Activision Blizzard is a computer and video game company based in Santa Monica, USA. The company emerged from the merger of the publisher Activision with Vivendi Universal Games. In terms of sales, the company is the market leader in the computer and video game sector.
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, 1996 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 Identification No.) incorporation or organization) 11601 Wilshire Blvd., Los Angeles, CA 90025 (Address of principal executive offices) (Zip Code) (310) 473-9200 (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 14, 1997 was 14,078,060. ACTIVISION, INC. INDEX Page No. PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets as of December 31, 1996 (unaudited) and March 31, 1996 3 Condensed Consolidated Statements of Operations for the quarters and nine months ended December 31, 1996 and 1995 (unaudited) 4 Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 1996 and 1995 (unaudited) 5 Notes to Condensed Consolidated Financial Statements for the quarter and nine months ended December 31, 1996 (unaudited) 6-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8-16 PART II. OTHER INFORMATION Item 1. Legal Proceedings 17 Item 6. Exhibits and Reports on Form 8-K 17 SIGNATURES 18 Exhibit Index 19 Part I - Financial Information Item 1. Financial Statements ACTIVISION, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (in thousands except share data) December 31, March 31, 1996 1996 ------------------ ----------------- (Unaudited) Assets Current assets: Cash and cash equivalents $17,336 $25,288 Accounts receivable, net of allowances of $8,618 and $7,005 respectively 33,373 19,909 Inventories, net 3,275 2,975 Prepaid software and license royalties 6,788 3,652 Other current assets 1,500 1,183 Deferred income taxes 505 1,500 ----------------- ----------------- Total current assets 62,777 54,507 Property and equipment, net 4,186 3,326 Other assets 260 200 Excess purchase price over identifiable assets acquired, net 18,618 19,580 ------------------ ------------------ Total assets $85,841 $77,613 ========== ========== Liabilities and Shareholders' Equity Current liabilities: Accounts payable $7,543 $4,592 Accrued expenses 10,130 9,688 ----------------- ----------------- Total current liabilities 17,673 14,280 Other liabilities 319 334 ----------------- ---------------- Total liabilities 17,992 14,614 ----------------- ----------------- Commitments and contingencies Shareholders' equity: Common stock, $.000001 par value, 50,000,000 and 100,000,000 shares authorized, 14,475,450 and 14,250,180 shares issued and 13,975,450 and 13,750,180 outstanding , respectively - - Additional paid-in capital 69,796 67,904 Retained earnings (accumulated deficit) 3,533 708 Cumulative foreign currency translation (202) (335) Less: Treasury stock, cost of 500,000 shares (5,278) (5,278) ------------------ ----------------- Total shareholders' equity 67,849 62,999 ------------------ ----------------- Total liabilities and shareholders' equity $85,841 $77,613 ========== ========== The accompanying notes are an integral part of these condensed consolidated financial statements <TABLE> ACTIVISION, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Operations (in thousands except income (loss) per share data) (Unaudited) <CAPTION> Quarter ended Nine months ended December 31, December 31, ----------------------------- ----------------------------- 1996 1995 1996 1995 -------------- -------------- --------------- ------------- <S> <C> <C> <C> <C> Net revenues $ 31,361 $ 17,578 $ 57,557 $ 39,745 Cost of goods sold 11,878 7,131 19,099 15,428 -------------- -------------- -------------- -------------- Gross profit 19,483 10,447 38,458 24,317 -------------- -------------- -------------- -------------- Operating expenses: Product development 4,707 4,163 13,861 12,807 Sales and marketing 6,883 3,200 15,930 9,290 General and administrative 1,362 1,190 3,951 3,332 Amortization of intangible assets 321 321 963 963 -------------- -------------- -------------- -------------- Total operating expenses 13,273 8,874 34,705 26,392 -------------- -------------- -------------- -------------- Operating income (loss) 6,210 1,573 3,753 (2,075) Other income: Interest, net 172 409 728 1,343 ------------- -------------- -------------- -------------- Income (loss) before income tax provision 6,382 1,982 4,481 (732) Income tax provision 2,262 34 1,656 83 -------------- -------------- -------------- -------------- Net income (loss) $ 4,120 $ 1,948 $ 2,825 $ (815) =============== ============== ============== ============== Net income (loss) per share $ 0.28 $ 0.13 $ 0.19 $ (0.06) =============== ============== ============== ============== Number of shares used in computing net income (loss) per share 14,644 15,209 14,565 14,077 =============== ============== ============== ============== </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. ACTIVISION, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows For the nine months ended December 31, (in thousands) Increase (Decrease) in Cash (Unaudited) 1996 1995 ------------- ------------ Net cash used in operating activities $ (6,746) $ (1,840) ------------- ------------ Cash flows from investing activities: Capital expenditures (2,349) (2,244) ------------- ------------ Net cash used in investing activities (2,349) (2,244) ------------- ------------ Cash flows from financing activities: Proceeds from issuance and exercise of common stock options and warrants 1,010 214 Purchase of Treasury Stock - (5,278) ------------- ------------ Net cash provided (used) by financing activities 1,010 (5,064) ------------- ------------ Effect of exchange rate changes on cash 133 (130) ------------- ------------ Net decrease in cash and cash equivalents (7,952) (9,278) ------------- ------------ Cash and cash equivalents at beginning of period 25,288 37,355 ------------- ------------ Cash and cash equivalents at end of period $ 17,336 $ 28,077 ============= ============ Non-cash investing activities: Stock issued in exchange for licensing rights $ 822 $ - ============= ============ Activision, Inc. Notes to Condensed Consolidated Financial Statements For the Quarter and Nine Months Ended December 31, 1996 (Unaudited) The accompanying notes are an integral part of these condensed consolidated financial statements. 1. Basis of Presentation The accompanying condensed consolidated financial statements include the accounts of Activision, Inc. and its subsidiaries. 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 Company's Annual Report on Form 10-K for the year ended March 31, 1996. 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. 2. Inventories Inventories, net comprise (amounts in thousands): December 31, March 31, 1996 1996 Finished goods $ 2,307 $ 2,099 Purchased parts and components 968 876 --------- --------- $ 3,275 $ 2,975 ========= ========= 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. 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. Amortization of Intangible Assets Effective April 1, 1992, the Disc Company, Inc. ("TDC"), a Delaware corporation and a wholly-owned subsidiary of International Consumer Technologies Corporation, was merged with and into the Company, with the Company as the surviving corporation. The excess of the purchase price over the estimated fair values of the net assets acquired was recorded as an intangible asset in the amount of $24,417,000. This intangible asset is being amortized on a straight-line basis over a 20 year period. Amortization was approximately $305,000 for each of the quarters ended December 31, 1996 and 1995 and $915,000 for each of the nine month periods ended December 31, 1996 and 1995. The Company systematically evaluates current and expected cash flow from operations on a non- discounted basis for the purpose of assessing the recoverability of recorded intangible assets. Some of the factors considered in this evaluation include operating results, business plans, budgets and economic projections. Should such factors indicate that recoverability might be impaired, the Company would appropriately adjust the recorded amount of the intangible asset and/or the period over which the recorded intangible asset is amortized. 6. Computation of Net Income (Loss) per Share The net income (loss) per common share and common equivalent shares for the quarter and nine month periods ended December 31, 1996 and 1995 have been computed using the weighted average number of common shares and common stock equivalent shares, unless anti-dilutive, outstanding for each period as summarized below (amounts in thousands): Quarter ended Nine months ended December 31, December 31, ------------------- ------------------- 1996 1995 1996 1995 -------- -------- -------- -------- Weighted average common shares outstanding during the period 13,941 13,969 13,877 14,077 Common stock equivalent shares 703 1,240 688 - -------- -------- -------- -------- Shares used in net income (loss) per share calculation 14,644 15,209 14,565 14,077 ======== ======== ======== ======== Common stock equivalent shares consist of outstanding stock options and director warrants. 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 including those discussed below in "Factors Affecting Future Performance" on pages 12 to 16, as well as under the heading, "Certain Cautionary Information" in the Company's Annual Report on Form 10-K on pages 4 to 8 of such Report. 