Activision Blizzard, Inc.
Activision Blizzard, Inc. (Form: 10-Q, Received: 05/06/2014 16:17:50)

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, 2014

 

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 April 29, 2014 was 714,998,372.

 

 

 



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, 2014 and December 31, 2013

4

 

 

 

 

Condensed Consolidated Statements of Operations for the three months ended March 31, 2014 and March 31, 2013

5

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2014 and March 31, 2013

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and March 31, 2013

7

 

 

 

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity for the three months ended March 31, 2014

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

43

 

 

 

Item 4.

Controls and Procedures

44

 

 

 

PART II.

OTHER INFORMATION

45

 

 

 

Item 1.

Legal Proceedings

45

 

 

 

Item 1A.

Risk Factors

47

 

 

 

Item 6.

Exhibits

48

 

 

 

SIGNATURE

 

49

 

 

 

EXHIBIT INDEX

 

50

 

 

 

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 facts 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 involving the repurchase of shares from Vivendi, S.A., and the debt financing related thereto; 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, the current regulatory environment, litigation risks and associated costs, protection of proprietary rights, maintenance of relationships with key personnel, customers, financing providers, 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, 2013. 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.

 

3



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Amounts in millions, except share data)

 

 

 

At March 31,

 

At December 31,

 

 

 

2014

 

2013

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

4,279

 

$

4,410

 

Short-term investments

 

8

 

33

 

Accounts receivable, net of allowances of $264 and $381 at March 31, 2014 and December 31, 2013, respectively

 

219

 

510

 

Inventories, net

 

158

 

171

 

Software development

 

361

 

367

 

Intellectual property licenses

 

12

 

11

 

Deferred income taxes, net

 

336

 

321

 

Other current assets

 

321

 

418

 

Total current assets

 

5,694

 

6,241

 

 

 

 

 

 

 

Long-term investments

 

9

 

9

 

Software development

 

44

 

21

 

Property and equipment, net

 

152

 

138

 

Other assets

 

66

 

35

 

Intangible assets, net

 

41

 

43

 

Trademark and trade names

 

433

 

433

 

Goodwill

 

7,089

 

7,092

 

Total assets

 

$

13,528

 

$

14,012

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

166

 

$

355

 

Deferred revenues

 

1,092

 

1,389

 

Accrued expenses and other liabilities

 

635

 

636

 

Current portion of long-term debt

 

 

25

 

Total current liabilities

 

1,893

 

2,405

 

Long-term debt, net

 

4,320

 

4,668

 

Deferred income taxes, net

 

86

 

66

 

Other liabilities

 

305

 

251

 

Total liabilities

 

6,604

 

7,390

 

 

 

 

 

 

 

Commitments and contingencies (Note 13)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.000001 par value, 2,400,000,000 shares authorized, 1,143,446,956 and 1,132,385,424 shares issued at March 31, 2014 and December 31, 2013, respectively

 

 

 

Additional paid-in capital

 

9,812

 

9,682

 

Less: Treasury stock, at cost, 428,676,471 shares at March 31, 2014 and December 31, 2013

 

(5,783

)

(5,814

)

Retained earnings

 

2,832

 

2,686

 

Accumulated other comprehensive income

 

63

 

68

 

Total shareholders’ equity

 

6,924

 

6,622

 

Total liabilities and shareholders’ equity

 

$

13,528

 

$

14,012

 

 

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

 

4



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Amounts in millions, except per share data)

 

 

 

For the Three Months Ended

 

 

 

March 31,

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Net revenues

 

 

 

 

 

Product sales

 

$

769

 

$

990

 

Subscription, licensing, and other revenues

 

342

 

334

 

Total net revenues

 

1,111

 

1,324

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

Cost of sales — product costs

 

225

 

260

 

Cost of sales — online

 

58

 

57

 

Cost of sales — software royalties and amortization

 

57

 

61

 

Cost of sales — intellectual property licenses

 

2

 

38

 

Product development

 

143

 

125

 

Sales and marketing

 

104

 

107

 

General and administrative

 

95

 

89

 

Total costs and expenses

 

684

 

737

 

 

 

 

 

 

 

Operating income

 

427

 

587

 

 

 

 

 

 

 

Interest and other investment income (expense), net

 

(51

)

2

 

 

 

 

 

 

 

Income before income tax expense

 

376

 

589

 

 

 

 

 

 

 

Income tax expense

 

83

 

133

 

 

 

 

 

 

 

Net income

 

$

293

 

$

456

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

Basic

 

$

0.40

 

$

0.40

 

Diluted

 

$

0.40

 

$

0.40

 

 

 

 

 

 

 

Weighted-average number of shares outstanding

 

 

 

 

 

Basic

 

709

 

1,113

 

Diluted

 

720

 

1,120

 

 

 

 

 

 

 

Dividends per common share

 

$

0.20

 

$

0.19

 

 

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

 

5



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Amounts in millions)

 

 

 

For the Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Net income

 

$

293

 

$

456

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

Foreign currency translation adjustment

 

(5

)

(70

)

Unrealized gains on investments, net of deferred income taxes of $0 million for March 31, 2014 and 2013

 

 

1

 

Other comprehensive income (loss)

 

$

(5

)

$

(69

)

 

 

 

 

 

 

Comprehensive income

 

$

288

 

$

387

 

 

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

 

6



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Amounts in millions)

 

 

 

For the Three Months Ended March 31,

 

 

 

2014

 

2013

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

293

 

$

456

 

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

 

 

 

 

 

Deferred income taxes

 

6

 

140

 

Provision for inventories

 

9

 

8

 

Depreciation and amortization

 

19

 

24

 

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

 

51

 

83

 

Amortization of debt discount and debt financing costs

 

2

 

 

Stock-based compensation expense (2)

 

29

 

27

 

Excess tax benefits from stock awards

 

(17

)

(4

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

290

 

463

 

Inventories

 

5

 

39

 

Software development and intellectual property licenses

 

(71

)

(73

)

Other assets

 

111

 

93

 

Deferred revenues

 

(298

)

(511

)

Accounts payable

 

(189

)

(149

)

Accrued expenses and other liabilities

 

(104

)

(271

)

Net cash provided by operating activities

 

136

 

325

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities of available-for-sale investments

 

21

 

113

 

Purchases of available-for-sale investments

 

 

(26

)

Capital expenditures

 

(37

)

(17

)

Decrease (increase) in restricted cash

 

4

 

10

 

Net cash provided by (used in) investing activities

 

(12

)

80

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

119

 

33

 

Tax payment related to net share settlements on restricted stock rights

 

(13

)

(14

)

Excess tax benefits from stock awards

 

17

 

4

 

Repayment of long-term debt

 

(375

)

 

Net cash provided by (used in) financing activities

 

(252

)

23

 

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

(3

)

(88

)

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(131

)

340

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

4,410

 

3,959

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

4,279

 

$

4,299

 

 


(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.

