SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one) | ||
/x/ |
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 September 30, 2001 |
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OR |
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/ / |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-12699
ACTIVISION, INC.
(Exact name of registrant as specified in its charter)
Delaware | 95-4803544 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
3100 Ocean Park Boulevard, Santa Monica, CA |
90405 |
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(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 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 / /
The number of shares of the registrant's Common Stock outstanding as of November 5, 2001 was 34,693,108.
ACTIVISION, INC. AND SUBSIDIARIES
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Page No. |
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PART I. |
FINANCIAL INFORMATION |
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Item 1. |
Financial Statements |
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Consolidated Balance Sheets as of September 30, 2001 (Unaudited) and March 31,2001 |
3 |
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Consolidated Statements of Operations for the three and six months ended September 30, 2001 and 2000 (Unaudited) |
4 |
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Consolidated Statements of Cash Flows for the six months ended September 30, 2001 and 2000 (Unaudited) |
5 |
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Consolidated Statement of Changes in Shareholders' Equity for the six months ended September 30, 2001 (Unaudited) |
6 |
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Notes to Consolidated Financial Statements for the three and six months ended September 30, 2001 (Unaudited) |
7 |
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Item 2. |
Management's Discussion and Analysis of Financial Condition and Results of Operations |
16 |
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Item 3. |
Quantitative and Qualitative Disclosures About Market Risk |
24 |
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PART II. |
OTHER INFORMATION |
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Item 1. |
Legal Proceedings |
26 |
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Item 4. |
Submission of Matters to a Vote of Security Holders |
26 |
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Item 6. |
Exhibits and Reports on Form 8-K |
27 |
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SIGNATURES |
28 |
Part I. Financial Information.
Item 1. Financial Statements.
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
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September 30, 2001 (Unaudited) |
March 31, 2001 |
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Assets | ||||||||||
Current assets: | ||||||||||
Cash and cash equivalents | $ | 122,152 | $ | 125,550 | ||||||
Accounts receivable, net of allowances of $27,450 and $28,461 at September 30, 2001 and March 31, 2001, respectively | 86,391 | 73,802 | ||||||||
Inventories | 33,892 | 43,888 | ||||||||
Prepaid royalties and capitalized software costs | 38,377 | 27,502 | ||||||||
Deferred income taxes | 12,553 | 14,292 | ||||||||
Other current assets | 14,758 | 13,196 | ||||||||
Total current assets | 308,123 | 298,230 | ||||||||
Prepaid royalties and capitalized software costs | 23,538 | 14,703 | ||||||||
Property and equipment, net | 17,209 | 15,240 | ||||||||
Deferred income taxes | 39,697 | 13,759 | ||||||||
Other assets | 5,786 | 7,709 | ||||||||
Goodwill | 10,458 | 10,316 | ||||||||
Total assets | $ | 404,811 | $ | 359,957 | ||||||
Liabilities and Shareholders' Equity | ||||||||||
Current liabilities: | ||||||||||
Current portion of long-term debt | $ | 2,337 | $ | 10,231 | ||||||
Accounts payable | 60,417 | 60,980 | ||||||||
Accrued expenses | 43,612 | 44,039 | ||||||||
Total current liabilities | 106,366 | 115,250 | ||||||||
Long-term debt, less current portion | 3,425 | 3,401 | ||||||||
Convertible subordinated notes | | 60,000 | ||||||||
Total liabilities | 109,791 | 178,651 | ||||||||
Commitments and contingencies | ||||||||||
Shareholders' equity: | ||||||||||
Preferred stock, $.000001 par value, 4,500,000 shares authorized, no shares issued at September 30, 2001 and March 31, 2001 | | | ||||||||
Series A Junior Preferred stock, $.000001 par value, 500,000 shares authorized, no shares issued at September 30, 2001 and March 31, 2001 | | | ||||||||
Common stock, $.000001 par value, 125,000,000 and 50,000,000 shares authorized, 36,201,749 and 30,166,455 shares issued and 33,317,770 and 27,282,476 shares outstanding at September 30, 2001 and March 31, 2001, respectively | | | ||||||||
Additional paid-in capital | 310,744 | 200,786 | ||||||||
Retained earnings | 14,390 | 12,146 | ||||||||
Accumulated other comprehensive loss | (9,865 | ) | (11,377 | ) | ||||||
Less: Treasury stock, at cost, 2,883,979 shares at September 30, 2001 and March 31, 2001 | (20,249 | ) | (20,249 | ) | ||||||
Total shareholders' equity | 295,020 | 181,306 | ||||||||
Total liabilities and shareholders' equity | $ | 404,811 | $ | 359,957 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
3
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
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For the three months ended September 30, |
For the six months ended September 30, |
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2001 |
2000 |
2001 |
2000 |
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Net revenues | $ | 139,604 | $ | 144,363 | $ | 250,181 | $ | 228,921 | |||||||
Costs and expenses: | |||||||||||||||
Cost of salesproduct costs | 88,157 | 64,351 | 152,281 | 107,984 | |||||||||||
Cost of salesroyalties and software amortization | 13,165 | 24,819 | 23,161 | 38,465 | |||||||||||
Product development | 9,020 | 11,107 | 18,210 | 18,531 | |||||||||||
Sales and marketing | 16,425 | 23,909 | 35,181 | 41,779 | |||||||||||
General and administrative | 9,693 | 10,641 | 19,439 | 19,124 | |||||||||||
Total costs and expenses | 136,460 | 134,827 | 248,272 | 225,883 | |||||||||||
Operating income | 3,144 | 9,536 | 1,909 | 3,038 | |||||||||||
Interest income (expense), net | 372 | (2,683 | ) | 1,653 | (4,406 | ) | |||||||||
Income (loss) before income tax provision | 3,516 | 6,853 | 3,562 | (1,368 | ) | ||||||||||
Income tax provision (benefit) | 1,301 | 2,547 | 1,318 | (495 | ) | ||||||||||
Net income (loss) | $ | 2,215 | $ | 4,306 | $ | 2,244 | $ | (873 | ) | ||||||
Basic earnings (loss) per share | $ | 0.07 | $ | 0.18 | $ | 0.07 | $ | (0.04 | ) | ||||||
Weighted average common shares outstanding | 33,241 | 23,835 | 31,683 | 24,388 | |||||||||||
Diluted earnings (loss) per share | $ | 0.06 | $ | 0.17 | $ | 0.06 | $ | (0.04 | ) | ||||||
Weighted average common shares outstanding assuming dilution | 38,100 | 25,799 | 36,752 | 24,388 | |||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
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For the six months ended September 30, |
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2001 |
2000 |
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Cash flows from operating activities: | |||||||||
Net income (loss) | $ | 2,244 | $ | (873 | ) | ||||
Adjustments to reconcile net income (loss) to net cash used in operating activities: | |||||||||
Deferred income taxes | (24,199 | ) | (5,275 | ) | |||||
Depreciation and amortization | 2,679 | 2,964 | |||||||
Amortization of prepaid royalties and capitalized software costs | 17,531 | 34,101 | |||||||
Tax benefit attributable to employee stock options and common stock warrants | 24,371 | 1,445 | |||||||
Expense related to common stock warrants | 566 | 703 | |||||||
Changes in assets and liabilities: | |||||||||
Accounts receivable | (12,589 | ) | (28,760 | ) | |||||
Inventories | 9,996 | (6,789 | ) | ||||||
Prepaid royalties and capitalized software costs | (37,241 | ) | (37,182 | ) | |||||
Other assets | (1,489 | ) | (1,677 | ) | |||||
Accounts payable | (563 | ) | 6,200 | ||||||
Accrued expenses and other liabilities | 2,790 | 8,493 | |||||||
Net cash used in operating activities | (15,904 | ) | (26,650 | ) | |||||
Cash flows from investing activities: | |||||||||
Capital expenditures | (4,652 | ) | (3,531 | ) | |||||
Proceeds from disposal of property and equipment | 391 | 1,394 | |||||||
Net cash used in investing activities | (4,261 | ) | (2,137 | ) | |||||
Cash flows from financing activities: | |||||||||
Proceeds from issuance of common stock pursuant to employee stock option plans, employee stock purchase plan and common stock warrants | 23,716 | 5,451 | |||||||
Borrowing under line-of-credit agreements | | 234,296 | |||||||
Payment under line-of-credit agreements | | (211,055 | ) | ||||||
Payment on term loan | (8,550 | ) | (5,000 | ) | |||||
Other borrowings, net | 680 | (458 | ) | ||||||
Redemption of convertible subordinated notes | (62 | ) | | ||||||
Purchase of treasury stock | | (14,971 | ) | ||||||
