Activision Blizzard, Inc.
Activision Blizzard, Inc. (Form: 10-Q, Received: 08/05/2014 17:15:50)

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 June 30, 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
incorporation or organization)

 

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

 

 

 

3100 Ocean Park Boulevard, Santa Monica, CA

 

90405

(Address of principal executive offices)

 

(Zip Code)

 

(310) 255-2000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x   No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer  x

 

Accelerated Filer  o

 

 

 

Non-accelerated filer  o

 

Smaller reporting company  o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

 

The number of shares of the registrant’s Common Stock outstanding at July 29, 2014 was 717,482,060.

 

 

 



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

 

Table of Con tents

 

 

Cautionary Statement

3

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets at June 30, 2014 and December 31, 2013

4

 

 

 

 

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2014 and June 30, 2013

5

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2014 and June 30, 2013

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and June 30, 2013

7

 

 

 

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity for the six months ended June 30, 2014

8

 

 

 

 

Notes to Condensed Consolidated Financial Statements

9

 

 

 

Item 2.

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

29

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

48

 

 

 

Item 4.

Controls and Procedures

49

 

 

 

PART II.

OTHER INFORMATION

49

 

 

 

Item 1.

Legal Proceedings

49

 

 

 

Item 1A.

Risk Factors

52

 

 

 

Item 6.

Exhibits

52

 

 

 

SIGNATURE

53

 

 

 

EXHIBIT INDEX

54

 

 

 

CERTIFICATIONS

 

 

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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 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,” “plan,” “plans,” “believes,” “may,” “might,” “expects,” “intends,” “intends as,” “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 and “toys to life” games, 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 transactions involving the repurchase of shares from 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.

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Amounts in millions, except share data)

 

 

 

At June 30,

 

At December 31,

 

 

 

2014

 

2013

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

4,199

 

$

4,410

 

Short-term investments

 

5

 

33

 

Accounts receivable, net of allowances of $246 and $381 at June 30, 2014 and December 31, 2013, respectively

 

107

 

510

 

Inventories, net

 

151

 

171

 

Software development

 

391

 

367

 

Intellectual property licenses

 

3

 

11

 

Deferred income taxes, net

 

359

 

321

 

Other current assets

 

259

 

418

 

Total current assets

 

5,474

 

6,241

 

 

 

 

 

 

 

Long-term investments

 

9

 

9

 

Software development

 

68

 

21

 

Property and equipment, net

 

162

 

138

 

Other assets

 

86

 

35

 

Intangible assets, net

 

39

 

43

 

Trademark and trade names

 

433

 

433

 

Goodwill

 

7,089

 

7,092

 

Total assets

 

$

13,360

 

$

14,012

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

167

 

$

355

 

Deferred revenues

 

769

 

1,389

 

Accrued expenses and other liabilities

 

507

 

636

 

Current portion of long-term debt

 

 

25

 

Total current liabilities

 

1,443

 

2,405

 

Long-term debt, net

 

4,321

 

4,668

 

Deferred income taxes, net

 

82

 

66

 

Other liabilities

 

343

 

251

 

Total liabilities

 

6,189

 

7,390

 

 

 

 

 

 

 

Commitments and contingencies (Note 14)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.000001 par value, 2,400,000,000 shares authorized, 1,145,378,067 and 1,132,385,424 shares issued at June 30, 2014 and December 31, 2013, respectively

 

 

 

Additional paid-in capital

 

9,853

 

9,682

 

Less: Treasury stock, at cost, 428,676,471 shares at June 30, 2014 and December 31, 2013

 

(5,762

)

(5,814

)

Retained earnings

 

3,036

 

2,686

 

Accumulated other comprehensive income

 

44

 

68

 

Total shareholders’ equity

 

7,171

 

6,622

 

Total liabilities and shareholders’ equity

 

$

13,360

 

$

14,012

 

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Amounts in millions, except per share data)

 

 

 

For the Three Months Ended
June 30,

 

For the Six Months Ended
June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

 

 

 

 

 

 

 

 

Product sales

 

$

587

 

$

727

 

$

1,357

 

$

1,717

 

Subscription, licensing, and other revenues

 

383

 

323

 

724

 

658

 

Total net revenues

 

970

 

1,050

 

