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
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-12699
ACTIVISION, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4803544
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3100 OCEAN PARK BOULEVARD, SANTA MONICA, CA 90405
(Address of principal executive offices) (Zip Code)
(310) 255-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or 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 February
9, 2001 was $26,282,864 .
ACTIVISION, INC. AND SUBSIDIARIES
INDEX
PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 2000 (Unaudited) and
March 31, 2000 3
Consolidated Statements of Operations for the three and nine months
ended December 31, 2000 and 1999 (Unaudited) 4
Consolidated Statements of Cash Flows for the nine months
ended December 31, 2000 and 1999 (Unaudited) 5
Consolidated Statement of Changes in Shareholders' Equity
for the nine months ended December 31, 2000 (Unaudited) 6
Notes to Consolidated Financial Statements for the three and nine months
ended December 31, 2000 (Unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
2
PART I. FINANCIAL INFORMATION.
Item 1. Financial Statements.
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
December 31, March 31,
2000 2000
------------ ----------
ASSETS
Current assets:
Cash and cash equivalents $ 52,348 $ 49,985
Accounts receivable, net of allowances of $44,751 and
$31,521 at December 31, 2000 and March 31, 2000, respectively 166,871 108,108
Inventories 49,772 40,453
Prepaid royalties and capitalized software costs 21,224 31,655
Deferred income taxes 21,870 14,159
Other current assets 16,309 17,815
---------- ----------
Total current assets 328,394 262,175
Prepaid royalties and capitalized software costs 11,060 9,153
Property and equipment, net 15,053 10,815
Deferred income taxes 3,748 6,055
Goodwill, net 10,892 12,347
Other assets 8,268 9,192
---------- ----------
Total assets $ 377,415 $ 309,737
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 11,390 $ 16,260
Accounts payable 80,560 38,284
Accrued expenses 73,929 49,404
---------- ----------
Total current liabilities 165,879 103,948
Long-term debt, less current portion 5,722 13,778
Convertible subordinated notes 60,000 60,000
Other liabilities 2 2
---------- ----------
Total liabilities 231,603 177,728
---------- ----------
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.000001 par value, 5,000,000 shares
authorized, no shares issued at December 31, 2000
and March 31, 2000 - -
Common stock, $.000001 par value, 50,000,000 shares authorized,
27,555,492 and 26,488,260 shares issued and 24,671,513 and
25,988,260 shares outstanding at December 31, 2000 and
March 31, 2000, respectively - -
Additional paid-in capital 163,017 151,714
Retained earnings (deficit) 11,271 (8,361)
Accumulated other comprehensive loss (8,227) (6,066)
Less: Treasury stock, at cost, 2,883,979 shares
and 500,000 shares at December 31, 2000 and March 31,
2000, respectively (20,249) (5,278)
---------- ----------
Total shareholders' equity 145,812 132,009
---------- ----------
Total liabilities and shareholders' equity $ 377,415 $ 309,737
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
3
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
For the three months ended For the nine months ended
December 31, December 31,
--------------------------------- ---------------------------------
2000 1999 2000 1999
--------------- ---------------- --------------- ----------------
Net revenues $ 264,473 $ 268,862 $ 493,393 $ 468,367
Costs and expenses:
Cost of sales - product costs 139,430 139,357 247,414 259,180
Cost of sales - royalties and software
amortization 39,364 39,733 77,829 61,213
Product development 11,779 6,235 30,311 16,576
Sales and marketing 26,725 33,947 68,505 67,392
General and administrative 12,421 11,349 31,542 28,340
----------- ---------- --------- ---------
Total costs and expenses 229,719 230,621 455,601 432,701
----------- ---------- --------- ---------
Income from operations 34,754 38,241 37,792 35,666
Interest expense, net (2,225) (2,835) (6,631) (5,833)
----------- ---------- --------- ---------
Income before income tax provision 32,529 35,406 31,161 29,833
Income tax provision 12,024 13,105 11,529 11,043
----------- ---------- --------- ---------
Net income $ 20,505 $ 22,301 $ 19,632 $ 18,790
=========== ========== ========= =========
Basic earnings per share $ 0.84 $ 0.89 $ 0.80 $ 0.77
=========== ========== ========= =========
Weighted average common shares
outstanding 24,443 25,075 24,407 24,367
=========== ========== ========= =========
Diluted earnings per share $ 0.70 $ 0.75 $ 0.75 $ 0.71
=========== ========== ========= =========
Weighted average common shares
outstanding - assuming dilution 30,372 30,483 28,883 29,431
=========== ========== ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
4
ACTIVISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
For the nine months ended December 31,
---------------------------------------
2000 1999
------------------ -------------------
Cash flows from operating activities: $ 19,632 $ 18,790
Net income
Adjustments to reconcile net income to net cash provided
by operating activities:
Deferred income taxes (5,190) 12,130
Depreciation and amortization 4,502 6,400
Amortization of prepaid royalties and capitalized
software costs 63,397 49,546
Expense related to common stock warrants 1,055 966
Tax benefit from exercise of stock options 2,295 2,686
Change in assets and liabilities (net of effects of
purchases and acquisitions):
Accounts receivable (58,763) (97,299)
Inventories (9,319) (8,761)
Other current assets 1,506 (8,207)
Other assets (131) (1,013)
Accounts payable 38,363 39,790
Accrued expenses 24,799 19,793
Other liabilities (1) (4)
------------ ------------
Net cash provided by operating activities 82,145 34,817
------------ ------------
Cash flows from investing activities:
Cash used in purchase acquisitions (net of cash acquired) - (20,523)
Investment in prepaid royalties and capitalized software costs (50,960) (54,931)
Capital expenditures (8,835) (2,520)
Proceeds from disposal of property and equipment 1,394 -
------------ ------------
Net cash used in investing activities (58,401) (77,974)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common stock pursuant to
employee stock option plans 8,148 14,916
Proceeds from issuance of common stock pursuant to
employee stock purchase plan 327 419
Borrowing under line-of-credit agreements 361,282 202,956
Payment under line-of-credit agreements (364,340) (171,463)
Proceeds from term loan - 25,000
Payment on term loan (9,300) -
Other notes payable, net (368) (5,449)
Cash paid to acquire line of credit and term loan - (3,355)
Purchase of treasury stock (14,971) -
------------ ------------
Net cash provided by (used in) financing activities (19,222) 63,024
------------ ------------
Effect of exchange rate changes on cash (2,159) (1,170)
------------ ------------
Net increase in cash and cash equivalents 2,363 18,697
Cash and cash equivalents at beginning of period 49,985 33,037
------------ ------------
Cash and cash equivalents at end of period $ 52,348 $ 51,734
============ ============
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 nine months ended December 31, 2000
(Unaudited)
(In thousands)
Common Stock Additional Retained
------------------- Paid-In Earnings
Shares Amount Capital (Deficit)
- ------------------------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2000 26,488 $ - $ 151,714 $ (8,361)
Components of comprehensive income:
Net income - - - 19,632
Foreign currency translation adjustment - - - -
Total comprehensive income
Acquisition of treasury stock - - - -
Issuance of common stock pursuant to employee stock
purchase plan 35 - 327 -
Issuance of common stock pursuant to employee stock
option plans 1,032 - 8,148 -
Tax benefit attributable to employee stock option plans - - 2,295 -
Tax benefit derived from net operating loss carryforward
utilization - - 533 -
-------------------------------------------------------
BALANCE, DECEMBER 31, 2000 27,555 $ - $ 163,017 $ 11,271
=======================================================
Accumulated
Treasury Stock Other
------------------- Comprehensive Shareholders'
Shares Amount Income Equity
(Loss)
- ----------------------------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2000 (500) $ (5,278) $ (6,066) $ 132,009
Components of comprehensive income:
Net income - - - 19,632
Foreign currency translation adjustment - - (2,161) (2,161)
----------
Total comprehensive income 17,471
----------
Acquisition of treasury stock (2,384) (14,971) - (14,971)
Issuance of common stock pursuant to employee stock
purchase plan - - - 327
Issuance of common stock pursuant to employee stock
option plans - - - 8,148
Tax benefit attributable to employee stock option plans - - - 2,295
Tax benefit derived from net operating loss carryforward
utilization - - - 533
-------------------------------------------------------
BALANCE, DECEMBER 31, 2000 (2,884) $ (20,249) $ (8,227) $ 145,812
=======================================================
The accompanying notes are an integral part of these consolidated financial
statements.
