Activision Blizzard, Inc.
Activision Blizzard, Inc. (Form: 10-Q, Received: 11/05/2010 16:51:37)

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 September 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 October 29, 2010 was 1,206,030,404.

 

 

 



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

 

Table of Contents

 

 

Cautionary Statement

3

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

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

4

 

 

 

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and September 30, 2009

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and September 30, 2009

6

 

 

 

 

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

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements

8

 

 

 

Item 2.

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

22

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

36

 

 

 

Item 4.

Controls and Procedures

37

 

 

 

PART II.

OTHER INFORMATION

37

 

 

 

Item 1.

Legal Proceedings

37

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

38

 

 

 

Item 6.

Exhibits

38

 

 

 

SIGNATURE

39

 

 

EXHIBIT INDEX

40

 

 

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, Activision Blizzard’s ability to predict consumer preferences among competing hardware platforms, possible 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. Although these forward-looking statements are believed to be true when made, they 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 September 30,

 

At December 31,

 

 

 

2010

 

2009

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

2,123

 

$

2,768

 

Short-term investments

 

726

 

477

 

Accounts receivable, net of allowances of $203 million and $317 million at September 30, 2010 and December 31, 2009, respectively

 

246

 

739

 

Inventories

 

258

 

241

 

Software development

 

248

 

224

 

Intellectual property licenses

 

26

 

55

 

Deferred income taxes, net

 

419

 

498

 

Other current assets

 

102

 

327

 

Total current assets

 

4,148

 

5,329

 

 

 

 

 

 

 

Long-term investments

 

23

 

23

 

Software development

 

37

 

10

 

Intellectual property licenses

 

36

 

28

 

Property and equipment, net

 

169

 

138

 

Other assets

 

14

 

9

 

Intangible assets, net

 

566

 

618

 

Trademark and trade names

 

433

 

433

 

Goodwill

 

7,144

 

7,154

 

Total assets

 

$

12,570

 

$

13,742

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

238

 

$

302

 

Deferred revenues

 

622

 

1,426

 

Accrued expenses and other liabilities

 

533

 

779

 

Total current liabilities

 

1,393

 

2,507

 

Deferred income taxes, net

 

231

 

270

 

Other liabilities

 

200

 

209

 

Total liabilities

 

1,824

 

2,986

 

 

 

 

 

 

 

Commitments and contingencies (Note 12)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.000001 par value, 2,400,000,000 shares authorized, 1,376,067,589 and 1,364,117,675 shares issued at September 30, 2010 and December 31, 2009, respectively

 

 

 

Additional paid-in capital

 

12,313

 

12,376

 

Less: Treasury stock, at cost, 170,214,263 and 113,686,498 at September 30, 2010 and December 31, 2009, respectively

 

(1,848

)

(1,235

)

Retained earnings (accumulated deficit)

 

290

 

(361

)

Accumulated other comprehensive loss

 

(9

)

(24

)

Total shareholders’ equity

 

10,746

 

10,756

 

Total liabilities and shareholders’ equity

 

$

12,570

 

$

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

 

For the Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

 

 

 

 

 

 

 

 

Product sales

 

$

397

 

$

411

 

$

2,025

 

$

1,848

 

Subscription, licensing, and other revenues

 

348

 

292

 

994

 

874

 

Total net revenues

 

745

 

703

 

3,019

 

2,722

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

Cost of sales — product costs

 

194

 

185

 

765

 

762

 

Cost of sales — software royalties and amortization

 

61

 

54

 

211

 

212

 

Cost of sales — intellectual property licenses

 

33

 

45

 

105

 

163

 

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

 

61

 

55

 

168

 

158

 

Product development

 

119

 

122

 

366

 

362

 

Sales and marketing

 

111

 

128

 

294

 

329

 

General and administrative

 

111

 

106

 

245

 

301

 

Restructuring

 

 

(1

)

 

29

 

Total costs and expenses

 

690

 

694

 

2,154

 

2,316

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

55

 

9

 

865

 

406

 

 

 

 

 

 

 

 

 

 

 

Investment and other income, net

 

14

 

11

 

15

 

21

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense

 

69

 

20

 

880

 

427

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

18

 

5

 

229

 

28

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

51

 

$

15

 

$

651

 

$

399

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.04

 

$

0.01

 

$

0.53

 

$

0.31

 

Diluted

 

$

0.04

 

$

0.01

 

$

0.52

 

$

0.30

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

1,212

 

1,271

 

1,230

 

1,289

 

Diluted

 

1,227

 

