the projects progress.
Based on currently available information, management does not
believe that the year 2000 issues discussed above related to the Company's
internal systems or its products sold to customers will have a material
adverse impact on the Company's financial condition or results of operations;
however, the specific extent to which the Company may be affected by such
matters is not certain. In addition, there can be no assurance that the
failure by a supplier or another third party to ensure year 2000
compatibility would not have a material adverse effect on the Company.
EURO CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the
European Union adopted the "euro" as their common currency. The sovereign
currencies of the participating countries are scheduled to remain legal
tender as denominations of the euro between January 1, 1999 and January 1,
2002. Beginning January 1, 2002, the participating countries will issue new
euro-denominated bills and coins for use in cash transactions. No later than
July 1, 2002, the participating countries will withdraw all bills and coins
denominated in the sovereign currencies, so that the sovereign currencies no
longer will be legal tender for any transactions, making conversion to the
euro complete. The Company has performed an internal analysis of the possible
implications of the euro conversion on the
24
Company's business and financial condition, and has determined that the
impact of the conversion will be immaterial to its overall operations. The
Company's wholly owned subsidiaries operating in participating countries
represented 24.1% and 22.1% of the Company's consolidated net revenues for
the years ended March 31, 1999 and 1998, respectively.
RECENTLY ISSUED ACCOUNTING STANDARDS
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," is effective for all fiscal years beginning after June 15, 2000.
SFAS No. 133 establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The Company does not
currently participate in hedging activities or own derivative instruments but
plans to adopt SFAS No. 133 beginning April 1, 2001.
25
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company transacts business in many different foreign currencies
and may be exposed to financial market risk resulting from fluctuations in
foreign currency exchange rates, particularly the British Pound sterling. The
volatility of the pound (and all other applicable currencies) will be
monitored frequently throughout the coming year and the Company may use
hedging programs, currency forward contracts, currency options and/or other
derivative financial instruments commonly utilized to reduce financial market
risks.
In June 1999, the Company obtained a $125 million revolving credit
facility and term loan (the "New Facility") with a group of banks. The
interest rate applied to any debt outstanding under the New Facility is based
on the published prime rate or LIBOR rate and is, therefore subject to a
certain amount of risk arising from fluctuations in these rates.
26
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page
----
Independent Auditors' Report F-1
Consolidated Balance Sheets as of March 31, 1999 and 1998 F-2
Consolidated Statements of Operations for the Years ended March 31, 1999, 1998
and 1997 F-3
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended
March 31, 1999, 1998 and 1997 F-4
Consolidated Statements of Cash Flows for the Years Ended March 31, 1999,
1998 and 1997 F-5
Notes to Consolidated Financial Statements F-6
Schedule II-Valuation and Qualifying Accounts and Reserves as of March 31,
1999, 1998 and 1997 F-22
Item 14. Exhibit Index F-23
All other schedules of the Registrant are omitted because of the
absence of conditions under which they are required or because the
required information is included elsewhere in the financial statements
or in the notes thereto.
27
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated by reference to
the sections of the Company's definitive Proxy Statement for its 1999
Annual Meeting of Shareholders, entitled "Election of Directors" and
"Executive Officers and Key Employees" 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.
Item 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
the sections of the Company's definitive Proxy Statement for its 1999
Annual Meeting of Shareholders, entitled "Executive Compensation" and
"Indebtedness of Management" 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.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to
the sections of the Company's definitive Proxy Statement for its 1999
Annual Meeting of Shareholders, entitled "Security Ownership of Certain
Beneficial Owners and Management" 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.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to
the sections of the Company's definitive Proxy Statement for its 1999
Annual Meeting of Shareholders, entitled "Certain Relationships and
Related Transactions" 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.
28
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS See Item 8. - Consolidated Financial
Statements and Supplementary Data Index for Financial
Statements and Schedule on page 25 herein.
2. FINANCIAL STATEMENT SCHEDULE The following financial
statement schedule of Activision, Inc. for the years ended
March 31, 1999, 1998 and 1997 is filed as part of this report
and should be read in conjunction with the Consolidated
Financial Statements of Activision, Inc.
Schedule II -- Valuation and Qualifying Accounts and Reserves
Other financial statement schedules are omitted because the
information called for is not required or is shown either in
the Consolidated Financial Statements or the notes thereto.
3. EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K
Exhibit
Number Exhibit
------- -------
3.1 Amended and Restated Articles of Incorporation of
Activision, Inc., dated October 15, 1992
(incorporated by reference to Exhibit 4.5 of
Amendment No. 1 to the Company's Form S-8,
Registration No. 33-48411 filed on June 1, 1993).
3.2 Bylaws of Activision, Inc. (incorporated by
reference to Exhibit 4.6 of Amendment No. 1 to the
Company's Form S-8, Registration No. 33-48411 filed
on June 1, 1993).
10.1 Mediagenic 1991 Stock Option and Stock Award Plan,
as amended (incorporated by reference to Exhibit 4.1
to the Company's Registration Statement on Form S-8,
Registration No. 33-63638, filed on December 8,
1995).
10.2 Mediagenic 1991 Director Warrant Plan as amended
(incorporated by reference to Exhibit 28.2 to the
Company's Registration Statement on Form S-8,
Registration No. 33-63638, filed on June 1, 1993).
10.3 Activision, Inc. Employee Stock Purchase Plan
(incorporated by reference to Exhibit 4.1 the
Company's Form S-8 filed on September 25, 1996).
10.4 Activision, Inc. 1998 Incentive Plan (incorporated
by reference to Appendix I of the Company's 1998
Proxy Statement).
10.5 Lease Agreement dated as of December 20, 1996,
between the Company and Barclay Curci Investment
Company (incorporated by reference to Exhibit 10.14
of the Company's Form 10-Q for the quarter ended
December 31, 1996).
10.6 Share Exchange Agreement dated November 23, 1997,
among the Company and the holders of all of the
issued and outstanding capital stock of Combined
Distribution (Holdings), Inc. (incorporated by
reference to Exhibit 10.1 of the Company's Form 8-K
filed December 5, 1997).
10.7 Purchase Agreement dated as of December 16, 1997,
among the Company and Credit Suisse First Boston
Corporation, Piper Jaffray, Inc. and UBS Securities
LLC (the "Initial Purchasers") (incorporated by
reference to Exhibit 10.1 of the Company's Form 8-K
filed December 23, 1997).
10.8 Registration Rights Agreement dated as of December
16, 1997, among the Company and the Initial
Purchasers (incorporated
29
by reference to Exhibit 10.2 of the Company's Form
8-K filed December 23, 1997).
10.9 Indenture dated as of December 22, 1997, between
the Company and State Street Bank and Trust Company
of California, N.A., as Trustee (incorporated by
reference to Exhibit 10.3 of the Company's Form 8-K
filed December 23, 1997).
10.10 Employment agreement dated January 12, 1999 between
the Company and Robert A. Kotick.
10.11 Employment agreement dated January 12, 1999 between
the Company and Brian G. Kelly.
10.12 Employment agreement dated October 19, 1998 between
the Company and Ronald Doornink.
10.13 Employment agreement dated March 4, 1999 between the
Company and Lawrence Goldberg.
10.14 Employment agreement dated March 4, 1999 between the
Company and Barry J. Plaga.
10.15 Employment agreement dated April 1, 1998 between the
Company and Mitchell Lasky.
10.16 Employment agreement dated April 1, 1998 between the
Company and Ronald Scott.
10.17 Service Agreement dated November 24, 1997 between
the Combined Distribution (Holdings) Limited and
Richard Andrew Steele.
10.18 Employment Agreement dated September 1, 1997 between
the Company and Robert Dewar.
10.19 Articles of Merger dated June 30, 1998 between
S.B.F. Acquisition Corp., a wholly owned subsidiary
of the Company, and S.B.F. Services Limited, Head
Games Publishing, (incorporated by reference to
Exhibit 2.1 of the Company's Form 8-K, filed on
July 2, 1998).
10.20 Share Exchange Agreement dated September 29, 1998
by and between the Company and Mr. Frank d'Oleire,
Mrs. Christa d'Oleire, Ms. Fiona d'Oleire, Ms.
Alexa d'Oleire acting as Dr. d'Oleire
Beteiligungsgesellschaft bR, Mr. Martinus J.C.
Bubbert, and Mr. Dennis W. Buis (incorporated by
reference to Exhibit 10.1 of the Company's Form 8-K,
filed on October 8, 1998).
10.21 Amended and Restated Agreement and Plan of Merger
dated April 19, 1999 by and among the Company,
Expert Acquisition Corp. and Expert Software, Inc.
(incorporated by reference to Exhibit 2.1 of the
Form 8-K of Expert Software, Inc., filed April 29,
1999).
10.22 Credit Agreement dated as of June 21, 1999 among the
Company, Head Games Publishing, Inc., Expert
Software, Inc., various lenders, PNC Bank, National
Association, as issuing bank, administrative agent
and collateral agent for such lenders, and Credit
Suisse First Boston, as syndication agent.
21. Principal subsidiaries of the Company.
23. Independent Auditors' Consent.
30
27.1 Fiscal 1996 Year to Date financial Data Schedule.
27.2 Fiscal 1997 Year to Date Financial Data
Schedule.
27.3 Fiscal 1998 Year to Date Financial Data
Schedule.
27.4 Fiscal 1999 Year to Date Financial Data
Schedule.