6
ACTIVISION, INC. AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
For the three months and nine months ended December 31, 2000
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Activision, Inc. (together with its subsidiaries, "Activision" or the
"Company"). 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 the Company's Annual Report on Form 10-K for the
year ended March 31, 2000 as filed with the Securities and Exchange
Commission (the "SEC").
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 net income,
shareholders' equity or cash flows.
2. ORGANIZATIONAL STRUCTURE
Effective June 9, 2000, Activision reorganized into a holding company form
of organizational structure, whereby Activision Holdings, Inc., a Delaware
corporation ("Activision Holdings"), became the holding company for
Activision and its subsidiaries. The new holding company organizational
structure will allow Activision to manage its entire organization more
effectively and broadens the alternatives for future financings.
The holding company organizational structure was effected by a merger
conducted pursuant to Section 251(g) of the General Corporation Law of the
State of Delaware, which provides for the formation of a holding company
structure without a vote of the stockholders of the constituent
corporations. In the merger, ATVI Merger Sub, Inc., a Delaware corporation,
organized for the purpose of implementing the holding company
organizational structure (the "Merger Sub"), merged with and into
Activision with Activision as the surviving corporation (the "Surviving
Corporation"). Prior to the merger, Activision Holdings was a direct,
wholly-owned subsidiary of Activision and Merger Sub was a direct, wholly
owned subsidiary of Activision Holdings. Pursuant to the merger, (i) each
issued and outstanding share of common stock of Activision (including
treasury shares) was converted into one share of common stock of Activision
Holdings, (ii) each issued and outstanding share of Merger Sub was
converted into one share of the Surviving Corporation's common stock, and
Merger Sub's corporate existence ceased, and (iii) all of the issued and
outstanding shares of Activision Holdings owned by Activision were
automatically canceled and retired. As a result of the merger, Activision
became a direct, wholly owned subsidiary of Activision Holdings.
Immediately following the merger, Activision changed its name to
"Activision Publishing, Inc." and Activision Holdings changed its name to
"Activision, Inc." The holding company's common stock will continue to
trade on The Nasdaq National Market under the symbol ATVI.
The conversion of shares of Activision's common stock in the merger
occurred without an exchange of certificates. Accordingly, certificates
formerly representing shares of outstanding common stock of Activision are
deemed to represent the same number of shares of common stock of Activision
Holdings. The change to the holding company structure was tax free for
federal income tax purposes for stockholders.
These transactions had no impact on the Company's consolidated financial
statements.
3. PREPAID ROYALTIES AND CAPITALIZED SOFTWARE COSTS
Prepaid royalties include payments made to independent software developers
under development agreements and license fees paid to intellectual property
rights holders for use of their trademarks or copyrights. Intellectual
property rights, which have alternative future uses, are capitalized.
Capitalized software costs represent costs incurred for development that
are not recoupable against future royalties.
The Company accounts for prepaid royalties relating to development
agreements and capitalized software costs in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased, or Otherwise Marketed." Software
development costs and prepaid royalties are capitalized once technological
feasibility is established. Technological feasibility is evaluated on a
product-by-product basis. Software development costs are expensed if and
when they are deemed
7
unrecoverable. Amounts related to software development, which are not
capitalized, are charged immediately to product development expense.
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 the
Company's budgeted amount.
Commencing upon product release, capitalized software development costs are
amortized to cost of sales - royalties and software amortization on a
straight-line basis over the estimated product life (generally one year or
less) or on the ratio of current revenues to total projected revenues,
whichever amortization amount is greater. Prepaid royalties are amortized
to cost of sales - royalties and software amortization commencing upon the
product release at the contractual royalty rate based on actual net product
sales or on the ratio of current revenues to total projected revenues,
whichever amortization amount is greater. For products that have been
released, management evaluates the future recoverability of capitalized
amounts on a quarterly basis.
As of December 31, 2000, prepaid royalties and unamortized capitalized
software costs totaled $30.7 million (including $11.1 million classified as
non-current) and $1.6 million, respectively. As of March 31, 2000, prepaid
royalties and unamortized capitalized software costs totaled $29.2 million
(including $9.2 million classified as non-current) and $11.6 million,
respectively.
4. REVENUE RECOGNITION
Product Sales: The Company recognizes revenue from the sale of its products
upon shipment. Subject to certain limitations, the Company permits
customers to obtain exchanges or return products within certain specified
periods and provides price protection on certain unsold merchandise.
Management of the Company estimates the amount of future returns and price
protections based upon historical results and current known circumstances.
Revenue from product sales is reflected net of the allowance for returns
and price protection.
Software Licenses: For those license agreements that provide the customers
the right to multiple copies in exchange for guaranteed amounts, revenue is
recognized at delivery. Per copy royalties on sales which exceed the
guarantee are recognized as earned.
5. INTEREST EXPENSE, NET
Interest expense, net is comprised of the following (amounts in thousands):
Three months ended December 31, Nine months ended December 31,
------------------------------------------- ---------------------------------------
2000 1999 2000 1999
---------------------- -------------------- ------------------ ------------------
Interest expense $ (2,600) $ (3,056) $ (7,703) $ (6,465)
Interest income 375 221 1,072 632
---------------------- -------------------- ------------------ ------------------
Net interest income
(expense) $ (2,225) $ (2,835) $ (6,631) $ (5,833)
====================== ==================== ================== ==================
8
6. SUPPLEMENTAL CASH FLOW INFORMATION
Non-cash investing and financing activities and supplemental cash flow
information is as follows (amounts in thousands):
Nine months ended December 31,
------------------------------
2000 1999
------------- --------------
Non-cash investing and financing activities:
Stock and warrants to acquire common stock
issued in exchange for licensing rights $ - $ 6,482
Tax benefit derived from net operating loss
carryforward utilization 533 -
Stock and options issued to effect business
combination - 5,971
Supplemental cash flow information:
Cash paid for income taxes $ 5,500 $ 4,775
============= ==============
Cash paid for interest $ 5,803 $ 9,133
============= ==============
7. OPERATIONS BY REPORTABLE SEGMENTS AND GEOGRAPHIC AREA
The Company publishes, develops and distributes interactive entertainment
and leisure products for a variety of game platforms, including PCs, the
Sony PlayStation and PlayStation 2 console systems, the Nintendo 64 console
system, the Nintendo Game Boy and the Sega Dreamcast console system. The
Company has also begun product development for next-generation console
systems and hand held devices, including Microsoft's Xbox and Nintendo's
GameCube and Game Boy Advance. Based on its organizational structure, the
Company operates in two reportable segments: publishing and distribution.
