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, 2012

 

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 23, 2012 was 1,111,086,287.

 

 

 



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

 

Table of Contents

 

 

 

Cautionary Statement

3

 

 

 

 

PART I.

 

FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

 

Financial Statements (Unaudited)

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets at June 30, 2012 and December 31, 2011

4

 

 

 

 

 

 

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2012 and June 30, 2011

5

 

 

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2012 and June 30, 2011

6

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and June 30, 2011

7

 

 

 

 

 

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity for the six months ended June 30, 2012

8

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

9

 

 

 

 

Item 2.

 

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

21

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

36

 

 

 

 

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

38

 

 

 

 

Item 6.

 

Exhibits

38

 

 

 

 

SIGNATURE

 

 

39

 

 

 

 

EXHIBIT INDEX

 

 

40

 

 

 

 

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 fact and include, but are not limited to: (1) projections of revenues, expenses, income or loss, earnings or loss per share, cash flow or other financial items; (2) statements of our plans and objectives, including those relating to product releases; (3) statements of future financial or operating performance; and (4) statements of assumptions underlying such statements. Activision Blizzard, Inc. (“Activision Blizzard”) generally uses words such as “outlook,” “forecast,” “will,” “could,” “should,” “would,” “to be,” “plans,” “believes,” “may,” “expects,” “intends,” “anticipates,” “estimate,” “future,” “positioned,” “potential,” “project,” “remain,” “scheduled,” “set to,” “subject to,” “upcoming” and other similar expressions to help identify forward-looking statements. Forward-looking statements are subject to business and economic risk, reflect management’s current expectations, estimates and projections about our business, and are inherently uncertain and difficult to predict. Our actual results could differ materially. Risks and uncertainties that may affect our future results include, but are not limited to, sales levels of Activision Blizzard’s titles, increasing concentration of titles, shifts in consumer spending trends, the impact of the current macroeconomic environment and market conditions within the video game industry, Activision Blizzard’s ability to predict consumer preferences, including interest in specific genres such as first-person action and massively multiplayer online games and preferences among competing hardware platforms, the seasonal and cyclical nature of the interactive game market, changing business models including digital 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, rapid changes in technology and industry standards, litigation risks and associated costs, protection of proprietary rights, maintenance of relationships with key personnel, customers, licensees, licensors, vendors, and third-party developers, including the ability to attract, retain and develop key personnel and developers that can create high quality “hit” titles, counterparty risks relating to customers, licensees, licensors and manufacturers, domestic and international economic, financial and political conditions and policies, foreign exchange rates and tax rates, and the identification of suitable future acquisition opportunities and potential challenges associated with geographic expansion, and the other  factors  identified in “Risk Factors” included in Part II, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011 and in our other periodic filings with the Securities and Exchange Commission (the “SEC”). The forward-looking statements contained herein are based upon information available to us as of the date of this Quarterly Report on Form 10-Q and we assume no obligation to update any such forward-looking statements. Although these forward-looking statements are believed to be true when made, they may ultimately prove to be incorrect. These statements are not guarantees of our future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and may cause actual results to differ materially from current expectations.

 

Activision Blizzard’s names, abbreviations thereof, logos, and product and service designators are all either the registered or unregistered trademarks or trade names of Activision Blizzard. 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,

 

 

 

2012

 

2011

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

2,786

 

$

3,165

 

Short-term investments

 

406

 

360

 

Accounts receivable, net of allowances of $261 million and $300 million at June 30, 2012 and December 31, 2011, respectively

 

227

 

649

 

Inventories, net

 

128

 

144

 

Software development

 

141

 

137

 

Intellectual property licenses

 

8

 

22

 

Deferred income taxes, net

 

484

 

507

 

Other current assets

 

152

 

396

 

Total current assets

 

4,332

 

5,380

 

 

 

 

 

 

 

Long-term investments

 

17

 

16

 

Software development

 

123

 

62

 

Intellectual property licenses

 

12

 

12

 

Property and equipment, net

 

149

 

163

 

Other assets

 

12

 

12

 

Intangible assets, net

 

83

 

88

 

Trademark and trade names

 

433

 

433

 

Goodwill

 

7,108

 

7,111

 

Total assets

 

$

12,269

 

$

13,277

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

163

 

$

390

 

Deferred revenues

 

905

 

1,472

 

Accrued expenses and other liabilities

 

416

 

694

 

Total current liabilities

 

1,484

 

2,556

 

Deferred income taxes, net

 

61

 

55

 

Other liabilities

 

160

 

174

 

Total liabilities

 

1,705

 

2,785

 

 

 

 

 

 

 

Commitments and contingencies (Note 11)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.000001 par value, 2,400,000,000 shares authorized, 1,110,870,141 and 1,133,391,371 shares issued at June 30, 2012 and December 31, 2011, respectively

 

 

 

Additional paid-in capital

 

9,375

 

9,616

 

Retained earnings

 

1,313

 

948

 

Accumulated other comprehensive income (loss)

 

(124

)

(72

)

Total shareholders’ equity

 

10,564

 

10,492

 

Total liabilities and shareholders’ equity

 

$

12,269

 

$

13,277

 

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Amounts in millions, except per share data)

 

 

 

For the Three Months Ended

 

For the Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

 

 

 

 

 

 

 

 

Product sales

 

$

798

 

$

768

 

$

1,672

 

$

1,829

 

Subscription, licensing, and other revenues

 

277

 

378

 

575

 

766

 

Total net revenues

 

1,075

 

1,146

 

2,247

 

2,595

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

Cost of sales – product costs

 

229

 

213

 

486

 

512

 

Cost of sales – online subscriptions

 

64

 

59

 

