Activision Blizzard, Inc.
Activision Blizzard, Inc. (Form: 10-Q, Received: 08/06/2010 16:17:48)

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, 2010

 

 

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

 

 

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 30, 2010 was 1,224,397,305.

 

 

 



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

 

Table of Cont ents

 

 

Cautionary Statement

 

3

 

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets at June 30, 2010 and December 31, 2009

 

4

 

 

 

 

 

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2010 and June 30, 2009

 

5

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and June 30, 2009

 

6

 

 

 

 

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity for the six months ended June 30, 2010

 

7

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

8

 

 

 

 

Item 2.

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

 

21

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

32

 

 

 

 

Item 4.

Controls and Procedures

 

33

 

 

 

 

PART II.

OTHER INFORMATION

 

33

 

 

 

 

Item 1.

Legal Proceedings

 

33

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

34

 

 

 

 

Item 6.

Exhibits

 

34

 

 

 

 

SIGNATURE

 

 

35

 

 

 

 

EXHIBIT INDEX

 

 

36

 

 

 

 

CERTIFICATIONS

 

 

 

2



Table of Contents

 

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 Quarterly Report on Form 10-Q was first filed. Risks and uncertainties that may affect our future results include, but are not limited to, sales levels of Activision Blizzard’s 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 World of Warcraft in China, Activision Blizzard’s ability to predict consumer preferences among competing hardware platforms, declines in software pricing, product returns and price protection, product delays, retail acceptance of Activision Blizzard’s products, adoption rate and availability of new hardware (including peripherals) and related software, industry competition, including from used games, and from other forms of entertainment, litigation risks and associated costs, rapid changes in technology, industry standards, business models, including online and used games and consumer preferences including interest in specific genres such as music, first-person action and massively multiplayer online games, protection of proprietary rights,  maintenance of relationships with key personnel, customers, licensees, licensors, vendors, and third-party developers, including the ability to attract, retain and develop key personnel and developers that can create high quality “hit” titles, counterparty risks relating to customers, licensees, licensors and manufacturers, domestic and international economic, financial and political conditions and policies, foreign exchange rates and tax rates, and the identification of suitable future acquisition opportunities, and potential challenges associated with geographic expansion, and the other factors identified in “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2009. 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.

 

Activision Blizzard’s names, abbreviations thereof, logos, and product and service designators are all either the registered or unregistered trademarks or trade names of Activision Blizzard.

 

3



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 data)

 

 

 

At June 30,
2010

 

At December 31,
2009

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

2,214

 

$

2,768

 

Short-term investments

 

632

 

477

 

Accounts receivable, net of allowances of $201 million and $317 million at June 30, 2010 and December 31, 2009, respectively

 

190

 

739

 

Inventories

 

157

 

241

 

Software development

 

219

 

224

 

Intellectual property licenses

 

27

 

55

 

Deferred income taxes, net

 

401

 

498

 

Other current assets

 

128

 

327

 

Total current assets

 

3,968

 

5,329

 

 

 

 

 

 

 

Long-term investments

 

23

 

23

 

Software development

 

30

 

10

 

Intellectual property licenses

 

32

 

28

 

Property and equipment, net

 

160

 

138

 

Other assets

 

13

 

9

 

Intangible assets, net

 

587

 

618

 

Trademark and trade names

 

433

 

433

 

Goodwill

 

7,147

 

7,154

 

Total assets

 

$

12,393

 

$

13,742

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

149

 

$

302

 

Deferred revenues

 

482

 

1,426

 

Accrued expenses and other liabilities

 

459

 

779

 

Total current liabilities

 

1,090

 

2,507

 

Deferred income taxes, net

 

249

 

270

 

Other liabilities

 

196

 

209

 

Total liabilities

 

1,535

 

2,986

 

 

 

 

 

 

 

Commitments and contingencies (Note 12)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $.000001 par value, 2,400,000,000 shares authorized, 1,370,008,534 and 1,364,117,675 shares issued at June 30, 2010 and December 31, 2009, respectively

 

 

 

Additional paid-in capital

 

12,260

 

12,376

 

Less: Treasury stock, at cost, 146,059,301 and 113,686,498 at June 30, 2010 and December 31, 2009, respectively

 

(1,584

)

(1,235

)

Retained earnings (accumulated deficit)

 

239

 

(361

)

Accumulated other comprehensive loss

 

(57

)

(24

)

Total shareholders’ equity

 

10,858

 

10,756

 

Total liabilities and shareholders’ equity

 

$

12,393

 

$

13,742

 

 

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,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

 

 

 

 

 

 

 

 

Product sales

 

$

643

 

$

747

 

$

1,629

 

$

1,437

 

Subscription, licensing, and other revenues

 

324

 

291

 

646

 

582

 

Total net revenues

 

967

 

1,038

 

2,275

 

2,019

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

Cost of sales — product costs

 

235

 

281

 

572

 

577

 

Cost of sales — software royalties and amortization

 

51

 

86

 

150

 

158

 

Cost of sales — intellectual property licenses

 

29

 

54

 

72

 

118

 

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

 

52

 

51

 

106

 

103

 

Product development

 

104

 

123

 

247

 

240

 

Sales and marketing

 

126

 

118

 

182

 

201

 

General and administrative

 

70

 

92

 

135

 

195

 

Restructuring

 

 

15

 

 

30

 

Total costs and expenses

 

667

 

820

 

1,464

 

1,622

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

300

 

