SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

For the transition period fromto

Commission File Number 0-12699

ACTIVISION, INC.
(Exact name of registrant as specified in its charter)

(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 ý  No o

        The number of shares of the registrant's Common Stock outstanding as of August 2,October 23, 2002 was 66,730,202.67,079,857.

ACTIVISION, INC. AND SUBSIDIARIES

INDEX

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Part I.Financial Information.

Item 1. Financial Statements.

ACTIVISION, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

The accompanying notes are an integral part of these consolidated financial statements.

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ACTIVISION, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

The accompanying notes are an integral part of these consolidated financial statements.

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ACTIVISION, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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ACTIVISION, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY

For the threesix months ended JuneSeptember 30, 2002

(Unaudited)

(In thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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ACTIVISION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

For the three and six months ended JuneSeptember 30, 2002

1.    Basis of Presentation

        The accompanying consolidated financial statements include the accounts of Activision, Inc. and its subsidiaries ("Activision" or "we"). The information furnished is unaudited and 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 consolidated financial statements should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the year ended March 31, 2002 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.    Stock Split

        In October 2001, the Board of Directors approved a three-for-two stock split effected in the form of a 50% stock dividend. The stock split was paid at the close of business on November 20, 2001, to shareholders of record as of November 6, 2001. The consolidated financial statements, including all share and per share data, have been restated as if the stock split had occurred as of the earliest period presented.

3.    Acquisition

        Effective May 20, 2002, we acquired all of the outstanding ownership interests of Z-Axis Ltd. ("Z-Axis"), a privately held interactive software development company, in exchange for $12.5 million in cash and 249,190 shares of our common stock valued at approximately $8.2 million. Z-Axis is a console software developer with a focus on action sports video games. This acquisition further enables us to implement our multi-platform development strategy by augmenting our internal product development capabilities for console systems and enhances our position in the action sports genre. The purchase price of the transaction, including acquisition costs, was valued at approximately $20.9 million and has been allocated to assets acquired and liabilities assumed as follows (amounts in thousands):

        Goodwill has been included in the publishing segment of our business and is non-deductible for tax purposes. A significant portion of the purchase price for this acquisition was assigned to goodwill as the primary asset we acquired in the transaction was an assembled workforce with proven technical and design talent with a history of high quality product creation. The results of operations of Z-Axis are included in our consolidated statement of operations beginning May 20, 2002. Pro forma consolidated statements of operations are not shown, as they would not differ materially from reported results.

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        Approximately 93,000 additional shares of our common stock also may be issued to Z-Axis' equity holders over the course of several years, depending on the satisfaction of certain product performance requirements and other criteria. This contingent consideration will be recorded as an additional element of the purchase price for Z-Axis when those contingencies are resolved.

74.    Short-term Investments

        Short-term investments generally mature between three months and two years. Investments with maturities beyond one year may be classified as short-term based on their liquid nature and because such securities represent the investment of cash that is available for current operations. All of our short-term investments are classified as available-for-sale and are carried at fair market value with unrealized appreciation (depreciation) reported as a separate component of accumulated other comprehensive loss in shareholders' equity.

        The following table summarizes our investments in securities as of September 30, 2002 (amounts in thousands):

        The following table summarizes the maturities of our investments in debt securities as of September 30, 2002 (amounts in thousands):

        The specific identification method is used to determine the cost of securities disposed with realized gains and losses reflected in investment income, net. For the three and six months ended September 30,

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2002, net realized losses on short-term investments consisted of $2,000 of gross realized gains and $60,000 of gross realized losses.

4.    5.    Inventories

        Inventories are valued at the lower of cost (first-in, first-out) or market. Our inventories consist of the following (amounts in thousands):

5.    6.    Goodwill and Other Intangible Assets

Goodwill

        The changes in the carrying amount of goodwill for the threesix months ended JuneSeptember 30, 2002 are as follows (amounts in thousands):

        In July 2002, we issued 101,635 of our common shares with an assigned value of $2.7 million in conjunction with the resolution of certain contingencies relating to a prior acquisition.