1,297

 

1,245

 

1,320

 

 

 

 

 

 

 

 

 

 

 

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 Nine Months Ended

 

 

 

September 30,

 

 

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

651

 

$

399

 

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

 

 

 

 

 

Deferred income taxes

 

51

 

(70

)

Depreciation and amortization

 

97

 

187

 

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

 

(7

)

(3

)

Loss on ARS rights from UBS

 

7

 

3

 

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

 

182

 

192

 

Stock-based compensation expense (2)

 

94

 

109

 

Tax (shortfall) benefit from employee stock option exercises

 

 

(1

)

Excess tax benefits from stock option exercises

 

(11

)

(68

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

471

 

748

 

Inventories

 

(19

)

(89

)

Software development and intellectual property licenses

 

(238

)

(229

)

Other assets

 

218

 

53

 

Deferred revenues

 

(810

)

(452

)

Accounts payable

 

(60

)

(39

)

Accrued expenses and other liabilities

 

(243

)

(370

)

Net cash provided by operating activities

 

383

 

370

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities of investments

 

473

 

9

 

Proceeds from sale of available-for-sale investments

 

 

2

 

Payment of contingent consideration

 

(4

)

 

Purchases of short-term investments

 

(681

)

(228

)

Capital expenditures

 

(76

)

(41

)

(Increase) decrease in restricted cash

 

(35

)

(40

)

Net cash used in investing activities

 

(323

)

(298

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

54

 

63

 

Repurchase of common stock

 

(613

)

(834

)

Dividends paid

 

(187

)

 

Excess tax benefits from stock option exercises

 

11

 

68

 

Net cash used in financing activities

 

(735

)

(703

)

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

30

 

33

 

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(645

)

(598

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

2,768

 

2,958

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

2,123

 

$

2,360

 

 


(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 nine months ended September 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

 

 

 

 

 

 

651

 

 

651

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

15

 

15

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

666

 

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

 

12

 

 

54

 

 

 

 

 

54

 

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

 

 

 

72

 

 

 

 

 

72

 

Dividends ($0.15 per common share)

 

 

 

(189

)

 

 

 

 

(189

)

Shares repurchased

 

 

 

 

(56

)

(613

)

 

 

(613

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2010

 

1,376

 

$

 

$

12,313

 

(170

)

$

(1,848

)

$

290

 

$

(9

)

$

10,746

 

 

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 The NASDAQ Stock Market under the ticker symbol “ATVI.” Vivendi owned approximately 60% of Activision Blizzard’s outstanding common stock at September 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.

 

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 September 30, 2010

 

At December 31, 2009

 

Finished goods

 

$

212

 

$

201

 

Purchased parts and components

 

46

 

40

 

 

 

 

 

 

 

 

 

$

258

 

$

241

 

 

3.      Intangible assets, net

 

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

 

 

 

At September 30, 2010

 

 

 

Estimated

 

Gross

 

 

 

 

 

 

 

useful

 

carrying

 

Accumulated

 

Net carrying

 

 

 

lives

 

amount

 

amortization

 

amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

173

 

$

(75

)

$

98

 

Game engines

 

2 - 5 years

 

61

 

(44

)

17

 

Internally developed franchises

 

11 - 12 years

 

574

 

(129

)

445

 

Favorable leases

 

1 - 4 years

 

5

 

(4

)

1

 

Distribution agreements

 

4 years

 

18

 

(13

)

5

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

386

 

 

386

 

Acquired trade names

 

Indefinite

 

47

 

 

47

 

Total

 

 

 

$

1,264

 

$

(265

)

$

999

 

 

 

 

At December 31, 2009

 

 

 

Estimated

 

Gross

 

 

 

 

 

 

 

useful

 

carrying

 

Accumulated

 

Net carrying

 

 

 

lives

 

amount

 

amortization

 

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 $21 million and $50 million for the three and nine months ended September 30, 2010, respectively.  Amortization expense of intangible assets was $39 million and $129 million for the three and nine months ended September 30, 2009, respectively.

 

The gross carrying amount as of September 30, 2010 and December 31, 2009 in the tables above reflect a new cost basis for

 

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

 

2010 (remaining three months)

 

$

74

 

2011

 

113

 

2012

 

94

 

2013

 

67

 

2014

 

50

 

Thereafter

 

168

 

 

 

 

 

Total

 

$

566

 

 

4.      Income taxes

 

The income tax expense of $18 million for the three months ended September 30, 2010 reflects an effective tax rate of 26%. The effective tax rate of 26% for the three months ended September 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 September 30, 2010 since, as of September 30, 2010, the federal research credit had not yet been approved for use in 2010.