218

 

811

 

397

 

 

 

 

 

 

 

 

 

 

 

Investment and other income, net

 

1

 

 

1

 

10

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense

 

301

 

218

 

812

 

407

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

82

 

23

 

212

 

23

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

219

 

$

195

 

$

600

 

$

384

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.18

 

$

0.15

 

$

0.48

 

$

0.29

 

Diluted

 

$

0.17

 

$

0.15

 

$

0.47

 

$

0.28

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

1,232

 

1,289

 

1,239

 

1,299

 

Diluted

 

1,248

 

1,332

 

1,254

 

1,345

 

 

 

 

 

 

 

 

 

 

 

Dividends per common share

 

$

 

$

 

$

0.15

 

$

 

 

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,

 

 

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

600

 

$

384

 

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

 

 

 

 

 

Deferred income taxes

 

81

 

(119

)

Depreciation and amortization

 

59

 

129

 

Gain on auction rate securities (“ARS”) classified as trading securities

 

(7

)

(2

)

Loss on ARS rights from UBS

 

7

 

2

 

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

 

142

 

154

 

Stock-based compensation expense (2)

 

61

 

73

 

Excess tax benefits from stock option exercises

 

(6

)

(56

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

525

 

706

 

Inventories

 

78

 

64

 

Software development and intellectual property licenses

 

(158

)

(166

)

Other assets

 

224

 

90

 

Deferred revenues

 

(936

)

(500

)

Accounts payable

 

(144

)

(199

)

Accrued expenses and other liabilities

 

(325

)

(351

)

Net cash provided by operating activities

 

201

 

209

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities of investments

 

188

 

3

 

Proceeds from sale of available-for-sale investments

 

 

2

 

Payment of contingent consideration

 

(4

)

 

Purchases of short-term investments

 

(388

)

 

Capital expenditures

 

(39

)

(24

)

(Increase) decrease in restricted cash

 

16

 

(5

)

Net cash used in investing activities

 

(227

)

(24

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

30

 

45

 

Repurchase of common stock

 

(349

)

(542

)

Dividends paid

 

(187

)

 

Excess tax benefits from stock option exercises

 

6

 

56

 

Net cash used in financing activities

 

(500

)

(441

)

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

(28

)

26

 

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(554

)

(230

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

2,768

 

2,958

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

2,214

 

$

2,728

 

 


(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, 2010

(Unaudited)

(Amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Retained

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Earnings

 

Other

 

Total

 

 

 

Common Stock

 

Paid-In

 

Treasury Stock

 

(Accumulated

 

Comprehensive

 

Shareholders’

 

 

 

Shares

 

Amount

 

Capital

 

Shares

 

Amount

 

Deficit)

 

Loss

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2009

 

1,364

 

$

 

$

12,376

 

(114

)

$

(1,235

)

$

(361

)

$

(24

)

$

10,756

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

600

 

 

600

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

(33

)

(33

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

567

 

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

 

6

 

 

30

 

 

 

 

 

30

 

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

 

 

 

43

 

 

 

 

 

43

 

Dividends ($0.15 per common share)

 

 

 

(189

)

 

 

 

 

(189

)

Shares repurchased

 

 

 

 

(32

)

(349

)

 

 

(349

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2010

 

1,370

 

$

 

$

12,260

 

(146

)

$

(1,584

)

$

239

 

$

(57

)

$

10,858

 

 

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.      Description of Business and Business Combination

 

Description of Business

 

Activision Blizzard, Inc. is a worldwide online, personal computer (“PC”), console, handheld and mobile game publisher. The terms “Activision Blizzard,” the “Company,” “we,” “us,” and “our” are used to refer collectively to Activision Blizzard, Inc. and its subsidiaries.

 

In 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 Blizzard, Inc. (“Activision Blizzard”).

 

The common stock of Activision Blizzard is traded on NASDAQ under the ticker symbol “ATVI.” Vivendi owned approximately 59% of Activision Blizzard’s outstanding common stock at June 30, 2010.

 

We maintain significant operations in the United States, Canada, the United Kingdom, France, Germany, Ireland, Italy, Spain, Australia, Sweden, South Korea, China and the Netherlands.

 

Basis of Consolidation and 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, 2009. 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.

 

The prior year condensed consolidated statement of cash flows for the period ended June 30, 2009 has been adjusted to correct immaterial errors related to the elimination of intercompany receivables and payables in the consolidated balance sheets at June 30, 2009 and December 31, 2008 (not included herein). The corrections reduced the accounts receivable and accounts payable line items in the June 30, 2009 consolidated balance sheet by $14 million and reduced the accounts receivable and accounts payable line items in the December 31, 2008 consolidated balance sheet by $236 million. These corrections correspondingly impacted the change in accounts receivable and accounts payable in the condensed consolidated statement of cash flows for the period ended June 30, 2009 by $222 million. These corrections had no impact on net income, earnings per share or net cash provided by operating, investing and financing activities.

 

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

 

The Company considers events or transactions that occur after the balance sheet date, but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosures.

