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Activision Blizzard 10-Q 2009

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, 2009

 

 

 

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

 

GRAPHIC

 

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 o No o

 

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

 

Large Accelerated Filer x

 

Accelerated Filer o       

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

The number of shares of the registrant’s Common Stock outstanding at May 1, 2009 was 1,286,763,247.

 

 

 



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

 

Table of Contents

 

 

Explanatory Note

3

 

 

 

 

Cautionary Statement

3

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets at March 31, 2009 and December 31, 2008

4

 

 

 

 

Condensed Consolidated Statements of Operations for the three months ended March 31, 2009 and March 31, 2008

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2009 and March 31, 2008

6

 

 

 

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity for the three months ended March 31, 2009

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements

8

 

 

 

Item 2.

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

24

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

35

 

 

 

Item 4.

Controls and Procedures

36

 

 

 

PART II.

OTHER INFORMATION

37

 

 

 

Item 1.

Legal Proceedings

37

 

 

 

Item 1A.

Risk Factors

37

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

37

 

 

 

Item 6.

Exhibits

37

 

 

 

SIGNATURE

 

38

 

 

 

EXHIBIT INDEX

 

39

 

 

 

CERTIFICATIONS

 

 

 

2



Table of Contents

 

EXPLANATORY NOTE

 

On July 9, 2008, a business combination by and among Activision, Inc., Sego Merger Corporation, a wholly-owned subsidiary of Activision, Inc., Vivendi S.A. (“Vivendi”), VGAC LLC, a wholly-owned subsidiary of Vivendi, and Vivendi Games, Inc., a wholly-owned subsidiary of VGAC LLC, was consummated.  As a result of the consummation of the business combination, Activision, Inc. was renamed Activision Blizzard, Inc.  For accounting purposes, the business combination is treated as a “reverse acquisition,” with Vivendi Games, Inc. deemed to be the acquirer.  The historical financial statements of Activision Blizzard, Inc. prior to July 9, 2008 are those of Vivendi Games, Inc. (see Note 1 of Condensed Consolidated Financial Statements for more details).

 

CAUTIONARY STATEMENT

 

This Quarterly Report on Form 10-Q contains, or incorporates by reference, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements consist of any statement other than a recitation of historical fact and include, but are not limited to, (1) projections of revenues, expenses, income or loss, earnings or loss per share, cash flow or other financial items; (2) statements of our plans and objectives, including those relating to product releases; (3) statements of future economic performance; and (4) statements of assumptions underlying such statements. We generally use words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “future,” “intend,” “may,” “outlook,” “plan,” “positioned,” “potential,” “project,” “remain,” “scheduled,” “set to,” “subject to,” “to be,” “upcoming,” “will,” and other similar expressions to help identify forward-looking statements. Forward-looking statements are subject to business and economic risk, reflect management’s current expectations, estimates and projections about our business, and are inherently uncertain and difficult to predict. Our actual results could differ materially. The forward-looking statements contained herein speak only at the date on which this Form 10-Q was first filed, and we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of this Quarterly Report. Risks and uncertainties that may affect our future results include, but are not limited to sales levels of our titles, shifts in consumer spending trends, the impact of the current macroeconomic environment, the seasonal and cyclical nature of the interactive game market, any difficulties experienced during the transition of World of Warcraft in China from the current licensee to NetEase, our ability to predict consumer preferences among competing hardware platforms (including next-generation hardware), declines in software pricing, product returns and price protection, product delays, retail acceptance of our products, adoption rate and availability of new hardware and related software, industry competition, rapid changes in technology and industry standards, protection of proprietary rights, litigation against us, maintenance of relationships with key personnel, customers, licensees, licensors, vendors and third-party developers, counterparty risks relating to customers, licensees, licensors and manufacturers, domestic and international economic, financial and political conditions and policies, foreign exchange rates, integration of recent acquisitions and the identification of suitable future acquisition opportunities, our success in completing the integration of the operations of Activision and Vivendi Games in a timely manner, or at all, and the combined company’s ability to realize the anticipated benefits and synergies of the transaction to the extent, or in the timeframe, anticipated, and the other factors identified in “Risk Factors” included in Part II, Item 1A of this Quarterly Report on Form 10-Q and  in our Annual Report on Form 10-K for the year ended December 31, 2008.  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.  Forward-looking statements believed to be true when made 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.