The Company's publishing segment publishes titles that are developed both
internally through the studios owned by the Company and externally through
third party developers. In the United States, the Company's products are
sold primarily on a direct basis to major computer and software retailing
organizations, mass market retailers, consumer electronic stores, discount
warehouses and mail order companies. The Company conducts its international
publishing activities through offices in the United Kingdom, Germany,
France, Australia and Japan. The Company's products are sold
internationally on a direct to retail basis and through third party
distribution and licensing arrangements and through the Company's
wholly-owned distribution subsidiaries located in the United Kingdom, the
Netherlands and Germany.
The Company's distribution segment, located in the United Kingdom, the
Netherlands and Germany, distributes interactive entertainment software and
hardware and provides logistical services for a variety of publishers and
manufacturers.
The President and Chief Operating Officer allocates resources to each of
these segments using information on their respective revenues and operating
profits before interest and taxes. The President and Chief Operating
Officer has been identified as the Chief Operating Decision Maker as
defined by SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information," ("SFAS No. 131").
The President and Chief Operating Officer does not evaluate individual
segments based on assets or depreciation.
The accounting policies of these segments are the same as those described
in the Summary of Significant Accounting Policies in the Company's Annual
Report on Form 10-K for the year ended March 31, 2000. Revenue derived from
sales between segments is eliminated in consolidation.
9
Information on the reportable segments for the three and nine months ended
December 31, 2000 and 1999 is as follows:
Three months ended December 31, 2000
--------------------------------------------------------
Publishing Distribution Total
----------------- ------------------ -----------------
Total segment revenues $ 201,009 $ 63,464 $ 264,473
Revenue from sales between segments (15,230) 15,230 -
----------------- ------------------ -----------------
Revenues from external customers $ 185,779 $ 78,694 $ 264,473
================= ================== =================
Operating income $ 30,708 $ 4,046 $ 34,754
================= ================== =================
Nine months ended December 31, 2000
--------------------------------------------------------
Publishing Distribution Total
----------------- ------------------ -----------------
Total segment revenues $ 383,638 $ 109,755 $ 493,393
Revenue from sales between segments (31,806) 31,806 -
----------------- ------------------ -----------------
Revenues from external customers $ 351,832 $ 141,561 $ 493,393
================= ================== =================
Operating income $ 35,262 $ 2,530 $ 37,792
================= ================== =================
Three months ended December 31, 1999
--------------------------------------------------------
Publishing Distribution Total
----------------- ------------------ -----------------
Total segment revenues $ 183,504 $ 85,358 $ 268,862
Revenue from sales between segments (14,950) 14,950 -
----------------- ------------------ -----------------
Revenues from external customers $ 168,554 $ 100,308 $ 268,862
================= ================== =================
Operating income $ 31,201 $ 7,040 $ 38,241
================= ================== =================
Nine months ended December 31, 1999
--------------------------------------------------------
Publishing Distribution Total
------------------ ----------------- -----------------
Total segment revenues $ 323,976 $ 144,391 $ 468,367
Revenue from sales between segments (28,620) 28,620 -
------------------ ----------------- -----------------
Revenues from external customers $ 295,356 $ 173,011 $ 468,367
================= ================== =================
Operating income $ 28,663 $ 7,003 $ 35,666
================= ================== =================
10
Geographic information for the three months and nine months ended December
31, 2000 and 1999 is based on the location of the selling entity. Revenues
from external customers by geographic region were as follows:
Three months ended December 31, Nine months ended December 31,
----------------------------------------- -----------------------------------------
2000 1999 2000 1999
-------------------- ------------------- -------------------- -------------------
United States $161,383 $145,241 $299,686 $239,842
Europe 100,032 119,372 185,441 220,137
Other 3,058 4,249 8,266 8,388
-------------------- ------------------- -------------------- -------------------
Total $264,473 $268,862 $493,393 $468,367
==================== =================== ==================== ===================
Revenues by platform were as follows:
Three months ended December 31, Nine months ended December 31,
----------------------------------------- -----------------------------------------
2000 1999 2000 1999
-------------------- ------------------- -------------------- -------------------
Console $203,855 $193,921 $365,552 $328,854
PC 60,618 74,941 127,841 139,513
-------------------- ------------------- -------------------- -------------------
Total $264,473 $268,862 $493,393 $468,367
==================== =================== ==================== ===================
11
8. COMPUTATION OF EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted
earnings per share (amounts in thousands, except per share data):
Three months ended Nine months ended
December 31, December 31,
---------------------------- ----------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
NUMERATOR
Numerator for basic earnings per
share - income available to common
shareholders $20,505 $22,301 $19,632 $18,790
Interest relating to dilutive convertible
subordinated notes, net of tax 683 666 2,048 1,997
------------- ------------- ------------- -------------
Numerator for diluted earnings per share $21,188 $22,967 $21,680 $20,787
============= ============= =============== =============
DENOMINATOR
Denominator for basic earnings per share-
weighted average common shares
outstanding 24,443 25,075 24,407 24,367
Effect of dilutive securities:
Employee stock options 2,532 1,958 1,295 1,614
Warrants 218 271 2 271
Conversion of convertible subordinated notes 3,179 3,179 3,179 3,179
------------- ------------- ------------- -------------
Denominator for diluted earnings per
share - weighted average common shares
outstanding plus assumed conversions 30,372 30,483 28,883 29,431
============= ============= =============== =============
Basic earnings per share $ 0.84 $ 0.89 $ 0.80 $ 0.77
============= ============= =============== =============
Diluted earnings per share $ 0.70 $ 0.75 $ 0.75 $ 0.71
============= ============= =============== =============
Options to purchase 2.2 million and 7.4 million shares of common stock at
exercise prices ranging from $12.69 to $23.04 and from $10.06 to $23.04,
respectively, were outstanding for the three months and nine months ended
December 31, 2000, respectively, but were not included in the calculations
of diluted earnings per share because their effect would be antidilutive.
Options to purchase 719,000 and 948,000 shares of common stock at exercise
prices ranging from $14.76 to $23.04 and from $13.81 to $23.04,
respectively, were outstanding for the three months and nine months ended
December 31, 1999, respectively, but were not included in the calculations
of diluted earnings per share because their effect would be antidilutive.
12
9. COMMITMENTS
BANK LINES OF CREDIT AND OTHER DEBT
In June 1999, the Company obtained a $100.0 million revolving credit
facility and a $25.0 million term loan (the "U.S. Facility") with a
syndicate of banks ("the lender"). The U.S. Facility provides the Company
with the ability to borrow up to $100.0 million and issue letters of credit
up to $80.0 million on a revolving basis against eligible accounts
receivable and inventory. The term loan portion of the U.S. Facility has a
three year term with principal amortization on a straight-line quarterly
basis which began 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%. The revolving portion of the U.S Facility
has a borrowing rate based on the banks' base rate plus 1.75% or LIBOR plus
2.75% and matures June 2002. The U.S. Facility had a weighted average
interest rate on outstanding borrowings of approximately 9.85% and 9.79%
for the three months and nine months ended December 31, 2000, respectively.
The Company pays a commitment fee of 1/2% on the unused portion of the
revolving line. The U.S. Facility is collateralized by substantially all of
the assets of the Company and its U.S. subsidiaries. The U.S. Facility
contains various covenants that limit the ability of the Company to incur
additional indebtedness, pay dividends or make other distributions, create
certain liens, sell assets, or enter into certain mergers or acquisitions.