(b) 1. Reports on Form 8-K. The following reports on Form 8-K have
been filed by the Company during the last quarter of the
fiscal year ended March 31, 1999:
1.1 Form 8-K dated March 10, 1999, containing items 5
and 7.
31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: June 28, 1999
ACTIVISION, INC.
By: /s/ ROBERT A. KOTICK
---------------------------
(Robert A. Kotick)
Chairman
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
By: /s/ ROBERT A. KOTICK Chairman, Chief Executive Officer June 28, 1999
----------------------------- (Principal Executive Officer) and
(Robert A. Kotick) Director
By: /s/ BRIAN G. KELLY Co-Chairman and Director June 28, 1999
-----------------------------
(Brian G. Kelly)
By: /s/ BARRY J. PLAGA Chief Financial Officer, and June 28, 1999
----------------------------- Chief Accounting Officer
(Barry J. Plaga)
By: /s/ HAROLD A. BROWN Director June 28, 1999
-----------------------------
(Harold A. Brown)
By: /s/ BARBARA S. ISGUR Director June 28, 1999
-----------------------------
(Barbara S. Isgur)
By: /s/ STEVEN T. MAYER Director June 28, 1999
-----------------------------
(Steven T. Mayer)
By: /s/ ROBERT J. MORGADO Director June 28, 1999
-----------------------------
(Robert J. Morgado)
32
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders:
We have audited the accompanying consolidated balance sheets of ACTIVISION, INC.
and subsidiaries as of March 31, 1999 and 1998 and the related consolidated
statements of operations, changes in shareholders' equity and cash flows for
each of the years in the three-year period ended March 31, 1999. In connection
with our audit of the consolidated financial statements, we also have audited
financial statement schedule II for each of the years in the three-year period
ended March 31, 1999. These consolidated financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of ACTIVISION, INC. and
subsidiaries as of March 31, 1999 and 1998, and the results of their operations
and their cash flows for each of the years in the three-year period ended March
31, 1999, in conformity with generally accepted accounting principles. Also in
our opinion, the related financial statement schedule for each of the years in
the three-year period ended March 31, 1999, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.
KPMG LLP
Los Angeles, California
May 3, 1999
F-1
PART I. FINANCIAL INFORMATION.
Item I. Financial Statements.
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except share data)
March 31, March 31,
1999 1998
--------- ---------
Restated
---------
ASSETS
Current assets:
Cash and cash equivalents $ 32,847 $ 74,241
Accounts receivable, net of allowances of $14,979 and
$15,582, respectively 117,522 73,926
Inventories, net 30,931 19,425
Prepaid royalties and capitalized software costs 38,997 12,444
Deferred income taxes 6,044 3,852
Other current assets 9,960 1,988
--------- ---------
Total current assets 236,301 185,876
Prepaid royalties and capitalized software costs 6,923 -
Property and equipment, net 10,841 11,944
Deferred income taxes 2,618 4,665
Excess purchase price over identifiable assets acquired, net 21,647 23,473
Other assets 5,282 3,322
--------- ---------
Total assets $ 283,612 $ 229,280
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable to bank $ 5,992 $ 4,292
Accounts payable 43,853 50,473
Accrued expenses 45,142 15,338
--------- ---------
Total current liabilities 94,987 70,103
Notes payable to bank, less current portion 1,143 1,692
Convertible subordinated notes 60,000 60,000
Other liabilities 7 88
--------- ---------
Total liabilities 156,137 131,883
--------- ---------
Commitments and contingencies
Shareholders' equity:
Common stock, $.000001 par value, 50,000,000 shares
authorized, 23,104,927 and 22,408,415 shares issued and
22,604,927 and 21,908,415 outstanding, respectively - -
Additional paid-in capital 109,251 91,825
Retained earnings 26,012 10,758
Accumulated other comprehensive income (loss) (2,510) 92
Less: Treasury stock, cost of 500,000 shares (5,278) (5,278)
--------- ---------
Total shareholders' equity 127,475 97,397
--------- ---------
Total liabilities and shareholders' equity $ 283,612 $ 229,280
========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-2
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
For the years ended March 31,
----------------------------------------------------
1999 1998 1997
------------- ------------------- ---------------
Restated Restated
------------------- ---------------
Net revenues $ 436,485 $ 312,058 $ 189,239
Costs and expenses:
Cost of sales - product costs 260,041 176,188 103,124
Cost of sales - royalties and software
amortization 37,825 29,840 13,108
Product development 21,422 27,393 20,470
Sales and marketing 66,419 47,714 31,178
General and administrative 21,348 18,401 8,284
Amortization of intangible assets 1,585 1,562 1,505
Merger expenses 600 1,474 39
------------- ------------------- ---------------
Total costs and expenses 409,240 302,572 177,708
------------- ------------------- ---------------
Income from operations 27,245 9,486 11,531
Interest income (expense), net (3,030) (1,112) 81
------------- ------------------- ---------------
Income before income tax provision 24,215 8,374 11,612
Income tax provision 8,961 3,235 3,981
------------- ------------------- ---------------
Net income $ 15,254 $ 5,139 $ 7,631
============= =================== ===============
Basic net income per share $ 0.69 $ 0.24 $ 0.37
============= =================== ===============
Diluted net income per share $ 0.66 $ 0.23 $ 0.36
============= =================== ===============
Number of shares used in computing basic net
income per share 22,162 21,339 20,262
============= =================== ===============
Number of shares used in computing diluted net
income per share 23,233 22,210 20,951
============= =================== ===============
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
Common Stock Additional
------------------- Paid-in Retained
Shares Amount Capital Earnings
---------------------------------------------------
BALANCE MARCH 31, 1996 18,471 - $ 67,990 $ 2
Components of comprehensive income:
Net income for the year - - - 7,631
Foreign currency translation adjustment - - - -
Total comprehensive income - - - -
Issuance of common stock 63 - 848 -
Issuance of common stock pursuant to employee stock option plan 313 - 2,209 -
Issuance of common stock pursuant to employee stock purchase plan 19 - 179 -
Tax benefit attributable to employee stock option plan - - 736 -
Tax benefit derived from net operating loss carryforward utilization - - 6,634 -
Issuance of stock on formation of CentreSoft 2,468 - 268 -
Conversion of notes payable to common stock - - 283 -
Dividends declared - - - (1,270)
---------------------------------------------------
BALANCE MARCH 31, 1997 21,334 - $ 79,147 $ 6,363
Components of comprehensive income:
Net income for the year - - - 5,139
Foreign currency translation adjustment - - - -
Total comprehensive income - - - -
Issuance of common stock and common stock warrants 82 - 1,214
Issuance of common stock pursuant to employee stock option plan 599 - 4,756 -
Issuance of common stock pursuant to employee stock purchase plan 64 - 582 -
Tax benefit attributable to employee stock option plan - - 1,247 -
Adjustment for change in year-end of pooled subsidiary - - - (639)
Conversion of Redeemable Preferred Stock 87 - 1,286 -
Conversion of Convertible Preferred Stock 15 - 214 -
Conversion of Subordinated Loan Stock Debentures 217 - 3,216 -
Issuance of stock to affect business combination 10 - 163 11
Dividends declared - - - (116)
---------------------------------------------------
BALANCE MARCH 31, 1998 22,408 - $ 91,825 $ 10,758
Components of comprehensive income:
Net income for the year - - - 15,254
Foreign currency translation adjustment - - - -
Total comprehensive income - - - -
Issuance of common stock and common stock warrants - - 3,368 -
Issuance of common stock pursuant to employee stock option plan 605 - 5,271 -
Issuance of common stock pursuant to employee stock purchase plan 92 - 798 -
Tax benefit attributable to employee stock option plan - - 1,059 -
Tax benefit derived from net operating loss carryforward utilization - - 2,430 -
Conversion of notes payable to common stock - - 4,500 -
---------------------------------------------------
BALANCE MARCH 31, 1999 $23,105 $ - $ 109,251 $ 26,012
===================================================
Accumulated
Treasury Stock Other
------------------------- Comprehensive Shareholders'
Shares Amount Income (loss) Equity
---------------------------------------------------------
BALANCE MARCH 31, 1996 (500) $ (5,278) $ (335) $ 62,379
Components of comprehensive income:
Net income for the year - - - 7,631
Foreign currency translation adjustment - - 177 177
---------------
Total comprehensive income - - - 7,808
---------------
Issuance of common stock - - - 848
Issuance of common stock pursuant to employee stock option plan - - - 2,209
Issuance of common stock pursuant to employee stock purchase plan - - - 179
Tax benefit attributable to employee stock option plan - - - 736
Tax benefit derived from net operating loss carryforward utilization - - - 6,634
Issuance of stock on formation of CentreSoft - - - 268
Conversion of notes payable to common stock - - - 283
Dividends declared - - - (1,270)
--------------------------------------------------------
BALANCE MARCH 31, 1997 (500) $ (5,278) $ (158) $ 80,074
Components of comprehensive income:
Net income for the year - - - 5,139
Foreign currency translation adjustment - - 250 250
---------------
Total comprehensive income - - - 5,389
---------------
Issuance of common stock and common stock warrants - - - 1,214
Issuance of common stock pursuant to employee stock option plan - - - 4,756
Issuance of common stock pursuant to employee stock purchase plan - - - 582
Tax benefit attributable to employee stock option plan - - - 1,247
Adjustment for change in year-end of pooled subsidiary - - - (639)
Conversion of Redeemable Preferred Stock - - - 1,286
Conversion of Convertible Preferred Stock - - - 214
Conversion of Subordinated Loan Stock Debentures - - - 3,216
Issuance of stock to affect business combination - - - 174
Dividends declared - - - (116)
--------------------------------------------------------
BALANCE MARCH 31, 1998 (500) $ (5,278) $ 92 $ 97,397
Components of comprehensive income:
Net income for the year - - - 15,254
Foreign currency translation adjustment - - (2,602) (2,602)
---------------
Total comprehensive income - - - 12,652
---------------
Issuance of common stock and common stock warrants - - - 3,368
Issuance of common stock pursuant to employee stock option plan - - - 5,271
Issuance of common stock pursuant to employee stock purchase plan - - - 798
Tax benefit attributable to employee stock option plan - - - 1,059
Tax benefit derived from net operating loss carryforward utilization - - - 2,430
Conversion of notes payable to common stock - - - 4,500