123

 

122

 

Cost of sales – software royalties and amortization

 

57

 

47

 

88

 

109

 

Cost of sales – intellectual property licenses

 

20

 

24

 

27

 

53

 

Product development

 

152

 

116

 

276

 

258

 

Sales and marketing

 

136

 

90

 

216

 

150

 

General and administrative

 

190

 

127

 

291

 

228

 

Restructuring

 

 

3

 

 

22

 

Total costs and expenses

 

848

 

679

 

1,507

 

1,454

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

227

 

467

 

740

 

1,141

 

 

 

 

 

 

 

 

 

 

 

Investment and other income (expense), net

 

2

 

2

 

3

 

5

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense

 

229

 

469

 

743

 

1,146

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

44

 

134

 

174

 

308

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

185

 

$

335

 

$

569

 

$

838

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.16

 

$

0.29

 

$

0.50

 

$

0.71

 

Diluted

 

$

0.16

 

$

0.29

 

$

0.50

 

$

0.71

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

1,109

 

1,141

 

1,115

 

1,157

 

Diluted

 

1,115

 

1,150

 

1,121

 

1,166

 

 

 

 

 

 

 

 

 

 

 

Dividends per common share

 

$

 

$

 

$

0.18

 

$

0.165

 

 

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,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

185

 

$

335

 

$

569

 

$

838

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

(91

)

1

 

(53

)

40

 

Unrealized gains on investments, net of deferred income taxes of $0 million and $1 million for the three and six months ended ended June 30, 2012 and 2011

 

 

2

 

1

 

2

 

Other comprehensive income

 

$

(91

)

$

3

 

$

(52

)

$

42

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

94

 

$

338

 

$

517

 

$

880

 

 

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,

 

 

 

2012

 

2011

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

569

 

$

838

 

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

 

 

 

 

 

Deferred income taxes

 

29

 

119

 

Depreciation and amortization

 

45

 

52

 

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

 

102

 

124

 

Stock-based compensation expense (2)

 

49

 

43

 

Excess tax benefits from stock option exercises

 

(3

)

(4

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

421

 

518

 

Inventories, net

 

15

 

21

 

Software development and intellectual property licenses

 

(146

)

(116

)

Other assets

 

246

 

209

 

Deferred revenues

 

(564

)

(1,164

)

Accounts payable

 

(228

)

(216

)

Accrued expenses and other liabilities

 

(290

)

(368

)

Net cash provided by operating activities

 

245

 

56

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities of available-for-sale investments

 

253

 

374

 

Payment of contingent consideration

 

 

(3

)

Purchases of available-for-sale investments

 

(302

)

(300

)

Capital expenditures

 

(26

)

(18

)

Decrease in restricted cash

 

1

 

10

 

Net cash (used in) provided by investing activities

 

(74

)

63

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

20

 

26

 

Repurchase of common stock

 

(315

)

(501

)

Dividends paid

 

(204

)

(192

)

Excess tax benefits from stock option exercises

 

3

 

4

 

Net cash used in financing activities

 

(496

)

(663

)

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

(54

)

66

 

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(379

)

(478

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

3,165

 

2,812

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

2,786

 

$

2,334

 

 


(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, 2012

(Unaudited)

(Amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Other

 

Total

 

 

 

Common Stock

 

Paid-In

 

Treasury Stock

 

Retained

 

Comprehensive

 

Shareholders’

 

 

 

Shares

 

Amount

 

Capital

 

Shares

 

Amount

 

Earnings

 

Income (Loss)

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2011

 

1,133

 

$

 

$

9,616

 

 

$

 

$

948

 

$

(72

)

$

10,492

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

569

 

 

569

 

Other comprehensive income

 

 

 

 

 

 

 

(52

)

(52

)

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

 

4

 

 

20

 

 

 

 

 

20

 

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

 

 

 

54

 

 

 

 

 

54

 

Dividends ($0.18 per common share) (See Note 10)

 

 

 

 

 

 

(204

)

 

(204

)

Shares repurchased (See Note 10)

 

 

 

 

(26

)

(315

)

 

 

(315

)

Retirement of treasury shares

 

(26

)

 

(315

)

26

 

315

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2012

 

1,111

 

$

 

$

9,375

 

 

$

 

$

1,313

 

$

(124

)

$

10,564

 

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.     Description of business and basis of consolidation and presentation

 

Description of Business

 

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

 

The common stock of Activision Blizzard is traded on The NASDAQ Stock Market under the ticker symbol “ATVI.” Vivendi S.A. (“Vivendi”) owned approximately 62% of Activision Blizzard’s outstanding common stock at June 30, 2012.

 

Currently, we operate under three operating segments:

 

Activision Publishing, Inc.

 

Activision Publishing, Inc. (“Activision”) is a leading international developer and publisher of interactive software products and content. Activision develops games based on both internally-developed and licensed intellectual property. Activision markets and sells games we develop and, through our affiliate label program, games developed by certain third-party publishers. We sell games both through retail channels and by digital download. Activision currently offers games that operate on the Sony Computer Entertainment, Inc. (“Sony”) PlayStation 3 (“PS3”), Nintendo Co. Ltd. (“Nintendo”) Wii (“Wii”), and Microsoft Corporation (“Microsoft”) Xbox 360 (“Xbox 360”) console systems; the Nintendo Dual Screen handheld game systems; the PC; Apple iOS devices and other handheld and mobile devices.

 

Blizzard Entertainment, Inc.

