UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES | |
EXCHANGE ACT OF 1934 | |||
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For the Quarterly Period Ended | |||
OR |
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| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
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For the transition period from to
Commission File Number 001-15839
ACTIVISION, INC.
(Exact name of registrant as specified in its charter)
Delaware | 95-4803544 | |
(State or other jurisdiction of |
| (I.R.S. Employer Identification No.) |
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3100 Ocean Park Boulevard, Santa Monica, CA | 90405 | |
(Address of principal executive offices) |
| (Zip Code) |
(310) 255-2000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large | Accelerated Filer x Accelerated Filer o Non-accelerated filer o |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The number of shares of the registrant’s Common Stock outstanding as of JuneNovember 1, 2007 was 283,310,734.291,310,208.
ACTIVISION, INC. AND SUBSIDIARIES
INDEX
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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CERTIFICATIONS |
2
This Quarterly Report on Form 10-Q contains, or incorporates by reference, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to, (1) projections of revenues, expenses, income or loss, earnings or loss per share, cash flow projections or other financial items; (2) statements of our plans and objectives, including those relating to product releases; (3) statements of future economic performance; and (4) statements of assumptions underlying such statements. We generally use words such as “anticipate”, “believe”, “could”, “estimate”, “expect”, “forecast”, “future”, “intend”, “may”, “plan”“outlook”, “plan, “positioned”, “potential”, “project”,“remain”, “scheduled”, “set to”, “subject to”, “to be”, “upcoming”, “will” and other similar expressions to help identify forward-looking statements. These forward-looking statements are subject to business and economic risk, reflect management’s current expectations, estimates and projections about our business, and are inherently uncertain and difficult to predict. Our actual results could differ materially. The forward-looking statements contained herein speak only as of the date on which they were made, and we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of this Quarterly Report. Risks and uncertainties that may affect our future results include, but are not limited to, those discussed under the heading “Risk Factors”, included in Part II,I, Item 1A.1A of our Annual Report on Form 10-K for the fiscal year ended March 31, 2007. All references to “we”, “us”, “our”, “Activision” or “the Company” in the following discussion and analysis mean Activision, Inc. and its subsidiaries.
3
Restatement of Consolidated Financial Results
We recently completed a voluntary review of our historical stock option granting practices and a restatement of our consolidated financial statements as of and for the fiscal years ended March 31, 2006, 2005 and 2004 and related disclosures and a restatement of our selected consolidated financial data as of and for the fiscal years ended March 31, 2006, 2005, 2004, 2003 and 2002 and our unaudited quarterly financial data for each of the quarters in the fiscal years ended March 31, 2006 and 2005, and for the fiscal quarter ended June 30, 2006. The impacts of the restatement adjustments extend to periods from the fiscal year ended March 31, 1994 through the fiscal quarter ended June 30, 2006.
The restatement reflected the findings of a special subcommittee of independent members of our Board of Directors, which was established in July 2006 to review our historical stock option granting practices (the “Special Subcommittee”). The Special Subcommittee conducted its investigation with the assistance of Munger Tolles & Olson LLP as its independent counsel and Deloitte & Touche USA LLP (“Deloitte”) as forensic accounting experts retained by counsel. The Special Subcommittee found that 3,450 of the option grants reviewed, covering 148,747,202 shares, required measurement date corrections. As a result, we recorded approximately $66.7 million in additional pre-tax ($45.4 million after-tax) non-cash stock-based compensation expense over the thirteen year period from April 1, 1993 through March 31, 2006 in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and $0.6 million in additional pre-tax non-cash stock-based compensation expense during the quarter ended June 30, 2006 in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment”. More than 80% or $55.4 million of the $66.7 million relates to periods through March 31, 2003 and 4% or $2.6 million of the non-cash pre-tax expense relates to the fiscal year ended March 31, 2006. Separately, the restatement reflects an additional $1.7 million pre-tax charge ($1.1 million after-tax) related to recently identified insufficient payroll tax withholdings in fiscal 2005.
This Quarterly Report on Form 10-Q should be read in conjunction with our Amended Annual Report on Form 10-K/A for the year ended March 31, 2006 filed with the SEC on May 25, 2007 and our Amended Quarterly Report on Form 10-Q/A for the three months ended June 30, 2006 filed with the SEC on June 7, 2007. Information regarding the effect of the restatement on our financial position and results of operations is provided in Note 2 of the Notes to Unaudited Consolidated Financial Statements included in Part I, Item 1 of this Report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2 of this Report.
Financial information included in our previously filed reports on Form 10-K and Form 10-Q, the related opinions of our independent registered public accounting firm, and all earnings press releases and similar communications issued by us, for all periods ended on or before June 30, 2006 should not be relied upon and are superseded in their entirety by the information in our amended Annual Report on Form 10-K/A for the year ended March 31, 2006 filed with the SEC on May 25, 2007 and our Amended Quarterly Report on Form 10-Q/A for the three months ended June 30, 2006 and our Quarterly Reports on Form 10-Q for the three months ended September 30, 2006 and the three months ended December 31, 2006 filed with the SEC today.
All share and per share information presented in this report has been adjusted to reflect splits and dividends of our common stock.
ACTIVISION, INC. AND SUBSIDIARIES
(In thousands, except share data)
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| December 31, |
| March 31, |
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Assets |
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Current assets: |
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Cash and cash equivalents |
| $ | 367,910 |
| $ | 354,331 |
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Short-term investments |
| 437,290 |
| 590,629 |
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Accounts receivable, net of allowances of $107,124 and $98,253 at December 31, 2006 and March 31, 2006, respectively |
| 456,589 |
| 28,782 |
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Inventories |
| 85,680 |
| 61,483 |
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Software development |
| 86,119 |
| 40,260 |
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Intellectual property licenses |
| 28,628 |
| 4,973 |
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Deferred income taxes |
| 4,266 |
| 9,664 |
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Other current assets |
| 17,896 |
| 25,933 |
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Total current assets |
| 1,484,378 |
| 1,116,055 |
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Software development |
| 15,688 |
| 20,359 |
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Intellectual property licenses |
| 64,800 |
| 82,073 |
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Property and equipment, net |
| 46,713 |
| 45,368 |
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Deferred income taxes |
| 85,552 |
| 52,545 |
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Other assets |
| 5,941 |
| 1,409 |
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Goodwill |
| 188,398 |
| 100,446 |
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Total assets |
| $ | 1,891,470 |
| $ | 1,418,255 |
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Liabilities and Shareholders’ Equity |
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Current liabilities: |
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Accounts payable |
| $ | 193,875 |
| $ | 88,994 |
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Accrued expenses |
| 247,581 |
| 104,862 |
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Total current liabilities |
| 441,456 |
| 193,856 |
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Other liabilities |
| 41,128 |
| 1,776 |
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Total liabilities |
| 482,584 |
| 195,632 |
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Commitments and contingencies (Note 14) |
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Shareholders’ equity: |
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Preferred stock, $.000001 par value, 3,750,000 shares authorized, no shares issued at December 31, 2006 and March 31, 2006 |
| — |
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Series A Junior Preferred stock, $.000001 par value, 1,250,000 shares authorized, no shares issued at December 31, 2006 and March 31, 2006 |
| — |
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Common stock, $.000001 par value, 450,000,000 shares authorized, 282,934,869 and 277,020,898 shares issued and outstanding at December 31, 2006 and March 31, 2006, respectively |
| — |
| — |
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Additional paid-in capital |
| 948,028 |
| 867,297 |
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Retained earnings |
| 442,199 |
| 341,990 |
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Accumulated other comprehensive income |
| 18,659 |
| 16,369 |
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Unearned compensation (Note 1) |
| — |
| (3,033 | ) | ||
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Total shareholders’ equity |
| 1,408,886 |
| 1,222,623 |
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Total liabilities and shareholders’ equity |
| $ | 1,891,470 |
| $ | 1,418,255 |
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| September 30, |
| March 31, |
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Assets |
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Current assets: |
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Cash and cash equivalents |
| $ | 392,529 |
| $ | 384,409 |
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Short-term investments |
| 569,231 |
| 570,440 |
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Accounts receivable, net of allowances of $106,619 and $91,418 at September 30, 2007 and March 31, 2007, respectively |
| 109,725 |
| 148,694 |
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Inventories |
| 189,033 |
| 91,231 |
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Software development |
| 104,236 |
| 107,779 |
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Intellectual property licenses |
| 10,645 |
| 27,784 |
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Deferred income taxes |
| 60,032 |
| 51,564 |
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Other current assets |
| 31,453 |
| 19,332 |
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Total current assets |
| 1,466,884 |
| 1,401,233 |
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Software development |
| 40,433 |
| 23,143 |
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Intellectual property licenses |
| 71,145 |
| 72,490 |
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Property and equipment, net |
| 53,500 |
| 46,540 |
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Deferred income taxes |
| 38,252 |
| 48,791 |
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Other assets |
| 10,738 |
| 6,376 |
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Goodwill |
| 280,248 |
| 195,374 |
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Total assets |
| $ | 1,961,200 |
| $ | 1,793,947 |
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Liabilities and Shareholders’ Equity |
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Current liabilities: |
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Accounts payable |
| $ | 158,059 |
| $ | 136,517 |
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Accrued expenses and other liabilities |
| 255,266 |
| 204,652 |
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Total current liabilities |
| 413,325 |
| 341,169 |
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Other liabilities |
| 18,325 |
| 41,246 |
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Total liabilities |
| 431,650 |
| 382,415 |
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Commitments and contingencies (Note 12) |
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Shareholders’ equity: |
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Preferred stock, $.000001 par value, 3,750,000 shares authorized, no shares issued at September 30, 2007 and March 31, 2007 |
| — |
| — |
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Series A Junior Preferred stock, $.000001 par value, 1,250,000 shares authorized, no shares issued at September 30, 2007 and March 31, 2007 |
| — |
| — |
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Common stock, $.000001 par value, 450,000,000 shares authorized, 289,072,399 and 283,310,734 shares issued and outstanding at September 30, 2007 and March 31, 2007, respectively |
| — |
| — |
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Additional paid-in capital |
| 1,045,891 |
| 963,553 |
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Retained earnings |
| 456,301 |
| 427,777 |
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Accumulated other comprehensive income |
| 27,358 |
| 20,202 |
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Total shareholders’ equity |
| 1,529,550 |
| 1,411,532 |
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Total liabilities and shareholders’ equity |
| $ | 1,961,200 |
| $ | 1,793,947 |
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The accompanying notes are an integral part of these consolidated financial statements.
4
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
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| For the three months ended |
| For the nine months ended |
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| 2006 |
| 2005 |
| 2006 |
| 2005 |
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| As restated(1) |
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| As restated(1) |
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Net revenues |
| $ | 824,259 |
| $ | 816,242 |
| $ | 1,200,500 |
| $ | 1,279,875 |
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Costs and expenses: |
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Cost of sales – product costs |
| 382,165 |
| 367,685 |
| 618,162 |
| 617,021 |
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Cost of sales – software royalties and amortization |
| 77,449 |
| 104,264 |
| 106,058 |
| 139,267 |
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Cost of sales – intellectual property licenses |
| 23,566 |
| 26,376 |
| 37,838 |
| 55,765 |
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Product development |
| 37,162 |
| 53,254 |
| 88,395 |
| 99,698 |
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Sales and marketing |
| 87,410 |
| 156,013 |
| 156,139 |
| 259,110 |
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General and administrative |
| 43,387 |
| 24,757 |
| 91,647 |
| 67,228 |
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Total costs and expenses |
| 651,139 |
| 732,349 |
| 1,098,239 |
| 1,238,089 |
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Operating income |
| 173,120 |
| 83,893 |
| 102,261 |
| 41,786 |
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Investment income, net |
| 9,724 |
| 9,162 |
| 26,031 |
| 22,840 |
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Income before income tax provision |
| 182,844 |
| 93,055 |
| 128,292 |
| 64,626 |
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Income tax provision |
| 40,024 |
| 25,199 |
| 28,083 |
| 15,247 |
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Net income |
| $ | 142,820 |
| $ | 67,856 |
| $ | 100,209 |
| $ | 49,379 |
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Basic earnings per share |
| $ | 0.51 |
| $ | 0.25 |
| $ | 0.36 |
| $ | 0.18 |
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Weighted average common shares outstanding |
| 282,512 |
| 274,965 |
| 280,499 |
| 272,089 |
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Diluted earning per share |
| $ | 0.46 |
| $ | 0.23 |
| $ | 0.33 |
| $ | 0.17 |
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Weighted average common shares outstanding assuming dilution |
| 307,175 |
| 296,205 |
| 304,317 |
| 293,397 |
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(1) See Note 2 “Restatement of Unaudited Consolidated Financial Statements.”
The accompanying notes are an integral part of these consolidated financial statements.
ACTIVISION, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)(In thousands)
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| For the nine months ended |
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| 2006 |
| 2005 |
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| As restated(1) |
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Cash flows from operating activities: |
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Net income |
| $ | 100,209 |
| $ | 49,379 |
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Adjustments to reconcile net income to net cash used in operating activities: |
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Deferred income taxes |
| (33,254 | ) | (6,023 | ) | ||
Realized gain on short-term investments |
| (1,823 | ) | (4,295 | ) | ||
Depreciation and amortization |
| 13,303 |
| 10,228 |
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Amortization and write-offs of capitalized software development costs and intellectual property licenses |
| 77,358 |
| 168,351 |
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Stock-based compensation expense |
| 18,433 |
| 2,506 |
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Tax benefit of stock options and warrants exercised |
| 11,377 |
| 21,269 |
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Excess tax benefit from stock option exercises |
| (9,012 | ) | — |
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Changes in operating assets and liabilities: |
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Accounts receivable |
| (416,697 | ) | (305,305 | ) | ||
Inventories |
| (20,573 | ) | (36,810 | ) | ||
Software development and intellectual property licenses |
| (117,636 | ) | (162,793 | ) | ||
Other assets |
| 21,128 |
| 321 |
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Accounts payable |
| 98,473 |
| 104,895 |
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Accrued expenses and other liabilities |
| 133,297 |
| 74,345 |
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Net cash used in operating activities |
| (125,417 | ) | (83,932 | ) | ||
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Cash flows from investing activities: |
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Capital expenditures |
| (13,106 | ) | (20,174 | ) | ||
Cash payment to effect business combinations, net of cash acquired |
| (30,545 | ) | (7,081 | ) | ||
Increase in restricted cash |
| — |
| (7,500 | ) | ||
Purchases of short-term investments |
| (215,721 | ) | (143,162 | ) | ||
Proceeds from sales and maturities of short-term investments |
| 361,339 |
| 182,504 |
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Net cash provided by investing activities |
| 101,967 |
| 4,587 |
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Cash flows from financing activities: |
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Proceeds from issuance of common stock to employees |
| 18,956 |
| 37,850 |
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Excess tax benefit from stock option exercises |
| 9,012 |
| — |
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Net cash provided by financing activities |
| 27,968 |
| 37,850 |
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Effect of exchange rate changes on cash |
| 9,061 |
| (5,044 | ) | ||
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Net increase (decrease) in cash and cash equivalents |
| 13,579 |
| (46,539 | ) | ||
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Cash and cash equivalents at beginning of period |
| 354,331 |
| 313,608 |
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Cash and cash equivalents at end of period |
| $ | 367,910 |
| $ | 267,069 |
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(1) See Note 2 “Restatement of Unaudited Consolidated Financial Statements.”
The accompanying notes are an integral part of these consolidated financial statements.
ACTIVISION, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITYFor the Nine Months ended December 31, 2006(Unaudited)(In thousands)
|
| Common Stock |
| Additional |
| Retained |
| Accumulated |
| Unearned |
| Shareholders’ |
| ||||||||
|
| Shares |
| Amount |
| Capital |
| Earnings |
| Income |
| Compensation |
| Equity |
| ||||||
Balance, March 31, 2006 |
| 277,021 |
| $ | — |
| $ | 867,297 |
| $ | 341,990 |
| $ | 16,369 |
| $ | (3,033 | ) | $ | 1,222,623 |
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Components of comprehensive income: |
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| ||||||
Net income |
| — |
| — |
| — |
| 100,209 |
| — |
| — |
| 100,209 |
| ||||||
Unrealized loss on short-term investments (net of tax benefit of $0.9 million) |
| — |
| — |
| — |
| — |
| (8,693 | ) | — |
| (8,693 | ) | ||||||
Foreign currency translation adjustment |
| — |
| — |
| — |
| — |
| 10,983 |
| — |
| 10,983 |
| ||||||
Total comprehensive income |
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|
|
| 102,499 |
| ||||||
Issuance of common stock pursuant to employee stock option and stock purchase plans |
| 3,532 |
| — |
| 18,956 |
| — |
| — |
| — |
| 18,956 |
| ||||||
Issuance of stock to effect business combination |
| 2,382 |
| — |
| 30,000 |
| — |
| — |
| — |
| 30,000 |
| ||||||
Stock based compensation expense related to employee stock options, restricted stock, and employee stock purchases |
| — |
| — |
| 23,431 |
| — |
| — |
| — |
| 23,431 |
| ||||||
Tax benefit associated with options and warrants |
| — |
| — |
| 11,377 |
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|
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| 11,377 |
| ||||||
Reclassification of unearned compensation |
| — |
| — |
| (3,033 | ) | — |
| — |
| 3,033 |
| — |
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Balance, December 31, 2006 |
| 282,935 |
| $ | — |
| $ | 948,028 |
| $ | 442,199 |
| $ | 18,659 |
| $ | — |
| $ | 1,408,886 |
|
|
| For the three months ended |
| For the six months ended |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net revenues |
| $ | 317,746 |
| $ | 188,172 |
| $ | 813,201 |
| $ | 376,241 |
|
|
|
|
|
|
|
|
|
|
| ||||
Costs and expenses: |
|
|
|
|
|
|
|
|
| ||||
Cost of sales – product costs |
| 151,996 |
| 127,374 |
| 369,225 |
| 235,997 |
| ||||
Cost of sales – software royalties and amortization |
| 38,427 |
| 9,348 |
| 116,679 |
| 28,609 |
| ||||
Cost of sales – intellectual property licenses |
| 14,533 |
| 4,356 |
| 47,012 |
| 14,272 |
| ||||
Product development |
| 33,085 |
| 25,608 |
| 65,982 |
| 51,233 |
| ||||
Sales and marketing |
| 51,868 |
| 32,550 |
| 120,580 |
| 68,729 |
| ||||
General and administrative |
| 37,382 |
| 26,346 |
| 73,176 |
| 48,260 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total costs and expenses |
| 327,291 |
| 225,582 |
| 792,654 |
| 447,100 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Operating income (loss) |
| (9,545 | ) | (37,410 | ) | 20,547 |
| (70,859 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Investment income, net |
| 12,132 |
| 8,032 |
| 23,694 |
| 16,307 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Income (loss) before income tax provision (benefit) |
| 2,587 |
| (29,378 | ) | 44,241 |
| (54,552 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Income tax provision (benefit) |
| 1,889 |
| (5,076 | ) | 15,717 |
| (11,941 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Net income (loss) |
| $ | 698 |
| $ | (24,302 | ) | $ | 28,524 |
| $ | (42,611 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Basic earnings (loss) per share |
| $ | 0.00 |
| $ | (0.09 | ) | $ | 0.10 |
| $ | (0.15 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Weighted average common shares outstanding |
| 287,315 |
| 280,627 |
| 285,450 |
| 279,487 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Diluted earnings (loss) per share |
| $ | 0.00 |
| $ | (0.09 | ) | $ | 0.09 |
| $ | (0.15 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Weighted average common shares outstanding assuming dilution |
| 313,263 |
| 280,627 |
| 312,510 |
| 279,487 |
|
The accompanying notes are an integral part of these consolidated financial statements.
5
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
|
| For the six months ended |
| ||||
|
| 2007 |
| 2006 |
| ||
|
|
|
|
|
| ||
Cash flows from operating activities: |
|
|
|
|
| ||
Net income (loss) |
| $ | 28,524 |
| $ | (42,611 | ) |
Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
|
|
|
|
| ||
Deferred income taxes |
| (1,327 | ) | (70,149 | ) | ||
Realized gain on short-term investments |
| — |
| (2 | ) | ||
Depreciation and amortization |
| 15,885 |
| 8,519 |
| ||
Loss on disposal of property and equipment |
| 987 |
| — |
| ||
Amortization and write-offs of capitalized software development costs and intellectual property licenses (1) |
| 99,560 |
| 26,283 |
| ||
Stock-based compensation expense (2) |
| 15,029 |
| 10,740 |
| ||
Tax benefit of stock options and warrants exercised |
| 9,199 |
| 5,888 |
| ||
Excess tax benefits from stock option exercises |
| (8,141 | ) | (4,405 | ) | ||
Changes in operating assets and liabilities: |
|
|
|
|
| ||
Accounts receivable |
| 41,784 |
| (57,194 | ) | ||
Inventories |
| (97,802 | ) | (5,956 | ) | ||
Software development and intellectual property licenses |
| (88,775 | ) | (84,630 | ) | ||
Other assets |
| (10,219 | ) | 1,377 |
| ||
Accounts payable |
| 21,666 |
| (11,984 | ) | ||
Accrued expenses and other liabilities |
| 20,029 |
| 54,853 |
| ||
|
|
|
|
|
| ||
Net cash provided by (used in) operating activities |
| 46,399 |
| (169,271 | ) | ||
|
|
|
|
|
| ||
Cash flows from investing activities: |
|
|
|
|
| ||
Capital expenditures |
| (15,253 | ) | (7,540 | ) | ||
Proceeds from disposal of property and equipment |
| 135 |
| — |
| ||
Cash payment to effect business combinations, net of cash acquired |
| (68,875 | ) | (30,545 | ) | ||
Increase in restricted cash |
| (33,413 | ) | (12,500 | ) | ||
Purchases of short-term investments |
| (378,727 | ) | (147,278 | ) | ||
Proceeds from sales and maturities of short-term investments |
| 414,233 |
| 180,993 |
| ||
|
|
|
|
|
| ||
Net cash used in investing activities |
| (81,900 | ) | (16,870 | ) | ||
|
|
|
|
|
| ||
Cash flows from financing activities: |
|
|
|
|
| ||
Proceeds from issuance of common stock to employees |
| 30,262 |
| 11,922 |
| ||
Excess tax benefit from stock option exercises |
| 8,141 |
| 4,405 |
| ||
|
|
|
|
|
| ||
Net cash provided by financing activities |
| 38,403 |
| 16,327 |
| ||
|
|
|
|
|
| ||
Effect of exchange rate changes on cash |
| 5,218 |
| 5,204 |
| ||
|
|
|
|
|
| ||
Net increase (decrease) in cash and cash equivalents |
| 8,120 |
| (164,610 | ) | ||
|
|
|
|
|
| ||
Cash and cash equivalents at beginning of period |
| 384,409 |
| 354,331 |
| ||
|
|
|
|
|
| ||
Cash and cash equivalents at end of period |
| $ | 392,529 |
| $ | 189,721 |
|
(1) Excludes amortization of stock-based compensation expense.
(2) Includes the net effects of capitalization and amortization of stock-based compensation expense.
The accompanying notes are an integral part of these consolidated financial statements.
6
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Six Months ended September 30, 2007
(Unaudited)
(In thousands)
|
| Common Stock |
| Additional |
| Retained |
| Accumulated |
| Shareholders’ |
| |||||||
|
| Shares |
| Amount |
| Capital |
| Earnings |
| Income |
| Equity |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31, 2007 |
| 283,311 |
| $ | — |
| $ | 963,553 |
| $ | 427,777 |
| $ | 20,202 |
| $ | 1,411,532 |
|
Components of comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net income |
| — |
| — |
| — |
| 28,524 |
| — |
| 28,524 |
| |||||
Unrealized appreciation on short-term investments, net of taxes |
| — |
| — |
| — |
| — |
| 543 |
| 543 |
| |||||
Foreign currency translation adjustment |
| — |
| — |
| — |
| — |
| 6,613 |
| 6,613 |
| |||||
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
| 35,680 |
| |||||
Issuance of common stock pursuant to employee stock options, employee stock purchase plans and employee bonuses |
| 4,473 |
| — |
| 32,119 |
| — |
| — |
| 32,119 |
| |||||
Issuance of common stock to effect business combination (see Note 4) |
| 1,288 |
| — |
| 24,039 |
| — |
| — |
| 24,039 |
| |||||
Stock based compensation expense related to employee stock options, restricted stock rights, and employee stock purchase plans |
| — |
| — |
| 20,044 |
| — |
| — |
| 20,044 |
| |||||
Tax benefit associated with options and warrants |
| — |
| — |
| 9,199 |
| — |
| — |
| 9,199 |
| |||||
Employee tender offer (see Note 13) |
| — |
| — |
| (3,063 | ) | — |
| — |
| (3,063 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Balance, September 30, 2007 |
| 289,072 |
| $ | — |
| $ | 1,045,891 |
| $ | 456,301 |
| $ | 27,358 |
| $ | 1,529,550 |
|
The accompanying notes are an integral part of these consolidated financial statements.
7
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006(Unaudited)
(Unaudited)
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statementsConsolidated Financial Statements include the accounts of Activision, Inc. and its subsidiaries (“Activision,” the “Company,”Activision” or “we”). The information furnished is unaudited and consiststhe adjustments included consist of only normal recurring adjustments that, in the opinion of management, are necessary to provide a fair statement of the results for the interim periods presented. The Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements included in our Amended Annual Report on Form 10-K/A10-K for the fiscal year ended March 31, 20062007 as filed with the Securities and Exchange Commission (“SEC”) on May 25,June 14, 2007.
Software Development Costs and Intellectual Property Licenses
Software development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products.
We account for software development costs in accordance with Statement of Financial Accounting StandardsSFAS No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” Software development costs are capitalized once the technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation. For products where proven technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product basis. Prior to a product’s release, we expense, as part of “cost of sales —– software royalties and amortization,” capitalized costs when we believe such amounts are not recoverable. Capitalized costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation. Amounts related to software development which are not capitalized are charged immediately to product development expense. We evaluate the future recoverability of capitalized amounts on a quarterly basis. The recoverability of capitalized software development costs is evaluated based on the expected performance of the specific products for which the costs relate.Criteria used to evaluate expected product performance include: historical performance of comparable products using comparable technology; orders for the product prior to its release; and estimated performance of a sequel product based on the performance of the product on which the sequel is based.
Commencing upon product release, capitalized software development costs are amortized to “cost of sales —– software royalties and amortization” based on the ratio of current revenues to total projected revenues, generally resulting in an amortization period of six months or less. For products that have been released in prior periods, we evaluate the future recoverability of capitalized amounts on a quarterly basis. The primary evaluation criterion is actual title performance.
Significant management judgments and estimates are utilized in the assessment of when technological feasibility is established, as well as in the ongoing assessment of the recoverability of capitalized costs. In evaluating the recoverability of capitalized costs, the assessment of expected product performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual product sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge.
Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks, copyrights, software, technology, or other intellectual property or proprietary rights in the development of our products. Depending upon the agreement with the rights holder, we may obtain the rights to use acquired intellectual property in multiple products over multiple years, or alternatively, for a single product.
8
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006(Unaudited)
(Unaudited)
We evaluate the future recoverability of capitalized intellectual property licenses on a quarterly basis. The recoverability of capitalized intellectual property license costs is evaluated based on the expected performance of the specific products in which the licensed trademark or copyright is to be used. As many of our intellectual property licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized intellectual property license costs based on certain qualitative factors such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned theatrical releases or television series based on the intellectual property, and the rights holder’s continued promotion and exploitation of the intellectual property. Prior to the related product’s release, we expense, as part of “cost of sales – intellectual property licenses,” capitalized intellectual property costs when we believe such amounts are not recoverable. Capitalized intellectual property costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation. Criteria used to evaluate expected product performance include: historical performance of comparable products using comparable technology; orders for the product prior to its release; and estimated performance of a sequel product based on the performance of the product on which the sequel is based.
Commencing upon the related product’s release, capitalized intellectual property license costs are amortized to “cost of sales – intellectual property licenses” based on the ratio of current revenues for the specific product to total projected revenues for all products in which the licensed property will be utilized. As intellectual property license contracts may extend for multiple years, the amortization of capitalized intellectual property license costs relating to such contracts may extend beyond one year. For intellectual property included in products that have been released, we evaluate the future recoverability of capitalized amounts on a quarterly basis. The primary evaluation criterion is actual title performance.
Significant management judgments and estimates are utilized in the assessment of the recoverability of capitalized costs. In evaluating the recoverability of capitalized costs, the assessment of expected product performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual product sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge. Additionally, as noted above, as many of our intellectual property licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized intellectual property license costs based on certain qualitative factors such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned theatrical releases or television series based on the intellectual property and the rights holder’s continued promotion and exploitation of the intellectual property. Material differences may result in the amount and timing of charges for any period if management makes different judgments or utilizes different estimates in evaluating these qualitative factors.
Revenue Recognition
We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers.customers, and once any performance obligations have been completed. Certain products are sold to customers with a street date (i.e., a(the earliest date on whichthese products are made widely availablemay be sold by retailers). For these products we recognize revenue no earlier thanon the later of the street date or the sale date. Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection. With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery of such copies.a master copy. Per copy royalties on sales that exceed the guarantee are recognized as earned.
Some of our software products provide limited online features at no additional cost to the consumer. Generally, we consider such features to be incidental to the overall product offering and an inconsequential deliverable. Accordingly, we do not defer any revenue related to products containing these limited online features. In instances where online features or additional functionality is considered a substantive deliverable
9
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
in addition to the software product, the company contemplates such when determining the appropriate revenue recognition. This evaluation is performed for each software product when it is released. We determined that one of our software titles released this quarter, Enemy Territory: Quake Wars (which is primarily an online multiplayer PC game), contains online functionality that constitutes a more-than-inconsequential separate service deliverable in addition to the product, principally because of its importance to game play. As such, our performance obligations for this title extend beyond the sale of the game, which is unique compared to other prior titles. Vendor-specific objective evidence of fair value (“VSOE”) does not exist for the online functionality, as we do not separately charge for this component of the title. As a result, we are recognizing all of the revenue from the sale of this title ratably over an estimated service period, which is estimated to be six months beginning the month after shipment. In addition, we are deferring the costs of sales for this title. Cost of sales includes: manufacturing costs, software royalties and amortization, and intellectual property licenses. Overall, online play functionality is still an emerging area for us. As we move forward, we will monitor this developing functionality and its significance for our products. Our assessment of our obligations with respect to this functionality and the resulting accounting may change in the future.
With respect to on-lineonline transactions, such as electronic downloads of titles or product add-ons, revenue is recognized when the fee is paid by the on-lineonline customer to purchase online content and we are notified by the online retailer that the product has been downloaded. In addition, in order to recognize revenue for both product sales and licensing transactions, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable. Revenue recognition also determines the timing of certain expenses, including “cost of sales – intellectual property licenses” and “cost of sales – software royalties and amortization.”
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
Sales incentives or other consideration given by us to our customers is accounted for in accordance with the Financial Accounting Standards Board’s Emerging Issues Task Force (“EITF”) Issue 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).” In accordance with EITF Issue 01-9, sales incentives and other consideration that are considered adjustments of the selling price of our products, such as rebates and product placement fees, are reflected as reductions of revenue. Sales incentives and other consideration that represent costs incurred by us for assets or services received, such as the appearance of our products in a customer’s national circular ad, are reflected as sales and marketing expenses.
Allowances for Returns, Price Protection, Doubtful Accounts, and Inventory Obsolescence
In determining the appropriate unit shipments to our customers, we benchmark our titles using historical and industry data. We closely monitor and analyze the historical performance of our various titles, the performance of products released by other publishers, and the anticipated timing of other releases in order to assess future demands of current and upcoming titles. Initial volumes shipped upon title launch and subsequent reorders are evaluated to ensure that quantities are sufficient to meet the demands from the retail markets but at the same time, are controlled to prevent excess inventory in the channel.
We may permit product returns from, or grant price protection to, our customers under certain conditions. In general, price protection refers to the circumstances when we elect to decrease the wholesale price of a product by a certain amount and, when granted and applicable, allows customers a credit against amounts owed by such customers to us with respect to open and/or future invoices. The conditions our customers must meet to be granted the right to return products or price protection are, among other things, compliance with applicable payment terms, and consistent delivery to us of inventory and sell-through reports. We may also consider other factors, including the facilitation of slow-moving inventory and other market factors. Management must make estimates of potential future product returns and price protection related to current period product revenue. We estimate the amount of future returns and price protection for current period product revenue utilizing historical experience and information regarding inventory levels and the demand and acceptance of our products by the end consumer. The following factors are used to estimate the amount of future returns and price protection for a particular title: historical performance of titles in similar genres;genres, historical performance of the hardware platform;platform, historical performance of the brand;brand, console hardware life cycle;cycle, Activision sales force and retail customer feedback;feedback, industry pricing;pricing, weeks of on-hand retail channel inventory;inventory, absolute
10
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
quantity of on-hand retail channel inventory;inventory, our warehouse on-hand inventory levels;levels, the title’s recent sell-through history (if available);, marketing trade programs;programs, and competing titles. The relative importance of these factors varies among titles depending upon, among other items, genre, platform, seasonality, and sales strategy. Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price protection in any accounting period. Based upon historical experience we believe our estimates are reasonable. However, actual returns and price protection could vary materially from our allowance estimates due to a number of reasons including, among others, a lack of consumer acceptance of a title, the release in the same period of a similarly themed title by a competitor, or technological obsolescence due to the emergence of new hardware platforms. Material differences may result in the amount and timing of our revenue for any period if factors or market conditions change or if management makes different judgments or utilizes different estimates in determining the allowances for returns and price protection. For example, a 1% change in our December 31, 2006September 30, 2007 allowance for returns and price protection would impact net revenues by $1.1$1.0 million.
Similarly, management must make estimates of the uncollectibility of our accounts receivable. In estimating the allowance for doubtful accounts, we analyze the age of current outstanding account balances, historical bad debts, customer concentrations, customer creditworthiness, current economic trends, and changes in our customers’ payment terms and their economic condition, as well as whether we can obtain sufficient credit insurance. Any significant changes in any of these criteria would affect management’s estimates in establishing our allowance for doubtful accounts.
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
We value inventory at the lower of cost or market. We regularly review inventory quantities on hand and in the retail channel and record a provision for excess or obsolete inventory based on the future expected demand for our products. Significant changes in demand for our products would impact management’s estimates in establishing our inventory provision.
Stock-Based Compensation Expense
On April 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”Payment,” (“SFAS No. 123R”), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan (“employee stock purchases”), based on estimated fair values. SFAS No. 123R supersedes our previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). In March 2005, the SECSecurities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS No. 123R. We have applied the provisions of SAB 107 in our adoption of SFAS No. 123R.
We adopted
SFAS 123R using the modified prospective transition method, which requires the application of the accounting standard as of April 1, 2006, the first day of our fiscal year 2007. The Company’s Consolidated Financial Statements as of and for the three and nine months ended December 31, 2006 reflect the impact of SFAS 123R. In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R. Stock-based compensation expense recognized under SFAS 123R for the three and nine months ended December 31, 2006 was $7.7 million and $18.4 million, respectively. See Note 15 for additional information.
SFASNo. 123R requires companies to estimate the fair value of share-based payment awards on the measurement date using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Consolidated Statement of Operations. Prior to the adoption of SFAS 123R, the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Under APB 25,Stock-based compensation expense was recordedrecognized under SFAS No. 123R for the issuance of stock options and other stock-based compensation based on the intrinsic value of the stock options and other stock-based compensation on the date of grant or measurement date. Under the intrinsic value method, compensation expense was recorded on the measurement date only if the current market price of the underlying stock exceeded the stock option or other stock-based award’s exercise price. For the three and ninesix months ended December 31, 2005, we recognized $322,000September 30, 2007 was $6.9 million and $2.5$15.0 million, respectively in stock-based compensation expense related to employee stock options and restricted stock, under APB 25.for the three and six months ended September 30, 2006 was $4.9 million and $10.7 million, respectively. See Notes 2 and 15Note 13 for additional information.
Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in our Consolidated StatementsStatement of Operations for the three and ninesix months ended December 31, 2006September 30, 2007, included compensation expense for share-based payment awards granted prior to, but not yet vested as of April 1, 2006, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and compensation expense for the share-based payment awards granted subsequent to April 1, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. As stock-basedStock-based compensation expense recognized in the
11
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
Consolidated Statement of Operations for the three and nine months ended December 31, 2006 is based on awards ultimately expected to vest itand has been reduced for estimated forfeitures. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
ForWe estimate the Three and Nine Months ended December 31, 2006
(Unaudited)
Asvalue of April 1, 2005, we changed our methodemployee stock options on the date of valuation for share-based awards togrant using a binomial-lattice model from the Black-Scholes option-pricing model (“Black-Scholes model”) which was used for options granted prior to April 1, 2005.model. For additional information, see Note 15.13. Our determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to our expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.
Restricted Stock
In June 2005, we issued the rights to 155,763 shares of restricted stock to an employee. Additionally, in October 2005 we issued the rights to 96,712 shares of restricted stock to an employee. These shares all vest over a five-year period and remain subject to forfeiture if vesting conditions are not met. In accordance with APB 25, we recognized unearned compensation in connection with the grant of restricted shares equal to the fair value of our common stock on the date of grant. The fair value of these shares when issued was approximately $12.84 and $15.51 per share, respectively, and resulted in a total increase in “Additional paid-in capital” and “Unearned compensation” of $2.0 million and $1.5 million on the respective balance sheets at the times of grant. Prior to the adoption of SFAS 123R, we reduced unearned compensation and recognized compensation expense over the vesting periods. Upon adoption of SFAS 123R, unearned compensation was reclassified against additional paid in capital and we will increase additional paid in capital and recognize compensation expense over the respective remaining vesting periods. Additionally, in the third quarter of fiscal 2007 we issued the rights to an aggregate of 81,000 shares of restricted stock to various employees. These shares vest over two and three year periods (with some subject to vesting acceleration clauses if the holder achieves certain performance objectives) and remain subject to forfeiture if vesting conditions are not met. In accordance with SFAS 123R we will recognize compensation expense and increase additional paid in capital related to these restricted stock shares over the requisite service period. For the three and nine months ended December 31, 2006, we recorded expenses related to these shares of approximately $292,000 and $642,000, respectively, which was included as a component of stock-based compensation expense within “General and administrative” on the accompanying Consolidated Statements of Operations. Since the issuance dates, we have recognized $1.1 million of the $4.8 million total fair value, with the remainder to be recognized over a weighted-average period of 3.12 years.
2.Restatement of Unaudited Consolidated Financial Statements
We recently completed a voluntary review of our historical stock option granting practices and a restatement of our consolidated financial statements as of and for the fiscal years ended March 31, 2006, 2005 and 2004 and related disclosures and a restatement of our selected consolidated financial data as of and for the fiscal years ended March 31, 2006, 2005, 2004, 2003 and 2002 and our unaudited quarterly financial data for each of the quarters in the fiscal years ended March 31, 2006 and 2005, and the fiscal quarter ended June 30, 2006. The impacts of the restatement adjustments extend to periods from the fiscal year ended March 31, 1994 through the fiscal quarter ended June 30, 2006.
The restatement reflects the findings of a special subcommittee of independent members of our Board of Directors, which was established in July 2006 to review our historical stock option granting practices (the “Special Subcommittee”). The Special Subcommittee conducted its investigation with the assistance of Munger Tolles & Olson LLP as its independent counsel and Deloitte & Touche USA LLP (“Deloitte”) as forensic accounting experts retained by counsel. The Special Subcommittee found that 3,450 of the option grants reviewed, covering 148,747,202 shares, required measurement date corrections. As a result, we recorded approximately $66.7 million in additional pre-tax ($45.4 million after-tax) non-cash stock-based compensation expense over the thirteen year period from April 1, 1993 through March 31, 2006 in accordance with APB 25, and $0.6 million in additional pre-tax non-cash stock-based compensation expense during the quarter ended June 30, 2006 in accordance with SFAS 123R. More than 80% or $55.4 million of the $66.7 million relates to periods through March 31, 2003 and 4% or $2.6 million of the non-
12
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
cash pre-tax expense relates to the fiscal year ended March 31, 2006. Separately, the restatement reflected an additional $1.7 million pre-tax charge ($1.1 million after-tax) related to recently identified insufficient payroll tax withholdings in fiscal 2005. Additional information regarding the restatement is available with the Company’s Amended Annual Report on Form 10-K/A for the period ending March 31, 2006.
The following table summarizes additional pre-tax stock-based compensation expense and related tax adjustments resulting from the review of our equity award practices for the three and nine months ended December 31, 2005 (in thousands):
| For the three months |
| For the nine months |
| |||
|
| December 31, 2005 |
| December 31, 2005 |
| ||
|
|
|
|
|
| ||
Net income, as previously reported |
| $ | 67,945 |
| $ | 51,118 |
|
|
|
|
|
|
| ||
Additional compensation expense resulting from improper measurement dates for stock option grants (1) |
| 174 |
| 2,286 |
| ||
|
|
|
|
|
| ||
Tax related effects |
| (85 | ) | (547 | ) | ||
|
|
|
|
|
| ||
Total effect on net income |
| 89 |
| 1,739 |
| ||
|
|
|
|
|
| ||
Net income, as restated |
| $ | 67,856 |
| $ | 49,379 |
|
(1) Also includes an immaterial amount of interest expense related to our $1.7 million charge for insufficient payroll tax withholdings in fiscal 2005.
