<PAGE>
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, 1997
O R
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-12699
ACTIVISION, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2606438
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3100 OCEAN PARK BLVD., 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 [ ]
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a
plan confirmed by a court: Yes [ X ] No [ ]
The number of shares of the registrant's Common Stock outstanding as of
February 12, 1998 was 18,894,489.
1
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ACTIVISION, INC.
1997 QUARTERLY REPORT ON 10Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
December 31, 1997 (unaudited) and March 31, 1997 3
Condensed Consolidated Statements of Operations for the quarters
and nine months ended December 31, 1997 and 1996 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended December 31, 1997 and 1996 (unaudited) 5
Notes to Condensed Consolidated Financial Statements for the
quarter and nine months ended December 31, 1997 (unaudited) 6-8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9-20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
</TABLE>
2
<PAGE>
ACTIVISION, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands except per share data)
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
December 31, March 31,
1997 1997
---------------- ---------------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 91,617 $ 21,358
Accounts receivable, net of allowances of $13,911
and $7,674 respectively 99,431 46,633
Inventories, net 17,588 8,283
Prepaid software and license royalties 8,281 6,559
Other current assets 2,440 1,222
Deferred income taxes 1,151 1,493
---------------- ---------------
Total current assets 220,508 85,548
Property and equipment, net 10,916 5,990
Deferred income taxes 4,665 4,212
Other assets 2,426 255
Excess purchase price over identifiable assets
acquired, net 23,838 23,749
---------------- ---------------
Total assets $ 262,353 $ 119,754
---------------- ---------------
---------------- ---------------
LIABILITIES
Current liabilities:
Notes payable to bank $ 1,812 $ 1,600
Current portion of subordinated loan stock debentures - 683
Accounts payable 76,583 19,291
Accrued expenses 25,278 12,136
---------------- ---------------
Total current liabilities 103,673 33,710
Note payable to bank 1,157 -
Convertible subordinated notes 60,000 -
Subordinated loan stock debentures - 2,533
Other liabilities 135 31
---------------- ---------------
Total liabilities 164,965 36,274
---------------- ---------------
Commitments and contingencies
Redeemable preferred stock - 1,286
Convertible preferred stock - 214
Shareholders' equity:
Common stock, $.000001 par value, 50,000,000 shares
authorized, 19,322,443 and 17,113,007 shares issued
and 18,822,443 and 16,613,077 outstanding, respectively - -
Additional paid-in capital 89,143 78,752
Retained earnings 13,544 8,664
Cumulative foreign currency translation (21) (158)
Less: Treasury stock, cost of 500,000 shares (5,278) (5,278)
---------------- ---------------
Total shareholders' equity 97,388 81,980
---------------- ---------------
Total liabilities and shareholders' equity $ 262,353 $ 119,754
---------------- ---------------
---------------- ---------------
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
<PAGE>
ACTIVISION, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
(in thousands except income per share data)
<TABLE>
<CAPTION>
Quarter ended Nine months ended
December 31, December 31,
------------------------ ----------------------
1997 1996 1997 1996
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Net revenues $ 122,141 $ 60,480 $ 201,670 $ 97,058
Cost of goods sold 77,078 36,185 127,089 51,562
---------- ----------- ---------- ----------
Gross profit 45,063 24,295 74,581 45,496
---------- ----------- ---------- ----------
Operating expenses:
Product development 8,045 4,707 21,963 13,861
Sales and marketing 16,400 8,344 31,960 18,276
General and administrative 3,586 2,563 8,416 6,056
Amortization of intangible assets 404 393 1,159 1,104
Merger expenses 1,474 - 1,474 -
---------- ----------- ---------- ----------
Total operating expenses 29,909 16,007 64,972 39,297
---------- ----------- ---------- ----------
Operating income 15,154 8,288 9,609 6,199
Other income (expense):
Interest, net (232) (31) (377) 284
---------- ----------- ---------- ----------
Income before income tax provision 14,922 8,257 9,232 6,483
Income tax provision 5,644 2,937 3,531 2,373
---------- ----------- ---------- ----------
Net income $ 9,278 $ 5,320 $ 5,701 $ 4,110
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
Basic net income per share $ 0.50 $ 0.30 $ 0.31 $ 0.24
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
Diluted net income per share $ 0.47 $ 0.29 $ 0.30 $ 0.23
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
Number of shares used in computing
basic net income per share 18,581 17,781 18,296 16,908
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
Numbers of shares used in computing
diluted net income per share 20,027 18,484 19,264 17,596
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
<PAGE>
ACTIVISION, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
For the Nine Months Ended
December 31,
1997 1996
----------- ----------
(in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,701 $ 4,110
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Deferred income taxes 410 995
Depreciation and amortization 3,871 2,746
Change in assets and liabilities:
Accounts receivable (52,934) (15,377)
Inventories (9,367) (4,359)
Prepaid software and license royalties (1,291) (2,314)
Other assets (3,389) (377)
Accounts payable 57,482 14,989
Accrued liabilities 14,416 (1,605)
Other liabilities (5) (46)
----------- ----------
Net cash provided by (used in) operating activities 14,894 (1,238)
----------- ----------
Cash flows from investing activities:
Cash paid by Combined Distribution (Holdings)
Limited to acquire CentreSoft Limited (net of
cash acquired) (1,043) (3,878)
Capital expenditures (6,197) (2,393)
Cash used in purchase acquisition (246) -
Adjustment for effect of poolings on prior periods (1,641) -
Other - (250)
----------- ----------
Net cash used in investing activities (9,127) (6,521)
----------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock - 5,037
Issuance of common stock pursuant to employee stock
option plan 3,961 1,067
Issuance of common stock pursuant to employee stock
purchase plan 230 -
Dividends paid (1,258) (66)
Proceeds from note payable to bank (net of payments) 1,371 (58)
Proceeds from borrowings on line-of-credit 8,800 -
Payments on line-of-credit (8,800) -
Proceeds from issuance of subordinated convertible
notes 60,000 -
Other 51 (30)
----------- ----------
Net cash provided by financing activities 64,355 5,950
----------- ----------
Effect of exchange rate changes on cash 137 457
----------- ----------
Net increase (decrease) in cash and cash equivalents 70,259 (1,352)
----------- ----------
Cash and cash equivalents at beginning of period 21,358 25,288
----------- ----------
Cash and cash equivalents at end of period $ 91,617 $ 23,936
----------- ----------
----------- ----------
Non Cash Investing Activities:
Stock issued in exchange for licensing rights $ 431 $ 822
Tax benefit derived from stock option exercises 521 -
Stock issued in purchase acquisition 136 -
Preferred stock converted to common stock in pooling
transaction 1,286 -
Redeemable preferred stock converted to common
stock in pooling transaction 214 -
Conversion of subordinated loan stock debentures to
common stock in pooling transaction 3,216 -
Supplemental flow information:
Cash paid for income taxes $ 2,607 $ 831
Cash paid for interest 696 203
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
<PAGE>
ACTIVISION, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include the
accounts of Activision, Inc. and its subsidiaries ("Company"). The
information furnished is unaudited and reflects all adjustments which, 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
CompanyOs Annual Report on Form 10-K for the year ended March 31, 1997, and
the Company's restated supplemental consolidated financial statements for
the year ended March 31, 1997 and for the quarter and six months ended
September 30, 1997 filed in the Company's Current Report on Form 8-K. These
supplemental consolidated financial statements reflect the pooling of
interests of the Company with Combined Distribution (Holdings) Limited
("CentreSoft") (see note 6 "Acquisitions"). Such supplemental consolidated
financial statements did not, however, extend through the date of
consummation of the CentreSoft acquisition or the pooling of interests of
the Company with NBG Handels und Verlags GmbH ("NBG"), both of which
occurred in November 1997. These supplemental statements have become the
historical consolidated financial statements of the Company as financial
statements covering the date of consummation of the business combination
are being issued herein.
