<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------
FORM 10-Q
X QUARTERLY REPORT UNDER SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT
--- OF 1934 for Quarterly period ended June 30, 1995
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
--- AND EXCHANGE ACT OF 1934 for the Quarterly period from _____ to _____.
Commission file number: 0-17154
SIERRA ON-LINE, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0164293
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
3380 - 146TH PLACE SE., SUITE 300, BELLEVUE, WA 98007
------------------------------------------------------
(Address of principal executive offices)
(206) 649-9800
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registration 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 July
17, 1995 was 17,766,340.
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<PAGE> 2
SIERRA ON-LINE, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at June 30, 1995 and March 31, 1995 . . . . . . . . . 3
Consolidated Statements of Operations --
three months ended June 30, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Cash Flows --
three months ended June 30, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements --
three months ended June 30, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . 8
PART II. OTHER INFORMATION
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Item 6. Exhibits and Reports of Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . 31
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
</TABLE>
2
<PAGE> 3
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SIERRA ON-LINE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
June 30, March 31,
1995 1995
---------- ----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40,680 $ 48,888
Marketable investment securities . . . . . . . . . . . . . . . . . . . . . . . . 46,286 50,573
Accounts receivable, net of allowances of $6,704 and $7,262 . . . . . . . . . . . 20,051 11,024
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,819 4,838
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,300 1,760
Refundable income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 670
Other current assets (including $792 receivable from related parties on March 31) 3,652 4,226
---------- ----------
Total Current Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117,903 121,979
PROPERTY, PLANT AND EQUIPMENT, net . . . . . . . . . . . . . . . . . . . . . . . . . . 9,355 8,851
SOFTWARE DEVELOPMENT COSTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,048 1,048
GOODWILL, net of accumulated amortization of $3,256 and $2,871 . . . . . . . . . . . . 6,113 6,498
DEFERRED INCOME TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,370 1,515
OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 628 1,807
---------- ----------
$ 136,417 $ 141,698
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,924 $ 5,829
Accrued compensation and related benefits . . . . . . . . . . . . . . . . . . . . 3,438 3,804
Accrued incentive payments . . . . . . . . . . . . . . . . . . . . . . . . . . . --- 1,562
Royalties payable (including $239 and $633 payable to a related party) . . . . . 1,931 2,840
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,201 1,261
Accrued interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 543 1,160
Other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,485 3,977
---------- ----------
Total Current Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 16,522 20,433
ADVANCES UNDER PUBLISHING AGREEMENT AND OTHER LIABILITIES . . . . . . . . . . . . . . . 5,136 5,326
CONVERTIBLE DEBT, net of unamortized discount and issuance costs of $954 and $1,066 . . 32,396 34,634
STOCKHOLDERS' EQUITY:
Preferred stock, par value of $.01 per share;
1,000,000 shares authorized; none outstanding . . . . . . . . . . . . . . . . --- ---
Common stock and paid in capital, par value $.01 per share;
40,000,000 shares authorized; 17,758,732 and 17,557,115 shares
issued as of June 30, 1995 and March 31,1995, respectively . . . . . . . . . . 71,933 70,021
Retained earnings, including net unrealized holding gain . . . . . . . . . . . . 10,672 11,514
Cumulative translation adjustment . . . . . . . . . . . . . . . . . . . . . . . . 107 119
---------- ----------
82,712 81,654
Less common stock in treasury, 94,154 shares at cost . . . . . . . . . . . . . . . 349 349
---------- ----------
Total Stockholders' Equity . . . . . . . . . . . . . . . . . . . . . . . 82,363 81,305
---------- ----------
$ 136,417 $ 141,698
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
3
<PAGE> 4
SIERRA ON-LINE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three months ended
June 30 ,
-------------------------
1995 1994
-------- --------
<S> <C> <C>
REVENUES:
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 21,166 $ 12,091
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290 770
-------- --------
21,456 12,861
-------- --------
OPERATING EXPENSES:
Manufacturing costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,483 3,400
Amortization of software development costs . . . . . . . . . . . . . . . . . . --- 1,590
Royalties (including $151 and $41 earned by related party) . . . . . . . . . . 1,616 680
Selling, general and administrative . . . . . . . . . . . . . . . . . . . . . 8,097 6,600
Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,485 3,721
-------- --------
21,681 15,991
-------- --------
LOSS FROM OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (225) (3,130)
-------- -------
OTHER INCOME (EXPENSE):
Equity in loss from The ImagiNation Network . . . . . . . . . . . . . . . . . --- (1,538)
Interest income (including $21 and $20 earned from related parties) . . . . . 1,388 612
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (695) (789)
Amortization of goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . (436) (305)
-------- --------
257 (2,020)
-------- --------
INCOME (LOSS) BEFORE INCOME TAXES . . . . . . . . . . . . . . . . . . . . . . . . . 32 (5,150)
INCOME TAX BENEFIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . --- 1,005
-------- --------
NET INCOME (LOSS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 32 $ (4,145)
======== ========
NET INCOME (LOSS) PER SHARE . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.00 $ (0.26)
======== ========
Weighted average shares outstanding . . . . . . . . . . . . . . . . . . . . . . . 18,673 16,124
======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE> 5
SIERRA ON-LINE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Three months ended
June 30,
-------------------------
1995 1994
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 32 $ (4,145)
Reconciliation to net cash provided by (used for) operating activities:
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 878 1,016
Amortization of intangible assets and issuance costs . . . . . . . . . . . . 426 2,020
Equity loss from The ImagiNation Network . . . . . . . . . . . . . . . . . --- 1,538
Provision for doubtful accounts . . . . . . . . . . . . . . . . . . . . . . 565 188
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . (395) (1,005)
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,436) (13)
Cash provided (used) by changes in assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9,592) (1,052)
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 (441)
Refundable income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 555 1,357
Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 573 (416)
Software development costs . . . . . . . . . . . . . . . . . . . . . . . . --- (2,074)
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,179 106
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 33
Royalties payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (909) (228)
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (60)
Other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,037) 1,348
Advances under publishing agreement and other liabilities . . . . . . . . . (190) (2)
-------- --------
Net cash used for operating activities . . . . . . . . . . . . . . . . . . (11,296) (1,770)
INVESTING ACTIVITIES:
Proceeds from matured or retired marketable investment securities . . . . . . . 29,916 14,986
Purchases of marketable investment securities . . . . . . . . . . . . . . . . . (25,393) (14,279)
Net purchase of property, plant, and equipment . . . . . . . . . . . . . . . . . (1,382) (1,381)
Loan to The ImagiNation Network . . . . . . . . . . . . . . . . . . . . . . . . --- (2,895)
Payment for purchase of subsidiaries, net of cash acquired and
research and development . . . . . . . . . . . . . . . . . . . . . . . . . . --- (307)
-------- --------
Net cash provided by (used for) investing activities . . . . . . . . . . . . 3,141 (3,876)
FINANCING ACTIVITIES:
Proceeds from convertible debt offering . . . . . . . . . . . . . . . . . . . . --- 48,250
Proceeds from exercise of options and warrants . . . . . . . . . . . . . . . . . 112 254
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (165) (67)
-------- --------
Net cash provided by (used for) financing activities . . . . . . . . . . . . (53) 48,437
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS . . . . . . . . . . . . . . . . (8,208) 42,791
CASH AND CASH EQUIVALENTS:
BEGINNING OF PERIOD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48,888 3,281
-------- --------
END OF PERIOD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40,680 $ 46,072
======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
5
<PAGE> 6
SIERRA ON-LINE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 1995 AND 1994
NOTE 1 - BASIS OF PRESENTATION
The accompanying financial statements should be read in conjunction with Item 5
in this Form 10-Q and the Company's Form 10-K for the year ended March 31,
1995.
The unaudited financial information, as of and for the periods ended June 30,
1995 and 1994, was prepared in a manner consistent with the audited financial
statements and pursuant to the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, the accompanying interim
financial statements reflect all adjustments which are of a normal recurring
nature and necessary to present fairly the financial position, results of
operations and cash flows for the periods presented. The results of operations
for the three months ended June 30, 1995 are not necessarily indicative of the
results to be expected for the entire year.
NOTE 2 - BUSINESS COMBINATIONS
On May 31, 1995 the Company merged with The Pixellite Group ("Pixellite"), a
developer of personal printing software, in exchange for 245,779 shares of
Sierra's common stock. On June 20, 1995 the Company also merged with Software
Inspiration, Ltd. ("Inspiration"), a developer of strategy games, in exchange
for 730,352 shares of Sierra's common stock.
The mergers have been accounted for as poolings-of-interests. The
pooling-of-interests method of accounting is intended to present as a single
interest two or more common shareholders' interests which were previously
independent; accordingly, the unaudited financial information presented herein
reflects the combined results of Sierra, Pixellite and Inspiration for all
periods presented.
All fees and expenses related to the merger of the combined companies have been
expensed as required under the pooling-of-interests accounting method. These
expenses have been reflected in the consolidated statement of operations of the
Company for the three months ended June 30, 1995. Such fees and expenses total
approximately $220,000 and include legal and accounting fees.