The following tables reflect the impact of the additional non-cash charges for stock-based compensation expense and related tax effects on:
Certain Tax Consequences: Certain stock options were granted with an exercise price lower than the fair market value on the actual measurement dates, with vesting occurring after December 31, 2004, which resulted in nonqualified deferred compensation for purposes of Section 409A of the Internal Revenue Code. Section 409A subjects the option holders to additional income tax, penalties and interest on the value of the options deferred and, in certain cases, exercised each year. We do not have any tax liability associated with Section 409A. For options that have already been exercised by non-executive officer employees, that are subject to Section 409A consequences, the Company has elected to participate in the Internal Revenue Service program described in IRS Announcement 2007-18 pursuant to which the Company was able to pay the Section 409A taxes on behalf of its non-executive officer employees, and has incurred $7.3 million in additional pre-tax compensation expense in the fiscal quarter ended March 31, 2007, in absorbing these related costs on behalf of these employees. With respect to unexercised options subject to Section 409A held by such current and former non-executive officer employees, the Company on or about June 7, 2007 is commencing an offer to amend the exercise price of these options to eliminate their Section 409A tax liability consistent with Internal Revenue Service guidance. Pursuant to the offer, the Company will also make a cash payment in January 2008 to employees who accept the offer, in an amount equal to the difference between the original exercise price of each amended option and the amended exercise price of each amended option. This will likely result in additional future compensation expense to the Company once these actions occur.
· the Consolidated Statements of Operations for the three and nine months ended December 31, 2005 (Unaudited).
· the Consolidated Statement of Cash Flows for the nine months ended December 31, 2005 (Unaudited).
· the pro forma information required by SFAS No. 123 for the three and nine months ended December 31, 2005 (Unaudited).
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
Consolidated Statement of Operations (Unaudited)
|
| For the three months ended December 31, 2005 |
| |||||||
(in thousands, except per share data) |
| As previously |
| Adjustments |
| As restated |
| |||
|
|
|
|
|
|
|
| |||
Net revenues |
| $ | 816,242 |
| $ | — |
| $ | 816,242 |
|
|
|
|
|
|
|
|
| |||
Costs and expenses: |
|
|
|
|
|
|
| |||
Cost of sales – product costs |
| 367,685 |
| — |
| 367,685 |
| |||
Cost of sales – software royalties and amortization |
| 104,264 |
| — |
| 104,264 |
| |||
Cost of sales – intellectual property licenses |
| 26,376 |
| — |
| 26,376 |
| |||
Product development |
| 53,139 |
| 115 |
| 53,254 |
| |||
Sales and marketing |
| 155,999 |
| 14 |
| 156,013 |
| |||
General and administrative |
| 24,712 |
| 45 |
| 24,757 |
| |||
|
|
|
|
|
|
|
| |||
Total costs and expenses |
| 732,175 |
| 174 |
| 732,349 |
| |||
|
|
|
|
|
|
|
| |||
Operating income |
| 84,067 |
| (174 | ) | 83,893 |
| |||
|
|
|
|
|
|
|
| |||
Investment income, net |
| 9,162 |
| — |
| 9,162 |
| |||
|
|
|
|
|
|
|
| |||
Income before income tax provision |
| 93,229 |
| (174 | ) | 93,055 |
| |||
|
|
|
|
|
|
|
| |||
Income tax provision |
| 25,284 |
| (85 | ) | 25,199 |
| |||
|
|
|
|
|
|
|
| |||
Net income |
| $ | 67,945 |
| $ | (89 | ) | $ | 67,856 |
|
|
|
|
|
|
|
|
| |||
Basic earnings per share |
| $ | 0.25 |
| $ | — |
| $ | 0.25 |
|
|
|
|
|
|
|
|
| |||
Weighted average common shares outstanding |
| 274,965 |
| — |
| 274,965 |
| |||
|
|
|
|
|
|
|
| |||
Diluted earnings per share |
| $ | 0.23 |
| $ | — |
| $ | 0.23 |
|
|
|
|
|
|
|
|
| |||
Weighted average common shares outstanding assuming dilution |
| 298,752 |
| (2,547 | ) | 296,205 |
|
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
Consolidated Statement of Operations (Unaudited)
|
| For the nine months ended December 31, 2005 |
| |||||||
(in thousands, except per share data) |
| As previously |
| Adjustments |
| As restated |
| |||
|
|
|
|
|
|
|
| |||
Net revenues |
| $ | 1,279,875 |
| $ | — |
| $ | 1,279,875 |
|
|
|
|
|
|
|
|
| |||
Costs and expenses: |
|
|
|
|
|
|
| |||
Cost of sales – product costs |
| 617,021 |
| — |
| 617,021 |
| |||
Cost of sales – software royalties and amortization |
| 139,267 |
| — |
| 139,267 |
| |||
Cost of sales – intellectual property licenses |
| 55,765 |
| — |
| 55,765 |
| |||
Product development |
| 99,013 |
| 685 |
| 99,698 |
| |||
Sales and marketing |
| 258,957 |
| 153 |
| 259,110 |
| |||
General and administrative |
| 65,780 |
| 1,448 |
| 67,228 |
| |||
|
|
|
|
|
|
|
| |||
Total costs and expenses |
| 1,235,803 |
| 2,286 |
| 1,238,089 |
| |||
|
|
|
|
|
|
|
| |||
Operating income |
| 44,072 |
| (2,286 | ) | 41,786 |
| |||
|
|
|
|
|
|
|
| |||
Investment income, net |
| 22,840 |
| — |
| 22,840 |
| |||
|
|
|
|
|
|
|
| |||
Income before income tax provision |
| 66,912 |
| (2,286 | ) | 64,626 |
| |||
|
|
|
|
|
|
|
| |||
Income tax provision |
| 15,794 |
| (547 | ) | 15,247 |
| |||
|
|
|
|
|
|
|
| |||
Net income |
| $ | 51,118 |
| $ | (1,739 | ) | $ | 49,379 |
|
|
|
|
|
|
|
|
| |||
Basic earnings per share |
| $ | 0.19 |
| $ | (0.01 | ) | $ | 0.18 |
|
|
|
|
|
|
|
|
| |||
Weighted average common shares outstanding |
| 272,089 |
| — |
| 272,089 |
| |||
|
|
|
|
|
|
|
| |||
Diluted earnings per share |
| $ | 0.17 |
| $ | — |
| $ | 0.17 |
|
|
|
|
|
|
|
|
| |||
Weighted average common shares outstanding assuming dilution |
| 295,963 |
| (2,566 | ) | 293,397 |
|
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
Consolidated Statement of Cash Flows (Unaudited)
|
| For the nine months ended December 31, 2005 |
| |||||||
(in thousands) |
| As previously |
| Adjustments |
| As restated |
| |||
Cash flows from operating activities: |
|
|
|
|
|
|
| |||
Net income |
| $ | 51,118 |
| $ | (1,739 | ) | $ | 49,379 |
|
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
| |||
Deferred income taxes |
| (10,819 | ) | 4,796 |
| (6,023 | ) | |||
Realized gain on sale of short term investments |
| (4,295 | ) | — |
| (4,295 | ) | |||
Depreciation and amortization |
| 10,228 |
| — |
| 10,228 |
| |||
Amortization of capitalized software development costs and intellectual property licenses |
| 168,351 |
| — |
| 168,351 |
| |||
Stock-based compensation expense |
| 292 |
| 2,214 |
| 2,506 |
| |||
Tax benefit of stock options and warrants exercised |
| 26,612 |
| (5,343 | ) | 21,269 |
| |||
|
|
|
|
|
|
|
| |||
Changes in operating assets and liabilities (net of effects of acquisitions): |
|
|
|
|
|
|
| |||
Accounts receivable |
| (305,305 | ) | — |
| (305,305 | ) | |||
Inventories |
| (36,810 | ) | — |
| (36,810 | ) | |||
Software development and intellectual property licenses |
| (162,793 | ) | — |
| (162,793 | ) | |||
Other assets |
| 321 |
| — |
| 321 |
| |||
Accounts payable |
| 104,895 |
| — |
| 104,895 |
| |||
Accrued expenses and other liabilities |
| 74,273 |
| 72 |
| 74,345 |
| |||
| ||||||||||
Net cash used in operating activities |
| (83,932 | ) | — |
| (83,932 | ) | |||
|
|
|
|
|
|
|
| |||
Cash flows from investing activities: |
|
|
|
|
|
|
| |||
Capital expenditures |
| (20,174 | ) | — |
| (20,174 | ) | |||
Cash payments to effect business combinations, net of cash acquired |
| (7,081 | ) | — |
| (7,081 | ) | |||
Increase in restricted cash |
| (7,500 | ) | — |
| (7,500 | ) | |||
Purchases of short-term investments |
| (143,162 | ) | — |
| (143,162 | ) | |||
Proceeds from sales and maturities of short-term investments |
| 182,504 |
| — |
| 182,504 |
| |||
|
|
|
|
|
|
|
| |||
Net cash provided by investing activities |
| 4,587 |
| — |
| 4,587 |
| |||
|
|
|
|
|
|
|
| |||
Cash flows from financing activities: |
|
|
|
|
|
|
| |||
Proceeds from issuance of common stock to employees |
| 37,850 |
| — |
| 37,850 |
| |||
|
|
|
|
|
|
|
| |||
Net cash provided by financing activities |
| 37,850 |
| — |
| 37,850 |
| |||
|
|
|
|
|
|
|
| |||
Effect of exchange rate changes on cash |
| (5,044 | ) | — |
| (5,044 | ) | |||
|
|
|
|
|
|
|
| |||
Net decrease in cash and cash equivalents |
| (46,539 | ) | — |
| (46,539 | ) | |||
|
|
|
|
|
|
|
| |||
Cash and cash equivalents at beginning of period |
| 313,608 |
| — |
| 313,608 |
| |||
Cash and cash equivalents at end of period |
| $ | 267,069 |
| $ | — |
| $ | 267,069 |
|
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
Pro forma information regarding net income and net income per share is required by SFAS No. 123 and has been determined as if the Company had accounted for its employee stock purchase plan and employee stock option plans under the fair value method of SFAS No. 123. The impact of the restatements on the pro forma information is as follows (in thousands, except per share data):
| For the three months ended December 31, 2005 |
| ||||||||
(in thousands, except per share data) |
| As previously |
| Adjustments |
| As restated |
| |||
Net income, as reported |
| $ | 67,945 |
| $ | (89 | ) | $ | 67,856 |
|
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects |
| — |
| 72 |
| 72 |
| |||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
| (4,841 | ) | 619 |
| (4,222 | ) | |||
|
|
|
|
|
|
|
| |||
Pro forma net income |
| $ | 63,104 |
| $ | 602 |
| $ | 63,706 |
|
|
|
|
|
|
|
|
| |||
Earnings per share |
|
|
|
|
|
|
| |||
|
|
|
|
|
|
|
| |||
Basic – as reported |
| $ | 0.25 |
| $ | — |
| $ | 0.25 |
|
Basic – pro forma |
| $ | 0.23 |
| $ | — |
| $ | 0.23 |
|
|
|
|
|
|
|
|
| |||
Diluted – as reported |
| $ | 0.23 |
| $ | — |
| $ | 0.23 |
|
Diluted – pro forma |
| $ | 0.21 |
| $ | 0.01 |
| $ | 0.22 |
|
| For the nine months ended December 31, 2005 |
| ||||||||
(in thousands, except per share data) |
| As previously |
| Adjustments |
| As restated |
| |||
Net income, as reported |
| $ | 51,118 |
| $ | (1,739 | ) | $ | 49,379 |
|
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects |
| — |
| 1,695 |
| 1,695 |
| |||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
| (11,517 | ) | (671 | ) | (12,188 | ) | |||
|
|
|
|
|
|
|
| |||
Pro forma net income |
| $ | 39,601 |
| $ | (715 | ) | $ | 38,886 |
|
|
|
|
|
|
|
|
| |||
Earnings per share |
|
|
|
|
|
|
| |||
|
|
|
|
|
|
|
| |||
Basic – as reported |
| $ | 0.19 |
| $ | (0.01 | ) | $ | 0.18 |
|
Basic – pro forma |
| $ | 0.15 |
| $ | (0.01 | ) | $ | 0.14 |
|
|
|
|
|
|
|
|
| |||
Diluted – as reported |
| $ | 0.17 |
| $ | — |
| $ | 0.17 |
|
Diluted – pro forma |
| $ | 0.13 |
| $ | — |
| $ | 0.13 |
|
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
3. Acquisitions
RedOctane, Inc.Bizarre Creations
On June 6, 2006,September 26, 2007, we completed our acquisition ofacquired 100% of RedOctane, Inc.Bizarre Creations Limited (“RedOctane”Bizarre Creations”) for an aggregate accounting purchase price of $99.9 million, including transaction costs, consisting of: $30.9$67.4 million in cash; 2,382,077 shares of Activision common stock valued at approximately $30.0 million based upon prevailing market prices which was issued on the closing date; and $39.0 million payable in Activision common stock within two years of the closing date, which is recorded in other liabilities.cash. In addition, inin the event the adjusted net incomethat certain financial performance measures of theBizarre Creations’ business over a certain period of time (currently estimated to be 5 years from fiscal 2008) exceeds specified target levels, by certain amounts, certainthe former shareholders of RedOctaneBizarre Creations will be entitled to an additional amount of up to $51.0$40 million payable in shares of Activisionour common stock. The contingent consideration will be recorded as an additional element ofaddition to the purchase price if those contingenciesthe specified target levels are achieved.met. Based in Sunnyvale, California, RedOctanethe United Kingdom (“UK”), Bizarre Creations is a publisher,video game developer and distributor of interactive entertainment software, hardware and accessories. RedOctane offers its interactive entertainment products in versions that operatefocusing on the Sony PlayStation 2 (“PS2”),racing category with its multi-million unit selling franchise Project Gotham Racing, a series for the Microsoft Xbox (“Xbox”), and the personal computerMicrosoft Xbox360 (“PC”Xbox360”), platforms. Bizarre Creations has also developed and its leading product offering is Guitar Heroowns the Geometry Wars intellectual property. We expect that Bizarre Creations will play a role in our growth strategy as we develop intellectual property for the PS2. RedOctane also designs, manufactures,racing segment, expand our development capability and markets high quality video game peripheralscapacity for other genres and accessories. This acquisition provides Activision with an early leadership position in music-based gaming, which we expect will be one of the fastest growing genres in the coming years.utilize Bizarre Creations’ proprietary development technology.
The results of operations of RedOctaneBizarre Creations and the estimated fair market values of the acquired assets and liabilities have been included in the Consolidated Financial Statements since the date of acquisition. Pro forma Consolidated Statementsconsolidated statements of Operationsoperations for this acquisition are not shown, as they would not differ materially from reported results. The acquired finite-lived intangible assets are being amortized over the estimated lives ranging from 0.6useful life in proportion to 1.6 years.the economic benefits consumed, which for some intangible assets are approximated by using the straight-line method. Goodwill has been included in the publishing segment of our business and is non-deductibleamortized over 15 years for tax purposes.
12
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
Preliminary Purchase Price Allocation
We accounted for this acquisition in accordance with SFAS No. 141, “Business Combinations.”Combinations” (“SFAS No. 141”). SFAS No. 141 addresses financial accounting and reporting for business combinations, requiring that the purchase method be used to account and report for all business combinations. The purchase price for the RedOctaneBizarre Creations transaction was preliminarily allocated to assets acquired and liabilities assumed as set forth below (in thousands):
Current assets |
| $ | 17,530 |
|
Property and equipment, net |
| 207 |
| |
Other assets |
| 1,033 |
| |
Goodwill |
| 87,004 |
| |
Trademark and other intangibles |
| 16,700 |
| |
Deferred tax liability |
| (6,496 | ) | |
Other liabilities |
| (16,033 | ) | |
Total consideration |
| $ | 99,945 |
|
Current assets |
| $ | 4,352 |
|
Property and equipment, net |
| 2,203 |
| |
Goodwill |
| 55,833 |
| |
Trademark, acquired contracts and other intangibles |
| 9,500 |
| |
Deferred tax liability |
| (1,876 | ) | |
Other liabilities |
| (2,639 | ) | |
Total consideration |
| $ | 67,373 |
|
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
Purchased Intangible Assets
The following table presents details of the purchased finite-lived intangible assets acquired in the RedOctaneBizarre Creations acquisition (in thousands):
| Estimated |
|
|
| ||
|
| Life |
|
|
| |
|
| (in years) |
| Amount |
| |
Finite-lived intangibles: |
|
|
|
|
| |
Trademark |
| 1.3 |
| $ | 1,000 |
|
Other intangibles |
| 0.6-1.6 |
| 15,700 |
| |
|
|
|
|
|
| |
Total finite-lived intangibles |
|
|
| $ | 16,700 |
|
|
| Estimated |
| Amount |
| |
Finite-lived intangibles: |
|
|
|
|
| |
Trademark |
| 8 |
| $ | 1,100 |
|
Acquired contracts |
| 0.5 |
| 2,800 |
| |
Other intangibles |
| 1 - 5 |
| 5,600 |
| |
|
|
|
|
|
| |
Total finite-lived intangibles |
|
|
| $ | 9,500 |
|
The following tables present details of our total purchased finite-lived intangible assets as of December 31, 2006September 30, 2007 (in thousands):
| Gross |
| Accumulated |
| Net |
| ||||
Trademark |
| $ | 1,000 |
| $ | 520 |
| $ | 480 |
|
Other intangibles |
| 15,700 |
| 9,121 |
| 6,579 |
| |||
|
|
|
|
|
|
|
| |||
Total |
| $ | 16,700 |
| $ | 9,641 |
| $ | 7,059 |
|
|
| Gross |
| Accumulated Amortization |
| Net |
| |||
|
|
|
|
|
|
|
| |||
Trademark |
| $ | 1,100 |
| $ | — |
| $ | 1,100 |
|
Acquired contracts |
| 2,800 |
| — |
| 2,800 |
| |||
Other intangibles |
| 5,600 |
| — |
| 5,600 |
| |||
|
|
|
|
|
|
|
| |||
Total |
| $ | 9,500 |
| $ | — |
| $ | 9,500 |
|
13
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
The estimated future amortization expense of purchased finite-lived intangible assets as of December 31, 2006September 30, 2007 is as follows (in thousands):
Fiscal year ending March 31, |
| Amount |
| |
2007 (remaining three months) |
| $ | 2,061 |
|
2008 |
| 4,998 |
| |
2009 |
| — |
| |
2010 |
| — |
| |
2011 |
| — |
| |
Thereafter |
| — |
| |
|
|
|
| |
Total |
| $ | 7,059 |
|
Fiscal year ending March 31, |
| Amount |
| |
2008 (remaining six months) |
| $ | 3,500 |
|
2009 |
| 700 |
| |
2010 |
| 1,153 |
| |
2011 |
| 1,538 |
| |
2012 |
| 1,538 |
| |
Thereafter |
| 1,071 |
| |
|
|
|
| |
Total |
| $ | 9,500 |
|
DemonWare
On May 11, 2007, Activision completed its acquisition of DemonWare, Ltd., a provider of network middleware technologies for console and personal computer (“PC”) games headquartered in Dublin, Ireland. The acquisition is expected to enable Activision to gain efficiencies related to online game development and to position us to take advantage of the growth in online gameplay that is expected to be driven by the next-generation consoles. The acquisition is expected to be immaterial to fiscal 2008 earnings per share and cash flow. Additionally, pro forma consolidated statements of operations for this acquisition are not shown, as they would not differ materially from reported results.
4.Cash, Cash Equivalents, and Short-Term Investments
Short-term investments generally consist of investments with maturities between three and thirty months. Investments with maturities beyond one year may be classified as short-term if they are liquid and represent the investment of cash that is available for current operations. All of our short-term investments are classified as available-for-sale and are carried at fair market value with unrealized appreciation (depreciation) reported as a separate component of accumulated other comprehensive income (loss) in shareholders’ equity. The specific identification method is used to determine the cost of securities disposed with realized gains and losses reflected in investment income, net.
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
The following table summarizes our investments in securities as of December 31, 2006 (amounts in thousands):
| Amortized |
| Gross |
| Gross |
| Fair |
| |||||
Cash and cash equivalents: |
|
|
|
|
|
|
|
|
| ||||
Cash and time deposits |
| $ | 257,084 |
| $ | — |
| $ | — |
| $ | 257,084 |
|
Money market instruments |
| 96,605 |
| — |
| — |
| 96,605 |
| ||||
Commercial paper |
| 14,229 |
| — |
| (8 | ) | 14,221 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Cash and cash equivalents |
| 367,918 |
| — |
| (8 | ) | 367,910 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Short-term investments: |
|
|
|
|
|
|
|
|
| ||||
U.S. agency issues |
| 231,511 |
| 6 |
| (1,579 | ) | 229,938 |
| ||||
Corporate bonds |
| 92,126 |
| 5 |
| (216 | ) | 91,915 |
| ||||
Commercial paper |
| 44,257 |
| — |
| (50 | ) | 44,207 |
| ||||
Mortgage-backed securities |
| 42,789 |
| — |
| (322 | ) | 42,467 |
| ||||
Asset-backed securities |
| 11,289 |
| 3 |
| (20 | ) | 11,272 |
| ||||
Certificate of deposit |
| 9,997 |
| — |
| (6 | ) | 9,991 |
| ||||
Restricted cash |
| 7,500 |
| — |
| — |
| 7,500 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Short-term investments |
| 439,469 |
| 14 |
| (2,193 | ) | 437,290 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Cash, cash equivalents and short-term investments |
| $ | 807,387 |
| $ | 14 |
| $ | (2,201 | ) | $ | 805,200 |
|
The following table summarizes the contractual maturities of our investments in debt securities as of December 31, 2006 (amounts in thousands):
| Amortized |
| Fair |
| |||
Due in one year or less |
| $ | 308,320 |
| $ | 307,005 |
|
Due after one year through two years |
| 56,875 |
| 56,731 |
| ||
Due after two years through three years |
| 4,022 |
| 4,014 |
| ||
Due in three years or more |
| 12,906 |
| 12,531 |
| ||
|
| 382,123 |
| 380,281 |
| ||
Asset and mortgage-backed securities |
| 54,078 |
| 53,739 |
| ||
Certificate of deposit |
| 9,997 |
| 9,991 |
| ||
|
|
|
|
|
| ||
Total |
| $ | 446,198 |
| $ | 444,011 |
|
For the three and nine months ended December 31, 2006, there were no gross realized losses and gross realized gains of $1.8 million on the sale of short-term investments. For the three months ended December 31, 2005, there were no gross realized gains and $2,000 of gross realized losses on the sale or maturity of short-term investments. For the nine months ended December 31, 2005, there were $1.3 million of gross realized gains and $2,000 of gross realized losses on the sale or maturity of short-term investments.
In accordance with EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” the fair value of investments in an unrealized loss position for which an other-than-
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the Three and Nine Months ended December 31, 2006
(Unaudited)
temporary impairment has not been recognized was $430.7 million and $672.4 million at December 31, 2006 and March 31, 2006, respectively, with related gross unrealized losses of $2.2 million and $5.5 million, respectively. At December 31, 2006, the gross unrealized losses were comprised mostly of unrealized losses on U.S. agency issues, corporate bonds, and mortgage-backed securities, with $1.8 million of unrealized loss being in a continuous unrealized loss position for twelve months or greater. At March 31, 2006, the gross unrealized losses were comprised mostly of unrealized losses on U.S. agency issues, corporate bonds, and mortgage-backed securities with $3.9 million of unrealized loss being in a continuous unrealized loss position for twelve months or greater.
Our investment portfolio consists of government and corporate securities with effective maturities of less than 30 months. The longer the term or holding period of the securities, the more susceptible they are to changes in market rates of interest, yields on bonds, and market price volatility. Investments are reviewed periodically to identify possible impairment. When evaluating the investments, we review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer, and our ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery in market value. We have the intent and ability to hold these securities for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the initial cost of the investment. We expect to realize the full value of all of these investments upon maturity or sale.
5.3. Inventories
Inventories are valued at the lower of cost (first-in, first-out) or market. Our inventories consist of the following (amounts in thousands):
| December 31, 2006 |
| March 31, 2006 |
| |||
Finished goods |
| $ | 81,652 |
| $ | 58,876 |
|
Purchased parts and components |
| 4,028 |
| 2,607 |
| ||
|
|
|
|
|
| ||
|
| $ | 85,680 |
| $ | 61,483 |
|
|
| September 30, 2007 |
| March 31, 2007 |
| ||
Finished goods |
| $ | 151,584 |
| $ | 89,048 |
|
Purchased parts and components |
| 37,449 |
| 2,183 |
| ||
|
|
|
|
|
| ||
|
| $ | 189,033 |
| $ | 91,231 |
|
6.4. Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill for the ninesix months ended December 31, 2006September 30, 2007 are as follows (amounts in thousands):
| Publishing |
| Distribution |
| Total |
| ||||
Balance as of March 31, 2006 |
| $ | 95,094 |
| $ | 5,352 |
| $ | 100,446 |
|
Goodwill acquired during the period |
| 87,257 |
| — |
| 87,257 |
| |||
Adjustment to prior period purchase allocation |
| 51 |
| — |
| 51 |
| |||
Effect of foreign currency exchange rates |
| (5 | ) | 649 |
| 644 |
| |||
|
|
|
|
|
|
|
| |||
Balance as of December 31, 2006 |
| $ | 182,397 |
| $ | 6,001 |
| $ | 188,398 |
|
|
| Publishing |
| Distribution |
| Total |
| |||
|
|
|
|
|
|
|
| |||
Balance as of March 31, 2007 |
| $ | 189,342 |
| $ | 6,032 |
| $ | 195,374 |
|
Goodwill acquired during the period |
| 58,609 |
| — |
| 58,609 |
| |||
Issuance of contingent consideration |
| 25,703 |
| — |
| 25,703 |
| |||
Adjustment-prior period purchase allocation |
| (127 | ) | — |
| (127 | ) | |||
Effect of foreign currency exchange rates |
| 474 |
| 215 |
| 689 |
| |||
Balance as of September 30, 2007 |
| $ | 274,001 |
| $ | 6,247 |
| $ | 280,248 |
|
Goodwill acquired during the period represents goodwill related to the acquisition of RedOctane of $87.0 million and goodwill related to the acquisition of a recently acquired South Korean publishing company of $253,000.14
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For(Unaudited)
Goodwill acquired during the Threeperiod represents goodwill of $55.8 million and Nine Months ended December 31, 2006$2.8 million related to the acquisitions of Bizarre Creations and DemonWare, respectively. See Note 2 for additional information. Issuance of contingent consideration consists of additional purchase consideration related to the acquisition of RedOctane Inc. and Vicarious Visions Inc. for $22.6 million and $3.1 million, respectively, which was paid in shares of our common stock. Additional contingent purchase consideration of $3.1 million related to the acquisition of Vicarious Visions Inc. was earned on June 30, 2007 as a result of the achievement of certain sell through targets released during the second quarter of fiscal 2008. As a result, shares of our common stock with an aggregate value of $1.4 million were issued to the former stockholders of Vicarious Visions Inc. with the remaining $1.7 million accrued as of September 30, 2007.
(Unaudited)
7.5. Income Taxes
The income tax provision of $40.0 million and $28.1$1.9 million for the three months ended September 30, 2007 reflects our effective income tax rate for the quarter of 73.0%, and ninethe income tax provision of $15.7 million for the six months ended September 30December 31,, 2007 reflects our estimated effective income tax rate of 35.5% for the six months ended September 30, 2007. Due to our relatively small net income before tax provision for the three months ended September 30, 2007, small changes in discrete items resulted in a large effect on our effective income tax rate for the quarter ended September 30, 2007. The significant items that generated the variance between our effective rate for the three months ended September 30, 2007 and our statutory rate of 35% were federal and state research and development tax credits, the impact of foreign tax rate differentials, and the federal deduction for domestic production activities, partially offset by state taxes and the impact of a decrease in the tax benefit of deferred tax assets on the books of our UK affiliates due to the enactment of a decrease in the UK statutory tax rate.
The aforementioned effective income tax rate for the quarter of 73.0% differs from our effective income tax rate of 17.3% for the three months ended September 30, 2006 due to an increase in anticipated pretax income for fiscal 2008 determined at September 30, 2007 versus the anticipated pretax income for fiscal 2007 determined at September 30, 2006, without a corresponding increase in the benefit of book/tax differences, in addition to the impact of a decrease in the tax benefit of deferred tax assets on the books of our UK affiliates due to the recent enactment of a decrease in the UK statutory tax rate.
The income tax benefit of $5.1 million for the three months ended September 30, 2006 reflects our effective income tax rate for the quarter of 17.3%, which differs from our effective tax rate of 21.9%. This is lower than prior for the year as a resultended March 31, 2007 due to (1) an increase in the federal research and development credit for the full year ended March 31, 2007 over the amount originally anticipated for the year at September 30, 2006 due to the Congressional reinstatement of improved profitability leading to utilizationthe federal R&D credit in quarter ended December 31, 2006; and (2) the elimination of net operating loss carry forwards and in turn a reduction inthe valuation allowances related to federal and stateallowance for research and development tax credits, partially offset by the nondeductible portion of annual cash bonuses determined in the three months ended March 31, 2007 under Section 162(m), and the establishment of tax reserves.reserves for these credits and other deferred tax assets. The significant items that generated the variance between our effective rate and our statutory rate of 35% for the three months ended September 30, 2006 were federal and state research and development tax credits and the impact of foreign tax rate differentials, offset byfor state taxes. The realization of deferred tax assets depends primarily on the generation of future taxable income. We believe that it is more likely than not that we will generate taxable income sufficient to realize the benefit of net deferred tax assets recognized.
The income tax expense of $25.2 million for the three months ended December 31, 2005 reflects our effective income tax rate for the quarter of 27.1%, which differs from our effective tax rate of 12.2% for the year ended March 31, 2006 primarily due to an increase in federal and state research and development credits for the full year ended March 31, 2006 over the amounts originally anticipated for the year. The significant items that generated the variance between our effective rate and our federal statutory rate of 35% were research and development tax creditspurposes, and the impact of foreign tax rate differentials, partially offset by state taxes.
We adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48 Accounting for Uncertainty in Income Taxes (“FIN 48”) an interpretation of FASB Statement No. 109 (“SFAS 109”) on April 1, 2007. As a result of the implementation of FIN 48, we recognized no material adjustment in the liability for unrecognized income tax benefits. At the adoption date of April 1, 2007, we had $65.5 million of unrecognized tax benefits, of which $26.2 million would affect our effective tax rate if recognized. The liability for unrecognized tax benefits was unchanged during the three months ended September 30, 2007.
In addition, consistent with the provisions of FIN 48, we reclassified $15.6 million of income tax liabilities from current to non-current liabilities because payment of cash is not anticipated within one year of the
15
8.ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
balance sheet date. These non-current income tax liabilities are recorded in Other Liabilities in the Consolidated Balance Sheets.
We recognize interest and penalties related to uncertain tax positions in income tax expense. As of April 1, 2007, we had approximately $296,000 of accrued interest related to uncertain tax positions. There were no material changes to the accrued interest expense related to estimated obligations for unrecognized tax benefits net of federal benefit during the three months ended September 30, 2007.
The tax years 2002 through 2007 remain open to examination by the major taxing jurisdictions to which we are subject, including U.S. and non-U.S. locations. We are currently under audit by the Internal Revenue Service and the California Franchise Tax Board, and it is possible that the current portion of our unrecognized tax benefits will significantly decrease within the next twelve months.
6. Software Development Costs and Intellectual Property Licenses
As of December 31, 2006,September 30, 2007, capitalized software development costs included $77.7$102.5 million of internally developed software costs and $24.1$42.2 million of payments made to third-party software developers. As of March 31, 2006,2007, capitalized software development costs included $45.0$94.3 million of internally developed software costs and $15.6$36.6 million of payments made to third-party software developers. Capitalized intellectual property licenses were $93.4$81.8 million and $87.0$100.3 million as of December 31, 2006September 30, 2007 and March 31, 2006,2007, respectively. Amortization and write-offs of capitalized software development costs and intellectual property licenses were $79.2$101.7 million and $168.4$26.3 million for the ninesix months ended December 31,September 30, 2007 and 2006, and 2005, respectively.
9.7. Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss)
Comprehensive Income (Loss)
The components of comprehensive income (loss) for the three and ninesix months ended December 31,September 30, 2007 and 2006 and 2005 were as follows (amounts in thousands):
| Three months ended December 31, |
| Nine months ended December 31, |
| |||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
|
|
| As restated |
|
|
| As restated |
| ||||
Net income |
| $ | 142,820 |
| $ | 67,856 |
| $ | 100,209 |
| $ | 49,379 |
|
|
|
|
|
|
|
|
|
|
| ||||
Other comprehensive income (loss): |
|
|
|
|
|
|
|
|
| ||||
Foreign currency translation adjustment |
| 4,742 |
| (937 | ) | 10,983 |
| (6,925 | ) | ||||
Unrealized appreciation (depreciation) on short-term investments |
| 1,342 |
| (1,432 | ) | (8,693 | ) | (2,172 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Other comprehensive income (loss) |
| 6,084 |
| (2,369 | ) | 2,290 |
| (9,097 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Comprehensive income |
| $ | 148,904 |
| $ | 65,487 |
| $ | 102,499 |
| $ | 40,282 |
|
|
| Three months ended September 30, |
| Six months ended September 30, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net income (loss) |
| $ | 698 |
| $ | (24,302 | ) | $ | 28,524 |
| $ | (42,611 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Other comprehensive income (loss): |
|
|
|
|
|
|
|
|
| ||||
Foreign currency translation adjustment |
| 3,891 |
| 2,663 |
| 6,613 |
| 6,241 |
| ||||
Unrealized appreciation (depreciation) on short-term investments, net of taxes |
| 950 |
| 8,447 |
| 543 |
| (10,035 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Other comprehensive income (loss) |
| 4,841 |
| 11,110 |
| 7,156 |
| (3,794 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Comprehensive income (loss) |
| $ | 5,539 |
| $ | (13,192 | ) | $ | 35,680 |
| $ | (46,405 | ) |
2216
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006
(Unaudited)
Accumulated Other Comprehensive Income (Loss)
For the ninesix months ended December 31, 2006September 30, 2007 the components of accumulated other comprehensive income (loss) were as follows (amounts in thousands):
|
|
| Unrealized |
| Accumulated |
| ||||
|
|
|
| Appreciation |
| Other |
| |||
|
| Foreign |
| (Depreciation) |
| Comprehensive |
| |||
|
| Currency |
| on Investments |
| Income |
| |||
|
|
|
|
|
|
|
| |||
Balance, March 31, 2006 |
| $ | 9,013 |
| $ | 7,356 |
| $ | 16,369 |
|
Other comprehensive income (loss) |
| 10,983 |
| (8,693 | ) | 2,290 |
| |||
|
|
|
|
|
|
|
| |||
Balance, December 31, 2006 |
| $ | 19,996 |
| $ | (1,337 | ) | $ | 18,659 |
|
|
|
|
| Unrealized |
| Accumulated |
| |||
|
|
|
| Appreciation |
| Other |
| |||
|
| Foreign |
| (Depreciation) |
| Comprehensive |
| |||
|
| Currency |
| on Investments |
| Income |
| |||
|
|
|
|
|
|
|
| |||
Balance, March 31, 2007 |
| $ | 21,070 |
| $ | (868 | ) | $ | 20,202 |
|
Other comprehensive income |
| 6,613 |
| 543 |
| 7,156 |
| |||
|
|
|
|
|
|
|
| |||
Balance, September 30, 2007 |
| $ | 27,683 |
| $ | (325 | ) | $ | 27,358 |
|
ComprehensiveOther comprehensive income is presented net of taxestax benefits of $0.9$0.3 million related to unrealized depreciationappreciation on investments.the Company’s investments for the six months ended September 30, 2007. Income taxes were not provided for foreign currency translation items as these are considered indefinite investments in non-U.S. subsidiaries.
10.8. Investment Income, Net
Investment income, net is comprised of the following (amounts in thousands):
| Three months ended December 31, |
| Nine months ended December 31, |
| |||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
Interest income |
| $ | 7,917 |
| $ | 6,299 |
| $ | 24,286 |
| $ | 18,743 |
|
Interest expense |
| (16 | ) | (85 | ) | (80 | ) | (198 | ) | ||||
Net realized gain on investments |
| 1,823 |
| 2,948 |
| 1,825 |
| 4,295 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Investment income, net |
| $ | 9,724 |
| $ | 9,162 |
| $ | 26,031 |
| $ | 22,840 |
|
|
| Three months ended September 30, |
| Six months ended September 30, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Interest income |
| $ | 12,169 |
| $ | 8,013 |
| $ | 23,755 |
| $ | 16,369 |
|
Interest expense |
| (37 | ) | 19 |
| (61 | ) | (64 | ) | ||||
Net realized gain on investments |
| — |
| — |
| — |
| 2 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Investment income, net |
| $ | 12,132 |
| $ | 8,032 |
| $ | 23,694 |
| $ | 16,307 |
|
17
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006
(Unaudited)
11.9. Supplemental Cash Flow Information
Non-cash operating, investing and financing activities and supplemental cash flow information is as follows (amounts in thousands):
| Nine months ended December 31, |
| |||||
|
| 2006 |
| 2005 |
| ||
Non-cash operating, investing and financing activities: |
|
|
|
|
| ||
Subsidiaries acquired with common stock |
| $ | 30,000 |
| $ | 2,793 |
|
Change in unrealized appreciation (depreciation) on short-term investments, net of taxes |
| (8,693 | ) | 2,172 |
| ||
Common stock payable related to acquisition |
| 39,000 |
| — |
| ||
Capitalization of stock option expense, net of amortization |
| 4,996 |
| — |
| ||
Adjustment - prior period purchase allocation |
| 51 |
| — |
| ||
|
|
|
|
|
| ||
Supplemental cash flow information: |
|
|
|
|
| ||
Cash paid for income taxes |
| $ | 3,040 |
| $ | 4,469 |
|
Cash received for interest, net |
| 23,691 |
| 16,956 |
|
|
| Six months ended September 30, |
| ||||
|
| 2007 |
| 2006 |
| ||
Non-cash investing and financing activities: |
|
|
|
|
| ||
Subsidiaries acquired with common stock |
| $ | — |
| $ | 30,000 |
|
Change in unrealized appreciation (depreciation) on short-term investments, net of taxes |
| 543 |
| (10,035 | ) | ||
Common stock issued related to acquisition |
| 24,039 |
| — |
| ||
Common stock issuable related to acquisition |
| — |
| 39,000 |
| ||
Common stock issued related to employee bonuses |
| 1,857 |
| — |
| ||
Adjustment - prior period purchase allocation |
| (127 | ) | 46 |
| ||
|
|
|
|
|
| ||
Supplemental cash flow information: |
|
|
|
|
| ||
Cash paid for income taxes |
| $ | 2,806 |
| $ | 5,456 |
|
Cash paid for interest |
| 42 |
| 63 |
|
12.10. Operations by Reportable Segments and Geographic Area
Based upon our organizational structure, we operate two business segments: (i) publishing of interactive entertainment software and peripherals and (ii) distribution of interactive entertainment software and hardware products.
Publishing refers to the development, marketing and sale of products, either directly, by license or through our affiliate label program with certain third-party publishers. In the United States and Canada, we primarily sell our products on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses, and game specialty stores. We conduct our international publishing activities through offices in the United Kingdom (“UK”), Germany, France, Italy, Spain, Australia, Sweden, the Netherlands, Canada, South Korea, and Japan where products are sold on a direct-to-retail basis and through third-party distribution and licensing arrangements and through our wholly owned distribution subsidiaries.
Distribution refers to our operations in the UK, the Netherlands, and Germany that provide logistical and sales services to third-party publishers of interactive entertainment software, our own publishing operations and manufacturers of interactive entertainment hardware.
Resources are allocated to each of these segments using information on their respective net revenues and operating profits before interest and taxes.
The accounting policies of these segments are the same as those described in the “Summary of Significant Accounting Policies” in our Amended Annual Report on Form 10-K/A10-K for the year ended March 31, 2006.2007. Revenue derived from sales between segments is eliminated in consolidation.