Certain amounts in the condensed consolidated financial statements have
been reclassified to conform with the current period's presentation. These
reclassifications had no impact on previously reported working capital or
results of operations.
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, EARNINGS PER SHARE. Statement 128
replaced the previously reported primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary earnings
per share, basic earnings per share excludes any dilutive effects of
options, warrants, and convertible securities. Diluted earnings per share
is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been presented,
and where necessary, restated to conform to the Statement 128 requirements.
2. INVENTORIES
Inventories, net (amounts in thousands):
<TABLE>
<CAPTION>
December 31, March 31,
1997 1997
----------- ---------
<S> <C> <C>
Finished goods $ 15,067 $ 7,121
Purchased parts and components 2,521 1,162
----------- ---------
$ 17,588 $ 8,283
----------- ---------
----------- ---------
</TABLE>
3. SOFTWARE DEVELOPMENT COSTS
Statement of Financial Accounting Standard No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed,"
provides for the capitalization of certain software development costs once
technological feasibility is established. The capitalized costs are then
amortized on a straight-line basis over the estimated product life, or on
the ratio of current revenues to total projected revenues, whichever is
greater. The software development costs that have been capitalized to date
have been immaterial.
6
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ACTIVISION, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. REVENUE RECOGNITION
Product Sales: The Company recognizes revenues from the sale of its
products upon shipment. Subject to certain limitations, the Company permits
customers to obtain exchanges within certain specified periods and provides
price protection on certain unsold merchandise. Revenues from product sales
are reflected net of the allowance for returns and price protection.
Software Licenses: For those license agreements which provide the customers
the right to multiple copies in exchange for guaranteed amounts, revenues
are recognized at delivery of the product master or the first copy. Per
copy royalties on sales which exceed the guarantee are recognized as
earned.
5. COMPUTATION OF NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
(in thousands)
Quarter ended Nine months ended
December 31, December 31,
------------------------ -------------------------
1997 1996 1997 1996
----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
NUMERATOR:
Net income $ 9,278 $ 5,320 $ 5,701 $ 4,110
----------- ----------- ------------ -----------
Numerator for basic earnings per share-income
available to common stockholders 9,278 5,320 5,701 4,110
Effect of dilutive securities
Interest add-back on convertible debt 70 - 70 -
----------- ----------- ------------ -----------
Numerator for diluted earnings per share-income
available to common stockholders after assumed
conversions $ 9,348 $ 5,320 $ 5,771 $ 4,110
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
DENOMINATOR:
Denominator for basic earnings per share-weighted
average shares 18,581 17,781 18,296 16,908
Effect of dilutive securities:
Employee stock options 1,100 703 852 688
Convertible debentures 346 - 116 -
----------- ----------- ------------ -----------
Dilutive potential common shares 1,446 703 968 688
----------- ----------- ------------ -----------
Denominator for diluted earnings per share-adjusted
weighted average shares and assumed conversions 20,027 18,484 19,264 17,596
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
Basic earnings per share $ 0.50 $ 0.30 $ 0.31 $ 0.24
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
Diluted earnings per share $ 0.47 $ 0.29 $ 0.30 $ .23
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
</TABLE>
7
<PAGE>
ACTIVISION, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
For the quarter and nine months ended December 31, 1997, options to
purchase 793,000 and 1,397,000, respectively, shares of the Company's
common stock were outstanding but were not included in the computation of
diluted earnings per share because the options' exercise price was greater
than the average market price of the common shares.
For the quarter and nine months ended December 31, 1996, options to
purchase 2,260,000 and 2,377,000 shares of the Company's common stock were
outstanding but were not included in the computation of diluted earnings
per share because the options' exercise price was greater than the average
market price of the common shares.
6. ACQUISITIONS
On November 26, 1997, the Company completed its acquisition of CentreSoft
by the issuance of 2,787,043 shares of the Company's common stock in
exchange for all the outstanding Ordinary Shares, "A" Ordinary Shares, "B"
Ordinary Shares, redeemable preferred stock, convertible preferred stock
and secured loan stock debentures of CentreSoft. In addition, the Company
issued options to acquire 50,325 shares of the Company's common stock which
were in exchange for outstanding CentreSoft stock options. The acquisition
of CentreSoft was accounted for in accordance with the pooling of interests
method of accounting and, accordingly, the accompanying consolidated
financial statements have been retroactively adjusted as if CentreSoft and
the Company had operated as one since June 28, 1996 (inception of
CentreSoft).
Also on November 26, 1997, the Company completed its acquisition of NBG by
the issuance of 281,206 shares of the Company's common stock in exchange
for all outstanding common stock of NBG. In addition, as part of the
transaction, the Company acquired the real property (including land and
buildings) used by NBG that was owned by the two equity owners of NBG, in
exchange for assumption of certain debt secured by a mortgage on the
property. The transaction was accounted for as an immaterial pooling;
accordingly, the Company's operating results were not restated for periods
prior to October 1, 1997. However, weighted average shares outstanding and
earnings per share data were retroactively restated for the effect of the
NBG acquisition for all periods presented.
7. PRIVATE PLACEMENT OF CONVERTIBLE SUBORDINATED NOTES
In December 1997, the Company completed the private placement of $60.0
million principal amount of 6 3/4% Convertible Subordinated Notes due 2005
(the "Notes"). The Notes are convertible, in whole or in part, at the
option of the holder at any time after December 22, 1997 (the date of
original issuance) and prior to the close of business on the business day
immediately preceding the maturity date, unless previously redeemed or
repurchased, into common stock, $.000001 par value, of the Company, at a
conversion price of $18.875 per share, (equivalent to a conversion rate of
52.9801 shares per $1,000 principal amount of Notes), subject to adjustment
in certain circumstances. The Notes are redeemable, in whole or in part, at
the option of the Company at any time on or after January 10, 2001, subject
to premiums through December 31, 2003.