Acquired Intangible Assets

        As of JuneAcquired intangible assets are as follows (amounts in thousands):

        Acquired intangible assets are included in the consolidated balance sheets in other current assets. For the three and six months ended September 30, 2002, grossaggregate amortization expense related to acquired intangible assets were $2.2 millionwas $113,400. There was no such amortization for the three and were the result of the acquisition of software development and royalty agreements. Such assets had yet to be amortized as of Junesix months ended September 30, 2002 as the related titles had not been released and/or no revenues had been earned on such titles.2001. All gross acquired intangible assets as of JuneSeptember 30, 2002 are expected to be expensed during the year ended March 31, 2003.

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6.    7.    Income Taxes

        The income tax provision of $11.7$5.1 million and $16.8 million for the three and six months ended JuneSeptember 30, 2002, respectively, reflects our effective income tax rate of approximately 36%. The income tax provision of $17,000$1.3 million for the three and six months ended JuneSeptember 30, 2001 reflects our effective income tax rate of approximately 37%. For both periods, the significant item that generated the variance between our effective rate and our statutory rate of 35% was state taxes, partially offset by research and development tax credits.

7.    8.    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 Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." Software development costs are capitalized once technological feasibility of a product is established and such costs are determined to be recoverable. 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.

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        We evaluate the future recoverability of capitalized amounts on a quarterly basis. The following criteria are 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, 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.

        Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks or copyrights in the development of our products.

        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 used. The following criteria are used to evaluate expected product performance: 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.

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        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 trademark or copyright 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 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 JuneSeptember 30, 2002, capitalized software development costs included $18.3$24.2 million of internally developed software costs and $32.1 million of payments made to independent software developers. As of March 31, 2002, capitalized software development costs included $16.0 million of internally developed software costs and $23.5 million of payments made to independent software developers. Capitalized intellectual property licenses were $21.0$44.5 million and $17.2 million as of JuneSeptember 30, 2002 and March 31, 2002, respectively. In July 2002, we extended our partnership with professional skateboarder, Tony Hawk, through an exclusive multi-year licensing agreement that expires in 2015. Amortization of capitalized software development costs and intellectual property licenses, combined, was $18.5$34.7 million and $6.4$17.5 million for the threesix months ended JuneSeptember 30, 2002 and 2001, respectively.

8.    9.    Accumulated Other Comprehensive Income (Loss)

        For the threesix months ended JuneSeptember 30, 2002, the accumulated other comprehensive loss balance primarily consisted of $5.3 million of foreign currency translation adjustments.adjustments and $0.1 million of unrealized depreciation on short-term investments.

9.    10.    Revenue Recognition

        We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers. We may permit product returns from or grant price protection to our customers on unsold merchandise under certain conditions. Price protection policies, when granted and applicable, allow customers a credit against amounts they owe us with respect to merchandise unsold by them. With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery of such copies. Per copy royalties on sales that exceed the guarantee are recognized as earned. In addition, in order to recognize

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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 from product sales is reflected after deducting the estimated allowance for returns and price protection. 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 based upon historical experience, customer inventory levels current economic trends and changes in the demand and acceptance of our products by the end consumer.

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10.  Interest11.    Investment Income, Net

        InterestInvestment income, net is comprised of the following (amounts in thousands):

11.  12.    Supplemental Cash Flow Information

        Non-cash investing and financing activities and supplemental cash flow information is as follows (amounts in thousands):

12.  13.    Operations by Reportable Segments and Geographic Area

        Based upon our organizational structure, we operate two business segments: (i) publishing of interactive entertainment software and (ii) distribution of interactive entertainment software and hardware products.

        Publishing refers to the development, marketing and sale of products, either directly, by license or through our affiliate label program with third party publishers. In the United States, our products are sold primarily on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses and office super-stores. We conduct our international publishing activities through offices in the United Kingdom, Germany, France, Australia, Sweden, Canada and Japan. Our products are sold internationally on a direct to retail basis, through third party distribution and licensing arrangements and through our wholly-owned European distribution subsidiaries.

        Distribution refers to our European operations located in the United Kingdom, the Netherlands and Germany that provide logistical and sales services to third party publishers of interactive

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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, 2002. Revenue derived from sales between segments is eliminated in consolidation.