2,081

 

2,375

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

Cost of sales — product costs

 

187

 

179

 

412

 

440

 

Cost of sales — online

 

56

 

54

 

115

 

111

 

Cost of sales — software royalties and amortization

 

46

 

38

 

102

 

99

 

Cost of sales — intellectual property licenses

 

11

 

14

 

13

 

52

 

Product development

 

112

 

123

 

255

 

247

 

Sales and marketing

 

141

 

116

 

245

 

223

 

General and administrative

 

107

 

96

 

202

 

186

 

Total costs and expenses

 

660

 

620

 

1,344

 

1,358

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

310

 

430

 

737

 

1,017

 

 

 

 

 

 

 

 

 

 

 

Interest and other investment income (expense), net

 

(50

)

 

(101

)

3

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense

 

260

 

430

 

636

 

1,020

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

56

 

106

 

139

 

240

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

204

 

$

324

 

$

497

 

$

780

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.28

 

$

0.28

 

$

0.68

 

$

0.68

 

Diluted

 

$

0.28

 

$

0.28

 

$

0.67

 

$

0.68

 

 

 

 

 

 

 

 

 

 

 

Weighted-average number of shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

716

 

1,118

 

712

 

1,116

 

Diluted

 

725

 

1,127

 

723

 

1,124

 

 

 

 

 

 

 

 

 

 

 

Dividends per common share

 

$

 

$

 

$

0.20

 

$

0.19

 

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Amounts in millions)

 

 

 

For the Three Months Ended

 

For the Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

204

 

$

324

 

$

497

 

$

780

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

(19

)

33

 

(24

)

(37

)

Unrealized gains on investments, net of deferred income taxes of $0 million for June 30, 2014 and 2013

 

 

 

 

1

 

Other comprehensive income (loss)

 

$

(19

)

$

33

 

$

(24

)

$

(36

)

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

185

 

$

357

 

$

473

 

$

744

 

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Amounts in millions)

 

 

 

For the Six Months Ended June 30,

 

 

 

2014

 

2013

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

497

 

$

780

 

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

 

 

 

 

 

Deferred income taxes

 

(21

)

209

 

Provision for inventories

 

20

 

12

 

Depreciation and amortization

 

38

 

47

 

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

 

97

 

126

 

Amortization of debt discount and debt financing costs

 

3

 

 

Stock-based compensation expense (2)

 

52

 

50

 

Excess tax benefits from stock awards

 

(23

)

(5

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

402

 

583

 

Inventories

 

1

 

64

 

Software development and intellectual property licenses

 

(161

)

(140

)

Other assets

 

182

 

132

 

Deferred revenues

 

(622

)

(974

)

Accounts payable

 

(190

)

(197

)

Accrued expenses and other liabilities

 

(33

)

(253

)

Net cash provided by operating activities

 

242

 

434

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities of available-for-sale investments

 

21

 

229

 

Purchases of available-for-sale investments

 

 

(26

)

Capital expenditures

 

(62

)

(36

)

Decrease in restricted cash

 

7

 

9

 

Net cash (used in) provided by investing activities

 

(34

)

176

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

137

 

51

 

Tax payment related to net share settlements on restricted stock rights

 

(34

)

(16

)

Excess tax benefits from stock awards

 

23

 

5

 

Dividends paid

 

(147

)

(216

)

Repayment of long-term debt

 

(375

)

 

Net cash used in financing activities

 

(396

)

(176

)

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

(23

)

(52

)

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(211

)

382

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

4,410

 

3,959

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

4,199

 

$

4,341

 

 


(1)          Excludes deferral and amortization of stock-based compensation expense.

(2)          Includes the net effects of capitalization, deferral, and amortization of stock-based compensation expense.