 

7



Table of Contents

 

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Three Months Ended March 31, 2014

(Unaudited)

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Retained

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Earnings

 

Other

 

Total

 

 

 

Common Stock

 

Treasury Stock

 

Paid-In

 

(Accumulated

 

Comprehensive

 

Shareholders’

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Deficit)

 

Income (Loss)

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2013

 

1,132

 

$

 

(429

)

$

(5,814

)

$

9,682

 

$

2,686

 

$

68

 

$

6,622

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

293

 

 

293

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

(5

)

(5

)

Issuance of common stock pursuant to employee stock options

 

10

 

 

 

 

119

 

 

 

119

 

Issuance of common stock pursuant to restricted stock rights

 

2

 

 

 

 

 

 

 

 

Restricted stock surrendered for employees’ tax liability

 

(1

)

 

 

 

(27

)

 

 

(27

)

Tax benefit associated with employee stock awards

 

 

 

 

 

11

 

 

 

11

 

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

 

 

 

 

 

27

 

 

 

27

 

Dividends ($0.20 per common share)

 

 

 

 

 

 

(147

)

 

(147

)

Indemnity on tax attributes assumed in connection with the Purchase Transaction (see Note 10)

 

 

 

 

31

 

 

 

 

31

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2014

 

1,143

 

$

 

(429

)

$

(5,783

)

$

9,812

 

$

2,832

 

$

63

 

$

6,924

 

 

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

 

8



Table of Contents

 

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. (“Activision Blizzard”) 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 games for video game consoles, personal computers (“PC”), the Apple Mac (“Mac”), and handheld, mobile and tablet devices.  We maintain significant operations in the United States (“U.S.”), Canada, the United Kingdom (“U.K.”), France, Germany, Ireland, Italy, Sweden, Spain, the Netherlands, Australia, South Korea and China.

 

The Business Combination and Recently Consummated Share Repurchase

 

Activision Blizzard is the result of the 2008 business combination (“Business Combination”) by and among the Company (then known as 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.  As a result of the consummation of the Business Combination, Activision, Inc. was renamed Activision Blizzard, Inc. and Vivendi became a majority shareholder of Activision. The common stock of Activision Blizzard is traded on The NASDAQ Stock Market under the ticker symbol “ATVI.”

 

On October 11, 2013, we repurchased approximately 429 million shares of our common stock, pursuant to a 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 approximately 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 Activision Blizzard’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 7 of the Notes to Condensed Consolidated Financial Statements for further information regarding the financing of the Purchase Transaction.

 

As a result of the Purchase Transaction and the Private Sale, we ceased to be a controlled company and, as of March 31, 2014, we had approximately 715 million shares of our common stock issued and outstanding, of which Vivendi held approximately 12%, ASAC held approximately 24% and our other stockholders held approximately 64%.

 

Operating Segments

 

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

 

(i) Activision Publishing, Inc.

 

Activision Publishing, Inc. (“Activision”) is a leading international developer and publisher of interactive software products and content. Activision develops games based on internally-developed properties, including games in the Call of Duty® and Skylanders™ franchises, and to a lesser extent, based on licensed intellectual properties. Additionally, we have established a long-term alliance with Bungie to release its next big-action game universe, Destiny , in September 2014.  Activision sells games through both retail channels and digital downloads.  Activision delivers content to a broad range of gamers, ranging from children to adults, and from core gamers to mass-market consumers to “value” buyers seeking budget-priced software, in a variety of geographies.  Activision currently offers games that operate on the Microsoft Corporation (“Microsoft”) Xbox One (“Xbox One”) and Xbox 360 (“Xbox 360”), Nintendo Co. Ltd. (“Nintendo”) Wii U (“Wii U”) and Wii (“Wii”), and Sony Computer Entertainment, Inc. (“Sony”) PlayStation 4 (“PS4”) and PlayStation 3 (“PS3”) console systems (Xbox One, Wii U, and PS4 are collectively referred to as “next-generation”; Xbox 360, Wii, and PS3 are collectively referred to as “current-generation”); the PC; the Nintendo 3DS, Nintendo Dual Screen, and Sony PlayStation Vita handheld game systems; and other handheld and mobile devices.

 

9



Table of Contents

 

(ii) 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 its 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 consoles, including games in the multiple-award winning Diablo ® and StarCraft ® franchises.  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 in-game purchases and services; 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.  In addition, Blizzard is the creator of Hearthstone™: Heroes of Warcraft™ , a free-to-play digital collectible card game available on the PC and iPad, and is currently developing Heroes of the Storm™ , a new free-to-play online hero brawler.

 

(iii) Activision Blizzard Distribution

 

Our 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, 2013. 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.

 

2.               Inventories, Net

 

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

 

 

 

At March 31,

 

At December 31,

 

 

 

2014

 

2013

 

Finished goods

 

$

139

 

$

149

 

Purchased parts and components

 

19

 

22

 

 

 

 

 

 

 

Inventories, net

 

$

158

 

$

171

 

 

10



Table of Contents

 

Inventory reserves were $47 million and $42 million at March 31, 2014 and December 31, 2013, respectively.

 

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

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Internally developed software costs

 

$

186

 

$

189

 

Payments made to third-party software developers

 

219

 

199

 

Total software development costs

 

$

405

 

$

388

 

 

 

 

 

 

 

Intellectual property licenses

 

$

12

 

$

11

 

 

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 March 31,

 

 

 

2014

 

2013

 

Amortization of capitalized software development costs and intellectual property licenses

 

$

58

 

$

62

 

Write-offs and impairments

 

 

26

 

 

4.               Intangible Assets, Net

 

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

 

11



Table of Contents

 

 

 

At March 31, 2014

 

 

 

Estimated

 

Gross

 

 

 

 

 

 

 

useful

 

carrying

 

Accumulated

 

Net carrying

 

 

 

lives

 

amount

 

amortization

 

amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements and other

 

3 - 10 years

 

$

98

 

$

(90

)

$

8

 

Internally-developed franchises

 

11 - 12 years

 

309

 

(276

)

33

 

Total definite-lived intangible assets

 

 

 

$

407

 

$

(366

)

$

41

 

 

 

 

 

 

 

 

 

 

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

 

 

 

 

386

 

Acquired trade names

 

Indefinite

 

 

 

 

 

47

 

Total indefinite-lived intangible assets

 

 

 

 

 

 

 

$

433

 

 

 

 

At December 31, 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

 

$

(90

)

$

8

 

Internally-developed franchises

 

11 - 12 years

 

309

 

(274

)

35

 

Total definite-lived intangible assets

 

 

 

$

407

 

$

(364

)

$

43

 

 

 

 

 

 

 

 

 

 

 

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 $2 million and $3 million for the three months ended March 31, 2014 and 2013, respectively.

 

At March 31, 2014, future amortization of definite-lived intangible assets is estimated as follows (amounts in millions):

 

2014 (remaining nine months)

 

$

13

 

2015

 

12

 

2016

 

7

 

2017

 

4

 

2018

 

3

 

Thereafter

 

2

 

Total

 

$

41

 

 

5.               Goodwill

 

The changes in the carrying amount of goodwill by operating segment for the three months ended March 31, 2014 are as follows (amounts in millions):

 

12



Table of Contents

 

 

 

Activision

 

Blizzard

 

Total

 

 

 

 

 

 

 

 

 

Balance at December 31, 2013

 

$

6,914

 

$

178

 

$

7,092

 

Tax benefit credited to goodwill

 

(3

)

 

(3

)

Balance at March 31, 2014

 

$

6,911

 

$

178

 

$

7,089

 

 

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.