--------------------------------------------------------
BALANCE MARCH 31, 1999 $ (500) $ (5,278) $ (2,510) $ 127,475
========================================================
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the years ended March 31,
------------------------------------------------
Restated
-----------------------------
1999 1998 1997
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 15,254 $ 5,139 $ 7,631
Adjustments to reconcile net income to net cash provided
by operating activities:
Deferred income taxes 3,344 (1,327) 2,929
Adjustment for change in fiscal year-end for pooled
subsidiaries - (639) -
Depreciation and amortization 6,488 5,315 4,167
Amortization of prepaid royalties and capitalized
software costs 27,055 29,167 9,045
Expense related to common stock warrants - 200 -
Loss on disposal of fixed assets - - 34
Change in assets and liabilities (net of effects of
purchases and acquisitions):
Accounts receivable (43,596) (25,079) (13,244)
Inventories (11,506) (6,798) (5,169)
Other current assets (7,972) 458 (1,137)
Other assets 1,408 168 (600)
Accounts payable (6,620) 25,410 5,688
Accrued expenses 34,304 (308) (5,652)
Deferred revenue - - 1,301
Other liabilities (81) (83) (37)
---------- ---------- ----------
Net cash provided by operating activities 18,078 31,180 4,956
---------- ---------- ----------
Cash flows from investing activities:
Cash paid by Combined Distribution (Holdings) Ltd. to
acquire CentreSoft (net of cash acquired) - (812) (3,878)
Capital expenditures (3,800) (8,872) (4,580)
Cash used in purchase acquisitions - (246) -
Investment in prepaid royalties and capitalized
software costs (60,531) (33,213) (11,130)
Other - (228) -
---------- ---------- ----------
Net cash used in investing activities (64,331) (43,371) (19,588)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock - - 282
Proceeds from issuance of common stock upon exercise of
warrants - - 2,209
Issuance of common stock pursuant to employee stock
option plans 5,271 4,756 -
Issuance of common stock pursuant to employee stock
purchase plan 798 582 179
Proceeds from issuance of subordinated loan stock
debentures - - 3,216
Proceeds from issuance of convertible preferred stock - - 214
Proceeds from issuance of redeemable preferred stock - - 1,286
Dividends paid (Combined Distribution (Holdings) Ltd.) - (1,256) (130)
Borrowing under line-of-credit agreement 5,300 8,800 1,600
Payment under line-of-credit agreement (5,300) (8,800) -
Note payable to bank, net 1,151 886 3,123
Proceeds from issuance of subordinated convertible notes - 57,900 -
Other - (6) 2
---------- ---------- ----------
Net cash provided by financing activities 7,220 62,862 11,981
---------- ---------- ----------
Effect of exchange rate changes on cash (2,361) 250 179
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents (41,394) 50,921 (2,472)
---------- ---------- ----------
Cash and cash equivalents at beginning of period 74,241 23,320 25,792
---------- ---------- ----------
Cash and cash equivalents at end of period $ 32,847 $ 74,241 $ 23,320
========== ========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
ACTIVISION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Activision, Inc. (together with its subsidiaries, "Activision" or the
"Company") is a leading international publisher, developer and
distributor of interactive entertainment and leisure products. The
Company was incorporated in California in 1979. In December 1992, the
Company reincorporated in Delaware.
The Company's products span a wide range of genres (including action,
adventure, strategy and simulation) and target markets (including game
enthusiasts, value buyers and children). In addition to its genre and
market diversity, the Company publishes, develops and distributes
products for a variety of game platforms, including personal computers
("PCs"), the Sony Playstation console system and the Nintendo 64 console
system.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Activision,
Inc., a Delaware corporation, and its wholly-owned subsidiaries (the
"Company"). All intercompany accounts and transactions have been
eliminated in consolidation.
BASIS OF PRESENTATION
These consolidated financial statements have been retroactively restated
to reflect the pooling of interests of the Company with Raven Software
Corporation ("Raven"), NBG EDV Handels- und Verlags GmbH ("NBG"), S.B.F.
Services, Limited dba Head Games Publishing ("Head Games") and CD Contact
Data GmbH ("CD Contact"). Each of the above transactions originally had
been accounted for by the Company as an immaterial pooling of interests.
The financial results for each such acquired company and related cash
flows had therefore been included in the reported operations of the
Company beginning on the date of acquisition. Based on a reevaluation of
these transactions, including the results of operations of each entity,
statements by the Securities and Exchange Commission ("the SEC") on
materiality of pooling transactions and requirements to evaluate the
impact on each line item in the financial statements and the impact on
the Company's trends, the Company has restated all financial information
reported in this Annual Report on Form 10-K for all periods prior to the
consummation of each transaction to include the financial position,
results of operations and cash flows of such acquired companies.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and short-term investments with
original maturities of not more than 90 days.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentration of credit risk consist principally of temporary cash
investments and accounts receivable. The Company places its temporary
cash investments with financial institutions. At various times during the
fiscal years ended March 31, 1999, 1998 and 1997, the Company had
deposits in excess of the $100,000 Federal Deposit Insurance Corporation
("FDIC") limit at these financial institutions. At March 31, 1999, the
Company had approximately $3.9 million invested in short-term commercial
paper and short-term United States government backed securities. The
Company's customer base includes retail outlets and distributors
including consumer electronics and computer specialty stores, discount
chains, video rental stores and toy stores in the United States and
countries worldwide. The Company performs ongoing credit evaluations of
its customers and maintains allowances for potential credit losses. The
Company generally does not require collateral or other security from its
customers.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of the Company's cash and cash equivalents, accounts
receivable, accounts payable, and accrued liabilities approximate their
carrying values due to the relatively short maturities of these
instruments. Trade receivables are primarily due from retailers and
original equipment manufacturers ("OEMs").
F-6
PREPAID ROYALTIES AND CAPITALIZED SOFTWARE COSTS
Prepaid royalties include payments made to independent software
developers under development agreements and license fees paid to
intellectual property rights holders for use of their trademarks or
copyrights. Intellectual property rights which have alternative future
uses are capitalized. Capitalized software costs represent costs incurred
for development that are not recoupable against future royalties.
The Company accounts for prepaid royalties relating to development
agreements and capitalized software costs in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased, or Otherwise Marketed". Software
development costs and prepaid royalties are capitalized once
technological feasibility is established. Technological feasibility is
evaluated on a product by product basis. For products where proven game
engine technology exists, this may occur early in the development cycle.
Software development costs are expensed if and when they are deemed
unrecoverable. Amounts related to software development which are not
capitalized are charged immediately to product development expense.
The following criteria is used to evaluate recoverability of software
development costs: historical performance of comparable products; the
commercial acceptance of prior products released on a given game engine;
orders for the product prior to its release; estimated performance of a
sequel product based on the performance of the product on which the
sequel is based; and actual development costs of a product as compared to
the Company's budgeted amount.
Capitalized software development costs are amortized to cost of sales -
royalties and software amortization on a straight-line basis over the
estimated product life (generally one year or less) commencing upon
product release, or on the ratio of current revenues to total projected
revenues, whichever amortization amount is greater. Prepaid royalties are
amortized to cost of sales - royalties and software amortization
commencing upon the product release at the contractual royalty rate based
on actual net product sales, or on the ratio of current revenues to total
projected revenues, whichever amortization amount is greater. For
products that have been released, management evaluates the future
recoverability of capitalized amounts on a quarterly basis.
As of March 31, 1999, prepaid royalties and unamortized capitalized
software costs totaled $37.1 million (including $6.9 million classified
as non-current) and $8.8 million, respectively. As of March 31, 1998,
prepaid royalties and unamortized capitalized software costs totaled
$10.7 million and $1.7 million, respectively. At March 31, 1998, all
prepaid royalties and unamortized capitalized software costs were
classified as current. Amortization of prepaid royalties and capitalized
software costs was $27.1 million, $29.2 million and $9.0 million for the
years ended March 31, 1999, 1998 and 1997, respectively. Write-offs of
prepaid royalties and capitalized software costs prior to product release
were $2.4 million, $363,000 and $588,000 for the years ended March 31,
1999, 1998 and 1997, respectively.
INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or
market.
REVENUE RECOGNITION
The American Institute of Certified Public Accountant's (the "AICPA")
Statement of Position 97-2 "Software Revenue Recognition" (SOP 97-2) was
effective for all transactions entered into subsequent to March 31, 1998.
The adoption of SOP 97-2 did not have a material impact on the Company's
financial position, results of operations or liquidity.
Product Sales: The Company recognizes revenue from the sale of its
products upon shipment. Subject to certain limitations, the Company
permits customers to obtain exchanges or return products within certain
specified periods, and provides price protection on certain unsold
merchandise. Management of the Company has the ability to estimate the
amount of future exchanges, returns, and price protections. Revenue from
product sales is reflected net of the allowance for returns and price
protection.
