Activision Blizzard, Inc.
Activision Blizzard, Inc. (Form: 10-Q, Received: 11/06/2013 16:32:35)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark one)

 

x       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2013

 

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

 

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

incorporation or organization)

 

 

 

 

 

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 30, 2013 was 695,432,548.

 

 

 



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, 2013 and December 31, 2012

4

 

 

 

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2013 and September 30, 2012

5

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2013 and September 30, 2012

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and September 30, 2012

7

 

 

 

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity for the nine months ended September 30, 2013

8

 

 

 

 

Notes to Condensed Consolidated Financial Statements

9

 

 

 

Item 2.

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

27

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

45

 

 

 

Item 4.

Controls and Procedures

46

 

 

 

PART II.

OTHER INFORMATION

47

 

 

 

Item 1.

Legal Proceedings

47

 

 

 

Item 1A.

Risk Factors

49

 

 

 

Item 6.

Exhibits

50

 

 

 

SIGNATURE

 

51

 

 

 

EXHIBIT INDEX

52

 

 

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 financial or operating performance; (4) statements about the impact of the recently consummated transactions described herein; and (5) statements of assumptions underlying such statements. Activision Blizzard, Inc. (“Activision Blizzard”) generally uses 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. 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, Activision Blizzard’s ability to predict consumer preferences, including interest in specific genres such as first-person action, massively multiplayer online games and “toys to life”, and preferences among hardware platforms, the seasonal and cyclical nature of the interactive game market, changing business models, including digital delivery of content, 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, particularly during the ongoing console transition, rapid changes in technology and industry standards, litigation risks and associated costs, 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 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, the identification of suitable future acquisition opportunities and potential challenges associated with geographic expansion, capital market risks, the possibility that expected benefits related to the recently consummated transactions with Vivendi S.A. may not materialize as expected, the amount of our debt and the limitations imposed by the covenants in the agreements governing our debt, and the other factors identified in “Risk Factors” included in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012, as amended, and this Quarterly Report on Form 10-Q. 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 Inc.’s names, abbreviations thereof, logos, and product and service designators are all either the registered or unregistered trademarks or trade names of Activision Blizzard. All other product or service names are the property of their respective owners.

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Amounts in millions, except share data)

 

 

 

At September 30,

 

At December 31,

 

 

 

2013

 

2012

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

 4,444

 

$

 3,959

 

Cash in escrow

 

2,282

 

 

Short-term investments

 

95

 

416

 

Accounts receivable, net of allowances of $193 and $332 at September 30, 2013 and December 31, 2012, respectively

 

205

 

707

 

Inventories, net

 

313

 

209

 

Software development

 

347

 

164

 

Intellectual property licenses

 

12

 

11

 

Deferred income taxes, net

 

341

 

487

 

Other current assets

 

212

 

321

 

Total current assets

 

8,251

 

6,274

 

 

 

 

 

 

 

Long-term investments

 

9

 

8

 

Software development

 

54

 

129

 

Intellectual property licenses

 

 

30

 

Property and equipment, net

 

139

 

141

 

Other assets

 

18

 

11

 

Intangible assets, net

 

58

 

68

 

Trademark and trade names

 

433

 

433

 

Goodwill

 

7,098

 

7,106

 

Total assets

 

$

 16,060

 

$

 14,200

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

 286

 

$

 343

 

Deferred revenues

 

641

 

1,657

 

Accrued expenses and other liabilities

 

506

 

652

 

Total current liabilities

 

1,433

 

2,652

 

Long-term debt, net

 

2,211

 

 

Deferred income taxes, net

 

71

 

25

 

Other liabilities

 

206

 

206

 

Total liabilities

 

3,921

 

2,883

 

 

 

 

 

 

 

Commitments and contingencies (Note 13)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.000001 par value, 2,400,000,000 shares authorized, 1,123,569,395 and 1,111,606,087 shares issued at September 30, 2013 and December 31, 2012, respectively

 

 

 

Additional paid-in capital

 

9,608

 

9,450

 

Retained earnings

 

2,513

 

1,893

 

Accumulated other comprehensive income (loss)

 

18

 

(26

)

Total shareholders’ equity

 

12,139

 

11,317

 

Total liabilities and shareholders’ equity

 

$

 16,060

 

$

 14,200

 

 

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

 

For the Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

 

 

 

 

 

 

 

 

Product sales

 

$

332

 

$

536

 

$

2,049

 

$

2,208

 

Subscription, licensing, and other revenues

 

359

 

305

 

1,016

 

880

 

Total net revenues

 

691

 

841

 

3,065

 

3,088

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

Cost of sales — product costs

 

111

 

146

 

551

 

633

 

Cost of sales — online subscriptions

 

43

 

62

 

154

 

201

 

Cost of sales — software royalties and amortization

 

16

 

19

 

116

 

107

 

Cost of sales — intellectual property licenses

 

5

 

10

 

56

 

37

 

Product development

 

140

 

125

 

387

 

384

 

Sales and marketing

 

144

 

131

 

367

 

346

 

General and administrative

 

162

 

121

 

347

 

413

 

Total costs and expenses

 

621

 

614

 

1,978

 

2,121

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

70

 

227

 

1,087

 

967

 

 

 

 

 

 

 

 

 

 

 

Interest and other investment income (expense), net

 

(4

)

1

 

(1

)

4

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense

 

66

 

228

 

1,086

 

971

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

10

 

2

 

249

 

176

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

56

 

$

226

 

$

837

 

$

795

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.05

 

$

0.20

 

$

0.73

 

$

0.70

 

Diluted

 

$

0.05

 

$

0.20

 

$

0.73

 

$

0.70

 

 

 

 

 

 

 

 

 

 

 

Weighted-average number of shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

1,122

 

1,109

 

1,118

 

1,113

 

Diluted

 

1,134

 

1,114

 

1,127

 

1,118

 

 

 

 

 

 

 

 

 

 

 

Dividends per common share

 

$

 

$

 

$

0.19

 

$

0.18

 

 

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 COMPREHENSIVE INCOME

(Unaudited)

(Amounts in millions)

 

 

 

For the Three Months Ended

 

For the Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

56

 

$

226

 

$

837

 

$

795

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

80

 

49

 

43

 

(3

)