 

6.                  Fair Value Measurements

 

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.

 

Fair Value Measurements on a Recurring Basis

 

The table below segregates all of our 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

 

 

 

 

 

 

 

March 31, 2014 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

Significant

 

 

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

As of

 

Identical

 

Observable

 

Unobservable

 

 

 

 

 

March 31,

 

Assets

 

Inputs

 

Inputs

 

Balance Sheet

 

 

 

2014

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

4,017

 

$

4,017

 

$

 

$

 

Cash and cash equivalents

 

Foreign government treasury bills

 

36

 

36

 

 

 

Cash and cash equivalents

 

Auction rate securities (“ARS”)

 

9

 

 

 

9

 

Long-term investments

 

Total recurring fair value measurements

 

$

4,062

 

$

4,053

 

$

 

$

9

 

 

 

 

13



Table of Contents

 

 

 

 

 

Fair Value Measurements at

 

 

 

 

 

 

 

December 31, 2013 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

Significant

 

 

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

As of

 

Identical

 

Observable

 

Unobservable

 

 

 

 

 

December 31,

 

Assets

 

Inputs

 

Inputs

 

Balance Sheet

 

 

 

2013

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

4,000

 

$

4,000

 

$

 

$

 

Cash and cash equivalents

 

Foreign government treasury bills

 

30

 

30

 

 

 

Cash and cash equivalents

 

U.S. treasuries and government agency securities

 

21

 

21

 

 

 

Short-term investments

 

ARS

 

9

 

 

 

9

 

Long-term investments

 

Total recurring fair value measurements

 

$

4,060

 

$

4,051

 

$

 

$

9

 

 

 

 

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 March 31, 2014 and 2013, respectively:

 

 

 

Level 3

 

 

 

 

 

Total

 

 

 

 

 

financial

 

 

 

 

 

assets at

 

 

 

ARS

 

fair

 

 

 

(a)

 

value

 

Balance at December 31, 2013

 

$

9

 

$

9

 

Total unrealized gains included in other comprehensive income

 

 

 

Balance at March 31, 2014

 

$

9

 

$

9

 

 

 

 

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 March 31, 2013

 

$

9

 

$

9

 

 


(a)          Fair value measurements have been estimated using an income-approach model. 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 March 31, 2014, 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.

 

14



Table of Contents

 

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 which are generally 12 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 the counterparty since July 3, 2013. Since the consummation of the Purchase Transaction, our counterparties for our currency derivative contracts have been large and reputable commercial or investment banks. We did not have any outstanding foreign currency contracts at March 31, 2014.  The gross notional amount of outstanding foreign currency contracts was $34 million at December 31, 2013. 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, 2013.

 

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 sheets and the changes in fair value within “General and administrative expense” and “Interest and other investment income (expense), net” in our condensed consolidated statements of operations, depending on the nature of the contracts. For the three months ended March 31, 2014 and 2013, pre-tax net losses and gains were not material.

 

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 months ended March 31, 2014 and 2013, there were no impairment charges related to assets that are measured on a non-recurring basis.

 

7.               Debt

 

The proceeds from the credit facilities and the unsecured senior notes, as described below, were used to fund the Purchase Transaction disclosed in Note 1 of the Notes to Condensed Consolidated Financial Statements.

 

Credit Facilities

 

On October 11, 2013, in connection and simultaneously with the Purchase Transaction, we entered into a credit agreement (the “Credit Agreement”) for a $2.5 billion secured term loan facility maturing in October 2020 (the “Term Loan”), and a $250 million secured revolving credit facility maturing in October 2018 (the “Revolver” and, together with the Term Loan, the “Credit Facilities”). A portion of the Revolver can be used to issue letters of credit of up to $50 million, subject to the availability of the Revolver.  To date, we have not drawn on the Revolver.

 

Borrowings under the Term Loan and the Revolver bear interest, payable on a quarterly basis, at an annual rate equal to an applicable margin plus, at our option, (A) a base rate determined by reference to the highest of (a) the interest rate in effect determined by the administrative agent as its “prime rate,” (b) the federal funds rate plus 0.5%, and (c) the London InterBank Offered Rate (“LIBOR”) rate for an interest period of one month plus 1.00%, or (B) LIBOR. Further, LIBOR borrowings under the Term Loan will be subject to a LIBOR floor of 0.75%.  At March 31, 2014, the Term Loan bore interest at 3.25%. In certain circumstances, our applicable interest rate under the Credit Facilities will increase.

 

In addition to paying interest on outstanding principal balances under the Credit Facilities, we are required to pay the lenders a commitment fee on unused commitments under the Revolver. Commitment fees are recorded within “Interest and other investment income (expense), net” on the condensed consolidated statement of operations. We are also required to pay customary letter of credit fees and agency fees.

 

We are required to make quarterly principal repayments of 0.25% of the Term Loan’s original principal amount, with the balance due on the maturity date.  On February 11, 2014, we made a voluntary repayment of $375 million on our Term Loan.  This repayment satisfied the required quarterly principal repayments.  Since this voluntary principal repayment was not a contractual requirement as of December 31, 2013 and the Board of Directors did not approve the repayment until January 2014, only the contractual principal repayment of $25 million for 2014 has been reflected as “Current portion of long-term debt” in our condensed consolidated balance sheet as of December 31, 2013.  Amounts borrowed under the Term Loan and repaid may not be re-borrowed.

 

15



Table of Contents

 

The Credit Facilities are guaranteed by certain of the Company’s U.S. subsidiaries, whose assets represent approximately 69% of our consolidated assets.  The Credit Agreement contains 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.  If our obligations under the Revolver exceed 15% of the total amount of that facility as of the end of any fiscal quarter (subject to certain exclusions for letters of credit), we are also subject to certain financial covenants. A violation of any of these covenants could result in an event of default under the Credit Agreement.  Upon the occurrence of such event of default or certain other customary events of default, payment of any outstanding amounts under the Credit Agreement may be accelerated, and the lenders’ commitments to extend credit under the Credit Agreement may be terminated.  In addition, an event of default under the Credit Agreement could, under certain circumstances, permit the holders of other outstanding unsecured debt, including the debt holders described below, to accelerate the repayment of such obligations. The Company was in compliance with the terms of the Credit Facilities as of March 31, 2014.

 

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.

 

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 above. The Notes are guaranteed on a senior basis by certain of our U.S. subsidiaries . 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. 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 March 31, 2014.

 

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 March 31, 2014 and December 31, 2013, we had interest payable of $6 million and $38 million, respectively, related to the Notes recorded within “Accrued expenses and other liabilities” in our condensed consolidated balance sheets.

 

We may redeem the 2021 Notes on or after September 15, 2016 and the 2023 Notes on or after September 15, 2018, in each case, 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 were not accounted for separately upon issuance.