 

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Table of Contents

 

2.     Inventories

 

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

 

 

 

At June 30, 2010

 

At December 31, 2009

 

Finished goods

 

$

123

 

$

201

 

Purchased parts and components

 

34

 

40

 

 

 

 

 

 

 

 

 

$

157

 

$

241

 

 

3.     Intangible assets, net

 

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

 

 

 

At June 30, 2010

 

 

 

Estimated
useful
lives

 

Gross
carrying
amount

 

Accumulated
amortization

 

Net carrying
amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

173

 

$

(71

)

$

102

 

Game engines

 

2 - 5 years

 

61

 

(39

)

22

 

Internally developed franchises

 

11 - 12 years

 

574

 

(118

)

456

 

Favorable leases

 

1 - 4 years

 

5

 

(4

)

1

 

Distribution agreements

 

4 years

 

18

 

(12

)

6

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

386

 

 

386

 

Acquired trade names

 

Indefinite

 

47

 

 

47

 

Total

 

 

 

$

1,264

 

$

(244

)

$

1,020

 

 

 

 

At December 31, 2009

 

 

 

Estimated
useful
lives

 

Gross
carrying
amount

 

Accumulated
amortization

 

Net carrying
amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

173

 

$

(65

)

$

108

 

Developed software

 

1 - 2 years

 

288

 

(288

)

 

Game engines

 

2 - 5 years

 

61

 

(33

)

28

 

Internally developed franchises

 

11 - 12 years

 

574

 

(101

)

473

 

Favorable leases

 

1 - 4 years

 

5

 

(4

)

1

 

Distribution agreements

 

4 years

 

18

 

(10

)

8

 

Other intangibles

 

0 - 2 years

 

5

 

(5

)

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

386

 

 

386

 

Acquired trade names

 

Indefinite

 

47

 

 

47

 

Total

 

 

 

$

1,557

 

$

(506

)

$

1,051

 

 

Amortization expense of intangible assets was $11 million and $29 million for the three and six months ended June 30, 2010, respectively.  Amortization expense of intangible assets was $41 million and $90 million for the three and six months ended June 30, 2009, respectively.

 

The gross carrying amount as of June 30, 2010 and December 31, 2009 in the tables above reflect a new cost basis for license agreements, game engines and internally developed franchises due to impairment charges taken for the year ended December 31, 2009.  The new cost basis includes the original gross carrying amount, less accumulated amortization and impairment charges of the impaired assets as of December 31, 2009.

 

At June 30, 2010, future amortization of definite-lived intangible assets is estimated as follows (amounts in millions):

 

2010 (remaining six months)

 

$

85

 

2011

 

97

 

2012

 

87

 

2013

 

63

 

2014

 

54

 

Thereafter

 

201

 

 

 

 

 

Total

 

$

587

 

 

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4.     Income taxes

 

The income tax expense of $82 million for the three months ended June 30, 2010 reflects an effective tax rate of 27%. The effective tax rate of 27% for the three months ended June 30, 2010 differs from the statutory rate of 35% primarily due to foreign income taxes provided at lower rates, geographic mix in profitability, recognition of California research and development credits and IRC 199 domestic production deductions. We did not record a tax benefit for federal research credits during the quarter ended June 30, 2010 since as of June 30, 2010, unlike in past years, the federal research credit extension had not yet been signed into law.

 

For the six months ended June 30, 2010, the tax rate is based on our projected annual effective tax rate for 2010, and also includes certain discrete tax items recorded during the period. Our tax expense of $212 million for the six months ended June 30, 2010 reflects an effective tax rate of 26% which differs from the effective tax rate of 6% for the six months ended June 30, 2009 primarily due to tax benefits recorded during the prior period related to the release of valuation allowances on foreign net operating losses and the impact of changes to California tax laws.

 

5.     Software development and intellectual property licenses

 

The following table summarizes the components of our software development and intellectual property licenses (amounts in millions):

 

 

 

At
June 30,

 

At
December 31,

 

 

 

2010

 

2009

 

Internally developed software costs

 

$

172

 

$

182

 

Payments made to third-party software developers

 

77

 

52

 

Total software development costs

 

$

249

 

$

234

 

 

 

 

 

 

 

Intellectual property licenses

 

$

59

 

$

83

 

 

Amortization, write-offs and impairments are comprised of the following (amounts in millions):

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Amortization of capitalized software development costs and intellectual property licenses

 

$

67

 

$

97

 

$

168

 

$

169

 

Write-offs and impairments

 

 

 

15

 

 

 

6.     Comprehensive income and accumulated other comprehensive loss

 

Comprehensive Income

 

The components of comprehensive income for the three and six months ended June 30, 2010 and 2009 were as follows (amounts in millions):

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

219

 

$

195

 

$

600

 

$

384

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

(13

)

31

 

(33

)

29

 

Unrealized appreciation (depreciation) on investments, net of taxes

 

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

(13

)

32

 

(33

)

29

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

206

 

$

227

 

$

567

 

$

413

 

 

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The components of accumulated other comprehensive loss at June 30, 2010 and December 31, 2009 were as follows (amounts in millions):

 

 

 

At June 30,

 

At December 31,

 

 

 

2010

 

2009

 

Foreign currency translation adjustment

 

$

(55

)

$

(22

)

Unrealized depreciation on investments, net of deferred income taxes of $(2) for each of June 30, 2010 and December 31, 2009

 

(2

)

(2

)

Accumulated other comprehensive loss

 

$

(57

)

$

(24

)

 

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

 

7.      Fair value measurements

 

Fair Value Measurements on a Recurring Basis

 

Financial Accounting Standards Board (“FASB”) literature regarding fair value measurements for financial and non-financial assets and liabilities establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of “observable inputs” and minimize the use of “unobservable inputs.” 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.