Software Licenses: For those license agreements which provide the
customers the right to multiple copies in exchange for guaranteed
amounts, revenue is recognized at delivery of the product master or the
first copy. Per copy royalties on sales which exceed the guarantee are
recognized as earned.
ADVERTISING EXPENSES
The Company expenses advertising and the related costs as incurred.
Advertising expenses for the years ended March 31, 1999, 1998 and 1997
were approximately $15,572,000 $6,336,000 and $3,285,000, respectively,
and are included in sales and marketing expense in the consolidated
statements of operations.
F-7
EXCESS PURCHASE PRICE OVER IDENTIFIABLE ASSETS ACQUIRED, NET AND
LONG-LIVED ASSETS
The excess cost over net assets acquired is being amortized on a
straight-line basis over a 20 year period. As of March 31, 1999 and 1998,
accumulated amortization amounted to $9,069,000 and $7,904,000,
respectively. The Company adopted the provisions of SFAS No. 121,
"Accounting for Impairment of Long-Lived Assets and Long-Lived Assets to
Be Disposed Of," on April 1, 1996. This Statement requires that
long-lived assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying
amount of the asset to undiscounted cash flows expected to be generated
by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the
carrying amount exceeds the fair value of the assets. Adoption of this
Statement did not have a material impact on the Company's financial
position, results of operations, or liquidity.
INTEREST INCOME (EXPENSE)
Interest income (expense), net is comprised of (amounts in thousands):
1999 1998 1997
---------- ---------- ----------
Restated Restated
---------- ----------
Interest expense $(4,973) $(2,223) $ (843)
Interest income 1,943 1,111 924
---------- ---------- ----------
Net interest income (expense) $(3,030) $(1,112) $ 81
========== ========== ==========
INCOME TAXES
The Company accounts for income taxes using Statement of Financial
Accounting Standards No. 109 (SFAS No. 109), "Accounting for Income
Taxes." Under SFAS No. 109, income taxes are accounted for under the
asset and liability method. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years
in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the
enactment date.
FOREIGN CURRENCY TRANSLATION
The Company's foreign subsidiaries maintain their accounting records in
their local currency. The currencies are then converted to United States
dollars and the effect of the foreign currency translation is reflected
as a component of shareholders' equity in accordance with Statement of
Financial Accounting Standards No. 52, "Foreign Currency Translation."
ESTIMATES
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.
STOCK BASED COMPENSATION
Prior to April 1, 1996, the Company accounted for its stock option plan
in accordance with the provisions of Accounting Principles Board ("APB")
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. As such, compensation expense would be recorded on the
date of the grant only if the current market price of the underlying
stock exceeded the exercise price. On April 1, 1996 the Company adopted
SFAS No. 123, Accounting for Stock-Based Compensation, which permits
entities to recognize as expense over the vesting period the fair value
of all stock-based awards on the date of the grant. Alternatively, SFAS
No. 123 also allows entities to continue to apply the provisions of APB
Opinion No. 25 and provide pro forma net income and pro forma earnings
per share disclosures for employee stock option grants made in 1995 and
future years as if the fair-value-based method defined in SFAS No. 123
had been applied. The Company has elected to continue to apply the
provisions of APB No. 25 and provide the pro forma disclosure provisions
of SFAS No. 123.
F-8
RECLASSIFICATIONS
Certain amounts in the consolidated financial statements have been
reclassified to conform with the current year's presentation.
2. ACQUISITIONS
1999 TRANSACTIONS
As stated below, the acquisition of Head Games and CD Contact were
originally treated as immaterial poolings of interest. However,
after reviewing the results of operations of the entities, including
the materiality and impact on the the Company's trends, the Company
has restated the financial statements for all periods prior to the
closing of each respective transaction.
ACQUISITION OF HEAD GAMES
On June 30, 1998, the Company acquired Head Games in exchange for
1,000,000 shares of the Company's common stock. The acquisition of Head
Games was initially accounted for as an immaterial pooling of interests;
accordingly, periods prior to April 1, 1998 were not retroactively
restated for this transaction. However with this Annual Report on Form
10-K, all prior periods have been retroactively restated to reflect the
effect of the Head Games acquisition in all periods presented.
ACQUISITION OF CD CONTACT
On September 29, 1998, the Company acquired CD Contact in exchange for
1,900,000 shares of the Company's common stock. In addition, $9.1 million
in outstanding debt was acquired in connection with the CD Contact
acquisition. The debt is evidenced by notes payable which are due on
demand and bear interest at approximately 8% per annum. The acquisition
of CD Contact was initially accounted for as an immaterial pooling of
interests; accordingly, periods prior to July 1, 1998 were not
retroactively restated for this transaction. However with this Annual
Report on Form 10-K, all prior periods have been retroactively restated
to reflect the effect of the CD Contact acquisition in all periods
presented.
The following table represents the results of operations of the
previously separate companies for the period before the combination was
consummated that are included in the current combined net income of the
Company:
Fiscal Year 1999
-----------------------------------------------------------------------------------------------
Head Games CD Contact
Activision 3 Months 6 Months Total
Year Ended Ended Ended Year Ended
March 31, 1999 June 30, 1998 September 30, 1998 March 31, 1999
------------------------ --------------------- ---------------------- ----------------------
Revenues $412,225 $ 2,195 $ 22,065 $436,485
Net income (loss) $ 14,194 $ 394 $ 666 $ 15,254
Results for Head Games from July 1, 1998, subsequent to its acquisition
by the Company and for CD Contact from October 1, 1998, subsequent to
its acquisition by the Company, are included in the Activision year ended
March 31, 1999 column above.
1998 TRANSACTIONS
As discussed below, the acquisitions of NBG and Raven were originally
accounted for as immaterial poolings of interest. However, based on
statements by the SEC regarding materiality and the requirement to
evaluate the impact on each line item of the Company's financial
statement and the impact on the Company's trends, the Company has
restated the financial statements for periods prior to the closing of
each respective transaction.
ACQUISITION OF NBG
On November 26, 1997, the Company acquired NBG in exchange for 281,206
shares of the Company's common stock. The acquisition of NBG was
initially accounted for as an immaterial pooling of interests;
accordingly, periods prior to October 1, 1997 were not retroactively
restated for this transaction. However, with this Annual Report on Form
10-K, all prior periods have been retroactively restated to reflect the
effect of the NBG acquisition in all periods presented.
ACQUISITION OF RAVEN SOFTWARE CORPORATION
On August 26, 1997, the Company acquired Raven in exchange for 1,040,000
shares of the Company's common stock. The acquisition of Raven was
initially accounted for as an immaterial pooling of interests;
accordingly, periods prior to April 1, 1997 were not retroactively
restated for this transaction. However, with this Annual Report on Form
10-K, all prior periods have been retroactively restated to reflect the
effect of the Raven acquisition in all periods presented.
Fiscal Year 1998
-----------------------------------------------------------------------------------------------
Activision
as Previously NBG Head Games CD Contact Total
Reported 6 Months Year Year Restated Year
Year Ended Ended Ended Ended Ended
March 31, 1998 Sept. 30, 1997 March 31, 1998 March 31, 1998 March 31, 1998
--------------------- ---------------- ----------------- --------------- ------------------
Revenues $259,926 $ 7,081 $ 3,715 $ 41,336 $312,058
Net income (loss) $ 5,827 $ (106) $ (70) $ (512) $ 5,139
F-9
Fiscal Year 1997
----------------------------------------------------------------------------------------------------
Activision
as Previously Raven NBG Head Games CD Contact Total
Reported Year Year Year Year Year
Year Ended Ended Ended Ended Ended Ended
March 31, 1997 March 31, 1997 March 31, 1997 March 31, 1997 March 31, 1997 March 31, 1997
----------------- --------------- -------------- -------------- ---------------- ---------------
Revenues $154,644 $ 428 $ 19,628 $ 1,083 $ 13,456 $189,239
Net income (loss) $ 9,226 $ (419) $ 179 $ (1,510) $ 155 $ 7,631
Acquisition of Centresoft
On November 26, 1997, the Company acquired Centresoft in exchange for
2,787,043 shares and 50,325 options to acquire shares of the Company's
common stock. The acquisition of Centresoft was accounted for in
accordance with the pooling of interests method of accounting and
accordingly, the Company's consolidated financial statements were
retroactively adjusted as if Centresoft and the Company had operated
as one since June 28, 1996 (inception of Centresoft).
3. INVENTORIES
Inventories at March 31, 1999, 1998 and 1997 are stated net of an
adjustment to net realizable value of approximately $1,493,000, $828,000
and $471,000, respectively. The provisions to adjust inventories to net
realizable value for the years ended March 31, 1999, 1998 and 1997 were
approximately $828,000, $1,082,000 and $478,000, respectively.
Inventories, net of reserves, consisted of (amounts in thousands):
March 31, 1999 March 31, 1998
------------------ ---------------------
Restated
---------------------
Purchased parts and components $ 2,326 $ 1,409
Finished goods 28,605 18,016
------------------ ---------------------
$30,931 $19,425
================== =====================
4. PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation and
amortization are provided using the straight-line method over the shorter
of the estimated useful lives or the lease term: buildings, 30 years;
computer equipment, office furniture and other equipment, 3 years;
leasehold improvements, through the life of the lease. Property and
equipment, stated at cost, was as follows (amounts in thousands):
March 31, 1999 March 31, 1998
------------------ ---------------------
Restated
---------------------
Land $ 581 $ 581
Buildings 759 801
Computer equipment 18,067 15,576
Office furniture and other equipment 3,522 3,480
Leasehold improvements 3,189 2,974
------------------ ---------------------
Total cost of property and equipment 26,118 23,412
Less accumulated depreciation (15,277) (11,468)
------------------ ---------------------
Net cost of property and equipment $ 10,841 $ 11,944
================== =====================
Depreciation expense for the years ended March 31, 1999, 1998 and 1997
was $4,903,000, $3,753,000 and $2,662,000, respectively.