Net cash provided by financing activities | 15,784 | 8,263 | |||||||
Effect of exchange rate changes on cash | 983 | (4,257 | ) | ||||||
Net decrease in cash and cash equivalents | (3,398 | ) | (24,781 | ) | |||||
Cash and cash equivalents at beginning of period | 125,550 | 49,985 | |||||||
Cash and cash equivalents at end of period | $ | 122,152 | $ | 25,204 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
5
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the six months ended September 30, 2001
(Unaudited)
(In thousands)
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Accumulated Other Comprehensive Income (Loss) |
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Common Stock |
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Treasury Stock |
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Additional Paid-In Capital |
Retained Earnings |
Shareholders' Equity |
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Shares |
Amount |
Shares |
Amount |
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Balance, March 31, 2001 | 30,166 | $ | | $ | 200,786 | $ | 12,146 | (2,884 | ) | $ | (20,249 | ) | $ | (11,377 | ) | $ | 181,306 | |||||||
Components of comprehensive income (loss): | ||||||||||||||||||||||||
Net income | | | | 2,244 | | | | 2,244 | ||||||||||||||||
Foreign currency translation adjustment | | | | | | | 1,512 | 1,512 | ||||||||||||||||
Total comprehensive income | 3,756 | |||||||||||||||||||||||
Issuance of common stock pursuant to conversion of convertible subordinated notes | 3,175 | | 59,938 | | | | | 59,938 | ||||||||||||||||
Issuance of common stock pursuant to employee stock option plans, employee stock purchase plan and common stock warrants | 2,861 | | 23,716 | | | | | 23,716 | ||||||||||||||||
Tax benefit attributable to employee stock options and common stock warrants | | | 24,371 | | | | | 24,371 | ||||||||||||||||
Other | | | 1,933 | | | | | 1,933 | ||||||||||||||||
Balance, September 30, 2001 | 36,202 | $ | | $ | 310,744 | $ | 14,390 | (2,884 | ) | $ | (20,249 | ) | $ | (9,865 | ) | $ | 295,020 | |||||||
The accompanying notes are an integral part of these consolidated financial statements.
6
ACTIIVION INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the three and six months ended September 30, 2001
(Unaudited)
1. Basis of Presentation
The accompanying consolidated financial statements include the accounts of Activision, Inc. and its subsidiaries. The information furnished is unaudited and reflects all adjustments that, in the opinion of management, are necessary to provide a fair statement of the results for the interim periods presented. The financial statements should be read in conjunction with the financial statements included in our Annual Report on Form 10-K for the year ended March 31, 2001 as filed with the Securities and Exchange Commission.
Certain amounts in the consolidated financial statements have been reclassified to conform to the current period's presentation. These reclassifications had no impact on previously reported working capital or results of operations.
2. Recently Issued Accounting Standards
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", was issued on July 20, 2001 and addresses financial accounting and reporting for business combinations. SFAS No. 141 requires that the purchase method be used to account and report for all business combinations. The provisions of this Statement apply to all business combinations initiated after June 30, 2001. This Statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001 or later.
SFAS No. 142 "Goodwill and Other Intangibles", was issued on July 20, 2001 and addresses financial accounting and reporting for acquired goodwill and other intangible assets. SFAS No. 142 addresses how intangible assets should be accounted for after they have been initially recognized in the financial statements. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not previously been issued. We adopted the provisions of this Statement effective April 1, 2001.
In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" was issued, which supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and the accounting and reporting provisions of Accounting Principles Board ("APB") No. 30, "Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS No.144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. We believe the adoption of SFAS No. 144 will not have a material impact on our financial statements.
3. Goodwill and Other Intangible AssetsAdoption of SFAS No. 142
We adopted SFAS No. 142 effective April 1, 2001, and as a result we were not required to expense goodwill in the amount of $375,000 and $750,000 for the three months and six months ended September 30, 2001, respectively. The following table reconciles net income (loss) and earnings (loss) per share as reported for the three and six months ended September 30, 2001 and 2000 to net income
7
(loss) and earnings (loss) per share as adjusted to exclude goodwill amortization (amounts in thousands, except per share data).
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Three months ended September 30, |
Six months ended September 30, |
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2001 |
2000 |
2001 |
2000 |
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Reported net income (loss) | $ | 2,215 | $ | 4,306 | $ | 2,244 | $ | (873 | ) | |||||
Add back: Goodwill amortization | | 375 | | 753 | ||||||||||
Adjusted net income (loss) | $ | 2,215 | $ | 4,681 | $ | 2,244 | $ | (120 | ) | |||||
Basic earnings (loss) per share: | ||||||||||||||
Reported net income (loss) | $ | 0.07 | $ | 0.18 | $ | 0.07 | $ | (0.04 | ) | |||||
Goodwill amortization | | 0.02 | | 0.03 | ||||||||||
Adjusted net income (loss) | $ | 0.07 | $ | 0.20 | $ | 0.07 | $ | (0.01 | ) | |||||
Diluted earnings (loss) per share: | ||||||||||||||
Reported net income (loss) | $ | 0.06 | $ | 0.17 | $ | 0.06 | $ | (0.04 | ) | |||||
Goodwill amortization | | 0.01 | | 0.03 | ||||||||||
Adjusted net income (loss) | $ | 0.06 | $ | 0.18 | $ | 0.06 | $ | (0.01 | ) | |||||
4. Prepaid Royalties and Capitalized Software Costs
Prepaid royalties include payments made to independent software developers under development agreements and license fees paid to intellectual property rights holders for use of their trademarks or copyrights. Intellectual property rights which have alternative future uses are capitalized. Capitalized software costs represent costs incurred for internal development of products.
We account for prepaid royalties relating to development agreements and capitalized software costs in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." Software development costs and prepaid royalties are capitalized once technological feasibility is established and such costs are determined to be recoverable. For products where proven game engine 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 product development costs, capitalized costs when we believe such amounts are not recoverable. 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 following criteria is used to evaluate recoverability of software development costs: historical performance of comparable products; the commercial acceptance of prior products released on a given game engine; orders for the product prior to its release; estimated performance of a sequel product based on the performance of the product on which the sequel is based; and actual development costs of a product as compared to our budgeted amount.
Commencing upon product release prepaid royalties and capitalized software development costs are amortized to cost of salesroyalties and software amortization on the ratio of current revenues to total projected revenues, generally resulting in an amortization period of one year or less. For 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.
As of September 30, 2001, prepaid royalties and unamortized capitalized software costs totaled $51.8 million (including $23.5 million classified as non-current) and $10.2 million, respectively. As of
8
March 31, 2001, prepaid royalties and unamortized capitalized software costs totaled $38.3 million (including $14.7 million classified as non-current) and $3.9 million, respectively.
5. Revenue Recognition
We recognize revenue from the sale of our products once they are shipped and are available for general release to customers. Subject to certain limitations, we permit customers to exchange and return our products within certain specified periods and we provide our customers with price protection on certain unsold merchandise. Price protection policies, when negotiated and applicable, allow customers to take a deduction on unsold merchandise.
Revenue from product sales is reflected after deducting the estimated allowance for returns and price protection. We estimate the amount of future returns and price protection based upon historical results and current known circumstances. With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery. Per copy royalties on sales that exceed the guarantee are recognized as earned.