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 diversified international publisher of interactive entertainment software. The Company develops and publishes entertainment software for a variety of platforms, including both personal computer CD- ROM desktop systems, such as the Windows 95 operating system, and videogame set-top hardware systems, such as the Sony PlayStation and Sega Saturn. The Company distributes its products worldwide through its direct sales force and, to a lesser extent, through third party distributors and licensees. For purposes of the presentation set forth below, net revenues from and cost of goods sold related to set-top systems consist of sales and costs relating to all entertainment software products designed by the Company for operation on a hardware device that is connected to a television set and displayed on a television screen. Examples of set-top systems include Sony PlayStation ("PlayStation"), Sega Saturn ("Saturn"), Super Nintendo Entertainment System ("SNES"), Sega Genesis ("SGS") and 3DO Multiplayer. The Company designs products for operation on many of these systems, and normally it is required to pay a license fee for the right to create products for a particular system. Net revenues from and cost of goods sold related to desktop systems consist of sales and costs relating to all entertainment software products designed by the Company for operation through a personal computer's operating system software and that is displayed on the computer's monitor. Examples of computer operating systems include Windows, MS-DOS and the Macintosh operating systems. The Company generally is not obligated to pay an operating system license fee for the right to produce desktop products. Results of Operations Net Revenues Net revenues for the quarter and nine months ended December 31, 1996 increased $13,783,000 or 78.4% and $17,812,000 or 44.8%, respectively, from the same periods last year. These increases in net revenues were due to increases in set-top, desktop and OEM net revenues during the current periods. The increase in set-top net revenues during the current quarter was attributable to the initial release of "Blood Omen: Legacy of Kain" (PlayStation), "Blast Chamber" (PlayStation) and "Power Move Pro Wrestling" (PlayStation). The increase in desktop net revenues during the current quarter was attributable to the initial release of "Hyperblade" (Windows 95 CD), "A-10 Cuba!" (Windows 95 CD) and continuing sales of "MechWarrior 2: Mercenaries" (Windows 95 CD), "MechWarrior 2" (Windows 95/MS-DOS/Mac CD) and "Zork Nemesis" (Windows 95/Mac CD). Total OEM and licensing net revenues increased during the current quarter and nine month period due to OEM and licensing revenues related to enhanced 3-D versions of "MechWarrior 2" (Windows 95 CD/Matrox Mystique, ATI, S3 Virge, Rave and Power VR), "Time Commando" (Windows 95 CD), "Zork Nemesis" (Windows 95 CD) and "Spycraft: The Great Game" (Windows 95 CD). <TABLE> Net revenues by territory were as follows (amounts in thousands): <CAPTION> Quarter Ended December 31, Nine Months Ended December 31, -------------------------------- -------------------------------- 1996 1995 1996 1995 --------------- --------------- --------------- --------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> % of Net % of Net % of Net % of Net Amount Revenues Amount Revenues Amount Revenues Amount Revenues North America $24,648 78.6% $13,062 74.3% $45,117 78.4% $30,034 75.6% Europe 3,886 12.4% 1,791 10.2% 6,625 11.5% 3,819 9.6% Japan 1,014 3.2% 1,901 10.8% 2,265 3.9% 3,797 9.6% Australia and Pacific Rim 1,813 5.8% 824 4.7% 3,550 6.2% 2,095 5.2% ------- ------ ------- ------ ------- ------ ------- ------ $31,361 100.0% $17,578 100.0% $57,557 100.0% $39,745 100.0% ======= ====== ======= ====== ======= ====== ======= ====== </TABLE> <TABLE> Net revenues by device/medium were as follows (amounts in thousands): <CAPTION> Quarter Ended December 31, Nine Months Ended December 31, ------------------------------- -------------------------------- 1996 1995 1996 1995 --------------- -------------- -------------- ---------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> % of Net % of Net % of Net % of Net Amount Revenues Amount Revenues Amount Revenues Amount Revenues Set-top $10,423 33.2% $1,323 7.5% $12,121 21.1% $4,092 10.3% Desktop 20,938 66.8% 16,255 92.5% 45,436 78.9% 35,653 89.7% ------- ------ ------ ------ ------- ------ ------ ------ $31,361 100.0% $17,578 100.0% $57,557 100.0% $39,745 100.0% ======= ====== ======= ====== ======= ====== ======= ====== </TABLE> <TABLE> Net revenues by distribution channel were as follows (amounts in thousands): <CAPTION> Quarter Ended December 31, Nine Months Ended December 31, --------------------------------- ---------------------------------- 1996 1995 1996 1995 --------------- --------------- --------------- ----------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> % of Net % of Net % of Net % of Net Amount Revenues Amount Revenues Amount Revenues Amount Revenues Retailer/Reseller $25,850 82.4% $13,389 76.2% $44,311 77.0% $31,695 79.8% OEM 4,849 15.5% 3,099 17.6% 11,184 19.4% 4,104 10.3% On-line, licensing and other 662 2.1% 1,090 6.2% 2,062 3.6% 3,946 9.9% ------- ------ ------- ------ ------- ------ ------- ------ $31,361 100.0% $17,578 100.0% $57,557 100.0% $39,745 100.0% ======= ====== ======= ====== ======= ====== ======= ====== Cost