Activision Blizzard, Inc.
Activision Blizzard, Inc. (Form: 10-Q, Received: 05/09/2011 16:27:15)

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 March 31, 2011

 

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 May 2, 2011 was 1,144,164,508.

 

 

 



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 March 31, 2011 and December 31, 2010

 

4

 

 

 

 

 

Condensed Consolidated Statements of Operations for the three months ended March 31, 2011 and March 31, 2010

 

5

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and March 31, 2010

 

6

 

 

 

 

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity for the three months ended March 31, 2011

 

7

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

8

 

 

 

 

Item 2.

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

 

24

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

38

 

 

 

 

Item 4.

Controls and Procedures

 

38

 

 

 

 

PART II.

OTHER INFORMATION

 

39

 

 

 

 

Item 1.

Legal Proceedings

 

39

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

40

 

 

 

 

Item 6.

Exhibits

 

40

 

 

 

 

SIGNATURE

 

41

 

 

 

EXHIBIT INDEX

 

42

 

 

 

CERTIFICATIONS

 

 

 

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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 “outlook,” “forecast,” “will,” “could,” “should,” “would,” “to be,” “plans,” “believes,” “may,” “expects,” “intends,” “anticipates,” “estimate,” “future,” “positioned,” “potential,” “project,” “remain,” “scheduled,” “set to,” “subject to,” “upcoming” 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, increasing concentration of titles, shifts in consumer spending trends, the impact of the current macroeconomic environment and market conditions within the video game industry, Activision Blizzard’s ability to predict consumer preferences, including interest in specific genres such as first-person action and massively multiplayer online games and preferences among competing hardware platforms, the seasonal and cyclical nature of the interactive game market, changing business models including digital and used games, competition including from used games and other forms of entertainment, possible declines in software pricing, product returns and price protection, product delays, adoption rate and availability of new hardware (including peripherals) and related software, rapid changes in technology and industry standards, litigation risks and associated costs, the effectiveness of Activision Blizzard’s restructuring efforts, 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 Part II, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010. 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 March 31,

 

At December 31,

 

 

 

2011

 

2010

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

2,658

 

$

2,812

 

Short-term investments

 

701

 

696

 

Accounts receivable, net of allowances of $276 million and $377 million at March 31, 2011 and December 31, 2010, respectively

 

95

 

640

 

Inventories

 

103

 

112

 

Software development

 

129

 

147

 

Intellectual property licenses

 

32

 

45

 

Deferred income taxes, net

 

464

 

620

 

Other current assets

 

167

 

293

 

Total current assets

 

4,349

 

5,365

 

 

 

 

 

 

 

Long-term investments

 

25

 

23

 

Software development

 

65

 

55

 

Intellectual property licenses

 

29

 

28

 

Property and equipment, net

 

165

 

169

 

Other assets

 

25

 

21

 

Intangible assets, net

 

152

 

160

 

Trademark and trade names

 

433

 

433

 

Goodwill

 

7,134

 

7,132

 

Total assets

 

$

12,377

 

$

13,386

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

172

 

$

363

 

Deferred revenues

 

1,043

 

1,726

 

Accrued expenses and other liabilities

 

676

 

838

 

Total current liabilities

 

1,891

 

2,927

 

Deferred income taxes, net

 

83

 

92

 

Other liabilities

 

166

 

164

 

Total liabilities

 

2,140

 

3,183

 

 

 

 

 

 

 

Commitments and contingencies (Note 14)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.000001 par value, 2,400,000,000 shares authorized, 1,383,620,047 and 1,382,479,839 shares issued at March 31, 2011 and December 31, 2010, respectively

 

 

 

Additional paid-in capital

 

12,382

 

12,353

 

Less: Treasury stock, at cost, 230,246,372 and 199,159,987 at March 31, 2011 and December 31, 2010, respectively

 

(2,537

)

(2,194

)

Retained earnings

 

366

 

57

 

Accumulated other comprehensive income (loss)

 

26

 

(13

)

Total shareholders’ equity

 

10,237

 

10,203

 

Total liabilities and shareholders’ equity

 

$

12,377

 

$

13,386

 

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Amounts in millions, except per share data)

 

 

 

For the Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Net revenues

 

 

 

 

 

Product sales

 

$

1,061

 

$

986

 

Subscription, licensing, and other revenues

 

388

 

322

 

Total net revenues

 

1,449

 

1,308

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

Cost of sales — product costs

 

299

 

337

 

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

 

63

 

54

 

Cost of sales — software royalties and amortization

 

61

 

99

 

Cost of sales — intellectual property licenses

 

29

 

43

 

Product development

 

142

 

143

 

Sales and marketing

 

64

 

56

 

General and administrative

 

98

 

65

 

Restructuring

 

19

 

 

Total costs and expenses

 

775

 

797

 

 

 

 

 

 

 

Operating income

 

674

 

511

 

 

 

 

 

 

 

Investment and other income, net

 

2

 

 

 

 

 

 

 

 

Income before income tax expense

 

676

 

511

 

 

 

 

 

 

 

Income tax expense

 

173

 

130

 

 

 

 

 

 

 

Net income

 

$

503

 

$

381

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

Basic

 

$

0.42

 

$

0.30

 

Diluted

 

$

0.42

 

$

0.30

 

 

 

 

 

 

 

Weighted-average shares outstanding

 

 

 

 