Unrealized gains on investments, net of deferred income taxes of $0 million for the periods ended September 30, 2013 and $1 million for the periods ended September 30, 2012

 

 

1

 

1

 

1

 

Other comprehensive income (loss)

 

$

80

 

$

50

 

$

44

 

$

(2

)

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

136

 

$

276

 

$

881

 

$

793

 

 

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 Nine Months Ended

 

 

 

September 30,

 

 

 

2013

 

2012

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

837

 

$

795

 

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

 

 

 

 

 

Deferred income taxes

 

203

 

20

 

Depreciation and amortization

 

68

 

69

 

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

 

140

 

123

 

Stock-based compensation expense (2)

 

76

 

83

 

Excess tax benefits from stock awards

 

(14

)

(4

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

498

 

450

 

Inventories, net

 

(103

)

(145

)

Software development and intellectual property licenses

 

(212

)

(218

)

Other assets

 

99

 

228

 

Deferred revenues

 

(1,008

)

(639

)

Accounts payable

 

(56

)

(141

)

Accrued expenses and other liabilities

 

(144

)

(252

)

Net cash provided by operating activities

 

384

 

369

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities of available-for-sale investments

 

295

 

305

 

Proceeds from sales of available-for-sale investments

 

60

 

 

Purchases of available-for-sale investments

 

(26

)

(382

)

Capital expenditures

 

(58

)

(46

)

Decrease (increase) in restricted cash

 

(9

)

(22

)

Deposit into escrow

 

(71

)

 

Net cash provided by (used in) investing activities

 

191

 

(145

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

92

 

30

 

Tax payment related to net share settlements of restricted stock rights

 

(19

)

(5

)

Excess tax benefits from stock awards

 

14

 

4

 

Repurchase of common stock

 

 

(315

)

Dividends paid

 

(216

)

(204

)

Net cash used in financing activities

 

(129

)

(490

)

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

39

 

10

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

485

 

(256

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

3,959

 

3,165

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

4,444

 

$

2,909

 

 


(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 Nine Months Ended September 30, 2013

(Unaudited)

(Amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

Total

 

 

 

Common Stock

 

Paid-In

 

Retained

 

Comprehensive

 

Shareholders’

 

 

 

Shares

 

Amount

 

Capital

 

Earnings

 

Income (Loss)

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2012

 

1,112

 

$

 

$

9,450

 

$

1,893

 

$

(26

)

$

11,317

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

837

 

 

837

 

Other comprehensive income (loss)

 

 

 

 

 

44

 

44

 

Issuance of common stock pursuant to employee stock options

 

9

 

 

92

 

 

 

92

 

Issuance of common stock pursuant to restricted stock rights

 

4

 

 

 

 

 

 

Restricted stock surrendered for employees’ tax liability

 

(1

)

 

(19

)

 

 

(19

)

Tax benefit associated with employee stock awards

 

 

 

3

 

 

 

3

 

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

 

 

 

82

 

 

 

82

 

Dividends ($0.19 per common share) (See Note 12)

 

 

 

 

(217

)

 

(217

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2013

 

1,124

 

$

 

$

9,608

 

$

2,513

 

$

18

 

$

12,139

 

 

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 leading global developer and publisher of interactive entertainment. The terms “Activision Blizzard,” the “Company,” “we,” “us,” and “our” are used to refer collectively to Activision Blizzard, Inc. and its subsidiaries.  We publish online, personal computer (“PC”), video game console, handheld, mobile and tablet games. We maintain significant operations in the United States, Canada, the United Kingdom, France, Germany, Ireland, Italy, Sweden, Spain, the Netherlands, Australia, South Korea and China.

 

Activision Blizzard is the result of the 2008 business combination (“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.  In connection with the consummation of the Business Combination, Activision, Inc. was renamed Activision Blizzard, Inc. The common stock of Activision Blizzard is traded on The NASDAQ Stock Market under the ticker symbol “ATVI.”

 

On October 11, 2013, we repurchased 429 million shares of our common stock, pursuant to the stock purchase agreement (the “Stock Purchase Agreement”) we entered into on July 25, 2013 with Vivendi and ASAC II LP (“ASAC”), an exempted limited partnership established under the laws of the Cayman Islands, acting by its general partner, ASAC II LLC. Pursuant to the terms of the Stock Purchase Agreement, we acquired all of the capital stock of Amber Holding Subsidiary Co., a Delaware corporation and wholly-owned subsidiary of Vivendi (“New VH”), which was the direct owner of 429 million shares of our common stock, for a cash payment of $5.83 billion, or $13.60 per share, before taking into account the benefit to the Company of certain tax attributes of New VH assumed in the transaction (collectively, the “Purchase Transaction”). Immediately following the completion of the Purchase Transaction, ASAC purchased from Vivendi 172 million shares of the Company’s common stock, pursuant to the Stock Purchase Agreement, for a cash payment of $2.34 billion, or $13.60 per share (the “Private Sale”). Refer to Note 16 of the Notes to Condensed Consolidated Financial Statements for further information regarding the Purchase Transaction and Private Sale.

 

At September 30, 2013, Vivendi owned approximately 61% of our outstanding common stock. As a result of the Purchase Transaction and the Private Sale, Vivendi’s ownership was reduced to approximately 12% of our outstanding common stock as of October 11, 2013.

 

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 developer and publisher of interactive software products and content, including games from the Call of Duty® and Skylanders® franchises. Activision develops games primarily based on internally-developed properties, as well as some licensed intellectual properties. We sell games through both retail channels and digital downloads. Activision currently offers games that operate on the Sony Computer Entertainment, Inc. (“Sony”) PlayStation 3 (“PS3”), Nintendo Co. Ltd. (“Nintendo”) Wii (“Wii”) and Nintendo Wii U (“Wii U”), and Microsoft Corporation (“Microsoft”) Xbox 360 (“Xbox 360”) console systems; the Nintendo Dual Screen (“DS”) and Nintendo 3DS (“3DS”) handheld game systems; the PC; and other handheld and mobile devices. We are investing in, developing, and planning to release games for Sony’s and Microsoft’s next-generation console systems, the PlayStation 4 (“PS4”) and Xbox One (“Xbox One”), respectively.

 

Blizzard Entertainment, Inc.