of Goods Sold Cost of goods sold related to set-top, desktop and OEM net revenues represent the manufacturing and related costs of computer software and video games. Manufacturers of the Company's computer software are located in the United States and Europe and are readily available. Set-top CDs and cartridges are manufactured by the respective video game console manufacturers, such as Sony, Nintendo and Sega, who require significant lead time to fulfill the Company's orders. Also included in cost of goods sold is royalty expense related to amounts due to developers, title owners or other royalty participants based on product sales. Various contracts are maintained with developers, product title owners or other royalty participants which state a royalty rate and term of agreement, among other items. Cost of goods sold as a percentage of net revenues decreased to 37.9% for the quarter ended December 31, 1996 compared to 40.6% for the quarter ended December 31, 1995. The nine month comparative figures also show a decrease in cost of goods sold as a percentage of net revenues to 33.2% for the nine month period ended December 31, 1996 compared to 38.8% for the nine month period ended December 31, 1995. These decreases are the result of increased efficiencies in the manufacturing and distribution process partially offset by an increase of CD-based set-top products in the net revenues mix. Variability in the cost of goods sold as a percentage of net revenues will be driven primarily by the mix of desktop versus set-top products, as well as the mix of internal versus external product development, the latter in each case resulting in higher cost of goods sold. Gross Profit For the quarter ended December 31, 1996, gross profit as a percentage of net revenues was 62.1% compared to 59.4% for the quarter ended December 31, 1995. Gross profit as a percentage of net revenues increased to 66.8% for the nine months ended December 31, 1996 from 61.2% for the nine months ended December 31, 1995. The increase in gross profit as a percentage of net revenues during both the current quarter and nine month period was the result of increased efficiencies in the manufacturing and distribution process partially offset by an increase of CD-based set-top products in the net revenues mix. Gross margin variability will be driven primarily by the mix of desktop versus set-top products, as well as the mix of internal versus external product development, the latter in each case resulting in lower gross margins. </TABLE> <TABLE> Operating Expenses <CAPTION> Quarter Ended December 31, Nine Months Ended December 31, ---------------------------------- ---------------------------------- 1996 1995 1996 1995 ---------------- ---------------- ---------------- ---------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> % of Net % of Net % of Net % of Net Amount Revenues Amount Revenues Amount Revenues Amount Revenues Product development $4,707 15.0% $4,163 23.7% $13,861 24.1% $12,807 32.2% Sales and marketing 6,883 22.0% 3,200 18.2% 15,930 27.7% 9,290 23.4% General and administrative 1,362 4.3% 1,190 6.8% 3,951 6.8% 3,332 8.4% Amortization of intangible assets 321 1.0% 321 1.8% 963 1.7% 963 2.4% ------ ------ ------ ------ ------- ------ ------ ------ $13,273 42.3% $8,874 50.5% $34,705 60.3% $26,392 66.4% ======= ====== ====== ====== ======= ====== ======= ====== </TABLE> Product development expenses increased in amount for the quarter and nine months ended December 31, 1996 due to an overall increase in the number of products in development, an increase in production costs associated with 3-D programming technology and continued investment in development for new CD-based set-top platforms. Sales and marketing expenses increased both in amount and as a percentage of revenues as a result of a worldwide expansion of the sales and marketing organization needed to manage the Company's increased product release schedule. General and administrative expenses increased in amount due to an increase in head count related expenses as compared to the same periods in the prior year. Other Income (Expense) Interest income was approximately $172,000 and $728,000 for the quarter and nine months ended December 31, 1996, respectively, compared to approximately $409,000 and $1,343,000 for the quarter and nine months ended December 31, 1995, respectively. The decreases were due to a decrease in cash and cash equivalents during the current fiscal quarter and nine month period as compared to the same periods in the prior year. Income Tax Provision The income tax provision of approximately $2,262,000 and $1,656,000 for the quarter and nine months ended December 31, 1996, respectively, reflects the Company's expected effective income tax rate for the fiscal year ending March 31, 1997. The Company did not record an income tax provision benefit for the nine months ended December 31, 1995 due to the fact that, as of