 

3



Table of Contents

 

Part I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Amounts in millions, except share data)

 

 

 

At March 31,
2009

 

At December 31,
2008

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

2,988

 

$

2,958

 

Short-term investments

 

42

 

44

 

Accounts receivable, net of allowances of $224 million and $268 million at March 31, 2009 and December 31, 2008, respectively

 

185

 

1,210

 

Inventories

 

230

 

262

 

Software development

 

245

 

235

 

Intellectual property licenses

 

35

 

35

 

Deferred income taxes, net

 

571

 

536

 

Intangible assets, net

 

4

 

14

 

Other current assets

 

210

 

201

 

Total current assets

 

4,510

 

5,495

 

 

 

 

 

 

 

Long-term investments

 

79

 

78

 

Software development

 

6

 

1

 

Intellectual property licenses

 

5

 

5

 

Property and equipment, net

 

138

 

149

 

Other assets

 

23

 

30

 

Intangible assets, net

 

1,244

 

1,283

 

Trade names

 

433

 

433

 

Goodwill

 

7,213

 

7,227

 

Total assets

 

$

13,651

 

$

14,701

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

163

 

$

555

 

Deferred revenues

 

647

 

923

 

Accrued expenses and other liabilities

 

504

 

842

 

Total current liabilities

 

1,314

 

2,320

 

Deferred income taxes, net

 

708

 

615

 

Other liabilities

 

181

 

239

 

Total liabilities

 

2,203

 

3,174

 

 

 

 

 

 

 

Commitments and contingencies (Note 15)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $.000001 par value, 2,400,000,000 shares authorized, 1,331,364,196 and 1,325,206,032 shares issued at March 31, 2009 and December 31, 2008, respectively

 

 

 

Additional paid-in capital

 

12,218

 

12,170

 

Less: Treasury stock, at cost, 44,845,025 and 12,967,265 at March 31, 2009 and December 31, 2008, respectively

 

(439

)

(126

)

Accumulated deficit

 

(285

)

(474

)

Accumulated other comprehensive loss

 

(46

)

(43

)

Total shareholders’ equity

 

11,448

 

11,527

 

Total liabilities and shareholders’ equity

 

$

13,651

 

$

14,701

 

 

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,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Net revenues

 

 

 

 

 

Product sales

 

$

690

 

$

61

 

Subscription, licensing, and other revenues

 

291

 

264

 

Total net revenues

 

981

 

325

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

Cost of sales — product costs

 

296

 

35

 

Cost of sales — software royalties and amortization

 

72

 

21

 

Cost of sales — intellectual property licenses

 

64

 

2

 

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

 

52

 

49

 

Product development

 

117

 

104

 

Sales and marketing

 

83

 

27

 

General and administrative

 

103

 

24

 

Restructuring

 

15

 

 

Total costs and expenses

 

802

 

262

 

 

 

 

 

 

 

Operating income

 

179

 

63

 

 

 

 

 

 

 

Investment income, net

 

10

 

2

 

 

 

 

 

 

 

Income before income tax expense

 

189

 

65

 

 

 

 

 

 

 

Income tax expense

 

 

22

 

 

 

 

 

 

 

Net income

 

$

189

 

$

43

 

 

 

 

 

 

 

Earnings per common share, basic and diluted

 

$

0.14

 

$

0.07

 

 

 

 

 

 

 

Weighted-average shares outstanding

 

 

 

 

 

Basic

 

1,308

 

591

 

Diluted

 

1,359

 

591

 

 

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 CASH FLOWS

(Unaudited)
(Amounts in millions)

 

 

 

For the three months ended 
March 31,

 

 

 

2009

 

2008

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

189

 

$

43

 

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

 

 

 

 

 

Deferred income taxes

 

56

 

21

 

Depreciation and amortization

 

69

 

16

 

Unrealized gain on auction rate securities classified as trading securities

 

(3

)

 

Unrealized loss on put option from UBS

 

3

 

 

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

 

68

 

22

 

Stock-based compensation expense (2)

 

30

 

8

 

Excess tax benefits from stock option exercises

 

(17

)

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

1,026

 

72

 

Inventories

 

32

 

2

 

Software development and intellectual property licenses

 

(75

)

(19

)

Other assets

 

(5

)

(6

)

Deferred revenues

 

(276

)

5

 

Accounts payable

 

(392

)

(18

)

Accrued expenses and other liabilities

 

(378

)

(50

)

Net cash provided by operating activities

 

327

 

96

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(10

)

(6

)

Proceeds from sale of investments

 

2

 

 

Proceeds from maturities of investments

 

1

 

 

Cash payments to effect acquisitions, net of cash acquired

 

 

(4

)

Decrease in restricted cash

 

 

2

 

Net cash used in investing activities

 

(7

)

(8

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

7

 

 

Repurchase of common stock

 

(313

)

 

Excess tax benefits from stock option exercises

 

17

 

 

Net cash transfers to Vivendi and affiliated companies

 

 

(107

)

Net cash used in financing activities

 

(289

)

(107

)

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

(1

)

4

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

30

 

(15

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

2,958

 

62

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

2,988

 

$

47

 

 


(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.

