Activision Blizzard, Inc.
Activision Blizzard, Inc. (Form: 10-Q, Received: 08/07/2009 16:13:35)

Table of Contents

 

 

 

UNITED STATES

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 June 30, 2009

 

OR

 

 

o

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 1-15839

 

GRAPHIC

 

ACTIVISION BLIZZARD, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-4803544

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

3100 Ocean Park Boulevard, Santa Monica, CA

 

90405

(Address of principal executive offices)

 

(Zip Code)

 

(310) 255-2000
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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   o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   x   No   o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer  x

 

Accelerated Filer  o

 

 

 

Non-accelerated filer  o

 

Smaller reporting company  o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   o   No   x

 

The number of shares of the registrant’s Common Stock outstanding at July 31, 2009 was 1,271,537,403.

 

 

 



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

 

Table of Contents

 

 

Explanatory Note

3

 

 

 

 

Cautionary Statement

3

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets at June 30, 2009 and December 31, 2008

4

 

 

 

 

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2009 and June 30, 2008

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2009 and June 30, 2008

6

 

 

 

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity for the six months ended June 30, 2009

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements

8

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

28

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

43

 

 

 

Item 4.

Controls and Procedures

44

 

 

 

PART II.

OTHER INFORMATION

44

 

 

 

Item 1.

Legal Proceedings

44

 

 

 

Item 1A.

Risk Factors

44

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

45

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

45

 

 

 

Item 5.

Other Information

46

 

 

 

Item 6.

Exhibits

46

 

 

 

SIGNATURE

 

47

 

 

 

EXHIBIT INDEX

 

48

 

 

 

CERTIFICATIONS

 

 

 

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Table of Contents

 

EXPLANATORY NOTE

 

On July 9, 2008, a business combination by and among Activision, Inc., Sego Merger Corporation, a wholly-owned subsidiary of Activision, Inc., Vivendi S.A. (“Vivendi”), VGAC LLC, a wholly-owned subsidiary of Vivendi, and Vivendi Games, Inc., a wholly-owned subsidiary of VGAC LLC, was consummated.  As a result of the consummation of the business combination, Activision, Inc. was renamed Activision Blizzard, Inc.  For accounting purposes, the business combination is treated as a “reverse acquisition,” with Vivendi Games, Inc. deemed to be the acquirer.  The historical financial statements of Activision Blizzard, Inc. prior to July 9, 2008 are those of Vivendi Games, Inc. (see Note 1 of Condensed Consolidated Financial Statements for more details).

 

CAUTIONARY STATEMENT

 

This Quarterly Report on Form 10-Q contains, or incorporates by reference, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements consist of any statement other than a recitation of historical fact and include, but are not limited to, (1) projections of revenues, expenses, income or loss, earnings or loss per share, cash flow or other financial items; (2) statements of our plans and objectives, including those relating to product releases; (3) statements of future economic performance; and (4) statements of assumptions underlying such statements. We generally use words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “future,” “intend,” “may,” “outlook,” “plan,” “positioned,” “potential,” “project,” “remain,” “scheduled,” “set to,” “subject to,” “to be,” “upcoming,” “will,” and other similar expressions to help identify forward-looking statements. Forward-looking statements are subject to business and economic risk, reflect management’s current expectations, estimates and projections about our business, and are inherently uncertain and difficult to predict. Our actual results could differ materially. The forward-looking statements contained herein speak only at the date on which this Form 10-Q was first filed, and we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of this Quarterly Report. Risks and uncertainties that may affect our future results include, but are not limited to, sales levels of our titles, shifts in consumer spending trends, the impact of the current macroeconomic environment, the seasonal and cyclical nature of the interactive game market, any further difficulties related to the transition of World of Warcraft in China from the former licensee to NetEase, our ability to predict consumer preferences among competing hardware platforms (including next-generation hardware), declines in software pricing, product returns and price protection, product delays, retail acceptance of our products, adoption rate and availability of new hardware and related software, industry competition, rapid changes in technology, industry standards and customer preferences, protection of proprietary rights, litigation against us, maintenance of relationships with key personnel, customers, licensees, licensors, vendors and third-party developers, counterparty risks relating to customers, licensees, licensors and manufacturers, domestic and international economic, financial and political conditions and policies, foreign exchange rates, integration of recent acquisitions and the identification of suitable future acquisition opportunities, our success in completing the integration of the operations of Activision and Vivendi Games in a timely manner and the combined company’s ability to realize the anticipated benefits and synergies of the transaction to the extent, or in the timeframe, anticipated, and the other factors identified in “Risk Factors” included in Part II, Item 1A of this Quarterly Report on Form 10-Q and  in our Annual Report on Form 10-K for the year ended December 31, 2008.  The forward-looking statements contained herein are based upon information available to us as of the date of this Quarterly Report on Form 10-Q and we assume no obligation to update any such forward-looking statements.  Forward-looking statements believed to be true when made may ultimately prove to be incorrect.  These statements are not guarantees of our future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and may cause actual results to differ materially from current expectations.