6. Interest Income (Expense)
Interest income (expense), net is comprised of the following (amounts in thousands):
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Three months ended September 30, |
Six months ended September 30, |
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2001 |
2000 |
2001 |
2000 |
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Interest expense | $ | (662 | ) | $ | (2,913 | ) | $ | (1,263 | ) | $ | (5,103 | ) | |
Interest income | 1,034 | 230 | 2,916 | 697 | |||||||||
Net interest income (expense) | $ | 372 | $ | (2,683 | ) | $ | 1,653 | $ | (4,406 | ) | |||
7. Supplemental Cash Flow Information
Non-cash investing and financing activities and supplemental cash flow information is as follows (amounts in thousands):
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Six months ended September 30, |
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2001 |
2000 |
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Non-cash investing and financing activities: | |||||||
Conversion of convertible subordinated notes | $ | 59,938 | $ | | |||
Tax benefit derived from net operating loss carryforward utilization | | 533 | |||||
Other | 1,933 | | |||||
Supplemental cash flow information: |
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Cash paid for income taxes | 978 | 2,723 | |||||
Cash paid (received) for interest | (1,211 | ) | 3,174 |
8. Operations by Reportable Segments and Geographic Area
We publish, develop and distribute interactive entertainment software products. Our products cover the action, adventure, extreme sports, racing, role playing, simulation and strategy game categories. We offer our products in versions which operate on the Sega Dreamcast, Sony PlayStation, Sony PlayStation 2 and Nintendo 64 console systems, the Nintendo Game Boy Color and Game Boy Advance hand held devices, as well as on personal computers. We have also begun product
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development for next generation console systems, including Microsoft's Xbox and Nintendo's GameCube.
Based upon our organizational structure, we operate two business segments: (i) publishing of interactive entertainment software and (ii) distribution of interactive entertainment software and hardware products.
Publishing refers to the development, marketing and sale of products, either directly, by license or through our affiliate label program with third party publishers. In the United States, our products are sold primarily on a direct basis to major computer and software retailing organizations, mass market retailers, consumer electronic stores, discount warehouses and mail order companies. We conduct our international publishing activities through offices in the United Kingdom, Germany, France, Australia, Canada and Japan. Our products are sold internationally on a direct to retail basis and through third party distribution and licensing arrangements and through our wholly-owned distribution subsidiaries located in the United Kingdom, the Netherlands and Germany.
Distribution refers to our operations in the United Kingdom, the Netherlands and Germany that provide logistical and sales services to third party publishers of interactive entertainment software, our own publishing operations and manufacturers of interactive entertainment hardware.
Resources are allocated to each of these segments using information on their respective net revenues and operating profits before interest and taxes. The segments are not evaluated based on assets or depreciation.
The accounting policies of these segments are the same as those described in the Summary of Significant Accounting Policies in our Annual Report on Form 10-K for the year ended March 31, 2001. Revenue derived from sales between segments is eliminated in consolidation.
10
Information on the reportable segments for the three and six months ended September 30, 2001 and 2000 is as follows (amounts in thousands):
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Three months ended September 30, 2001 |
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Publishing |
Distribution |
Total |
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Total segment revenues | $ | 97,627 | $ | 41,977 | $ | 139,604 | |||
Revenues from sales between segments | (7,481 | ) | 7,481 | | |||||
Revenues from external customers | $ | 90,146 | $ | 49,458 | $ | 139,604 | |||
Operating income | $ | 2,118 | $ | 1,026 | $ | 3,144 | |||
Goodwill | $ | 5,941 | $ | 4,517 | $ | 10,458 | |||
Total assets | $ | 319,236 | $ | 85,575 | $ | 404,811 | |||
|
Three months ended September 30, 2000 |
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Publishing |
Distribution |
Total |
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Total segment revenues | $ | 121,630 | $ | 22,733 | $ | 144,363 | |||
Revenues from sales between segments | (10,715 | ) | 10,715 | | |||||
Revenues from external customers | $ | 110,915 | $ | 33,448 | $ | 144,363 | |||
Operating income (loss) | $ | 10,461 | $ | (925 | ) | $ | 9,536 | ||
Goodwill | $ | 6,544 | $ | 4,630 | $ | 11,174 | |||
Total assets | $ | 262,743 | $ | 66,784 | $ | 329,527 | |||
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Six months ended September 30, 2001 |
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Publishing |
Distribution |
Total |
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Total segment revenues | $ | 180,457 | $ | 69,724 | $ | 250,181 | |||
Revenues from sales between segments | (13,481 | ) | 13,481 | | |||||
Revenues from external customers | $ | 166,976 | $ | 83,205 | $ | 250,181 | |||
Operating income | $ | 812 | $ | 1,097 | $ | 1,909 | |||
Goodwill | $ | 5,941 | $ | 4,517 | $ | 10,458 | |||
Total assets | $ | 319,236 | $ | 85,575 | $ | 404,811 | |||
|
Six months ended September 30, 2000 |
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Publishing |
Distribution |
Total |
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Total segment revenues | $ | 182,629 | $ | 46,292 | $ | 228,921 | |||
Revenues from sales between segments | (16,576 | ) | 16,576 | | |||||
Revenues from external customers | $ | 166,053 | $ | 62,868 | $ | 228,921 | |||
Operating income (loss) | $ | 4,554 | $ | (1,516 | ) | $ | 3,038 | ||
Goodwill | $ | 6,544 | $ | 4,630 | $ | 11,174 | |||
Total assets | $ | 262,743 | $ | 66,784 | $ | 329,527 | |||
11
Geographic information for the three and six months ended September 30, 2001 and 2000 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 September 30, |
Six months ended September 30, |
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2001 |
2000 |
2001 |
2000 |
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United States | $ | 71,680 | $ | 92,308 | $ | 137,944 | $ | 138,303 | ||||
Europe | 65,537 | 48,039 | 107,370 | 85,409 | ||||||||
Other | 2,387 | 4,016 | 4,867 | 5,209 | ||||||||
Total | $ | 139,604 | $ | 144,363 | $ | 250,181 | $ | 228,921 | ||||
Revenues by platform were as follows (amounts in thousands):
|
Three months ended September 30, |
Six months ended September 30, |
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2001 |
2000 |
2001 |
2000 |
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Console | $ | 115,086 | $ | 115,159 | $ | 208,619 | $ | 161,804 | ||||
PC | 24,518 | 29,204 | 41,562 | 67,117 | ||||||||
Total | $ | 139,604 | $ | 144,363 | $ | 250,181 | $ | 228,921 | ||||
9. Computation of Earnings 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 September 30, |
Six months ended September 30, |
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2001 |
2000 |
2001 |
2000 |
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Numerator | |||||||||||||||
Numerator for basic and diluted earnings per share income (loss) available to common shareholders | $ | 2,215 | $ | 4,306 | $ | 2,244 | $ | (873 | ) | ||||||
Denominator | |||||||||||||||
Denominator for basic earnings per share- weighted average common shares outstanding | 33,241 | 23,835 | 31,683 | 24,388 | |||||||||||
Effect of dilutive securities: | |||||||||||||||
Employee stock options | 4,485 | 1,891 | 4,663 | | |||||||||||
Warrants to purchase common stock | 374 | 73 | 406 | | |||||||||||
Potential dilutive common shares | 4,859 | 1,964 | 5,069 | | |||||||||||
Denominator for diluted earnings per share weighted average common shares outstanding plus assumed conversions | 38,100 | 25,799 | 36,752 | 24,388 | |||||||||||
Basic earnings (loss) per share | $ | 0.07 | $ | 0.18 | $ | 0.07 | $ | (0.04 | ) | ||||||
Diluted earnings (loss) per share | $ | 0.06 | $ | 0.17 | $ | 0.06 | $ | (0.04 | ) | ||||||
Options to purchase 56,050 shares of common stock at exercise prices ranging from $32.70 to $37.90 and options to purchase 38,145 shares of common stock at exercise prices ranging from $31.05 to $37.90 were outstanding for the three and six months ended September 30, 2001, respectively, but were not included in the calculation of diluted earnings per share because their effect would be
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antidilutive. Options to purchase 3,212,806 of common stock at exercise prices ranging from $11.05 to $23.04 and options to purchase 10,804,882 shares of common stock at exercise prices ranging from $0.75 to $23.04 were outstanding for the three and six months ended September 30, 2000, respectively, but were not included in the calculation of diluted earnings (loss) per share because their effect would be antidilutive. Shares issuable upon the conversion of convertible subordinated notes were not included in the calculation of diluted earnings (loss) per share for the three and six months ended September 30, 2000 because their effect would be antidilutive.