18
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006
(Unaudited)
Information on the reportable segments for the three and ninesix months ended December 31,September 30, 2007 and 2006 and 2005 is as follows (amounts in thousands):
| Three months ended December 31, 2006 |
| ||||||||
|
| Publishing |
| Distribution |
| Total |
| |||
|
|
|
|
|
|
|
| |||
Total segment revenues |
| $ | 649,797 |
| $ | 174,462 |
| $ | 824,259 |
|
Revenues from sales between segments |
| (43,937 | ) | 43,937 |
| — |
| |||
|
|
|
|
|
|
|
| |||
Revenues from external customers |
| $ | 605,860 |
| $ | 218,399 |
| $ | 824,259 |
|
|
|
|
|
|
|
|
| |||
Operating income |
| $ | 160,628 |
| $ | 12,492 |
| $ | 173,120 |
|
|
|
|
|
|
|
|
| |||
Total assets |
| $ | 1,667,103 |
| $ | 224,367 |
| $ | 1,891,470 |
|
| Three months ended December 31, 2005 |
| ||||||||||||||||||
|
| Publishing |
| Distribution |
| Total |
|
| Three months ended September 30, 2007 |
| ||||||||||
|
| As restated |
| As restated |
| As restated |
|
| Publishing |
| Distribution |
| Total |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Total segment revenues |
| $ | 667,500 |
| $ | 148,742 |
| $ | 816,242 |
|
| $ | 253,759 |
| $ | 63,987 |
| $ | 317,746 |
|
Revenues from sales between segments |
| (87,652 | ) | 87,652 |
| — |
|
| (20,509 | ) | 20,509 |
| — |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Revenues from external customers |
| $ | 579,848 |
| $ | 236,394 |
| $ | 816,242 |
|
| $ | 233,250 |
| $ | 84,496 |
| $ | 317,746 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Operating income |
| $ | 65,534 |
| $ | 18,359 |
| $ | 83,893 |
| ||||||||||
Operating income (loss) |
| $ | (9,667 | ) | $ | 122 |
| $ | (9,545 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Total assets |
| $ | 1,392,523 |
| $ | 197,592 |
| $ | 1,590,115 |
|
| $ | 1,808,494 |
| $ | 152,706 |
| $ | 1,961,200 |
|
| Nine months ended December 31, 2006 |
|
| Three months ended September 30, 2006 |
| |||||||||||||||
|
| Publishing |
| Distribution |
| Total |
|
| Publishing |
| Distribution |
| Total |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Total segment revenues |
| $ | 909,963 |
| $ | 290,537 |
| $ | 1,200,500 |
|
| $ | 125,404 |
| $ | 62,768 |
| $ | 188,172 |
|
Revenues from sales between segments |
| (63,288 | ) | 63,288 |
| — |
|
| (12,922 | ) | 12,922 |
| — |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Revenues from external customers |
| $ | 846,675 |
| $ | 353,825 |
| $ | 1,200,500 |
|
| $ | 112,482 |
| $ | 75,690 |
| $ | 188,172 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Operating income |
| $ | 92,503 |
| $ | 9,758 |
| $ | 102,261 |
| ||||||||||
Operating loss |
| $ | (36,607 | ) | $ | (803 | ) | $ | (37,410 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Total assets |
| $ | 1,667,103 |
| $ | 224,367 |
| $ | 1,891,470 |
|
| $ | 1,429,824 |
| $ | 103,205 |
| $ | 1,533,029 |
|
|
| Six months ended September 30, 2007 |
| |||||||
|
| Publishing |
| Distribution |
| Total |
| |||
|
|
|
|
|
|
|
| |||
Total segment revenues |
| $ | 682,981 |
| $ | 130,220 |
| $ | 813,201 |
|
Revenues from sales between segments |
| (43,356 | ) | 43,356 |
| — |
| |||
|
|
|
|
|
|
|
| |||
Revenues from external customers |
| $ | 639,625 |
| $ | 173,576 |
| $ | 813,201 |
|
|
|
|
|
|
|
|
| |||
Operating income |
| $ | 19,449 |
| $ | 1,098 |
| $ | 20,547 |
|
|
|
|
|
|
|
|
| |||
Total assets |
| $ | 1,808,494 |
| $ | 152,706 |
| $ | 1,961,200 |
|
19
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006
(Unaudited)
| Nine months ended December 31, 2005 |
| ||||||||
|
| Publishing |
| Distribution |
| Total |
| |||
|
| As restated |
| As restated |
| As restated |
| |||
|
|
|
|
|
|
|
| |||
Total segment revenues |
| $ | 1,028,458 |
| $ | 251,417 |
| $ | 1,279,875 |
|
Revenues from sales between segments |
| (124,530 | ) | 124,530 |
| — |
| |||
|
|
|
|
|
|
|
| |||
Revenues from external customers |
| $ | 903,928 |
| $ | 375,947 |
| $ | 1,279,875 |
|
|
|
|
|
|
|
|
| |||
Operating income |
| $ | 21,932 |
| $ | 19,854 |
| $ | 41,786 |
|
|
|
|
|
|
|
|
| |||
Total assets |
| $ | 1,392,523 |
| $ | 197,592 |
| $ | 1,590,115 |
|
|
| Six months ended September 30, 2006 |
| |||||||
|
| Publishing |
| Distribution |
| Total |
| |||
|
|
|
|
|
|
|
| |||
Total segment revenues |
| $ | 260,166 |
| $ | 116,075 |
| $ | 376,241 |
|
Revenues from sales between segments |
| (19,352 | ) | 19,352 |
| — |
| |||
|
|
|
|
|
|
|
| |||
Revenues from external customers |
| $ | 240,814 |
| $ | 135,427 |
| $ | 376,241 |
|
|
|
|
|
|
|
|
| |||
Operating loss |
| $ | (68,125 | ) | $ | (2,734 | ) | $ | (70,859 | ) |
|
|
|
|
|
|
|
| |||
Total assets |
| $ | 1,429,824 |
| $ | 103,205 |
| $ | 1,533,029 |
|
Geographic information for the three and ninesix months ended December 31,September 30, 2007 and 2006 and 2005 is based on the location of the selling entity. Revenues from external customers by geographic region were as follows (amounts in thousands):
| Three months ended December 31, |
| Nine months ended December 31, |
| |||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
North America |
| $ | 463,388 |
| $ | 402,314 |
| $ | 637,251 |
| $ | 626,538 |
|
Europe |
| 345,969 |
| 397,356 |
| 535,556 |
| 622,035 |
| ||||
Other |
| 14,902 |
| 16,572 |
| 27,693 |
| 31,302 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 824,259 |
| $ | 816,242 |
| $ | 1,200,500 |
| $ | 1,279,875 |
|
|
| Three months ended September 30, |
| Six months ended September 30, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
North America |
| $ | 161,804 |
| $ | 74,249 |
| $ | 471,340 |
| $ | 173,863 |
|
Europe |
| 146,525 |
| 107,775 |
| 316,539 |
| 189,588 |
| ||||
Other |
| 9,417 |
| 6,148 |
| 25,322 |
| 12,790 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 317,746 |
| $ | 188,172 |
| $ | 813,201 |
| $ | 376,241 |
|
Revenues by platform were as follows (amounts in thousands):
| Three months ended December 31, |
| Nine months ended December 31, |
| |||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Console |
| $ | 647,585 |
| $ | 575,094 |
| $ | 884,035 |
| $ | 893,417 |
|
Hand-held |
| 128,386 |
| 111,186 |
| 219,757 |
| 203,879 |
| ||||
PC |
| 48,288 |
| 129,962 |
| 96,708 |
| 182,579 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 824,259 |
| $ | 816,242 |
| $ | 1,200,500 |
| $ | 1,279,875 |
|
|
| Three months ended September 30, |
| Six months ended September 30, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Console |
| $ | 240,484 |
| $ | 117,473 |
| $ | 642,358 |
| $ | 236,450 |
|
Hand-held |
| 57,740 |
| 46,574 |
| 133,472 |
| 91,371 |
| ||||
PC |
| 19,522 |
| 24,125 |
| 37,371 |
| 48,420 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 317,746 |
| $ | 188,172 |
| $ | 813,201 |
| $ | 376,241 |
|
We had two customers that accounted for 14% and 9% of consolidated net revenues for the three months ended September 30, 2007, respectively and 18% and 13% of consolidated net revenues for the six months ended September 30, 2007, respectively. These customers accounted for 13% and 5% of consolidated accounts receivable, gross at September 30, 2007, respectively. These customers were customers of both our publishing and distribution businesses. We had one customer that accounted for 21%23% and 22%25% of consolidated net revenues for the three and ninesix month periods ended December 31,September 30, 2006, respectively, and 29%19% of consolidated gross accounts receivable at December 31,September 30, 2006. This customer was a customer of both our publishing and distribution businesses. As of and for the three and nine months ended December 31, 2005, this same customer accounted for 21% and 22% of consolidated net revenues, respectively, and 25% of consolidated gross accounts receivable.
20
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006
(Unaudited)
13.11. Computation of Earnings (Loss) Per Share
The following table sets forth the computations of basic and diluted earnings (loss) per share (amounts in thousands, except per share data):
| Three months ended |
| Nine months ended |
| |||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
|
|
| As restated |
|
|
| As restated |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Numerator: |
|
|
|
|
|
|
|
|
| ||||
Numerator for basic and diluted earnings per share – income available to common shareholders |
| $ | 142,820 |
| $ | 67,856 |
| $ | 100,209 |
| $ | 49,379 |
|
|
|
|
|
|
|
|
|
|
| ||||
Denominator: |
|
|
|
|
|
|
|
|
| ||||
Denominator for basic earnings per share- weighted average common shares outstanding |
| 282,512 |
| 274,965 |
| 280,499 |
| 272,089 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
| ||||
Employee stock options and stock purchase plan |
| 24,025 |
| 20,625 |
| 23,222 |
| 20,713 |
| ||||
Warrants to purchase common stock |
| 638 |
| 615 |
| 596 |
| 595 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Potential dilutive common shares |
| 24,663 |
| 21,240 |
| 23,818 |
| 21,308 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Denominator for diluted earnings per share - weighted average common shares outstanding plus assumed conversions |
| 307,175 |
| 296,205 |
| 304,317 |
| 293,397 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Basic earnings per share |
| $ | 0.51 |
| $ | 0.25 |
| $ | 0.36 |
| $ | 0.18 |
|
|
|
|
|
|
|
|
|
|
| ||||
Diluted earnings per share |
| $ | 0.46 |
| $ | 0.23 |
| $ | 0.33 |
| $ | 0.17 |
|
|
| Three months ended |
| Six months ended |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Numerator: |
|
|
|
|
|
|
|
|
| ||||
Numerator for basic and diluted earnings (loss) per share – income (loss) available to common shareholders |
| $ | 698 |
| $ | (24,302 | ) | $ | 28,524 |
| $ | (42,611 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Denominator: |
|
|
|
|
|
|
|
|
| ||||
Denominator for basic earnings (loss) per share - weighted-average common shares outstanding |
| 287,315 |
| 280,627 |
| 285,450 |
| 279,487 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
| ||||
Employee stock options, employee stock purchase plans, and restricted stock units |
| 23,223 |
| — |
| 23,709 |
| — |
| ||||
Warrants to purchase common stock and other dilutive common stock equivalents |
| 2,725 |
| — |
| 3,351 |
| — |
| ||||
Potential dilutive common shares |
| 25,948 |
| — |
| 27,060 |
| — |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Denominator for diluted earnings (loss) per share – weighted-average common shares outstanding assuming dilution |
| 313,263 |
| 280,627 |
| 312,510 |
| 279,487 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Basic earnings (loss) per share |
| $ | 0.00 |
| $ | (0.09 | ) | $ | 0.10 |
| $ | (0.15 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Diluted earnings (loss) per share |
| $ | 0.00 |
| $ | (0.09 | ) | $ | 0.09 |
| $ | (0.15 | ) |
Options and restricted stock units to purchase 6,686,8997.0 million and 34.5 million shares of our common stock at exercise prices ranging from $11.68 to $17.21 and options to purchase 9,610,059 shares of common stock at exercise prices ranging from $8.73 to $17.21 were outstanding for the three and nine months ended December 31,September 30, 2007 and 2006, respectively, but were not included in the calculationcalculations of diluted earnings per share because their effect would be antidilutive.
Options and restricted stock units to purchase 1,655,8124.1 million and 34.0 million shares of our common stock at exercise prices ranging from $14.27 to $17.21 and options to purchase 632,103 shares of common stock at exercise prices ranging from $3.38 to $17.21 were outstanding for the three and ninesix months ended December 31, 2005,September 30, 2007 and 2006, respectively, but were not included in the calculationcalculations of diluted earnings per share because their effect would be antidilutive.
21
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006
(Unaudited)
14.12. Commitments and Contingencies
Credit Facilities
We have revolving credit facilities with our Centresoft distribution subsidiary located in the UK (the “UK Facility”) and our NBG distribution subsidiary located in Germany (the “German Facility”). As of December 31, 2006, theThe UK Facility provided Centresoft with the ability to borrow up to GBP 12.0 million (approximately $23.5($24.5 million), including issuing letters of credit, on a revolving basis (including the issuance of letters of credit on its behalf). Furthermore, under the UK Facility, Centresoft provided a GBP 0.6 million (approximately $1.2 million) guarantee for the benefit of our CD Contact distribution subsidiary as of December 31, 2006.September 30, 2007. The UK Facility bore interest at LIBOR plus 2.0% as of December 31, 2006,September 30, 2007, is collateralized by substantially all of the assets of the subsidiary and expires in January 2007.2008. The UK Facility also contains various covenants that require the subsidiary to maintain specified financial ratios related to, among others, fixed charges. As of December 31, 2006, we were in compliance with these covenants. No borrowings were outstanding against the UK Facility as of December 31, 2006. As of December 31, 2006, theThe German Facility provided for revolving loans up to EUR 0.5 million (approximately $0.7($0.7 million) andas of September 30, 2007, bore interest at a Eurocurrency rate plus 2.5%. The German Facility, is collateralized by certain of the subsidiary’s property and equipment and has no expiration date. No borrowings were outstanding against the UK Facility and the German Facility as of December 31, 2006.September 30, 2007.
As of December 31, 2006,September 30, 2007, we maintained a $7.5$40.0 million irrevocable standby letter of credit. The standby letter of credit so that we canis required by one of our inventory manufacturers to qualify for certain payment terms on our purchases from one of our inventory manufacturers.purchases. Under the terms of this arrangement, we are required to maintain on deposit with the bank a compensating balance, restricted as to use, of not less than the sum of the available amount of thatthe letter of credit plus the aggregate amount of any drawings under the letter of credit that have been honored thereunder but not reimbursed. At December 31, 2006,September 30, 2007, the $40.0 million deposit in the amount of $7.5 million is included in short-term investments as restricted cash. AsNo borrowings were outstanding as of December 31, 2006, we had no borrowings outstanding against this letter of credit.September 30, 2007.
As of December 31, 2006,September 30, 2007, our publishing subsidiary located in the UK maintained a EUR 4.0 million (approximately $5.3($5.7 million) irrevocable standby letter of credit. The standby letter of credit so that it can qualify for certain payment terms on purchases fromis required by one of our inventory manufacturers.manufacturers to qualify for payment terms on our inventory purchases. The standby letter of credit does not require a compensating balance and is collateralized by substantially all of the assets of the subsidiary and expires in AugustFebruary 2008. No borrowings were outstanding as of September 30, 2007. As of December 31, 2006, we had no borrowing outstanding against this letter of credit.
ACTIVISION, INC. AND SUBSIDIARIESNotes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006(Unaudited)
Commitments
In the normal course of business, we enter into contractual arrangements with third parties for non-cancelable operating lease agreements for our offices, for the development of products, and for the rights to intellectual property. Under these agreements, we commit to provide specified payments to a lessor, developer or intellectual property holder, as the case may be, based upon contractual arrangements. The payments to third-party developers are generally conditioned upon the achievement by the developers of contractually specified development milestones. Further, these payments to third-party developers and intellectual property holders typically are deemed to be advances and are recoupable against future royalties earned by the developer or intellectual property holder based on the sale of the related game. Additionally, in connection with certain intellectual property right acquisitions and development agreements, we will commit to spend specified amounts for marketing support for the related game(s) which is to be developed or in which the intellectual property will be utilized. Assuming all contractual provisions are met, the total future minimum commitments for these and other contractual arrangements in place as of December 31, 2006,September 30, 2007, are scheduled to be paid as follows (amounts in thousands):
22
ACTIVISION, INC. AND SUBSIDIARIES
| Contractual Obligations |
| |||||||||||
|
| Facility and |
| Developer |
|
|
|
|
| ||||
|
| Equipment Leases |
| and IP |
| Marketing |
| Total |
| ||||
Fiscal year ending March 31, |
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
2007 (remaining three months) |
| $ | 3,456 |
| $ | 37,962 |
| $ | 25 |
| $ | 41,443 |
|
2008 |
| 14,069 |
| 29,340 |
| 40,468 |
| 83,877 |
| ||||
2009 |
| 13,033 |
| 28,036 |
| 26,496 |
| 67,565 |
| ||||
2010 |
| 11,997 |
| 29,586 |
| 100 |
| 41,683 |
| ||||
2011 |
| 9,754 |
| 30,586 |
| 100 |
| 40,440 |
| ||||
Thereafter |
| 22,959 |
| 64,173 |
| — |
| 87,132 |
| ||||
Total |
| $ | 75,268 |
| $ | 219,683 |
| $ | 67,189 |
| $ | 362,140 |
|
Notes to Consolidated Financial Statements
(Unaudited)
|
| Contractual Obligations(1) |
| ||||||||||
|
| Facility and |
| Developer |
|
|
|
|
| ||||
|
| Equipment Leases |
| and IP |
| Marketing |
| Total |
| ||||
Fiscal year ending March 31, |
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
2008 (remaining six months) |
| $ | 9,268 |
| $ | 29,080 |
| $ | 8,741 |
| $ | 47,089 |
|
2009 |
| 19,265 |
| 55,572 |
| 46,015 |
| 120,852 |
| ||||
2010 |
| 17,454 |
| 23,036 |
| 11,100 |
| 51,590 |
| ||||
2011 |
| 15,045 |
| 30,586 |
| 13,100 |
| 58,731 |
| ||||
2012 |
| 10,772 |
| 16,586 |
| — |
| 27,358 |
| ||||
Thereafter |
| 41,879 |
| 47,587 |
| — |
| 89,466 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 113,683 |
| $ | 202,447 |
| $ | 78,956 |
| $ | 395,086 |
|
(1) We have omitted FIN 48 liabilities from this table due to the inherent uncertainty regarding the timing of potential issue resolution. Specifically, either (a) the underlying positions have not been fully enough developed under audit to quantify at this time or, (b) the years relating to the issues for certain jurisdictions are not currently under audit. At the adoption date of April 1, 2007, the Company had $65.5 million of unrecognized tax benefits.
Compensation Guarantee
In June 2005, we entered into an employment agreement with the President and Chief Executive Officer of Activision Publishing, Inc., a wholly owned subsidiary of the Company and the Company's principal operating subsidiary, containing a guarantee related to his total compensation. The agreement guarantees that, if on May 15, 2010 his total compensation and any severance payments received by him has not exceeded $20.0 million, we will make a payment for the amount of the shortfall. The $20.0 million guarantee will be recognized as compensation expense over the term of the employment agreement comprisingand consists of salary payments, bonus payments, restricted stock expense, stock option expense, and an accrual for any anticipated remaining portion of the guarantee. The remaining portion of the guarantee is accrued over the term of the agreement in “Other liabilities” and will remain accrued until the end of the employment agreement, at which point it will be used to make a payment for any shortfall or reclassified into shareholders’ equity.
Legal Proceedings
The following describes the material legal proceedings, examinations and other matters in which the Company and its subsidiaries are involved that: (1) were pending as of December 31, 2006; (2) were terminated during the period from December 31, 2006 through June 7, 2007; or (3) are pending as of June 7, 2007. Thus, the description of a matter may include developments that occurred since December 31, 2006, as well as those that occurred during 2006. The matters include legal proceedings relating to the restatement of our consolidated financial statements, such as class action securities lawsuits, shareholder derivative actions and governmental proceedings.
29
ACTIVISION, INC. AND SUBSIDIARIESNotes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006(Unaudited)
In July 2006, individuals and/or entities claiming to be stockholders of the Company have filed derivative lawsuits, purportedly on behalf of the Company, against certain current and former members of the Company’s Board of Directors as well as several current and former officers of the Company. Three derivative actions have been filed in Los Angeles Superior Court: Vazquez v. Kotick, et al.al ., L.A.S.C. Case No. BC355327 (filed July 12, 2006); Greuer v. Kotick, et al., L.A.S.C. Case No. SC090343 (filed July 12, 2006); and Amalgamated Bank v. Baker, et al., L.A.S.C. Case No. BC356454 (filed August 3, 2006). These actions have been consolidated by the court under the caption In re Activision Shareholder Derivative Litigation, L.A.S.C. Master File No. SC090343 (West, J.). Two derivative actions have been filed in the United States District Court for the Central District of California: Pfeiffer v. Kotick, et al., C.D. Cal. Case No. CV06-4771 MRP (JTLx) (filed July 31, 2006); and Hamian v. Kotick, et al.al., C.D. Cal. Case No. CV06-5375 MRP (JLTx) (filed August 25, 2006). These actions have also been consolidated, under the caption In re Activision, Inc. Shareholder Derivative Litigation, C.D. Cal. Case No. CV06-4771 MRP (JTLx) (Pfaelzer, J.). The consolidated complaints allege, among other things, purported improprieties in the Company’s issuance of stock options. Plaintiffs seek various relief on behalf of the Company, including damages, restitution of benefits obtained from the alleged misconduct, equitable relief, including an accounting and rescission of option contracts; and various corporate governance reforms. The Company
23
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
expects that defense expenses associated with the matters will be covered by its directors and officers insurance, subject to the terms and conditions of the applicable policies.
On May 24, 2007, the Superior Court granted the Company’s motion to stay the state action. The court’s order stays the action pending the resolution of motions to dismiss in the federal action, but is without prejudice to any party’s right to seek modification of the stay upon a showing of good cause, including a showing that matters may be addressed in the Superior Court without the potential for conflict with or duplication of the federal court proceedings. On July 13, 2007, Plaintiffs filed their second amended complaint, which alleges substantially the same claims as the previous complaints, with new allegations related to Plaintiffs’ standing, recent public facts and additional analyses. The parties are briefing the threshold issues and a hearing on them is scheduled for November 7, 2007.
The Company filed motions to dismiss in the federal action on June 1, 2007, which will be fully briefed by August 15, 2007. A hearing on the motions has been continued to December 3, 2007.
The Company was also was informed that, on June 1, 2007, a derivative case, Abdelnur vs. Kotick et al., was filed in the United States District Court for the Central District of California, C.D. Case No. CV07-3575 AHM (PJWx), by the same law firm that previously filed the Hamian case, alleging substantially the same claims. The action has now been consolidated with the existing federal consolidated action and the motions to dismiss filed June 1, 2007 have been deemed to have also been filed in response to the Abdelnurcomplaint.
On July 27,18, 2007, the Company was informed that another derivative case, Scarborough v. Kotick et al., was filed in the United States District Court for the Central District of California, Case No. CV07-4602 SVW (PLAx), also by the same law firm that previously filed the Hamian case, alleging substantially the same claims. This action has been consolidated with the federal consolidated case. The parties attended a mediation related to the consolidated federal case on November 1, 2007.
On July 24, 2006, the Company received a letter of informal inquiry from the SEC requesting certain documents and information relating to the Company’s historical stock option grant practices. In early June 2007,Thereafter, the SEC informed us that the SEC has issued a formal order of non-public investigation, pursuant to which allowsit has subpoenaed documents from the SEC, among other things,Company related to subpoena witnessesthe investigation, and requirehas subpoenaed testimony and documents from certain current and former directors, officers and employees of the production of documents. Company.
The Company is cooperating with the SEC’s investigation, and representatives of the Special Subcommitteespecial subcommittee of independent members of our Board of Directors established in July 2006 to review our historical stock option granting practices (the “Special Subcommittee”) and its legal counsel have met with members of the staff of the SEC on several occasions, in person and by telephone (as has the Company’s outside legal counsel), to discuss the progress of the Special Subcommittee’s investigation and on February 28, 2007 to brief the SEC staff on the Special Subcommittee’s findings and recommendations following the substantial completion of the Special Subcommittee’s investigation.recommendations. A representative of the U.S. Department of Justice has attended certain of these meetings and requested copies of certain documents that we have provided to the staff of the SEC. At this time, the Company has not received any grand jury subpoenas or written requests from the Department of Justice.
In addition, we are party to other routine claims and suits brought by us and against us in the ordinary course of business, including disputes arising over the ownership of intellectual property rights, contractual claims, employment laws, regulations and relationships, and collection matters. In the opinion of management, after consultation with legal counsel, the outcome of such routine claims and lawsuits will not have a material adverse effect on our business, financial condition, results of operations, or liquidity.
24
15.ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
13. StockStock-Based Compensation and Employee Benefit Plans
We have a stock-based compensation program that provides
Equity Incentive Plans
On July 30, 2007, our Board of Directors adopted the Activision 2007 Incentive Plan (the “2007 Plan”), subject to shareholder approval, and reserved 15,000,000 shares for issuance thereunder and, on September 27, 2007, the 2007 Plan was approved by our shareholders and became effective. The 2007 Plan authorizes the Compensation Committee of our Board of Directors to provide equity-based compensation in the form of stock options, share appreciation rights, restricted stock, restricted stock units, performance shares, performance units and other performance- or value-based awards structured by the Compensation Committee within parameters set forth in the 2007 Plan, including custom awards that are denominated or payable in, valued in whole or in part by reference to, or otherwise based on or related to, shares of our common stock, or factors that may influence the value of our common stock or that are valued based on our performance or the performance of any of our subsidiaries or business units or other factors designated by the Compensation Committee, as well as incentive bonuses, for the purpose of providing incentives and rewards for superior performance to the directors, officers, employees of, and consultants to, Activision and its subsidiaries.
While the Compensation Committee has broad discretion in creating employeeto create equity incentives. Thisincentives, our equity-based compensation program includes incentive and non-statutorycurrently primarily utilizes a combination of options, restricted stock options and restricted stock units. Such awards granted under various plans, the majority of which are stockholder approved. Stock options are generally have time-based vesting on each annual anniversary of the grant dateschedules, vesting annually over periods of three to five years, or vest in their entirety on an anniversary of date of grant, subject to possible earlier vesting if certain performance measures are met, and all such awards which are options generally expire ten years from the grant date. Under the terms of the 2007 Plan, the exercise price for the options, must be equal to or greater than the closing price per share of our common stock on the date with some options containing performance clauses which would accelerate the vesting into earlier annual periods. Additionally,award is granted, as reported on the NASDAQ.
Upon the effective date of the 2007 Plan, we haveceased to make awards under the following equity incentive plans (collectively, the “Rolled-Up Plans”), although such plans will remain in effect and continue to govern outstanding awards: (i) Activision, Inc. 1998 Incentive Plan, as amended; (ii) Activision, Inc. 1999 Incentive Plan, as amended; (iii) Activision, Inc. 2001 Incentive Plan, as amended; (iv) Activision, Inc. 2002 Incentive Plan, as amended; (v) Activision, Inc. 2002 Executive Incentive Plan, as amended; (vi) Activision, Inc. 2002 Studio Employee Retention Incentive Plan, as amended; and (vii) Activision, Inc. 2003 Incentive Plan, as amended.
The number of shares available for issuance under the 2007 Plan was increased by an Employee Stock Purchase Plan (“ESPP”) that allows employees to purchaseadditional 2,685,577 shares of our common stock to reflect the shares reserved for issuance but not subject to outstanding awards under the Rolled-Up Plans at 85%the time the 2007 Plan became effective. Additionally, the number of shares of our common stock reserved for issuance under the 2007 Plan may be further increased from time to time by: (i) the number of shares relating to awards outstanding under any Rolled-Up Plan that: (a) expire, or are forfeited, terminated or cancelled, without the issuance of shares; (b) are settled in cash in lieu of shares; or (c) are exchanged, prior to the issuance of shares of our common stock, for awards not involving our common stock; and (ii) if the exercise price of any option outstanding under any Rolled-Up Plan is, or the tax withholding requirements with respect to any award outstanding under any Rolled-Up Plan are, satisfied by withholding shares otherwise then deliverable in respect of the fair market value at either the date of enrollmentaward or the dateactual or constructive transfer to the Company of purchase, whichever is lower. Shares issued as a
ACTIVISION, INC. AND SUBSIDIARIESNotesshares already owned, the number of shares equal to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006(Unaudited)
result of stock option exercises and our ESPP are generally issued as new stock issuances.withheld or transferred shares. As of December 31, 2006,September 30, 2007, we had approximately 14.517.7 million shares of our common stock reserved for future issuance under our stock option plans and ESPP.
Stock Incentive Plans
We sponsor several stock option plans for the benefit of officers, employees, consultants, and others.
On February 28, 1992, the shareholders of Activision approved the Activision 1991 Stock Option and Stock Award Plan, as amended, (the “1991 Plan”) which permits the granting of “Awards”2007 Plan. Shares issued in the form of non-qualified stock options, incentive stock options (“ISOs”), stock appreciation rights (“SARs”), restricted stockconnection with awards deferred stock awards, and other common stock-based awards to directors, officers, employees, consultants, and others. The total number of shares of common stock available for distributionmade under the 19912007 Plan is 45,400,000. The 1991 Plan requires available shares to consist in whole or in part of authorized and unissued shares or treasury shares. There were no shares remaining available for grant under the 1991 Planare generally issued as of December 31, 2006.new stock issuances.
On September 23, 1998, the shareholders of Activision approved the Activision 1998 Incentive Plan, as amended (the “1998 Plan”). The 1998 Plan permits the granting of “Awards” in the form of non-qualified stock options, ISOs, SARs, restricted stock awards, deferred stock awards, and other common stock-based awards to directors, officers, employees, consultants, and others. The total number of shares of common stock available for distribution under the 1998 Plan is 18,000,000. The 1998 Plan requires available shares to consist in whole or in part of authorized and unissued shares or treasury shares. There were approximately 50,000 shares remaining available for grant under the 1998 Plan as of December 31, 2006.
On April 26, 1999, the Board of Directors approved the Activision 1999 Incentive Plan, as amended (the “1999 Plan”). The 1999 Plan permits the granting of “Awards” in the form of non-qualified stock options, ISOs, SARs, restricted stock awards, deferred share awards, and other common stock-based awards to directors, officers, employees, consultants, and others. The total number of shares of common stock available for distribution under the 1999 Plan is 30,000,000. The 1999 Plan requires available shares to consist in whole or in part of authorized and unissued shares or treasury shares. There were approximately 39,400 shares remaining available for grant under the 1999 Plan as of December 31, 2006.
On August 23, 2001, the shareholders of Activision approved the Activision 2001 Incentive Plan, as amended (the “2001 Plan”). The 2001 Plan permits the granting of “Awards” in the form of non-qualified stock options, ISOs, SARs, restricted stock awards, deferred stock awards, and other common stock-based awards to directors, officers, employees, consultants, and others. The total number of shares of common stock available for distribution under the 2001 Plan is 9,000,000. The 2001 Plan requires available shares to consist in whole or in part of authorized and unissued shares or treasury shares. There were approximately 562,300 shares remaining available for grant under the 2001 Plan as of December 31, 2006.
On April 4, 2002, the Board of Directors approved the Activision 2002 Incentive Plan (the “2002 Plan”). The 2002 Plan permits the granting of “Awards” in the form of non-qualified stock options, ISOs, SARs, restricted stock awards, deferred share awards, and other common stock-based awards to officers (other than executive officers), employees, consultants, advisors, and others. The 2002 Plan requires available shares to consist in whole or in part of authorized and unissued shares or treasury shares. The total number of shares of common stock available for distribution under the 2002 Plan is 17,400,000. There were approximately 274,400 shares remaining available for grant under the 2002 Plan as of December 31, 2006.
On September 19, 2002, the shareholders of Activision approved the Activision 2002 Executive Incentive Plan (the “2002 Executive Plan”). The 2002 Executive Plan permits the granting of “Awards” in the form of non-qualified stock options, ISOs, SARs, restricted stock awards, deferred share awards, and other common stock-based awards to officers, employees, directors, consultants, and advisors. The total number25
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial StatementsFor the Three
(Unaudited)
Restricted Stock Units and Nine Months ended December 31, 2006(Unaudited)Restricted Stock
of shares of common
We grant restricted stock available for distribution under the 2002 Executive Plan is 10,000,000. The 2002 Executive Plan requires available shares to consist in whole or in part of authorized and unissued shares or treasury shares. There were approximately 488,700 shares remaining available for grant under the 2002 Executive Plan as of December 31, 2006.
On December 16, 2002, the Board of Directors approved the Activision 2002 Studio Employee Retention Incentive Plan, as amended (the “2002 Studio Plan”). The 2002 Studio Plan permits the granting of “Awards” in the form of non-qualified stock optionsunits and restricted stock awards(collectively referred to key studio employees (other than executive officers) of Activision, its subsidiaries and affiliates, and to contractors and others. The 2002 Studio Plan requires available shares to consist in whole or in part of authorized and unissued shares or treasury shares. The total number of shares of commonas “restricted stock available for distributionrights”) under the 2002 Studio Plan is 6,000,000. There were approximately 4,2002007 Plans to employees around the world. Restricted stock units entitle the holders thereof to receive shares remaining available for grant under the 2002 Studio Plan as of December 31, 2006.
On April 29, 2003, our Board of Directors approved the Activision 2003 Incentive Plan (the “2003 Plan”). On September 15, 2005, the shareholders of Activision approved the 2003 Plan. The 2003 Plan permits the granting of “Awards” in the form of non-qualified stock options, SARs, restricted stock awards, deferred stock awards, and other common stock-based awards to directors, officers, employees, consultants, and others. The 2003 Plan requires available shares to consist in whole or in part of authorized and unissued shares or treasury shares. The total number of shares of common stock available for distribution under the 2003 Plan is 24,000,000. There were approximately 8,756,700 shares remaining available for grant under the 2003 Plan as of December 31, 2006.
Under the terms of the plans, the exercise price for Awards issued under the 1991 Plan, 1998 Plan, 1999 Plan, 2001 Plan, 2002 Plan, 2002 Executive Plan, 2002 Studio Plan, and 2003 Plan (collectively, the “Plans”) is determined at the discretion of the Board of Directors (or the Compensation Committee of the Board of Directors, which administers the Plans), and under the terms of the plans, the exercise price for ISOs is not to be less than the fair market value of our common stock at the end of a specified period of time. Restricted stock is issued and outstanding upon grant; however, restricted stock holders are restricted from selling the shares until they vest. Upon vesting of restricted stock rights, we may withhold shares otherwise deliverable to satisfy tax withholding requirements. Restricted stock rights are subject to forfeiture and transfer restrictions. Vesting for restricted stock rights is based upon the holders’ continued employment with us. If the vesting conditions are not met, unvested restricted stock rights will be forfeited.
During the first quarter of fiscal 2008, we issued restricted stock rights of 8,000 shares to an employee with a total grant date fair value of $163,000. During the second quarter of fiscal 2008, we issued restricted stock rights of 75,333 shares to employees with a total grant and in the casedate fair value of non-qualified options, the exercise price must exceed or be equal to 85%$1,513,000. The value of the fairshares is based on the closing market value of our common stock at the date of grant. Options typically become exercisable in installments over a period of three to five years and must be exercised within 10 years of the date of grant. We have recently determined that, for the reasons described in Note 2, certain Awards issued in certain past periods were issued with exercise prices below the fair market valueprice of our common stock on the date of grant. In accordance with SFAS No. 123R, we will recognize compensation expense and increase additional paid in capital related to restricted stock rights over the requisite service period. For the three and six months ended September 30, 2007, we recorded expenses related to total restricted stock rights of approximately $548,000 and $879,000, respectively. For the three and six months ended September 30, 2006, we recorded expenses related to total restricted stock rights of approximately $175,000 and $350,000, respectively. Since the issuance dates, that we have determinedrecognized $2.3 million of the $6.4 million total fair value, with the remainder to be the correct grant and measurement dates for those Awards.recognized over a weighted-average period of 1.72 years.
OtherNon-Plan Employee Stock Options
In connection with prior employment agreements between Activision and Robert A. Kotick, Activision’s Chairman and Chief Executive Officer, and Brian G. Kelly, Activision’s Co-Chairman, Mr. Kotick and Mr. Kelly were granted options to purchase our common stock. The Board of Directors approved the granting of these options. RelatingAs of September 30, 2007, options to such grants, as of December 31, 2006,purchase approximately 8,304,800 optionsshares under such grants were outstanding with a weighted averageweighted-average exercise price of $1.74.
We additionally have approximately 9,500 options outstanding to employees as of December 31, 2006, with a weighted average exercise price of $3.48. The Board of Directors approved the granting of these options. Such options have terms similar to those options granted under the Plans.
Employee Stock Purchase Plan
On April 11,
Effective October 1, 2005, the Board of Directors approved the Activision, Inc. Third Amended and Restated 2002 Employee Stock Purchase Plan and on February 11, 2003 the Board approved theActivision, Inc. Second Amended and Restated 2002 Employee Stock Purchase Plan for International Employees (together, the “2002 Employee Stock Purchase Plan”“ESPP”). Under the 2002 Employee Stock Purchase Plan,ESPP, up to an aggregate of 4,000,000 shares of our common stock may be purchased by eligible employees during two six-month offering periods that commence each April 1 and October 1 (the
ACTIVISION, INC. AND SUBSIDIARIESNotes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006(Unaudited)
“Offering “Offering Period”). Common stock is purchased by the Amended 2002 Purchase PlansESPP participants at a price per share generally equal to 85% of the lower of the fair market value of theour common stock on the first day of the Offering Period and the fair market value of theour common stock on the purchase date (the last day of the Offering Period). Employees may purchase shares having a value not exceeding 15% of their gross compensation during an Offering Period and are limited to a maximum of $10,000 in value for any two purchases within the same calendar year. On September 30, 2006, the most recent purchase date,June 13, 2007, employees purchased 178,638228,242 shares of our common stock at a purchase price of $11.7215$12.835 per share. On September 28, 2007, the most recent purchase date, employees purchased 126,008 shares of our common stock at a purchase price of $16.099 per share. As of September 30, 2007, we had approximately 1.2 million shares of our common stock reserved for future issuance under the ESPP. Shares issued in connection with purchases made under the ESPP are generally issued as new stock issuances.
26
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
Non-Employee Warrants
In prior years, we have granted stock warrants to third parties in connection with the development of software and the acquisition of licensing rights for intellectual property. The warrants generally vest upon grant and are exercisable over the term of the warrant. The exercise price of third-party warrants is generally greater than or equal to theirthe fair market value of our common stock at the date of grant. No third-party warrants were granted during the quarters or six months ended December 31, 2006September 30, 2007 and 2005.2006. As of December 31,September 30, 2007 and 2006, and 2005,respectively, third-party warrants to purchase 919,800 and 936,000 shares of our common stock were outstanding with a weighted averageweighted-average exercise price of $4.59 and $4.54 per share.share, respectively.
In accordance with EITF 96-18, we measure the fair value of the securities on the measurement date. The fair value of each warrant is capitalized and amortized to expense when the related product is released and the related revenue is recognized. Additionally, as more fully described in Note 1, the recoverability of capitalized software development costs and intellectual property licenses is evaluated on a quarterly basis with amounts determined as not recoverable being charged to expense. In connection with the evaluation of capitalized software development costs and intellectual property licenses, any capitalized amounts for related third-party warrants are additionally reviewed for recoverability with amounts determined as not recoverable being amortized to expense. For the quarter ended DecemberAs of March 31, 2006, and 2005, there was no amortization related tocapitalized amounts of third-party warrants and no remaining unamortized expense.had been fully amortized.
Employee Retirement Plan
We have a retirement plan covering substantially all of our 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 the lesser of 92% of their pre-tax salary, andup to the maximum amount allowed by law. We contribute an amount equal to 20% of each dollar contributed by a participant. Our matching contributions to the plan were approximately $293,600$278,020 and $1,037,800$867,600 during the three and ninesix months ended December 31, 2006,September 30, 2007, respectively. Our matching contributions to the plan were approximately $342,400$284,500 and $918,400$744,200 during the three and ninesix months ended December 31, 2005,September 30, 2006, respectively.
Restricted Stock
In June 2005, we issued the rights to 155,763 shares of restricted stock to an employee. Additionally, in October 2005 we issued the rights to 96,712 shares of restricted stock to an employee. These shares vest over a five-year period and remain subject to forfeiture if vesting conditions are not met. In accordance with APB 25, we recognize unearned compensation in connection with the grant of restricted shares equal to the fair value of our common stock on the date of grant. The fair value of these shares when issued was approximately $12.84 and $15.51 per share, respectively, and resulted in a total increase in “Additional paid-in capital” and “Unearned compensation” of $2.0 million and $1.5 million on the respective balance sheets at the times of grant. Prior to the adoption of SFAS 123R, we reduced unearned compensation and recognized compensation expense over the vesting periods. Upon adoption of SFAS 123R, unearned compensation was reclassified against additional paid in capital and we will increase additional paid in capital and recognize compensation expense over the respective remaining vesting periods. Additionally, in the third quarter of fiscal 2007 we issued the rights to an aggregate of 81,000 shares of restricted stock to various employees. These shares vest over two and three year periods (with some subject to vesting
ACTIVISION, INC. AND SUBSIDIARIESNotes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006(Unaudited)
acceleration clauses if the holder achieves certain performance objectives) and remain subject to forfeiture if vesting conditions are not met. In accordance with SFAS 123R we will recognize compensation expense and increase additional paid in capital related to these restricted stock shares over the requisite service period. For the three and nine months ended December 31, 2006, we recorded expenses related to these shares of approximately $292,000 and $642,000, respectively, which was included as a component of share-based compensation expense within “General and administrative” on the accompanying Consolidated Statements of Operations. Since the issuance dates, we have recognized $1.1 million of the $4.8 million total fair value, with the remainder to be recognized over a weighted-average period of 3.12 years.
On April 1, 2006, we adopted the provisions of SFAS 123R, requiring us to recognize expense related to the fair value of our stock-based compensation awards. We elected to use the modified prospective transition method as permitted by SFAS 123R and therefore have not restated our financial results for prior periods. Under this transition method, stock-based compensation expense for the three and nine months ended December 31, 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of April 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. Stock-based compensation expense for all stock-based compensation awards granted subsequent to April 1, 2006 was based on the grant-date fair value, estimated in accordance with the provisions of SFAS 123R.