 

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Table of Contents

 

Part I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Amounts in millions, except share and per share data)

 

 

 

At June 30,
2009

 

At December 31,
2008

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

2,728

 

$

2,958

 

Short-term investments

 

102

 

44

 

Accounts receivable, net of allowances of $242 million and $268 million at June 30, 2009 and December 31, 2008, respectively

 

282

 

1,210

 

Inventories

 

198

 

262

 

Software development

 

231

 

235

 

Intellectual property licenses

 

51

 

35

 

Deferred income taxes, net

 

792

 

536

 

Intangible assets, net

 

2

 

14

 

Other current assets

 

124

 

201

 

Total current assets

 

4,510

 

5,495

 

Long-term investments

 

23

 

78

 

Software development

 

16

 

1

 

Intellectual property licenses

 

5

 

5

 

Property and equipment, net

 

134

 

149

 

Other assets

 

16

 

30

 

Intangible assets, net

 

1,206

 

1,283

 

Trademark and trade names

 

433

 

433

 

Goodwill

 

7,176

 

7,227

 

Total assets

 

$

13,519

 

$

14,701

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

135

 

$

555

 

Deferred revenues

 

423

 

923

 

Accrued expenses and other liabilities

 

533

 

842

 

Total current liabilities

 

1,091

 

2,320

 

Deferred income taxes, net

 

699

 

615

 

Other liabilities

 

198

 

239

 

Total liabilities

 

1,988

 

3,174

 

 

 

 

 

 

 

Commitments and contingencies (Note 16)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $.000001 par value per share, 2,400,000,000 shares authorized, 1,346,293,791 and 1,325,206,032 shares issued at June 30, 2009 and December 31, 2008, respectively

 

 

 

Additional paid-in capital

 

12,303

 

12,170

 

Less: Treasury stock, at cost, 64,216,272 and 12,967,265 shares at June 30, 2009 and December 31, 2008, respectively

 

(668

)

(126

)

Accumulated deficit

 

(90

)

(474

)

Accumulated other comprehensive loss

 

(14

)

(43

)

Total shareholders’ equity

 

11,531

 

11,527

 

Total liabilities and shareholders’ equity

 

$

13,519

 

$

14,701

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Amounts in millions, except per share data)

 

 

 

For the three months ended
June 30,

 

For the six months ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

 

 

 

 

 

 

 

 

Product sales

 

$

747

 

$

80

 

$

1,437

 

$

141

 

Subscription, licensing, and other revenues

 

291

 

272

 

582

 

536

 

Total net revenues

 

1,038

 

352

 

2,019

 

677

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

Cost of sales – product costs

 

281

 

39

 

577

 

74

 

Cost of sales – software royalties and amortization

 

86

 

16

 

158

 

37

 

Cost of sales – intellectual property licenses

 

54

 

7

 

118

 

9

 

Cost of sales – massively multi-player online role-playing game (“MMORPG”)

 

51

 

44

 

103

 

93

 

Product development

 

123

 

99

 

240

 

203

 

Sales and marketing

 

118

 

51

 

201

 

78

 

General and administrative

 

92

 

50

 

195

 

74

 

Restructuring

 

15

 

 

30

 

 

 

 

 

 

 

 

 

 

 

 

Total costs and expenses

 

820

 

306

 

1,622

 

568

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

218

 

46

 

397

 

109

 

 

 

 

 

 

 

 

 

 

 

Investment income, net

 

 

2

 

10

 

4

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense

 

218

 

48

 

407

 

113

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

23

 

20

 

23

 

42

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

195

 

$

28

 

$

384

 

$

71

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share, basic

 

$

0.15

 

$

0.05

 

$

0.29

 

$

0.12

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share, diluted

 

$

0.15

 

$

0.05

 

$

0.28

 

$

0.12

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

1,289

 

591

 

1,299

 

591

 

Diluted

 

1,332

 

591

 

1,345

 

591

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)
(Amounts in millions)

 

 

 

For the six months ended 
June 30,

 

 

 

2009

 

2008

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

384

 

$

71

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Deferred income taxes

 

(118

)

34

 

Depreciation and amortization

 

129

 

32

 

Unrealized gain on auction rate securities classified as trading securities

 

(2

)

 

Unrealized loss on put option from UBS

 

2

 

 

Amortization and write-off of capitalized software development costs and intellectual property licenses (1)

 

154

 

44

 

Stock-based compensation expense (2)

 

73

 

20

 

Tax shortfall from employee stock option exercises

 

(1

)

 

Excess tax benefits from stock option exercises

 

(56

)

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

928

 

47

 

Inventories

 

64

 

(2

)

Software development and intellectual property licenses

 

(166

)

(43

)

Other assets

 

90

 

(7

)

Deferred revenues

 

(500

)

 

Accounts payable

 

(421

)

8

 

Accrued expenses and other liabilities

 

(351

)

(14

)

Net cash provided by operating activities

 

209

 

190

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(24

)

(16

)

Proceeds from sale of investments

 

2

 

 

Proceeds from maturities of investments

 

3

 

 

Cash payments to effect acquisitions, net of cash acquired

 

 

(5

)

(Increase) decrease in restricted cash

 

(5

)

2

 

Net cash used in investing activities

 

(24

)

(19

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

45

 

 

Repurchase of common stock

 

(542

)

 

Excess tax benefits from stock option exercises

 

56

 

 

Net cash transfers to Vivendi and affiliated companies

 

 

(172

)

Net cash used in financing activities

 

(441

)

(172

)

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

26

 

(2

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(230

)

(3

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

2,958

 

62

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

2,728

 

$

59

 

 


(1)           Excludes deferral and amortization of stock-based compensation expense.

(2)           Includes the net effects of capitalization, deferral, and amortization of stock-based compensation expense.

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Six Months ended June 30, 2009

(Unaudited)

(Amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Other

 

Total

 

 

 

Common Stock

 

Paid-In

 

Treasury Stock

 

Accumulated

 

Comprehensive

 

Shareholders’

 

 

 

Shares

 

Amount

 

Capital

 

Shares

 

Amount

 

Deficit

 

Loss

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2008

 

1,325

 

$

 

$

12,170

 

(13

)

$

(126

)

$

(474

)

$

(43

)

$

11,527

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

384

 

 

384

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

29

 

29

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

413

 

Issuance of common stock pursuant to employee stock options and restricted stock rights

 

21

 

 

45

 

 

 

 

 

45

 

Stock-based compensation expense related to employee stock options and restricted stock rights

 

 

 

87

 

 

 

 

 

87

 

Tax shortfall from employee stock option exercises

 

 

 

(1

)

 

 

 

 

(1

)

Issuance of contingent consideration

 

 

 

2

 

 

 

 

 

2

 

Shares repurchased

 

 

 

 

(51

)

(542

)

 

 

(542

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2009

 

1,346

 

$

 

$

12,303

 

(64

)

$

(668

)

$

(90

)

$

(14

)

$

11,531

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.               Background and basis of presentation

 

Business

 

Activision Blizzard, Inc. is a worldwide pure-play online, personal computer (“PC”), console and hand-held game publisher. The terms “Activision Blizzard,” the “Company,” “we,” “us,” and “our” are used to refer collectively to Activision Blizzard, Inc. and its subsidiaries. Based upon our organizational structure, we operate four operating segments as follows:

 

Activision Publishing, Inc.