 

Fees associated with the closing of the Term Loan and the Notes are recorded as debt discount, which reduce the carrying value of the Term Loan and the Notes. The debt discount is amortized over the respective terms of the Term Loan and the Notes. Amortization expense related to the debt discount is recorded within “Interest and other investment income (expense), net” in our condensed consolidated statement of operations.

 

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

 

16



Table of Contents

 

 

 

March 31, 2014

 

 

 

Gross Carrying

 

Unamortized

 

Net Carrying

 

 

 

Amount

 

Discount

 

Amount

 

Term Loan

 

$

2,119

 

$

(12

)

$

2,107

 

2021 Notes

 

1,500

 

(25

)

1,475

 

2023 Notes

 

750

 

(12

)

738

 

Total debt

 

$

4,369

 

$

(49

)

$

4,320

 

Less: current portion of long-term debt

 

 

 

 

Total long-term debt

 

$

4,369

 

$

(49

)

$

4,320

 

 

 

 

December 31, 2013

 

 

 

Gross Carrying

 

Unamortized

 

Net Carrying

 

 

 

Amount

 

Discount

 

Amount

 

Term Loan

 

$

2,494

 

$

(12

)

$

2,482

 

2021 Notes

 

1,500

 

(26

)

1,474

 

2023 Notes

 

750

 

(13

)

737

 

Total debt

 

$

4,744

 

$

(51

)

$

4,693

 

Less: current portion of long-term debt

 

(25

)

 

(25

)

Total long-term debt

 

$

4,719

 

$

(51

)

$

4,668

 

 

For the three months ended March 31, 2014, interest expense was $51 million, amortization of the debt discount for the Credit Facilities and Notes was $2 million, and commitment fees for the Revolver were not material.

 

As of March 31, 2014, the scheduled maturities and contractual principal repayments of our debt for each of the five succeeding years are as follows (amounts in millions):

 

For the year ending December 31,

 

 

 

2014 (remaining nine months)

 

$

 

2015

 

 

2016

 

 

2017

 

 

2018

 

 

Thereafter

 

4,369

 

Total

 

$

4,369

 

 

As of March 31, 2014 and December 31, 2013, the carrying value of the Term Loan approximates the fair value, based on Level 2 inputs, as the interest rate is variable over the selected interest period and is similar to current rates at which we can borrow funds. Based on Level 2 inputs (observable market prices in less than active market), the fair values of the 2021 Notes and 2023 Notes were $1,599 million and $816 million, respectively, at March 31, 2014 and $1,559 million and $785 million, respectively, at December 31, 2013.

 

Deferred Financing Costs

 

Costs incurred to obtain our long-term debt are recorded as deferred financing costs within “Other assets — non-current” in our condensed consolidated balance sheets and are amortized over the terms of the respective debt agreements using a straight-line basis for costs related to the Revolver and the interest earned method for costs related to the Term Loan and Notes.  Amortization expense related to the deferred financing costs is recorded within “Interest and other investment income (expense), net” in our condensed consolidated statement of operations.  For the three months ended March 31, 2014, this amount was not material.

 

17



Table of Contents

 

8.               Accumulated Other Comprehensive Income (Loss)

 

The components of accumulated other comprehensive income (loss) at March 31, 2014 and 2013, were as follows (amounts in millions):

 

 

 

For the Three Months Ended March 31, 2014

 

 

 

Foreign currency

 

Unrealized gain

 

 

 

 

 

translation

 

on available-for-

 

 

 

 

 

adjustments

 

sale securities

 

Total

 

Balance at December 31, 2013

 

$

67

 

$

1

 

$

68

 

Other comprehensive income (loss) before reclassifications

 

(5

)

 

(5

)

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

 

 

Balance at March 31, 2014

 

$

62

 

$

1

 

$

63

 

 

 

 

For the Three Months Ended March 31, 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

 

(70

)

1

 

(69

)

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

 

 

Balance at March 31, 2013

 

$

(96

)

$

1

 

$

(95

)

 

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, restructuring expense, amortization of intangible assets as a result of purchase price accounting, impairment of goodwill and intangible assets, 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 months ended March 31, 2014 and 2013 are presented below (amounts in millions):

 

18



Table of Contents

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

Income (loss) from operations

 

 

 

 

 

 

 

operations before income

 

 

 

Net revenues

 

tax expense

 

Activision

 

$

237

 

$

423

 

$

2

 

$

112

 

Blizzard

 

462

 

330

 

239

 

135

 

Distribution

 

73

 

51

 

(1

)

 

Operating segments total

 

772

 

804

 

240

 

247

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

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

 

339

 

520

 

219

 

369

 

Stock-based compensation expense

 

 

 

(30

)

(26

)

Amortization of intangible assets

 

 

 

(2

)

(3

)

Consolidated net revenues / operating income

 

$

1,111

 

$

1,324

 

427

 

587

 

Interest and other investment income (expense), net

 

 

 

 

 

(51

)

2

 

Consolidated income before income tax expense

 

 

 

 

 

$

376

 

$

589

 

 

Geographic information presented below for the three months ended March 31, 2014 and 2013 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,

 

 

 

2014

 

2013

 

Net revenues by geographic region:

 

 

 

 

 

North America

 

$

563

 

$

738

 

Europe

 

462

 

487

 

Asia Pacific

 

86

 

99

 

Total consolidated net revenues

 

$

1,111

 

$

1,324

 

 

The Company’s net revenues in the U.S. were 48%, and 53% of consolidated net revenues for the three months ended March 31, 2014 and 2013, respectively.  The Company’s net revenues in the U.K. were 15% and 12% of consolidated net revenues for the three months ended March 31, 2014 and 2013, respectively. The Company’s net revenues in France were 13% and 12% of consolidated net revenues for the three months ended March 31, 2014 and 2013, respectively.  No other country’s net revenues exceeded 10% of consolidated net revenues.

 

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

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Net revenues by platform:

 

 

 

 

 

Console

 

$

654

 

$

749

 

Online (1)

 

201

 

275

 

PC

 

100

 

93

 

Mobile and other (2)

 

83

 

156

 

Total Activision Blizzard net revenues

 

1,038

 

1,273

 

Distribution

 

73

 

51

 

Total consolidated net revenues

 

$

1,111

 

$

1,324

 

 

19



Table of Contents

 


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

 

(2)                                  Revenues from mobile and 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 March 31, 2014 and December 31, 2013 were as follows (amounts in millions):

 

 

 

At March 31,

 

At December 31,

 

 

 

2014

 

2013

 

Long-lived assets* by geographic region:

 

 

 

 

 

North America

 

$

107

 

$

102

 

Europe

 

36

 

29

 

Asia Pacific

 

9

 

7

 

Total long-lived assets by geographic region

 

$

152

 

$

138

 

 


*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 customers that accounted for 10% or more of consolidated net revenues for the three months ended March 31, 2014 and 2013.

 

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 our 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 $83 million for the three months ended March 31, 2014 reflected an effective tax rate of 22.1%, which is slightly lower than the effective tax rate of 22.6% for the three months ended March 31, 2013. This decrease is primarily due to a deferred tax benefit in the current year in foreign jurisdictions and is partially offset by the expiration of the federal research credit.