 

Basic

 

1,173

 

1,248

 

Diluted

 

1,182

 

1,264

 

 

 

 

 

 

 

Dividends per common share

 

$

0.165

 

$

0.15

 

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Amounts in millions)

 

 

 

For the Three Months Ended

 

 

March 31,

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

503

 

$

381

 

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

 

 

 

 

 

Deferred income taxes

 

150

 

90

 

Depreciation and amortization

 

26

 

33

 

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

 

69

 

88

 

Stock-based compensation expense (2)

 

23

 

44

 

Excess tax benefits from stock option exercises

 

(1

)

(4

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

554

 

593

 

Inventories

 

11

 

40

 

Software development and intellectual property licenses

 

(45

)

(80

)

Other assets

 

129

 

162

 

Deferred revenues

 

(716

)

(637

)

Accounts payable

 

(199

)

(146

)

Accrued expenses and other liabilities

 

(370

)

(337

)

Net cash provided by operating activities

 

134

 

227

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities of investments

 

154

 

17

 

Payment of contingent consideration

 

(3

)

(2

)

Purchases of short-term investments

 

(161

)

(187

)

Capital expenditures

 

(4

)

(12

)

Net cash used in investing activities

 

(14

)

(184

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

5

 

16

 

Repurchase of common stock

 

(343

)

(107

)

Excess tax benefits from stock option exercises

 

1

 

4

 

Net cash used in financing activities

 

(337

)

(87

)

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

63

 

(29

)

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(154

)

(73

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

2,812

 

2,768

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

2,658

 

$

2,695

 

 


(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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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Three Months Ended March 31, 2011

(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)

 

Income (Loss)

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2010

 

1,382

 

$

 

$

12,353

 

(199

)

$

(2,194

)

$

57

 

$

(13

)

$

10,203

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

503

 

 

503

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

39

 

39

 

Total comprehensive income

 

 

 

 

 

 

 

 

542

 

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

 

1

 

 

5

 

 

 

 

 

5

 

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

 

 

 

24

 

 

 

 

 

24

 

Dividends ($0.165 per common share) (See Note 13)

 

 

 

 

 

 

(194

)

 

(194

)

Shares repurchased (See Note 13)

 

 

 

 

(31

)

(343

)

 

 

(343

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2011

 

1,383

 

$

 

$

12,382

 

(230

)

$

(2,537

)

$

366

 

$

26

 

$

10,237

 

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.               Description of Business and Basis of Consolidation and Presentation

 

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.

 

The common stock of Activision Blizzard is traded on The NASDAQ Stock Market under the ticker symbol “ATVI.” Vivendi S.A. (“Vivendi”) owned approximately 62% of Activision Blizzard’s outstanding common stock at March 31, 2011.

 

We maintain significant operations in the United States, Canada, the United Kingdom, Germany, France, Italy, Spain, Australia, Sweden, South Korea, Norway, Denmark, 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, 2010. 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.

 

2.               Summary of significant accounting policies

 

Revenue Recognition

 

Revenue Arrangements with Multiple Deliverables

 

On January 1, 2011, we adopted amendments to an accounting standard related to revenue recognition for arrangements with multiple deliverables (which standard as amended is referred to herein as the “new accounting principles”).  The new accounting principles establish a selling price hierarchy for determining the selling price of a deliverable and require the application of the relative selling price method to allocate the arrangement consideration to each deliverable in a multiple deliverables revenue arrangement. Certain of our revenue arrangements have multiple deliverables and, as such, are accounted for under the new accounting principles. These revenue arrangements include our product sales consisting of both software and hardware deliverables (such as peripherals or other ancillary collectors’ items sold together with the physical “boxed” software) and our sales of the World of Warcraft boxed products, expansion packs and value-added services, each of which is considered with the related subscription services.  Our assessment of deliverables and units of accounting does not change under the new accounting

 

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principles.  When determining the selling prices of our significant deliverables to enable us to allocate the revenues from the sale of our product using the relative selling price method, we use a variation of vendor-specific objective evidence (“VSOE”) of fair value and third-party evidence (“TPE”) of selling price.  When neither VSOE nor TPE is available for a deliverable, we use our best estimate of the selling price (“BESP”). We do not have significant revenue arrangements that require our BESP for the quarter ended March 31, 2011.  The inputs we use to determine the selling price of our significant deliverables include the actual price charged by the Company for a deliverable that the Company sells separately, which represents the VSOE, and the wholesale prices of the same or similar products, which represents TPE. The pattern and timing of revenue recognition for our deliverables and allocation of the arrangement consideration did not change upon the adoption of the new accounting principles. Also, we do not expect the adoption of the new accounting principles to have a material effect on our financial statements in the periods after our initial adoption.

 

Product Sales

 

We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers and once any performance obligations have been completed. Certain products are sold to customers with a street date ( i.e.,  the earliest date these products may be sold by retailers). For these products we recognize revenue on the later of the street date or the sale date. Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection.

 

For our software products with online functionality, we evaluate whether those features or functionality are more than an inconsequential separate deliverable in addition to the software product. This evaluation is performed for each software product and any online transaction, such as a digital download of a title or product add-ons, when it is released.