The following summarizes amounts previously reported by Sierra prior to the
transaction for the three months ended June 30, 1994 (in thousands, except per
share data):
<TABLE>
<CAPTION>
Net Income
Net Income (Loss)
Revenues (Loss) Per Share
-------- ---------- ---------
<S> <C> <C> <C>
Sierra . . . . . . . . . . . . . . . . . . . . . $ 11,506 $ (4,271) $ (0.28)
Pixellite and Inspiration . . . . . . . . . . . 1,355 126 0.02
-------- -------- --------
Combined . . . . . . . . . . . . . . . . . . . . $ 12,861 $ (4,145) $ (0.26)
======== ======== ========
</TABLE>
NOTE 3 - NET INCOME (LOSS) PER SHARE
Net income (loss) per share is based upon the weighted average number of common
shares outstanding during the period as adjusted for the shares issued in the
merger with Pixellite and Inspiration described in Note 2 and after
consideration of the dilutive effect, if any, of stock options granted using
the treasury stock method. In addition, conversion of the Company's 6-1/2%
Convertible Subordinated Notes are included in fully diluted income per share
using the if-converted method when such securities are dilutive.
6
<PAGE> 7
NOTE 4 - INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
(Dollars in thousands)
June 30, March 31,
1995 1995
--------- --------
<S> <C> <C>
Raw materials . . . . . . . . . . . . . . . $ 3,202 $ 2,793
Work in progress . . . . . . . . . . . . . . 24 65
Finished goods . . . . . . . . . . . . . . . 1,593 1,980
-------- --------
$ 4,819 $ 4,838
======== ========
</TABLE>
7
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This discussion and analysis of operations should be read in conjunction with
the accompanying financial statements, Item 5 in this Form 10-Q, and the
Company's Form 10-K for the year ended March 31, 1995. The analysis is
provided pursuant to applicable Securities and Exchange Commission regulations
and is not intended to serve as a basis for projection of future events.
On May 31, 1995 the Company merged with The Pixellite Group ("Pixellite"), a
developer of personal printing software, in exchange for 245,779 shares of
Sierra's common stock. On June 20, 1995 the Company also merged with Software
Inspiration, Ltd. ("Inspiration"), a developer of strategy games, in exchange
for 730,352 shares of Sierra's common stock. Both mergers have been accounted
for as poolings-of-interests. Accordingly, the unaudited financial information
presented herein reflects the combined results of Sierra, Pixellite and
Inspiration for all periods presented.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1995 AND 1994
REVENUES: Net sales of $21,166,000 and total revenues of $21,456,000 for the
current quarter represented an increase of 75% and 67%, respectively, when
compared to the same quarter in the prior year. International revenues were
approximately $7.9 million for the current quarter compared to approximately
$2.9 million for the comparable quarter of the prior year, an increase of 171%.
Of this $5 million increase in international sales, $3.5 million was
attributable to increased distribution of the Company's products in Europe
through its Coktel subsidiary.
Historically the Company's sales are seasonal and the Company's quarter ending
December 31 frequently has the highest sales volume of the four fiscal quarters
because of the holiday season. Besides seasonality, factors having a major
impact on sales volume include consumer perception of the general economy,
competition for retail shelf space, and the success of the Company's most
recent product releases.
For the quarter ended June 30, 1995, 35% of net sales was derived from products
released in the current quarter and 66% was from products released in the
preceding 12 months. In the first fiscal quarter of last year, 48% of net
sales was derived from current quarter releases and 66% was from products
released in the prior 12 months.
The following table sets forth the percentage of the Company's net sales
derived from software product categories for the two quarters indicated:
<TABLE>
<CAPTION>
Quarter Ended June 30,
----------------------
1995 1994
-------- --------
<S> <C> <C>
Series:
Adventure . . . . . . . . 37% 43%
Strategy/Simulation . . . 22% 28%
Educational . . . . . . . 23% 12%
Action/Family . . . . . . 12% 8%
Sports . . . . . . . . . 3% 1%
Other . . . . . . . . . . 3% 8%
---- ----
100% 100%
==== ====
Net Sales . . . . . . . . . $21,166,000 $12,091,000
</TABLE>
Other revenues include income from the Company's telephone hint line.
OPERATING EXPENSE: Manufacturing costs decreased from 28% to 21% of net sales
due primarily to increases in manufacturing efficiencies, decreases in media
costs and volume purchase discounts.
Royalty costs increased from 6% to 8% of net sales due primarily to
increased royalties on licensing income.
Selling, general and administrative ("SG&A") expense increased $1.5 million,
but decreased from 51% to 38% of total revenues. Of this increase, $1.2
million was attributable to increased spending on sales and marketing
activities.
8
<PAGE> 9
Research and development expense, which reflects total research and development
expenditures less capitalized software development costs, increased $3.8
million, from 29% to 35% of revenues. The increase in expense was due
primarily to a decrease in deferred development spending of $2.1 million.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1995, the Company had cash, cash equivalents and marketable
investment securities aggregating approximately $87 million, a decrease of $12
million from the balance at March 31, 1995.
The Company's working capital requirements are seasonal and tend to be for
accounts receivable and inventories. Cash was used by operating activities due
primarily to increases in net receivables of $9.0 million. Net receivables
increased due to strong shipments of Police Quest Collection and Space Quest 6
which were released near the end of June 1995 as compared to only one title
(Outpost) in June 1994. The Company has provided adequate allowances for sales
returns and discount allowances.
The Company is continually evaluating business acquisition opportunities that
will broaden its product selection for the home consumer.
The Company believes its existing cash, cash equivalents and marketable
securities, are sufficient to meet its current planned requirements for the
foreseeable future.
9
<PAGE> 10
PART II
OTHER INFORMATION
ITEM 5. OTHER INFORMATION
On May 31, 1995 the Company merged with The Pixellite Group ("Pixellite"), a
developer of personal printing software, in exchange for 245,779 shares of
Sierra's common stock. On June 20, 1995 the Company also merged with Software
Inspiration, Ltd. ("Inspiration"), a developer of strategy games, in exchange
for 730,352 shares of Sierra's common stock. Both transactions have been
accounted for as poolings-of-interests.
The following represents the historical financial information of Sierra
On-Line, Inc. and subsidiaries restated as if the mergers of The Pixellite
Group and Software Inspiration, Ltd. were consummated as of the beginning of
the earliest period presented.
OVERVIEW
The Company derives its revenues primarily from the sale of entertainment and
education software products. Substantially all of net sales, ninety-five
percent in fiscal 1995, represent product sold primarily through large computer
superstores, software specialty retail chains, wholesale clubs, and mass
merchandisers. The remainder represents income from licensing of software
products for software bundling arrangements. Other revenues consist of income
from the Company's 900 telephone number hintline and advertising revenue from
the Company's INTERAction! magazine.
Sales arrangements with retailers and mass merchandisers permit them to
exchange products or receive price protection under certain circumstances. Net
sales reflects allowances for estimated returns and exchanges and price
protection. During 1995, the Company increased direct distribution sales to
superstores and wholesale clubs and experienced an increase in average price
per unit through a movement in technology platform from disk-based to
CD-ROM-based sales. These changes have led to a disproportionate increase in
the reserve for sales returns and allowances, included in accounts receivable,
relative to net sales.
A majority of product development is done internally through employees and
independent contractors. The Company's average cost for developing a product
has continued to increase substantially each year due to the greater number of
more technologically sophisticated products being developed simultaneously.
The Company typically owns all rights to contributions to products by
independent contractors under license or assignment agreements requiring the
payment of royalties by the Company. Aggregate royalty rates on the Company's
current principal software products generally range from approximately 3% to
16% of gross revenue derived from the product, less certain associated costs.
Royalties as a percentage of net sales were 4%, 5% and 8% in fiscal 1993, 1994
and 1995, respectively. As the Company develops more complex multimedia
products, such as CD-ROM-based products, it anticipates that royalty costs will
increase as a percentage of net sales.
SEASONALITY AND QUARTERLY RESULTS
The Company's revenues and earnings are highly seasonal due to traditional
consumer buying habits, and the Company expects the historical trend of
realizing its highest revenues and earnings during the Christmas holiday season
in the quarter ended December 31 and its seasonal lows in revenues and earnings
in the quarter ended June 30 to continue. The Company's quarterly operating
results may fluctuate throughout the year as a result of a variety of
additional factors, including delays in market acceptance, changes in platform
standards, the timing of the introduction of the Company's or its competitors'
products, the timing of orders for the Company's products and increases in
product returns. Because a majority of the unit sales for a particular product
typically occurs in the first several months after the product is introduced,
the Company's revenues may increase in a quarter in which a major product
introduction occurs and may decline in following quarters. The Company's
expenses are based, in part, on expected future revenues. A significant amount
of the Company's marketing, administrative, design and development expenses do
not vary in relation to revenues. As a result, if net revenues are below
expectations, the Company's operating results are likely to be materially and
adversely affected. During any given fiscal year, a substantial proportion of
the Company's gross sales is generated from titles introduced during that
fiscal year. During fiscal years 1993, 1994, and 1995, sales of new titles
represented 51%, 54%, and 69% of gross sales, respectively. Over the next
several years, the Company expects that an increasing portion of its revenues
will come from sales of simulation, action and educational products, as well as
new product lines. The Company believes that the impact of inflation and
changing prices has not had a significant impact on income.
10
<PAGE> 11
FOREIGN CURRENCY
The Company generates revenues from customers throughout the world, maintains
sales and representative offices in its major foreign markets and holds certain
deposits and accounts in foreign currencies. The majority of the Company's
foreign operations are conducted by its France and United Kingdom subsidiaries
in French Francs (the Franc) and British Pound Sterling (the Pound). Foreign
revenues, expenses, currency and other accounts can be affected by foreign
currency fluctuations. Revenues generally exceed expenses and assets exceed
liabilities in non-U.S. currencies.
For the fiscal year ended March 31, 1995, there was a weakening of the U.S.
