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2004 Annual Report
25th Anniversary

Table of contents

  • Page 1
    25th Anniversary 2004 Annual Report

  • Page 2
    ...94,847 66,180 0.43 2002 $786,434 80,574 52,238 0.39 Net revenues Operating income Net earnings Diluted earnings per share Net Revenues in millions of dollars Net Earnings in millions of dollars Diluted Earnings per common share $948 $864 $786 $52 $66 $78 $0.43 $0.39 $0.54 '02 '03 '04 '02...

  • Page 3
    ...LucasArts Entertainment Company to publish and distribute LucasArts' video game console and PC products in more than 60 countries in Europe and Africa. Additionally, we recently expanded our agreement with Columbia Pictures/Marvel Enterprises, Inc. to publish games based on the upcoming feature film...

  • Page 4
    ... 2004 Annual Report We added resources to our internal development studios through the acquisition of Infinity Ward which created Call of Duty, the #1 best-selling PC game in the U.S. during the holiday season. Additionally, we expanded our relationships with retailers and increased our shelf space...

  • Page 5
    Activision, Inc. - 2004 Annual Report Production values, the way games look and sound, continue to increase as console technology advances and we expect that the production values of the next generation of console systems will approximate those of movies and TV. In 1981, "ER" and "Jurassic Park" ...

  • Page 6
    Activision, Inc. - 2004 Annual Report Activision, Inc. - 2004 Annual Report ௡ ௡ Capitalizing on 25 Years of Achievement page 4 page 5

  • Page 7
    ... to release our strongest game slate ever. The company's lineup is comprised of high-profile entertainment properties and titles created by some of the industry's premier development talent. Our release schedule includes games based on such highly anticipated movies as "Shrek 2 ீ"; "Spider-Man...

  • Page 8
    ... programs that drive sales Aggressive marketing is not a new concept at Activision. In support of our fiscal year 2004 holiday titles, we increased our trade and consumer marketing programs and raised awareness for our products through in-store merchandising, as well as in-theater, print, online...

  • Page 9
    ... "Greenlight Process," a disciplined methodology for the selection, development, production and quality assurance of our titles. With our recent acquisition of Infinity Ward, we now have eight wholly owned studios and employ more than 700 of the best artists, programmers, designers and storytellers...

  • Page 10
    Activision, Inc. - 2004 Annual Report Financial Review Selected Consolidated Financial Data 13 Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Report of Independent Registered Public Accounting Firm 41 Consolidated Balance Sheets 42 Consolidated ...

  • Page 11
    ...sales-product costs Cost of sales-intellectual property licenses and software royalties and amortization Income (loss) from operations Income (loss) before income tax provision (benefit) Net income (loss) Basic earnings (loss) per share Diluted earnings (loss) per share Basic weighted average common...

  • Page 12
    ... generation platforms given their large and growing installed base. Our publishing business involves the development, marketing and sale of products directly, by license or through our affiliate label program with certain third-party publishers. In the United States, we primarily sell our products...

  • Page 13
    ... for the holiday season. We expect to develop a variety of games on multiple platforms based on these two new original properties and hope to establish them as a source of recurring revenues. For example, in fiscal 2005, we are scheduled to release Call of Duty: Finest Hour which will be released on...

  • Page 14
    ... order to recognize revenue for both product sales and licensing transactions, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable. Revenue recognition also determines the timing of certain expenses, including cost of sales-intellectual property...

  • Page 15
    ... our inventory provision. Software Development Costs. Software development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products. We account for software development costs in accordance...

  • Page 16
    ... planned theatrical releases or television series based on the intellectual property and the rights holder's continued promotion and exploitation of the intellectual property. Prior to the related product's release, we expense, as part of cost of sales-intellectual property licenses, capitalized...

  • Page 17
    ... Cost of sales-intellectual property licenses Product development Sales and marketing General and administrative Total costs and expenses Income from operations Investment income, net Income before income tax provision Income tax provision Net income Net Revenues by Territory: United States...

  • Page 18
    ... games designed for play on video game consoles (such as the PS2, Xbox and GameCube), PCs and hand-held game devices (such as the GBA). We also derive revenue from our distribution business in Europe that provides logistical and sales services to third-party publishers of interactive entertainment...