The following table sets forth the total stock-based compensation expense resulting from stock options, restricted stock awards,rights, and the ESPP included in our Consolidated Statements of Operations for the three and ninesix months ended December 31,September 30, 2007 and 2006 (in thousands) in accordance with SFAS 123R::
| Three Months Ended |
| Nine Months Ended |
| |||
Cost of sales - software royalties and amortization |
| $ | 1,836 |
| $ | 1,872 |
|
Product development |
| 1,394 |
| 4,064 |
| ||
Sales and marketing |
| 1,559 |
| 3,488 |
| ||
General and administrative |
| 2,904 |
| 9,009 |
| ||
|
|
|
|
|
| ||
Stock-based compensation expense before income taxes |
| 7,693 |
| 18,433 |
| ||
Income tax benefit |
| (3,008 | ) | (7,207 | ) | ||
|
|
|
|
|
| ||
Total stock-based compensation expense after income taxes |
| $ | 4,685 |
| $ | 11,226 |
|
|
| Three Months Ended |
| Six Months Ended September 30, 2007 |
| ||
Cost of sales - software royalties and amortization |
| $ | 248 |
| $ | 2,093 |
|
Product development |
| 2,414 |
| 3,921 |
| ||
Sales and marketing |
| 1,868 |
| 3,639 |
| ||
General and administrative |
| 2,339 |
| 5,376 |
| ||
|
|
|
|
|
| ||
Stock-based compensation expense before income taxes |
| 6,869 |
| 15,029 |
| ||
Income tax benefit |
| (2,686 | ) | (5,876 | ) | ||
|
|
|
|
|
| ||
Total stock-based compensation expense after income taxes |
| $ | 4,183 |
| $ | 9,153 |
|
27
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006
(Unaudited)
|
| Three Months Ended |
| Six Months Ended September 30, 2006 |
| ||
Cost of sales - software royalties and amortization |
| $ | — |
| $ | 36 |
|
Product development |
| 991 |
| 2,670 |
| ||
Sales and marketing |
| 889 |
| 1,929 |
| ||
General and administrative |
| 3,011 |
| 6,105 |
| ||
|
|
|
|
|
| ||
Stock-based compensation expense before income taxes |
| 4,891 |
| 10,740 |
| ||
Income tax benefit |
| (1,912 | ) | (4,199 | ) | ||
|
|
|
|
|
| ||
Total stock-based compensation expense after income taxes |
| $ | 2,979 |
| $ | 6,541 |
|
Additionally, stock option expenses are capitalized in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed” as discussed in Note 1. For the three months ended December 31, 2006 stock-based compensation costs in the amount of $2.3 million were capitalized and $1.8 million of capitalized stock-based compensation costs were amortized. The following table summarizes stock option expense included in our Consolidated Balance Sheets as a component of software development (in thousands):
| Software |
| ||
Balance, March 31, 2006 |
| $ | — |
|
Stock based compensation expense capitalized during period |
| 6,868 |
| |
Amortization of capitalized stock-based compensation expense |
| (1,872 | ) | |
Balance, December 31, 2006 |
| $ | 4,996 |
|
|
| Software |
| |
Balance, March 31, 2007 |
| $ | 6,566 |
|
Stock-based compensation expense capitalized during period |
| 8,141 |
| |
Amortization of capitalized stock-based compensation expense |
| (2,093 | ) | |
Balance, September 30, 2007 |
| $ | 12,614 |
|
Net cash proceeds from the exercise of stock options were $7.0$19.1 million and $19.0$30.3 million for the three and ninesix months ended December 31, 2006,September 30, 2007, respectively. Net cash proceeds from the exercise of stock options were $10.5$7.1 million and $37.9$11.9 million for the three and ninesix months ended December 31, 2005, respectively. Income tax benefit from stock option exercises was $5.5 million and $11.4 million for the three and nine months ended December 31,September 30, 2006, respectively. Income tax benefit from stock option exercises was $9.7$8.8 million and $21.3$9.2 million for the three and ninesix months ended December 31, 2005,September 30, 2007, respectively. Income tax benefit from stock option exercises was $3.1 million and $5.9 million for the three and six months ended September 30, 2006, respectively. In accordance with SFAS No. 123R, we present excess tax benefits from the exercise of stock options, if any, as financing cash flows rather than operating cash flows.
Prior to the adoption of SFAS 123R, we applied SFAS 123, amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (SFAS 148), which allowed companies to apply the existing accounting rules under APB 25 and related Interpretations. As a result of our options investigation, we determined that there were options granted where the exercise price was set at a price lower than the market price on the actual date of grant. According to APB 25, a non-cash stock-based compensation expense should be recognized for any options granted where the exercise price is lower than the market price on the actual date of grant. This expense is then to be amortized over the vesting period of the associated option. As such, we have restated prior periods (see Note 2 to the Consolidated Financial Statements) to properly account for these options. As required by SFAS 148 prior to the adoption of SFAS 123R, we provided pro forma net income (loss) and pro forma net income (loss) per common share disclosures for stock-based awards, as if the fair-value-based method defined in SFAS 123 had been applied.
ACTIVISION, INC. AND SUBSIDIARIESNotes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006(Unaudited)
The following table illustrates the effect on net income after tax and net earnings per common share as if we had applied the fair value recognition provisions of SFAS 123 to stock-based compensation during the three and nine months ended December 31, 2005 (in thousands, except per share amounts):
| Three Months Ended |
| Nine Months Ended |
| |||
|
| As restated |
| As restated |
| ||
Net income, as reported |
| $ | 67,856 |
| $ | 49,379 |
|
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects |
| 72 |
| 1,695 |
| ||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
| (4,222 | ) | (12,188 | ) | ||
|
|
|
|
|
| ||
Pro forma net income |
| $ | 63,706 |
| $ | 38,886 |
|
|
|
|
|
|
| ||
Earnings per share |
|
|
|
|
| ||
|
|
|
|
|
| ||
Basic - as reported |
| $ | 0.25 |
| $ | 0.18 |
|
Basic - pro forma |
| $ | 0.23 |
| $ | 0.14 |
|
|
|
|
|
|
| ||
Diluted - as reported |
| $ | 0.23 |
| $ | 0.17 |
|
Diluted - pro forma |
| $ | 0.22 |
| $ | 0.13 |
|
In addition, included in net income, as reported, is $175,000 and $292,000 for the three and nine months ended December 31, 2005, respectively, related to amortization of unearned compensation related to restricted stock.
As of April 1, 2005, the Company began estimating the value of employee stock options on the date of grant using a binomial-lattice model. Prior to April 1, 2005 the value of each employee stock option was estimated on the date of grant using the Black-Scholes model for the purpose of the pro forma financial information in accordance with SFAS 123.
Our employee stock options have features that differentiate them from exchange-traded options. These features include lack of transferability, early exercise, vesting restrictions, pre- and post-vesting termination provisions, blackout dates, and time-varying inputs. In addition, some of the options have non-traditional features, such as accelerated vesting upon the satisfaction of certain performance conditions, that must be reflected in the valuation. A binomial-lattice model was selected because it is better able to explicitly address these features than closed-form models such as the Black-Scholes model, and is able to reflect expected future changes in model inputs, including changes in volatility, during the option’s contractual term.
Consistent with SFAS No. 123R, we have attempted to reflectdata input into our model reflects expected future changes in model inputs during the option’s contractual term. The inputs required by our binomial-latticebinomial lattice model include expected volatility, risk-free interest rate, risk-adjusted stock return, dividend yield, contractual term, and vesting schedule, as well as measures of employees’ forfeiture, exercise, and post-vesting termination behavior. Statistical methods were used to estimate employee typetermination rates for specific termination rates.types of employees. These termination rates, in turn, were used to model the number of options that are expected to vest and post-vesting
ACTIVISION, INC. AND SUBSIDIARIESNotes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006(Unaudited)
termination behavior. Employee type specificEmployee-type-specific estimates of Expected Time-To-Exercise (“ETTE”) were used to reflect employee exercise behavior. ETTE was estimated by using statistical procedures to first estimate the conditional probability of exercise occurring during each time period, conditional on the option surviving to
28
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
that time period. These probabilities are then used to estimate ETTE. The model was calibrated by adjusting parameters controlling exercise and post-vesting termination behavior so that the measures output by the model matched values of these measures that were estimated from historical data. The weighted-average estimated value of employee stock options granted during the three months ended December 31,September 30, 2007 and 2006 was $8.16 and 2005 was $7.44 and $6.38$5.66 per share, respectively, using the binomial-lattice model with the following weighted-average assumptions:
|
| Employee and Director Options |
| Employee Stock |
| ||||||||
|
| Three Months Ended |
| Three Months Ended |
| ||||||||
|
| December |
| December |
| December |
| December |
| ||||
Expected term (in years) |
| 5.76 |
| 4.97 |
| 0.5 |
| 0.5 |
| ||||
Risk-free interest rate |
| 4.70 | % | 4.64 | % | 4.74 | % | 4.08 | % | ||||
Volatility |
| 53.10 | % | 49.02 | % | 44.34 | % | 43.02 | % | ||||
Dividend yield |
| — |
| — |
| — |
| — |
| ||||
Weighted-average fair value at grant date |
| $ | 7.44 |
| $ | 6.38 | (1) | $ | 3.89 |
| $ | 4.04 |
|
|
| Employee and Director Options |
| Employee Stock |
| |||||||||||||||||||||
|
| Nine Months Ended |
| Nine Months Ended |
|
| Three Months Ended |
| Three Months Ended |
| ||||||||||||||||
|
| December |
| December |
| December |
| December |
|
| September |
| September |
| September |
| September |
| ||||||||
Expected term (in years) |
| 4.80 |
| 4.79 |
| 0.5 |
| 0.5 |
|
| 5.41 |
| 5.67 |
| 0.5 |
| 0.5 |
| ||||||||
Risk-free interest rate |
| 5.00 | % | 4.63 | % | 4.74 | % | 4.08 | % |
| 4.81 | % | 5.00 | % | 5.07 | % | 4.68 | % | ||||||||
Volatility |
| 54.19 | % | 46.96 | % | 44.34 | % | 43.02 | % |
| 50.83 | % | 54.60 | % | 34.58 | % | 41.40 | % | ||||||||
Dividend yield |
| — |
| — |
| — |
| — |
|
| — |
| — |
| — |
| — |
| ||||||||
Weighted-average fair value at grant date |
| $ | 5.68 |
| $ | 5.06 | (1) | $ | 3.89 |
| $ | 4.04 |
|
| $ | 8.16 |
| $ | 5.66 |
| $ | 4.58 |
| $ | 3.55 |
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||
|
| Six Months Ended |
| Six Months Ended |
| |||||||||||||||||||||
|
| September |
| September |
| September |
| September |
| |||||||||||||||||
Expected term (in years) |
| 5.43 |
| 4.67 |
| 0.5 |
| 0.5 |
| |||||||||||||||||
Risk-free interest rate |
| 4.81 | % | 5.04 | % | 5.07 | % | 4.68 | % | |||||||||||||||||
Volatility |
| 50.90 | % | 54.33 | % | 34.58 | % | 41.40 | % | |||||||||||||||||
Dividend yield |
| — |
| — |
| — |
| — |
| |||||||||||||||||
Weighted-average fair value at grant date |
| $ | 8.26 |
| $ | 5.44 |
| $ | 4.58 |
| $ | 3.55 |
|
(1) As restated.
To estimate volatility for the binomial-lattice model, we use methods or capabilities that are discussed in SFAS No. 123R and SAB No. 107. These methods included the implied volatility method based upon the volatilities for exchange-traded options on our stock to estimate short-term volatility, the historical method (annualized standard deviation of the instantaneous returns on Activision’s stock) during the option’s contractual term to estimate long-term volatility and a statistical model to estimate the transition or “mean reversion” from short-term volatility to long-term volatility. Based on these methods, for options granted during the three months ended September 30, 2007, the expected stock price volatility ranged from 45.56% to 51.95%, with a weighted-average volatility of 50.83% for options granted during the quarter ended December 31,September 30, 2007. For options granted during the three months ended September 30, 2006, the expected stock price volatility ranged from 44.20%50.70% to 56.10%55.84%, with a weighted averageweighted-average volatility of 53.10%54.60% for options granted during the quarter ended December 31, 2006. For options granted during the three months ended December 31, 2005, the expected stock price volatility ranged from 37% to 64%, with a weighted average volatility of 49%.September 30, 2006.
As iswas the case for volatility, the risk-free rate is assumed to change during the option’s contractual term. Consistent with the calculation required by a binomial lattice model, the risk-free rate reflects the interest from one time period to the next (“forward rate”) as opposed to the interest rate from the grant date to the given time period (“spot rate”). Since we do not currently pay dividends and are not expected to pay them in the future, we have assumed that the dividend yield is zero.
ACTIVISION, INC. AND SUBSIDIARIESNotes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006(Unaudited)
The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding and is, as required by SFAS No. 123R, an output by the binomial-lattice model. The expected life of employee stock options depends on all of the underlying assumptions and
29
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
calibration of our model. A binomial-lattice model can be viewed as assuming that employees will exercise their options when the stock price equals or exceeds an exercise boundary. The exercise boundary is not constant but continually declines as one approaches the option’s expiration date. The exact placement of the exercise boundary depends on all of the model inputs as well as the measures that are used to calibrate the model to estimated measures of employees’ exercise and termination behavior.
As stock-based
Stock-based compensation expense recognized in the Consolidated Statement of Operations for the three and nine months ended December 31, 2006 is based on awards ultimately expected to vest itand has been reduced for estimated forfeitures. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience.
Accuracy of Fair Value Estimates
The Company uses third-party analyses to assist in developing the assumptions used in the binomial-latticebinomial lattice model, including model inputs and measures of employees’ exercise and post-vesting termination behavior. However, we are ultimately responsible for the assumptions used to estimate the fair value of our share-based payment awards.
Our ability to accurately estimate the fair value of share-based payment awards as of the grant date depends upon the accuracy of the model and our ability to accurately forecast model inputs as long as ten years into the future. These inputs include, but are not limited to, expected stock price volatility, risk-free rate, dividend yield, and employee termination rates. Although the fair value of employee stock options is determined in accordance with SFAS No. 123R and SAB 107 using an option-pricing model, the estimates that are produced by this model may not be indicative of the fair value observed between a willing buyer/willing seller. Unfortunately, it is difficult to determine if this is the case, because markets do not currently exist that permit the active trading of employee stock option and other share-based instruments.
ACTIVISION, INC. AND SUBSIDIARIESNotes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006(Unaudited)
Stock option activity for the ninesix months ended December 31, 2006September 30, 2007 is as follows (in thousands, except per share amounts):
|
| Shares |
| Weighted- |
| Weighted- |
| Aggregate |
| ||
Outstanding at March 31, 2007 |
| 49,429 |
| $ | 7.18 |
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
| ||
Granted |
| 8,270 |
| 18.92 |
|
|
|
|
| ||
Exercised |
| (3,682 | ) | 6.88 |
|
|
|
|
| ||
Forfeited |
| (1,174 | ) | 10.75 |
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Outstanding at September 30, 2007 |
| 52,843 |
| $ | 9.03 |
| 6.08 |
| $ | 663,699 |
|
|
|
|
|
|
|
|
|
|
| ||
Exercisable at September 30, 2007 |
| 32,346 |
| $ | 5.27 |
| 4.45 |
| $ | 527,808 |
|
30
| Shares |
| Weighted- |
| Weighted- |
| Aggregate |
| |||
Outstanding at March 31, 2006 |
| 48,337 |
| $ | 6.20 |
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
| ||
Granted |
| 5,796 |
| 13.57 |
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Exercised |
| (3,353 | ) | 5.03 |
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Forfeiture |
| (1,650 | ) | 8.21 |
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Outstanding at December 31, 2006 |
| 49,130 |
| $ | 7.08 |
| 6.18 |
| $ | 497,692 |
|
|
|
|
|
|
|
|
|
|
| ||
Exercisable at December 31, 2006 |
| 30,402 |
| $ | 4.45 |
| 4.85 |
| $ | 368,064 |
|
ACTIVISION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
The aggregate intrinsic value in the table above represents the total pretax intrinsic value (i.e., the difference between our closing stock price on the last trading day of our thirdsecond quarter of fiscal 20072008 and the exercise price, times the number of shares) that would have been received by the option holders had all option holders exercised their options on December 31, 2006.September 30, 2007. This amount changes based on the fair market value of our common stock. Total intrinsic value of options actually exercised was $15.3is $34.3 million and $32.0$46.4 million for the three and ninesix months ended December 31,September 30, 2007, respectively. Total intrinsic value of options exercised is $9.0 million and $16.7 million for the three and six months ended September 30, 2006, respectively.
As of December 31, 2006, $38.3September 30, 2007, $69.7 million of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 1.641.8 years.
ACTIVISION, INC. AND SUBSIDIARIESNotes
On June 8, 2007, with respect to Consolidated Financial StatementsForunexercised options subject to Section 409A of the ThreeInternal Revenue Code held by employees who are not executive officers, Activision commenced an offer to amend the exercise price of these options to eliminate the grantee’s Section 409A tax liability consistent with Internal Revenue Service guidance. Pursuant to the offer, which closed on July 6, 2007, the Company will make a cash payment in January 2008 to employees who have accepted the offer, totaling approximately $4.1 million, which represents the difference between the original exercise price of each amended option and Nine Months ended December 31, 2006(Unaudited)
the amended exercise price of each amended option. The following table summarizes information aboutoffer with respect to all employee and director stockeligible options outstandingis considered a modification of those options for financial reporting purposes. Pursuant to the accounting standards in effect under SFAS No. 123R, the incremental fair value of approximately $1 million, created as a result of December 31, 2006 (share amounts in thousands):cash payments that become payable pursuant to the terms of the offer, was recognized as compensation expense at the expiration of the offer period on July 6, 2007.
| Outstanding Options |
| Exercisable Options |
| |||||||||
|
| Shares |
| Remaining |
| Wtd. Avg. |
| Shares |
| Wtd. Avg. |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Range of exercise prices: |
|
|
|
|
|
|
|
|
|
|
| ||
$1.00 to $1.08 |
| 665 |
| 3.36 |
| $ | 1.05 |
| 665 |
| $ | 1.05 |
|
$1.72 to $1.75 |
| 8,202 |
| 2.22 |
| 1.75 |
| 8,202 |
| 1.75 |
| ||
$1.76 to $3.52 |
| 5,357 |
| 5.33 |
| 3.34 |
| 4,699 |
| 3.34 |
| ||
$3.54 to $5.00 |
| 5,712 |
| 5.99 |
| 4.04 |
| 5,099 |
| 4.07 |
| ||
$5.08 to $5.74 |
| 4,959 |
| 5.61 |
| 5.72 |
| 4,292 |
| 5.72 |
| ||
$5.79 to $7.73 |
| 6,607 |
| 6.21 |
| 7.12 |
| 5,800 |
| 7.09 |
| ||
$7.75 to $11.10 |
| 5,535 |
| 7.86 |
| 9.78 |
| 861 |
| 8.80 |
| ||
$11.15 to $13.08 |
| 4,930 |
| 8.57 |
| 12.31 |
| 476 |
| 12.02 |
| ||
$13.13 to $14.33 |
| 4,935 |
| 9.25 |
| 13.65 |
| 61 |
| 13.90 |
| ||
$14.37 to $17.21 |
| 2,228 |
| 9.08 |
| 15.36 |
| 247 |
| 15.49 |
| ||
|
| 49,130 |
| 6.18 |
| $ | 7.08 |
| 30,402 |
| $ | 4.45 |
|
16.14. Impact of Recently Issued Accounting Standards and Laws
On February 16, 2006, the FASB issued Statement No. 155 (“SFAS No. 155”), Accounting for Certain Hybrid Financial Instruments – An amendment of FASB Statements No. 133 and 140. SFAS No. 155 amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities to resolve issues addressed in Statement 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS No. 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133; establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not expect that the adoption of SFAS No. 155 will have a material effect on our financial position or results of operations.
On March 17, 2006, the FASB issued Statement No. 156 (“SFAS No. 156”), Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140. SFAS No. 156 amends Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in certain situations; requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable;
40
ACTIVISION, INC. AND SUBSIDIARIESNotes to Consolidated Financial StatementsFor the Three and Nine Months ended December 31, 2006(Unaudited)
permits either the “amortization method”or the “fair value measurement method,”as subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities; permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights; and requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. SFAS No. 156 is effective in the first fiscal year that begins after September 15, 2006. We do not expect that the adoption of SFAS No. 156 will have a material effect on our financial position or results of operations.
In July 2006, the FASB issued Final Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest, and penalties, accounting in interim periods, disclosure, and transition. In addition, FIN 48 excludes income taxes from the scope of SFAS No. 5, Accounting for Contingencies. FIN 48 is effective for fiscal years beginning after December 15, 2006. Differences between the amounts recognized in the consolidated balance sheets prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We are currently evaluating the effect that the adoption of FIN 48 will have on our results of operations and financial position.
On September 20, 2006, the FASB issued Statement No. 157 (“SFAS No. 157”), Fair Value Measurements.SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 applies underto other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We do not expect that the adoption of SFAS No. 157 will have a material effect on our financial position or results of operations.
In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, Financial Statements — Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 requires the use of both the “iron curtain” and “rollover” approach in quantifying the materiality of misstatements. SAB 108 also discusses the implications of misstatements uncovered upon the application of SAB 108 in situations when a registrant has historically been using either the iron curtain approach or the rollover approach. SAB 108 is effective for fiscal years ending after November 15, 2006. We are currently evaluating the effect that the adoption of SAB 108 will have on our results of operations and financial position.
On September 29, 2006,February 2007, the FASB issued Statement No. 158,159, Employers’ AccountingThe Fair Value Option for Defined Benefit PensionFinancial Assets and Other Postretirement Plans,Financial Liabilities — Including an amendment of FASB StatementsStatement No. 87, 88, 106, and 132(R) 115(“ (“SFAS No. 158”159”). This new standard aims to make it easier for investors, employees, retirees and other parties to understand and assess an employer’s financial position and its ability to fulfill the obligations under its benefit plans. SFAS No. 158 requires employers159 permits entities to fully recognizechoose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in theirearnings. The provisions of SFAS No. 159 are effective for financial statements issued for fiscal years beginning after November 15, 2007. We are evaluating if we will adopt the obligations associatedfair value option of SFAS No. 159 and what impact the adoption will have on our Consolidated Financial Statements if we adopt.
In June 2007, the FASB ratified the Emerging Issues Task Force’s (“EITF”) consensus conclusion on EITF 07-03, “Accounting for Advance Payments for Goods or Services to Be Used in Future Research and Development”. EITF 07-03 addresses the diversity which exists with single-employer defined benefit pension plans, retiree healthcare plans, and other postretirement plans. Specifically, it requires a companyrespect to (1) recognize on its balance sheet an assetthe accounting for a plan’s overfunded status or a liability for a plan’s underfunded status, (2) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year, and (3) recognize changes in the funded statusnon-refundable portion of a plan through comprehensive incomepayment made by a research and development entity for future research and development activities. Under this conclusion, an entity is required to defer and capitalize non-refundable advance payments made for research and development activities until the related goods are delivered or the related services are performed. EITF 07-03 is effective for interim or annual reporting periods in fiscal years beginning after December 15, 2007 and requires prospective application for new contracts entered into after the year in which the changes occur.effective date. We do not expect that the adoption of SFAS No. 158 willEITF 07-03 to have an effecta material impact on our financial position or results of operations as we do not maintain any single-employer defined benefit pension plans, retiree healthcare plans, and other postretirement plans.Consolidated Financial Statements.
31
Stock Option Practices and Restatement of Consolidated Financial Statements
We recently completed a voluntary review of our historical stock option granting practices and a restatement of our consolidated financial statements as of and for the fiscal years ended March 31, 2006, 2005 and 2004 and related disclosures and a restatement of our selected consolidated financial data as of and for the fiscal years ended March 31, 2006, 2005, 2004, 2003 and 2002 and our unaudited quarterly financial data for each of the quarters in the fiscal years ended March 31, 2006 and 2005, and for the fiscal quarter ended June 30, 2006. The impacts of the restatement adjustments extend to periods from the fiscal year ended March 31, 1994 through the fiscal quarter ended June 30, 2006.
The restatement reflected the findings of a special subcommittee of independent members of our Board of Directors, which was established in July 2006 to review our historical stock option granting practices (the “Special Subcommittee”). The Special Subcommittee conducted its investigation with the assistance of Munger Tolles & Olson LLP as its independent counsel and Deloitte & Touche USA LLP (“Deloitte”) as forensic accounting experts retained by counsel. The Special Subcommittee found that 3,450 of the option grants reviewed, covering 148,747,202 shares, required measurement date corrections. As a result, we recorded approximately $66.7 million in additional pre-tax ($45.4 million after-tax) non-cash stock-based compensation expense over the thirteen year period from April 1, 1993 through March 31, 2006 in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and $0.6 million in additional pre-tax non-cash stock-based compensation expense during the quarter ended June 30, 2006 in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment”. More than 80%, or $55.4 million of the $66.7 million, relates to periods through March 31, 2003 and 4% or $2.6 million of the non-cash pre-tax expense relates to the fiscal year ended March 31, 2006. Separately, the restatement reflected an additional $1.7 million pre-tax charge ($1.1 million after-tax) related to recently identified insufficient payroll tax withholdings in fiscal 2005.
The following table summarizes additional pre-tax stock-based compensation expense and related tax adjustments resulting from the review of our equity award practices for the three and nine months ended December 31, 2005:
|
| For the three months |
| For the nine months |
| ||
(in thousands) |
| December 31, 2005 |
| December 31, 2005 |
| ||
|
|
|
|
|
| ||
Net income, as previously reported |
| $ | 67,945 |
| $ | 51,118 |
|
|
|
|
|
|
| ||
Additional compensation expense resulting from improper measurement dates for stock option grants (1) |
| 174 |
| 2,286 |
| ||
|
|
|
|
|
| ||
Tax related effects |
| (85 | ) | (547 | ) | ||
|
|
|
|
|
| ||
Total effect on net income |
| 89 |
| 1,739 |
| ||
|
|
|
|
|
| ||
Net income, as restated |
| $ | 67,856 |
| $ | 49,379 |
|
(1) Also includes an immaterial amount of interest expense related to our $1.7 million charge for insufficient payroll tax withholdings in fiscal 2005.
Certain Tax Consequences: Certain stock options were granted with an exercise price lower than the fair market value on the actual measurement dates, with vesting occurring after December 31, 2004, which resulted in nonqualified deferred compensation for purposes of Section 409A of the Internal Revenue Code. Section 409A subjects the option holders to additional income tax, penalties and interest on the value of the options deferred and, in certain cases, exercised each year. We do not have any tax liability associated with Section 409A. For options that have already been exercised by non-executive officer employees, that are subject to Section 409A consequences, the Company has elected to participate in the Internal Revenue Service program described in IRS Announcement 2007-18 pursuant to which the Company was able to pay the Section 409A taxes on behalf of its non-executive officer employees, and has incurred $7.3 million in additional pre-tax compensation expense in the fiscal quarter ended March 31, 2007, in absorbing these related costs on behalf of these employees. With respect to unexercised options subject to Section 409A held by such current and former non-executive officer employees, the Company on or about June 7, 2007 is commencing an offer to amend the exercise price of these options to eliminate their Section 409A tax liability consistent with Internal Revenue Service guidance. Pursuant to the offer, the Company will also make a cash payment in January 2008 to employees who accept the offer, in an amount equal to the difference between the original exercise price of each amended option and the amended exercise price of each amended option. This will likely result in additional future compensation expense to the Company once these actions occur.
Overview
Our Business
We are a leading international publisher of interactive entertainment software products. We have built a company with a diverse portfolio of products that spans a wide range of categories and target markets and that are used on a variety of game hardware platforms and operating systems. We have created, licensed, and acquired a group of highly recognizable brands, which we market to a variety of consumer demographics. Our fiscal 20072008 product portfolio includes titles such as OverGuitar Hero II for the Hedge, X-Men:Microsoft Xbox360, Spider-Man 3 The Official Game Marvel: Ultimate Alliance, Tony Hawk’s Project 8, Tony Hawk’s Downhill Jam,(“Spider-Man 3”), Shrek the Third, TRANSFORMERS: The Game, Enemy Territory: Quake Wars, Call of Duty 3, 4: Modern Warfare, Tony Hawk’s Proving Ground, Bee Movie Game, Spider-Man: Friend or Foe, andGuitar Hero 2.III.
Our products cover diverse game categories including action/adventure, action sports, racing, role-playing, simulation, first-person action, music-based gaming, and strategy. Our target customer base ranges from casual players to game enthusiasts, children to adults, and mass-market consumers to “value” buyers. We currently offer our products primarily in versions that operate on the Sony PlayStation 2 (“PS2”), the Sony PlayStation 3 (“PS3”), the Nintendo GameCube (“GameCube”), the Nintendo Wii (“Wii”), the Microsoft Xbox (“Xbox”), and the Microsoft Xbox360 (“Xbox360”) console systems, the Nintendo Game Boy Advance (“GBA”), the Nintendo Dual Screen (“NDS”), and the Sony PlayStation Portable (“PSP”) hand-held devices, and the personal computer (“PC”). The installed base for the currentprevious generation of hardware platforms (e.g., PS2, Microsoft Xbox) is significant and the fiscal 2006 release of the Xbox360 and the fiscal 2007 third quarter releases of the PS3 in Japan and North America, and the Wii will further expand the software market. During the third quarter of fiscal 2007, we had a successful and significant presence at the launches of the PS3 and the Wii with three launch titles for the PS3, Call of Duty 3, Marvel: Ultimate Alliance,and Tony Hawk’s Project 8,and five launch titles for the Wii, Call of Duty 3, Marvel: Ultimate Alliance, World Series of Poker: Tournament of Champions, Rapala Tournament Fishing, and Tony Hawk’s Downhill Jam.In the first quarter of fiscal 2008, we had strong releases of Guitar Hero II for the Xbox360, and multi platform releases of Spider-Man 3, Shrek the Third, and TRANSFORMERS: The Game in North America. In the second quarter of fiscal 2008, we continued the strong momentum of Guitar Hero II and released Guitar Hero: Rocks the 80s for the PS2. Further, we released TRANSFORMERS: The Game in Europe in the second quarter of fiscal 2008. Our plan is to continue to build on oura significant launch presence on the PS3, Wii, and Xbox360 (“the next-generation platforms”) by continuing to expand the number of titles released on the next generation and hand-held platforms while continuing to market to current-generation platformsthe PS2 platform as long as economically attractive given their large installed base.
Our publishing business involves the development, marketing, and sale of products directly, by license, or through our affiliate label program with certain third partythird-party publishers. In North America, we primarily sell our products on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses, and game specialty stores. We conduct our international publishing activities through offices in the United Kingdom (“UK”), Germany, France, Italy, Spain, the Netherlands, Sweden, Australia, Scandinavia, Canada, South Korea, and Japan. Our products are sold internationally on a direct-to-retail basis, through third party distribution and licensing arrangements, and through our wholly owned European distribution subsidiaries. Our distribution business consists of operations located in the UK, the Netherlands, and Germany that provide logistical and sales services to third-party publishers of interactive entertainment software, our own publishing operations, and manufacturers of interactive entertainment hardware.
Our profitability is directly affected by the mix of revenues from our publishing and distribution businesses. Operating margins realized from our publishing business are typically substantially higher than margins realized from our distribution business. Operating margins in our publishing business are affected by our ability to release highly successful or “hit” titles. Though many of these titles have substantial production or acquisition costs and marketing budgets, once a title recoups these costs, incremental net revenues directly and positively impact our operating margin. Operating margins in our distribution business are affected by the mix of hardware and software sales, with software typically producing higher margins than hardware.
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Our Focus
With respect to future game development, we will continue to focus on our “big propositions,” products that are backed by strong brands and high quality development, for which we will provide significant marketing support.
Our fiscal 20072008 releases have includedinclude well-established brands, which are backed by high-profile intellectual property and/or highly anticipated motion picture releases. For example, we have a long-term
relationship with Marvel Entertainment, Inc. through an exclusive licensing agreement for the Spider-Man and X-Men franchises through 2017. This agreement grants us the exclusive rights to develop and publish video games based on Marvel’s comic book franchisesand movie franchises; Spider-Man and X-Men. Through December 31, 2006,September 30, 2007, games based on the Spider-Man and X-Men franchises have generated approximately $850 million$1.0 billion in net revenues worldwide. Under this agreement, in the first quarter of fiscal 2007 we released the video game, X-Men: The Official Game, coinciding with the theatrical release of “X-Men: The Last Stand.” In the third quarter of fiscal 2007, we released Marvel: Ultimate Allianceacross multiple platformsand Spider-Man: Battle for New York on the NDS and GBA. In addition, through our licensing agreement with the first quarter of fiscal 2008 we released Spider-Man Merchandising, LP, we developed and published video games3 based on Columbia Pictures/Marvel Entertainment, Inc.’s feature film “Spider-Man 3,” which was released in May 2007. We also have an2007 through our licensing agreement with Spider-Man Merchandising, LP. Our agreement with Spider-Man Merchandising, LP for thegrants us exclusive worldwide publishing rights to publish entertainment software products based on subsequent Spider-Man movie sequels or new television series through 2017.
We also have an exclusive licensing agreement with professional skateboarder Tony Hawk. The agreement grants us exclusive rights to develop and publish video games through 2015 using Tony Hawk’s name and likeness. Through December 31, 2006,September 30, 2007, we have released nineeight successful titles in the Tony Hawk franchise with cumulative net revenues of $1.2 billion, including the two fiscal 2007 third quarter releases, Tony Hawk’s Project 8,which was released on the PSP, Xbox360, PS2, and PS3, and Tony Hawk’s Downhill Jamwhich was released on the Wii, NDS, and GBA. According to the NPD Group, which is a provider of consumer and retail market research information for a wide range of industries, for the eighth consecutive year in 2007 the Tony Hawk franchise had a top 10 best-selling gamein the U.S. for the month of December. We will continue to build on the highly successful Tony Hawk franchise with future releases currently in development for multiple platforms.
We continue to develop a number of original intellectual properties internally. For example, in the third quarter of fiscal 2007 we released Call of Duty 3 on the PS2, PS3, Xbox, Xbox360, and the Wii. According to the NPD Group, Call of Duty 3 was the #3 best-selling console game in the U.S. Call of Duty 3 was the sixth2008 release based upon this original intellectual property following two PC exclusive titles, Call of Duty and Call of Duty: United Offensive, as well as multi-platform releases of Call of Duty: Finest Hour, Call of Duty: Big Red One, Tony Hawk’s Proving Groundand Call of Duty 2. We expect to continue to develop a variety of games on multiple platforms based on this original intellectual property as well as continue to invest in developing other original intellectual properties..
We have continued our focus on establishing and maintaining relationships with talented and experienced software development and publishing teams. In June 2006, we acquired RedOctane, Inc. (“RedOctane”), the publisher of the popular Guitar Hero franchise. In the third quarter of fiscal 2007, we released Guitar Hero 2 IIon the PS2, which according to the NPD Group was the #1 game in dollars for the U.S. for the month of December and the #2 game overall for the third quarter of fiscal 2007. We are also currently developingIn the first quarter of fiscal 2008 we released Guitar Hero 2 IIfor the Xbox360 andXbox360. Additionally, further strengthening the Guitar Hero franchise, in the second quarter of fiscal 2008, we released our first expansion pack, Guitar Hero: Rocks the 80s on the PS2. We plan on continuing to build on this franchise by investing in future development of Guitar Hero titles across a variety of platforms. In September 2007, we acquired U.K.-based video game developer Bizarre Creations, a leader in the racing category. With more than 10 years experience in the racing genre, Bizarre Creations was the developer of the innovative multi-million unit selling franchise, Project Gotham Racing, a critically-acclaimed series for the Xbox and Xbox360. Bizarre Creations and its games have won numerous industry awards including: Best Racing Game for Project Gotham Racing 2 from the prestigious British Academy of Film and Television Arts (BAFTA); the Industry Grand Prix Award from Develop; MCV’s UK Development Team 2006 award; Best Racing/Driving Game from IGN; Game of the Year from OXM and Gamespy for Project Gotham Racing 3; and IGN’s Best XBLA Game for Geometry Wars: Retro Evolved. Bizarre Creations will play role in our growth strategy as we develop intellectual property for the racing segment, expand our development capability and capacity for other genres and utilize Bizarre Creations’ proprietary development technology. We also have development agreements with other top-level, third-party developers such as id Software, Inc., Edge of Reality, Ltd., Splash Damage, Ltd., and Traveller’s Tales.Next Level Games.
We will also continue to evaluate and exploit emerging brands that we believe have potential to become successful game franchises. For example, we have a multi-year, multi-property, publishing agreement
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with DreamWorks Animation LLC that grantsgranted us the exclusive rights to publish video games based on DreamWorks Animation SKG’s theatrical release “Shrek 2,” which was released in the first quarter of fiscal 2005, “Shark Tale,” which was released in the second quarter of fiscal 2005, “Madagascar,” which was released in the first quarter of fiscal 2006, “Over the Hedge,” which was released in the first quarter of fiscal 2007, “Shrek the Third” which was released in the first quarter of fiscal 2008, and all of their respective sequels. In addition, our multi-year agreement with DreamWorks Animation SKGLLC also grants us the exclusive video game rights to fourthe recently released The Bee Movie and three upcoming feature films, including Kung Fu Panda, Monsters vs Aliens as well as potential future films in the “Shrek” franchise beyond “Shrek the “Shrek the Third.Third.”
Additionally, we have a strategic alliance with Harrah’s Entertainment, Inc. that grants us the exclusive, worldwide interactive rights to develop and publish “World Series of Poker” video games based on the popular World Series of Poker Tournament. In the second quarter of fiscal 2006, we released our first title under this alliance, World Series of Poker,which became the number one poker title of calendar 2005. Further building on this franchise, in the second quarter of fiscal 2007, we released our second title under this alliance, World Series of Poker: Tournament of Champions. Further, we released our third title under this alliance, World Series of Poker: Battle for the Bracelet in the second quarter of fiscal 2008.
We also continue to build on our portfolio of licensed intellectual property. In February 2006, we signed an agreement with Hasbro Properties Group granting us the exclusive global rights (excluding Japan) to develop console, hand-held, and PC games based on Hasbro’s “Transformers” brand. We anticipate releasing thehad a strong initial release of our first game in late June 2007 concurrently with the early July 2007 movie release of the live action “Transformers” film from DreamWorks Pictures and Paramount Pictures. In April 2006, we signed an agreement with MGM Interactive and EON Productions Ltd. granting us the exclusive rights to develop and publish interactive entertainment games based on the James Bond license through 2014. In MayApril 2006, we signed a multi-year agreement with Mattel, Inc. which grants us the exclusive worldwide distribution rights to newfor the catalog of video games on all platforms based on Mattel, Inc.’s Barbie brand. brand on all platforms. In the third quarter of fiscal 2006,2007, we distributed six Barbie titles: Barbie in the 12 Dancing Princesses, The Barbie Diaries: High School Mystery, Barbie Fashion Show, Barbie Horse Adventures: Mystery Ride, Barbie and the Magic of Pegasus,and Barbie as the Princess and the Pauper. Based on the success of this distribution, we signed multi-year license agreements with Mattel, Inc. in January 2007 which grant us the exclusive worldwide rights to develop and publish new video games based on Mattel Inc.’s Barbie and Hot Wheels brands on all platforms. In the second quarter of fiscal 2008, we released Hot Wheels: Beat That!. In September 2006, we entered into a distribution agreement with MTV Networks Kids and Family Group’s Nickelodeon, a division of Viacom Inc., to be the exclusive distributor of three new Nick Jr. PC CD-ROM titles, published by Nickelodeon and based on the top preschool series on commercial television, Dora The Explorer, The Backyardigans,and Go, Diego, Go!.
We are utilizing these developer relationships, new intellectual property acquisitions, new original intellectual property creations, and our existing library of intellectual property to further focus our game development on product lines that will deliver significant, lasting, and recurring revenues and operating profits.
Critical Accounting Policies and Estimates
We have identified the policies below as critical to our business operations and the understanding of our financial results. The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 to the Notes to Consolidated Financial Statements included in Item 1. The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition.We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers.customers, and once any performance obligations have been completed. Certain products are sold to customers with a street date (the earliest date thatthese products are made widely available for salemay be sold by retailers). For these products we recognize revenue no earlier thanon the later of the street date or the sale date. Revenue from product sales is
34
recognized after deducting the estimated allowance for returns and price protection. With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery of such copies.a master copy. Per copy royalties on sales that exceed the guarantee are recognized as earned.
Some of our software products provide limited online features at no additional cost to the consumer. Generally, we consider such features to be incidental to the overall product offering and an inconsequential deliverable. Accordingly, we do not defer any revenue related to products containing these limited online features. In instances where online features or additional functionality is considered a substantive deliverable in addition to the software product, the company contemplates such when determining the appropriate revenue recognition. This evaluation is performed for each software product when it is released. We determined that one of our software titles released this quarter, Enemy Territory: Quake Wars (which is primarily an online multiplayer PC game), contains online functionality that constitutes a more-than-inconsequential separate service deliverable in addition to the product, principally because of its importance to game play. As such, our performance obligations for this title extend beyond the sale of the game, which is unique compared to other prior titles. Vendor-specific objective evidence of fair value (“VSOE”) does not exist for the online functionality, as we do not separately charge for this component of the title. As a result, we are recognizing all of the revenue from the sale of this title ratably over an estimated service period, which is estimated to be six months beginning the month after shipment. In addition, we are deferring the costs of sales for this title. Cost of sales includes: manufacturing costs, software royalties and amortization, and intellectual property licenses. Overall, online play functionality is still an emerging area for us. As we move forward, we will monitor this developing functionality and its significance for our products. Our assessment of our obligations with respect to this functionality and the resulting accounting may change in the future.
With respect to online transactions, such as electronic downloads of titles or product add-ons, revenue is recognized when the fee is paid by the on-lineonline customer to purchase on-lineonline content and we are notified by the online retailer that the product has been downloaded. In addition, in order to recognize revenue for both product sales and licensing transactions, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable. Revenue recognition also determines the timing of certain expenses, including cost of sales — intellectual property licenses and cost of sales — software royalties and amortization.
Sales incentives or other consideration given by us to our customers is accounted for in accordance with the Financial Accounting Standards Board’s Emerging Issues Task Force (“EITF”) Issue 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).” In accordance with EITF Issue 01-9, sales incentives and other consideration that are considered adjustments of the selling price of our products, such as rebates and product placement fees, are reflected as reductions of revenue. Sales incentives and other consideration that represent costs incurred by us for assets or services received, such as the appearance of our products in a customer’s national circular ad, are reflected as sales and marketing expenses.
Allowances for Returns, Price Protection, Doubtful Accounts, and Inventory Obsolescence.In determining the appropriate unit shipments to our customers, we benchmark our titles using historical and industry data. We closely monitor and analyze the historical performance of our various titles, the performance of products released by other publishers and the anticipated timing of other releases in order to assess future demands of current and upcoming titles. Initial volumes shipped upon title launch and subsequent reorders are evaluated to ensure that quantities are sufficient to meet the demands from the retail markets but at the same time, are controlled to prevent excess inventory in the channel.