        Information on the reportable segments for the three and six months ended JuneSeptember 30, 2002 and 2001 is as follows (amounts in thousands):

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        Geographic information for the three and six months ended JuneSeptember 30, 2002 and 2001 is based on the location of the selling entity. Revenues from external customers by geographic region were as follows (amounts in thousands):

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        Revenues by platform were as follows (amounts in thousands):

        As of and for the three and six months ended JuneSeptember 30, 2002, we had one customer that accounted for 17%15% and 16%, respectively, of our consolidated net revenues and 27% of our consolidated accounts receivable, net. As of and for the three and six months ended JuneSeptember 30, 2001, we had one customer that same customer accounted for 15%13% and 14%, respectively, of our consolidated net revenues and 22%18% of our consolidated accounts receivable, net. This customer was the same customer in all periods and was a customer of both our publishing and distribution businesses.

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13.  

14.    Computation of Earnings Per Share

        The following table sets forth the computations of basic and diluted earnings per share (amounts in thousands, except per share data):

        Options to purchase 15,3532,155,223 shares of common stock at exercise prices ranging from $28.34$26.34 to $33.24 and options to purchase 7,920160,588 shares of common stock at exercise prices ranging from $19.66$28.17 to $33.24 were outstanding for the three and six months ended September 30, 2002, respectively, but were not included in the calculation of diluted earnings per share because their effect would be antidilutive.

        Options to purchase 84,075 shares of common stock at exercise prices ranging from $21.80 to $25.27 and options to purchase 57,218 shares of common stock at exercise prices ranging from $20.70 to $25.27 were outstanding for the three and six months ended JuneSeptember 30, 2002 and 2001, respectively, but were not included in the calculation of diluted earnings per share because their effect would be antidilutive.

14.  15.    Commitments

Bank Lines of Credit Facilities and Other

        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, including issuing letters of credit up to $80 million, on a

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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, 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.SU.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

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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 of¹/4% on the unused portion of the revolver. The Amended and Restated U.S. Facility iswas collateralized by substantially all of our assets and was scheduled to expireexpired in June 2002. However, in June 2002, we obtained an extension of the expiration date to August 21, 2002. Due to our improved financial position, including significant cash, cash equivalent and short-term investment balances and minimal debt, we willdid not seek additional bank financing upon the expiration of the Amended and Restated U.S. Facility.

        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. As of June 30, 2002, we were in compliance with these covenants. As of June 30, 2002, there were no borrowings outstanding and $1.8 million of letters of credit outstanding against the revolving portion of the Amended and Restated U.S. Facility.

        We have a revolving credit facility through our CD Contact subsidiary in the Netherlands (the "Netherlands Facility"). The Netherlands Facility permitted revolving credit loans and letters of credit up to Euro ("EUR") 4.52.5 million ($4.52.5 million) as of JuneSeptember 30, 2002, based upon eligible accounts receivable and inventory balances. The Netherlands Facility is due on demand, bears interest at a Eurocurrency rate plus 1.5%1.25%, is collateralized by the subsidiary's accounts receivable and inventory and a British Pounds ("GBP") 1.5EUR 0.5 million ($2.30.5 million) guarantee made by our Centresoft subsidiary through its bank facility and expires August 2003. As of JuneSeptember 30, 2002, there was $962,000 ofwere no borrowings and noor letters of credit outstanding under the Netherlands Facility.

        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"). As of JuneSeptember 30, 2002, the UK Facility provided Centresoft with the ability to borrow up to GBPBritish Pounds ("GBP") 7.0 million ($10.710.9 million), including issuing letters of credit, on a revolving basis. Furthermore, as of JuneSeptember 30, 2002, under the UK Facility, Centresoft has provided a GBP 1.5EUR 0.5 million ($2.30.5 million) guarantee which servesserved as collateral for the Netherlands Facility. The UK Facility bears interest at LIBOR plus 2%, is collateralized by substantially all of the assets of the subsidiary and expires in October 2002.2003. The UK Facility also contains various covenants that require the subsidiary to maintain specified financial ratios related to, among others, fixed charges. As of JuneSeptember 30, 2002, we were in compliance with these covenants. No borrowings were outstanding against the UK Facility at JuneSeptember 30, 2002. The German Facility provided for revolving loans up to EUR 2.0 million ($2.0 million) as of JuneSeptember 30, 2002, bears interest at a Eurocurrency rate plus 2.5%, is collateralized by the subsidiary's accounts receivable and inventory and a cash deposit of approximately GBP 732,0000.7 ($1.1 million) made by our CentreSoft subsidiary and has no expiration date. No borrowings were outstanding against the German Facility as of JuneSeptember 30, 2002.

