Activision Blizzard, Inc.
Activision Blizzard, Inc. (Form: 10-Q, Received: 11/04/2016 06:05:29)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark one)

 

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

 

For the Quarterly Period Ended September 30, 2016

 

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 October 27, 2016 was 743,213,371.

 

 

 



Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

 

Table of Contents

 

 

Cautionary Statement

3

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets at September 30, 2016 and December 31, 2015

4

 

 

 

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2016 and September 30, 2015

5

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2016 and September 30, 2015

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and September 30, 2015

7

 

 

 

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity for the nine months ended September 30, 2016

8

 

 

 

 

Notes to Condensed Consolidated Financial Statements

9

 

 

 

Item 2.

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

35

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

65

 

 

 

Item 4.

Controls and Procedures

67

 

 

 

PART II.

OTHER INFORMATION

68

 

 

 

Item 1.

Legal Proceedings

68

 

 

 

Item 1A.

Risk Factors

68

 

 

 

Item 5.

Other Information

68

 

 

 

Item 6.

Exhibits

68

 

 

 

SIGNATURE

69

 

 

EXHIBIT INDEX

70

 

 

CERTIFICATIONS

 

 

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Table of Contents

 

CAUTIONARY STATEMENT

 

This Quarterly Report on Form 10-Q contains, or incorporates by reference, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements consist of any statement other than a recitation of historical facts and include, but are not limited to: (1) projections of revenues, expenses, income or loss, earnings or loss per share, cash flow or other financial items; (2) statements of our plans and objectives, including those relating to releases of products and services; (3) statements of future financial or operating performance; (4) statements relating to the acquisition of King Digital Entertainment and expected impact of that transaction, including without limitation, the expected impact on Activision Blizzard’s future financial results; and (5) statements of assumptions underlying such statements. Activision Blizzard generally uses words such as “outlook,” “forecast,” “will,” “could,” “should,” “would,” “to be,” “plan,” “plans,” “believes,” “may,” “might,” “expects,” “intends,” “intends as,” “anticipates,” “estimate,” “future,” “positioned,” “potential,” “project,” “remain,” “scheduled,” “set to,” “subject to,” “upcoming” and other similar expressions to help identify forward-looking statements. Forward-looking statements are subject to business and economic risks, reflect management’s current expectations, estimates and projections about our business, and are inherently uncertain and difficult to predict.

 

The Company cautions that a number of important factors could cause Activision Blizzard’s actual future results and other future circumstances to differ materially from those expressed in any forward-looking statements. Such factors include, but are not limited to: uncertainties as to whether and when Activision Blizzard will be able to realize the anticipated financial benefits from the acquisition of King Digital Entertainment; the integration of King Digital Entertainment being more difficult, time-consuming, or costly than expected; the diversion of management time and attention to issues relating to the operations and integration of King Digital Entertainment and Major League Gaming; sales levels of Activision Blizzard’s titles, products and services; concentration of revenue among a small number of titles; Activision Blizzard’s ability to predict consumer preferences, including interest in specific genres, and preferences among hardware platforms; the amount of our debt and the limitations imposed by the covenants in the agreements governing our debt; adoption rate and availability of new hardware (including peripherals) and related software; counterparty risks relating to customers, licensees, licensors, and manufacturers; maintenance of relationships with key personnel, customers, financing providers, licensees, licensors, manufacturers, vendors, and third-party developers, including the ability to attract, retain, and develop key personnel and developers that can create high-quality titles, products and services; risks relating to the expansion into new businesses, including the potential impact on our existing businesses; changing business models within the video game industry, including digital delivery of content and the increased prevalence of free-to-play games; product delays or defects; competition, including from used games and other forms of entertainment; rapid changes in technology and industry standards; possible declines in software pricing; product returns and price protection; the identification of suitable future acquisition opportunities and potential challenges associated with geographic expansion; the seasonal and cyclical nature of the interactive entertainment market; the outcome of current or future tax disputes; litigation risks and associated costs; protection of proprietary rights; shifts in consumer spending trends; capital market risks; applicable regulations; domestic and international economic, financial, and political conditions and policies; tax rates and foreign exchange rates; the impact of the current macroeconomic environment; and the other factors identified in “Risk Factors” included in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2015. 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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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 September 30,
2016

 

At December 31,
2015

Assets

 

 

 

 

Current assets:

 

 

 

 

Cash and cash equivalents

 

  $

4,029

 

  $

1,823

Accounts receivable, net of allowances of $152 and $343, at September 30, 2016 and December 31, 2015, respectively

 

446

 

679

Inventories, net

 

131

 

128

Software development

 

414

 

336

Other current assets

 

314

 

421

Total current assets

 

5,334

 

3,387

Cash in escrow

 

 

3,561

Software development

 

64

 

80

Property and equipment, net

 

258

 

189

Deferred income taxes, net

 

485

 

275

Other assets

 

382

 

177

Intangible assets, net

 

2,070

 

482

Goodwill

 

9,787

 

7,095

Total assets

 

  $

18,380

 

  $

15,246

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

Current liabilities:

 

 

 

 

Accounts payable

 

  $

211

 

  $

284

Deferred revenues

 

1,320

 

1,702

Accrued expenses and other liabilities

 

689

 

625

Current portion of long-term debt, net

 

1,481

 

Total current liabilities

 

3,701

 

2,611

Long-term debt, net

 

4,881

 

4,074

Deferred income taxes, net

 

43

 

10

Other liabilities

 

937

 

483

Total liabilities

 

9,562

 

7,178

Commitments and contingencies (Note 13)

 

 

 

 

Shareholders’ equity:

 

 

 

 

Common stock, $0.000001 par value, 2,400,000,000 shares authorized, 1,171,794,694 and 1,163,179,140 shares issued at September 30, 2016 and December 31, 2015, respectively

 

 

Additional paid-in capital

 

10,427

 

10,242

Less: Treasury stock, at cost, 428,676,471 shares at September 30, 2016 and December 31, 2015

 

(5,572)

 

(5,637)

Retained earnings

 

4,616

 

4,096

Accumulated other comprehensive loss

 

(653)

 

(633)

Total shareholders’ equity

 

8,818

 

8,068

Total liabilities and shareholders’ equity

 

  $

18,380

 

  $

15,246

 

 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
September 30,

 

For the Nine Months Ended
September 30,

 

 

2016

 

2015

 

2016

 

2015

 

 

 

 

 

 

 

 

 

Net revenues

 

 

 

 

 

 

 

 

Product sales

 

  $

355

 

  $

425

 

  $

1,501

 

  $

1,736

Subscription, licensing and other revenues

 

1,213

 

565

 

3,093

 

1,576

Total net revenues

 

1,568

 

990

 

4,594

 

3,312

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

Cost of revenues - product sales:

 

 

 

 

 

 

 

 

Product costs

 

111

 

179

 

429

 

528

Software royalties, amortization, and intellectual property licenses

 

42

 

62

 

250

 

273

Cost of revenues - subscription, licensing, and other revenues:

 

 

 

 

 

 

 

 

Game operations and distribution costs

 

237

 

71

 

620

 

192

Software royalties, amortization, and intellectual property licenses

 

139

 

25

 

319

 

54

Product development

 

249

 

159

 

673

 

453

Sales and marketing

 

340

 

189

 

830

 

445

General and administrative

 

156

 

109

 

486

 

297

Total costs and expenses

 

1,274

 

794

 

3,607

 

2,242

 

 

 

 

 

 

 

 

 

Operating income

 

294

 

196

 

987

 

1,070

 

 

 

 

 

 

 

 

 

Interest and other expense (income), net

 

63

 

51

 

181

 

151

 

 

 

 

 

 

 

 

 

Income before income tax expense

 

231

 

145

 

806

 

919

 

 

 

 

 

 

 

 

 

Income tax expense

 

32

 

18

 

93

 

186

 

 

 

 

 

 

 

 

 

Net income

 

  $

199

 

  $

127

 

  $

713

 

  $

733

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

Basic

 

  $

0.27

 

  $

0.17

 

  $

0.96

 

  $

0.99

Diluted

 

  $

0.26

 

  $

0.17

 

  $

0.94

 

  $

0.98

 

 

 

 

 

 

 

 

 

Weighted-average number of shares outstanding

 

 

 

 

 

 

 

 

Basic

 

742

 

730

 

739

 

727

Diluted

 

756

 

739

 

753

 

736

 

 

 

 

 

 

 

 

 

Dividends per common share

 

  $

 

  $

 

  $

0.26

 

  $

0.23

 

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
September 30,

 

For the Nine Months Ended
September 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

Net income

 

 $

199

 

 $

127

 

 $

713

 

 $

733

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

5

 

(20)