F-10
5. ACCRUED EXPENSES
Accrued expenses were as follows (amounts in thousands):
March 31, 1999 March 31, 1998
----------------- -----------------
Restated
-----------------
Accrued royalties payable $11,249 $ 5,996
Affiliated label payable 11,999 -
Accrued selling and marketing costs 3,082 2,937
Income tax payable 5,068 1,360
Accrued interest expense 1,013 1,125
Accrued bonus and vacation pay 4,473 1,210
Other 8,258 2,710
----------------- -----------------
$45,142 $15,338
================= =================
6. OPERATIONS BY REPORTABLE SEGMENTS AND GEOGRAPHIC AREA
The Company adopted SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information," as of April 1, 1998. SFAS No. 131
establishes standards for reporting information about an enterprise's
operating segments and related disclosures about its products, geographic
areas and major customers.
The Company publishes, develops and distributes interactive
entertainment and leisure products for a variety of game platforms,
including PCs, the Sony PlayStation console system and the Nintendo 64
console system. Based on its organizational structure, the Company
operates in two reportable segments: publishing and distribution.
The Company's publishing segment develops and publishes titles
both internally through the studios owned by the Company and externally,
through third party developers. In the United States, the Company's
products are sold primarily on a direct basis to major computer and
software retailing organizations, mass market retailers, consumer
electronic stores, discount warehouses and mail order companies. The
Company conducts its international publishing activities through offices
in the United Kingdom, Germany, France, Australia and Japan. The
Company's products are sold internationally on a direct to retail basis,
through third party distribution and licensing arrangements, and through
the Company's owned distribution subsidiaries located in the United
Kingdom, the Benelux territories and Germany.
The Company's distribution segment, located in the United Kingdom,
the Benelux territories and Germany, distributes interactive
entertainment software and hardware and provides logistical services for
a variety of publishers and manufacturers. A small percentage of
distribution sales is derived from Activision-published titles.
The President and Chief Operating Officer allocates resources to
each of these segments using information on their respective revenues
and operating profits before interest and taxes. The President and Chief
Operating Officer has been identified as the Chief Operating Decision
Maker as defined by SFAS No. 131.
The President and Chief Operating Officer does not evaluate
individual segments based on assets or depreciation.
The accounting policies of these segments are the same as those
described in the Summary of Significant Accounting Policies. Revenue
derived from sales between segments is eliminated in consolidation.
Information on the reportable segments for the three years ended
March 31, 1999 is as follows:
Fiscal Year Ended March 31, 1999
--------------------------------------------------------------
Publishing Distribution Corporate Total
------------- --------------- ------------- ---------------
Revenues from external customers $186,299 $250,186 $ - $436,485
Revenue from sales between segments $ 19,202 $ - $ - $ 19,202
Operating income (loss) $ 17,784 $ 10,685 $ (1,224) $ 27,245
F-11
Fiscal Year Ended March 31, 1998
--------------------------------------------------------------
Publishing Distribution Corporate Total
------------- --------------- ------------- ---------------
Revenues from external customers $125,067 $186,991 $ - $312,058
Revenue from sales between segments $ 7,759 $ - $ - $ 7,759
Operating income (loss) $ 5,836 $ 4,842 $ (1,192) $ 9,486
Fiscal Year Ended March 31, 1997
--------------------------------------------------------------
Publishing Distribution Corporate Total
------------- --------------- ------------- ---------------
Revenues from external customers $ 87,994 $101,245 $ - $189,239
Revenue from sales between segments $ - $ - $ - $ -
Operating income (loss) $ 10,077 $ 2,721 $ (1,267) $ 11,531
Operating expenses in the Corporate column consist entirely of
amortization of goodwill resulting from the Company's merger with the
Disc Company Inc., on April 1, 1992.
Geographic information for the three years ended March 31, 1999 is based
on the location of the selling entity. Revenues from external customers
by geographic region were as follows:
Fiscal Year Ended March 31,
----------------------------------------------------
1999 1998 1997
----------------- ----------------- --------------
United States $149,664 $ 89,936 $ 65,695
Europe 278,032 208,817 113,456
Other 8,789 13,305 10,088
----------------- ----------------- --------------
Total $436,485 $312,058 $189,239
================= ================= ==============
Revenues by platform were as follows:
1999 1998 1997
----------------- ----------------- --------------
Restated Restated
Console $268,205 $131,890 $ 68,480
PC 168,280 180,168 120,759
----------------- ----------------- --------------
Total $436,485 $312,058 $189,239
================= ================= ==============
F-12
7. COMPUTATION OF NET INCOME PER SHARE
The following table sets forth the computations of basic and diluted net
income per share:
(amounts in thousands, except per share data)
1999 1998 1997
--------------- --------------- ---------------
Restated
--------------------------------
NUMERATOR
Net income $ 15,254 $ 5,139 $ 7,631
Preferred stock dividends - (116) (151)
--------------- --------------- ---------------
Numerator for basic and diluted net income
per share-income available to common
stockholders $ 15,254 $ 5,023 $ 7,480
=============== =============== ===============
DENOMINATOR
Denominator for basic net income per
share-weighted average shares outstanding 22,162 21,339 20,262
Effect of dilutive securities:
Employee stock options 942 801 689
Warrants to purchase common stock 129 70 -
--------------- --------------- ---------------
Potential dilutive common shares 1,071 871 689
--------------- --------------- ---------------
Denominator for diluted net income per
share-adjusted weighted average shares and
assumed conversions 23,233 22,210 20,951
=============== =============== ===============
Basic net income per share $ 0.69 $ 0.24 $ 0.37
=============== =============== ===============
Diluted net income per share $ 0.66 $ 0.23 $ 0.36
=============== =============== ===============
Options to purchase 2,188,175, 1,978,000 and 2,838,000 shares of common
stock were outstanding for the years ended March 31, 1999, 1998 and 1997,
respectively, but were not included in the calculations of diluted net
income per share because their effect would be antidilutive. Convertible
subordinated notes and convertible preferred stock were not included in
the calculations of diluted net income per share because their effect
would be antidilutive.
F-13
8. INCOME TAXES
Domestic and foreign income (loss) before income taxes and details of the
income tax provision (benefit) are as follows (amounts in thousands):
Year ended March 31,
-------------------------------------------------------
Restated
-------------------------------------
1999 1998 1997
---------------- ------------------- ----------------
Income (loss) before income taxes:
Domestic $ 6,524 $ (2,215) $ 2,838
Foreign 17,691 10,589 8,774
---------------- ------------------- ----------------
$ 24,215 $ 8,374 $ 11,612
================ =================== ================
Income tax expense (benefit):
Current:
Federal $ 37 $ 1,133 $ (745)
State 124 14 31
Foreign 5,456 3,653 1,530
---------------- ------------------- ----------------
Total current 5,617 4,800 816
---------------- ------------------- ----------------
Deferred:
Federal (202) (2,580) (2,961)
State 57 (232) (1,244)
---------------- ------------------- ----------------
Total deferred (145) (2,812) (4,205)
---------------- ------------------- ----------------
Add back benefit credited to additional
paid-in capital:
Tax benefit related to stock option
exercises 1,059 1,247 736
Tax benefit related to utilization of pre-
bankruptcy net operating loss
carryforwards 2,430 - 6,634
---------------- ------------------- ----------------
3,489 1,247 7,370
---------------- ------------------- ----------------
$ 8,961 $ 3,235 $ 3,981
================ =================== ================
The items accounting for the difference between income taxes computed at
the U.S. federal statutory income tax rate and the income tax provision
for each of the years are as follows:
Year ended March 31,
-------------------------------------------------------
Restated
-------------------------------------
1999 1998 1997
--------------- -------------------- ----------------
Federal income tax provision at statutory rate 34.0% 34.0% 35.0%
State taxes, net of federal benefit 1.3% (1.2%) 2.6%
Nondeductible amortization 1.7% 4.4% 3.0%
Nondeductible merger fees 0.8% 3.6% -
Research and development credits (5.4%) (5.3%) (6.4%)
Incremental effect of foreign tax rates (0.9%) 0.7% (3.1%)
Increase (reduction) of valuation allowance 5.1% - 3.1%
Other 0.4% 2.4% 0.1%
--------------- -------------------- ----------------
37.0% 38.6% 34.3%
=============== ==================== ================
F-14
The components of the net deferred tax asset and liability were as
follows (amounts in thousands):
March 31, 1999 March 31, 1998
----------------------------------------------
Restated
-------------------
Deferred asset:
Allowance for bad debts $ 942 $ 358
Allowance for sales returns 144 2,458
Royalty reserve 1,649 -
Miscellaneous 1,591 1,304
Tax credit carryforwards 6,726 3,320
Net operating loss carryforwards 10,534 9,184
------------------ -------------------
Deferred asset 21,586 16,624
Valuation allowance (6,916) (8,107)
------------------ -------------------
Net deferred asset 14,670 8,517
------------------ -------------------
Deferred liability:
Deferred compensation 110 -
Capitalized research expenses 5,512 -
State taxes 386 -
------------------ -------------------
Deferred liability 6,008 -
------------------ -------------------
Net deferred asset $ 8,662 $ 8,517
================== ===================
In accordance with Statement of Position 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code," issued by the
AICPA, benefits from loss carryforwards arising prior to the Company's
reorganization are recorded as additional paid-in capital. During the
year ended March 31, 1999, $2.4 million of such benefit was recognized
through a reduction in the valuation allowance. The reduction in the
valuation allowance during the years ended March 31, 1999 was determined
based on the Company's assessment of the realizability of its deferred
tax assets, which assessment was based on recent operating history, and
the Company's expectation that operations will continue to generate
taxable income, as well as other factors. Realization of the deferred tax
assets is dependent upon the continued generation of sufficient taxable
income prior to expiration of tax credits and loss carryforwards.