 

The effective tax rate of 22.1% for the three months ended March 31, 2014 differed from the U.S. statutory rate of 35.0%, primarily due to the amount of foreign earnings at relatively lower statutory rates, as compared to domestic earnings at relatively higher statutory rates, recognition of California research and development credits and federal domestic production deductions, offset by increases to the Company’s reserve for uncertain tax positions.

 

The overall effective income tax rate for the year could be different from the effective tax rate for the three months ended March 31, 2014 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 2014 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.

 

20



Table of Contents

 

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.

 

In connection with the Purchase Transaction, we assumed certain tax attributes of New VH, which generally consist of New VH’s net operating loss (“NOL”) carryforwards of approximately $676 million, which represent a potential future tax benefit of approximately $237 million. The utilization of such NOL carryforwards will be subject to certain annual limitations and will begin to expire in 2021. The Company also obtained indemnification from Vivendi against losses attributable to the disallowance of claimed utilization of such NOL carryforwards of up to $200 million in unrealized tax benefits in the aggregate, limited to taxable years ending on or prior to December 31, 2016. No benefit for these tax attributes or indemnification was recorded upon the close of the Purchase Transaction as the benefit from these tax attributes did not meet the “more-likely-than-not” standard.

 

For the quarter ended March 31, 2014, we utilized $87 million of the NOL, which resulted in a benefit of $31 million, and a corresponding reserve was established as the position did not meet the “more-likely-than-not” standard. For the period ended March 31, 2014, an indemnification asset of $31 million has been recorded in “Other Assets”, and correspondingly, the same amount has been recorded as a reduction to the consideration paid for the shares repurchased in “Treasury Stock” (see Note 1 of the Notes to Condensed Consolidated Financial Statements for details about the share repurchase).

 

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 March 31,

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

Consolidated net income

 

$

293

 

$

456

 

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

 

(5

)

(5

)

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

 

(3

)

(5

)

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

 

285

 

446

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

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

 

709

 

1,113

 

 

 

 

 

 

 

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

 

11

 

7

 

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

 

720

 

1,120

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.40

 

$

0.40

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.40

 

$

0.40

 

 

Certain of our unvested restricted stock rights (including restricted stock units, restricted stock awards, and performance shares) met the definition of participating securities based on their respective rights to dividends or dividend equivalents.

 

21



Table of Contents

 

Therefore, 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, 2014 and 2013, we had outstanding unvested restricted stock rights that are participating in earnings with respect to 17 million and 26 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 the inclusion of such shares would be anti-dilutive. Therefore, options to acquire 3 million and 14 million shares of common stock were not included in the calculation of diluted earnings per common share for the three months ended March 31, 2014 and 2013, respectively, as the effect of their inclusion would be anti-dilutive.

 

Certain of our employee-related restricted stock rights are contingently issuable upon the satisfaction of pre-defined performance measures.  These shares are included in the weighted average dilutive common shares only if the performance measures are met as of the end of the reporting period.   Approximately 3 million shares are not included in the computation of diluted earnings per share for the three months ended March 31, 2014, as their respective performance measures have not been met.

 

See Note 1 of the Notes to Condensed Consolidated Financial Statements for details of the Purchase Transaction which reduced outstanding shares as compared to prior year.

 

12.    Capital Transactions

 

Stock Purchase Agreement

 

On October 11, 2013, as described in Note 1 of the Notes to Condensed Consolidated Financial Statements, we completed the Purchase Transaction, repurchasing approximately 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 7 of the Notes to Condensed Consolidated Financial Statements for financing details of the Purchase Transaction).  The repurchased shares were recorded in “Treasury Stock” in our condensed consolidated balance sheet.

 

Dividend

 

On February 6, 2014, our Board of Directors declared a cash dividend of $0.20 per common share, payable on May 14, 2014, to shareholders of record at the close of business on March 19, 2014. As such, we have included $147 million of dividends payable in “Accrued expense and other liabilities” and “Other liabilities” on our condensed consolidated balance sheet as of March 31, 2014.

 

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.

 

13.        Commitments and Contingencies

 

Letters of Credit

 

As described in Note 7 of the Notes to Condensed Consolidated Financial Statements, a portion of our Revolver can be used to issue letters of credit of up to $50 million, subject to the availability of the Revolver. At March 31, 2014, we did not issue any letter of credit under the Revolver.

 

Legal Proceedings

 

We are subject to various legal proceedings and claims. SEC regulations govern disclosure of legal proceedings in periodic report and 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.

 

22



Table of Contents

 

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, profitability, cash flows or liquidity.

 

Purchase Transaction Matters

 

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. On January 28, 2014, the parties filed a stipulation and proposed order temporarily staying the California action.  On February 6, 2014, the court entered the order granting a stay of the California action.

 

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 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 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 for breach of fiduciary duty, 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.  On December 3, 2013, the court selected Pacchia as lead plaintiff.  Pacchia filed a second amended complaint on December 11, 2013 and Activision filed an answer on January 31, 2014.  Also on January 31, 2014, the special committee, ASAC, Messrs. Kotick and Kelly, Vivendi and the Vivendi-affiliated directors each filed motions to dismiss certain claims in the second amended complaint. On February 21, 2014, Pacchia filed a third amended complaint under seal.  In response to Pacchia’s filing of a third amended complaint, the special committee, ASAC, Messrs. Kotick and Kelly, Vivendi and the Vivendi-affiliated directors each filed motions to dismiss certain claims in the third amended complaint. The Court of Chancery has set a hearing date of June 6, 2014 to consider the motions to dismiss such claims. The trial is scheduled for December 2014.

 

23



Table of Contents

 

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 certain provisions of our Amended and Restated Certificate of Incorporation by failing to submit the matters contemplated by the Stock Purchase Agreement for approval by a majority of our stockholders (other than Vivendi and its controlled affiliates); that our Board of Directors committed breaches of their fiduciary duties in approving the Stock Purchase Agreement; that Vivendi violated fiduciary duties owed to other stockholders of the Company in entering into the Stock Purchase Agreement; that our Chief Executive Officer and our Chairman usurped a corporate opportunity from the Company; that our Board of Directors and Vivendi have engaged in actions to entrench our Board of Directors and officers in their offices; that the ASAC Entities, Davis and FMR aided and abetted breaches of fiduciary duties by the Board of Directors and Vivendi; and that our Chief Executive Officer and our Chairman, the ASAC Entities, Davis and FMR will be unjustly enriched through the Private Sale. The complaint seeks, among other things, the rescission of the Private Sale; an order requiring the transfer to the Company of all or part of the shares that are the subject of the Private Sale; an order implementing measures to eliminate or mitigate the alleged entrenching effects of the Private Sale; an order requiring our Chief Executive Officer and our Chairman, the ASAC Entities, Davis and FMR to disgorge to the Company the amounts by which they have allegedly been unjustly enriched; and alleged damages sustained by the class and the Company. In addition, the stockholder sought a temporary restraining order preventing the defendants from consummating the transactions contemplated by the Stock Purchase Agreement without stockholder approval. Following a hearing on the motion for a temporary restraining order, on September 18, 2013, the Court of Chancery issued a preliminary injunction order, enjoining the consummation of the transactions contemplated by the Stock Purchase Agreement pending (a) the issuance of a final decision after a trial on the merits; (b) receipt of a favorable Activision Blizzard stockholder vote on the transactions contemplated by the Stock Purchase Agreement under Section 9.1(b) of our Amended and Restated Certificate of Incorporation or (c) modification of such preliminary injunction order by the Court of Chancery or the Delaware Supreme Court. On September 20, 2013, the Court of Chancery certified its order issuing the preliminary injunction for interlocutory appeal to the Delaware Supreme Court. The defendants moved the Delaware Supreme Court to accept and hear the appeal on an expedited basis. On September 23, 2013, the Delaware Supreme Court accepted the appeal of the Court of Chancery’s decision and granted the defendant’s motion to hear the appeal on an expedited basis.  Following a hearing on October 10, 2013, the Delaware Supreme Court reversed the Court of Chancery’s order issuing a preliminary injunction, and determined that the Stock Purchase Agreement was not a merger, business combination or similar transaction that would require a vote of Activision’s unaffiliated stockholders under the charter.