 

When we determine that a software title contains online functionality that constitutes a more-than-inconsequential separate service deliverable in addition to the product, principally because of its importance to gameplay, we consider that our performance obligations for this title extend beyond the sale of the game. Vendor-specific objective evidence (“VSOE”) of fair value does not exist for the online functionality, as we do not separately charge for this component of the title. As a result, we recognize all of the software-related revenue from the sale of the title ratably over the estimated service period, which is estimated to begin the month after either the sale date or the street date of the title, whichever is later. In addition, we initially defer the costs of sales for the title (excluding intangible asset amortization), and recognize the costs of sales as the related revenues are recognized. Cost of sales includes manufacturing costs, software royalties and amortization, and intellectual property licenses.

 

We recognize revenues from World of Warcraft boxed product, expansion packs and value-added services, in each case with the related subscription service revenue, ratably over the estimated service periods beginning upon activation of the software and delivery of the services. Revenues attributed to the sale of World of Warcraft boxed software and related expansion packs are classified as product sales and revenues attributable to subscriptions and other value-added services are classified as subscription, licensing and other revenues.

 

Revenues for software products with more than inconsequential separate service deliverables and World of Warcraft products are recognized over the estimated service periods, which range from a minimum of five months to a maximum of less than a year.

 

For our software products with features we consider to be incidental to the overall product offering and an inconsequential deliverable, such as products which provide limited online features at no additional cost to the consumer, we recognize the related revenue from them upon the transfer of title and risk of loss of the product to our customer.

 

With respect to online transactions, such as online downloads of titles or product add-ons that do not include a more-than-inconsequential separate service deliverable, revenue is recognized when the fee is paid by the online customer to purchase online content, the product is available for download and is activated for gameplay. In addition, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable.

 

Sales incentives and other consideration given by us to our customers, such as rebates and product replacement fees, are considered adjustments of the selling price of our products and are reflected as reductions to revenue. Sales incentives and other consideration that represent costs incurred by us for assets or services received, such as the appearance of our products in a

 

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customer’s national circular ad, are reflected as sales and marketing expenses when the benefit from the sales incentive is separable from sales to the same customer and we can reasonably estimate the fair value of the benefit.

 

Subscription Revenues

 

Subscription revenues are derived from World of Warcraft , a game that is playable through Blizzard’s servers on a subscription-only basis. After the first month of free usage that is included with the World of Warcraft boxed software, the World of Warcraft end user may enter into a subscription agreement for additional future access. Revenues associated with the sale of subscriptions via boxed software and prepaid subscription cards, as well as prepaid subscriptions sales, are deferred until the subscription service is activated by the consumer and recognized ratably over the subscription period. Revenue from internet gaming rooms in Asia is recognized upon usage of the time packages sold. Value-added service revenues associated with subscriptions are recognized ratably over the estimated service periods.

 

Licensing Revenues

 

Third-party licensees in Russia, China and Taiwan distribute and host Blizzard’s World of Warcraft game in their respective countries under license agreements with Blizzard. We receive royalties from the licensees as a result. We recognize these royalties as revenues based on the end users’ activation of the underlying prepaid time, if all other performance obligations have been completed or based on usage by the end user when we have continuing service obligations. We recognize any upfront licensing fee received over the term of the contracts.

 

With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is generally recognized upon delivery of a master copy. Per copy royalties on sales that exceed the guarantee are recognized as earned. In addition, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable.

 

Breakage Revenues

 

World of Warcraft boxed product sales and subscription revenues are recognized upon activation of the game. We analyze historical activation patterns over time to determine when the likelihood of activation ever occurring becomes remote. We recognize revenues from subscriptions that have not yet been activated, prepaid subscription cards, as well as prepaid subscription sales, when the likelihood of future activation occurring is remote (defined as “breakage revenues”).

 

Other Revenues

 

Other revenues primarily include licensing activity of intellectual property other than software to third-parties. Revenue is recorded upon receipt of licensee statements, or upon the receipt of cash, provided the license period has begun.

 

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3.               Inventories

 

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

 

 

 

At March 31, 2011

 

At December 31, 2010

 

Finished goods

 

$

80

 

$

82

 

Purchased parts and components

 

23

 

30

 

 

 

 

 

 

 

Inventories

 

$

103

 

$

112

 

 

4.               Intangible assets, net

 

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

 

 

 

At March 31, 2011

 

 

 

Estimated

 

Gross

 

 

 

 

 

 

 

useful

 

carrying

 

Accumulated

 

Net carrying

 

 

 

lives

 

amount

 

amortization

 

amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

88

 

$

(75

)

$

13

 

Game engines

 

2 - 5 years

 

32

 

(31

)

1

 

Internally-developed franchises

 

11 - 12 years

 

309

 

(173

)

136

 

Distribution agreements

 

4 years

 

18

 

(16

)

2

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

386

 

 

386

 

Acquired trade names

 

Indefinite

 

47

 

 

47

 

Total

 

 

 

$

880

 

$

(295

)

$

585

 

 

 

 

At December 31, 2010

 

 

 

Estimated

 

Gross

 

 

 

 

 

 

 

useful

 

carrying

 

Accumulated

 

Net carrying

 

 

 

lives

 

amount

 

amortization

 

amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

88

 

$

(74

)

$

14

 

Game engines

 

2 - 5 years

 

32

 

(30

)

2

 

Internally-developed franchises

 

11 - 12 years

 

309

 

(167

)

142

 

Distribution agreements

 

4 years

 

18

 

(16

)

2

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

386

 

 

386

 

Acquired trade names

 

Indefinite

 

47

 

 

47

 

Total

 

 

 

$

880

 

$

(287

)

$

593

 

 

Amortization expense of intangible assets was $8 million and $18 million for the three months ended March 31, 2011 and 2010, respectively.