The Company is also required to maintain specified financial ratios related
to net worth and fixed charges. The Company was in compliance with these
covenants as of December 31, 2000. As of December 31, 2000, $10.7 million
was outstanding under the term loan portion of the U.S. Facility. As of
December 31, 2000, there were no borrowings outstanding and $ 28.3 million
of letters of credit outstanding against the revolving portion of the U.S.
Facility.
On June 8, 2000, the Company amended certain of the covenants of its U.S.
Facility. The amended U.S. Facility permits the Company to purchase up to
$15.0 million in shares of its common stock as well as its convertible
subordinated notes in accordance with the Company's stock repurchase
program (described in Note 10), to distribute "Rights" under the Company's
shareholders' rights plan (described in Note 11), and to reorganize the
Company's organizational structure into a holding company form.
The Company has a revolving credit facility through its 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") 26 million ($11.1 million), based upon
eligible accounts receivable and inventory balances. The Netherlands
Facility is due on demand, bears interest at a Eurocurrency rate plus 1.25%
(weighted average interest rate of 5.5% as of December 31, 2000), is
collateralized by British Pounds ("GBP") 3.0 million ($4.5 million) letters
of credit issued by the Company's CentreSoft subsidiary and matures August
2003. As of December 31, 2000, letters of credit outstanding under the
Netherlands Facility were approximately NLG 134,000 ($57,000) and
borrowings outstanding were NLG 6.2 million ($2.7 million).
The Company also has revolving credit facilities through its CentreSoft
subsidiary located in the United Kingdom (the "UK Facility") and its NBG
subsidiary located in Germany (the "German Facility"). The UK Facility
provides for GBP 7.0 million ($10.5 million) of revolving loans and GBP 3.0
million ($4.5 million) of letters of credit, bears interest at LIBOR plus
2%, is collateralized by substantially all of the assets of the subsidiary
and matures July 2001. The UK Facility also contains various covenants that
require the subsidiary to maintain specified financial ratios related to,
among others, fixed charges. The Company was in compliance with these
covenants as of December 31, 2000. No borrowings were outstanding against
the UK facility as of December 31, 2000. Letters of credit of GBP 3.0
million ($4.5 million) were outstanding against the UK Facility as of
December 31, 2000, issued on behalf of the Company's CD Contact subsidiary
as described above. The German Facility provides for revolving loans up to
Deutsche Mark ("DM") 4 million ($1.9 million), bears interest at 5.9%, is
collateralized by a cash deposit of approximately GBP 650,000 ($971,000)
made by the Company's CentreSoft subsidiary and has no expiration date. No
borrowings were outstanding against the German Facility as of December 31,
2000.
As of December 31, 2000, the Company had $3.7 million of mortgage loans
relating to the land, office and warehouse facilities of it's German and
Netherlands subsidiaries.
13
DEVELOPER CONTRACTS
In the normal course of business, the Company enters into contractual
arrangements with third parties for the development of products. Under
these agreements, the Company commits 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 December 31, 2000 is approximately $55.1 million and is
scheduled to be distributed as follows (amounts in thousands):
Fiscal
2001 $ 11,632
2002 23,743
2003 10,477
2004 3,000
2005 2,125
Thereafter 4,125
--------
Total $ 55,102
========
Additionally, under the terms of a production financing arrangement, the
Company has a commitment to purchase two future PlayStation 2 titles from
independent third party developers upon their completion for an estimated
$8.0 million in the aggregate. Failure by the developers to complete the
project within the contractual time frame or specifications alleviates the
Company's commitment.
LEGAL PROCEEDINGS
The Company is party to routine claims and suits brought against it in the
ordinary course of business, including disputes arising over the ownership
of intellectual property rights and collection matters. In the opinion of
management, the outcome of such routine claims will not have a material
adverse effect on the Company's business, financial condition, results of
operations or liquidity.
The federal income tax return for fiscal 1997 is currently under
examination. While the ultimate results of such examination cannot be
predicted with certainty, the Company's management believes that the
examination will not have a material adverse effect on its consolidated
financial condition or results of operations.
10. REPURCHASE PLAN
As of May 9, 2000, the Board of Directors authorized the Company to
purchase up to $15.0 million in shares of its common stock as well as its
convertible subordinated notes. The shares and notes could be purchased
from time to time through the open market or in privately negotiated
transactions. The amount of shares and notes purchased and the timing of
purchases was based on a number of factors, including the market price of
the shares and notes, market conditions, and such other factors as the
Company's management deemed appropriate. The Company has financed the
purchase of shares with available cash. During the quarter ended June 30,
2000, the Company repurchased 2.3 million shares of its common stock for
approximately $15.0 million.
11. SHAREHOLDERS' RIGHTS PLAN
On April 18, 2000, the Company's Board of Directors approved a shareholders
rights plan (the "Rights Plan"). Under the Rights Plan, each common
stockholder at the close of business on April 19, 2000 will receive a
dividend of one right for each share of common stock held. Each right
represents the right to purchase one one-hundredth (1/100) of a share of
the Company's Series A Junior Preferred Stock at an exercise price of
$40.00.
14
Initially, the rights are represented by the Company's common stock
certificates and are neither exercisable nor traded separately from the
Company's common stock. The rights will only become exercisable if a person
or group acquires 15% or more of the common stock of the Company, or
announces or commences a tender or exchange offer which would result in the
bidder's beneficial ownership of 15% or more of the Company's common stock.
In the event that any person or group acquires 15% or more of the Company's
outstanding common stock, each holder of a right (other than such person or
members of such group) will thereafter have the right to receive, upon
exercise of such right, in lieu of shares of Series A Junior Preferred
Stock, the number of shares of common stock of the Company having a value
equal to two times the then current exercise price of the right. If the
Company is acquired in a merger or other business combination transaction
after a person has acquired 15% or more the Company's common stock, each
holder of a right will thereafter have the right to receive, upon exercise
of such right, a number of the acquiring company's common shares having a
market value equal to two times the then current exercise price of the
right. For persons who, as of the close of business on April 18, 2000,
beneficially own 15% or more of the common stock of the Company, the Rights
Plan "grandfathers" their current level of ownership, so long as they do
not purchase additional shares in excess of certain limitations.
The Company may redeem the rights for $.01 per right at any time until the
first public announcement of the acquisition of beneficial ownership of 15%
of the Company's common stock. At any time after a person has acquired 15%
or more (but before any person has acquired more than 50%) of the Company's
common stock, the Company may exchange all or part of the rights for shares
of common stock at an exchange ratio of one share of common stock per
right. The rights expire on April 18, 2010.
As discussed in Note 9, the Company obtained an amendment to its U.S.
Facility relating to the Rights Plan and the Company's repurchase plan.
12. NEW ACCOUNTING PRONOUNCEMENTS
In July 2000, the Emerging Issues Task Force reached a consensus on issue
No. 00-15 ("EITF 00-15"), "Classification in the Statement of Cash Flows of
the Income Tax Benefit Realized by a Company upon Employee Exercise of a
Nonqualified Stock Option." The EITF concluded that income tax benefits
realized upon an employee's exercise of a nonqualified stock option should
be classified as an operating cash flow. Accordingly, the Company
reclassified tax benefits resulting from the exercise of stock options on
its Consolidated Statements of Cash Flows.