 

On October 29, 2013, an amended complaint was filed. It added factual allegations but no new claims or relief. Also on October 29, 2013, Hayes filed a motion to consolidate the Hayes case with the Pacchia case.  As noted above, 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.  See the discussion above related to the Pacchia matter (now the consolidated matter) for any further updates to the status of the litigation.

 

Further, on September 18, 2013, the Company received a letter from another purported stockholder of the Company, Milton Pfeiffer, seeking, pursuant to Section 220 of the Delaware General Corporation Law, to inspect the books and records of the Company to investigate potential wrongdoing or mismanagement in connection with the approval of the Stock Purchase Agreement.  On November 11, 2013, Pfeiffer filed a lawsuit in the Court of Chancery of the State of Delaware pursuant to Delaware Section 220 containing claims similar to Hayes , Pacchia and Miller .  The Company answered on November 27, 2013.  On January 21, 2014, the Court of Chancery entered the parties’ stipulation and order of dismissal.

 

On December 17, 2013, the Company received a letter from Mark Benston requesting certain books and records of the Company pursuant to Section 220 of the Delaware General Corporation Law.  Benston is represented by the same law firm as Pfeiffer.  On January 2, 2014, Benston filed a lawsuit in the Court of Chancery of the State of Delaware pursuant to Delaware Section 220 containing claims similar to Hayes , Pacchia , Pfeiffer and Miller .  The Company answered on January 17, 2014. On February 14, 2014, the Court of Chancery entered the parties’ stipulation and order of dismissal.

 

On March 14, 2014, Benston filed a putative class action and derivative complaint in the Court of Chancery, captioned Benston v. Vivendi S.A. et al. , No. 9447-VCL. The complaint makes claims similar to Hayes , Pacchia, Pfeiffer and Miller , but also adds J.P. Morgan Chase & Co. and J.P. Morgan Securities LLC as defendants and a so-called Brophy claim for insider trading against certain of the defendants. Benston and his attorneys have petitioned the Court of Chancery to appoint them as co-lead plaintiff and co-lead counsel, respectively, for purposes of pursuing the Brophy claim as part of the consolidated Pacchia litigation. The Court of Chancery will hear arguments on Benston’s motion for a leadership role in the consolidated Pacchia litigation on June 6, 2014.

 

We believe that the defendants have meritorious defenses and intend to defend each of these lawsuits vigorously. However, these lawsuits and any other lawsuits are subject to inherent uncertainties and the actual outcome and costs will depend upon many unknown factors. The outcome of litigation is necessarily uncertain, and the Company could be forced to expend significant resources in the defense of these lawsuits and may not prevail.

 

The Company also may be subject to additional claims in connection with the Purchase Transaction and Private Sale.

 

24



Table of Contents

 

Monitoring and defending against legal actions is time consuming for our management and detracts from our ability to fully focus our internal resources on our business activities. In addition, the Company may incur substantial legal fees and costs in connection with litigation and, although coverage may be available under relevant insurance policies, coverage could be denied or prove to be insufficient. Under our Amended and Restated Certificate of Incorporation and the indemnification agreements that the Company has entered into with our officers and directors, the Company may be required in certain circumstances to indemnify and advance expenses to them in connection with their participation in proceedings arising out of their service to us. There can be no assurance that any of these payments will not be material.

 

The Company is not currently able to estimate the range of possible losses or costs to us from these lawsuits and related indemnification obligations, as they are in the early stages and it cannot be determined how long it may take to resolve these matters. Moreover, the Company cannot be certain what the impact on our operations or financial position will be if any of the purported stockholder plaintiffs are successful in having the Stockholders Agreement dated October 11, 2013 among the Company, ASAC and, for limited purposes, Messrs. Kotick and Kelly (the “Stockholders Agreement”) reformed.  A decision adverse to the Company on these actions could result in the reformation of the Stockholders Agreement and could have a material adverse effect on our business, reputation, financial condition, results of operations, profitability, cash flows or liquidity.

 

Other Matters

 

In addition, we are party to routine claims, suits, investigations, audits and other proceedings arising from the ordinary course of business, including with respect to intellectual property rights, contractual claims, labor and employment matters, regulatory matters, tax matters, unclaimed property matters, compliance matters, and collection matters. In the opinion of management, after consultation with legal counsel, such routine claims and lawsuits are not significant and we do not expect them to have a material adverse effect on our business, financial condition, results of operations, or liquidity.

 

14.  Related Party Transactions

 

Transactions with Vivendi and Its Affiliates

 

As part of the Business Combination in 2008, we entered into various transactions and agreements, including cash management services agreements, a tax sharing agreement and an investor agreement, with Vivendi and its subsidiaries. In connection with the consummation of the Purchase Transaction, we terminated the cash management arrangements with Vivendi and amended our investor agreement with Vivendi. We are also party to a number of agreements with subsidiaries and other affiliates of Vivendi, including music licensing and distribution arrangements and promotional arrangements, none of which were impacted by the Purchase Transaction.  None of these services, transactions and agreements with Vivendi and its affiliates were material, either individually or in the aggregate, to the consolidated financial statements as a whole.