 

Blizzard Entertainment, Inc. (“Blizzard”) is a leader in the subscription-based massively multi-player online role-playing game (“MMORPG”) category in terms of both subscriber base and revenues generated through its World of Warcraft® franchise, which it develops, hosts and supports.  Blizzard also develops, markets and sells role-playing action and strategy PC-based computer games, 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 (which consist of fees from individuals playing World of Warcraft, prepaid cards and other value-added service revenues such as realm transfers, faction changes, and other character customizations within World of Warcraft gameplay); retail sales of physical “boxed” products; online download sales of PC products; and licensing of software to third-party or related party companies that distribute World of Warcraft and StarCraft® II.

 

Activision Blizzard Distribution

 

Activision Blizzard Distribution (“Distribution”) consists of operations in Europe that provide warehousing, logistical and sales distribution services to third-party publishers of interactive entertainment software, our own publishing operations, and manufacturers of interactive entertainment hardware.

 

Basis of Consolidation and Presentation

 

Activision Blizzard prepared the accompanying unaudited condensed consolidated financial statements in accordance with the rules and regulations of the Securities and Exchange Commission for interim reporting. As permitted under those rules and regulations, certain notes or other information that are normally required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted if they substantially duplicate the disclosures contained in the annual audited consolidated financial statements. The year-end condensed balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for 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.

 

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The accompanying consolidated financial statements include the accounts and operations of the Company. All intercompany accounts and transactions have been eliminated. The consolidated financial statements have been prepared in conformity with U.S. GAAP. The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates and assumptions.

 

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

 

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

 

Results of Adjustment

 

We identified through our internal processes that, in previous years, we erroneously over-recognized revenue for a country in our Europe region. We performed an evaluation under SEC Staff Accounting Bulletin No. 108 and concluded the effect of this error was immaterial to prior years’ financial statements as well as the projected full-year 2012 financial statements. As such, during the three months ended June 30, 2012, we recorded an adjustment to reduce net revenues and operating income by $11 million in our consolidated statements of operations, and similarly reduced net revenues and income from operations before income tax expenses in our Blizzard segment, Europe region, and online subscriptions as presented in footnote 7 of the notes to the condensed consolidated financial statements by $11 million.  There was no impact to operating cash flows. The adjustment increased the deferred revenues on our consolidated balance sheet and represents a correction of an error. The $11 million adjustment related to prior periods as follows: (i) approximately $1 million for the quarter ended March 31, 2012; (ii) approximately $1 million for each quarter of 2011 (totaling approximately $4 million for the year ended December 31, 2011); (iii) $2 million for the year ended December 31, 2010; and (iv) approximately $4 million for periods prior to the year ended December 31, 2010. Net income decreased by approximately $9 million, or less than $0.01 earnings per basic and diluted share, as a result of recording this adjustment.

 

2.     Inventories, net

 

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

 

 

 

At June 30, 2012

 

At December 31, 2011

 

Finished goods

 

$

92

 

$

116

 

Purchased parts and components

 

36

 

28

 

 

 

 

 

 

 

Inventories, net

 

$

128

 

$

144

 

 

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3.     Intangible assets, net

 

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

 

 

 

At June 30, 2012

 

 

 

Estimated

 

Gross

 

 

 

 

 

 

 

useful

 

carrying

 

Accumulated

 

Net carrying

 

 

 

lives

 

amount

 

amortization

 

amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

88

 

$

(83

)

$

5

 

Internally-developed franchises

 

11 - 12 years

 

309

 

(231

)

78

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

386

 

 

386

 

Acquired trade names

 

Indefinite

 

47

 

 

47

 

Total

 

 

 

$

830

 

$

(314

)

$

516

 

 

 

 

At December 31, 2011

 

 

 

Estimated

 

Gross

 

 

 

 

 

 

 

useful

 

carrying

 

Accumulated

 

Net carrying

 

 

 

lives

 

amount

 

amortization

 

amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements

 

3 - 10 years

 

$

88

 

$

(82

)

$

6

 

Game engines

 

2 - 5 years

 

32

 

(32

)

 

Internally-developed franchises

 

11 - 12 years

 

309

 

(227

)

82

 

Distribution agreements

 

4 years

 

18

 

(18

)

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

386

 

 

386

 

Acquired trade names

 

Indefinite

 

47

 

 

47

 

Total

 

 

 

$

880

 

$

(359

)

$

521

 

 

Amortization expense of intangible assets was $2 million and $5 million for the three and six months ended June 30, 2012, respectively.  Amortization expense of intangible assets was $7 million and $16 million for the three and six months ended June 30, 2011, respectively.

 

At June 30, 2012, future amortization of definite-lived intangible assets is estimated as follows (amounts in millions):

 

2012 (remaining six months)

 

$

29

 

2013

 

28

 

2014

 

14

 

2015

 

7

 

2016

 

3

 

Thereafter

 

2

 

 

 

 

 

Total

 

$

83

 

 

4.     Income taxes

 

The income tax expense of $44 million for the three months ended June 30, 2012 reflected an effective tax rate of 19.2%, which differed from the effective tax rate of 28.6% for the three months ended June 30, 2011 primarily due to an increase in the amount of earnings in foreign jurisdictions with a lower statutory rate (relative to domestic earnings with a higher statutory rate). The effective tax rate of 19.2% for the three months ended June 30, 2012 differed from the statutory rate of 35.0% primarily due to foreign income taxes levied at relatively lower rates, geographic mix in profitability, recognition of California research and development credits and federal domestic production deductions. The federal research credit expired on December 31, 2011 and, as of June 30, 2012, an extension of the credit had not been signed into law and, as such, we have excluded the benefit from this tax credit in our income tax calculation for the three months ended June 30, 2012.