Dollar in Europe which had the effect of increasing the dollar value of net
revenues denominated in these non-U.S. currencies. The Company estimates that
the weakening of the U.S. Dollar accounted for approximately $1.1 million of
the Company's consolidated net revenues and approximately $70,000 of the
consolidated net income for the fiscal year ended March 31, 1995. Foreign
currency denominated transactions and the respective fluctuations in foreign
currency in fiscal 1994 and 1993 did not have a significant impact on results
of operations.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED MARCH 31, 1995 COMPARED TO FISCAL YEAR ENDED MARCH 31, 1994
REVENUES
Net sales of $87.4 million and total revenues of $89.5 million for fiscal
year 1995 represented increases of 33% and 32%, respectively, over the prior
fiscal year. European net sales were $17.3 million for fiscal 1995 compared
to $9.5 million in the prior year. Sales outside the United States and
Europe increased $1.3 million primarily due to growth in Asia.
During fiscal 1995, 22 new products were released compared to 38 new product
releases in the prior year. In addition, four collections of series titles
were released in fiscal 1995. In fiscal 1995, 69% of gross software sales
were derived from titles released in that fiscal year while 54% of gross
software sales were derived from current releases in fiscal 1994.
The following table provides a comparison of net sales by category:
<TABLE>
<CAPTION>
Fiscal Year Ended March 31
-------------------------------
1995 1994
----------- -----------
<S> <C> <C>
Category:
Adventure . . . . . . . . 34% 44%
Simulation/Strategy . . . 32% 20%
Education . . . . . . . . 13% 13%
Action/Family . . . . . . 10% 8%
Sports . . . . . . . . . . 8% 6%
Other . . . . . . . . . . 3% 9%
-------- -------
100% 100%
======== =======
Net Sales . . . . . . . . . . $87,449,000 $65,529,000
</TABLE>
Other revenues include income from the Company's telephone hint line and
advertising. These revenues decreased from $2.4 million to $2.1 million.
OPERATING EXPENSES
Manufacturing costs increased $1.1 million, but decreased from 30% to 24% of
net sales over the prior fiscal year. This decrease was due primarily to
decreases in media costs, increased manufacturing efficiencies, and the shift
from disk-based to CD-based products.
Amortization of software development costs increased $1.3 million, but
decreased as a percentage of net sales from 13% to 11%. The increase in
software amortization costs was the result of a corresponding increase in
revenue derived from current year releases.
11
<PAGE> 12
Royalty costs increased $3.3 million, from 5% to 8% of net sales, due to
increased sales of sports titles, which have higher royalties and increased
payments to authors due to the increasing complexity of developing multimedia
products.
Selling, general and administrative ("SG&A") expense increased $5.2 million,
but decreased from 36% to 33% of total revenues. Of this increase, $3.0
million was attributable to increased spending on sales and marketing
activities, and $1 million was due to increased spending on technical and
customer support. The amount of SG&A expense attributable to the Company's
European operations increased $3.3 million but was partially offset by the
$2.6 million decrease in SG&A expense attributable to INN for the period
through July 1993 when INN was consolidated.
Research and development expense, which reflects total research and
development expenditures less capitalized software development costs,
increased $3.8 million but decreased from 23% to 22% of total revenues.
NON-OPERATING INCOME OR EXPENSE
The Company recorded a gain of $19.7 million as a result of the sale of its
remaining equity ownership interest in INN to AT&T on December 19, 1994.
In December 1994 the Company also recorded $1.5 million in shareholder
litigation costs in settlement of a securities class action lawsuit filed in
December 1992. The Company determined that this settlement was in the best
interests of its shareholders by obviating the burden and expense of the
litigation process even though it believed that it had good defenses to the
claims asserted and that the Company would have prevailed at trial.
Amortization of goodwill increased approximately $0.5 million due to
approximately $1.6 million in accrued incentive payments attributable to
prior acquisitions being added to goodwill at March 31, 1994.
FISCAL YEAR ENDED MARCH 31, 1994 COMPARED TO FISCAL YEAR ENDED MARCH 31, 1993
REVENUES
Net sales of $65.5 million and total revenues of $67.9 million for the fiscal
year ended March 31, 1994 represented increases of 23% and 25%, respectively,
over the prior fiscal year. European net sales were $9.5 million for the
current year compared to $5.2 million for fiscal 1993. The increase in
European net sales was primarily attributable to the $2.7 million in net
sales from Coktel Vision, the Company's French subsidiary acquired in October
1993.
During fiscal 1994, 38 new products were released compared to 22 new product
releases in the prior year. In fiscal 1994, 54% of gross software sales were
derived from titles released in that fiscal year while in fiscal 1993 51% of
gross software sales were derived from current releases. Revenues for fiscal
1994 attributable to INN and included in the Company's consolidated financial
statements were $2.6 million compared to $2.8 million in fiscal 1993.
Other revenues increased $1.0 million over the prior year total of $1.4
million due primarily to increased hint line revenue.
OPERATING EXPENSE
Manufacturing costs decreased from 35% to 30% of net sales due primarily to
decreases in disk and CD costs and to increases in manufacturing
efficiencies. Coktel's manufacturing costs in fiscal 1994 were $0.8 million,
or 31% of associated net sales.
Amortization of software development costs decreased from $11.6 million in
fiscal 1993 to $8.4 million in fiscal 1994. In fiscal 1993, the Company,
recognizing new market conditions that reduced the estimated shelf lives of
certain titles, accelerated amortization of capitalized software development
costs by an additional $1.8 million.
Royalty costs increased from 4% to 5% of net sales due to an increase in
sales from sports titles.
Selling, general and administrative ("SG&A") expense increased $0.6 million
over the prior year but decreased as a percentage of total revenues from 44%
to 36%. The amount of INN's SG&A expense included in the Company's
consolidated statements in fiscal 1994 (through July 26, 1993) was $2.6
million, a decrease of $2.4 million. Coktel's SG&A
12
<PAGE> 13
expense was $0.2 million in fiscal 1994. After accounting for INN and Coktel,
fiscal 1994 SG&A expense increased $2.6 million, or 5% of total revenues.
This increase was attributable primarily to increased spending on selling and
marketing activities.
Research and development ("R&D") expense, which reflects total research and
development expenditures less capitalized software development costs,
increased $3.7 million to $15.6 million. Total R&D expenditures increased by
$1.6 million to 33% of total revenues compared to 39% in fiscal 1993.
However, after excluding INN and Coktel, total R&D expenditures increased
$0.3 million to $20 million. This increase was attributable to the
increasingly complex technical and artistic nature of the Company's products.
Although the Company's development headcount (excluding INN and Coktel)
remained relatively stable, the Company increased its focus on education
products by increasing R&D spending in its Bright Star subsidiary by
approximately $1.5 million. Part of this increase was attributable to the
fact that Bright Star was acquired after the first quarter in fiscal 1993.
In accordance with Financial Accounting Standards Board Statement No. 86
("FASB 86"), the Company capitalizes software development costs once
technological and market feasibility have been established. Within the
guidelines of FASB 86, the Company determines the anticipated life of a
product in months. During fiscal 1993, in recognition of increased
competition in the retail marketplace that has tended to shorten the shelf
life of the Company's products, the Company accelerated the amortization of
certain of its older titles and reduced the estimated lives of newer titles
to 6 to 18 months (from 12 to 24 months), except for CD-ROM-based products
which are amortized over 24 months. The Company intends to continue to
evaluate its amortization policy in light of any changes in competition and
product life cycles that may occur in the future.
As a result of the Coktel acquisition, the Company incurred a charge of $1.1
million in fiscal 1994 representing the estimated fair market value of
in-process technology expensed at the acquisition date.
LOSS FROM THE IMAGINATION NETWORK
Fiscal 1994 reflects a loss of $5.1 million for the Company's share of INN's
losses as accounted for under the equity method starting on July 27, 1993.
Prior to this date, INN's results were consolidated with the Company's
results of operations. As a result, the Company's Consolidated Statements of
Operations also reflected a $2.4 million operating loss from INN for the
fiscal period prior to July 27, 1993.
AMORTIZATION OF GOODWILL
Amortization of goodwill increased $0.2 million as a result of the Coktel
acquisition. Sierra's goodwill was increased by $2.4 million to reflect the
excess of the purchase price paid over the estimated fair value of Coktel's
net assets. This goodwill is being amortized over a seven-year period.
INCOME TAX PROVISION
The Company did not consolidate INN's results for income tax purposes after
July 26, 1993 since the Company no longer owned 80% or more of INN's stock
and therefore the losses of INN did not generate a tax benefit to the
Company. Fiscal 1994 reflected a tax benefit of $0.8 million, or 17% of the
pretax loss excluding the loss from INN under the equity method, compared to
a tax benefit of $3.3 million, or 28% of the pretax loss, in fiscal 1993.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1995, the Company had cash, cash equivalents and marketable
investment securities aggregating approximately $99 million, an increase of $75
million from March 31, 1994. In addition, the Company has a $10 million line
of credit available. There was no outstanding balance under this line at March
31, 1995.
The Company raised approximately $48 million in cash from a convertible debt
offering in April 1994 and $25 million from the sale of INN and the signing of
a multi-year publishing agreement with AT&T in December 1994, accounting for
most of the $75 million increase in cash, cash equivalents and marketable
investment securities.
The Company's working capital requirements are seasonal and tend to be
primarily for accounts receivable and inventories. Net cash was provided by
operating activities due primarily to net income of $12.2 million plus
amortization and depreciation of approximately $14.4 million.