 

The gross carrying amounts as of March 31, 2011 and December 31, 2010 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, 2010.  The new cost basis includes the original gross carrying amount, less accumulated amortization and impairment charges of the impaired assets as of December 31, 2010.

 

At March 31, 2011, future amortization of definite-lived intangible assets is estimated as follows (amounts in millions):

 

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2011 (remaining nine months)

 

$

61

 

2012

 

37

 

2013

 

18

 

2014

 

10

 

2015

 

8

 

Thereafter

 

18

 

 

 

 

 

Total

 

$

152

 

 

5.               Income taxes

 

The income tax expense of $173 million for the three months ended March 31, 2011 reflected an effective tax rate of 26%. The effective tax rate of 26% for the three months ended March 31, 2011 differed from the statutory rate of 35% primarily due to foreign income taxes provided at lower rates, geographic mix in profitability, recognition of federal and California research and development credits and IRC 199 domestic production deductions.

 

For the three months ended March 31, 2011, the tax rate was based on our projected annual effective tax rate for 2011, and also included certain discrete tax items recorded during the period. Our tax expense of $173 million for the three months ended March 31, 2011 reflected an effective tax rate of 26% which differed from the effective tax rate of 25% for the three months ended March 31, 2010, primarily due to a minor increase in the amount of domestic earnings with a higher statutory rate, relative to earnings in foreign jurisdictions with a lower statutory rate, which resulted in a slightly higher overall effective tax rate over the prior period.

 

The overall effective income tax rate for the year could be different from the effective tax rate for the three months ended March 31, 2011 and will be dependent on our profitability for the remainder of the year. In addition, our effective income tax rates for the remainder of 2011 and future periods will depend on a variety of factors, such as changes in the mix of income by tax jurisdiction, applicable accounting rules, applicable tax laws and regulations, rulings and interpretations thereof, developments in tax audit and other matters, and variations in the estimated and actual level of annual pre-tax income or loss.  Further, the effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected by the extent that income (loss) before income tax expenses (benefit) are lower than anticipated in foreign regions where we have lower statutory rates and/or higher than anticipated in our domestic region where we have higher statutory rates.

 

6.               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

 

 

 

March 31,

 

December 31,

 

 

 

2011

 

2010

 

Internally developed software costs

 

$

133

 

$

142

 

Payments made to third-party software developers

 

61

 

60

 

Total software development costs

 

$

194

 

$

202

 

 

 

 

 

 

 

Intellectual property licenses

 

$

61

 

$

73

 

 

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

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Amortization of capitalized software development costs and intellectual property licenses

 

$

73

 

$

101

 

Write-offs and impairments

 

 

15

 

 

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7.               Comprehensive income and accumulated other comprehensive income (loss)

 

Comprehensive Income

 

The components of comprehensive income for the three months ended March 31, 2011 and 2010 were as follows (amounts in millions):

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Net income

 

$

503

 

$

381

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

Foreign currency translation adjustment

 

39

 

(20

)

Other comprehensive income (loss)

 

39

 

(20

)

 

 

 

 

 

 

Comprehensive income

 

$

542

 

$

361

 

 

The components of accumulated other comprehensive income (loss) at March 31, 2011 and December 31, 2010 were as follows (amounts in millions):

 

 

 

At

 

At

 

 

 

March 31,

 

December 31,

 

 

 

2011

 

2010

 

Foreign currency translation adjustment

 

$

28

 

$

(11

)

Unrealized depreciation on investments, net of deferred income taxes of $(1) for both March 31, 2011 and December 31, 2010

 

(2

)

(2

)

Accumulated other comprehensive income (loss)

 

$

26

 

$

(13

)

 

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

 

8.                  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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Table of Contents

 

 

 

 

 

Fair Value Measurements at

 

 

 

 

 

 

 

March 31, 2011 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

 

 

 

 

 

 

 

 

 

 

Markets for

 

Significant

 

 

 

 

 

 

 

 

 

Identical

 

Other

 

Significant

 

 

 

 

 

As of

 

Financial

 

Observable

 

Unobservable

 

 

 

 

 

March 31,

 

Instruments

 

Inputs

 

Inputs

 

Balance Sheet

 

 

 

2011

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

2,359

 

$

2,359

 

$

 

$

 

Cash and cash equivalents

 

U.S. treasuries and foreign government bonds with original maturities of three months or less

 

200

 

200

 

 

 

Cash and cash equivalents

 

U.S. treasuries and government agency securities

 

678

 

678

 

 

 

Short-term investments

 

ARS held through Morgan Stanley Smith Barney LLC

 

25

 

 

 

25

 

Long-term investments

 

Total financial assets at fair value

 

$

3,262

 

$

3,237

 

$

 

$

25

 

 

 

 

 

 

 

 

Fair Value Measurements at

 

 

 

 

 

 

 

December 31, 2010 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

 

 

 

 

 

 

 

 

 

 

Markets for

 

Significant

 

 

 

 

 

 

 

 

 

Identical

 

Other

 

Significant

 

 

 

 

 

As of

 

Financial

 

Observable

 