 

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For the six months ended June 30, 2012, the tax rate was based on our projected annual effective tax rate for 2012, and also included certain discrete tax items recorded during the period.  Our tax expense of $174 million for the six months ended June 30, 2012 reflected an effective tax rate of 23.4%, which differed from the effective tax rate of 26.9% for the six months ended June 30, 2011 primarily due to an increase in the amount of earnings in foreign jurisdictions with a lower statutory rate (relative to domestic earnings with a higher statutory rate).

 

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, 2012 and will be dependent, in part, on our profitability for the remainder of the year. In addition, our effective income tax rates for the remainder of 2012 and future periods will depend on a variety of factors, such as changes in the mix of income by tax jurisdiction, applicable accounting rules, applicable tax laws and regulations, and rulings and interpretations thereof, developments in tax audits and other matters, and variations in the estimated and actual level of annual pre-tax income or loss.  Further, the effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected by the extent that income (loss) before income tax expenses (benefit) is lower than anticipated in foreign regions where taxes are levied at relatively lower statutory rates and/or higher than anticipated in the United States where taxes are levied at relatively higher statutory rates.

 

The Internal Revenue Service (“IRS”) is currently examining the Company’s federal tax returns for the 2009 tax year. The Company also 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 the Company’s business and results of operations in an interim period in which the matters are ultimately resolved.

 

5.     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,

 

 

 

2012

 

2011

 

Internally developed software costs

 

$

138

 

$

115

 

Payments made to third-party software developers

 

126

 

84

 

Total software development costs

 

$

264

 

$

199

 

 

 

 

 

 

 

Intellectual property licenses

 

$

20

 

$

34

 

 

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,

 

 

 

2012

 

2011

 

2012

 

2011

 

Amortization of capitalized software development costs and intellectual property licenses

 

$

68

 

$

57

 

$

99

 

$

130

 

Write-offs and impairments

 

6

 

 

8

 

 

 

 

 

 

 

 

 

 

 

 

 

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.

 

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·                  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.

 

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 six-month period ended June 30, 2012, there were no impairment charges related to assets that are measured on a non-recurring basis.

 

The tables below segregate all financial assets and liabilities that are measured at fair value on a recurring basis and non-financial assets and liabilities that are not subject to recurring fair value measurement into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value on June 30, 2012 and December 31, 2011 (amounts in millions):

 

 

 

 

 

Fair Value Measurements at

 

 

 

 

 

 

 

June 30, 2012 Using

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

Active

 

Significant

 

 

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

 

 

Identical

 

Observable

 

Unobservable

 

 

 

 

 

June 30,

 

Assets

 

Inputs

 

Inputs

 

Balance Sheet

 

 

 

2012

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Classification

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

2,607

 

$

2,607

 

$

 

$

 

Cash and cash equivalents

 

U.S. treasuries and government agency securities

 

391

 

391

 

 

 

Short-term investments

 

Auction rate securities (“ARS”)

 

17

 

 

 

17

 

Long-term investments

 

Foreign exchange contract derivatives

 

(1

)

 

(1

)

 

Other current liabilities

 

Total recurring fair value measurements

 

$

3,014

 

$

2,998

 

$

(1

)

$

17

 

 

 

 

 

 

 

 

Fair Value Measurements at

 

 

 

 

 

 

 

 

 

December 31, 2011 Using

 

 

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

 

 

Prices in

 

 

 

 

 

 

 

 

 

 

 

 

 

Active

 

Significant

 

 

 

 

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

 

 

 

 

Identical

 

Observable

 

Unobservable

 

 

 

 

 

 

 

December 31,

 

Assets

 

Inputs

 

Inputs

 

Total Gains

 

Balance Sheet

 

 

 

2011

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

(Losses)

 

Classification

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

2,869

 

$

2,869

 

$

 

$

 

 

 

Cash and cash equivalents

 

U.S. treasuries with original maturities of three months or less

 

2

 

2

 

 

 

 

 

Cash and cash equivalents

 

U.S. treasuries and government agency securities

 

344

 

344

 

 

 

 

 

Short-term investments

 

ARS

 

16

 

 

 

16

 

 

 

Long-term investments

 

Total recurring fair value measurements

 

$

3,231

 

$

3,215

 

$

 

$

16

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill (a)

 

$

7,111

 

$

 

$

 

$

7,111

 

$

(12

)

 

 

Total non-recurring fair value measurements

 

$

7,111

 

$

 

$

 

$

7,111

 

$

(12

)

 

 

 


(a) During our annual impairment review of goodwill performed as of December 31, 2011, we identified and recorded an impairment of $12 million in our Distribution segment. The decrease in fair value of the reporting unit was primarily due to the decrease of forecasted revenue from our Distribution segment in view of the industry trend towards digital distribution.

 

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The following tables provide a reconciliation of the beginning and ending balances of our financial assets classified as Level 3 by major categories (amounts in millions) at June 30, 2012 and 2011, respectively:

 

 

 

Level 3

 

 

 

 

 

Total

 

 

 

 

 

financial

 

 

 

 

 

assets at

 

 

 

 

 

fair

 

 

 

ARS (a)

 

value

 

Balance at January 1, 2012

 

$

16

 

$

16

 

Total unrealized gains included in other comprehensive income

 

1

 

1

 

Balance at June 30, 2012

 

$

17

 

$

17

 

 

 

 

Level 3

 

 

 

 

 

Total

 

 

 

 

 

financial

 

 

 

 

 

assets at

 

 

 

 

 

fair

 

 

 

ARS (a)

 

value

 

Balance at January 1, 2011

 

$

23

 

$

23

 

Total unrealized gains included in other comprehensive income

 

2

 

2

 

Balance at June 30, 2011

 

$

25

 

$

25

 

 


(a)Fair value measurements of the ARS have been estimated using an income-approach model (specifically, discounted cash-flow analysis). When estimating the fair value, we consider both observable market data and non-observable factors, including credit quality, duration, insurance wraps, collateral composition, maximum rate formulas, comparable trading instruments and the likelihood of redemption. Significant assumptions used in the analysis include estimates for interest rates, spreads, cash flow timing and amounts, and holding periods of the securities.