 

Activision Publishing, Inc. (“Activision”) is a leading international publisher of interactive software products and peripherals. Activision develops and publishes video games on various consoles, hand-held platforms and the PC platform through internally developed franchises and license agreements. Activision currently offers games that operate on the Sony Computer Entertainment (“Sony”) PlayStation 2 (“PS2”), Sony PlayStation 3 (“PS3”), Nintendo Co. Ltd. (“Nintendo”) Wii (“Wii”), and Microsoft Corporation (“Microsoft”) Xbox 360 (“Xbox 360”) console systems; the Sony PlayStation Portable (“PSP”) and Nintendo Dual Screen (“NDS”) hand-held devices; the PC; and the new hand-held game system Nintendo DSi. Our Activision business involves the development, marketing, and sale of products directly, by license, or through our affiliate label program with certain third-party publishers. Activision’s products cover diverse game categories including action/adventure, action sports, racing, role-playing, simulation, first-person action, music, and strategy. Activision’s target customer base ranges from casual players to game enthusiasts, and children to adults.

 

Blizzard Entertainment, Inc.

 

Blizzard Entertainment, Inc. (“Blizzard”) is a leader in terms of subscriber base and revenues generated in the subscription-based massively multi-player online role-playing game (“MMORPG”) category. Blizzard internally develops and publishes PC-based computer games and maintains its proprietary online-game related service, Battle.net. Our Blizzard business involves the development, marketing, sales and support of role playing action and strategy games. Blizzard also develops, hosts, and supports its online subscription-based games in the MMORPG category. Blizzard is the development studio and publisher best known as the creator of World of Warcraft and the multiple award winning Diablo, StarCraft, and Warcraft franchises. Blizzard distributes its products and generates revenues worldwide through various means, including: subscription revenues (which consist of fees from individuals playing World of Warcraft, such as prepaid cards and other ancillary online revenues); retail sales of physical “boxed” products; electronic download sales of PC products; and licensing of software to third-party companies that distribute World of Warcraft in China, Russia, and Taiwan.

 

Activision Blizzard Distribution

 

Activision Blizzard Distribution (“Distribution”) consists of operations in Europe that provide warehousing, logistical, and sales distribution services to third-party publishers of interactive entertainment software, our own publishing operations, and manufacturers of interactive entertainment hardware.

 

Activision Blizzard’s non-core exit operations

 

Activision Blizzard’s non-core exit operations (“Non-Core”) represent legacy Vivendi Games’ divisions or business units that we have exited or substantially wound down as part of our restructuring and integration efforts as a result of the Business Combination described below, but do not meet the criteria for separate reporting of discontinued operations.

 

Business Combination

 

On July 9, 2008, a business combination (the “Business Combination”) by and among Activision, Inc., Sego Merger Corporation, a wholly-owned subsidiary of Activision, Inc., Vivendi S.A. (“Vivendi”), VGAC LLC, a wholly-owned subsidiary of Vivendi, and Vivendi Games, Inc. (“Vivendi Games”), a wholly-owned subsidiary of VGAC LLC, was consummated.  As a result of the consummation of the Business Combination, Activision, Inc. was renamed Activision

 

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Blizzard, Inc.  For accounting purposes, the Business Combination is treated as a “reverse acquisition,” with Vivendi Games deemed to be the acquirer.  The historical financial statements of Activision Blizzard, Inc. prior to July 9, 2008 are those of Vivendi Games.  See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2008 for a more complete discussion of the Business Combination.

 

Activision Blizzard continues to operate as a public company traded on NASDAQ under the ticker symbol ATVI and now conducts the combined business operations of Activision, Inc. and Vivendi Games including its subsidiary, Blizzard Entertainment.

 

We maintain significant operations in the United States, Canada, the United Kingdom (“UK”), Germany, France, Italy, Spain, Australia, Sweden, South Korea, Norway, Denmark, China, and the Netherlands.

 

Basis of Presentation

 

Activision Blizzard prepared the accompanying unaudited Condensed Consolidated Financial Statements in accordance with the rules and regulations of the Securities and Exchange Commission for interim reporting. As permitted under those rules and regulations, certain notes or other information that are normally required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted if they substantially duplicate the disclosures contained in the annual audited Consolidated Financial Statements. The unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2008. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation of our financial position and results of operations in accordance with U.S. GAAP have been included.

 

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts and operations of Activision Blizzard . All intercompany accounts and transactions have been eliminated. The Condensed Consolidated Financial Statements have been prepared in conformity with U.S. GAAP. The preparation of the Condensed Consolidated Financial Statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the Condensed Consolidated Financial Statements. Actual results could differ from these estimates and assumptions.

 

Certain reclassifications have been made to prior period amounts to conform to the current period presentation.

 

We have evaluated subsequent events through August 7, 2009, which is the date these Condensed Consolidated Financial Statements were issued.

 

2.               Summary of significant accounting policies

 

Financial Instruments

 

The estimated fair values of financial instruments have been determined using available market information and valuation methodologies described below. However, considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein may not be indicative of the amounts that we could realize in a current market exchange. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.