8
<PAGE>
1
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q, INCLUDING ITEM 2 ("MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS"),
CONTAINS FORWARD LOOKING STATEMENTS REGARDING FUTURE EVENTS OR THE FUTURE
FINANCIAL PERFORMANCE OF THE COMPANY THAT INVOLVE CERTAIN RISKS AND
UNCERTAINTIES DISCUSSED IN THE COMPANY'S RESTATED SUPPLEMENTAL CONSOLIDATED
FINANCIAL STATEMENTS FILED ON FORM 8-K UNDER "CERTAIN CAUTIONARY
INFORMATION". ACTUAL EVENTS OR THE ACTUAL FUTURE RESULTS OF THE COMPANY MAY
DIFFER MATERIALLY FROM ANY FORWARD LOOKING STATEMENT DUE TO SUCH RISKS AND
UNCERTAINTIES.
OVERVIEW
The Company is a leading international publisher, developer and
distributor of interactive entertainment software. The Company currently
focuses its publishing and development efforts on products designed for PCs
and the Sony PlayStation console system. In selecting titles for acquisition
or development, the Company currently pursues a balance between internally
and externally developed titles, products based on proven technology and
those based on newer technology, and PC and console products.
The Company distributes its products worldwide through its direct
sales force and through third party distributors and licensees. In addition,
in November 1997 the Company acquired CentreSoft and NBG and significantly
increased its worldwide distribution capabilities. Financial information as
of and for the year ended March 31, 1997 has been restated to reflect the
CentreSoft acquisition as a pooling of interests.
The Company recognizes revenue from the sale of its products upon
shipment. Subject to certain limitations, the Company permits customers to
obtain exchanges within certain specified periods and provides price
protection on certain unsold merchandise. Revenue from product sales is
reflected after deducting the allowance for returns and price protection.
With respect to license agreements which provide customers the right to
multiple copies in exchange for guaranteed amounts, revenue is recognized
upon delivery of the product master or the first copy. Per copy royalties on
sales which exceed the guarantee are recognized as earned.
Cost of goods sold related to console, PC and OEM net revenues
represents the manufacturing and related costs of computer software and
console games. Manufacturers of the Company's computer software are located
worldwide and are readily available. Console CDs and cartridges are
manufactured by the respective video game console manufacturers, Sony, Sega
and Nintendo, who often require significant lead time to fulfill the
Company's orders. Also included in cost of goods sold is the royalty expense
related to amounts due developers, product owners and other royalty
participants as a result of product sales. 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. Royalties
and license fees prepaid in advance of a product's release are capitalized.
Upon a product's release, prepaid royalties and license fees are charged to
cost of goods sold based on the contractual royalty rate. Management
evaluates the future realization of prepaid royalties quarterly and charges
to cost of goods sold any amounts that management deems unlikely to be
amortized at the contract royalty rate through product sales.
Product development costs are accounted for in accordance with
accounting standards which provide for the capitalization of certain software
development costs once technological feasibility is established. The
capitalized costs are then amortized on a straight-line basis over the
estimated product life or on the ratio of current revenues to total projected
revenues, whichever is greater. The software development costs that have been
capitalized to date have been immaterial.
9
<PAGE>
As a result of the CentreSoft Management Buyout occurring in June
1996 and the commencement therefrom of CentreSoft's operations (See note 3 to
the Supplemental Consolidated Financial Statements filed on form 8-K),
results of operations for the fiscal year ended March 31, 1997 and the
quarter ended June 30, 1997 versus the fiscal year ended March 31, 1996 and
the quarter ended June 30, 1996, respectively, are not indicative of
comparative combined results for the Company combined with CentreSoft for the
two periods.
The following tables set forth certain consolidated statements of
operations data for the periods indicated as a percentage of total net
revenues and also breaks down net revenues by territory, platform and channel:
<TABLE>
<CAPTION>
Quarter Ended December 31, Nine Months Ended December 31,
1997 1996 1997 1996
------------------- ---------------- ----------------- ----------------
% of Net % of Net % of Net % of Net
Amount Revenues Amount Revenues Amount Revenues Amount Revenues
---------- -------- ------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net revenues $122,141 100.0% $60,480 100.0% $201,670 100.0% $ 97,058 100.0%
Cost of goods sold 77,078 63.1% 36,185 59.8% 127,089 63.0% 51,562 53.1%
---------- ------- ------- ------- -------- ------- -------- -------
Gross profit 45,063 36.9% 24,295 40.2% 74,581 37.0% 45,496 46.9%
---------- ------- ------- ------- -------- ------- -------- -------
Operating expenses:
Product development $ 8,045 6.6% $ 4,707 7.8% $ 21,963 10.9% $ 13,861 14.3%
Sales and marketing 16,400 13.4% 8,344 13.8% 31,960 15.8% 18,276 18.8%
General and administrative 3,586 2.9% 2,563 4.2% 8,416 4.2% 6,056 6.2%
Amortization of intangible
assets 404 0.4% 393 0.6% 1,159 0.6% 1,104 1.1%
Merger expenses 1,474 1.2% - - 1,474 0.7% - -
---------- ------- ------- ------- -------- ------- -------- -------
Total operating expenses 29,909 24.5% 16,007 26.4% 64,972 32.2% 39,297 40.4%
---------- ------- ------- ------- -------- ------- -------- -------
Operating income 15,154 12.4% 8,288 13.7% 9,609 4.8% 6,199 6.5%
Other income (expense) (232) (0.2%) (31) - (377) (0.2%) 284 0.2%
---------- ------- ------- ------- -------- ------- -------- -------
Income before income tax provision 14,922 12.2% 8,257 13.7% 9,232 4.6% 6,483 6.7%
Income tax provision 5,644 4.6% 2,937 4.9% 3,531 1.8% 2,373 2.4%
---------- ------- ------- ------- -------- ------- -------- -------
Net income (loss) $ 9,278 7.6% $ 5,320 8.8% $ 5,701 2.8% $ 4,110 4.3%
---------- ------- ------- ------- -------- ------- -------- -------
---------- ------- ------- ------- -------- ------- -------- -------
NET REVENUES BY TERRITORY:
North America $ 42,329 34.6% $ 24,295 40.2% $ 67,468 33.5% $ 44,456 45.8%
Europe 73,811 60.4% 33,005 54.6% 123,048 61.0% 46,126 47.5%
Japan 2,505 2.1% 1,014 1.7% 3,100 1.5% 2,265 2.3%
Australia and Pacific Rim 2,589 2.1% 1,813 3.0% 5,988 3.0% 3,550 3.7%
Latin America 907 0.8% 353 0.5% 2,066 1.0% 661 0.7%
--------- -------- --------- ------- ---------- ------- --------- --------
$ 122,141 100.0% $ 60,480 100.0% $201,670 100.0% $ 97,058 100.0%
---------- ------- ------- ------- -------- ------- -------- -------
---------- ------- ------- ------- -------- ------- -------- -------
NET REVENUES BY PLATFORM:
Console $ 49,040 40.2% $ 20,514 33.9% $ 75,780 37.6% $ 22,837 23.5%
PC 73,101 59.8% 39,966 66.1% 125,890 62.4% 74,221 76.5%
--------- -------- --------- ------- ---------- ------- --------- --------
$ 122,141 100.0% $ 60,480 100.0% $201,670 100.0% $ 97,058 100.0%
--------- -------- --------- ------- ---------- ------- --------- --------
--------- -------- --------- ------- ---------- ------- --------- --------
NET REVENUES BY CHANNEL:
Retailer/Reseller $ 114,321 93.6% $ 53,659 88.7% $181,568 90.0% $ 82,502 85.0%
OEM 3,540 2.9% 4,849 8.0% 10,890 5.4% 11,184 11.5%
Licensing, on-line and other 4,280 3.5% 1,972 3.3% 9,212 4.6% 3,372 3.5%
--------- -------- --------- ------- ---------- ------- --------- --------
$ 122,141 100.0% $ 60,480 100.0% $201,670 100.0% $ 97,058 100.0%
--------- -------- --------- ------- ---------- ------- --------- --------
--------- -------- --------- ------- ---------- ------- --------- --------
</TABLE>
10
<PAGE>
RESULTS OF OPERATIONS
NET REVENUES
Net revenues for the quarter ended December 31, 1997 increased
102.0% from the same period last year, from $60.5 million to $122.1 million.