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Six Months Ended June 30, 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

 

 

 

 

 

 

497

 

 

497

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

(24

)

(24

)

Issuance of common stock pursuant to employee stock options

 

11

 

 

 

 

137

 

 

 

137

 

Issuance of common stock pursuant to restricted stock rights

 

3

 

 

 

 

 

 

 

 

Restricted stock surrendered for employees’ tax liability

 

(1

)

 

 

 

(34

)

 

 

(34

)

Tax benefit associated with employee stock awards

 

 

 

 

 

16

 

 

 

16

 

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

 

 

 

 

 

52

 

 

 

52

 

Dividends ($0.20 per common share)

 

 

 

 

 

 

(147

)

 

(147

)

Indemnity on tax attributes assumed in connection with the Purchase

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Transaction (see Note 11)

 

 

 

 

52

 

 

 

 

52

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2014

 

1,145

 

$

 

(429

)

$

(5,762

)

$

9,853

 

$

3,036

 

$

44

 

$

7,171

 

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.               Description of Business and Basis of Consolidation and Presentation

 

Description of Business

 

Activision Blizzard, Inc. (“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”), 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 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, Vivendi sold ASAC 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.

 

On May 28, 2014, as permitted by the investor agreement entered into in connection with the Purchase Transaction, Vivendi sold approximately 41 million shares, or approximately 50% of their then-current holdings, of our common stock in a registered public offering.  Vivendi received proceeds of approximately $850 million from that sale; we did not receive any proceeds. Vivendi currently owns approximately 41 million shares of our common stock, and is generally restricted from selling that stock until approximately fifteen months after the date on which the Purchase Transaction closed.

 

As a result of the Purchase Transaction, the Private Sale, and Vivendi’s sale of approximately 41 million shares of our common stock in May 2014, as of June 30, 2014, we had approximately 717 million shares of our common stock issued and outstanding, of which Vivendi held approximately 6%, ASAC held approximately 24% and our other stockholders held approximately 70%.

 

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 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 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 ™, which is anticipated to launch in September 2014.   Activision sells games through both retail and digital online channels.  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.

 

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(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

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) and accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim reporting. Accordingly, certain notes or other information that are normally required by U.S. GAAP have been condensed or omitted if they substantially duplicate the disclosures contained in the annual audited consolidated financial statements. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013.

 

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. 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.  Actual results could differ from these estimates and assumptions.

 

The accompanying condensed consolidated financial statements include the accounts and operations of the Company. All intercompany accounts and transactions have been eliminated.

 

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

 

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

 

Results of Adjustments

 

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

 

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2.      Inventories, Net

 

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

 

 

 

At June 30,

 

At December 31,

 

 

 

2014

 

2013

 

Finished goods

 

$

132

 

$

149

 

Purchased parts and components

 

19

 

22

 

 

 

 

 

 

 

Inventories, net

 

$

151

 

$

171

 

 

Inventory reserves were $56 million and $42 million at June 30, 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

 

 

 

June 30,

 

December 31,

 

 

 

2014

 

2013

 

Internally developed software costs

 

$

211

 

$

189

 

Payments made to third-party software developers

 

248

 

199

 

Total software development costs

 

$

459

 

$

388

 

 

 

 

 

 

 

Intellectual property licenses

 

$

3

 

$

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 June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Amortization of capitalized software development costs and intellectual property licenses

 

$

50

 

$

46

 

$

108

 

$

108

 

Write-offs and impairments

 

 

 

 

26

 

 

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4.      Intangible Assets, Net

 

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

 

 

 

At June 30, 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

 

$

(91

)

$

7

 

Internally-developed franchises

 

11 - 12 years

 

309

 

(277

)

32

 

Total definite-lived intangible assets

 

 

 

$

407

 

$

(368

)

$

39

 

 

 

 

 

 

 

 

 

 

 

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 $1 million and $3 million for the three and six months ended June 30, 2014, respectively.  Amortization expense of intangible assets was $3 million and $6 million for the three and six months ended June 30, 2013, respectively.

 

At June 30, 2014, future amortization of definite-lived intangible assets is estimated as follows (amounts in millions):

 

2014 (remaining six months)

 

$

11

 

2015

 

12

 

2016

 

7

 

2017

 

4

 

2018

 

3

 

Thereafter

 

2

 

Total

 

$

39

 

 

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5.               Goodwill

 

The changes in the carrying amount of goodwill by operating segment for the six months ended June 30, 2014 are as follows (amounts in millions):

 

 

 

Activision

 

Blizzard

 

Total

 

 

 

 

 

 

 

 

 

Balance at December 31, 2013

 

$

6,914

 

$

178

 

$

7,092

 

Tax benefit credited to goodwill

 

(3

)

 

(3

)

Balance at June 30, 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

 