 

The carrying amount of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses are a reasonable approximation of fair value due to their short-term nature. At June 30, 2009, our $102 million of short-term investments included $57 million of auction rate securities (“ARS”) classified as trading, $42 million of restricted cash, and $3 million of mortgage-backed securities. The mortgage-backed securities are carried at fair value with fair values estimated based on quoted market prices. Long-term investments represent ARS classified as available-for-sale. Both short-term and long-term ARS , which are comprised of student loan backed securities, are carried at fair value with fair values estimated using an income-approach model (discounted cash -flow analysis) .

 

Derivative Financial Instruments

 

On January 1, 2009, we adopted Statement of Financial Accounting Standard (“SFAS”) No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS No. 161”). The adoption of SFAS No. 161 had no financial impact on our Condensed Consolidated Financial Statements and only required additional financial statement disclosures. We have applied the requirements of SFAS No. 161 on a prospective basis. Accordingly, disclosures related to interim periods prior to the date of adoption have not been presented.

 

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Foreign Currency Swaps and Forward Contracts Not Designated as Hedges

 

We transact business in various currencies other than the U.S. dollar and have significant international sales and expenses denominated in currencies other than the U.S. dollar, subjecting us to currency exchange rate risks. To mitigate our risk from foreign currency fluctuations we periodically enter into currency derivative contracts, principally swaps and forward contracts with maturities of twelve months or less with Vivendi as our principal counterparty. We do not hold or purchase any foreign currency contracts for trading or speculative purposes and we do not designate these forward contracts or swaps as hedging instruments.  Accordingly, we report the fair value of these contracts in our Condensed Consolidated Balance Sheet with changes in fair value recorded in our Condensed Consolidated Statement of Operations.

 

The effects of derivative instruments on our Condensed Consolidated Financial Statements were as follows (amounts in millions):

 

Fair Value of Derivative Instruments in Condensed
Consolidated Balance Sheet

 

Fair Value
At June 30, 2009

 

Balance Sheet Location

 

Foreign currency swaps and forward contracts not designated as hedges

 

$

1

 

Accrued expenses and other liabilities

 

 

Effect of Derivative Instruments on Condensed Consolidated
Statement of Operations

 

Amount of Net Realized and
Unrealized Gain (Loss)
Recognized in Income on
Derivatives for the Three
Months Ended June 30, 2009

 

Income Statement Location

 

Foreign currency swaps and forward contracts not designated as hedges

 

$

(2

)

Investment income, net

 

 

Net realized and unrealized gains related to foreign currency swaps and forward contracts not designated as hedges were less than $1 million for the six months ended June 30, 2009.

 

3.               Inventories

 

Our inventories consist of the following (amounts in millions):

 

 

 

At June 30, 2009

 

At December 31, 2008

 

Finished goods

 

$

184

 

$

251

 

Purchased parts and components

 

14

 

11

 

 

 

 

 

 

 

 

 

$

198

 

$

262

 

 

4.               Goodwill

 

The changes in the carrying amount of goodwill by operating segment for the six months ended June 30, 2009 are as follows (amounts in millions):

 

 

 

Activision

 

Blizzard

 

Distribution

 

Total

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2008

 

$

7,037

 

$

178

 

$

12

 

$

7,227

 

Issuance of contingent consideration

 

2

 

 

 

2

 

Goodwill acquired

 

3

 

 

 

3

 

Purchase accounting adjustment

 

(1

)

 

 

(1

)

Tax benefit credited to goodwill

 

(55

)

 

 

(55

)

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2009

 

$

6,986

 

$

178

 

$

12

 

$

7,176

 

 

Issuance of contingent consideration consists of additional purchase consideration paid during 2009 in relation to a previous acquisition. The tax benefit credited to goodwill represents the tax deduction resulting from the exercise of

 

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stock options that were outstanding and vested at the consummation of the Business Combination and included in the purchase price of Activision, Inc. to the extent that the tax deduction did not exceed the fair value of those options.

 

5.               Intangible assets, net

 

Intangible assets, net consist of the following (amounts in millions):

 

 

 

At June 30, 2009

 

 

 

Estimated
useful
lives

 

Gross
carrying
amount

 

Accumulated
amortization

 

Net carrying
amount

 

Finite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

208

 

$

(22

)

$

186

 

Developed software

 

1 - 2 years

 

287

 

(284

)

3

 

Game engines

 

2 - 5 years

 

134

 

(59

)

75

 

Internally developed franchises

 

11 - 12 years

 

1,124

 

(193

)

931

 

Favorable leases

 

1 - 4 years

 

5

 

(2

)

3

 

Distribution agreements

 

4 years

 

18

 

(8

)

10

 

Total finite-lived intangible assets

 

 

 

1,776

 

(568

)

1,208

 

Indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

386

 

 

386

 

Acquired trade names

 

Indefinite

 

47

 

 

47

 

Total

 

 

 

$

2,209

 

$

(568

)

$

1,641

 

 

 

 

At December 31, 2008

 

 

 

Estimated
useful
lives

 

Gross
carrying
amount

 

Accumulated
amortization

 

Net carrying
amount

 

Finite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

207

 

$

(12

)

$

195

 

Developed software

 

1 - 2 years

 

286

 

(272

)

14

 

Game engines

 

2 - 5 years

 

134

 

(42

)

92

 

Internally developed franchises

 

11 - 12 years

 

1,124

 

(145

)

979

 

Favorable leases

 

1 - 4 years

 

5

 

(1

)

4

 

Distribution agreements

 

4 years

 

17

 

(5

)

12

 

Other intangibles

 

0 - 2 years

 

5

 

(4

)

1

 

Total finite-lived intangible assets

 

 

 

1,778

 

(481

)

1,297

 

Indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

386

 

 

386

 

Acquired trade names

 

Indefinite

 

47

 

 

47

 

Total

 

 

 

$

2,211

 

$

(481

)

$

1,730

 

 

Amortization expense of intangible assets for the three and six months ended June 30, 2009 was $41 million and $90 million, respectively.  Amortization expense of intangible assets for the three and six months ended June 30, 2008 was $1 million and $2 million, respectively.