Although realization is not assured, management believes it is more
likely than not that the deferred tax asset of $8.7 million will be
realized. The amount of deferred tax assets considered realizable,
however, could be reduced in the future if estimates of future taxable
income are reduced.
The Company's available net operating loss carryforward for federal tax
reporting purposes approximates $31.0 million and is subject to certain
limitations as defined under Section 382 of the Internal Revenue Code.
The net operating loss carryforwards expire from 2006 to 2013. The
Company has tax credit carryforwards of $4.6 million and $2.2 million for
federal and state purposes, respectively, which expire from 2006 to 2013.
9. COMMITMENTS, CONTINGENCIES AND DEBT
BANK LINE OF CREDIT
As of March 31, 1999, the Company had a $40.0 million revolving credit
and letter of credit facility (the "Prior Facility") with a group of
banks. The Prior Facility currently provides the Company with the
ability to borrow funds and issue letters of credit against eligible
accounts receivable up to $40.0 million. The Prior Facility was
scheduled to expire in October 2001. As of March 31, 1999 the Company
had $22.4 million in letters of credit outstanding and no borrowings
against the Prior Facility (there were no outstanding letters of
credit or borrowings against the Prior Facility in the fiscal year
ended March 31, 1998). In addition, the Company had a $2 million line
of credit agreement (the "Asset Line") with a bank that expired in
September 1998. Approximately $1.1 million and $1.2 million was
outstanding on this line as of March 31, 1999 and 1998, respectively.
In addition, the Company's CentreSoft subsidiary has a revolving credit
facility (the "UK Facility") with its bank in the United Kingdom for
approximately $11.2 million. The UK Facility can be used for working
capital requirements and expires in June 2000. The Company had no
borrowings outstanding against the UK facility as of March 31, 1999. In
the Netherlands, the Company's CD Contact subsidiary has a credit
facility ("the Netherlands Facility") with a bank that permits borrowings
against eligible accounts receivable and inventory up to approximately
$25 million. Borrowings under the Netherlands Facility are due on demand
and totaled $6.0 as of March 31, 1999. Letters of credit outstanding
under the Netherlands facility totaled $6.9 million as of March 31, 1999.
F-15
PRIVATE PLACEMENT OF CONVERTIBLE SUBORDINATED NOTES
In December 1997, the Company completed the private placement of $60.0
million principal amount of 6 3/4% convertible subordinated notes due
2005 (the "Notes"). The Notes are convertible, in whole or in part, at
the option of the holder at any time after December 22, 1997 (the date of
original issuance) and prior to the close of business on the business day
immediately preceding the maturity date, unless previously redeemed or
repurchased, into common stock, $.000001 par value, of the Company, at a
conversion price of $18.875 per share, (equivalent to a conversion rate
of 52.9801 shares per $1,000 principal amount of Notes), subject to
adjustment in certain circumstances. The Notes are redeemable, in whole
or in part, at the option of the Company at any time on or after January
10, 2001, subject to premiums through December 31, 2003.
LEASE OBLIGATIONS
The Company leases certain of its facilities under non-cancelable
operating lease agreements. Total future minimum lease commitments as of
March 31, 1999 are as follows (amounts in thousands):
Year ending March 31,
2000 $ 3,760
2001 3,608
2002 3,281
2003 3,139
2004 3,123
Thereafter $11,450
Rent expense for the years ended March 31, 1999, 1998 and 1997 was
approximately $3,900,000, $3,219,000 and $2,279,000, respectively.
LEGAL PROCEEDINGS
The Company is party to routine claims and suits brought against it in
the ordinary course of business, including disputes arising over the
ownership of intellectual property rights and collection matters. In the
opinion of management, the outcome of such routine claims will not have a
material adverse effect on the Company's business, financial condition,
results of operations or liquidity.
10. STOCKHOLDERS' EQUITY AND COMPENSATION PLANS
OPTION PLANS
The Company has two stock option plans for the benefit of officers,
employees, consultants and others.
The Activision 1991 Stock Option and Stock Award Plan, as amended, (the
"1991 Plan") permits the granting of non-qualified stock options,
incentive stock options ("ISOs"), stock appreciation rights ("SARs"),
restricted stock awards, deferred stock awards and other
Common-Stock-based awards. The total number of shares of Common Stock
available for distribution under the 1991 Plan is 7,666,667. The 1991
Plan requires available shares to consist in whole or in part of
authorized and unissued shares for treasury shares. There were 156,500
shares remaining available for grant under the 1991 Plan as of March 31,
1999.
On September 23, 1998, the stockholders of the Company approved the
Activision 1998 Incentive Plan (the "1998 Plan"). The 1998 Plan permits
the granting of non-qualified stock options, ISOs, restricted stock
awards, deferred stock awards and other common stock-based awards to
officers, employees, consultants and others. The total number of shares
of Common Stock available for distribution under the 1998 Plan is
3,000,000. The 1998 Plan requires available shares to consist in whole or
in part of authorized and unissued shares or treasury shares. There were
1,087,435 remaining shares available for grant under the Incentive Plan
as of March 31, 1999.
The exercise price for stock options issued under the 1991 Plan and 1998
Plan (collectively, the "Plans") is determined at the discretion of the
Board of Directors (or the Compensation Committee of the Board of
Directors), and for ISOs, is not to be less than the fair market value of
the Company's common stock at the date of grant, or in the case of
non-qualified options, must exceed or be equal to 85% of fair market
value at date of grant. Options typically become exercisable in equal
installments over a period not to exceed five years and must be exercised
within 10 years of date of grant. Historically, stock options have been
granted with exercise prices equal to or greater than the fair market
value at the date of grant.
F-16
Activity of the Plans during the last three fiscal years was as follows
(amounts in thousands, except weighted average exercise price amounts):
1999 1998 1997
---------------------- ---------------------- ---------------------
Shares Wtd Avg Shares Wtd Avg Shares Wtd Avg
(000) Ex Price (000) Ex Price (000) Ex Price
------- --------- ------- --------- ------- ---------
Outstanding at beginning of year 6,218 $ 11.47 5,228 $ 11.69 3,725 $ 11.37
Granted 3,538 $ 10.27 2,776 $ 12.14 1,997 $ 11.28
Exercised (605) $ 8.68 (599) $ 8.35 (313) $ 7.05
Forfeited (1,202) $ 15.33 (1,187) $ 14.45 (181) $ 9.24
------- --------- ------- --------- ------- ---------
Outstanding at end of year 7,949 $ 10.54 6,218 $ 11.47 5,228 $ 11.69
======= ========= ======= ========= ======= =========
Exercisable at end of year 3,754 10.00 2,532 $ 9.78 3,292 $ 12.62
The range of exercise prices for options outstanding as of March 31, 1999
was $.75 to $17.75. The range of exercise prices for options is wide due
to increases and decreases in the Company's stock price over the period
of the grants. For the year ended March 31, 1999, 3,320,000 options were
granted at an exercise price equal to the fair market value on the date
of grant and 218,000 options were granted at an exercise price greater
than fair market value on the date of grant.
The following tables summarize information about stock options
outstanding as of March 31, 1999:
Outstanding Options Exercisable Options
------------------------------------------- --------------------------
Remaining Wtd
Avg
Contractual
Shares Life Wtd Avg Shares Wtd Avg
(000) (in years) Exercise Price (000) Exercise Price
------- ------------- -------------- ------- --------------
Range of exercise prices:
$0.75 to $9.44 1,366 6.67 $ 6.91 815 $ 5.52
$9.46 to $9.87 1,741 8.45 $ 9.69 1,268 $ 9.71
$10.00 to $10.50 1,429 8.88 $10.27 463 $10.30
$10.56 to $11.06 1,324 8.78 $10.77 341 $10.77
$11.12 to $13.56 1,300 7.60 $12.62 530 $13.03
$13.62 to $17.00 788 7.98 $15.37 336 $15.98
$17.75 to $17.75 1 6.49 $17.75 1 $17.75
These options will expire if not exercised at specific dates ranging from
January 2000 to April 2009. Prices for options exercised during the three
year period ended March 31, 1999 ranged from $.75 to $15.75.
EMPLOYEE STOCK PURCHASE PLAN
The Company has an employee stock purchase plan for all eligible
employees (the "Purchase Plan"). Under the Purchase Plan, shares of the
Company's common stock may be purchased at six-month intervals at 85% of
the lower of the fair market value on the first or last day of each
six-month period (the "Offering Period"). Employees may purchase shares
having a value not exceeding 10% of their gross compensation during an
Offering Period. Employees purchased 42,093 shares at a price of $9.24
per share and 45,868 shares at a price of $8.92 per share during the
Purchase Plan's offering period ended September 30, 1998 and March 31,
1999, respectively. As of March 31, 1999, 29,939 shares were reserved for
future issuance under the Purchase Plan.