 

 

 

 

 

 

June 30, 2014 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

Significant

 

 

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

As of

 

Identical

 

Observable

 

Unobservable

 

 

 

 

 

June 30,

 

Assets

 

Inputs

 

Inputs

 

Balance Sheet

 

 

 

2014

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Financial Assets:

 

 

 

 

 

 

 

 

 

 

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

4,005

 

$

4,005

 

$

 

$

 

Cash and cash equivalents

 

Foreign government treasury bills

 

37

 

37

 

 

 

Cash and cash equivalents

 

Auction rate securities (“ARS”)

 

9

 

 

 

9

 

Long-term investments

 

Total recurring fair value measurements

 

$

4,051

 

$

4,042

 

$

 

$

9

 

 

 

 

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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 June 30, 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 June 30, 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 June 30, 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 June 30, 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.

 

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Foreign Currency Forward Contracts

 

The Company transacts business in various foreign currencies and has significant international sales and expenses denominated in foreign currencies, subjecting us to foreign currency risk. In addition, the Company transacts intercompany business in various foreign currencies other than its functional currency, subjecting us to variability in the functional currency-equivalent cash flows. To mitigate our foreign currency risk resulting from our foreign currency-denominated monetary assets, liabilities, and earnings, and our foreign currency risk related to functional currency-equivalent cash flows resulting from our intercompany transactions, we periodically enter into currency derivative contracts, principally forward contracts with maturities of generally less than one year. We report the fair value of these contracts within “Other current assets” or “Other current liabilities” in our condensed consolidated balance sheets based on the prevailing exchange rates of the various hedged currencies as of the end of the relevant period.

 

We do not hold or purchase any foreign currency forward contracts for trading or speculative purposes.

 

Foreign Currency Forward Contracts Not Designated as Hedges

 

In the recent periods, the foreign currency forward contracts that we enter into to mitigate risk from foreign currency-denominated monetary assets, liabilities, and earnings were not designated as hedging instruments under FASB Accounting Standards Codification (“ASC”) Topic 815, Derivatives and Hedging (“ASC 815”). Changes in the estimated fair value of these derivatives are recorded within “General and administrative expenses” and “Interest and other investment income (expense), net” in our condensed consolidated statements of operations, depending on the nature of the underlying transactions.

 

At June 30, 2014, we did not have any outstanding foreign currency forward contracts that are not designated as hedges.  At December 31, 2013, the gross notional amount of outstanding foreign currency forward contracts not designated as hedges was $34 million. The fair value of these foreign currency forward contracts was not material as of December 31, 2013. For the three and six months ended June 30, 2014 and 2013, pre-tax net losses and gains associated with these forward contracts were not material.

 

Foreign Currency Forward Contracts Designated as Hedges

 

During the three months ended June 30, 2014, we entered into foreign currency forward contracts to hedge forecasted intercompany cash flows that are subject to foreign currency risk and designated them as cash flow hedges in accordance with ASC 815.  The Company assesses the effectiveness of these cash flow hedges at inception and on an ongoing basis and determines if the hedges are effective at providing offsetting changes in cash flows of the hedged items. The Company records the effective portion of changes in the estimated fair value of these derivatives in “Accumulated other comprehensive income (loss)” and subsequently reclassifies the related amount of accumulated other comprehensive income (loss) to earnings when the hedged item impacts earnings. The Company measures hedge ineffectiveness, if any, and if it is determined that a derivative has ceased to be a highly effective hedge, the Company will discontinue hedge accounting for the derivative.

 

The gross notional amount of all outstanding foreign currency forward contracts designated as cash flow hedges was approximately $119 million at June 30, 2014. The Company’s assets and liabilities at fair value were immaterial relating to these outstanding foreign currency forward contracts. During the three months ended June 30, 2014, there was no ineffectiveness relating to these hedges.

 

Fair Value Measurements on a Non-Recurring Basis

 

We measure the fair value of certain assets on a non-recurring basis, generally annually or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. For the three and six months ended June 30, 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.

 

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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 June 30, 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 statements of operations. We are also required to pay customary letter of credit fees and agency fees.

 

Under the terms of the Credit Agreement, 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 satisfies the required quarterly principal repayments for the entire term of the Credit Agreement.  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.