 

The table below segregates all assets and liabilities that are measured at fair value on a recurring basis (which means they are so 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
June 30, 2010 Using

 

 

 

 

 

As of
June 30,

 

Quoted
Prices in
Active
Markets for
Identical
Financial
Instruments

 

Significant
Other
Observable
Inputs

 

Significant
Unobservable
Inputs

 

Balance Sheet

 

 

 

2010

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

1,888

 

$

1,888

 

$

 

$

 

Cash and cash equivalents

 

U.S. treasuries with original maturities of three months or less

 

200

 

200

 

 

 

Cash and cash equivalents

 

Mortgage backed securities

 

1

 

 

1

 

 

Short-term investments

 

U.S. treasuries and government sponsored agency debt securities

 

615

 

615

 

 

 

Short-term investments

 

ARS held through Morgan Stanley Smith Barney LLC

 

23

 

 

 

23

 

Long-term investments

 

Foreign exchange contract derivatives

 

5

 

 

5

 

 

Other assets—current

 

Total financial assets at fair value

 

$

2,732

 

$

2,703

 

$

6

 

$

23

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Other financial liability

 

$

(23

)

$

 

$

 

$

(23

)

Other liabilities—current

 

Total financial liabilities at fair value

 

$

(23

)

$

 

$

 

$

(23

)

 

 

 

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Table of Contents

 

 

 

 

 

Fair Value Measurements at
December 31, 2009 Using

 

 

 

 

 

As of
December 31,

 

Quoted
Prices in
Active
Markets for
Identical
Financial
Instruments

 

Significant
Other
Observable
Inputs

 

Significant
Unobservable
Inputs

 

Balance Sheet

 

 

 

2009

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

2,304

 

$

2,304

 

$

 

$

 

Cash and cash equivalents

 

Mortgage backed securities

 

2

 

 

2

 

 

Short-term investments

 

ARS held through UBS

 

54

 

 

 

54

 

Short-term investments

 

U.S. government sponsored agency debt securities

 

389

 

389

 

 

 

Short-term investments

 

ARS held through Morgan Stanley Smith Barney LLC

 

23

 

 

 

23

 

Long-term investments

 

ARS rights from UBS(a)

 

7

 

 

 

7

 

Other assets—current

 

Total financial assets at fair value

 

$

2,779

 

$

2,693

 

$

2

 

$

84

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Other financial liability

 

$

(23

)

$

 

$

 

$

(23

)

Other liabilities—current

 

Total financial liabilities at fair value

 

$

(23

)

$

 

$

 

$

(23

)

 

 

 


(a)                                   ARS rights from UBS represent an offer from UBS providing us with the right to require UBS to purchase our ARS held through UBS at par value. To value the ARS rights, we considered the intrinsic value, time value of money, and our assessment of the credit worthiness of UBS.  We exercised our ARS rights with UBS on June 30, 2010.

 

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

 

The following table provides a reconciliation of the beginning and ending balances of our financial assets and financial liabilities classified as Level 3 by major categories (amounts in millions) at June 30, 2010:

 

 

 

Level 3

 

 

 

ARS
(a)

 

ARS rights
from UBS
(b)

 

Total
financial
assets at
fair
value

 

Other financial
liabilities

 

Balance at January 1, 2010

 

$

77

 

$

7

 

$

84

 

$

(23

)

Total gains or (losses) (realized/unrealized) included in investment and other income, net

 

7

 

(7

)

 

 

Purchases or acquired sales, issuances and settlements

 

(61

)

 

(61

)

 

Balance at June 30, 2010

 

$

23

 

$

 

$

23

 

$

(23

)

 

The following table provides a reconciliation of the beginning and ending balances of our financial assets and financial liabilities classified as Level 3 by major categories (amounts in millions) at June 30, 2009:

 

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Level 3

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

Financial

 

 

 

 

 

 

 

ARS rights

 

assets at

 

 

 

 

 

ARS

 

from UBS

 

fair

 

Other financial

 

 

 

(a)

 

(b)

 

value

 

liabilities

 

Balance at January 1, 2009

 

$

78

 

$

10

 

$

88

 

$

(31

)

Total gains or (losses) (realized/unrealized) included in investment and other income, net

 

2

 

(2

)

 

 

Balance at June 30, 2009

 

$

80

 

$

8

 

$

88

 

$

(31

)

The amount of total gains or (losses) for the period included in investment and other income, net attributable to the change in unrealized gains or losses relating to assets and liabilities still held at June 30, 2009

 

$

2

 

$

(2

)

$

 

$

 

 


(a)                                   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 auction rate securities in our investment portfolio at June 30, 2010 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 auction rate securities in the near term may be limited or non-existent.

 

Consequently, fair value measurements 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. Assets measured at fair value using significant unobservable inputs (Level 3) represent 1% of our financial assets measured at fair value on a recurring basis.

 

In June 2010, we sold the remainder of our ARS held with UBS at par and recognized a gain of $7 million included within investment and other income, net in our condensed consolidated statement of operations for the six months ended June 30, 2010.  Unsettled funds of $36 million from the sale of ARS held with UBS were included within other current assets in our condensed consolidated balance sheet at June 30, 2010 and were received on July 1, 2010.

 

(b)                                  ARS rights from UBS represent an offer from UBS providing us with the right to require UBS to purchase our ARS held through UBS at par value. To value the ARS rights, we considered the intrinsic value, time value of money, and our assessment of the credit worthiness of UBS. We exercised our ARS rights with UBS on June 30, 2010 and recorded a loss of $7 million included within investment and other income in our condensed consolidated statement of operations.