 

6



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Three Months ended March 31, 2009

(Unaudited)

(Amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Other

 

Total

 

 

 

Common Stock

 

Paid-In

 

Treasury Stock

 

Accumulated

 

Comprehensive

 

Shareholders’

 

 

 

Shares

 

Amount

 

Capital

 

Shares

 

Amount

 

Deficit

 

Loss

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2008

 

1,325

 

$

 

$

12,170

 

(13

)

$

(126

)

$

(474

)

$

(43

)

$

11,527

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

189

 

 

189

 

Change in unrealized depreciation on investments, net of taxes

 

 

 

 

 

 

 

(1

)

(1

)

Foreign currency translation adjustment

 

 

 

 

 

 

 

(2

)

(2

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

186

 

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

 

6

 

 

7

 

 

 

 

 

7

 

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

 

 

 

39

 

 

 

 

 

39

 

Issuance of contingent consideration

 

 

 

2

 

 

 

 

 

2

 

Shares repurchased

 

 

 

 

(32

)

(313

)

 

 

(313

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2009

 

1,331

 

$

 

$

12,218

 

(45

)

$

(439

)

$

(285

)

$

(46

)

$

11,448

 

 

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

 

7



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.     Background and basis of presentation

 

Business

 

Activision Blizzard, Inc. and subsidiaries (“Activision Blizzard,” “we,” “us,” the “Company,” or “our”) is a worldwide pure-play online, personal computer (“PC”), console, and hand-held game publisher. Through Activision Publishing, Inc. (“Activision”), we are a leading international publisher of interactive software products and peripherals. Activision develops and publishes video games on various consoles, hand-held platforms and the PC platform through internally developed franchises and license agreements. Activision currently offers games that operate on the Sony Computer Entertainment (“Sony”) PlayStation 2 (“PS2”), Sony PlayStation 3 (“PS3”), Nintendo Co. Ltd. (“Nintendo”) Wii (“Wii”), and Microsoft Corporation (“Microsoft”) Xbox 360 (“Xbox 360”) console systems; the Sony PlayStation Portable (“PSP”) and Nintendo Dual Screen (“NDS”) hand-held devices; the PC; and the new handheld game system Nintendo DSi. Through Blizzard Entertainment, Inc. (“Blizzard”), we are a leader in terms of subscriber base and revenues generated in the subscription-based massively multi-player online role-playing game (“MMORPG”) category. Blizzard internally develops and publishes PC-based computer games and maintains its proprietary online-game related service, Battle.net.

 

Our Activision business involves the development, marketing, and sale of products directly, by license, or through our affiliate label program with certain third-party publishers. Activision’s products cover diverse game categories including action/adventure, action sports, racing, role-playing, simulation, first-person action, music, and strategy. Activision’s target customer base ranges from casual players to game enthusiasts, and children to adults.

 

Our Blizzard business involves the development, marketing, sales and support of role playing action and strategy games. Blizzard also develops, hosts, and supports its online subscription-based games in the MMORPG category. Blizzard is the development studio and publisher best known as the creator of World of Warcraft and the multiple award winning Diablo, StarCraft, and Warcraft franchises. Blizzard distributes its products and generates revenues worldwide through various means, including: subscription revenues (which consist of fees from individuals playing World of Warcraft, such as prepaid-cards and other ancillary online revenues); retail sales of physical “boxed” product; electronic download sales of PC products; and licensing of software to third-party companies that distribute World of Warcraft in China, Russia and Taiwan.

 

Our distribution business 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.

 

We maintain significant operations in the United States, Canada, the United Kingdom (“UK”), Germany, France, Italy, Spain, Australia, Sweden, South Korea, Norway, Denmark, China, and the Netherlands.

 

Business Combination

 

On July 9, 2008, a business combination (the “Business Combination”) by and among Activision, Inc., Sego Merger Corporation, a wholly-owned subsidiary of Activision, Inc., Vivendi S.A. (“Vivendi”), VGAC LLC, a wholly-owned subsidiary of Vivendi, and Vivendi Games, Inc., a wholly-owned subsidiary of VGAC LLC, was consummated.  As a result of the consummation of the Business Combination, Activision, Inc. was renamed Activision Blizzard, Inc.  For accounting purposes, the Business Combination is treated as a “reverse acquisition,” with Vivendi Games, Inc. deemed to be the acquirer.  The historical financial statements of Activision Blizzard, Inc. prior to July 9, 2008 are those of Vivendi Games, Inc. Activision, Inc.’s businesses were included in Activision Blizzard’s financial statements for all periods subsequent to the consummation of the Business Combination only. See Note 1 of the Notes to Consolidated Financial Statements of the Annual Report on Form 10-K for the year ended December 31, 2008 for more details.

 

Activision Blizzard continues to operate as a public company traded on NASDAQ under the ticker symbol ATVI and now conducts the combined business operations of Activision, Inc. and Vivendi Games including its subsidiary, Blizzard Entertainment.