 

At June 30, 2009, future amortization of finite-lived intangible assets is estimated as follows (amounts in millions):

 

2009 (remaining six months)

 

$

191

 

2010

 

212

 

2011

 

147

 

2012

 

123

 

2013

 

106

 

Thereafter

 

429

 

 

 

 

 

Total

 

$

1,208

 

 

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6.               Income taxes

 

The income tax expense of $23 million for the three months ended June 30, 2009 reflects an effective tax rate of 11%. The effective tax rate of 11% for the three months ended June 30, 2009 differs from the statutory rate of 35% primarily due to foreign income taxes provided at lower rates, geographic mix in profitability, recognition of research and development credits and IRC 199 domestic production deductions.

 

For the six months ended June 30, 2009, the tax rate is based on our projected annual effective tax rate for 2009, and also includes certain discrete tax benefits recorded during the period. Our tax expense of $23 million for the six months ended June 30, 2009 reflects an effective tax rate of 6% which differs from our effective tax rate of 37% for the six months ended June 30, 2008 primarily due to lower foreign income tax rates and certain discrete tax benefits recorded during the period related to the release of valuation allowances on foreign net operating losses and the impact of changes to California tax laws.

 

We evaluate our deferred tax assets, including net operating losses, to determine if a valuation allowance is required.  We assess whether a valuation allowance should be established or released based on the consideration of all available evidence using a “more likely than not” standard.  In making such judgments, significant weight is given to evidence that can be objectively verified. At December 31, 2008 we had a foreign net operating loss valuation allowance of $23 million.  The ultimate realization of the foreign net operating losses depends upon the generation of future taxable income during the periods in which those temporary differences become deductible.  We currently expect to realize these net operating losses through taxable income; therefore, in the first quarter of 2009, we released a valuation allowance of $23 million against our deferred tax assets.

 

California Senate Bill No.15 was enacted in February 20, 2009 and contains significant changes to the state of California tax landscape. When there is an enacted change in tax laws or rate, we adjust our deferred tax liabilities and assets to reflect the change.   During the six months ended June 30, 2009, we reduced our net deferred tax liabilities and tax provision by $10 million.

 

7.               Software development costs and intellectual property licenses

 

At June 30, 2009, capitalized software development costs included $199 million of internally developed software costs and $48 million of payments made to third-party software developers. At December 31, 2008, capitalized software development costs included $173 million of internally developed software costs and $63 million of payments made to third-party software developers. Capitalized intellectual property licenses were $56 million and $40 million at June 30, 2009 and December 31, 2008, respectively. Amortization of capitalized software development costs and intellectual property licenses for the three months ended June 30, 2009 and 2008 was $97 million and $3 million, respectively. There were no write-offs or impairments for the three months ended June 30, 2009. Write-offs and impairments were $18 million for the three months ended June 30, 2008. Amortization of capitalized software development costs and intellectual property licenses for the six months ended June 30, 2009 and 2008 was $169 million and $4 million, respectively. Write-offs and impairments were less than $1 million and $39 million for the six months ended June 30, 2009 and 2008, respectively.

 

8.               Restructuring

 

The Company has been implementing its organizational restructuring plan as a result of the Business Combination described in Note 1 of the Notes to Condensed Consolidated Financial Statements. This organizational restructuring plan includes the integration of different operations to streamline the combined organization of Activision Blizzard.

 

The primary goals of the organizational restructuring were to rationalize the title portfolio and consolidate certain corporate functions so as to realize the synergies of the Business Combination.

 

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The following table details the changes in restructuring reserves included in accrued expenses and other liabilities in the Condensed Consolidated Balance Sheets for the six months ended June 30, 2009 (amounts in millions):

 

 

 

Severance

 

Facilities
costs

 

Total

 

Balance at December 31, 2008

 

$

37

 

$

7

 

$

44

 

Costs charged to expense

 

22

 

8

 

30

 

Costs paid or otherwise settled

 

(31

)

(4

)

(35

)

Foreign exchange and other

 

(2

)

 

(2

)

Balance at June 30, 2009

 

$

26

 

$

11

 

$

37

 

 

The total restructuring reserve balance and the net restructuring charges are presented below by reporting segment (amounts in millions):

 

 

 

Restructuring Reserve Balance

 

Restructuring
Charges

 

 

 

At

 

At

 

Six months ended

 

 

 

June 30, 2009

 

December 31, 2008

 

June 30, 2009

 

 

 

 

 

 

 

 

 

Activision

 

$

 

$

 

$

8

 

Blizzard

 

 

 

 

Distribution

 

4

 

 

5

 

Activision Blizzard’s core operations

 

4

 

 

13

 

Activision Blizzard’s non-core exit operations

 

33

 

44

 

17

 

Total

 

$

37

 

$

44

 

$

30

 

 

The expected restructuring charges to be incurred principally by Activision Blizzard’s non-core exit operations related to the Business Combination during the three months ending September 30, 2009 are presented below (amounts in millions):

 

 

 

Low

 

High

 

Expected future restructuring costs, before tax

 

$

3

 

$

6

 

 

 

 

 

 

 

Expected future restructuring costs, after tax

 

2

 

4

 

 

The total expected restructuring charges related to the Business Combination from the Business Combination date through September 30, 2009 are presented below (amounts in millions):

 

 

 

Low

 

High

 

Total expected restructuring costs, before tax

 

$

126

 

$

129

 

 

 

 

 

 

 

Total expected restructuring costs, after tax

 

76

 

78

 

 

The after tax cash charges are expected to consist primarily of employee-related severance cash costs (approximately $52 million), facility exit cash costs (approximately $8 million) and cash contract terminations costs (approximately $18 million). Separately, through June 30, 2009 these restructuring charges were partially offset by cash proceeds of approximately $37 million from asset disposals and after tax cash benefits related to the streamlining of the Vivendi Games title portfolio.