 

Transactions with ASAC’s Affiliates

 

Pursuant to the Stock Purchase Agreement, the Company and each of Mr. Kotick, the Company’s Chief Executive Officer, and Mr. Kelly, the Company’s Chairman of the board of directors, entered into certain waiver and acknowledgement letters (the “Waivers”), which provide, among other things, (i) that the Purchase Transaction, Private Sale, any public offerings by Vivendi and restructurings by Vivendi and its subsidiaries contemplated by the Stock Purchase Agreement and other transaction documents, shall not (or shall be deemed not to) constitute a “change in control” (or similar term) under their respective employment arrangements, including their employment agreements with the Company, the Company’s 2008 Incentive Plan or any award agreements in respect of awards granted thereunder, or any Other Benefit Plans and Arrangements (as defined in the Waivers), (ii) (A) that the shares of Activision Blizzard common stock acquired by ASAC and held or controlled by the ASAC Investors (as defined in the Waivers) in connection with the Transactions (as defined in the Waivers) will not be included in or count toward, (B) that the ASAC Investors will not be deemed to be a group for purposes of, and (C) any changes in the composition in the board of directors of the Company, in connection with or during the one-year period following the consummation of the Transactions will not contribute towards, a determination that a “change in control” or similar term has occurred with respect to Messrs. Kotick and Kelly’s employment arrangements with the Company, and (iii) for the waiver by Messrs. Kotick and Kelly of their rights to change in control payments or benefits under their employment agreements with the Company, the Company’s 2008 Incentive Plan or any award agreements in respect of awards granted thereunder, and any Other Benefit Plans and Arrangements (in each case, with respect to all current and future grants, awards, benefits or entitlements) in connection with or as a consequence of the Transactions.

 

25



Table of Contents

 

Also pursuant to the Stock Purchase Agreement, on October 11, 2013, we, ASAC and, for the limited purposes set forth therein, Messrs. Kotick and Kelly entered into a stockholders agreement. The stockholders agreement contains various agreements among the parties regarding voting rights, transfer rights, and a standstill agreement, among other things.

 

15.        Recently issued accounting pronouncements

 

Accounting for cumulative translation adjustments

 

In February 2013, the FASB issued an update to the authoritative guidance related to the release of cumulative translation adjustments into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a foreign entity. This update will be effective for fiscal years beginning after December 15, 2013. Upon adoption of this guidance on January 1, 2014, there was no material impact on our consolidated financial statements.

 

Presentation of unrecognized tax benefits

 

In July 2013, the FASB issued an update to the authoritative guidance related to the presentation of an unrecognized tax benefit in the financial statements. The update will require entities to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss or other tax credit carryforwards when settlement in this manner is available under the tax laws. This update is effective for fiscal years beginning after December 15, 2013. Upon our adoption of this guidance, “Deferred income taxes, net” under non-current liabilities increased by approximately $46 million, and correspondingly, “Other liabilities” under non-current liabilities decreased by the same amount in our condensed consolidated balance sheet as of December 31, 2013 to conform with the presentation as of March 31, 2014.

 

26



Table of Contents

 

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

 

Recently Consummated Share Repurchase and Related Debt Financing

 

On October 11, 2013, we repurchased approximately 429 million shares of our common stock, pursuant to a 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 approximately 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”). The Purchase Transaction was funded with a combination of $1.2 billion of cash on hand, the net proceeds from a $2.5 billion secured term loan facility, maturing in October 2020 (the “Term Loan”), and the net proceeds from the issuance of $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”). The repurchased shares were recorded in “Treasury Stock” in our condensed consolidated balance sheets.

 

Immediately following the completion of the Purchase Transaction, ASAC purchased from Vivendi 172 million shares of Activision Blizzard common stock, pursuant to the Stock Purchase Agreement, for a cash payment of $2.34 billion, or $13.60 per share (the “Private Sale”).  Robert A. Kotick, our Chief Executive Officer, and Brian G. Kelly, Chairman of our Board of Directors, are affiliates of ASAC II LLC.

 

As a result of the Purchase Transaction and the Private Sale, we ceased to be a controlled company and, as of March 31, 2014, we had approximately 715 million shares of our common stock issued and outstanding, of which Vivendi held approximately 12%, ASAC held approximately 24% and our other stockholders held approximately 64%.

 

For further details of our debt financing, refer to “Liquidity and Capital Resources” below, and Note 7 of the Notes to Condensed Consolidated Financial Statements.

 

Business Overview

 

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 games for video game consoles, personal computers (“PC”), and handheld, mobile and tablet devices. 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. Activision develops games based on internally-developed properties, including games in the Call of Duty® and Skylanders™ franchises, and to a lesser extent, based on licensed intellectual properties. Additionally, we have established a long-term alliance with Bungie to release its next big-action game universe, Destiny , in September 2014.  Activision sells games through both retail channels and digital downloads.  Activision delivers content to a broad range of gamers, ranging from children to adults, and from core gamers to mass-market consumers to “value” buyers seeking budget-priced software, in a variety of geographies.  Activision currently offers games that operate on the Microsoft Corporation (“Microsoft”) Xbox One (“Xbox One”) and Xbox 360 (“Xbox 360”), Nintendo Co. Ltd. (“Nintendo”) Wii U (“Wii U”) and Wii (“Wii”), and Sony Computer Entertainment, Inc. (“Sony”) PlayStation 4 (“PS4”) and PlayStation 3 (“PS3”) console systems (Xbox One, Wii U, and PS4 are collectively referred to as “next-generation”; Xbox 360, Wii, and PS3 are collectively referred to as “current-generation”); the PC; the Nintendo 3DS, Nintendo Dual Screen, and Sony PlayStation Vita handheld game systems; and other handheld and mobile devices.

 

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 its 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 consoles, including games in the multiple-award winning Diablo ® and StarCraft ® franchises.  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 in-game purchases and services; 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.  In addition, Blizzard released Hearthstone™: Heroes of Warcraft™ , a free-to-play digital collectible card game available on the PC and iPad, and is currently developing Heroes of the Storm™ , a new free-to-play online hero brawler.

 

27



Table of Contents

 

Activision Blizzard Distribution

 

Our 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.

 

Business Highlights

 

For the three months ended March 31, 2014, Activision Blizzard had net revenues of $1.1 billion, as compared to net revenues of $1.3 billion for the same period in 2013. Earnings per diluted share were $0.40 for the three months ended both March 31, 2014 and 2013.

 

As a result of the Purchase Transaction, we reduced our common shares outstanding by approximately 429 million shares, which has resulted in a lower weighted-average share count since the transaction closed on October 11, 2013. Additionally, for the three months ended March 31, 2014, interest expense of $51 million and associated tax benefits of $19 million were included in our consolidated net income, partially offsetting the earnings per share benefits from the reduction in our share count.  For details of our debt arrangements, our interest expense, and cash paid for interest, refer to Note 7 of the Notes to Condensed Consolidated Financial Statements included in Item 1, and Interest and Other Investment Income(Expense), Net,  and Liquidity and Capital Resources in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 2, of this Quarterly Report on Form 10-Q.

 

According to The NPD Group with respect to North America, GfK Chart-Track with respect to Europe, and Activision Blizzard internal estimates, during the first quarter of 2014:

 

·                   In North America and Europe combined, Activision Publishing had the #1 and #2 best-selling titles — Skylanders SWAP Force™ , including accessory packs and figures, and Call of Duty: Ghosts™ .

 

·                  In North America and Europe combined, Activision Publishing’s Skylanders SWAP Force was the #1 best-selling kids game overall in dollars.

 

·                   Blizzard Entertainment had the #1 PC title in dollars in both North America and Europe with Diablo III: Reaper of Souls™ .

 

·                   As of March 31, 2014, Blizzard Entertainment’s World of Warcraft remains the #1 subscription-based MMORPG, with approximately 7.6 million subscribers.