such date, the Company had not yet generated taxable income. Income taxes for the quarter and nine months ended December 31, 1995 represent foreign taxes withheld, which may be available in the future as tax credits against future tax liability. Net Income (Loss) For the reasons noted above, net income increased to $4,120,000 for the quarter ended December 31, 1996 from a net income of $1,948,000 for the same period of the prior fiscal year. For the nine months ended December 31, 1996, net income increased to $2,825,000 from a net loss of $815,000 for the same period of the prior fiscal year. Liquidity and Capital Resources The Company's working capital increased $4.9 million from March 31, 1996 to December 31, 1996 primarily as a result of the increase in net revenues and the resulting increase in accounts receivable. At December 31, 1996, net accounts receivable and inventories were $36.7 million, an increase of $13.8 million from $22.9 million as of March 31, 1996. Prepaid royalties increased as a result of an increase in third party intellectual property and product right acquisitions. As of December 31, 1996, total accounts payable and accrued liabilities were approximately $17.7 million versus $14.3 million at March 31, 1996. The increase at December 31, 1996 is primarily due to the increase in inventories and accrued expenses related to the increase in net revenues during the quarter. During the nine months ended December 31, 1996, the Company invested approximately $2.3 million in computer hardware, software and information systems required to support the Company's growth in product development and distribution. During fiscal 1997, the Company expects to incur additional capital expenditures relating to the development of its products and the general operation of its business. In December 1996, the Company signed a new long term lease for its headquarters and will be moving from its current facility in Los Angeles to a nearby facility in Santa Monica, California in the first quarter of fiscal 1998. The Company's principal source of liquidity is $17.3 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 Company's existing capital resources are sufficient to meet its current operational requirements for the foreseeable future. The Company's management currently believes that inflation has not had a material impact on continuing operations. 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 in the past varied significantly and will likely in the future vary significantly depending on numerous factors, many 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 desktop and set-top 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. Products are generally shipped as orders are received, and consequently, the Company 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 large part on the Company's product development and marketing budgets. Product development and marketing costs are expensed as incurred, which is often long before a product ever 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 are typically 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 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 five quarters were $31.3 million for the quarter ended December 31, 1996, $19.2 million for the quarter ended September 30, 1996, $7.0 million for the quarter ended June 31, 1996, $21.6 million for the quarter ended March 31, 1996 and $17.6 million for the quarter ended December 31, 1995. The Company expects its net revenues 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 and marketing costs. The lack of market acceptance or the significant delay in the introduction of, or the presence of a defect in, one or more new 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 is generally associated with initial shipments, the delay of a product introduction expected near the end of a fiscal quarter may have a material adverse affect on the 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 will likely be delays in developing and introducing new products in the future. There can be no assurance that new products will be introduced on schedule, or at all, or that they will achieve market acceptance or generate significant revenues. From time to time, the Company utilizes independent contractors for certain aspects of product development and production. The Company has less control over the scheduling and the quality of work by independent contractors than that of its own employees. A delay in the work performed by independent contractors or a lack of quality in such work may result in product delays and poor product performance. Although the Company intends to rely in significant part on internal product development, the Company's business and future operating results also will depend, to a certain extent, on the Company's continued ability to maintain relationships with skilled 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 efforts on selected, high quality entertainment software products. The Company derives a significant portion of its revenues from a select number of high quality entertainment software products released each year, and many of these products have substantial production and marketing budgets. Due to this dependence on a limited number of products, the Company may be adversely affected if one or more principal products fail to achieve anticipated results. 