This increase was primarily attributable to a 74.2% increase in net revenues
in North America from $24.3 million to $42.3 million, a 123.6% increase in
net revenues in Europe from $33.0 million to $73.8 million, and a 42.8%
increase in net revenues in the Australia and Pacific Rim territories from
$1.8 million to $2.6 million.
Net revenues for the nine months ended December 31, 1997 increased
107.8% from the same period last year, from $97.1 million to $201.7 million.
This increase was attributable to 51.8% increase in net revenues in North
America from $44.4 million to $67.4 million, a 166.8% increase in net
revenues in Europe from $46.1 million to $123.0 million, and a 68.7% increase
in net revenues in the Australia and Pacific Rim territories from $3.6
million to $6.0 million.
The overall increase in net revenues and the increases in net
revenues in the specific territories for the quarter and nine months ended
December 31, 1997 were due to the initial releases during such periods of
QUAKE II (Windows 95), NIGHTMARE CREATURES (PlayStation), ZORK GRAND
INQUISITOR (Windows 95), HEAVY GEAR (Windows 95), SHANGHAI DYNASTY (Windows
95), HEXEN II (Windows 95), DARK REIGN: THE FUTURE OF WAR (Windows 95), CAR &
DRIVER'S GRAND TOUR RACING 1998 (PlayStation) and TWINSEN'S ODYSSEY (Windows
95). Net revenues also increased during such nine months period due to the
fact that CentreSoft, which began operations in June 1996, contributed only
seven months of revenue for the periods ended December 31, 1996, as opposed
to nine months of revenue for the periods ended December 31, 1997. In
addition, revenues attributable to NBG, which was acquired in November 1997,
were only included in the Company's net revenues for the quarter ended
December 31, 1997.
COST OF GOODS SOLD; GROSS PROFIT
Gross profit as a percentage of net revenues decreased to 36.9% for
the quarter ended December 31, 1997, from 40.2% for the same period last
year. Gross profit as a percentage of net revenues decreased from 46.9% to
37.0% for the nine months ended December 31, 1997. The decrease in gross
profit as a percentage of net revenues is due to the increase in the sales
mix of console net revenues versus PC net revenues and the increase in net
revenues derived from distribution arrangements as opposed to publishing
arrangements. Future determination of gross profit as a percentage of net
revenues will be driven primarily by the mix of new PC and console products
released by the Company during the applicable period, the mix of revenues
related to publishing arrangements versus distribution arrangements during
the applicable period, as well as the mix of internal versus external product
development, the latter in each case resulting in lower gross profit margins.
OPERATING EXPENSES
Product development expenses for the quarter ended December 31, 1997
increased 70.9% from the same period last year, from $4.7 million to $8.0
million. As a percentage of net revenues, product development expenses
decreased from 7.8% to 6.6%. Product development expenses for the nine months
ended December 31, 1997 increased 58.4% from the same period last year, from
$13.9 million to $22.0 million. As a percentage of net revenues, product
development expense decreased slightly from 14.3% to 10.9%. The increases in
the amount of product development expenses for the quarter and nine month
periods were due to an increase in the number of products in development, the
acquisition of Raven Software Corporation, and the increase in costs
associated with enhanced content and new technologies incorporated into the
Company's recent products. In addition, the increase was partly attributable
to an increase in the number of products being localized for international
territories.
Sales and marketing expenses for the quarter ended December 31, 1997
increased 96.5% from the same period last year, from $8.3 million to $16.4
million. As a percentage of net revenues, sales and marketing expenses
decreased from 13.8% to 13.4%. Sales and marketing expenses for the nine
months ended December 31, 1997 increased 74.9% from the same period last
year, from $18.2 million to $32.0
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million. As a percentage of net revenues, sales and marketing expenses
decreased from 18.8% to 15.8%. The increases in the amount of sales and
marketing expenses for the quarter and nine month periods were due to the
partial variable nature of sales and marketing expenses, the effect of the
increase in net revenues, and an increase in the number of products released
and to be released during the current fiscal year.
General and administrative expenses for the quarter ended December
31, 1997 increased 39.9% from the same period last year, from $2.6 million to
$3.6 million, but decreased as a percentage of net revenues from 4.2% to
2.9%. General and administrative expenses for the nine months ended December
31, 1997 increased 39.0% from the same period last year, from $6.1 million to
$8.4 million, but decreased as a percentage of net revenues from 6.2% to
4.2%. The period over period increase in the amount of general and
administrative expenses for both the quarter and nine month periods was due
to an increase in head count related expenses, the expansion of facilities
both in North America and internationally, and the implementation of new
management information systems. The decrease for the quarter and nine month
periods in sales and marketing as a percentage of revenues, however, is due
to the operating expense leverage gained as a result of an increased revenue
base.
OTHER INCOME (EXPENSE)
Net interest expense increased from $31,000 for the quarter ended
December 31, 1996 to $232,000 for the quarter ended December 31, 1997. Net
interest income of $284,000 for the nine months ended December 31, 1996
decreased to net interest expense of $377,000 for the nine months ended
December 31, 1997. Interest expense increased due to lower average cash and
cash equivalent balances, an increase in average outstanding borrowings on
the Company's lines of credit and the issuance of the subordinated
convertible notes in December 1997.
INCOME TAX PROVISION
The income tax provision of approximately $5,644,000 and $3,531,000
for the quarter and nine months ended December 31, 1997, respectively,
reflects the Company's expected effective income tax rate for the fiscal year
ending March 31, 1998.
NET INCOME
For the reasons noted above, net income increased to $9.3 million
for the quarter ended December 31, 1997, from a net income of $5.3 million
for the same period in the prior fiscal year. For the nine months ended
December 31, 1997, net income increased to $5.7 million, from a net income of
$4.1 million for the same period in the prior fiscal year.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased $70.2 million,
from $21.4 million at March 31, 1997 to $91.6 million at December 31, 1997.
Approximately $14.9 million in cash and cash equivalents were provided by
operating activities during the nine month period ended December 31, 1997.