10. Commitments
Bank Lines of Credit
In June 1999, we obtained a $100.0 million revolving credit facility and a $25.0 million term loan with a syndicate of banks (the "U.S. Facility"). The revolving portion of the U.S. Facility provided us with the ability to borrow up to $100.0 million and issue letters of credit up to $80 million on a revolving basis against eligible accounts receivable and inventory. The term loan had a three year term with principal amortization on a straight-line quarterly basis beginning December 31, 1999 and a borrowing rate based on the banks' base rate (which is generally equivalent to the published prime rate) plus 2% or LIBOR plus 3% and was to expire June 2002. The revolving portion of the U.S Facility had a borrowing rate based on the banks' base rate plus 1.75% or LIBOR plus 2.75%. In May 2001, we accelerated our repayment of the outstanding balance under the term loan portion of the U.S. Facility. In connection with the accelerated repayment, we amended the U.S. Facility (the "Amended and Restated U.S. Facility"). The Amended and Restated U.S. Facility eliminated the term loan, reduced the revolver to $78.0 million and reduced the interest rate to the banks' base rate plus 1.25% or LIBOR plus 2.25%. We pay a commitment fee of 1/4% on the unused portion of the revolver. The Amended and Restated U.S. Facility is collateralized by substantially all of our assets and expires June 2002. The Amended and Restated U.S. Facility contains various covenants that limit our ability to incur additional indebtedness, pay dividends or make other distributions, create certain liens, sell assets, or enter into certain mergers or acquisitions. We are also required to maintain specified financial ratios related to net worth and fixed charges. We were in compliance with these covenants as of September 30, 2001. As of September 30, 2001, there were no borrowings outstanding under the Amended and Restated U.S. Facility. Letters of credit of $27.4 million were outstanding against the Amended and Restated U.S. Facility as of September 30, 2001.
We have a revolving credit facility through our CD Contact subsidiary in the Netherlands (the "Netherlands Facility"). The Netherlands Facility permits revolving credit loans and letters of credit up to Netherlands Guilders ("NLG") 10 million ($4.2 million) as of September 30, 2001, based upon eligible accounts receivable and inventory balances. The Netherlands Facility is due on demand, bears interest at a Eurocurrency rate plus 1.50% and expires August 2003. Borrowings outstanding and letters of credit outstanding under the Netherlands Facility were $1.6 million and NLG 0.3 million ($0.1 million), respectively, as of September 30, 2001.
We also have revolving credit facilities with our CentreSoft subsidiary located in the United Kingdom (the "UK Facility") and our NBG subsidiary located in Germany (the "German Facility"). The UK Facility provides for British Pounds ("GBP") 7.0 million ($10.3 million) of revolving loans and GBP 1.5 million ($2.2 million) of letters of credit as of September 30, 2001. The UK Facility bears interest at LIBOR plus 2%, is collateralized by substantially all of the assets of the subsidiary and expires in October 2002. The UK Facility also contains various covenants that require the subsidiary to maintain specified financial ratios related to, among others, fixed charges. As of September 30, 2001, we were in compliance with these covenants. No borrowings were outstanding against the UK facility as of September 30, 2001. Letters of credit of GBP 1.5 million ($2.2 million) were outstanding against the UK Facility as of September 30, 2001. As of September 30, 2001, the German Facility provides for revolving loans up to Euro dollar ("EUR") 2.6 million ($2.3 million), bears interest at 7.0%, is
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collateralized by a cash deposit of approximately GBP 650,000 ($1.0 million) made by our CentreSoft subsidiary and has no expiration date. Borrowings outstanding against the German Facility as of September 30, 2001 were $0.6 million.
Private Placement of Convertible Subordinated Notes
In December 1997, we completed the private placement of $60.0 million principal amount of 63/4% convertible subordinated notes due 2005 (the "Notes"). The Notes were convertible, in whole or in part, at the option of the holder at any time after December 22, 1997 (the date of original issuance) and prior to the close of business on the business day immediately preceding the maturity date, unless previously redeemed or repurchased, into our common stock, $.000001 par value, at a conversion price of $18.875 per share, (equivalent to a conversion rate of 52.9801 shares per $1,000 principal amount of Notes), subject to adjustment in certain circumstances. During the three months ended June 30, 2001, we called for the redemption of the Notes. In connection with that call, holders converted to common stock approximately $59.9 million aggregate principal amount of their Notes. The remaining Notes were redeemed for cash.
Developer Contracts
In the normal course of business, we enter into contractual arrangements with third parties for the development of products. Under these agreements, we commit to provide specified payments to a developer, contingent upon the developer's achievement of contractually specified milestones. Assuming all contractually specified milestones are achieved, the total future minimum contract commitment for contracts in place as of September 30, 2001 is approximately $61.7 million and is scheduled to be distributed as follows (amounts in thousands):
Fiscal year ending March 31, |
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2002 | $ | 23,178 | ||
2003 | 25,314 | |||
2004 | 6,070 | |||
2005 | 2,925 | |||
2006 | 1,675 | |||
Thereafter | 2,500 | |||
Total | $ | 61,662 | ||
Legal Proceedings
We are party to routine claims and suits brought against us in the ordinary course of business, including disputes arising over the ownership of intellectual property rights and collection matters. In the opinion of management, the outcome of such routine claims will not have a material adverse effect on our business, financial condition, results of operations or liquidity.
11. Subsequent Events
Registration Statement
On July 30, 2001, we filed with the Securities and Exchange Commission a Registration Statement on Form S-3, as amended, for purposes of registering 6,000,000 shares of our common stock, $.000001 par value (excluding shares registered to cover the underwriters' over-allotment option), in connection with a proposed public offering of such shares. On October 22, 2001, we withdrew the registration statement.
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Acquisition
Effective October 1, 2001, we acquired all of the outstanding capital of Treyarch Invention, LLC ("Treyarch"), a privately held interactive software development company in exchange for 545,974 shares of Activision, Inc. common stock with a market value of $14.9 million based on our opening stock price as of October 1, 2001. Additional shares of Activision common stock also may be issued to Treyarch's equity holders and employees over the course of several years, depending on the satisfaction of certain performance requirements and other criteria.
Stock Split
On October 23, 2001, the Board of Directors authorized a three-for-two split of our outstanding common shares. The split is payable on November 20, 2001 to shareholders of record as of November 6, 2001. The par value of our common stock will be maintained at the pre-split amount of $.000001. Following is the pro forma effect of the split on earnings per share data (in thousands, except per share data).
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(Unaudited) |
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Three months ended September 30, |
Six months ended September 30, |
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2001 |
2000 |
2001 |
2000 |
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Basic earnings (loss) per share | $ | 0.04 | $ | 0.12 | $ | 0.05 | $ | (0.02 | ) | ||||
Weighted average common shares outstanding | 49,862 | 35,753 | 47,525 | 36,582 | |||||||||
Diluted earnings (loss) per share | $ | 0.04 | $ | 0.11 | $ | 0.04 | $ | (0.02 | ) | ||||
Weighted average common shares outstanding assuming dilution | 57,150 | 38,699 | 55,128 | 36,582 | |||||||||
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
We are a leading international publisher of interactive entertainment software products. We have built a company with a diverse portfolio of products that spans a wide range of categories and target markets and that is used on a variety of game hardware platforms and operating systems.
Our products cover the action, adventure, extreme sports, racing, role playing, simulation and strategy game categories. We offer our products in versions which operate on the Sega Dreamcast, Sony PlayStation, Sony PlayStation 2 and Nintendo 64 console systems, the Nintendo Game Boy Color and Game Boy Advance hand held devices, as well as on personal computers ("PC's"). Over the next few years, we plan to produce many titles for the recently released Sony PlayStation 2 console system and Game Boy Advance hand held device, and the Microsoft Xbox and Nintendo GameCube console systems, which are expected to launch in North America in November 2001 and in Europe in the next calendar year. Driven partly by the enhanced capabilities of the next generation platforms, we believe that in the next few years there will be significant growth in the market for interactive entertainment software and we plan to leverage our skills and resources to extend our leading position in the industry.