Unobservable

 

 

 

 

 

December 31,

 

Instruments

 

Inputs

 

Inputs

 

Balance Sheet

 

 

 

2010

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

2,216

 

$

2,216

 

$

 

$

 

Cash and cash equivalents

 

U.S. treasuries and foreign government bonds with original maturities of three months or less

 

332

 

332

 

 

 

Cash and cash equivalents

 

U.S. treasuries and government agency securities

 

672

 

672

 

 

 

Short-term investments

 

ARS held through Morgan Stanley Smith Barney LLC

 

23

 

 

 

23

 

Long-term investments

 

Foreign exchange contract derivatives

 

1

 

 

1

 

 

Other assets—current

 

Total financial assets at fair value

 

$

3,244

 

$

3,220

 

$

1

 

$

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 March 31, 2011:

 

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Level 3

 

 

 

 

 

Total

 

 

 

 

 

financial

 

 

 

 

 

assets at

 

 

 

ARS

 

fair

 

 

 

(a)

 

value

 

Balance at January 1, 2011

 

$

23

 

$

23

 

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

 

2

 

2

 

Balance at March 31, 2011

 

$

25

 

$

25

 

 

 

 

 

 

 

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 March 31, 2011

 

$

2

 

$

2

 

 

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 March 31, 2010:

 

 

 

Level 3

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

financial

 

 

 

 

 

 

 

ARS rights

 

assets at

 

 

 

 

 

ARS

 

from UBS

 

fair

 

Other financial

 

 

 

(a)

 

(b)

 

value

 

liabilities

 

Balance at January 1, 2010

 

$

78

 

$

10

 

$

88

 

$

(31

)

Total gains or (losses) (realized/unrealized)

 

 

 

 

 

 

 

 

 

Included in earnings

 

2

 

(3

)

(1

)

 

Included in other comprehensive loss

 

(1

)

 

(1

)

 

Balance at March 31, 2010

 

$

79

 

$

7

 

$

86

 

$

(31

)

 

 

 

 

 

 

 

 

 

 

The amount of total gains or (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at March 31, 2010

 

$

2

 

$

(3

)

$

(1

)

$

 

 


(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 March 31, 2011.

 

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 consolidated statement of operations for the year ended December 31, 2010.

 

(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

 

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$7 million included within investment and other income in our consolidated statement of operations for the year ended December 31, 2010.

 

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.

 

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 three-month period ended March 31, 2011, 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, 2010 (amounts in millions):

 

 

 

 

 

Fair Value Measurements at

 

 

 

 

 

 

 

December 31, 2010 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

 

 

 

 

 

 

 

 

 

 

Markets for

 

Significant

 

 

 

 

 

 

 

 

 

Identical

 

Other

 

Significant

 

 

 

 

 

As of

 

Financial

 

Observable

 

Unobservable

 

 

 

 

 

December 31,

 

Instruments

 

Inputs

 

Inputs

 

 

 

 

 

2010

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total Losses

 

Non-financial assets:

 

 

 

 

 

 

 

 

 

 

 

Intangible assets, net

 

$

 

$

 

$

 

$

 

$

326

 

Total non-financial assets at fair value

 

$

 

$

 

$

 

$

 

$

326

 

 

In the fourth quarter of 2010, with the franchise and industry results of the holiday season, our outlook for the retail sales of software was significantly revised. With the continued economic downturn within our industry in 2010 and the change in the buying habits of casual consumers, we reassessed our overall expectations. We considered these economic changes while planning for 2011 during the fourth quarter of 2010, resulting in a strategy change to, among other things, focus on fewer title releases in the casual genre and discontinue the development of music titles. As we considered this change in strategy to be an indicator of a potential impairment of our intangible assets, we updated our future projected revenue streams for certain franchises in the casual games and music genres. We performed recoverability tests and, where applicable, measured the impairment of the related intangible assets in accordance with ASC Subtopic 360-10.

 

Determining whether an 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 these cash flows will occur, the amount of these cash flows and the asset’s residual value, if any. For intangible assets that do not pass the recoverability test, the measurement of an impairment loss requires a determination of fair value, which is based on the best information available. Based on the characteristics of the assets being valued and the availability of information, the Company

 

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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 $67 million, $9 million and $250 million to license agreements, game engines and internally-developed franchises intangible assets, respectively, for the year ended December 31, 2010 within our Activision segment.

 

9.  Restructuring

 

On February 3, 2011, the Board of Directors of the Company approved a restructuring plan (the “2011 Restructuring”) involving a focus on the development and publication of a reduced slate of titles on a going-forward basis, including the discontinuation of the development of music-based games, the closure of the related business unit and the cancellation of other titles then in production, along with a related reduction in studio headcount and corporate overhead.