        In connection with our purchases of Nintendo 64, Nintendo GameCube and Game Boy software for distribution in North America and Europe, Nintendo requires us to either provide standby letters of credit or cash prepayment prior to accepting purchase orders.

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 at a conversion price of $12.583 per share, subject to adjustment     in certain circumstances. During the three months ended June 30, 2001, we called

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for the redemption of the Notes. In connection with that call, holders converted to common stock approximately $58.7 million aggregate principal amount of their Notes, net of conversion costs. The remaining Notes were redeemed for cash.

Software Developer and Intellectual Property License Contracts

        In the normal course of business, we enter into contractual arrangements with third parties for the development of products, as well as for the rights to intellectual property ("IP"). Under these agreements, we commit to provide specified payments to a developer or IP holder, based upon contractual arrangements. Assuming all contractual provisions are met, the total future minimum

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contract commitment for contracts in place as of JuneSeptember 30, 2002 is approximately $74.9$99.4 million and is scheduled to be paid as follows (amounts in thousands):

Legal Proceedings

        We are party to routine claims and suits brought by us and against us in the ordinary course of business, including disputes arising over the ownership of intellectual property rights, contractual claims and collection matters. In the opinion of management, the outcome of such routine claims will not have a material adverse effect on our business, financial condition, results of operations or liquidity.

15.  16.    Related Parties

        As of June 30, 2002, we had a $419,000 loan, including accrued interest, due from an executive which bore interest at 6.75%. The loan has subsequently been repaid.

        In August 2001, we elected to our Board of Directors an individual who is a partner in a law firm that has provided legal services to Activision for more than ten years. We paid approximately $325,000$140,000 and $643,000 during the three and six months ended JuneSeptember 30, 2002, respectively, for legal services rendered by the law firm.

16.  17.    Recently Issued Accounting Standards

        In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue ("EITF") No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be initially measured at fair value and recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of the Company's commitment to an exit plan. The provisions of SFAS No. 146 are required to be applied prospectively to exit or disposal activities initiated after December 31, 2002.

1418.    Subsequent Events

        Further enhancing our internal console development capabilities, effective October 4, 2002, we acquired all of the outstanding ownership interests of Luxoflux Corporation ("Luxoflux"), a privately held interactive software development company, in exchange for $9.0 million in cash and 110,391 shares of our common stock. The common stock is deliverable upon the satisfaction of certain future product performance requirements and other criteria.

        On October 4, 2002, our Board of Directors authorized a buyback program under which we can repurchase up to $150 million of our common stock. Under the program, shares may be purchased as determined by management from time to time in the open market or in privately negotiated transactions, including privately negotiated structured option transactions, and through transactions in the options markets. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time-to-time without prior notice.

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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. We have created, licensed and acquired a group of highly recognizable brands which we market to a growing variety of consumer demographics.

        Our products cover the action/adventure, action sports, racing, role-playing, simulation, first-person shootersaction and strategy game categories. Historically, we have offeredWe offer our products in versions that operate on the Sony PlayStation ("PS1"), Sony PlayStation 2 ("PS2"), Nintendo 64 ("N64"), Nintendo GameCube ("GameCube") and Microsoft Xbox ("Xbox") console systems, Nintendo Game Boy Advance ("GBA") and Game Boy Color ("GBC") handheld devices,hand-held device, as well as on personal computers ("PC").

        Our publishing business involves 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 mass-market retailers, consumer electronics stores, discount warehouses and office super-stores. We conduct our international publishing activities through offices in the United Kingdom, Germany, France, Australia, Sweden, Canada and Japan. Our products are sold internationally on a direct to retail basis, through third party distribution and licensing arrangements and through our wholly-owned European distribution subsidiaries. In addition to publishing, we maintain distribution operations located 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.

        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.