13
<PAGE> 14
The Company is continually evaluating business acquisition opportunities that
will broaden its product selection for the home consumer.
The Company believes its existing cash, cash equivalents and marketable
investment securities, are sufficient to meet its current planned requirements
and requirements for the foreseeable future.
14
<PAGE> 15
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Sierra On-Line, Inc.
Bellevue, Washington
We have audited the accompanying consolidated balance sheets of Sierra On-Line,
Inc. and subsidiaries (the "Company") as of March 31, 1995 and 1994, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended March 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
and its subsidiaries as of March 31, 1995 and 1994, and the results of its
operations and its cash flows for each of the three years in the period ended
March 31, 1995 in conformity with generally accepted accounting principles.
The financial statements give retroactive effect to the mergers of The
Pixellite Group and Software Inspiration, Ltd., with the Company on May 31,
1995 and June 20, 1995, respectively, which have been accounted for as poolings
of interests as described in Note 1 to the financial statements.
DELOITTE & TOUCHE LLP
Seattle, Washington
August 14, 1995
15
<PAGE> 16
SIERRA ON-LINE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1995 AND 1994
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1995 1994
ASSETS ---------- ----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . $ 48,888 $ 3,281
Marketable investment securities . . . . . . . . . . . . . . . . . . . . . 50,573 20,859
Accounts receivable, net of allowances of $7,262 and $4,088 . . . . . . . . 11,024 10,664
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,838 4,955
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,760 3,051
Refundable income taxes . . . . . . . . . . . . . . . . . . . . . . . . . 670 1,986
Other current assets (including $792 and $845 receivable from
related parties - Note 13) . . . . . . . . . . . . . . . . . . . . . . . 4,226 2,774
---------- ----------
Total Current Assets . . . . . . . . . . . . . . . . . . . . . . . . . 121,979 47,570
PROPERTY, PLANT AND EQUIPMENT, net . . . . . . . . . . . . . . . . . . . . . . 8,851 7,339
SOFTWARE DEVELOPMENT COSTS, net of accumulated amortization of
$8,535 in 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,048 5,683
GOODWILL, net of accumulated amortization of $2,871 and $1,687 . . . . . . . . 6,498 6,119
DEFERRED INCOME TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,515
OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,807 787
---------- ----------
$ 141,698 $ 67,498
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,829 $ 4,602
Accrued compensation and related benefits . . . . . . . . . . . . . . . . 3,804 1,993
Accrued incentive payments . . . . . . . . . . . . . . . . . . . . . . . . 1,562 1,620
Royalties payable (including $633 and $117 payable to a related party -
Note 13) 2,840 1,267
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,261 835
Accrued interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,160 ---
Other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 3,977 3,360
---------- ----------
Total Current Liabilities . . . . . . . . . . . . . . . . . . . . . . 20,433 13,677
DEFERRED INCOME TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . --- 2,592
ADVANCES UNDER PUBLISHING AGREEMENT AND
OTHER LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,326 634
CONVERTIBLE DEBT, net of unamortized discount and issuance costs of $1,066 . . 34,634 ---
COMMITMENTS AND CONTINGENCIES (Note 11) . . . . . . . . . . . . . . . . . . --- ---
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.01 per share;
1,000,000 shares authorized, none outstanding . . . . . . . . . . . . . --- ---
Common stock and paid-in capital, par value $.01 per share; 40,000,000
shares authorized; 17,557,115 and 16,201,887 shares issued and outstanding 70,021 51,955
Retained earnings (deficit), including net unrealized holding
gain on marketable investment securities of $101 in 1995 . . . . . . . . 11,514 (749)
Cumulative translation adjustment . . . . . . . . . . . . . . . . . . . . 119 (219)
---------- ----------
81,654 50,987
Less common stock in treasury, 94,154 and 104,474 shares, at cost . . . . 349 392
---------- ----------
Total Stockholders' Equity . . . . . . . . . . . . . . . . . . . . . 81,305 50,595
---------- ----------
$ 141,698 $ 67,498
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
16
<PAGE> 17
SIERRA ON-LINE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED MARCH 31, 1995, 1994 AND 1993
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1995 1994 1993
--------- ---------- ----------
<S> <C> <C> <C>
REVENUES:
Net sales . . . . . . . . . . . . . . . . . . . . $ 87,449 $ 65,529 $ 53,174
Other . . . . . . . . . . . . . . . . . . . . . . 2,058 2,389 1,363
--------- ---------- ----------
89,507 67,918 54,537
--------- ---------- ----------
OPERATING EXPENSES:
Manufacturing costs . . . . . . . . . . . . . . . 20,568 19,586 18,402
Amortization of software development costs . . . 9,672 8,379 11,572
Royalties (including $819, $256, and $443 earned
by related party - Note 13) . . . . . . . . . 6,575 3,291 2,339
Selling, general and administrative . . . . . . . 29,801 24,555 23,943
Research and development . . . . . . . . . . . . 19,352 15,562 11,842
Purchased in-process research and development . . --- 1,102 ---
--------- ---------- ----------
85,968 72,475 68,098
--------- ---------- ----------
INCOME (LOSS) FROM OPERATIONS . . . . . . . . . . . . 3,539 (4,557) (13,561)
--------- ---------- ----------
OTHER INCOME (EXPENSE):
Gain on sale of The ImagiNation Network . . . . . 19,739 --- ---
Equity in loss from The ImagiNation Network . . . (1,990) (5,066) ---
Shareholder litigation costs . . . . . . . . . . . (1,500) --- ---
Interest income (including $84, $152 and $81
earned from related parties - Note 13) . . . . 3,721 1,326 1,657
Interest expense . . . . . . . . . . . . . . . . (4,312) (279) (473)
Amortization of goodwill and convertible debt
issuance costs . . . . . . . . . . . . . . . . (1,212) (722) (504)
--------- ---------- ----------
14,446 (4,741) 680
--------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES . . . . . . . . . . 17,985 (9,298) (12,881)
INCOME TAX PROVISION (BENEFIT) . . . . . . . . . . . . 5,823 (679) (3,257)
--------- ---------- ----------
NET INCOME (LOSS) . . . . . . . . . . . . . . . . . . $ 12,162 $ (8,619) $ (9,624)
========= ========== ==========
NET INCOME (LOSS) PER SHARE:
Primary . . . . . . . . . . . . . . . . . . . . . $ 0.71 $ (0.55) $ (0.62)
Fully diluted . . . . . . . . . . . . . . . . . . 0.69 --- ---
WEIGHTED AVERAGE SHARES OUTSTANDING:
Primary . . . . . . . . . . . . . . . . . . . . . 17,113 15,743 15,426
Fully diluted . . . . . . . . . . . . . . . . . . 20,816 --- ---
</TABLE>
See Notes to Consolidated Financial Statements.
17
<PAGE> 18
SIERRA ON-LINE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED MARCH 31, 1995, 1994 AND 1993
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Common Stock
and Paid-in Capital Retained Cumulative Treasury Stock Total
----------------------- Earnings Translation --------------------- Stockholders'
Shares Amount (Deficit) Adjustment Shares Amount Equity
---------- --------- --------- ----------- ------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, APRIL 1, 1992 15,498,079 $ 43,319 $ 17,494 $ (224) 104,474 $ (392) $ 60,197
Net loss (9,624) (9,624)
Equity contributions 4 4
Stock options exercised 138,428 501 501
Tax benefit of stock option
transactions 243 243
Shares issued to Dynamix
shareholders 24,272 221 221
Foreign currency translation
adjustment (23) (23)
---------- -------- -------- ------- -------- ------- ----------
BALANCE, MARCH 31, 1993 15,660,779 44,288 7,870 (247) 104,474 (392) 51,519
Net loss (8,619) (8,619)
Stock options exercised 541,108 3,248 3,248
Tax benefit of stock option
transactions 442 442
INN liquidation preference 3,977 3,977
Foreign currency translation
adjustment 28 28
---------- -------- -------- ------- -------- ------- ----------
BALANCE, MARCH 31, 1994 16,201,887 51,955 (749) (219) 104,474 (392) 50,595
Net income 12,162 12,162
Equity contributions 266 266
Stock options exercised 333,807 2,131 2,131
Tax benefit of stock option
transactions 1,772 1,772
Conversion of convertible
debt 1,021,421 13,897 13,897
Treasury stock issued (10,320) 43 43
Net unrealized holding gains
on marketable investment
securities available-for-sale 101 101
Foreign currency translation
adjustment 338 338
---------- -------- -------- ------- -------- ------- ----------
BALANCE, MARCH 31, 1995 17,557,115 $ 70,021 $ 11,514 $ 119 94,154 $ (349) $ 81,305
========== ======== ======== ======= ======== ======= ==========
</TABLE>
See Notes to Consolidated Financial Statements.