We may permit product returns from, or grant price protection to, our customers under certain conditions. In general, price protection refers to the circumstances when we elect to decrease the wholesale price of a product by a certain amount and, when granted and applicable, allows customers a credit against amounts owed by such customers to us with respect to open and/or future invoices. The conditions our customers must meet to be granted the right to return products or price protection are, among other things, compliance with applicable payment terms, and consistent delivery to us of inventory and sell-through reports. We may also consider other factors, including the facilitation of slow-moving inventory and other market factors. Management must make estimates of potential future product returns and price protection related to current period product revenue. We estimate
35
the amount of future returns and price protection for current period product revenue utilizing historical experience and information regarding inventory levels and the demand and acceptance of our products by the end consumer. The following factors are used to estimate the amount of future returns and price protection for a particular title: historical performance of titles in similar genres, historical performance of the hardware platform, historical performance of the brand, console hardware life cycle, Activision sales force and retail customer feedback, industry pricing, weeks of on-hand retail channel inventory, absolute quantity of on-hand retail channel inventory, our warehouse on-hand inventory levels, the title’s recent sell-through history (if available), marketing trade programs, and competing titles. The relative importance of these factors varies among titles depending upon, among other items, genre, platform, seasonality, and sales strategy. Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price protection in any accounting period. Based upon historical experience we believe our estimates are reasonable. However, actual returns and price protection could vary materially from our allowance estimates due to a number of reasons including, among others, a lack of consumer acceptance of a title, the release in the same period of a similarly themed title by a competitor, or technological obsolescence due to the emergence of new hardware platforms. Material differences may result in the amount and timing of our revenue for any period if factors or market conditions change or if management makes different judgments or utilizes different estimates in determining the allowances for returns and price protection. For example, a 1% change in our December 31, 2006September 30, 2007 allowance for returns and price protection would impact net revenues by $1.1$1.0 million.
Similarly, management must make estimates of the uncollectibility of our accounts receivable. In estimating the allowance for doubtful accounts, we analyze the age of current outstanding account balances, historical bad debts, customer concentrations, customer creditworthiness, current economic trends, and changes in our customers’ payment terms and their economic condition, as well as whether we can obtain sufficient credit insurance. Any significant changes in any of these criteria would affect management’s estimates in establishing our allowance for doubtful accounts.
We value inventory at the lower of cost or market. We regularly review inventory quantities on hand and in the retail channel and record a provision for excess or obsolete inventory based on the future expected
demand for our products. Significant changes in demand for our products would impact management’s estimates in establishing our inventory provision.
Software Development Costs.Software development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products.
We account for software development costs in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” Software development costs are capitalized once the technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation. For products where proven technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product basis. Prior to a product’s release, we expense, as part of “cost of sales — software royalties and amortization,” capitalized costs when we believe such amounts are not recoverable. Capitalized costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation. Amounts related to software development which are not capitalized are charged immediately to product development expense. We evaluate the future recoverability of capitalized amounts on a quarterly basis. The recoverability of capitalized software development costs is evaluated based on the expected performance of the specific products for which the costs relate. Criteria used to evaluate expected product performance include: historical performance of comparable products using comparable technology; orders for the product prior to its release; and estimated performance of a sequel product based on the performance of the product on which the sequel is based.
Commencing upon product release, capitalized software development costs are amortized to “cost of sales — software royalties and amortization” based on the ratio of current revenues to total projected revenues, generally resulting in an amortization period of six months or less. For products that have been released in prior
36
periods, we evaluate the future recoverability of capitalized amounts on a quarterly basis. The primary evaluation criterion is actual title performance.
Significant management judgments and estimates are utilized in the assessment of when technological feasibility is established, as well as in the ongoing assessment of the recoverability of capitalized costs. In evaluating the recoverability of capitalized costs, the assessment of expected product performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual product sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge.
Intellectual Property Licenses. Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks, copyrights, software, technology, or other intellectual property or proprietary rights in the development of our products. Depending upon the agreement with the rights holder, we may obtain the rights to use acquired intellectual property in multiple products over multiple years, or alternatively, for a single product.
We evaluate the future recoverability of capitalized intellectual property licenses on a quarterly basis. The recoverability of capitalized intellectual property license costs is evaluated based on the expected performance of the specific products in which the licensed trademark or copyright is to be used. As many of our intellectual property licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized intellectual property license costs based on certain qualitative factors such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned theatrical releases or television series based on the intellectual property, and the rights holder’s continued promotion and exploitation of the intellectual property. Prior to the related product’s release, we expense, as part of “cost of sales — intellectual property licenses,” capitalized intellectual property costs when we believe such amounts are not recoverable. Capitalized intellectual property costs for those products that are
cancelled or abandoned are charged to product development expense in the period of cancellation. Criteria used to evaluate expected product performance include: historical performance of comparable products using comparable technology; orders for the product prior to its release; and estimated performance of a sequel product based on the performance of the product on which the sequel is based.
Commencing upon the related product’s release, capitalized intellectual property license costs are amortized to “cost of sales — intellectual property licenses” based on the ratio of current revenues for the specific product to total projected revenues for all products in which the licensed property will be utilized. As intellectual property license contracts may extend for multiple years, the amortization of capitalized intellectual property license costs relating to such contracts may extend beyond one year. For intellectual property included in products that have been released, and unreleased products, we evaluate the future recoverability of capitalized amounts on a quarterly basis. The primary evaluation criterion is actual title performance.
Significant management judgments and estimates are utilized in the assessment of the recoverability of capitalized costs. In evaluating the recoverability of capitalized costs, the assessment of expected product performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual product sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge. Additionally, as noted above, as many of our intellectual property licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized intellectual property license costs based on certain qualitative factors such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned theatrical releases or television series based on the intellectual property and the rights holder’s continued promotion and exploitation of the intellectual property. Material differences may result in the amount and timing of charges for any period if management makes different judgments or utilizes different estimates in evaluating these qualitative factors.
37
Stock-based Compensation Expense. Expense
On April 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”Payment,” (“SFAS No. 123R”), which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan based on estimated fair values. Stock-based compensation expense recognized under SFAS No. 123R for the three and ninesix months ended December 31, 2006September 30, 2007 was $7.7$6.9 million and $18.4$15.0 million, respectively. Stock-based compensation expense under Accounting Principles Board Opinion No. 25, “Accountingrespectively and for Stock Issued to Employees” (“APB 25”) related to employee stock options, restricted stock, and employee stock purchases recognized during the three and ninesix months ended December 31, 2005September 30, 2006 was $322,000$4.9 million and $2.5$10.7 million, respectively. See Note 1513 to the Consolidated Financial Statementsconsolidated financial statements for additional information.
As of April 1, 2005, the
The Company began estimatingestimates the value of employee stock options on the date of grant using a binomial-lattice model. Prior to April 1, 2005 the value of each employee stock option was estimated on the date of grant using the Black-Scholes model for the purpose of the pro-forma financial information in accordance with SFAS 123. The fair value of a share-based payment as of the grant date estimated by an option pricing model depends upon our future stock price andas well as assumptions concerning expected volatility, risk-free interest rate, and risk-adjusted stock return, as well as measures of employees’ forfeiture, exercise, and post-vesting termination behavior. Statistical methods were used to estimate employee type specific termination rates. These termination rates, in turn, were used to model the number of options that are expected to vest and post-vesting termination behavior. Employee type specific estimates of Expected Time-To-Exercise (“ETTE”) were used to reflect employee exercise behavior. ETTE was estimated by using statistical procedures to first estimate the conditional probability of exercise occurring during each time period, conditional on the option surviving to that time period. These probabilities were then used to estimate ETTE. The model was calibrated by adjusting parameters controlling exercise and post-vesting termination behavior so that the measures output by the model matched values of these measures that were estimated from historical data. The weighted-average estimated value of employee stock options granted during the three and nine
months ended December 31, 2006September 30, 2007 was $7.44 and $5.68$8.16 per share using the binomial-lattice model with the following weighted-average assumptions:
|
| Three Months Ended |
| Nine Months Ended |
|
Expected volatility |
| 53.10 | % | 54.19 | % |
Risk-free interest rate |
| 4.70 | % | 5.00 | % |
Expected dividends |
| — |
| — |
|
|
| Three Months Ended |
| Six Months Ended |
|
Expected volatility |
| 50.83 | % | 50.90 | % |
Risk-free interest rate |
| 4.81 | % | 4.81 | % |
Expected dividends |
| — |
| — |
|
To estimate volatility for the binomial-lattice model, we use methods or capabilities that are discussed in SFAS No. 123R and Staff Accounting Bulletin No. 107.107 (“SAB 107”). These methods included the implied volatility method which usesbased upon the market price of tradedvolatilities for exchange-traded options on our stock to estimate short-term volatility, the historical method (annualized standard deviation of the instantaneous returns on Activision’s stock) during the option’s contractual term to estimate long-term volatility and a statistical model to estimate the transition or “mean reversion” from short-term volatility to long-term volatility. Based on these methods, for options granted during the three months ended December 31,September 30, 2007, the expected stock price volatility ranged from 45.56% to 51.95%, with a weighted-average volatility of 50.83% for options granted during the quarter ended September 30, 2007. For options granted during the three months ended September 30, 2006, the expected stock price volatility ranged from 44.20%50.70% to 56.10%55.84%, with a weighted averageweighted-average volatility of 53.10%. For54.60% for options granted during the three months ended December 31, 2005, the expected stock price volatility ranged from 37% to 64%, with a weighted average volatility of 49%.September 30, 2006.
As was the case for volatility, the risk-free rate is assumed to change during the option’s contractual period. As required by a binomial lattice model, the risk-free rate reflects the interest from one time period to the next (“forward rate”) as opposed to the interest rate from the grant date to the given time period (“spot rate”). Since we do not currently pay dividends and aredo not expectedcurrently expect to pay them in the future, we have assumed that the dividend yield is zero.
The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding and is, as required by SFAS No. 123R, output by the binomial-lattice model. The expected life of employee stock options depends on all of the underlying assumptions and calibration of our
38
model. The binomial-lattice model assumes that employees will exercise options when the stock price equals or exceeds an exercise boundary. The exercise boundary is not constant but continually declines as one approaches the option’s expiration date. The exact placement of the exercise boundary depends on all of the model inputs as well as the measures that were used to calibrate the model to estimated measures of employees’ exercise and termination behavior.
As stock-based
Stock-based compensation expense recognized in the Consolidated Statement of Operations for the three and nine months ended December 31, 2006 is based on awards ultimately expected to vest itand has been reduced for estimated forfeitures. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience.
If factors change and we employ different assumptions in the application of SFAS No. 123R in future periods, the compensation expense that we record under SFAS No. 123R may differ significantly from what we have recorded in the current period.
39
Selected Consolidated Statements of Operations Data
The following table sets forth certain Consolidated Statements of Operations data for the periods indicated as a percentage of total net revenues and also breaks down net revenues by territory, business segment and platform, as well as operating income (loss) by business segment as a percentage of segment net revenues (amounts in thousands):
|
| Three Months Ended December 31, |
| Nine Months Ended December 31, |
| ||||||||||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||||||||||
|
|
|
|
|
| As restated |
| As restated |
|
|
|
|
| As restated |
| As restated |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net revenues |
| $ | 824,259 |
| 100 | % | $ | 816,242 |
| 100 | % | $ | 1,200,500 |
| 100 | % | $ | 1,279,875 |
| 100 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Cost of sales — product costs |
| 382,165 |
| 46 |
| 367,685 |
| 45 |
| 618,162 |
| 52 |
| 617,021 |
| 48 |
| ||||
Cost of sales — software royalties and amortization |
| 77,449 |
| 9 |
| 104,264 |
| 13 |
| 106,058 |
| 9 |
| 139,267 |
| 11 |
| ||||
Cost of sales — intellectual property licenses |
| 23,566 |
| 3 |
| 26,376 |
| 3 |
| 37,838 |
| 3 |
| 55,765 |
| 5 |
| ||||
Product development |
| 37,162 |
| 5 |
| 53,254 |
| 7 |
| 88,395 |
| 7 |
| 99,698 |
| 8 |
| ||||
Sales and marketing |
| 87,410 |
| 11 |
| 156,013 |
| 19 |
| 156,139 |
| 13 |
| 259,110 |
| 20 |
| ||||
General and administrative |
| 43,387 |
| 5 |
| 24,757 |
| 3 |
| 91,647 |
| 8 |
| 67,228 |
| 5 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total costs and expenses |
| 651,139 |
| 79 |
| 732,349 |
| 90 |
| 1,098,239 |
| 92 |
| 1,238,089 |
| 97 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Operating income |
| 173,120 |
| 21 |
| 83,893 |
| 10 |
| 102,261 |
| 8 |
| 41,786 |
| 3 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Investment income, net |
| 9,724 |
| 1 |
| 9,162 |
| 1 |
| 26,031 |
| 2 |
| 22,840 |
| 2 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Income before income tax provision |
| 182,844 |
| 22 |
| 93,055 |
| 11 |
| 128,292 |
| 10 |
| 64,626 |
| 5 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Income tax provision |
| 40,024 |
| 5 |
| 25,199 |
| 3 |
| 28,083 |
| 2 |
| 15,247 |
| 1 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net income |
| $ | 142,820 |
| 17 | % | $ | 67,856 |
| 8 | % | $ | 100,209 |
| 8 | % | $ | 49,379 |
| 4 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net Revenues by Territory: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
North America |
| $ | 463,388 |
| 56 | % | $ | 402,314 |
| 49 | % | $ | 637,251 |
| 53 | % | $ | 626,538 |
| 49 | % |
Europe |
| 345,969 |
| 42 |
| 397,356 |
| 49 |
| 535,556 |
| 45 |
| 622,035 |
| 49 |
| ||||
Other |
| 14,902 |
| 2 |
| 16,572 |
| 2 |
| 27,693 |
| 2 |
| 31,302 |
| 2 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total net revenues |
| $ | 824,259 |
| 100 | % | $ | 816,242 |
| 100 | % | $ | 1,200,500 |
| 100 | % | $ | 1,279,875 |
| 100 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net Revenues by Segment/Platform Mix Publishing: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Console |
| $ | 545,070 |
| 66 | % | $ | 479,686 |
| 59 | % | $ | 719,395 |
| 60 | % | $ | 730,073 |
| 57 | % |
Hand-held |
| 71,339 |
| 9 |
| 74,032 |
| 9 |
| 121,125 |
| 10 |
| 143,650 |
| 11 |
| ||||
PC |
| 33,388 |
| 4 |
| 113,782 |
| 14 |
| 69,443 |
| 6 |
| 154,735 |
| 12 |
| ||||
Total publishing net revenues |
| 649,797 |
| 79 |
| 667,500 |
| 82 |
| 909,963 |
| 76 |
| 1,028,458 |
| 80 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Distribution: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Console |
| 102,515 |
| 12 |
| 95,408 |
| 12 |
| 164,640 |
| 14 |
| 163,344 |
| 13 |
| ||||
Hand-held |
| 57,047 |
| 7 |
| 37,154 |
| 4 |
| 98,632 |
| 8 |
| 60,229 |
| 5 |
| ||||
PC |
| 14,900 |
| 2 |
| 16,180 |
| 2 |
| 27,265 |
| 2 |
| 27,844 |
| 2 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total distribution net revenues |
| 174,462 |
| 21 |
| 148,742 |
| 18 |
| 290,537 |
| 24 |
| 251,417 |
| 20 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total net revenues |
| $ | 824,259 |
| 100 | % | $ | 816,242 |
| 100 | % | $ | 1,200,500 |
| 100 | % | $ | 1,279,875 |
| 100 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Operating Income by Segment and as a percentage of segment net revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Publishing |
| $ | 160,628 |
| 25 | % | $ | 65,534 |
| 10 | % | $ | 92,503 |
| 10 | % | $ | 21,932 |
| 2 | % |
Distribution |
| 12,492 |
| 7 |
| 18,359 |
| 12 |
| 9,758 |
| 3 |
| 19,854 |
| 8 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total operating income |
| $ | 173,120 |
| 21 | % | $ | 83,893 |
| 10 | % | $ | 102,261 |
| 8 | % | $ | 41,786 |
| 3 | % |
|
| Three Months Ended September 30, |
| Six Months Ended September 30, |
| ||||||||||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net revenues |
| $ | 317,746 |
| 100 | % | $ | 188,172 |
| 100 | % | $ | 813,201 |
| 100 | % | $ | 376,241 |
| 100 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Cost of sales – product costs |
| 151,996 |
| 48 |
| 127,374 |
| 68 |
| 369,225 |
| 45 |
| 235,997 |
| 63 |
| ||||
Cost of sales – software royalties and amortization |
| 38,427 |
| 12 |
| 9,348 |
| 5 |
| 116,679 |
| 14 |
| 28,609 |
| 7 |
| ||||
Cost of sales – intellectual property licenses |
| 14,533 |
| 5 |
| 4,356 |
| 2 |
| 47,012 |
| 6 |
| 14,272 |
| 4 |
| ||||
Product development |
| 33,085 |
| 10 |
| 25,608 |
| 14 |
| 65,982 |
| 8 |
| 51,233 |
| 14 |
| ||||
Sales and marketing |
| 51,868 |
| 16 |
| 32,550 |
| 17 |
| 120,580 |
| 15 |
| 68,729 |
| 18 |
| ||||
General and administrative |
| 37,382 |
| 12 |
| 26,346 |
| 14 |
| 73,176 |
| 9 |
| 48,260 |
| 13 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total costs and expenses |
| 327,291 |
| 103 |
| 225,582 |
| 120 |
| 792,654 |
| 97 |
| 447,100 |
| 119 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Operating income (loss) |
| (9,545 | ) | (3 | ) | (37,410 | ) | (20 | ) | 20,547 |
| 3 |
| (70,859 | ) | (19 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Investment income, net |
| 12,132 |
| 4 |
| 8,032 |
| 4 |
| 23,694 |
| 3 |
| 16,307 |
| 5 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Income (loss) before income tax provision (benefit) |
| 2,587 |
| 1 |
| (29,378 | ) | (16 | ) | 44,241 |
| 6 |
| (54,552 | ) | (14 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Income tax provision (benefit) |
| 1,889 |
| 1 |
| (5,076 | ) | (3 | ) | 15,717 |
| 2 |
| (11,941 | ) | (3 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net income (loss) |
| $ | 698 |
| 0 | % | $ | (24,302 | ) | (13 | )% | $ | 28,524 |
| 4 | % | $ | (42,611 | ) | (11 | )% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net Revenues by Territory: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
North America |
| $ | 161,804 |
| 51 | % | $ | 74,249 |
| 40 | % | $ | 471,340 |
| 58 | % | $ | 173,863 |
| 46 | % |
Europe |
| 146,525 |
| 46 |
| 107,775 |
| 57 |
| 316,539 |
| 39 |
| 189,588 |
| 51 |
| ||||
Other |
| 9,417 |
| 3 |
| 6,148 |
| 3 |
| 25,322 |
| 3 |
| 12,790 |
| 3 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total net revenues |
| $ | 317,746 |
| 100 | % | $ | 188,172 |
| 100 | % | $ | 813,201 |
| 100 | % | $ | 376,241 |
| 100 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net Revenues by Segment/Platform Mix Publishing: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Console |
| $ | 200,159 |
| 63 | % | $ | 84,136 |
| 45 | % | $ | 558,932 |
| 69 | % | $ | 174,325 |
| 46 | % |
Hand-held |
| 39,070 |
| 12 |
| 23,202 |
| 12 |
| 95,686 |
| 12 |
| 49,786 |
| 13 |
| ||||
PC |
| 14,530 |
| 5 |
| 18,066 |
| 10 |
| 28,363 |
| 3 |
| 36,055 |
| 10 |
| ||||
Total publishing net revenues |
| 253,759 |
| 80 |
| 125,404 |
| 67 |
| 682,981 |
| 84 |
| 260,166 |
| 69 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Distribution: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Console |
| 40,325 |
| 13 |
| 33,337 |
| 18 |
| 83,426 |
| 10 |
| 62,125 |
| 17 |
| ||||
Hand-held |
| 18,670 |
| 6 |
| 23,372 |
| 12 |
| 37,786 |
| 5 |
| 41,585 |
| 11 |
| ||||
PC |
| 4,992 |
| 1 |
| 6,059 |
| 3 |
| 9,008 |
| 1 |
| 12,365 |
| 3 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total distribution net revenues |
| 63,987 |
| 20 |
| 62,768 |
| 33 |
| 130,220 |
| 16 |
| 116,075 |
| 31 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total net revenues |
| $ | 317,746 |
| 100 | % | $ | 188,172 |
| 100 | % | $ | 813,201 |
| 100 | % | $ | 376,241 |
| 100 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Operating Income (Loss) by Segment and as a Percentage of Total Net Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Publishing |
| $ | (9,667 | ) | (3 | )% | $ | (36,607 | ) | (19 | )% | $ | 19,449 |
| 3 | % | $ | (68,125 | ) | (18 | )% |
Distribution |
| 122 |
| 0 |
| (803 | ) | (1 | ) | 1,098 |
| 0 |
| (2,734 | ) | (1 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total operating income (loss) |
| $ | (9,545 | ) | (3 | )% | $ | (37,410 | ) | (20 | )% | $ | 20,547 |
| 3 | % | $ | (70,859 | ) | (19 | )% |
5040
Results of Operations —– Three and NineSix Months Ended December 31,September 30, 2007 and 2006 and 2005
Net Revenues
We primarily derive revenue from sales of packaged interactive software games designed for play on video game consoles (such as the PS3, PS2, Xbox360, Xbox, Wii, and GameCube)Wii), PCs, and hand-held game devices (such as the GBA, NDS, and PSP). We also derive revenue from our distribution business in Europe, which provides logistical and sales services to third-party publishers of interactive entertainment software, to our own publishing operations, and to third-party manufacturers of interactive entertainment hardware.
The following table details our consolidated net revenues by business segment and our publishing net revenues by territory for the three months ended December 31,September 30, 2007 and 2006 and 2005 (in thousands):
|
| Three Months Ended December 31, |
| Increase/ |
| Percent |
| |||||
|
| 2006 |
| 2005 |
| (Decrease) |
| Change |
| |||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
| |||
North America |
| $ | 463,388 |
| $ | 402,314 |
| $ | 61,074 |
| 15 | % |
Europe |
| 171,507 |
| 248,614 |
| (77,107 | ) | (31 | )% | |||
Asia-Pacific |
| 14,902 |
| 16,572 |
| (1,670 | ) | (10 | )% | |||
Total international |
| 186,409 |
| 265,186 |
| (78,777 | ) | (30 | )% | |||
Total publishing net revenues |
| 649,797 |
| 667,500 |
| (17,703 | ) | (3 | )% | |||
Distribution net revenues |
| 174,462 |
| 148,742 |
| 25,720 |
| 17 | % | |||
Consolidated net revenues |
| $ | 824,259 |
| $ | 816,242 |
| $ | 8,017 |
| 1 | % |
|
| Three Months Ended September 30, |
| Increase/ |
| Percent |
| |||||
|
| 2007 |
| 2006 |
| (Decrease) |
| Change |
| |||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
| |||
North America |
| $ | 161,804 |
| $ | 74,249 |
| $ | 87,555 |
| 118 | % |
Europe |
| 82,538 |
| 45,007 |
| 37,531 |
| 83 | % | |||
Other |
| 9,417 |
| 6,148 |
| 3,269 |
| 53 | % | |||
Total International |
| 91,955 |
| 51,155 |
| 40,800 |
| 80 | % | |||
Total Publishing Net Revenues |
| 253,759 |
| 125,404 |
| 128,355 |
| 102 | % | |||
Distribution Net Revenues |
| 63,987 |
| 62,768 |
| 1,219 |
| 2 | % | |||
Consolidated Net Revenues |
| $ | 317,746 |
| $ | 188,172 |
| $ | 129,574 |
| 69 | % |
Consolidated net revenues increased 1%69% from $816.2$188.2 million for the three months ended December 31, 2005September 30, 2006 to $824.3$317.7 million for the three months ended December 31, 2006. ThisSeptember 30, 2007.
Commencing with this fiscal quarter, we have determined that for one of our titles released this quarter, Enemy Territory: Quake Wars (which is primarily an online multiplayer PC game), that all of the net revenue from the sale of this title will be recognized on a deferred basis — straight-line over an estimated service period, which we estimate to be six months beginning in the month after shipment. As a result, $8.9 million of net revenues was not included for the three months ended September 30, 2007. We do not anticipate any material amounts to be deferred from fiscal year 2008 into fiscal year 2009. Further, we do not anticipate deferrals for any other titles in fiscal year 2008.
Overall, the increase of consolidated net revenues for the three months ended September 30, 2007, was primarily the result of the following:
·• Strong performanceOur total publishing net revenues increased by $128.4 million. This was primarily due to the worldwide release of ourGuitar Hero: Rocks the 80s for PS2, and the Europe release of TRANSFORMERS: The Game in the second quarter of fiscal 2008. Further, the continued momentum from Guitar Hero II, and the North American publishing business ledand Asian release of TRANSFORMERS: The Game late in the first quarter of fiscal 2008 contributed to anthe increase of 15% in North Americanoverall publishing net revenues. Our fiscal 2007 third quarter benefited from additional net revenues of $73.5 million associated with the releases of launch titles for the PS3 and the Wii next generation console platforms, while experiencing only a small corresponding combined decrease of $11.4 million on the respective current generation console platforms, the PS2 and the GameCube. In addition, in the third quarter of fiscal 2007, we released a focused but very high quality slate of titles, which helped to spur consumer demand for our new releases. In North America, net revenues were impacted by strong performances from the new releases of Call of Duty 3,Guitar Hero 2, Tony Hawk’s Project 8, Marvel: Ultimate Alliance, and the addition of the Barbie franchise. AccordingThis compares to the NPD Group,release of an affiliate title, LucasArts’ Guitar Hero 2 Lego Star Wars II: The Original Trilogywas the #1 game in dollars for the U.S. for the month of December 2006 and the #2 game overall for the third quarter of fiscal 2007, and Call of Duty 3 was the #3 best-selling console game in the U.S. for the third quarter of fiscal 2007.
· An increase in net revenues from our distribution business resulting from a stronger release schedule for certain third-party publishers, increased hardware sales due to strong sales of NDS, PSP and Xbox360 hardware platforms, and the addition of a significant new customerEurope in the second quarter of fiscal 2007.
·• AInternational net revenues were impacted by a year over year strengthening of the Euro (“EUR”), Australian Dollar (“AUD”), and Great Britain Pound (“GBP”), Euro (“EUR”), and Australian Dollar (“AUD”) in relation to the United States Dollar (“USD”). Foreign exchange rates increased reported consolidated net revenues by approximately $29.7$12.5 million for the three months ended December 31, 2006.September 30, 2007. Excluding the impact of changing foreign currency rates, our consolidated net revenues decreased 3%increased 62% year over year.
Partially offset by:
· Consistent with our ongoing plan to have a more focused slate of titles throughout fiscal 2007 due to the console transition we had fewer title releases in the third quarter of fiscal 2007. In the third quarter of fiscal 2007, we had five major mainline releases: Call of Duty 3, Guitar Hero 2, Tony Hawk’s Project 8, Tony Hawk’s Downhill Jam, Marvel: Ultimate Alliance as well as additional platform specific and value titles. In the third quarter of fiscal 2006, we had a significantly larger number of new releases with the following major releases: Tony Hawk’s American Wasteland, Call of Duty 2, Call of Duty 2: Big Red One, GUN, True Crime: New York City, Quake 4, Shrek SuperSlam, The Movies, the PSP release of X-Men Legends II, and, in our international territories, Ultimate Spider-Man, and X-Men Legends II.41
· A decrease in publishing net revenues from our European publishing operations. Our European publishing operations had a stronger third quarter fiscal 2006 base period than North America publishing due to the strength of our European affiliate business in that period as well as the third quarter fiscal 2006 European releases of Ultimate Spider-Man and X-Men Legends, which were released in North America in the second quarter of fiscal 2006. Additionally our European publishing operations did not benefit from the release of the PS3, which was only released in Japan and North America. As a result of the delayed release of the PS3 in Europe, we also delayed our European releases of all PS3 titles as well as certain PSP titles.
The following table details our consolidated net revenues by business segment and our publishing net revenues by territory for the ninesix months ended December 31,September 30, 2007 and 2006 and 2005 (in thousands):
|
| Nine Months Ended December 31, |
| Increase/ |
| Percent |
| |||||
|
| 2006 |
| 2005 |
| (Decrease) |
| Change |
| |||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
| |||
North America |
| $ | 637,251 |
| $ | 626,538 |
| $ | 10,713 |
| 2 | % |
Europe |
| 245,019 |
| 370,618 |
| (125,599 | ) | (34 | )% | |||
Other |
| 27,693 |
| 31,302 |
| (3,609 | ) | (12 | )% | |||
Total international |
| 272,712 |
| 401,920 |
| (129,208 | ) | (32 | )% | |||
Total publishing net revenues |
| 909,963 |
| 1,028,458 |
| (118,495 | ) | (12 | )% | |||
Distribution net revenues |
| 290,537 |
| 251,417 |
| 39,120 |
| 16 | % | |||
Consolidated net revenues |
| $ | 1,200,500 |
| $ | 1,279,875 |
| $ | (79,375 | ) | (6 | )% |
|
| Six Months Ended September 30, |
| Increase/ |
| Percent |
| |||||
|
| 2007 |
| 2006 |
| (Decrease) |
| Change |
| |||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
| |||
North America |
| $ | 471,340 |
| $ | 173,863 |
| $ | 297,477 |
| 171 | % |
Europe |
| 186,319 |
| 73,513 |
| 112,806 |
| 153 | % | |||
Other |
| 25,322 |
| 12,790 |
| 12,532 |
| 98 | % | |||
Total International |
| 211,641 |
| 86,303 |
| 125,338 |
| 145 | % | |||
Total Publishing Net Revenues |
| 682,981 |
| 260,166 |
| 422,815 |
| 163 | % | |||
Distribution Net Revenues |
| 130,220 |
| 116,075 |
| 14,145 |
| 12 | % | |||
Consolidated Net Revenues |
| $ | 813,201 |
| $ | 376,241 |
| $ | 436,960 |
| 116 | % |
Consolidated net revenues decreased 6%increased 116% from $1,279.9$376.2 million for the ninesix months ended December 31, 2005September 30, 2006 to $1,200.5$813.2 million for the ninesix months ended December 31, 2006. The decrease was dueSeptember 30, 2007.
Commencing with this fiscal quarter, we have determined that for one of our titles released this quarter, Enemy Territory: Quake Wars (which is primarily an online multiplayer PC game), that all of the net revenue from the sale of this title will be recognized on a deferred basis — straight-line over an estimated service period, which we estimate to be six months beginning in the following:
· A decreasemonth after shipment. As a result, $8.9 million of $129.2 million in net revenues for our international publishing operations. Our international publishing operations did not benefit from additional net revenues from the release of the PS3, which was only released in Japan and North America, and as a result was not able to fully
compensateincluded for the more focused slatesix months ended September 30, 2007. We do not anticipate any material amounts to be deferred from fiscal year 2008 into fiscal year 2009. Further, we do not anticipate deferrals for any other titles in fiscal 2007. Additionally, in Europe, our net revenues were impacted by a decline in affiliate business due toyear 2008.
Overall, the numberincrease of affiliate releases. Prior year Europeanconsolidated net revenues, for the ninesix months ended December 31, 2005 were largely impacted bySeptember 30, 2007, was primarily the affiliate releases of LucasArts’ Star Wars: Episode III Revengeresult of the Sith following:
• Our overall publishing net revenues increased by $422.8 million. This was primarily attributable to the successful worldwide release of titles for the first six months of fiscal 2008, such as, Guitar Hero II for Xbox360, Guitar Hero: Rocks the 80s for PS2, Spider-Man 3, TRANSFORMERS: The Game, and LucasArts’ Star Wars Battlefront IIShrek the Third. Although we experienced strong performance fromThe continued momentum of Guitar Hero II for PS2 which was released in the one majorthird quarter of fiscal 2007 further contributed to the increase in consolidated net revenues. This compares to the releases in the first six months of fiscal 2007 of Over the Hedge, X-Men: The Official Game, and the release of an affiliate label release -title, LucasArts’ Lego Star Wars II: The Original Trilogy the base period, with two major affiliate label releases, was stronger.in Europe.
Partially offset by:
·• An increase inInternational net revenues from our distribution business resulting fromwere impacted by a stronger release schedule for certain third-party publishers in the first nine months of fiscal 2007, increased hardware sales due to continued sales of NDS, PSP, and Xbox360 hardware platforms, and the addition of a significant new customer in the second quarter of fiscal 2007.
· Strong performance of our North America publishing business led by strong consumer demand for our fiscal third quarter 2007 title releases and the benefit of additional revenues of $73.5 million associated with the releases of the PS3 and the Wii with only a small corresponding combined decrease of $11.4 million on the respective current generation console platforms, the PS2 and the GameCube.
· A year over year strengthening of the EUR, AUD,Euro (“EUR”), Australian Dollar (“AUD”), and GBPGreat Britain Pound (“GBP”) in relation to the USD. Foreign exchange rates increased reported consolidated net revenues by approximately $32.6$27.6 million for the ninesix months ended December 31, 2006.September 30, 2007. Excluding the impact of changing foreign currency rates, our consolidated net revenues decreased 9%increased 109% year over year.
North America Publishing Net Revenues (in thousands)
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| December 31, |
| Net |
| December 31, |
| Net |
| Increase/ |
| Percent |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 463,388 |
| 56 | % | $ | 402,314 |
| 49 | % | $ | 61,074 |
| 15 | % |
Nine Months Ended |
| 637,251 |
| 53 | % | 626,538 |
| 49 | % | 10,713 |
| 2 | % | |||
|
| September 30, |
| % of Consolidated |
| September 30, |
| % of Consolidated |
| Increase/ |
| Percent |
| |||
Three Months Ended |
| $ | 161,804 |
| 51 | % | $ | 74,249 |
| 40 | % | $ | 87,555 |
| 118 | % |
Six Months Ended |
| 471,340 |
| 58 | % | 173,863 |
| 46 | % | 297,477 |
| 171 | % | |||
42
North America publishing net revenues increased 15%118% from $402.3$74.2 million for the three months ended December 31, 2005September 30, 2006 to $463.4$161.8 million for the three months ended December 31, 2006.September 30, 2007. The increase was primarily attributable to the releases of Guitar Hero: Rocks the 80s on the PS2 in the second quarter of fiscal 2008, and continued strong momentum from our key title releases, Guitar Hero II for the Xbox360 and TRANSFORMERS: The Game in the first quarter of fiscal 2008, and Guitar Hero II for the PS2 released in the third quarter of fiscal 2007. There were no major releases in North America in the second quarter of fiscal 2007.
For the ninesix months ended December 31, 2006,September 30, 2007, North America publishing net revenues were $637.3$471.3 million, an increase of 2%171% from $626.5$173.9 million for the ninesix months ended December 31, 2005.September 30, 2006. The increases inincrease was mainly due to the strong performance of several key titles, Guitar Hero II for the Xbox360, Spider-Man 3, Shrekthe Third, and TRANSFORMERS: The Game. Publishing net revenues were further increased by the strong momentum of Guitar Hero IIfor both the quarter and nine months ended December 31, 2006 were due to strong consumer demand for our fiscal 2007 third quarter releases. Despite a decrease in the number of titlesPS2 released compared to the third quarter of fiscal 2006, where we had the biggest title release slate in our history, North American publishing benefited from significant additional net revenues associated with the releases of the PS3 and the Wii next generation console platforms. In addition, in the third quarter of fiscal 2007,2007.This compares to the six months ended September 30, 2006 when we released a focused but very high quality slate of titles which helped spur consumer demand. In North America, net revenues were impacted by strong performances from Marvel: Ultimate Alliance, Call of Duty 3,Over the Hedge Guitar Hero 2, Tony Hawk’s Project 8, and the addition of the Barbie franchiseX-Men: The Official Game.
According to the NPD Group, for the third quarter of fiscal 2007, we were the only publisher with fourhave three of the top 1110 titles in the U.S., Guitar Hero 2, Call of Duty 3, Marvel: Ultimate Alliance, and Tony Hawk’s Project 8, with Call of Duty 3 being the #3 best selling console game in the U.S. over that same period. In addition, Guitar Hero 2 was the number #1 game in dollars for the U.S. for the monthquarter ended September 30, 2007, Guitar Hero II, Guitar Hero: Rocks the 80s, and TRANSFORMERS: The Game which is also the #1 action title. TRANSFORMERS: Decepticon and TRANSFORMERS: Autobots were ranked the #1 third party NDS titles for the second quarter of Decemberfiscal 2008. The Guitar Hero franchise is the #1 best-selling franchise in the U.S. for the calendar year 2007 to date, and the #2 game overall#3 franchise in the U.S. for the third quarter of fiscalended September 30, 2007, according to the NPD Group. For the
nine months ended December 31, 2006, the increase in North America publishing net revenues experienced in the third quarter of fiscal 2007 was partially offset by the impact of having fewer title releases in the first six months of fiscal 2007 as compared to the first six months of fiscal 2006, and reduced pricing on current generation catalog titles as a result of the console transition.
North America publishing net revenues also increased as a percentage of consolidated net revenues from 49% for both the three40% and nine months ended December 31, 2005, to 56% and 53%46% for the three and ninesix months ended December 31,September 30, 2006, respectively, to 51% and 58% for the three and six months ended September 30, 2007, respectively. The increases in the percentages of total consolidated net revenues are a result of the stronger net revenue growth within North Americafor the publishing and a significant decline in net revenues generated from our international publishing operationssegment than that of the distribution segment during the same period.
International Publishing Net Revenues (in thousands)
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| December 31, |
| Net |
| December 31, |
| Net |
| Increase/ |
| Percent |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 186,409 |
| 23 | % | $ | 265,186 |
| 33 | % | $ | (78,777 | ) | (30 | )% |
Nine Months Ended |
| 272,712 |
| 23 | % | 401,920 |
| 31 | % | (129,208 | ) | (32 | )% | |||
|
| September 30, |
| % of Consolidated |
| September 30, |
| % of Consolidated |
| Increase/ |
| Percent |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 91,955 |
| 29 | % | $ | 51,155 |
| 27 | % | $ | 40,800 |
| 80 | % |
Six Months Ended |
| 211,641 |
| 26 | % | 86,303 |
| 23 | % | 125,338 |
| 145 | % | |||
International publishing net revenues decreasedincreased by 30%80% from $265.2$51.2 million for the three months ended December 31, 2005,September 30, 2006, to $186.4$92.0 million for the three months ended December 31, 2006. When compared toSeptember 30, 2007. $8.9 million of net revenues was not included as of result of deferring net revenues for the three months ended December 31, 2005,September 30, 2007. Our international publishing operations recorded an increase of net revenue of 80%, mainly resulting from the decreaserelease of TRANSFORMERS: The Game in net revenues reflects a decreaseEurope in the number of new releases, reduced pricing on current-generation catalog titles due to the console transition to the next-generation console systems, and a decrease in net revenues from our European affiliate label program. In the thirdsecond quarter of fiscal 2006, we released thirteen titles2008, concurrent with the movie release dates in those geographies, and the continued momentum from the release of TRANSFORMERS: The Game in Asia late in the first quarter of fiscal 2008, which outperformed our international territoriesfiscal 2007 second quarter releases of Over the Hedge in several European countries and onean affiliate title, LucasArts’ Lego Star Wars Battlefront II.II: The Original Trilogy This compares to the third quarter of fiscal 2007 where we released eight titles: Call of Duty 3, Marvel: Ultimate Alliance, Tony Hawk’s Project 8, Tony Hawk’s Downhill Jam, Guitar Hero 2, Over the Hedge: Hammy Goes Nuts!, Shrek Smash N’ Crash, and Spider-Man: Battle for New York. We did not have any affiliate title releases in the third quarter of fiscal 2007. The decrease was partially offsetEurope. International publishing net revenues were further increased by a quarter over quarter strengthening of the EUR, AUD, and GBP in relation to the USD for our international publishing business of approximately $14.4$7.8 million for the three months ended December 31, 2006September 30, 2007 as compared to the three months ended December 31, 2005.September 30, 2006. Excluding the impact of changing foreign currency rates, our international publishing net revenues decreased 35%increased 64% year over year. As a percentage of consolidated net revenues, international publishing net revenues decreasedincreased from 33% at December 31, 200527% for the three months ended September 30, 2006 to 23% at December 31, 2006.29% for the three months ended September 30, 2007. The decrease as a percentageincreases in the percentages of total consolidated net revenues is primarily due toare a result of the significant increase instronger net revenue growth for the publishing segment than that of the distribution net revenues and North American publishing net revenues while international publishing net revenues decreased oversegment during the same period.