 

The carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses is a reasonable approximation of fair value due to their short-term nature. Our U.S. treasuries and government sponsored agency debt securities and mortgage-backed securities are carried at fair value with fair values estimated based on quoted market prices or estimated based on quoted market prices of financial instruments with similar characteristics.

 

Foreign Currency 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 fair value of foreign currency contracts is estimated based on the prevailing exchange rates of the various hedged currencies as of the end of the period.

 

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Table of Contents

 

Fair Value Measurements on a Non-Recurring Basis

 

We measure the fair value of certain assets on a non-recurring basis, generally annually or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.  For the six month period ended June 30, 2010, there were no impairment charges related to assets that are measured on a non-recurring basis.

 

The table below presents intangible assets that are not subject to recurring fair value measurement at December 31, 2009 (amounts in millions):

 

 

 

 

 

Fair Value Measurements at
Reporting Date Using

 

 

 

 

 

As of
December 31,

 

Quoted
Prices in
Active
Markets for
Identical
Financial
Instruments

 

Significant
Other
Observable
Inputs

 

Significant
Unobservable
Inputs

 

 

 

 

 

2009

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total Losses

 

Non-financial assets:

 

 

 

 

 

 

 

 

 

 

 

Intangible assets, net

 

$

278

 

$

 

$

 

$

278

 

$

409

 

Total non-financial assets at fair value

 

$

278

 

$

 

$

 

$

278

 

$

409

 

 

In the fourth quarter of fiscal year ending 2009, with the franchise and industry results of the holiday season, our outlook for the console platforms was significantly revised. With the continued economic downturn within our industry in 2009 and the change in the buying habits of casual consumers, we reassessed our overall expectations as of December 31, 2009. We considered these economic changes during our 2010 planning process conducted during the months of November and December, which resulted in a strategy change to focus on fewer title releases in the casual and music genres. As we consider this a triggering event, we updated our future projected revenues streams for certain franchises in the casual games and music genres. We performed recoverability and, where applicable, impairment tests on the related intangible assets in accordance with ASC Subtopic 360-10.

 

Determining whether impairment has occurred requires various estimates and assumptions, including determining which cash flows are directly related to the potentially impaired asset, the estimated remaining useful life over which cash flows will occur, the amount of these cash flows and the asset’s residual value, if any. For intangible assets that did not pass the recoverability test, measurement of an impairment loss requires a determination of fair value, which is based on the best information available. Considering the characteristics of the assets being valued and the availability of information, the Company used the income approach, which presumes that the value of an asset can be estimated by the net economic benefit to be received over the estimated remaining useful life of the asset, discounted to present value. We derived the required cash flow estimates from our historical experience and our internal business plans and applied an appropriate discount rate. Based on this analysis, we recorded impairment charges of $24 million, $12 million and $373 million to license agreements, game engines and internally developed franchises intangible assets, respectively, in the quarter ended December 31, 2009 within our Activision operating segment.

 

8.     Operating segments and geographic region

 

Our operating segments are consistent with 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. We do not aggregate operating segments.

 

Currently, we operate under three operating segments:

 

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, handheld platforms and the PC platform through internally developed franchises and license agreements. Activision currently offers games that operate on the Sony Computer Entertainment, Inc. (“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”) Nintendo Dual Screen (“NDS”) and Nintendo DSi handheld devices; the PC; and the Apple iPhone and  iPad . Our Activision business

 

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Table of Contents

 

involves the development, marketing, and sale of products through retail channels or digital downloads, by license, or from 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 core gamers, 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 World of 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 , prepaid cards and other value added service revenues); retail sales of physical “boxed” products; electronic download sales of PC products; and licensing of software to third-party or related party companies that distribute World of Warcraft .

 

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.

 

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 (loss) from operations to consolidated net revenues and operating income for the three and six months ended June 30, 2010 and 2009 are presented below (amounts in millions):

 

 

 

Three months ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

Net revenues

 

Income (loss) from
operations

 

Activision

 

$

333

 

$

448

 

$

(53

)

$

21

 

Blizzard

 

299

 

290

 

155

 

134

 

Distribution

 

51

 

63

 

(1

)

1

 

Operating segments total

 

683

 

801

 

101

 

156

 

 

 

 

 

 

 

 

 

 

 

Reconciliation to consolidated net revenues / operating income:

 

 

 

 

 

 

 

 

 

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

 

284

 

237

 

227

 

164

 

Stock-based compensation expense

 

 

 

(17

)

(43

)

Restructuring

 

 

 

(1

)

(15

)

Amortization of intangible assets and purchase price accounting related adjustments

 

 

 

(10

)

(38

)

Integration and transaction costs

 

 

 

 

(3

)

Other*

 

 

 

 

(3

)

Consolidated net revenues / operating income

 

$

967

 

$

1,038

 

$

300

 

$

218

 

 

 

 

Six months ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

Net revenues

 

Income (loss) from
operations

 

Activision

 

$

670

 

$

796

 

$

(46

)

$

(6

)

Blizzard

 

605

 

581

 

313

 

277

 

Distribution

 

122

 

148

 

(1

)

4

 

Operating segments total

 

1,397

 

1,525

 

266

 

275

 

 

 

 

 

 

 

 

 

 

 

Reconciliation to consolidated net revenues / operating income:

 

 

 

 

 

 

 

 

 

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

 

878

 

493

 

637

 

331

 

Stock-based compensation expense

 

 

 

(60

)

(71

)

Restructuring

 

 

 

(4

)

(30

)

Amortization of intangible assets and purchase price accounting related adjustments

 

 

 

(28

)

(83

)

Integration and transaction costs

 

 

 

 

(17

)

Other*

 

 

1

 

 

(8

)

Consolidated net revenues / operating income

 

$

2,275

 

$

2,019

 

$

811

 

$

397

 

 

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Table of Contents

 

Geographic information for the three and six months ended June 30, 2010 and 2009 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,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net revenues by geographic region:

 

 

 

 

 

 

 

 

 

North America

 

$

567

 

$

557

 

$

1,270

 

$

1,081

 

Europe

 

337

 

408

 

861

 

800

 

Asia Pacific

 

63

 

73

 

144

 

137

 

Total geographic region net revenues

 

967

 

1,038

 

2,275

 

2,018

 

Other*

 

 

 

 

1

 

Total consolidated net revenues

 

$

967

 

$

1,038

 

$

2,275

 

$

2,019

 

 

Net revenues by platform were as follows (amounts in millions):

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net revenues by platform:

 

 

 

 

 

 

 

 

 

MMORPG

 

$

289

 

$

324

 

$

594

 

$

638

 

Console

 

507

 

545

 

1,346

 

1,048

 

Hand-held

 

39

 

65

 

78

 

97

 

PC and other

 

81

 

41

 

135

 

87

 

Total platform net revenues

 

916

 

975

 

2,153

 

1,870

 

Distribution

 

51

 

63

 

122

 

148

 

Other*

 

 

 

 

1

 

Total consolidated net revenues

 

$

967

 

$

1,038

 

$

2,275

 

$

2,019

 

 


*Represents Non-Core activities, which are legacy Vivendi Games’ divisions or business units that we have exited, divested or wound down as part of our restructuring and integration efforts as a result of the Business Combination. Prior to July 1, 2009, Non-Core activities were managed as a stand-alone operating segment; however, in light of the minimal activities and insignificance of Non-Core activities, as of that date we ceased their management as a separate operating segment and consequently, we are no longer providing separate operating segment disclosure and have reclassified our prior periods’ segment presentation so that it conforms to the current period’s presentation.

 

We did not have any single external customer that accounted for 10% or more of consolidated net revenues for the three and six months ended June 30, 2010.  We had one customer, GameStop, that accounted for 10% and 8% of consolidated net revenues for the three and six months ended June 30, 2009, respectively, and 14% of consolidated gross accounts receivable at June 30, 2009.

 

9.     Goodwill

 

The changes in the carrying amount of goodwill by operating segment for the six months ended June 30, 2010 are as follows (amounts in millions):

 

 

 

Activision

 

Blizzard

 

Distribution

 

Total

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2009

 

$

6,964

 

$

178

 

$

12

 

$

7,154

 

Tax benefit credited to goodwill

 

(6

)

 

 

(6

)

Foreign exchange

 

(1

)

 

 

(1

)

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2010

 

$

6,957

 

$

178

 

$

12

 

$

7,147

 

 

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The tax benefit credited to goodwill represents the tax deduction resulting from the exercise of 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. Conversely, to the extent that the tax deduction did exceed the fair value of those options, the tax benefit is credited to additional paid-in capital.

 

10.  Computation of basic/diluted earnings per common share

 

The following table sets forth the computation of basic and diluted earnings per common share (amounts in millions, except per share data):

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Consolidated net income

 

$

219

 

$

195

 

$

600

 

$

384

 

Less: Distributed earnings to common shareholders

 

 

 

(187

)

 

Less: Distributed earnings to unvested share-based awards that participate in earnings

 

 

 

(2

)

 

Undistributed earnings

 

219

 

195

 

411

 

384

 

Less: Undistributed earnings allocated to unvested share-based awards that participate in earnings

 

(2

)

(2

)

(3

)

(3

)

Undistributed earnings allocated to common shareholders

 

217

 

193

 

408

 

381

 

Add back: Distributed earnings to common shareholders

 

 

 

187

 

 

Numerator for basic and diluted earnings per common share - income available to common shareholders

 

217

 

193

 

595

 

381

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Denominator for basic earnings per common share - weighted-average common shares outstanding

 

1,232

 

1,289

 

1,239

 

1,299

 

 

 

 

 

 

 

 

 

 

 

Effect of potential dilutive common shares under the treasury stock method:

 

 

 

 

 

 

 

 

 

Employee stock options

 

16

 

43

 

15

 

46

 

Denominator for diluted earnings per common share - weighted-average common shares outstanding plus dilutive effect of employee stock options

 

1,248

 

1,332

 

1,254

 

1,345

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.18

 

$

0.15

 

$

0.48

 

$

0.29

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.17

 

$

0.15

 

$

0.47

 

$

0.28

 

 

Our unvested restricted stock rights (including restricted stock units, restricted stock awards, and performance share awards) are considered participating securities since these securities have non-forfeitable rights to dividends or dividend equivalents during the contractual period of the award. Since the unvested restricted stock rights are considered participating securities, we are required to use the two-class method in our computation of basic and diluted earnings per common share. For the three and six months ended June 30, 2010 and 2009, we had outstanding unvested restricted stock rights with respect to 10 million shares of common stock on a weighted-average basis.