 

(240)

 

Unrealized gains (losses) on forward contracts designated as hedges, net of tax

 

(4)

 

(3)

 

 

3

 

Unrealized losses on investments, net of tax

 

 

(1)

 

 

(4)

 

Total other comprehensive income (loss)

 

 $

(4)

 

 $

1

 

 $

(20)

 

 $

(241)

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 $

195

 

 $

128

 

 $

693

 

 $

492

 

 

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

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Amounts in millions)

 

 

 

For the Nine Months Ended September 30,

 

 

 

2016

 

2015

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

 $

713

 

 $

733

 

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

 

 

 

 

 

Deferred income taxes

 

(200)

 

(22)

 

Provision for inventories

 

29

 

16

 

Depreciation and amortization

 

584

 

65

 

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

248

 

303

 

Amortization of debt discount, financing costs, and non-cash write-off due to extinguishment of debt

 

26

 

5

 

Stock-based compensation expense(2)

 

107

 

71

 

Changes in operating assets and liabilities, net of effect from business acquisitions:

 

 

 

 

 

Accounts receivable, net

 

395

 

142

 

Inventories

 

(32)

 

(135)

 

Software development and intellectual property licenses

 

(295)

 

(249)

 

Other assets

 

85

 

158

 

Deferred revenues

 

(396)

 

(833)

 

Accounts payable

 

(76)

 

(7)

 

Accrued expenses and other liabilities

 

108

 

(51)

 

Net cash provided by operating activities

 

1,296

 

196

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities of available-for-sale investments

 

 

15

 

Purchases of available-for-sale investments

 

 

(144)

 

Acquisition of business, net of cash acquired

 

(4,588)

 

 

Release of cash in escrow

 

3,561

 

 

Capital expenditures

 

(99)

 

(95)

 

Payment to acquire equity method investment

 

(5)

 

 

Increase in restricted cash

 

(19)

 

(15)

 

Net cash used in investing activities

 

(1,150)

 

(239)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

86

 

82

 

Tax payment related to net share settlements on restricted stock rights

 

(76)

 

(36)

 

Dividends paid

 

(195)

 

(170)

 

Proceeds from debt financing

 

6,925

 

 

Repayment of long-term debt

 

(4,604)

 

(250)

 

Payment of debt discount and financing costs

 

(53)

 

 

Proceeds received from shareholder lawsuit settlement

 

 

202

 

Net cash provided by (used in) financing activities

 

2,083

 

(172)

 

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

(23)

 

(268)

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

2,206

 

(483)

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

1,823

 

4,848

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

 $

4,029

 

 $

4,365

 

 

(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 STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2016

(Unaudited)

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

 

 

 

Common Stock

 

Treasury Stock

 

Additional
Paid-In

 

Retained

 

Accumulated
Other
Comprehensive

 

Total
Shareholders’

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Earnings

 

Income (Loss)

 

Equity

 

Balance at December 31, 2015

 

1,163

 

$

 

(429)

 

$

(5,637)

 

$

10,242

 

$

4,096

 

$

(633)

 

$

8,068

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

713

 

 

713

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

(20)

 

(20)

 

Issuance of common stock pursuant to employee stock options

 

6

 

 

 

 

86

 

 

 

86

 

Issuance of common stock pursuant to restricted stock rights

 

5

 

 

 

 

 

 

 

 

Restricted stock surrendered for employees’ tax liability

 

(2)

 

 

 

 

(80)

 

 

 

(80)

 

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

 

 

 

 

 

103

 

 

 

103

 

Stock-based compensation assumed in acquisition (see Note 14)

 

 

 

 

 

76

 

 

 

76

 

Dividends ($0.26 per common share)

 

 

 

 

 

 

(193)

 

 

(193)

 

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

 

 

 

 

65

 

 

 

 

65

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2016

 

1,172

 

$

 

(429)

 

$

(5,572)

 

$

10,427

 

$

4,616

 

$

(653)

 

$

8,818

 

 

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

 

Activision Blizzard, Inc. is a leading global developer and publisher of interactive entertainment. The terms “Activision Blizzard,” the “Company,” “we,” “us,” and “our” are used to refer collectively to Activision Blizzard, Inc. and its subsidiaries. We currently offer games for video game consoles, personal computers (“PC”), and handheld, mobile, and tablet devices. We maintain significant operations in the United States (“U.S.”), Canada, the United Kingdom (“U.K.”), France, Germany, Ireland, Italy, Sweden, Spain, the Netherlands, Australia, South Korea, and China.

 

Activision Blizzard is the result of the 2008 business combination (“Business Combination”) by and among the Company (then known as Activision, Inc.), Sego Merger Corporation, a wholly-owned subsidiary of Activision, Inc., Vivendi S.A. (“Vivendi”), VGAC LLC, a wholly-owned subsidiary of Vivendi, and Vivendi Games, Inc. (“Vivendi Games”), a wholly-owned subsidiary of VGAC LLC.  As a result of the consummation of the Business Combination, Activision, Inc. was renamed Activision Blizzard, Inc.

 

As of December 31, 2015, ASAC II LP, an exempted limited partnership established under the laws of the Cayman Islands (“ASAC LP”), held approximately 172 million shares, or approximately 23% of the outstanding shares of our common stock at that time. Robert A. Kotick, our Chief Executive Officer, and Brian G. Kelly, Chairman of our Board of Directors, are the managers of ASAC II LLC, the general partner of ASAC LP (“ASAC GP”). On June 8, 2016, ASAC GP distributed the approximately 141 million shares allocable to the limited partners of ASAC LP to those limited partners. On July 7, 2016, ASAC LP distributed approximately 18 million of its remaining approximately 31 million shares to ASAC GP. On August 15, 2016, ASAC GP sold approximately 4 million shares of our common stock and distributed 14 million shares pro rata to its members, consisting of trusts for the benefit of Messrs. Kotick and Kelly, which shares were ultimately sold on that day for financial and estate-planning purposes. On August 19, 2016, ASAC LP distributed its remaining shares of common stock to ASAC GP, leaving ASAC LP without any shares and ASAC GP with approximately 13 million shares of our common stock, which represented approximately 2% of the outstanding shares of our common stock as of September 30, 2016. We did not receive any proceeds from any of the distributions or sales of the shares.

 

The common stock of Activision Blizzard is traded on The NASDAQ Stock Market under the ticker symbol “ATVI.”

 

The King Acquisition

 

On November 2, 2015, we and King Digital Entertainment plc (“King”), a leading interactive mobile entertainment company, entered into a transaction agreement (the “Transaction Agreement”) under the terms of which we would acquire King (the “King Acquisition”) and King would become a wholly-owned subsidiary of the Company. On February 23, 2016, we completed the King Acquisition, as further described in Note 14 of the notes to the condensed consolidated financial statements. Our condensed consolidated financial statements include the operations of King commencing on February 23, 2016.

 

Reportable Segments

 

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

 

(i) Activision Publishing, Inc.

 

Activision Publishing, Inc. (“Activision”) is a leading global developer and publisher of interactive software products and content. Activision delivers content to a broad range of gamers, ranging from children to adults, and from core gamers to mass-market consumers, in a variety of geographies. Activision develops, markets, and sells products through retail channels or digital downloads, which are principally based on our internally-developed intellectual properties, including games in the Call of Duty ®  and Skylanders ®  franchises, as well as some licensed properties. Additionally, we have established a long-term alliance with Bungie to publish its game universe, Destiny. Activision currently offers games that operate on the Microsoft Corporation (“Microsoft”) Xbox One (“Xbox One”) and Xbox 360 (“Xbox 360”), Nintendo Co. Ltd. (“Nintendo”) Wii U (“Wii U”) and Wii (“Wii”), and Sony Computer Entertainment, Inc. (“Sony”) PlayStation 4 (“PS4”) and PlayStation 3 (“PS3”) console systems; the PC; the Nintendo 3DS, Nintendo Dual Screen, and Sony PlayStation Vita handheld game systems; and mobile and tablet devices.

 

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(ii) Blizzard Entertainment, Inc.

 

Blizzard Entertainment, Inc. (“Blizzard”) is a leader in online PC gaming, including the subscription-based massively multi-player online role-playing game category, in terms of both subscriber base and revenues generated through its World of Warcraft ®  franchise. Blizzard also develops, markets, and sells role-playing action and strategy games for the PC, console, mobile and tablet platforms, including games in the multiple-award winning Diablo ® , StarCraft ® , Hearthstone ® : Heroes of Warcraft , and Heroes of the Storm ®  franchises. On May 24, 2016, Blizzard added a new franchise, Overwatch ® , a team-based first-person shooter available on the PC and console platforms. In addition, Blizzard maintains a proprietary online gaming service, Battle.net ® , which facilitates digital distribution and online social connectivity across all Blizzard games. Blizzard distributes its products and generates revenues worldwide through various means, including: subscriptions; sales of prepaid subscription cards; in-game purchases and services; retail sales of physical “boxed” products; online sales of downloadable PC products; purchases and downloads via third-party console, mobile, and tablet platforms; and licensing of software to third-party or related party companies that distribute Blizzard products.