 

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9 .               Comprehensive income and accumulated other comprehensive loss

 

Comprehensive Income

 

The components of comprehensive income for the three and six months ended June 30, 2009 and 2008 were as follows (amounts in millions):

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

195

 

$

28

 

$

384

 

$

71

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

31

 

(2

)

29

 

1

 

Unrealized appreciation on investments, net of taxes

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

32

 

(2

)

29

 

1

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

227

 

$

26

 

$

413

 

$

72

 

 

Accumulated Other Comprehensive Loss

 

For the six months ended June 30, 2009 the components of accumulated other comprehensive loss were as follows (amounts in millions):

 

 

 

Foreign currency
translation
adjustment

 

Unrealized
depreciation
on investments

 

Accumulated
other
comprehensive
loss

 

 

 

 

 

 

 

 

 

Balance at December 31, 2008

 

$

(41

)

$

(2

)

$

(43

)

Other comprehensive income

 

29

 

 

29

 

 

 

 

 

 

 

 

 

Balance at June 30, 2009

 

$

(12

)

$

(2

)

$

(14

)

 

Income taxes were not provided for foreign currency translation items as these are considered indefinite investments in non-U.S. subsidiaries.

 

10.        Investment income, net

 

Investment income, net is comprised of the following (amounts in millions):

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Interest income

 

$

3

 

$

2

 

$

12

 

$

5

 

Interest expense

 

(1

)

 

(2

)

 

Unrealized gain on trading securities

 

(1

)

 

2

 

 

Unrealized loss on put option from UBS

 

1

 

 

(2

)

 

Net realized and unrealized gain (loss) on foreign exchange contracts and swaps with Vivendi

 

(2

)

 

 

(1

)

 

 

 

 

 

 

 

 

 

 

Investment income, net

 

$

 

$

2

 

$

10

 

$

4

 

 

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11.  Investments

 

Available-for-Sale Investments

 

The following table summarizes our short-term and long-term investments classified as available-for-sale at June 30, 2009 and December 31, 2008 (amounts in millions):

 

At June 30, 2009

 

Amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Fair
value

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

$

3

 

$

 

$

 

$

3

 

Long-term investments:

 

 

 

 

 

 

 

 

 

Taxable auction rate securities

 

27

 

 

(4

)

23

 

Total available-for-sale investments

 

$

30

 

$

 

$

(4

)

$

26

 

 

At December 31, 2008

 

Amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Fair
value

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

$

8

 

$

 

$

(1

)

$

7

 

Long-term investments:

 

 

 

 

 

 

 

 

 

Taxable auction rate securities

 

27

 

 

(4

)

23

 

Total available-for-sale investments

 

$

35

 

$

 

$

(5

)

$

30

 

 

The following table illustrates the gross unrealized losses on available-for-sale securities and the fair value of those securities, aggregated by investment category at June 30, 2009 and December 31, 2008. The table also illustrates the length of time that they have been in a continuous unrealized loss position at June 30, 2009 and December 31, 2008 (amounts in millions):

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

At June 30, 2009

 

Unrealized
losses

 

Fair value

 

Unrealized
losses

 

Fair value

 

Unrealized
losses

 

Fair value

 

Taxable auction rate securities

 

$

(4

)

$

23

 

$

 

$

 

$

(4

)

$

23

 

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

At December 31, 2008

 

Unrealized
losses

 

Fair value

 

Unrealized
losses

 

Fair value

 

Unrealized
losses

 

Fair value

 

Mortgage-backed securities

 

$

(1

)

$

7

 

$

 

$

 

$

(1

)

$

7

 

Taxable auction rate securities

 

(4

)

23

 

 

 

(4

)

23

 

Total

 

$

(5

)

$

30

 

$

 

$

 

$

(5

)

$

30

 

 

The total unrealized loss of $4 million at June 30, 2009 is due to the taxable ARS held through Morgan Stanley Smith Barney LLC, which is 51% owned by Morgan Stanley and 49% owned by Citigroup, Inc., as a result of failed auctions. (The ARS were held directly through Citigroup, Inc. until the Morgan Stanley Smith Barney LLC joint-venture closed in the second quarter 2009.) Our investments in ARS are all backed by higher education student loans.

 

Based upon our analysis of the available-for-sale investments with unrealized losses, we have concluded that the gross unrealized losses of $4 million at June 30, 2009 were temporary in nature. We do not intend to sell the investment securities that are in an unrealized loss position and do not consider that it is more-likely-than-not that we will be required to sell the investment securities before recovery of their amortized cost basis, which may be maturity. We have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities. However, facts and circumstances may change which could result in a decline in fair value considered to be other-than-temporary in the future.