EMPLOYEE RETIREMENT PLAN
The Company has a retirement plan covering substantially all of its
eligible employees. The retirement plan is qualified in accordance with
Section 401(k) of the Internal Revenue Code. Under the plan, employees
may defer up to 15% of their pre-tax salary, but not more than statutory
limits. The Company contributes 5% of each dollar contributed by a
participant. The Company's matching contributions to the plan were
$40,000, $40,000 and $25,000 during the years ended March 31, 1999, 1998
and 1997, respectively.
DIRECTOR WARRANT PLAN
The Director Warrant Plan, which expired on December 19, 1996, provided
for the automatic granting of warrants ("Director Warrants") to purchase
16,667 shares of the Common Stock to each director of the Company who was
not an officer or employee of the Company or any of its subsidiaries.
Director Warrants granted under the Director
F-17
Warrant Plan vest 25% on the first anniversary of the date of grant,
and 12.5% each six months thereafter. The expiration of the Plan had
no effect on the outstanding Warrants. As of March 31, 1999, there
were no shares of Common Stock available for distribution under the
Director Warrant Plan.
Director Warrant activity was as follows (amounts in thousands, except
weighted average exercise price amounts):
1999 1998 1997
--------------------- --------------------- ---------------------
Shares Wtd Avg Shares Wtd Avg Shares Wtd Avg
(000) Ex Price (000) Ex Price (000) Ex Price
-------- --------- -------- --------- -------- ---------
Outstanding at beginning and end of
year 73 $4.43 73 $4.43 73 $4.43
======== ========= ======== ========= ======== =========
Exercisable at end of year 73 $4.43 73 $4.43 73 $4.43
======== ========= ======== ========= ======== =========
The range of exercise prices for Director Warrants outstanding as of
March 31, 1999 was $.75 to 8.50. The range of exercise prices for
Director Warrants is wide due to increases and decreases in the Company's
stock price over the period of the grants. As of March 31, 1999, 33,300
of the outstanding and vested Director Warrants have a weighted average
remaining contractual life of 2.78 years and a weighted average exercise
price of $.75; 20,000 of the outstanding and vested Director Warrants
have a weighted average remaining contractual life of 5.82 years and a
weighted average exercise price of $6.50; and 20,000 of the outstanding
and vested Director Warrants have a weighted average remaining
contractual life of 5.82 years and a weighted average exercise price of
$8.50.
OTHER OPTIONS AND WARRANTS
On March 23, 1999, 1,000,000 options to purchase common stock were issued
to each of Robert A. Kotick, the Company's Chairman and Chief Executive
Officer, and Brian G. Kelly, the Company's Co-Chairman. The options were
granted in connection with employment agreements between the Company and
each of Mr. Kotick and Mr. Kelly dated January 12, 1999. The options
vest in five equal annual installments beginning on the date of issuance,
have an exercise price of $10.50 per share, and expire on January 12,
2009.
On December 11, 1998, the Company granted options to purchase 80,000
shares of the Company's common stock to four of its outside directors.
The options have an exercise price of $11.50, vest in five equal
annual installments beginning a year from the date of issuance, and
expire on December 11, 2008.
On June 4, 1998, the Company granted options to purchase 60,000 shares
of the Company's common stock to four of its outside directors. The
options have an exercise price of $9.50, vest in two equal annual
installments beginning a year from the date of issuance, and expire on
June 4, 2008.
During the fiscal year ended March 31, 1998, the Company issued warrants
to purchase 40,000 shares of the Company's common stock, with a weighted
average exercise price of $12.88 to two of its outside directors in
connection with their election to the Board. Such warrants have vesting
terms identical to the Directors Warrants and expire within 10 years. As
of March 31, 1999, 19,338 of such warrants were vested and exercisable.
During the fiscal year ended March 31, 1999, the Company issued the
following warrants to purchase 1,000,000 shares of common stock in
connection with software license agreements:
Exercise Expiration
Warrants Shares Price Vesting Schedule Date
-------- ---------- -------- ---------------------------------------------- -------------
#1 500,000 $ 10.27 Vest ratably over 5 years beginning on date of 9/16/08
grant.
#2 250,000 (a) Vest ratably over 5 years beginning on 9/16/03. 9/16/08
#3 250,000 $ 12.70 Vest in full on 7/2/99. 7/2/08
---------- --------
Total 1,000,000
==========
(a) Exercise price is equal to the average closing price of the Company's
common stock on the NASDAQ National Market for the thirty trading
days preceding September 16, 2003.
The fair value of the warrants was determined using the Black-Scholes
pricing model, assuming a risk-free rate of 4.77%, a volatility factor
of .66 and expected terms as noted in the above table. In accordance
with the Financial Accounting Standards Board's Emerging Issues Task
Force Issue No. 96-18 "Accounting for Equity Instruments that are
Issued To Other Than Employees for Acquiring or in Connection With
Selling Goods or Services" (EITF 96-18), the Company measures the fair
value of the securities on the measurement date. The measurement date
is the earlier of the date on which the other party's performance is
completed or the date of a performance commitment, as defined. The
fair value of each warrant is capitalized and amortized to royalty
expense when the related product is released and the related revenue
is recognized. During 1999, $387,620 was amortized and included in
royalty expense relating to warrants. No amortization was recognized
in 1998.
PRO FORMA INFORMATION
The Company has elected to follow APB Opinion No. 25, "Accounting for
Stock Issued to Employees," in accounting for its employee stock options.
Under APB No. 25, if the exercise price of the Company's employee stock
options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized in the Company's financial
statements.
F-18
Pro forma information regarding net income (loss) and net income (loss)
per share is required by SFAS No. 123. This information is required to be
determined as if the Company had accounted for its employee stock options
(including shares issued under the Purchase Plan and Director Warrant
Plan, collectively called "options") granted during fiscal 1999, 1998 and
1997 under the fair value method of that statement. The fair value of
options granted in the years ended March 31, 1999, 1998 and 1997 reported
below has been estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted average assumptions:
Incentive Plan Purchase Plan Director Warrant Plan
---------------------- ----------------------- ----------------------
1999 1998 1997 1999 1998 1997 1999 1998 1997
----- ----- ----- ----- ----- ----- ----- ----- -----
Expected life (in years) 1.5 3.0 2.2 0.5 0.5 0.5 0.5 - -
Risk free interest rate 4.77% 5.62% 6.45% 4.77% 5.62% 6.45% 4.77% - -
Volatility .66 .63 .60 .66 .71 .60 .66 - -
Dividend yield - - - - - - - - -
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions, including the
expected stock price volatility. Because the Company's options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect
the fair value estimate, in the opinion of management, the existing
models do not necessarily provide a reliable single measure of the fair
value of its options. The weighted average estimated fair value of Plan
shares granted during the years ended March 31, 1999, 1998 and 1997 was
$11.12, $13.47 and $12.72 per share, respectively. The weighted average
estimated fair value of Employee Stock Purchase Plan shares granted
during the year ended March 31, 1999 and 1998 were $2.85 and $2.65,
respectively. No Director Warrants were granted during the year ended
March 31, 1999.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows (amounts in thousands except for
net income (loss) per share information):
Year ended March 31,
------------------------------------------------
1999 1998 1997
---------- ---------- ---------
Restated Restated
---------- ---------
Pro forma net income (loss) $ 1,111 $ (2,253) $ 633
Pro forma basic net income (loss) per share $ 0.05 $ (0.11) $ 0.03
Pro forma diluted net income (loss) per share $ 0.05 $ (0.11) $ 0.03
The effects on pro forma disclosures of applying SFAS No. 123 are not
likely to be representative of the effects on pro forma disclosures of
future years. Because SFAS No. 123 is applicable only to options granted
during fiscal 1996 through 1999, the pro forma effect will not be fully
reflected until the fiscal year ended March 31, 2000.