 

(iii) King Digital Entertainment Limited

 

King Digital Entertainment Limited (“King”) is a leading interactive mobile entertainment company that develops and distributes games on mobile platforms, such as Android and iOS, and on online and social platforms, such as Facebook and the king.com websites. King has four established free-to-play franchises: Candy Crush , Farm Heroes , Bubble Witch , and Pet Rescue , where monetization occurs through players purchasing virtual items and in-game virtual currency.

 

(iv) Other

 

We also engage in other businesses that do not represent reportable segments, including:

 

·                   The Major League Gaming (“MLG”) business (which we formerly referred to as Activision Blizzard Media Networks or Media Networks), which is devoted to eSports and builds on our competitive gaming efforts by creating ways to deliver best-in-class fan experiences across games, platforms, and geographies with a long-term strategy of monetization through advertising, sponsorships, tournaments, and premium content.

 

·                   The Activision Blizzard Studios (“Studios”) business, which is devoted to creating original film and television content based on our extensive library of iconic and globally-recognized intellectual properties.

 

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

 

Basis of Consolidation and Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) and accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim reporting. Accordingly, certain notes or other information that are normally required by U.S. GAAP have been condensed or omitted if they substantially duplicate the disclosures contained in the annual audited consolidated financial statements. The year-end condensed consolidated 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, 2015.

 

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The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for the fair statement of our financial position and results of operations in accordance with U.S. GAAP have been included in the accompanying unaudited condensed consolidated financial statements. Actual results could differ from these estimates and assumptions.

 

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

 

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.

 

Cost of revenues presentation

 

In periods prior to the second quarter of 2016, we presented cost of revenues in our consolidated statements of operations in four financial statement captions: “Cost of sales - product costs,” “ Cost of sales - online,” “Cost of sales - software royalties and amortization,” and “Cost of sales - intellectual property licenses.” Commencing with the second quarter of 2016, we have revised the presentation in our condensed consolidated statements of operations to more clearly align our costs of revenues with the associated revenue captions as follows:

 

Cost of revenues - product sales:

 

(i)              “Product costs” - includes the manufacturing costs of goods produced and sold. These generally include product costs, manufacturing royalties, net of volume discounts, personnel-related costs, warehousing, and distribution costs. We generally recognize volume discounts when they are earned (typically in connection with the achievement of unit-based milestones).

 

(ii)           “Software royalties, amortization, and intellectual property licenses” - includes the amortization of capitalized software costs and royalties attributable to product sales revenues. These are costs capitalized on the balance sheet until the respective games are released, at which time the capitalized costs are amortized. Also included is amortization of intangible assets recognized in purchase accounting attributable to product sales revenues.

 

Cost of revenues - subscription, licensing, and other revenues:

 

(i)              “Game operations and distribution costs” - includes costs to operate our games, such as customer service, internet bandwidth and server costs, platform provider fee, and payment provider fees.

 

(ii)           “Software royalties, amortization, and intellectual property licenses” - includes the amortization of capitalized software costs and royalties attributable to subscription, licensing and other revenues. These are costs capitalized on the balance sheet until the respective games are released, at which time the capitalized costs are amortized. Also included is amortization of intangible assets recognized in purchase accounting attributable to subscription, licensing and other revenues.

 

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Prior periods have been reclassified to conform to the current presentation.

 

Summary of Significant Accounting Policies

 

During the nine months ended September 30, 2016, there were no significant changes to our accounting policies but we did expand the accounting policy disclosure for revenue recognition to include virtual currency as noted below. Refer to Note 2 contained in our Annual Report on Form 10-K for the year ended December 31, 2015 for our full summary of significant accounting policies.

 

Microtransaction Revenues

 

Microtransaction revenues are derived from the sale of virtual goods and currencies to our players to enhance their gameplay experience. Proceeds from the sales of virtual goods and currencies are initially recorded in deferred revenues. Proceeds from the sales of virtual currencies are recognized as a player uses the virtual goods purchased with the virtual currency. We categorize our virtual goods as either consumable or durable. Consumable virtual goods represent goods that can be consumed by a specific player action; accordingly, we recognize revenues from the sale of consumable virtual goods as the goods are consumed. Durable virtual goods represent goods that are accessible to the player over an extended period of time. We recognize revenues from the sale of durable virtual goods ratably over the period of time the goods are available to the player, which is generally the estimated service period of the game.

 

Supplemental Cash Flow Information: Non-cash investing and financing activities

 

For the nine months ended September 30, 2016, we had non-cash purchase price consideration of $89 million related to vested and unvested stock options and awards that were assumed and replaced with Activision Blizzard equity or deferred cash awards in the King Acquisition. Refer to Note 14 for further discussion.

 

2.                                       Inventories, Net

 

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

 

 

 

At September 30, 2016

 

At December 31, 2015

 

Finished goods

 

  $

103

 

  $

101

 

Purchased parts and components

 

28

 

27

 

Inventories, net

 

  $

131

 

  $

128

 

 

At September 30, 2016, and December 31, 2015, inventory reserves were $52 million and $54 million, respectively.

 

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3.                                       Software Development and Intellectual Property Licenses

 

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

 

 

 

At September 30, 2016

 

At December 31, 2015

 

Internally-developed software costs

 

  $

304

 

  $

266

 

Payments made to third-party software developers

 

174

 

150

 

Total software development costs

 

  $

478

 

  $

416

 

 

 

 

 

 

 

Intellectual property licenses

 

  $

3

 

  $

30

 

 

Intellectual property licenses are classified within “Other current assets” and “Other assets” in our condensed consolidated balance sheets.

 

Amortization of capitalized software development costs and intellectual property licenses was the following (amounts in millions):

 

 

 

For the Three Months Ended September 30,

 

For the Nine Months Ended September 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

Amortization of capitalized software development costs and intellectual property licenses

 

  $

47

 

  $

80

 

  $

260

 

  $

312

 

 

4.                                       Intangible Assets, Net

 

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

 

 

 

At September 30, 2016

 

 

 

Estimated useful
lives

 

Gross carrying
amount

 

Accumulated
amortization

 

Net carrying
amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Internally-developed franchises

 

3 - 11 years

 

  $

1,154

 

  $

(495)

 

  $

659

 

Developed software

 

3 - 5 years

 

595

 

(102)

 

493

 

Customer base

 

2 years

 

617

 

(188)

 

429

 

Trade names

 

7 - 10 years

 

54

 

(5)

 

49

 

Other

 

1 - 8 years

 

18

 

(11)

 

7

 

Total definite-lived intangible assets

 

 

 

  $

2,438

 

  $

(801)

 

  $

1,637

 

 

 

 

 

 

 

 

 

 

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

 

 

 

 

386

 

Acquired trade names

 

Indefinite

 

 

 

 

 

47

 

Total indefinite-lived intangible assets

 

 

 

 

 

 

 

  $

433

 

Total intangible assets, net

 

 

 

 

 

 

 

  $

2,070

 

 

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At December 31, 2015

 

 

 

Estimated useful
lives

 

Gross carrying
amount

 

Accumulated
amortization

 

Net carrying
amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

License agreements and other

 

1 - 10 years

 

  $

116

 

  $

(93)

 

  $

23

 

Internally-developed franchises

 

11 years

 

309

 

(298)

 

11

 

Developed software

 

5 years

 

15

 

 

15

 

Total definite-lived intangible assets

 

 

 

  $

440

 

  $

(391)

 

  $

49

 

 

 

 

 

 

 

 

 

 

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

 

 

 

 

386

 

Acquired trade names

 

Indefinite

 

 

 

 

 

47

 

Total indefinite-lived intangible assets

 

 

 

 

 

 

 

  $

433

 

Total intangible assets, net

 

 

 

 

 

 

 

  $

482

 

 

The balances of intangible assets, net presented in the table above at September 30, 2016, does not include license agreement intangible assets that were fully amortized at December 31, 2015, and hence have been removed from the September 30, 2016 balances, as presented. Amortization expense of intangible assets was $211 million and $496 million for the three and nine months ended September 30, 2016, respectively. Amortization expense of intangible assets was $2 million and $5 million for the three and nine months ended September 30, 2015, respectively.