        In July 2002, we extended our partnership with professional skate-boarder,skateboarder, Tony Hawk, through an exclusive multi-year licensing agreement that expires in 2015. The continuation of our long-term relationship with Tony Hawk is part of our strategy to continue to be a leader in the action sports category. Activision O₂, our action sports umbrella brand, has featured such franchises asTony Hawk's Pro Skater,Mat Hoffman's Pro BMX andShaun Palmer's Pro Snowboarder.    This quarter, in the action sports category, we releasedStreet Hoops,Mat Hoffman's Pro BMX 2 andKelly Slater's Pro Surfer. We will continue to promote our action sports franchises throughout fiscal 2003 with the expected release of several titles for existing franchises, includingTony Hawk's Pro Skater 4 andMat Hoffman's Pro BMX 2, which was released across multiple platforms on October 23, 2002, as well as several new action sports titles, includingKelly Slater's Pro Surfer andShaun Murray's Pro Wakeboarder. which is expected to be released in the fourth quarter of fiscal 2003. We also plan to continue to focus on our super hero brands.Spider-Man: The Movie was a key release for the first quarter of fiscal 2003. AdditionalThis quarter, under our super hero titlesbrands, we releasedBlade 2. More recently, on October 22, 2002, we releasedX-Men: Next Dimension. We have also recently exercised an option to develop and publish the game based on the movie sequel to the successful feature film, "Spider-Man" which is expected to be released in fiscal 2003 includeBlade II andX-Men Next Dimension.the spring of 2004. Additionally, we will continue to focus on our other key brands. We will also continue to evaluate emerging brands that we believe have potential for growth. A significant number of our fiscal 2003 releases will be cross-platform releases, as we believe this provides us with many benefits with regards to sales and consumer awareness, as well as savings in our cost structures.structure savings. We believe fiscal 2003 will be a strong growth year for our industry as the installed hardware bases for PS2, GameCube Xbox and GBAXbox continue to increase, and as technological advances are made, enabling the interactive entertainment industry to continue to reach a broader audience.

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Critical Accounting Policies

        We have identified the policies below as critical to our business operations and the understanding of our financial results. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and

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Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 to the Notes to the Consolidated Financial Statements in Item 8 of our Annual Report on Form 10-K for the year ended March 31, 2002 as filed with the Securities and Exchange Commission. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

        Revenue Recognition.    We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers. Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection. We may permit product returns from or grant price protection to our customers on unsold merchandise under certain conditions. Price protection policies, when granted and applicable, allow customers a credit against amounts they owe us with respect to merchandise unsold by them. With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery of such copies. Per copy royalties on sales that exceed the guarantee are recognized as earned. In addition, in order to recognize revenue for both product sales and licensing transactions, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable. Revenue recognition also determines the timing of certain expenses, including cost of sales—intellectual property licenses and cost of sales—software royalties and amortization.

        Allowances for Returns, Price Protection, Doubtful Accounts and Inventory Obsolescence.    We may permit product returns from or grant price protection to our customers under certain conditions.    The conditions our customers must meet to be granted the right to return products or price protection are, among other things, compliance with applicable payment terms, delivery to us of weekly inventory and sell-through reports, and consistent participation in the launches of our premium title releases. We may also consider other factors, including the facilitation of slow moving inventory and other market factors. 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 based upon historical experience, customer inventory levels current economic trends and changes in the demand and acceptance of our products by the end consumer. 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. Material differences may result in the amount and timing of our revenue for any period if management made different judgments or utilized different estimates.

        Similarly, management must make estimates of the uncollectibility of our accounts receivable. In estimating allowance for doubtful accounts, we analyze historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in our customers' payment terms and their economic condition, as well as whether we can obtain sufficient credit insurance. Any significant changes in any of these criteria would impact 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.

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        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 Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or

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Otherwise Marketed." Software development costs are capitalized once technological feasibility of a product 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 are 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, 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 judgment 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.

        Intellectual Property Licenses.    Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks or copyrights in the development of our products.

        We evaluate the future recoverability of capitalized amounts 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 used. The following criteria are used to evaluate expected product performance: 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 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 trademark or copyright 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 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 judgment and estimates are utilized in the assessment of the recoverability of capitalized costs.

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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 and platform, as well as operating income (loss) by business segment (amounts in thousands):