43
International publishing net revenues decreasedincreased from $401.9$86.3 million for the ninesix months ended December 31, 2005September 30, 2006 to $272.7$211.6 million for the ninesix months ended December 31, 2006.September 30, 2007. $8.9 million of net revenues was not included as of result of deferring net revenues for the six months ended September 30, 2007. The decreasesignificant increase in international publishing net revenues was dueprimarily attributable to our European publishing business which released, Spider-Man 3,Shrek the decrease in the number of titles released internationally from nineteen in the first nine months of fiscal 2006, to fourteen in the first nine months of fiscal 2007. Additionally, in Europe, our net revenues were impacted by a decline in affiliate business due to the timing of affiliate releases. Prior year international net revenuesThird, Guitar Hero II for the nine months ended December 31, 2005 were largely impacted by the affiliate titleXbox360 and TRANSFORMERS: The Game. This compares to releases of LucasArts’ Star Wars: Episode III Revenge ofOver the Sith Hedge, X-Men: The Official Game, and LucasArts’ Star Wars Battlefront II. Although we experienced strong performance from the one majoran affiliate label release oftitle, LucasArts’ Lego Star Wars II: The Original Trilogyit compares to a stronger base period with two major affiliate label releases. The decrease in internationalEurope in the first six months of fiscal 2007. International publishing net revenues was partially offsetfurther increased by the year over year strengthening of the EUR, AUD, and GBP in relation to the USD of approximately $15.8$17.8 million for the ninesix months ended December 31, 2006September 30, 2007 as compared to the ninesix months ended December 31, 2005.September 30, 2006. Excluding the impact of changing foreign currency rates, our international publishing net revenues decreased 36%increased 125% year over year. As a percentage of consolidated net revenues, international publishing net revenues decreasedincreased from 31% for the nine months ended December 31, 2005 to 23% for the ninesix months ended December 31, 2006.September 30, 2006 to 26% for the six months ended September 30, 2007. The decrease is primarily due toincreases in the percentage of total consolidated net revenues are a result of the stronger net revenue growth for the publishing segment than that of ourthe distribution business oversegment during the same period.
Publishing Net Revenues by Platform (in thousands)
The following table details our publishing net revenues by platform and as a percentage of total publishing net revenues for the three months ended December 31,September 30, 2007 and 2006 and 2005 (in thousands):
|
| Three Months |
| % of |
| Three Months |
| % of |
| Increase/ |
| Percent |
| |||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
PC |
| $ | 14,530 |
| 6 | % | $ | 18,066 |
| 14 | % | $ | (3,536 | ) | (20 | )% |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Console |
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Sony PlayStation 3 |
| 10,179 |
| 4 | % | — |
| — | % | 10,179 |
| n/a |
| |||
Sony PlayStation 2 |
| 118,560 |
| 47 | % | 56,044 |
| 45 | % | 62,516 |
| 112 | % | |||
Microsoft Xbox360 |
| 58,088 |
| 23 | % | 18,285 |
| 14 | % | 39,803 |
| 218 | % | |||
Nintendo Wii |
| 13,115 |
| 5 | % | — |
| — | % | 13,115 |
| n/a |
| |||
Other |
| 217 |
| — | % | 9,807 |
| 8 | % | (9,590 | ) | (98 | )% | |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Total console |
| 200,159 |
| 79 | % | 84,136 |
| 67 | % | 116,023 |
| 138 | % | |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Hand-held |
| 39,070 |
| 15 | % | 23,202 |
| 19 | % | 15,868 |
| 68 | % | |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Total publishing net revenues |
| $ | 253,759 |
| 100 | % | $ | 125,404 |
| 100 | % | $ | 128,355 |
| 102 | % |
44
The following table details our publishing net revenues by platform and as a percentage of total publishing net revenues for the ninesix months ended December 31,September 30, 2007 and 2006 and 2005 (in thousands):
|
| Nine Months |
| % of |
| Nine Months |
| % of |
|
|
|
|
| |||
|
| December 31, |
| Publishing |
| December 31, |
| Publishing |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revs. |
| 2005 |
| Net Revs. |
| (Decrease) |
| Change |
| |||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
PC |
| $ | 69,443 |
| 8 | % | $ | 154,735 |
| 15 | % | $ | (85,292 | ) | (55 | )% |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Console |
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Sony Playstation 3 |
| 28,786 |
| 3 | % | — |
| — | % | 28,786 |
| n/a |
| |||
Sony PlayStation 2 |
| 397,498 |
| 44 | % | 388,375 |
| 38 | % | 9,123 |
| 2 | % | |||
Microsoft Xbox 360 |
| 176,019 |
| 19 | % | 71,456 |
| 7 | % | 104,563 |
| 146 | % | |||
Microsoft Xbox |
| 52,544 |
| 6 | % | 195,382 |
| 19 | % | (142,838 | ) | (73 | )% | |||
Nintendo Wii |
| 44,669 |
| 5 | % | — |
| — | % | 44,669 |
| n/a |
| |||
Nintendo GameCube |
| 19,882 |
| 2 | % | 74,475 |
| 7 | % | (54,593 | ) | (73 | )% | |||
Other |
| (3 | ) | — | % | 385 |
| — | % | (388 | ) | (101 | )% | |||
Total console |
| 719,395 |
| 79 | % | 730,073 |
| 71 | % | (10,678 | ) | (1 | )% | |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Hand-held |
| 121,125 |
| 13 | % | 143,650 |
| 14 | % | (22,525 | ) | (16 | )% | |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Total publishing net revenues |
| $ | 909,963 |
| 100 | % | $ | 1,028,458 |
| 100 | % | $ | (118,495 | ) | (12 | )% |
|
| Six Months Ended |
| % of |
| Six Months Ended |
| % of |
| Increase/ |
| Percent |
| |||
Publishing Net Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
PC |
| $ | 28,363 |
| 4 | % | $ | 36,055 |
| 14 | % | $ | (7,692 | ) | (21 | )% |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Console |
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Sony Playstation 3 |
| 36,615 |
| 5 | % | — |
| — | % | 36,615 |
| n/a |
| |||
Sony PlayStation 2 |
| 265,427 |
| 39 | % | 107,345 |
| 41 | % | 158,082 |
| 147 | % | |||
Microsoft Xbox360 |
| 208,693 |
| 31 | % | 30,106 |
| 12 | % | 178,587 |
| 593 | % | |||
Nintendo Wii |
| 45,814 |
| 7 | % | — |
| — | % | 45,814 |
| n/a |
| |||
Other |
| 2,383 |
| — | % | 36,874 |
| 14 | % | (34,491 | ) | (94 | )% | |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Total console |
| 558,932 |
| 82 | % | 174,325 |
| 67 | % | 384,607 |
| 221 | % | |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Hand-held |
| 95,686 |
| 14 | % | 49,786 |
| 19 | % | 45,900 |
| 92 | % | |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Total publishing net revenues |
| $ | 682,981 |
| 100 | % | $ | 260,166 |
| 100 | % | $ | 422,815 |
| 163 | % |
Personal Computer Net Revenues (in thousands)
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 33,388 |
| 5 | % | $ | 113,782 |
| 17 | % | $ | (80,394 | ) | (71 | )% |
Nine Months Ended |
| 69,443 |
| 8 | % | 154,735 |
| 15 | % | (85,292 | ) | (55 | )% | |||
|
| September 30, |
| % of |
| September 30, |
| % of |
| Increase/ |
| Percent |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 14,530 |
| 6 | % | $ | 18,066 |
| 14 | % | $ | (3,536 | ) | (20 | )% |
Six Months Ended |
| 28,363 |
| 4 | % | 36,055 |
| 14 | % | (7,692 | ) | (21 | )% | |||
Net revenues from sales of titles for the PC decreased 71% from $113.8 million and 17% of publishing net revenues for the three months ended December 31, 2005 to $33.4 million and 5% of publishing net revenues for the three months ended December 31, 2006. The decreases were primarily due to the strong performance of our third quarter fiscal 2006 PC releases as well as a decrease in the number of titles released for the PC during the third quarter of fiscal 2007 as compared to the third quarter of fiscal 2006. During the third quarter of fiscal 2006 we released the highly successful PC title, Call of Duty 2, which was ranked by the NPD Group as the number two best selling PC title in the United States for the quarter, as well as Quake 4, and The Movies, which was exclusive to the PC. For the third quarter of fiscal 2007, we had only one new PC release, Marvel: Ultimate Alliance.
Net revenues from sales of titles for the PC decreased 55%20% from $154.7$18.1 million and 15%or 14% of publishing net revenues for the ninethree months ended December 31, 2005September 30, 2006 to $69.4$14.5 million and 8%or 6% of publishing net revenues for the ninethree months ended December 31, 2006.September 30, 2007. $8.9 million of net revenues, or 4% of publishing net revenues, was not included as of result of deferring net revenues for the three months ended September 30, 2007. We released TRANSFORMERS: The Game on the PC in Europe in the second quarter of fiscal 2008. This compares to the release of our European affiliate title, LucasArts’ Lego Star Wars II: The Original Trilogy in the second quarter of fiscal 2007.
Net revenues from sales of titles for the PC decreased 21% from $36.1 million or 14% of publishing net revenues for the six months ended September 30, 2006 to $28.4 million or 4% of publishing net revenues for the six months ended September 30, 2007. $8.9 million of net revenues, or 1% of publishing net revenues, was not included as of result of deferring net revenues for the six months ended September 30, 2007. The decreases were due to a stronger base period which included the third quarter fiscal 2006 releases of Call of Duty 2, Quake IV, and The Movies, as well as thefirst
quarter fiscal 2006 release of Doom 3: Resurrection of Evil. This compares to theour first nine monthstwo quarters of fiscal 2007 where net revenues were primarily derived from continued catalog salesreleases which consisted of Call of Duty 2 as well as the releases of Marvel: Ultimate Alliance, The Movies: Stunts and Effects, X-Men: The Official Game, Over the Hedge, and our European affiliate title LucasArts’ Lego Star Wars II: The Original Trilogy.Trilogy. This compares to the first six months of fiscal 2008 where net revenues were primarily derived from Spider-Man 3, Shrek the Third, and TRANSFORMERS: The Game.
45
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 28,786 |
| 4 | % | $ | — |
| — | % | $ | 28,786 |
| n/m |
|
Nine Months Ended |
| 28,786 |
| 3 | % | — |
| — | % | 28,786 |
| n/m |
| |||
|
| September 30, |
| % of |
| September 30, |
| % of |
| Increase/ |
| Percent |
| ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||
Three Months Ended |
| $ | 10,179 |
| 4 | % | — |
| — | % | $ | 10,179 |
| n/a |
|
Six Months Ended |
| 36,615 |
| 5 | % | — |
| — | % | 36,615 |
| n/a |
| ||
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 290,153 |
| 45 | % | $ | 258,233 |
| 39 | % | $ | 31,920 |
| 12 | % |
Nine Months Ended |
| 397,498 |
| 44 | % | 388,375 |
| 38 | % | 9,123 |
| 2 | % | |||
|
| September 30, |
| % of |
| September 30, |
| % of |
| Increase/ |
| Percent |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 118,560 |
| 47 | % | $ | 56,044 |
| 45 | % | $ | 62,516 |
| 112 | % |
Six Months Ended |
| 265,427 |
| 39 | % | 107,345 |
| 41 | % | 158,082 |
| 147 | % | |||
Net revenues from sales of titles and accessories (primarily consisting of hardware associated with Guitar Hero II) for the PS2 increased 12%112% from $258.2$56.0 million for the three months ended December 31, 2005September 30, 2006 to $290.2$118.6 million for the three months ended December 31, 2006.September 30, 2007. For the ninesix months ended December 31, 2006September 30, 2007 net revenues from sales of titles for the PS2 were $397.5$265.4 million, an increase of 2%147% from the ninesix months ended December 31, 2005.September 30, 2006. The strong performance of our third quarter fiscal 2007 title releases more than offset the impact of having a more focused product slateTRANSFORMERS: The Game released in Europe and the corresponding release of fewer “big proposition” titles. In particular, our net revenues were driven byGuitar Hero: Rocks the 80s in the second quarter of fiscal 2008, and continued strong performancessales ofCall of Duty 3 and Guitar Hero 2, IIas well as a robust for PS2 market in Europe duecontributed to the delay ofincrease in PS2 net revenues. This compares to the European release of an affiliate label title, LucasArts’ Lego Star Wars II: The Original Trilogy in the PS3 until March 2007. According to the NPD Group, Guitar Hero 2 was the #1 best selling title on the PS2 platform for the thirdsecond quarter of fiscal 2007.In For the six months ended September 30, 2007, the increase in absolute dollars is primarily due to continued momentum for our fiscal 2007 third quarter title, Guitar Hero II for PS2 (game and accessories), as well as strong performance of fiscal 2007, we releasedour worldwide releases of Call of DutySpider-Man 3 Marvel: Ultimate Alliance, , Shrek the Third, Tony Hawk’s Project 8,Downhill Jam, Guitar Hero 2, Pimp My Ride, Harley-Davidson: Race toHero: Rocks the Rally,80s, The History Channel®: Civil War- A Nation Divided, Rapala Tournament Fishing, and Cabela’s African SafariTRANSFORMERS: The Game. during the six months ended September 30, 2007. This compares to the third quarterreleases during the first six months of fiscal 2006 where we released2007 of our PS2 titlesversions of Tony Hawk’s American Wasteland, Shrek SuperSlam, Call of Duty 2: Big Red One, GUN,True Crime: New York City,Over the Hedge, X-Men: The Official Game, and Cabela’s Dangerous Hunts 2 Lego Star Wars II: The Original Trilogyas well as, internationally, Ultimate Spider-Man and X-Men Legends II. For the nine month period ended December 31, 2006, the increase in net revenues from sales of titles for the PS2 was partially offset by reduced pricing on a number of catalog titles due to the release of the PS3. Europe. As a percentage of publishing net revenues, net revenues from the sale of titles for the PS2 increased from 39%45% to 45%47% for the quarters ended December 31, 2005September 30, 2006 and 2006, respectively, and2007, respectively. The increase is the result of the release of Guitar Hero: Rocks the 80s exclusively on the PS2 in the second quarter of fiscal 2008. Net revenues from 38% to 44%the sale of titles for the nine months ended December 31, 2005 and 2006, respectively. The increasesPS2 as a percentage of publishing net revenues reflect the
impact of high consumer demanddecreased from 41% to 39% for the currently PS2 exclusive title,six months ended September 30, 2006 and 2007, respectively. This is due to the strong fiscal 2008 first quarter performance of the Xbox360 platform with the release of Guitar Hero 2, IIcausing for Xbox360, and a higher proportionate increase inshift to the next generation PS3 platform of 5% of total publishing net revenues.
Although we expect net revenues from sales of titles for the PS2 to decline over time as consumers transition to next generation platforms, we continue to expect significant net revenues.revenues for PS2 for fiscal 2008 as we plan to develop and release many of our key titles on this platform.
46
Microsoft Xbox360 Net Revenues (in thousands)
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 145,913 |
| 22 | % | $ | 71,456 |
| 11 | % | $ | 74,457 |
| 104 | % |
Nine Months Ended |
| 176,019 |
| 19 | % | 71,456 |
| 7 | % | 104,563 |
| 146 | % | |||
|
| September 30, |
| % of |
| September 30, |
| % of |
| Increase/ |
| Percent |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 58,088 |
| 23 | % | $ | 18,285 |
| 14 | % | $ | 39,803 |
| 218 | % |
Six Months Ended |
| 208,693 |
| 31 | % | 30,106 |
| 12 | % | 178,587 |
| 593 | % | |||
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 32,401 |
| 5 | % | $ | 103,422 |
| 15 | % | $ | (71,021 | ) | (69 | )% |
Nine Months Ended |
| 52,544 |
| 6 | % | 195,382 |
| 19 | % | (142,838 | ) | (73 | )% | |||
September 30, 2006. Net revenues from sales of titles for the Xbox decreased 69%Xbox360 increased from $103.4 million and 15% of publishing net revenues for the three months ended December 31, 2005 to $32.4 million and 5% of publishing net revenues for the three months ended December 31, 2006. For the nine months ended December 31, 2006, net revenues from sales of titles for the Xbox decreased 73% from $195.4 million and 19% of publishing net revenues to $52.5 million and 6% of publishing net revenues. The decreases for both periods in absolute dollars and as a percentage of publishing net revenues were primarily attributable to the slowdown of sales for the Xbox as customers migrate to its successor, the Xbox360, combined with the release of fewer titles on the Xbox platform. For the third quarter of fiscal 2007 net revenues were mainly comprised of sales from our three Xbox titles releases, Call of Duty 3, Tony Hawk’s Project 8, and Marvel: Ultimate Alliance as well as continued sales of our European affiliate label title, LucasArts’ Lego Star Wars II: The Original Trilogy. This compares to the third quarter of fiscal 2006 where we had the biggest release slate in our history with worldwide Xbox releases of Tony Hawk’s American Wasteland, Shrek SuperSlam, Call of Duty 2: Big Red One, GUN,True Crime: New York City, and Cabela’s Dangerous Hunts 2 as well as, internationally, Ultimate Spider-Man and X-Men Legends II. For the nine months ended December 31, 2005, Xbox net revenues were driven by strong performance of the first quarter fiscal 2006 release of the Xbox exclusive Doom 3. In the first nine months of fiscal 2007, there were no comparable Xbox exclusive titles.
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 44,669 |
| 7 | % | $ | — |
| — | % | $ | 44,669 |
| n/m |
|
Nine Months Ended |
| 44,669 |
| 5 | % | — |
| — | % | 44,669 |
| n/m |
| |||
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 3,152 |
| 1 | % | $ | 46,430 |
| 7 | % | $ | (43,278 | ) | (93 | )% |
Nine Months Ended |
| 19,882 |
| 2 | % | 74,475 |
| 7 | % | (54,593 | ) | (73 | )% | |||
Net revenues from sales of titles for the Nintendo GameCube decreased 93% from $46.4 million and 7% of publishing net revenues for the three months ended December 31, 2005 to $3.2 million and 1% of publishing net revenues for the three months ended December 31, 2006. The decrease in absolute dollars and as a percentage of publishing net revenues is primarily due to the decrease in the number of new releases on the GameCube combined with a gradual slowdown in sales on the GameCube platform as customers transition over to the next-generation console from Nintendo, the Wii. In the third quarter of fiscal 2007 we released one title for the GameCube, Shrek Smash n’ Crash Racing as compared to six worldwide major releases and two additional international releases in the third quarter of fiscal 2006. In addition, net revenue for the quarter was affected by pricing declines on catalog titles due to the effects of the console transition.
Net revenues from sales of titles for the Nintendo GameCube decreased 73% from $74.5$30.1 million for the ninesix months ended December 31, 2005September 30, 2006 to $19.9$208.7 million for the ninesix months ended December 31, 2006. The decrease was a result of fewer title releases in the second and third quarters of fiscal 2007 where the only title release was our European affiliate title, LucasArts’ Lego Star Wars II: The Original Trilogy. This compares to the second quarter of fiscal 2006 where we released Ultimate Spider-Man and X-Men Legends II on the GameCube and experienced strong catalog sales from Madagascar and Fantastic Four. These decreases were partially offset by the strength of our first quarter fiscal 2007 releasesSeptember 30, 2007. of Over the Hedge and X-Men: The Official Game, which outperformed the two titles released for the GameCube in the first quarter of fiscal 2006, Madagascar and Fantastic Four.
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 71,339 |
| 11 | % | $ | 74,032 |
| 11 | % | $ | (2,693 | ) | (4 | )% |
Nine Months Ended |
| 121,125 |
| 13 | % | 143,650 |
| 14 | % | (22,525 | ) | (16 | )% | |||
Net revenues from sales of titles for hand-held platforms for the three months ended December 31, 2006 decreased 4% from the prior fiscal year, from $74.0 million or 11% of publishing net revenues to $71.3 million or 11% of publishing net revenues. The decrease in absolute dollars is primarily due to a 42% decline over the same period in net revenues on the GBA hand-held platform as we released fewer titles on that platform and had slower GBA catalog sales due to wider acceptance of the NDS platform. During the third quarter of fiscal 2007, the key titles contributing to GBA net revenues were Tony Hawk’s Downhill Jam, Over the Hedge: Hammy Goes Nuts!, Barbie in the 12 Dancing Princesses, Marvel: Ultimate Alliance, Spider-Man: Battle for New York, and LucasArts’ Lego Star Wars II: The Original Trilogy. This compares to the third quarter of fiscal 2006 where the key titles contributing to GBA net revenues were Madagascar Operation Penguin, Shrek SuperSlam, Madagascar, Ultimate Spider-Man, Tony Hawk’s American Sk8land, and Shrek 2. The decrease in GBA net revenues was partially offset by increases of 67% and 12% on the NDS and PSP, respectively, in the third quarter of fiscal 2007 when compared to the third quarter of fiscal 2006. The increase in NDS net revenues quarter over quarter is primarily due to wider consumer acceptance of the platform and an increase in new releases on the platform. For the quarter ending December 31, 2006, we released Tony Hawk’s Downhill Jam, Spider-Man: Battle for New York, Other the Hedge: Hammy Goes Nuts!, and Barbie in the 12 Dancing Princesses and had continued strong catalog sales from Over the Hedge, Madagascar, and a European affiliate title, LucasArts’ Lego Star Wars II: The Original Trilogy. New releases for the NDS in the third quarter of fiscal 2006 were Tony Hawk’s American Sk8land, Shrek SuperSlam, and Ultimate Spider-Man. The increase in net revenues from sales of titles for the PSP platform relates primarily to an increase in the number of titles released in the third quarter of fiscal 2007 when compared to the third quarter of fiscal 2006. In the third quarter of fiscal 2007, we released Marvel: Ultimate Alliance, Tony Hawk’s Project 8, GUN Showdown, and Activision Hits Remixed. This compares to the release of one European affiliate title on the PSP in the third quarter of fiscal 2006, LucasArts’ Star Wars Battlefront II.
Microsoft announced reduction of the retail price of Xbox360 by $50 in the United States market and by 50 euros in European markets on September 30, % of September 30, % of Increase/ Percent Three Months Ended $ 13,115 5 % — — % $ 13,115 n/a Six Months Ended 45,814 7 % — — % 45,814 n/a Net revenues from sales of titles for hand-held platforms for the nine months ended December 31, 2006 decreased 16% from the prior fiscal year, from $143.7 million to $121.1 million. As a percentage of publishing net revenues, net revenues from the sale of titles for hand-held platforms also decreasedthe Xbox360 increased from 14% to 23% for the ninequarter ended September 30, 2006 and 2007, respectively, and from 12% to 31% for the six months ended December 31, 2005 to 13% for the nine months ended December 31, 2006.September 30, 2006 and 2007, respectively. The decreases in both absolute dollars and as a percentage of net revenues is a resultsignificant growth of the decreaseinstalled base since the introduction of the Xbox360 and our successful title releases contributed to the increase in Xbox360 net revenues. The increase in net revenues on the GBA platformXbox360 is the result from our Xbox360 release of 40%TRANSFORMERS: The Game in Europe in the second quarter of fiscal 2008 and a decrease inthe continued net revenues from Guitar Hero II released in the first quarter of fiscal 2008. This compares to the release of theEuropean affiliate title release of LucasArts’ Lego Star Wars II: The Original Trilogy in the second quarter of fiscal 2007. We continued to increase our presence in the Xbox360 by publishing Guitar Hero II (game and accessories), Spider-Man 3, Shrek the Third, and TRANSFORMERS: The Game during the first two quarters of fiscal 2008. For the same period of fiscal 2007, we released X-Men: The Official Game and Lego Star Wars II: The Original Trilogy.the PSP platform of 27%August 2007. It is uncertain how this price reduction will impact consumer demand for the nine months ended December 31, 2006. The decrease inplatform. However, we expect net revenues for the nine months ended December 31, 2006 from sales of titles for the GBA isXbox360 to increase significantly in fiscal 2008 as compared to fiscal 2007 due to slower GBAthe growing installed base and our strong slate of Xbox360 titles.Nintendo Wii Net Revenues (in thousands)
2007
Publishing
Net Revenues
2006
Publishing
Net Revenues
(Decrease)
ChangeThe Nintendo Wii was released in November 2006 and quickly gained strong consumer acceptance due to its innovative technology and mass market appeal. We released TRANSFORMERS: The Game in Europe and a value title Hot Wheels: Beat That! for the Wii in the second quarter of fiscal 2008 which are the primary revenue drivers for the three months ended September 30, 2007. For the six months ended September 30, 2007, net revenues were derived from Spider-Man 3, Shrek the Third, TRANSFORMERS: The Game, Hot Wheels: Beat That! and continued catalog sales
due to wider acceptance of the NDS platform and a decrease in the number of titles released on that platform from 10 to 9. The decrease in net revenues for the nine months ended December 31, 2006 from sales of titles for the PSP is due to a strong comparable base period in which we not only had a stronger release slate, but also had stronger sales due to consumer excitement surrounding the initial release of the PSP platform in March 2005 in North America and in September 2005 in Europe. In the first nine months of fiscal 2006 we had some of our strongest titles release on the PSP with releases of Tony Hawk’s Underground 2, Spider-Man: The Movie 2, X-Men Legends 2, World Series of Poker, and two strong performing affiliate titles in Europe. This compares to the first nine months of fiscal 2007 where our key newthird quarter releases, were MarvelCall of Duty 3, Marvel: Ultimate Alliance, Tony Hawk’s Project 8, Gun Showdown, Activision Hits Remixed, Cabela’s Dangerous Hunts, Cabela’s African Safari, MTX: Mototrax 2006, World Series of Poker: Tournament of Champions, Rapala Tournament Fishing, and one European affiliate title which was outperformed by each of the affiliate titles released in the first nine months of fiscal 2006, Tony Hawk’s Downhill Jam.The decreases on the PSP and GBA platforms were
partially offset by an increase inWe expect net revenues from sales of titles for the Wii to significantly increase with the growth of the installed based and our strong slate of key titles for fiscal 2008.
47
|
| September 30, |
| % of |
| September 30, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2007 |
| Net Revenues |
| 2006 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 39,070 |
| 15 | % | $ | 23,202 |
| 19 | % | $ | 15,868 |
| 68 | % |
Six Months Ended |
| 95,686 |
| 14 | % | 49,786 |
| 19 | % | 45,900 |
| 92 | % | |||
Net revenues from sales of titles for hand-held platforms for the three and six months ended September 30, 2007 increased 68% and 92% from the same period of prior fiscal year. Net revenues increased from $23.2 million and $49.8 million for the three and six months ended September 30, 2006, respectively, to $39.1 million and $95.7 million for the three and six months ended September 30, 2007, respectively. The increase in absolute dollars is primarily due to the fiscal 2008 second quarter European releases of two products, TRANSFORMERS: Decepticon and TRANSFORMERS: Autobots exclusively on the NDS, TRANSFORMERS: The Game on the PSP, and the release of 74% asseveral value titles, Animal Genius, Puppy Luv Spa & Resort, and Jewel Quest Expedition on the platform has continuedNDS. Further, we released Spider-Man 3, Shrek the Third, and two products, TRANSFORMERS: Decepticon and TRANSFORMERS: Autobots exclusively on the NDS and TRANSFORMERS: The Game on the PSP in North America and Asia in the first quarter of fiscal 2008. This compares to gain consumer acceptancethe second quarter of fiscal 2007, when we had new releases of World Series of Poker: Tournament of Champions and market share, as well as particularly strong performance ofRapala Trophies in North America on the PSP and our European affiliate title, LucasArts’ Lego Star Wars II: The Original Trilogy on the NDS and the GBA, and our first quarter fiscal 2007 releases of Over the Hedgeand X-Men: X-Men: The Official Gameon the PSP and GBA.
With the installed base of the PSP and NDS and GBA and continued strong catalog sales of Madagascar on the GBA and NDS.continuing to increase, we expect that fiscal 2008 hand-held net revenues will continue to increase year over year.
Overall
The platform mix of our future publishing net revenues will likely be impacted by a number of factors, including the ability of hardware manufacturers to continue to increase their installed hardware base andfor the introduction of new hardwarenext-generation platforms, as well as the performance of our key product releases. According to the NPD Group, Activision was the #2 third party publisher in the United States on next-generation platforms for the six months ended September 30, 2007. We expect that net revenues from console titles will continue to represent the largest component of our publishing net revenues with PS2Xbox360 having the largest percentage of consolethat business in the short term while thefiscal 2008 due to its larger installed base of the next generation consoles continues to increase. As the NDS and PSP platforms continue to build their installedhardware base and gain popularity, weour strong slate of titles. We expect to seesignificant growth in net revenues from PS3, Xbox360 and Wii next-generation console systems and a long term increasedecrease in our hand-heldthe percentage of PS2 business in line with the growth in the installed base.fiscal 2008. Our net revenues from PC and hand-held titles will be primarily driven by our product release schedule.
A significant portion of our revenues and profits are derived from a relatively small number of popular titles and brands each year, so revenues and profits are significantly affected by our ability to release highly successful “hit” titles. For example, for the three months ended December 31, 2006, 42%September 30, 2007, 58% of our consolidated net revenues and 53%72% of worldwide publishing net revenues were derived from net revenues from the releases ofCall of Duty 3, Guitar Hero 2,II (including Guitar Hero: Rocks the 80s), Spider-Man 3, Shrek the Thirdand Marvel: Ultimate Alliance.TRANSFORMERS: The Game. For the ninesix months ended December 31, 2006, 29%September 30, 2007, 67% of our consolidated net revenues and 38%80% of worldwide publishing net revenues were derived from net revenues from those same titles. Though many of our titles have substantial production or acquisition costs and marketing budgets, once a title recoups these costs, incremental net revenues directly and positively impact operating profits resulting in a disproportionate amount of operating income being derived from these select titles. We expect that a limited number of titles and brands will continue to produce a disproportionately large amount of our net revenues and profits.
Three key factors that could affect future publishing and distribution net revenue performance are console hardware pricing, software pricing, and transitions in console platforms. As console hardware moves through its life cycle, hardware manufacturers typically enact price reductions. Reductions in the price of console hardware typically result in an increase in the installed base of hardware owned by consumers. Historically, we have also seen that lower console hardware prices put downward pressure on software pricing. WhileHowever, we expect console software launch pricing for the Xbox360 and PS3 titles to be $59.99hold at current levels as a result of the strong consumer acceptance of these price points that has occurred since the launch of the next-generation
48
platforms and Wii titlesthe greater product capability and value of next generation titles. We continue to be $49.99, we are seeingexpect software pricing declines on the current-generation console systems. Additionally, when new console platforms are announced or introduced into the market, such as the November 2006 releases of the Wii and, in North America, the PS3, consumers typically reduce their purchases of game console entertainment software products for current console platforms as they upgradePS2 to the new platforms. During these periods, sales of our game console entertainment software products may be expected to slow or even decline until new platforms achieve wide consumer acceptance.hold at $39.99 with continued momentum on this platform.
Distribution Net Revenues (in thousands)
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 174,462 |
| 21 | % | $ | 148,742 |
| 18 | % | $ | 25,720 |
| 17 | % |
Nine Months Ended |
| 290,537 |
| 24 | % | 251,417 |
| 20 | % | 39,120 |
| 16 | % | |||
|
| September 30, |
| % of |
| September 30, |
| % of |
| Increase/ |
| Percent |
| |||
|
| 2007 |
| Net Revenues |
| 2006 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 63,987 |
| 20 | % | $ | 62,768 |
| 33 | % | $ | 1,219 |
| 2 | % |
Six Months Ended |
| 130,220 |
| 16 | % | 116,075 |
| 31 | % | 14,145 |
| 12 | % | |||
Distribution net revenues for the three months ended December 31, 2006September 30, 2007 increased 17%2% from the same period of the prior fiscal year, from $148.7 million or 18% of consolidated net revenues to $174.5 million or 21% of consolidated
net revenues.year. For the ninesix months ended December 31, 2006September 30, 2007 distribution net revenues increased 16%12% from the same period of prior fiscal year, from $251.4 million and 20% of consolidatedyear. Distribution net revenues to $290.5 million and 24% of consolidated net revenues. The increases for both the three and nine month periods ended December 31, 2006, was primarily the result of strong performance of our title releases during the third quarter of fiscal 2007, strong release schedules for certain third-party publishers, increased hardware sales due to strong sales of NDS, PSP, and Xbox360 hardware platforms, and the addition of a significant new customer in the second quarter of fiscal 2007. In addition to these increases, the growth as a percentage of consolidated net revenues was alsodecreased from 33% and 31% for the three and six months ended September 30, 2006, respectively, to 20% and 16% for the three and six months ended September 30, 2007, respectively, primarily due to the declinesignificant increase in publishing net revenues from our international publishing business as discussed above. Further contributing to the increase was a year over year strengthening of the EUR and GBP in relation to the USD.revenues. Foreign exchange rates increased reported distribution net revenues by approximately $15.2$4.7 million and $16.8$9.8 million for the three months and ninesix months ended December 31, 2006,September 30, 2007, respectively. Excluding the impact of changing foreign currency rates, distribution net revenues decreased 5% and increased 7% and 9%4% year over year from the three and six months ended September 30, 2006, respectively. The increase in absolute dollars of distribution net revenues for the three and ninesix months ended December 31, 2006, respectively.September 30, 2007 is primarily due to the acquisition of a significant new customer and the effect of foreign currency rates, more than offsetting the termination of a significant customer at the end of July.
The mix of distribution net revenues between hardware and software sales varied slightly year over year with approximately 20% of distribution net revenues from hardware sales in the first two quarters of fiscal 2008 as compared to 16% in the prior year first two quarters. Prior year results included sales for the PSP, NDS, and Xbox360 hardware platforms. Current year first and second quarters net revenues included PS3, NDS, Wii, and Xbox360 hardware sales. The mix of future distribution net revenues will be driven by a number of factors including our title release slate, the introduction of new hardware platforms, the occurrence of further hardware price reductions instituted by hardware manufacturers, and our ability to establish and maintain distribution agreements with hardware manufacturers, and third-party software publishers.publishers and retail customers. For the remainder of fiscal 2008, we expect distribution net revenues to decrease in absolute dollars and as a percentage of consolidated net revenues when compared to fiscal 2007. This is a result of having exited a line of distribution business that was not meaningful to earnings and the strong growth of our publishing business.
Costs and Expenses
Cost of Sales —– Product Costs (in thousands)
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| December 31, |
| Consolidated |
| December 31, |
| Consolidated |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 382,165 |
| 46 | % | $ | 367,685 |
| 45 | % | $ | 14,480 |
| 4 | % |
Nine Months Ended |
| 618,162 |
| 52 | % | 617,021 |
| 48 | % | 1,141 |
| — |
| |||
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| September 30, |
| Consolidated |
| September 30, |
| Consolidated |
| Increase/ |
| Percent |
| |||
|
| 2007 |
| Net Revenues |
| 2006 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 151,996 |
| 48 | % | $ | 127,374 |
| 68 | % | $ | 24,622 |
| 19 | % |
Six Months Ended |
| 369,225 |
| 45 | % | 235,997 |
| 63 | % | 133,228 |
| 56 | % | |||
“Cost of sales —– product costs” represented 46%48% and 45%68% of consolidated net revenues for the three months ended December 31,September 30, 2007 and 2006, and 2005, respectively. In absolute dollars,$0.4 million was not included in the “cost of sales —– product costs” increased 4% from $367.7 million at December 31, 2005 to $382.2 million at December 31, 2006.for the three months ended September 30, 2007 as a result of deferring “cost of sales – product costs.” The primary factors contributing to the increasedecrease in “cost of sales —– product costs” are:
· A shift in the mix of business between our publishing and distribution segments. Distribution net revenues as a percentage of consolidated net revenues increased from 18% in the third quarter of fiscal 2006 to 21% in the third quarter of fiscal 2007. Our distribution business typically has higher “cost of sales — product costs” than our publishing business as it is a lower margin business.
· An increase in net revenues in our North American publishing business due primarily to the release of Guitar Hero 2. Guitar Hero 2 carries a higher “cost of sales — product costs” due to the bundled guitar controller.
· A shift in the product mix versus the third quarter of fiscal 2006. PC net revenues represented 17% of publishing net revenues in the third quarter of fiscal 2006 compared to 5% in the third quarter of fiscal 2007. PC titles typically have significantly lower product costs associated with them as we do not pay royalty rates to platform licensors.
“Cost of sales — product costs” represented 52% and 48% of consolidated net revenues for the nine months ended December 31, 2006 and 2005, respectively. In absolute dollars, “cost of sales — product costs” remained relatively flat increasing only $1.1 million as compared to the first nine months of fiscal 2006. The
increase as a percentage of consolidated net revenues is partially due to a shifthigher percentage of net revenues for the three months ended September 30, 2007 relating to our publishing business which in general carries a lower percentage “cost of sales – product costs” than our distribution business. Further, the second quarter of fiscal 2008 publishing net revenues included a larger mix of next-generation product sales which carries a higher gross margin than the other console platforms. Net revenues from our publishing business were 80% of total net revenues for the three months ended September
49
30, 2007 as compared to 67% for the three months ended September 30, 2006. In absolute dollars, “cost of sales – product costs” increased 19% from $127.4 million for the three months ended September 30, 2006 to $152.0 million for the three months September 30, 2007. “Cost of sales – product costs” increased with the mix of business betweenour revenue growth in our publishing and distribution segments, a shiftbusinesses.
“Cost of sales – product costs” represented 45% and 63% of consolidated net revenues for the six months ended September 30, 2007 and 2006, respectively. $0.4 million was not included in the “cost of sales – product mix versuscosts” for the first ninesix months ended September 30, 2007 as a result of fiscal 2006, and reduced pricing on current generation title releases and a numberdeferring “cost of catalog titles. Distribution net revenuessales – product costs”. The decrease in “cost of sales – product costs” as a percentage of consolidated net revenues increased from 20%is partially due to a higher percentage of net revenues for the six months ended September 30, 2007 being attributable to our publishing business which in general carries a lower percentage “cost of sales – product costs” than our distribution business. Further, the first ninesix months of fiscal 20062008 publishing net revenues included a larger mix of next-generation product sales which carries a higher gross margin than the other console platforms. Net revenues from our publishing business composed 84% of total net revenues for the six months ended September 30, 2007 as compared to 24% in69% of total net revenues for the six months ended September 30, 2006. In absolute dollars, “cost of sales – product costs” increased by $133.2 million as compared to the first ninesix months of fiscal 2007. As mentioned above,“Cost of sales – product costs” increased with the mix of our revenue growth in our publishing and distribution business is a significantly lower margin business as it typically has higherbusinesses.
We expect “cost of sales —– product costs” than our publishing business. In addition, PC net revenues represented 8%as a percentage of publishingconsolidated net revenues for fiscal 2008 to be lower than fiscal 2007 due to a larger portion of our business being derived from the nine months ended December 31, 2006 comparedpublishing segment and the continued migration of consumers to 15% for the nine months ended December 31, 2005. PC titles typically have significantly lower product costs associated with them.next generation products.
Cost of Sales —– Software Royalties and Amortization (in thousands)
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| December 31, |
| Publishing |
| December 31, |
| Publishing |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 77,449 |
| 12 | % | $ | 104,264 |
| 16 | % | $ | (26,815 | ) | (26 | )% |
Nine Months Ended |
| 106,058 |
| 12 | % | 139,267 |
| 14 | % | (33,209 | ) | (24 | )% | |||
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| September 30, |
| Publishing |
| September 30, |
| Publishing |
| Increase/ |
| Percent |
| |||
|
| 2007 |
| Net Revenues |
| 2006 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 38,427 |
| 15 | % | $ | 9,348 |
| 7 | % | $ | 29,079 |
| 311 | % |
Six Months Ended |
| 116,679 |
| 17 | % | 28,609 |
| 11 | % | 88,070 |
| 308 | % | |||
“Cost of sales —– software royalties and amortization” as a percentage of publishing net revenues decreasedincreased from 16%7% for the three months ended December 31, 2005September 30, 2006 to 12%15% for the three months ended December 31, 2006September 30, 2007 and from 14%11% for the ninesix months ended December 31, 2005September 30, 2006 to 12%17% for the ninesix months ended December 31, 2006.September 30, 2007. In absolute dollars, “cost of sales —– software royalties and amortization” decreasedincreased 311% from the prior fiscal year, from $104.3$9.3 million to $77.4 million or 26% for the three months ended December 31,September 30, 2006 to $38.4 million for the three months ended September 30, 2007. For the six months ended September 30, 2007 “cost of sales – software royalties and from $139.3 millionamortization” increased to $106.1$116.7 million or 24% for the nine months ended December 31, 2006by 308% compared to the same periods ended December 31, 2005. The decreases are mainly due to:
· A decreaseperiod of fiscal 2007. $4.0 million was not included in the number“cost of titles released insales – software royalties and amortization” for the three and ninesix months ended December 31, 2006September 30, 2007 as a result of deferring “cost of sales – software royalties and amortization.” The increase in absolute dollars and the increase as a percentage of publishing net revenues, for the three and six months ended September 30, 2007, is primarily driven by a larger slate of titles in our publishing business versus the same period of prior year. For the first six months of fiscal 2008, we launched Spider-Man 3, Guitar Hero II for the Xbox360, Shrek the Third, and TRANSFORMERS: The Game, as compared to the threefirst quarter fiscal 2007 releases of Over the Hedge and nine months ended December 31, 2005. Our fiscal 2006 launch schedule forX-Men: The Official Game, and the three and nine months ended December 31, 2005 was the largest slate of new releases in our history. This compares to the three and nine months ended December 31, 2006, where we had a much more focused title slate in order to more properly align ourselves with the market uncertainty that was involved in the transition to the next-generation console systems.
· Impairment charges and recoverability write-offs of $11.7 million taken in the thirdsecond quarter of fiscal 20062007 release of Lego Star Wars II: The Original Trilogy in Europe. Additionally, our publishing business was a larger portion of our overall consolidated net revenues in relation to our distribution business, which drove a higher level of “cost of sales – software royalties and amortization”, given that this is a significant cost component of our publishing business.
For fiscal 2008, we expect “costs of sales – software royalties and amortization” as a resultpercentage of a detailed review of capitalized costs for released titles and future recoverability of capitalized amounts on titlespublishing net revenues to be in development. We did not incur any impairment and recoverability write-offs in the three or nine months ended December 31, 2006.line with fiscal 2007 levels.