 

At September 30, 2016, future amortization of definite-lived intangible assets is estimated as follows (amounts in millions):

 

2016 (remaining three months)

 

  $

211

 

2017

 

777

 

2018

 

361

 

2019

 

201

 

2020

 

66

 

Thereafter

 

21

 

Total

 

  $

1,637

 

 

5.                                       Goodwill

 

The changes in the carrying amount of goodwill by operating segment for the nine months ended September 30, 2016, are as follows (amounts in millions):

 

 

 

Activision

 

Blizzard

 

King

 

Other

 

Total

 

Balance at December 31, 2015

 

  $

6,905

 

  $

178

 

  $

 

  $

12

 

  $

7,095

 

Additions through acquisition

 

 

 

2,693

 

 

2,693

 

Other

 

(1)

 

 

 

 

(1)

 

Balance at September 30, 2016

 

  $

6,904

 

  $

178

 

  $

2,693

 

  $

12

 

  $

9,787

 

 

The addition to goodwill through acquisition is attributed to the King Acquisition (see Note 14 of the notes to condensed consolidated financial statements).

 

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6.                                       Fair Value Measurements

 

Financial Accounting Standards Board (“FASB”) literature regarding fair value measurements for financial and non-financial assets and liabilities establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of “observable inputs” and minimize the use of “unobservable inputs.” The three levels of inputs used to measure fair value are as follows:

 

·       Level 1 - Quoted prices in active markets for identical assets or liabilities;

 

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

 

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

 

Fair Value Measurements on a Recurring Basis

 

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

 

 

 

 

 

Fair Value Measurements at September 30, 2016 
Using

 

 

 

 

As of 
September 30,
2016

 

Quoted 
Prices in 
Active 
Markets for 
Identical 
Assets
(Level 1)

 

Significant 
Other 
Observable 
Inputs
(Level 2)

 

Significant 
Unobservable 
Inputs
(Level 3)

 

Balance Sheet Classification

Financial Assets:

 

 

 

 

 

 

 

 

 

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

Money market funds

 

  $

3,801

 

  $

3,801

 

  $

 

  $

 

Cash and cash equivalents

Foreign government treasury bills

 

39

 

39

 

 

 

Cash and cash equivalents

Foreign currency forward contracts not designated as hedges

 

4

 

 

4

 

 

Other current assets

Foreign currency forward contracts designated as hedges

 

1

 

 

1

 

 

Other current assets

Auction rate securities (“ARS”)

 

9

 

 

 

9

 

Other assets

Total recurring fair value measurements

 

  $

3,854

 

  $

3,840

 

  $

5

 

  $

9

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts designated as hedges

 

  $

(5)

 

  $

 

  $

(5)

 

  $

 

Accrued expenses and other liabilities

 

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Fair Value Measurements at December 31, 2015 
Using

 

 

 

 

As of 
December 31, 
2015

 

Quoted 
Prices in 
Active 
Markets for 
Identical 
Assets
(Level 1)

 

Significant 
Other 
Observable 
Inputs
(Level 2)

 

Significant 
Unobservable 
Inputs
(Level 3)

 

Balance Sheet Classification

Financial Assets:

 

 

 

 

 

 

 

 

 

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

Money market funds

 

  $

1,613

 

  $

1,613

 

  $

 

  $

 

Cash and cash equivalents

Foreign government treasury bills

 

34

 

34

 

 

 

Cash and cash equivalents

Foreign currency forward contracts not designated as hedges

 

11

 

 

11

 

 

Other current assets

ARS

 

9

 

 

 

9

 

Other assets

Total recurring fair value measurements

 

  $

1,667

 

  $

1,647

 

  $

11

 

  $

9

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts designated as hedges

 

  $

(4)

 

  $

 

  $

(4)

 

  $

 

Accrued expenses and other liabilities

 

ARS represented the only level 3 investment held by the Company. There were no changes in the fair value of these investments for the nine months ended September 30, 2016.

 

Foreign Currency Forward Contracts

 

Foreign Currency Forward Contracts Not Designated as Hedges

 

For foreign currency forward contracts entered into to mitigate risk from foreign currency-denominated monetary assets, liabilities, and earnings that are not designated as hedging instruments in accordance with FASB Accounting Standard Codification (“ASC”) Topic 815, changes in the estimated fair value of these derivatives are recorded within “General and administrative expenses” and “Interest and other expense (income), net” in our condensed consolidated statements of operations, consistent with the nature of the underlying transactions.

 

At September 30, 2016, the gross notional amount of outstanding foreign currency forward contracts not designated as hedges was approximately $165 million. The fair value of these foreign currency forward contracts was $4 million as of September 30, 2016, and recorded in “Other current assets” in our condensed consolidated balance sheet.

 

At December 31, 2015, the gross notional amount of outstanding foreign currency forward contracts not designated as hedges was approximately $489 million. The fair value of these foreign currency forward contracts was $11 million as of December 31, 2015, and recorded in “Other current assets” in our condensed consolidated balance sheet.

 

For the three and nine months ended September 30, 2016 and 2015, pre-tax net gains associated with these forward contracts were not material.

 

Foreign Currency Forward Contracts Designated as Hedges

 

For foreign currency forward contracts entered into to hedge forecasted intercompany cash flows that are subject to foreign currency risk and which we designated as cash flow hedges in accordance with ASC Topic 815, we assess the effectiveness of these cash flow hedges at inception and on an ongoing basis to determine if the hedges are effective at providing offsetting changes in cash flows of the hedged items. We record the effective portion of changes in the estimated fair value of these derivatives in “Accumulated other comprehensive income (loss)” and subsequently reclassify the related amount of accumulated other comprehensive income (loss) to earnings within “General and administrative expense” when the hedged item impacts earnings. Cash flows from these foreign currency forward contracts are classified in the same category as the cash flows associated with the hedged item in the condensed consolidated statements of cash flows. We measure hedge ineffectiveness, if any, and if it is determined that a derivative has ceased to be a highly effective hedge, we will discontinue hedge accounting for the derivative.

 

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The gross notional amount of all outstanding foreign currency forward contracts designated as cash flow hedges was approximately $599 million at September 30, 2016, and $381 million at December 31, 2015. These foreign currency forward contracts have remaining maturities of 15 months or less. During the three and nine months ended September 30, 2016, and 2015, there was no ineffectiveness relating to these hedges. At September 30, 2016, $4 million of net unrealized losses related to these contracts are expected to be reclassified into earnings within the next twelve months.

 

During the three and nine months ended September 30, 2016 and 2015, the amount pre-tax net realized gains reclassified out of “Accumulated other comprehensive income (loss)” due to maturity of these contracts was not material.

 

Fair Value Measurements on a Non-Recurring Basis

 

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

 

For the three and nine months ended September 30, 2016, and 2015, there were no impairment charges related to assets that are measured on a non-recurring basis.

 

7.                                       Debt

 

Credit Facilities

 

On October 11, 2013, we entered into a credit agreement (the “Credit Agreement”) for a $2.5 billion secured term loan facility maturing in October 2020 (the “Term Loan”), and a $250 million secured revolving credit facility (the “Original Revolver”). As of December 31, 2015, as a result of repayments and prepayments during the prior periods, we had $1.9 billion outstanding under the Term Loan.

 

In conjunction with the King Acquisition, we entered into three amendments to the Credit Agreement (the “Amendments”). The Amendments, among other things, provided for incremental term loans in the form of tranche A term loans in an aggregate principal amount of approximately $2.3 billion. The proceeds were provided on February 23, 2016 and were used to fund the King Acquisition. On March 31, 2016, we entered into a fourth amendment to the Credit Agreement which provided for an incremental tranche A term loan in the aggregate principal amount of $250 million (together with the $2.3 billion tranche A term loans, the “Existing TLA”); the proceeds from the incremental borrowing were used to make a voluntary prepayment on our Term Loan on March 31, 2016. In addition to this prepayment, we made voluntary prepayments on our Term Loan of $500 million and $800 million on February 25 and May 26, 2016, respectively.

 

On August 23, 2016 we entered into a fifth amendment to the Credit Agreement (the “Fifth Amendment”) that provided for new tranche A term loans of approximately $2.9 billion (the “New TLA”) and an amended revolving credit facility of $250 million (the “Revolver” and together with the New TLA, the “Credit Facilities”). Both the New TLA and Revolver are scheduled to mature on August 23, 2021 and are unsecured. The proceeds from the New TLA were primarily used to pay off the remaining outstanding principal balance on the Term Loan of $319 million and the Existing TLA of $2.5 billion. As a result of the payments to extinguish the Term Loan and Existing TLA, we wrote-off unamortized discount and deferred financing costs of $10 million, which is included in “Interest and other expense (income), net” in the condensed consolidated statement of operations. The remaining unamortized discount and deferred financing costs were deferred, along with new fees paid to the New TLA lenders, and will continue to be amortized over the maturity of the New TLA. Debt discounts and deferred financing costs incurred in relation to the Fifth Amendment were not material.