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities," ("SFAS No. 133") is
effective for all fiscal years beginning after June 15, 2000. SFAS No. 133
establishes accounting and reporting standards for derivative instruments
and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The Company does not
currently participate in hedging activities or own derivative instruments
but plans to adopt SFAS No. 133 beginning April 1, 2001. The Company does
not expect the adoption of SFAS No. 133 to have a material impact on its
financial position or results of operations.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on the recognition, presentation,
and disclosure of revenue in financial statements of all public
registrants. Any change in the Company's revenue recognition policy
resulting from the implementation of SAB 101 would be reported as a change
in accounting principle. In June 2000, the SEC issued SAB 101B which delays
the implementation date of SAB 101 until the fourth fiscal quarter of
fiscal years beginning after December 15, 1999. The Company does not expect
the adoption of SAB 101 to have a material impact on its financial position
or results of operations.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a leading international publisher, developer and distributor of
interactive entertainment and leisure products. The Company currently focuses
its publishing, development and distribution efforts on products designed for
personal computers ("PCs") as well as the Sony PlayStation ("PSX") and
PlayStation 2 ("PS2") and Nintendo N64 ("N64") console systems and Nintendo Game
Boy handheld game devices. The Company is also currently focusing on the
development of products for Microsoft's Xbox and Nintendo's GameCube and Game
Boy Advance. During January 2001, Sega Corp., the maker of the Sega Dreamcast
("Dreamcast") announced that it would quit making the Dreamcast in March 2001.
Net revenues from the Dreamcast have historically represented only a small
percentage of the Company's total net revenues. Accordingly, the Company
believes that the departure of the Dreamcast console system from the market will
not have a material impact upon its financial position or results of operations.
The Company's products span a wide range of genres and target markets.
The Company distributes its products worldwide through its direct sales forces,
through its distribution subsidiaries, and through third party distributors and
licensees.
The Company recognizes revenue from the sale of its products upon shipment.
Subject to certain limitations, the Company permits customers to obtain
exchanges and returns within certain specified periods and provides price
protection on certain unsold merchandise. Revenue from product sales is
reflected after deducting the estimated allowance for returns and price
protection. Management of the Company estimates 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 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 PC and console product units. Manufacturers of the Company's PC
software are located worldwide and are readily available. Console CDs and
cartridges are manufactured by the respective video game console manufacturers,
Sony, Nintendo and Sega or its agents, who often require significant lead time
to fulfill the Company's orders.
Cost of sales-royalties and software amortization represents amounts due
developers, product owners and other royalty participants as a result of product
sales, as well as amortization of capitalized software development costs. The
costs incurred by the Company to develop products are accounted for in
accordance with accounting standards 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.
Commencing upon product release, prepaid royalties are amortized to cost of
sales - royalties and software amortization at the contractual royalty rate
based on actual net product sales or on the ratio of current revenues to total
projected revenues, whichever is greater, and capitalized software costs are
amortized to cost of sales-royalties and software amortization on a
straight-line basis over the estimated product life or on the ratio of current
revenues to total projected revenues, whichever is greater.
For products that have been released, management evaluates the future
recoverability of prepaid royalties and capitalized software costs on a
quarterly basis. Prior to a product's release, the Company charges to expense,
as part of product development costs, capitalized costs when, in management's
estimate, such amounts are not recoverable. The following criteria are used to
evaluate recoverability: historical performance of comparable products; the
commercial acceptance of prior products released on a given game engine; orders
for the product prior to its release; estimated performance of a sequel product
based on the performance of the product on which the sequel is based; and actual
development costs of a product as compared to the Company's budgeted amount.
16
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, channel, platform and segment:
Three months ended December 31, Nine months ended December 31,
------------------------------------------- ------------------------------------------
(In thousands) (In thousands)
------------------------------------------- ------------------------------------------
2000 1999 2000 1999
-------------------- --------------------- -------------------- --------------------
Net revenues $264,473 100% $268,862 100% $493,393 100% $468,367 100%
Costs and expenses:
Cost of sales - product
costs 139,430 53% 139,357 52% 247,414 50% 259,180 55%
Cost of sales - royalties
and software
amortization 39,364 15% 39,733 15% 77,829 16% 61,213 13%
Product development 11,779 4% 6,235 2% 30,311 6% 16,576 4%
Sales and marketing 26,725 10% 33,947 13% 68,505 14% 67,392 14%
General and administrative 12,421 5% 11,349 4% 31,542 6% 28,340 6%
--------- --------- ---------- --------- --------- --------- --------- ---------
Total costs and expenses 229,719 87% 230,621 86% 455,601 92% 432,701 92%
--------- --------- ---------- --------- --------- --------- --------- ---------
Income from operations 34,754 13% 38,241 14% 37,792 8% 35,666 8%
Interest expense, net (2,225) (1%) (2,835) (1%) (6,631) (1%) (5,833) (1%)
--------- --------- ---------- --------- --------- --------- --------- ---------
Income before income tax
provision 32,529 12% 35,406 13% 31,161 7% 29,833 7%
Income tax provision 12,024 4% 13,105 5% 11,529 2% 11,043 2%
--------- --------- ---------- --------- --------- --------- --------- ---------
Net income $ 20,505 8% $ 22,301 8% $ 19,632 5% $ 18,790 5%
========= ========= ========== ========= ========= ========= ========= =========
NET REVENUES BY TERRITORY:
United States $161,383 61% $145,241 54% $299,686 61% $239,842 51%
Europe 100,032 38% 119,372 44% 185,441 38% 220,137 47%
Other 3,058 1% 4,249 2% 8,266 1% 8,388 2%
--------- --------- ---------- --------- --------- --------- --------- ---------
Total net revenues $264,473 100% $268,862 100% $493,393 100% $468,367 100%
========= ========= ========== ========= ========= ========= ========= =========
NET REVENUES BY CHANNEL:
Retailer/Reseller $255,451 97% $260,328 97% $476,514 97% $448,853 96%
OEM, Licensing, on-line
and other 9,022 3% 8,534 3% 16,879 3% 19,514 4%
--------- --------- ---------- --------- --------- --------- --------- ---------
Total net revenues $264,473 100% $268,862 100% $493,393 100% $468,367 100%
========= ========= ========== ========= ========= ========= ========= =========
ACTIVITY/PLATFORM MIX:
Publishing:
Console $154,759 77% $132,427 72% $283,827 74% $225,993 70%
PC 46,250 23% 51,077 28% 99,811 26% 97,983 30%
--------- --------- ---------- --------- --------- --------- --------- ---------
Total publishing net
revenues 201,009 76% 183,504 68% 383,638 78% 323,976 69%
--------- --------- ---------- --------- --------- --------- --------- ---------
Distribution:
Console 49,096 77% 61,494 72% 81,725 74% 102,861 71%
PC 14,368 23% 23,864 28% 28,030 26% 41,530 29%
--------- --------- ---------- --------- --------- --------- --------- ---------
Total distribution
net revenues 63,464 24% 85,358 32% 109,755 22% 144,391 31%
--------- --------- ---------- --------- --------- --------- --------- ---------
Total net revenues $264,473 100% $268,862 100% $493,393 100% $468,367 100%
========= ========= ========== ========= ========= ========= ========= =========
17
Three months ended December 31, Nine months ended December 31,
------------------------------------------- ------------------------------------------
(In thousands) (In thousands)
------------------------------------------- ------------------------------------------
2000 1999 2000 1999
-------------------- --------------------- -------------------- --------------------
OPERATING INCOME BY SEGMENT:
Publishing $ 30,708 12% $ 31,201 12% $ 35,262 7% $ 28,663 6%
Distribution 4,046 1% 7,040 2% 2,530 1% 7,003 2%
net revenues --------- --------- ---------- --------- --------- --------- --------- ---------
Total operating
income $ 34,754 13% $ 38,241 14% $ 37,792 8% $ 35,666 8%
========= ========= ========== ========= ========= ========= ========= =========
18
RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED DECEMBER 31, 2000 AND 1999
NET REVENUES
Net revenues decreased from $268.9 million to $264.5 million for the three month
period ended December 31, 1999 and 2000, respectively, and increased from $468.4
million to $493.4 million for the nine month period ended December 31, 1999 and
2000, respectively. Publishing net revenues increased 10% and 18% for the three
months and nine months ended December 31, 2000, respectively, over the same
period last year, from $183.5 million to $201.0 million for the three month
period and from $324.0 to $383.6 for the nine month period. These increases in
publishing net revenues were partially offset by a decrease in net revenues from
the Company's distribution business. Distribution net revenues for the three
months and nine months ended December 31, 2000 decreased 26% and 24%,
respectively, from the same period last year, from $85.4 million to $63.5
million for the three month period and from $144.4 million to $109.8 million for
the nine month period.