 

The following table details the amount of the 2011 Restructuring reserves included in accrued expenses and other liabilities in the consolidated balance sheet at March 31, 2011 (amounts in millions):

 

 

 

 

 

Facilities

 

 

 

 

 

Severance

 

costs

 

Total

 

Balance at December 31, 2010

 

$

 

$

 

$

 

Costs charged to expense

 

14

 

5

 

19

 

Costs paid or otherwise settled

 

(3

)

 

(3

)

Balance at March 31, 2011

 

$

11

 

$

5

 

$

16

 

 

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

 

 

 

2011 Restructuring Reserve Balance

 

2011 Restructuring Charges

 

 

 

At

 

At

 

Three Months Ended

 

 

 

March 31, 2011

 

December 31, 2010

 

March 31, 2011

 

Activision

 

$

16

 

$

 

$

19

 

Blizzard

 

 

 

 

Distribution

 

 

 

 

Total

 

$

16

 

$

 

$

19

 

 

The total expected restructuring charges related to the 2011 Restructuring, expected to be completed on June 30, 2011, are presented below (amounts in millions):

 

 

 

Low

 

High

 

Expected total restructuring costs, before tax

 

$

19

 

$

36

 

Expected total restructuring costs, after tax

 

14

 

30

 

 

The high end of the after tax cash charges are expected to consist primarily of employee-related severance cash costs of approximately $24 million and facility exist costs of approximately $6 million.  All of these items will be recorded within our Activision segment, which is the only segment impacted by the 2011 Restructuring.

 

We have substantially completed our implementation of our organizational restructuring plan as a result of the business combination (the “Business Combination”) by and among the Company (then known as Activision, Inc.), Sego Merger Corporation, a wholly-owned subsidiary of the Company, 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, consummated in July 2008. There is no significant cash payment and additional charges to the income statement for the three months ended March 31, 2011.

 

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10.        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 content. 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 3 (“PS3”), Nintendo Co. Ltd. (“Nintendo”) Wii (“Wii”), and Microsoft Corporation (“Microsoft”) Xbox 360 (“Xbox 360”) console systems; the Nintendo Dual Screen (“NDS”), Nintendo DSi (“DSi”) and Nintendo 3DS (“3DS”) handheld devices; the PC; the Apple iPhone (“iPhone”), the Apple iPad (“iPad”) and other mobile devices. 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.

 

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 gameplay); retail sales of physical “boxed” products; online 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 impairment of intangible assets. The CODM does not review any information regarding total assets on an operating segment basis, and accordingly, no disclosure is made with respect thereto.  Information on the operating segments and reconciliations of total net revenues and total segment income (loss) from operations to consolidated net revenues and income before income tax expense from external customers for the three months ended March 31, 2011 and 2010 are presented below (amounts in millions):

 

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Three Months Ended March 31,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

Income from operations

 

 

 

Net Revenues

 

before income tax expense

 

Activision

 

$

323

 

$

337

 

$

48

 

$

7

 

Blizzard

 

357

 

306

 

170

 

158

 

Distribution

 

75

 

71

 

 

 

Operating segments total

 

755

 

714

 

218

 

165

 

 

 

 

 

 

 

 

 

 

 

Reconciliation to consolidated net revenues / operating income and consolidated income before income tax expense:

 

 

 

 

 

 

 

 

 

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

 

694

 

594

 

506

 

410

 

Stock-based compensation expense

 

 

 

(23

)

(44

)

Restructuring

 

 

 

(19

)

(3

)

Amortization of intangible assets

 

 

 

(8

)

(17

)

Consolidated net revenues / operating income

 

$

1,449

 

$

1,308

 

 

674

 

 

511

 

Investment and other income, net

 

 

 

 

 

2

 

 

Consolidated income before income tax expense

 

 

 

 

 

$

676

 

$

511

 

 

Geographic information for the three months ended March 31, 2011 and 2010 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 March 31,

 

 

 

2011

 

2010

 

Net revenues by geographic region:

 

 

 

 

 

North America

 

$

748

 

$

703

 

Europe

 

594

 

524

 

Asia Pacific

 

107

 

81

 

Total consolidated net revenues

 

$

1,449

 

$

1,308

 

 

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

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Net revenues by platform:

 

 

 

 

 

Online subscriptions*

 

$

395

 

$

310

 

Console

 

824

 

839

 

Hand-held

 

31

 

39

 

PC and Other

 

124

 

49

 

Total platform net revenues

 

1,374

 

1,237

 

Distribution

 

75

 

71

 

Total consolidated net revenues

 

$

1,449

 

$

1,308

 

 


*Revenue from online subscriptions consists of revenue from all World of Warcraft products, including subscriptions, boxed products, expansion packs, licensing royalties, and value-added services.

 

We did not have any single external customer that accounted for 10% or more of net revenues for the three month ended March 31, 2011 or 2010.

 

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11.        Goodwill

 

The changes in the carrying amount of goodwill by operating segment for the three months ended March 31, 2011 are as follows (amounts in millions):

 

 

 

Activision

 

Blizzard

 

Distribution

 

Total

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2010

 

$

6,942

 

$

178

 

$

12

 

$

7,132

 

Tax benefit credited to goodwill

 

(1

)

 

 

(1

)

Issuance of contingent consideration

 

3

 

 

 

3

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2011

 

$

6,944

 

$

178

 

$

12

 

$

7,134

 

 

Issuance of contingent consideration consists of additional purchase consideration paid during 2011 in relation to a previous acquisition.

 

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 the Company, 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.

 

12.        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):

 

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Three Months Ended March 31,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

Consolidated net income

 

$

503

 

$

381

 

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

 

(3

)

(2

)

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

 

(4

)

(1

)

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

 

496

 

378

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

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

 

1,173

 

1,248

 

 

 

 

 

 

 

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

 

 

 

 

 

Employee stock options

 

9

 

16

 

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

 

1,182

 

1,264

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.42

 

$

0.30

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.42

 

$

0.30

 

 

Our unvested restricted stock rights 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 months ended March 31, 2011 and 2010, we had outstanding unvested restricted stock rights of 17 million and 11 million shares of common stock on a weighted-average basis, respectively.