 

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Borrowings under the Revolver may be borrowed, repaid, and re-borrowed by the Company, and are available for working capital and other general corporate purposes. Up to $50 million of the Revolver may be used for letters of credit. To date, we have not drawn on the Revolver. Borrowings under the New TLA and the Revolver will bear interest, at the Company’s option, at either (a) a base rate equal to the highest of (i) the federal funds rate, plus 0.5%, (ii) the prime commercial lending rate of Bank of America, N.A. and (iii) the London Interbank Offered Rate (“LIBOR”) for an interest period of one month beginning on such day plus 1.00%, or (b) LIBOR, in each case, plus an applicable interest margin.  LIBOR will be subject to a floor of 0% and the base rate will be subject to an effective floor of 1.00%.  The applicable interest margin for borrowings under the New TLA and Revolver will range from 1.125% to 2.00% for LIBOR borrowings and from 0.125% to 1.00% for base rate borrowings and will be determined by reference to a pricing grid based on the Company’s credit ratings. At September 30, 2016, the New TLA bore interest at 1.77%.

 

The Credit Agreement requires quarterly principal payments of 0.625% of the stated principal amount of the New TLA commencing on September 30, 2016, with increases to 1.250% starting on September 30, 2019 and 3.125% starting on September 30, 2020, with the remaining balance payable on the New TLA’s scheduled maturity date of August 23, 2021. On September 30, 2016, in addition to the required quarterly repayment of $18 million, we made a voluntary prepayment on our New TLA of $167 million. These payments satisfied the required quarterly principal repayments through December 31, 2018.

 

The Company is subject to a financial covenant requiring the Company’s Consolidated Total Net Debt Ratio (as defined in the Credit Agreement) not to exceed (i) 4.00:1.00 on or prior to March 31, 2017, and (ii) thereafter, 3.50:1.00. The Fifth Amendment contains other covenants consistent with the Credit Agreement, although the Fifth Amendment provides for additional exceptions from such covenants that are customary for transactions of this type for issuers with similar credit ratings. A violation of any of these covenants could result in an event of default under the Credit Agreement.  Upon the occurrence of such event of default or certain other customary events of default, payment of any outstanding amounts under the Credit Agreement may be accelerated, and the lenders’ commitments to extend credit under the Credit Agreement may be terminated.  In addition, an event of default under the Credit Agreement could, under certain circumstances, permit the holders of other outstanding unsecured debt, including the debt holders described below, to accelerate the repayment of such obligations. The Company was in compliance with the terms of the Credit Facilities as of September 30, 2016.

 

The Credit Facilities are guaranteed by certain of the Company’s U.S. subsidiaries, whose assets represent approximately 68% of our consolidated total assets.

 

Unsecured Senior Notes

 

On September 19, 2013, we issued, at par, $1.5 billion of 5.625% unsecured senior notes due September 2021 (the “Original 2021 Notes”) and $750 million of 6.125% unsecured senior notes due September 2023 (the “2023 Notes” and, together with the Original 2021 Notes, the “Notes”) in a private bond offering to qualified institutional buyers made in accordance with Rule 144A under the Securities Act of 1933, as amended.

 

The Notes are general senior obligations of the Company and rank pari passu in right of payment to all of the Company’s existing and future senior indebtedness, including the Credit Facilities described above. The Notes are guaranteed on a senior basis by certain of our U.S. subsidiaries. The Notes and related guarantees are not secured and are effectively subordinated to any of the Company’s existing and future indebtedness that is secured.

 

The Original 2021 Notes became eligible for redemption on September 15, 2016 (and, as described below, were redeemed on October 19, 2016).  We may redeem the 2023 Notes on or after September 15, 2018, in whole or in part on any one or more occasions, at specified redemption prices, plus accrued and unpaid interest. In addition, we may redeem some or all of the 2023 Notes prior to September 15, 2018, at a price equal to 100% of the aggregate principal amount thereof plus a “make-whole premium” and accrued and unpaid interest.   Further, upon the occurrence of one or more qualified equity offerings, we may also redeem up to 35% of the aggregate principal amount of the 2023 Notes outstanding with the net cash proceeds from such offerings.

 

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On September 19, 2016, we issued $650 million of 2.300% unsecured senior notes due September 2021 (the “New 2021 Notes”) and $850 million of 3.400% unsecured senior notes due September 2026 (the “2026 Notes” and together with the New 2021 Notes, the “New Notes”) in a private offering made in accordance with Rule 144A and Regulation S under the Securities Act of 1933, as amended.

 

In connection with the issuance of the New Notes, we entered into a registration rights agreement (the “Registration Rights Agreement”), among the Company, the Guarantors and the representatives of the initial purchasers of the New Notes. Under the Registration Rights Agreement, we are required to use commercially reasonable efforts to within one year of the issue date of the New Notes, among other things, (1) file a registration statement with respect to an offer to exchange each series of the New Notes for new notes that are substantially identical in all material respects, (except for the provisions relating to the transfer restrictions and payment of additional interest) and (2) cause the registration statement to be declared effective by the SEC under the Securities Act.

 

We may redeem the New 2021 Notes on or after August 15, 2021, and the 2026 Notes on or after June 15, 2026, in whole or in part on any one or more occasions and in each case at a price equal to 100% of the aggregate principal amount thereof plus accrued and unpaid interest. In addition, we may redeem some or all of the New 2021 Notes prior to August 15, 2021 and some or all of the 2026 Notes prior to June 15, 2026, in each case at a price equal to 100% of the aggregate principal amount thereof plus a “make-whole” premium and accrued and unpaid interest.

 

Upon the occurrence of certain change of control events, we will be required to offer to repurchase the Notes and New Notes at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest. These repurchase requirements are considered clearly and closely related to the Notes and New Notes and are not accounted for separately upon issuance.

 

The Notes contain customary covenants that place restrictions in certain circumstances on, among other things, the incurrence of debt, granting of liens, payment of dividends, sales of assets, and certain merger and consolidation transactions. The New Notes contain customary covenants that place restrictions in certain circumstances on, among other things, the incurrence of secured debt, entry into sale or leaseback transactions, and certain merger or consolidation transactions. The Company was in compliance with the terms of the Notes and New Notes as of September 30, 2016.

 

Interest on the Notes and New Notes is payable semi-annually in arrears on March 15 and September 15 of each year.  As of September 30, 2016, and December 31, 2015, we had interest payable of $7 million and $38 million, respectively, related to the Notes and New Notes recorded within “Accrued expenses and other liabilities” in our condensed consolidated balance sheet.

 

On September 19, 2016 we issued an irrevocable notice to the holders of the Original 2021 Notes that we were calling those notes which then had a 30-day period before payment. On October 19, 2016 we redeemed the notes in full for $1.6 billion, which resulted in a loss on extinguishment of approximately $82 million, comprised of a premium payment of $63 million and write off of unamortized discount and financing costs of $19 million. This loss was recognized at the time of extinguishment. As a result of the irrevocable notice of redemption, we presented the outstanding principal balance of the Original 2021 Notes and its related unamortized discount and deferred financing costs as “Current portion of long-term debt, net” on our condensed consolidated balance sheets as of September 30, 2016.

 

Debt Discounts and Deferred Financing Costs

 

Fees and discounts associated with the closing of our debt instruments are recorded as debt discount, which reduces their respective carrying values, and is amortized over their respective terms. Amortization expense is recorded within “Interest and other expense (income), net” in our condensed consolidated statement of operations.

 

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In connection with the debt financing for the Existing TLA and New Notes offering, we incurred $38 million and $17 million of discounts and financing costs, respectively, that were capitalized and recorded within “Long-term debt, net” in our condensed consolidated balance sheet. New lender fees and deferred financing costs related to the New TLA were not material.

 

For the three and nine months ended September 30, 2016: interest expense was $50 million and $158 million, respectively; amortization of the debt discount and deferred financing costs was $4 million and $16 million, respectively; and commitment fees for the Revolver were not material. For the three and nine months ended September 30, 2015: interest expense was $48 million and $145 million, respectively; amortization of the debt discount and deferred financing costs for the Credit Facilities and Notes was $2 million and $5 million, respectively; and commitment fees for the Original Revolver were not material.