 

Assets measured at fair value using significant unobservable inputs (Level 3) represent less than 1% of our financial assets measured at fair value on a recurring basis at June 30, 2012.

 

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, primarily swaps and forward contracts with maturities of twelve months or less, with Vivendi as our principal counterparty. We do not hold or purchase any foreign currency contracts for trading or speculative purposes and we do not designate these forward contracts or swaps as hedging instruments.  Accordingly, we report the fair value of these contracts in our condensed consolidated balance sheet with changes in fair value recorded in our condensed consolidated statement of operations. The fair value of foreign currency contracts is estimated based on the prevailing exchange rates of the various hedged currencies as of the end of the period.

 

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7.     Operating segments and geographic region

 

Our operating segments are consistent with our internal organizational structure, the manner in which our operations are reviewed and managed by our Chief Executive Officer, who is our Chief Operating Decision Maker (“CODM”), the manner in which operating performance is assessed and resources are allocated, and the availability of separate financial information. We do not aggregate operating segments.

 

The CODM reviews segment performance exclusive of the impact of the change in deferred net revenues and related cost of sales with respect to certain of our online-enabled games, stock-based compensation expense, restructuring expense, and amortization of intangible assets. The CODM does not review any information regarding total assets on an operating segment basis and, accordingly, no disclosure is made with respect thereto.  Please see footnote 1 of the notes to the condensed consolidated financial statements for the description of an adjustment recorded in the second quarter that impacted net revenues and income from operations before income tax expenses in our Blizzard segment, Europe region, and online subscriptions as presented in tables within this footnote.  Information on the operating segments and reconciliations of total segment net revenues and total segment income from operations to consolidated net revenues and income before income tax expense from external customers for the three and six months ended June 30, 2012 and 2011 are presented below (amounts in millions):

 

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Table of Contents

 

 

 

Three months ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

Income from operations

 

 

 

Net revenues

 

before income tax expense

 

Activision

 

$

373

 

$

323

 

$

(71

)

$

31

 

Blizzard

 

634

 

313

 

371

 

135

 

Distribution

 

47

 

63

 

 

(1

)

Operating segments total

 

1,054

 

699

 

300

 

165

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

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

 

21

 

447

 

(40

)

332

 

Stock-based compensation expense

 

 

 

(31

)

(20

)

Restructuring

 

 

 

 

(3

)

Amortization of intangible assets

 

 

 

(2

)

(7

)

Consolidated net revenues / operating income

 

$

1,075

 

$

1,146

 

227

 

467

 

Investment and other income (expense), net

 

 

 

 

 

2

 

2

 

Consolidated income before income tax expense

 

 

 

 

 

$

229

 

$

469

 

 

 

 

Six months ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

Income from operations

 

 

 

Net revenues

 

before income tax expense

 

Activision

 

$

645

 

$

646

 

$

(70

)

$

78

 

Blizzard

 

884

 

671

 

460

 

306

 

Distribution

 

112

 

137

 

 

 

Operating segments total

 

1,641

 

1,454

 

390

 

384

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

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

 

606

 

1,141

 

407

 

838

 

Stock-based compensation expense

 

 

 

(52

)

(43

)

Restructuring

 

 

 

 

(22

)

Amortization of intangible assets

 

 

 

(5

)

(16

)

Consolidated net revenues / operating income

 

$

2,247

 

$

2,595

 

$

740

 

$

1,141

 

Investment and other income (expense), net

 

 

 

 

 

3

 

5

 

Consolidated income before income tax expense

 

 

 

 

 

$

743

 

$

1,146

 

 

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Table of Contents

 

Geographic information for the three and six months ended June 30, 2012 and 2011 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,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net revenues by geographic region:

 

 

 

 

 

 

 

 

 

North America

 

$

562

 

$

580

 

$

1,163

 

$

1,328

 

Europe

 

403

 

467

 

888

 

1,061

 

Asia Pacific

 

110

 

99

 

196

 

206

 

Total consolidated net revenues

 

$

1,075

 

$

1,146

 

$

2,247

 

$

2,595

 

 

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

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net revenues by platform:

 

 

 

 

 

 

 

 

 

Online subscriptions*

 

$

220

 

$

359

 

$

475

 

$

754

 

Console

 

514

 

611

 

1,203

 

1,436

 

Hand-held

 

18

 

33

 

44

 

63

 

PC and Other

 

276

 

80

 

413

 

205

 

Total platform net revenues

 

1,028

 

1,083

 

2,135

 

2,458

 

Distribution

 

47

 

63

 

112

 

137

 

Total consolidated net revenues

 

$

1,075

 

$

1,146

 

$

2,247

 

$

2,595

 

 


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

 

Long-lived assets by geographic region at June 30, 2012 and December 31, 2011 were as follows (amounts in millions):  

 

 

 

At June 30, 2012

 

At December 31, 2011

 

Long-lived assets* by geographic region:

 

 

 

 

 

North America

 

$

96

 

$

105

 

Europe

 

42

 

46

 

Asia Pacific

 

11

 

12

 

Total long-lived assets by geographic region

 

$

149

 

$

163

 

 


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

 

We did not have any single external customer that accounted for 10% or more of consolidated net revenues for the three or six months ended June 30, 2012 and 2011.