The increase in publishing net revenues for the three months ended December 31,
2000 over the same period last year, was primarily driven by a 17% increase in
publishing console net revenues, from $132.4 million to $154.8 million. This
increase was due to the continued success of Tony Hawk Pro Skater 2 for the PSX
and Spiderman for the PSX, which were both launched in the quarter ending
September 30, 2000, as well as the continued sales of the original Tony Hawk Pro
Skater. As reported by NPD TRST (Toy Retail Sales Tracking System), Tony Hawk
Pro Skater 2 was the number one selling PSX game in North America in units and
dollars for calendar year 2000. Between its launch in late September 2000 and
December 31, 2000, over 2.5 million units of Tony Hawk Pro Skater 2 for the PSX
have been shipped on a worldwide basis. NPD TRST also reported that the original
Tony Hawk Pro Skater and Spiderman were the number five and number ten PSX
games, respectively, in North America in dollars for calendar year 2000.
Additionally, the increase was due to the release in the third quarter of fiscal
2001 of these titles on additional platforms, including Tony Hawk Pro Skater 2
for Dreamcast and Nintendo's Game Boy Color and Spiderman for N64 and Nintendo's
Game Boy Color. This increase in publishing console net revenues for the quarter
was slightly offset by a 9% decrease in publishing PC net revenues for the three
months ended December 31, 2000 from the same period last year, from $51.1
million to $46.3 million. This decrease is reflective of the strong results
experienced from the release of Quake 3 Arena for the PC during the third
quarter of fiscal 2000. During the third quarter of fiscal 2001, there was no
such comparable PC product performance. Additionally, in the third quarter of
fiscal 2000, approximately 16 PC titles were launched compared to only 9 PC
titles released in the third quarter of fiscal 2001.
For the nine months ended December 31, 2000, the increase in publishing net
revenues was primarily driven by a 26% increase in publishing console net
revenues over the same period last year, from $226.0 million to $283.8 million.
This increase was primarily due to the new launches of Tony Hawk Pro Skater 2
and Spiderman for the PSX and other console systems during the second and third
quarters of fiscal 2001 and the continued success of the original Tony Hawk Pro
Skater as described above. Also contributing to its continued revenue stream, in
September 2000, the original Tony Hawk Pro Skater was selected for inclusion in
Sony Computer Entertainment America's "Greatest Hits" series, which features a
selection of best-selling PSX games. For the nine months ended December 31,
2000, publishing PC net revenues remained relatively flat with a 2% increase
over the same period last year, from $98.0 million to $99.8 million.
The decrease in distribution net revenues for the three months and nine months
ended December 31, 2000 from the same period last year was mainly attributable
to the continued weakness in the European console market as a result of the
transition to next-generation console systems. Based on previous new hardware
launches, the Company expects that its distribution business will benefit in
future periods from the introduction of PS2.
Domestic net revenues increased 11% and 25% for three months and nine months
ended December 31, 2000, respectively, over the same period last year, from
$145.2 million to $161.4 million for the three month period and from $239.8
million to $299.7 million for the nine month period. For the reasons previously
described, these increases were driven by the increases in the Company's
publishing console net revenues.
International net revenues decreased 17% and 15% for the three months and nine
months ended December 31, 2000, respectively, over the same period last year,
from $123.6 million to $103.1 million for the three month period and from $228.5
million to $193.7 million for the nine month period. These decreases are due
primarily to the decrease in net revenues from the Company's distribution
business.
19
COSTS AND EXPENSES
Cost of sales - product costs as a percentage of net revenues for the three
months ended December 31, 2000 remained relatively consistent with the same
period last year, increasing only 1%, from 52% as of December 31, 1999 to 53% as
of December 31, 2000. Cost of sales - product costs as a percentage of net
revenues for the nine months ended December 31, 2000 decreased from 55% as of
December 31, 1999 to 50% as of December 31, 2000. This year to date decrease was
due to product mix. During the nine months ended December 31, 1999, the Company
shipped a larger number of lower margin, third party titles. In the nine months
ended December 31, 2000, the Company shipped significantly more Activision
titles.
Cost of sales - royalty and software amortization expense represented 15% of net
revenues for both the three months ended December 31, 2000 and 1999. Cost of
sales - royalty and software amortization expense represented 16% and 13% of net
revenues for the nine months ended December 31, 2000 and 1999, respectively.
This increase in cost of sales - royalty and software amortization expense as a
percentage of net revenues for the nine months ended December 31, 2000 was
primarily due to changes in the Company's product mix, with an increase in the
number of branded products with higher royalty obligations as compared to the
same period in the prior fiscal year.
Product development expenses of $11.8 million and $6.2 million represented 4%
and 2% of net revenues for the three months ended December 31, 2000 and 1999,
respectively. Product development expenses of $30.3 million and $16.6 million
represented 6% and 4% of net revenues for the nine months ended December 31,
2000 and 1999, respectively. These increases in product development expenses in
dollars and as a percentage of net revenues reflect the Company's investment in
the development of products for next-generation console and hand-held devices,
including PS2, Xbox, GameCube and Game Boy Advance. The increases are also
reflective the increase in the number of titles expected to be released in
fiscal 2002, 38 titles, compared to fiscal 2001, 30 titles. Of the 38 titles
expected to be released in fiscal 2002, 15 titles are for next-generation
platforms, which have higher development costs than existing-platform titles.
Sales and marketing expenses of $26.7 million and $33.9 million represented 10%
and 13% of net revenues for the three months ended December 31, 2000 and 1999,
respectively. Sales and marketing expenses of $68.5 million and $67.4 million
represented 14% and 14% of net revenues for the nine months ended December 31,
2000 and 1999, respectively. The decrease in sales and marketing expenses in
dollars and as a percentage of net revenues for the three months ended December
31, 2000 compared to the same period last year is due to the higher spending
incurred in the second quarter of fiscal 2001 on several new releases during
that quarter, including Tony Hawk 2 and Spiderman. Additionally, the decrease
reflects the Company's ability to generate savings by building on the existing
awareness of our branded products and sequel titles sold during the third
quarter of fiscal 2001.
General and administrative expenses of $12.4 million and $11.3 million
represented 5% and 4% of net revenues for the three months ended December 31,
2000 and 1999, respectively. General and administrative expenses of $31.5
million and $28.3 million represented 6% and 6% of net revenues for the nine
months ended December 31, 2000 and 1999, respectively. These changes in general
and administrative expenses were due to an increase in headcount related
expenses for worldwide administrative support, partially offset by a decrease in
goodwill amortization. Goodwill amortization in fiscal 2001 decreased compared
to fiscal 2000 due to the write-off in the fourth quarter of fiscal 2000 of
goodwill relating to Expert as described in the Company's Annual Report on Form
10-K for the year ended March 31, 2000.