This increase in cash and cash equivalents from operating activities was
primarily the result of an increase in net income from operations after
adding back depreciation and amortization, and increases in accounts payable
and accrued liabilities offset partially by increases in accounts receivables
and inventory.
In addition, approximately $9.1 million in cash and cash equivalents
were used in investing activities. Capital expenditures totaled approximately
$6.2 million, which were primarily composed of expenditures related to the
Company moving its Los Angeles office to a new facility in Santa Monica,
California.
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Sources of cash provided by financing activities totaled
approximately $64.4 million for the nine months ended December 31, 1997,
which included $60.0 million in proceeds from the private placement of
convertible subordinated notes completed in December 1997, as described
below, and approximately $4.0 million in proceeds from the exercise of
employee stock options.
In October 1997, the Company increased its revolving credit and
letter of credit facility (the "Facility") with its bank (the "Bank") from
$5.0 million to $12.5 million. The Facility provides the Company the ability
to borrow funds and issue letters of credit against eligible domestic
accounts receivable up to $12.5 million. The Facility expires in September
1998. The Company had no borrowings outstanding against the Facility as of
December 31, 1997. In addition, in September 1997, the Company entered into a
$2.0 million line of credit agreement (the "Asset Line") with the Bank;
drawings under the Asset Line are structured with 36 month repayment terms
and the Asset Line expires in September 1998. Borrowings under the Asset Line
totaled $1.3 million as of December 31, 1997, with an effective borrowing
rate of 8.3%. In June 1996, CentreSoft entered into a revolving credit
facility (the "CentreSoft Facility") with its bank for approximately $8.5
million. The CentreSoft Facility can be used for CentreSoft's working capital
requirements. The CentreSoft Facility expires in June 2000. The Company had
no borrowings outstanding against the CentreSoft facility as of December 31,
1997.
In December 1997, the Company completed the private placement of
$60.0 million principal amount of 6 3/4% Convertible Subordinated Notes due
2005 (the "Notes"). The Notes are convertible, in whole or in part, at the
option of the holder at any time after December 22, 1997 (the date of
original issuance) and prior to the close of business on the business day
immediately preceding the maturity date, unless previously redeemed or
repurchased, into common stock, $.000001 par value, of the Company, at a
conversion price of $18.875 per share, (equivalent to a conversion rate of
52.9801 shares per $1,000 principal amount of Notes), subject to adjustment
in certain circumstances. The Notes are redeemable, in whole or in part, at
the option of the Company at any time on or after January 10, 2001, subject
to premiums through December 31, 2003.
The Company's current principal source of liquidity is $91.6 million
in cash and cash equivalents. The Company uses its working capital to finance
ongoing operations, including acquisitions of inventory and equipment, to
fund the development, production, marketing and selling of new products, and
to obtain intellectual property rights for future products from third
parties. Management believes that the CompanyOs existing cash, together with
the capital available from the Facility, Asset Line and the CentreSoft
Facility, will be sufficient to meet the Company's operational requirements
for at least the next twelve months.
The Company's management currently believes that inflation has not
had a material impact on continuing operations.
RECENTLY ISSUED ACCOUNTING STANDARDS
Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings per Share," is effective for financial statements issued for
periods ending after December 15, 1997. SFAS No. 128 replaces Accounting
Principles Board Opinion ("APB") No. 15 and simplifies the computation of
earnings per share ("EPS") by replacing the presentation of primary EPS with
a presentation of basic EPS. Basic EPS includes no dilution and is computed
by dividing income available to common stockholders by the weighted-average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution from securities that could share in the earnings of the
Company, similar to fully diluted EPS under APB No. 15. The Statement
requires dual presentation of basic and diluted EPS by entities with complex
capital structures. The Company adopted SFAS No. 128 for the financial
statements for the three and nine months ended December 31, 1997.
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SFAS No. 130, "Reporting Comprehensive Income" is effective for
fiscal years beginning after December 15, 1997. SFAS No. 130 established
standards for the reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. The Statement requires that all items
that are required to be recognized under accounting standards as components
of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. The Company
will adopt SFAS No. 130 effective April 1, 1998.
SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" is effective for fiscal years beginning after December
15, 1997. SFAS No. 131 establishes standards for the way that public business
enterprises report financial and descriptive information about reportable
operating segments in annual financial statements and interim financial
reports issued to stockholders. SFAS No. 131 supersedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise," but retains the
requirement to report information about major customers. The Company will
adopt SFAS No. 131 effective April 1, 1998.
The AICPA recently issued Statement of Position 97-2, "Software
Revenue Recognition," (SOP 97-2) effective for transactions entered into in
fiscal years beginning after December 15, 1997. The Company will adopt SOP
97-2 for transactions occurring on or after April 1, 1998. The Company is
currently in substantial compliance with the provisions thereof.
FACTORS AFFECTING FUTURE PERFORMANCE
In connection with the Private Securities Litigation Reform Act of
1995 (the "Litigation Reform Act"), the Company is hereby disclosing certain
cautionary information to be used in connection with written materials
(including this 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. The discussion
below highlights some of the more important risks identified by management,
but should not be assumed to be the only factors that could affect future
performance. The reader or listener is cautioned that the Company does not
have a policy of updating or revising forward-looking statements and thus he
or she should not assume that silence by management over time means that
actual events are bearing out as estimated in such forward-looking statements.
FLUCTUATIONS IN QUARTERLY RESULTS; FUTURE OPERATING RESULTS
UNCERTAIN; SEASONALITY. The Company's quarterly operating results have varied
significantly in the past and will likely vary significantly in the future
depending on numerous factors, several of which are not under the Company's
control. Such factors include, but are not limited to, demand for the
Company's products and those of its competitors, the size and rate of growth
of the interactive entertainment software market, development and promotional
expenses relating to the introduction of new products, changes in computing
platforms, product returns, the timing of orders from major customers, delays
in shipment, the level of price competition, the timing of product
introduction by the Company and its competitors, product life cycles,
software defects and other product quality problems, the level of the
Company's international revenues, and personnel changes. In particular,
during the past few fiscal years the Company's operating results for the
quarters ended June 30 have been less favorable than in other quarters as a
result of the release of fewer new products during the June 30 quarters in
accordance with the Company's product release schedules. Products are
generally shipped as orders are received, and consequently, the Company
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operates with little or no backlog. Net revenues in any quarter are,
therefore, substantially dependent on orders booked and shipped in that
quarter.
The Company's expenses are based in part on the Company's product
development and marketing budgets. Product development and marketing costs
generally are expensed as incurred, which is often long before a product is
released. In addition, a large portion of the Company's expenses are fixed.
As the Company increases its development and marketing activities, current
expenses will increase and, if sales from previously released products are
below expectations, net income is likely to be disproportionately affected.
Due to all of the foregoing, revenues and operating results for any
future quarter are not predictable with any significant degree of accuracy.
Accordingly, the Company believes that period-to-period comparisons of its
operating results are not necessarily meaningful and should not be relied
upon as indications of future performance.
The Company's business has experienced and is expected to continue to
experience significant seasonality, in part due to consumer buying patterns.