 

8



Table of Contents

 

Basis of Presentation

 

Activision Blizzard prepared the accompanying unaudited Condensed Consolidated Financial Statements in accordance with the rules and regulations of the Securities and Exchange Commission for interim reporting. As permitted under those rules and regulations, certain notes or other information that are normally required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted if they substantially duplicate the disclosures contained in the annual audited Consolidated Financial Statements. The unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2008. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation of our financial position and results of operations in accordance with U.S. GAAP have been included.

 

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts and operations of Activision Blizzard. All intercompany accounts and transactions have been eliminated. The Condensed Consolidated Financial Statements have been prepared in conformity with U.S. GAAP. The preparation of the Condensed Consolidated Financial Statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the Condensed Consolidated Financial Statements. Actual results could differ from these estimates and assumptions.

 

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

 

2.     Summary of significant accounting policies

 

Financial Instruments

 

The estimated fair values of financial instruments have been determined using available market information and valuation methodologies described below. However, considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein may not be indicative of the amounts that we could realize in a current market exchange. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.

 

The carrying amount of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses are a reasonable approximation of fair value due to their short-term nature. Short-term investments are carried at fair value with fair values estimated based on quoted market prices. Long-term investments, comprised of student loan backed taxable auction rate securities, are carried at fair value with fair values estimated using an income-approach model (discounted cash-flow analysis).

 

Derivative Financial Instruments

 

On January 1, 2009, we adopted Statement of Financial Accounting Standard (“SFAS”) No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS No. 161”). The adoption of SFAS No. 161 had no financial impact on our Condensed Consolidated Financial Statements and only required additional financial statement disclosures. We have applied the requirements of SFAS No. 161 on a prospective basis. Accordingly, disclosures related to interim periods prior to the date of adoption have not been presented.

 

Foreign Currency Forward Contracts Not Designated as Hedges

 

We transact business in various currencies other than the U.S. dollar and have significant international sales and expenses denominated in currencies other than the U.S. dollar, subjecting us to currency exchange rate risks. To mitigate our risk from foreign currency fluctuations we periodically enter into currency derivative contracts, principally swaps and forward contracts with maturities of twelve months or less with Vivendi as our principal counterparty. We do not hold or purchase any foreign currency contracts for trading or speculative purposes and we do not designate these forward contracts or swaps as hedging instruments pursuant to FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.”  Accordingly, we report the fair value of these contracts in our Condensed Consolidated Balance Sheet with changes in fair value recorded in our Condensed Consolidated Statement of Operations.

 

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Table of Contents

 

The effects of derivative instruments on our Condensed Consolidated Financial Statements were as follows (amounts in millions):

 

Fair Value of Derivative Instruments in Condensed
Consolidated Balance Sheet

 

Fair Value
At March 31, 2009

 

Balance Sheet Location

 

Foreign currency swaps and forward contracts not designated as hedges

 

$

1

 

Accrued expenses and other liabilities

 

 

Effect of Derivative Instruments on Condensed Consolidated
Statement of Operations

 

Amount of Net Realized and
Unrealized Gain (Loss)
Recognized in Income on
Derivatives for the Three
Months Ended March 31, 2009

 

Income Statement Location

 

Foreign currency swaps and forward contracts not designed as hedges

 

$

2

 

Investment income, net

 

 

3.     Inventories

 

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

 

 

 

At March 31, 2009

 

At December 31, 2008

 

Finished goods

 

$

220

 

$

251

 

Purchased parts and components

 

10

 

11

 

 

 

 

 

 

 

 

 

$

230

 

$

262

 

 

4.     Goodwill

 

The changes in the carrying amount of goodwill by operating segment for the three months ended March 31, 2009 are as follows (amounts in millions):

 

 

 

Activision

 

Blizzard

 

Distribution

 

Total

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2008

 

$

7,037

 

$

178

 

$

12

 

$

7,227

 

Issuance of contingent consideration

 

2

 

 

 

2

 

Purchase accounting adjustment

 

1

 

 

 

1

 

Tax benefit credited to goodwill

 

(17

)

 

 

(17

)

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2009

 

$

7,023

 

$

178

 

$

12

 

$

7,213

 

 

Issuance of contingent consideration consists of additional purchase consideration paid during 2009 in relation to previous acquisitions. The tax benefit credited to goodwill represents the tax deduction resulting from the exercise of stock options that were outstanding and vested at the consummation of the Business Combination and included in the purchase price of Activision, Inc. to the extent that the tax deduction does not exceed the fair value of those options.