 

8.     Goodwill

 

The changes in the carrying amount of goodwill by operating segment for the six months ended June 30, 2012 are as follows (amounts in millions):  

 

 

 

Activision

 

Blizzard

 

Total

 

 

 

 

 

 

 

 

 

Balance at December 31, 2011

 

$

6,933

 

$

178

 

$

7,111

 

Tax benefit credited to goodwill

 

(3

)

 

(3

)

 

 

 

 

 

 

 

 

Balance at June 30, 2012

 

$

6,930

 

$

178

 

$

7,108

 

 

The tax benefit credited to goodwill represents the tax deduction resulting from the exercise of stock options that were outstanding and vested at the consummation of the Business Combination and included in the purchase price of the Company, to the extent that the tax deduction did not exceed the fair value of those options. Conversely, to the extent that the tax deduction did exceed the fair value of those options, the tax benefit is credited to additional paid-in capital.

 

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9.     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,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Consolidated net income

 

$

185

 

$

335

 

$

569

 

$

838

 

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

 

 

 

(4

)

(3

)

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

 

(4

)

(5

)

(7

)

(9

)

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

 

181

 

330

 

558

 

826

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

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

 

1,109

 

1,141

 

1,115

 

1,157

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Employee stock options

 

6

 

9

 

6

 

9

 

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

 

1,115

 

1,150

 

1,121

 

1,166

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.16

 

$

0.29

 

$

0.50

 

$

0.71

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.16

 

$

0.29

 

$

0.50

 

$

0.71

 

 

Our unvested restricted stock rights, which consist of restricted stock units, restricted stock awards, and performance shares, are considered participating securities since these securities have non-forfeitable rights to dividends or dividend equivalents during the contractual period of the award. Since the unvested restricted stock rights are considered participating securities, we are required to use the two-class method in our computation of basic and diluted earnings per common share. For the three and six months ended June 30, 2012, on a weighted-average basis, we had outstanding unvested restricted stock rights with respect to 24 million and 22 million shares of common stock.  For both the three and six months ended June 30, 2011, on a weighted-average basis, we had outstanding unvested restricted stock rights with respect to 17 million shares of common stock.

 

Potential common shares are not included in the denominator of the diluted earnings per common share calculation when inclusion of such shares would be anti-dilutive. Therefore, options to acquire 20 million shares of common stock were not included in the calculation of diluted earnings per common share for both the three and six months ended June 30, 2012 and options to acquire 31 million shares of common stock were not included in the calculation of diluted earnings per common share for both the three and six months ended June 30, 2011, as the effect of their inclusion in each case would be anti-dilutive.

 

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10. Capital transactions

 

Repurchase Program

 

On February 2, 2012, our Board of Directors authorized a new stock repurchase program under which we may repurchase up to $1 billion of our common stock, on terms and conditions to be determined by the Company, during the period between April 1, 2012 and the earlier of March 31, 2013 and a determination by the Board of Directors to discontinue the repurchase program.  For the six months ended June 30, 2012, we repurchased 4 million shares of our common stock for an aggregate purchase price of $54 million pursuant to that stock repurchase program.

 

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

 

For the six months ended June 30, 2011, we repurchased 45 million shares of our common stock for an aggregate purchase price of $501 million pursuant to stock repurchase plans authorized in 2010 and 2011.

 

Dividend

 

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

 

On February 9, 2011, our Board of Directors approved a cash dividend of $0.165 per common share to be paid on May 11, 2011 to shareholders of record as of March 16, 2011, and on May 11, 2011, we made a cash dividend payment of $192 million to such shareholders. On August 12, 2011, the Company made dividend equivalent payments of $2 million related to this cash dividend to the holders of restricted stock units.

 

11.  Commitments and contingencies

 

At June 30, 2012, we did not have any significant changes to our commitments since December 31, 2011.  See Note 17 of the Notes to Consolidated Financial Statements included in Item 8 of the Annual Report on Form 10-K for the year ended December 31, 2011 for more information regarding our commitments.

 

Legal Proceedings

 

The Company is subject to various legal proceedings and claims. FASB Accounting Standards Codification (ASC) Topic 450 governs the disclosure of loss contingencies and accrual of loss contingencies in respect of litigation and other claims.    The Company records an accrual for a potential loss when it is probable that a loss will occur and the amount of the loss can be reasonably estimated.   When the reasonable estimate of the potential loss is within a range of amounts, the minimum of the range of potential loss is accrued, unless a higher amount within the range is a better estimate than any other amount within the range. Moreover, even if an accrual is not required, the Company provides additional disclosure related to litigation and other claims when it is reasonably possible (i.e., more than remote) that the outcomes of such litigation and other claims include potential material adverse impacts on the Company.    The outcomes of legal proceedings and other claims are subject to significant uncertainties, many of which are outside the Company’s control.  There is significant judgment required in the analysis of these matters, including the probability determination and whether a potential exposure can be reasonably estimated. In making these determinations, the Company, in consultation with outside counsel, examines the relevant facts and circumstances on a quarterly basis assuming, as applicable, a combination of settlement and litigated outcomes and strategies. Moreover, legal matters are inherently unpredictable and the timing of development of factors on which reasonable judgments and estimates can be based can be slow.   As such, there can be no assurance that the final outcome of these matters will not materially and adversely affect our business, financial condition, results of operations, or liquidity.

 

The Company recognized expense associated with legal-related matters (i.e., accruals, settlements and fees) totaling $74 million and $34 million during the three months ended June 30, 2012 and 2011, respectively.

 

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In prior periods, the Company reported on litigation involving former employees at Infinity Ward, as well as Electronic Arts, Inc.  During the period ended June 30, 2012, as previously disclosed, all parties to these litigation matters reached a settlement of the disputes.