We operate two business segments: (i) publishing of interactive entertainment software and (ii) distribution of interactive entertainment software and hardware products. Publishing refers to the development, marketing and sale of products, either directly, by license or through our affiliate label program with third party publishers. Distribution refers to our operations in Europe that provide logistical and sales services to third party publishers of interactive entertainment software, our own publishing operations and manufacturers of interactive entertainment hardware.
We recognize revenue from the sale of our products once they are shipped and are available for general release to customers. Subject to certain limitations, we permit customers to exchange and return our products within certain specified periods and we provide our customers with price protection on certain unsold merchandise. Price protection policies, when negotiated and applicable, allow customers to take a deduction on unsold merchandise.
Revenue from product sales is reflected after deducting the estimated allowance for returns and price protection. We estimate the amount of future returns and price protection based upon historical results and current known circumstances. With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery. Per copy royalties on sales that exceed the guarantee are recognized as earned.
Cost of sales-product costs represents the cost to purchase, manufacture and distribute personal computer and console product units. Manufacturers of our software are located worldwide and are readily available. Console compact discs and cartridges are manufactured by the respective video game console manufacturers, Sony and Nintendo or our agents.
Cost of sales-royalties and software amortization represents amounts due to developers, product owners and other royalty participants as a result of product sales, as well as amortization of capitalized software development costs. Our costs to develop products are accounted for in accordance with accounting standards that provide for the capitalization of certain software development costs once technological feasibility is established and such costs are determined to be recoverable. Additionally, various contracts are maintained with developers, product owners or other royalty participants, which state a royalty rate, territory and term of agreement, among other items. Upon product release, prepaid royalties and capitalized software costs are amortized to cost of sales-royalties and software amortization based on the ratio of current revenues to total projected revenues, generally resulting in an amortization period of one year or less.
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For products that have been released, we evaluate the future recoverability of prepaid royalties and capitalized software costs on a quarterly basis based on actual title performance. Prior to a product's release, we expense, as part of product development costs, capitalized costs when we believe that such amounts are not recoverable. The following criteria are used to evaluate recoverability of unreleased titles: historical performance of comparable products; the commercial acceptance of prior products released on a given game engine; orders for the product prior to its release; estimated performance of a sequel product based on the performance of the product on which the sequel is based; and actual development costs of a product as compared to our budgeted amount.
Our profitability is directly affected by the mix of revenues from our publishing and distribution segments. Publishing operating margins are substantially higher than margins realized from our distribution segment. Operating margins in our distribution segment are also affected by the mix of hardware and software sales, with software producing higher margins than hardware.
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The following table sets forth certain consolidated statements of operations data for the periods indicated as a percentage of total net revenues and also breaks down net revenues by territory, platform and segment (amounts in thousands):
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Three months ended September 30, |
Six months ended September 30, |
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2001 |
2000 |
2001 |
2000 |
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Net revenues | $ | 139,604 | 100 | % | $ | 144,363 | 100 | % | $ | 250,181 | 100 | % | $ | 228,921 | 100 | % | ||||||||
Costs and expenses: | ||||||||||||||||||||||||
Cost of salesproduct costs | 88,157 | 63 | % | 64,351 | 45 | % | 152,281 | 61 | % | 107,984 | 47 | % | ||||||||||||
Cost of salesroyalties and software amortization | 13,165 | 9 | % | 24,819 | 17 | % | 23,161 | 9 | % | 38,465 | 17 | % | ||||||||||||
Product development | 9,020 | 7 | % | 11,107 | 8 | % | 18,210 | 7 | % | 18,531 | 8 | % | ||||||||||||
Sales and marketing | 16,425 | 12 | % | 23,909 | 16 | % | 35,181 | 14 | % | 41,779 | 18 | % | ||||||||||||
General and administrative | 9,693 | 7 | % | 10,641 | 7 | % | 19,439 | 8 | % | 19,124 | 9 | % | ||||||||||||
Total costs and expenses | 136,460 | 98 | % | 134,827 | 93 | % | 248,272 | 99 | % | 225,883 | 99 | % | ||||||||||||
Operating income | 3,144 | 2 | % | 9,536 | 7 | % | 1,909 | 1 | % | 3,038 | 1 | % | ||||||||||||
Interest income (expense), net | 372 | 1 | % | (2,683 | ) | (2 | %) | 1,653 | 1 | % | (4,406 | ) | (2 | %) | ||||||||||
Income (loss) before income tax provision | 3,516 | 3 | % | 6,853 | 5 | % | 3,562 | 2 | % | (1,368 | ) | (1 | %) | |||||||||||
Income tax provision (benefit) | 1,301 | 1 | % | 2,547 | 2 | % | 1,318 | 1 | % | (495 | ) | 0 | % | |||||||||||
Net income (loss) | $ | 2,215 | 2 | % | $ | 4,306 | 3 | % | $ | 2,244 | 1 | % | $ | (873 | ) | (1 | %) | |||||||
NET REVENUES BY TERRITORY: | ||||||||||||||||||||||||
United States | $ | 71,680 | 51 | % | $ | 92,308 | 64 | % | $ | 137,944 | 55 | % | $ | 138,303 | 61 | % | ||||||||
Europe | 65,537 | 47 | % | 48,039 | 33 | % | 107,370 | 43 | % | 85,409 | 37 | % | ||||||||||||
Other | 2,387 | 2 | % | 4,016 | 3 | % | 4,867 | 2 | % | 5,209 | 2 | % | ||||||||||||
Total net revenues | $ | 139,604 | 100 | % | $ | 144,363 | 100 | % | $ | 250,181 | 100 | % | $ | 228,921 | 100 | % | ||||||||
ACTIVITY/PLATFORM MIX: | ||||||||||||||||||||||||
Publishing: | ||||||||||||||||||||||||
Console | $ | 79,490 | 81 | % | $ | 99,057 | 81 | % | $ | 148,699 | 82 | % | $ | 129,100 | 71 | % | ||||||||
PC | 18,137 | 19 | % | 22,573 | 19 | % | 31,758 | 18 | % | 53,529 | 29 | % | ||||||||||||
Total publishing net revenues | 97,627 | 70 | % | 121,630 | 84 | % | 180,457 | 72 | % | 182,629 | 80 | % | ||||||||||||
Distribution: | ||||||||||||||||||||||||
Console | 35,596 | 85 | % | 16,102 | 71 | % | 59,920 | 86 | % | 32,704 | 71 | % | ||||||||||||
PC | 6,381 | 15 | % | 6,631 | 29 | % | 9,804 | 14 | % | 13,588 | 29 | % | ||||||||||||
Total distribution net revenues | 41,977 | 30 | % | 22,733 | 16 | % | 69,724 | 28 | % | 46,292 | 20 | % | ||||||||||||
Total net revenues | $ | 139,604 | 100 | % | $ | 144,363 | 100 | % | $ | 250,181 | 100 | % | $ | 228,921 | 100 | % | ||||||||
OPERATING INCOME (LOSS) BY SEGMENT: | ||||||||||||||||||||||||
Publishing | $ | 2,118 | 2 | % | $ | 10,461 | 7 | % | $ | 812 | 0 | % | $ | 4,554 | 2 | % | ||||||||
Distribution | 1,026 | 0 | % | (925 | ) | 0 | % | 1,097 | 0 | % | (1,516 | ) | (1 | %) | ||||||||||
Total operating income | $ | 3,144 | 2 | % | $ | 9,536 | 7 | % | $ | 1,909 | 0 | % | $ | 3,038 | 1 | % | ||||||||
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Results of OperationsThree and Six Months Ended September 30, 2001 and 2000
Net Revenues
Net revenues for the three months ended September 30, 2001 decreased 3% over the same period last year, from $144.4 million to $139.6 million. This decrease was primarily attributable to a decline in publishing net revenues, partially offset by an increase in distribution net revenues. Net revenues for the six months ended September 30, 2001 increased 9% over the same period last year, from $228.9 million to $250.2 million. This increase was driven primarily by our distribution business.