 

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

 

 

 

At September 30, 2016

 

 

Gross Carrying Amount

 

Unamortized
Discount and Deferred
Financing Costs

 

Net Carrying
Amount

New TLA

 

  $

2,690

 

  $

(31)

 

  $

2,659

New 2021 Notes

 

650

 

(6)

 

644

Original 2021 Notes

 

1,500

 

(19)

 

1,481

2023 Notes

 

750

 

(11)

 

739

2026 Notes

 

850

 

(11)

 

839

Total debt

 

  $

6,440

 

  $

(78)

 

  $

6,362

Less: current portion of long-term debt

 

(1,500)

 

19

 

(1,481)

Total long-term debt

 

  $

4,940

 

  $

(59)

 

  $

4,881

 

 

 

 

 

At December 31, 2015

 

 

Gross Carrying
Amount

 

Unamortized
Discount and Deferred
Financing Costs

 

Net Carrying
Amount

Term Loan

 

  $

1,869

 

  $

(11)

 

  $

1,858

Original 2021 Notes

 

1,500

 

(22)

 

1,478

2023 Notes

 

750

 

(12)

 

738

Total long-term debt

 

  $

4,119

 

  $

(45)

 

  $

4,074

 

As of September 30, 2016, the scheduled maturities and contractual principal repayments of our debt for each of the five succeeding years are as follows (amounts in millions):

 

For the year ending December 31,

 

 

2016 (remaining three months)

 

  $

1,500

2017

 

2018

 

2019

 

103

2020

 

252

Thereafter

 

4,585

Total

 

  $

6,440

 

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As of September 30, 2016, and December 31, 2015, the carrying value of the Term Loan and New TLA approximates the fair value, based on Level 2 inputs (observable market prices in less than active markets), as the interest rate is variable over the selected interest period and is similar to current rates at which we can borrow funds.  Based on Level 2 inputs, the fair values of the Original 2021 Notes, 2023 Notes, New 2021 Notes, and 2026 Notes were $1,565 million, $825 million, $652 million, and $854 million, respectively, as of September 30, 2016. Based on Level 2 inputs, the fair values of the Original 2021 Notes and 2023 Notes were $1,571 million and $795 million, respectively, as of December 31, 2015.

 

Debt Repayments

 

On February 2, 2016, the Board of Directors authorized debt repayments of up to $1.5 billion of our outstanding debt during 2016. For the nine months ended September 30, 2016, we have made payments to reduce our total outstanding term loans by $1.5 billion.

 

8.                                       Accumulated Other Comprehensive Income (Loss)

 

The components of accumulated other comprehensive income (loss) at September 30, 2016 and 2015, were as follows (amounts in millions):

 

 

 

For the Nine Months Ended September 30, 2016

 

 

Foreign currency 
translation 
adjustments

 

Unrealized gain 
(loss) on forward 
contracts

 

Unrealized gain 
(loss) on available-
for-sale securities

 

Total

Balance at December 31, 2015

 

  $

(630)

 

  $

(4)

 

  $

1

 

  $

(633)

Other comprehensive loss before reclassifications

 

(20)

 

(1)

 

 

(21)

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

1

 

 

1

Balance at September 30, 2016

 

  $

(650)

 

  $

(4)

 

  $

1

 

  $

(653)

 

 

 

 

 

For the Nine Months Ended September 30, 2015

 

 

Foreign currency
translation
adjustments

 

Unrealized gain 
(loss) on forward 
contracts

 

Unrealized gain 
(loss) on available-
for-sale securities

 

Total

Balance at December 31, 2014

 

  $

(304)

 

  $

 

  $

1

 

  $

(303)

Other comprehensive income (loss) before reclassifications

 

(240)

 

8

 

(4)

 

(236)

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

(5)

 

 

(5)

Balance at September 30, 2015

 

  $

(544)

 

  $

3

 

  $

(3)

 

  $

(544)

 

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

 

9.                                       Operating Segments and Geographic Region

 

Our operating segments are consistent with our internal organizational structure, the manner in which our operations are reviewed and managed by our Chief Executive Officer, who is our Chief Operating Decision Maker (“CODM”), the manner in which we assess operating performance and allocate resources, and the availability of separate financial information. Currently, we have three reportable operating segments (see Note 1 of the notes to condensed consolidated financial statements). We do not aggregate operating segments in determining and disclosing our reportable segments.

 

The CODM reviews segment performance exclusive of the impact of the change in deferred revenues and related cost of revenues with respect to certain of our online-enabled games, stock-based compensation expense, amortization of intangible assets as a result of purchase price accounting, and fees and other expenses related to financings and acquisitions. The CODM does not review any information regarding total assets on an operating segment basis, and, accordingly, no disclosure is made with respect thereto. Information on the operating segments and reconciliations of total net revenues and total segment operating income to consolidated net revenues from external customers and consolidated income before income tax expense for the three and nine months ended September 30, 2016 and 2015 are presented below (amounts in millions):

 

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For the Three Months Ended September 30,

 

 

2016

 

2015

 

2016

 

2015

 

 

Net revenues

 

Operating income and income before 
income tax expense

Activision

 

  $

377

 

  $

591

 

  $

123

 

  $

122

Blizzard

 

727

 

369

 

321

 

128

King

 

459

 

 

138

 

Reportable segments total

 

1,563

 

960

 

582

 

250

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Other segments (1)

 

67

 

80

 

(7)

 

1

Net effect from recognition (deferral) of deferred net revenues and related cost of revenues

 

(62)

 

(50)

 

(33)

 

(26)

Stock-based compensation expense

 

 

 

(33)

 

(28)

Amortization of intangible assets

 

 

 

(211)

 

(1)

Fees and other expenses related to acquisitions (2)

 

 

 

(4)

 

Consolidated net revenues / operating income

 

  $

1,568

 

  $

990

 

  $

294

 

  $

196

Interest and other expense (income), net

 

 

 

 

 

63

 

51

Consolidated income before income tax expense

 

 

 

 

 

  $

231

 

  $

145

 

 

 

 

 

For the Nine Months Ended September 30,

 

 

2016

 

2015

 

2016

 

2015

 

 

Net revenues

 

Operating income and income before 
income tax expense

Activision

 

  $

1,069

 

  $

1,208

 

  $

309

 

  $

244

Blizzard

 

1,760

 

1,106

 

740

 

383

King

 

1,149

 

 

381

 

Reportable segments total

 

3,978

 

2,314

 

1,430

 

627

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Other segments (1)

 

169

 

189

 

(15)

 

Net effect from recognition (deferral) of deferred net revenues and related cost of revenues

 

447

 

809

 

228

 

517

Stock-based compensation expense

 

 

 

(118)

 

(70)

Amortization of intangible assets

 

 

 

(495)

 

(4)

Fees and other expenses related to acquisitions (2)

 

 

 

(43)

 

Consolidated net revenues / operating income

 

  $

4,594

 

  $

3,312

 

  $

987

 

  $

1,070

Interest and other expense (income), net

 

 

 

 

 

181

 

151

Consolidated income before income tax expense

 

 

 

 

 

  $

806

 

  $

919

 

(1)                                  Other includes other income and expenses from operating segments managed outside the reportable segments, including MLG, Studios, and Distribution businesses. Other also includes unallocated corporate income and expenses.

 

(2)                                  Reflects fees and other expenses related to the King Acquisition, inclusive of related debt financings and integration costs.

 

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Geographic information presented below for the three and nine months ended September 30, 2016 and 2015, is based on the location of the paying customer. Net revenues from external customers by geographic region were as follows (amounts in millions):

 

 

 

For the Three Months Ended September 30,

 

For the Nine Months Ended September 30,

 

 

2016

 

2015

 

2016

 

2015

Net revenues by geographic region:

 

 

 

 

 

 

 

 

Americas

 

  $

796

 

  $

495

 

  $

2,411

 

  $

1,750

EMEA (1)

 

499

 

367

 

1,528

 

1,219

Asia Pacific

 

273

 

128

 

655

 

343

Total consolidated net revenues

 

  $

1,568

 

  $

990

 

  $

4,594

 

  $

3,312

 

(1)                                  EMEA consists of the Europe, Middle East, and Africa geographic regions.

 

The Company’s net revenues in the U.S. were 43% and 46% of consolidated net revenues for the three months ended September 30, 2016 and 2015, respectively. The Company’s net revenues in the U.K. were 10% and 13% of consolidated net revenues for the three months ended September 30, 2016 and 2015, respectively. No other country’s net revenues exceeded 10% of consolidated net revenues for the three months ended September 30, 2016 or 2015.

 

The Company’s net revenues in the U.S. were 46% and 50% of consolidated net revenues for the nine months ended September 30, 2016 and 2015, respectively. The Company’s net revenues in the U.K. were 10% and 13% of consolidated net revenues for the nine months ended September 30, 2016 and 2015, respectively. No other country’s net revenues exceeded 10% of consolidated net revenues for the nine months ended September 30, 2016 or 2015.