 

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 32 million and 23 million shares of common stock were not included in the calculation of diluted earnings per common share for the three months ended March 31, 2011 and 2010, respectively, as the effect of their inclusion would be anti-dilutive.

 

13.        Capital transactions

 

Repurchase Program

 

On February 10, 2010, our Board of Directors authorized a stock repurchase program (the “2010 Stock Repurchase Program”) under which we were authorized to repurchase up to $1 billion of our common stock.  In January 2011, we settled a $22 million purchase of 1.8 million shares of our common stock that we had committed to repurchase in December 2010 pursuant to the 2010 Stock Repurchase Program. The 2010 Stock Repurchase Program expired on December 31, 2010.

 

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On February 3, 2011, our Board of Directors authorized a new stock repurchase program (the “2011 Stock Repurchase Program”) under which we may repurchase up to $1.5 billion of our common stock, on terms and conditions to be determined by the Company, until the earlier of March 31, 2012 and a determination by the Board of Directors to discontinue the repurchase program.  For the three months ended March 31, 2011, we repurchased 29 million shares of our common stock for $321 million pursuant to the 2011 Stock Repurchase Program. In April 2011, we settled the purchase of 2.1 million shares of our common stock for $23 million that we had committed to repurchase in March 2011 pursuant to the 2011 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. On October 22, 2010, the Company made dividend equivalent payments of $2 million related to this cash dividend to the holders of restricted stock units.

 

On February 9, 2011, our Board of Directors approved a cash dividend of $0.165 per common share to be paid on May 11, 2011 to shareholders of record as of March 16, 2011.

 

14.        Commitments and contingencies

 

At March 31, 2011, we did not have any significant changes to our commitments since December 31, 2010.  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, 2010 for more information regarding our commitments.

 

Legal Proceedings

 

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.

 

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 ( Alderman et al. v. Activision Publishing, Inc. et al) .  An amended complaint was filed on July 8, 2010, which added seven additional plaintiffs.  On October 5, 2010, five plaintiffs, all current employees of Infinity Ward, filed dismissals without prejudice.  There are currently 40 plaintiffs in the case.  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 million and $125 million, plus punitive damages.  On October 12, 2010, the court consolidated this matter with the West and Zampella matter.

 

On August 10, 2010, the Company filed a demurrer to various causes of action in the amended Alderman complaint. On October 15, 2010, the court overruled the demurrer with respect to all causes of action other than conversion, for which it was sustained. On November 4, 2010, the Alderman plaintiffs filed a second amended complaint. On November 15, 2010, the Company filed a demurrer with respect to the claim for conversion in the second amended complaint.  On March 16, 2011, the Alderman plaintiffs filed a third amended complaint adding oral and implied contract claims, equitable claims and fraud claims.  On April 15, 2011, the Company filed a demurrer to a variety of claims in the third amended complaint.

 

On January 18, 2011, the court granted the Company’s motion to amend its cross complaint against West and Zampella to add allegations with respect to them and to add Electronic Arts, Inc. as a party. On January 26, 2011, Electronic Arts, Inc. filed a demurrer with respect to the claims asserted against it in the amended cross complaint. On January 31, 2011, the case was transferred to the complex division.  On March 16, 2011, the court overruled Electronic Arts, Inc.’s demurrer with respect to all causes of action except as to a declaratory relief claim.

 

On April 1, 2011, West and Zampella filed a cross-complaint and answer in response to the Company’s cross-complaint against West, Zampella and Electronic Arts. In the cross-complaint, West and Zampella asserted fraud claims.

 

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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.

 

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 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.

 

15.        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 $51 million at March 31, 2011. The gross notional amount of outstanding foreign exchange swaps was $138 million at December 31, 2010. A pre-tax net unrealized loss of less than a million dollars for each of the three months ended March 31, 2011 and 2010, resulted from the foreign exchange contracts and swaps with Vivendi and were recognized in the condensed consolidated statements of operations.

 

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.  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.

 

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Table of Contents

 

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, 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. Based upon our organizational structure, we conduct our business through three operating segments as follows:

 

Activision Publishing, Inc.

 

Activision Publishing, Inc. (“Activision”) is a leading international publisher of interactive software products and content. 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 3 (“PS3”), Nintendo Co. Ltd. (“Nintendo”) Wii (“Wii”), and Microsoft Corporation (“Microsoft”) Xbox 360 (“Xbox 360”) console systems; the Nintendo Dual Screen (“NDS”), Nintendo DSi (“DSi”) and Nintendo 3DS (“3DS”) handheld devices; the PC; the Apple iPhone (“iPhone”), the Apple iPad (“iPad”) and other mobile devices. 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.

 

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 gameplay); retail sales of physical “boxed” products; online 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 significant factors impacting our business environment are discussed below. For additional discussion refer to the “Business Overview” section in the Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

Business Highlights

 

For the three months ended March 31, 2011, Activision Blizzard’s results were strong, with net revenues of $1.4 billion as compared to the net revenues of $1.3 billion in same period in 2010, and earnings per diluted share of $0.42 as compared to the earnings per diluted share of $0.30 in same period in 2010.