Net revenues and net income typically are significantly higher during the
fourth calendar quarter, due primarily to the increased demand for consumer
software during the year-end holiday buying season. Net revenues and net
income in other quarters are generally lower and vary significantly as a
result of new product introductions and other factors. For example, the
Company's net revenues in its last seven quarters were $122.1 million for the
quarter ended December 31, 1997, $53.0 million for the quarter ended
September 30, 1997, $26.5 million for the quarter ended June 30, 1997, $57.6
million for the quarter ended March 31, 1997, $60.5 million for the quarter
ended December 31, 1996, $29.6 million for the quarter ended September 30,
1996 and $7.0 million for the quarter ended June 30, 1996. The Company's net
income (loss) for the last seven quarters were $9.3 million for the quarter
ended December 31, 1997, $1.8 million for the quarter ended September 30,
1997, $(5.4 million) for the quarter ended June 30, 1997, $5.1 million for
the quarter ended March 31, 1997, $5.3 million for the quarter ended December
31, 1996, $1.4 million for the quarter ended September 30, 1996, and $(2.6
million) for the quarter ended June 30, 1996. The Company expects its net
revenue and operating results to continue to reflect significant seasonality.
DEPENDENCE ON NEW PRODUCT DEVELOPMENT; PRODUCT DELAYS. The Company's
future success depends on the timely introduction of successful new products
to replace declining revenues from older products. If, for any reason,
revenues from new products were to fail to replace declining revenues from
older products, the Company's business, operating results and financial
condition would be materially and adversely affected. In addition, the
Company believes that the competitive factors in the interactive
entertainment software marketplace create the need for higher quality,
distinctive products that incorporate increasingly sophisticated effects and
the need to support product releases with increased marketing, resulting in
higher development, acquisition and marketing costs. The lack of market
acceptance or significant delay in the introduction of, or the presence of a
defect in, one or more products could have a material adverse effect on the
Company's business, operating results and financial condition, particularly
in view of the seasonality of the Company's business. Further, because a
large portion of a product's revenue generally is associated with initial
shipments, the delay of a product introduction expected near the end of a
fiscal quarter may have a material adverse effect on operating results for
that quarter.
The Company has, in the past, experienced significant delays in the
introduction of certain new products. The timing and success of interactive
entertainment products remain unpredictable due to the complexity of product
development, including the uncertainty associated with technological
developments. Although the Company has implemented substantial development
controls, there likely will be delays in developing and introducing new
products in the future. There can be no assurance that
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new products will be introduced on schedule, or at all, or that they will
achieve market acceptance or generate significant revenues.
RELIANCE ON THIRD PARTY DEVELOPERS AND INDEPENDENT CONTRACTORS. The
percentage of products published by the Company that are developed by
independent third party developers has increased over the last several fiscal
years. From time to time, the Company also utilizes independent contractors
for certain aspects of internal product development and production. The
Company has less control over the scheduling and the quality of work by third
party developers and independent contractors than that of its own employees.
A delay in the work performed by third party developers and independent
contractors or poor quality of such work may result in product delays.
Although the Company intends to continue to rely in part on products that are
developed primarily by its own employees, the Company's ability to grow its
business and its future operating results will depend, in significant part,
on the Company's continued ability to maintain relationships with skilled
third party developers and independent contractors. There can be no assurance
that the Company will be able to maintain such relationships.
UNCERTAINTY OF MARKET ACCEPTANCE; SHORT PRODUCT LIFE CYCLES. The market
for entertainment systems and software has been characterized by shifts in
consumer preferences and short product life cycles. Consumer preferences for
entertainment software products are difficult to predict and few
entertainment software products achieve sustained market acceptance. There
can be no assurance that new products introduced by the Company will achieve
any significant degree of market acceptance, that such acceptance will be
sustained for any significant period, or that product life cycles will be
sufficient to permit the Company to recoup development, marketing and other
associated costs. In addition, if market acceptance is not achieved, the
Company could be forced to accept substantial product returns to maintain its
relationships with retailers and its access to distribution channels. Failure
of new products to achieve or sustain market acceptance or product returns in
excess of the Company's expectations would have a material adverse effect on
the Company's business, operating results and financial condition.
PRODUCT CONCENTRATION; DEPENDENCE ON HIT PRODUCTS. A key aspect of the
Company's strategy is to focus its development and acquisition efforts on
selected, high quality entertainment software products. The Company derives a
significant portion of its revenues from a relatively small number of high
quality entertainment software products released each year, and many of these
products have substantial production or acquisition costs and marketing
budgets. During fiscal 1996 and 1997, one title accounted for approximately
49% and 26%, respectively, of the Company's consolidated net revenues. In
addition, during fiscal 1997, one other title accounted for approximately 13%
of the Company's consolidated net revenues. The Company anticipates that a
limited number of products will continue to produce a disproportionate amount
of revenues. Due to this dependence on a limited number of products, the
failure of one or more of the Company's principal new releases to achieve
anticipated results may have a material adverse effect on the Company's
business, operating results and financial condition.
The Company's strategy also includes as a key component developing and
releasing products that have franchise value, such that sequels, enhancements
and add-on products can be released over time, thereby extending the life of
the property in the market. While the focus on franchise properties, if
successful, results in extending product life cycles, it also results in the
Company depending on a limited number of titles for its revenues. There can
be no assurance that the Company's existing franchise titles can continue to
be exploited as successfully as in the past. In addition, new products that
the Company believes will have potential value as franchise properties may
not achieve market acceptance and therefore may not be a basis for future
releases.
INDUSTRY COMPETITION; COMPETITION FOR SHELF SPACE. The interactive
entertainment software industry is intensely competitive. Competition in the
industry is principally based on product quality and features, the
compatibility of products with popular platforms, company or product line
brand name recognition,
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access to distribution channels, marketing effectiveness, reliability and
ease of use, price and technical support. Significant financial resources
also have become a competitive factor in the entertainment software industry,
principally due to the substantial cost of product development and marketing
that is required to support best-selling titles. In addition, competitors
with broad product lines and popular titles typically have greater leverage
with distributors and other customers who may be willing to promote titles
with less consumer appeal in return for access to such competitor's most
popular titles.
The Company's competitors range from small companies with limited
resources to large companies with substantially greater financial, technical
and marketing resources than those of the Company. The Company's competitors
currently include Electronic Arts, Lucas Arts, Microsoft, Sega, Nintendo,
Sony, Cendant, GT Interactive, Broderbund, Midway, Interplay, Virgin and
Eidos, among many others.
As competition increases, significant price competition, increased
production costs and reduced profit margins may result. Prolonged price
competition or reduced demand would have a material adverse effect on the
Company's business, operating results and financial condition. There can be
no assurance that the Company will be able to compete successfully against
current or future competitors or that competitive pressures faced by the
Company will not have a material adverse effect on its business, operating
results and financial condition.