 

Potential common shares are not included in the denominator of the diluted earnings per common share calculation when inclusion of such shares would be anti-dilutive. Therefore, options to acquire 23 million shares of common stock were not included in the calculation of diluted earnings per common share for the three and six months ended June 30, 2010 and options to

 

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acquire 19 million shares of common stock were not included in the calculation of diluted earnings per common share for the three and six months ended June 30, 2009 as the effect of their inclusion would be anti-dilutive.

 

11.  Capital transactions

 

Repurchase Program

 

On November 5, 2008, we announced that our Board of Directors authorized a stock repurchase program under which we were able to repurchase up to $1 billion of our common stock. On July 31, 2009, our Board of Directors authorized an increase of $250 million to the stock repurchase program bringing the total authorization to $1.25 billion.  On February 10, 2010, we announced that our Board of Directors authorized a new stock repurchase program under which we may repurchase up to $1 billion of our common stock until the earlier of December 31, 2010 or a determination by our Board of Directors to discontinue the repurchase program.

 

In January 2010, we settled a $15 million purchase of 1.3 million shares of our common stock that we had agreed to repurchase in December 2009 pursuant to the $1.25 billion stock repurchase program, completing that program. During the six months ended June 30, 2010, we repurchased 31 million shares of our common stock for $334 million pursuant to the new $1 billion stock repurchase program.

 

Dividend

 

On February 10, 2010, Activision Blizzard’s Board of Directors declared a cash dividend of $0.15 per common share payable on April 2, 2010 to shareholders of record at the close of business on February 22, 2010, and on April 2, 2010, we made a cash dividend payment of $187 million to such shareholders.  We intend to make dividend equivalent payments related to this cash dividend to certain holders of restricted stock rights later this year.

 

12.  Commitments and contingencies

 

At June 30, 2010, we did not have any significant changes to our commitments since December 31, 2009.  See Note 18 of the Notes to Consolidated Financial Statements included in Item 8 of the Annual Report on Form 10-K for the year ended December 31, 2009 for more information regarding our commitments.

 

Legal Proceedings

 

On February 8, 2008, the Wayne County Employees’ Retirement System filed a lawsuit challenging the Business Combination in the Delaware Court of Chancery. The suit is a putative class action filed against the parties to the Business Combination Agreement as well as certain current and former members of our Board of Directors. The plaintiff alleged, among other things, that our current and former directors named therein failed to fulfill their fiduciary duties with regard to the Business Combination by “surrendering” the negotiating process to “conflicted management,” that those breaches were aided and abetted by Vivendi and those of its subsidiaries named in the complaint, and that the preliminary proxy statement filed by the Company on January 31, 2008 contains certain statements that the plaintiff alleges are false and misleading. The plaintiff sought an order from the court that, among other things, certifies the case as a class action, enjoins the Business Combination, requires the defendants to disclose all material information, declares that the Business Combination is in breach of the directors’ fiduciary duties and therefore unlawful and unenforceable, awards the plaintiff and the putative class damages for all profits and special benefits obtained by the defendant in connection with the Business Combination and tender offer, and awards the plaintiff its cost and expense, including attorney’s fees.

 

After various initial motions were filed and ruled upon, on May 8, 2008, the plaintiff filed an amended complaint that, among other things, added allegations relating to a revised preliminary proxy statement filed by the Company on April 30, 2008. Additional motions were then filed, including a motion for preliminary injunction filed by the plaintiff and a motion to dismiss filed by Vivendi and its subsidiaries. On June 14, 2008, the plaintiff filed a motion for leave to file a second amended complaint. On June 30, 2008, the court granted Vivendi and its subsidiaries’ motion to dismiss, pursuant to a stipulation with the plaintiff, and on July 1, 2008, denied the plaintiff’s motion for preliminary injunction.

 

On December 23, 2008, the plaintiff filed an amended motion for leave to file a second amended complaint. The court granted the motion on January 14, 2009 and the second amended complaint was deemed filed on the same date. The second amended complaint asserts claims similar to the ones made in the original complaint, challenging Activision’s Board of Directors’ actions in connection with the negotiation and approval of the Business Combination, as well as disclosures made to our stockholders and certain amendments made to our certificate of incorporation in connection therewith. In addition, the second amended complaint asserts that Activision’s Board of Directors breached its fiduciary duties in approving and recommending those amendments to the certificate of incorporation. Among other things, the plaintiff seeks certification of the action as a class action, a declaration that amendments made to the certificate of incorporation are invalid and unenforceable, a declaration that our directors breached their fiduciary duties, rescission of the Business Combination and related transactions, and damages, interest, fees and costs. On July 24, 2009, the court granted the Company’s motion to dismiss the complaint for failure to state a claim.

 

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On August 21, 2009, the plaintiff filed a notice of appeal of the court’s dismissal. Appellate briefing has been completed and a hearing on the appeal occurred before a panel of the Delaware Supreme Court on January 13, 2010. The court then scheduled an additional hearing before the entire court, which occurred on March 31, 2010. On May 28, 2010, the court affirmed the lower court’s dismissal.  After this report, this matter will no longer be reported in the Company’s filings, since the only outstanding issues relate to the plaintiff’s motion for attorney’s fees.