 

According to The NPD Group, with respect to the U.S., and Charttrack and Gfk, for Europe, during the three months ended March 31, 2011, based on sales from the retail channels:

 

·                   Activision Blizzard was the #2 third-party publisher overall in the US and European retail channels;

·                   Call of Duty: Black Ops was the #1 title overall and the #1 title on each of the Xbox 360 and the PS3; and

·                   Activision Blizzard had 3 top 10 PC titles: World of Warcraft: Cataclysm , StarCraft II , and Call of Duty: Black Ops .

 

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Table of Contents

 

Additional Highlights

 

On February 3, 2011, our Board of Directors approved a new stock repurchase program under which we may repurchase up to $1.5 billion of our common stock until the earlier of March 31, 2012 and a determination by the Board of Directors to discontinue the repurchase program. In addition, on February 9, 2011, the Board of Directors declared a cash dividend of $0.165 per common share to be paid on May 11, 2011 to shareholders of record as of March 16, 2011.

 

Product Release Highlights

 

During the quarter ended March 31, 2011, we released Call of Duty: Black Ops First Strike , the first downloadable map pack for Call of Duty: Black Ops . In addition, we released Nascar The Game 2011, Lucas Arts’ title Lego Star Wars III, and a selection of casual titles including Zhu Zhu Puppies .

 

Activision Blizzard Upcoming Product Releases

 

On May 3, 2011, Activision Publishing released the Call of Duty: Black Ops Escalation content pack on the Xbox 360 video game and entertainment system from Microsoft.  The pack also is expected to be available during the second quarter on Sony’s PlayStation3 computer entertainment system and the PC.   During the quarter, Activision Publishing also expects to release Transformers: Dark of the Moon, which will launch in connection with the release of the upcoming feature film of the same name; and Wipeout In The Zone , a Kinect-ready title for the Xbox 360, which is expected to be available in conjunction with the premier of Wipeout’s summer television season.

 

Management’s Overview of Business Trends

 

We provide our products through both the retail channels and digital online delivery methods. Many of our video games that are available through retailers as physical “boxed” software products such as DVDs are also available by direct digital download through the Internet (both from websites that we own and from others owned by third parties). We also offer downloadable content as add-ons to our products ( e.g. , new multi-player map packs and additional songs). Digital online-delivered content is generally offered to consumers for a one-time fee. Our subscription based services are digitally delivered and hosted by Blizzard Entertainment’s proprietary online gaming service, Battle.net. Digital revenues have become an increasingly important part of our business and we continue to focus on and develop them. We currently define digital online channel-related sales as revenues from subscriptions and licensing royalties, value added services, downloadable content, digitally distributed products, and wireless devices. This definition may differ from that used by our competitors or other companies.  For the quarter ended March 31, 2011, our sales through digital online channels grew approximately 30% year-over-year, and by approximately $100 million.

 

Conditions in the retail channels of the video games industry have remained challenging for the first three months of 2011. In the U.S. and Europe, retail sales within the industry experienced a combined overall decrease of 11% for the three months ended March 31, 2011 as compared to the same period in 2010, according to The NPD Group, Charttrack and Gfk.  This suggests a continuing downward pressure in the retail channels and an increasing shift towards digital distribution. Year-over-year, we experienced growth of net revenues from digital online channels as a percentage of our total net revenues. Net revenues from digital online channels represented 30% of the total consolidated net revenues for the three months ended March 31, 2011 and $428 million as compared to 25% and $330 million in the same period in 2010. Net revenues from digital online channels, excluding the impact of change in deferred net revenues (a non-GAAP financial measure), represented 58% of the total consolidated net revenues for the three months ended March 31, 2011 and $440 million as compared to 47% and $339 million in the same period in 2010. Further, in the first quarter of 2011, we achieved 30% growth from revenues in the digital online channels year-over-year.  This digital revenue growth positively impacted operating margin, and helped the Company to achieve record operating margins in the first quarter of 2011.  We continue to expect growth from our higher-margin digital products for the full fiscal year of 2011, as we seek to extend our digital leadership and expand our core brands in this channel.  Please refer to the reconciliation between GAAP and non-GAAP net revenues by distribution channel and our non-GAAP financial measures disclosure below.

 

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Table of Contents

 

Consolidated Statements of Operations Data

 

The following table sets forth consolidated statements of operations data for the periods indicated in dollars and as a percentage of total net revenues (amounts in millions):

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Net revenues:

 

 

 

 

 

 

 

 

 

Product sales

 

$

1,061

 

73

%

$

986

 

75

%

Subscription, licensing, and other revenues

 

388

 

27

 

322

 

25

 

Total net revenues

 

1,449

 

100

 

1,308

 

100

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of sales — product costs

 

299

 

21

 

337

 

26

 

Cost of sales — MMORPG

 

63

 

4

 

54

 

4

 

Cost of sales — software royalties and amortization

 

61

 

4

 

99

 

8

 

Cost of sales — intellectual property licenses

 

29

 

2

 

43

 

3

 

Product development

 

142

 

10

 

143

 

11

 

Sales and marketing

 

64

 

4

 

56

 

4

 

General and administrative

 

98

 

7

 

65

 

5

 

Restructuring

 

19

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

Total costs and expenses

 

775

 

53

 

797

 

61

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

674

 

47

 

511

 

39

 

 

 

 

 

 

 

 

 

 

 

Investment and other income, net

 

2