 

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The following table summarizes the contractually stated maturities of our investments classified as available-for-sale at June 30, 2009 (amounts in millions):

 

At June 30, 2009

 

Amortized
cost

 

Fair
value

 

Mortgage-backed securities (not due at a single maturity date)

 

$

3

 

$

3

 

Due after ten years

 

27

 

23

 

 

 

$

30

 

$

26

 

 

Trading Investments

 

In connection with our acceptance of the UBS offer in November 2008, (see Note 3 and Note 6 of the Notes to Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31, 2008 for more details), resulting in our right to require UBS AG (“UBS”) to purchase our ARS at par value beginning on June 30, 2010 (the “Rights”), we reclassified our investments in ARS held through UBS from available-for-sale to trading securities. The reclassification to trading securities reflects management’s intent to exercise the Rights during the period between June 30, 2010 and July 3, 2012, which results in the securities being held for the purpose of selling them in the near future. Prior to our agreement with UBS, our intent was to hold the ARS until the market recovered. At the time of reclassification, the unrealized loss on our ARS was $5 million. This unrealized loss was included in accumulated other comprehensive income (loss). Upon reclassification to trading securities, we immediately recognized in investment income, net, the $5 million unrealized loss not previously recognized in earnings. Subsequently, we recognized an additional decline in fair value of $2 million for a total unrealized loss of $7 million, included in investment income, net, in our Consolidated Statements of Operations for the year ended December 31, 2008. For the six months ended June 30, 2009, we recognized a $2 million unrealized gain included in investment income, net. The fair value of the ARS held through UBS totaled $57 million and $55 million at June 30, 2009 and December 31, 2008, respectively.

 

We continue to monitor the ARS market and consider its impact (if any) on the fair value of our investments. If the market conditions deteriorate further, we may be required to record additional unrealized losses in earnings, which may be offset by corresponding increases in value of the UBS offer.

 

12.        Fair value measurements

 

The three levels of inputs used to measure fair value are as follows:

 

·                  Level 1 — Quoted prices in active markets for identical assets or liabilities.

 

·                  Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets or other inputs that are observable or can be corroborated by observable market data.

 

·                  Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

 

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The tables below segregate all assets and liabilities that are measured at fair value on a recurring basis (which means they are measured at least annually) into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date (amounts in millions):

 

 

 

 

 

Fair Value Measurements at
Reporting Date Using

 

 

 

 

 

At
June 30,
2009

 

Quoted
Prices in
Active
Markets for
Identical
Financial
Instruments
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Balance Sheet
Classification

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

2,621

 

$

2,621

 

$

 

$

 

Cash and cash equivalents

 

Mortgage-backed securities

 

3

 

 

3

 

 

Short-term investments

 

Auction rate securities held through UBS (a)

 

57

 

 

 

57

 

Short-term investments

 

Auction rate securities held through Morgan Stanley Smith Barney LLC (a)

 

23

 

 

 

23

 

Long-term investments

 

Put option from UBS (b)

 

8

 

 

 

8

 

Other assets—current

 

Total financial assets at fair value

 

$

2,712

 

$

2,621

 

$

3

 

$

88

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contract derivatives

 

$

1

 

$

 

$

1

 

$

 

Other liabilities—current

 

Other financial liability

 

31

 

 

 

31

 

Other liabilities—non-current

 

Total financial liabilities at fair value

 

$

32

 

$

 

$

1

 

$

31

 

 

 

 

 

 

 

 

Fair Value Measurements at
Reporting Date Using

 

 

 

 

 

At
December 31,
2008

 

Quoted
Prices in
Active
Markets for
Identical
Financial
Instruments
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Balance Sheet
Classification

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

2,609

 

$

2,609

 

$

 

$

 

Cash and cash equivalents

 

Mortgage-backed securities

 

7

 

 

7

 

 

Short-term investments

 

Auction rate securities held through UBS and Citigroup, Inc. (a)

 

78

 

 

 

78

 

Long-term investments

 

Put option from UBS (b)

 

10

 

 

 

10

 

Other assets—non-current

 

Foreign exchange contract derivatives

 

5

 

 

5

 

 

Other assets—current

 

Total financial assets at fair value

 

$

2,709

 

$

2,609

 

$

12

 

$

88

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contract derivatives

 

$

2

 

$

 

$

2

 

$

 

Other liabilities—current

 

Other financial liability

 

31

 

 

 

31

 

Other liabilities—non-current

 

Total financial liabilities at fair value

 

$

33

 

$

 

$

2

 

$

31

 

 

 

 

Other financial liability represents the earn-out liability from a previous acquisition. The earn-out liability was recorded

 

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at fair value at the date of the Business Combination as it will be settled by a variable number of shares of our common stock based on the average closing price for the five business days immediately preceding issuance of the shares. When estimating the fair value, we considered our projection of revenues from the related titles under the earn-out provisions. For the six months ended June 30, 2009, there was no change in our fair value estimate of this financial liability.

 

The following table provides a reconciliation of the beginning and ending balances of our financial assets and financial liabilities classified as Level 3 (amounts in millions):

 

 

 

Level 3

 

Balance at December 31, 2008, net

 

$

57

 

Total losses realized/unrealized included in earnings (a) (b)

 

 

Total losses included in other comprehensive income (a)

 

 

Balance at June 30, 2009, net

 

$

57

 

 


(a)           Due to uncertainties surrounding the timing of liquidation of our ARS held through Morgan Stanley Smith Barney LLC, which is 51% owned by Morgan Stanley and 49% owned by Citigroup, Inc., we classify these instruments as long-term investments in our Condensed Consolidated Balance Sheet at June 30, 2009. (The ARS were held directly through Citigroup, Inc. until the Morgan Stanley Smith Barney LLC joint-venture closed in the second quarter 2009.) Liquidity for these ARS is typically provided by an auction process which allows holders to sell their notes and resets the applicable interest rate at pre-determined intervals, usually every 7 to 35 days. On an industry-wide basis, many auctions have failed, and there is, as yet, no meaningful secondary market for these instruments. Each of the ARS in our long-term investment portfolio at June 30, 2009 has experienced a failed auction and there is no assurance that future auctions for these securities will succeed. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. In the event that there is a failed auction, the indenture governing the security requires the issuer to pay interest at a contractually defined rate that is generally above market rates for other types of similar instruments. The securities for which auctions have failed will continue to earn interest at the contractual rate and be auctioned every 7 to 35 days until the auction succeeds, the issuer calls the securities or they mature. As a result, our ability to liquidate and fully recover the carrying value of our ARS in the near term may be limited or not exist.