  • Page 19
    ... of our key fiscal 2004 releases, we were able to maintain the original price points for those titles for an extended period of time. • International net revenues benefited from the strong year-over-year strengthening of the Euro ("EUR") and Great British Pound ("GBP") in relation to the...

  • Page 20
    ... select European markets, Jedi Knight: Jedi Academy, performed very well in both the domestic and international markets. According to NPD Group, a third-party sales tracking agency, Call of Duty was the number one selling PC title in North America during the quarter of its release, our third quarter...

  • Page 21
    ... ended March 31, 2003 to $289.0 million for the year ended March 31, 2004. Though the number of new PS2 titles reduced in fiscal 2004 to 10 from 13 in fiscal 2003, we were able to increase our PS2 sales in both the domestic and international markets. The increase is primarily due to strong worldwide...

  • Page 22
    ... the ability of hardware manufacturers to continue to increase their installed hardware base, the introduction of new hardware platforms, as well as the timing of key product releases from our product release schedule. We expect that net revenues from console titles will continue to represent...

  • Page 23
    ... customers that generate a higher percentage of sales from software. In both fiscal years, hardware sales were principally comprised of sales of console hardware. The mix of future distribution net revenues will be driven by a number of factors including the occurrence of further hardware price...

  • Page 24
    ... of our investments in long-term licensing agreements. We expect cost of sales-intellectual property licenses to increase in fiscal 2005 as compared to fiscal 2004, as we expect to have more titles releasing with licensed intellectual property. Product Development (In thousands) March 31, 2004 $97...

  • Page 25
    ...year was primarily generated by our publishing business as a result of significant marketing programs, including television and in-theatre ad campaigns and in-store promotions, run in support of our three key fiscal 2004 third quarter title releases, Tony Hawk's Underground, and our two new original...

  • Page 26
    ...fiscal 2004 third quarter title releases. Partially offset by: • Increased sales and marketing spending. • The product development charge recorded in the fiscal 2004 third quarter in connection with the cancellation of ten products. Distribution operating income for the year ended March 31, 2004...

  • Page 27
    ... rate of 35% were research and development tax credits and the impact of foreign tax rate differentials, partially offset by an increase in our deferred tax asset valuation allowance and state taxes. The realization of deferred tax assets depends primarily on the generation of future taxable income...

  • Page 28
    ... decrease reflects the fact that the GBA hardware was launched in June 2001. Our GBA software sales for the year ended March 31, 2002 benefited from the related hardware launch. We also released fewer titles for the hand-held platforms in fiscal 2003-11 titles, in comparison to 19 titles in fiscal...

  • Page 29
    ...-held devices generally have the highest manufacturing per unit cost of all platforms. Second, our manufacturing costs for console titles for the year ended March 31, 2003 benefited from the economies of scale due to the high volume of Spider-Man: The Movie units manufactured. Cost of Sales-Software...

  • Page 30
    ... additional costs relating to common stock warrants issued in connection with those licensing agreements. The impact of these costs was partially offset by the fact that one of our top performing titles released in fiscal 2002 had a higher intellectual property royalty rate structure than the...

  • Page 31
    ...increase in sales and marketing expense dollars in our publishing business was the result of a significant marketing program in support of the simultaneous cross-platform, multinational release of Spider-Man: The Movie during the first quarter of fiscal 2003, as well as increased TV and print ads in...

  • Page 32
    ...effected in the form of a 50% stock dividend to shareholders of record as of February 23, 2004, paid March 15, 2004. (2) See Note 5, "Software Development Costs and Intellectual Property Licenses" of the Notes to the Consolidated Financial Statements included elsewhere in this Annual Report. page 34

  • Page 33
    ...and equipment, the funding of the development, production, marketing and sale of new products and the acquisition of intellectual property rights for future products from third parties. Cash Flows from Operating Activities In recent years, the primary drivers of cash flows from operating activities...

  • Page 34
    Activision, Inc. - 2004 Annual Report Management's Discussion and Analysis of Financial Condition and Results of Operations third parties, as well as the capitalization of product development costs relating to internally developed products. We expect that we will continue to make significant ...

  • Page 35
    ... distribution rights for products being developed by third parties, the execution of new license agreements granting us long-term rights to intellectual property of third parties, as well as the capitalization of product development costs relating to internally developed products. Offset by: • $87...

  • Page 36
    ...primarily driven by: • Marketing support for our key title releases. • Increased foreign income taxes payable. • Increased annual bonuses as a result of company performance. Partially offset by: • A $7.5 million accrual at March 31, 2003 for the settlement of treasury stock purchases. Credit...