 

We are party to routine claims and suits brought by us and against us in the ordinary course of business, including disputes arising over intellectual property rights, contractual claims, employment laws, regulations and relationships, and collection matters. In the opinion of management, after consultation with legal counsel, such routine claims and lawsuits are not significant and we do not expect them to have a material adverse effect on our business, financial condition, results of operations, or liquidity.

 

12.  Related party transactions

 

Treasury

 

Our foreign currency risk management program seeks to reduce risks arising from foreign currency fluctuations. We use derivative financial instruments, primarily currency forward contracts and swaps, with Vivendi as our principal counterparty. The gross notional amount of outstanding foreign exchange swaps were $322 million and $85 million at June 30, 2012 and December 31, 2011, respectively. A pre-tax net unrealized loss of $1 million and a gain of less than a million for the three months ended June 30, 2012 and 2011, respectively, resulted from the foreign exchange contracts and swaps with Vivendi and were recognized in the condensed consolidated statements of operations.  A pre-tax net unrealized loss of $1 million and a loss of less than a million for the six months ended June 30, 2012 and 2011, respectively, resulted from the foreign exchange contracts and swaps with Vivendi and were recognized in the condensed consolidated statements of operations.

 

Other

 

Activision Blizzard has entered into various transactions and agreements, including cash management services, investor agreement, and music royalty agreements with Vivendi and its subsidiaries and other affiliates.  None of these services, transactions and agreements with Vivendi and its affiliates is material, either individually or in the aggregate, to the condensed consolidated financial statements as a whole.

 

13.  Recently issued accounting pronouncements

 

Fair value measurements and disclosures

 

Effective January 1, 2012, we adopted an update to the accounting rules for fair value measurement.  The new accounting principal establishes a consistent definition of fair value in an effort to ensure that the fair value measurement and disclosure requirements between U.S. GAAP and International Financial Reporting Standards (“IFRS”) are comparable. This update changes certain fair value measurement principles and enhances the disclosure requirements for fair value measurements. This update does not extend the use of fair value accounting, but provides guidance on how it should be applied where its use was already required or permitted by other standards within U.S. GAAP or IFRS. This update is effective for interim and annual periods beginning after December 15, 2011 and is applied prospectively. The adoption of this pronouncement did not have a material impact on the Company’s Condensed Consolidated Financial Statements and accompanying disclosures.

 

Statement of comprehensive income

 

Effective January 1, 2012, we adopted the FASB issued authoritative guidance on the presentation of comprehensive income. This update requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This update does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The adoption of this pronouncement did not have a material impact on the Company’s Condensed Consolidated Financial Statements and accompanying disclosures.

 

Goodwill impairment

 

Effective January 1, 2012, the Company adopted an update to the authoritative guidance related to goodwill impairment testing. This update gives companies the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount before performing the two-step test mandated prior to the update. If, after assessing the totality of events and circumstances, a company determines it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then it must perform the two-step test. Otherwise, a company may skip the two-step test. Companies are not required to perform the qualitative assessment and may, instead proceed directly to the first step of the two-part test. The adoption of this updated guidance does not have a material impact on the Company’s Condensed Consolidated Financial Statements.

 

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

 

Business Overview

 

Activision Blizzard, Inc. is a worldwide online, personal computer (“PC”), console, handheld, and mobile game publisher. The terms “Activision Blizzard,” the “Company,” “we,” “us,” and “our” are used to refer collectively to Activision Blizzard, Inc. and its subsidiaries. Based upon our organizational structure, we conduct our business through three operating segments as follows:

 

Activision Publishing, Inc.

 

Activision Publishing, Inc. (“Activision”) is a leading international developer and publisher of interactive software products and content. Activision develops games based on both internally-developed and licensed intellectual property. Activision markets and sells games we develop and, through our affiliate label program, games developed by certain third-party publishers. We sell games both through retail channels and by digital download. Activision currently offers games that operate on the Sony Computer Entertainment, Inc. (“Sony”) PlayStation 3 (“PS3”), Nintendo Co. Ltd. (“Nintendo”) Wii (“Wii”), and Microsoft Corporation (“Microsoft”) Xbox 360 (“Xbox 360”) console systems; the Nintendo Dual Screen (“NDS”) handheld game systems; the PC; Apple iOS devices and other handheld and mobile devices.

 

Blizzard Entertainment, Inc.

 

Blizzard Entertainment, Inc. (“Blizzard”) is a leader in the subscription-based massively multi-player online role-playing game (“MMORPG”) category in terms of both subscriber base and revenues generated through its World of Warcraft® franchise, which it develops, hosts and supports.  Blizzard also develops, markets and sells role-playing action and strategy PC-based computer games, 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 (which consist of fees from individuals playing World of Warcraft, prepaid cards and other value-added service revenues such as realm transfers, faction changes, and other character customizations within World of Warcraft gameplay); retail sales of physical “boxed” products; online download sales of PC products; and licensing of software to third-party or related party companies that distribute World of Warcraft and StarCraft® II.

 

Activision Blizzard Distribution

 

Activision Blizzard Distribution (“Distribution”) consists of operations in Europe that provide warehousing, logistical and sales distribution services to third-party publishers of interactive entertainment software, our own publishing operations, and manufacturers of interactive entertainment hardware.

 

Business Highlights

 

For both the three months ended June 30, 2012 and June 30, 2011, Activision Blizzard’s net revenues were $1.1 billion. For the three months ended June 30, 2012, Activision Blizzard’s earnings per diluted share were $0.16, as compared to earnings per diluted share of $0.29 for the same period in 2011.