18
<PAGE> 19
SIERRA ON-LINE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED MARCH 31, 1995, 1994 AND 1993
(IN THOUSANDS)
<TABLE>
<CAPTION>
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . $ 12,162 $ (8,619) $ (9,624)
Reconciliation to net cash provided by (used for)
operating activities:
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . 3,214 3,040 2,647
Amortization of intangible assets and issuance costs . . . . . 11,136 9,100 12,076
Gain on sale of The ImagiNation Network . . . . . . . . . . . . (19,739) --- ---
Equity loss from The ImagiNation Network . . . . . . . . . . . 1,990 5,066 ---
Purchased in-process research and development . . . . . . . . . --- 1,102 ---
Provision for doubtful accounts . . . . . . . . . . . . . . . 829 647 1,115
Deferred income taxes . . . . . . . . . . . . . . . . . . . . (2,816) (1,394) (1,394)
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,209 (474) (96)
Cash provided (used) by changes in assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . (1,189) (4,538) (2,230)
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . 117 (823) 842
Refundable income taxes . . . . . . . . . . . . . . . . . . . . 3,088 1,825 (825)
Other current assets . . . . . . . . . . . . . . . . . . . . . . (548) 485 (2,064)
Software development costs . . . . . . . . . . . . . . . . . . (5,037) (6,060) (9,414)
Research and development acquired . . . . . . . . . . . . . . --- (2,452) ---
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . (1,020) (225) (40)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . 1,226 (230) 1,186
Accrued compensation and related benefits . . . . . . . . . . . 1,811 154 ---
Royalties payable . . . . . . . . . . . . . . . . . . . . . . 1,573 482 17
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . 426 835 ---
Accrued interest . . . . . . . . . . . . . . . . . . . . . . . 1,160 --- ---
Other accrued expenses . . . . . . . . . . . . . . . . . . . . 617 (78) 2,592
Advances under publishing agreement and other liabilities . . . 4,692 (14) 105
----------- ----------- -----------
Net cash provided by (used for) operating activities . . . . . 14,901 (2,171) (5,107)
INVESTING ACTIVITIES:
Proceeds from sale of The ImagiNation Network . . . . . . . . . . 19,739 --- ---
Proceeds from matured marketable investment securities . . . . . . 40,319 67,865 119,435
Purchases of marketable investment securities . . . . . . . . . (69,880) (65,550) (139,209)
Net purchases of property, plant and equipment . . . . . . . . . (4,735) (3,524) (3,444)
Loan to The ImagiNation Network . . . . . . . . . . . . . . . . . (2,895) --- ---
Payment for purchase of subsidiaries, net of cash acquired
and research and development . . . . . . . . . . . . . . . . . (1,620) (2,797) (1,056)
Net repayment of advances to The ImagiNation Network . . . . . . --- 1,646 ---
----------- ----------- -----------
Net cash used by investing activities . . . . . . . . . . . . (19,072) (2,360) (24,274)
FINANCING ACTIVITIES:
Net proceeds from convertible debt offering . . . . . . . . . . . 48,250 --- ---
Proceeds from exercise of options and warrants . . . . . . . . . 2,131 3,248 501
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (699) (15) (20)
----------- ----------- -----------
Net cash provided by financing activities . . . . . . . . . . 49,682 3,233 481
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS . . . . . . . . 45,511 (1,298) (28,900)
EFFECT OF EXCHANGE RATE CHANGES ON CASH . . . . . . . . . . . . . . 96 --- 27
CASH AND CASH EQUIVALENTS:
BEGINNING OF YEAR . . . . . . . . . . . . . . . . . . . . . . . 3,281 4,579 33,452
----------- ----------- -----------
END OF YEAR . . . . . . . . . . . . . . . . . . . . . . . . . $ 48,888 $ 3,281 $ 4,579
=========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
19
<PAGE> 20
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Supplemental disclosure of cash flow and noncash investing and financing
information for the years ended March 31 is as follows (in thousands):
<TABLE>
<CAPTION>
1995 1994 1993
------- -------- -------
<S> <C> <C> <C>
Cash paid (received) during the year for:
Income taxes . . . . . . . . . . . $ 7,123 $ (741) $ 22
Interest . . . . . . . . . . . . . $ 4,577 $ (70) $ (59)
</TABLE>
1995:
During fiscal 1995 the Company induced conversion of $14,300,000 of
convertible debt into 1,021,421 shares of common stock.
1994:
The Company purchased all of the capital stock of Coktel Vision for
$5,332,000. In connection with the acquisition, liabilities assumed were
as follows (in thousands):
<TABLE>
<S> <C>
Fair value of net assets acquired . . . $ 7,641
Cash paid . . . . . . . . . . . . . . (5,332)
-------
Liabilities assumed . . . . . . . . . $ 2,309
=======
</TABLE>
1993:
The Company purchased all of the capital stock of Bright Star for
$1,087,000. In connection with this acquisition, liabilities assumed were
as follows (in thousands):
<TABLE>
<S> <C>
Fair value of net assets acquired . . . $ 1,193
Cash paid . . . . . . . . . . . . . . (1,087)
-------
Liabilities assumed . . . . . . . . . $ 106
=======
</TABLE>
See Notes to Consolidated Financial Statements.
20
<PAGE> 21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 31, 1995, 1994 AND 1993
NOTE 1: BASIS OF PRESENTATION AND ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Sierra On-Line,
Inc. (Sierra), a Delaware corporation, and its wholly-owned subsidiaries,
Sierra On-Line Limited (Sierra U.K.), Dynamix, Inc. (Dynamix), Sierra On-Line
Japan, K.K. (Sierra Japan), Bright Star Technology, Inc. (Bright Star),
Coktel Vision, S.A. (Coktel), Interactive Associates, Inc., and
Sierra/Dynamix International Sales Company, Inc., a foreign sales
corporation, Software Inspiration, Ltd. (Inspiration), and The Pixellite
Group (Pixellite) (collectively referred to as the Company). The accounts of
The ImagiNation Network, Inc. (INN) were consolidated with those of the
Company through July 26, 1993 and accounted for under the equity method until
December 1994, when the Company sold its remaining interest in INN to AT&T.
As described in Note 2, on May 31, 1995 and June 20, 1995, respectively,
Pixellite and Inspiration became wholly owned subsidiaries of Sierra On-Line,
Inc. These consolidated financial statements have been prepared under the
pooling-of-interests method of accounting and reflect the combined financial
position and operating results of Sierra, Pixellite and Inspiration for all
periods presented. Upon issuance of the Company's first quarter fiscal 1996
results of operations in this Form 10-Q these consolidated financial
statements will become the historical financial statements of the Company.
All significant intercompany balances and transactions are eliminated.
BUSINESS
The Company's primary business is the development and publication of
entertainment and educational software for personal computers for
distribution in North America, Europe and Asia.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash, certificates of deposit and short
term investments with original maturities of three months or less.
MARKETABLE INVESTMENT SECURITIES
Marketable investment securities consist of municipal securities, corporate
stocks and bonds, U.S. Treasury notes, and commercial paper. The Company
adopted Statement of Financial Accounting Standard (SFAS) No. 115, Accounting
for Certain Investments in Debt and Equity Securities, effective April 1,
1994 and classified all investment securities as available-for-sale. As a
result, securities are reported at fair value with net unrealized holding
gains and losses excluded from earnings and reported in stockholders' equity.
Fair value is based upon quoted market prices using the specific
identification method. The impact of the adoption of this statement on
stockholders' equity was insignificant.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or
market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost. Depreciation and
amortization are provided using a straight-line method over estimated useful
lives ranging from approximately 2 to 18 years.
SOFTWARE DEVELOPMENT COSTS AND PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
EXPENSES
Under the criteria set forth in SFAS No. 86, Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed, capitalization of
software development costs begins upon the establishment of technological
feasibility of the product. The establishment of technological feasibility
and the on-going assessment of the recoverability of costs require
considerable judgment by management with respect to certain external factors,
including, but not limited to, anticipated future gross product revenues,
estimated economic life and changes in software and hardware technology.
Amounts that
21
<PAGE> 22
have been capitalized under this statement, after consideration of the above
factors, are amortized on either a straight-line basis over the estimated
useful lives of the products (6 to 24 months) or the ratio of current product
revenues to the total revenues expected over the life of the product,
whichever produces the greater expense.
Purchased in-process research and development is charged to expense on the
date acquired if it has no alternative future use and technological
feasibility is not established.
GOODWILL
Goodwill represents the excess purchase price paid over the net assets of
acquired companies. Goodwill is amortized on a straight-line basis over
seven years.
The carrying value of goodwill is reviewed on a regular basis for the
existence of facts or circumstances both internally and externally that may
suggest impairment. To date, no such impairment has been indicated. Should
there be an impairment in the future, the Company will measure the amount of
the impairment based on the undiscounted expected future cash flows from the
impaired assets.
FOREIGN CURRENCY
Assets and liabilities denominated in foreign currencies are translated to
U.S. dollars at the exchange rate on the balance sheet date. Revenues, costs
and expenses are translated at average rates of exchange prevailing during
the year. The translation adjustment resulting from this process is
presented separately in shareholders' equity. The gains and losses from
foreign currency transactions are included in selling, general and
administrative expense in the statements of operations.
REVENUE RECOGNITION
The Company recognizes revenue in accordance with the American Institute of
Certified Public Accountants Statement of Position (SOP) No. 91-1, Software
Revenue Recognition. Revenue from product sales is recognized upon shipment,
provided no significant vendor obligations remain and collection of the
resulting receivable is deemed probable. Other insignificant vendor
obligations consisting primarily of costs associated with telephone support
to customers after delivery of software are accrued.
The Company's agreements with certain distributors and retailers permit them
to exchange products or provide price protection under certain circumstances.
The Company provides an allowance for estimated exchanges and price
protection.
During the period that INN was consolidated with the balances of the Company,
revenue from INN was recognized over the period services were provided.
ADVERTISING
The Company accounts for advertising costs in accordance with SOP No. 93-7,
Reporting on Advertising Costs. Direct response advertising is capitalized
only if customer sales can be directly correlated to the advertising and if
future benefit can be demonstrated. Capitalized advertising costs are
amortized using the straight-line method over the estimated benefit period.