Retailers typically have a limited amount of shelf space, and there is
intense competition among entertainment software producers for adequate
levels of shelf space and promotional support from retailers. As the number
of entertainment software products increase, the competition for shelf space
has intensified, resulting in greater leverage for retailers and distributors
in negotiating terms of sale, including price discounts and product return
policies. The Company's products constitute a relatively small percentage of
a retailer's sales volume, and there can be no assurance that retailers will
continue to purchase the Company's products or promote the Company's products
with adequate levels of shelf space and promotional support.
DEPENDENCE ON DISTRIBUTORS; RISK OF CUSTOMER BUSINESS FAILURE; PRODUCT
RETURNS. Certain mass market retailers have established exclusive buying
relationships under which such retailers will buy consumer software only from
one intermediary. In such instances, the price or other terms on which the
Company sells to such retailers may be adversely affected by the terms
imposed by such intermediary, or the Company may be unable to sell to such
retailers on terms which the Company deems acceptable. The loss of, or
significant reduction in sales attributable to, any of the Company's
principal distributors or retailers could materially adversely affect the
Company's business, operating results and financial condition.
Distributors and retailers in the computer industry have from time to
time experienced significant fluctuations in their businesses and there have
been a number of business failures among these entities. The insolvency or
business failure of any significant distributor or retailer of the Company's
products could have a material adverse effect on the Company's business,
operating results and financial condition. Sales are typically made on
credit, with terms that vary depending upon the customer and the nature of
the product. The Company does not hold collateral to secure payment. Although
the Company has obtained insolvency risk insurance to protect against any
bankruptcy, insolvency or liquidation that occur to its customers, such
insurance contains a significant deductible as well as a co-payment
obligation, and the policy does not cover all instances of non-payment. In
addition, the Company maintains a reserve for uncollectible receivables that
it believes to be adequate, but the actual reserve that is maintained may not
be sufficient in every circumstance. As a result of the foregoing, a payment
default by a significant customer could have a material adverse effect on the
Company's business, operating results and financial condition.
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The Company also is exposed to the risk of product returns from
distributors and retailers. Although the Company provides reserves for
returns that it believes are adequate, and although the Company's agreements
with certain of its customers place certain limits on product returns, the
Company could be forced to accept substantial product returns to maintain its
relationships with retailers and its access to distribution channels. Product
returns that exceed the Company's reserves could have a material adverse
effect on the Company's business, operating results and financial condition.
CHANGES IN TECHNOLOGY AND INDUSTRY STANDARDS. The consumer software
industry is undergoing rapid changes, including evolving industry standards,
frequent new platform introductions and changes in consumer requirements and
preferences. The introduction of new technologies, including operating
systems such as Microsoft's Windows 95, technologies that support
multi-player games, and new media formats such as on-line delivery and
digital video disks ("DVD"), could render the Company's previously released
products obsolete or unmarketable. The development cycle for products
utilizing new operating systems, microprocessors or formats may be
significantly longer than the Company's current development cycle for
products on existing operating systems, microprocessors and formats and may
require the Company to invest resources in products that may not become
profitable. There can be no assurance that the mix of the Company's future
product offerings will keep pace with technological changes or satisfy
evolving consumer preferences, or that the Company will be successful in
developing and marketing products for any future operating system or format.
Failure to develop and introduce new products and product enhancements in a
timely fashion could result in significant product returns and inventory
obsolescence and could have a material adverse effect on the Company's
business, operating results and financial condition.
LIMITED PROTECTION OF INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS; RISK
OF LITIGATION. The Company holds copyrights on its products, manuals,
advertising and other materials and maintains trademark rights in the Company
name, the ACTIVISION logo, and the names of products owned by the Company.
The Company regards its software as proprietary and relies primarily on a
combination of trademark, copyright and trade secret laws, employee and
third-party nondisclosure agreements, and other methods to protect its
proprietary rights. Unauthorized copying is common within the software
industry, and if a significant amount of unauthorized copying of the
Company's products were to occur, the Company's business, operating results
and financial condition could be adversely affected. There can be no
assurance that third parties will not assert infringement claims against the
Company in the future with respect to current or future products. As is
common in the industry, from time to time the Company receives notices from
third parties claiming infringement of intellectual property rights of such
parties. The Company investigates these claims and responds as it deems
appropriate. Any claims or litigation, with or without merit, could be costly
and could result in a diversion of management's attention, which could have a
material adverse effect on the Company's business, operating results and
financial condition. Adverse determinations in such claims or litigation
could also have a material adverse effect on the Company's business,
operating results and financial condition.
Policing unauthorized use of the Company's products is difficult, and
while the Company is unable to determine the extent to which piracy of its
software products exists, software piracy can be expected to be a persistent
problem. In selling its products, the Company relies primarily on "shrink
wrap" licenses that are not signed by licensees and, therefore, may be
unenforceable under the laws of certain jurisdictions. Further, the Company
enters into transactions in countries where intellectual property laws are
not well developed or are poorly enforced. Legal protections of the Company's
rights may be ineffective in such countries.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a
significant extent on the performance and continued service of its senior
management and certain key employees. Competition for highly skilled
employees with technical, management, marketing, sales, product development
and other specialized training is intense, and there can be no assurance that
the Company will be successful in
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attracting and retaining such personnel. Specifically, the Company may
experience increased costs in order to attract and retain skilled employees.
Although the Company generally enters into term employment agreements with
its skilled employees and other key personnel, there can be no assurance that
such employees will not leave the Company or compete against the Company. The
Company's failure to attract or retain qualified employees could have a
material adverse effect on the Company's business, operating results and
financial condition.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. International sales and
licensing accounted for 28%, 23% and 58% of the Company's total revenues in
the fiscal years 1995, 1996 and 1997, respectively. The Company intends to
continue to expand its direct and indirect sales, marketing and localization
activities worldwide. Such expansion will require significant management time
and attention and financial resources in order to develop adequate
international sales and support channels. There can be no assurance, however,
that the Company will be able to maintain or increase international market
demand for its products. International sales are subject to inherent risks,
including the impact of possible recessionary environments in economies
outside the United States, the costs of transferring and localizing products
for foreign markets, longer receivable collection periods and greater
difficulty in accounts receivable collection, unexpected changes in
regulatory requirements, difficulties and costs of staffing and managing
foreign operations, and political and economic instability. There can be no
assurance that the Company will be able to sustain or increase international
revenues or that the foregoing factors will not have a material adverse
effect on the Company's future international revenues and, consequently, on
the Company's business, operating results and financial condition. The
Company currently does not engage in currency hedging activities. Although
exposure to currency fluctuations to date has been insignificant, there can
be no assurance that fluctuations in currency exchange rates in the future
will not have a material adverse impact on revenues from international sales
and licensing and thus the Company's business, operating results and
financial condition.
RISK OF SOFTWARE DEFECTS. Software products such as those offered by the
Company frequently contain errors or defects. Despite extensive product
testing, in the past the Company has released products with defects and has
discovered software errors in certain of its product offerings after their
introduction. In particular, the PC hardware environment is characterized by
a wide variety of non-standard peripherals (such as sound cards and graphics
cards) and configurations that make pre-release testing for programming or
compatibility errors very difficult and time-consuming. There can be no
assurance that, despite testing by the Company, errors will not be found in
new products or releases after commencement of commercial shipments,
resulting in a loss of or delay in market acceptance, which could have a
material adverse effect on the Company's business, operating results and
financial condition.