 

Our ARS held through UBS are classified as short-term investments in our Condensed Consolidated Balance Sheet at June 30, 2009 as we expect to sell our ARS under the put option from UBS within one year if we cannot liquidate them at par prior to then. See (b) below for further details.

 

Consequently, fair value measurements of our ARS have been estimated using an income-approach model (discounted cash-flow analysis). When estimating the fair value, we consider both observable market data and non-observable factors, including credit quality, duration, insurance wraps, collateral composition, maximum rate formulas, comparable trading instruments, and likelihood of redemption. Significant assumptions used in the analysis include estimates for interest rates, spreads, cash flow timing and amounts, and holding periods of the securities. See Notes 3 and 6 of the Notes to Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31, 2008 for additional information regarding our ARS .

 

(b)          Put option from UBS represents an offer from UBS providing us with the right to require UBS to purchase our ARS held through UBS at par value (see Note 3 of the Notes to Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31, 2008 for more details). To value the put option, we considered a number of factors including its intrinsic value, interest rates, the maturity of the option, and our assessment of the credit quality of UBS.

 

13.        Operating segments, geographic regions, and platforms

 

Our operating segments are a reflection of our internal organizational structure, the manner in which our operations are reviewed and managed by our Chief Executive Officer, our Chief Operating Decision Maker (“CODM”), the manner in which operating performance is assessed and resources are allocated, and the availability of separate financial information.

 

Prior to the Business Combination, Vivendi Games managed its business in two main divisions: Blizzard Entertainment and Sierra Entertainment (including Sierra online and Vivendi Games Mobile). As a result of the Business Combination, we provide our CODM financial information based upon management’s new organizational structure.

 

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Currently , we operate under four operating segments: (i) Activision, which publishes interactive entertainment software and peripherals, which includes businesses operated by Activision, Inc. prior to the Business Combination and certain studios, assets, and titles previously included in Vivendi Games’ Sierra Entertainment operating segment prior to the Business Combination, (ii) Blizzard, which publishes traditional games and online subscription-based games in the MMORPG category, (iii)  Distribution, which distributes interactive entertainment software and hardware products (these three operating segments form Activision Blizzard’s core operations) and (iv) Non-Core, Activision Blizzard’s non-core exit operations represent legacy Vivendi Games’ divisions or business units that we have exited or substantially wound down as part of our restructuring and integration efforts as a result of the Business Combination, but do not meet the criteria for separate reporting of discontinued operations. All prior period segment information has been restated to conform to this new segment presentation.

 

The consummation of the Business Combination resulted in net revenues and segment income (loss) from the businesses operated by Activision, Inc. prior to the Business Combination being included for the three and six months ended June 30, 2009, but not for the same periods in 2008. Also, the Activision operating segment includes Vivendi Games titles retained after the Business Combination.

 

The CODM reviews segment performance exclusive of the impact of the deferred net revenues and related cost of sales, stock-based compensation expense, restructuring expense, amortization of intangible assets and purchase price accounting related adjustments, and integration and transaction costs. Information on the operating segments and reconciliations of total net revenues and total segment income from operations to consolidated net revenues and operating income for the three and six months ended June 30, 2009 and 2008 are presented below (amounts in millions):

 

 

 

Three months ended June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

Net revenues

 

Segment income (loss) from
operations

 

Activision

 

$

448

 

$

54

 

$

21

 

$

(16

)

Blizzard

 

290

 

291

 

134

 

147

 

Distribution

 

63

 

 

1

 

 

Activision Blizzard’s core operations

 

801

 

345

 

156

 

131

 

Activision Blizzard’s non-core exit operations

 

 

5

 

(3

)

(75

)

Operating segments total

 

801

 

350

 

153

 

56

 

 

 

 

 

 

 

 

 

 

 

Reconciliation to consolidated net revenues / operating income:

 

 

 

 

 

 

 

 

 

Net effect from deferral of net revenues and related cost of sales

 

237

 

2

 

164

 

3

 

Stock-based compensation expense

 

 

 

(43

)

(12

)

Restructuring expense

 

 

 

(15

)

 

Amortization of intangible assets and purchase price accounting related adjustments

 

 

 

(38

)

(1

)

Integration and transaction costs

 

 

 

(3

)

 

Consolidated net revenues / operating income

 

$

1,038

 

$

352

 

$

218

 

$

46

 

 

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Table of Contents

 

 

 

Six months ended June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

Net revenues

 

Segment income (loss) from
operations

 

Activision

 

$

796

 

$

92

 

$

(6

)

$

(34

)

Blizzard

 

581

 

571

 

277

 

301

 

Distribution

 

148

 

 

4

 

 

Activision Blizzard’s core operations

 

1,525

 

663

 

275

 

267

 

Activision Blizzard’s non-core exit operations

 

1

 

10

 

(8

)

(140

)

Operating segments total

 

1,526

 

673

 

267

 

127

 

 

 

 

 

 

 

 

 

 

 

Reconciliation to consolidated net revenues / operating income:

 

 

 

 

 

 

 

 

 

Net effect from deferral of net revenues and related cost of sales

 

493

 

4

 

331

 

5

 

Stock-based compensation expense

 

 

 

(71

)

(21

)

Restructuring expense

 

 

 

(30

)

 

Amortization of intangible assets and purchase price accounting related adjustments

 

 

 

(83

)

(2

)

Integration and transaction costs

 

 

 

(17

)

 

Consolidated net revenues / operating income

 

$

2,019

 

$

677

 

$

397

 

$

109

 

 

Geographic information for the three and six months ended June 30, 2009 and 2008 is based on the location of the selling entity.  Net revenues from external customers by geographic region were as follows (amounts in millions):

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

 557

 

$

 155

 

$

 1,081

 

$

 294

 

Europe

 

345

 

147

 

652

 

283

 

Asia Pacific

 

73

 

45

 

137

 

90