Advertising expense for fiscal 1995, 1994 and 1993 was $8,670,000, $7,795,000
and $5,491,000, respectively. Amounts capitalized at March 31, 1995 and 1994
approximated $598,000 and $296,000, respectively.
INCOME TAXES (BENEFIT)
During 1994, the Company adopted Statement of Financial Accounting Standard
No. 109, Accounting for Income Taxes. Accordingly, the Company computes
income taxes using the asset and liability method, under which deferred
income taxes are provided for the temporary differences between the financial
reporting basis and the tax basis of the Company's assets and liabilities.
The cumulative effect of this change in accounting method was not
significant.
Prior to 1994, the Company utilized APB Opinion No. 11, Accounting for Income
Taxes.
22
<PAGE> 23
NET INCOME (LOSS) PER SHARE
Net income (loss) per share is based upon the weighted average number of
common shares outstanding during the period as adjusted for the shares issued
in the merger with Pixellite and Inspiration described in Note 2 and after
consideration of the dilutive effect, if any, of stock options granted using
the treasury stock method. In addition, conversion of the Company's 6-1/2%
Convertible Subordinated Notes (see Note 8) are included in fully diluted
income per share using the if-converted method when such securities are
dilutive.
STOCK SPLIT
On March 3, 1995, the Company recorded a two-for-one stock split to holders
of record on February 17, 1995. Outstanding shares, stock options and per
share data have been retroactively restated for all periods to give effect to
the stock split.
CONCENTRATION OF CREDIT RISK
Accounts receivable include amounts from geographically dispersed dealers and
distributors in the computer software industry. Concentrations of credit
risk are considered minimal and bad debts have not been significant. The
Company does not require collateral or other security to support credit
sales.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1993 and 1994 balances to
conform with the 1995 presentation.
23
<PAGE> 24
NOTE 2: BUSINESS COMBINATIONS
PIXELLITE AND INSPIRATION
On May 31, 1995 the Company merged with The Pixellite Group ("Pixellite"), a
developer of personal printing software, in exchange for 245,779 shares of
Sierra's common stock. On June 20, 1995 the Company also merged with
Software Inspiration, Ltd. ("Inspiration"), a developer of strategy games, in
exchange for 730,352 shares of Sierra's common stock.
The mergers have been accounted for as poolings of interests. The
pooling-of-interests method of accounting is intended to present as a single
interest two or more common shareholders' interests which were previously
independent; accordingly, the historical financial statements for the periods
prior to the merger are restated as though the companies had been combined.
All fees and expenses related to the merger of the combined companies will be
expensed as required under the pooling-of-interests accounting method. These
expenses have not been reflected in the consolidated statements of earnings
but will be reflected in the consolidated statement of operations of the
Company for the three months ended June 30, 1995. Such fees and expenses
total approximately $220,000 and include legal and accounting fees.
The following summarizes amounts previously reported by Sierra prior to the
transaction for the years ended March 31, 1995, 1994 and 1993 (in thousands,
except per share data):
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
REVENUES:
Sierra . . . . . . . . . . . . . . . . $ 83,440 $ 62,745 $ 49,716
Pixellite and Inspiration . . . . . . . 6,067 5,173 4,821
-------- -------- --------
Combined . . . . . . . . . . . . . . . $ 89,507 $ 67,918 54,537
======== ======== ========
NET INCOME (LOSS)
Sierra . . . . . . . . . . . . . . . . $ 11,938 $ (8,676) $ (8,398)
Pixellite and Inspiration . . . . . . . 224 57 (1,226)
-------- -------- --------
Combined . . . . . . . . . . . . . . $ 12,162 $ (8,619) $ (9,624)
======== ======== ========
PRIMARY NET INCOME (LOSS) PER SHARE:
Sierra . . . . . . . . . . . . . . . . $ 0.74 $ (0.59) $ (0.58)
Pixellite and Inspiration . . . . . . . (0.03) 0.04 (0.04)
-------- -------- --------
Combined . . . . . . . . . . . . . . . $ 0.71 $ (0.55) (0.62)
======== ======== ========
FULLY DILUTED NET INCOME (LOSS) PER SHARE:
Sierra . . . . . . . . . . . . . . . . $ 0.71 $ --- $ ---
Pixellite and Inspiration . . . . . . . (0.02) --- ---
-------- -------- --------
Combined . . . . . . . . . . . . . . . $ 0.69 $ --- ---
======== ======== ========
</TABLE>
COKTEL
On October 29, 1993, the Company acquired Coktel Vision S.A. ("Coktel"), a
developer and publisher of educational and entertainment software products,
for an initial purchase price of approximately $5,332,000. This business
combination was accounted for as a purchase, and, accordingly, the net assets
and operations of Coktel are included in the Company's consolidated financial
statements beginning on October 29, 1993. Approximately $1,102,000 of the
purchase price was attributed to in-process research and development and
accordingly was charged to expense at the date of acquisition. Amounts
allocated to software development costs approximated $1,350,000 and amounts
allocated to goodwill were approximately $2,419,000 and will be amortized
over its estimated useful life of seven years on a straight-line basis. The
remainder of the purchase price was allocated to the net assets of Coktel and
consist primarily of current assets and current liabilities.
Contingent purchase payments may be due under an incentive payment plan.
Maximum amounts payable under the incentive payment plan approximate
$6,250,000 (30 million French francs), to be earned ratably over a three and
one-half year period. Any amounts due under the incentive plan will be
capitalized as goodwill and paid, at management's discretion, in either cash,
or a combination of cash and common stock with a maximum stock allocation of
75%. During the fiscal years ended
24
<PAGE> 25
March 31, 1995 and 1994, approximately $1,562,000 and $1,313,000 were earned
under this plan. At March 31, 1995 and 1994, incentive payments due
approximated $1,562,000 and $1,313,000.
BRIGHT STAR
On July 6, 1992, the Company acquired Bright Star, a developer and publisher
of educational computer software, for an initial purchase price of $1,000,000
plus transaction costs of $87,000. This business combination was accounted
for as a purchase and, accordingly, the net assets and operations of Bright
Star are included in the Company's consolidated financial statements
beginning on July 6, 1992. The $1,087,000 purchase price was assigned to the
net assets acquired based on the fair values of such assets and liabilities
at the date of acquisition. The excess of cost and liabilities assumed over
tangible assets acquired was recorded as goodwill ($929,000 at the purchase
date). Goodwill is being amortized on a straight-line basis over seven years
from the date of the original acquisition.
As part of this transaction, the common and preferred shareholders of Bright
Star as of July 2, 1992, certain key executives and a financial advisor
obtained the right to receive a maximum of up to $2,500,000 in cash or a
maximum of up to 400,000 shares of the Company's common stock over a
five-year period based on the attainment of certain revenue goals, in
addition to the $1,000,000 cash payment described above. Amounts earned by
the shareholders and executives may be paid in cash, stock or a combination
of cash and stock, at the sole discretion of the Company. Amounts received
by the financial advisor may only be paid in cash. These contingent amounts
will be allocated to goodwill as they are earned. In fiscal 1994, $307,000
was earned under this agreement and payable at March 31, 1994. No amounts
were earned during 1995 and 1993.
UNAUDITED PRO FORMA INFORMATION
The following unaudited combined pro forma information shows the results of
the Company's operations for the fiscal year presented had the acquisition of
Coktel occurred at the beginning of the year (in thousands, except per share
data).
<TABLE>
<CAPTION>
1994
--------
<S> <C>
Net sales . . . . . . . . . . . . . . . . . . . . . $ 67,617
Net loss . . . . . . . . . . . . . . . . . . . . . . $ (8,848)
Net loss per share . . . . . . . . . . . . . . . . $ (0.56)
</TABLE>
This pro forma information may not be indicative of the results that actually
would have been obtained had the acquisition occurred at the beginning of the
period, and is not intended to be a projection of future results.
NOTE 3: SALE OF THE IMAGINATION NETWORK
The operating activities of INN were consolidated with those of the Company
through July 26, 1993. On July 27, 1993, the Company sold 42% of INN's
voting stock and reduced its ownership interest to 58% and reduced its voting
control such that the Company began recording INN operations utilizing the
equity method. Upon sale of its 42% interest, the Company recorded its
liquidation preference in excess of recorded book value as shareholders'
equity.
In December 1994, the Company sold its remaining equity interest in INN to
AT&T and recorded a gain of $19,739,000. The Company also entered into a
multi-year publishing agreement with AT&T to provide content for INN. The
publishing agreement provides for AT&T to fund up to $4,000,000 of the
Company's development expenditures under an existing publishing agreement and
up to $23,000,000 of Sierra's development expenditures, subject to certain
limitations, through non-refundable royalty advances. The non-refundable
royalty advances are reflected net of research and development expense. A
summary of gross research and development expense and non-refundable royalty
advances for the year ended March 31 is as follows (in thousands):
<TABLE>
<CAPTION>
1995
--------
<S> <C>
Research and development expense $20,937
Non-refundable royalty advances (1,585)
-------
$19,352
=======
</TABLE>
25
<PAGE> 26
NOTE 4: MARKETABLE INVESTMENT SECURITIES
The Company's investments, including aggregate fair values, cost, gross
unrealized holding gains, and gross unrealized holding losses, consist of the
following at March 31 (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
FAIR HOLDING HOLDING
VALUE COST GAINS LOSSES
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C> <C>
1995:
U.S. Government obligations $ 10,394 $ 10,357 $ 39 $ 2
Corporate securities 23,050 22,996 80 26
Commercial paper 17,129 17,067 64 2
------------ ------------ ------------ -----------
$ 50,573 $ 50,420 $ 183 $ 30
============ ============ ============ ===========
1994:
U.S. Government obligations $ 14,939 $ 15,003 $ --- $ 64
Corporate securities 544 438 106 ---
Tax-exempt municipal bonds and notes 1,831 1,830 1 ---
Commercial paper 2,915 2,915 --- ---
Money market funds 673 673 --- ---
------------ ------------ ------------ -----------
$ 20,902 $ 20,859 $ 107 $ 64
============ ============ ============ ===========
</TABLE>
Fair values of investments are based on quoted market prices on the last
business day of the fiscal year. All investments available-for-sale at
March 31, 1995 will mature within one year.