RISKS ASSOCIATED WITH ACQUISITIONS. The Company intends to integrate the
operations of its recently acquired CentreSoft and NBG subsidiaries with its
previously existing European operations. This process, as well as the process
of managing two significant new operations, will require substantial
management time and effort and could divert the attention of management from
other matters. In addition, there is a risk of loss of key employees,
customers and vendors of the newly acquired operations as well as existing
operations as this process is implemented. There is no assurance that the
Company will be successful in integrating these operations or that, if the
operations are combined, that there will not be adverse effects on its
business.
Consistent with its strategy to enhance distribution and product
development capabilities, the Company intends to continue to pursue
acquisitions of companies and intellectual property rights and other assets
that can be acquired on acceptable terms and which the Company believes can
be operated or exploited profitably. Some of these acquisitions could be
material in size and scope. While the Company will continually be searching
for appropriate acquisition opportunities, there can be no assurance that the
Company will be successful in identifying suitable acquisitions. If any
potential acquisition opportunities are identified, there can be no assurance
that the Company will consummate such acquisitions or if any
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such acquisition does occur, that it will be successful in enhancing the
Company's business or be accretive to the Company's earnings. As the
entertainment software business continues to consolidate, the Company faces
significant competition in seeking acquisitions and may in the future face
increased competition for acquisition opportunities, which may inhibit its
ability to complete suitable transactions. Future acquisitions could also
divert substantial management time, could result in short term reductions in
earnings or special transaction or other charges and may be difficult to
integrate with existing operations or assets.
The Company may, in the future, issue additional shares of Common Stock
in connection with one or more acquisitions, which may dilute its
shareholders, including investors in the offering. Additionally, with respect
to most of its future acquisitions, the Company's shareholders may not have
an opportunity to review the financial statements of the entity being
acquired or to vote on such acquisitions.
RISK OF CENTRESOFT VENDOR DEFECTIONS; VENDOR CONCENTRATION.
The Company's recently acquired CentreSoft subsidiary performs software
distribution services in the United Kingdom and, via export, in other
European territories for a variety of entertainment software publishers many
of which are competitors of the Company. These services are generally
performed under limited term contracts some of which provide for cancellation
in the event of a change of control. While the Company expects to use
reasonable efforts to retain these clients, there can be no assurance that
the Company will be successful in this regard. The cancellation or
non-renewal of one or more of these contracts could have a material adverse
effect on the Company's business, operating results and financial condition.
Two of CentreSoft's vendors accounted for 37%, 14% and 10%, respectively, of
CentreSoft's net revenues in fiscal year 1997.
20
<PAGE>
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.
ITEM 5. OTHER INFORMATION
The following table presents the previous five fiscal years ended March
31, 1997 earnings per share:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Basic earnings per share 0.52 0.36 (0.10) (0.78) (0.73)
Basic earnings per
share-dissolution of - - - - (0.06)
discontinued operations
Basic earnings per
share-discontinued - - - - (0.17)
operations
Diluted earnings per share 0.50 0.34 (0.10) (0.78) (0.73)
Diluted earnings per
share-dissolution - - - - (0.06)
of discontinued operations
Diluted earnings per share
discontinued operations - - - - (0.17)
</TABLE>
The following table presents the reconciliation of earnings per share
calculations restated in accordance with Statement of Financial
Accounting Standards No. 128, Earnings Per Share (SFAS No. 128), for
each of the years in the three year period ended March 31, 1997:
<TABLE>
<CAPTION>
For the Year Ended
March 31, 1997 March 31, 1996 March 31, 1995
------------------- ------------------- --------------------
(amounts in thousands)
<S> <C> <C> <C>
NUMERATOR:
Net income (loss) from continuing operations $ 9,226 $ 5,530 $ (1,520)
Less: Preferred stock dividends (151) - -
------------------- ------------------- --------------------
Numerator for basic and diluted net income
(loss) per share-income available to
common stockholders $ 9,075 $ 5,530 $ (1,520)
------------------- ------------------- --------------------
------------------- ------------------- --------------------
DENOMINATOR:
Denominator for basic net income (loss) per
share-weighted average shares 17,362 15,332 15,265
Effect of dilutive securities:
Employee stock options and warrants 689 939 -
------------------- ------------------- --------------------
Denominator for diluted net income (loss) per
share-adjusted weighted average shares and
assumed conversions 18,051 16,271 15,265
------------------- ------------------- --------------------
------------------- ------------------- --------------------
</TABLE>
Weighted average options to purchase 4,599,000, 2,786,000 and 1,190,000
shares of common stock were outstanding for the years ended March 31, 1997,
1996 and 1995, respectively, these options were not included in the
calculations of diluted earnings per share because their effect would be
antidilutive.
21
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
None.
(b) REPORTS ON FORM 8-K
On December 5, 1997, the Company filed a Current Report on Form
8-K reporting the completion of the acquisitions of CentreSoft and
NBG on November 26, 1997. The transactions were accounted for as
"pooling of interests."
On December 12, 1997, the Company filed a Form 8-K/A containing
the audited consolidated financial statements of Combined
Distribution (Holdings) Limited as of and for the ten months ended
April 30, 1997.
On December 23, 1997, the Company filed a Current Report on Form
8-K reporting the Company's private placement of $60,000,000
principal amount of 6 3/4% Convertible Subordinated Notes due
2005.
On January 9, 1998, the Company filed a Current Report on Form 8-K
reporting information under Item 5, Other Events, and under Item
7, Financial Statements, Pro Forma Financial Information and
Exhibits. In the report, the Company restated financial statements
and supplemental data as a result of the acquisition of CentreSoft
in November 1997. All balances were restated as if the acquisition
had occurred June 28, 1996, the inception of CentreSoft.
22
<PAGE>
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, 1998
ACTIVISION, INC.
/s/ BARRY J. PLAGA Senior Vice President and February 14, 1998
- ----------------------- Chief Financial Officer
(Barry J. Plaga) (Duly Authorized Officer)
23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 91,617
<SECURITIES> 0
<RECEIVABLES> 113,342
<ALLOWANCES> 13,911
<INVENTORY> 17,588
<CURRENT-ASSETS> 220,508
<PP&E> 21,013
<DEPRECIATION> (10,097)
<TOTAL-ASSETS> 262,353
<CURRENT-LIABILITIES> 103,673
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 97,388
<TOTAL-LIABILITY-AND-EQUITY> 262,353
<SALES> 201,670
<TOTAL-REVENUES> 201,670
<CGS> 127,089
<TOTAL-COSTS> 127,089
<OTHER-EXPENSES> 64,972
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 377
<INCOME-PRETAX> 9,232
<INCOME-TAX> 3,531
<INCOME-CONTINUING> 5,701
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,701
<EPS-PRIMARY> 0.31
<EPS-DILUTED> 0.30
</TABLE>