 

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

 

 

 

For the Three Months Ended September 30,

 

For the Nine Months Ended September 30,

 

 

2016

 

2015

 

2016

 

2015

Net revenues by platform:

 

 

 

 

 

 

 

 

Console

 

  $

452

 

  $

420

 

  $

1,867

 

  $

1,737

PC (1)

 

609

 

359

 

1,421

 

1,114

Mobile and ancillary (2)

 

440

 

131

 

1,137

 

272

Other (3)

 

67

 

80

 

169

 

189

Total consolidated net revenues

 

  $

1,568

 

  $

990

 

  $

4,594

 

  $

3,312

 

(1)                Net revenues from PC includes revenues that were historically shown as Online.

(2)                Net revenues from mobile and ancillary includes revenues from handheld, mobile and tablet devices, as well as non-platform specific game-related revenues such as standalone sales of toys and accessories from our Skylanders franchise and other physical merchandise and accessories.

(3)                Net revenues from Other include revenues from MLG, Studios, and Distribution businesses.

 

Long-lived assets by geographic region at September 30, 2016, and December 31, 2015, were as follows (amounts in millions):

 

 

 

At September 30, 2016

 

At December 31, 2015

Long-lived assets (1) by geographic region:

 

 

 

 

Americas

 

  $

 145

 

  $

 138

EMEA

 

97

 

42

Asia Pacific

 

16

 

9

Total long-lived assets by geographic region

 

  $

258

 

  $

189

 

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

 

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10.           Income Taxes

 

The Company accounts for its provision for income taxes in accordance with ASC 740,  Income Taxes , which requires an estimate of the annual effective tax rate for the full year to be applied to the interim period, taking into account year-to-date amounts and projected results for the full year.  The provision for income taxes represents federal, foreign, state, and local income taxes.  Our effective tax rate differs from the statutory U.S. income tax rate due to the effect of state and local income taxes, tax rates in foreign jurisdictions, and certain nondeductible expenses. Our effective tax rate could fluctuate significantly from quarter to quarter based on recurring and nonrecurring factors including, but not limited to: variations in the estimated and actual level of pre-tax income or loss by jurisdiction; changes in the mix of income by tax jurisdiction (as taxes are levied at relatively lower statutory rates in foreign regions and relatively higher statutory rates in the U.S.); research and development credits; changes in enacted tax laws and regulations, rulings, and interpretations thereof, including with respect to tax credits, and state and local income taxes; developments in tax audits and other matters;  and certain nondeductible expenses. Changes in judgment from the evaluation of new information resulting in the recognition, derecognition, or remeasurement of a tax position taken in a prior annual period are recognized separately in the quarter of the change.

 

The income tax expense of $32 million for the three months ended September 30, 2016, reflects an effective tax rate of 14%, which is higher than the effective tax rate of 13% for the three months ended September 30, 2015.  The increase is due to the change in the mix of domestic and foreign earnings and increases to the Company’s reserve for uncertain tax positions, partially offset by recognition of excess tax benefits from share-based payments (see Note 15 of the notes to condensed consolidated financial statements) and favorable return to provision adjustments.

 

The income tax expense of $93 million for the nine months ended September 30, 2016, reflects an effective tax rate of 12%, which is lower than the effective tax rate of 20% for the nine months ended September 30, 2015. The decrease is due to the change in the mix of domestic and foreign earnings, the recognition of excess tax benefits from share-based payments, the net benefit related to the settlement of an income tax audit during the first quarter of 2016, and favorable return to provision adjustments, partially offset by increases to the Company’s reserve for uncertain tax positions.

 

The effective tax rate of 14% for the three months ended September 30, 2016 differs from the US statutory rate of 35%, primarily due to the tax benefit from foreign earnings taxed at relatively lower statutory rates, the recognition of excess tax benefits from share-based payments, the recognition of federal and California research and development credits, favorable return to provision adjustments, and increases to the Company’s reserve for uncertain tax positions.

 

The effective tax rate of 12% for the nine months ended September 30, 2016 differs from the U.S. statutory rate of 35%, primarily due to the tax benefit from foreign earnings taxed at relatively lower statutory rates, the recognition of excess tax benefits from share-based payments, the recognition of federal and California research and development credits, the net benefit related to the settlement of an income tax audit during the first quarter of 2016, favorable return to provision adjustments, and increases to the Company’s reserve for uncertain tax positions.

 

The overall effective income tax rate for the year will be dependent, in part, on our profitability for the remainder of the year, as well as the other factors described above.

 

The Internal Revenue Service (“IRS”) is currently examining Activision Blizzard’s federal tax returns for the 2009, 2010, and 2011 tax years.  During the second quarter of 2015, the Company transitioned the review of its transfer pricing methodology from the advanced pricing agreement review process to the IRS examination team. Their review could result in a different allocation of profits and losses under the Company’s transfer pricing agreements. Such allocation could have a positive or negative impact on our provision for uncertain tax positions for the period in which such a determination is reached and the relevant periods thereafter. In addition, as part of purchase price accounting for the King Acquisition, the Company assumed $93 million of uncertain tax positions primarily related to the transfer pricing on King tax years occurring prior to the King Acquisition. The Company is currently in negotiations with the relevant jurisdictions and taxing authorities, which could result in a different allocation of profits and losses between the relevant jurisdictions.

 

Vivendi Games’ results for the period from January 1, 2008 through July 9, 2008 are included in the consolidated federal and certain foreign state and local income tax returns filed by Vivendi or its affiliates, while Vivendi Games’ results for the period from July 10, 2008 through December 31, 2008 are included in the consolidated federal and certain foreign, state and local income tax returns filed by Activision Blizzard. IRS Appeals proceedings concerning Vivendi Games’ tax return for the 2008 tax year were concluded during July 2016, but that year remains open to examination by other major taxing authorities. The resolution of the 2008 IRS Appeals process did not have a material impact to the Company’s condensed consolidated financial statements.

 

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Certain of our subsidiaries are under examination or investigation or may be subject to examination or investigation by tax authorities in various jurisdictions, including France. These proceedings may lead to adjustments or proposed adjustments to our taxes or provisions for uncertain tax positions. Such proceedings may have a material adverse effect on the Company’s consolidated financial position, liquidity or results of operations in the period or periods in which the matters are resolved or in which appropriate tax provisions are taken into account in our financial statements. If we were to receive a materially adverse assessment from a taxing jurisdiction, we would plan to vigorously contest it and consider all of our options, including the pursuit of judicial remedies.

 

The final resolution of the Company’s global tax disputes is uncertain. There is significant judgment required in the analysis of disputes, including the probability determination and estimation of the potential exposure. Based on current information, in the opinion of the Company’s management, the ultimate resolution of these matters is not expected to have a material adverse effect on the Company’s consolidated financial position, liquidity or results of operations, except as noted above. However, the Company’s global tax disputes could have a material adverse effect on our consolidated financial position, liquidity or results of operations in the period or periods in which the matters are ultimately resolved or in which appropriate tax provisions are taken into account in our financial statements.

 

In 2013, in connection with a share repurchase from Vivendi (the “Purchase Transaction”), we assumed certain tax attributes, generally consisting of net operating loss (“NOL”) carryforwards of approximately $760 million, which represent a potential future tax benefit of approximately $266 million. The utilization of such NOL carryforwards will be subject to certain annual limitations and will begin to expire in 2021. The Company also obtained indemnification from Vivendi against losses attributable to the disallowance of claimed utilization of such NOL carryforwards of up to $200 million in unrealized tax benefits in the aggregate, limited to taxable years ending on or prior to December 31, 2016. No benefit for these tax attributes or indemnification was recorded upon the close of the Purchase Transaction.  For the nine months ended September 30, 2016, we utilized $291 million of the NOL, which resulted in a tax benefit of $102 million, and a corresponding reserve of $102 million was established.  As of September 30, 2016, an indemnification asset of $191 million has been recorded in “Other Assets,” and, correspondingly, the same amount has been recorded as a reduction to the consideration paid for the shares repurchased in “Treasury Stock.”