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, 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 needed for best-selling titles. In addition, competitors with larger product lines and a greater number of 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 competitors' 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, Inc., Lucas Arts Entertainment Company, Microsoft Corporation ("Microsoft"), Sony, Sega, Nintendo, CUC International, Inc., Good Times Interactive, Inc., Interplay, Inc. and Maxis, Inc., among many others. In addition, the Company believes that new competitors, including large divisions of major media and communications companies such as The Walt Disney Company and Dreamworks SKG, are entering or considering entering the market or are increasing their focus on the entertainment software market, resulting in greater competition for the Company. As competition increases, significant price competition, increased production costs and reduced profit margins may result. In addition, competition from new technologies, such as on-line or networked games, may reduce demand in markets in which the Company has traditionally competed. 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 affect 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 has increased, 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. Changes In Technology And Industry Standards. The consumer software industry is continuing to undergo rapid changes, including evolving industry standards, frequent new platform introductions and changes in consumer requirements and preferences. The introduction and adoption of new technologies, including operating systems such as Microsoft's Windows 95 and multi-player gaming over the Internet, 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's 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. 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. 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. 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. In particular, the loss of the services of Robert A. Kotick, Brian G. Kelly or Howard E. Marks could have a material adverse effect on the Company. The Company maintains life insurance policies only on Messrs. Kotick, Kelly and Marks. 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 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 additional qualified employees or to retain the services of key personnel could have a material adverse affect on the Company's business, operating results and financial condition. 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 or two intermediaries. 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 intermediaries, 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 maintains a reserve for uncollectible receivables that it believes to be adequate, a payment default by a significant customer could have a material adverse affect on the Company's business, operating results and financial condition. 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. Risks Associated With International Operations. International net revenues accounted for 24%, 28%, 23% and 22% of the Company's total revenues in the fiscal years 1994, 1995 and 1996 and nine months ended December 31, 1996, respectively. The Company intends to continue to expand its direct and indirect sales and marketing 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 personal computer 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 significant 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. 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 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.14 Lease Agreement dated as of December 20, 1996 between the Company and Barclay-Curci Investment Company (b) Reports on Form 8-K The Company filed Form 8-K on January 17, 1997 reporting a change in the Company's certifying accountant from Coopers & Lybrand LLP to KPMG Peat Marwick LLP, effective January 17, 1997. 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 14, 1997 ACTIVISION, INC. Chairman, Chief Executive February 14, 1997 (Robert A. Kotick) Officer (Principal Executive Officer), President and Director Chief Financial and Operating February 14, 1997 (Brian G. Kelly) Officer and Director (Principal Financial Officer) Chief Accounting Officer February 14, 1997 (Barry J. Plaga) (Principal Accounting Officer) Exhibit Index Exhibit No. Description Sequential Page No. 10.14 Lease Agreement between the 20 Company and Barclay-Curci Investment Company