Publishing net revenues decreased 20% for the three months ended September 30, 2001, over the same period last year, from $121.6 million to $97.6 million. Publishing console net revenues decreased from $99.1 million to $79.5 million, and publishing PC net revenues decreased from $22.6 million to $18.1 million. These decreases are due to the fact that in the prior year, we released most of our major holiday titles by September 30th, including Tony Hawk's Pro Skater 2, Spider-Man, Tenchu II and X-Men Mutant Academy for the PlayStation and two Star Trek titles for the PC. However, in fiscal 2002, a number of our major holiday titles, including Tony Hawk's Pro Skater 3 and Shaun Palmer's Pro Snowboarder for the PlayStation 2, Spider-Man 2: Enter Electro for the PlayStation and Return to Castle Wolfenstein for the PC, have been slated to be released in the third quarter. Additionally, the release of our titles for the Microsoft Xbox and Nintendo GameCube platforms will coincide with the North American hardware launches, which are expected to occur in November 2001. The decrease in our publishing net revenues was offset by the increase in net revenues from our distribution business. Distribution net revenues for the three months ended September 30, 2001 increased 85% from the same period last year, from $22.7 million to $42.0 million, primarily driven by an increase in our distribution console net revenues. Distribution console net revenues for the three months ended September 30, 2001 increased 121% over the same period last year, from $16.1 million to $35.6 million. We are the sole distributor of Sony products in the independent channel in the UK. Accordingly, we have benefited from the launch of the PlayStation 2, as well as from the subsequent price reduction, effective September 28, 2001, on the hardware. Additionally, in fiscal 2002, we began distributing Nintendo products within the UK, including titles for the recently released Game Boy Advance. These items, along with the improved market conditions in Europe, have resulted in the improvements in our distribution business.
For the six months ended September 30, 2001, publishing net revenues remained flat, at $180.5 million as of September 30, 2001, compared to $182.6 as of September 30, 2000. We experienced a 15% increase in publishing console net revenues over the same period last year, from $129.1 million to $148.7 million due to the release of several titles that sold well in the marketplace, including titles for Nintendo's Game Boy Advance hand held device which was released early in June 2001. Such titles included Tony Hawk's Pro Skater 2 for the Game Boy Advance and the Nintendo 64 and Matt Hoffman's Pro BMX and Spiderman: Mysterio's Menace for the PlayStation. This publishing console net revenue increase was offset by a decrease in our publishing PC net revenues. For the six months ended September 30, 2001, publishing PC net revenues decreased 41% over the same period last year, from $53.5 million to $31.8 million. This decrease was primarily attributable to the fact that there were several PC launches in the six months ended September 30, 2000 that performed well in the marketplace, including Vampire: The Masquerade Redemption and Star Trek Voyager: Elite Force. We did not have such PC releases in the six months ended September 30, 2001 as our major holiday PC titles such as Return to Castle Wolfenstein and Star Trek Armada 2 are not being released until the third quarter. Distribution net revenues for the six months ended September 30, 2001 increased 51% from $46.3 million to $69.7 million, primarily driven by an increase in our distribution console net revenues. For the six months ended September 30, 2001, our distribution console net revenues increased 83% from $32.7 million for the six months ended September 30, 2000 to $59.9 million for the six months ended September 30, 2001. As described above, our distribution console net revenues reflect
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the accelerating benefits our distribution business has experienced from the introduction of next generation console systems and hand held devices.
Domestic net revenues decreased 22% for three months ended September 30, 2001, over the same period last year, from $92.3 million to $71.7 million. This decrease is due to the decrease in our publishing net revenues as described above. Domestic net revenues for the six months ended September 30, 2001 remained level with the comparable prior year period.
International net revenues increased 30% and 24% for the three months and six months ended September 30, 2001, respectively, over the same period last year, from $52.1 million to $67.9 million for the three month period and from $90.6 million to $112.2 million for the six month period. These increases are due primarily to the increase in net revenues from our distribution business as described above.
Costs and Expenses
Cost of salesproduct costs represented 63% and 45% of net revenues for the three months ended September 30, 2001 and 2000, respectively. Cost of salesproduct costs represented 61% and 47% of net revenues for the six months ended September 30, 2001 and 2000, respectively. The increase in cost of salesproduct costs as a percentage of net revenues for the three months and six months ended September 30, 2001 was due to the increase in distribution net revenues as a percentage of total net revenues, as well as an increase in console net revenues as a percentage of total net revenues. Distribution net revenues and console net revenues have a higher per unit cost as compared to publishing net revenues and PC net revenues, respectively. Additionally, of console net revenues, the product mix for the three months and six months ended September 30, 2001 reflects a heavier concentration of hand held devices due to the release of Game Boy Advance in June 2001. Hand held devices generally have a higher manufacturing per unit cost than PC's and other console systems.
Cost of salesroyalty and software amortization expense represented 9% and 17% of net revenues for the three months ended September 30, 2001 and 2000, respectively. Cost of salesroyalty and software amortization expense also represented 9% and 17% of net revenues for the six months ended September 30, 2001 and 2000, respectively. The decrease in cost of salesroyalty and software amortization expense as a percentage of net revenues is reflective of the increase in net revenues from hand held devices as a percentage of our total net revenues as hand held devices generally have lower product development costs than PC's or other console systems.
Product development expenses of $9.0 million and $11.1 million represented 7% and 8% of net revenues for the three months ended September 30, 2001 and 2000, respectively. Product development expenses of $18.2 million and $18.5 million represented 7% and 8% of net revenues for the six months ended September 30, 2001 and 2000, respectively. Product development expenses for the three and six months ended September 30, 2001 remained level with the comparable prior year period, reflecting our continued investment in next generation console systems and hand held devices.
Sales and marketing expenses for the three months ended September 30, 2001 and 2000 were $16.4 million, 12% of net revenues, and $23.9 million, 16% of net revenues, respectively. Sales and marketing expenses for the six months ended September 30, 2001 and 2000 were $35.2 million, 14% of net revenues, and $41.8 million, 18% of net revenues, respectively. These decreases reflect our ability to generate savings by building on the existing awareness of our branded products and sequel titles sold during fiscal 2002.
General and administrative expenses remained level with prior year amounts. General and administrative expenses for the three months ended September 30, 2001 and 2000 were $9.7 million, 7% of net revenues, and $10.6 million, 7% of net revenues, respectively. General and administrative
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expenses for the six months ended September 30, 2001 and 2000 were $19.4 million, 8% of net revenues, and $19.1 million, 9% of net revenues, respectively.
Operating Income (Loss)
Operating income for the three months ended September 30, 2001 and 2000 was $3.1 million and $9.5 million, respectively. Operating income for the six months ended September 30, 2001 and 2000 was $1.9 million and $3.0 million, respectively.
The decrease in operating income for the three months ended September 30, 2001 over the same period last year was primarily due to a decrease in publishing operating income from $10.5 million to $2.1 million, slightly offset by an increase in distribution operating income, from an operating loss of ($925,000) to operating income of $1.0 million. The decrease in operating income for the six months ended September 30, 2001 over the same period last year was primarily due to a decrease in publishing operating income, from operating income of $4.6 million to $812,000, partially offset by an increase in the distribution operating income, from an operating loss of ($1.5) million to operating income of $1.1 million. Publishing operating income decreases were primarily the result of a change in our product mix. Our product mix for the three months and six months ended September 30, 2001, reflects a heavier concentration of hand held devices due to the release of Game Boy Advance in June 2001. Hand held devices generally have a higher manufacturing per unit cost than PC's and other console systems. The increases in distribution operating income is reflective of the accelerating benefits our distribution business has experienced from the introduction of next generation console systems and hand held devices as previously described.