NOTE 5: INVENTORIES
Inventories consist of the following at March 31 (in thousands):
<TABLE>
<CAPTION>
1995 1994
--------- ---------
<S> <C> <C>
Raw materials . . . . . . . . . . . . $ 2,793 $ 3,411
Work in progress . . . . . . . . . . . 65 85
Finished goods . . . . . . . . . . . . 1,980 1,459
--------- ---------
$ 4,838 $ 4,955
========= =========
</TABLE>
NOTE 6: PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following at March 31 (in
thousands):
<TABLE>
<CAPTION>
1995 1994
---------- ----------
<S> <C> <C>
Land . . . . . . . . . . . . . . . . . $ 203 $ 203
Buildings and improvements . . . . . . 3,591 3,236
Computers and equipment . . . . . . . 16,259 12,533
Furniture and fixtures . . . . . . . . 1,312 785
---------- ----------
21,365 16,757
Less accumulated depreciation . . . . . (12,514) (9,418)
---------- ----------
$ 8,851 $ 7,339
========== ==========
</TABLE>
26
<PAGE> 27
NOTE 7: SOFTWARE DEVELOPMENT COSTS
In fiscal 1993, the Company reduced capitalized software development costs for
certain current titles and deferred fewer costs related to software development
due to a changing retail environment and increased competition in the
marketplace. Following careful review of its markets, the Company recognized
that the increase in the number of new titles and emerging formats in the
entertainment and educational software industries significantly reduced the
shelf life for products in these categories. To address the new market
conditions, the Company reduced capitalization of software development costs
for certain current products that had been discontinued or had experienced
shortened shelf life, expensed development costs of certain products for new
markets and new platforms where market acceptance was less predictable and
amortized new titles over a shorter life. The effect of accelerating
amortization was to increase net loss by $1,842,000, or $0.12 per common share
in fiscal 1993.
NOTE 8: FINANCING ARRANGEMENTS
LINE OF CREDIT
In fiscal 1995, the Company entered into an unsecured bank line of credit
that provides for borrowings of up to $10 million, expiring August 31, 1995.
Any borrowings under this line of credit would be collateralized by
substantially all the Company's assets and incur interest at either the
bank's prime rate or IBOR plus 175 basis points at borrower's choice. The
line contains covenants requiring the Company to maintain certain financial
ratios and minimum balances in cash and cash equivalents. The Company is in
compliance with all covenants under this line of credit as of March 31, 1995.
There have been no borrowings by the Company under this line of credit to
date.
CONVERTIBLE NOTES
On April 12, 1994, the Company issued $50,000,000 in principal amount of
6-1/2% convertible subordinated notes due April 1, 2001 (the "Notes").
Interest on the Notes is payable semi-annually on April 1 and October 1 of
each year and commenced October 1, 1994. The Notes are convertible into
common stock of the Company, at a conversion price of $14.00 per share,
subject to adjustment under certain conditions. The Notes are redeemable
after April 2, 1997, at the option of the Company, at specified redemption
prices. The Notes will be subordinated to all existing and future Senior
Indebtedness (as defined in the Indenture governing the Notes) of the
Company. Issuance costs have been netted against the principal convertible
debt balance and are being amortized on a straight-line basis over seven
years. The fair value of these notes at March 31, 1995 was $58,548,000 as
determined by the Private Offerings, Resales and Trading through Automated
Linkages ("PORTAL") Market.
During fiscal 1995 the Company paid $1.0 million, included in interest
expense, to induce conversion of $14,300,000 of convertible debt into
1,021,421 shares of common stock. If conversion had occurred on April 1,
1994, earnings per share and weighted average shares outstanding would have
been as follows:
<TABLE>
<S> <C>
Supplementary primary earnings per share: $0.72
Supplementary primary weighted average shares outstanding: 17,488,000
</TABLE>
27
<PAGE> 28
NOTE 9: INCOME TAX PROVISION (BENEFIT)
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate is as follows for the years ended March 31:
<TABLE>
<CAPTION>
1995 1994 1993
------- ------- -------
<S> <C> <C> <C>
Statutory rate . . . . . . . . . . . . . . . . . . . . 35.0% (35.0)% (34.0)%
State income taxes, net of federal income tax benefit . 3.0
Utilization of net operating losses . . . . . . . . . . (3.9)
Non-consolidated losses . . . . . . . . . . . . . . . . (4.5) 18.3
Foreign subsidiaries . . . . . . . . . . . . . . . . . (2.2) 3.4 1.5
Non-deductible expenses . . . . . . . . . . . . . . . . 4.5 2.1 2.1
Other . . . . . . . . . . . . . . . . . . . . . . . . . 0.5 3.9 5.1
------- ------- -------
Effective rate . . . . . . . . . . . . . . . . . . . . 32.4% (7.3)% (25.3)%
======= ======= =======
</TABLE>
The provision for income taxes (benefit) consists of the following for the
years ended March 31 (in thousands):
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Current:
Federal . . . . . . . . . . . . . . . . . . . . . . $ 7,772 $ 540 $ (1,686)
State . . . . . . . . . . . . . . . . . . . . . . . 922 32 5
Foreign . . . . . . . . . . . . . . . . . . . . . . (55) 143 (182)
--------- ---------- ---------
8,639 715 (1,863)
Deferred:
Federal . . . . . . . . . . . . . . . . . . . . . . (2,298) (1,003) (1,394)
State . . . . . . . . . . . . . . . . . . . . . . . (310) (391) ---
Foreign . . . . . . . . . . . . . . . . . . . . . . . (208) --- ---
--------- --------- ---------
(2,816) (1,394) (1,394)
--------- --------- ---------
$ 5,823 $ (679) $ (3,257)
========= ========= =========
</TABLE>
Deferred income tax liabilities (assets) reflect the tax effect of temporary
differences between the amounts of assets and liabilities for financial
reporting purposes and amounts as measured for tax purposes. A valuation
allowance against deferred tax assets has been provided for when it is more
likely than not that some or all of the deferred tax assets will not be
realized. The effect of temporary differences that cause significant portions
of deferred tax assets and liabilities are as follows at March 31 (in
thousands):
<TABLE>
<CAPTION>
1995 1994
--------- --------
<S> <C> <C>
Deferred Assets:
Inventory overhead allocation . . . . . . . . . . . . . . . $ (398) $ (778)
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . (5,638) (1,991)
Tax credits . . . . . . . . . . . . . . . . . . . . . . . . . (77) (1,845)
Net operating losses . . . . . . . . . . . . . . . . . . . . (334) (899)
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . (163) (717)
--------- --------
Subtotal . . . . . . . . . . . . . . . . . . . . . . . . (6,610) (6,230)
Valuation allowance . . . . . . . . . . . . . . . . . . . . . 3,230 3,772
--------- --------
Deferred Liabilities:
Software development costs . . . . . . . . . . . . . . . . . 105 1,999
--------- --------
$ (3,275) $ (459)
========= ========
</TABLE>
28
<PAGE> 29
NOTE 10: STOCK OPTION PLAN
The Company has reserved 4,170,000 shares of common stock for issuance under
its 1987 Stock Option Plan (the "1987 Plan") for officers, employees,
directors, vendors, consultants and independent contractors. Options granted
under this plan may be either incentive stock options or nonqualified stock
options and are granted at the fair market value of the Company's common stock
at the date of grant. Options vest and expire under the terms established at
the date of grant. A summary of stock option transactions follows:
<TABLE>
<CAPTION>
Range of Price
Shares Per Share
---------- ----------------
<S> <C> <C>
Options outstanding, April 1, 1992 . . . . . . 1,464,446 0.47 - 10.13
Granted . . . . . . . . . . . . . . . . . 947,700 5.62 - 8.57
Exercised . . . . . . . . . . . . . . . . (138,428) 0.47 - 5.50
Canceled . . . . . . . . . . . . . . . . . (158,950) 4.58 - 7.75
---------- ----------------
Options outstanding, March 31, 1993 . . . . . 2,114,768 0.47 - 10.13
Granted . . . . . . . . . . . . . . . . . 616,100 5.50 - 11.50
Exercised . . . . . . . . . . . . . . . . (541,108) 0.47 - 10.13
Canceled . . . . . . . . . . . . . . . . . (457,366) 3.86 - 10.13
---------- ----------------
Options outstanding, March 31, 1994 . . . . . . 1,732,394 0.47 - 11.50
Granted . . . . . . . . . . . . . . . . . . 889,000 8.38 - 22.00
Exercised . . . . . . . . . . . . . . . . . (333,807) 0.47 - 11.50
Canceled . . . . . . . . . . . . . . . . . (215,482) 4.59 - 11.88
---------- ----------------
Options outstanding, March 31, 1995 . . . . . . 2,072,105 $0.47 - 22.00
==========
</TABLE>
Of the options outstanding at March 31, 1995, 415,163 options are currently
exercisable at prices ranging from $0.47 to $11.50 per share, and 397,444
options remain available for future grants.