F-19
11. SUPPLEMENTAL CASH FLOW INFORMATION
Non-cash activities and supplemental cash flow information for the fiscal
years ended March 31, 1999, 1998 and 1997 is as follows (amounts in
thousands):
For the years ended March 31,
--------------------------------------
Restated
----------------------
1999 1998 1997
------ ------ ------
Non-cash activities:
Stock and warrants to acquire common stock issued in
exchange for licensing rights $3,368 $1,214 $ 822
Tax benefit derived from net operating loss carryforward 2,430 - 6,634
utilization
Tax benefit attributable to stock option exercises 1,059 1,247 736
Subordinated loan stock debentures converted to common
stock in pooling transaction - 3,216 -
Redeemable preferred stock converted to common stock - 1,286 -
in pooling transaction
Convertible preferred stock converted to common stock - 214 -
in pooling transaction
Stock issued to effect business combination - 136 -
Conversion of notes payable to common stock 4,500 - 259
Supplemental cash flow information:
Cash paid for income taxes $2,814 $2,174 $ 473
Cash paid for interest 5,513 675 -
F-20
12. QUARTERLY FINANCIAL AND MARKET INFORMATION (UNAUDITED)
Quarter Ended
-----------------------------------------------------
Year
(Amounts in thousands, except per share data) June 30 Sept 30 Dec 31 Mar 31 Ended
------- ------- -------- -------- --------
Fiscal 1999 (quarter ended June 30 restated):
Net revenues $61,531 $66,182 $193,537 $115,235 $436,485
Operating income (loss) (5,637) (2,783) 26,328 9,337 27,245
Net income (loss) (3,744) (2,234) 16,022 5,210 15,254
Basic income (loss) per share $ (0.17) $ (0.10) $ 0.72 $ 0.23 $ 0.69
Diluted net income (loss) per share $ (0.17) $ (0.10) $ 0.64 $ 0.22 $ 0.66
Common stock price per share
High $ 11.62 $ 13.75 $ 14.87 $ 13.81 $ 14.87
Low $ 9.37 $ 9.37 $ 8.75 $ 9.75 $ 8.75
Fiscal 1998 (restated):
Net revenues $38,560 $65,788 $139,587 $ 68,123 $312,058
Operating income (loss) (9,383) 3,591 13,742 1,536 9,486
Net income (loss) (5,925) 2,041 8,334 689 5,139
Basic income (loss) per share $ (0.28) $ 0.09 $ 0.39 $ 0.03 $ 0.24
Diluted net income (loss) per share $ (0.28) $ 0.09 $ 0.36 $ 0.03 $ 0.23
Common stock price per share
High $ 14.75 $ 15.50 $ 18.62 $ 17.87 $ 18.62
Low $ 9.87 $ 11.00 $ 13.00 $ 9.50 $ 9.50
13. SUBSEQUENT EVENTS -- UNAUDITED
BANK LINE OF CREDIT
On June 22, 1999, the Company replaced the Prior Facility with a $125
million revolving credit facility and term loan (the "New Facility") with
a new group of banks that provides the Company with the ability to borrow
up to $100 million and issue letters of credit up to $80 million against
eligible accounts receivable and inventory. The $25 million term loan
portion of the New Facility was used to acquire Expert and pay costs
related to such acquisition and the securing of the new facility. The
term loan has a three year term with principal amortization on a straight
line quarterly basis beginning December 31, 1999 and a borrowing rate of
the banks' base rate (which is generally equivalent to the published
prime rate) plus 2.0%, or the LIBOR rate plus 3.0%. The revolving portion
of the New Facility has a borrowing rate of the banks' base rate plus
1.75%, or the LIBOR rate plus 2.75%. The Company pays a commitment fee of
1/2% based on the unused portion of the line.
ACQUISITION OF EXPERT SOFTWARE
On March 3, 1999, the Company announced that it had entered into a merger
agreement with Expert Software ("Expert"), a developer and distributor
and value-line interactive leisure products, for $2.65 per share of
outstanding Expert common stock, or total consideration of approximately
$20.4 million. On June 21, 1999, Expert's shareholders approved the
merger at a special meeting of shareholders and on June 22, 1999, the
merger was consummated. Proceeds from the term loan portion of the New
Facility were used to pay the merger consideration. The acquisition of
Expert will be accounted for using the purchase method of accounting.
F-21
SCHEDULE II
ACTIVISION, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(amounts in thousands)
Col. A Col. B Col. C Col. D Col. E
------ ------ ------ ------ ------
Balance at
Beginning of Deductions Balance at End
Description Period Additions (Describe) of Period
- --------------------------------------------------------------------------------------------------------------------
Year ended March 31, 1999
Allowance for sales returns,
price protection and doubtful
accounts $15,582 $53,773 $54,376(A) $14,979
Inventory valuation $ 828 $ 828 $ 163(B) $ 1,493
Deferred tax valuation allowance $ 8,107 $ 1,239 $ 2,430 $ 6,916
Year ended March 31, 1998 (Restated)
Allowance for sales returns,
price protection and doubtful
accounts $ 7,674 $39,437 $31,529(A) $15,582
Inventory valuation $ 471 $ 1,082 $ 725(B) $ 828
Deferred tax valuation allowance $ 8,107 - - $ 8,107
Year ended March 31, 1997 (Restated)
Allowance for sales returns,
price protection and doubtful $ 7,005 $18,878 $18,209(A) $ 7,674
accounts
Inventory valuation $ 145 $ 478 $ 152(B) $ 471
Deferred tax valuation allowance $14,305 $ 436 $ 6,634 $ 8,107
(A) Actual write-offs of uncollectible accounts receivable or sales returns and
price protection.
(B) Actual write-offs of obsolete inventory, scrap and reduction in carrying
value of certain portions of inventory.
F-22
EXHIBIT INDEX
ITEM 14(a). EXHIBITS.
Exhibit Sequential Page
Number Exhibit Number
------- ------- ------
3.1 Amended and Restated Articles of Incorporation of Activision,
Inc., dated October 15, 1992 (incorporated by reference to Exhibit
4.5 of Amendment No. 1 to the Company's Form S-8, Registration No.
33-48411 filed on June 1, 1993).
3.2 Bylaws of Activision, Inc. (incorporated by reference to Exhibit
4.6 of Amendment No. 1 to the Company's Form S-8, Registration No.
33-48411 filed on June 1, 1993).
10.1 Mediagenic 1991 Stock Option and Stock Award Plan, as amended
(incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-8, Registration No. 33-63638,
filed on December 8, 1995).
10.2 Mediagenic 1991 Director Warrant Plan as amended (incorporated by
reference to Exhibit 28.2 to the Company's Registration Statement
on Form S-8, Registration No. 33-63638, filed on June 1, 1993).
10.3 Activision, Inc. Employee Stock Purchase Plan (incorporated by
reference to Exhibit 4.1 the Company's Form S-8 filed on September
25, 1996.
10.4 Activision 1998 Incentive Plan (incorporated by reference to
Appendix I of the Company's 1998 Proxy Statement).
10.5 Lease Agreement dated as of December 20, 1996, between the Company
and Barclay Curci Investment Company (incorporated by reference to
Exhibit 10.14 of the Company's Form 10-Q for the quarter ended
December 31, 1996).
10.6 Share Exchange Agreement dated November 23, 1997, among the
Company and the holders of all of the issued and outstanding
capital stock of Combined Distribution (Holdings), Inc.
(incorporated by reference to Exhibit 10.1 of the Company's Form
8-K filed December 5, 1997).
10.7 Purchase Agreement dated as of December 16, 1997, among the
Company and Credit Suisse First Boston Corporation, Piper Jaffray,
Inc. and UBS Securities LLC (the "Initial Purchasers")
(incorporated by reference to Exhibit 10.1 of the Company's Form
8-K filed December 23, 1997).
10.8 Registration Rights Agreement dated as of December 16, 1997, among
the Company and the Initial Purchasers (incorporated by reference
to Exhibit 10.2 of the Company's Form 8-K filed December 23,
1997).
10.9 Indenture dated as of December 22, 1997, between the Company and
State Street Bank and Trust Company of California, N.A., as
Trustee (incorporated by reference to Exhibit 10.3 of the
Company's Form 8-K filed December 23, 1997).
10.10 Employment agreement dated January 12, 1999 between the Company
and Robert A. Kotick.
10.11 Employment agreement dated January 12, 1999 between the Company
and Brian G. Kelly.
10.12 Employment agreement dated October 19, 1998 between the Company
and Ronald Doornink.
F-23
10.13 Employment agreement dated March 4, 1999 between the Company and
Lawrence Goldberg.
10.14 Employment agreement dated March 4, 1999 between the Company and
Barry J. Plaga.
10.15 Employment agreement dated April 1, 1998 between the Company and
Mitchell Lasky.
10.16 Employment agreement dated April 1, 1998 between the Company and
Ronald Scott.
10.17 Service Agreement dated November 24, 1997 between Combined
Distribution (Holdings) Limited and Richard Andrew Steele.
10.18 Employment Agreement dated September 1, 1997 between the Company
and Robert Dewar.
10.19 Articles of Merger dated June 30, 1998 between S.B.F. Acquisition
Corp., a wholly owned subsidiary of the Company and S.B.F.
Services Limited, Head Games Publishing, (incorporated by
reference to Exhibit 2.1 of the Company's Form 8-K, filed on
July 2, 1998).
10.20 Share Exchange Agreement dated September 29, 1998 by and between
the Company and Mr. Frank d'Oleire, Mrs. Christa d'Oleire, Ms.
Fiona d'Oleire, Ms. Alexa d'Oleire acting as Dr. d'Oleire
Beteiligungsgesellschaft bR, Mr. Martinus J.C. Bubbert, and Mr.
Dennis W. Buis (incorporated by reference to Exhibit 10.1 of the
Company's Form 8-K, filed on October 8, 1998).
10.21 Amended and Restated Agreement and Plan of Merger dated April 19,
1999 by and among the Company, Expert Acquisition Corp. and Expert
Software, Inc. (incorporated by reference to Exhibit 2.1 of the
Form 8-K of Expert Software, Inc., filed April 29, 1999).
10.22 Credit Agreement dated as of June 21, 1999 among the Company, Head
Games Publishing, Inc., Expert Software, Inc., various lenders,
PNC Bank, National Association, as issuing bank, administrative
agent and collateral agent for such lenders, and Credit Suisse
First Boston, as syndication agent.
21. Principal subsidiaries of the Company.
23. Independent Auditors' Consent.
27.1 Fiscal 1996 Year to Date financial Data Schedule.
27.2 Fiscal 1997 Year to Date Financial Data Schedule.
27.3 Fiscal 1998 Year to Date Financial Data Schedule.
27.4 Fiscal 1999 Year to Date Financial Data Schedule.
(b) REPORTS ON FORM 8-K. The following reports on Form 8-K have been filed
by the Company during the last quarter of the fiscal year ended March 31,
1999:
1.1 Form 8-K dated March 10, 1999, containing items 5 and 7.
F-24