 

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5.     Intangible assets, net

 

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

 

 

 

At March 31, 2009

 

 

 

Estimated
useful
lives

 

Gross
carrying
amount

 

Accumulated
amortization

 

Net carrying
amount

 

Acquired finite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

207

 

$

(16

)

$

191

 

Developed software

 

1 - 2 years

 

286

 

(281

)

5

 

Game engines

 

2 - 5 years

 

134

 

(50

)

84

 

Internally developed franchises

 

11 - 12 years

 

1,124

 

(171

)

953

 

Favorable leases

 

1 - 4 years

 

5

 

(2

)

3

 

Distribution agreements

 

4 years

 

17

 

(6

)

11

 

Other intangibles

 

0 - 2 years

 

5

 

(4

)

1

 

Total finite-lived intangible assets

 

 

 

1,778

 

(530

)

1,248

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

385

 

 

385

 

Acquired trade names

 

Indefinite

 

48

 

 

48

 

Total

 

 

 

$

2,211

 

$

(530

)

$

1,681

 

 

 

 

At December 31, 2008

 

 

 

Estimated
useful
lives

 

Gross
carrying
amount

 

Accumulated
amortization

 

Net carrying
amount

 

Acquired finite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

207

 

$

(12

)

$

195

 

Developed software

 

1 - 2 years

 

286

 

(272

)

14

 

Game engines

 

2 - 5 years

 

134

 

(42

)

92

 

Internally developed franchises

 

11 - 12 years

 

1,124

 

(145

)

979

 

Favorable leases

 

1 - 4 years

 

5

 

(1

)

4

 

Distribution agreements

 

4 years

 

17

 

(5

)

12

 

Other intangibles

 

0 - 2 years

 

5

 

(4

)

1

 

Total finite-lived intangible assets

 

 

 

1,778

 

(481

)

1,297

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

385

 

 

385

 

Acquired trade names

 

Indefinite

 

48

 

 

48

 

Total

 

 

 

$

2,211

 

$

(481

)

$

1,730

 

 

Amortization expense of intangible assets for the three months ended March 31, 2009 and 2008 was $49 million and $1 million, respectively.

 

At March 31, 2009, future amortization of finite-lived intangible assets is estimated as follows (amounts in millions):

 

2009 (remaining nine months)

 

$

251

 

2010

 

208

 

2011

 

144

 

2012

 

120

 

2013

 

104

 

Thereafter

 

421

 

 

 

 

 

Total

 

$

1,248

 

 

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6.     Income taxes

 

The tax rate reported for the three months ended March 31, 2009 is based on our projected annual effective tax rate for 2009, and also includes certain discrete tax benefits recorded during the period. Our tax expense of less than a million dollars for the three months ended March 31, 2009 reflects an effective tax rate of 0% which differs from our effective tax rate of 34% for the three months ended March 31, 2008. The effective tax rate of 0% for the three months ended March 31, 2009 differs from the statutory rate of 35% primarily due to foreign income taxes provided at lower rates and certain discrete tax benefits recorded during the period related to the release of valuation allowances on foreign net operating losses and the impact of changes to the state of California tax laws.   The effective rate for the three months ended March 31, 2009 differs from the same period in 2008 primarily due to the discrete tax benefits recorded in the three months ended March 31, 2009 and the foreign income tax rate differential mentioned above.

 

In accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), we evaluate our deferred tax assets, including net operating losses, to determine if a valuation allowance is required.  SFAS No. 109 requires that companies assess whether a valuation allowance should be established or released based on the consideration of all available evidence using a “more likely than not” standard.  In making such judgments, significant weight is given to evidence that can be objectively verified. At December 31, 2008, we had a valuation allowance relating to foreign net operating loss carryforwards of $23 million.  The ultimate realization of the net operating losses depends upon the generation of future taxable income during the periods in which those temporary differences become deductible.  We currently expect to realize these net operating losses through taxable income; therefore, during the first quarter of 2009, we released the valuation allowance against our deferred tax assets.

 

California Senate Bill No.15 was enacted in February 20, 2009 and contains significant changes to the state of California tax landscape. In accordance with SFAS No. 109, when there is an enacted change in tax laws or rate, we adjust our deferred tax liabilities and assets to reflect the change.   During the first quarter of 2009, we reduced our net deferred tax liabilities and tax provision by $9 million.

 

We recognize interest and penalties related to uncertain tax positions in the income tax expense.  At March 31, 2009, we had $3 million of accrued interest related to uncertain tax positions.  For the three months ended March 31, 2009, we recorded $1 million of interest expense related to uncertain tax positions.

 

7.     Software development costs and intellectual property licenses

 

At March 31, 2009, capitalized software development costs included $187 million of internally developed software costs and $64 million of payments made to third-party software developers. At December 31, 2008, capitalized software development costs included $173 million of internally developed software costs and $63 million of payments made to third-party software developers. Capitalized intellectual property licenses were $40 million at each of March 31, 2009 and December 31, 2008. Amortization of capitalized software development costs and intellectual property licenses for the three months ended March 31, 2009 and 2008 was $72 million and $1 million, respectively. Write-offs and impairments was less than a million dollars and $21 million for the three months ended March 31, 2009 and 2008, respectively.