In March 1995, the Board of Directors approved the adoption of the 1995 Stock
Option and Award Plan (the "1995 Plan") and the Employee Stock Purchase Plan
(the "ESPP"). The Company will reserve 2,000,000 and 200,000 shares of common
stock for issuance under the 1995 Plan and the ESPP, respectively. Both plans
are subject to shareholder approval.
NOTE 11: COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
The Company has entered into long-term lease obligations for certain office
and warehouse facilities in addition to various leases for office equipment
and company vehicles. These commitments expire at various times through
fiscal 2003. The Company's expense for lease obligations for the years ended
March 31, 1995, 1994 and 1993 were $1,979,000, $1,305,000 and $712,000,
respectively.
Future minimum annual lease payments on these obligations are as follows for
the years ended March 31 (in thousands):
<TABLE>
<CAPTION>
Year Ending March 31, Payments
--------------------- --------
<S> <C>
1996 . . . . . . . . . . . . . . . . $ 2,065
1997 . . . . . . . . . . . . . . . . 1,926
1998 . . . . . . . . . . . . . . . . 1,779
1999 . . . . . . . . . . . . . . . . 1,578
2000 . . . . . . . . . . . . . . . . 1,497
Thereafter . . . . . . . . . . . . . 2,107
--------
Total . . . . . . . . . . . . . . $ 10,952
========
</TABLE>
CONTINGENCIES
The Company is a defendant in various lawsuits arising in the ordinary course
of business. Management believes that losses to the Company from these
lawsuits, if any, will not have a material adverse effect on its financial
condition or results of operations. In fiscal 1995, the Company paid
approximately $1.5 million in shareholder litigation costs in settlement of a
securities class action lawsuit filed in December 1992.
29
<PAGE> 30
NOTE 12: GEOGRAPHIC INFORMATION
The following schedule presents financial information of the Company classified
by geographic area for the years ended March 31 (in thousands):
<TABLE>
<CAPTION>
UNITED
STATES EUROPE OTHER ELIMINATIONS CONSOLIDATED
---------- ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
1995
Sales to unaffiliated customers $ 65,158 $ 17,286 $ 5,005 $ --- $ 87,449
Intercompany transfers 880 --- --- (880) ---
---------- ----------- ----------- ---------- ----------
$ 66,038 $ 17,286 $ 5,005 $ (880) $ 87,449
========== =========== =========== ========== ==========
Income from operations $ 1,701 $ 1,838 $ --- $ --- $ 3,539
========== =========== =========== ========== ==========
Identifiable assets $ 139,158 $ 8,238 $ (38) $ (5,660) $ 141,698
========== =========== =========== ========== ==========
1994
Sales to unaffiliated customers $ 53,074 $ 8,745 $ 3,710 $ --- $ 65,529
Intercompany transfers 3,901 720 --- (4,621) ---
---------- ----------- ----------- ---------- ----------
$ 56,975 $ 9,465 $ 3,710 $ (4,621) $ 65,529
========== =========== =========== ========== ==========
Income (loss) from operations $ (4,931) $ 462 $ --- $ (88) $ (4,557)
========== =========== =========== ========== ==========
Identifiable assets $ 62,009 $ 5,902 $ (443) $ 30 $ 67,498
========== =========== =========== ========== ==========
1993
Sales to unaffiliated customers $ 45,216 $ 5,166 $ 2,792 $ --- $ 53,174
Intercompany transfers 3,707 --- --- (3,707) ---
---------- ----------- ----------- ---------- ----------
$ 48,923 $ 5,166 $ 2,792 $ (3,707) $ 53,174
========== =========== =========== ========== ==========
Income (loss) from operations $ (12,752) $ (980) $ --- $ 171 $ (13,561)
========== =========== =========== ========== ==========
Identifiable assets $ 67,344 $ 445 $ (362) $ (2,432) $ 64,995
========== =========== =========== ========== ==========
</TABLE>
Intercompany transfers primarily represent shipments of finished goods
inventory to international subsidiaries. The intercompany transfers are made
at transfer prices which approximate prices charged to unaffiliated customers
and have been eliminated from consolidated net sales. In the years ended March
31, 1995, 1994 and 1993, the majority of the Company's sales to Europe were
conducted by Coktel and Sierra U.K. Export sales, primarily to Canada and
Asia, were $5,005,000, $3,710,000 and $2,792,000, for the years ended March 31,
1995, 1994 and 1993, respectively.
NOTE 13: RELATED PARTY TRANSACTIONS
The Company pays royalties to certain independent developers, including a
director of the Company. Royalty expense related to this director was
approximately $819,000, $256,000 and $443,000 during the years ended March 31,
1995, 1994 and 1993, respectively. Royalties payable to the director at March
31, 1995 and 1994 were $633,000 and $117,000, respectively.
From July 1993 through December 1994, the Company paid certain operating
expenses on behalf of INN. Total amounts advanced under this arrangement
totaled $456,000 and $3,271,000 during fiscal 1995 and fiscal 1994,
respectively. In April 1994, the Company accepted an unsecured Promissory Note
from INN for approximately $2,895,000. This amount was paid in full, including
interest accrued at Bank of America's prime rate, in December 1994.
As of March 31, 1995, the Company held certain notes receivable from officers
of a subsidiary. Amounts receivable from those officers at March 31, 1995 and
1994 were $792,000 and $845,000, respectively. Interest earned under these
agreements was $84,000, $152,000 and $81,000 for the years ended March 31,
1995, 1994 and 1993, respectively. The notes were paid in full in May 1995.
30
<PAGE> 31
NOTE 14: QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Summarized quarterly financial information for fiscal 1995 and fiscal 1994 is
as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
Primary Fully
Net Diluted
Net Income Net
Income (Loss) Income
Revenues (Loss) Per Share Per Share
---------- --------- --------- ---------
<S> <C> <C> <C> <C>
Quarter ended:
June 30, 1994 $ 12,861 $ (4,145) $ (0.26) $ ---
September 30, 1994 19,456 (855) (0.05) ---
December 31, 1994(1) 37,152 16,807 0.99 0.84
March 31, 1995 20,038 355 0.03 ---
--------- ---------
$ 89,507 $ 12,162
========= =========
Quarter ended:
June 30, 1993(2) $ 11,817 $ (3,488) $ (0.22) $ ---
September 30, 1993 15,566 (1,612) (0.10) ---
December 31, 1993 28,604 3,361 0.20 ---
March 31, 1994 11,931 (6,880) (0.44) ---
--------- ---------
$ 67,918 $ (8,619)
========= =========
</TABLE>
(1) Includes $19,739,000 gain on sale of the Company's 58% interest in The
ImagiNation Network to AT&T.
(2) One hundred percent of the operating activities of INN have been
included in the Company's operating results through July 26, 1993.
Subsequent to that date, the Company sold 42% of INN's voting stock
and reduced its ownership interest to 58% and began recording INN
operations under the equity method.
NOTE 15: SUBSEQUENT EVENT
On July 12, 1995 the Company announced the formation of a joint venture with
Pioneer Electronic Corporation to market and develop entertainment and other
software titles for the Japanese market. The joint venture requires a minimum
capital contribution from the Company of approximately $1.8 million. Under
certain circumstances, the Company may be required to contribute up to a
maximum of $6.0 million over the duration of the joint venture.
ITEM 6. EXHIBITS AND REPORTS OF FORM 8-K.
(a) The following exhibits are filed herewith:
Exhibit 11.0 - Statement Re Computation of Per Share
Earnings
(b) Reports on Form 8-K.
None.
31
<PAGE> 32
SIERRA ON-LINE, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SIERRA ON-LINE, INC.
Date: August 14, 1995 By: /s/ Michael A. Brochu
----------------------------
Michael A. Brochu
Executive Vice President and
Chief Financial Officer
By: /s/ Fred Schapelhouman
----------------------------
Fred Schapelhouman
Chief Accounting Officer
32
<PAGE> 1
EXHIBIT 11.0
SIERRA ON-LINE, INC. AND SUBSIDIARIES
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
JUNE 30, 1995 JUNE 30, 1994
------------- -------------
<S> <C> <C>
Weighted average number of common shares outstanding . . . . . . . . 17,643 16,124
Dilutive effect of stock options . . . . . . . . . . . . . . . . . . 1,030 ---
-------- ---------
Total average common and common equivalent shares . . . . . . 18,673 16,124
======== =========
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . $ 32 $ (4,145)
======== =========
Net income (loss) per common and common equivalent share . . . . . . $ 0.00 $ (0.26)
======== =========
</TABLE>
33
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1995
<PERIOD-END> JUN-30-1995
<CASH> 40,680
<SECURITIES> 46,286
<RECEIVABLES> 26,755
<ALLOWANCES> 6,704
<INVENTORY> 4,819
<CURRENT-ASSETS> 117,903
<PP&E> 22,524
<DEPRECIATION> 13,169
<TOTAL-ASSETS> 136,417
<CURRENT-LIABILITIES> 16,522
<BONDS> 0
<COMMON> 71,933
0
0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 136,417
<SALES> 21,166
<TOTAL-REVENUES> 21,456
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 21,681
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 695
<INCOME-PRETAX> 32
<INCOME-TAX> 0
<INCOME-CONTINUING> 32
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 32
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