 

Blizzard Entertainment, Inc. (“Blizzard”) is a leader in the subscription-based massively multi-player online role-playing game (“MMORPG”) category in terms of both subscriber base and revenues generated through the World of Warcraft ®  franchise, which it develops, hosts and supports. Blizzard also develops, markets and sells role-playing action and strategy games for the PC and iPad, including games in the multiple-award winning Diablo® and StarCraft® franchises. Blizzard has adapted Diablo III for certain current- and next-generation console platforms and released Diablo III for the PS3 and Xbox 360 in September 2013. In addition, Blizzard maintains a proprietary online-game related service, Battle.net®. Blizzard distributes its products and generates revenues worldwide through various means, including: subscriptions; sales of prepaid subscription cards; value-added services 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, Diablo III, and StarCraft II products.

 

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Activision Blizzard Distribution

 

Activision Blizzard’s distribution segment (“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.

 

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 year-end condensed balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. 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, 2012, as amended. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for the fair statement of our financial position and results of operations in accordance with U.S. GAAP have been included in the accompanying unaudited condensed consolidated financial statements.

 

The accompanying condensed consolidated financial statements include the accounts and operations of the Company. 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 and accompanying notes. Actual results could differ from these estimates and assumptions.

 

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

 

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.

 

Results of Adjustments

 

During the six months ended June 30, 2013, we identified through our internal processes that, in previous years, we erroneously under-accrued for certain indirect taxes for two countries in our Europe region. We performed an evaluation under SEC Staff Accounting Bulletin No. 108 and concluded the effect of this error was immaterial to prior years’ financial statements as well as the projected full-year 2013 financial statements. As such, during the six months ended June 30, 2013, we recorded an adjustment in our condensed consolidated statements of operations which reduced “Total net revenues” by $8 million, “Interest and other investment income (expense), net” by $1 million, “Income before income tax expense” by $9 million, and “Net income” by $7 million. This adjustment reduced net revenues and income from operations before income tax expense by $8 million and $9 million, respectively, in each of our Blizzard segment, Europe region, and online subscriptions platform, as presented in Note 9 of the Notes to Condensed Consolidated Financial Statements.  The adjustment increased “Accrued expenses and other liabilities” on our condensed consolidated balance sheet by $9 million and represents a correction of an error. Operating cash flows will be impacted by $9 million in the period we settle the liability. The adjustment related to prior periods’ net income as follows: (i) approximately $1 million for the quarter ended March 31, 2013; (ii) approximately $1 million for each quarter of 2012 (totaling approximately $4 million for the year ended December 31, 2012); (iii) approximately $2 million for the year ended December 31, 2011; and (iv) less than $1 million for the year ended December 31, 2010. Earnings per basic and diluted share were affected by less than $0.01 as a result of recording this adjustment.

 

During the six months ended June 30, 2012, we identified through our internal processes that, in previous years, we erroneously over-recognized revenues for a country in our Europe region. We performed an evaluation under SEC Staff Accounting Bulletin No. 108 and concluded the effect of this error was immaterial to prior years’ financial statements as well as the projected full-year 2012 financial statements. As such, during the six months ended June 30, 2012, we recorded an adjustment in our condensed consolidated statements of operations which reduced “Total net revenues” by $11 million and “Net income” by $8 million. This adjustment reduced net revenues and income from operations before income tax expense by $11 million in each of our Blizzard segment, Europe region, and online subscriptions platform, as presented in Note 9 of the Notes to Condensed Consolidated Financial Statements.  The adjustment increased “Deferred revenues” on our condensed consolidated balance sheet by $11 million and represents a correction of an error. There was no impact to operating cash flows. The adjustment related to prior periods’ net income as follows: (i) approximately $1 million for the quarter ended March 31, 2012; (ii) less than $1 million for each quarter of 2011 (totaling approximately $3 million for the year ended December 31, 2011); (iii) approximately $2 million for the year ended December 31, 2010; and (iv) approximately $3 million for periods prior to the year ended December 31, 2010. Earnings per basic and diluted share were affected by less than $0.01 as a result of recording this adjustment.

 

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2.               Inventories, net

 

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

 

 

 

At September 30, 2013

 

At December 31, 2012

 

Finished goods

 

$

201

 

$

151

 

Purchased parts and components

 

112

 

58

 

Inventories, net

 

$

313

 

$

209

 

 

3.               Software development and intellectual property licenses

 

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

 

 

 

At

 

At

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

Internally developed software costs

 

$

200

 

$

159

 

Payments made to third-party software developers

 

201

 

134

 

Total software development costs

 

$

401

 

$

293

 

 

 

 

 

 

 

Intellectual property licenses

 

$

12

 

$

41

 

 

Amortization, write-offs and impairments of capitalized software development costs and intellectual property licenses are comprised of the following (amounts in millions):

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Amortization of capitalized software development costs and intellectual property licenses

 

$

15

 

$

22

 

$

123

 

$

121

 

Write-offs and impairments

 

 

 

26

 

8

 

 

4.               Intangible assets, net

 

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

 

 

 

At September 30, 2013

 

 

 

Estimated

 

Gross

 

 

 

 

 

 

 

useful

 

carrying

 

Accumulated

 

Net carrying

 

 

 

lives

 

amount

 

amortization

 

amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements and other

 

3 - 10 years

 

$

98

 

$

(89

)

$

9

 

Internally-developed franchises

 

11 - 12 years

 

309

 

(260

)

49

 

Total definite-lived intangible assets

 

 

 

$

407

 

$

(349

)

$

58

 

 

 

 

 

 

 

 

 

 

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

 

 

 

 

386

 

Acquired trade names

 

Indefinite

 

 

 

 

 

47

 

Total indefinite-lived intangible assets

 

 

 

 

 

 

 

$

433

 

 

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At December 31, 2012

 

 

 

Estimated

 

Gross

 

 

 

 

 

 

 

useful

 

carrying

 

Accumulated

 

Net carrying

 

 

 

lives

 

amount

 

amortization

 

amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements and other

 

3 - 10 years

 

$

98

 

$

(88

)

$

10

 

Internally-developed franchises

 

11 - 12 years

 

309

 

(251

)

58

 

Total definite-lived intangible assets

 

 

 

$

407

 

$

(339

)

$

68

 

 

 

 

 

 

 

 

 

 

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

 

 

 

 

386

 

Acquired trade names

 

Indefinite

 

 

 

 

 

47

 

Total indefinite-lived intangible assets

 

 

 

 

 

 

 

$

433

 

 

Amortization expense of intangible assets was $3 million and $9 million for the three and nine months ended September 30, 2013, respectively.  Amortization expense of intangible assets was $3 million and $7 million for the three and nine months ended September 30, 2012, respectively.