Other Income (Expense)
Interest income (expense), net increased to $372,000 and $1.7 million for the three months and six months ended September 30, 2001, respectively, from ($2.7) million and ($4.4) million for the three months and six months ended September 30, 2000, respectively. This change was due to our improved cash position resulting in higher investment income and elimination of borrowings and the conversion and/or redemption of our $60.0 million convertible subordinated notes.
Provision for Income Taxes
The income tax provision of $1.3 million for the three months and six months ended September 30, 2001, reflects our effective income tax rate of approximately 37%. The significant item that generated the variance between our effective rate and our statutory rate of 35% was state taxes. The realization of deferred tax assets primarily is dependent 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.
Liquidity and Capital Resources
Our cash and cash equivalents were $122.2 million at September 30, 2001 compared to $125.6 million at March 31, 2001. This was in comparison to the comparable prior year periods of $25.2 million at September 30, 2000 compared to $50.0 million at March 31, 2000. This change in cash and cash equivalents for the six months ended September 30, 2001, resulted from $15.9 million and $4.3 million utilized in operating and investing activities, respectively, offset by $15.8 million provided by financing activities. Cash used in operating activities was primarily the result of our continued investment in product development and changes in accounts receivable and accounts payable, driven by a seasonal change in working capital needs. Approximately $37.2 million was utilized in connection with the acquisition of publishing or distribution rights to products being developed by third parties, the execution of new license agreements granting us long-term rights to intellectual property of third
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parties, as well as the capitalization of product development costs relating to internally developed products. The cash used in investing activities primarily was the result of capital expenditures. The cash provided by financing activities primarily was the result of proceeds from the issuance of common stock pursuant to employee option and stock purchase plans and common stock warrants, offset by the accelerated repayment of our term loan.
In connection with our purchases of Nintendo 64 and Game Boy hardware and software cartridges for distribution in North America and Europe, Nintendo requires us to provide irrevocable letters of credit prior to accepting purchase orders. Furthermore, Nintendo maintains a policy of not accepting returns of Nintendo 64 and Game Boy hardware and software cartridges. Because of these and other factors, the carrying of an inventory of Nintendo 64 and Game Boy hardware and software cartridges entails significant capital and risk. As of September 30, 2001, we had $2.5 million of Nintendo 64 and $7.0 million of Game Boy hardware and software cartridge inventory on hand, which represented approximately 8% and 20%, respectively, of all inventory.
In December 1997, we completed the private placement of $60.0 million principal amount of 63/4% convertible subordinated notes due 2005 (the "Notes"). During the three months ended June 30, 2001, we called for the redemption of the Notes. In connection with that call, holders converted to common stock approximately $59.9 million aggregate principal amount of their Notes. The remaining Notes were redeemed for cash.
In June 1999, we obtained a $100.0 million revolving credit facility and a $25.0 million term loan with a syndicate of banks (the "U.S. Facility"). The revolving portion of the U.S. Facility provided us with the ability to borrow up to $100.0 million and issue letters of credit up to $80 million on a revolving basis against eligible accounts receivable and inventory. The term loan had a three year term with principal amortization on a straight-line quarterly basis beginning December 31, 1999 and a borrowing rate based on the banks' base rate (which is generally equivalent to the published prime rate) plus 2% or LIBOR plus 3% and was to expire June 2002. The revolving portion of the U.S Facility had a borrowing rate based on the banks' base rate plus 1.75% or LIBOR plus 2.75%. In May 2001, we accelerated our repayment of the outstanding balance under the term loan portion of the U.S. Facility. In connection with the accelerated repayment, we amended the U.S. Facility (the "Amended and Restated U.S. Facility"). The Amended and Restated U.S. Facility eliminated the term loan, reduced the revolver to $78.0 million and reduced the interest rate to the banks' base rate plus 1.25% or LIBOR plus 2.25%. We pay a commitment fee of 1/4% on the unused portion of the revolver. The Amended and Restated U.S. Facility is collateralized by substantially all of our assets and expires June 2002. The Amended and Restated U.S. Facility contains various covenants that limit our ability to incur additional indebtedness, pay dividends or make other distributions, create certain liens, sell assets, or enter into certain mergers or acquisitions. We are also required to maintain specified financial ratios related to net worth and fixed charges. We were in compliance with these covenants as of September 30, 2001. As of September 30, 2001, there were no borrowings outstanding under the Amended and Restated U.S. Facility. Letters of credit of $27.4 million were outstanding against the Amended and Restated U.S. Facility as of September 30, 2001.
We have a revolving credit facility through our CD Contact subsidiary in the Netherlands (the "Netherlands Facility"). The Netherlands Facility permits revolving credit loans and letters of credit up to Netherlands Guilders ("NLG") 10 million ($4.2 million) as of September 30, 2001, based upon eligible accounts receivable and inventory balances. The Netherlands Facility is due on demand, bears interest at a Eurocurrency rate plus 1.50% and expires August 2003. Borrowings outstanding and letters of credit outstanding under the Netherlands Facility were $1.6 million and NLG 0.3 million ($0.1 million), respectively, as of September 30, 2001.
We also have revolving credit facilities with our CentreSoft subsidiary located in the United Kingdom (the "UK Facility") and our NBG subsidiary located in Germany (the "German Facility").
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The UK Facility provides for British Pounds ("GBP") 7.0 million ($10.3 million) of revolving loans and GBP 1.5 million ($2.2 million) of letters of credit as of September 30, 2001. The UK Facility bears interest at LIBOR plus 2%, is collateralized by substantially all of the assets of the subsidiary and expires in October 2002. The UK Facility also contains various covenants that require the subsidiary to maintain specified financial ratios related to, among others, fixed charges. As of September 30, 2001, we were in compliance with these covenants. No borrowings were outstanding against the UK facility as of September 30, 2001. Letters of credit of GBP 1.5 million ($2.2 million) were outstanding against the UK Facility as of September 30, 2001. As of September 30, 2001, the German Facility provides for revolving loans up to Euro dollar ("EUR") 2.6 million ($2.3 million), bears interest at 7.0%, is collateralized by a cash deposit of approximately GBP 650,000 ($1.0 million) made by our CentreSoft subsidiary and has no expiration date. Borrowings outstanding against the German Facility as of September 30, 2001 were $0.6 million.
In the normal course of business, we enter into contractual arrangements with third parties for the development of products. Under these agreements, we commit to provide specified payments to a developer, contingent upon the developer's achievement of contractually specified milestones. Assuming all contractually specified milestones are achieved, the total future minimum contract commitment for contracts in place as of September 30, 2001 is approximately $61.7 million and is scheduled to be distributed as follows (amounts in thousands):
Fiscal year ending March 31, |
|
|||
---|---|---|---|---|
2002 | $ | 23,178 | ||
2003 | 25,314 | |||
2004 | 6,070 | |||
2005 | 2,925 | |||
2006 | 1,675 | |||
Thereafter | 2,500 | |||
Total | $ | 61,662 | ||
We have historically financed our acquisitions through the issuance of shares of common stock. We will continue to evaluate potential acquisition candidates as to the benefit they bring to us and as to our ability to make such acquisitions and maintain compliance with our bank facilities.
On July 30, 2001, we filed with the Securities and Exchange Commission a Registration Statement on Form S-3, as amended, for purposes of registering 6,000,000 shares of our common stock, $.000001 par value (excluding shares registered to cover the underwriters' over-allotment option), in connection with a proposed public offering of such shares. On October 22, 2001, we withdrew the registration statement.
We believe that we have sufficient working capital ($201.8 million at September 30, 2001), as well as proceeds available from the U.S. Facility, the UK Facility, the Netherlands Facility and the German Facility, to finance our operational requirements for at least the next twelve months, including acquisitions 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.