 

For the nine months ended September 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 $229 million for the nine months ended September 30, 2010 reflects an effective tax rate of 26% which differs from the effective tax rate of 7% for the nine months ended September 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

 

At

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Internally developed software costs

 

$

182

 

$

182

 

Payments made to third-party software developers

 

103

 

52

 

Total software development costs

 

$

285

 

$

234

 

 

 

 

 

 

 

Intellectual property licenses

 

$

62

 

$

83

 

 

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

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Amortization of capitalized software development costs and intellectual property licenses

 

$

50

 

$

41

 

$

217

 

$

210

 

Write-offs and impairments

 

1

 

2

 

16

 

2

 

 

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6.      Comprehensive income and accumulated other comprehensive loss

 

Comprehensive Income

 

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

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

51

 

$

15

 

$

651

 

$

399

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

48

 

9

 

15

 

38

 

Other comprehensive income

 

48

 

9

 

15

 

38

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

99

 

$

24

 

$

666

 

$

437

 

 

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

 

 

 

At

 

At

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Foreign currency translation adjustment

 

$

(7

)

$

(22

)

Unrealized depreciation on investments, net of deferred income taxes of $(1) and $(2) for September 30, 2010 and December 31, 2009

 

(2

)

(2

)

Accumulated other comprehensive loss

 

$

(9

)

$

(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):

 

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Fair Value Measurements at

 

 

 

 

 

 

 

September 30, 2010 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

 

 

 

 

 

 

 

 

 

 

Markets for

 

Significant

 

 

 

 

 

 

 

 

 

Identical

 

Other

 

Significant

 

 

 

 

 

As of

 

Financial

 

Observable

 

Unobservable

 

 

 

 

 

September 30,

 

Instruments

 

Inputs

 

Inputs

 

Balance Sheet

 

 

 

2010

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

1,826

 

$

1,826

 

$

 

$

 

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

 

658

 

658

 

 

 

Short-term investments

 

ARS held through Morgan Stanley Smith Barney LLC

 

23

 

 

 

23

 

Long-term investments

 

Foreign exchange contract derivatives

 

3

 

 

3

 

 

Other assets—current

 

Total financial assets at fair value

 

$

2,711

 

$

2,684

 

$

4

 

$

23

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Other financial liability

 

$

(10

)

$

 

$

 

$

(10

)

Other liabilities—current

 

Total financial liabilities at fair value

 

$

(10

)

$

 

$

 

$

(10

)

 

 

 

 

 

 

 

Fair Value Measurements at

 

 

 

 

 

 

 

December 31, 2009 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

 

 

 

 

 

 

 

 

 

 

Markets for

 

Significant

 

 

 

 

 

 

 

 

 

Identical

 

Other

 

Significant

 

 

 

 

 

As of

 

Financial

 

Observable

 

Unobservable

 

 

 

 

 

December 31,

 

Instruments

 

Inputs

 

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)            Auction Rate Securities (“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 of the closing prices on each of the five business days immediately preceding issuance of the shares. When

 

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estimating the fair value, we considered our projection of revenues from the related titles under the earn-out provisions.  For the nine months ended September 30, 2010, there was a $13 million decrease in our fair value estimate of this financial liability, which was recorded in investment and other income, net.

 

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 September 30, 2010:

 

 

 

Level 3

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

financial

 

 

 

 

 

 

 

ARS rights

 

assets at

 

 

 

 

 

ARS

 

from UBS

 

fair

 

Other financial

 

 

 

(a)

 

(b)

 

value

 

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

)

 

13

 

Purchases or acquired sales, issuances and settlements

 

(61

)

 

(61

)

 

Balance at September 30, 2010

 

$

23

 

$

 

$

23

 

$

(10

)

 

 

 

 

 

 

 

 

 

 

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 September 30, 2010

 

$

 

$

 

$

 

$

13

 

 

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 September 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

 

(3

)

(1

)

8

 

Purchases or acquired sales, issuances and settlements

 

(4

)

 

(4

)

 

Balance at September 30, 2009

 

$

76

 

$

7

 

$

83

 

$

(23

)

 

 

 

 

 

 

 

 

 

 

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 September 30, 2009

 

$

2

 

$

(3

)

$

(1

)

$

8

 

 


(a)            Fair value measurements have been estimated using an income-approach model (specifically, 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 the 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 at September 30, 2010.

 

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.