 

8.     Restructuring

 

The Company has been implementing its organizational restructuring plan as a result of the Business Combination described in Note 1 of the Notes to Condensed Consolidated Financial Statements. This organizational restructuring plan includes the integration of different operations to streamline the combined organization of Activision Blizzard.

 

The primary goals of the organizational restructuring were to rationalize the title portfolio and consolidate certain corporate functions so as to realize the synergies of the Business Combination.

 

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Table of Contents

 

The following table details the changes in restructuring reserves included in accrued expenses and other liabilities in the Condensed Consolidated Balance Sheets at March 31, 2009 (amounts in millions):

 

 

 

Severance(1)

 

Facilities
costs(1)

 

Total

 

Balance at December 31, 2008

 

$

37

 

$

7

 

$

44

 

Costs charged to expense

 

15

 

 

15

 

Costs paid or otherwise settled

 

(11

)

(1

)

(12

)

Foreign exchange and other

 

(2

)

(1

)

(3

)

Balance at March 31, 2009

 

$

39

 

$

5

 

$

44

 

 


(1)          Accounted for in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”).

 

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

 

 

 

Restructuring Reserve Balance

 

Restructuring Charges

 

 

 

At

 

At

 

Three months ended

 

 

 

March 31, 2009

 

December 31, 2008

 

March 31, 2009

 

 

 

 

 

 

 

 

 

Activision

 

$

5

 

$

 

$

7

 

Blizzard

 

 

 

 

Distribution

 

3

 

 

3

 

Activision Blizzard’s core operations

 

8

 

 

10

 

Activision Blizzard’s non- core exit operations

 

36

 

44

 

5

 

Total

 

$

44

 

$

44

 

$

15

 

 

The expected restructuring charges to be incurred principally by Activision Blizzard’s non-core exit operations related to the Business Combination during the three months ending June 30, 2009 are presented below (amounts in millions):

 

 

 

Low

 

High

 

Expected future restructuring costs, before tax

 

$

16

 

$

22

 

 

 

 

 

 

 

Expected future restructuring costs, after tax

 

9

 

13

 

 

The total expected restructuring charges related to the Business Combination from the Business Combination date through June 30, 2009 are presented below (amounts in millions):

 

 

 

Low

 

High

 

Total expected restructuring costs, before tax

 

$

124

 

$

130

 

 

 

 

 

 

 

Total expected restructuring costs, after tax

 

74

 

78

 

 

The after tax cash charges are expected to consist primarily of employee-related severance cash costs (approximately $55 million), facility exit cash costs (approximately $5 million) and cash contract terminations costs (approximately $18 million). Separately, through March 31, 2009 these restructuring charges were partially offset by cash proceeds of approximately $33 million from asset disposals and after tax cash benefits related to the streamlining of the Vivendi Games title portfolio.

 

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9.     Comprehensive income and accumulated other comprehensive loss

 

Comprehensive Income

 

The components of comprehensive income for the three months ended March 31, 2009 and 2008 were as follows (amounts in millions):

 

 

 

Three months ended March 31,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Net income

 

$

189

 

$

43

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

Foreign currency translation adjustment

 

(2

)

3

 

Change in unrealized depreciation on investments, net of taxes

 

(1

)

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

(3

)

3

 

 

 

 

 

 

 

Comprehensive income

 

$

186

 

$

46

 

 

Accumulated Other Comprehensive Loss

 

For the three months ended March 31, 2009 the components of accumulated other comprehensive loss were as follows (amounts in millions):

 

 

 

Foreign currency
translation
adjustment

 

Unrealized
depreciation
on investments

 

Accumulated
other
comprehensive
loss

 

 

 

 

 

 

 

 

 

Balance at December 31, 2008

 

$

(41

)

$

(2

)

$

(43

)

Other comprehensive loss

 

(2

)

(1

)

(3

)

 

 

 

 

 

 

 

 

Balance at March 31, 2009

 

$

(43

)

$

(3

)

$

(46

)

 

Other comprehensive loss is presented net of tax benefits related to the change in unrealized depreciation on our investments for the three months ended March 31, 2009.  Income taxes were not provided for foreign currency translation items as these are considered indefinite investments in non-U.S. subsidiaries.