 

11.               Computation of Basic/Diluted Earnings Per Common Share

 

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

 

 

 

For the Three Months Ended
September 30,

 

For the Nine Months Ended
September 30,

 

 

2016

 

2015

 

2016

 

2015

Numerator:

 

 

 

 

 

 

 

 

Consolidated net income

 

  $

 199

 

  $

 127

 

  $

 713

 

  $

 733

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

 

 

 

(2)

 

(4)

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

 

(1)

 

(2)

 

(2)

 

(6)

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

 

  $

 198

 

  $

 125

 

  $

 709

 

  $

 723

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

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

 

742

 

730

 

739

 

727

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

 

 

 

 

 

 

 

 

Employee stock options and awards

 

14

 

9

 

14

 

9

Denominator for diluted earnings per common share - weighted-average common shares outstanding plus dilutive common shares under the treasury stock method

 

756

 

739

 

753

 

736

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

  $

 0.27

 

  $

 0.17

 

  $

 0.96

 

  $

 0.99

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

  $

 0.26

 

  $

 0.17

 

  $

 0.94

 

  $

 0.98

 

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Certain of our unvested restricted stock rights (including certain restricted stock units and performance shares) met the definition of participating securities as they participate in earnings based on their rights to dividends or dividend equivalents.  Therefore, we are required to use the two-class method in our computation of basic and diluted earnings per common share. For the three and nine months ended September 30, 2016, on a weighted-average basis, we had outstanding unvested restricted stock rights with respect to 2 million and 3 million shares of common stock, respectively, that are participating in earnings. For the three and nine months ended September 30, 2015, on a weighted-average basis, we had outstanding unvested restricted stock rights with respect to 8 million and 9 million shares of common stock, respectively, that are participating in earnings.

 

Certain of our employee-related restricted stock rights and options are contingently issuable upon the satisfaction of pre-defined performance measures.  These shares are included in the weighted-average dilutive common shares only if the performance measures are met as of the end of the reporting period. Approximately 10 million shares are not included in the computation of diluted earnings per share for the three and nine months ended September 30, 2016, as their respective performance measures had not yet been met. Approximately 4 million shares are not included in the computation of diluted earnings per share for the three and nine months ended September 30, 2015, as their respective performance measures had not yet been met.

 

Potential common shares are not included in the denominator of the diluted earnings per common share calculation when the inclusion of such shares would be anti-dilutive. Therefore, options to acquire 1 million and 4 million shares of common stock were not included in the calculation of diluted earnings per common share for the three and nine months ended September 30, 2016, respectively, and options to acquire 1 million shares of common stock were not included in the calculation of diluted earnings per common share for the three and nine months ended September 30, 2015, as the effect of their inclusion would be anti-dilutive.

 

12.           Capital Transactions

 

Repurchase Program

 

On February 3, 2015, our Board of Directors authorized a stock repurchase program under which we may repurchase up to $750 million of our common stock during the two-year period from February 9, 2015 through February 8, 2017.  As of September 30, 2016, we have not repurchased any shares under this program.

 

Dividends

 

On February 2, 2016, our Board of Directors declared a cash dividend of $0.26 per common share, payable on May 11, 2016, to shareholders of record at the close of business on March 30, 2016. On May 11, 2016, we made an aggregate cash dividend payment of $192 million to such shareholders, and on May 27, 2016, we made related dividend equivalent payments of $3 million to certain holders of restricted stock rights.

 

On February 3, 2015, our Board of Directors declared a cash dividend of $0.23 per common share, payable on May 13, 2015, to shareholders of record at the close of business on March 30, 2015.  On May 13, 2015, we made an aggregate cash dividend payment of $167 million to such shareholders, and on May 29, 2015, we made related dividend equivalent payments of $3 million to certain holders of restricted stock rights.

 

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13.           Commitments and Contingencies

 

Legal Proceedings

 

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

 

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

 

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

 

14.           Acquisitions

 

King Digital Entertainment plc

 

On February 23, 2016 (the “King Closing Date”), we completed the King Acquisition under the terms of the Transaction Agreement, purchasing all of the outstanding shares of King. As a result, King became a wholly owned subsidiary of Activision Blizzard. King is a leading interactive entertainment company that develops and distributes games on mobile platforms, such as Android and iOS, and on online and social platforms, such as Facebook and the king.com websites. King’s results of operations since the King Closing Date are included in our condensed consolidated financial statements.

 

We made this acquisition because we believe that the addition of King’s highly-complementary mobile business will position the Company as a global leader in interactive entertainment across mobile, console, and PC platforms, as well as positioning us for future growth.

 

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The aggregate purchase price of the King Acquisition was approximately $5.8 billion, which was paid on the King Closing Date and funded primarily with $3.6 billion of existing cash and $2.2 billion of cash from new debt issued by the Company. The total aggregate purchase price for King was comprised of (amounts in millions):

 

Cash consideration for outstanding King common stock and vested equity options and awards (1)

 

  $

5,730

Fair value of King’s existing vested and unvested stock options and awards assumed (2)

 

98

Total purchase price

 

  $

5,828

 


(1)                Represents the cash consideration paid based on $18.00 per share to common stock holders of King and the fair value of King’s existing vested options and awards that were cash settled at the King Closing Date for the portion of the fair value related to pre-combination services. No future services are required.

 

(2)                Represents the fair value of King’s existing vested and unvested stock options and awards that were assumed and replaced with Activision Blizzard equity or deferred cash awards. The purchase price includes the portion of fair value related to pre-combination services. The fair value of the options and awards assumed was determined using binomial-lattice and Monte Carlo models with the following assumptions: (a) volatility of 36%, (b) time varying risk free interest rates based on the U.S. Treasury yield curves, (c) an expected life ranging from approximately 0.1 years to 7.6 years, and (d) an expected dividend yield of 0.9%. See additional discussion under “Stock-Based Compensation” below.

 

The Company identified and recorded assets acquired and liabilities assumed at their estimated fair values at the King Closing Date, and allocated the remaining value of approximately $2.7 billion to goodwill. The values assigned to certain acquired assets and liabilities are preliminary, and are based on information available as of the date of this Quarterly Report on Form 10-Q. Additional information may become available subsequently and may result in changes in the values allocated to various assets and liabilities, including the fair value of identified intangible assets, deferred income taxes, and contingent liabilities. Any changes in the fair values of the assets acquired and liabilities assumed during the measurement period of up to 12 months from the King Closing Date may result in material adjustments to goodwill. During the three months ended September 30, 2016, we recorded a measurement period adjustment for certain liabilities recorded in our preliminary purchase price allocation based on additional analysis of facts and circumstances that existed as of the King Closing Date.  The adjustment resulted in an increase to other liabilities and goodwill and was not material.

 

The preliminary purchase price allocation was as follows (amounts in millions):

 

 

 

February 23, 2016

 

Estimated useful lives

Tangible assets and liabilities assumed:

 

 

 

 

Cash and cash equivalents

 

  $

1,151

 

 

Accounts receivable

 

162

 

 

Other current assets

 

72

 

 

Property and equipment

 

57

 

2 - 7 years

Deferred income tax assets, net

 

27

 

 

Other assets

 

47

 

 

Accounts payable

 

(9)

 

 

Accrued expense and other liabilities

 

(272)

 

 

Other liabilities

 

(128)

 

 

Deferred income tax liabilities, net

 

(52)

 

 

Intangible assets

 

 

 

 

Internally-developed franchises

 

845

 

3 - 5 years

Customer base

 

609

 

2 years

Developed software

 

580

 

3 - 4 years

Trademark

 

46

 

7 years

 

 

 

 

 

Goodwill

 

2,693

 

 

Total purchase price

 

  $

5,828

 

 

 

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During the nine months ended September 30, 2016, the Company incurred $38 million of expenses related to the King Acquisition, which are included within “General and administrative” in the condensed consolidated statements of operations. In connection with the debt financing that occurred on the King Closing Date, we incurred $38 million of issuance costs that were capitalized and recorded within “Long-term debt, net” on our condensed consolidated balance sheet. The amortization of these capitalized costs was not material to our condensed consolidated statement of operations for the three and nine months ended September 30, 2016.

 

Stock-Based Compensation

 

In connection with the King Acquisition, a majority of the outstanding King options and awards that were unvested as of the King Closing Date were converted into equivalent options and awards with respect to shares of the Company’s common stock, using an equity award exchange ratio calculated in accordance with the Transaction Agreement. As a result, replacement equity options and awards of 10 million and 3 million, respectively, were issued in connection with the King Acquisition. The portion of the fair value related to pre-combination services of $76 million was included in the purchase price while the remaining fair value will be recognized over the remaining service periods. As of September 30, 2016, the future expense for the converted King unvested options and awards was approximately $53 million, which will be recognized over a weighted average service period of approximately 1.8 years.

 

The remaining portion of outstanding unvested awards that were assumed were replaced with deferred cash awards. The cash proceeds were placed in an escrow-like account with the cash releases to occur based on the awards’ original vesting schedule upon future service being rendered. The cash associated with these awards is recorded in “Other current assets” and “Other assets” in our condensed consolidated balance sheet. The portion of the fair value related to pre-combination services of $22 million was included in the purchase price while the remaining fair value of approximately $9 million will be recognized over the remaining service periods. A portion of the cash proceeds placed in an escrow-like account were released t