Factors Affecting Future Performance
In connection with the Private Securities Litigation Reform Act of 1995 (the "Litigation Reform Act"), we have disclosed 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
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the Litigation Reform Act. Such statements consist of any statement other than a recitation of historical fact and can be identified by the use of forward-looking terminology such as "may," "expect," "anticipate," "estimate" or "continue" or the negative thereof or other variations thereon or comparable terminology. The listener or reader is cautioned that all forward-looking statements are necessarily speculative and there are numerous risks and uncertainties that could cause actual events or results to differ materially from those referred to in such forward-looking statements. 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 our Annual Report on Form 10-K for the fiscal year ended March 31, 2001 and Registration Statement on Form S-3, Registration No. 333-66280, filed with the Securities and Exchange Commission on July 30, 2001, as amended, which are incorporated herein by reference. The reader or listener is cautioned that we do not have a policy of updating or revising forward-looking statements and thus he or she should not assume that silence by management over time means that actual events are bearing out as estimated in such forward-looking statements.
Recently Issued Accounting Standards
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", was issued on July 20, 2001 and addresses financial accounting and reporting for business combinations. SFAS No. 141 requires that the purchase method be used to account and report for all business combinations. The provisions of this Statement apply to all business combinations initiated after June 30, 2001. This Statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001 or later.
SFAS No. 142 "Goodwill and Other Intangibles", was issued July 20, 2001 and addresses financial accounting and reporting for acquired goodwill and other intangible assets. SFAS No. 142 addresses how intangible assets should be accounted for after they have been initially recognized in the financial statements. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not previously been issued. The Company has adopted the provisions of this Statement effective April 1, 2001.
In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" was issued, which supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and the accounting and reporting provisions of Accounting Principles Board ("APB") No. 30, "Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS No.144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. We believe the adoption of SFAS No. 144 will not have a material impact on our financial statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the potential loss arising from fluctuations in market rates and prices. Our market risk exposures primarily include fluctuations in interest rates and foreign currency exchange rates. Our market risk sensitive instruments are classified as "other than trading." Our exposure to market risk as discussed below includes "forward-looking statements" and represents an estimate of possible changes in fair value or future earnings that would occur assuming hypothetical future movements in interest rates or foreign currency exchange rates. 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 foreign currency exchange rates, interest rates and the timing of transactions.
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Interest Rate Risk
We have had a number of variable rate and fixed rate debt obligations, denominated both in U.S. dollars and various foreign currencies as detailed in Note 10 to the Consolidated Financial Statements appearing elsewhere in this Quarterly Report. We manage interest rate risk by monitoring our ratio of fixed and variable rate debt obligations in view of changing market conditions. Additionally, in the future, we may consider the use of interest rate swap agreements to further manage potential interest rate risk.
During the three months ended June 30, 2001, our holdings of market risk sensitive instruments changed. During that period, we called for the redemption of $60.0 million of the Notes. In connection with that call, holders converted to common stock approximately $59.9 million aggregate principal amount of their Notes. The remaining Notes were redeemed for cash. Additionally, in May 2001, we repaid in full the remaining $8.5 million balance of the term loan portion of the U.S. Facility.
As of September 30, 2001, the carrying value of our variable rate debt was approximately $2.2 million. A hypothetical 1% increase in the applicable interest rates of our variable rate debt would increase annual interest expense by approximately $22,000.
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 GBP. The volatility of GBP (and all other applicable currencies) will be monitored frequently throughout the coming year. While the we have not traditionally engaged in foreign currency hedging, we may in the future use hedging programs, 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.
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Item 1. Legal Proceedings
We are party to routine claims and suits brought against us in the ordinary course of business including disputes arising over the ownership of intellectual property rights and collection matters. In the opinion of management, the outcome of such routine claims will not have a material adverse effect on our business, financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its 2001 Annual Meeting of the Stockholders on August 23, 2001 in Beverly Hills, California. Four items were submitted to a vote of the stockholders: (1) the election of six directors to hold office for one year terms and until their respective successors are duly elected and qualified; (2) the approval of an amendment to our Amended and Restated Certificate of Incorporation, as amended, to increase the number of authorized shares of common stock from 50,000,000 to 125,000,000; (3) the approval of the adoption of the Company's 2001 Incentive Plan; and (4) the approval of the selection of PricewaterhouseCoopers LLP as our independent auditors for the fiscal year ending March 31, 2002.
All six directors were recommended by the Board of Directors and all were elected. Set forth below are the results of the voting for each director.
|
For |
Withheld |
||
---|---|---|---|---|
Kenneth L. Henderson | 27,638,824 | 1,700,902 | ||
Barbara S. Isgur | 28,483,589 | 856,137 | ||
Brian G. Kelly | 23,983,240 | 5,356,486 | ||
Robert A. Kotick | 23,936,038 | 5,403,688 | ||
Steven T. Mayer | 28,456,038 | 883,688 | ||
Robert J. Morgado | 28,488,411 | 851,315 |
The approval of the amendment to our Amended and Restated Certificate of Incorporation, as amended, to increase the number of authorized shares of common stock from 50,000,000 to 125,000,000 was approved. Set forth below are the results of the voting.
For |
Against |
Abstain |
||
---|---|---|---|---|
21,913,885 | 7,419,439 | 6,402 |
The approval of the adoption of the Company's 2001 Incentive Plan was approved. Set forth below are the results of the voting.
For |
Against |
Abstain |
||
---|---|---|---|---|
15,334,756 | 13,887,654 | 117,316 |
The approval of the selection of PricewaterhouseCoopers LLP as the Company's independent auditors for the fiscal year ending March 31, 2002 was approved. Set forth below are the results of the voting.
For |
Against |
Abstain |
||
---|---|---|---|---|
29,169,975 | 165,358 | 4,393 |
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Item 6. Exhibits and Reports on Form 8-K
3.1 | Our Amended and Restated Certificate of Incorporation, dated June 1, 2000 (incorporated by reference to Exhibit 2.5 of our Current Report on Form 8-K, filed on June 16, 2000). | |
3.2 | Our certificate of Amendment of Amended and Restated Certificate of Incorporation, dated June 9, 2000 (incorporated by reference to Exhibit 2.7 of our Current Report on Form 8-K, filed on June 16, 2000). | |
3.3 | Our Certificate of Amendment of Amended and Restated Certificate of Incorporation, dated August 23, 2001 (incorporated by reference to Exhibit 3.3 of our Registration Statement on Form S-3, Registration No. 333-66280, filed on July 30, 2001). | |
3.4 | Our Amended and Restated By-laws dated August 1, 2000 (incorporated by reference to our Current Report on Form 8-K, filed July 11, 2001). | |
4.1 | Rights Agreement dated as of April 18, 2000, between us 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 the Company as Exhibit C (incorporated by reference to our Registration Statement on Form 8-A, Registration No. 001-15839, filed April 19, 2000). | |
10.1 | Our 2001 Incentive Plan adopted on July 11, 2001 (incorporated by reference to our Proxy Statement on Schedule 14A for the 2001 Annual Meeting of Stockholders filed on July 30, 2001). | |
10.2 | Our 2001 Incentive Plan as amended through October 17, 2001. | |
10.3 | Our 1999 Incentive Plan as amended through October 17, 2001. | |
10.4 | Our 1998 Incentive Plan as amended through October 17, 2001. | |
10.5 | Our 1991 Stock Option and Stock Award Plan as amended through October 17, 2001. |
1.1 | We have filed a Form 8-K on October 4, 2001, reporting under "Item 5. Other Events" the acquisition of Treyarch Inventions LLC, under "Item 7. Financial Statements, Pro Forma Financial Statements and Exhibits" and under "Item 9. Regulation FD Disclosure" the postponement of our proposed common stock offering. | |
1.2 | We have filed a Form 8-K on July 31, 2001, reporting under "Item 7. Financial Statements, Pro Forma Financial Statements and Exhibits" and "Item 9. Regulation FD Disclosure", reaffirming our Fiscal 2002 and 2003 earnings guidance. | |
1.3 | We have filed a Form 8-K on July 11, 2001, reporting under "Item 5. Other Events" and "Items 7. Financial Statements, Pro Forma Financial Statements and Exhibits" the adoption by the Board of Directors of certain amendments to our by-laws and the execution of new employment agreements with Kathy Vrabeck and Lawrence Goldberg. |
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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 12, 2001
ACTIVISION, INC.
/s/ WILLIAM J. CHARDAVOYNE William J. Chardavoyne Chief Financial Officer and Chief Accounting Officer |
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