 

10.  Investment income, net

 

Investment income, net is comprised of the following (amounts in millions):

 

 

 

Three months ended March 31,

 

 

 

2009

 

2008

 

Interest income

 

$

9

 

$

3

 

Interest expense

 

(1

)

 

Unrealized gain on trading securities

 

3

 

 

Unrealized loss on put option from UBS

 

(3

)

 

Net realized and unrealized gain (loss) on foreign exchange contracts

 

2

 

(1

)

 

 

 

 

 

 

Investment income, net

 

$

10

 

$

2

 

 

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Table of Contents

 

11.  Fair value measurements

 

The three levels of inputs used to measure fair value are as follows:

 

·                 Level 1 — Quoted prices in active markets for identical assets or liabilities.

 

·                 Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets or other inputs that are observable or can be corroborated by observable market data.

 

·                 Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

 

The tables below segregate all assets and liabilities that are measured at fair value on a recurring basis (which means they are so measured at least annually) into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date (amounts in millions):

 

 

 

 

 

Fair Value Measurements at
Reporting Date Using

 

 

 

 

 

At
March 31,
2009

 

Quoted
Prices in
Active
Markets for
Identical
Financial
Instruments
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Balance Sheet
Classification

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

2,866

 

$

2,866

 

$

 

$

 

Cash and cash equivalents

 

Mortgage backed securities

 

5

 

 

5

 

 

Short-term investments

 

Auction rate securities

 

79

 

 

 

79

 

Long-term investments

 

Put option from UBS

 

7

 

 

 

7

 

Other assets—non-current

 

Total financial assets at fair value

 

$

2,957

 

$

2,866

 

$

5

 

$

86

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contract derivatives

 

$

1

 

$

 

$

1

 

$

 

Other liabilities—current

 

Other financial liability

 

31

 

 

 

31

 

Other liabilities—non-current

 

Total financial liabilities at fair value

 

$

32

 

$

 

$

1

 

$

31

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At December 31,
2008

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Balance Sheet
Classification

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

2,609

 

$

2,609

 

$

 

$

 

Cash and cash equivalents

 

Mortgage backed securities

 

7

 

 

7

 

 

Short-term investments

 

Auction rate securities

 

78

 

 

 

78

 

Long-term investments

 

Put option from UBS

 

10

 

 

 

10

 

Other assets—non-current

 

Foreign exchange contract derivatives

 

5

 

 

5

 

 

Other assets—current

 

Total financial assets at fair value

 

$

2,709

 

$

2,609

 

$

12

 

$

88

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contract derivatives

 

$

2

 

$

 

$

2

 

$

 

Other liabilities—current

 

Other financial liability

 

31

 

 

 

31

 

Other liabilities—non-current

 

Total financial liabilities at fair value

 

$

33

 

$

 

$

2

 

$

31

 

 

 

 

Other financial liability represents the earn-out liability from a previous acquisition. The earn-out liability was recorded at fair value at the date of the Business Combination as it will be settled by a variable number of shares of our common stock based on the average closing price for the five business days immediately preceding issuance of the shares. When estimating the fair value, we considered our projection of revenues from the related titles under the earn-out provisions. For the three months ended March 31, 2009, there was no change in our fair value estimate of this financial liability.

 

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Table of Contents

 

The following table provides a reconciliation of the beginning and ending balances of our financial assets and financial liabilities classified as Level 3 (amounts in millions):

 

 

 

Level 3

 

Balance at December 31, 2008, net

 

$

57

 

Total losses realized/unrealized included in earnings (a) (b)

 

(1

)

Total losses included in other comprehensive income (a)

 

(1

)

Balance at March 31, 2009, net

 

$

55

 

 


 (a) Due to uncertainties surrounding the timing of liquidation of our auction rate securities, we classify these instruments as long-term investments in our Condensed Consolidated Balance Sheet at March 31, 2009. Liquidity for these auction rate securities is typically provided by an auction process which allows holders to sell their notes and resets the applicable interest rate at pre-determined intervals, usually every 7 to 35 days. On an industry-wide basis, many auctions have failed, and there is, as yet, no meaningful secondary market for these instruments. Each of the auction rate securities in our investment portfolio at March 31, 2009 has experienced a failed auction and there is no assurance that future auctions for these securities will succeed. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. In the event that there is a failed auction, the indenture governing the security requires the issuer to pay interest at a contractually defined rate that is generally above market rates for other types of similar instruments. The securities for which auctions have failed will continue to earn interest at the contractual rate and be auctioned every 7 to 35 days until the auction succeeds, the issuer calls the securities or they mature. As a result, our ability to liquidate and fully recover the carrying value of our auction rate securities in the near term may be limited or not exist.

 

Consequently, fair value measurements have been estimated using an income-approach model (discounted cash-flow analysis). When estimating the fair value, we consider both observable market data and non-observable factors, including credit quality, duration, insurance wraps, collateral composition, maximum rate formulas, comparable trading instruments, and 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. See Notes 3 and 6 of the Notes to Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31, 2008 for additional information regarding our auction rate securities.