Partially offset by:
· An increase of $1.8 million and $1.9 million, respectively, for the three and nine months ended December 31, 2006 related to amortization of capitalized stock-based compensation expense as a result of the implementation of SFAS 123R50
Cost of Sales —– Intellectual Property Licenses (in thousands)
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| December 31, |
| Publishing |
| December 31, |
| Publishing |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 23,566 |
| 4 | % | $ | 26,376 |
| 4 | % | $ | (2,810 | ) | (11 | )% |
Nine Months Ended |
| 37,838 |
| 4 | % | 55,765 |
| 5 | % | (17,927 | ) | (32 | )% | |||
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| September 30, |
| Publishing |
| September 30, |
| Publishing |
| Increase/ |
| Percent |
| |||
|
| 2007 |
| Net Revenues |
| 2006 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 14,533 |
| 6 | % | $ | 4,356 |
| 3 | % | $ | 10,177 |
| 234 | % |
Six Months Ended |
| 47,012 |
| 7 | % | 14,272 |
| 5 | % | 32,740 |
| 229 | % | |||
“Cost of sales —– intellectual property licenses” increased 234% from $4.4 million or 3% of publishing net revenues for the three months ended December 31,September 30, 2006 decreased in absolute dollars by 11% from $26.4to $14.5 million or 6% of publishing net revenues for the three months ended December 31, 2005 to $23.6 million for the three months ended December 31, 2006 while the percentage of “costSeptember 30, 2007. “Cost of sales —– intellectual property licenses” to publishing net revenues remained constant at 4%. The decrease in absolute dollars is mainly due to a decrease in the number of titles released, a decrease of 3% in total publishing net revenues, and a slight shift in the composition of our title slate to one comprised of titles with lower intellectual property costs associated with them. In the quarter ended December 31, 2006, our top two selling titles were Call of Duty 3 and Guitar Hero 2, both of which are based upon intellectual property owned by us. In the quarter ended December 31, 2006, title releases which had associated intellectual property costs were Tony Hawk’s Project 8, Tony Hawk’s Downhill Jam, Over the Hedge: Hammy Goes Nuts!, Shrek Smash N’ Crash Racing, Cabela’s African Safari, and Marvel: Ultimate Alliance. In the third quarter of fiscal 2006, our “cost of sales — intellectual property licenses” was driven by intellectual property licenses associated with Ultimate Spider-Man, X-Men Legends II, Shrek SuperSlam, Madagascar, Tony Hawk’s American Wasteland, and Quake 4.
“Cost of sales — intellectual property licenses” decreasedincreased in both absolute dollars and as a percentage of publishing net revenues from $55.8$14.3 million andor 5% of publishing net revenues to $37.8$47.0 million and 4%or 7% of publishing net revenues for the ninesix months ended December 31,September 30, 2006 and 2005,2007, respectively. $1.4 million was not included in the “cost of sales – intellectual property licenses” for the three and six months ended September 30, 2007 as a result of deferring “cost of sales – intellectual property licenses.”
The decreasesincreases in both absolute dollars for both the three and six month periods ended September 30, 2007 were primarily the result of the releases of TRANSFORMERS: The Game in Europe in the second quarter of fiscal 2008, and amortization of intellectual property licenses expenses relating to Spider-Man 3 and Shrek the Third releasedworldwide in the first quarter fiscal 2008 and TRANSFORMERS: The Game released in North America and Asia in first quarter fiscal 2008. This compares to titles associated with intellectual property released in the first quarter of fiscal 2007, Over the Hedge and X-Men: The Official Game. The increase in “cost of sales – intellectual property licenses” as a percentage of publishing net revenues were mainlywas due to strong sales the increased number of new releases and catalog titles with no associated intellectual property royalties, the release of fewer titles in the first nine months of the current fiscal year with lower associated intellectual property royalties, and a decrease of 12% in total publishing net revenues. During the first nine months of fiscal 2007, our top two selling titles were Call of Duty 3 and Guitar Hero 2, both of which are based upon intellectual property owned by us. In addition, we had lower revenue from releases with associated intellectual property royalties which included, Tony Hawk’s Project 8, Tony Hawk’s Downhill Jam, Over the Hedge: Hammy Goes Nuts!, Shrek Smash N’ Crash Racing, Marvel: Ultimate Alliance, Over the Hedge, X-Men: The Official Game, World Series of Poker: Tournament of Champions, Cabela’s African Safari, and Cabela’s Alaskan Adventure. This compares to the key new releases with intellectual property royaltiescosts released in the first ninethree and six months of fiscal 2006: Madagascar,Fantastic Four, Ultimate Spider-Man, X-Men Legends II, Shrek SuperSlam, Tony Hawk’s American Wasteland, Doom 3 forperiods ended September 30, 2007 when compared to the Xboxthree and Quake 4.six months periods ended September 30, 2006.
Product Development (in thousands)
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| December 31, |
| Publishing |
| December 31, |
| Publishing |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
| As restated |
| As restated |
|
|
|
|
| |||
Three Months Ended |
| $ | 37,162 |
| 6 | % | $ | 53,254 |
| 8 | % | $ | (16,092 | ) | (30 | )% |
Nine Months Ended |
| 88,395 |
| 10 | % | 99,698 |
| 10 | % | (11,303 | ) | (11 | )% | |||
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| September 30, |
| Publishing |
| September 30, |
| Publishing |
| Increase/ |
| Percent |
| |||
|
| 2007 |
| Net Revenues |
| 2006 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 33,085 |
| 13 | % | $ | 25,608 |
| 20 | % | $ | 7,477 |
| 29 | % |
Six Months Ended |
| 65,982 |
| 10 | % | 51,233 |
| 20 | % | 14,749 |
| 29 | % | |||
Product development expenses for the three months ended December 31, 2006 decreased 30%September 30, 2007 increased 29%, from $25.6 million to $33.1 million, as compared to the three months ended December 31, 2005, from $53.3 million to $37.2 million.September 30, 2006. For the ninesix months ended December 31, 2006September 30, 2007 product development expenses decreased by $11.3increased $14.7 million, or 11%29%, from $99.7$51.2 million for the ninesix months ended December 31, 2005September 30, 2006 to $88.4$66.0 million for the ninesix months ended December 31, 2006.September 30, 2007. As a percentage of publishing net revenues, product development expenses decreased from 8%20% for the quarterthree and six months ended December 31, 2005September 30, 2006, respectively, to 6%13% and 10% for the quarterthree and six months ended December 31, 2006 while remaining at 10% of totalSeptember 30, 2007, respectively. This is primarily due to more consumers migrating to the next-generation console platforms, where we are able to charge premium pricing, and our successful titles in the next-generation console platforms. As a result, the growth in publishing net revenues foroutweighed the nine month periods ended December 31, 2006increase in product development expenses. The increase in absolute dollars primarily resulted from higher development, quality assurance, and 2005. The decreases in the three and nine months ended December 31, 2006 are primarily the result of product cancellation charges of $11.1 million, including termination fees,outside developer costs incurred during the third quarterfirst two quarters of fiscal 2006. The product cancellation charges were based upon a business decision we made2008 to cancel developmentsupport the greater number of certain titles and permanently remove them from our future title slate in order to better align opportunities associated with the next generation console platforms with income potential and risks associated with certain titles in development. There were nodevelopment and the more technologically advanced nature of those titles.
We expect product cancellation charges during the third quarter ofdevelopment costs for fiscal 2007. Additionally,2008 to be higher in absolute dollars than fiscal 2007, although lower as a percentage of publishing net revenues, due to the increased costs related to developing more technologically advanced titles for the next-generation console systems offset by the more than proportionate projected increase in publishing net revenues. Over time, we have implemented certain cost control initiatives including sharingintend to decrease the development costs of the next-generation console systems by leveraging technologies and tools across multiple platforms, increasing our development schedules to facilitate a longer pre-production phase and more predictable workflow times, and outsourcing certain areasincreasing the amount of game development toin lower cost service providers. The decreases were partially offset by product development expenses of $1.4 million and $4.1 million for the three and nine months ended December 31, 2006, respectively, related to stock-based compensation expense as a result of the implementation of SFAS 123R.locations.
51
Sales and Marketing (in thousands)
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| December 31, |
| Consolidated |
| December 31, |
| Consolidated |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
| As restated |
| As restated |
|
|
|
|
| |||
Three Months Ended |
| $ | 87,410 |
| 11 | % | $ | 156,013 |
| 19 | % | $ | (68,603 | ) | (44 | )% |
Nine Months Ended |
| 156,139 |
| 13 | % | 259,110 |
| 20 | % | (102,971 | ) | (40 | )% | |||
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| September 30, |
| Consolidated |
| September 30, |
| Consolidated |
| Increase/ |
| Percent |
| |||
|
| 2007 |
| Net Revenues |
| 2006 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 51,868 |
| 16 | % | $ | 32,550 |
| 17 | % | $ | 19,318 |
| 59 | % |
Six Months Ended |
| 120,580 |
| 15 | % | 68,729 |
| 18 | % | 51,851 |
| 75 | % | |||
Sales and marketing expenses for the three months ended September 30, 2007 increased 59%, from $32.6 million to $51.9 million, as compared to the three months ended September 30, 2006. For the six months ended September 30, 2007, sales and marketing expenses increased $51.9 million, or 75%, from $68.7 million for the six months ended September 30, 2006 to $120.6 million for the six months ended September 30, 2007. As a percentage of $87.4 millionpublishing net revenues, sales and $156.0 million represented 11%marketing expenses decreased from 17% and 19%18% for the three and six months ended September 30, 2006, respectively, to 16% and 15% for the three and six months ended September 30, 2007, respectively. The increases in absolute dollars were a result of higher spending associated with the larger fiscal 2008 first and second quarter releases which included three major movie-based releases, Spider-Man 3 and Shrek the Third worldwide releases in the first quarter of fiscal 2008, and TRANSFORMERS: The Game released in North America and Asia in the first quarter of fiscal 2008 and in Europe in the second quarter of fiscal 2008. This compares to the same period of the prior fiscal year which included Over the Hedge and X-Men: The Official Game in the first quarter of fiscal 2007, and our European release of Lego Star Wars II: The Original Trilogy in the second quarter of fiscal 2007.
We expect sales and marketing expenses to be higher on both an absolute basis and as a percentage of consolidated net revenues for the three months ended December 31, 2006reminder of fiscal 2008 versus the comparable period of fiscal 2007 due to a larger slate and 2005, respectively. For the nine months ended December 31, 2006 and 2005, sales and marketing expenses of $156.1 million and $259.1 million represented 13% and 20% of consolidated net revenues. These decreases were a result of the implementationour anticipation of a more targeted media program which worked more efficiently and was helped by the overall strength and high quality of our fiscal 2007 title slate. We also released fewer titleshighly competitive environment during the three and nine month periods ended December 31, 2006 as compared to the same periods of fiscal 2006, where we had the largest slate of new releases in our history. The decreases were partially offset by expenses of $1.6 million and $3.5 million for the three and nine month periods ended December 31, 2006, respectively, related to stock-based compensation expense as a result of the implementation of SFAS 123R, as well as sales and marketing expenses associated with the addition of the Guitar Hero franchise.upcoming holiday season.
General and Administrative (in thousands)
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| December 31, |
| Consolidated |
| December 31, |
| Consolidated |
| Increase/ |
| Percent |
| |||
|
| 2006 |
| Net Revenues |
| 2005 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
| As restated |
| As restated |
|
|
|
|
| |||
Three Months Ended |
| $ | 43,387 |
| 5 | % | $ | 24,757 |
| 3 | % | $ | 18,630 |
| 75 | % |
Nine Months Ended |
| 91,647 |
| 8 | % | 67,228 |
| 5 | % | 24,419 |
| 36 | % | |||
z
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| September 30, |
| Consolidated |
| September 30, |
| Consolidated |
| Increase/ |
| Percent |
| |||
|
| 2007 |
| Net Revenues |
| 2006 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 37,382 |
| 12 | % | $ | 26,346 |
| 14 | % | $ | 11,036 |
| 42 | % |
Six Months Ended |
| 73,176 |
| 9 | % | 48,260 |
| 13 | % | 24,916 |
| 52 | % | |||
65
General and administrative expenses for the three months ended December 31, 2006September 30, 2007 increased $18.642%, from $26.3 million to $37.4 million, as compared to the three months ended September 30, 2006. For the six months ended September 30, 2007, general and administrative expenses increased $24.9 million, or 75% over52%, from $48.3 million for the same period last year, from $24.8six months ended September 30, 2006 to $73.2 million to $43.4 million.for the six months ended September 30, 2007, respectively. As a percentage of consolidated net revenues, general and administrative expenses increaseddecreased from 3% to 5%14% and 13% for the three and six months ended December 31, 2005September 30, 2006, respectively, to 12% and 2006, respectively. For9% for the ninethree and six months ended December 31, 2006, general and administrative expenses increased $24.4 million or 36% over the same period last year, from $67.2 million to $91.6 million. As a percentage of consolidated net revenues, general and administrative expenses increased from 5% to 8% for the nine months ended December 31, 2005 as compared to the nine months ended December 31, 2006. The increasesSeptember 30, 2007, respectively. Expenses were higher than prior periods primarily due to increasedan increase in headcount related costs, higher legal and professional fees, relating primarily to our internal review of historical stock option granting practices, the consolidation of RedOctane and DemonWare (acquired in June 2006 and May 2007, respectively) into our results of operations for the quarter, amortization of intangible assets related to the RedOctane acquisition,acquisitions and stock-based compensation expensethe impact of $2.9 million and $9.0 million for the three and nine months ended December 31, 2006, respectively, associated with the implementation of SFAS 123R. These increases were partially offset by the benefits of our cost optimization program launchedchanges in the fourth quarter of fiscal 2006 and gains on foreign currency.currency rates.
52
Operating Income (Loss) (in thousands)
| Three Months |
| % of |
| Three Months |
| % of |
| Increase/ |
| Percent |
| ||||
|
|
|
|
|
| As restated |
| As restated |
|
|
|
|
| |||
Publishing |
| $ | 160,628 |
| 25 | % | $ | 65,534 |
| 10 | % | $ | 95,094 |
| 145 | % |
Distribution |
| 12,492 |
| 7 | % | 18,359 |
| 12 | % | (5,867 | ) | (32 | )% | |||
Consolidated |
| $ | 173,120 |
| 21 | % | $ | 83,893 |
| 10 | % | $ | 89,227 |
| 106 | % |
|
| Three Months |
| % of |
| Three Months |
| % of |
| Increase/ |
| Percent |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Publishing |
| $ | (9,667 | ) | (4 | )% | $ | (36,607 | ) | (29 | )% | $ | 26,940 |
| 74 | % |
Distribution |
| 122 |
| — | % | (803 | ) | (1 | )% | 925 |
| 115 | % | |||
Consolidated |
| $ | (9,545 | ) | (3 | )% | $ | (37,410 | ) | (20 | )% | $ | 27,865 |
| 74 | % |
| Nine Months |
| % of |
| Nine Months |
| % of |
| Increase/ |
| Percent |
|
| Six Months |
| % of |
| Six Months |
| % of |
| Increase/ |
| Percent |
| |||||||
|
|
|
|
|
| As restated |
| As restated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Publishing |
| $ | 92,503 |
| 10 | % | $ | 21,932 |
| 2 | % | $ | 70,571 |
| 322 | % |
| $ | 19,449 |
| 3 | % | $ | (68,125 | ) | (26 | )% | $ | 87,574 |
| 129 | % |
Distribution |
| 9,758 |
| 3 | % | 19,854 |
| 8 | % | (10,096 | ) | (51 | )% |
| 1,098 |
| 1 | % | (2,734 | ) | (2 | )% | 3,832 |
| 140 | % | ||||||
Consolidated |
| $ | 102,261 |
| 8 | % | $ | 41,786 |
| 3 | % | $ | 60,475 |
| 145 | % |
| $ | 20,547 |
| 3 | % | $ | (70,859 | ) | (19 | )% | $ | 91,406 |
| 129 | % |
Publishing operating incomeloss for the three months ended December 31, 2006 increased $95.1September 30, 2007 decreased $26.9 million or 145%74% from the same period lastprior fiscal year, from $65.5$36.6 million to $160.6$9.7 million, while the percentage of operating incomeloss to segment net revenues increaseddecreased from 10%29% to 25%4%. For the ninesix months ended December 31, 2006September 30, 2007 publishing operating income increased $70.6$87.6 million from the same period lastprior fiscal year, from $21.9an operating loss of $68.1 million to $92.5operating income of $19.5 million. These increases in operating income are primarily attributable to:
·• StrongStronger performance of our fiscal 2007 third quarter title slate.releases for the first three and six months ended September 30, 2007.
·• Decreased provision for returnsFaster growth in our publishing segment, which in general has a higher operating margin than our distribution segment.
• Cost control relative to significant growth in net revenues.
Partially offset by:
• Higher “cost of sales – software royalties and price protection in the third quarteramortization”and “cost of sales – intellectual property licenses” associated with our larger fiscal 20072008 slate of 7% and 10% of net revenuestitles for the three and ninesix months ended December 31, 2006, respectively, compared to 17%September 30, 2007.
• Higher “general and 19% of net revenues for the three and nine months ended December 31, 2005. The decrease in reserve requirements isadministrative” costs due to improved market conditions resultingthe increased headcount in strong sell through of our fiscal 2007 third quarter releases.
· The implementation of a more targeted salesinternational geographies and marketing program which provided significant cost savings while still delivering strong revenue performance.
· The implementation of certain cost control initiatives resulting in decreased product development costs and savings in general and administrative expenses.
Partially offset by:
· Higher expenses associated with stock-based compensation expense of $7.7 and $18.4 million for the three and nine months ended December 31, 2006 as a result of the implementation of SFAS 123R,at Red Octane, and higher overall general and administrative expenses due to increased legal expenses and professional fees relating primarily to our internal review of historical stock option granting practices, including expenses relating to the informal SEC inquiry and derivative litigation.fees.
For the three months ended December 31, 2006September 30, 2007 distribution operating income was $12.5$0.1 million or 7%0% of segment net revenues, which compares to operating incomeloss of $18.4$0.8 million or 12%(1)% of segment net revenues for the three months ended December 31, 2005.September 30, 2006. For the ninesix months ended December 31, 2006September 30, 2007 distribution operating income was $9.8$1.1 million or 3%1% of segment net revenues, which compares to operating incomeloss of $19.9$2.7 million or 8%(2)% of segment net revenues for the ninesix months ended December 31, 2005.September 30, 2006. The decreases areresults from distribution business have improved primarily due to increased business with large mass-market customersthe strong performance of Activision titles for the three and six months ended September 30, 2007, lower required reserves for returns and price protection, and a lower percentage of net revenues being comprised of hardware sales, which we earn smaller margins accompanied by increased costsis a lower margin category when compared to sales of distributing higher product volumes.software.
53
Investment Income, Net (in thousands)
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 9,724 |
| 1 | % | $ | 9,162 |
| 1 | % | $ | 562 |
| 6 | % |
Nine Months Ended |
| 26,031 |
| 2 | % | 22,840 |
| 2 | % | 3,191 |
| 14 | % | |||
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| September 30, |
| Consolidated |
| September 30, |
| Consolidated |
| Increase/ |
| Percent |
| |||
|
| 2007 |
| Net Revenues |
| 2006 |
| Net Revenues |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 12,132 |
| 4 | % | $ | 8,032 |
| 4 | % | $ | 4,100 |
| 51 | % |
Six Months Ended |
| 23,694 |
| 3 | % | 16,307 |
| 5 | % | 7,387 |
| 45 | % | |||
Net investment income for the three months ended December 31, 2006September 30, 2007 was $9.7$12.1 million as compared to $9.2$8.0 million for the three months ended December 31, 2005.September 30, 2006. Net investment income for the ninesix months ended December 31, 2006September 30, 2007 increased $3.2$7.4 million from $22.8$16.3 million for the ninesix months ended December 31, 2005 as comparedSeptember 30, 2006 to $26.0$23.7 million for the ninesix months ended December 31, 2006.September 30, 2007. The increases in both the three and ninesix months ended December 31, 2006September 30, 2007 as compared to the three and ninesix months ended December 31, 2005September 30, 2006 are mainly due to higher interest rates combined with higher average balances of cash and short term investments period over period, a realized gain of $1.8 million on the sale of a common stock investment, partially offset by a realized gain in the first quarter of fiscal 2006 of $1.3 million on the sale of an investment in common stock and a realized gain of $2.9 million on the sale of a cost basis investment.period.
Provision for Income Taxes (in thousands)
|
| December 31, |
| % of |
| December 31, |
| % of |
| Increase/ |
| Percent |
| |||
|
|
|
|
|
| As restated |
| As restated |
|
|
|
|
| |||
Three Months Ended |
| $ | 40,024 |
| 22 | % | $ | 25,199 |
| 27 | % | $ | 14,825 |
| 59 | % |
Nine Months Ended |
| 28,083 |
| 22 | % | 15,247 |
| 24 | % | 12,836 |
| 84 | % | |||
|
|
|
| % of |
|
|
| % of |
|
|
|
|
| |||
|
| September 30, |
| Pretax |
| September 30, |
| Pretax |
| Increase/ |
| Percent |
| |||
|
| 2007 |
| Income |
| 2006 |
| Income |
| (Decrease) |
| Change |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Three Months Ended |
| $ | 1,889 |
| 73 | % | $ | (5,076 | ) | 17 | % | $ | 6,965 |
| 137 | % |
Six Months Ended |
| 15,717 |
| 36 | % | (11,941 | ) | 22 | % | 27,658 |
| 232 | % | |||
The income tax provision of $40.0 million and $28.1$1.9 million for the three months ended September 30, 2007 reflects our effective income tax rate for the quarter of 73.0%, and ninethe income tax provision of $15.7 million for the six months ended September 30December 31,, 2007 reflects our estimated effective income tax rate of 35.5% for the six months ended September 30, 2007. Due to our relatively small net income before tax provision for the three months ended September 30, 2007, small changes in discrete items resulted in a large impact on our effective income tax rate for the quarter ended September 30, 2007. The significant items that generated the variance between our effective rate for the three months ended September 30, 2007 and our statutory rate of 35% were federal and state research and development tax credits, the impact of foreign tax rate differentials, and the federal deduction for domestic production activities, partially offset by state taxes and the impact of a decrease in the tax benefit of deferred tax assets on the books of our UK affiliates due to the recent enactment of a decrease in the UK statutory tax rate.
The aforementioned effective income tax rate for the quarter of 73.0% differs from our effective income tax rate of 17.3% for the three months ended September 30, 2006 due to an increase in anticipated pretax income for fiscal 2008 determined at September 30, 2007 versus the anticipated pretax income for fiscal 2007 determined at September 30, 2006, without a corresponding increase in the benefit of book/tax differences, in addition to the impact of a decrease in the tax benefit of deferred tax assets on the books of our UK affiliates due to the recent enactment of a decrease in the UK statutory tax rate.
The income tax benefit of $5.1 million for the three months ended September 30, 2006 reflects our effective income tax rate for the quarter of 17.3%, which differs from our effective tax rate of 21.9%. This is lower than prior for the year as a resultended March 31, 2007 due to (1) an increase in the federal research and development credit for the full year ended March 31, 2007 over the amount originally anticipated for the year at September 30, 2006 due to the Congressional reinstatement of improved profitability leading to utilizationthe federal R&D credit in quarter ended December 31, 2006; and (2) the elimination of net operating loss carry forwards and in turn a reduction inthe valuation allowances related to federal and stateallowance for research and development tax credits, partially offset by the nondeductible portion of annual cash bonuses determined in the three months ended March 31, 2007 under Section 162(m), and the establishment of tax reserves.reserves for these credits and other deferred tax assets. The significant items that generated the variance between our effective rate and our statutory rate of 35% for the three months ended September 30, 2006 were federal and state research and development tax credits for state purposes, and the impact of foreign tax rate differentials, partially offset by state taxes. The realization of deferred tax assets depends primarily on the generation of future taxable income. We believe that it is more likely than not that we will generate taxable income sufficient to realize the benefit of net deferred tax assets recognized.
54
Net Income (Loss)
Net income for the three months ended December 31, 2006September 30, 2007 was $142.8$0.7 million or $0.46$0.00 per diluted share, as compared to net incomeloss of $67.9$24.3 million or $0.23$0.09 loss per diluted share for the three months ended December 31, 2005.September 30, 2006.
Net income for the ninesix months ended December 31, 2006September 30, 2007 was $100.2$28.5 million or $0.33$0.09 per diluted share, as compared to net incomeloss of $49.4$42.6 million or $0.17$0.15 loss per diluted share for the ninesix months ended December 31, 2005.September 30, 2006.
Liquidity and Capital Resources
Sources of Liquidity (in thousands)
| December 31, 2006 |
| March 31, 2006 |
| Increase/ |
| ||||
Cash and cash equivalents |
| $ | 367,910 |
| $ | 354,331 |
| $ | 13,579 |
|
Short-term investments |
| 437,290 |
| 590,629 |
| (153,339 | ) | |||
|
|
|
|
|
|
|
| |||
|
| $ | 805,200 |
| $ | 944,960 |
| $ | (139,760 | ) |
|
|
|
|
|
|
|
| |||
Percentage of total assets |
| 43 | % | 67 | % |
|
|
| For the Nine Months |
| For the Nine Months |
| Increase/ |
| ||||
|
|
|
| As restated |
|
|
| |||
Cash flows used in operating activities |
| $ | (125,417 | ) | $ | (83,932 | ) | $ | (41,485 | ) |
Cash flows provided by investing activities |
| 101,967 |
| 4,587 |
| 97,380 |
| |||
Cash flows provided by financing activities |
| 27,968 |
| 37,850 |
| (9,882 | ) | |||
|
| September 30, 2007 |
| March 31, 2007 |
| Increase/ |
| |||
Cash and cash equivalents |
| $ | 392,529 |
| $ | 384,409 |
| $ | 8,120 |
|
Short-term investments |
| 569,231 |
| 570,440 |
| (1,209 | ) | |||
|
| $ | 961,760 |
| $ | 954,849 |
| $ | 6,911 |
|
|
|
|
|
|
|
|
| |||
Percentage of total assets |
| 49 | % | 53 | % |
|
| |||
|
|
|
|
|
|
|
|
|
| For the Six Months |
| For the Six Months |
| Increase/ |
| |||
|
|
|
|
|
|
|
| |||
Cash flows provided by (used in) operating activities |
| $ | 46,399 |
| $ | (169,271 | ) | $ | 215,670 |
|
Cash flows used in investing activities |
| (81,900 | ) | (16,870 | ) | (65,030 | ) | |||
Cash flows provided by financing activities |
| 38,403 |
| 16,327 |
| 22,076 |
| |||
As of December 31, 2006,September 30, 2007, our primary source of liquidity is comprised of $367.9$392.5 million of cash and cash equivalents and $437.3$569.2 million of short-term investments. Over the last two years, our primary sources of liquidity have included cash on hand at the beginning of the year and cash flows generated from continuing operations. We have also generated significant cash flows from the issuance of our common stock to employees through the exercise of options which is described in more detail below in “Cash Flows from Financing Activities.” We have not utilized debt financing as a significant source of cash flows. However, we do have credit facilities available at certain of our international locations, which are described below in “Credit Facilities,” that can be utilized if needed.
Our investment portfolio consists of government and corporate securities with effective maturities less than 30 months. The longer the term or holding period of the securities, the more susceptible they are to changes in market rates of interest, yields on bonds, and market price volatility. Investments are reviewed periodically to identify possible impairment. When evaluating the investments, we review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer, and our ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery in market value. Gross unrealized losses of $0.8 million and $1.5 million as of September 30, 2007 and March 31, 2007, respectively, were comprised mostly of unrealized losses on U.S. agency issues, commercial paper, corporate bonds, and mortgage-backed securities. We have the intent and ability to hold these securities for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the initial cost of the investment. We expect to realize the full value of all of these investments upon maturity or sale.
We believe that we have sufficient working capital ($1,042.91,053.6 million at December 31, 2006)September 30, 2007), in combination with proceeds available from our international credit facilities, to finance our operational requirements for at least the next twelve months, including purchases of inventory and equipment, the funding of the development, production, marketing and sale of new products, and the acquisition of intellectual property rights for future products from third parties.
55
Cash Flows from Operating Activities
The primary drivers of cash flows from operating activities typically have included the collection of customer receivables generated by the sale of our products, offset by payments to vendors for the manufacture, distribution and marketing of our products, third-party developers and intellectual property holders and our own employees. A significant operating use of our cash relates to our continued investment in software development and intellectual property licenses. We spent approximately $117.6$88.8 million and $162.8$84.6 million in the ninesix months ended December 31,September 30, 2007 and 2006, and 2005, respectively, primarily in connection with the acquisitioninternal development efforts and in support of publishing or distribution rightsthird-party developers for products being developed by third parties, the execution of new license agreements granting us long-term rights to intellectual property of third parties, as well as internal product development. The decrease period over period is primarily due to significant agreements with DreamWorks Animation SKG and Marvel Enterprises, both signed in the third quarter of fiscal 2006, partially offset by increased product development costs related to the development of fiscal 2007 and fiscal 2008 title releases for the next generation console systems, which are higher than current generation console systems, as well as a new agreement, signed in May 2006, with MGM Interactive and EON Productions Ltd. for the rights to develop and publish interactive entertainment games based on the James Bond license.our business. We expect that we will continue to make significant expenditures relating to our investment in software development and intellectual property licenses. Our future cash commitments relating to these investments are detailed below in “Commitments.” Cash flows from operations are affected by our ability to release highly successful, or “hit,” titles. Though many of these titles have substantial production or acquisition costs and marketing budgets, once a title recoups these costs, incremental net revenues typically will directly and positively impact cash flows.
For the ninesix months ended December 31, 2006 and 2005,September 30, 2007, cash flowsflow provided by operating activities was $46.4 million as compared to cash flow used in operating activities were $125.4of $169.3 million and $83.9 million, respectively.for the six months ended September 30, 2006. The principal components comprising the increased cash flows used infrom operating activities for the ninesix months ended December 31, 2006September 30, 2007 included investment in software development and intellectual property licenses and increasesa decrease in accounts receivable,receivables as a result of stronger collections and an increase in accounts payable partially offset by amortization of capitalized software development costs and intellectual property licenses.the increase in inventory for upcoming holiday season releases. An analysis of the change in key balance sheet accounts is below in ���Key“Key Balance Sheet Accounts.” We expect that a primary source of future liquidity, both short-term and long-term, will be the result of cash flows from continuing operations.
Cash Flows from Investing Activities
The primary drivers of cash used in investing activities typically have included capital expenditures, acquisitions of privately held interactive software development and publishing companies, and the net effect of purchases and sales/maturities of short-term investment vehicles. The goal of our short-term investments is to maximize return while minimizing risk, maintaining liquidity, coordinating with anticipated working capital needs, and providing for prudent investment diversification.
For the ninesix months ended December 31,September 30, 2007 and 2006, and 2005, cash flows provided byused in investing activities were $102.0$81.9 million and $4.6$16.9 million, respectively. For the ninesix months ended December 31, 2006,September 30, 2007, cash flows provided byused in investing activities were primarily the result of capital expenditures, cash paid for acquisitions, and purchases of short-term investments partially offset by proceeds from sales and maturities of short-term investments partially offset by purchases of short-term investments, capital expenditures, and cash paid for acquisitions.investments. We have historically financed our acquisitions through the issuance of shares of our common stock, cash or a combination of our common stock and cash. We will continue to evaluate potential acquisition candidates as to the benefit they bring to us.
Cash Flows from Financing Activities
The primary sources of cash provided by financing activities have historically related to transactions involving our common stock, including the issuance of shares of our common stock to employees. We have not utilized debt financing as a significant source of cash flows. However, we do have available credit facilities at certain of our international locations, which are described below in “Credit Facilities,” that can be utilized if needed.
For the ninesix months ended December 31,September 30, 2007 and 2006, and 2005, cash flows from financing activities were $28.0$38.4 million and $37.9$16.3 million, respectively. The cash provided by financing activities for the ninesix months ended December 31, 2006September 30, 2007 primarily is the result of the issuance of our common stock related to employee stock option and stock purchase plans. The decreaseincrease in cash provided by financing activities is due to suspension ofincrease in stock option exercises during the third quarter of fiscal 2007 due to our internal review of historical stock option granting practices.six months ended September 30, 2007.
During fiscal 2003, our Board of Directors authorized a buyback program under which we can repurchase up to $350.0 million of our common stock. Under the program, shares may be purchased as determined by management and within certain guidelines, from time to time, in the open market or in privately negotiated transactions, including privately negotiated structured stock repurchase transactions and through transactions in the options markets. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time to time without prior notice. As of December 31, 2006,September 30, 2007, we
56
had approximately $226.2 million available for utilization under the buyback program. We actively manage our capital structure as a component of our overall business strategy. Accordingly, in the future, when we determine that market conditions are appropriate, we may seek to achieve long term value for the shareholders through, among other things, new debt or equity financings or refinancings, share repurchases and other transactions involving our equity or debt securities.
Key Balance Sheet Accounts
Accounts Receivable
(amounts in thousands) |
| December 31, 2006 |
| March 31, 2006 |
| Increase/ |
| |||
|
|
|
|
|
|
|
| |||
Gross accounts receivable |
| $ | 563,713 |
| $ | 127,035 |
| $ | 436,678 |
|
Net accounts receivable |
| 456,589 |
| 28,782 |
| 427,807 |
| |||
|
|
|
|
|
| Increase/ |
| |||
(amounts in thousands) |
| September 30, 2007 |
| March 31, 2007 |
| (Decrease) |
| |||
|
|
|
|
|
|
|
| |||
Gross accounts receivable |
| $ | 216,344 |
| $ | 240,112 |
| $ | (23,768 | ) |
Net accounts receivable |
| 109,725 |
| 148,694 |
| (38,969 | ) | |||
The increasedecrease in gross accounts receivable was primarily the result of increased sales volume in both our distribution and publishing businesses due to more titles being released during the third quarter of fiscal 2007 comparedcollecting receivables related to the fourth quarter of fiscal 2006 and higher sales volume due to seasonalityMarch 2007 launch of the holiday selling season. Significant shipments were made to customersPS3 in November and December and the related receivables were not due prior to quarter end.Europe.
Reserves for returns, price protection, and doubtfulThe decrease in net accounts increasedreceivable from $98.3$148.7 million at March 31, 20062007 to $107.1$109.7 million at December 31, 2006 largely reflecting increased sales volume and inventory inSeptember 30, 2007, was greater than the retail channel and resulting increasedecrease in gross accounts receivable. The decreasereceivable due to the increase in the percentage of reserves for returns, price protection, and doubtful accounts as a percentage of gross receivablesbad debt from 77%$91.4 million at March 31, 20062007 to 19%$106.6 million at December 31, 2006 reflects an improvement in market conditions during the fiscal 2007 third quarter holiday season, the successful launch of the next generation hardware platforms, and the issuance of credits to customers on previously established reserves related to fiscal 2006 titles.September 30, 2007. Reserves for returns and price protection are a function of the number of units and pricing of titles in retail inventory (see description of Allowances for Returns, Price Protection, Doubtful Accounts, and Inventory Obsolescence in Item 2: Critical Accounting Policies)Policies and Estimates).
Inventories
(amounts in thousands) |
| December 31, 2006 |
| March 31, 2006 |
| Increase/ |
| |||
|
|
|
|
|
|
|
| |||
Inventories |
| $ | 85,680 |
| $ | 61,483 |
| $ | 24,197 |
|
|
|
|
|
|
| Increase/ |
| |||
(amounts in thousands) |
| September 30, 2007 |
| March 31, 2007 |
| (Decrease) |
| |||
|
|
|
|
|
|
|
| |||
Inventories |
| $ | 189,033 |
| $ | 91,231 |
| $ | 97,802 |
|
The increase in inventories at December 31, 2006September 30, 2007 compared to March 31, 20062007 is the result of additional inventories associated with RedOctane and theto support third quarter fiscal 2008 title releases such as Guitar Hero products, which was acquired in the first quarter of fiscal 2007, additional Wii inventory in Europe due to the European release of the console late in the third quarter of fiscal 2007, and an increase in inventories at our distribution business related to the addition of a significant new customer in the second quarter of fiscal 2007.III.
Software Development
(amounts in thousands) |
| December 31, 2006 |
| March 31, 2006 |
| Increase/ |
| |||
|
|
|
|
|
|
|
| |||
Software development |
| $ | 101,807 |
| $ | 60,619 |
| $ | 41,188 |
|
|
|
|
|
|
| Increase/ |
| |||
(amounts in thousands) |
| September 30, 2007 |
| March 31, 2007 |
| (Decrease) |
| |||
|
|
|
|
|
|
|
| |||
Software development |
| $ | 144,669 |
| $ | 130,922 |
| $ | 13,747 |
|
Software development increased from $60.6$130.9 million at March 31, 20062007 to $101.8$144.7 million at December 31, 2006.September 30, 2007. The effect of deferring “cost of sales – software royalties and amortization” increased software development by $4.0 million. The increase in software development was primarily the result of:
· Continued investmentof an increase in software development for titles being developed for release incapitalization of third quarter fiscal 2008 particularly software development costs related to three significant new games slated for release intitles releases and stock option expenses which was partially offset by the first quarteramortization of fiscal 2008. We incurred approximately $109.4 million inour movie-related titles released, such as Spider-Man 3, Shrek the nineThird, and TRANSFORMERS: The Game during the six months ended December 31, 2006 in connection with the third party development costs as well as the capitalization of product development costs relating to internally developed products including capitalization of stock based compensation expenses as a result of the implementation of SFAS 123R.September 30, 2007.
Partially offset by:
· $70.1 million of amortization of capitalized software development costs, including $1.9 million of capitalized stock based compensation expense as a result of the implementation of SFAS 123R, related to our title releases in the first nine months of fiscal 2007.57
Intellectual Property Licenses
(amounts in thousands) |
| December 31, 2006 |
| March 31, 2006 |
| Increase/ |
| |||
|
|
|
|
|
|
|
| |||
Intellectual property licenses |
| $ | 93,428 |
| $ | 87,046 |
| $ | 6,382 |
|
|
|
|
|
|
| Increase/ |
| |||
(amounts in thousands) |
| September 30, 2007 |
| March 31, 2007 |
| (Decrease) |
| |||
|
|
|
|
|
|
|
| |||
Intellectual property licenses |
| $ | 81,790 |
| $ | 100,274 |
| $ | (18,484 | ) |
Intellectual property licenses were slightly higherdecreased from $100.3 million at the endMarch 31, 2007 to $81.8 million at September 30, 2007. The effect of the third quarterdeferring “cost of fiscal 2007 as a result of:
· Continued investmentsales – intellectual property licenses” increased intellectual property licenses by $1.4 million. The decrease in intellectual property licenses. We spent approximately $15.5 million inlicenses primarily result from the nine months ended December 31, 2006 for license agreements granting us long-term rights to intellectual property of third parties, such as our agreement with MGM Interactive and EON Productions Ltd. granting us the rights to develop and publish interactive entertainment games based on the James Bond license.
Partially offset by:
· $9.1 million of amortization of intellectual property licenses mostly related to newupon releases inof titles during the first quartersix months of fiscal 2007.2008.
Accounts Payable
(amounts in thousands) |
| December 31, 2006 |
| March 31, 2006 |
| Increase/ |
| |||
|
|
|
|
|
|
|
| |||
Accounts payable |
| $ | 193,875 |
| $ | 88,994 |
| $ | 104,881 |
|
|
|
|
|
|
| Increase/ |
| |||
(amounts in thousands) |
| September 30, 2007 |
| March 31, 2007 |
| (Decrease) |
| |||
|
|
|
|
|
|
|
| |||
Accounts payable |
| $ | 158,059 |
| $ | 136,517 |
| $ | 21,542 |
|
The increase in accounts payablepayables of $104.9$21.5 million from March 31, 20062007 to December 31, 2006September 30, 2007 primarily reflects increased inventory purchases to support increased holiday sales volume in both our publishing and distributiondistributing segments.
Accrued Expenses and Other Liabilities
(amounts in thousands) |
| December 31, 2006 |
| March 31, 2006 |
| Increase/ |
| |||
|
|
|
|
|
|
|
| |||
Accrued expenses |
| $ | 247,581 |
| $ | 104,862 |
| $ | 142,719 |
|
|
|
|
|
|
| Increase/ |
| |||
(amounts in thousands) |
| September 30, 2007 |
| March 31, 2007 |
| (Decrease) |
| |||
|
|
|
|
|
|
|
| |||
Accrued expenses and other liabilities |
| $ | 255,266 |
| $ | 204,652 |
| $ | 50,614 |
|
·The increase in accrued expenses was primarily driven by accruals for increased marketing costs due to the large numberreclassification of titles releaseda long-term liability to a current liability of $39.0 million of deferred consideration related to the acquisition of RedOctane, Inc. payable before June 6, 2008 in the third quarterour common stock, and significant promotional costs on key titles, anthe increase in deferred income taxes payable,accruals for marketing and higher accrued royalties duerelated to higher sales volume in the thirdfirst quarter of fiscal 2007 compared to the fourth quarter of fiscal 2006. This2008 title releases which was partially offset by a decrease in paymentsthe payment of payroll accruals and separation and severance costs associated with a less than 7% reduction in workforce in the fourth quarter of fiscal 2006.accrued taxes payable.
Credit Facilities
We have revolving credit facilities with our Centresoft distribution subsidiary located in the UK (the “UK Facility”) and our NBG distribution subsidiary located in Germany (the “German Facility”). As of December 31, 2006, theThe UK Facility provided Centresoft with the ability to borrow up to GBP 12.0 million ($23.524.5 million), including issuing letters of credit, on a revolving basis (including the issuance of letters of credit on its behalf). Furthermore, under the UK Facility, Centresoft provided a GBP 0.6 million ($1.2 million) guarantee for the benefit of our CD Contact distribution subsidiary as of December 31, 2006.September 30, 2007. The UK Facility bore interest at LIBOR plus 2.0% as of December 31, 2006,September 30, 2007, is collateralized by substantially all of the assets of the subsidiary and expires in January 2007.2008. The UK Facility also contains various covenants that require the subsidiary to maintain specified financial ratios related to, among others, fixed charges. As of December 31, 2006, we were in compliance with these covenants. No borrowings were outstanding against the UK Facility as of December 31, 2006. As of
December 31, 2006, theThe German Facility provided for revolving loans up to EUR 0.5 million ($0.7 million) andas of September 30, 2007, bore interest at a Eurocurrency rate plus 2.5%. The German Facility, is collateralized by certain of the subsidiary’s property and equipment and has no expiration date. No borrowings were outstanding against the UK Facility and the German Facility as of December 31, 2006.September 30, 2007.