  • Page 37
    ... 2007 relating to an intellectual property rights agreement with a third party. Effective June 30, 2003, we terminated the agreement and filed a breach of contract suit against the third party. Financial Disclosure We maintain internal controls over financial reporting, which generally include...

  • Page 38
    ... may occur, since actual gains and losses will differ from those estimated, based upon actual fluctuations in interest rates, foreign currency exchange rates and market prices and the timing of transactions. Interest Rate Risk Our exposure to market rate risk for changes in interest rates relates...

  • Page 39
    .... - 2004 Annual Report Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Activision, Inc.: In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of Activision, Inc. and...

  • Page 40
    ... share data) March 31, Assets 2004 2003 Current assets: Cash and cash equivalents Short-term investments Accounts receivable, net of allowances of $47,028 and $57,356 at March 31, 2004 and 2003, respectively Inventories Software development Intellectual property licenses Deferred income taxes...

  • Page 41
    ...of sales-intellectual property licenses Product development Sales and marketing General and administrative Total costs and expenses Income from operations Investment income, net Income before income tax provision Income tax provision Net income Basic earnings per share Weighted average common shares...

  • Page 42
    ... year Unrealized depreciation on short-term investments Foreign currency translation adjustment Total comprehensive income Issuance of common stock to employees Issuance of common stock pursuant to warrants and common stock warrants Tax benefit attributable to employee stock options and common stock...

  • Page 43
    ... software development costs and intellectual property licenses Tax benefit of stock options and warrants exercised Change in operating assets and liabilities (net of effects of acquisitions): Accounts receivable Inventories Software development and intellectual property licenses Other assets...

  • Page 44
    ... next-generation console systems expected to be developed by Sony, Microsoft and Nintendo for release in the next two to three years. Our publishing business involves the development, marketing and sale of products directly, by license or through our affiliate label program with certain third-party...

  • Page 45
    ... to exercise significant influence, we account for our investment using the cost method. Software Development Costs Software development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products...

  • Page 46
    ... planned theatrical releases or television series based on the intellectual property and the rights holder's continued promotion and exploitation of the intellectual property. Prior to the related product's release, we expense, as part of cost of sales-intellectual property licenses, capitalized...

  • Page 47
    Activision, Inc. - 2004 Annual Report Notes to Consolidated Financial Statements Commencing upon the related product's release, capitalized intellectual property license costs are amortized to cost of sales-intellectual property licenses based on the ratio of current revenues for the specific ...

  • Page 48
    ... reports, and consistent participation in the launches of our premium title releases. We may also consider other factors, including the facilitation of slow-moving inventory and other market factors. Management must make estimates of potential future product returns and price protection related...

  • Page 49
    ... share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding, increased by common stock equivalents. Common stock equivalents are calculated using the treasury stock method and represent incremental shares issuable upon exercise...

  • Page 50
    ..., as reported Add: Stock-based employee compensation expense included in reported net income, net of related tax effects Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects Pro forma net income Earnings per share...

  • Page 51
    ... With Selling Goods or Services," the fair value of common stock warrants granted is determined as of the measurement date and is capitalized, expensed and amortized consistent with our policies relating to software development and intellectual property license costs. Related Parties In August 2001...

  • Page 52
    ... company, in exchange for $9.0 million in cash. Luxoflux is an experienced, multi-platform, console software developer. In accordance with the original acquisition agreement, approximately 248,000 shares of our common stock may be issued to Luxoflux's equity holders over the course of several years...

  • Page 53
    ... development company, in exchange for 581,897 shares of our common stock. Shaba is an experienced, multi-platform console software developer with a focus on action and action sports video games. Under the original acquisition agreement, approximately 155,000 additional shares of our common stock...

  • Page 54
    ... development company, in exchange for 1,842,663 shares of our common stock. Treyarch is an experienced, multi-platform console software developer with a focus on action and action sports video games. As part of the original acquisition agreement, approximately 540,000 additional shares of our common...

  • Page 55
    ...or losses for the year then ended. 5. Software Development Costs and Intellectual Property Licenses As of March 31, 2004, capitalized software development costs included $35.3 million of internally developed software costs and $51.5 million of payments made to third-party software developers. As of...