OPERATING INCOME
Operating income for the three months ended December 31, 2000 and 1999 was $34.8
million (13% of net revenues) and $38.2 million (14% of net revenues),
respectively. Operating income for the nine months ended December 31, 2000 and
1999 was $37.8 million (8% of net revenues) and $35.7 million (8% of net
revenues), respectively.
The decrease in operating income for the three months ended December 31, 2000
over the same period last year was primarily due to a decrease in the operating
income of the Company's distribution business, from $7.0 million to $4.0
million. The increase in operating income for the nine months ended December 31,
2000 over the same period last year was primarily due to an increase in
publishing operating income, from $28.7 million to $35.3 million, partially
offset by a decrease in distribution operating income, from $7.0 million to $2.5
million. The publishing
20
operating income increase for the nine months ended December 31, 2000 over the
same period last year was primarily the result of increased net revenues and a
change in the Company's product mix. In fiscal 2001, the Company shipped
significantly more Activision titles. In the prior year, the Company shipped a
significant number of lower margin, third-party titles. Distribution operating
income decreases were primarily due to reduced net revenues from the continued
weakness in the European console market as a result of the transition to
next-generation console systems. Based on previous new hardware launches, the
Company expects that its distribution business will benefit in future periods
from the introduction of PS2.
OTHER INCOME (EXPENSE)
Interest expense, net of interest income, decreased to $2.2 million for the
three months ended December 31, 2000, from $2.8 million for the three months
ended December 31, 1999. This decrease in interest expense was due to lower
average borrowings on the revolving portion of the Company's $125.0 million term
loan and revolving credit facility (the "U.S. Facility") during the third
quarter of fiscal 2001 when compared to the same period in prior year. Interest
expense, net of interest income increased to $6.6 million for the nine months
ended December 31, 2000 from $5.8 million for the nine months ended December 31,
1999. This increase is the result of a full nine months of interest expense
incurred relating to the Company's U.S. Facility for the nine months ended
December 31, 2000 versus only six months of interest expense in the same period
last year as the U. S. Facility was obtained in June 1999. Prior to obtaining
the U.S. Facility, the Company's previous line of credit only provided for
borrowings up to $40.0 million.
PROVISION FOR INCOME TAXES
The income tax provision of $12.0 million and $11.5 million for the three months
and nine months ended December 31, 2000, respectively, reflect the Company's
effective income tax rate of approximately 37%. The significant items generating
the variance between the Company's effective rate and its statutory rate of 35%
are state taxes and nondeductible goodwill amortization, partially offset by a
decrease in the Company's deferred tax asset valuation allowance and research
and development tax credits. The realization of deferred tax assets primarily is
dependent on the generation of future taxable income. Management believes that
it is more likely than not that the Company will generate taxable income
sufficient to realize the benefit of net deferred tax assets recognized.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased $2.4 million, from $50.0
million at March 31, 2000 to $52.3 million at December 31, 2000. The increase in
cash during the nine months ended December 31, 2000 resulted from $82.1 million
of cash provided by operating activities, partially offset by $58.4 million used
in investing activities and $19.2 million used in financing activities. The cash
provided by operating activities primarily was the result of changes in accounts
payable and accrued liabilities, driven by a seasonal change in working capital
needs. The cash used in investing activities primarily is the result of the
Company's continued investment in product development. Approximately $51.0
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 the Company long-term rights to intellectual
property of third parties, as well as the capitalization of product development
costs relating to internally developed products. The cash used in financing
activities is primarily the result of $12.7 in net cash payments on borrowings,
as well as $15.0 million of cash used by the Company to purchase its common
stock under its repurchase program. These outflows were partially offset by $8.5
million of cash proceeds from the issuance common stock pursuant to employee
stock option plans and the employee stock purchase plan.
In connection with the Company's purchases of Nintendo N64 software cartridges
for distribution in North America and Europe, Nintendo requires the Company to
provide irrevocable letters of credit prior to accepting purchase orders from
the Company. Furthermore, Nintendo maintains a policy of not accepting returns
of Nintendo N64 software cartridges. Because of these and other factors, the
carrying of an inventory of Nintendo N64 software cartridges entails significant
capital and risk. As of December 31, 2000, the Company had $4.2 million of
Nintendo N64 hardware and software cartridge inventory on hand, which
represented approximately 8.5% of all inventory.
In December 1997, the Company completed the private placement of $60.0 million
principal amount of 6 3/4% convertible subordinated notes due 2005 (the
"Notes"). The Notes are convertible, in whole or in part, at the option
21
of the holder at any time after December 22, 1997 (the date of original
issuance) and prior to the close of business on the business day immediately
preceding the maturity date, unless previously redeemed or repurchased, into
common stock, $.000001 par value, of the Company, at a conversion price of
$18.875 per share, (equivalent to a conversion rate of 52.9801 shares per $1,000
principal amount of Notes), subject to adjustment in certain circumstances. The
Notes are redeemable, in whole or in part, at the option of the Company at any
time on or after January 10, 2001. If redemption occurs prior to December 31,
2003, the Company must pay a premium on such redeemed Notes.
In June 1999, the Company obtained a $100.0 million revolving credit facility
and a $25.0 million term loan (the "U.S. Facility") with a syndicate of banks
("the lender"). The U.S. Facility provides the Company with the ability to
borrow up to $100.0 million and issue letters of credit up to $80.0 million on a
revolving basis against eligible accounts receivable and inventory. The term
loan portion of the U.S. Facility has a three year term with principal
amortization on a straight-line quarterly basis which began 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%. The revolving
portion of the U.S Facility has a borrowing rate based on the banks' base rate
plus 1.75% or LIBOR plus 2.75% and matures June 2002. The U.S. Facility had a
weighted average interest rate of approximately 9.85% and 9.79% for the three
months and nine months ended December 31, 2000, respectively. The Company pays a
commitment fee of 1/2% on the unused portion of the revolving line. The U.S.
Facility is collateralized by substantially all of the assets of the Company and
its U.S. subsidiaries. The U.S. Facility contains various covenants that limit
the ability of the Company to incur additional indebtedness, pay dividends or
make other distributions, create certain liens, sell assets, or enter into
certain mergers or acquisitions. The Company is also required to maintain
specified financial ratios related to net worth and fixed charges. The Company
was in compliance with these covenants as of December 31, 2000. As of December
31, 2000, $10.7 million was outstanding under the term loan portion of the U.S.
Facility. As of December 31, 2000, there were no borrowings outstanding and $
28.3 million of letters of credit outstanding against the revolving portion of
the U.S. Facility.
On June 8, 2000, the Company amended certain of the covenants of its U.S.
Facility. The amended U.S. Facility permits the Company to purchase up to $15.0
million in shares of its common stock as well as its convertible subordinated
notes in accordance with the Company's stock repurchase program (described in
Note 10), to distribute "Rights" under the Company's shareholders' rights plan
(described in Note 11), and to reorganize the Company's organizational structure
into a holding company form.
The Company has a revolving credit facility through its 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")
26 million ($11.1 million), based upon eligible accounts receivable and
inventory balances. The Netherlands Facility is due on demand, bears interest at
a Eurocurrency rate plus 1.25% (weighted average interest rate of 5.5% as of
December 31, 2000), is collateralized by GBP 3.0 million ($4.5 million) letters
of credit issued by the Company's CentreSoft subsidiary and matures August 2003.
As of December 31, 2000, letters of credit outstanding under the Netherlands
Facility were approximately NLG 134,000 ($57,000) and borrowings outstanding
were NLG 6.2 million ($2.7 million).