 

At September 30, 2013, future amortization of definite-lived intangible assets is estimated as follows (amounts in millions):

 

2013 (remaining three months)

 

$

18

 

2014

 

18

 

2015

 

10

 

2016

 

5

 

2017

 

3

 

Thereafter

 

4

 

Total

 

$

58

 

 

5.               Goodwill

 

The changes in the carrying amount of goodwill by operating segment for the nine months ended September 30, 2013 are as follows (amounts in millions):

 

 

 

Activision

 

Blizzard

 

Total

 

 

 

 

 

 

 

 

 

Balance at December 31, 2012

 

$

6,928

 

$

178

 

$

7,106

 

Tax benefit credited to goodwill

 

(8

)

 

(8

)

 

 

 

 

 

 

 

 

Balance at September 30, 2013

 

$

6,920

 

$

178

 

$

7,098

 

 

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.

 

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6.                  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; and

 

·                   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, including certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

 

The table below segregates all financial assets that are measured at fair value on a recurring basis into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date (amounts in millions):

 

 

 

 

 

Fair Value Measurements at

 

 

 

 

 

 

 

September 30, 2013 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

Significant

 

 

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

As of

 

Identical

 

Observable

 

Unobservable

 

 

 

 

 

September 30,

 

Assets

 

Inputs

 

Inputs

 

Balance Sheet

 

 

 

2013

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

4,174

 

$

4,174

 

$

 

$

 

Cash and cash equivalents

 

Foreign government treasury bills

 

32

 

32

 

 

 

Cash and cash equivalents

 

U.S. treasuries and government agency securities

 

68

 

68

 

 

 

Short-term investments

 

Auction rate securities (“ARS”)

 

9

 

 

 

9

 

Long-term investments

 

Total recurring fair value measurements

 

$

4,283

 

$

4,274

 

$

 

$

9

 

 

 

 

 

 

 

 

Fair Value Measurements at

 

 

 

 

 

 

 

December 31, 2012 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

Significant

 

 

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

As of

 

Identical

 

Observable

 

Unobservable

 

 

 

 

 

December 31,

 

Assets

 

Inputs

 

Inputs

 

Balance Sheet

 

 

 

2012

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

3,511

 

$

3,511

 

$

 

$

 

Cash and cash equivalents

 

U.S. treasuries and government agency securities

 

387

 

387

 

 

 

Short-term investments

 

Corporate bonds

 

11

 

11

 

 

 

Short-term investments

 

ARS

 

8

 

 

 

8

 

Long-term investments

 

Total recurring fair value measurements

 

$

3,917

 

$

3,909

 

$

 

$

8

 

 

 

 

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The following tables provide a reconciliation of the beginning and ending balances of our financial assets classified as Level 3 by major categories (amounts in millions) at September 30, 2013 and 2012, respectively:

 

 

 

Level 3

 

 

 

 

 

Total

 

 

 

 

 

financial

 

 

 

 

 

assets at

 

 

 

ARS

 

fair

 

 

 

(a)

 

value

 

Balance at December 31, 2012

 

$

8

 

$

8

 

Total unrealized gains included in other comprehensive income

 

1

 

1

 

Balance at September 30, 2013

 

$

9

 

$

9

 

 

 

 

Level 3

 

 

 

 

 

Total

 

 

 

 

 

financial

 

 

 

 

 

assets at

 

 

 

ARS

 

fair

 

 

 

(a)

 

value

 

Balance at December 31, 2011

 

$

16

 

$

16

 

Total unrealized gains included in other comprehensive income

 

3

 

3

 

Balance at September 30, 2012

 

$

19

 

$

19

 

 


(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. At September 30, 2013, assets measured at fair value using significant unobservable inputs (Level 3), all of which were ARS, represent less than 1% of our financial assets measured at fair value on a recurring basis.

 

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 forward contracts with maturities of twelve months or less. All foreign currency contracts are backed, in amount and by maturity, by an identified economic underlying item. In recent years, Vivendi has been our principal counterparty for our currency derivative contracts, but in connection with the Purchase Transaction described in Note 1 of the Notes to Condensed Consolidated Financial Statements, we terminated our cash management services agreement with Vivendi as of October 31, 2013. Further, we have not had any outstanding currency derivative contracts with Vivendi as counterparty since July 3, 2013. If we enter into similar contracts in the future, we expect that the counterparties for any such transactions will be large and reputable commercial or investment banks. We did not have any foreign currency contracts at September 30, 2013. The gross notional amount of outstanding foreign currency contracts was $355 million at December 31, 2012. 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 relevant period and was not material as of December 31, 2012.

 

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We do not hold or purchase any foreign currency contracts for trading or speculative purposes and we do not designate these contracts as hedging instruments. Accordingly, we report the fair value of these contracts within “Other current assets” or “Other current liabilities” in our condensed consolidated balance sheet and the changes in fair value within “General and administrative expense” and “Interest and other investment income (expense), net” in our condensed consolidated statement of operations. For the three and nine months ended September 30, 2013, pre-tax unrealized and realized net gains and losses were not material. For the three and nine months ended September 30, 2012, we recognized pre-tax unrealized net gains of $4 million and $3 million respectively, and a pre-tax realized net loss of $1 million and pre-tax realized net gain of $1 million, respectively.

 

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 and nine months ended September 30, 2013 and 2012, there were no impairment charges related to assets that are measured on a non-recurring basis.

 

7.               Debt

 

Unsecured Senior Notes

 

On September 19, 2013, we issued, at par, $1.5 billion of 5.625% unsecured senior notes due September 2021 (the “2021 Notes”) and $750 million of 6.125% unsecured senior notes due September 2023 (the “2023 Notes” and, together with the 2021 Notes, the “Notes”) in a private offering to qualified institutional buyers made in accordance with Rule 144A under the Securities Act of 1933, as amended. Total net proceeds from the issuance of the Notes were $2,211 million, net of the $39 million of fees we paid in connection with their issuance.  As described below, upon issuance, the net proceeds from the Notes were deposited into an escrow account. The proceeds were subsequently released from escrow on October 11, 2013 to fund the Purchase Transaction, as described in Note 1 of the Notes to Condensed Consolidated Financial Statements. For further details regarding the completion of the Purchase Transaction, see Note 16 of the Notes to Condensed Consolidated Financial Statements.

 

The Notes are general senior obligations of the Company and rank pari passu in right of payment to all of the Company’s existing and future senior indebtedness, including the Credit Facilities described under Note 16, “Subsequent Events” below. The Notes are guaranteed on a senior basis by certain of our U.S. subsidiaries (the “Guarantors”). The Notes and related guarantees are not secured and are effectively subordinated to any of the Company’s existing and future indebtedness that is secured, including the Credit Facilities described under Note 16, “Subsequent Events” below. The Notes contain customary covenants that place restrictions in certain circumstances on, among other things, the incurrence of debt, granting of liens, payment of dividends, sales of assets and mergers and acquisitions.  The Company was in compliance with the terms of the Notes as of September 30, 2013.

 

Interest on the Notes is payable semi-annually in arrears on March 15 and September 15 of each year, commencing on March 15, 2014.  As of September 30, 2013, we had interest payable of $3 million related to the 2021 Notes and $1 million related to the 2023 Notes recorded within “Accrued expenses and other liabilities” in our condensed consolidated balance sheet.

 

We may redeem the 2021 Notes on or after September 15, 2016 and the 2023 Notes on or after September 15, 2018, in whole or in part on any one or more occasions, at specified redemption prices, plus accrued and unpaid interest. At any time prior to September 15, 2016, with respect to the 2021 Notes, and at any time prior to September 15, 2018, with respect to the 2023 Notes, we may also redeem some or all of the Notes by paying a “make-whole premium”, plus accrued and unpaid interest.  Upon the occurrence of one or more qualified equity offerings, we may also redeem up to 35% of the aggregate principal amount of each of the 2021 Notes and 2023 Notes outstanding with the net cash proceeds from such offerings. The Notes are repayable, in whole or in part and at the option of the holders, upon the occurrence of a change in control and a ratings downgrade, at a purchase price equal to 101% of principal, plus accrued and unpaid interest.    These redemption options are considered clearly and closely related to the Notes and are not accounted for separately upon issuance.

 

For the three and nine months ended September 30, 2013, we recorded $39 million of fees as debt discount, which reduced the carrying value of the Notes. The debt discount will be amortized over the respective terms of the Notes and the amortization expense is recorded within “Interest and other investment income (expense), net” in our condensed consolidated statement of operations.

 

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A summary of our debt is as follows (amounts in millions):

 

 

 

September 30, 2013

 

 

 

Gross Carrying

 

Unamortized

 

Net Carrying

 

 

 

Amount

 

Discount

 

Amount

 

2021 Notes

 

$

1,500

 

$

(26

)

$

1,474

 

2023 Notes

 

750

 

(13

)

737

 

Total long-term debt

 

$

2,250

 

$

(39

)

$

2,211

 

 

For the three and nine months ended September 30, 2013, interest expense was $4 million and amortization of the debt discount was immaterial.

 

As of September 30, 2013, the scheduled maturities of our debt for each of the five succeeding years are as follows (amounts in millions):

 

For the year ending December 31, 2013 (remaining three months)

 

$

 

2014

 

 

2015

 

 

2016

 

 

2017

 

 

Thereafter

 

2,250

 

Total

 

$

2,250

 

 

As of September 30, 2013, the fair values of our 2021 Notes and 2023 Notes, based on Level 2 inputs, was $1,500 million and $750 million, respectively.

 

Supplemental Cash Flow Information

 

Because the consummation of the transactions contemplated by the Stock Purchase Agreement was enjoined, as described in Note 13 of the Notes to Condensed Consolidated Financial Statements, in accordance with the offering memorandum and purchase agreements for the Notes, the proceeds from the issuance of the Notes were required to be deposited into and held in an escrow account until the earlier of (i) the completion of the Purchase Transaction, (ii) the termination of the Stock Purchase Agreement, and (iii) December 18, 2013. The escrow account was required to be funded with the full redemption value of the Notes, along with interest payable through December 18, 2013. At September 30, 2013, none of the events had occurred and accordingly, we have accounted for the net proceeds from the issuance of the Notes of $2,211 million as a non-cash financing activity in our condensed consolidated statement of cash flows. We have accounted for the deposit of $71 million into the interest-bearing escrow account, which consists of interest that would be owed on the Notes through December 18, 2013 and the difference between the redemption value of and the net proceeds received from the Notes, as an investing activity in our condensed consolidated statement of cash flows. At September 30, 2013, we recorded the balance of the escrow account as “Cash in escrow” in our condensed consolidated balance sheet. On October 11, 2013, the funds were released from the escrow account and used to fund the Purchase Transaction.

 

Deferred Financing Costs

 

Costs incurred to obtain our long-term debt are amortized over the terms of the respective debt agreements using the interest method.  At September 30, 2013, we recorded $7 million of deferred financing costs related to the Notes within “Other assets — non-current” in our condensed consolidated balance sheet.  Amortization expense related to the deferred financing costs for each of the three and nine months ended September 30, 2013, was immaterial and is recorded within “Interest and other investment income (expense), net” in our condensed consolidated statement of operations.

 

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8.               Accumulated other comprehensive income (loss)

 

The components of accumulated other comprehensive income (loss) at September 30, 2013 and 2012, were as follows (amounts in millions):

 

 

 

For the nine months ended September 30, 2013

 

 

 

Foreign currency

 

Unrealized gain

 

 

 

 

 

translation

 

on available-for-

 

 

 

 

 

adjustments

 

sale securities

 

Total

 

Balance at December 31, 2012

 

$

(26

)

$

 

$

(26

)

Other comprehensive income (loss) before reclassifications

 

43

 

1

 

44

 

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

 

 

Balance at September 30, 2013

 

$

17

 

$

1

 

$

18

 

 

 

 

For the nine months ended September 30, 2012

 

 

 

Foreign currency

 

Unrealized gain

 

 

 

 

 

translation

 

on available-for-

 

 

 

 

 

adjustments

 

sale securities

 

Total

 

Balance at December 31, 2011

 

$

(72

)

$

 

$

(72

)

Other comprehensive income (loss) before reclassifications

 

(3

)

1

 

(2

)

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

 

 

Balance at September 30, 2012

 

$

(75

)

$

1

 

$

(74

)

 

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

 

9.               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 we assess operating performance and allocate resources, and the availability of separate financial information. Currently, we conduct our business through three operating segments: Activision, Blizzard and Distribution (see Note 1 of the Notes to Condensed Consolidated Financial Statements). We do not aggregate operating segments.

 

The CODM reviews segment performance exclusive of the impact of the change in deferred revenues and related cost of sales with respect to certain of our online-enabled games, stock-based compensation expense, amortization of intangible assets as a result of purchase price accounting, and expenses related to the Purchase Transaction and related debt financings. 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 operating income to consolidated net revenues from external customers and consolidated income before income tax expense for the three and nine months ended September 30, 2013 and 2012 are presented below (amounts in millions):

 

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Three months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

Net revenues

 

Income (loss) from operations
before income tax expense

 

Activision

 

$

319

 

$

283

 

$

41

 

$

(14

)

Blizzard

 

282

 

414

 

88

 

168

 

Distribution

 

56

 

54

 

(1

)

 

Operating segments total

 

657

 

751

 

128

 

154

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

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

 

34

 

90

 

32

 

110

 

Stock-based compensation expense

 

 

 

(25

)

(34

)

Amortization of intangible assets

 

 

 

(3

)

(3

)

Fees and other expenses related to the Purchase Transaction and related debt financings

 

 

 

(62

)

 

 

 

 

 

 

 

 

 

 

 

Consolidated net revenues / operating income

 

$

691

 

$

841

 

70

 

227

 

Interest and other investment income (expense), net

 

 

 

 

 

(4

)

1

 

 

 

 

 

 

 

 

 

 

 

Consolidated income before income tax expense

 

 

 

 

 

$

66

 

$

228

 

 

 

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

Net revenues

 

Income (loss) from operations
before income tax expense

 

Activision

 

$

1,090

 

$

928

 

$

214

 

$

(84

)

Blizzard

 

837

 

1,299

 

282

 

629

 

Distribution

 

143

 

166

 

(1

)

 

Operating segments total

 

2,070

 

2,393

 

495

 

545

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

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

 

995

 

695

 

738

 

514

 

Stock-based compensation expense

 

 

 

(76

)

(85

)

Amortization of intangible assets

 

 

 

(8

)

(7

)

Fees and other expenses related to the Purchase Transaction and related debt financings

 

 

 

(62

)

 

 

 

 

 

 

 

 

 

 

 

Consolidated net revenues / operating income

 

$

3,065

 

$

3,088

 

$

1,087

 

$

967

 

Interest and other investment income (expense), net

 

 

 

 

 

(1

)

4

 

 

 

 

 

 

 

 

 

 

 

Consolidated income before income tax expense

 

 

 

 

 

$

1,086

 

$

971

 

 

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Geographic information for the three and nine months ended September 30, 2013 and 2012 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 September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net revenues by geographic region:

 

 

 

 

 

 

 

 

 

North America

 

$

344

 

$

403

 

$

1,643

 

$

1,567

 

Europe

 

290

 

333

 

1,180

 

1,220

 

Asia Pacific

 

57

 

105

 

242

 

301

 

Total consolidated net revenues

 

$

691

 

$

841

 

$

3,065

 

$

3,088

 

 

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

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net revenues by platform:

 

 

 

 

 

 

 

 

 

Console

 

$

296

 

$

227

 

$

1,634

 

$

1,430

 

Online subscriptions(1)

 

205

 

226

 

714

 

701

 

Other(2)

 

55

 

62

 

300

 

320

 

PC

 

79

 

272

 

274

 

471

 

Total platform net revenues

 

635

 

787

 

2,922

 

2,922

 

Distribution

 

56

 

54

 

143

 

166

 

Total consolidated net revenues

 

$

691

 

$

841

 

$

3,065

 

$

3,088

 

 


(1)                                  Revenues from online subscriptions consist of revenues from all World of Warcraft products, including subscriptions, boxed products, expansion packs, licensing royalties, value-added services, and revenues from Call of Duty Elite memberships.

 

(2)                                  Revenues from other include revenues from handheld and mobile devices, as well as non-platform specific game related revenues such as standalone sales of toys and accessories products from the Skylanders franchise and other physical merchandise and accessories.

 

Long-lived assets by geographic region at September 30, 2013 and December 31, 2012 were as follows (amounts in millions):

 

 

 

At September 30, 2013

 

At December 31, 2012

 

Long-lived assets* by geographic region:

 

 

 

 

 

North America

 

$

101

 

$

90

 

Europe

 

31

 

40

 

Asia Pacific

 

7

 

11

 

Total long-lived assets by geographic region

 

$

139

 

$

141

 

 


*The only long-lived assets that we classify by region are our long-term tangible fixed assets, which only include property, plant and equipment assets; all other long-term assets are not allocated by location.

 

We did not have any single external customer that accounted for 10% or more of consolidated net revenues for the three and nine months ended September 30, 2013 and 2012.

 

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10.        Income taxes

 

The Company accounts for its provision for income taxes in accordance with Accounting Standards Codification (“ASC”) 740,  Income Taxes , which requires an estimate of the annual effective tax rate for the full year to be applied to the respective interim period, taking into account year-to-date amounts and projected results for the full year.   The provision for income taxes represents federal, foreign, state and local income taxes.  Our effective tax rate differs from the statutory U.S. income tax rate due to the effect of state and local income taxes, tax rates in foreign jurisdictions and certain nondeductible expenses. Our effective tax rate will change from quarter to quarter based on recurring and nonrecurring factors including, but not limited to, the geographical mix of earnings, changes in projected results for various jurisdictions, enacted tax legislation, including certain business tax credits, state and local income taxes, tax audit settlements, and the interaction of various global tax strategies. Changes in judgment from the evaluation of new information resulting in the recognition, derecognition or remeasurement of a tax position taken in a prior annual period are recognized separately in the quarter of the change.

 

The income tax expense of $10 million for the three months ended September 30, 2013 reflected an effective tax rate of 15.2%, which is higher than the effective tax rate of 0.8% for the three months ended September 30, 2012. This increase is primarily due to the tax benefit resulting from a federal income tax settlement recorded in the third quarter of 2012 and a decrease in the proportionate amount of earnings in the current year in foreign jurisdictions with relatively lower statutory rates, as compared to domestic earnings with relatively higher statutory rates.

 

The effective tax rate of 15.2% for the three months ended September 30, 2013 differed from the U.S. statutory rate of 35.0%, primarily due to the increase in the proportionate amount of foreign earnings at relatively lower statutory rates, as compared to domestic earnings at relatively higher statutory rates, the reduction in the projected U.S. pre-tax income attributable to costs associated with the Purchase Transaction and interest expense for the related debt financings, the recognition of federal and California research and development (“R&D”) credits, the federal domestic production deduction and favorable return to provision adjustments, offset by increases to the company’s reserve for uncertain tax positions. The favorable return to provision adjustments included a $9 million correction of an error in our deferred taxes related to prior periods, which is not material to either the forecasted fiscal 2013 results or any of the impacted prior periods.

 

Our tax expense of $249 million for the nine months ended September 30, 2013 reflected an effective tax rate of 22.9% compared to an effective tax rate of 18.1% for the nine months ended September 30, 2012. This increase is primarily due to the tax benefit resulting from a federal income tax settlement recorded in the third quarter of 2012, an increase in the proportionate amount of domestic earnings in the current year at relatively higher statutory rates, as compared to foreign earnings at relatively lower statutory rates, and increases to the company’s reserve for uncertain tax positions recorded in the third quarter of 2013. However, the impact of these increases was partially offset by favorable return to provision adjustments recorded in the third quarter of 2013 and the recognition of the retroactive reinstatement of the federal R&D tax credit for the tax year ended December 31, 2012, which was enacted in the first quarter of 2013, for which we recorded a benefit of $12 million as a discrete item in the first quarter of 2013.

 

The overall effective income tax rate for the year could be different from the effective tax rate for the three and nine months ended September 30, 2013 and will be dependent, in part, on our profitability for the remainder of the year. In addition, our effective income tax rates for the remainder of 2013 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 audits 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) is lower than anticipated in foreign regions, where taxes are levied at relatively lower statutory rates, and/or higher than anticipated in the United States, where taxes are levied at relatively higher statutory rates.

 

The Internal Revenue Service is currently examining Activision Blizzard’s federal tax returns for the 2008 and 2009 tax years and Vivendi Games’ tax returns for the 2005 through 2008 tax years. While Vivendi Games’ results for the period January 1, 2008 through July 9, 2008 are included in the consolidated federal and certain foreign, state and local income tax returns filed by Vivendi or its affiliates, Vivendi Games’ results for the period July 10, 2008 through December 31, 2008 are included in the consolidated federal and certain foreign, state and local income tax returns filed by Activision Blizzard. Additionally, the Company has several state and non-U.S. audits pending. Although the final resolution of the Company’s global tax disputes is uncertain, based on current information, in the opinion of the Company’s management, the ultimate resolution of these matters will not have a material adverse effect on the Company’s consolidated financial position, liquidity or results of operations. However, an unfavorable resolution of the Company’s global tax disputes could have a material adverse effect on our business and results of operations in the period in which the matters are ultimately resolved.

 

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11.        Computation of basic/diluted earnings per common share

 

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

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Consolidated net income

 

$

56

 

$

226

 

$

837

 

$

795

 

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

 

 

 

(4

)

(4

)

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

 

(1

)

(5

)

(14

)

(12

)

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

 

55

 

221

 

819

 

779

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

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

 

1,122

 

1,109

 

1,118

 

1,113

 

 

 

 

 

 

 

 

 

 

 

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

 

12

 

5

 

9

 

5

 

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

 

1,134

 

1,114

 

1,127

 

1,118

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.05

 

$

0.20

 

$

0.73

 

$

0.70

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.05

 

$

0.20

 

$

0.73

 

$

0.70

 

 

Our unvested restricted stock rights, which consist of restricted stock units, restricted stock awards, and performance shares, are considered participating securities, as they generally have non-forfeitable rights to dividends or dividend equivalents during the contractual period of the award. As such, we are required to use the two-class method in our computation of basic and diluted earnings per common share. For the three and nine months ended September 30, 2013, we had outstanding unvested restricted stock rights with respect to 24 million and 25 million shares of common stock on a weighted-average basis, respectively.  For the three and nine months ended September 30, 2012, we had outstanding unvested restricted stock rights with respect to 27 million and 23 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 2 million and 8 million shares of common stock were not included in the calculation of diluted earnings per common share for the three and nine months ended September 30, 2013, respectively, and options to acquire 24 million and 20 million shares of common stock were not included in the calculation of diluted earnings per common share for the three and nine months ended September 30, 2012, respectively.

 

Refer to Notes 12 and 16 of the Notes to Condensed Consolidated Financial Statements for information on our issued and outstanding common stock after the completion of the Purchase Transaction.

 

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12.    Capital transactions

 

Stock Purchase Agreement

 

As described in Note 1 of the Notes to Condensed Consolidated Financial Statements, on October 11, 2013, we completed the Purchase Transaction, repurchasing 429 million shares of our common stock for a cash payment of $5.83 billion, pursuant to the terms of the Stock Purchase Agreement (refer to Note 16 of the Notes to Condensed Consolidated Financial Statements for details of the Purchase Transaction).

 

Repurchase Program

 

On February 2, 2012, our Board of Directors authorized a stock repurchase program under which we were authorized to repurchase up to $1 billion of our common stock, on terms and conditions to be determined by the Company, during the period between April 1, 2012 and March 31, 2013.  There were no repurchases pursuant to this stock repurchase program during the nine months ended September 30, 2013. For the nine months ended September 30, 2012, we repurchased 4 million shares of our common stock for an aggregate purchase price of $54 million pursuant to this stock repurchase program.

 

On February 3, 2011, our Board of Directors authorized a stock repurchase program under which we were authorized to repurchase up to $1.5 billion of our common stock, on terms and conditions to be determined by the Company, until March 31, 2012.  For the nine months ended September 30, 2012, we repurchased 22 million shares of our common stock for an aggregate purchase price of $261 million pursuant to this stock repurchase program.

 

Dividend

 

On February 7, 2013, our Board of Directors declared a cash dividend of $0.19 per common share payable on May 15, 2013 to shareholders of record at the close of business on March 20, 2013. On May 15, 2013, we made an aggregate cash dividend payment of $212 million to such shareholders, and on May 31, 2013, we made related dividend equivalent payments of $4 million to the holders of restricted stock rights.

 

On February 9, 2012, our Board of Directors declared a cash dividend of $0.18 per common share to be paid on May 16, 2012 to shareholders of record at the close of business on March 21, 2012. On May 16, 2012, we made an aggregate cash dividend payment of $201 million to such shareholders, and on June 1, 2012, we made related dividend equivalent payments of $3 million to the holders of restricted stock rights.

 

13.        Commitments and contingencies

 

At September 30, 2013, except as disclosed below and in Note 7 of the Notes to Condensed Consolidated Financial Statements, we did not have any significant changes to our commitments since December 31, 2012.  See Note 17 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, 2012, as amended, for more information regarding our commitments.

 

Legal Proceedings

 

We are subject to various legal proceedings and claims. FASB ASC Topic 450 governs the disclosure of loss contingencies and accrual of loss contingencies in respect of litigation and other claims. We record an accrual for a potential loss when it is probable that a loss will occur and the amount of the loss can be reasonably estimated. When the reasonable estimate of the potential loss is within a range of amounts, the minimum of the range of potential loss is accrued, unless a higher amount within the range is a better estimate than any other amount within the range. Moreover, even if an accrual is not required, we provide additional disclosure related to litigation and other claims when it is reasonably possible ( i.e. , more than remote) that the outcomes of such litigation and other claims include potential material adverse impacts on us.

 

The outcomes of legal proceedings and other claims are subject to significant uncertainties, many of which are outside our control. There is significant judgment required in the analysis of these matters, including the probability determination and whether a potential exposure can be reasonably estimated. In making these determinations, we, in consultation with outside counsel, examine the relevant facts and circumstances on a quarterly basis assuming, as applicable, a combination of settlement and litigated outcomes and strategies. Moreover, legal matters are inherently unpredictable and the timing of development of factors on which reasonable judgments and estimates can be based can be slow. As such, there can be no assurance that the final outcome of any legal matter will not materially and adversely affect our business, financial condition, results of operations, or liquidity.

 

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Table of Contents

 

On August 1, 2013, a purported shareholder of the Company filed a shareholder derivative action in the Superior Court of the State of California, County of Los Angeles, captioned Miller v. Kotick, et al. , No. BC517086. The complaint names our Board of Directors and Vivendi as defendants, and the Company as a nominal defendant. The complaint alleges that our Board of Directors committed breaches of fiduciary duties, waste of corporate assets and unjust enrichment in connection with Vivendi’s sale of its stake in the Company and that Vivendi also breached its fiduciary duties. The plaintiff further alleges that demand by it on our Board of Directors to institute action would be futile because a majority of our Board of Directors is not independent and a majority of the individual defendants face a substantial likelihood of liability for approving the transactions contemplated by the Stock Purchase Agreement. The complaint seeks, among other things, damages sustained by the Company, rescission of the transactions contemplated by the Stock Purchase Agreement, an order restricting our Chief Executive Officer and our Chairman from purchasing additional shares of our common stock and an order directing us to take necessary actions to improve and reform our corporate governance and internal procedures to comply with applicable law, including ordering a shareholder vote on certain amendments to our by-laws or charter that would require half of our Board of Directors to be independent of Messrs. Kotick and Kelly and Vivendi and a proposal to appoint a new independent Chairman of the Board of Directors. The Company’s response to the Miller complaint is due on November 18, 2013.

 

In addition, on August 14, 2013, we received a letter dated August 9, 2013 from a shareholder seeking, pursuant to Section 220 of the Delaware General Corporation Law, to inspect the books and records of the Company to ascertain whether the Stock Purchase Transaction and Private Sale were in the best interests of the Company.  In response to that request, we provided the stockholder with certain materials under a confidentiality agreement. On September 11, 2013, a complaint was filed under seal by the same stockholder in the Court of Chancery of the State of Delaware in an action captioned Pacchia v. Kotick et al. , C.A. No. 8884-VCL. A public version of that complaint was filed on September 16, 2013. The allegations in the complaint were substantially similar to the allegations in the above referenced matter filed on August 1, 2013. On October 25, 2013, Pacchia filed an amended complaint under seal.  The amended complaint added claims on behalf of an alleged class of Activision stockholders other than the Company’s Chief Executive Officer and Chairman, Vivendi, ASAC, investors in ASAC and other stockholders affiliated with the investors of ASAC.  The added class claims are for breach of fiduciary duty against the Company’s Chief Executive Officer and Chairman, the Vivendi affiliated directors, the members of the special committee of the Board formed in connection with the Company’s consideration of the transactions with Vivendi and ASAC, and Vivendi, as well as aiding and abetting a breach of fiduciary duty against ASAC.  The amended complaint removed the derivative claims for waste of corporate assets and disgorgement but continued to allege derivative claims for breach of fiduciary duties. The amended complaint seeks, among other things, certification of a class, damages, reformation of the Private Sale, and disgorgement of any alleged profits received by the Company’s Chief Executive Officer, Chairman and ASAC.  On October 29, 2013, Pacchia filed a motion to consolidate the Pacchia case with the Hayes case described below.  On November 2, 2013, the Court of Chancery consolidated the Pacchia and Hayes cases and ordered the plaintiffs to file supplemental papers related to determining lead plaintiff and lead counsel no later than November 8, 2013.

 

Also, on September 11, 2013, another stockholder of the Company filed a putative class action and stockholder derivative action in the Court of Chancery of the State of Delaware, captioned Hayes v. Activision Blizzard, Inc., et al. , No. 8885-VCL. The complaint names our Board of Directors, Vivendi, New VH, ASAC, the General Partner of ASAC, Davis Selected Advisers, L.P. (“Davis”) and Fidelity Management & Research Co. (“FMR”) as defendants, and the Company as a nominal defendant. The complaint alleges that the defendants violated