 

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 June 30, 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 June 30, 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 June 30, 2014 and December 31, 2013, we had interest payable of $38 million 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.

 

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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):

 

 

 

June 30, 2014

 

 

 

Gross Carrying

 

Unamortized

 

Net Carrying

 

 

 

Amount

 

Discount

 

Amount

 

Term Loan

 

$

2,119

 

$

(11

)

$

2,108

 

2021 Notes

 

1,500

 

(24

)

1,476

 

2023 Notes

 

750

 

(13

)

737

 

Total debt

 

$

4,369

 

$

(48

)

$

4,321

 

Less: current portion of long-term debt

 

 

 

 

Total long-term debt

 

$

4,369

 

$

(48

)

$

4,321

 

 

 

 

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 and six months ended June 30, 2014, interest expense was $50 million and $101 million, respectively, amortization of the debt discount for the Credit Facilities and Notes was $2 million and $3 million, respectively, and commitment fees for the Revolver were not material.

 

As of June 30, 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 six months)

 

$

 

2015

 

 

2016

 

 

2017

 

 

2018

 

 

Thereafter

 

4,369

 

Total

 

$

4,369

 

 

As of June 30, 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 markets), the fair values of the 2021 Notes and 2023 Notes were $1,618 million and $829 million, respectively, at June 30, 2014 and $1,559 million and $785 million, respectively, at December 31, 2013.

 

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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 statements of operations.  For the three and six months ended June 30, 2014, this amount was not material.

 

8.     Accumulated Other Comprehensive Income (Loss)

 

The components of accumulated other comprehensive income (loss) at June 30, 2014 and 2013, were as follows (amounts in millions):

 

 

 

For the Six Months Ended June 30, 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

 

(24

)

 

(24

)

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

 

 

Balance at June 30, 2014

 

$

43

 

$

1

 

$

44

 

 

 

 

For the Six Months Ended June 30, 2013

 

 

 

Foreign currency

 

Unrealized gain

 

 

 

 

 

translation

 

on available-for-

 

 

 

 

 

adjustments

 

sale securities

 

Total

 

Balance at December 31, 2012

 

$

(26

)

$

 

$

(26

)

Other comprehensive income (loss) before reclassifications

 

(37

)

1

 

(36

)

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

 

 

Balance at June 30, 2013

 

$

(63

)

$

1

 

$

(62

)

 

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.

 

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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 and six months ended June 30, 2014 and 2013 are presented below (amounts in millions):

 

 

 

Three Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

Income (loss) from operations

 

 

 

Net revenues

 

before income tax expense

 

Activision

 

$

252

 

$

347

 

$

(31

)

$

60

 

Blizzard

 

340

 

224

 

145

 

60

 

Distribution

 

66

 

37

 

(1

)

(1

)

Operating segments total

 

658

 

608

 

113

 

119

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

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

 

312

 

442

 

220

 

338

 

Stock-based compensation expense

 

 

 

(22

)

(24

)

Amortization of intangible assets

 

 

 

(1

)

(3

)

Consolidated net revenues / operating income

 

$

970

 

$

1,050

 

310

 

430

 

Interest and other investment income (expense), net

 

 

 

 

 

(50

)

 

Consolidated income before income tax expense

 

 

 

 

 

$

260

 

$

430

 

 

 

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

Income (loss) from operations

 

 

 

Net revenues

 

before income tax expense

 

Activision

 

$

489

 

$

771

 

$

(29

)

$

173

 

Blizzard

 

801

 

554

 

383

 

194

 

Distribution

 

140

 

88

 

(1

)

(1

)

Operating segments total

 

1,430

 

1,413

 

353

 

366

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

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

 

651

 

962

 

440

 

707

 

Stock-based compensation expense

 

 

 

(53

)

(50

)

Amortization of intangible assets

 

 

 

(3

)

(6

)

Consolidated net revenues / operating income

 

$

2,081

 

$

2,375

 

$

737

 

$

1,017

 

Interest and other investment income (expense), net

 

 

 

 

 

(101

)

3

 

Consolidated income before income tax expense

 

 

 

 

 

$

636

 

$

1,020

 

 

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Geographic information presented below for the three and six months ended June 30, 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 June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net revenues by geographic region:

 

 

 

 

 