The Company also has revolving credit facilities through its CentreSoft
subsidiary located in the United Kingdom (the "UK Facility") and its NBG
subsidiary located in Germany (the "German Facility"). The UK Facility provides
for British Pounds ("GBP") 7.0 million ($10.5 million) of revolving loans and
GBP 3.0 million ($4.5 million) of letters of credit, bears interest at LIBOR
plus 2%, is collateralized by substantially all of the assets of the subsidiary
and matures July 2001. The UK Facility also contains various covenants that
require the subsidiary to maintain specified financial ratios related to, among
others, fixed charges. The Company was in compliance with these covenants as of
December 31, 2000. No borrowings were outstanding against the UK facility as of
December 31, 2000. Letters of credit of GBP 3.0 million ($4.5 million) were
outstanding against the UK Facility as of December 31, 2000, issued on behalf of
the Company's CD Contact subsidiary as described above. The German Facility
provides for revolving loans up to Deutsche Mark ("DM") 4 million ($1.9
million), bears interest at 5.9%, is collateralized by a cash deposit of
approximately GBP 650,000 ($971,000) made by the Company's CentreSoft subsidiary
and has no expiration date. No borrowings were outstanding against the German
Facility as of December 31, 2000.In the normal course of business, the Company
enters into contractual arrangements with third parties for the development of
products. Under these agreements, the Company commits 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
22
place as of December 31, 2000 is approximately $55.1 million and is scheduled to
be distributed as follows (amounts in thousands):
Fiscal
2001 $11,632
2002 23,743
2003 10,477
2004 3,000
2005 2,125
Thereafter 4,125
-------
Total $55,102
=======
Additionally, under the terms of a production financing arrangement, the Company
has a commitment to purchase two future PlayStation 2 titles from independent
third party developers upon their completion for an estimated $8.0 million in
the aggregate. Failure by the developers to complete the project within the
contractual time frame or specifications alleviates the Company's commitment.
The Company historically has financed its acquisitions through the issuance of
shares of its common stock. The Company will continue to evaluate potential
acquisition candidates as to the benefit they bring to the Company and as to the
ability of the Company to make such acquisitions and maintain compliance with
its bank facilities.
In May 2000, the Board of Directors authorized the Company to purchase up to
$15.0 million in shares of its common stock as well as its convertible
subordinated notes. The shares and notes could be purchased in the open market
or in privately negotiated transactions at such times and in such amounts as
management deemed appropriate, depending on market conditions and other factors.
In the quarter ended June 30, 2000, the Company repurchased 2.3 million shares
of its common stock for approximately $15.0 million.
The Company believes that it has sufficient working capital ($162.5 million at
December 31, 2000), as well as proceeds available from the U.S. Facility, the UK
Facility, the Netherlands Facility and the German Facility, to finance the
Company's 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"), the Company has 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 its
employees and representatives that may contain "forward-looking statements"
within the meaning of the Litigation Reform Act. Such statements consist of any
statement other than a recitation of historical fact and can be identified by
the use of forward-looking terminology such as "may," "expect," "anticipate,"
"estimate" or "continue" or the negative thereof or other variations thereon or
comparable terminology. The listener or reader is cautioned that all
forward-looking statements are necessarily speculative and there are numerous
risks and uncertainties that could cause actual events or results to differ
materially from those referred to in such forward-looking statements. For a
discussion that highlights some of the more important risks identified by
management, but which should not be assumed to be the only factors that could
affect future performance, see the Company's Annual Report on Form 10-K for the
year ended March 31, 2000 which is incorporated herein by reference. The reader
or listener is cautioned that the Company does not have a policy of updating or
revising forward-looking statements and thus he or she should not assume that
silence by management over time means that actual events are bearing out as
estimated in such forward-looking statements.
23
RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2000, the Emerging Issues Task Force reached a consensus on issue No.
00-15 ("EITF 00-15"), "Classification in the Statement of Cash Flows of the
Income Tax Benefit Realized by a Company upon Employee Exercise of a
Nonqualified Stock Option." The EITF concluded that income tax benefits realized
upon an employee's exercise of a nonqualified stock option should be classified
as an operating cash flow. Accordingly, the Company reclassified tax benefits
resulting from the exercise of stock options on its Consolidated Statements of
Cash Flows.
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities," ("SFAS No. 133") is effective for all
fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting
and reporting standards for derivative instruments and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The Company does not currently participate in hedging activities
or own derivative instruments but plans to adopt SFAS No. 133 beginning April 1,
2001. The Company does not expect the adoption of SFAS No. 133 to have a
material impact on its financial position or results of operations.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements."
SAB 101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements of all public registrants. Any change in the
Company's revenue recognition policy resulting from the implementation of SAB
101 would be reported as a change in accounting principle. In June 2000, the SEC
issued SAB 101B which delays the implementation date of SAB 101 until the fourth
fiscal quarter of fiscal years beginning after December 15, 1999. The Company
does not expect the adoption of SAB 101 to have a material impact on its
financial position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the potential loss arising from fluctuations in market rates and
prices. The Company's market risk exposures primarily include fluctuations in
interest rates and foreign currency exchange rates. The Company's market risk
sensitive instruments are classified as "other than trading." The Company's
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. The Company's 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.
INTEREST RATE RISK
The Company has a number of variable rate and fixed rate debt obligations,
denominated both in U.S. dollars and various foreign currencies as detailed in
Note 9 to the Consolidated Financial Statements appearing elsewhere in this
Quarterly Report. The Company manages interest rate risk by monitoring its ratio
of fixed and variable rate debt obligations in view of changing market
conditions. Additionally, in the future, the Company may consider the use of
interest rate swap agreements to further manage potential interest rate risk.
As of December 31, 2000, the carrying value of the Company's variable rate debt
was $13.4 million, which includes the U.S. Facility ($10.7 million) and the
Netherlands Facility ($2.7 million). Based upon the variable rate debt
outstanding as of December 31, 2000, a hypothetical 1% increase in the
applicable interest rates of the Company's variable rate debt would increase
annual interest expense by approximately $134,000.
The Company additionally has 6 3/4% convertible subordinated notes (the "Notes")
that have a carrying value of $60.0 million and a fair value of $55.2 million as
of December 31, 2000. The fair value of the Notes was determined based on quoted
market prices. A hypothetical 1% increase in market rate of the Notes would
decrease their fair value by approximately $552,000.
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FOREIGN CURRENCY EXCHANGE RATE RISK
The Company transacts business in many different foreign currencies and may be
exposed to financial market risk resulting from fluctuations in foreign currency
exchange rates, particularly British Pounds ("GBP"). The volatility of GBP (and
all other applicable currencies) will be monitored frequently throughout the
coming year. While the Company has not traditionally engaged in foreign currency
hedging, the Company 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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PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is party to routine claims and suits brought against it in
the ordinary course of business including disputes arising over the
ownership of intellectual property rights and collection matters. In the
opinion of management, the outcome of such routine claims will not have
a material adverse effect on the Company's business, financial condition
or results of operations.
The federal income tax return for fiscal 1997 is currently under
examination. While the ultimate results of such examination cannot be
predicted with certainty, the Company's management believes that the
examination will not have a material adverse effect on its consolidated
financial condition or results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
The Company has filed no reports on Form 8-K during the quarterly
period ended December 31, 2000.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Date: February 13, 2001
ACTIVISION, INC.
/s/ William J. Chardavoyne Chief Financial Officer and Chief Accounting Officer February 13, 2001
- ------------------------------
(William J. Chardavoyne)
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