 

For the six months ended June 30, 2012, Activision Blizzard had net revenues of $2.2 billion, as compared to net revenues of $2.6 billion for the same period in 2011, and earnings per diluted share of $0.50, as compared to earnings per diluted share of $0.71 for the same period in 2011.

 

According to The NPD Group, with respect to North American data, Chart-Track and GfK with respect to European data, and our internal estimates:

 

For the three months ended June 30, 2012,

 

·                  Activision Blizzard was the #1 publisher overall in North America and Europe; and

·                  Activision Publishing’s Skylanders Spyro’s Adventure™, including accessory packs and figures, was the #1 best-selling console and handheld game overall in dollars in North America and Europe.

 

For the six months ended June 30, 2012,

 

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·                  Blizzard Entertainment’s Diablo® III, which was released on May 15, 2012, set a new launch record for Blizzard, selling 10 million units through June 30, 2012, and was the #1 best-selling PC game in North America and Europe for the first six months of 2012.

·                  Activision Blizzard had the top three best-selling games in North America and Europe: Skylanders Spyro’s Adventure, Diablo III and Call of Duty®: Modern Warfare® 3.

 

During the six months ended June 30, 2012, Activision Publishing released Call of Duty: Modern Warfare 3 Content Collection #1 and Call of Duty: Modern Warfare 3 Content Collection #2.  In addition, Activision Publishing released Skylanders Cloud Patrol™, Prototype® 2, Battleship®, The Amazing Spider-Man and Men In Black: Alien Crisis.  Activision Publishing also released Ice Age Continental Drift Arctic Games in Europe and Asia Pacific.

 

Recent and Upcoming Product Releases

 

On July 10, 2012, Activision Publishing released Ice Age Continental Drift Arctic Games for Xbox 360, PS3, Wii, and NDS in North America.

 

During the third quarter of 2012, Activision Publishing expects to release the Call of Duty: Modern Warfare 3 Content Collection #3 content pack for Xbox 360 and PS3 and the Call of Duty: Modern Warfare 3 Content Collection #4 content pack for Xbox 360.  In addition, Activision Publishing expects to release Transformers™: Fall of Cyberton™, for Xbox 360, PS3, and PC, Wipeout 3 for Xbox 360, Wii, and NDS, and Angry Birds Trilogy for Xbox 360, PS3, and NDS.

 

Blizzard Entertainment expects to release World of Warcraft®: Mists of Pandaria™ on September 25, 2012.

 

Management’s Overview of Business Trends

 

We provide our products through both retail channels and digital online delivery methods. Many of our video games that are available through retailers as physical “boxed” software products such as DVDs are also available by direct digital download over the Internet (both from websites that we own and from others owned by third parties).  In addition, we offer players downloadable content as add-ons to our products (e.g., new multi-player content packs). Such digital online-delivered content is generally offered to consumers for a one-time fee.

 

We also offer subscription-based services for World of Warcraft, which are digitally delivered and hosted by Blizzard’s proprietary online-game related service, Battle.net, and for Call of Duty® Elite, a digital service that provides both free and paid subscription-based content and features for the Call of Duty franchise. Digital revenues remain an important part of our business, and we continue to focus on and develop products that can be delivered via digital online channels.  The amount of our digital revenues in any period may fluctuate depending, in part, on the timing and nature of our specific product releases.

 

Conditions in the retail channels of the video games industry have remained challenging for the first six months of 2012. In the U.S. and Europe, retail sales within the industry experienced a combined overall decrease of approximately 25% for the first six months of 2012, as compared to the same period in 2011, according to The NPD Group, Chart-Track and GfK. The declines in the U.S. and European retail channels were impacted by fewer releases in the six months ended June 30, 2012 as compared to the same period in 2011, as well as price declines over the prior year.  In addition, the decline in sales to the retail channel continues to be more pronounced for casual titles on the Nintendo Wii and handheld platforms (down over 38% year-to-date), than titles on high-definition platforms (i.e., Xbox 360, and PS3).

 

However, the top five titles (including accessory packs and figures) grew 15% for the six months ended June 30, 2012, compared to the same period in 2011.  This has resulted in the further concentration of revenues in the top titles, particularly for high-definition platforms, which experienced year over year growth, while non-premier titles experienced declines.  The Company’s results have been less impacted by the general declining trends in retail compared to our competitors because of our focus on premier top titles and a more focused slate of titles.

 

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Consolidated Statements of Operations Data

 

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

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product sales

 

$

798

 

74

%

$

768

 

67

%

$

1,672

 

74

%

$

1,829

 

70

%

Subscription, licensing, and other revenues

 

277

 

26

 

378

 

33

 

575

 

26

 

766

 

30

 

Total net revenues

 

1,075

 

100

 

1,146

 

100

 

2,247

 

100

 

2,595

 

100

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales — product costs

 

229

 

21

 

213

 

19

 

486

 

22

 

512

 

19

 

Cost of sales — online subscriptions

 

64

 

6

 

59

 

5

 

123

 

5

 

122

 

5

 

Cost of sales — software royalties and amortization

 

57

 

5

 

47

 

4

 

88

 

4

 

109

 

4

 

Cost of sales — intellectual property licenses

 

20

 

2

 

24

 

2

 

27

 

1

 

53

 

2

 

Product development

 

152

 

14

 

116

 

10

 

276

 

12

 

258

 

10

 

Sales and marketing

 

136

 

13

 

90

 

8

 

216

 

10

 

150

 

6

 

General and administrative

 

190

 

18

 

127

 

11

 

291

 

13

 

228

 

9

 

Restructuring

 

 

 

3

 

 

 

 

22

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total costs and expenses

 

848</