As of December 31, 2006,September 30, 2007, we maintained a $7.5$40.0 million irrevocable standby letter of credit. The standby letter of credit so that we canis required by one of our inventory manufacturers to qualify for certain payment terms on our purchases from one of our inventory manufacturers.purchases. Under the terms of this arrangement, we are required to maintain on deposit with the bank a compensating balance, restricted as to use, of not less than the sum of the available amount of the letter of credit plus the aggregate amount of any drawings under the letter of credit that have been honored thereunder but not reimbursed. At December 31, 2006,September 30, 2007, the $40.0 million deposit in the amount of $7.5 million is included in short-term investments as restricted cash. AsNo borrowings were outstanding as of December 31, 2006, we had no borrowing outstanding against this letter of credit.September 30, 2007.
58
As of December 31, 2006,September 30, 2007, our publishing subsidiary located in the UK maintained a EUR 4.0 million ($5.35.7 million) irrevocable standby letter of credit. The standby letter of credit so that it can qualify for certain payment terms on purchases fromis required by one of our inventory manufacturers.manufacturers to qualify for payment terms on our inventory purchases. The standby letter of credit does not require a compensating balance and is collateralized by substantially all of the assets of the subsidiary and expires in AugustFebruary 2008. No borrowings were outstanding as of September 30, 2007. As of December 31, 2006, we had no borrowings outstanding against this letter of credit.
Commitments
In the normal course of business, we enter into contractual arrangements with third parties for non-cancelable operating lease agreements for our offices, for the development of products, and for the rights to intellectual property. Under these agreements, we commit to provide specified payments to a lessor, developer or intellectual property holder, based upon contractual arrangements. Typically, the payments to third-party developers are conditioned upon the achievement by the developers of contractually specified development milestones. These payments to third-party developers and intellectual property holders typically are deemed to be advances and are recoupable against future royalties earned by the developer or intellectual property holder based on the sale of the related game. Additionally, in connection with certain intellectual property right acquisitions and development agreements, we will commit to spend specified amounts for marketing support for the related game(s) which is to be developed or in which the intellectual property will be utilized. Assuming all contractual provisions are met, the total future minimum commitments for these and other contractual arrangements in place as of December 31, 2006,September 30, 2007, are scheduled to be paid as follows (amounts in thousands):
| Contractual Obligations |
| |||||||||||
|
| Facility and |
| Developer |
| Marketing |
| Total |
| ||||
Fiscal year ending March 31, |
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
2007 (remaining three months) |
| $ | 3,456 |
| $ | 37,962 |
| $ | 25 |
| $ | 41,443 |
|
2008 |
| 14,069 |
| 29,340 |
| 40,468 |
| 83,877 |
| ||||
2009 |
| 13,033 |
| 28,036 |
| 26,496 |
| 67,565 |
| ||||
2010 |
| 11,997 |
| 29,586 |
| 100 |
| 41,683 |
| ||||
2011 |
| 9,754 |
| 30,586 |
| 100 |
| 40,440 |
| ||||
Thereafter |
| 22,959 |
| 64,173 |
| — |
| 87,132 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 75,268 |
| $ | 219,683 |
| $ | 67,189 |
| $ | 362,140 |
|
|
| Contractual Obligations(1) |
| ||||||||||
|
| Facility and |
| Developer |
|
|
|
|
| ||||
|
| Equipment Leases |
| and IP |
| Marketing |
| Total |
| ||||
Fiscal year ending March 31, |
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
2008 (remaining six months) |
| $ | 9,268 |
| $ | 29,080 |
| $ | 8,741 |
| $ | 47,089 |
|
2009 |
| 19,265 |
| 55,572 |
| 46,015 |
| 120,852 |
| ||||
2010 |
| 17,454 |
| 23,036 |
| 11,100 |
| 51,590 |
| ||||
2011 |
| 15,045 |
| 30,586 |
| 13,100 |
| 58,731 |
| ||||
2012 |
| 10,772 |
| 16,586 |
| — |
| 27,358 |
| ||||
Thereafter |
| 41,879 |
| 47,587 |
| — |
| 89,466 |
| ||||
Total |
| $ | 113,683 |
| $ | 202,447 |
| $ | 78,956 |
| $ | 395,086 |
|
(1) We have omitted FIN 48 liabilities from this table due to the inherent uncertainty regarding the timing of potential issue resolution. Specifically, either (a) the underlying positions have not been fully enough developed under audit to quantify at this time or, (b) the years relating to the issues for certain jurisdictions are not currently under audit. At the adoption date of April 1, 2007, the Company had $65.5 million of unrecognized tax benefits.
59
Financial Disclosure
We maintain internal controls over financial reporting, which generally include those controls relating to the preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America. We also are focused on our “disclosure controls and procedures,” which as defined by the SEC are generally those controls and procedures designed to ensure that financial and non-financial information required to be disclosed in our reports filed with the SEC is reported within the time periods specified in the SEC’s rules and forms, and that such information is communicated to management, including our principal executive and financial officers, as appropriate, to allow timely decisions regarding required disclosure.
Our Disclosure Committee, which operates under the boardBoard approved Disclosure Committee Charter and Disclosure Controls & Procedures Policy, includes senior management representatives and assists executive management in its oversight of the accuracy and timeliness of our disclosures, as well as in implementing and evaluating our overall disclosure process. As part of our disclosure process, senior finance and operational representatives from all of our corporate divisions and business units prepare quarterly reports regarding their current quarter operational performance, future trends, subsequent events, internal controls, changes in internal controls and other accounting and disclosure-relevant information. These quarterly reports are reviewed by certain key corporate finance representatives.executives. These corporate finance representatives also conduct quarterly interviews on a rotating basis with the preparers of selected quarterly reports. The results of the quarterly reports and related interviews are reviewed by the Disclosure Committee. Finance representatives also conduct reviews with our senior management team, our internal and external counsel and other appropriate personnel involved in the disclosure process, as appropriate. Additionally, senior finance and operational representatives provide internal certifications regarding the accuracy of information they provide that is utilized in the preparation of our periodic public reports filed with the SEC. Financial results and other financial information also are reviewed with the Audit Committee of the Board of Directors on a quarterly basis. As required by applicable regulatory requirements, the principal executive and financial officers review and make various certifications regarding the accuracy of our periodic public reports filed with the SEC, our disclosure controls and procedures, and our internal control over financial reporting. With the assistance of the Disclosure Committee, we will continue to assess and monitor our disclosure controls and procedures, and our internal control over financial reporting, and will make refinements as necessary.
Recently Issued Accounting Standards and Laws
On February 16, 2006, the FASB issued Statement No. 155 (“SFAS No. 155”), Accounting for Certain Hybrid Financial Instruments – An amendment of FASB Statements No. 133 and 140. SFAS No. 155 amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities to resolve issues addressed in Statement 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS No. 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133; establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not expect that the adoption of SFAS No. 155 will have a material effect on our financial position or results of operations.
On March 17, 2006, the FASB issued Statement No. 156 (“SFAS No. 156”), Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140. SFAS No. 156 amends Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a
financial asset by entering into a servicing contract in certain situations; requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; permits either the amortization method or the fair value measurement method, as subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities; permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights; and requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. SFAS No. 156 is effective in the first fiscal year that begins after September 15, 2006. We do not expect that the adoption of SFAS No. 156 will have a material effect on our financial position or results of operations.
In July 2006, the FASB issued Final Interpretation No. 48 (“FIN 48”) 48, Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest, and penalties, accounting in interim periods, disclosure, and transition. In addition, FIN 48 excludes income taxes from the scope of SFAS No. 5, Accounting for Contingencies. FIN 48 is effective for fiscal years beginning after December 15, 2006. Differences between the amounts recognized in the consolidated balance sheets prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We are currently evaluating the effect that the adoption of FIN 48 will have on our results of operations and financial position.
On September 20, 2006, the FASB issued Statement No. 157 (“SFAS No. 157”), Fair Value Measurements.SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 applies underto other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We do not expect that the adoption of SFAS No. 157 will have a material effect on our financial position or results of operations.
In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, Financial Statements — Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 requires the use of both the “iron curtain” and “rollover” approach in quantifying the materiality of misstatements. SAB 108 also discusses the implications of misstatements uncovered upon the application of SAB 108 in situations when a registrant has historically been using either the iron curtain approach or the rollover approach. SAB 108 is effective for fiscal years ending after November 15, 2006. We are currently evaluating the effect that the adoption of SAB 108 will have on our results of operation and financial position.
On September 29,February 2007, the FASB issued Statement No. 158,159, Employers’ AccountingThe Fair Value Option for Defined Benefit PensionFinancial Assets and Other Postretirement Plans,Financial Liabilities — Including an amendment of FASB StatementsStatement No. 87, 88, 106, and 132(R) 115(“ (“SFAS No. 158”159”). This new standard aims to make it easier for investors, employees, retirees and other parties to understand and assess an employer’s financial position and its ability to fulfill the obligations under its benefit plans. SFAS No. 158 requires employers159 permits entities to fully recognizechoose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in theirearnings. The provisions of SFAS No. 159 are effective for financial statements issued for fiscal years beginning after November 15, 2007. We are evaluating if we will adopt the obligations associatedfair value option of SFAS No. 159 and what impact the adoption will have on our Consolidated Financial Statements if we adopt.
In June 2007, the FASB ratified the Emerging Issues Task Force’s (“EITF”) consensus conclusion on EITF 07-03, “Accounting for Advance Payments for Goods or Services to Be Used in Future Research and Development.” EITF 07-03 addresses the diversity which exists with single-employer defined benefit pension plans, retiree healthcare plans, and other postretirement plans. Specifically, it requires a companyrespect to (1) recognize on its balance sheet an assetthe accounting for a plan’s overfunded status or a liability for a plan’s underfunded status, (2) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year, and (3) recognize changes in the funded statusnon-refundable portion of a plan through comprehensive incomepayment made by a research and development entity for future research and development activities. Under this conclusion, an entity is required to defer and capitalize non-refundable advance payments made for research and development activities until the related goods are delivered or the related services are performed. EITF 07-03 is effective for interim or annual reporting periods in fiscal years
60
beginning after December 15, 2007 and requires prospective application for new contracts entered into after the year in which the changes occur.effective date. We do not expect that the adoption of SFAS No. 158 willEITF 07-03 to have an effect on our financial position or results of operations as we do not maintain any single-employer defined benefit pension plans, retiree healthcare plans, and other postretirement plans.
Inflation
Our management currently believes that inflation has not had a material impact on continuing operations.our Consolidated Financial Statements.
Factors Affecting Future Performance
In connection with the Private Securities Litigation Reform Act of 1995 (the “Litigation Reform Act”), we are hereby disclosing certain cautionary information to be used in connection with written materials (including this Quarterly Report on Form 10-Q) and oral statements made by or on behalf of our employees and representatives that may contain “forward-looking statements” within the meaning of the Litigation Reform Act. Such statements consist of any statement other than a recitation of historical fact and can be identified by the use of forward-looking terminology such as “may,” “expect,” “anticipate,” “estimate,” or “continue” or the negative thereof or other variations thereon or comparable terminology. You are cautioned that all forward-looking statements are necessarily speculative and there are numerous risks and uncertainties that could cause actual events or results to differ materially from those referred to in such forward-looking statements. These forward-looking statements are subject to business, economic and economic risklegal risks and reflect management’s current expectations and are inherently uncertain and difficult to predict. For a discussion that highlights some of the more important risks identified by management, but which should not be assumed to be the only factors that could affect future performance, see the discussion under the heading “Risk Factors”, included in Part I, Item 1A of our Amended Annual Report on Form 10-K/A10-K for the fiscal year ended March 31, 20062007, which areis incorporated herein by reference and subsequent filings with the SEC. You are cautioned that we do not have a policy of updating or revising forward-looking statements, and thus you should not assume that silence by the Company over time means that actual events are bearing out as estimated in such forward-looking statements.
Market risk is the potential loss arising from fluctuations in market rates and prices. Our market risk exposures primarily include fluctuations in interest rates, foreign currency exchange rates and market prices. All of our market risk sensitive instruments are classified as instruments entered into for purposes “other than trading.” Our views on market risk are not necessarily indicative of actual results that may occur and do not represent the maximum possible gains and losses that may occur, since actual gains and losses will differ from those estimated based upon actual fluctuations in interest rates, foreign currency exchange rates and market prices and the timing of transactions.
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We manage our interest rate risk by maintaining an investment portfolio consisting primarily of debt instruments with high credit quality and relatively short average maturities generally between three and thirty months. We also manage our interest rate risk by maintaining sufficient cash and cash equivalent balances such that we are typically able to hold our investments to maturity. As of December 31, 2006,September 30, 2007, our cash equivalents and short-term investments included debt securities and certificates of $444.0deposit of $724.0 million.
The following table presents the amounts and related weighted average interest rates of our investment portfolio as of December 31, 2006September 30, 2007 (amounts in thousands):
| Average |
| Amortized |
| Fair |
| |||
Cash equivalents: |
|
|
|
|
|
|
| ||
Fixed rate |
| 5.35 | % | $ | 14,229 |
| $ | 14,221 |
|
Variable rate |
| 5.25 | % | 96,605 |
| 96,605 |
| ||
|
|
|
|
|
|
|
| ||
Short-term investments: |
|
|
|
|
|
|
| ||
Fixed rate |
| 4.45 | % | $ | 439,469 |
| $ | 437,290 |
|
|
| Average |
| Amortized |
| Fair |
| ||
Cash equivalents: |
|
|
|
|
|
|
| ||
Fixed rate |
| 5.77 | % | $ | 52,317 |
| $ | 52,301 |
|
Variable rate |
| 5.24 | % | 143,384 |
| 143,384 |
| ||
|
|
|
|
|
|
|
| ||
Short-term investments: |
|
|
|
|
|
|
| ||
Fixed rate |
| 5.37 | % | $ | 528,828 |
| $ | 528,318 |
|
61
Foreign Currency Exchange Rate Risk
We transact business in many different foreign currencies and may be exposed to financial market risk resulting from fluctuations in foreign currency exchange rates, particularly the EUR, GBP and AUD. The volatility of the EUR, GBP and AUD (and all other applicable currencies) will be monitored frequently throughout the coming year. When appropriate, we enter into hedging transactions in order to mitigate our risk from foreign currency fluctuations. We will continue to use hedging programs in the future and may use currency forward contracts, currency options and/or other derivative financial instruments commonly utilized to reduce financial market risks if it is determined that such hedging activities are appropriate to reduce risk. We do not hold or purchase any foreign currency contracts for trading purposes. At December 31, 2006As of September 30, 2007, we had outstanding hedgingforeign currency exchange forward contracts of approximately $33.7 million. In addition, accrued expenses included approximately $677,000 of pre-tax unrealized losses for the purchaseestimated fair value of approximately $73.7 million.outstanding foreign currency exchange forward contracts, which was recorded in earnings as the contracts did not qualify as hedging instruments.
1) Definition and Limitations of Disclosure Controls and Procedures.
Our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to ensure that: (i) information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) information is accumulated and communicated to management, including our Chief Executive Officers and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in our periodic reports. Inherent limitations to any system of disclosure controls and procedures include, but are not limited to, the possibility of human error and the circumvention or overriding of such controls by one or more persons. In addition, we have designed our system of controls based on certain assumptions, which we believe are reasonable, about the likelihood of future events, and our system of controls may therefore not achieve its desired objectives under all possible future events.
2) Evaluation of Disclosure Controls and Procedures.
Our management, with the participation of theour Chief Executive Officers and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2006,September 30, 2007. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the endcost-benefit relationship of the period covered by this report.possible controls and procedures. Based on thisthe evaluation of our disclosure controls evaluation, and subject to the limitations described above, theprocedures as of September 30, 2007, our Chief Executive Officers and Chief Financial Officer concluded that, as of December 31, 2006,such date, our disclosure controls and procedures were not effective due solely to and onlyprovide reasonable assurance that information required to be disclosed by the extent of, the material weakness in our historical stock option granting and modification practice described below.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
77
As of December 31, 2006, we did not maintain effective controls over the accounting for and disclosure of stock-based compensation expense. Specifically, effective controls, including monitoring, were not maintained to ensure the accuracy and valuation of our stock-based compensation transactions related to the granting and modification of our stock options. This control deficiency resultedCompany in the misstatement of stock-based compensation expense, income tax expense, retained earnings, additional paid-in capital,reports that it files or submits under the Exchange Act is recorded, processed, summarized, and deferred tax asset accounts and related financial disclosures, and in the restatement of our consolidated financial statements for the fiscal years 2006, 2005, and 2004, each of the quarters of fiscal 2006 and 2005, the first quarter of fiscal 2007, and in adjustments to the interim consolidated financial statements for the second, third, and fourth quarters of fiscal 2007. Additionally, this control deficiency could result in misstatements of the aforementioned accounts and disclosures that would result inreported on a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that this control deficiency constitutes a material weakness in our internal control over financial reporting.timely basis.
3) Changes in Internal Control Over Financial Reporting.
There was no change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) during the quarter ended December 31, 2006September 30, 2007 that has materially affected or is reasonably likely to materially affect, our internal control over financial reporting.
4) Plan of Remediation of the Material Weakness.
New policies and procedures for our stock option grant practices were approved on November 21, 2006 by the Joint Compensation and Nominating and Governance Committee of our Board, and became effective January 1, 2007. Our new option granting policies and procedures are designed to ensure internal control surrounding the pricing and modification of option grants is adequate, and also provide the Compensation Committee with the full ability to review and approve all grants prior to pricing on a date set on or after the date of the Compensation Committee action. Some of the highlights of the new option granting process are:
· All proposed grants during the month will be verified so as to comply with pre-approved grant guidelines and other financial and legal requirements by the seventh day of the following month. For these purposes, a team of legal, human resources and finance personnel (“Cross Functional Team”) has been established to review each proposed grant for compliance with documentation and procedures. No grant will be issued until such compliance is established and the grant is approved by the Compensation Committee.
· The Compensation Committee will meet at least quarterly, to review and approve all documented and verified proposed grants submitted by the Cross Functional Team. All grants approved by the Compensation Committee will be effective, and will be priced based on the closing price of our stock, on a date set by the Compensation Committee that will be on or after the date of Compensation Committee action. Details of the grant (including the exercise price) will be communicated to the grantees promptly following approval and pricing.
· All new hire offer letters and employee renewal agreements will provide that all grants and terms of grants are subject to approval by the Compensation Committee.
· Stock option data will be entered into Equity Edge, our stock option tracking software, promptly (and only) after grant approval is received from the Compensation Committee.
In addition, we have realigned certain internal responsibilities related to the granting and reporting of stock options. In this regard, the employment contract of our former head of human resources, which expired62
on March 31, 2007, was not renewed; a new head of human resources is being recruited and, in the interim, responsibilities for stock option granting and reporting have been reassigned. To further enhance our corporate governance practices, we have established and filled a position of principal compliance officer, with a reporting line directly to the Nominating and Governance Committee, and are reviewing the configuration of the Compensation Committee of the Board.
In addition, consistent with the recommendations of the Special Subcommittee, we have disengaged from our prior outside corporate counsel and have engaged new outside corporate counsel.
Finally, the Special Subcommittee recommended that Board meetings include more senior executives and that human resources, finance and legal personnel receive additional training on options and compliance issues. Many of these recommendations have already been implemented and we plan to implement the remaining recommendations in our fiscal year that began on April 1, 2007.
The following describes the material legal proceedings, examinations and other matters in which the Company and its subsidiaries are involved that: (1) were pending as of December 31, 2006; (2) were terminated during the period from December 31, 2006 through June 7, 2007; or (3) are pending as of June 7, 2007. Thus, the description of a matter may include developments that occurred since December 31, 2006, as well as those that occurred during 2006. The matters include legal proceedings relating to the restatement of our consolidated financial statements, such as class action securities lawsuits, shareholder derivative actions and governmental proceedings.
In July 2006, individuals and/or entities claiming to be stockholders of the Company have filed derivative lawsuits, purportedly on behalf of the Company, against certain current and former members of the Company’s Board of Directors as well as several current and former officers of the Company. Three derivative actions have been filed in Los Angeles Superior Court: Vazquez v. Kotick, et al.al., L.A.S.C. Case No. BC355327 (filed July 12, 2006); Greuer v. Kotick, et al., L.A.S.C. Case No. SC090343 (filed July 12, 2006); and Amalgamated Bank v. Baker, et al., L.A.S.C. Case No. BC356454 (filed August 3, 2006). These actions have been consolidated by the court under the caption In re Activision Shareholder Derivative Litigation, L.A.S.C. Master File No. SC090343 (West, J.). Two derivative actions have been filed in the United States District Court for the Central District of California: Pfeiffer v. Kotick, et al., C.D. Cal. Case No. CV06-4771 MRP (JTLx) (filed July 31, 2006); and Hamian v. Kotick, et al.al., C.D. Cal. Case No. CV06-5375 MRP (JLTx) (filed August 25, 2006). These actions have also been consolidated, under the caption In re Activision, Inc. Shareholder Derivative Litigation, C.D. Cal. Case No. CV06-4771 MRP (JTLx) (Pfaelzer, J.). The consolidated complaints allege, among other things, purported improprieties in the Company’s issuance of stock options. Plaintiffs seek various relief on behalf of the Company, including damages, restitution of benefits obtained from the alleged misconduct, equitable relief, including an accounting and rescission of option contracts; and various corporate governance reforms. The Company expects that defense expenses associated with the matters will be covered by its directors and officers insurance, subject to the terms and conditions of the applicable policies.
On May 24, 2007, the Superior Court granted the Company’s motion to stay the state action. The court’s order stays the action pending the resolution of motions to dismiss in the federal action, but is without prejudice to any party’s right to seek modification of the stay upon a showing of good cause, including a showing that matters may be addressed in the Superior Court without the potential for conflict with or duplication of the federal court proceedings. On July 13, 2007, Plaintiffs filed their second amended complaint, which alleges substantially the same claims as the previous complaints, with new allegations related to Plaintiffs’ standing, recent public facts and additional analyses. The parties are briefing the threshold issues and a hearing on them is scheduled for November 7, 2007.
The Company filed motions to dismiss in the federal action on June 1, 2007, which will be fully briefed by August 15, 2007. A hearing on the motions has been continued to December 3, 2007.
The Company was also was informed that, on June 1, 2007, a derivative case, Abdelnur vs. Kotick et al., was filed in the United States District Court for the Central District of California, C.D. Case No. CV07-3575 AHM (PJWx), by the same law firm that previously filed the Hamian case, alleging substantially the same claims. The action has now been consolidated with the existing federal consolidated action and the motions to dismiss filed June 1, 2007 have been deemed to have also been filed in response to the Abdelnurcomplaint.
On July 27,18, 2007, the Company was informed that another derivative case, Scarborough v. Kotick et al., was filed in the United States District Court for the Central District of California, Case No. CV07-4602 SVW (PLAx), also by the same law firm that previously filed the Hamian case, alleging substantially the same claims. This action has been consolidated with the federal consolidated case. The parties attended a mediation related to the consolidated federal case on November 1, 2007.
On July 24, 2006, the Company received a letter of informal inquiry from the SEC requesting certain documents and information relating to the Company’s historical stock option grant practices. In early June 2007,Thereafter, the SEC informed us that the SEC has issued a formal order of non-public investigation, pursuant to which allowsit has subpoenaed documents from the SEC, among other things,Company related to subpoena witnessesthe investigation, and requirehas subpoenaed testimony and documents from certain current and former directors, officers and employees of the production of documents. Company.
The Company is cooperating with the SEC’s investigation, and representatives of the Special Subcommitteespecial subcommittee of independent members of our Board of Directors established in July 2006 to review our historical stock option granting practices (the “Special Subcommittee”) and its legal counsel have
met with members of the staff of the SEC on several occasions, in person and by telephone (as has the Company’s
63
outside legal counsel), to discuss the progress of the Special Subcommittee’s investigation and on February 28, 2007 to brief the SEC staff on the Special Subcommittee’s findings and recommendations following the substantial completion of the Special Subcommittee’s investigation.recommendations. A representative of the U.S. Department of Justice has attended certain of these meetings and requested copies of certain documents that we have provided to the staff of the SEC. At this time, the Company has not received any grand jury subpoenas or written requests from the Department of Justice.
In addition, we are party to other routine claims and suits brought by us and against us in the ordinary course of business, including disputes arising over the ownership of intellectual property rights, contractual claims, employment laws, regulations and relationships, and collection matters. In the opinion of management, after consultation with legal counsel, the outcome of such routine claims and lawsuits will not have a material adverse effect on our business, financial condition, results of operations, or liquidity.
Item 1A. Risk Factors4. Submission of Matters to a Vote of Security Holders
Our business is subject
We held our 2007 Annual Meeting of the Stockholders on September 27, 2007 in Beverly Hills, California. The following five items were submitted to many risksa vote of the stockholders:
1. the election of eight directors to hold office until the next annual meeting of Activision’s stockholders and uncertainties, which may affectuntil their respective successors are duly elected and qualified;
2. the approval of the Activision, Inc. 2007 Incentive Plan;
3. the ratification of the appointment of PricewaterhouseCoopers LLP as our future financial performance, includingindependent registered public accounting firm for the risk factors set forth in Item 1Afiscal year ending March 31, 2008;
4. the approval of a stockholder proposal regarding diversity of our Amended Annual ReportBoard of Directors; and
5. the approval of a stockholder proposal regarding a stockholder advisory vote on Form 10-K/Aexecutive compensation.
All eight director nominees, each of whom was then a member of the Board of Directors and was recommended by the Board, were elected. Set forth below are the results of the voting,
|
| For |
| Withheld |
|
Robert A. Kotick |
| 244,668,136 |
| 14,158,909 |
|
|
|
|
|
|
|
Brian G. Kelly |
| 245,266,960 |
| 13,560,085 |
|
|
|
|
|
|
|
Ronald Doornink |
| 199,210,084 |
| 59,616,961 |
|
|
|
|
|
|
|
Robert J. Corti |
| 203,754,925 |
| 55,072,120 |
|
|
|
|
|
|
|
Barbara S. Isgur |
| 96,455,116 |
| 162,371,929 |
|
|
|
|
|
|
|
Robert J. Morgado |
| 95,555,580 |
| 163,271,465 |
|
|
|
|
|
|
|
Peter J. Nolan |
| 104,540,039 |
| 154,287,006 |
|
|
|
|
|
|
|
Richard Sarnoff |
| 252,327,419 |
| 6,499,626 |
|
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The Activision, Inc. 2007 Equity Incentive Plan was approved. Set forth below are the results of the voting.
For |
| Against |
| Abstained |
| Not Voted |
|
149,122,526 |
| 84,842,138 |
| 410,763 |
| 24,451,618 |
|
The selection of PricewaterhouseCoopers LLP as our independent auditors for the fiscal year ended March 31, 2006 and the risks set2008 was approved. Set forth below. If any of the events or circumstances described below occurs, our business and financial performance could be harmed, our actual results could differ materially from our expectations, and the market value of our securities could decline.
In our fiscal year 2007, we began to recognize expense for stock-based compensation related to our employee equity compensation and employee stock purchase programs. The recognition of this expense will significantly lower our reported net income (or increase our reported net loss).
Beginning in our current fiscal year, we adopted SFAS 123R, which requires us to recognize compensation expense for all stock-based compensation based on estimated fair values. As a result, beginning with our first quarter of fiscal 2007, our operating results contain a charge for stock-based compensation related to the equity-based compensation we provide to our employees, as well as stock purchases under our employee stock purchase plans. This expense is in addition to the stock-based compensation expense we have recognized in prior periods related to restricted stock unit grants, acquisitions and other grants. The stock-based compensation charges we incur depend on the number of equity-based awards we grant and the number of shares of common stock we sell under our employee stock purchase plans, as well as a number of estimates and variables such as estimated forfeiture rates, the trading price and volatility of our common stock, the expected term of our options, and interest rates. As a result, our stock-based compensation charges can vary significantly from period to period. Going forward, our adoption of SFAS 123R will continue to significantly lower our reported net income (or increase our reported net loss), which could have an adverse impact on the trading price of our common stock.
Risk Factors Relating to Results of Special Subcommittee Review of Our Stock Option Granting Practices
SEC inquiry and litigation relating to stock options remain pending and may adversely affect our business and results of operations.
Although a Special Subcommittee of our independent directors has completed its review of our stock option grants and practices in the period between 1992 and 2006, an investigation by the SEC relating to our stock option granting practices remains pending, as does derivative litigation against us and certain of our current and former directors and officers. Although we believe that we have taken appropriate action and made appropriate disclosures and corrections to the consolidated financial statements set forth in this report for matters relating to stock options, the SEC (or the court in the derivative action) may disagree with the findings of the Special Subcommittee or with the manner in which we have accounted for and reported, or not reported, the financial impact of past option grant measurement date errors. If so, we may need to further restate our prior financial statements, further amend our filings with the SEC, or take other actions not currently
contemplated. In addition, these proceedings are likely to result in additional legal expense that may affect our results in future periods, and may also result in diversion of management attention and other resources, as well as fines, penalties, damages and other sanctions. These eventualities could materially and adversely affect our business and results of operations. We cannot currently predict the ultimate outcome of these proceedings.
If we do not maintain compliance with Nasdaq listing requirements, our common stock could be delisted, which could, among other things, reduce the price of our common stock and the levels of liquidity available to our stockholders.
In connection with the Special Subcommittee’s review and the restatement of our Consolidated Financial Statements, we have not timely filed certain of our periodic reports with the SEC. As a result, we have not been in compliance with Nasdaq listing requirements. We are filing these reports today and believe that, with these filings, we will regain compliance with Nasdaq listing requirements. Nasdaq has, to date, permitted our securities to remain listed. However, our securities could be delisted in the future if we do not timely file our required reports with the SEC in the future, if we are required to further restate or amend our filings or if we otherwise do not maintain compliance with applicable listing requirements. If our securities are delisted from the Nasdaq Global Select Market, they would subsequently be transferred to the National Quotation Service Bureau, or “Pink Sheets”. The trading of our common stock through the Pink Sheets might reduce the price of our common stock and the levels of liquidity available to our stockholders. In addition, the trading of our common stock through the Pink Sheets could materially and adversely affect our access to the capital markets and our ability to raise capital through alternative financing sources on terms acceptable to us, or to raise capital at all. Securities that trade through the Pink Sheets are no longer eligible for margin loans, and a company trading through the Pink Sheets cannot avail itself of federal preemption of state securities or “blue sky” laws, which adds substantial compliance costs to securities issuances, including pursuant to employee option plans, stock purchase plans and private or public offerings of securities. If we are delisted in the future from the Nasdaq Global Select Market and transferred to the Pink Sheets, we could also be subject to other negative implications, including the potential loss of confidence by suppliers, customers and employees and the loss of institutional investor interest in our securities.
We had a material weakness in internal control over financial reporting and cannot assure you that additional material weaknesses will not be identified in the future. If our internal control over financial reporting or disclosure controls and procedures are not effective, there may be errors in our financial statements that could require a restatement or our filings may not be timely and investors may lose confidence in our reported financial information, which could lead to a decline in our stock price.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial reporting as of the end of each year, and to include a management report assessing the effectiveness of our internal control over financial reporting in each Annual Report on Form 10-K. Section 404 also requires our independent registered public accounting firm to attest to, and report on, management’s assessment of our internal control over financial reporting. In assessing the findings of the Special Subcommittee’s review and the restatement set forth in our Amended Annual Report on Form 10-K/A for the year ended March 31, 2006, our management concluded that there was a material weakness, as defined in the Public Company Accounting Oversight Board’s Auditing Standard No. 2, in our internal control over financial reporting as of March 31, 2006. Our management has also concluded that this weakness continued to exist as of December 31, 2006. See the discussion included in Part II, Item 9A of our Amended Annual Report on Form 10-K/A for the fiscal year ended March 31, 2006 and Part I, Item 4 of this Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 2006 for additional information regarding our internal control over financial reporting.
Our management does not expect that our internal control over financial reporting will prevent all error or all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. Over time, controls may become inadequate because
changes in conditions or deterioration in the degree of compliance with policies or procedures may occur. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
As a result, we cannot assure you that significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses, cause us to fail to timely meet our periodic reporting obligations, or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor attestation reportsthe voting.
For |
| Against |
| Abstained |
| Not Voted |
|
256,924,900 |
| 1,409,136 |
| 493,009 |
| — |
|
The stockholder proposal regarding diversity on our Board of Directors was not approved. Set forth below are the effectiveness of our internal control over financial reporting required under Section 404results of the Sarbanes-Oxley Actvoting.
For |
| Against |
| Abstained |
| Not Voted |
|
22,777,548 |
| 193,625,462 |
| 17,972,417 |
| 24,451,618 |
|
The stockholder proposal regarding a stockholder advisory vote on executive compensation was approved. Set forth below are the results of 2002the voting.
For |
| Against |
| Abstained |
| Not Voted |
|
156,125,135 |
| 68,188,924 |
| 10,061,368 |
| 24,451,618 |
|
Item 5. Other Information
Pursuant to an agreement dated September 12, 2007, Nintendo of America Inc. (“Nintendo”) and Activision Publishing, Inc., a wholly owned subsidiary of the Company and the rules promulgated thereunder.Company’s principal operating subsidiary, entered into a Confidential License Agreement for the Wii Console (Western Hemisphere), which is filed herewith as Exhibit 10.9. Pursuant to the agreement, Nintendo has granted to Activision Publishing a nonexclusive license to use intellectual property rights of Nintendo to develop, manufacture, advertise, market and sell video game software for the Wii Console until October 12, 2009 (subject to earlier termination in certain events). Under the agreement, Nintendo has the right to approve each game, including the artwork and the printed materials distributed with the game. The existenceamounts to be paid by Activision Publishing to Nintendo under the agreement will be based on Nintendo’s then current pricing schedule, and will include a royalty for the use of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements, cause usNintendo’s intellectual property rights.
Pursuant to fail to timely meet our reporting obligationsan amendment dated July 16, 2007, filed herewith as Exhibit 10.6, Activision Publishing and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.
As a resultNintendo have extended the term of the delayed filing of certain of our periodic reports, we will be ineligibleparties’ October 11, 2004 Confidential License Agreement for Nintendo DS (Western Hemisphere) for an additional two years, to use Form S-3 or Form S-4 for a period of time. This may adversely affect our ability to engage in certain types of corporate acquisition and capital-raising transactions.October 10, 2009.
As a result of our delayed filing of certain of our periodic reports, we will be ineligible to register our securities on Form S-3 or Form S-4 for sale by us or resale by other security holders until we have timely filed all periodic reports under the Securities Exchange Act of 1934 for a period of time. In the meantime, we have the ability to use Form S-1 to raise capital or complete acquisitions. The need to use Form S-1, and the inability to use Form S-3 or Form S-4, could increase our transaction costs and adversely affect our ability to engage in certain types of corporate acquisition and capital-raising transactions until we regain our S-3/S-4 eligibility.
The information set forth above should be read in conjunction with the risk factors and information disclosed in our Amended Annual Report on Form 10-K/A for the fiscal year ended March 31, 2006.65
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|
3.1 |
| Amended and Restated Certificate of Incorporation of Activision Holdings, | |
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| |
3.2 |
| Certificate of Amendment of Amended and Restated Certificate of Incorporation of Activision Holdings | |
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3.3 |
| Certificate of Designation of Series A Junior Preferred Stock of Activision, Inc. | |
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3.4 |
| Certificate of Amendment of Amended and Restated Certificate of Incorporation, as amended, of Activision, Inc., dated as of April 4, 2005 (incorporated by reference to Exhibit 3.1 of | |
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3.5 |
| Certificate of Designation of Series A Junior Preferred Stock of Activision, Inc. dated August 4, 2005 (incorporated by reference to Exhibit 3.1 of | |
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3.6 |
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4.1 |
| Rights Agreement dated as of April 18, 2000, between | |
10.1 | Confidential License Agreement for the Nintendo DS (Western Hemisphere), dated as of October 11, 2004, between Nintendo Co., Ltd. and Activision Publishing, Inc. | ||
10.2 | Notice of Share Option Award to Robin Kaminsky, dated as of October 19, 2006. | ||
10.3 | Notice of Share Option Award to Robin Kaminsky, dated as of October 19, 2006. | ||
10.4 | Notice of Restricted Stock Award to Robin Kaminsky, dated as of October 19, 2006. |
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10.5 | Notice of Restricted Stock Award to Robin Kaminsky, dated as of October 19, 2006. | ||
10.6 | First Amendment to Confidential License Agreement for Nintendo DS (Western Hemisphere), dated as of July 16, 2007, between Nintendo Co., Ltd. and Activision Publishing, Inc. | ||
10.7 | Employment Agreement, dated September 11, 2007, between George Rose and Activision Publishing, Inc. | ||
10.8 | Employment Agreement, dated September 12, 2007, between Ann Weiser and Activision Publishing, Inc. | ||
10.9 | Confidential License Agreement for the Wii Console (Western Hemisphere), dated September 12, 2007, between Nintendo of America, Inc. and Activision Publishing, Inc.* | ||
10.10 | Chart of Compensation Paid to Non-Employee Directors. | ||
10.11 | Activision, Inc. 2007 Incentive Plan (incorporated by reference to Exhibit | ||
10.12 | Notice of | ||
10.13 | Notice of Restricted Share Unit Award to George Rose, dated September 28, 2007. | ||
10.14 | Notice of Share Option Award to Ann Weiser, dated September 28, 2007. | ||
10.15 | Notice of Restricted Share Unit Award to Ann Weiser, dated September 28, 2007. | ||
31.1 | Certification of Robert A. Kotick pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
31.2 | Certification of Michael Griffith pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
31.3 | Certification of Thomas Tippl pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
32.1 | Certification of Robert A. Kotick pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||
32.2 | Certification of Michael Griffith pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||
32.3 | Certification of Thomas Tippl pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
*Portions omitted pursuant to a request for confidential treatment.
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Pursuant to the requirements 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: | November 7, 2007 | ||
ACTIVISION, INC. | |||
/s/ Thomas Tippl | |||
Thomas Tippl | |||
Chief Financial Officer of Activision Publishing, Inc. and | |||
Principal Financial and Accounting Officer of Activision, Inc. | |||
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3.1 | Amended and Restated Certificate of Incorporation of Activision Holdings, dated June 9, 2000 (incorporated by reference to Exhibit 2.5 of Activision’s Form 8-K, filed June 16, 2000). | |
3.2 | Certificate of Amendment of Amended and Restated Certificate of Incorporation of Activision Holdings dated as of June 9, 2000 (incorporated by reference to Exhibit 2.7 of Activision’s Form 8-K, filed June 16, 2000). | |
3.3 | Certificate of Designation of Series A Junior Preferred Stock of Activision, Inc. dated as of December 27, 2001 (incorporated by reference to Exhibit 3.4 of Activision’s Form 10-Q for the quarter ended December 31, 2001). | |
3.4 | Certificate of Amendment of Amended and Restated Certificate of Incorporation, as amended, of Activision, Inc., dated as of April 4, 2005 (incorporated by reference to Exhibit 3.1 of Activision’s Form 8-K, filed April 5, 2005). | |
3.5 | Certificate of Designation of Series A Junior Preferred Stock of Activision, Inc. dated August 4, 2005 (incorporated by reference to Exhibit 3.1 of Activision’s Form 8-K, filed August 5, 2005). | |
3.6 | Third Amended and Restated By-Laws of Activision, Inc., dated September 27, 2007 (incorporated by reference to Exhibit 3.6 to the Company’s Registration Statement on Form S-8, Registration No. 333-146431, filed October 1, 2007). | |
4.1 | Rights Agreement dated as of April 18, 2000, between Activision. Inc. and Continental Stock Transfer & Trust Company, which includes as exhibits the form of Right Certificates as Exhibit A, the Summary of Rights to Purchase Series A Junior Preferred Stock as Exhibit B and the form of Certificate of Designation of Series A Junior Preferred Stock of Activision as Exhibit C, (incorporated by reference to Activision’s Registration Statement on Form 8-A, Registration No. 001-15839, filed April 19, 2000). | |
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10.1 |
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10.2 |
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10.3 |
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10.4 |
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10.5 | Notice of Restricted Stock Award to | |
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| First Amendment to Confidential License Agreement |
10.7 | Employment Agreement, dated September 11, 2007, between George Rose and Activision Publishing, Inc. | |
10.8 | Employment Agreement, dated September 12, 2007, between Ann Weiser and Activision Publishing, Inc. | |
10.9 | Confidential License Agreement for the | |
10.10 | Chart of Compensation Paid to Non-Employee Directors. | |
10.11 | Activision, Inc. 2007 Incentive Plan (incorporated by reference to Exhibit | |
10.12 | Notice of Share Option Award to George Rose, dated September 28, 2007. | |
10.13 | Notice of Restricted Share Unit Award to George Rose, dated September 28, 2007. | |
10.14 | Notice of Share Option Award to Ann Weiser, dated September 28, 2007. | |
10.15 | Notice of Restricted Share Unit Award to Ann Weiser, dated September 28, 2007. | |
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31.1 |
| Certification of Robert A. Kotick pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2 |
| Certification of Michael Griffith pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.3 |
| Certification of Thomas Tippl pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1 |
| Certification of Robert A. Kotick pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2 |
| Certification of Michael Griffith pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.3 |
| Certification of Thomas Tippl pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
Pursuant*Portions omitted pursuant to the requirements 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.a request for confidential treatment.
Date: June 6, 2007
ACTIVISION, INC.
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