 

 

 

 

North America

 

$

471

 

$

562

 

$

1,035

 

$

1,300

 

Europe

 

395

 

402

 

856

 

889

 

Asia Pacific

 

104

 

86

 

190

 

186

 

Total consolidated net revenues

 

$

970

 

$

1,050

 

$

2,081

 

$

2,375

 

 

The Company’s net revenues in the U.S. were 46%, and 51% of consolidated net revenues for the three months ended June 30, 2014 and 2013, respectively.  The Company’s net revenues in the U.K. were 14% and 12% of consolidated net revenues for the three months ended June 30, 2014 and 2013, respectively. The Company’s net revenues in France were 16% and 13% of consolidated net revenues for the three months ended June 30, 2014 and 2013, respectively.  No other country’s net revenues exceeded 10% of consolidated net revenues.

 

The Company’s net revenues in the U.S. were 47%, and 52% of consolidated net revenues for the six months ended June 30, 2014 and 2013, respectively.  The Company’s net revenues in the U.K. were 14% and 12% of consolidated net revenues for the six months ended June 30, 2014 and 2013, respectively. The Company’s net revenues in France were 15% and 12% of consolidated net revenues for the six months ended June 30, 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 June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net revenues by platform:

 

 

 

 

 

 

 

 

 

Console

 

$

479

 

$

590

 

$

1,134

 

$

1,339

 

Online (1)

 

195

 

233

 

395

 

508

 

PC

 

182

 

100

 

281

 

195

 

Mobile and other (2)

 

48

 

90

 

131

 

245

 

Total Activision Blizzard net revenues

 

904

 

1,013

 

1,941

 

2,287

 

Distribution

 

66

 

37

 

140

 

88

 

Total consolidated net revenues

 

$

970

 

$

1,050

 

$

2,081

 

$

2,375

 

 


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

 

(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 June 30, 2014 and December 31, 2013 were as follows (amounts in millions):

 

 

 

At June 30,

 

At December 31,

 

 

 

2014

 

2013

 

Long-lived assets* by geographic region:

 

 

 

 

 

North America

 

$

120

 

$

102

 

Europe

 

34

 

29

 

Asia Pacific

 

8

 

7

 

Total long-lived assets by geographic region

 

$

162

 

$

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 and six months ended June 30, 2014 and 2013.

 

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10. Stock-Based Compensation

 

On June 5, 2014, our shareholders approved the Activision Blizzard, Inc. 2014 Incentive Plan (the “2014 Plan”) and the 2014 Plan became effective. The 2014 Plan authorizes the Compensation Committee of our Board of Directors to provide equity-based compensation in the form of stock options, share appreciation rights, restricted stock, restricted stock units, performance shares, performance units and other performance- or value-based awards structured by the Compensation Committee within parameters set forth in the 2014 Plan, including custom awards that are denominated or payable in, valued in whole or in part by reference to, or otherwise based on or related to, shares of our common stock, or factors that may influence the value of our common stock or that are valued based on our performance or the performance of any of our subsidiaries or business units or other factors designated by the Compensation Committee, as well as incentive bonuses, for the purpose of providing incentives and rewards for superior performance to the directors, officers, employees of, and consultants to, Activision Blizzard and its subsidiaries.

 

While the Compensation Committee has broad discretion to create equity incentives, our stock-based compensation program currently primarily utilizes a combination of options and restricted stock units. Options have time-based vesting schedules, generally vesting annually over a period of three to five years, and all options expire ten years from the grant date. Restricted stock units either have time-based vesting schedules, generally vesting in their entirety on an anniversary of the date of grant or vesting annually over a period of three to five years, or they vest only if certain performance measures are met. In addition, under the terms of the 2014 Plan, the exercise price for the options must be equal to or greater than the closing price per share of our common stock on the date the award is granted, as reported on NASDAQ.