 

(b)            ARS rights from UBS represented 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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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 nine-month period ended September 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

 

 

 

 

 

 

 

December 31, 2009 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

 

 

 

 

 

 

 

 

 

 

Markets for

 

Significant

 

 

 

 

 

 

 

 

 

Identical

 

Other

 

Significant

 

 

 

 

 

As of

 

Financial

 

Observable

 

Unobservable

 

 

 

 

 

December 31,

 

Instruments

 

Inputs

 

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 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 2009, 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, we 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, who is 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

 

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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 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 from 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 such as realm transfers, faction changes, and other character customizations within the World of Warcraft game play); 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 and StarCraft II .

 

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 change in deferred net revenues and related cost of sales with respect to certain of our online-enabled games, stock-based compensation expense, restructuring expense, amortization of intangible assets and purchase price accounting related adjustments, integration and transaction costs, and other. 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 nine months ended September 30, 2010 and 2009 are presented below (amounts in millions):

 

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Three Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

Income (loss) from

 

 

 

Net Revenues

 

operations

 

Activision

 

$

314

 

$

415

 

$

(43

)

$

(43

)

Blizzard

 

481

 

286

 

246

 

116

 

Distribution

 

62

 

54

 

1

 

2

 

Operating segments total

 

857

 

755

 

204

 

75

 

 

 

 

 

 

 

 

 

 

 

Reconciliation to consolidated net revenues / operating income:

 

 

 

 

 

 

 

 

 

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

 

(112

)

(52

)

(97

)

9

 

Stock-based compensation expense

 

 

 

(34

)

(36

)

Restructuring

 

 

 

 

1

 

Amortization of intangible assets and purchase price accounting related adjustments

 

 

 

(18

)

(33

)

Integration and transaction costs

 

 

 

 

(7

)

Consolidated net revenues / operating income

 

$

745

 

$

703

 

$

55

 

$

9

 

 

 

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

Income (loss) from

 

 

 

Net Revenues

 

operations

 

Activision

 

$

983

 

$

1,211

 

$

(88

)

$

(49

)

Blizzard

 

1,086

 

867

 

559

 

393

 

Distribution

 

185

 

202

 

(1

)

6

 

Operating segments total

 

2,254

 

2,280

 

470

 

350

 

 

 

 

 

 

 

 

 

 

 

Reconciliation to consolidated net revenues / operating income:

 

 

 

 

 

 

 

 

 

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

 

765

 

441

 

539

 

341

 

Stock-based compensation expense

 

 

 

(94

)

(107

)

Restructuring

 

 

 

(3

)

(29

)

Amortization of intangible assets and purchase price accounting related adjustments

 

 

 

(47

)

(117

)

Integration and transaction costs

 

 

 

 

(24

)

Other*

 

 

1

 

 

(8

)

Consolidated net revenues / operating income

 

$

3,019

 

$

2,722

 

$

865

 

$

406

 

 

Geographic information for the three and nine months ended September 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):

 

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Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net revenues by geographic region:

 

 

 

 

 

 

 

 

 

North America

 

$

406

 

$

378

 

$

1,675

 

$

1,458

 

Europe

 

281

 

287

 

1,142

 

1,088

 

Asia Pacific

 

58

 

38

 

202

 

175

 

Total geographic region net revenues

 

745

 

703

 

3,019

 

2,721

 

Other*

 

 

 

 

1

 

Total consolidated net revenues

 

$

745

 

$

703

 

$

3,019

 

$

2,722

 

 

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

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net revenues by platform:

 

 

 

 

 

 

 

 

 

MMORPG

 

$

289

 

$

306

 

$

890

 

$

952

 

Console

 

298

 

286

 

1,642

 

1,334

 

Hand-held

 

23

 

30

 

101

 

127

 

PC and other

 

73

 

27

 

201

 

106

 

Total platform net revenues

 

683

 

649

 

2,834

 

2,519

 

Distribution

 

62

 

54

 

185

 

202

 

Other*

 

 

 

 

1

 

Total consolidated net revenues

 

$

745

 

$

703

 

$

3,019

 

$

2,722

 

 


*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 net revenues for either of the three or nine months ended September 30, 2010 or 2009.

 

9.      Goodwill

 

The changes in the carrying amount of goodwill by operating segment for the nine months ended September 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

 

(10

)

 

 

(10

)

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2010

 

$

6,954

 

$

178

 

$

12

 

$

7,144

 

 

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.

 

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Table of Contents

 

10.   Computation of basic/diluted earnings per common share

 

The following table sets forth the computation of basic and diluted earni