 

After concluding an internal human resources inquiry into breaches of contract and insubordination by two senior employees at Infinity Ward, the Company terminated its employment of Jason West and Vince Zampella on March 1, 2010. On March 3, 2010, West and Zampella filed a complaint against the Company in Los Angeles Superior Court for breach of contract and wrongful termination, among other claims.   West and Zampella are seeking damages, including punitive damages, in excess of $36 million and declaratory relief.  On April 9, 2010, the Company filed a cross complaint against West and Zampella, asserting claims for breach of contract and fiduciary duty, among other claims.  The Company is seeking damages and declaratory relief.  The court set a trial date of May 23, 2011 The Company has accrued and will continue to accrue appropriate amounts related to bonuses and other monies allegedly owed in connection with this matter.  At present, the Company does not expect this lawsuit to have a material impact on the Company.

 

In addition, 38 current and former employees of Infinity Ward filed a complaint against the Company in Los Angeles Superior Court on April 27, 2010.  An amended complaint was filed on July 8, 2010, which added seven additional plaintiffs.  The plaintiffs have asserted claims for breach of contract, violation of the Labor Code of the State of California, conversion and other claims.  The plaintiffs claim that the Company failed to pay them bonuses and other compensation allegedly owed to them in an amount at least between $75 and $125 million, plus punitive damages.  The Company has not yet responded to the amended complaint.  A case management conference was held on July 9, 2010.  The court set a trial date of May 23, 2011 The Company has accrued and will continue to accrue appropriate amounts related to bonuses and other monies allegedly owed in connection with this matter.  The Company does not expect this lawsuit to have a material impact on the Company.  During the period from March 3, 2010 through July 30, 2010, approximately 45 employees of Infinity Ward resigned from the Company.

 

In addition, we are party to other routine claims and suits brought by us and against us in the ordinary course of business, including disputes arising over the ownership of intellectual property rights, contractual claims, employment laws, regulations and relationships, and collection matters. In the opinion of management, after consultation with legal counsel, the outcome of such routine claims and lawsuits will not have a material adverse effect on our business, financial condition, results of operations, or liquidity.

 

Credit Facilities

 

Effective July 23, 2010, we terminated our unsecured credit agreement with Vivendi, the lender, which provided for a revolving credit facility of up to $475 million.

 

13.  Related party transactions

 

Treasury

 

Our foreign currency risk management program seeks to reduce risks arising from foreign currency fluctuations. We use derivative financial instruments, primarily currency forward contracts and swaps, with Vivendi as our principal counterparty. The gross notional amount of outstanding foreign exchange swaps was $369 million at June 30, 2010. The gross notional amount of outstanding foreign exchange swaps was $120 million at December 31, 2009. A pre-tax net unrealized gain of $5 million and loss of $2 million for the three months ended June 30, 2010 and 2009, respectively, resulted from the foreign exchange contracts and swaps with Vivendi and were recognized in the condensed consolidated statements of operations.  A pre-tax net unrealized gain of $4 million and gain of less than $1 million for the six months ended June 30, 2010 and 2009, respectively, resulted from the foreign exchange contracts and swaps with Vivendi and were recognized in the condensed consolidated statements of operations.

 

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Other

 

Activision Blizzard has entered into various transactions and agreements, including cash management services, investor agreement, and music royalty agreements with Vivendi and its subsidiaries and affiliates. Effective July 23, 2010, we terminated our unsecured credit agreement with Vivendi, the lender, which provided for a revolving credit facility of up to $475 million.  None of these services, transactions and agreements with Vivendi and its subsidiaries and affiliates is material either individually or in the aggregate to the condensed consolidated financial statements as a whole.

 

14.  Recently issued accounting pronouncements

 

In October 2009, the FASB issued an update to Revenue Recognition—Multiple-Deliverable Revenue Arrangements . This update establishes the accounting and reporting guidance for arrangements including multiple revenue-generating activities. This update provides amendments to the criteria for separating deliverables, measuring and allocating arrangement consideration to one or more units of accounting. The amendments in this update also establish a selling price hierarchy for determining the selling price of a deliverable. Significantly enhanced disclosures are also required to provide information about a vendor’s multiple-deliverable revenue arrangements, including information about the nature and terms, significant deliverables, and its performance within arrangements. The amendments also require providing information about the significant judgments made and changes to those judgments and about how the application of the relative selling-price method affects the timing or amount of revenue recognition. The amendments in this update are effective prospectively for revenue arrangements entered into or materially modified in the fiscal years beginning on or after June 15, 2010. Early adoption is permitted. We are currently evaluating the impact, if any, of this new accounting update on our consolidated financial statements.

 

In October 2009, the FASB issued an update to Software—Certain Revenue Arrangements That Include Software Elements . This update changes the accounting model for revenue arrangements that include both tangible products and software elements that are “essential to the functionality,” and excludes these products from the scope of current software revenue guidance. The new guidance will include factors to help companies determine which software elements are considered “essential to the functionality.” The amendments will now subject software-enabled products to other revenue guidance and disclosure requirements, such as guidance surrounding revenue arrangements with multiple- deliverables. The amendments in this update are effective prospectively for revenue arrangements entered into or materially modified in the fiscal years beginning on or after June 15, 2010 although early adoption is permitted. We are currently evaluating the impact, if any, of this new accounting update on our consolidated financial statements.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Business Overview

 

Activision Blizzard, Inc. is a worldwide online, personal computer (“PC”), console, and handheld game publisher. The terms “Activision Blizzard,” the “Company,” “we,” “us,” and “our” are used to refer collectively to Activision Blizzard, Inc. and its subsidiaries.