FunMan2001 : SEC Focuses on Makers of Video Games
Accounting practices used by companies in determining when to record sales
apparently are under scrutiny.
The Securities and Exchange Commission is conducting an apparently broad investigation of accounting practices in the video game industry, according to SEC filings by three game publishers, including two in Southern California that produce some of the industry's most popular titles.
Activision Inc. of Santa Monica, publisher of the popular "Tony Hawk's Pro Skater" games; Calabasas Hills-based THQ Inc., which publishes the "SpongeBob SquarePants" series; and Acclaim Entertainment Inc., headquartered in Geneva, N.Y., said they received requests for information from the SEC.
The companies, which publish games for machines such as Sony Corp.'s PlayStation 2 and Nintendo's GameCube, said they were cooperating with the probe. Activision declined to comment further. Acclaim and THQ couldn't be reached for comment late Friday. An SEC spokesman declined to talk about the investigation.
In its filing, Activision said, "The investigation appears to be focused on certain accounting practices common to the interactive entertainment industry, with specific emphasis on revenue recognition," or when companies choose to record sales on their books.
Game industry analyst Michael Pachter of Wedbush Morgan Securities in Los Angeles said he believed the SEC was trying to determine whether the firms have been deliberately understating revenue, giving themselves the flexibility to artificially inflate earnings at some future occasion if the business were to take a turn for the worse.
The focus of the probe could be reserve funds set up as cushions against returns of unsold games or demands by big retailers for rebates when the games can't be sold for as much as anticipated. A firm selling $100 million worth of games during a quarter might book only $90 million as revenue, reasonably setting aside the other $10 million as insurance for these eventualities, Pachter said.
In a July 1 report, Pachter wrote, "We believe that overall reserve balances should grow in line with revenue growth, and that quarterly additions should generally offset actual charges during the preceding quarter." Instead, he noted, all of the four biggest companies he follows ? Activision, THQ, Take-Two Interactive Software Inc. and industry leader Electronic Arts Inc. ? have been increasing their reserve funds faster than their reported revenue.
At Activision, for example, game sales actually declined by 16%, but the company beefed up reserves by 42% as well, he noted.
Pachter said that raises the question of whether the companies are turning the reserves into "rainy day" funds: When revenue falls below expectations, the companies can simply draw down their overstuffed reserve funds as demands come in from retailers for rebates, "smoothing" revenue to make their business appear less volatile.
In their stepped-up scrutiny of corporate accounting, securities regulators have paid close attention to revenue recognition. A company that improperly accounts for sales could overstate its profit, boosting its stock price and enriching insiders and other big investors.
Last year, Take-Two, which publishes the popular "Grand Theft Auto: Vice City" game, said the SEC opened an investigation after the company restated seven quarters of financial results because some sales weren't recorded properly.