  • Page 56
    ... video game market, which is increasingly dominated by high quality products that are based on recognizable franchises and supported with big marketing programs. We completed a comprehensive review of our product portfolio in which we evaluated each product based on a number of criteria, including...

  • Page 57
    ... entertainment software and hardware products. Publishing refers to the development, marketing and sale of products directly, by license or through our affiliate label program with certain third-party publishers. In the United States, we primarily sell our products on a direct basis to mass-market...

  • Page 58
    ... Revenue from sales between segments Revenues from external customers Operating income Total assets Year ended March 31, 2002 Total segment revenues Revenue from sales between segments Revenues from external customers Operating income Total assets Geographic information is based on the location...

  • Page 59
    ... per share- income available to common shareholders Denominator: Denominator for basic earnings per share- weighted average common shares outstanding Effect of dilutive securities: Employee stock options and stock purchase plan Warrants to purchase common stock Potential dilutive common shares...

  • Page 60
    ...83,120 Income before income taxes: Domestic Foreign Income tax expense (benefit): Current: Federal State Foreign Total current Deferred: Federal State Foreign Total deferred Add back benefit credited to additional paid-in capital: Tax benefit related to stock option and warrant exercises Income tax...

  • Page 61
    ... fiscal year. Realization of the deferred tax assets is dependent upon the continued generation of sufficient taxable income prior to expiration of tax credits and loss carryforwards. Although realization is not assured, management believes it is more likely than not that the net carrying value of...

  • Page 62
    ... enter into contractual arrangements with third parties for the development of products, as well as for the rights to intellectual property. Under these agreements, we commit to provide specified payments to a developer, or intellectual property holder, based upon contractual arrangements. Typically...

  • Page 63
    ... terminated the agreement and filed a breach of contract suit against the third party. Marketing Commitments In connection with certain intellectual property right acquisitions and development agreements, we will commit to spend specified amounts for marketing support for the related game(s) which...

  • Page 64
    ... fully with the Securities and Exchange Commission in the conduct of this inquiry. On June 30, 2003, we terminated our Star Trek Merchandising License Agreement with Viacom Consumer Products, Inc. and filed a complaint in the Superior Court of the State of California for breach of contract and...

  • Page 65
    ... the granting of "Awards" in the form of non-qualified stock options, ISOs, SARs, restricted stock awards, deferred share awards and other common stock-based awards to officers, employees, directors, consultants and advisors. The total number of shares of common stock available for distribution...

  • Page 66
    ... have been granted with exercise prices equal to or greater than the fair market value at the date of grant. Other Employee Stock Options In connection with prior employment agreements between Activision and Robert A. Kotick, Activision's Chairman and Chief Executive Officer, and Brian G. Kelly...

  • Page 67
    ...For the years ended March 31, 2004, 2003 and 2002, all options were granted at an exercise price equal to the fair market value on the date of grant. The following tables summarize information about all employee and director stock options and warrants outstanding as of March 31, 2004 (share amounts...

  • Page 68
    Activision, Inc. - 2004 Annual Report Non-Employee Warrants In prior years, we have granted stock warrants to third parties in connection with the development of software and the acquisition of licensing rights for intellectual property. The warrants generally vest upon grant and are exercisable ...

  • Page 69
    ...right a number of the acquiring company's common shares having a market value equal to two times the then current exercise price of the right. For persons who, as of the close of business on April 18, 2000, beneficially own 15% or more of the common stock of Activision, the Rights Plan "grandfathers...

  • Page 70
    ... with common stock Issuance of options and common stock warrants Stock offering costs Change in unrealized appreciation on short-term investments Supplemental cash flow information: Cash paid for income taxes Cash paid (received) for interest, net 19. Quarterly Financial and Market Information...

  • Page 71
    ...Annual Report Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Our common stock is quoted on the Nasdaq National Market under the symbol "ATVI." The following table sets forth for the periods indicated the high and low reported sale prices...

  • Page 72
    ..., California Los Angeles, California Madison, Wisconsin New York, New York San Francisco, California Woodland Hills, California International Offices September 21, 2004 The Peninsula Hotel 9882 South Santa Monica Blvd. Beverly Hills, California 90212 Annual Report on Form 10-K Activision's Annual...

  • Page 73
    3100 Ocean Park Boulevard, Santa Monica, CA 90405 phone: (310) 255-2000 fax: (310) 255-2100 www.activision.com