 

(b) Put option from UBS represents an offer from UBS AG (“UBS”) providing us with the right to require UBS to purchase our auction rate securities held through UBS at par value (see Note 3 of the Notes to Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31, 2008 for more details). To value the put option, we considered a number of factors including its intrinsic value, interest rates, the maturity of the option, and our assessment of the credit quality of UBS.

 

12.  Operating segments and geographic regions

 

Our operating segments are in accordance with our internal organizational structure, the manner in which our operations are reviewed and managed by our Chief Executive Officer, our Chief Operating Decision Maker (“CODM”), the manner in which operating performance is assessed and resources are allocated, and the availability of separate financial information.

 

Prior to the Business Combination, Vivendi Games managed its business in two main divisions: Blizzard Entertainment and Sierra Entertainment (along with Sierra online and Vivendi Games Mobile). As a result of the Business Combination, we provide our CODM financial information based upon management’s new organizational structure.

 

Currently, we operate under four operating segments: (i) Activision Publishing—publishes interactive entertainment software and peripherals, which includes businesses operated by Activision, Inc. prior to the Business Combination and certain studios, assets, and titles previously included in Vivendi Games’ Sierra Entertainment operating segment prior to the Business Combination (“Activision”), (ii) Blizzard Entertainment, Inc. and its subsidiaries—publishes traditional games and online subscription-based games in the MMORPG category (“Blizzard”), (iii) Activision Blizzard Distribution—distributes of interactive entertainment software and hardware products (“Distribution”) (these three operating segments form Activision Blizzard’s core operations) and (iv) Activision Blizzard’s non-core exit operations (“Non-Core”). Activision Blizzard’s non-core exit operations represent legacy Vivendi Games’ divisions or business units that we have exited or are winding down as part of our restructuring and integration efforts as a result of the Business Combination, but do not meet the criteria for separate reporting of discontinued operations. In accordance with the provisions of SFAS No. 131, “Disclosure About Segments of an Enterprise and Related Information,” (“SFAS No. 131”) all prior period segment information has been restated to conform to this new segment presentation.

 

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Table of Contents

 

The consummation of the Business Combination resulted in net revenues and segment income (loss) from the businesses operated by Activision, Inc. prior to the Business Combination being included for the quarter ended March 31, 2009, but not for the same period in 2008. Also, the Activision operating segment includes Vivendi Games titles retained after the Business Combination.

 

The CODM reviews segment performance exclusive of the impact of the deferred net revenues and related cost of sales, stock-based compensation expense, restructuring expense, amortization of intangible assets and purchase price accounting related adjustments, and integration and transaction costs. Information on the operating segments and reconciliations of total net revenues and total segment income (loss) from operations to consolidated net revenues and operating income (loss) for the three months ended March 31, 2009 and 2008 are presented below (amounts in millions):

 

 

 

Three months ended March 31,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

Net revenues

 

Segment income (loss) from
operations

 

Activision

 

$

348

 

$

38

 

$

(27

)

$

(19

)

Blizzard

 

291

 

280

 

143

 

154

 

Distribution

 

85

 

 

3

 

 

Activision Blizzard’s core operations

 

724

 

318

 

119

 

135

 

Activision Blizzard’s non-core exit operations

 

1

 

5

 

(4

)

(65

)

Operating segments total

 

725

 

323

 

115

 

70

 

 

 

 

 

 

 

 

 

 

 

Reconciliation to consolidated net revenues / operating income (loss):

 

 

 

 

 

 

 

 

 

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

 

256

 

2

 

167

 

2

 

Stock-based compensation expense

 

 

 

(28

)

(8

)

Restructuring expense

 

 

 

(15

)

 

Amortization of intangible assets and purchase price accounting related adjustments

 

 

 

(46

)

(1

)

Integration and transaction costs

 

 

 

(14

)

 

Consolidated net revenues / operating income

 

$

981

 

$

325

 

$

179

 

$

63

 

 

Geographic information for the three months ended March 31, 2009 and 2008 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,

 

 

 

2009

 

2008

 

Net revenues by geographic region

 

 

 

 

 

North America

 

$

524

 

$

139

 

Europe

 

307

 

136

 

Asia Pacific

 

64

 

45

 

Total geographic region net revenues

 

895

 

320

 

Distribution net revenues

 

85

 

 

Activision Blizzard’s non-core exit operations

 

1

 

5

 

Total consolidated net revenues

 

$

981

 

$

325

 

 

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

 

 

 

Three months ended March 31,

 

 

 

2009

 

2008

 

MMORPG

 

$

314

 

$

275

 

Console

 

503

 

22

 

Hand-held

 

32

 

11

 

PC and other

 

46

 

12

 

 

 

 

 

 

 

Total platform net revenues

 

895

 

320

 

 

 

 

 

 

 

Distribution

 

85