 

Activision Blizzard Recent and Upcoming Product Releases

 

We have recently released the following titles and games, among other titles:

 

·                   On March 10, 2014, Blizzard began accepting pre-purchases for World of Warcraft: Warlords of Draenor TM , which includes a character level 90 boost and value-added services, both of which are available immediately upon purchase.  World of Warcraft: Warlords of Draenor is expected to be released on or before December 20, 2014.

 

·                   Blizzard commercially released Hearthstone: Heroes of Warcraft on the PC on March 11, 2014, and released it on the iPad in April 2014.

 

·                   On March 25, 2014, Blizzard released Diablo III: Reaper of Souls™ , the first expansion pack to Blizzard’s action role-playing game Diablo III .

 

·                   On April 3, 2014, Activision released the second digital downloadable map pack for Call of Duty: Ghosts , Call of Duty: Ghosts Devastation (“ Devastation ”) on the Xbox One and Xbox 360.  Devastation is expected to be released on other platforms later in the second quarter of 2014.

 

28



Table of Contents

 

Management’s Overview of Business Trends

 

Online Content and Digital Downloads

 

We provide our products through both 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 over the Internet (from our websites and from websites owned by third parties).  In addition, we offer players digital downloadable content as add-ons to our products ( e.g. , new multi-player content packs), generally for a one-time fee. We also offer subscription-based services for World of Warcraft , which are digitally delivered and hosted by Battle.net, Blizzard’s proprietary online-game related service.

 

We currently define digital online channel-related sales as revenues from subscriptions, licensing royalties, value-added services, downloadable content, and digitally distributed products. This definition may differ from that used by our competitors or other companies.

 

For the three months ended March 31, 2014, revenues through digital online channels increased slightly by $2 million, as compared to the same period in 2013, and represented 34% of our total consolidated net revenues in the first quarter of 2014, as compared to 28% in the first quarter of 2013. Digital online channel revenues were a greater portion of total revenues in 2014 as compared to the prior year, because of the year-over-year decrease in retail channel revenues.  The slight increase in digital revenues year-over-year was mainly attributed to revenues from Hearthstone: Heroes of Warcraft, and the recognition of deferred revenues for Call of Duty: Black Ops II digital downloadable content, partially offset by lower recognition of deferred revenues from World of Warcraft: Mists of Pandaria, which was released in 2012, and lower subscription revenues from World of Warcraft . On a non-GAAP basis (which excludes the impact of deferred revenues), revenues through digital online channels for the three months ended March 31, 2014 increased by $98 million, as compared to the same period in 2013, and represented 68% of our total non-GAAP net revenues in the first quarter of 2014 as compared to 53% in 2013.  This increase was primarily due to revenues from Diablo III: Reaper of Souls , which was released in March 2014, and Hearthstone: Heroes of Warcraft, which was commercially released in March 2014, as compared to StarCraft II: Heart of the Swarm® , which was released in March 2013, and was partially offset by lower sales of digital downloadable content for Call of Duty: Ghosts, as compared to Call of Duty: Black Ops II in 2013.

 

Please refer to the reconciliation between GAAP and non-GAAP financial measures later in this document for further discussions of retail and digital online channels.

 

Our sales of digital downloadable content are driven in part by our sales of retail products.  Lower revenues in our retail distribution channel in the current year might impact our digital online channel revenues in the subsequent year.  Digital revenues remain an important part of our business, and we continue to focus on and develop products that can be delivered via digital online channels.  The amount of our digital revenues in any period may fluctuate depending, in part, on the timing and nature of our specific product releases.

 

We have further plans to introduce games, based on some of our most successful franchises, which operate online on a free-to-play model with microtransactions. These games include Blizzard’s Heroes of the Storm , and Activision’s Call of Duty™ Online .

 

Conditions in the Retail Distribution Channels

 

Conditions in the retail channels of the video games industry continued to be challenging during the first three months of 2014.  In the U.S. and Europe, retail sales of video games declined by 24% as compared to the same period in 2013, according to The NPD Group and GfK Chart-Track.  The decline was partially attributed to fewer releases in the first quarter of 2014, as compared to 2013, and the shift of Easter sales, which were in the first quarter of 2013, into the second quarter of 2014, as well as the overall impact of the console transition.

 

Concentration of Top Titles

 

The industry’s top five titles (including accessory packs and figures) accounted for 13% of the total industry software sales for the first quarter of 2014 and 2013.  However, the top five titles’ sales decreased by 25% for the three months ended March 31, 2014, as compared to the same period in 2013, reflecting the overall challenge of the console transition.  The console transition has negatively impacted sales of current-generation titles, which declined at a faster pace than the growth of sales for next-generation titles.

 

29



Table of Contents

 

Console Platform Transition

 

In November 2012, Nintendo released the Wii U, and in November 2013, Sony released the PS4 and Microsoft released the Xbox One, their respective next- generation game consoles and entertainment systems. According to The NPD Group and GfK Chart-Track, as of March 31, 2014, the installed base of PS4 and Xbox One hardware in the U.S. and Europe was approximately 11 million units.

 

When new console platforms are announced or introduced into the market, consumers may reduce their purchases of game console software products for current console platforms in anticipation of new platforms becoming available. During these periods, sales of the game console software products we publish may slow or even decline until new platforms are introduced and achieve wide consumer acceptance. Platform transitions may have a comparable impact on sales of downloadable content, amplifying the impact on our revenue. During platform transitions, we simultaneously incur costs to develop and market new titles for current-generation video game platforms, which may not sell at premium prices, and to develop and market products for next-generation platforms, which may not generate immediate or near-term revenues. We continually monitor console hardware sales and manage our product delivery on each of the current- and next-generation platforms in a manner we believe to be most effective to maximize our revenue opportunities and achieve the desired return on our investments in product development. Long term, we expect the new consoles to drive industry growth and expand our opportunities.

 

While the new console cycle has started strongly and demand for next-generation games was higher than expected, we expect that this will result in a lower-than-expected demand for current-generation games. For example, for the quarter ended March 31, 2014, we experienced slower catalog sales of Call of Duty: Ghosts, which was released in the fourth-quarter of 2013, than catalog sales of Call of Duty: Black Ops II , which was released in the fourth-quarter of 2012, during the same period in 2013.  We believe this is partly attributable to the console platform transition.

 

30



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,

 

 

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Net revenues:

 

 

 

 

 

 

 

 

 

Product sales

 

$

769

 

69

%

$

990

 

75

%

Subscription, licensing, and other revenues

 

342

 

31

 

334

 

25

 

Total net revenues

 

1,111

 

100

 

1,324

 

100

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of sales — product costs

 

225

 

20

 

260

 

20

 

Cost of sales — online

 

58

 

5

 

57

 

4

 

Cost of sales — software royalties and amortization

 

57

 

5

 

61

 

5

 

Cost of sales — intellectual property licenses

 

2

 

 

38

 

3

 

Product development

 

143

 

13

 

125

 

9

 

Sales and marketing

 

104

 

9

 

107

 

8

 

General and administrative

 

95

 

9

 

89

 

7

 

Total costs and expenses

 

684

 

61

 

737