 

Upon the effective date of the 2014 Plan, we ceased making awards under the following equity incentive plans (collectively, the “Prior Plans”), although such plans will remain in effect and continue to govern outstanding awards:  (i) Activision, Inc. 1998 Incentive Plan, as amended; (ii) Activision, Inc. 1999 Incentive Plan, as amended; (iii) Activision, Inc. 2001 Incentive Plan, as amended; (iv) Activision, Inc. 2002 Incentive Plan, as amended; (v) Activision, Inc. 2002 Executive Incentive Plan, as amended; (vi) Activision, Inc. 2002 Studio Employee Retention Incentive Plan, as amended; (vii) Activision, Inc. 2003 Incentive Plan, as amended; (viii) Activision, Inc. 2007 Incentive Plan; and (ix) Activision Blizzard, Inc. 2008 Incentive Plan.

 

As of the date it was approved by our shareholders, there were 46 million shares available for issuance under the 2014 Plan.  The number of shares of our common stock reserved for issuance under the 2014 Plan may be further increased from time to time by:  (i) the number of shares relating to awards outstanding under any Prior Plan that:  (a) expire, or are forfeited, terminated or cancelled, without the issuance of shares; (b) are settled in cash in lieu of shares; or (c) are exchanged, prior to the issuance of shares of our common stock, for awards not involving our common stock; (ii) if the exercise price of any option outstanding under any Prior Plan is, or the tax withholding requirements with respect to any award outstanding under any Prior Plan are, satisfied by withholding shares otherwise then deliverable in respect of the award or the actual or constructive transfer to the Company of shares already owned, the number of shares equal to the withheld or transferred shares; and (iii) if a share appreciation right is exercised and settled in shares, a number of shares equal to the difference between the total number of shares with respect to which the award is exercised and the number of shares actually issued or transferred. As of June 30, 2014, we had approximately 47 million shares of our common stock reserved for future issuance under the 2014 Plan. Shares issued in connection with awards made under the 2014 Plan are generally issued as new stock issuances.

 

11.  Income Taxes

 

The Company accounts for its provision for income taxes in accordance with 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, changes in 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 $56 million for the three months ended June 30, 2014 reflected an effective tax rate of 21.5%, which is lower than the effective tax rate of 24.7% for the three months ended June 30, 2013. The income tax expense of $139 million for the six months ended June 30, 2014 reflected an effective tax rate of 21.8%, which is lower than the effective tax rate of 23.5% for the six months ended June 30, 2013.  These decreases are primarily due to a deferred tax benefit recognized in the current year in foreign jurisdictions, partially offset by the expiration of the federal research credit.

 

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The effective tax rate of 21.5% and 21.8% for the three and six months ended June 30, 2014, respectively, differed from the U.S. statutory rate of 35.0%, primarily due to the amount of foreign earnings taxed at relatively lower statutory rates, as compared to domestic earnings taxed at relatively higher statutory rates, and recognition of California research and development credits and federal domestic production deductions, partially 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 and six months ended June 30, 2014 and will be dependent, in part, on our profitability for the remainder of the year. Our effective income tax rates for the remainder of 2014 and future periods will depend on a variety of other 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 our pre-tax income is lower than anticipated in foreign regions, where taxes are levied at relatively lower statutory rates, and/or our pre-tax income is higher than anticipated in the United States, where taxes are levied at relatively higher statutory rates.

 

The Internal Revenue Service (“IRS”) is currently examining Activision Blizzard’s federal tax returns for the 2008 and 2009 tax years and during the second quarter of 2014, the Company was notified that our tax returns for the 2010 and 2011 tax years will be subject to examination.  Additionally, the IRS is currently reviewing the Company’s application for an advanced pricing agreement (“APA”) covering tax years 2010 through 2016.  An APA is an agreement between a taxpayer and a taxing authority on an appropriate intercompany transfer pricing methodology for a specific period of time.  If ongoing discussions with the IRS result in a mutually acceptable APA, this could result in a different allocation of profits and losses under the Company’s transfer pricing agreements.  Such allocation could have an impact on the Company’s provision for uncertain tax positions for the period in which such an agreement is reached and the relevant periods thereafter.

 

In addition, Vivendi Games’ tax returns for the 2005 through 2008 tax years are under examination by the Internal Revenue Service. 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 six months ended June 30, 2014, we utilized $147 million of the NOL, which resulted in a benefit of $52 million, and a corresponding reserve was established as the position did not meet the “more-likely-than-not” standard.  In addition, for the six months ended June 30, 2014, an indemnification asset of $52 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).

 

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12.        Computation of Basic/Diluted Earnings Per Common Share

 

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

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Numerator: