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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one) | ||
ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the | ||
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 0-126991-15839
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 Blvd., Santa Monica, CA | 90405 | |
(Address of principal executive offices) | (Zip Code) |
Registrant's telephone number, including area code:(310) 255-2000
Securities registered pursuant to Section 12(b) of the Act:
Title of Class | Name of Each Exchange on Which Registered | |
---|---|---|
Common Stock, par value $.000001 per share | The NASDAQ Global Select Market |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act. Yes o No ý
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 ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
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 ý | Accelerated Filer o | Non-accelerated Filer o (Do not check if a smaller reporting company) | Smaller Reporting Company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý
The aggregate market value of the registrant's Common Stock of the registrant held by non-affiliates ofon June 30, 2008 as reported on the registrant on September 28, 2007NASDAQ was $4,764,158,372.$9,910,273,014.
The number of shares of the registrant's Common Stock outstanding as of May 20, 2008at February 19, 2009 was 296,748,734.1,307,215,125.
Documents Incorporated by Reference
Portions of the registrant's definitive Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K, with respect to the 20082009 Annual Meeting of Shareholders, are incorporated by reference into Part III of this Annual Report.
INDEXTable of Contents
EXPLANATORY NOTE
On July 9, 2008, a business combination (the "Business Combination") by and among Activision, Inc., Sego Merger Corporation, a wholly-owned subsidiary of Activision, Inc., Vivendi S.A., ("Vivendi"), VGAC LLC, a wholly-owned subsidiary of Vivendi S.A., and Vivendi Games, Inc. ("Vivendi Games"), a wholly-owned subsidiary of VGAC LLC, was consummated. As a result of the consummation of the Business Combination, Activision, Inc. was renamed Activision Blizzard, Inc. For accounting purposes, the Business Combination is treated as a "reverse acquisition," with Vivendi Games, Inc. deemed to be the acquirer. The historical financial statements of Activision Blizzard, Inc. prior to July 9, 2008 are those of Vivendi Games, Inc. (see Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K).
CAUTIONARY STATEMENT
This Annual Report on Form 10-K contains, or incorporates by reference, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements consist of any statement other than a recitation of historical fact and include, but are not limited to,to: (1) projections of revenues, expenses, income or loss, earnings or loss per share, cash flow projections or other financial items; (2) statements of our plans and objectives, including those relating to product releases; (3) statements of future economic performance; and (4) statements of assumptions underlying such statements. We generally use words such as "anticipate," "believe," "could," "would," "estimate," "expect," "forecast," "future," "intend," "may," "outlook," "plan," "positioned," "potential," "project," "remain," "scheduled," "set to," "subject to," "to be," "upcoming," "will," and other similar expressions to help identify forward-looking statements. These forward-lookingForward-looking statements are subject to business and economic risk, reflect management's current expectations, estimates and projections about our business, and are inherently uncertain and difficult to predict. Our actual results could differ materially. The forward-looking statements contained herein speak only as ofat the date on which they werethis Form 10-K was first made,filed, and we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of this Annual Report on Form 10-K was initially filed with the SEC.Report. Risks and uncertainties that may affect our future results include, but are not limited to those discussed under the headingincluded in "Risk Factors,"Factors" included in Part I, Item 1A.1A of this Report. Except whereas otherwise noted (including in connection with the context otherwise requires,review and presentation of results of operations for the year ended December 31, 2008), all references to "we," "us," "our," "Activision""Activision Blizzard," or "the Company" in this Annual Report on Form 10-K mean Activision Blizzard, Inc. and its subsidiaries as of the date of this Annual Report on Form 10-K.subsidiaries.
(a) General and Description of Business
Activision Blizzard is a worldwide pure-play online, personal computer ("PC"), console, and hand-held game publisher. Through Blizzard Entertainment, Inc. is("Blizzard"), we are the leader in terms of subscriber base and revenues generated in the subscription-based massively multiplayer online role-playing game ("MMORPG") category. Blizzard internally develops and publishes PC-based computer games and maintains its proprietary online-game related service, Battle.net. Through Activision Publishing, Inc. ("Activision"), we are a leading international publisher of interactive entertainment software products and peripheral products. We have built a company with a diverse portfolio of products that spans a wide range of categoriesperipherals. Activision develops and target markets and that are usedpublishes video games on a variety of game hardwarevarious consoles, hand-held platforms and operating systems. We have created, licensed,the PC platform through internally developed franchises and acquired a group of highly recognizable franchises, which we market to a variety of consumer demographics. Our fiscal 2008 product portfolio included titles such asGuitar Hero III: Legends of Rock, Guitar Hero II for the Microsoft Xbox360, Guitar Hero: Rocks the 80s for the PS2,Call of Duty 4: Modern Warfare, Spider-Man 3 The Game ("Spider-Man 3"), Shrek the Third, TRANSFORMERS: The Game, Enemy Territory: Quake Wars, Tony Hawk's Proving Ground, Bee Movie Game, andSpider-Man: Friend or Foe.
Our products cover diverse game categories including action/adventure, action sports, racing, role-playing, simulation, first-person action, music-based gaming, and strategy. Our target customer base ranges from casual players to game enthusiasts, children to adults, and mass-market consumers to "value" buyers. Welicense agreements. Activision currently offer our products primarily in versionsoffers games that operate on the Sony Computer Entertainment ("Sony") PlayStation 2 ("PS2"), the Sony PlayStation 3 ("PS3"), the Nintendo Co. Ltd. ("Nintendo") Wii ("Wii"), and the Microsoft Xbox360Corporation ("Xbox360"Microsoft") Xbox 360 ("Xbox 360") console systems, the Nintendo Dual Screen ("NDS"), andsystems; the Sony PlayStation Portable ("PSP") and Nintendo Dual Screen ("NDS") hand-held devices,devices; and the personal computer ("PC"). The installed base for the previous generation of hardware platforms (e.g., the PS2) is significant and the fiscal 2006 release of the Xbox360 and the fiscal 2007 releases of the PS3 and the Wii have further expanded the software market. To take advantage of the growth of the PS3, the Xbox360, and the Wii ("the next-generation platforms"), during fiscal 2008, we increased our presence on the next-generation platforms through the increased number of new released titles on the next-generation platforms. For example, the number of new released titles for the Wii tripled from 5 releases during fiscal 2007 to 15 releases, and we successfully released several major titles for the PS3, the Xbox360 and/or the Wii—Guitar Hero III: Legends of Rock,Call of Duty 4: Modern Warfare,Spider-Man 3,Shrek the Third,TRANSFORMERS: The Game, andTony Hawk's Proving Ground. Some of these titles are also available on the PS2. Our plan is to continue to build a significant presence on the next-generation platforms by continuing to expandPC.
Our publishingActivision business involves the development, marketing, and sale of products directly, by license, or through our affiliate label program with certain third-party publishers. Activision's products cover diverse game categories including action/adventure, action sports, racing, role-playing, simulation, first-person action, music, and strategy. Activision's target customer base ranges from casual players to game enthusiasts, and children to adults. During 2008, Activision releasedGuitar Hero World Tour andCall of Duty: World at War, and continued to expand its licensed products with such titles asMadagascar: Escape 2 Africa,Spider-Man: Web of Shadows, its first James Bond title,Quantum of Solace, and several other titles. Activision is currently developing sequels to the Guitar Hero and Call of Duty franchises,Wolfenstein through id Software,Marvel Ultimate Alliance 2: Fusion through Vicarious Visions,Prototype through Radical, andSingularity through Raven Software, and a yet to be named game for the racing genre, among other titles.
Our Blizzard business involves the development, marketing, sales and support of role playing action and strategy games. Blizzard also develops, hosts, and supports its online subscription-based games in the MMORPG category. Blizzard is the development studio and publisher best known as the creator ofWorld of Warcraft and the multiple award winning Diablo, StarCraft, and Warcraft franchises. Blizzard distributes its products and generates revenues worldwide through various means, including: subscription revenues (which consist of fees from individuals playingWorld of Warcraft, such as prepaid-cards and other ancillary online revenues); retail sales of physical "boxed" product; electronic download sales of PC products; and licensing of software to third-party companies that distributeWorld of Warcraft in China and Taiwan. During 2008, Blizzard releasedWorld of Warcraft: Wrath of the Lich King, the second expansion pack ofWorld of Warcraft. Blizzard is currently developing new games, including sequels to the StarCraft and Diablo franchises.
Our distribution business consists of operations in Europe that provide warehousing, logistical and sales distribution services to third-party publishers of interactive entertainment software, our own publishing operations, and manufacturers of interactive entertainment hardware.
We were(b) Business Combination and Acquisitions
Activision, Inc. was originally incorporated in California in 1979. In December 1992, we1979 and was reincorporated in Delaware.Delaware in December 1992. In June 2000, weActivision, Inc. reorganized into our currenta holding company organizational structure.
(b) Business Combinations As described in the explanatory note above, Activision, Inc. consummated a business combination with Vivendi Games during the year ended December 31, 2008 and was renamed Activision Blizzard, Inc. Activision Blizzard is a public company traded on the NASDAQ under the ticker symbol ATVI.
We have completed a number of acquisitions of both softwareAlso, to further strengthen our development companiesresources and interactive entertainment product distribution companies. In fiscalunderscore our commitment and leadership in the music-based genre, on September 11, 2008, we acquired Bizarre Creations Limited,Freestyle Games, Ltd., a premier United Kingdom-based video game developer focusingspecializing in the music-based genre. Additionally, on November 10, 2008, we acquired Budcat Creations, LLC, an award-winning Iowa City, Iowa based development studio with expertise on the racing category. Also, in fiscal 2008, we completedWii and the acquisition of DemonWare, Ltd., a provider of network middleware technologies for console and PC games.NDS.
See Note 34 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information regarding the accounting treatment of thesethe Business Combination and priorour acquisitions.
On December 2, 2007, we and Vivendi S.A. ("Vivendi") (Euronext Paris: VIV) announced the signing of a definitive agreement to combine Vivendi Games, Inc. ("Vivendi Games"), Vivendi's interactive entertainment business which includes Blizzard Entertainment, Inc. with us. If the transaction closes, we will be renamed Activision Blizzard, Inc. ("Activision Blizzard"), and we expect to continue to operate as a public company traded on NASDAQ under the ticker ATVI. While we will be the legal acquirer and the surviving entity in this transaction, Vivendi Games will be deemed to be the accounting acquirer in the transaction treated as a reverse acquisition for accounting purposes. See Note 20 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information regarding the pending business combination with Vivendi Games.
(c) Financial Information About Industry SegmentsOperating Segment Changes
We have two reportableIn conjunction with the Business Combination, we changed the manner in which senior management assesses the operating performance of, and allocates resources to our operating segments. As a result, we operate four operating segments: (i) Activision Publishing—publishing and distribution. Publishing relates to the development (both internally and externally), marketing and sale of DVD, CD, UMD, online, and cartridge-based interactive entertainment software and peripheral products owned or controlled by us directly, by license, or through our affiliate label program withperipherals which includes Activision, Inc. and certain third-party publishers. Distribution primarily refersstudios, assets, and titles previously included in Vivendi Games' Sierra Entertainment operating segment prior to logisticalthe
Business Combination ("Activision"), (ii) Blizzard Entertainment, Inc. and sales services provided by our European its subsidiaries—publishing traditional games and online subscription-based games in the MMORPG category ("Blizzard"), (iii) Activision Blizzard Distribution—distribution subsidiaries to third-party publishers of interactive entertainment software and hardware products ("Distribution") (these three operating segments form Activision Blizzard's core operations) and (iv) Activision Blizzard's non-core exit operations. Activision Blizzard's non-core exit operations represent legacy Vivendi Games' divisions or business units we have exited or are winding down as part of our own publishing operationsrestructuring and manufacturersintegration efforts as a result of interactive entertainment hardware.the Business Combination, but do not meet the criteria for separate reporting of discontinued operations. In accordance with the provisions of Statement of Financial Accounting Standards, No. 131, "Disclosures about Segments of an Enterprise and Related Information," ("SFAS No. 131"), all prior period segment information has been restated, when practical, to conform to this new segment presentation. See Note 1014 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for certain financial information regarding reporting segmentoperating segments and geographic areas required by Item 1 of Form 10-K.
(d) Narrative Description of BusinessOur Objective
Our objective is to be a worldwide leader in the development, publishing, and distribution of quality interactive entertainment software, and peripheral products, and online games that deliver a highly satisfying consumer entertainment experience. Through Blizzard, we plan to maintain and build upon our worldwide leadership position of online subscription-based games in the MMORPG category. Our business strategy, the key components of our business operations and the risk factors that could impact our business are detailed below.
Strategy
Create, Acquire, and Maintain Strong Franchises. We focus development and publishing activities principally on products that are, or have the potential to become, franchises with sustainable consumer appeal and recognition. It is our experience that these products can then serve as the basis for sequels, prequels, and related new products that can be released over an extended period of time. We believe that the publishing and distribution of products based in large part on franchises enhances predictability of revenues and the probability of high unit volume sales and operating profits. We have created a number of successful internally developed intellectual properties such as the Guitar Hero and Call of Duty franchises. We have also entered into a series of strategic relationships with the owners of intellectual property pursuant to which we have acquired the rights to publish products based on franchises such as Marvel Entertainment, Inc. properties, including Spider-Man and X-Men. We have multi-year, multi-property agreements with DreamWorks Animation LLC that grant us the exclusive rights to publish video games based on DreamWorks Animation SKG's theatrical releases, including "Shark Tale," which was released in the second quarter fiscal 2005, "Madagascar," which was released in the first quarter fiscal 2006, "Over the Hedge," which was released in the first quarter fiscal 2007, "Shrek the Third," which was released in the first quarter fiscal 2008, "Bee Movie," which was released in the third quarter fiscal 2008, and all of their respective sequels. In addition, our multi-year agreements with DreamWorks Animation LLC grant us the exclusive video game rights to three upcoming DreamWorks Animation feature films, including "Kung Fu Panda," "Monsters vs Aliens" and "How to Train Your Dragon." We plan to release(e) Kung Fu PandaOur Strategy,Monsters vs Aliens, andMadagascar 2 during fiscal 2009 coinciding with each of their respective theatrical releases. We have a strategic alliance with Harrah's Entertainment, Inc. that grants us the exclusive, worldwide interactive rights to develop and publish "World Series of Poker" video games based on the popular World Series of Poker Tournament. We also have an agreement with MGM Interactive and EON Productions Ltd. to develop and publish video games based on the James Bond license and with Hasbro Properties Group ("Hasbro") to develop and publish video games based on the "Transformers" franchise.
Execute Disciplined Product Selection and Development Processes. The success of our publishing business depends, in significant part, on our ability to develop high quality games that will generate high unit volume sales. Our publishing units have implemented a formal control process for the selection, development, production, and quality assurance of our products. We apply this process, which we refer to as the "Greenlight Process," to all of our products, whether externally or internally developed. The Greenlight Process includes in-depth reviews of each project at several important stages of development by a team that includes many of our highest-ranking operating managers and coordination between our sales and marketing personnel and development staff at each step in the process.
We develop our products using a combination of our internal development resources and external development resources acting under contract with us. We typically select our external developers based on their track record and expertise in producing products in the same category. One developer will often produce the same game for multiple platforms and will produce sequels to the original game. We believe that selecting and using development resources in this manner allows us to leverage the particular expertise of our internal and external development resources, which we believe adds to the quality of our products.
Create and Maintain Diversity in Product Mix, Platforms, and Markets. We believe that maintaining a diversified mix of products can reduce our operating risks and enhance profitability. Therefore, we develop and publish products spanning a wide range of product categories, including action/adventure, action sports, racing, role-playing, simulation, first-person action, music-based gaming, and strategy. We also develop products designed for target audiences ranging from casual players to game enthusiasts, children to adults, and mass-market consumers to "value" buyers. Presently, we concentrate on developing, publishing, and distributing products that operate on the PS2, PS3, Xbox360, and Wii
console systems, PSP and NDS hand-held devices, and the PC. We typically offer our products for use on multiple platforms in order to reduce the risks associated with any single platform, leverage our costs over a larger installed hardware base, and increase unit sales.
Continue to Improve Profitability. We continually strive to manage risk and increase our operating leverage and efficiency with the goal of increased profitability. We believe that the key factorfactors affecting our future profitability will be the success rate of our product releases. Therefore, our product selection and development process includes, as a significant component, periodic evaluations of the expected commercial success of products under development. Through this process, for titles that we determine to be less promising, corrections are made in the development process or, if necessary, they are discontinued before we incur additional development costs. In addition, we believe our focus on cross platform releases and franchised products will contribute to improved profitability.proven franchises.
We continue to focus on increasing our margins. We have, for example, acquired certain experienced and specialized developers in instances where we can enhance profitability through the elimination of royalty obligations. Additionally, we often rely on independent third-party interactive entertainment software developers to develop some of our software products, thereby taking advantage of specialized independent developers without incurring the fixed overhead obligations associated with increased internally employed staff.
Our sales and marketing staff work with our studio resources to increase the visibility of new product launches and to coordinate the timing and promotion of product releases. Our finance and sales and marketing personnel work together to improve inventory management and receivables collections. We have instituted broad, objective-based reward programs that provide incentives to management and staff throughout the organization to produce results that meet our financial objectives.
Grow Through Continued Strategic Acquisitions and Alliances. The interactive entertainment industry has been consolidating, and we believe that success in this industry will be driven in part by the ability to take advantage of scale. Specifically, smaller companies are more capital constrained, enjoy less predictability of revenues and cash flow, lack product diversity and must spread fixed costs over a smaller revenue base. Several industry leaders are emerging that combine the entrepreneurial and creative spirit of the industry with professional management, the ability to access the capital markets, and the ability to maintain favorable relationships with developers, intellectual property owners, and retailers. Through numerous completed acquisitions since 1997,in the past years and the Business Combination with Vivendi Games in 2008, we believe that we have successfully diversified our operations and channels of distribution, developmentdistribution; developed our talent pool and library of titles,titles; gained licensing relationships in Asia; and we have emerged as one of the industry's leaders. We intend to continue to evaluate the expansion of our resources through acquisitions, strategic relationships, and key license transactions. We intend to continue expanding our intellectual property library through key license transactions and strategic relationships with intellectual property owners. We will continue to evaluate opportunities to increase our development capacity through the acquisition of, or investment in, selected experienced software development firms.
Products
Historically, we have been best known for our action/adventure, strategy, and simulation products. We have been successful in the superheroes category with our release of titles based on the Spider-Man and X-Men properties. We have also been successful in the first person action categories through the Call of Duty original intellectual property, which we plan on continuing as a successful long-term franchise. Call of Duty has achieved over $1 billion life-to-date sales. In fiscal 2007 we successfully entered the music-based gaming genre with the acquisition of the Guitar Hero franchise. This franchise combines interactive software with a hardware peripheral in the form of a guitar. In fiscal 2008 the Guitar Hero franchise has set an industry record, surpassing $1 billion in North America retail sales in
26 months. We have established ourselves as a leader in the "value" software publishing business with products under our Cabela's, Rapala, World Series of Poker, and Greg Hasting's Paintball licenses, as well as with products distributed on behalf of our "value" affiliate label partners. Products published by us in this category are generally developed by third parties, often under contract with us. Value software is typically less sophisticated and less complex, both in terms of the development process and consumer gameplay.
Hardware Licenses. Our products currently are being developed or published primarily for the PS2, PS3, Wii, and Xbox360 console systems; PSP and NDS hand-held devices; and PCs. In order to maintain general access to the console systems and hand-held devices marketplace, we have maintained licenses for the PS2, PS3, Wii, and Xbox360 console systems and PSP, and NDS hand-held devices with the owners of each such platform. Each license allows us to create multiple products for the applicable platform, subject to certain approval rights which are reserved by each licensor. Each license also requires that we pay the licensor a per unit royalty for each unit manufactured. In contrast, we are not required to obtain any license for the development and production of products for PCs.
Intellectual Property Rights. Many of our current and planned releases are based on intellectual property, other character or story rights, and music rights licensed from third parties, as well as a combination of characters, worlds, and concepts derived from our extensive library of titles, and original characters and concepts owned and created by us. When publishing products based on licensed intellectual property rights, we generally seek to capitalize on the name recognition, marketing efforts, and goodwill associated with the underlying property. For intellectual property owned by Activision, we generally attempt to establish such properties as sustainable, long-term game franchises.
In acquiring intellectual property rights from third parties, we seek to obtain rights to publish titles across a variety of platforms, to include the ability to produce multiple titles and to retain rights over an extended period of time. In past years, we have been able to enter into a series of long-term or multi-product agreements with owners of various intellectual properties that are well known throughout the world and to create products based on these recognizable characters, story lines, or concepts. These agreements typically provide us with exclusive publishing rights for a specific period of time and, in some cases, for specified platforms and, in other cases, with renewal rights upon the satisfaction of certain conditions. The scope of our licensing activities includes theatrical motion pictures, television shows, animated films and series, comic books, literary works, music, sports personalities and events, and celebrities. We intend to continue expanding relationships with our existing intellectual property partners and to enter into agreements with other intellectual property owners for additional recognizable properties, characters, story lines and concepts. However, we may not be able to maintain or expand our existing relationships or to seek out and sustain new long-term relationships of similar caliber in the future.
Product Development and Support
We develop and produce titles using a model in which a core group of creative, production, and technical professionals, in coordination with our marketing and finance departments, have responsibility for the entire development and production process including the supervision and coordination of internal and external resources. This team assembles the necessary creative elements to complete a title using, where appropriate, outside programmers, artists, animators, scriptwriters, musicians and songwriters, sound effects and special effects experts, and sound and video studios. We believe that this model allows us to supplement internal expertise with top quality external resources on an as-needed basis.
In addition, we often seek out and engage independent third-party developers to create products on our behalf. Such products are sometimes owned by us, and usually we have unlimited rights to commercially exploit these products. In other circumstances, the third-party developer may retain
In consideration for the services that the independent third-party developer provides, the developer receives a royalty generally based on net sales of the product that it has developed. Typically, the developer also receives an advance, which we recoup from the royalties otherwise payable to the developer. The advance generally is paid in "milestone" stages. The payment at each stage is tied to the completion and delivery of a detailed performance milestone. Some contracts include minimum guaranteed royalty payments which are recorded as an asset when actually paid and as a liability when incurred, rather than recording the asset and liability upon execution of the contract. Working with an independent developer allows us to reduce our fixed development costs, share development risks with the third-party developer, take advantage of the third-party developer's expertise in connection with certain categories of products or certain platforms, and gain access to proprietary development technologies.
"Greenlight Process"
We have adopted and implemented a rigorous procedure for the selection, development, production, and quality assurance of our internally and externally produced interactive entertainment software titles. The process, known internally as the "Greenlight Process," involves several phases throughout the development and production and the post-release review of a title, each of which includes a number of specific performance milestones. The phases of the "Greenlight Process" are the concept, developer selection, prototype, first playable, alpha, and post-mortem. This procedure is designed to enable us to manage and control production and development budgets and timetables, to identify and address production and technical issues at the earliest opportunity, and to coordinate marketing and quality control strategies throughout the production and development phases, all in an environment that fosters creativity. The post-release review of a title is critical to provide feedback and ideas to our future development. Checks and balances are intended to be provided through the structured interaction of the project team with our creative, technical, marketing, and quality assurance/customer support personnel, as well as our legal, accounting, and finance departments. In order to maintain the competitiveness of our products and to take advantage of increasingly sophisticated technology associated with hardware platforms, our development process includes a significant amount of time for play-testing new products, and extensive product quality evaluations.
Product Support
We provide various forms of product support to both our internally and externally developed titles. Our quality assurance personnel are involved throughout the development and production of each title published by us. We subject all such products to extensive testing before release to ensure compatibility with all appropriate hardware systems and configurations and to minimize the number of bugs and other defects found in the products. To support our products after release, we provide online access to our customers on a 24-hour basis as well as telephone operator help lines during regular business
hours. The customer support group tracks customer inquiries and we use this data to help improve the development and production processes.
Publishing Activities
Marketing
Our marketing efforts include online activities (such as the creation of World Wide Web pages to promote specific titles and build user communities around our franchises), public relations, print and broadcast advertising, coordinated in-store and industry promotions (including merchandising and point of purchase displays), participation in cooperative advertising programs, direct response vehicles, and product sampling through demonstration software distributed through the Internet or on compact discs. From time to time, we also receive marketing support from hardware manufacturers and retailers in connection with their own promotional efforts. In addition, certain of our products contain software that enables customers to "electronically register" their purchases with us online.
We believe that certain of our franchises have loyal and devoted audiences who purchase our sequels as a result of dedication to the property and satisfaction from previous product purchases. We therefore market these sequels both toward the established market as well as broader audiences. In addition, in marketing titles based on licensed properties, we believe that we derive benefits from the continued exploitation of these licensed properties and the marketing and promotional activities of the property owners.
Sales and Distribution
North America. Our products are available for sale or rental in thousands of retail outlets domestically. Our North American customers include Best Buy, Blockbuster, Circuit City, GameStop, Target, Toys "R" Us, and Wal-Mart.
In the United States and Canada, our products are sold primarily on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses, and game specialty stores. We believe that a direct relationship with retail accounts results in more effective inventory management, merchandising, and communications than would be possible through indirect relationships. We have implemented electronic data interchange linkages with many of our retailers to facilitate the placing and shipping of orders. We sell our products to a limited number of distributors.
International. Our products are sold internationally on a direct-to-retail basis, through third-party distribution and licensing arrangements, and through our wholly-owned European distribution subsidiaries. We conduct our international publishing activities through offices in the United Kingdom, Germany, France, Italy, Spain, Norway, the Netherlands, Canada, Sweden, Australia, South Korea, and Japan. We seek to maximize our worldwide revenues and profits by releasing high quality foreign language releases concurrently with English language releases and by continuing to expand the number of direct selling relationships we maintain with key retailers in major territories.
On a worldwide basis, our largest customers, Wal-Mart and GameStop, accounted for approximately 14% and 13%, respectively, of consolidated net revenues for the fiscal year ended March 31, 2008. For the fiscal year ended March 31, 2007, our largest customers, Wal-Mart and GameStop, accounted for 22% and 8%, respectively, of consolidated net revenues.
Affiliate Labels. In addition to our own products, we distribute a select number of interactive entertainment products that are developed and marketed by other third-party publishers through our "affiliate label" programs in North America, Europe, and the Asia Pacific region. The distribution of other publishers' products allows us to increase the efficiencies of our sales force and provides us with the ability to better ensure adequate shelf presence at retail stores for all of the products that we distribute. Distributing other publishers' titles mitigates the risk associated with a particular title or
titles published by us failing to achieve expectations. Services provided by us under our affiliate label program include order solicitation, in-store marketing, logistics and order fulfillment, sales channel management, as well as other accounting and general administrative functions. Our current affiliate label partners include LucasArts, as well as several affiliate label partners in our "value" business. Each affiliate label relationship is unique and may pertain only to distribution in certain geographic territories such as the North America, Europe, or the Asia Pacific region and may be further limited only to specific titles or titles for specific platforms.
See Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for certain financial information regarding reporting segments and geographic areas required by Item 1.
Distribution
We distribute interactive entertainment hardware and software products in Europe through our European distribution subsidiaries: Centresoft in the United Kingdom; NBG in Germany; and CD Contact in the Benelux countries. These subsidiaries act as wholesalers in the distribution of products and also provide packaging and logistical and sales services. They provide services to our publishing operations and to various third-party publishers, including Sony Computer Entertainment ("Sony"), Nintendo Co. Ltd. ("Nintendo"), and Microsoft Corporation ("Microsoft"). Centresoft is Sony's exclusive distributor of PlayStation products to the independent channel in the United Kingdom. In the fiscal year ended March 31, 2008, sales for Sony, Nintendo, and Microsoft accounted for approximately 29%, 5%, and 2%, respectively, of our worldwide distribution net revenues.
We entered into the distribution business to obtain distribution capacity in Europe for our own products, while supporting the distribution infrastructure with third-party sales, and to diversify our operations into the European market. Centresoft and our other distribution subsidiaries operate in accordance with strict confidentiality procedures in order to provide independent services to various third-party publishers.
Emerging Technologies
We are actively supporting emerging platforms (wireless devices, digital downloads, and closed and open online networks) by publishing and licensing key franchises for these emerging platforms. We have published and licensed rights to various franchises, such as the Call of Duty franchise, the Guitar Hero franchise,(f) Tony Hawk's Project 8Competition, andTony Hawk's Downhill Jam for various hand-held wireless devices. We also develop and optimize many of our titles for consoles that support online play, such as PS2, Xbox Live on the Xbox360, and the Sony PS3 and Nintendo Wii consoles. We believe that more of our franchises can be successfully published for wireless and online platforms, as well as exploited through other emerging technologies, as they continue to evolve.
In addition, we derive revenue from in-game advertising consisting primarily of fixed product placement. We are developing and expanding on dynamic ad serving technology and will continue to focus on attracting third parties to advertise in our video games.
Manufacturing
We prepare a set of master program copies, documentation, and packaging materials for our products for each hardware platform on which the product will be released. We also manufacture separate hardware peripherals, such as the guitar in Guitar Hero. Except with respect to products for use on the Sony, Nintendo, and Microsoft systems, our disk and hardware peripheral's duplication, packaging, printing, manufacturing, warehousing, assembly, and shipping are performed by third-party subcontractors.
To maintain protection over their hardware technologies, Sony, Nintendo, and Microsoft generally specify or control the manufacturing and assembly of finished products. We deliver the master materials to the licensor or its approved replicator, which then manufactures finished goods and delivers them to us for distribution under our label. We use the manufacturers who are authorized by Sony, Nintendo, or Microsoft to make the hardware peripheral for Guitar Hero. At the time our product unit orders are filled by the manufacturer, we become responsible for the costs of manufacturing and the applicable per unit royalty on such units, even if the units do not ultimately sell.
To date, we have not experienced any material difficulties or delays in the manufacture and assembly of our products or material returns due to product defects.
Competition
The interactive entertainment industry is intensely competitive and new interactive entertainment software products and platforms are regularly introduced. Our competitors vary in size from small companies with limited resources to large corporations with greater financial, marketing, and product development resources than we have. Due to their different focuses and allocation of resources, certain of our competitors spend more money and time on developing and testing products, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, pay higher fees to licensors for desirable motion picture, television, sports and character properties, and pay more to third-party software developers. In addition, competitors with large product lines and popular titles typically have greater leverage with retailers, distributors, and other customers who may be willing to promote titles with less consumer appeal in return for access to such competitor's most popular titles. We believe that the main competitive factors in the interactive entertainment industry include: product features and playability; brand name recognition; compatibility of products with popular platforms; access to distribution channels; quality of products; ease of use; price; marketing support; and quality of customer service.
We compete primarily with other publishers of personal computer and video game console interactive entertainment software. SignificantIn addition to third-party software competitors, currently include, among others: Capcom Co. Ltd.; Eidos PLC; Electronic Arts Inc.; Konami Company Ltd.; Midway Games Inc.; Namco Bandai Games Ltd.; Sega Enterprises, Ltd.; Take-Two Interactive Software, Inc.; THQ Inc.; Ubisoft Entertainment; Viacom/MTV; Vivendi Games Publishing; Warner Bro's Interactive; and the Walt Disney Company. In addition, integrated video game console hardware and software companies such as Sony, Nintendo, and Microsoft compete directly with us in the development of software titles for their respective platforms. Further, certain major media companies, such as Disney and Time Warner, who have been investing in video game products, have increased competition within the industry.
(g) Employees
As of MarchWe had approximately 7,000 total full-time and part-time employees at December 31, 2008. At December 31, 2008, we had approximately 2,640 employees, including approximately 1,200 in product development, 500 in North American publishing, 500 in international publishing, 170 in operations, corporate finance and administration, and 270 in European distribution activities.
As of March 31, 2008, approximately 260227 of our full-time employees were subject to term employment agreements with us. These agreements generally commit such employees to employment terms of between one and five years from the commencement of their respective agreements. Most of the employees subject to such agreements are executive officers or key members of the product development, sales, or marketing divisions. These individuals perform services for us as executives, directors, producers, associate producers, computer programmers, game designers, sales directors, andor marketing product managers. The execution by us of employment agreements with such employees, in our experience, reduces our turnover during the development, production, and distribution phases of our entertainment software products and allows us to plan more effectively for future development and marketing activities.
None of our employees are subject to a collective bargaining agreement except for the employees of our German distribution subsidiary who are allowed by German law to belong to an organized labor council. To date, we have not experienced any labor-related work stoppages.
Activision Publishing Segment ("Activision")—Business Overview
Strategy
Create, Acquire, and Maintain Strong Franchises. Activision focuses on development and publishing activities principally on products that are, or have the potential to become, franchises with sustainable consumer appeal and recognition. It is our experience that these products can then serve as the basis for sequels, prequels, and related new products that can be released over an extended period of time. We believe that the publishing and distribution of products based on franchises enhances predictability of revenues and the probability of high unit volume sales and operating profits. We own a number of successful intellectual properties such as the Guitar Hero and Call of Duty franchises. We intend to continue to develop owned franchises in the future. We have also entered into a series of strategic relationships with the owners of intellectual properties pursuant to which we have acquired the rights to
publish products based on franchises such as DreamWorks' Animation LLC ("DreamWorks"), Harrah's Entertainment, Inc. ("Harrah"), Hasbro Properties Group ("Hasbro"), MGM Interactive and EON Productions Ltd. ("MGM & EON"), Mattel, Inc. ("Mattel"), Marvel Entertainment, Inc. ("Marvel"), and professional skateboarder Tony Hawk, to develop video games based on their intellectual property.
Execute Disciplined Product Selection and Development Processes. The success of our publishing business depends, in significant part, on our ability to develop high quality games that will generate high unit volume sales. Our publishing units have implemented a formal control process for the selection, development, production, and quality assurance of our products. We apply this process, which we refer to as the "Greenlight Process," to all of our products, whether externally or internally developed. The Greenlight Process includes in-depth reviews of each project at several important stages of development by a team that includes many of our highest-ranking operating managers and coordination between our sales and marketing personnel and development staff at each step in the process.
We develop our products using a combination of our internal development resources and external development resources acting under contract with us. We typically select our external developers based on their track records and expertise in producing products in the same category. One developer will often produce the same game for multiple platforms and will produce sequels to the original game. We believe that selecting and using development resources in this manner allows us to leverage the particular expertise of our internal and external development resources, which we believe enhances the quality of our products.
Create and Maintain Diversity in Product Mix, Platforms, and Markets. We believe that maintaining a diversified mix of products can reduce our operating risks and enhance profitability. Therefore, we develop and publish products spanning a wide range of product categories, including action/adventure, action sports, racing, role-playing, simulation, first-person action, music-based gaming, and strategy. We also develop products designed for target audiences ranging from casual players to game enthusiasts, children to adults, and mass-market consumers to "value" buyers. Presently, we are developing, publishing, and distributing products that operate on the PS2, PS3, Xbox 360, and Wii console systems, the PSP and NDS hand-held devices, and the PC. We typically offer our products for use on multiple platforms to reduce the risks associated with any single platform, leverage our costs over a larger installed hardware base, and increase unit sales.
Products
Activision has been best known for our action/adventure, action sports, role-playing, simulation, first-person action, and music video game products. We have been successful in the first person action categories through the Call of Duty original intellectual property, which we plan on continuing as a successful long-term franchise. Call of Duty has achieved over $1 billion life-to-date sales. We are a leading company in the music-based gaming genre with the Guitar Hero franchise. We became the first publisher to surpass the $1 billion in sales from a single title:Guitar Hero III: Legends of Rock. The Guitar Hero franchise combines interactive software with hardware peripherals of a guitar, drum, and microphone. We have been successful in the superheroes category with our releases of titles based on the Spider-Man and X-Men properties. Our Tony Hawk franchise has been a leader in the action sports genre, and we have a new game in development to continue the strength of this franchise. We have continued our success with the DreamWorks animated movie titles, with the recent launches ofKung Fu Panda andMadagascar Escape 2 Africa, and the upcoming release ofMonsters vs. Aliens. We have expanded our portfolio in the action/adventure genre with the recent launch ofJames Bond: Quantum of Solace. Our top three franchises accounted for approximately 68% of Activision's consolidated net revenues for the year ended December 31, 2008. We will further expand our portfolio with entry into the large racing genre with the upcoming launch of a new racing title in 2009 from
Bizarre Creations, a studio with a proven track record of developing hit racing games for the past 10 years.
Product Development and Support
Activision develops and produces titles using a model in which a core group of creative, production, and technical professionals, in coordination with our marketing and finance departments, have responsibility for the entire development and production process including the supervision and coordination of internal and external resources. This team assembles the necessary creative elements to complete a title using, where appropriate, outside programmers, artists, animators, scriptwriters, musicians and songwriters, sound effects and special effects experts, and sound and video studios. Activision believes that this model allows us to supplement internal expertise with top quality external resources on an as-needed basis.
In addition, Activision often seeks out and engages independent third-party developers to create products on our behalf. Such products are either owned by us, or Activision has unlimited rights to commercially exploit these products. In other circumstances, a third-party developer may retain ownership of the intellectual property and/or technology included in the product and reserves certain exploitation rights. Activision typically selects these independent third-party developers based on their expertise in developing products in a specific category for specific platforms. Each of our third-party developers is under contract with us for specific or multiple titles. From time to time, Activision also acquires the license rights to publish and/or distribute software products that are or will be independently created by third-party developers. In such cases, the agreements with such developers provide us with exclusive publishing and/or distribution rights for a specific period of time, often for specified platforms and territories. In either case, Activision often has the ability to publish and/or distribute sequels, conversions, enhancements, and add-ons to the product initially being produced by the independent developer and Activision frequently has the right to engage the services of the original developer with regard to the further development of such products.
In consideration for the services that independent third-party developers provide, the developers receive a royalty generally based on net sales of the developed products. Typically, developers also receive an advance, which Activision recoups from the royalties otherwise payable to the developers. The advance generally is paid in "milestone" stages. The payment at each stage is tied to the completion and delivery of a detailed performance milestone. Some contracts include minimum guaranteed royalty payments which are recorded as an asset when actually paid and as a liability when incurred. Working with independent developers allows us to reduce our fixed development costs, share development risks with the third-party developers, take advantage of the third-party developers' expertise in connection with certain categories of products or certain platforms, and gain access to proprietary development technologies.
Activision provides various forms of product support to both our internally and externally developed titles. Activision quality assurance personnel are involved throughout the development and production of each title published. Activision subjects all such products to extensive testing before release to ensure compatibility with all appropriate hardware systems and configurations and to minimize the number of bugs and other defects found in the products. To support our products after release, Activision provides its customers online access on a 24-hour basis as well as live telephone operators who answer the help lines during regular business hours.
Marketing, Sales, and Distribution
Activision's marketing efforts include online activities (such as the creation of World Wide Web pages to promote specific titles and build user communities around our franchises), public relations, print and broadcast advertising, coordinated in-store and industry promotions (including merchandising
and point of purchase displays), participation in cooperative advertising programs, direct response vehicles, and product sampling through demonstration software distributed through the Internet or on compact discs. From time to time, we also receive marketing support from hardware manufacturers and retailers in connection with their own promotional efforts. In addition, certain of our products contain software that enables customers to "electronically register" their purchases with us online.
We believe that our strong proven franchises and genres generate a loyal and devoted customer base that continues to purchase our sequels as a result of such dedication to the franchise and satisfaction from previous product purchases. We therefore market these sequels and expansion packs toward the established market as well as to broader audiences. In addition, for marketing titles based on licensed properties, we believe that we derive benefits from our continued marketing of these licensed properties as well as marketing and promotional activities of the property owners.
North America. Our products are available for sale or rental in thousands of retail outlets in North America. Our North American retail customers include Best Buy, GameStop, Target, Toys "R" Us, and Wal-Mart.
In the United States and Canada, our products are sold primarily on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses, and game specialty stores. We believe that a direct relationship with retail accounts results in more effective inventory management, merchandising, and communications than would be possible through indirect relationships. We have implemented electronic data interchange linkages with many of our retailers to facilitate the placing and shipping of orders. We also sell our products to a limited number of distributors.
International. Our products are sold internationally on a direct-to-retail basis, through third-party distribution and licensing arrangements, and through our wholly-owned European distribution subsidiaries. We conduct our international publishing activities through offices in the United Kingdom ("U.K."), Germany, France, Italy, Spain, Norway, the Netherlands, Canada, Sweden, Australia, and South Korea. We seek to maximize our worldwide revenues and profits by releasing high quality foreign language releases concurrently with English language releases and by continuing to expand the number of direct selling relationships we maintain with key retailers in major territories.
On a worldwide basis, our largest customers, Wal-Mart and GameStop, each accounted for 11% of consolidated net revenues for the year ended December 31, 2008. No sales made to one customer accounted for more than 10% of Vivendi Games' total net sales during 2007 or 2006.
Affiliate Labels. In addition to our own products, we distribute a select number of interactive entertainment products that are developed and marketed by other third-party publishers through our "affiliate label" programs in North America, Europe, and the Asia Pacific region. The distribution of other publishers' products allows us to increase the efficiencies of our sales force and provides us with the ability to better ensure adequate shelf presence at retail stores for all of the products that we distribute. Revenues that we receive from distributing other publishers' titles mitigate the risk associated with a particular title or titles published by us failing to achieve expectations. Services provided by us under our affiliate label programs include order solicitation, in-store marketing, logistics and order fulfillment, sales channel management, as well as other accounting and general administrative functions. Our current affiliate label partners include LucasArts, as well as several affiliate label partners in our "value" business. Each affiliate label relationship is unique and may pertain only to distribution in certain geographic territories and may be further limited only to specific titles or titles for specific platforms.
Manufacturing
Activision prepares a set of master program copies, documentation, and packaging materials for our products for each hardware platform on which the product will be released. We also manufacture
separate hardware peripheral, such as the guitar, drum and microphone forGuitar Hero World Tour. With respect to products for use on the Sony, Nintendo, and Microsoft systems, our disk and hardware peripheral duplication, packaging, printing, manufacturing, warehousing, assembly, and shipping are performed by third-party subcontractors.
To maintain protection over their hardware technologies, Sony, Nintendo, and Microsoft generally specify or control the manufacturing and assembly of finished products. We deliver the master materials to the licensor or its approved replicator, which then manufactures finished goods and delivers them to us for distribution under our label. We use the manufacturers who are authorized by Sony, Nintendo, or Microsoft to make the hardware peripherals for Guitar Hero. At the time our product unit orders are filled by the manufacturer, we become responsible for the costs of manufacturing and the applicable per unit royalty on such units, even if the units do not ultimately sell.
Blizzard Entertainment Segment ("Blizzard")—Business Overview
Strategy
Maintain and Build upon Our Leadership Position in the MMORPG Category and PC Online categories. Blizzard plans to maintain and build upon our leadership position in the MMORPG genre by regularly providing new content and game features to further solidify the loyalty of our subscriber base, as well as to expand the global game footprint to new markets.
We believe that the PC online market will remain a fast growing category throughout the world. The large and still growing PC installed base in all regions and the continuing development of broadband connectivity facilitates online games and community experiences while creating access to new potential customers. Given the success ofWorld of Warcraft in Asia, we expect to be well positioned to capture the growing consumer demand in this region. Blizzard is among the few companies with video game franchises created and developed in the United States ("U.S.") that have gained and retained success in Asia. Warcraft and StarCraft are strong brands in Asia. Titles in those series have been among the most played games in the region for many years and support a thriving professional gaming industry, particularly in South Korea. Also, asWorld of Warcraft is a server-based game, only playable online, Blizzard is one of the few companies that can target markets that have been dominated by piracy and be able to monetize former illegitimate players as well as expand in markets that have not been penetrated by consoles, but offer a large PC installed base.
Products
Blizzard is a leading company in the subscription-based MMORPG category.World of Warcraft was initially launched in November 2004 in North America, Australia, and New Zealand; and was subsequently launched in South Korea, Europe, China, Singapore, Taiwan, Hong Kong, and Macau in 2005; Malaysia in 2006; and Thailand in 2007. In December 2008,World of Warcraft had more than 11.5 million paying subscribers worldwide.World of Warcraft is available in various different languages based on the regions in which it is played and has earned awards and praise from publications around the world. Blizzard launched an expansion pack toWorld of Warcraft,World of Warcraft: The Burning Crusade, in January 2007 in North America, Europe, Australia, New Zealand, Singapore, Malaysia, and Thailand.World of Warcraft: The Burning Crusade was launched in South Korea in February 2007; Taiwan, Hong Kong, and Macau in April 2007; and China in September 2007. Blizzard launched the secondWorld of Warcraft expansion pack,World of Warcraft: Wrath of the Lich King in November 2008 in all territories except China where we anticipate launching in 2009. Revenues associated with theWorld of Warcraft franchises accounted for 97%, 97%, and 95% of Blizzard's consolidated net revenues for the years ended December 31, 2008, 2007, and 2006, respectively.
Additionally, in the PC online category, we have announced the development of sequels for StarCraft, a real-time strategy game, and Diablo, an action role-playing game.
Product Development and Support
As a development studio, creator and publisher ofWorld of Warcraft, Diablo, StarCraft, and Warcraft franchises, Blizzard focuses on creating well-designed, high quality games. All product development is done internally by a strong core group of talented designers, producers, programmers, artists, and sound engineers. To maintain its current subscribers and attract new subscribers, Blizzard continues to develop new patches to upgradeWorld of Warcraft. In addition to its headquarters in Irvine, California, Blizzard maintains offices in or around Austin, Texas; Paris, France; Cork, Ireland; Seoul, South Korea; Shanghai, China; and Taipei, Taiwan, to provide 24/7 game support toWorld of Warcraft players in their native language, enhance online community management, and tailor marketing initiatives to specific regions.
Marketing, Sales, and Distribution
The Blizzard business involves the development, marketing, sales and support of traditional games and online subscription-based games in the MMORPG category. Blizzard distributes its product and generates revenues worldwide through various means: subscription revenues (which consist of fees from individuals playing World of Warcraft and other ancillary online revenues); retail sales of physical "boxed" product; electronic download sales of PC products; and licensing revenues from third-party companies who distribute World of Warcraft in China and Taiwan. In addition, Blizzard operates a free online game service, Battle.net, which attracts millions of active players making it one of the largest online-game related services in the world. Battle.net is a service that allows millions of players to connect and play Blizzard games and strengthens brand loyalty among current Blizzard gamers.
Activision Blizzard Distribution Segment ("Distribution")—Business Overview
We distribute interactive entertainment hardware and software products in Europe through our European distribution subsidiaries: Centresoft in the United Kingdom; NBG in Germany; and CD Contact in the Benelux countries. These subsidiaries act as wholesalers in the distribution of products and also provide packaging and logistical and sales services. They provide services to our publishing operations and to various third-party publishers, including Sony, Nintendo, and Microsoft. Centresoft is Sony's exclusive distributor of PlayStation products to the independent market sector of the United Kingdom.
We entered into the distribution business to obtain distribution capacity in Europe for our own products, while supporting the distribution infrastructure with third-party sales, and to diversify our operations into the European market. Centresoft and our other distribution subsidiaries operate in accordance with strict confidentiality procedures to provide independent services to various third-party publishers.
Activision Blizzard Non-Core Exit Operations Segment ("Non-core")—Overview
As part of our restructuring and integration efforts, we have exited or are winding down several of Vivendi Games' legacy divisions, studios or businesses, including Vivendi Games Mobile, and Sierra Online, to achieve synergies and form the streamlined organization of Activision Blizzard. Our goal is to substantially exit or wind down these divisions by June 2009 to maximize synergies.
Financial Information about Operating Segments and Foreign Geographic Areas
See Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 1014 of the Notes to Consolidated Financial Statements included in Item 8.
Available Information
Our website is located athttp://www.activision.comwww.activisionblizzard.com. Furthermore, ourOur Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), are available free of charge through our website. The information found on our website is not a part of, and is not incorporated by reference into, this or any other report that we file with or furnish to the SEC.Securities and Exchange Commission ("SEC").
The public may also read and copy any materials we file with the SEC at the SEC's Public Reference Room at Station Place, 100 F Street, N.E., Washington, D.C. 20549 (information on the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330). The SEC also maintains a web site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC athttp://www.sec.gov.
A continuing deterioration of general economic conditions could result in a reduction in discretionary spending by consumers that could reduce demand for our products.
Most of our products involve discretionary spending on the part of consumers. Consumers are generally more willing to make discretionary purchases, including purchases of products like ours, during periods in which favorable economic conditions prevail. As a result, our products may be sensitive to general economic conditions and economic cycles. A continuation or worsening of current, adverse worldwide economic conditions, including declining consumer confidence, inflation, recession, rising unemployment and volatile gasoline prices, may lead consumers to delay or reduce purchases of our products. Reduced consumer spending may also require us to incur increased selling and promotional expenses. A reduction or shift in domestic or international consumer spending could negatively impact our business, results of operations and financial condition.
Our business ismay be harmed if our distributors, retailers or other parties with which we do business cannot honor their existing credit arrangements, default on their obligations to us, or seek protection under the bankruptcy laws.
We rely on various business partners for several important aspects of our business, including distribution of our products, product development, and intellectual property licensing. Some of these business partners are highly-leveraged or small businesses that may be particularly vulnerable to difficult economic conditions. As a result of the current economic downturn, we are subject to manyincreased counterparty risks, including the risks that our business partners may default on their obligations to us or seek protection under the bankruptcy laws.
For example, retailers and uncertainties, whichdistributors in the interactive entertainment industry have from time to time experienced significant fluctuations in their businesses and a number of them have failed. We typically make sales to most such retailers and some such distributors on unsecured credit, with terms that vary depending upon the customer's credit history, solvency, credit limits, and sales history, as well as whether such customer can obtain sufficient credit insurance. Challenging economic conditions may affectimpair the ability of such customers to pay for products they have purchased, and as a result, our future financial performance. If anyreserves for doubtful accounts and write-off of accounts receivable could increase and, even if increased, may turn out to be insufficient. Moreover, even in cases where we have insolvency risk insurance to protect against a customer's bankruptcy, insolvency, or liquidation, this insurance typically contains a significant deductible and co-payment obligation, and does not cover all instances of non-payment. As a result, a payment default by or the eventsinsolvency or circumstances described below occurs,business failure of a significant customer could significantly harm our business and financial performanceresults.
The insolvency or business failure of other types of business partners could result in disruptions to the manufacturing or distribution of our products or the cancellation of contractual arrangements that we consider to be harmed,favorable.
Current general economic conditions may adversely affect other aspects of our actual results could differ materially frombusiness.
We are unable to predict the likely duration and severity of the current disruption in financial markets and adverse economic conditions in the U.S. and other countries, and all of the effects the disruptions and current macroeconomic conditions may have on our expectations, andbusiness. Among other things, because we generally maintain large cash reserves, we are subject to the marketrisk that inflation may cause the real value of our securitiescash and cash equivalents to decline. Furthermore, uncertainties concerning the likely length and severity of the economic downturn cause our forecasts to be subject to even greater risks and uncertainties.
Fluctuations in currency exchange rates may have a negative impact on our results of operations.
We transact business in various currencies other than the U.S. dollar and have significant international sales and expenses denominated in currencies other than the U.S. dollar, subjecting us to currency exchange rate risks. A substantial portion of our international sales and expenses are made in local currencies, including certain major currencies, such as the euro and U.K. pound, and emerging market currencies, such as the Korean won and Chinese renminbi, which could decline. The risks discussed below are notfluctuate against the only onesU.S. dollar. We have, in the past, utilized currency derivative contracts to hedge certain foreign exchange exposures, principally anticipated transactions and firm commitments, with hedge tenors of generally less than 12 months. We may also, from time to time, hedge non-U.S. dollar earnings. Our principal counterparty in respect of currency derivative contracts is Vivendi, though we face. Additional risks existperiodically evaluate and may use similar arrangements with other counterparties. There can be no assurance that we do notwill continue these programs, or that we will be successful in managing exposure to currency exchange rate risks. We currently believe to be material, and there may also be other risksexpect that are not currently known to us, that may also harm our business anda stronger U.S. dollar in 2009 than in 2008 will adversely affect our future financial performanceresults of operations in 2009 compared to 2008.
Although we expect that the Business Combination will result in benefits to Activision Blizzard, we may not realize those benefits because of integration difficulties and other challenges.
The success of the combination of Activision and Vivendi Games will be dependent in large part on the success of our management in integrating the operations, technologies and personnel of the two companies. Though we have largely achieved the integration in North America, other regions are still underway.
Our failure to meet the challenges involved in successfully completing the integration of the operations of Activision and Vivendi Games in those other regions or to otherwise realize any of the anticipated benefits of the Business Combination, including additional revenue opportunities, could impair our results of operations.
Challenges involved in this integration include, without limitation:
We may not successfully complete the integration of the operations of Activision and Vivendi Games in a timely manner and we may not realize the anticipated benefits or synergies of the Business Combination to the extent, or in the timeframe, anticipated. The anticipated benefits and synergies include cost savings associated with anticipated restructurings and other operational efficiencies, greater economies of scale and revenue enhancement opportunities. However, these anticipated benefits and synergies assume a successful integration and are based on projections, which are inherently uncertain, and other assumptions. Even if integration is successful, anticipated benefits and synergies may not be achieved.
Vivendi owns a majority of our outstanding shares of common stock, and the market valueinterests of Vivendi and its subsidiaries may conflict with the interests of our other shareholders.
Vivendi and its subsidiaries currently own approximately 55% of our issued and outstanding shares of common stock.
Risks Factors Relating As a result of the Business Combination, Vivendi has the ability to nominate a majority of our board of directors and determine the outcome of certain matters submitted to our stockholders, such as the approval of significant transactions. As a result, actions that may be supported by a majority of other stockholders may be blocked by Vivendi. In addition, Vivendi's ownership may affect the liquidity in the market for our common stock.
Furthermore, the ownership position and governance rights of Vivendi may discourage a third party from proposing a change of control or other strategic transaction concerning Activision Blizzard. As a result, our common stock may trade at prices that do not reflect a "control premium" to the Interactive Entertainment Industrysame extent as do the stocks of similarly situated companies that do not have a stockholder with an ownership interest as large as Vivendi's ownership interest.
We are a "controlled company" within the meaning of NASDAQ rules and, Our Businessas a result, are exempt from certain corporate governance requirements.
For so long as Vivendi or any other entity or group owns more than 50% of the total voting power of our common shares, we will be a "controlled company" within the meaning of NASDAQ rules and, as a result, qualify for exemptions from certain corporate governance requirements. As a controlled company, we are exempt from several NASDAQ standards, including the requirements:
We currently rely on these exemptions and as a result, a majority of our Board is not independent (as defined by the NASDAQ rules). In addition, while we have a nominating and corporate governance committee and a compensation committee, these committees do not consist entirely of independent directors. Accordingly, our stockholders do not have the same protections afforded to stockholders of companies that are subject to all of the NASDAQ corporate governance requirements.
We depend on a relatively small number of franchises for a significant portion of our revenues and profits.
A significant portion of our revenues ishas historically been derived from products based on a relatively small number of popular franchises each year, and these products are responsible for a disproportionatedisproportionately large amount of our profits. In addition, many of these products have substantial production or acquisition costs and marketing budgets. In fiscal 2008, 65% of our consolidated net revenues and 75% of our worldwide publishing net revenues were derived from three franchises and in fiscal 2007, 39% of our consolidated net revenues and 52% of our worldwide publishing net revenues were derived from three franchises. We expect that a limited number of popular franchises will continue to produce a disproportionately large amount of our revenues and profits. Due to this dependence on a limited number of franchises, the failure to achieve anticipated results by one or more products based on these franchises may significantly harm our business and financial results.
Sales of certain titles such as Guitar Hero are affected by hardware peripheral availability, which increases our exposure to imbalances between projected and actual demand.
Some of our titles involve one or more separate hardware peripherals, such as the guitar controller in Guitar Hero. Typically, we sell such software both in bundles with the hardware peripheral and on a stand-alone basis. Consumers may not want to buy such game software if they cannot also buy the hardware peripheral. If we underestimate demand or otherwise are unable to produce sufficient quantities of the hardware peripheral of an acceptable quality or allocate too few peripherals to geographic markets and hardware platforms where demand exceeds supply, we will forego revenue. This may also create greater opportunities for competitors to develop or gain market share with competitive product offerings.
In addition, if we overestimate demand and make too many peripherals, or allocate too many peripherals to geographic markets and hardware platforms where there is insufficient demand, we will incur unrecoverable manufacturing costs for unsold units as well as for unsold game software. In either case, hardware peripheral manufacturing and allocation decisions may negatively affect our financial performance.
The increasing importance and complexity of hardware peripherals in our business increases our exposure to hardware manufacturing and shipping risks, including availability of sufficient third-party manufacturing capacity, and increases in manufacturing and shipping costs.
A limited number of manufacturers are authorized by Sony, Nintendo or Microsoft to make the hardware peripherals for Guitar Hero, and the majority of those manufacturers are located in China. Anything that impacts the ability of those manufacturers to produce or otherwise supply the hardware peripherals for us or increases their costs of production, including the revocation of the first party license to produce the hardware, the utilization of such manufacturer's capacity by one of our competitors, natural disasters that disrupt manufacturing, transportation or communications, labor shortages, civil unrest or issues generally negatively impacting international companies operating in China, increases in the price of petroleum or other raw materials, increases in fuel prices and other shipping costs, and increases in local labor costs in China, may adversely impact our ability to supply those peripherals to the market and the prices we must pay for those peripherals, and therefore our financial performance. Additionally, the increasing complexity and expense of these hardware peripherals increases the risk of production delays or product defects.
Our sales may decline substantially without warning and in a brief period of time because a substantial portion of our sales are made to a relatively small number of key customers and because we do not have long-term contracts for the sale of our products.
In the U.S. and Canada, Activision has primarily sold its products on a direct basis to mass-market retailers, consumer electronics stores, discount warehouses, and game specialty stores. Activision products are sold internationally on a direct-to-retail basis, through third-party distribution and licensing arrangements and through our wholly-owned European distribution subsidiaries. Activision's sales are made primarily on a purchase order basis without long-term agreements or other forms of commitments. Activision's largest customers, Wal-Mart and GameStop, accounted for approximately 20% and 22%, respectively, of Activision's net revenues for the year ended December 31, 2008. The loss of, or significant reduction in sales to, any of Activision's principal retail customers or distributors could significantly harm our business and financial results. The concentration of sales in a small number of large customers also could make us more vulnerable to collection risk if one or more of these large customers became unable to pay for our products or sought protection under the bankruptcy laws. In addition, having such a large portion of our total net revenue concentrated in a few customers reduces our negotiating leverage with these customers.
We may not be able to maintain our distribution relationships with key vendors and customers.
Our CD Contact, NBG, and Centresoft subsidiaries distribute interactive entertainment software and hardware products and provide related services in the Benelux countries, Germany, and the UK, respectively, and via export in other European countries for a variety of entertainment software publishers, many of which are our competitors, and hardware manufacturers. From time to time, they also maintain exclusive relationships to serve certain retail customers. These services are generally performed subject to limited-term arrangements. Although we expect to use reasonable efforts to retain these vendors and retail customer relationships, we may not be successful in this regard. The cancellation or non-renewal of one or more of these arrangements could adversely affect our business and financial results.
As online functionality has become an increasingly important feature of our software products, we may need to defer the recognition of an increasing amount of revenue, which may adversely affect the net revenue, net income and earnings per share that we will report under GAAP.
As online functionality has become a more important component of gameplay, an increasing number of our online-enabled games contain a more-than-inconsequential separate service deliverable in addition to the product, and our performance obligations for these games extend beyond the sale of the games. Vendor-specific objective evidence of fair value does not exist for the online services, as we do not plan to separately charge for this component of online-enabled games. As a result, we recognize revenues from the sale of certain online-enabled games for certain platforms ratably over an estimated service period. In addition, we defer the costs of sales of those titles. This has an adverse effect on the revenue, net income and earnings per share that we report under GAAP. If we are required to recognize a greater portion of the revenue of a sale after shipment, or if we are required to recognize revenue over a longer service period, there may be an adverse effect on our reported net revenue, net income and earnings per share under GAAP.
A substantial portion of our revenue and profitability will depend on the subscription-based massively multiplayer online role-playing game category. If we do not maintain our leadership position in this category, our financial results could suffer.
Activision Blizzard is the leading global developer, publisher and distributor in terms of subscriber base and revenues in the subscription-based massively multiplayer online role-playing game ("MMORPG") category, due to the popularity ofWorld of Warcraft and related expansion packs. Subscription revenues from this game comprise a significant portion of our consolidated revenues. To remain the leader in the MMORPG category, it is important that we continue to refreshWorld of Warcraft or develop new MMORPG products that are favorably received by our existing customer base and new customers. A number of software publishers have developed and commercialized or are currently developing online games for use by consumers over the Internet which pose a threat to the popularity ofWorld of Warcraft, and we expect new competitors to continue to emerge in the MMORPG category. If consumer demand forWorld of Warcraft games declines and we have not introduced new MMORPG or other products that replaceWorld of Warcraft's potentially decreasing revenue, or added other sources of revenue, our financial condition could suffer. Additionally, if new technologies are developed that replace MMORPG games, if consumer preferences trend away from MMORPG games or if new business models emerge that offer online subscriptions for free or at a substantial discount to current MMORPG subscription fees, our revenue and profitability may decline.
The development of MMORPG products requires substantial up-front expenditures. We may not be able to recover development costs for our future MMORPG products.
Consumer preferences for games are usually cyclical and difficult to predict, and even the most successful titles remain popular for only limited periods of time, unless refreshed with new content. In
order to remain competitive in the MMORPG market, we must continuously develop new products and enhancements to existing products. Because of the significant complexity of MMORPG games, these products require a longer development time and are more expensive to create than traditional console game products. In addition, the long lead time involved in developing a MMORPG product and the significant allocation of financial resources that each product requires means it is critical that we accurately predict consumer demand for new MMORPG products. If future MMORPG products do not achieve expected market acceptance or generate sufficient sales and subscription revenues upon introduction, we may not be able to recover the development and marketing costs associated with new products, and our financial results could suffer.
A substantial portion of Activision Blizzard's revenues is derived from subscriptions paid by World of Warcraft subscribers. If these customers cancel their subscriptions, our results of operations may suffer.
A substantial portion of our revenues is generated by subscription fees paid by consumers who playWorld of Warcraft. Typically,World of Warcraft subscribers purchase one to three month memberships that are cancelable, without penalty, at the end of the membership period. IfWorld of Warcraft subscribers become dissatisfied, they may chose not to renew their memberships in order to engage in other forms of entertainment (including competing MMORPG offerings) and we may not be able to replace lost subscribers. Additionally, if general economic conditions deteriorate further, consumers may decrease their discretionary spending on entertainment items such as MMORPG games and users may choose not to renew theirWorld of Warcraft subscriptions. A decrease in the overall subscription base ofWorld of Warcraft could substantially harm our operating results.
We depend on servers to operate our MMORPG business. If we were to lose server capacity, for any reason, our business could suffer.
Our business relies on the continuous operation of our data servers. Any broad based catastrophic server malfunction, a significant intrusion by hackers that circumvents our security measures, or a failure of our disaster recovery service would likely interrupt the operation of our MMORPG games and could result in the loss of subscription-based sales. An extended interruption of service could harm our reputation and operating results.
We must project our future server needs and make advance purchases of servers to accommodate expected business demands. If we underestimate the amount of server capacity our business requires or if our business were to grow more quickly than expected, our customers may experience service problems, such as slow or interrupted gaming access. Insufficient server capacity may result in our experiencing decreased sales, a loss of our customer base, and adverse consequences to our reputation. Conversely, if we overestimate the amount of server capacity required by our business, we may incur additional operating costs that would adversely affect our operating margins.
We may not accurately predict the amount of Internet bandwidth necessary to sustain our online gaming businesses.
Our online gaming businesses are dependent on the availability of sufficient Internet bandwidth. An increase in the price of bandwidth could have an adverse effect on operating margins since we may not be able to increase our prices or subscriber levels to compensate for such costs. Because of the importance of our MMORPG business to our revenues and results of operations, our ability to access adequate bandwidth to support our business is critical. To secure bandwidth access, we have entered into arrangements with several bandwidth providers and entered into long-term contracts with some of them to secure future bandwidth capacity. If the price of bandwidth were to decrease, our contractual commitments to pay higher prices could affect our ability to compete with other video game producers.
Conversely, because we purchase additional bandwidth based on anticipated growth, our bandwidth capacity is sometimes larger than necessary to sustain our existing needs. If our projected online business growth is delayed or does not occur, we will incur larger bandwidth expenses than necessary. If we underestimate the amount of bandwidth that our online business requires, and our purchased bandwidth capacity is insufficient to meet demand, our business and reputation may suffer.
Our results of operations or reputation may be harmed as a result of offensive consumer posted content.
We are subject to risks associated withWorld of Warcraft's collaborative online features, specifically our online chat feature. Consumers may post narrative comment, in real time, ontoWorld of Warcraft's gaming sites that is visible to other users. Despite our efforts to police and restrict inappropriate consumer content, from time to time objectionable and offensive consumer content may be posted to aWorld of Warcraft's gaming site. We may be subject to lawsuits, governmental regulation or restrictions, and consumer backlash (including decreased sales and harmed reputation), as a result of consumers posting offensive content, any of which could harm our operating results.
A substantial portion of World of Warcraft's subscribers pays their subscription fees using credit cards. Credit card fraud could have a negative impact on our business and operating results.
A substantial portion of the subscription revenue generated byWorld of Warcraft is paid by subscribers using credit cards. At times, there may be attempts to use fraudulently obtained credit card numbers to pay forWorld of Warcraft upgrades or subscriptions. Additionally, the credit card numbers ofWorld of Warcraft's subscribers are maintained in a proprietary database that may be compromised internally or externally by fraudulent maneuvers. As fraudulent schemes become more sophisticated, it may become more difficult and more costly for us to detect credit card fraud and protect subscriber information. An increase in credit card fraud could have an adverse effect on our business and operating results.
The future success of our business depends on our ability to release popular products.
The life of any one console or handheldhand-held game product is relatively short and generally involves a relatively high level of sales during the first few months after introduction followed by a rapid decline in sales. Because revenues associated with an initial product launch generally constitute a high percentage of the total revenues associated with the life of a product, delays in product releases or disruptions following the commercial release of one or more new products could have a materialan adverse effect on our operating results and cause suchour operating results to be materially different from expectations. It is therefore important for us to be able to continue to develop many high quality new products that are popularly received. We focus our development and publishing activities principally on
products that are, or have the potential to become, franchise brand properties. If we are unable to do this,continue to develop many high quality new products that are popularly received, our business and financial results may be negatively affected.
Our business is "hit" driven. If we do not deliver "hit" titles, or if consumers prefer competing products, our sales could suffer.
While many new products are regularly introduced, only a relatively small number of "hit" titles account for a significant portion of net revenues.revenue. Competitors may develop titles that imitate or compete with our "hit" titles, and take sales away from usthem or reduce our ability to command premium prices for those titles. Hit"Hit" products published by our competitors may take a larger share of consumer spending than anticipated, which could cause our product sales to fall below expectations. If our competitors develop more successful products or offer competitive products at lower prices, or if we do not continue to develop consistently high-quality and well received products, our revenue,revenues, margins, and profitability willcould decline.
If we are unable to maintain or acquire licenses to intellectual property, we may publish fewer "hit" titles and our revenuerevenues may decline.
Some of our products are based on intellectual property and other character or story rights acquired or licensed from third parties. These license and distribution agreements are limited in scope and time, and we may not be able to renew key licenses when they expire or to include new products in existing licenses. TheOur loss of a significant number of our intellectual property licenses or of our relationships with licensors, or our inability to obtain additional licenses of significant commercial value could have a materialan adverse effect on our ability to develop new products and therefore on our business and financial results. Additionally, the failure of intellectual property acquired by us to be popularly received could impact the market acceptance of those products in which the intellectual property is included. Such lack of market acceptance could result in the write-off of the unrecovered portion of acquired intellectual property assets, which could cause material harm to our business and financial results. Furthermore, the competition for these licenses and distribution agreements is often intense. Competition for these licenses may also increase the advances, guarantees, and royalties that must be paid to the licensor.
The interactive entertainment industry is highly competitive and competitors may succeed in reducing our market share and sales.
We compete with other publishers of PC and video game console interactive entertainment software and peripherals. Those competitors vary in size from small companies with limited resources to very large corporations with significantly greater financial, marketing, and product development resources than we have. For example, integrated video game console hardware and software companies such as Sony, Nintendo, and Microsoft compete directly with us in the development of software titles for their respective platforms. Certain of these competitors may spend more money and time on developing and testing products, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, pay higher fees to licensors for desirable motion picture, television, sports, music and character properties, and pay more to third-party software developers than we do. Further, certain major media companies, such as Disney and Time Warner, who have been investing in the videogame products, have increased the competition within the industry.
We also compete with other forms of entertainment and leisure activities. For example, the overall growth in the use of the Internet and online services by consumers may pose a competitive threat if customers and potential customers spend less of their available time using interactive entertainment software and more using the Internet and online services. A number of software publishers who compete with us have developed and commercialized or are currently developing online games for use by consumers over the Internet. Future increased consumer acceptance and increases in the availability of online games or technological advances in online game software or the Internet could result in a decline in platform-based software and negatively impact sales of our console and hand-held products. Newer technological advances in online game software may also render products such asWorld of Warcraft obsolete. Direct sales of software over the Internet by competitors could adversely affect our distribution business as well.
Competition in the interactive entertainment industry is intense and we expect new competitors to continue to emerge.
Our business is subject to the risks and uncertainties of international trade.
We conduct business throughout the world, and we derive a substantial amount of revenue from international trade, particularly from Europe, Australia, and Asia. We expect that international revenues will continue to account for a significant portion of total revenues in the future. We are subject to risks inherent in foreign trade, including increased tariffs and duties, fluctuations in currency exchange rates, shipping delays, increases in transportation costs, increases in local labor costs in
overseas locations where our hardware peripherals are manufactured, and international political, regulatory and economic developments, all of which may impact operating margins or make it more difficult, if not impossible, for us to conduct business in foreign markets.
For example, a deterioration in relations between the U.S. and any country in which we have significant operations or sales, including China in particular, could result in the adoption or expansion of trade restrictions that harm our business and operating results as could the implementation of government regulations in a country where we have significant operations or sales. For example, to operate in China,World of Warcraft must have a publishing number. A decision by the Chinese government to revoke this number would adversely impact our operating results. A publishing number will also be required to sell theWorld of Warcraft: Wrath of the Lich King expansion pack in China. A decision by the Chinese government to decline to grant a number for this or other future products would adversely impact our operating results. Additionally, in the past, legislation has been implemented in China that has required modifications to theWorld of Warcraft software. The future implementation of similar laws may require engineering modifications to our products that are not cost-effective, if even feasible at all or could degrade the customer experience to the point where customers ceased to purchase such products.
Further, if government regulations or restrictions prevent us from repatriating internationally derived revenue into the U.S., or a country's tax structure makes repatriation prohibitively expensive, we may not transfer such revenue into the U.S., which could affect our ability to reinvest or utilize such amounts in our business.
In addition, cultural differences may affect consumer preferences and limit the popularity of titles that are "hits" in the U.S. If we do not correctly assess consumer preferences in the countries in our market, our sales and revenue may be lower than expected.
We rely on independent third parties to develop some of our software products.
We rely on independent third-party software developers to develop some of our software products. Because we depend on these developers, we are subject to the following risks:
Increased competition for skilled third-party software developers also has compelled us to agree to make significant advance payments on royalties to game developers. If the products subject to these arrangements do not generate sufficient revenues to recover these royalty advances, we would have to write-off unrecovered portions of these payments, which could harm our business and financial results. Typically, we pay developers a royalty based on a percentage of net revenues from product sales, less agreed upon deductions, but from time to time, we have agreed to pay developers fixed per unit product royalties after royalty advances are fully recouped. To the extent that sales prices of products on which we have agreed to pay a fixed per unit royalty are marked down, our profitability could be adversely affected.
Our platform licensors set the royalty rates and other fees that must be paid to publish games for their platforms, and therefore have significant influence on our costs.
We pay a licensing fee to the hardware manufacturer for each copy of a product manufactured for that manufacturer's game platform. In order to publish products for new hardware platforms, we must take a license from the platform licensor which gives the platform licensor the opportunity to set the fee structure that we must pay in order to publish games for that platform. Similarly, the licensor.platform licensors have retained the flexibility to change their fee structures for online gameplay and features for their consoles and the manufacturing of products. The control that platform licensors have over the fee structures for their platforms and online access makes it difficult for us to predict our costs and profitability in the medium to long term. It is also possible that platform licensors will not renew our existing licenses. Any increase in fee structures or nonrenewal of licenses could have a significant negative impact on our business models and profitability, particularly for Activision Publishing, as the publishing of products for console systems is the largest portion of Activision Publishing's business.
Our business is highly dependent on the success, timely release and availability of new video game platforms, on the continued availability of existing video game platforms, as well as our ability to develop commercially successful products for these platforms.
We derive mosta substantial portion of our revenue from the sale of products for play on video game platforms manufactured by third parties, such as Sony's PlayStation 2, PlayStation 3 and PlayStation Portable, Microsoft's Xbox 360 and Nintendo's Wii and DS.NDS. The success of our business is driven in large part by the availability of an adequate supply of these video game platforms, our ability to accurately predict which platforms will be successful in the marketplace, and our ability to develop commercially successful products for these platforms. We must make product development decisions and commit significant resources well in advance of the anticipated introduction of a new platform. A new platform for which we are developing products may be delayed, may not succeed or may have a shorter life cycle than anticipated. Alternatively, a platform for which we have not devoted significant resources could be more successful than initially anticipated, causing us to miss a meaningful revenue opportunity. Additionally, if the platforms for which we are developing products are not released when anticipated, are not available in adequate quantities to meet consumer demand, or do not attain wide market acceptance, our revenuerevenues may suffer, we may be unable to fully recover the investments we have madeour investment in developing those products, and our financial performance may be harmed.
Transitions in console platforms could have a material impact onadversely affect the market for interactive entertainment software.
In 2005, Microsoft released the Xbox 360 and, in 2006, Sony and Nintendo introduced their respective next-generation hardware platforms, the PlayStation 3 and Wii. When new console platforms are announced or introduced into the market, consumers typically reduce their purchases of game console entertainment software products for current console platforms in anticipation of new platforms becoming available. During these periods, sales of our game console entertainment software products published by us may be expected to slow or even decline until new platforms are introduced and achieve wide consumer acceptance. This decline may not be offset by increased sales of products for the new console platforms. As console hardware moves through its life cycle, hardware manufacturers typically enact price reductions and decreasing prices may put downward pressure on software prices. During platform transitions, we may simultaneously incur costs both in continuing to develop and market new titles for prior-generation video game platforms, which may not sell at premium prices, and also in developing products for next-generation platforms, which will not generate immediate or near-term revenue. As a result, our operating results during platform transitions may be more volatile and more difficult to predict than during other times, and such volatility may cause greater fluctuations in our stock price.
We must make significant expenditures to develop products for new platforms which may not be successful.
We must make substantial product development and other investments in a particular platform well in advance of introduction of the platform and may be required to realign our product portfolio and development efforts in response to market changes. Furthermore, development costs for new console platforms are greater than such costs for current console platforms. If increased costs are not offset by higher revenues and other cost efficiencies, our operating results will suffer and our financial position will be harmed. If the platforms for which we develop new software products or modify existing products do not attain significant market penetration, we may not be able to recover our development costs, which could be significant, and our business and financial results could be significantly harmed.
If the average price of prior-generation titles continues to decline or if we are unable to sustain launch pricing on next-generation titles, our operating results will suffer.
We have experienced a decrease in the average price of titles for prior-generation platforms. With the transition of the interactive entertainment software industry to next-generation video game platforms, fewer prior-generation titles are able to command premium prices, and we expect that even those titles that can do so will be subject to price reductions at an earlier point in their sales cycle than was the case with prior platform transitions. We expect the average price of prior-generation titles to continue to be under pressure, which may have a negative effect on our margins and operating results.
Next-generation titles for the Microsoft Xbox 360, Sony's PlayStation 3, and the Nintendo Wii have been offered at premium retail prices since the launch of such consoles. We expect to continue to price next-generation titles at a premium level, but if we are unable to sustain launch pricing on these next-generation titles we may experience a negative effect on our margins and operating results.
The interactive entertainment industry is highly competitive and our competitors may succeed in narrowing our market share and reducing our sales.
We compete with other publishers of PC and video game console interactive entertainment software and peripherals. Those competitors vary in size from small companies with limited resources to very large corporations with significantly greater financial, marketing, and product development resources than we have. For example, integrated video game console hardware and software companies such as Sony, Nintendo, and Microsoft compete directly with us in the development of software titles
for their respective platforms. Certain of these competitors may spend more money and time on developing and testing products, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, pay higher fees to licensors for desirable motion picture, television, sports, music and character properties, and pay more to third-party software developers than we do.
We also compete with other forms of entertainment and leisure activities. For example, the overall growth in the use of the Internet and online services by consumers may pose a competitive threat if customers and potential customers spend less of their available time using interactive entertainment software and more using the Internet and online services. A number of software publishers who compete with us have developed and commercialized or are currently developing online games for use by consumers over the Internet. Future increased consumer acceptance and increases in the availability of online games or technological advances in online game software or the Internet could result in a decline in platform-based software and negatively impact sales of our console and handheld products. Direct sales of software over the Internet by competitors could materially adversely affect our distribution business as well.
Competition in the interactive entertainment industry is intense and we expect new competitors to continue to emerge.
Our platformPlatform licensors are our chief competitors and frequently control the manufacturing of and have broad approval rights over our console and handheldhand-held video game products.
Generally, when we develop interactive entertainment software products for hardware platforms offered by Sony, Nintendo, or Microsoft, the products are manufactured exclusively by that hardware manufacturer or their approved replicator.
The agreements with these manufacturers include certain provisions, such as approval rights over all software products and related hardware peripherals and promotional materials and the ability to change the fee they charge for the manufacturing of products, which allow them substantial influence over the cost and the release schedule of such interactive entertainment software products. In addition, sincebecause each of the manufacturers is also a publisher of games for its own hardware platforms and manufactures products for all of its other licensees, a manufacturer may give priority to its own products or those of our competitors in the event of insufficient manufacturing capacity. Accordingly, Sony, Nintendo, or Microsoft could cause unanticipated delays in the release of our products as well as increases to our projected development, manufacturing, marketing, or distribution costs, which could materially harm our business and financial results.
In addition, platform licensors control our ability to provide online game capabilities for console platform products and in large part establish the financial terms on which these services are offered to consumers. Currently, Microsoft provides online capabilities for the Xbox 360 and Sony provides online capabilities for PlayStation 2 and PlayStation 3 products. In each case, compatibility code and/or the consent of the licensor are required for us to include online capabilities in ourits console products. As these capabilities become more significant, the failure or refusal of licensors to approve our products may harm our business and financial results.
Our platform licensors set the royalty ratesmarket is subject to rapid technological change, and other fees thatif we must paydo not adapt to, publish games for their platforms, and therefore have significant influence onappropriately allocate our costs.new resources among, emerging technologies, our revenues would be negatively affected.
Technology changes rapidly in the interactive entertainment industry. We paymust continually anticipate and adapt our products to emerging technologies. When we choose to incorporate a licensing feenew technology into a product or to develop a product for a new platform, operating system or media format, we often are required to make a substantial investment one to two years prior to the hardware manufacturerintroduction of the product. If we invest in the development of video games incorporating a new technology or for each copya new platform that does not achieve significant commercial success, our revenues from those products likely will be lower than we anticipated and may not cover our development costs. If, on the other hand, we elect not to pursue the development of products incorporating a product manufactured for that manufacturer's game platform. In order to publish productsnew technology or for new hardware platforms we mustthat achieve significant commercial success, our revenues would also be adversely affected, and it may take a license fromsignificant time and resources to shift product development resources to that technology or platform. Any such failure to adapt to, and appropriately allocate resources among, emerging technologies would harm our competitive position, reduce our market share and significantly increase the platform licensor which gives the platform licensor the opportunity to set the fee structure that we must pay in order to publish games for that platform. Similarly, the platform licensors have retained the flexibility to change their fee structures for online gameplay and features for their consoles and the manufacturing of products. The control that platform licensors have over the fee
structures for their platforms and online access makes it difficult for us to predict our costs and profitability in the medium to long term. It is also possible that platform licensors will not renew our existing licenses. Because publishing products for console systems is the largest portion of our business, any increase in fee structures or nonrenewal of licenses could have a significant negative impact on our business model and profitability.
We rely on independent third parties to develop some of our software products.
We rely on independent third-party software developers to develop some of our software products. Since we depend on these developers, in the aggregate, we remain subject to the following risks:
Increased competition for skilled third-party software developers also has compelled us to agree to make significant advance payments on royalties to game developers. If the products subject to these arrangements do not generate sufficient revenues to recover these royalty advances, we would have to write-off unrecovered portions of these payments, which could cause material harm to our business and financial results. Typically, we pay developers a royalty based on a percentage of net revenues, less agreed upon deductions, but from time to time we have agreedtake to pay developers fixed per unit product royalties after royalty advances are fully recouped. To the extent that sales prices ofbring popular products on which we have agreed to pay a fixed per unit royalty are marked down, our profitability could be adversely affected.
If our products contain defects, our business could be harmed significantly.
Software products and hardware peripherals as complex as the ones we publish and distribute may contain undetected errors and defects. This risk is often higher when such products or peripherals are first introduced or when new versions are released. Failure to avoid, or to timely detect and correct, such errors or defects could result in loss of, or delay in, market acceptance, and could significantly harm our business, financial results, and reputation.
We may permit our customers to return products and to receive pricing concessions which could reduce our net revenues and results of operations.
We are exposed to the risk of product returns and price protection with respect to our distributors and retailers. Return policies allow distributors and retailers to return defective, shelf-worn, and damaged products in accordance with terms granted. Price protection, when granted and applicable, allows customers a credit against amounts owed to us with respect to merchandise unsold by them. We may permit product returns from, or grant price protection to, our customers under certain conditions. These conditions include compliance with applicable payment terms, delivery of weekly inventory and sell-through reports, and consistent participation in the launches of our premium title releases. We may also consider other factors, including the facilitation of slow-moving inventory and other market factors.
When we offer price protection, we offer it with respect to a particular product to all of our retail customers (although only customers who meet the conditions detailed above are entitled to such price protection). We also offer a 90-day limited warranty to our end users that our products will be free from manufacturing defects. Although we maintain a reserve for returns and price protection, and although we may place limits on product returns and price protection, we could be forced to accept substantial product returns and provide substantial price protection to maintain our relationships with retailers and our access to distribution channels. Product returns and price protection that exceed our reserves could significantly harm our business and financial results.
Sales of certain titles such as Guitar Hero are affected by hardware peripheral availability.
Some of our titles involve one or more separate hardware peripherals, such as the guitar controller inGuitar Hero. Typically, we sell such software both in bundles with the hardware peripheral and on a stand-alone basis. Consumers may not want to buy such game software if they cannot also buy the hardware peripheral. If we underestimate demand or otherwise are unable to produce sufficient quantities of the hardware peripheral of an acceptable quality or allocate too few peripherals to geographic markets and hardware platforms where demand exceeds supply, we will forego revenue. This may also create greater opportunities for competitors to develop or gain market share with competitive product offerings. If we overestimate demand and make too many peripherals, or allocate too many peripherals to geographic markets and hardware platforms where there is insufficient demand, we will incur unrecoverable manufacturing costs for unsold units as well as for unsold game software. In either case, hardware peripheral manufacturing and allocation decisions may negatively affect our financial performance.
A limited number of manufacturers are authorized by Sony, Nintendo or Microsoft to make the hardware peripherals forGuitar Hero, and the majority of those manufacturers are located in China. Anything that adversely impacts the ability of those manufacturers to produce or otherwise supply the hardware peripherals for us, including the revocation of the first-party license to produce the hardware, the utilization of such manufacturer's capacity by one of our competitors, natural disasters that disrupt manufacturing, transportation or communications, labor shortages, civil unrest or issues generally negatively impacting international companies operating in China, may adversely impact our ability to supply those peripherals to the market.
We may face difficulty obtaining access to retail shelf space necessary to market and sell our products effectively.
Retailers typically have a limited amount of shelf space and promotional resources, and there is intense competition among consumer interactive entertainment software products for high quality retail shelf space and promotional support from retailers. To the extent that the number of products and platforms increases, competition for shelf space may intensify and may require us to increase our marketing expenditures. Retailers with limited shelf space typically devote the most and highest quality shelf space to those products expected to be best sellers. We cannot be certain that our new products will consistently achieve such "best seller" status. Due to increased competition for limited shelf space, retailers and distributors are in an increasingly better position to negotiate favorable terms of sale, including price discounts, price protection, marketing and display fees, and product return policies. Our products constitute a relatively small percentage of any retailer'smost retailers' sales volume. We cannot be certain that retailers will continue to purchase our products or to provide those products with adequate levels of shelf space and promotional support on acceptable terms. A prolonged failure in this regard may significantly harm our business and financial results.
Our salesproducts may decline substantially without warning and in a brief period of time because a majority of our sales are madebe subject to a relatively small number of key customers and because we do not have long-term contracts for the sale of our products.legal claims.
In prior fiscal years, at least two lawsuits have been filed against numerous video game companies, including against Activision, by the United Statesfamilies of victims who were shot and Canada,killed by teenage gunmen in attacks perpetrated at schools. These lawsuits alleged that the video game companies manufactured and/or supplied these teenagers with violent video games, teaching them how to use a gun and causing them to act out in a violent manner. These lawsuits have been dismissed. Similar additional lawsuits may be filed in the future. Although, with respect to the prior lawsuits of this nature against us, our general liability insurance carrier agreed to defend such suits, it is uncertain whether insurance carriers would do so in the future, or if such insurance carriers would cover all or any amounts for which we primarily sellmight be liable if such future lawsuits are not decided in our favor. If such future lawsuits are filed and ultimately decided against us and the relevant insurance carrier does not cover the amounts for which we may be liable, it could have an adverse effect on our business and financial results. Payment of significant claims by insurance carriers may make such insurance coverage materially more expensive or unavailable in the future, thereby exposing us to additional risk.
If our products on a direct basiscontain defects, our business could be harmed significantly.
Software products and hardware peripherals as complex as the ones published and distributed by us may contain undetected errors and defects. This risk is often higher when such products or peripherals are first introduced or when new versions are released. Failure to mass-market retailers, consumer electronics stores, discount warehouses,avoid, or to timely detect and game specialty stores. Our products are sold internationally on a direct-to-retail basis, through third-party distribution and licensing arrangements and through our wholly-owned European distribution subsidiaries. Our sales are made primarily on a purchase order basis without long-term agreementscorrect, such errors or other forms of commitments. Our largest customers, Wal-Mart and GameStop, accounted for approximately 14% and 13%, respectively, of our consolidated net revenues for the fiscal year ended March 31, 2008 and approximately 22% and 8%, respectively, of our consolidated net revenues for the fiscal year ended March 31, 2007. Thedefects could result in loss of, or significant reductiondelay in, sales to, any of our principal retail customers or distributorsmarket acceptance, and could significantly harm our business, financial results, and financial results. The concentration of sales in a small number of large customers also could make us more vulnerable to collection risk if one or more of these large customers became unable to pay for our products. In addition, having such a large portion of our total net revenue concentrated in a few customers reduces our negotiating leverage with these customers.reputation.
We may be burdened with payment defaultspermit our customers to return products and uncollectible accounts if our distributors or retailers cannot honor their existing credit arrangements.to receive pricing concessions which could reduce net revenues and results of operations.
DistributorsWe are exposed to the risk of product returns and price protection with respect to our distributors and retailers. Return policies allow distributors and retailers to return defective, shelf-worn, and damaged products in accordance with terms granted. Price protection, when granted and applicable, allows customers a credit against amounts owed with respect to merchandise unsold by them. We may permit product returns from, or grant price protection to, our customers under certain conditions. These conditions include compliance with applicable payment terms, delivery of weekly inventory and sell-through reports, and consistent participation in the interactive entertainment industry have from timelaunches of premium title releases. We may also consider other factors, including the facilitation of slow-moving inventory and other market factors. When we offer price protection, it is offered with respect to time experienced significant fluctuations in their businesses and a number of them have failed. The insolvency or business failure of any significant retailer or distributorparticular product to all of our retail customers (although only customers who meet the conditions detailed above are entitled to such price protection). Activision also offers a 90-day limited warranty to its end users that Activision products could materially harm our business and financial results. We typically make sales to most such retailers and some such distributors on unsecured credit, with terms that vary depending upon the customer's credit history, solvency, credit limits, and sales history, as well as whether we can obtain sufficient credit insurance.will be free from manufacturing defects. Although as in the case with most of our customers, we have insolvency risk insurance to protect against a customer's bankruptcy, insolvency, or liquidation, this insurance contains a significant deductible and co-payment obligation, and does not cover all instances of non-payment. In addition, although we maintain a reserve for uncollectible receivables, the reservereturns and price protection, and although we may notplace limits on product returns and price protection, we could be sufficient in every circumstance. As a result, a payment default by a significant customerforced to accept substantial product returns and provide substantial price protection to maintain our relationships with retailers and our access to distribution channels. Product returns and price protection that exceed reserves could significantly harm our business and financial results.
We may not be able to maintain our distribution relationships with key vendors and customers.
Our CD Contact, NBG, and Centresoft subsidiaries distribute interactive entertainment software and hardware products and provide related services in the Benelux countries, Germany, and the United Kingdom, respectively, and via export in other European countries for a variety of entertainment software publishers, many of which are our competitors, and hardware manufacturers. From time to time, they also maintain exclusive relationships to serve certain retail customers. These services are generally performed subject to limited-term arrangements. Although we expect to use reasonable efforts to retain these vendors and retail customer relationships, we may not be successful in this regard. The cancellation or non-renewal of one or more of these arrangements could adversely affect business and financial results.
Our business is subject to risks generally associated with the entertainment industry, any of which could significantly harm our operating results.
Our business is subject to risks that are generally associated with the entertainment industry, including the popularity, price and timing of the release of our games and the platforms on which they are played;played, economic conditions that adversely affect discretionary consumer spending;spending, changes in consumer demographics;demographics, the availability and popularity of other forms of entertainment;entertainment, and critical
reviews and public tastes and preferences, which may change rapidly and cannot necessarily be predicted. Many of these risks are beyond our control. These risks could negatively impact our business and financial results.
As online functionality becomes an increasingly important feature of our software products, we may need to defer the recognition of an increasing amount of revenue, which may adversely affect the net revenue, net income and earnings per share that we will report under GAAP.
As online functionality becomes a more important component of gameplay, an increasing number of our online-enabled games may contain a more-than-inconsequential separate service deliverable in addition to the product, and our performance obligations for these games will extend beyond the sale of the games. Vendor-specific objective evidence of fair value does not exist for the online services, as we do not plan to separately charge for this component of online-enabled games. As a result, for certain key titles to be released in the December quarter of fiscal year 2009 and thereafter, we will recognize all of the revenues from the sale of certain online-enabled games for certain platforms ratably over an estimated service period, which we currently estimate to be six months beginning the month after shipment. In addition, we will defer the costs of sales of those titles. This may have an adverse effect on the revenue, net income and earnings per share that we will report for future periods under GAAP. If we are required to recognize a greater portion of the revenue of a sale after shipment, or if we are required to recognize revenue over a longer service period, there may be an adverse effect on our reported net revenue, net income and earnings per share under GAAP.
We are exposed to seasonality in the sale of our products.
The interactive entertainment industry is highly seasonal, with the highest levels of consumer demand occurring during the calendar year end holiday buying season. As a result, net revenues, gross profits, and operating income have historically been highest during the second half of the calendar year. Our receivablesReceivables and credit risk are likewise higher during the second half of the calendar year as customers stock up on our products for the holiday season. Further, delays in development, licensor approvals, or manufacturing can also affect the timing of the release of our products, causing us to miss key selling periods such as the calendar year end holiday buying season.
We may not be able to adequately adjust our cost structurestructures in a timely fashion in response to a sudden decrease in demand.
A significant portion of our selling and general and administrative expense is comprised of personnel and facilities. In the event of a significant decline in revenues, we may not be able to exit facilities, reduce personnel, or make other changes to our cost structurestructures without disruption to operations or without significant termination and exit costs. Management may not be able to implement such actions in a timely manner, if at all, to offset an immediate shortfall in revenues and profit.
If we do not continue to attract and retain key personnel, we will be unable to effectively conduct our business.
Our success depends to a significant extent on our ability to identify, hire, and retain skilled personnel. The software industry is characterized by a high level of employee mobility and aggressive recruiting among competitors for personnel with technical, marketing, sales, product development, and management skills. We may have difficulties in attracting and retaining skilled personnel or may incur significant costs in order to do so. If we are unable to attract additional qualified employees or retain the services of key personnel, our business and financial results could be negatively impacted.
Our products are subject to the threat of piracy and unauthorized copying, and inadequate intellectual property laws and other protections could prevent us from enforcing or defending our proprietary technologies. We may also face legal risks arising out of user-generated content.
We regard our software as proprietary and rely on a combination of copyright, patent, trademark and trade secret laws, employee and third-party nondisclosure agreements, and other methods to protect our proprietary rights. We own or license various copyrights, patents, and trademarks. We are aware that some unauthorized copying occurs, and if a significantly greater amount of unauthorized copying of our software products were to occur, it could cause material harm to our business and financial results.
Policing unauthorized use of our products is difficult, and software piracy is a persistent problem, especially in certain countries. Further, the laws of some countries where our products are or may be distributed either do not protect ourtheir products and intellectual property rights to the same extent as the laws of the United States,U.S., or are poorly enforced. Legal protection of our rights may be ineffective in such countries. In addition, though we take steps to make the unauthorized copying and distribution of our products more difficult, as do the manufacturers of consoles on which thesome of those games (and a majority of ourthose games published by Activision) are played, our efforts and thosethe efforts of the console manufacturers may not be successful in controlling the piracy of our products. Organized pirate operations have been expanding globally. In addition, the proliferation of technology designed to circumvent the protection measures used in our products, the availability of broadband access to the Internet, the ability to download pirated copies of our games from various Internet sites and peer-to-peer networks, and the widespread proliferation of Internet cafes using pirated copies of our products all have contributed to an expansion in piracy. This could have a negative effect on our growth and profitability in the future.
Moreover, as we leverage our software products using technologies such as the Internet and online services, and as user-generated content increases, our ability to protect our intellectual property rights and to avoid infringing intellectual property rights of others may diminish. We cannot be certain that existing intellectual property laws will provide adequate protection for our products in connection with these emerging technologies.
Data breaches involving the source code for our products or customer or employee data we storestored by us could adversely affect our reputation and revenue.revenues.
We store the source code and game assets for our interactive entertainment software products as it is created on multiple electronic devices.created. In addition, we store confidential information with respect to our customers and employees. A breach of the systems on which such source code and assets, account information (including personally identifiable information) and other sensitive data is stored could lead to piracy of our software or fraudulent activity resulting in claims and lawsuits against us in connection with data security breaches. A data intrusion intoWorld of Warcraft servers could also disrupt the operation ofWorld of Warcraft. If we are subject to data security breaches, we may have a loss in sales or be forced to pay damages or other amounts, which could materially and adversely affect profitability. In addition, any damage to our reputation resulting from a data breach could have a materialan adverse impact on either revenueour revenues and future growth prospects, or increased costs arising from the implementation of additional security measures.
We may be subject to intellectual property claims.
As the number of interactive entertainment software products increases and the features and content of these products continue to overlap, software developers increasingly may become subject to infringement claims. Many of our products are highly realistic and feature materials that are based on real world examples, which may be the subject of intellectual property infringement claims of others. In addition, our products often utilize complex, cutting edge technology that may become subject to emerging intellectual property rights of others. Although we believe that we make reasonable effortstake steps to ensure that our products do not violateavoid knowingly violating the intellectual property rights of others, it is possible that third
parties still may claim infringement. From time to time, we receive communications from third parties regarding such claims. Existing or future infringement claims against us, whether valid or not, may be time consuming, distracting to management and expensive to defend.
Intellectual property litigation or claims could force us to do one or more of the following:
Any of these actions may cause material harm to our business and financial results.
Our products are subject to ratings by the Entertainment Software Rating Board and similar agencies. FailureOur failure to obtain our target ratings for our products could negatively impact our sales.
The Entertainment Software Rating Board or ESRB,(the "ESRB") is a self-regulatory body in the U.S. whichthat provides consumers of interactive entertainment software with ratings information, including information relating to violence, nudity, or sexual content contained in software titles. Certain countries other than the U.S. have also established similar rating systems as prerequisites for product sales in those countries. In some instances, wea company may be required to modify ourits products to comply with the requirements of the rating systems, which could delay or disrupt the release of any given product, or may prevent its sale altogether in certain territories. The relevant ESRB ratings include "Everyone" (age 6 and older), "Everyone 10+" (age 10 and older), "Teen" (age 13 and over), or "Mature" (age 17 and over). Certain of our titles have received a "Mature" rating. None of our titles has received the "Adults Only" rating (18 and over). We believe that we comply with rating systems and properly display the ratings and content descriptions received for our titles. If we are unable to obtain the ratings we have targeted for our
products as a result of changes in the ESRB's ratings standards or for other reasons, including the adoption of legislation in this area, our business and prospects could be negatively affected.
Our business, products, and distribution are subject to increasing regulation of content in key territories. If we do not successfully respond to these regulations, our business may suffer.
Legislation is continually being introduced that may affect both the content and the distribution of our products. For example, privacy laws in the United StatesU.S and Europe impose various restrictions on the collection, storage and storageuse of personal information. Those laws and regulations vary by territory. In addition, many foreign countries have laws that permit governmental entities to censor the content and/or advertising of interactive entertainment software. Other countries, such as Germany, prohibit certain types of content.
In the United States,U.S, numerous laws have been introduced at the federal and state level which attempt to restrict the content of games or the distribution of such products. For example, legislation has been adopted in several states, and proposed at the federal level, that prohibits the sale of certain games (e.g.(e.g., violent games or those with "M (Mature)" or "AO (Adults Only)" ratings) to minors. In addition, a number of state legislative bodies in states such as Illinois, California, Michigan, and Washington have introduced various forms of legislation designed to regulate and control sales of video games deemed inappropriate for sales to minors. Some argue that there is a link between video games and violence, which may lead to increased pressure for legislative activity. To date, most courts that have ruled on such legislation have ruled in a manner favorable to the interactive entertainment industry. But in the event such legislation is adopted and enforced, the sales of our products may be
harmed because the products we are able to offer to our customers and the size of the potential market for our products may be limited. We may also be required to modify certain products or alter our marketing strategies to comply with new and possibly inconsistent regulations, which could be costly or delay the release of our products.
If one or more of our titles were found to contain objectionable undisclosed content, our business could suffer.
Throughout the history of the interactive entertainment industry, many video games have been designed to include certain hidden content and gameplay features that are accessible through the use of in-game cheat codes or other technological means that are intended to enhance the gameplay experience. However, in some cases, objectionable undisclosed content or features have been found in other publishers' interactive entertainment software products. In a few cases, the ESRB has reacted to discoveries of undisclosed content and features by changing the rating that was originally assigned to the product, requiring the publisher to change the game and/or game packaging and/or fining the publisher. Retailers have on occasion reacted to the discovery of such undisclosed content by removing these games from their shelves, refusing to sell them, and demanding that their publishers accept them as product returns. Likewise, some interactive entertainment software consumers have reacted to the revelation of undisclosed content by refusing to purchase such games, demanding refunds for games they have already purchased, refraining from buying other games published by the company whose game contained the objectionable material, and, inon at least one occasion, filing a lawsuit against the publisher of the product containing such content.
We have implemented preventive measures designed to reduce the possibility of objectionable undisclosed content from appearing in the video games we publish. Nonetheless, these preventive measures are subject to human error, circumvention, overriding, and reasonable resource constraints. If a video game we published were found to contain undisclosed content, the ESRBwe could demand that the game be recalledsubject to any of these consequences and its packaging changed to reflect a revised rating, retailers could refuse to sell it and demand the acceptance of returns of any unsold copies or returns from customers, and/or consumers could refuse to buy it, demand refunds or file lawsuits against us. This could have a material negative impact on operating results and financial condition. In addition, our reputation could be harmed, which could have a negative impact sales ofon our other video games. If any of these consequences were to occur,operating results and financial condition, and our business and financial performance could be significantly harmed.
Our productsWe engage in acquisitions, and may be subject to legal claims.encounter difficulties in integrating these businesses and therefore we may not realize the anticipated benefits of the acquisitions.
As part of our business strategy we, from time to time, acquire complementary companies or businesses, enter into strategic alliances and joint ventures and make investments to further our business. In prior fiscalthe past several years, at least two lawsuitswe have been filed against numerous video game companies, including against us, by the families of victims who were shotmade various acquisitions and killed by teenage gunmen in attacks perpetrated at schools. These lawsuits alleged that the video game companies manufactured and/entered into joint venture arrangements intended to complement or supplied these teenagers with violent video games, teaching them howexpand our business, and may continue to use a gun and causing them to act out in a violent manner. These lawsuits have been dismissed. Similar additional lawsuits may be filed in the future. Although, our general liability insurance carrier agreed to defend prior lawsuits of this nature against us, it is uncertain whether our insurance carrier would do so in the future, or if such insurance carriers would cover all or any amounts for which we might be liable if such future lawsuits are not decidedfuture. The success of these transactions will depend on our ability to integrate assets and personnel acquired in these transactions and to cooperate with our favor. If such future lawsuits are filedstrategic partners. We may encounter difficulties in integrating acquisitions with our operations, and ultimately decided against us and our insurance carrier does not cover the amounts for whichin managing strategic investments. Furthermore, we may be liable, itnot realize the degree, or timing, of benefits we anticipate when we first enter into a transaction. Any of the foregoing could have a material adverse effect onadversely affect our business and financial results. Paymentresults of significant claims by insurance carriers may make such insurance coverage materially more expensive or unavailable in the future, thereby exposing us to additional risk.operations.
Our business is subjectinvolvement in joint ventures decreases our ability to risks and uncertainties of international trade.manage risk.
We conduct business throughout the world, and derive a substantial amount of revenue from international trade, particularly from Europe and Australia. Revenues outside of North America have accounted for 39%, 50% and 52%many of our consolidated net revenuesoperations through joint ventures in fiscal 2008, 2007which we share control with our joint venture partners. Although we often enter into joint venture arrangements in order to share risks with our joint venture partners, these arrangements may decrease our ability to manage risk. As with any joint venture arrangement, differences in views among the joint venture participants may result in delayed decisions or in failures to agree on major issues. There is the risk that our joint venture partners may at any time have economic, business or legal interests or goals that are inconsistent with ours. There is also risk that our joint venture partners may be unable to meet their economic or other obligations and 2006,
respectively. We expect that international revenues will continuewe may be required to account for a significant portion of total revenues in the future.
We are subject to risks inherent in foreign trade, including increased tariffs and duties, fluctuations in currency exchange rates, shipping delays, and international political, regulatory and economic developments, all of which may impact our operating marginsfulfill those obligations alone. Failure by us, or make it more difficult, if not impossible, for us to conduct business in foreign markets.
For example, a deterioration in relations between the U.S. and any countryan entity in which we have significanta joint venture interest, to adequately manage the risks associated with any joint ventures could have an adverse effect on the financial condition or results of operations or sales could resultof our joint ventures and, in the adoption or expansion of trade restrictions that harmturn, our business and operating results, as could the implementation of government regulations in a country in which we have significant operations or sales.
If government regulations or restrictions prevent us from repatriating internationally derived revenue into the U.S., or a country's tax structure makes repatriation prohibitively expensive, we may not transfer this revenue into the U.S., which could affect our ability to reinvest or utilize such amounts in our business.
In addition, cultural differences may affect consumer preferences and limit the popularity of titles that are "hits" in the United States. If we do not correctly assess consumer preferences in the countries in our market, our sales and revenue may be lower than expected.
Fluctuations in currency exchange rates may have a negative impact on our business.operations.
We transact business in various currenciesanticipate entering into additional joint ventures with other than the U.S. dollar and have significant international sales and expenses denominated in currencies other than the U.S. dollar, subjecting us to currency exchange rate risks.entities. We have engaged in limited currency hedging activities and, while these hedging activities mitigate some currency exchange rate risks, our reported revenues from international sales and licensing, and thus our results of operations and financial condition would be adversely affected by unfavorable movements in currency exchange rates.
Other Risks Relating to Our Business and Ownership of Our Stock
We seek to manage our business with a view to achieving long-term results, and this could have a negative effect on short-term trading.
We focus on creation of shareholder value over time, and we intend to make decisions that will be consistent with this long-term view. As a result, some of our decisions, such as whether to make or discontinue operating investments, manage our balance sheet and capital structure, or pursue or discontinue strategic initiatives, may be in conflict with the objectives of short-term traders. Further, this could adversely affect our quarterly or other short-term results of operations.
We may face limitations on our ability to find suitable acquisition opportunities or to integrate additional acquired businesses.
We intend to pursue additional acquisitions of companies, properties, and other assets that can be purchased or licensed on acceptable terms and which we believe can be operated or exploited profitably. Some of these transactions could be material in size and scope. Although we continue to search for additional acquisition opportunities, we may not be successful in identifying suitable acquisitions. As the interactive entertainment software industry continues to consolidate, we face significant competition in seeking and consummating acquisition opportunities. We may not be able to consummate potential acquisitions or an acquisition may not enhance our business or may decrease rather than increase our earnings. In the future, we may issue additional shares of our common stock in connection with one or more acquisitions, which may dilute our existing shareholders. Future acquisitions could also divert substantial management time and result in short-term reductions in earnings or special transaction, ongoing goodwill amortization or other charges . In addition, we cannot
guarantee assure that we will be able to successfully integrate the businesses that we may acquire into our existing business. Our shareholders may not have the opportunity to review, vote on,undertake such joint ventures or, evaluate future acquisitions.
From time to time, we may make a capital investment and hold a minority interest in a third-party developer in connection with interactive entertainment software products to be developed by such developer for us, which we believe helps to create a closer relationship between us and the developer. We account for those capital investments over which we have the ability to exercise significant influence using the equity method. For those investments over which we do not have the ability to exercise significant influence, we account for our investment using the cost method. There can be no assurance that we will realize long-term benefits from such investments or that we will continue to carry such investments at their current value.
Our shareholder rights plan, charter documents, and other agreements may make it more difficult to acquire us without the approval of our Board of Directors.
We have adopted a shareholder rights plan under which one right entitles the holder to purchase one six-hundredths of a share of our Series A Junior Preferred Stock, as adjusted on account of stock dividends made since the plan's adoption (as so adjusted, one-hundredths (1/100) of a share), at an exercise price of $6.67 per share, as adjusted on account of stock dividends made since the plan's adoption (as so adjusted, $1.11 per share) is attached to each outstanding share of common stock. Such rights only become exercisable if a person or group acquires 15% or more of our common stock (or announces or commences an offer which would result in their owning 15% of the stock) and if such an acquisition occurs, generally each holder of a right may exercise that right for a number of shares of our common stock having a value equal to two times the then-current exercise price of the right (which would currently be $2.22) in lieu of shares of Series A Junior Preferred Stock. This plan therefore makes an acquisition of control in a transaction not approved by our Board of Directors more difficult. The rights plan was amended in connection with the proposed transaction with Vivendi to provideundertaken, that such transactionjoint ventures will not triggerbe successful or produce the rights under the plan and will terminate if and when the transaction is consummated, extinguishing all rights thereunder. However, until such time as the transaction closes the rights plan continues to make it difficult for a company to acquire us without approval of our Board of Directors. In addition, our Amended and Restated By-laws have advance notice provisions for nominations for election of nominees to the Board of Directors which may make it more difficult to acquire control of us. Our long-term incentive plans provide, in the discretion of a committee, for acceleration of stock options following a change in control under certain circumstances, which has the effect of making an acquisition of control more expensive. In addition, some of our officers have severance compensation agreements that provide for substantial cash payments or the acceleration of other benefits in the event of a change in control. These agreements and arrangements may also inhibit a change in control.anticipated benefits.
Historically, our stock price has been highly volatile.
The trading price of our common stock has been and could continue to be subject to wide fluctuations in response to many factors, including:including for example, but without limitation:
In addition, the public stock markets may experiencehave been experiencing extreme price and trading volume volatility, particularly in high technology sectors of the market.volatility. This volatility has significantly affected the market prices of securities of many technology companies for reasons often unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.
Subject to certain limitations, Vivendi may sell common stock at any time, which could cause our stock price to decrease.
Vivendi may sell the shares of our stock that it owns, including pursuant to a registered underwritten public offering under the Securities Act of 1933, as amended (the "Securities Act"), or in accordance with Rule 144 under the Securities Act. We have entered into an investor agreement with Vivendi, which includes registration rights and which gives Vivendi the right to require us to register all or a portion of its shares at any time, subject to certain limitations. The sale of a substantial number of shares of common stock by Vivendi within a short period of time could cause our stock price to decrease, and make it more difficult for us to raise funds through future offerings of common stock.
Integrating and maintaining internal controls for the combined business may strain our resources and divert management's attention. If we fail to establish and maintain proper internal controls, our ability to produce accurate financial statements or comply with applicable regulations could be impaired.
Prior to the consummation of the Business Combination, Vivendi Games was a wholly-owned subsidiary of Vivendi and not subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, the Sarbanes-Oxley Act of 2002 and the rules and regulations of any stock exchange. As a wholly-owned subsidiary of Activision Blizzard, Vivendi Games will be subject to such rules and regulations. Prior to the consummation of the Business Combination, as described in Item 9A of this Form 10-K, it was determined that Vivendi Games had material weaknesses in its internal control over financial reporting. Integrating and maintaining appropriate internal controls and procedures for the combined business will require specific compliance training of certain officers and employees, will entail substantial costs in order to modify existing accounting systems, and will take a significant period of time to complete.
We are currently in the process of incorporating the internal controls and procedures of Vivendi Games into our internal control over financial reporting, and we expect to be able to perform an assessment of and report on internal control over financial reporting for the year ending December 31, 2009. We may not, however, be efficient in establishing the adequacy of internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could impair our ability to operate the business. In the event that we are not able to demonstrate compliance with Section 404 of the Sarbanes-Oxley Act in a timely manner, or that our internal controls are perceived as inadequate, or that we are unable to produce timely or accurate financial statements, investors may lose confidence in our operating results and our stock price could decline.
Changes in our tax rates or exposure to additional tax liabilities could adversely affect our operating results and financial condition.
We are subject to income taxes in the United StatesU.S. and in various other jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and, in the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is
uncertain. We are required to estimate future taxes. Although we currently believe our tax estimates are reasonable, the estimate process is inherently uncertain, and such estimates are not binding on tax authorities. OurThe effective tax rate could be adversely affected by changes in ourthe business, including the mix of earnings in countries with differing statutory tax rates, changes in our tax elections, and changes in applicable tax laws, as well as other factors. Further, tax determinations are regularly subject to audit by tax authorities and developments in those audits could adversely affect our income tax provision. Should ourthe ultimate tax liability exceed estimates, our income tax provision and net income could be materiallyadversely affected.
We are also required to pay taxes other than income taxes, such as payroll, sales, use, value-added, net worth, property, and goods and services taxes, in both the United StatesU.S. and various other jurisdictions. Tax authorities regularly examine these non-income taxes. There can be no assurance that the outcomes from these examinations, changes in ourthe business or changes in applicable tax rules will not have an adverse effect on our operating results and financial condition.
SEC investigation and litigation relating to stock options remain pending and may adversely affect our business and results of operations.
Although the special subcommittee of independent members of our board of directors established in July 2006 to review our historical stock option granting practices, which we refer to as the special subcommittee, has completed its review of those practices and our stock option grants made in the period between 1992 and 2006, and although we have made to the SEC Staff an offer of settlement of the SEC's formal investigation relating to our stock option granting practices, which the SEC Staff has indicated it is prepared to recommend to the SEC, and have agreed to a settlement of the derivative litigation against us and certain of our current and former directors and officers, the settlement with the SEC remains subject to final documentation and then approval by the Commission and the settlement of the derivative litigation remain subject to final court approval. We believe that we have taken appropriate action by restating our financial statements through the fiscal year ended March 31, 2006, as filed in our amended Annual Report on Form 10-K/A on May 25, 2007, and made appropriate disclosures for matters relating to stock options. If, however, the pending settlements are not approved,
the SEC could institute enforcement action seeking other or additional relief or the court in the derivative actions could make findings disagreeing with the findings of the special subcommittee or with the manner in which we have accounted for and reported, or not reported, the financial impact of past option grant measurement date errors. If so, we could be required to further restate our prior financial statements, further amend our filings with the SEC, or take other actions not currently contemplated. In addition, additional proceedings would be likely to result in additional legal expense that may affect our results in future periods, and may also result in diversion of management attention and other resources, as well as fines, penalties, damages and other sanctions against the company or individual directors and officers. These eventualities could materially and adversely affect our business and results of operations. We cannot currently predict the ultimate outcome of these proceedings.
Our investments in auction rate securities are subject to risks that may have an adverse effect on our liquidity.
As of March 31, 2008, the par value of our investment in auction rate securities was $95.2 million, or approximately 6%, of our cash, cash equivalents and investments, and the fair value of these securities was estimated to be $90.9 million, or $4.3 million below par. The change in fair value was recorded as a component of comprehensive income (loss) in the consolidated statement of changes in shareholders' equity, as the decline in fair value is not considered to be "other-than-temporary". The auction rate securities we currently hold are all long term debt obligations secured by student loans, and they carry a "AAA" credit rating—the highest rating given to securities—by a nationally recognized rating agency.
Liquidity for these auction rate securities is typically provided by an auction process which allows holders to sell their notes and resets the applicable interest rate at pre-determined intervals, usually every 7 to 35 days. Each of the auction rate securities in our investment portfolio as of March 31, 2008 has experienced a failed auction. There is no assurance that future auctions for these securities will succeed. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. In the event that there is a failed auction, the indenture governing the security requires the issuer to pay interest at a contractually defined rate that is generally above market rates for other types of similar short-term instruments. The securities for which auctions have failed will continue to earn interest at the contractual rate and be auctioned every 7 to 35 days until the auction succeeds, the issuer calls the securities or they mature. As a result, our ability to liquidate and fully recover the carrying value of our auction rate securities in the near term may be limited or not exist. All of our investments were classified as short-term as of December 31, 2007, because such securities were reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business, however we have classified these securities as non-current investments in our consolidated financial statements as of March 31, 2008 due to uncertainties of the timing of liquidation.
If the issuers of these auction rate securities are unable to successfully close future auctions, their credit ratings deteriorate and we determine that an "other-than-temporary" decline in fair market value has occurred, we may in the future be required to record an impairment charge on these investments. We believe we will be able to liquidate our investment without significant loss, and we currently believe these securities are not significantly impaired, primarily due to the government guarantee of a substantial portion of the underlying loans, however, it could take until the final maturity of the underlying notes (up to 39 years) to realize our investments' par value. Based on our other available cash and expected operating cash flows and financing, we do not anticipate the potential lack of liquidity on these investments will affect our ability to execute our current business plan or to consummate the proposed post-closing self tender offer described in Note 20 of the Notes to Consolidated Financial Statements included in Item 8. Additionally, we have received indications from certain lenders that we may borrow against the par value of the securities at competitive rates.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Our principal corporate and administrative offices are located in approximately 122,200141,836 square feet of leased space in a building located at 3100 Ocean Park Boulevard, Santa Monica, California 90405. The following is a listing of the principal offices maintained by us:
PROPERTY | LOCATION | SQ FT | OWNERSHIP | LEASE EXPIRATION | |||||
---|---|---|---|---|---|---|---|---|---|
Corporate Offices | Santa Monica, CA, USA | 142,000 | Lease | December 2010 | |||||
Activision Product Development & Publishing Facilities | |||||||||
Activision Canada | Ontario, Canada | 2,400 | Lease | October 2012 | |||||
Beenox, Inc. | Quebec City, Quebec, Canada | 18,500 | Lease | ||||||
Budcat Creations | Iowa City, Iowa, USA | 7,948 | Lease | April 2011 | |||||
Bizarre Creations | Merseyside, UK | 24,000 | Lease | June 2020 | |||||
Central Tech | Shanghai, China | 1,400 | Lease | Month to Month | |||||
DemonWare | Dublin, Ireland | 11,194 | Lease | June 2027 | |||||
DemonWare | Vancouver, BC, Canada | 1,141 | Lease | ||||||
FreeStyle | West Midlands, UK | 4,132 | Lease | August 2011 | |||||
Infinity Ward, Inc. | Encino, CA, USA | 35,300 | Lease | October 2012 | |||||
Luxoflux, Inc. | Santa Monica, CA, USA | 14,800 | Lease | ||||||
High Moon | Carlsbad, CA, USA | 49,628 | Lease | November 2009 | |||||
Motion Capture Studio | Los Angeles, CA, USA | 11,500 | Lease | March 2009 | |||||
Neversoft Entertainment, Inc. | Woodland Hills, CA, USA | 53,300 | Lease | September 2014 | |||||
Quality Assurance | Quebec City, Quebec, Canada | 6,200 | Lease | ||||||
Radical | Vancouver, British Columbia, Canada | 69,600 | Lease | January 2011 | |||||
Raven Studios | Middleton, WI, USA | 35,300 | Lease | June 2015 | |||||
RedOctane | Chennai, India | 6,500 | Lease | ||||||
Shaba Games, Inc. | San Francisco, CA, USA | 23,300 | Lease | February 2013 | |||||
Studio Chin | Shanghai, China | 12,000 | Lease | April 2009 | |||||
Toys For Bob, Inc. | Novato, CA, USA | 11,800 | Lease | October 2012 | |||||
Treyarch Corporation | Santa Monica, CA, USA | 56,200 | Lease | November 2009 | |||||
Vicarious Visions, Inc. | Menands, NY, USA | 37,100 | Lease | March 2016 | |||||
Underground | Foster City, CA, USA | 24,000 | Lease | February 2009 | |||||
Amsterdam Publishing | Amsterdam, the Netherlands | 4,000 | Lease | June 2012 | |||||
Australia Publishing | Sydney, Australia | 7,300 | Lease | June 2012 | |||||
France Publishing | Paris, France | 5,600 | Lease | August 2016 | |||||
Italy Publishing | Legnano, Italy | 4,700 | Lease | March 2013 | |||||
Korea Publishing | Seoul, South Korea | 1,700 | Lease | August | |||||
Nordic Publishing | Stockholm, Sweden | 3,500 | Lease | July 2010 | |||||
RedOctane | Mountain View, CA, USA | 13,900 | Lease | October 2012 | |||||
Spain Publishing | Madrid, Spain | 3,400 | Lease | April 2009 | |||||
United Kingdom Publishing | Stockley Park, UK | 20,600 | Lease | September 2015 | |||||
Activision Value Publishing | Eden Prairie, MN, USA | 14,000 | Lease | May | |||||
Blizzard Product Development & Publishing Facilities (Blizzard Segment) | |||||||||
Blizzard | Irvine, CA, USA | 278,700 | Lease | October 2013 & November 2014 | |||||
Blizzard | Austin, TX, USA | 46,900 | Lease | June 2012 | |||||
Blizzard | Velizy, France | 52,000 | Lease | December 2013 | |||||
Blizzard | Cork, Ireland | 34,000 | Lease | October 2027 | |||||
Blizzard | Shanghai, China | 12,000 | Lease | April 2009 | |||||
Blizzard | Taipei, Taiwan | 17,450 | Lease | May 2009 | |||||
Blizzard | Seoul, South Korea | 59,900 | Lease | March 2009 | |||||
Distribution Facilities (Distribution Segment) | |||||||||
German Distribution | Burglengenfeld, Germany | 43,100 | Own | N/A | |||||
Netherlands Distribution-warehouse | Venlo, the Netherlands | 44,600 | Own | N/A | |||||
N.A. Distribution | Fresno, CA, USA | 216,832 | Lease | February 2011 | |||||
United Kingdom Distribution | Birmingham, UK | 415,000 | Lease | May 2011-2018 |
Our publishing operations additionally lease facilities in Arkansas, Canada, Minnesota, New York, Texas and TexasCanada for purposes of sales and branch offices. We anticipate no difficulty in extending these leases or obtaining comparable facilities in suitable locations and consider our facilities to be adequate for our current needs.
On February 8, 2008, the Wayne County Employees' Retirement System filed a lawsuit challenging the transactions contemplated byBusiness Combination in the business combination agreement, dated asDelaware Court of December 1, 2007, among us, a wholly owned subsidiary of ours established in connection with the proposed transaction, Vivendi, S.A., Vivendi Games, Inc., a wholly owned subsidiary of Vivendi, S.A., and VGAC, a wholly owned subsidiary of Vivendi, S.A., and the sole stockholder of Vivendi Games, Inc.Chancery. The suit is a putative class action filed against the parties to that business combination agreementthe Business Combination Agreement as well as certain current and former members of our Board of Directors. The plaintiff alleges, among other things, that our current and former directors named therein failed to fulfill their fiduciary duties with regard to the transactionsBusiness Combination by "surrendering" the negotiating process to "conflicted management," that those breaches were aided and abetted by Vivendi S.A., and those of its subsidiaries named in the complaint, and that athe preliminary proxy
statement filed by the Company on January 31, 2008 contains certain statements that the plaintiff alleges are false and misleading. The plaintiff seeks an order from the court that, among other things, certifies the case as a class action, enjoins the transaction,Business Combination, requires the defendants to disclose all material information, declares that the transactionBusiness Combination is in breach of the directors' fiduciary duties and therefore unlawful and unenforceable, awards the plaintiff and the putative class damages for all profits and special benefits obtained by the defendant in connection with the transactionBusiness Combination and tender offer, and awards the plaintiff its cost and expense, including attorney's fees.
In a rulingAfter various initial motions were filed and ruled upon, on March 12, 2008, the court initially declined to schedule a preliminary injunction hearing or allow broad discovery, pending the Company's filing of a revised preliminary proxy statement in connection with the proposed transactions. The court did order the parties to initiate discovery of core documents, and the Company made an initial production of documents. On March 7, 2008, the Company filed a motion to dismiss the complaint, the grounds for which were detailed in a brief filed on April 30, 2008. On April 30, 2008, the Company also filed a motion to stay discovery in the case pending a ruling on the motion to dismiss. Separately, on March 6, 2008, Vivendi, S.A., and those of its subsidiaries named in the complaint filed a motion to dismiss the sole claim alleged against them.
On May 8, 2008, the plaintiff filed an amended complaint that, among other things, added allegations relating to a revised preliminary proxy statement filed by the Company on April 30, 2008. That same date,Additional motions were then filed, including a motion for preliminary injunction filed by the plaintiff also renewedand a motion to dismiss filed by Vivendi and its subsidiaries. On June 14, 2008, the plaintiff filed a motion for expedited proceedings. On May 13, 2008, the Company movedleave to dismiss thefile a second amended complaint. On May 14,June 30, 2008, the court granted Vivendi and its subsidiaries named insubsidiaries' motion to dismiss, pursuant to a stipulation with the amended complaint also moved to dismiss. On May 22,plaintiff, and on July 1, 2008, the court scheduled a combined hearing for June 30, 2008 ondenied the plaintiff's motion for preliminary injunction.
On December 23, 2008, the plaintiff filed an amended motion for leave to file a preliminary injunctionsecond amended complaint. The court granted the motion on January 14, 2009 and the defendants' motions to dismiss, but withheld a rulingsecond amended complaint was deemed filed on the plaintiff's motion for expedited discovery, pending further briefing. On May 28, 2008,same date. The second amended complaint asserts claims similar to the court ordered that expedited discovery proceed as to certain claims and that final briefing onones made in the motions to be heard on June 30, 2008 be filed with the court on June 27, 2008.
In July 2006, individuals and/or entities claiming to be our stockholders filed derivative lawsuits, purportedly on our behalf, against certain current and former members of ouroriginal complaint, challenging Activision's Board of Directors as well as several of our current and former officers. Three derivativeDirectors' actions have been filed in Los Angeles Superior Court: Vazquez v. Kotick, et al ., L.A.S.C. Case No. BC355327 (filed July 12, 2006); Greuer v. Kotick, et al. L.A.S.C. Case No. SC090343 (filed July 12, 2006); and Amalgamated Bank v. Baker, et al., L.A.S.C. Case No. BC356454 (filed August 3, 2006). These actions have been consolidated by the court under the caption In re Activision Shareholder Derivative Litigation, L.A.S.C. Master File No. SC090343 (West, J.). Four derivative actions have been filed in the United States District Court for the Central District of California: Pfeiffer v. Kotick, et al., C.D. Cal. Case No. CV06-4771 MRP (JTLx) (filed July 31, 2006), Hamian v. Kotick, et al., C.D. Cal. Case No. CV06-5375 MRP (JLTx) (filed August 25, 2006) Abdelnur vs. Kotick et al., C.D. Cal. Case No. CV07-3575 AHM (PJWx) (filed June 1, 2007), and Scarborough v. Kotick et al., C.D. Cal. Case No. CV07-4602 SVW (PLAx) (filed July 18, 2007). These actions have also been consolidated, under the caption In re Activision, Inc. Shareholder Derivative Litigation, C.D. Cal. Case No. CV06-4771 MRP (JTLx) (Pfaelzer, J.). The consolidated complaints allege, among other things, purported improprieties in our issuance of stock options. Plaintiffs seek various relief on our behalf, including damages, restitution of benefits obtained from the alleged misconduct, equitable relief, including an accounting and rescission of option contracts; and various corporate governance reforms. We expect that defense expenses associated with the matters will be covered by our directors and officers insurance, subject to the terms and conditions of the applicable policies.
On or about December 4, 2007, we, the plaintiffs, and certain of our current and former officers and directors notified the court in the federal action that we had reached agreement in principle to settle the shareholder derivative litigation pending against such current and former directors and officers of ours. On January 17, 2008, the parties amended that agreement to, among other things,
include the plaintiffs in the state court action as parties thereto. The nonbinding agreement in principle was subject, among other things, to the negotiation of a binding definitive settlement agreement addressing all settlement terms, as well as to further approval by the parties and the court.
Effective as of May 8, 2008, the parties signed a Stipulation of Settlement with respect to these matters. In entering into the Stipulation of Settlement, neither we nor any of the settling parties has admitted to any liability or wrongdoing. Under the terms of the Stipulation of Settlement, which is subject to court approval, we will adopt, implement and/or maintain certain corporate governance and internal control measures, relating principally to the following: board composition, structure and practices, director independence standards, stock ownership and compensation, and education; shareholder proposal evaluation process; nomination procedures for shareholder-nominated directors; shareholder meeting procedures; executive compensation policies and procedures; insider trading controls; and stock option granting procedures. We have agreed to keep these measures in place for a period of three years, subject to certain exceptions. The Stipulation of Settlement also addresses matters relating to the agreements by certain of our current and former directors and officers to reimburse the Company in connection with the receiptnegotiation and approval of options that required measurement date corrections. In the caseBusiness Combination, as well as disclosures made to our shareholders and certain amendments made to our certificate of options already exercised, the agreements allowed reimbursement to be made either by cancellation of vested but unexercised options with a value equivalent to the additional exercise price or by payment of additional exercise price. In the case of options not yet exercised, the exercise price to be paid upon future exercise of those options is increased. In the aggregate, settling defendants have elected to cancel options to acquire approximately 800,000 shares of our common stock and have agreed to increasesincorporation in the exercise prices of approximately 16.1 million options.connection therewith. In addition, the Stipulationsecond amended complaint asserts that Activision's Board of Settlement provides for usDirectors breached its fiduciary duties in approving and recommending those amendments to pay $10,000,000the certificate of incorporation. Among other things, the plaintiff seeks certification of the action as a class action, a declaration that amendments made to plaintiffs' attorneys forthe certificate of incorporation are invalid and unenforceable, a declaration that our directors breached their fiduciary duties, rescission of the Business Combination and related transactions, and damages, interest, fees and expenses, subjectcosts.
On February 13, 2009, the defendants filed their opening brief in support of their motion to court approval of such fees and expenses and subject to our reservation ofdismiss all rights against our D&O insurance carriers, reinsurers and co-insurers. The Stipulation of Settlement provides that plaintiffs' attorneys will also be entitled to 15% (up to $750,000) of any payment made by our insurance carriers to us in connection with the settlement. We have not reached agreements with our insurers related to the settlement. The stipulation also provides for the forgiveness of approximately $2.3 million in legal fees previously billed to us by former outside corporate counsel.
The Stipulation of Settlement was filed in federal court on May 12, 2008 and was preliminarily approved by the U.S. District Court for the Central District of California by order dated May 13, 2008 and entered on May 14, 2008. The settlement is subject to final court approval after notice and a hearing at which shareholders will have the opportunity to object, which is currently scheduled to be held on July 21, 2008. The court will then decide whether to approve the settlement as fair, adequate andclaims in the best interest of our stockholders. While we believe thatcomplaint. The plaintiff's opposition is due on March 31, 2009 and the settlement meets these criteria, there can be no guarantee thatCompany's reply is due on April 30, 2009. No hearing date has yet been set on the settlement will receive the required court approval. If final approval is granted, all claims against all defendants in the litigation will be dismissed with prejudice, and all claims that were or could have been brought by any derivative plaintiff, and all claims that arise from or relatemotion to the matters or occurrences that were or could have been alleged in the federal and state derivative actions, will be fully, finally and forever released.dismiss. The individual settling defendants make no admission of wrongdoing under the Stipulation of Settlement, and they have denied (andCompany intends to continue to deny) all charges of wrongdoing and liability and each and all of the claims and contentions alleged in the derivative actions.
On July 24, 2006, we received a letter of informal inquiry from the SEC requesting certain documents and information relating to our historical stock option grant practices. Thereafter, in early June 2007, the SEC issued a formal order of non-public investigation, pursuant to which it subpoenaed documents from us related to the investigation, and testimony and documents from certain current and former directors, officers and employees of ours. The Company has made an offer of settlement to the Staff of the SEC, which the SEC Staff has indicated it is prepared to recommend to the SEC. The tentative settlement of the SEC's investigation, which would allege violations of various provisions of the Federal securities laws, is subject to agreement on the specific language of the settlement
documents, and then to review and approval by the SEC. There can be no assurance that a final settlement will be approved. In connection with the proposed settlement, the Company would not be required to pay a monetary penalty. Under the proposed settlement, the Company would settle this matter without admitting or denying the SEC's findings.defend itself vigorously.
In addition, we are party to other routine claims and suits brought by us and against us in the ordinary course of business, including disputes arising over the ownership of intellectual property rights, contractual claims, employment laws, regulations and relationships, and collection matters. In the opinion of management, after consultation with legal counsel, the outcome of such routine claims and lawsuits will not have a material adverse effect on our business, financial condition, results of operations, or liquidity.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDERSTOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is quoted on the NASDAQ National Market under the symbol "ATVI."
The following table sets forth for the periods indicated the high and low reported sale prices for our common stock. As of May 20, 2008,At February 19, 2009, there were approximately 2,0451,857 holders of record of our common stock.
| High | Low | ||||
---|---|---|---|---|---|---|
Fiscal 2007 | ||||||
First Quarter ended June 30, 2006 | $ | 15.11 | $ | 10.71 | ||
Second Quarter ended September 30, 2006 | 16.00 | 10.47 | ||||
Third Quarter ended December 31, 2006 | 18.19 | 14.22 | ||||
Fourth Quarter ended March 31, 2007 | 19.20 | 16.05 | ||||
Fiscal 2008 | ||||||
First Quarter ended June 30, 2007 | $ | 21.43 | $ | 18.16 | ||
Second Quarter ended September 30, 2007 | 21.91 | 16.94 | ||||
Third Quarter ended December 31, 2007 | 29.87 | 18.81 | ||||
Fourth Quarter ended March 31, 2008 | 29.76 | 25.11 |
On May 20, For periods prior to July 9, 2008, the last reported sales priceprices are for shares of Activision, Inc. before completion of the Business Combination. In addition, in July 2008, the Board of Directors approved a two-for-one split of our outstanding common stock was $32.68.and the prices set forth below have been restated as if the split had occurred as of the earliest period presented.
| High | Low | |||||
---|---|---|---|---|---|---|---|
2007 | |||||||
First Quarter ended March 31, 2007 | $ | 9.60 | $ | 8.03 | |||
Second Quarter ended June 30, 2007 | 10.72 | 9.08 | |||||
Third Quarter ended September 30, 2007 | 10.96 | 8.47 | |||||
Fourth Quarter ended December 31, 2007 | 14.94 | 9.41 | |||||
2008 | |||||||
First Quarter ended March 31, 2008 | $ | 14.88 | $ | 12.56 | |||
Second Quarter ended June 30, 2008 | 18.65 | 13.46 | |||||
Third Quarter ended September 30, 2008 | 19.28 | 14.04 | |||||
Fourth Quarter ended December 31, 2008 | 15.39 | 8.28 |
Stock Performance Graph
This performance graph shall not be deemed "filed" for purposes of Section 18 of the Exchange Act of or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Activision Blizzard Inc. under the Exchange Act or the Securities Act of 1933, as amended.
The following graph below compares the cumulative 5-year69-month total return of holders ofto shareholders on Activision Inc.'sBlizzard's common stock withrelative to the cumulative total returns of the NASDAQ Composite index and the RDG Technology Composite index. The graph tracksassumes that the performancevalue of a $100the investment in ourthe Company's common stock and in each of the indexes (with the(including reinvestment of all dividends) was $100 on March 31, 2003 and tracks it through December 31, 2008.
For periods prior to July 9, 2008, the share price information for Activision Blizzard is for Activision, Inc. before completion of the Business Combination. In connection with the Business Combination, Activision, Inc. changed its fiscal year end from March 31 2003 to March 31, 2008. We have never paid cash dividends on our common stock and have no present plans to do so.December 31.
COMPARISON OF 5 YEARS CUMULATIVE TOTAL RETURN*Among Activision, Inc., The NASDAQ Composite IndexAnd The RDG Technology Composite Index
| 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | ||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Activision, Inc. | 100.00 | 246.33 | 307.27 | 381.73 | 524.29 | 755.99 | ||||||||||||||||||||||||||||
| 3/03 | 3/04 | 3/05 | 3/06 | 3/07 | 3/08 | 12/08 | |||||||||||||||||||||||||||
Activision Blizzard, Inc. | 100.00 | 246.33 | 307.27 | 381.73 | 524.29 | 755.99 | 478.34 | |||||||||||||||||||||||||||
NASDAQ Composite | 100.00 | 151.01 | 152.38 | 181.06 | 189.63 | 177.49 | 100.00 | 150.10 | 152.13 | 180.76 | 190.41 | 177.85 | 120.58 | |||||||||||||||||||||
RDG Technology Composite | 100.00 | 149.02 | 144.21 | 170.59 | 175.88 | 168.47 | 100.00 | 148.72 | 143.88 | 170.03 | 175.84 | 169.44 | 113.55 |
The stock price performance included in this graph is not necessarily indicative of future stock price performance.
Cash Dividends
We have neither paid no cash dividends in our fiscal years 2008 or 2007 nor do we anticipate paying any cash dividends at any time in the foreseeable future. We expect that earnings will be retained for the continued growth and development of theour business. Future dividends, if any, will depend upon our earnings, financial condition, cash requirements, future prospects, and other factors deemed relevant by our Board of Directors. Although Vivendi Games did not pay cash dividends in 2007 or 2006, Vivendi Games had net transfers to Vivendi of $340 million and $59 million for the years ended December 31, 2007 and 2006, respectively. Also, upon completion of the Business Combination on July 9, 2008, Vivendi Games returned $79 million of capital to Vivendi and distributed its excess cash on-hand, as defined in the Business Combination Agreement, of $79 million to Vivendi.
Stock Splits
In April 2003,July 2008, the Board of Directors approved a three-for-twotwo-for-one split of our outstanding common sharesstock effected in the form of a 50% stock dividend.dividend ("the split"). The split was paid on June 6, 2003September 5, 2008 to shareholders of record as of May 16, 2003. In February 2004, the Board of Directors approved a second three-for-two split of our outstanding common shares effected in the form of a 50% stock dividend. The split was paid on March 15, 2004 to shareholders of record as of February 23, 2004. In February 2005, the Board of Directors approved a four-for-three split of our outstanding common shares effected in the form of a 331/3% stock dividend. The split was paid on March 22, 2005 to shareholders of record as of March 7, 2005. In September 2005, the Board of Directors approved a four-for-three split of our outstanding common shares effected in the form of a 331/3% stock dividend. The split was paid October 24, 2005 to shareholders of record as of October 10, 2005.August 25, 2008. The par value of our common stock was maintained at the pre-split amount of $.000001. All$.000001 per share. The Consolidated Financial Statements and Notes thereto, including all share and per share data, have been restated as if the stock splitssplit had occurred as of the earliest period presented.
On March 7, 2005, in connection with our March 22, 2005 stock split, all shares of common stock held as treasury stock were formally cancelled and restored to the status of authorized but unissued shares of common stock.
Buyback ProgramIssuer Repurchase of Equity Securities (amounts in millions, except number of shares and per share data)
During fiscal 2003,The following table provides the number of shares repurchased and average price paid per share during the quarter ended December 31, 2008, and the approximate dollar value of shares that may yet be purchased under our $1 billion stock repurchase program as of December 31, 2008.
Period | Total number of shares repurchased | Average price paid per share | Total dollar value of shares purchased as part of publicly announced plans or programs (in millions) | Approximate dollar value of shares that may yet be purchased under the plan (in millions) | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
October 1, 2008—October 31, 2008 | — | $ | — | $ | — | $ | — | ||||||
November 1, 2008—November 30, 2008 | — | — | — | — | |||||||||
December 1, 2008—December 31, 2008 (1) | 12,967,265 | 9.68 | 126 | 874 | |||||||||
Total | 12,967,265 | $ | 9.68 | $ | 126 | $ | 874 | ||||||
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
Under the buyback program, we did not repurchase any sharesOn July 9, 2008, a business combination (the "Business Combination") by and among Activision, Inc., Sego Merger Corporation, a wholly-owned subsidiary of our common stock in the fiscal years ended March 31, 2008, 2007, 2006 or 2005. We repurchased approximately 3.4 million sharesActivision, Inc., Vivendi S.A. ("Vivendi"), VGAC LLC, a wholly-owned subsidiary of our common stock for $12.4 million in the fiscal year ended March 31, 2004. In addition, approximately 3.1 million sharesVivendi S.A., and Vivendi Games, Inc., a wholly-owned subsidiary of common stock were acquired in the fiscal year ended March 31, 2004 asVGAC LLC, was consummated. As a result of the settlement of $10.0 million of structured stock repurchase transactions entered into in fiscal 2003. As of March 31, 2008, we had no outstanding structured stock repurchase transactions. Structured stock repurchase transactions are settled in cash or stock based on the market price of our common stock on the dateconsummation of the settlement. Upon settlement, we either have our capital investment returnedBusiness Combination, Activision, Inc. was renamed Activision Blizzard, Inc. For accounting purposes, the Business Combination is treated as a "reverse acquisition," with a premium or receive shares of our common stock, depending, respectively, on whetherVivendi Games, Inc. deemed to be the market price of our common stock is above or below a pre-determined price agreed in connection with each such transaction.
Shareholders' Rights Plan
On April 18, 2000, our Board of Directors approved a shareholders rights plan (the "Rights Plan.") Under the Rights Plan, each common shareholder at the close of business on April 19, 2000 received a dividend of one right for each share of common stock held. Each right represents the right to purchase one six-hundredths (1/600) of a share, as adjusted on account of stock dividends made since the plan's adoption, of our Series A Junior Preferred Stock at an exercise price of $6.67, as adjusted on account of stock dividends made since the plan's adoption. Initially, the rights are represented by our common stock certificates and are neither exercisable nor traded separately from our common stock.acquirer. The rights will only become exercisable if a person or group acquires 15% or more of the common stockhistorical financial statements of Activision or announces or commences a tender or exchange offer which would result in the bidder's beneficial ownershipBlizzard, Inc. prior to July 9, 2008 are those of 15% or more of our common stock.
In the event that any person or group acquires 15% or more of our outstanding common stock, each holder of a right (other than such person or members of such group) will thereafter have the right to receive upon exercise of such right, in lieu of shares of Series A Junior Preferred Stock, the number of shares of common stock of Activision having a value equal to two times the then current exercise price of the right. If we are acquired in a merger or other business combination transaction after a person has acquired 15% or more of our common stock, each holder of a right will thereafter have the right to receive upon exercise of such right a number of the acquiring company's common shares having a market value equal to two times the then current exercise price of the right. For persons who, as of the close of business on April 18, 2000, beneficially own 15% or more of the common stock of Activision, the Rights Plan "grandfathers" their current level of ownership, so long as they do not purchase additional shares in excess of certain limitations.
We may redeem the rights for $0.01 per right at any time until the first public announcement of the acquisition of beneficial ownership of 15% of our common stock. At any time after a person has acquired 15% or more (but before any person has acquired more than 50%) of our common stock, we may exchange all or part of the rights for shares of common stock at an exchange ratio of one share of common stock per right. The rights expire on April 18, 2010.
We amended the Rights Plan concurrent with the execution of the business combination agreement with Vivendi Games, Inc. (see Note 20 of the Notes to Consolidated Financial Statements included in Item 8) to provide that (a) the Rights Plan will not be triggered by the business combination agreement or the transaction and (b) the Rights Plan will terminate upon the completion of the transaction and all rights existing under the Rights Plan will be extinguished.
Securities Authorized for Issuance under Equity Compensation Plans
Information for our equity compensation plans in effect as of March 31, 2008 is as follows (amounts in thousands, except per share amounts):
Plan Category | (a) Number of securities to be issued upon exercise of outstanding options, warrants and rights | (b) Weighted-average exercise price of outstanding options, warrants and rights | (c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||||
---|---|---|---|---|---|---|---|---|
Equity compensation plans approved by security holders | 40,871 | $ | 12.68 | 16,118 | ||||
Equity compensation plans not approved by security holders | 9,581 | $ | 2.46 | — | ||||
Total | 50,452 | 16,118 |
See Note 141 of the Notes to Consolidated Financial Statements included in Item 8 for the material features of each equity compensation plan that was adopted without security holder approval.
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
this Annual Report on Form 10-K). Therefore, 2008 financial data is not comparable with prior periods.
The following table summarizes certain selected consolidated financial data, which should be read in conjunction with our Consolidated Financial Statements and Notes thereto and with Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.in this Form 10-K. The selected consolidated financial data presented below as ofat and for each of the fiscal years in the five-year period ended MarchDecember 31, 2008 are derived from our Consolidated Financial Statements. The Consolidated Balance Sheets as of March 31, 2008 and 2007 and the Consolidated Statements of Operations and Consolidated Statements of Cash Flows for each of the fiscal yearsAll amounts set forth in the three-year period ended March 31, 2008, and the report thereon,following tables are included elsewhere in this Form 10-K (amounts in thousands,millions, except per share data).data.
| For the fiscal years ended March 31, | |||||||||||||||
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| 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||
Statement of Operations Data: | ||||||||||||||||
Net revenues | $ | 2,898,136 | $ | 1,513,012 | $ | 1,468,000 | $ | 1,405,857 | $ | 947,656 | ||||||
Cost of sales—product costs | 1,240,605 | 799,587 | 734,874 | 658,949 | 475,541 | |||||||||||
Cost of sales—intellectual property licenses and software royalties and amortization | 404,830 | 178,478 | 205,488 | 185,997 | 91,606 | |||||||||||
Income from operations | 479,614 | 73,147 | 15,226 | 179,608 | 104,537 | |||||||||||
Income before income tax provision | 530,868 | 109,825 | 45,856 | 192,700 | 110,712 | |||||||||||
Net income | 344,883 | 85,787 | 40,251 | 135,057 | 74,098 | |||||||||||
Basic earnings per share(1) | 1.19 | 0.31 | 0.15 | 0.54 | 0.31 | |||||||||||
Diluted earnings per share(1) | 1.10 | 0.28 | 0.14 | 0.49 | 0.29 | |||||||||||
Basic weighted average common shares outstanding(1) | 288,957 | 281,114 | 273,177 | 250,023 | 236,887 | |||||||||||
Diluted weighted average common shares outstanding(1) | 314,731 | 305,339 | 294,002 | 277,712 | 258,350 | |||||||||||
Net Cash Provided By (Used In): | ||||||||||||||||
Operating activities | 573,500 | 27,162 | 86,007 | 215,309 | 67,403 | |||||||||||
Investing activities | 326,291 | (35,242 | ) | (85,796 | ) | (143,896 | ) | (170,155 | ) | |||||||
Financing activities | 105,163 | 27,968 | 45,088 | 72,654 | 117,569 |
| As of March 31, | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||
Balance Sheet Data: | |||||||||||||||
Working capital | $ | 1,423,324 | $ | 1,060,064 | $ | 922,199 | $ | 913,819 | $ | 675,796 | |||||
Cash, cash equivalents and short-term investments | 1,449,212 | 954,849 | 944,960 | 840,864 | 587,649 | ||||||||||
Capitalized software development and intellectual property licenses | 193,337 | 231,196 | 147,665 | 127,340 | 135,201 | ||||||||||
Long-term investments | 91,215 | — | — | — | — | ||||||||||
Goodwill | 279,161 | 195,374 | 100,446 | 91,661 | 76,493 | ||||||||||
Total assets | 2,530,673 | 1,793,947 | 1,418,255 | 1,305,919 | 966,220 | ||||||||||
Shareholders' equity | 1,947,892 | 1,411,532 | 1,222,623 | 1,097,274 | 830,141 |
| For the years ended December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007(2) | 2006 | 2005 | 2004 | |||||||||||
| | (As Adjusted) | | | | |||||||||||
Statements of Operations Data: | ||||||||||||||||
Net revenues | $ | 3,026 | $ | 1,349 | $ | 1,018 | $ | 780 | $ | 567 | ||||||
Net income (loss) | (107 | ) | 227 | 139 | 45 | (274 | ) | |||||||||
Net income (loss) per share(1) | (0.11 | ) | 0.38 | 0.24 | 0.08 | (0.46 | ) |
| At December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007(2) | 2006 | 2005 | 2004 | |||||||||||
| | (As Adjusted) | | | | |||||||||||
Balance Sheets Data: | ||||||||||||||||
Total assets | $ | 14,701 | $ | 879 | $ | 758 | $ | 539 | $ | 685 |
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Our Business
We Activision Blizzard is a worldwide pure-play online, personal computer, console and hand-held game publisher. The terms "Activision Blizzard," the "Company," "we," "us," or "our" are used to refer collectively to the Activision Blizzard, Inc. and its subsidiaries.
Through Blizzard Entertainment, Inc ("Blizzard"), we are the leader in terms of subscriber base and revenues generated in the subscription-based MMORPG category. Blizzard internally develops and publishes PC-based computer games and maintains its proprietary online-game related service, Battle.net. Through Activision Publishing, Inc. ("Activision"), we are a leading international publisher of interactive entertainment software products. We have built a company with a diverse portfolio of products that spans a wide range of categories and target marketsperipherals. Activision develops and that are usedpublishes video games on a variety of game hardwarevarious consoles, hand-held platforms and operating systems. We have created, licensed,the PC platform through internally developed franchises and acquired a group of highly recognizable franchises, which we market to a variety of consumer demographics. Our fiscal 2008 product portfolio includes titles such asGuitar Hero III: Legends of Rock,Guitar Hero II for the Microsoft Xbox360, Guitar Hero: Rocks the 80s for the PS2,Call of Duty 4: Modern Warfare, Spider-Man 3 The Game ("Spider-Man 3"), Shrek the Third, TRANSFORMERS: The Game, Enemy Territory: Quake Wars, Tony Hawk's Proving Ground, Bee Movie Game, andSpider-Man: Friend or Foe.
Our products cover diverse game categories including action/adventure, action sports, racing, role-playing, simulation, first-person action, music-based gaming, and strategy. Our target customer base ranges from casual players to game enthusiasts, children to adults, and mass-market consumers to "value" buyers. Welicense agreements. Activision currently offer our products primarily in versionsoffers games that operate on the Sony Computer Entertainment ("Sony") PlayStation 2 ("PS2"), the Sony PlayStation 3 ("PS3"), the Nintendo Co. Ltd. ("Nintendo") Wii ("Wii"), and the Microsoft Xbox360Corporation ("Xbox360"Microsoft") Xbox 360 ("Xbox 360") console systems, the Nintendo Dual Screen ("NDS"), andsystems; the Sony PlayStation Portable ("PSP") and Nintendo Dual Screen ("NDS") hand-held devices,devices; and the personal computer ("PC"). The installed base for the previous generation of hardware platforms (e.g., the PS2) is significant and the fiscal 2006 release of the Xbox360 and the fiscal 2007 releases of the PS3 and the Wii have further expanded the software market. To take advantage of the growth of the PS3, the Xbox360, and the Wii ("the next-generation platforms"), during fiscal 2008, we increased our presence on the next-generation platforms through the increased number of new released titles on the next-generation platforms. For example, the number of new released titles for the Wii tripled from 5 releases during fiscal 2007 to 15 releases, and we successfully released several major titles for the PS3, the Xbox360 and/or the Wii—PC.
Guitar Hero III: Legends of Rock,Call of Duty 4: Modern Warfare,Spider-Man 3,Shrek the Third,TRANSFORMERS: The Game, andTony Hawk's Proving Ground. Some of these titles are also available on the PS2. Our plan is to continue to build a significant presence on the PS3, the Wii, and the Xbox360 ("the next-generation platforms") by continuing to expand the number of titles released on the next-generation and hand-held platforms while continuing to market to the PS2 platform as long as economically attractive given its large installed base.
Our publishingActivision business involves the development, marketing, and sale of products directly, by license, or through our affiliate label program with certain third-party publishers. In North America, we primarily sell ourActivision's products oncover diverse game categories including action/adventure, action sports, racing, role-playing, simulation, first-person action, music, and strategy. Activision's target customer base ranges from casual players to game enthusiasts, and children to adults. During 2008, Activision releasedGuitar Hero World Tour andCall of Duty: World at War, and continued to expand its licensed products with titles such asMadagascar: Escape 2 Africa,Spider-Man: Web of Shadows, its first James Bond title,Quantum of Solace, and several other titles. Activision is currently developing sequels to the Guitar Hero and Call of Duty franchises,Wolfenstein through id Software,Marvel Ultimate Alliance 2: Fusion through Vicarious Visions,Prototype through Radical, andSingularity through Raven Software, and a direct basisyet to mass-market retailers, consumer electronics stores, discount warehouses,be named game for the racing genre, among other titles.
Our Blizzard business involves the development, marketing, sales and game specialty stores. We conduct our international publishing activities through officessupport of role playing action and strategy games. Blizzard also develops, hosts, and supports its online subscription-based games in the United Kingdom ("UK"), Germany, France, Italy, Spain,MMORPG category. Blizzard is the Netherlands, Norway, Sweden, Australia, Canada, South Korea,development studio and Japan. Ourpublisher best known as the creator ofWorld of Warcraft and the multiple award winning Diablo, StarCraft, and Warcraft franchises. Blizzard distributes its products are sold internationally on a direct-to-retail basis,and generates revenues worldwide through third-party distributionvarious means, including: subscription revenues (which consist of fees from individuals playingWorld of Warcraft, such as prepaid-cards and other ancillary online revenues); retail sales of physical "boxed" products; electronic download sales of PC products; and licensing arrangements,of software to third-party companies that distributeWorld of Warcraft in China and through our wholly owned European distribution subsidiaries.Taiwan. During 2008, Blizzard releasedWorld of Warcraft: Wrath of the Lich King, the second expansion pack ofWorld of Warcraft. Blizzard is currently developing new games, including sequels to the StarCraft and Diablo franchises.
Our distribution business consists of operations located in the UK, the Netherlands, and GermanyEurope 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.
Our profitability is directly affected by the mixManagement's Overview of revenues from our publishing and distribution businesses. Operating margins realized from our publishing business are typically substantially higher than margins realized from our distribution business. Operating margins in our publishing business are affected by our ability to release highly successful or "hit" titles. Though many of these titles have substantial production or acquisition costs and marketing budgets, once a title recoups these costs,
incremental net revenues directly and positively impact our operating margin. Operating margins in our distribution business are affected by the mix of hardware and software sales, with software typically producing higher margins than hardware.
Our FocusBusiness Trends
With respect Activision's 2009 scheduled releases—We expect to future game development, we will continue to focuslaunch games based on our "big propositions" products that are backed by strongproven franchises and high quality development, for which we will provide significant marketing support.
We have focused on establishing and maintaining relationships with talented and experienced software development and publishing teams. In June 2006, we acquired RedOctane, Inc. ("RedOctane"), the publisher of the popular Guitar Hero franchise. The Guitar Hero franchise has set an industry record, surpassing $1 billion in North America retail sales in 26 months, according to The NPD Group, which is a provider of consumer and retail market research information for a wide range of industries.Guitar Hero III: Legends of Rock was the number one best-selling game in dollars in the U.S. and Europe for fiscal 2008, according to The NPD Group, Charttrack and Gfk. We plan on continuing to build on this franchise by investing in the future development of Guitar Hero titles across a variety of platforms. We have also been successful in the first person action categories through thesuch as Call of Duty, original franchise, which we plan on continuing as a successful long-term franchise. Call of Duty has achieved over $1 billion life-to-date net revenues in fiscal 2008.Call of Duty 4: Modern WarfareGuitar Hero, Transformers, Wolverine, Marvel, Tony Hawk, Wolfenstein, and Ice Age. Games scheduled for release during the quarter ended the fiscal year as the number two best-selling game worldwide in dollars, according to The NPD Group, Charttrack and Gfk. In September 2007, we acquired U.K.-based video game developer Bizarre Creations Limited ("Bizarre Creations"), a leader in the racing category. With more than 10 years of experience in the racing genre, Bizarre Creations developed the innovative multi-million unit selling franchise, Project Gotham Racing for Microsoft, a critically-acclaimed series for the Xbox and Xbox360. Bizarre Creations and its games have won numerous industry awards including: Best Racing Game forProject Gotham Racing 2 from the British Academy of Film and Television Arts (BAFTA); the Industry Grand Prix Award from Develop; MCV's UK Development Team 2006 award; Best Racing/Driving Game from IGN; Game of the Year from OXM and Gamespy forProject Gotham Racing 3; and IGN's Best Xbox Live Arcade ("XBLA") Game forGeometry Wars: Retro Evolved. Bizarre Creations will play a role in our growth strategy as we develop new intellectual property for the racing segment, expand our development capability and capacity for other genres and utilize Bizarre Creations' proprietary development technology. We also have development agreements with other top-level, third-party developers such as id Software, Inc., Splash Damage, Ltd., and Next Level Games.
Our fiscal 2008 releases include well-established franchises, which are backed by high-profile intellectual property and/or highly anticipated motion picture releases. For example, we have a long-term relationship with Marvel Entertainment, Inc. through an exclusive licensing agreement for the Spider-Man and X-Men franchises through 2017. This agreement grants us the exclusive, worldwide rights to develop and publish video games based on Marvel's comic book franchises: Spider-Man and X-Men. In addition, we have an agreement with Spider-Man Merchandising, LP which grants us exclusive, worldwide rights to publish video games based on subsequent Spider-Man feature films through 2017. Through March 31, 2008, games based on the Spider-Man and X-Men franchises have generated approximately $1.1 billion in net revenues worldwide. Under this agreement, in the first quarter fiscal 2007 we released the video game,2009 includeX-Men: The Official GameGuitar Hero: Metallica coinciding with the theatrical release ofX-Men: The Last Stand. In the third quarter fiscal 2007, we releasedMarvel: Ultimate Alliance across multiple platforms andSpider-Man: Battle for New York on the NDS and the GBA. In the first quarter fiscal 2008, we releasedSpider-Man 3 based on Columbia Pictures/Marvel Entertainment, Inc.'s feature film "Spider-Man 3," which was released in May 2007. We also releasedSpider-Man: Friend or Foe in the third quarter fiscal 2008.
We also haveTable of Contents
for the Xbox 360, PS3, Wii in North America;Monsters vs. Aliens worldwide on multiple platforms; approximately 50 downloadable songs for Guitar Hero; and the first map pack forCall of Duty: World at War. The more notable games, among other titles, scheduled for release during 2009 include:Marvel Ultimate Alliance 2;Wolverine, based on XMen: Origins Wolverine, which is one of the most popular Marvel characters;Transformers: Revenge of the Fallen;Prototype, an exclusive licensing agreement with professional skateboarder Tony Hawk. The agreement grants us exclusive rights to developall new and publish video games through 2015 using Tony Hawk's name and likeness. Through March 31, 2008, we have released nine titles inthird-person open-world action game;Ice Age 3;DJ Hero, a new line extension of the Guitar Hero franchise;Call of Duty: Modern Warfare 2; a new racing game developed by Bizarre Creations; a new game based on the Tony Hawk franchise with cumulative net revenues of $1.3 billion, includingfranchise; an all newWolfenstein; and our new wholly owned first-person action game calledSingularity.
Console hardware platforms—In 2005, Microsoft released the fiscal 2008 third quarter release,Tony Hawk's Proving Ground, which was releasedXbox 360 and, in 2006, Sony and Nintendo introduced their respective hardware platforms, the PlayStation 3 and Wii. Activision's plan is to continue to build a significant presence on the PS3, Wii, and Xbox 360 by expanding the number of titles released on these platforms and hand-held platforms while continuing to market to the PS2 platform as long as it is economically attractive to do so given its large installed base.
Business combination and investments—We have engaged in, evaluated, and expect to continue to engage in and evaluate, a wide array of potential strategic transactions, including acquisitions of companies, businesses, intellectual properties, and other assets. On July 9, 2008, we consummated our Business Combination with Vivendi Games. Upon the closing of the Business Combination, Activision, Inc. was renamed Activision Blizzard, Inc. As of December 31, 2008, Vivendi owned approximately 55% of our common stock. Activision Blizzard now conducts the combined business operations of Activision, Inc. and Vivendi Games including Blizzard Entertainment, Inc. See also Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
To further strengthen our development resources and underscore our commitment as leader in the music-based genre, on September 11, 2008, we acquired Freestyle Games, Ltd., a premier United Kingdom-based video game developer specializing in the music-based genre. Additionally, on November 10, 2008, we acquired Budcat Creations, LLC, an Iowa City, Iowa based video game developer. Budcat Creations is an award-winning development studio with expertise on the Wii the Xbox360 and the NDS.
We willInternational operations—Activision focuses on the growth of the European market through developing localized contents for its Guitar Hero franchises and other franchises or titles in terms of contents and packaging. For the Asian market, Blizzard distributesWorld of Warcraft through direct operations and licenses. Blizzard has licensing arrangements with The9 to distributeWorld of Warcraft in China and with SoftWorld in Taiwan. Internet game room players and prepaid cards are also continue to evaluate and exploit emerging franchises that we believe have potential to become successful game franchises. For example, we have multi-year, multi-property, agreements with DreamWorks Animation LLC that grant us the exclusive rights to publish video games based on DreamWorks Animation SKG's theatrical releases, including "Shark Tale," which was releasedvery popular in the second quarter fiscal 2005, "Madagascar," which was releasedAsia, particularly in the first quarter fiscal 2006, "Over the Hedge," which was released in the first quarter fiscal 2007, "Shrek the Third," which was released in the first quarter fiscal 2008, "Bee Movie," which was released in the third quarter fiscal 2008, and all of their respective sequels. In addition, our multi-year agreements with DreamWorks Animation LLC also grant us the exclusive video game rights to three upcoming DreamWorks Animation feature films, including "Kung Fu Panda," "Monsters vs Aliens" and "How to Train Your Dragon." We plan to releaseSouth Korea. Recently, Blizzard has licensed itsKung Fu PandaStarCraft II,Monsters vs AliensWarcraft III: Reign of Chaos,Warcraft III: The Frozen Throne, andMadagascar 2 during fiscal 2009.
Additionally, we Battle.net platform to a company affiliated with NetEase.com, Inc. Blizzard and NetEase have also established a strategic alliance with Harrah's Entertainment, Inc. that grants us the exclusive, worldwide interactive rights to develop and publish "World Series of Poker" video games based on the popular World Series of Poker Tournament. In the second quarter fiscal 2006, we released our first title under this alliance,World Series of Poker,joint venture, which became the number one poker title of calendar year 2005. Further building on this franchise, in the second quarter fiscal 2007, we released our second title under this alliance,World Series of Poker: Tournament of Champions. Additionally, we released our third title under this alliance,World Series of Poker: Battlewill provide support for the Bracelet in the second quarter fiscal 2008.
We also continue to build on our portfolio of licensed intellectual property. In February 2006, we signed an agreement with Hasbro Properties Group granting us the exclusive global rights (excluding Japan) to develop console, hand-held, and PC games based on Hasbro's "Transformers" franchise. We released our first "Transformers" game,TRANSFORMERS: The Game, in late June 2007 concurrently with the early July 2007 movie releaseoperation of the live action "Transformers" film from DreamWorks Pictureslicensed games and Paramount Pictures. In April 2006, we signed an agreement with MGM Interactive and EON Productions Ltd. granting usBattle.net platform in China. For the exclusive rights to develop and publish video games based on the James Bond license through 2014. We plan to release our first James Bond title,Quantum of Solace, during fiscal 2009.
In April 2006, we signedyear ended December 31, 2008, Blizzard released a multi-year agreement with Mattel, Inc. which grants us the exclusive, worldwide distribution rights for the catalog of video games based on Mattel, Inc.'s Barbie franchise on all platforms. Through the third quarter fiscal 2007, we distributed six Barbie titles:Barbie and the 12 Dancing Princesses, The Barbie Diaries: High School Mystery, Barbie Fashion Show, Barbie Horse Adventures: Mystery Ride, Barbie and the Magic of Pegasus, andBarbie as the Princess and the Pauper. Based on the success of this distribution, we signed multi-year license agreements with Mattel, Inc. in January 2007 which grant us the exclusive worldwide rights to develop and publish new video games based on Mattel Inc.'sBarbie andHot Wheels franchises on all platforms. In the second quarter fiscal 2008, we releasedHot Wheels: Beat That!. In September 2006, we entered into a distribution agreement with MTV Networks Kids and Family Group's Nickelodeon, a division of Viacom Inc., to be the exclusive distributor of three new Nick Jr. PC CD-ROM titles, published by Nickelodeon and based on the top preschool series on commercial television,Dora The Explorer, The Backyardigans, andGo, Diego, Go!
We are utilizing these developer relationships, new intellectual property acquisitions, new original intellectual property creations, and our existing library of intellectual property to further focus our game development on product lines that will deliver significant, lasting, and recurring revenues and operating profits.
Business Combination
On December 2, 2007, we and Vivendi S.A. ("Vivendi") announced an agreement to combine Vivendi Games, Inc. ("Vivendi Games,") Vivendi's interactive entertainment business which includes Blizzard Entertainment, Inc., the creatorRussian language version ofWorld of Warcraft, a massively multi-player online role-playing game ("MMORPG") franchise, with us. If in Russia and expanded its Spanish version into Latin America.
Integration and reorganization—Following the transaction closes,Business Combination on July 9, 2008, we will be renamedhave restructured the Vivendi Games businesses to capture cost-synergies and to streamline the combined Activision Blizzard Inc. ("Activision Blizzard") andorganization. For the first six months of 2009, we expect to continue to operateincur restructuring expenses mainly relating to severance payments of remaining interim employees who are currently assisting us to exit our non-core operations and under-utilized facilities. We anticipate substantially exiting or winding down our non-core operations and substantially completing our organizational restructuring activities as a public company traded on NASDAQ underresult of the ticker ATVI.Business Combination by June 2009.
For the six months ending June 30, 2009, we anticipate incurring between $20 million and $40 million of additional before tax restructuring charges, and after tax cash restructuring charges
between $15 million and $25 million relating to the Business Combination. Overall, including charges incurred through December 31, 2008, we expect to incur before tax restructuring charges between $113 million and $133 million by June 30, 2009, with an after tax cash impact between $55 million and $70 million. The after tax charges are expected to consist primarily of employee-related severance cash costs (approximately $47 million), facility exit cash costs (approximately $18 million), and cash contract terminations costs (approximately $5 million). Separately, through December 31, 2008, these restructuring charges were partially offset by cash proceeds of approximately $28 million from asset disposals and after tax cash benefits related to the streamlining of the Vivendi Games title portfolio. For the next six months, we anticipate between $2 million to $7 million of further cash proceeds to partially offset future restructuring cash charges. We do not expect these anticipated restructuring expenses to materially effect future earnings and cash flow of Activision Blizzard.
Console online games—Activision has published games with online functionality that constitutes a more-than-inconsequential separate service deliverable in addition to the product, and in which our performance obligations extend beyond the sale of the game. Vendor-specific objective evidence of fair value does not exist for these online features, as we do not separately charge for this component of these titles. As a result, we recognize all of the revenue from the sale of these titles ratably over an estimated service period. In addition, we defer the costs of sales of these titles to match revenue.
MMORPG online games—Blizzard published the first expansion packWorld of Warcarft: The Burning Crusade, in January 2007 and the second expansion pack,World of Warcraft: Wrath of the Lich King in November 2008. We expect these expansions will extend Blizzard's subscription revenues by retaining existing customers and attracting new customers.
All information included in this report reflects only Activision's results,Impact of deferred revenues and does not reflect anyrelated cost of sales—For the year ended December 31, 2008, the net impact of deferred revenues and related cost of sales decreased consolidated net revenues and total cost of sales by $713 million and $217 million, respectively. We anticipate, for the proposed combination. The forward-looking commentsyear ending December 31, 2009, the net impact of deferred revenues and related cost of sales will decrease consolidated net revenues and total cost of sales by approximately $500 million and $220 million, respectively. As our major releases are planned in this Management's Discussion & Analysisthe December quarter of Financial Condition and Results of Operations are prepared on an Activision standalone basis, without considering any potential impacts2009, we expect that a majority of the proposed business combination with Vivendi Games.revenues and related costs of sales will be deferred in the December quarter of 2009, and recognized in 2010. However, the actual amount of revenues and cost of sales deferred will vary significantly depending upon the timing of the release of these titles and the sales volume of such products.
Other revenues—Activision is continuing the development of online capabilities for its games. Activision plans to continue to exploit other revenue sources, including downloadable content and in-game advertising for its console games.
Economic conditions—We continue to monitor the recent adverse changes in economic conditions which may have unfavorable impacts on our businesses, such as deteriorating consumer demand, pricing pressure on our products, credit quality of our receivables, and foreign currency exchange rates.
Critical Accounting Policies and Estimates
We have identified the policies below as critical to our business operations and the understanding of our financial results. The impact and any associated risks related to these policies on our business operations are discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion of the application of these and other accounting policies, see Note 1 of the Notes to Consolidated Financial Statements included in Item 8. The preparation of financial statements in conformity with accounting principles generally accepted accounting principlesin the United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. The estimates discussed below are considered by management to be critical because they are both important to the portrayal of our financial condition and results of operations and because their application places the most significant demands on management's judgment, with financial reporting
results relying on estimates about the effect of matters that are inherently uncertain. Specific risks for these critical accounting estimates are described in the following paragraphs.
Revenue Recognition. We recognize revenue from the sale of our products upon the transfer of title and risk of loss to our customers, and once any performance obligations have been completed. Certain products are sold to customers with a street date (the earliest date these products may be sold by retailers). For these products we recognize revenue on the later of the street date or the sale date. Revenue from product sales is recognized after deducting the estimated allowance for returns and price protection. With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery of a master copy. Per copy royalties on sales that exceed the guarantee are recognized as earned.
Some of our software products provide limited online features at no additional cost to the consumer. Generally, we consider such features to be incidental to the overall product offering and an inconsequential deliverable. Accordingly, we do not defer anyrecognize revenue related to products containing these limited online features.features upon the transfer of title and risk of loss to our customer. In instances where online features or additional functionality is considered a substantivemore than an inconsequential separate deliverable in addition to the software product, we take this into account when applying our revenue recognition policy. This evaluation is performed for each software product together with any online transactions, such as electronic downloads of titles with product add-ons when it is released. We determined that one of our software titles,Enemy Territory: Quake Wars (which
In instances where the online service is primarilyconsidered more than an online multiplayer PC game), contains online functionality that constitutes a more-than-inconsequentialinconsequential separate service deliverable in addition to the software product, principally because of its importance to game play. As such, our performance obligationswe account for this title extend beyond the sale as a "bundled" sale, or multiple element arrangement, in which we sell both the software product and the online service for one combined price. Vendor specific objective evidence for the fair value of the game, which is unique compared to other previously released titles. Vendor-specific objective
evidence of fair value ("VSOE")online service does not exist for the online functionality, as we do not separately offer or charge for this component of the title. As a result,online service. Therefore, when the online service is determined to be more than an inconsequential deliverable, we are recognizing all ofrecognize the revenue from the salesales of this titlesuch software products ratably over anthe estimated online service period, which is currently estimated to be six months beginning the month after shipment. In addition, we are deferringshipment of the software product. Costs of sales (excluding intangible asset amortization classified as costs of sales for this title. Cost of sales includes:sales) related to such products are also deferred and recognized with the related revenues, including manufacturing costs, software royalties and amortization and intellectual property licenses. Overall, online play functionality is still an emerging area for us.
We continue to monitorconsider the developmentWorld of online functionality (togetherWarcraft boxed product including expansion packs and other ancillary revenues as a single deliverable with online transactions, suchthe total arrangement consideration combined and recognized ratably as electronics downloadsrevenue over the estimated product life beginning upon activation of titles or product add-ons)the software and its significance to our products. Based on our current assessmentdelivery of obligations with respectthe services. Revenues attributed to the online functionality for certain of our fiscal 2009 titles on certain platforms, we expect that certain fiscal 2009 titles will contain online functionality that constitutes a more-than-inconsequential separate service deliverable in addition to the product, and that our performance obligations for these fiscal 2009 titles will extend beyond the sale ofWorld of Warcraft boxed software and related expansion packs are classified as product sales and revenues attributable to subscription and other ancillary services are classified as subscription, licensing and other revenues.
Determining whether the game. VSOE of fair value does not existonline service for these online features, as we do not plan to separately charge for this component of these fiscal 2009 titles. As a result, we expect to recognize all ofparticular game constitutes more than an inconsequential deliverable is subjective and requires management's judgment. Determining the revenue from the sale of these fiscal 2009 titles ratably over an estimated service period over which is currently estimated to be six months beginningrecognize the month after shipment. In addition, we expect to defer the costs of sales of these fiscal 2009 titles. We anticipate that, in fiscal 2009, we will likely defer approximately $350.0 million in net revenues and $150.0 million in costs of sales from the sale of these fiscal 2009 titles into fiscal 2010. Since most of these fiscal 2009 titles are planned to release in the third quarter fiscal 2009, we expect that a majority of revenuesrelated revenue and costs of sales for these products will be deferred in the third quarter fiscal 2009,is also subjective and recognized later in the calendar year 2009. However, the actual amount of revenues and costs of sales deferred will vary significantly depending upon the timing of the release of these fiscal 2009 titles and the sales volume of such products.
With respect to online transactions, such as electronic downloads of titles or product add-ons, revenue is recognized when the fee is paid by the online customer to purchase online content and we are notified by the online retailer that the product has been downloaded. In addition, in order to recognize revenue for both product sales and licensing transactions, persuasive evidence of an arrangement must exist and collection of the related receivable must be probable.
Sales incentives or other consideration given by us to our customers is accounted for in accordance with the Financial Accounting Standards Board's Emerging Issues Task Force ("EITF") Issue 01-9,Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products). In accordance with EITF Issue 01-9, sales incentives and other consideration that are considered adjustments of the selling price of our products, such as rebates and product placement fees, are reflected as reductions of revenue. Sales incentives and other consideration that represent costs incurred by us for assets or services received, such as the appearance of our products in a customer's national circular advertisement, are reflected as sales and marketing expenses.involves management's judgment.
Allowances for Returns, Price Protection, Doubtful Accounts, and Inventory Obsolescence. We closely monitor and analyze the historical performance of our various titles, the performance of products released by other publishers and the anticipated timing of other releases in order to assess future demands of current and upcoming titles. Initial volumes shipped upon title launch and subsequent reorders are evaluated to ensure that quantities are sufficient to meet the demands from the retail markets but at the same time, are controlled to prevent excess inventory in the channel. We benchmark our units to be shipped to our customers using historical and industry data.
We may permit product returns from, or grant price protection to, our customers under certain conditions. In general, price protection refers to the circumstances when we elect to decrease the wholesale price of a product by a certain amount and, when granted and applicable, allows customers a credit against amounts owed by such customers to us with respect to open and/or future invoices. The conditions our customers must meet to be granted the right to return products or price protection are,
include, among other things, compliance with applicable trading and payment terms, and consistent delivery to usreturn of inventory and delivery of sell-through reports.reports to us. We may also consider other factors, including the facilitation of slow-moving inventory and other market factors. Management must make estimates of potential future product returns and price protection related to current period product revenue. We estimate the amount of future returns and price protection for current period product revenue utilizing historical experience and information regarding inventory levels and the demand and acceptance of our products by the end consumer. The following factors are used to estimate the amount of future returns and
price protection for a particular title: historical performance of titles in similar genres,genres; historical performance of the hardware platform,platform; historical performance of the franchise,franchise; console hardware life cycle, ourcycle; sales force and retail customer feedback,feedback; industry pricing,pricing; weeks of on-hand retail channel inventory,inventory; absolute quantity of on-hand retail channel inventory,inventory; our warehouse on-hand inventory levels,levels; the title's recent sell-through history (if available),; marketing trade programs,programs; and competing titles. The relative importance of these factors varies among titles depending upon, among other items, genre, platform, seasonality, and sales strategy. Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price protection in any accounting period. Based upon historical experience, we believe that our estimates are reasonable. However, actual returns and price protection could vary materially from our allowance estimates due to a number of reasons including, among others, a lack of consumer acceptance of a title, the release in the same period of a similarly themed title by a competitor, or technological obsolescence due to the emergence of new hardware platforms. Material differences may result in the amount and timing of our revenue for any period if factors or market conditions change or if management makes different judgments or utilizes different estimates in determining the allowances for returns and price protection. For example, a 1% change in our MarchDecember 31, 2008 allowance for returns and price protection would impact net revenues by $1.3approximately $3 million.
Similarly, management must make estimates of the uncollectibility of our accounts receivable. In estimating the allowance for doubtful accounts, we analyze the age of current outstanding account balances, historical bad debts, customer concentrations, customer creditworthiness, current economic trends, and changes in our customers' payment terms and their economic condition, as well as whether we can obtain sufficient credit insurance. Any significant changes in any of these criteria would affect management's estimates in establishing our allowance for doubtful accounts.
We value inventory at the lower of cost or market. We regularly review inventory quantities on handon-hand and in the retail channel and record a provision for excess or obsolete inventory based on the future expected demand for our products. Significant changes in demand for our products would impact management's estimates in establishing our inventory provision.
Software Development Costs and Intellectual Property Licenses. Software development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products.
We account for software development costs in accordance with Statement of Financial Accounting Standards ("SFAS") No. 86,Accounting "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed," ("SFAS No. 86"). Software development costs are capitalized once the technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation.documentation, or the completed and tested product design and working model. Significant management judgments and estimates are utilized in the assessment of when technological feasibility is established. For products where proven technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product basis. Prior to a product's release, we expense, as part of "cost of sales—software royalties and amortization," capitalized costs when we believe such amounts are not recoverable. Capitalized costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation. Amounts related
to software development which are not capitalized are charged immediately to product development expense.
Commencing upon product release, capitalized software development costs are amortized to "cost of sales—software royalties and amortization" based on the ratio of current revenues to total projected revenues for the specific product, generally resulting in an amortization period of six months or less.
Intellectual property license costs represent license fees paid to intellectual property rights holders for use of their trademarks, copyrights, software, technology, music, or other intellectual property or proprietary rights in the development of our products. Depending upon the agreement with the rights
holder, we may obtain the rights to use acquired intellectual property in multiple products over multiple years, or alternatively, for a single product. Prior to the related product's release, we expense, as part of "cost of sales—intellectual property licenses," capitalized intellectual property costs when we believe such amounts are not recoverable. Capitalized intellectual property costs for those products that are cancelled or abandoned are charged to product development expense in the period of cancellation.
Commencing upon the related product's release, capitalized intellectual property license costs are amortized to "cost of sales—intellectual property licenses" based on the ratio of current revenues for the specific product to total projected revenues for all products in which the licensed property will be utilized. As intellectual property license contracts may extend for multiple years, the amortization of capitalized intellectual property license costs relating to such contracts may extend beyond one year.
We evaluate the future recoverability of capitalized software development costs and intellectual property licenses on a quarterly basis. For products that have been released in prior periods, the primary evaluation criterion is actual title performance. For products that are scheduled to be released in future periods, the recoverability of capitalized software development costs is evaluated based on the expected performance of the specific products to which the costs relate or in which the licensed trademark or copyright is to be used. Criteria used to evaluate expected product performance include: historical performance of comparable products developed with comparable technology; orders for the product prior to its release; and, for any sequel product, estimated performance based on the performance of the product on which the sequel is based. AsFurther, as many of our intellectual property licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized intellectual property license costs based on certain qualitative factors, such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned theatrical releases or television series based on the intellectual property, and the rights holder's continued promotion and exploitation of the intellectual property.
Significant management judgments and estimates are utilized in the assessment of the recoverability of capitalized costs. In evaluating the recoverability of capitalized costs, the assessment of expected product performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual product sales are less than, and/or revised forecasted or actual costs are greater than the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge. Additionally, as noted above, as many of our intellectual property licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized intellectual property license costs based on certain qualitative factors such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned theatrical releases or television series based on the intellectual property and the rights holder's continued promotion and exploitation of the intellectual property. Material differences may result in the amount and timing of charges for any period if management makes different judgments or utilizes different estimates in evaluating these qualitative factors.
Stock-based Compensation Expense. On April 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004),Share-Based Payment, ("SFAS No. 123R") which requires
the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors, including employee stock options and employee stock purchases made pursuant to the Employee Stock Purchase Plan based on estimated fair values. Stock-based compensation expense recognized under SFAS No. 123R for the years ended March 31, 2008, and 2007 was $53.6 million, and $25.5 million, respectively. See Note 14 of the Notes to Consolidated Financial Statements included in Item 8 for additional information.
We estimate the value of employee stock options on the date of grant using a binomial-lattice model. The fair value of a share-based payment as of the grant date estimated in accordance with this option pricing model depends upon our future stock price as well as assumptions concerning expected volatility, risk-free interest rate, and risk-adjusted stock return, and measures of employees' forfeiture, exercise, and post-vesting termination behavior. Statistical methods were used to estimate employee rank specific termination rates. These termination rates, in turn, were used to model the number of options that are expected to vest and employees' post-vesting termination behavior. Employee rank specific estimates of expected time-to-exercise ("ETTE") were used to reflect employee exercise behavior. ETTE was estimated by using statistical procedures to first estimate the conditional probability of exercise occurring during each time period, conditional on the option surviving to that time period and then using those probabilities to estimate ETTE. The model was calibrated by adjusting parameters controlling exercise and post-vesting termination behavior so that the measures output by the model matched values of these measures that were estimated from historical data. The weighted-average estimated value of employee stock options granted during the years ended March 31, 2008 and 2007 was $9.21 and $5.86, respectively, per share using the binomial-lattice model with the following weighted-average assumptions:
| Employee and Director Options For the years ended March 31, | ||||
---|---|---|---|---|---|
| 2008 | 2007 | |||
Expected life (in years) | 5.41 | 4.87 | |||
Risk free interest rate | 4.70 | % | 4.99 | % | |
Volatility | 51 | % | 54 | % | |
Dividend yield | — | — |
To estimate volatility for the binomial-lattice model, we use methods or capabilities that are discussed in SFAS No. 123R and SAB No. 107. These methods included the implied volatility method, which is based upon the volatilities for exchange-traded options with respect to our stock, to estimate short-term volatility, the historical method which is based upon the annualized standard deviation of the instantaneous returns on Activision's stock during the option's contractual term, to estimate long-term volatility and a statistical model to estimate the transition or "mean reversion" from short-term volatility to long-term volatility. Based on these methods, for options granted during the year ended March 31, 2008, the expected stock price volatility ranged from 34% to 53%, with a weighted-average volatility of 51%. For options granted during the year ended March 31, 2007, the expected stock price volatility ranged from 38% to 56%, with a weighted average volatility of 54%.
As was the case for volatility, the risk-free rate is assumed to change during the option's contractual period. As required by a binomial-lattice model, the risk-free rate reflects the interest from one time period to the next (the "forward rate") as opposed to the interest rate from the grant date to the given time period (the "spot rate.") Since we do not currently pay dividends and do not currently expect to pay them in the future, we have assumed that the dividend yield is zero.
The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding and is, as required by SFAS No. 123R, output by the binomial-lattice model. The expected life of employee stock options depends on all of the underlying
assumptions and calibration of our model. The binomial-lattice model assumes that employees will exercise options when the stock price equals or exceeds an exercise boundary. The exercise boundary is not constant but continually declines as one approaches the option's expiration date. The exact placement of the exercise boundary depends on all of the model inputs as well as the measures that were used to calibrate the model to estimated measures of employees' exercise and termination behavior.
Stock-based compensation expense recognized in the Consolidated Statement of Operations is based on awards ultimately expected to vest and has been reduced for estimated forfeitures. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
If factors change and we employ different assumptions in the application of SFAS No. 123R in future periods, the compensation expense that we record under SFAS No. 123R may differ significantly from what we have recorded in the current period.
Income Taxes. We record a tax provision for the anticipated tax consequences of the reported results of operations. In accordance with Statement of Financial Accounting Standards No. 109,Accounting "Accounting for Income TaxesTaxes", the provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We record a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. Effective at the beginning
Table of fiscal 2008, we adopted Financial Interpretation No. ("FIN") 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109. Further information may be found in Note 12 of the Notes to Consolidated Financial Statements included in Item 8.Contents
Management believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining deferred tax assets. In the event that all or part of the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of FINFinancial Interpretation No. ("FIN") 48, "Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109" and other complex tax laws. Resolution of these uncertainties in a manner inconsistent with management's expectations could have a material impact on our financial condition and operating results.
For a detailed discussion of the application of these and other accounting policies see Note 3 of the Notes to Consolidated Financial Statements.
Fair Value Estimates
The preparation of financial statements in conformity with U.S. GAAP often requires us to determine the fair value of a particular item to fairly present our Consolidated Financial Statements. Without an independent market or another representative transaction, determining the fair value of a particular item requires us to make several assumptions that are inherently difficult to predict and can have a material impact on the conclusion of the appropriate accounting.
There are various valuation techniques used to estimate fair value. These include (1) the market approach where market transactions for identical or comparable assets or liabilities are used to determine the fair value, (2) the income approach, which uses valuation techniques to convert future amounts (for example, future cash flows or future earnings) to a single present amount, and (3) the cost approach, which is based on the amount that would be required to replace an asset. For many of our fair value estimates, including our estimates of the fair value of acquired intangible assets, we use the income approach. Using the income approach requires the use of financial models, which require us to make various estimates including, but not limited to (1) the potential future cash flows for the asset, liability or equity instrument being measured, (2) the timing of receipt or payment of those future cash flows, (3) the time value of money associated with the delayed receipt or payment of such cash flows, and (4) the inherent risk associated with the cash flows (risk premium). Making these cash flow estimates are inherently difficult and subjective, and, if any of the estimates used to determine the fair value using the income approach turns out to be inaccurate, our financial results may be negatively impacted. Furthermore, relatively small changes in many of these estimates can have a significant impact on the estimated fair value resulting from the financial models or the related accounting conclusion reached. For example, a relatively small change in the estimated fair value of an asset may change a conclusion as to whether an asset is impaired. While we are required to make certain fair value assessments associated with the accounting for several types of transactions, the following areas are the most sensitive to the assessments:
Business Combinations. We must estimate the fair value of assets acquired and liabilities assumed in a business combination. Our assessment of the estimated fair value of each of these can have a material effect on our reported results as intangible assets are amortized over various lives. Furthermore, a change in the estimated fair value of an asset or liability often has a direct impact on the amount to recognize as goodwill, which is an asset that is not amortized. Often determining the fair value of these assets and liabilities assumed requires an assessment of expected use of the asset, the expected cost to extinguish the liability or our expectations related to the timing and the successful completion of development of an acquired in-process technology. Such estimates are inherently difficult and subjective and can have a material impact on our financial statements.
Assessment of Impairment of Assets. Management evaluates the recoverability of our identifiable intangible assets and other long-lived assets in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-lived Assets," which generally requires the assessment of these assets for recoverability when events or circumstances indicate a potential impairment exists. We considered certain events and circumstances in determining whether the carrying value of identifiable intangible assets and other long-lived assets may not be recoverable including, but are not limited to: significant changes in performance relative to expected operating results; significant changes in the use of the assets; significant negative industry or economic trends; a significant decline in our stock price for a sustained period of time; and changes in our business strategy. In determining if an impairment exists, we estimate the undiscounted cash flows to be generated from the use and ultimate disposition of these assets. If an impairment is indicated based on a comparison of the assets' carrying values and the undiscounted cash flows, the impairment loss is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. The decision to dispose of certain assets of the non-core operating segment as part of our restructuring plan following the Business Combination was considered to be an indicator of impairment under SFAS No. 144. We performed an impairment test on the long-lived assets of the non-core operating segment and determined that an acquired trade name was impaired. As a result, an impairment charge of $5 million was recorded as part of restructuring costs. Other than this event, during 2008, we did not perform any other impairment tests of our long-lived assets as there were no significant and adverse underlying changes to our expected operating results or other indicators of impairment. Other than the $5 million impairment of the acquired trade name, we determined that there was no other impairment of long-lived assets for the years ended December 31, 2008, 2007 and 2006.
SFAS No. 142, "Goodwill and other Intangibles" ("SFAS No. 142") requires a two-step approach to testing goodwill for impairment for each reporting unit. Our reporting units are determined by the components of our operating segments that constitute a business for which both (1) discrete financial information is available and (2) segment management regularly reviews the operating results of that component. SFAS No. 142 requires that the impairment test be performed at least annually by applying a fair-value-based test. The first step measures for impairment by applying fair-value-based tests at the reporting unit level. The second step (if necessary) measures the amount of impairment by applying fair-value-based tests to the individual assets and liabilities within each reporting unit.
To determine the fair values of the reporting units used in the first step, we use a discounted cash flow approach. Each step requires us to make judgments and involves the use of significant estimates and assumptions. These estimates and assumptions include long-term growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates based on our weighted average cost of capital, future economic and market conditions. These estimates and assumptions have to be made for each reporting unit evaluated for impairment. Our estimates for market growth, our market share and costs are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates we are using to manage the underlying business. If future forecasts are revised, they may indicate or require future impairment charges. We base our fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates.
Stock-Based Compensation. We estimate the value of employee stock options on the date of grant using a binomial-lattice model. Our determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.
For more detailed information about Activision Blizzard's accounting policy for the measurement of fair value of financial assets and financial liabilities and information about the financial assets and financial liabilities, see Notes 3 and 17 of the Notes to Consolidated Financial Statements.
Selected Table of Contents
Consolidated Statements of Operations Data
Special Note—The consummation of the Business Combination has resulted in financial information of Activision, Inc. being included from the date of the Business Combination (i.e. from July 9, 2008 onwards), but not for prior periods.
The following table sets forth certain Consolidated Statements of Operations data for the periods indicated in dollars and as a percentage of consolidatedtotal net revenues and also breaks down net revenues by territory, business segment, and platform, as well as operating income by business segment (amounts in thousands)millions):
| For the fiscal years ended March 31, | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007 | 2006 | |||||||||||||||
Net revenues | $ | 2,898,136 | 100 | % | $ | 1,513,012 | 100 | % | $ | 1,468,000 | 100 | % | ||||||
Costs and expenses: | ||||||||||||||||||
Cost of sales—product costs | 1,240,605 | 43 | 799,587 | 52 | 734,874 | 50 | ||||||||||||
Cost of sales—software royalties and amortization | 294,279 | 10 | 132,353 | 9 | 147,822 | 10 | ||||||||||||
Cost of sales—intellectual property licenses | 110,551 | 4 | 46,125 | 3 | 57,666 | 4 | ||||||||||||
Product development | 269,535 | 9 | 133,073 | 9 | 132,651 | 9 | ||||||||||||
Sales and marketing | 308,143 | 10 | 196,213 | 13 | 283,395 | 19 | ||||||||||||
General and administrative | 195,409 | 7 | 132,514 | 9 | 96,366 | 7 | ||||||||||||
Total costs and expenses | 2,418,522 | 83 | 1,439,865 | 95 | 1,452,774 | 99 | ||||||||||||
Income from operations | 479,614 | 17 | 73,147 | 5 | 15,226 | 1 | ||||||||||||
Investment income, net | 51,254 | 1 | 36,678 | 2 | 30,630 | 2 | ||||||||||||
Income before income tax provision | 530,868 | 18 | 109,825 | 7 | 45,856 | 3 | ||||||||||||
Income tax provision | 185,985 | 6 | 24,038 | 1 | 5,605 | — | ||||||||||||
Net income | $ | 344,883 | 12 | % | $ | 85,787 | 6 | % | $ | 40,251 | 3 | % | ||||||
Net Revenues by Territory: | ||||||||||||||||||
North America | $ | 1,761,753 | 61 | % | $ | 753,376 | 50 | % | $ | 710,040 | 48 | % | ||||||
Europe | 1,037,257 | 36 | 718,973 | 47 | 717,494 | 49 | ||||||||||||
Other | 99,126 | 3 | 40,663 | 3 | 40,466 | 3 | ||||||||||||
Total net revenues | $ | 2,898,136 | 100 | % | $ | 1,513,012 | 100 | % | $ | 1,468,000 | 100 | % | ||||||
Net Revenues by Segment/Platform Mix: | ||||||||||||||||||
Publishing: | ||||||||||||||||||
Console | $ | 2,129,799 | 73 | % | $ | 886,795 | 59 | % | $ | 812,345 | 55 | % | ||||||
Hand-held | 219,299 | 8 | 153,357 | 10 | 158,861 | 11 | ||||||||||||
PC | 156,068 | 5 | 78,886 | 5 | 183,457 | 13 | ||||||||||||
Total publishing net revenues | 2,505,166 | 86 | 1,119,038 | 74 | 1,154,663 | 79 | ||||||||||||
Distribution: | ||||||||||||||||||
Console | 268,794 | 9 | 238,662 | 16 | 196,413 | 13 | ||||||||||||
Hand-held | 94,918 | 4 | 122,293 | 8 | 76,973 | 5 | ||||||||||||
PC | 29,258 | 1 | 33,019 | 2 | 39,951 | 3 | ||||||||||||
Total distribution net revenues | 392,970 | 14 | 393,974 | 26 | 313,337 | 21 | ||||||||||||
Total net revenues | $ | 2,898,136 | 100 | % | $ | 1,513,012 | 100 | % | $ | 1,468,000 | 100 | % | ||||||
Operating Income (Loss) by Segment: | ||||||||||||||||||
Publishing | $ | 461,718 | 16 | % | $ | 64,076 | 4 | % | $ | (6,715 | ) | — | % | |||||
Distribution | 17,896 | 1 | 9,071 | 1 | 21,941 | 1 | ||||||||||||
Total operating income | $ | 479,614 | 17 | % | $ | 73,147 | 5 | % | $ | 15,226 | 1 | % | ||||||
| For the years ended December 31, | |||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007 | 2006 | |||||||||||||||||||
| (as adjusted) | |||||||||||||||||||||
Net revenues: | ||||||||||||||||||||||
Product sales | $ | 1,872 | 62 | % | $ | 457 | 34 | % | $ | 421 | 41 | % | ||||||||||
Subscription, licensing, and other revenues | 1,154 | 38 | 892 | 66 | 597 | 59 | ||||||||||||||||
Total net revenues | 3,026 | 100 | 1,349 | 100 | 1,018 | 100 | ||||||||||||||||
Costs and expenses: | ||||||||||||||||||||||
Cost of sales—product costs | 1,160 | 38 | 171 | 13 | 153 | 15 | ||||||||||||||||
Cost of sales—software royalties and amortization | 267 | 9 | 52 | 4 | 71 | 7 | ||||||||||||||||
Cost of sales—intellectual property licenses | 219 | 7 | 9 | 1 | 24 | 2 | ||||||||||||||||
Cost of sales—MMORPG | 193 | 7 | 204 | 15 | 119 | 12 | ||||||||||||||||
Product development | 592 | 20 | 397 | 29 | 246 | 24 | ||||||||||||||||
Sales and marketing | 464 | 15 | 172 | 13 | 147 | 14 | ||||||||||||||||
Restructuring costs | 93 | 3 | (1 | ) | — | 4 | — | |||||||||||||||
General and administrative | 271 | 9 | 166 | 12 | 133 | 14 | ||||||||||||||||
Total costs and expenses | 3,259 | 108 | 1,170 | 87 | 897 | 88 | ||||||||||||||||
Operating income (loss) | (233 | ) | (8 | ) | 179 | 13 | 121 | 12 | ||||||||||||||
Investment income (loss), net | 46 | 2 | (4 | ) | — | (15 | ) | (1 | ) | |||||||||||||
Income (loss) before income tax benefit | (187 | ) | (6 | ) | 175 | 13 | 106 | 11 | ||||||||||||||
Income tax benefit | (80 | ) | (2 | ) | (52 | ) | (4 | ) | (33 | ) | (3 | ) | ||||||||||
Net income (loss) | $ | (107 | ) | (4 | )% | $ | 227 | 17 | % | $ | 139 | 14 | % | |||||||||
ResultsTable of Operations—Fiscal Years Ended MarchContents
Annual Highlights
Operating Highlights (amounts in millions)
| For the years ended December 31, | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007 | 2006 | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | ||||||||||||
| (as adjusted) | | | ||||||||||||||
Net revenues: | |||||||||||||||||
Activision | $ | 2,152 | $ | 272 | $ | 360 | $ | 1,880 | $ | (88 | ) | ||||||
Blizzard | 1,343 | 1,107 | 638 | 236 | 469 | ||||||||||||
Distribution | 227 | — | — | 227 | — | ||||||||||||
Activision Blizzard's core operations | 3,722 | 1,379 | 998 | 2,343 | 381 | ||||||||||||
Activision Blizzard's non-core exit operations | 17 | 10 | 3 | 7 | 7 | ||||||||||||
Operating segments total | 3,739 | 1,389 | 1,001 | 2,350 | 388 | ||||||||||||
Reconciliation to consolidated net revenues: | |||||||||||||||||
Net effect from deferred net revenues | (713 | ) | (40 | ) | 17 | (673 | ) | (57 | ) | ||||||||
Consolidated net revenues | $ | 3,026 | $ | 1,349 | $ | 1,018 | $ | 1,677 | $ | 331 | |||||||
Segment income (loss) from operations: | |||||||||||||||||
Activision | $ | 307 | $ | (13 | ) | $ | (22 | ) | $ | 320 | $ | 9 | |||||
Blizzard | 704 | 568 | 321 | 136 | 247 | ||||||||||||
Distribution | 22 | — | — | 22 | — | ||||||||||||
Activision Blizzard's core operations | 1,033 | 555 | 299 | 478 | 256 | ||||||||||||
Activision Blizzard's non-core exit operations | (266 | ) | (198 | ) | (136 | ) | (68 | ) | (62 | ) | |||||||
Operating segments total | 767 | 357 | 163 | 410 | 194 | ||||||||||||
Reconciliation to consolidated operating income (loss): | |||||||||||||||||
Net effect from deferred net revenues and related costs of sales | (496 | ) | (38 | ) | 14 | (458 | ) | (52 | ) | ||||||||
Stock-based compensation expense | (90 | ) | (137 | ) | (48 | ) | 47 | (89 | ) | ||||||||
Restructuring expense | (93 | ) | 1 | (4 | ) | (94 | ) | 5 | |||||||||
Amortization of intangible assets and purchase price accounting related adjustments | (292 | ) | (4 | ) | (4 | ) | (288 | ) | — | ||||||||
Integration and transaction costs | (29 | ) | — | — | (29 | ) | — | ||||||||||
Total consolidated operating income (loss) | $ | (233 | ) | $ | 179 | $ | 121 | $ | (412 | ) | $ | 58 | |||||
Each of our segments' net revenues increased for the year ended December 31, 2008, compared to the same period in 2007. In North America, Activision Blizzard was the #1 console and hand-held software publisher in dollars for the quarter ended December 31, 2008, according to The NPD Group. Blizzard's net revenues also increased for the year ended December 31, 2007, compared to the same period in 2006. The increases in 2008 and 2007 were mainly attributable to:
Net RevenuesGuitar Hero World Tour
We primarily derive revenue from band bundle products consisting of a package of software, drum, guitars and/or microphone in the quarter ended December 31, 2008. For the quarter ended December 31, 2008, Activision Blizzard had the #1 and #2 best-selling console titles,Guitar Hero World Tour andCall of Duty: World at War, respectively, in dollars in North America and Europe, according to The NPD Group, Gfk and Charttrack;
Warcraft
; | For the fiscal years ended March 31, | | | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Increase/ (Decrease) | Percent Change | ||||||||||||
| 2008 | 2007 | ||||||||||||
Publishing net revenues | ||||||||||||||
North America | $ | 1,761,753 | $ | 753,376 | $ | 1,008,377 | 134 | % | ||||||
Europe | 644,287 | 324,999 | 319,288 | 98 | % | |||||||||
Other | 99,126 | 40,663 | 58,463 | 144 | % | |||||||||
Total international | 743,413 | 365,662 | 377,751 | 103 | % | |||||||||
Total publishing net revenues | 2,505,166 | 1,119,038 | 1,386,128 | 124 | % | |||||||||
Distribution net revenues | 392,970 | 393,974 | (1,004 | ) | 0 | % | ||||||||
Consolidated net revenues | $ | 2,898,136 | $ | 1,513,012 | $ | 1,385,124 | 92 | % | ||||||
Consolidated net revenues increased 92% from $1,513.0nearly 2 million for the fiscal year ended March 31, 2007 to $2,898.1 million for the fiscal year ended March 31, 2008.
In the second quarter fiscal 2008, we determined to recognize all of the net revenues from the sale of one of our titles,which is more than 20% greater than in December 2007.Enemy Territory: Quake WarsWorld of Warcraft (which is primarilyalso recorded an online multiplayer PC game)increase of approximately 2 million subscribers in 2007 when compared to the same period in 2006;
Overall, theThe above increase in 2008 was partially offset by year over year strengthening of the U.S. Dollar in relation to GBP, EUR, AUD, KRW, and SEK which impacted international net revenues, particularly in the December quarter of 2008. We estimate that the change in foreign exchange rates decreased reported consolidated net revenues by approximately $112 million for the fiscal year ended MarchDecember 31, 2008.
Our segments' operating income for the year ended December 31, 2008 was driven by the following:
Partially offset by:
major releases includedCall of Duty 3, Guitar Hero 2, Marvel: Ultimate Alliance, Tony Hawk's Project 8, Over the Hedge, X-Men: Official Game, Shrek Smash N' Crash, Tony Hawk's Downhill Jam,World Series of Poker Tournament of Champions, Pimp My Ride, and titles for our Cabela's History Channel and Barbie franchises.
In fiscal 2009, we plan to publishGuitar Hero: On Tour for the NDS;Guitar Hero: Aerosmith,Guitar Hero: Metallica, andGuitar Hero IV across multiple platforms. We plan to releaseCall of Duty 5, and continue to expand our licensed titles such asKung Fu Panda, Madagascar: Escape 2 Africa,Monsters vs. Aliens, Marvel Ultimate Alliance 2, our first James Bond title,Quantum of Solace, and several other titles. We also expect to increase our titles across multiple platforms to take advantage of the expected growth of different hardware platforms in fiscal 2009. As a result, we anticipate net revenues will increase in fiscal 2009 in comparison to the record net revenues achieved in fiscal 2008. However, such increases may be offset by the impact of revenue deferral described below.
When we plan our fiscal 2009 titles releases, we continue to monitor the development of online functionality (together with online transactions, such as electronics downloads of titles or product add-ons) and its significance to our products. Based on our current assessment of obligations with respect to the online functionality for certain of our fiscal 2009 titles on certain platforms, we expect that certain fiscal 2009 titles will contain online functionality that constitutes a more-than-inconsequential separate service deliverable in addition to the product, and that our performance obligations for these fiscal 2009 titles will extend beyond the sale of the game. Vendor specific objective evidence of fair value does not exist for these online features, as we do not plan to separately charge for this component of these fiscal 2009 titles. As a result, we expect to recognize all of the revenue from the sale of these fiscal 2009 titles ratably over an estimated service period, which is currently estimated to be six months beginning the month after shipment. In addition, we expect to defer the costs of sales of these fiscal 2009 titles. We anticipate that, in fiscal 2009, we will likely defer approximately $350.0 million in net revenues and $150.0 million in costs of sales from the sale of these fiscal 2009 titles into fiscal 2010. Since most of these fiscal 2009 titles are planned to release in the third quarter fiscal 2009, we expect that a majority of revenues and costs of sales for these products will be deferred in the third quarter fiscal 2009, and recognized later in the calendar year 2009. However, the actual amount of revenues and costs of sales deferred will vary significantly depending upon the timing of the release of these fiscal 2009 titles and the sales volume of such products.
North America Publishing Net Revenues (amounts in thousands)
March 31, 2008 | % of Consolidated Net Revenues | March 31, 2007 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 1,761,753 | 61 | % | $ | 753,376 | 50 | % | $ | 1,008,377 | 134 | % |
North America publishing net revenues increased 134% from $753.4 million for the year ended March 31, 2007 to $1,761.8 million for the year ended March 31, 2008. The main revenue drivers for the year ended MarchDecember 31, 2008, wereGuitar Hero III:Legends of Rock andCall of Duty 4: Modern Warfare.Guitar Hero III: Legends of Rock, was the number one best-selling game in dollars in the U.S. for fiscal 2008, according to The NPD Group.Call of Duty 4: Modern Warfare ended the fiscal 2008 as the number three best-selling game in dollars in the U.S., according to The NPD Group. Other key revenue contributors during the year includeGuitar Hero II for the Xbox360,Spider-Man 3,Shrek the Third, and our new licensed intellectual propertyTRANSFORMERS: The Game.
North America publishing net revenues increased as a percentage of consolidated net revenues from 50% for the year ended March 31, 2007 to 61% for the year ended March 31, 2008. The increases in the percentages of total consolidated net revenues were a result of the stronger growth in net revenues for the publishing segment than that of the distribution segment during the year.
International Publishing Net Revenues (amounts in thousands)
March 31, 2008 | % of Consolidated Net Revenues | March 31, 2007 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 743,413 | 26 | % | $ | 365,662 | 24 | % | $ | 377,751 | 103 | % |
International publishing net revenues increased by 103% from $365.7 million for the year ended March 31, 2007 to $743.4 million for the year ended March 31, 2008. The increase in international publishing net revenues was primarily due to the increase in the number of titles released internationally in fiscal 2008, and the success ofGuitar Hero III:Legends of Rock andCall of Duty 4: Modern Warfare. We also grew our European market share from 4.8 percent to 7.4 percent during fiscal 2008, according to Charttrack and Gfk.
International publishing net revenues were further increased by a year over year strengthening of the EUR, AUD, and GBP in relation to the USD of approximately $63.0 million for the year ended March 31, 2008 as compared to the year ended March 31, 2007. Excluding the impact of changing foreign currency rates, our international publishing net revenues increased 86% year over year. As a percentage of consolidated net revenues, international publishing net revenues increased slightly from 24% for the year ended March 31, 2007 to 26% for the year ended March 31, 2008. The slight increase in the percentage of total consolidated net revenues was a result of the stronger growth in net revenues for the publishing segment than that of the distribution segment during the year.
Publishing Net Revenues by Platform
Publishing net revenues increased 124% from $1,119.0 million for the year ended March 31, 2007 to $2,505.2 million for the year ended March 31, 2008. The following table details our publishing net revenues by platform and as a percentage of total publishing net revenues for the years ended March 31, 2008 and 2007 (amounts in thousands):
| Year Ended March 31, 2008 | % of Publishing Net Revs | Year Ended March 31, 2007 | % of Publishing Net Revs | Increase/ (Decrease) | Percent Change | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Publishing Net Revenues | ||||||||||||||||||
PC | $ | 156,068 | 6 | % | $ | 78,886 | 7 | % | $ | 77,182 | 98 | % | ||||||
Console | ||||||||||||||||||
Sony PlayStation 3 | 313,123 | 13 | % | 53,842 | 5 | % | 259,281 | 482 | % | |||||||||
Sony PlayStation 2 | 716,922 | 29 | % | 500,927 | 45 | % | 215,995 | 43 | % | |||||||||
Microsoft Xbox360 | 785,476 | 31 | % | 200,394 | 18 | % | 585,082 | 292 | % | |||||||||
Nintendo Wii | 309,867 | 12 | % | 54,636 | 5 | % | 255,231 | 467 | % | |||||||||
Other | 4,411 | — | % | 76,996 | 7 | % | (72,585 | ) | (94 | )% | ||||||||
Total console | 2,129,799 | 85 | % | 886,795 | 80 | % | 1,243,004 | 140 | % | |||||||||
Hand-held | 219,299 | 9 | % | 153,357 | 13 | % | 65,942 | 43 | % | |||||||||
Total publishing net revenues | $ | 2,505,166 | 100 | % | $ | 1,119,038 | 100 | % | $ | 1,386,128 | 124 | % | ||||||
Personal Computer Net Revenues (amounts in thousands)
March 31, 2008 | % of Publishing Net Revenues | March 31, 2007 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 156,068 | 6 | % | $ | 78,886 | 7 | % | $ | 77,182 | 98 | % |
Net revenues from sales of titles for the PC increased 98% from $78.9 million for the year ended March 31, 2007 to $156.1 million for the year ended March 31, 2008. The increases were primarily due to the strong performance of our fiscal 2008 PC release ofCall of Duty 4: Modern Warfare. For fiscal 2008,Call of Duty 4: Modern Warfare was the number one PC title in dollars worldwide, according to The NPD Group, Charttrack and Gfk. The increase also resulted from an increased number of titles, both mainline titles and value titles, released on the PC. This compares to fiscal 2007 where net revenues were primarily derived from catalog sales ofCall of Duty 2,Quake 4 andThe Movies, as well as revenues from our European affiliate title LucasArts'Lego Star Wars II: The Original Trilogy.
We plan to release several key titles on the PC in fiscal 2009, however, we anticipate net revenues from the PC to be partially offset by the impact of revenue deferral as previously discussed.
Sony PlayStation 3 Net Revenues (amounts in thousands)
March 31, 2008 | % of Publishing Net Revenues | March 31, 2007 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 313,123 | 13 | % | $ | 53,842 | 5 | % | $ | 259,281 | 482 | % |
The PS3 was released in North America in November 2006 and in Europe in March 2007. With more than a full year for the installed base of the PS3 to expand, and our increased number of titles available on the PS3, net revenues from sales of titles for the PS3 increased 482% from $53.8 million, or 5% of publishing net revenues for the year ended March 31, 2007 to $313.1 million, or 13% of publishing net revenues for the year ended March 31, 2008. The increase was primarily attributable to the success ofCall of Duty 4: Modern Warfare, which was the number one best-selling title in dollars on the PS3, according to The NPD Group. Further, the increased number of titles available on the PS3 has increased our revenues from this platform. We released eight titles on the PS3 during fiscal 2008 as compared to three titles for fiscal 2007. During fiscal 2008, we releasedGuitar Hero III: Legends of Rock,Call of Duty 4: Modern Warfare,Spider-Man 3,TRANSFORMERS: The Game,Tony Hawk's Proving Ground,Soldier of Fortune: Payback,History Channel: Battle for the Pacific, and our European affiliate title LucasArts'Lego Star Wars: The Complete Saga on the PS3. This compares to the third quarter fiscal 2007 releases ofCall of Duty 3,Marvel:Ultimate Alliance andTony Hawk's Project 8.
Over the last twelve months, Sony has cut prices and introduced lower priced models of the PS3 hardware. These price reductions have grown the installed base of the PS3, which combined with our strong slate of titles led to a significant increase in net revenues on the PS3 platform. We expect net revenues from sales of titles for the PS3 to continue to increase as we plan to increase our releases on the PS3 to take advantage of the expected growth of the hardware installed base, however, we anticipate such increase will be partially offset by the impact of revenue deferral as previously discussed.
Sony PlayStation 2 Net Revenues (amounts in thousands)
March 31, 2008 | % of Publishing Net Revenues | March 31, 2007 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 716,922 | 29 | % | $ | 500,927 | 45 | % | $ | 215,995 | 43 | % |
In general, there was an overall decline in industry sales of titles for the PS2 as more consumers migrated to the next-generation platforms as compared to the prior year. However, net revenues from sales of our titles for the PS2 increased 43% from $500.9 million for the year ended March 31, 2007 to $716.9 million for the year ended March 31, 2008. The key titles impacting the fiscal 2008 results wereGuitar Hero III: Legends of Rock,Spider-Man: Friend or Foe,Bee Movie Game, Tony Hawk's Proving Ground,Guitar Hero: Rocks the 80s,Spider-Man 3,Shrek the Third, andTRANSFORMERS: The Game and the continued momentum for our fiscal 2007 third quarter titles. This compares to the titles released in fiscal 2007 such asCall of Duty 3, the number three title overall in dollars for the third quarter fiscal 2007, according to The NPD Group, andGuitar Hero II (game and accessories), the number one best-selling title in dollars on the PS2 platform for the third quarter fiscal 2007 per The NPD Group. Also, in fiscal 2007, we releasedMarvel: Ultimate Alliance, Over the Hedge, Tony Hawk's Project 8, X-Men: The Official Game, Shrek Smash N' Crash Racing and our European affiliate title, LucasArts'Star Wars Lego 2. As a percentage of publishing net revenues, net revenues from the PS2 decreased from 45% for the year ended March 31, 2007 to 29% for the year ended March 31, 2008. This was mainly attributable to the growth of net revenues from the next-generation platforms at a faster pace than revenues from the PS2.
Although we expect net revenues from sales of titles for the PS2 to decline over time as consumers transition to the next-generation platforms, we expect significant net revenues for the PS2 for fiscal 2009 as we plan to develop and release many of our key titles on this platform.
Microsoft Xbox360 Net Revenues (amounts in thousands)
March 31, 2008 | % of Publishing Net Revenues | March 31, 2007 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 785,476 | 31 | % | $ | 200,394 | 18 | % | $ | 585,082 | 292 | % |
Net revenues from sales of titles for the Xbox360 increased 292% from $200.4 million for the year ended March 31, 2007 to $785.5 million for the year ended March 31, 2008. As a percentage of publishing net revenues, net revenues from sales of titles for the Xbox360 increased from 18% for the year ended March 31, 2007 to 31% for the year ended March 31, 2008. These increases are due to the growing installed base for the Xbox360, as well as an increase in the number of new titles we released. In fiscal 2008, we released seventeen titles for this platform, and the key revenue drivers wereGuitar Hero III: Legends of Rock which was the number one best-selling game in dollars in the U.S. and Europe, andCall of Duty 4: Modern Warfare which was the number two best-selling game in dollars worldwide, according to The NPD Group, Charttrack, and Gfk. Other major titles released on the Xbox360 in fiscal 2008 such asTony Hawk's Proving Ground,Guitar Hero II, Spider-Man 3, andTRANSFORMERS: The Game also contributed to the increase in revenues. This compares to our fiscal 2007 releases of ten titles for this platform, three of which,Call of Duty 3, Tony Hawk's Project 8 andMarvel: Ultimate Alliance ranked among the top ten Xbox360 titles during the third quarter fiscal 2007, according to The NPD Group.
In August 2007, Microsoft announced a reduction of the retail price of the Xbox360 by $50 in the U.S. market and by EUR 50 in European markets. These price reductions have grown the installed base of the Xbox360, which combined with our strong slate of titles led to a significant increase in net revenues on the Xbox360 platform. We expect net revenues from sales of titles for the Xbox360 to continue to increase as we plan several key releases on the Xbox360 to take advantage of the expected growth of the hardware installed base, however, we anticipate such increase will be partially offset by the impact of revenue deferral as previously discussed.
Nintendo Wii Net Revenues (amounts in thousands)
March 31, 2008 | % of Publishing Net Revenues | March 31, 2007 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 309,867 | 12 | % | $ | 54,636 | 5 | % | $ | 255,231 | 467 | % |
The Wii was released in November 2006 and quickly gained strong consumer acceptance due to its innovative controller and mass market appeal. With more than a full year of expanding the installed base of the Wii and our increased number of new titles on the Wii, net revenues from the sales of titles for the Wii increased to $309.9 million for the year ended March 31, 2008 from $54.6 million for the year ended March 31, 2007. As a percentage of publishing net revenues, net revenues from the sales of titles for the Wii increased from 5% to 12% year over year. We released the first version of Guitar Hero for the Wii,Guitar Hero III: Legends of Rock in the third quarter fiscal 2008 which was the main contributor to our net revenues on the platform and the primary reason for the increase in net revenues from sales of Wii titles for the year ended March 31, 2008. Further, we have released fourteen other Wii titles during fiscal 2008 as compared to five Wii titles released during fiscal 2007. Some of the titles we released during fiscal 2008 wereBee Movie Game,Spider-Man: Friend or Foe,Tony Hawk's Proving Ground,Dancing with Stars,Barbie Island Princess,Cabela's: Big Game Hunter 2008 and, in Europe our affiliate LucasArt's titles,Thrillville: Off the Rails, andLego Star Wars: The Complete Saga. This compares to the five titles concurrently released with the release of the Wii in November 2006,Call of Duty 3,Marvel: Ultimate Alliance,World Series of Poker: Tournament of Champions,Rapala Tournament Fishing, andTony Hawk's Downhill Jam.
We expect net revenues from sales of titles for the Wii to continue to increase as we plan key releases on the Wii for the expected growth of the hardware installed base, however, we anticipate such increase will be partially offset by the impact of revenue deferral as previously discussed.
Hand-held Net Revenues (amounts in thousands)
March 31, 2008 | % of Publishing Net Revenues | March 31, 2007 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 219,299 | 9 | % | $ | 153,357 | 13 | % | $ | 65,942 | 43 | % |
Net revenues from sales of titles for the hand-held platforms increased 43% from $153.4 million for the year ended March 31, 2007 to $219.3 million for the year ended March 31, 2008. During fiscal 2008, we have released more "big proposition" titles which contributed to the increase in net revenues. The increase in net revenues was primarily due to the releases ofBee Movie Game,Call of Duty 4: Modern Warfare,Spider-Man: Friend or Foe,Shrek: Ogres and Donkeys, TRANSFORMERS: The Game on the PSP,TRANSFORMERS: Decepticon andTRANSFORMERS: Autobots exclusively on the NDS, and our European releases of two LucasArts' titles,Thrillville: Off the Rails, andLego Star Wars: The Complete Saga. This compares to the fiscal 2007 releases ofTony Hawk's Downhill Jam,Over the Hedge: Hammy Goes Nuts!,Barbie and the 12 Dancing Princesses,Marvel: Ultimate Alliance,Spider-Man: Battle for New York,Over the Hedge,X-Men: The Official Game,World Series of Poker: Tournament of Champions andRapala Trophies and our European affiliate title, LucasArts'Lego Star Wars II: The Original Trilogy. As a percentage of publishing net revenues, net revenues from hand-held platforms decreased from 13% for the year ended March 31, 2007 to 9% for the year ended March 31, 2008. This was mainly attributable to the growth of net revenues from the Guitar Hero titles on the next-generation platforms and the Guitar Hero titles were not yet available on the hand-held platforms during fiscal 2008. Our first Guitar Hero title on the hand-held platform will be released in fiscal 2009.
With the installed base of the NDS and PSP continuing to increase and our increasing presence on hand-held platform, such asGuitar Hero: On Tour, and several other titles, we expect fiscal 2009 hand-held net revenues to continue to increase year over year.
Overall
The platform mix of our future publishing net revenues will likely be impacted by a number of factors, including the ability of hardware manufacturers to continue to increase their installed hardware base for the next-generation platforms, as well as the performance of key product releases from our product release schedule. According to The NPD Group, we were the number one console and handheld software publisher in dollars for fiscal 2008. Additionally,Guitar Hero III: Legends of Rock, was the number one best-selling game in dollars in the U.S. and Europe for fiscal 2008, according to The NPD Group, Charttrack, and Gfk.Call of Duty 4: Modern Warfare ended the fiscal year as the number two best-selling game worldwide in units, with sell-through of more than 9 million units to date, according to The NPD Group, Charttrack and Gfk. In fiscal 2008, both the Guitar Hero and Call of Duty franchises surpassed a billion dollars in life to date net revenues.
A significant portion of our revenues and profits are derived from a relatively small number of popular titles and franchises each year, so revenues and profits are significantly affected by our ability to release highly successful "hit" titles. For example, for the year ended March 31, 2008, 65% of our consolidated net revenues and 75% of publishing net revenues were derived from net revenues from three franchises. This revenue concentration reflects an industry wide trend, with market share of the top 10 titles of calendar year 2007 doubling versus a year ago, according to The NPD Group. For fiscal 2008, we published three top-10 best-selling titles in dollars overall, according to The NPD Group. Though many of our titles have substantial production or acquisition costs and marketing budgets, once a title recoups these costs, incremental net revenues directly and positively impact operating profits resulting in a disproportionate amount of operating income being derived from these select titles. We expect that a limited number of titles and franchises will continue to produce a disproportionately large amount of our net revenues and profits.
Three key factors that could affect future publishing and distribution net revenues performance are console hardware pricing, software pricing, and transitions in console platforms. As console hardware moves through its life cycle, hardware manufacturers typically enact price reductions. Reductions in the price of console hardware typically result in an increase in the installed base of hardware owned by consumers. Historically, we have also seen that lower console hardware prices put downward pressure on software pricing. However, we expect console software launch pricing for the next-generation platforms to hold at current levels as a result of the strong consumer acceptancerationalization of these price points that has occurred since the launchour title portfolio; and
Distribution Net Revenues (amounts in thousands)
March 31, 2008 | % of Consolidated Net Revenues | March 31, 2007 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 392,970 | 14 | % | $ | 393,974 | 26 | % | $ | (1,004 | ) | 0 | % |
Distribution net revenues for the year ended March 31, 2008 decreased slightly from $394.0 million to $393.0 million year over year. Foreign exchange rates increased reported distribution net revenues by approximately $24.7 million for the year ended March 31, 2008. Excluding the impact of the changing foreign currency rates, our distribution net revenues decreased $25.7 million or 7% year over year. The decrease in absolute dollars of distribution net revenues for the year ended March 31, 2008 was primarily duesales related to the effectmanufacturing and distribution costs of the termination of a significant customer, which outweighed the beneficial effect of foreign currency rates. Distribution net revenues as a percentage of consolidated net revenues decreased from 26% for the year ended March 31, 2007 to 14% for the year ended March 31, 2008, primarily due to the significant increase in publishing net revenues.
The mix of distribution net revenues between hardware and software sales varied slightly year over year with approximately 26% of distribution net revenues from hardware sales for the year ended March 31, 2008 as compared to 17% for the year ended March 31, 2007. The mix of future distribution net revenues will be driven by a number of factors including the occurrence of further hardware price reductions instituted by hardware manufacturers, and our ability to establish and maintain distribution agreements with hardware manufacturers, third-party software publishers and retail customers. For fiscal 2009, we expect distribution net revenues to decrease in absolute dollars due to the full year effect of the termination of the significant customer when compared to fiscal 2008.
Costs and Expenses
Cost of Sales—Product Costs (amounts in thousands)
March 31, 2008 | % of Consolidated Net Revenues | March 31, 2007 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 1,240,605 | 43 | % | $ | 799,587 | 52 | % | $ | 441,018 | 55 | % |
"Cost of sales—product costs" increased 55% from $799.6 million for the year ended March 31, 2007 to $1,240.6 million for the year ended March 31, 2008. "Cost of sales—product costs" increased as a result of the revenue growth in our publishing businesses. "Cost of sales—product costs" as a percentage of consolidated net revenues decreased from 52% for the year ended March 31, 2007 to 43% for year ended March 31, 2008. The decrease in "cost of sales—product costs" as a percentage of consolidated net revenues was partially due to a higher percentage of net revenues for fiscal 2008 as compared to fiscal 2007, relating to our publishing business which in general carries a lower percentage "cost of sales—product costs" than our distribution business. Net revenues from our publishing business was 86% of total net revenues for the year ended March 31, 2008 as compared to 74% for the year ended March 31, 2007. As we increase our presence on the next-generation platforms, publishing net revenues during fiscal 2008 included a larger mix of next-generation product sales which carries lower product costs than the other console platforms.
We expect "cost of sales—product costs" as a percentage of consolidated net revenues for fiscal 2009 to be about in line with fiscal 2008.
Cost of Sales—Software Royalties and Amortization (amounts in thousands)
March 31, 2008 | % of Publishing Net Revenues | March 31, 2007 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 294,279 | 12 | % | $ | 132,353 | 12 | % | $ | 161,926 | 122 | % |
"Cost of sales—software royalties and amortization" as a percentage of publishing net revenues for the year ended March 31, 2008 remained constant from the prior fiscal year at 12%. In absolute dollars, "cost of sales—software royalties and amortization" increased from $132.4 million for the year ended March 31, 2007 to $294.3 million for the year ended March 31, 2008. The increase was the result of a larger slate of titles released leading to an increase in net revenues during fiscal 2008 when compared to fiscal 2007.
For fiscal 2009, we expect "costs of sales—software royalties and amortization" as a percentage of publishing net revenues to be about in line with fiscal 2008 levels.
Cost of Sales—Intellectual Property Licenses (amounts in thousands)
March 31, 2008 | % of Publishing Net Revenues | March 31, 2007 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 110,551 | 4 | % | $ | 46,125 | 4 | % | $ | 64,426 | 140 | % |
"Cost of sales—intellectual property licenses" increased in absolute dollars from $46.1 million for the year ended March 31, 2007 to $110.6 million for the year ended March 31, 2008 and remained constant as a percentage of publishing net revenues over the last fiscal year. This was primarily the result of the increase in net revenues and a larger movie slate with higher overall intellectual property costs, offset on a percentage of publishing net revenues by the larger growth of net revenues from titles of our wholly owned intellectual properties, such asGuitar Hero III: Legends of RockWorld Tour andband bundle products.Call of Duty 4: Modern Warfare, which do not have significant intellectual property costs.
For fiscal 2009, we expect "costs of sales—intellectual property licenses" as a percentage of publishing net revenues to be about in line with fiscal 2008 levels.
Product Development (amounts in thousands)
March 31, 2008 | % of Publishing Net Revenues | March 31, 2007 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 269,535 | 11 | % | $ | 133,073 | 12 | % | $ | 136,462 | 103 | % |
Product development expenses of $269.5 million and $133.1 million represented 11% and 12% of publishing net revenues for the years ended March 31, 2008 and 2007, respectively. The increase in product development expenses primarily resulted from costs incurred during fiscal 2008 to support the greater number of new titles in development, the more technologically advanced nature of those titles, the development costs of those titles that have not yet reached technological feasibility, and exceptional title performance during fiscal 2008 leading to increased costs for studio performance incentive plans.
For fiscal 2009, we expect product development expenses as a percentage of publishing net revenues to be about in line with fiscal 2008 levels.
Sales and Marketing (amounts in thousands)
March 31, 2008 | % of Consolidated Net Revenue | March 31, 2007 | % of Consolidated Net Revenue | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 308,143 | 10 | % | $ | 196,213 | 13 | % | $ | 111,930 | 57 | % |
Sales and marketing expenses of $308.1 million and $196.2 million represented 10% and 13% of consolidated net revenues for the years ended March 31, 2008 and 2007, respectively. The increases in absolute dollars were a result of higher spending associated with several larger and successful releases particularly in the third quarter fiscal 2008 and the movie-based releases in the first quarter fiscal 2008, and several marketing programs conducted in the fourth quarter fiscal 2008. As a result of the success of our title releases, our consolidated net revenues increased by a higher percentage than sales and marketing expenses which led to the decrease of sales and marketing expenses as a percentage of consolidated net revenues.
For fiscal 2009, we expect sales and marketing expenses as a percentage of consolidated net revenues to increase when compared to fiscal 2008 levels because of the effect of revenue deferral as previously discussed and the expected spending increases on sales and marketing to grow market share internationally and to support a larger slate of titles planned in fiscal 2009.
General and Administrative (amounts in thousands)
March 31, 2008 | % of Consolidated Net Revenues | March 31, 2007 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 195,409 | 7 | % | $ | 132,514 | 9 | % | $ | 62,895 | 47 | % |
General and administrative expenses of $195.4 million and $132.5 million represented 7% and 9% of consolidated net revenues for the years ended March 31, 2008 and 2007, respectively. Expenses were higher than prior year primarily due to an increase in headcount related costs due to the expansion of RedOctane to support the growth of the Guitar Hero titles, increased bonus accruals due to strong financial performances of the Company, costs related to Activision's pending merger with Vivendi Games, the consolidation and related amortization of intangibles related to DemonWare and Bizarre Creations (acquired in May 2007 and September 2007, respectively) included in our results of operations, and the impact of changes in foreign currency rates.
For fiscal 2009, we expect general and administrative expenses as a percentage of consolidated net revenues to increase when compared to fiscal 2008 levels because of the effect of revenue deferral as previously discussed although the expenses are expected to be about in line with fiscal 2008.
Operating Income (amounts in thousands)
| March 31, 2008 | % of Segment/ Consolidated Net Revs | March 31, 2007 | % of Segment/ Consolidated Net Revs | Increase/ (Decrease) | Percent Change | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Publishing | $ | 461,718 | 18 | % | $ | 64,076 | 6 | % | $ | 397,642 | 621 | % | |||||
Distribution | 17,896 | 5 | % | 9,071 | 2 | % | 8,825 | 97 | % | ||||||||
Consolidated | $ | 479,614 | 17 | % | $ | 73,147 | 5 | % | $ | 406,467 | 556 | % | |||||
Publishing Blizzard's operating income for the year ended MarchDecember 31, 2007 increased when compared to the year ended December 31, 2006 mainly attributable to the successful release in multiple markets ofWorld of Warcraft: The Burning Crusade (which had higher operating margins than the typical PC or console release), coupled with the implementation of new cost controls in the areas of sales and
marketing and general and administrative expenses. This was partially offset by higher expenses for incentive plans and increased product development spending.
Cash Flow Highlights (amounts in millions)
| For the years ended December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007 | 2006 | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | |||||||||||
| (as adjusted) | | | |||||||||||||
Cash provided by operating activities | $ | 379 | $ | 431 | $ | 233 | $ | (52 | ) | $ | 198 | |||||
Cash provided by (used in) investing activities | 1,101 | (68 | ) | (124 | ) | 1,169 | 56 | |||||||||
Cash provided by (used in) financing activities | 1,488 | (371 | ) | (77 | ) | 1,859 | (294 | ) |
For the year ended December 31, 2008, increased $397.6 million from $64.1 million for fiscal 2007 to $461.7 million for fiscal 2008. The increase was primarily due to:the following major cash activities occurred:
Distribution operating income for$22 million during the year ended MarchDecember 31, 2008 increased over2008;
On November 5, 2008, we announced that our Board of Directors authorized a significant customer that generated limited operating income, andstock repurchase program under which we may repurchase up to $1 billion of our common stock. Under this program, we may repurchase our common stock from time to time on the strong performanceopen market or in private transactions, including structured or accelerated transactions. In December 2008, we repurchased approximately 13 million shares of Activision titles for the year ended March 31, 2008.
Investment Income, Net (amounts in thousands)
March 31, 2008 | % of Consolidated Net Revenues | March 31, 2007 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 51,254 | 2 | % | $ | 36,678 | 2 | % | $ | 14,576 | 40 | % |
Investment income, net for the year ended Marchour common stock. At December 31, 2008, was $51.3we had approximately $874 million as compared to $36.7 millionavailable for utilization under the year ended March 31, 2007.buyback program and no outstanding stock repurchase transactions. The increase was primarily due to higher yields earned on our increasing portfolio of investments and cash equivalents, and a net realized gain inrepurchase program may be suspended or discontinued by the fourth quarter fiscal 2008 of $1.1 million on the sale of investments.Company at any time.
Provision for Income Taxes (amounts in thousands)
March 31, 2008 | % of Pre Tax Income | March 31, 2007 | % of Pre Tax Income | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 185,985 | 35 | % | $ | 24,038 | 22 | % | $ | 161,947 | 674 | % |
The aforementioned effective income tax rate for the year ended March 31, 2008 of 35% differs from our effective income tax rate of 22% for the year ended March 31, 2007 due to an increase in pretax income for fiscal 2008 versus the pretax income for fiscal 2007, without a corresponding increase in the benefit of book/tax differences. The lower effective income tax rate in fiscal 2007 was also due to the reversal of valuation allowance.
Net IncomeContents
Net income for the year ended March 31, 2008 was $344.9 million or $1.10 per diluted earnings per share, as compared to net income of $85.8 million or $0.28 per diluted earnings per share for the year ended March 31, 2007.
Results of Operations—Fiscal Years Ended MarchDecember 31, 2008, 2007, and 2006
Net RevenuesSpecial Note—The consummation of the Business Combination has resulted in financial information of Activision, Inc. being included from the date of the Business Combination (i.e. from July 9, 2008 onwards), but not for prior periods.
The following table details our consolidated net revenues by business segment and our publishing net revenues by territorygeographic area for the years ended MarchDecember 31, 2008, 2007, and 2006 (amounts in thousands)millions):
| For the fiscal years ended March 31, | | | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Increase/ (Decrease) | Percent Change | ||||||||||||
| 2007 | 2006 | ||||||||||||
Publishing net revenues | ||||||||||||||
North America | $ | 753,376 | $ | 710,040 | $ | 43,336 | 6 | % | ||||||
Europe | 324,999 | 404,157 | (79,158 | ) | (20 | )% | ||||||||
Other | 40,663 | 40,466 | 197 | — | % | |||||||||
Total international | 365,662 | 444,623 | (78,961 | ) | (18 | )% | ||||||||
Total publishing net revenues | 1,119,038 | 1,154,663 | (35,625 | ) | (3 | )% | ||||||||
Distribution net revenues | 393,974 | 313,337 | (80,637 | ) | 26 | % | ||||||||
Consolidated net revenues | $ | 1,513,012 | $ | 1,468,000 | $ | 45,012 | 3 | % | ||||||
| For the years ended December 31, | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007 | 2006 | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | ||||||||||||
| | (as adjusted) | | | | ||||||||||||
Geographic area net revenues: | |||||||||||||||||
North America | $ | 1,494 | $ | 620 | $ | 521 | $ | 874 | $ | 99 | |||||||
Europe | 1,288 | 555 | 359 | 733 | 196 | ||||||||||||
Asia Pacific | 227 | 164 | 135 | 63 | 29 | ||||||||||||
Total geographic area net revenues | 3,009 | 1,339 | 1,015 | 1,670 | 324 | ||||||||||||
Activision Blizzard's non-core exit operations | 17 | 10 | 3 | 7 | 7 | ||||||||||||
Consolidated net revenues | $ | 3,026 | $ | 1,349 | $ | 1,018 | $ | 1,677 | $ | 331 | |||||||
The increase inGeographically, consolidated net revenues increased in all regions for fiscalthe year ended December 31, 2008 compared to the same periods in 2007 was driven byand 2006 as a result of the following:
major releases:Doom 3 for the Xbox,Madagascar, Fantastic Four, Ultimate Spider-Man, X-Men Legends II, THAW, Call of Duty 2, Call of Duty 2: Big Red One, GUN, True Crime: New York City, Quake 4, Shrek SuperSlam, The Movies, Cabela's Dangerous Hunts 2, andWorld Series of Poker.
Partially offset by:
North America Publishing Net Revenues (amounts in thousands)
March 31, 2007 | % of Consolidated Net Revenues | March 31, 2006 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 753,376 | 50 | % | $ | 710,040 | 48 | % | $ | 43,336 | 6 | % |
North America publishing net revenues increased 6% from $710.0 million for the year ended March 31, 2006 to $753.4 million for the year ended March 31, 2007. Although the company released fewer titles in fiscal 2007, the high quality slate drove strong consumer demand and enabled the company to maintain pricing and record lower provisions for returns and price protection than in fiscal 2006. Net revenues were impacted by strong performances fromGuitar Hero 2, Call of Duty 3, Marvel: Ultimate Alliance andTony Hawk's Project 8. North America publishing net revenues increased as a percentage of consolidated net revenues from 48% for the year ended March 31, 2006 to 50% for the year ended March 31, 2007. The increase in the percentage of consolidated net revenues is due to a combination of strong performance in North America and a decrease in our international publishing net revenues due to a smaller slate and a decrease in the number of affiliate titles in Europe released in fiscal 2007.
International Publishing Net Revenues (amounts in thousands)
March 31, 2007 | % of Consolidated Net Revenues | March 31, 2006 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 365,662 | 24 | % | $ | 444,623 | 30 | % | $ | (78,961 | ) | (18 | )% |
International publishing net revenues decreased by 18% from $444.6 million for the year ended March 31, 2006 to $365.7 million for the year ended March 31, 2007. Additionally, international publishing net revenues as a percentage of consolidated net revenues decreased from 30% for the year ended March 31, 2006 to 24% for the year ended March 31, 2007. The decrease in international publishing net revenues was primarily due to the decrease in the number of titles released internationally in fiscal 2007. Additionally, in Europe, our net revenues were impacted by a decrease in revenues from our affiliate titles. Fiscal 2006 included the successful LucasArts' titles,Star Wars:
Revenge of the Sith andStar Wars Battlefront II, while fiscal 2007 included one major affiliate label release, LucasArts'Lego Star Wars II: The Original Trilogy. The decrease in international publishing net revenues was partially offset by a year over year strengthening of the EUR and the GBP in relation to the USD, which increased reported net revenues for fiscal 2007 by approximately $24.2 million. Excluding the impact of changing foreign currency rates, our international publishing net revenues decreased 23% year over year.
Publishing Net Revenues by Platform
Publishing net revenues decreased 3% from $1,154.7 million for the year ended March 31, 2006 to $1,119.0 million for the year ended March 31, 2007. The following table details our publishing net revenues by platform and as a percentage of total publishing net revenues for the years ended March 31, 2007 and 2006 (amounts in thousands):
| Year Ended March 31, 2007 | % of Publishing Net Revs | Year Ended March 31, 2006 | % of Publishing Net Revs | Increase/ (Decrease) | Percent Change | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Publishing Net Revenues | |||||||||||||||||
PC | $ | 78,886 | 7 | % | $ | 183,457 | 16 | % | $ | (104,571 | ) | (57 | )% | ||||
Console | |||||||||||||||||
Sony PlayStation 3 | 53,842 | 5 | % | — | — | % | 53,842 | n/a | |||||||||
Sony PlayStation 2 | 500,927 | 45 | % | 422,239 | 36 | % | 78,688 | 19 | % | ||||||||
Microsoft Xbox360 | 200,394 | 18 | % | 102,809 | 9 | % | 97,585 | 95 | % | ||||||||
Microsoft Xbox | 54,232 | 5 | % | 205,864 | 18 | % | (151,632 | ) | (74 | )% | |||||||
Nintendo Wii | 54,636 | 5 | % | — | — | % | 54,636 | n/a | |||||||||
Nintendo GameCube | 22,761 | 2 | % | 80,964 | 7 | % | (58,203 | ) | (72 | )% | |||||||
Other | 3 | — | % | 469 | — | % | (466 | ) | (99 | )% | |||||||
Total console | 886,795 | 80 | % | 812,345 | 70 | % | 74,450 | 9 | % | ||||||||
Hand-held | |||||||||||||||||
Game Boy Advance | 48,478 | 4 | % | 79,738 | 7 | % | (31,260 | ) | (39 | )% | |||||||
PlayStation Portable | 49,931 | 4 | % | 52,016 | 5 | % | (2,085 | ) | (4 | )% | |||||||
Nintendo Dual Screen | 54,948 | 5 | % | 27,107 | 2 | % | 27,841 | 103 | % | ||||||||
Total hand-held | 153,357 | 13 | % | 158,861 | 14 | % | (5,504 | ) | (3 | )% | |||||||
Total publishing net revenues | $ | 1,119,038 | 100 | % | $ | 1,154,663 | 100 | % | $ | (35,625 | ) | (3 | )% | ||||
Personal Computer Net Revenues (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 78,886 | 7 | % | $ | 183,457 | 16 | % | $ | (104,571 | ) | (57 | )% |
Net revenues from sales of titles for the PC decreased 57% from $183.5 million and 16% of publishing net revenues for the year ended March 31, 2006 to $78.9 million and 7% of publishing net revenues for the year ended March 31, 2007. The decreases were primarily due to the strong performance of our fiscal 2006 PC releases, as well as a decrease in the number of titles released for the PC during fiscal 2007 as compared to fiscal 2006. In fiscal 2006, we released the highly successful PC title,Call of Duty 2, which was ranked by NPD Funworld as the number two best selling PC title in the United States for the third quarter fiscal 2006, as well asQuake 4,The Movies, andDoom 3: Resurrection of Evil. This compares to fiscal 2007 where net revenues were primarily derived from catalog sales ofCall of Duty 2,Quake 4 andThe Movies, as well as revenues from our European affiliate title LucasArts'Lego Star Wars II: The Original Trilogy.
Sony PlayStation 3 Net Revenues (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 53,842 | 5 | % | $ | — | — | % | $ | 53,842 | n/a |
The PS3 was released in November 2006 in North America and in March 2007 in Europe. Consistent with our goal of having a significant presence at the launch of each new platform, we released three titles concurrently with the hardware releases:Call of Duty 3, Marvel: Ultimate Alliance, andTony Hawk's Project 8. All of these titles were released at premium retail pricing (i.e. $59.99 in the United States).
Sony PlayStation 2 Net Revenues (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 500,927 | 45 | % | $ | 422,239 | 36 | % | $ | 78,688 | 19 | % |
Net revenues from sales of titles for the PS2 increased 19% from $422.2 million for the year ended March 31, 2006 to $500.9 million for the year ended March 31, 2007. Although we released a fewer number of major titles for the PS2 in fiscal 2007, the strong performance of these releases, particularly the PS2 exclusive title Guitar Hero 2, resulted in higher net revenues in absolute dollars and as a percentage of publishing net revenues. The key titles impacting the fiscal 2007 results wereCall of Duty 3, the #3 title overall for the third quarter fiscal 2007, according to NPD Funworld, andGuitar Hero 2 (game and accessories), the #1 best selling title on the PS2 platform for the third quarter fiscal 2007 per NPD Funworld. In addition, we releasedMarvel: Ultimate Alliance, Over the Hedge, Tony Hawk's Project 8, X-Men: The Official Game, Shrek Smash N' Crash Racing and our European affiliate title, LucasArts'Star Wars Lego 2. This compares to fiscal 2006 where we released the PS2 titlesCall of Duty 2: Big Red One, Tony Hawk's American Wasteland, Shrek SuperSlam, GUN, True Crime: New York City, Madagascar, Fantastic Four, X-Men Legends 2, Ultimate Spiderman and two affiliate titles in Europe, LucasArts'Star Wars: Revenge of the Sith andStar Wars Battlefront II.
Microsoft Xbox360 Net Revenues (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 200,394 | 18 | % | $ | 102,809 | 9 | % | $ | 97,585 | 95 | % |
Net revenues from sales of titles for the Xbox360 increased 95% from $102.8 million for the year ended March 31, 2006 to $200.4 million for the year ended March 31, 2007. As a percentage of publishing net revenues, net revenues from sales of titles for the Xbox360 doubled from 9% for the year ended March 31, 2006 to 18% for the year ended March 31, 2007. These increases are due to the growing installed base for the Xbox360, as well as an increase in the number of titles released. In fiscal 2007, we released ten titles for this platform, and according to NPD Funworld, three of our titles,Call of Duty 3, Tony Hawk's Project 8 andMarvel: Ultimate Alliance ranked among the top ten Xbox 360 titles during the third quarter fiscal 2007. In fiscal 2006, we released four titles concurrently with the November 2005 launch of the Xbox360 hardware,Call of Duty 2, THAW, Quake 4, andGUN, and we experienced strong sales for these four titles although limited by hardware availability.
Microsoft Xbox Net Revenues (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 54,232 | 5 | % | $ | 205,864 | 18 | % | $ | (151,632 | ) | (74 | )% |
Net revenues from sales of titles for the Xbox decreased 74% from $205.9 million for the year ended March 31, 2006 to $54.2 million for the year ended March 31, 2007. As a percentage of publishing net revenues, net revenues from sales of titles for the Xbox decreased from 18% for the year ended March 31, 2006 to 5% for the year ended March 31, 2007. These decreases were primarily attributable to a slowdown in sales for the Xbox as customers upgrade to the Xbox360, and the reduction in the number of titles released by us for this platform. In fiscal 2007 we released five major titles for Xbox:Call of Duty 3, Tony Hawk's Project 8, Marvel: Ultimate Alliance, Over the Hedge andX-Men: The Official Game. In fiscal 2006, we released our largest slate includingCall of Duty: Big Red One, Tony Hawk's American Wasteland, GUN, Ultimate Spiderman, X-Men Legends 2, True Crime: New York City, Shrek: SuperSlam, Madagascar, Fantastic Four and the Xbox exclusive, Doom 3.
Nintendo Wii Net Revenues (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 54,636 | 5 | % | $ | — | — | % | $ | 54,636 | n/a | % |
The Nintendo Wii was released in November 2006. Consistent with our goal of having a significant presence at the launch of each next generation platform, we released five titles concurrently with the release of Wii;Call of Duty 3, Marvel: Ultimate Alliance, World Series of Poker: Tournament of Champions, Rapala Tournament Fishing, andTony Hawk's Downhill Jam. With the strong consumer demand for the platform, our five releases performed well, three of which were top ten Wii titles in the third quarter fiscal 2007, according to NPD Funworld:Call of Duty 3, Marvel Ultimate Alliance and Tony Hawk's Downhill Jam.
Nintendo GameCube Net Revenues (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 22,761 | 2 | % | $ | 80,964 | 7 | % | $ | (58,203 | ) | (72 | )% |
Net revenues from sales of titles for the Nintendo GameCube decreased 72% from $81.0 million for the year ended March 31, 2006 to $22.8 million for the year ended March 31, 2007. The decrease in absolute dollars and as a percentage of publishing net revenues reflects a decrease in the number of new releases in fiscal 2007 compared to fiscal 2006 and a significant slowdown in sales on the GameCube platform as customers transition to the next generation platforms. In fiscal 2006, we released nine major titles:Madagascar, Tony Hawk's American Wasteland, Ultimate Spiderman, Fantastic Four, Call of Duty: Big Red One, True Crime: New York City, GUN, Shrek Super Slam andX-Men Legends 2. This compares to fiscal 2007 when we released four titles:Over the Hedge, X-Men: The Official Game, Shrek Smash N' Crash Racing, and our European affiliate title,Star Wars Lego 2.
Hand-held Net Revenues (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 153,357 | 13 | % | $ | 158,861 | 14 | % | $ | (5,504 | ) | (3 | )% |
Net revenues from sales of titles for the hand-held platforms decreased 3% from $158.9 million for the year ended March 31, 2006 to $153.4 million for the year ended March 31, 2007. Hand-held net revenues as a percentage of publishing net revenues decreased slightly from 14% to 13%. Within the hand-held platforms, net revenues for the GBA platform decreased 39%, from $79.7 million for the prior fiscal year, to $48.5 million for fiscal 2007, PSP decreased by 4%, from $52.0 million to $49.9 million, and net revenues for the NDS doubled from $27.1 million for fiscal 2006 to $54.9 million for the current year. The decrease in net revenues for GBA is primarily related to slower GBA sales due to wider acceptance of the NDS platform. The net revenue increase for NDS reflects the strong performance of our key fiscal 2007 titles which includesOver the Hedge, Tony Hawk's Downhill Jam, X-Men: The Official Game, Spider-Man: Battle for New York and LucasArts'Star Wars Lego 2 in Europe, as the platform continued to gain consumer acceptance and market share. PSP net revenues for fiscal 2007 were slightly lower than the previous year. In fiscal 2006, we released a stronger PSP slate and our titles performed well with the consumer excitement for the March 2005 North America platform launch, and the September 2005 European platform launch. The 2006 slate includedTony Hawk's Underground 2, Spider-Man: The Movie 2, X-Men Legends 2, World Series of Poker, and two affiliate titles in Europe. Our key releases in fiscal 2007 wereMarvel: Ultimate Alliance, Tony Hawk's Project 8, Call of Duty: Roads to Victory, and one European affiliate title, LucasArts'Star Wars Lego 2.
Distribution Net Revenues (amounts in thousands)
March 31, 2007 | % of Consolidated Net Revenues | March 31, 2006 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 393,974 | 26 | % | $ | 313,337 | 21 | % | $ | 80,637 | 26 | % |
Distribution net revenues for the year ended March 31, 2007 increased 26% from the prior fiscal year, from $313.3 million to $394.0 million. Foreign exchange rates increased reported distribution net revenues by approximately $27.3 million for the year ended March 31, 2007. Excluding the impact of the changing foreign currency rates, our distribution net revenues increased $53.3 million or 17% year over year. This year over year increase was primarily due to the strong releases for certain third-party publishers, increased hardware sales primarily related to the launch of two new platforms in fiscal 2007, the PS3 and the Nintendo Wii, as well as ongoing sales of NDS and PSP hardware, and the addition of a new customer in the second quarter fiscal 2007.
The mix of distribution net revenues between hardware and software sales varied year over year with approximately 17% of distribution net revenues from hardware sales in the year ended March 31, 2007 as compared to 20% in the prior fiscal year. Fiscal 2007 results included the hardware releases of the Nintendo Wii in November 2006 and the PS3 in late March 2007. Fiscal 2006 included the release of the PSP in Europe in the second quarter and the Xbox360 in November 2005. The mix of future distribution net revenues will be driven by a number of factors including the occurrence of further hardware price reductions instituted by hardware manufacturers, and our ability to establish and maintain distribution agreements with hardware manufacturers, third-party software publishers and retail customers.
Costs and Expenses
Cost of Sales—Product Costs (amounts in thousands)
March 31, 2007 | % of Consolidated Net Revenues | March 31, 2006 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 799,587 | 52 | % | $ | 734,874 | 50 | % | $ | 64,713 | 9 | % |
"Cost of sales—product costs" represented 52% and 50% of consolidated net revenues for the years ended MarchDecember 31, 2008, 2007, and 2006 respectively. In absolute dollars, "cost of sales—product costs"(amounts in millions):
| Year ended December 31, 2008 | % of total consolidated net revs. | Year ended December 31, 2007 | % of total consolidated net revs. | Year ended December 31, 2006 | % of total consolidated net revs. | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | (as adjusted) | | | | | | |||||||||||||||||||
Platform net revenues: | |||||||||||||||||||||||||||
MMORPG | $ | 1,152 | 38 | % | $ | 1,024 | 76 | % | $ | 621 | 61 | % | $ | 128 | $ | 403 | |||||||||||
PC | 99 | 3 | 94 | 7 | 80 | 8 | 5 | 14 | |||||||||||||||||||
Console: | |||||||||||||||||||||||||||
Sony PlayStation 3 | 241 | 8 | 22 | 2 | —- | — | 219 | 22 | |||||||||||||||||||
Sony PlayStation 2 | 284 | 9 | 71 | 5 | 155 | 15 | 213 | (84 | ) | ||||||||||||||||||
Microsoft Xbox 360 | 361 | 12 | 35 | 3 | 30 | 3 | 326 | 5 | |||||||||||||||||||
Nintendo Wii | 407 | 14 | 25 | 2 | 4 | 1 | 382 | 21 | |||||||||||||||||||
Microsoft Xbox | 1 | — | 3 | — | 29 | 3 | (2 | ) | (26 | ) | |||||||||||||||||
Nintendo GameCube | — | — | — | — | 13 | 1 | — | (13 | ) | ||||||||||||||||||
Total console | 1,294 | 43 | 156 | 12 | 231 | 23 | 1,138 | (75 | ) | ||||||||||||||||||
Hand-held | 237 | 8 | 65 | 4 | 83 | 8 | 172 | (18 | ) | ||||||||||||||||||
Total platform net revenues: | 2,782 | 92 | 1,339 | 99 | 1,015 | 100 | 1,443 | 324 | |||||||||||||||||||
Distribution | 227 | 7 | — | — | — | — | 227 | — | |||||||||||||||||||
Activision Blizzard's non-core exit operations | 17 | 1 | 10 | 1 | 3 | — | 7 | 7 | |||||||||||||||||||
Total consolidated net revenues | $ | 3,026 | 100 | % | $ | 1,349 | 100 | % | $ | 1,018 | 100 | % | $ | 1,677 | $ | 331 | |||||||||||
MMORPG net revenues increased 9% from $734.9 million for the year ended MarchDecember 31, 20062008 compared to $799.6 millionthe same period in 2007 as a result of the continued growth ofWorld of Warcraft, including the successful launch ofWorld of Warcraft: Wrath of the Lich King in the fourth quarter of 2008. According to The NPD Group, Gfk, and Charttrack, Blizzard'sWorld of Warcraft: Wrath of the Lich King was the #1 PC title by dollars in North America and Europe. MMORPG net revenues increased for the year ended December 31, 2007 compared to the same period in 2006 as a result of the continued growth ofWorld of Warcraft, including the successful release ofWorld of Warcraft: The Burning Crusade in January 2007.
Net revenues from various consoles and hand-held platforms increased for the year ended December 31, 2008, compared to the same periods in 2007 and 2006 due to the following:
Cost of Sales
The primary factors affectingfollowing table details the increasenature of our cost of sales in "cost of sales—product costs" in absolute dollars and as a percentage of total consolidated net revenues were:
Partially offset by:
Cost of Sales—Software Royalties and Amortization (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 132,353 | 12 | % | $ | 147,822 | 13 | % | $ | (15,469 | ) | (10 | )% |
"Cost of sales—software royalties and amortization" for the year ended March 31, 2007 decreased as a percentage of publishing net revenues from the prior fiscal year, from 13% to 12%. In absolute dollars, "cost of sales—software royalties and amortization" for the year ended March 31, 2007 also decreased from the prior fiscal year, from $147.8 million to $132.4 million. The decreases were mainly due to:
Cost of Sales—Intellectual Property Licenses (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 46,125 | 4 | % | $ | 57,666 | 5 | % | $ | (11,541 | ) | (20 | )% |
"Cost of sales—intellectual property licenses" for the year ended March 31, 2007 decreased in absolute dollars and as a percentage of publishing net revenues over the same period last year, from $57.7 million to $46.1 million and from 5% to 4%, respectively. The decreases in both absolute dollars and as a percentage of publishing net revenues were due mainly to a decrease in the number of titles with associated intellectual property in fiscal 2007 compared to fiscal 2006. In fiscal 2007, we released the following titles with associated intellectual property:Marvel: Ultimate Alliance, Over the Hedge, X-Men: Official Game, Guitar Hero 1 and 2, Tony Hawk's Project 8 andTony Hawk's Downhill Jam. In fiscal 2006, we released the following titles with associated intellectual property:Doom 3 for the Xbox,Madagascar, Fantastic Four, Ultimate Spider-Man, X-Men Legends II, THAW, Quake IV, andShrek SuperSlam.
Product Development (amounts in thousands)
March 31, 2007 | % of Publishing Net Revenues | March 31, 2006 | % of Publishing Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 133,073 | 12 | % | $ | 132,651 | 11 | % | $ | 422 | — | % |
Product development expenses of $133.1 million and $132.7 million represented 12% and 11% of publishing net revenues for the years ended MarchDecember 31, 2008, 2007, and 2006 respectively. The increases(amounts in both absolute dollarsmillions):
| Year ended December 31, 2008 | % of total consolidated net revs. | Year ended December 31, 2007 | % of total consolidated net revs. | Year ended December 31, 2006 | % of total consolidated net revs. | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | (as adjusted) | | | | | | |||||||||||||||||
Product costs | $ | 1,160 | 38 | % | $ | 171 | 13 | % | $ | 153 | 15 | % | $ | 989 | $ | 18 | |||||||||
Software royalties and amortization | 267 | 9 | 52 | 4 | 71 | 7 | 215 | (19 | ) | ||||||||||||||||
Intellectual property licenses | 219 | 7 | 9 | 1 | 24 | 2 | 210 | (15 | ) | ||||||||||||||||
MMORPG | 193 | 7 | 204 | 15 | 119 | 12 | (11 | ) | 85 |
For the year ended December 31, 2008, cost of sales increased compared to the same periods in 2007 and as a percentage of net revenues was2006 primarily generated by:due to:
Product Development (amounts in millions)
| Year ended December 31, 2008 | % of consolidated net revenues | Year ended December 31, 2007 | % of consolidated net revenues | Year ended December 31, 2006 | % of consolidated net revenues | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Product development | $ | 592 | 20 | % | $ | 397 | 29 | % | $ | 246 | 24 | % | $ | 195 | $ | 151 |
For the year ended December 31, 2008, product development capacity at certain studios as well ascosts increased compared to the addition of Red Octane.
same periods in 2007 and 2006. The increase was primarily attributable to the following:
Partially offset by:
Sales and Marketing (amounts in thousands)millions)
March 31, 2007 | % of Consolidated Net Revenue | March 31, 2006 | % of Consolidated Net Revenue | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 196,213 | 13 | % | $ | 283,395 | 19 | % | $ | (87,182 | ) | (31 | )% |
| Year ended December 31, 2008 | % of total consolidated net revs. | Year ended December 31, 2007 | % of total consolidated net revs. | Year ended December 31, 2006 | % of total consolidated net revs. | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Sales and marketing | $ | 464 | 15 | % | $ | 172 | 13 | % | $ | 147 | 14 | % | $ | 292 | $ | 25 |
SalesFor the year ended December 31, 2008, sales and marketing expensesincreased compared to the same periods in 2007 and 2006. The increase in sales and marketing was mainly the result of:
Restructuring Charges (amounts in millions)
| Year ended December 31, 2008 | % of total consolidated net revs. | Year ended December 31, 2007 | % of total consolidated net revs. | Year ended December 31, 2006 | % of total consolidated net revs. | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Restructuring | $ | 93 | 3 | % | $ | (1 | ) | — | % | $ | 4 | — | % | $ | 94 | $ | (5 | ) |
In the September quarter of 2008, we implemented an organizational restructuring as a result of the Business Combination. This organizational restructuring is to integrate different operations and 19%to streamline the combined Activision Blizzard organization. The implementation of the organizational restructuring resulted in the following restructuring charges: severance costs, contract termination costs, fixed asset write-off on disposals, impairment charges on acquired trade names, prepaid royalties, intellectual property licenses, impairment charges on goodwill and loss on disposal of assets/liabilities. We communicated to the affected employees and ceased use of certain offices under operating lease contracts. We anticipate substantially exiting or winding down our non-core operations and substantially completing the organizational restructuring activities as a result of the Business Combination by June 2009.
See Note 8 of the Notes to Consolidated Financial Statements for more detail and a roll forward of the restructuring liability that includes the beginning and ending liability, costs incurred for the year, cash payments, and non-cash write-downs.
General and Administrative (amounts in millions)
| Year ended December 31, 2008 | % of total consolidated net revs. | Year ended December 31, 2007 | % of total consolidated net revs. | Year ended December 31, 2006 | % of total consolidated net revs. | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
General and administrative | $ | 271 | 9 | % | $ | 166 | 12 | % | $ | 133 | 14 | % | $ | 105 | $ | 33 |
For the year ended December 31, 2008, general and administrative costs increased in absolute amount and decreased as percentage of consolidated net revenues forcompared to the years ended March 31,same periods in 2007 and 2006, respectively.2006. The decrease in both absolute dollars and as a percentage of net revenuesincrease was a resultmainly attributable to the consummation of the implementationBusiness Combination, which resulted in general and administrative expenses from Activision, Inc. of a more targeted media program which worked more efficiently helped byapproximately $125 million, (including integration and transaction expenses of $29 million) being included from the overall strength and high qualitydate of our fiscal 2007 title slate. We also released fewer titles in fiscal 2007 compared to fiscal 2006, when we had the largest slate of new releases in our history.Business Combination, but not for prior periods. The decreases wereincrease was partially offset by expenses of $5.1 million in fiscal 2007 related to stock-based compensation expensereduced salary and benefit costs as a result of the implementation of SFAS No. 123R, as well as sales and marketing expenses associated with the acquisition of the Guitar Hero franchise.our organizational restructuring.
General and AdministrativeInvestment Income (Loss), Net (amounts in thousands)millions)
March 31, 2007 | % of Consolidated Net Revenues | March 31, 2006 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 132,514 | 9 | % | $ | 96,366 | 7 | % | $ | 36,148 | 38 | % |
| Year ended December 31, 2008 | % of total consolidated net revs. | Year ended December 31, 2007 | % of total consolidated net revs. | Year ended December 31, 2006 | % of total consolidated net revs. | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2008 v 2006 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Investment income (loss) | $ | 46 | 2 | % | $ | (4 | ) | — | % | $ | (15 | ) | (1 | )% | $ | 50 | $ | 11 |
GeneralOur cash, cash equivalents, and administrative expensesinvestment portfolio, comprised primarily of $132.5 millioncash and $96.4 million represented 9% and 7% of consolidatedcash equivalents, was $3 billion at December 31, 2008. Vivendi Games maintained a net revenues for the years ended Marchpayable balance with Vivendi at December 31, 2007 and 2006, respectively. The increases were primarily due to increased legal expenses and professional fees relating primarily to our internal review of historical stock option granting practices, the consolidation of RedOctane into our results of operations, amortization of intangible assets related to the RedOctane acquisition, and stock-based compensation expense of $10.0 million in fiscal 2007 as a result of the implementation of SFAS No. 123R. These increases were partially offset by the benefits of our cost optimization program launched in the fourth quarter fiscal 2006 and gains on foreign currency.
Operating Income (amounts in thousands)
| March 31, 2007 | % of Segment Net Revenues | March 31, 2006 | % of Segment Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Publishing | $ | 64,076 | 6 | % | $ | (6,715 | ) | (1 | )% | $ | 70,791 | 1,054 | % | ||||
Distribution | 9,071 | 2 | % | 21,941 | 7 | % | (12,870 | ) | (59 | )% | |||||||
Consolidated | $ | 73,147 | 5 | % | $ | 15,226 | 1 | % | $ | 57,921 | 380 | % | |||||
Publishing operating2006. Investment income for the year ended MarchDecember 31, 2007 increased $70.8 million2008, was primarily derived from the same period lastinterest income from investments in money market funds, mark-to-market gains on our outstanding currency forward contracts, and an unrealized gain on a put option from UBS AG ("UBS"), compared with net interest expense for the past two years.
Income Tax Benefit (amounts in millions)
| Year ended December 31, 2008 | % of Pretax income | Year ended December 31, 2007 | % of Pretax income | Year ended December 31, 2006 | % of Pretax income | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Income Tax Benefit | $ | (80 | ) | (43 | )% | $ | (52 | ) | (30 | )% | $ | (33 | ) | (31 | )% | $ | 28 | $ | 19 |
The effective tax rate was (43)%, (30)%, and (31)% for the years ended December 31, 2008, 2007, and 2006, respectively. For the year from an operating loss of $6.7 million to operating income of $64.1 million. The increase was primarily due to:
Partially offset by:
Distribution operating income for the year ended March 31, 2007 decreased over the same period last year, from $21.9 million to $9.1 million. The decrease in operating income in 2007 was primarily due to increased business from large mass-market customers for which we earn smaller margins, anvaluation allowances.
increase in hardware sales which carries a lower margin than software, and higher reserves for inventory obsolescence.
Investment Income, Net (amounts in thousands)
March 31, 2007 | % of Consolidated Net Revenues | March 31, 2006 | % of Consolidated Net Revenues | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 36,678 | 2 | % | $ | 30,630 | 2 | % | $ | 6,048 | 20 | % |
Investment income, net for the year ended March 31, 2007 was $36.7 million as compared to $30.6 million for the year ended March 31, 2006. The increase was primarily due to higher yields earned on our short term investments and cash equivalents, and a realized gain in the third quarter fiscal 2007Table of $1.8 million on the sale of an investment in common stock.
Provision for Income Taxes (amounts in thousands)
March 31, 2007 | % of Pre Tax Income | March 31, 2006 | % of Pre Tax Income | Increase/ (Decrease) | Percent Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
$ | 24,038 | 22 | % | $ | 5,605 | 12 | % | $ | 18,433 | 329 | % |
The income tax provision of $24.0 million for the year ended March 31, 2007 reflects our effective income tax rate of 22%. This is higher than prior years as a result of an increase in pretax income for the year ended March 31, 2007, versus the amount of pretax income for the year ended March 31, 2006, without a corresponding increase in the benefit of book/tax differences. The significant items that generated the variance between our effective rate and our statutory rate of 35% were research and development tax credits, the impact of foreign tax rate differentials, and the elimination of the valuation allowance for research and development tax credits, partially offset by state taxes and the establishment of tax reserves for these credits and other deferred tax assets.
Net IncomeContents
Net income for the year ended March 31, 2007 was $85.8 million or $0.28 per diluted share, as compared to $40.3 million or $0.14 per diluted share for the year ended March 31, 2006.
Selected Quarterly Operating Results
Our quarterly operating results have in the past varied significantly and will likely vary significantly in the future, depending on numerous factors, several of which are not under our control. See Item 1A—"Risk Factors." Our business also has experienced and is expected to continue to experience significant seasonality, largely due to consumer buying patterns and our product release schedule focusing on those patterns. Net revenues typically are significantly higher during the fourth calendar quarter, primarily due to the increased demand for consumer software during the year-end holiday buying season. Accordingly, we believe that period to period comparisons of our operating results are not necessarily meaningful and should not be relied upon as indications of future performance.
The following table is a comparative breakdown of our unaudited quarterly results for the immediately preceding eight quarters (amounts in thousands, except per share data):
| For the quarters ended | ||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| March 31, 2008 | Dec. 31, 2007 | Sept. 30, 2007 | June 30, 2007 | March 31, 2007 | Dec. 31, 2006 | Sept. 30, 2006 | June 30, 2006 | |||||||||||||||||
Net revenues | $ | 602,451 | $ | 1,482,484 | $ | 317,746 | $ | 495,455 | $ | 312,512 | $ | 824,259 | $ | 188,172 | $ | 188,069 | |||||||||
Cost of sales | 350,229 | 762,290 | 204,956 | 327,960 | 216,007 | 483,180 | 141,078 | 137,800 | |||||||||||||||||
Operating income (loss) | 54,533 | 404,534 | (9,545 | ) | 30,092 | (29,114 | ) | 173,120 | (37,410 | ) | (33,449 | ) | |||||||||||||
Net income (loss) | 44,163 | 272,196 | 698 | 27,826 | (14,422 | ) | 142,820 | (24,302 | ) | (18,309 | ) | ||||||||||||||
Basic earnings (loss) per share | 0.15 | 0.93 | 0.00 | 0.10 | (0.05 | ) | 0.51 | (0.09 | ) | (0.07 | ) | ||||||||||||||
Diluted earnings (loss) per share | 0.14 | 0.86 | 0.00 | 0.09 | (0.05 | ) | 0.46 | (0.09 | ) | (0.07 | ) |
Liquidity and Capital Resources
Sources of Liquidity (amounts in millions)
| As of and for the years ended March 31, | | ||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Increase/ (Decrease) | |||||||||||||||||||||||||
| 2008 | 2007 | For the years ended December 31, | |||||||||||||||||||||||
| (amounts in thousands) | 2008 | 2007 | 2006 | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | ||||||||||||||||||||
Cash and cash equivalents | $ | 1,396,250 | $ | 384,409 | $ | 1,011,841 | $ | 2,958 | $ | 62 | $ | 68 | $ | 2,896 | $ | (6 | ) | |||||||||
Short-term investments | 52,962 | 570,440 | (517,478 | ) | 44 | 3 | 2 | 41 | 1 | |||||||||||||||||
$ | 1,449,212 | $ | 954,849 | $ | 494,363 | $ | 3,002 | $ | 65 | $ | 70 | $ | 2,937 | $ | (5 | ) | ||||||||||
Percentage of total assets | 57 | % | 53 | % | 20 | % | 7 | % | 9 | % | ||||||||||||||||
Cash flows provided by operating activities | $ | 573,500 | $ | 27,162 | $ | 546,338 | ||||||||||||||||||||
Cash flows provided by (used in) investing activities | 326,291 | (35,242 | ) | 361,533 | ||||||||||||||||||||||
Cash flows provided by financing activities | 105,163 | 27,968 | 77,195 |
As of March 31, 2008,
| For the years ended December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | 2007 | 2006 | Increase/ (decrease) 2008 v 2007 | Increase/ (decrease) 2007 v 2006 | |||||||||||
| | (as adjusted) | | | | |||||||||||
Cash flows provided by operating activities | $ | 379 | $ | 431 | $ | 233 | $ | (52 | ) | $ | 198 | |||||
Cash flows provided by (used in) investing activities | 1,101 | (68 | ) | (124 | ) | 1,169 | 56 | |||||||||
Cash flows provided by (used in) financing activities | 1,488 | (371 | ) | (77 | ) | 1,859 | (294 | ) | ||||||||
Effect of foreign exchange rate changes | (72 | ) | 2 | 4 | (74 | ) | (2 | ) | ||||||||
Net increase (decrease) in cash and cash equivalents | $ | 2,896 | $ | (6 | ) | $ | 36 | $ | 2,902 | $ | (42 | ) | ||||
In addition to cash flows provided by operating activities, our primary source of liquidity is comprised of $1,396.3 millionwas $3 billion of cash and cash equivalents and $53.0 million of short-term investments. Overat December 31, 2008. Through the last two years, our primary sources of liquidity have includedBusiness Combination, Activision, Inc.'s cash on hand at the beginning of the year and cash flows generatedequivalents of approximately $1.1 billion became part of Activision Blizzard's balances and we received $1.7 billion of cash from continuing operations. We have also generated cash flows from theVivendi in exchange for issuance of shares of our common stockstock. With our liquid investment portfolio and expected cash flows provided by operating activities, we believe that we have sufficient liquidity to employees through the exercise of options, which is described in more detail below in "Cash Flows from Financing Activities." We have not utilized debt financing as a significant source of cash flows. However, we do have available at certain of our international locations credit facilities, which are described below in "Credit Facilities," that can be utilized if needed.
Following the closing of our proposed business combination with Vivendi Games, Inc. (see Note 20 of the Notes to Consolidated Financial Statements included in Item 8), Activision Blizzard, Inc. ("Activision Blizzard") will commence a cash tender offer for up to 146.5 million of its shares at $27.50 per share. If the tender offer is fully subscribed, the aggregate consideration will be approximately $4.028 billion. Under the terms of the business combination agreement ("BCA"), we and Vivendi S.A. ("Vivendi") have agreed the purchase of the shares tenderedmeet daily operations in the tender offer will be funded as follows: (a) the first $2.928 billion of the aggregate consideration will be funded by Activision Blizzard with proceeds from the share purchase described in Note 20 of the Notes to Consolidated Financial Statements included in Item 8, available cash on hand and, if necessary, borrowings made under one or more new credit facilities; (b) if the aggregate consideration is more than $2.928 billion, Vivendi has agreed to purchase from Activision Blizzard, at a purchase price of $27.50 per share, additional newly issued shares of Activision Blizzard common stock in an amount equal to the lesser of (x) $700.0 million and (y) the excess of the aggregate consideration over $2.928 billion, which amount will be used to fund the amount of the aggregate consideration that is in excess of $2.928 billion; and (c) if the aggregate consideration exceeds $3.628 billion, Activision Blizzard will fund the additional amount of the aggregate consideration that is in excess of $3.628 billion (up to the maximum aggregate consideration of $4.028 billion) through borrowings made under the new credit facilities issued by Vivendi (see below and Note 21 of the Notes to Consolidated Financial Statements included in Item 8.)
On April 29, 2008, we, acting on behalf of Activision Blizzard, entered into a senior unsecured credit agreement (the "Credit Agreement") with Vivendi. Borrowings under the Credit Agreement cannot be effected until the consummation of the transactions contemplated by the business combination agreement described above (the "Transactions.") After the closing of the Transactions, among other things, the Company's name will be changed to Activision Blizzard.
After the closing of the Transactions, the Credit Agreement will provide Activision Blizzard with (i) a term loan credit facility (the "Tranche A Facility") in an aggregate amount of up to $400.0 million to be applied to fund that portion of the post-closing tender offer consideration in excess of
$3.628 billion as set forth in the BCA, (ii) a term loan credit facility (the "Tranche B Facility") in an aggregate amount of up to $150.0 million to be applied to repay certain indebtedness of Vivendi Games after the closing in accordance with the terms of the BCA, and (iii) a revolving credit facility (the "Revolving Facility," and collectively with the Tranche A Facility and the Tranche B Facility, the "New Credit Facilities") in an aggregate amount of up to $475.0 million to be used after the closing of the Transactions for general corporate purposes. In the event the BCA terminates prior to the closing of the Transactions, the New Credit Facilities will terminate effective on the same date (see Note 21 of the Notes to Consolidated Financial Statements included in Item 8).
foreseeable future. We also believe that we have sufficient working capital ($1,423.3 million(approximately $3 billion at MarchDecember 31, 2008), as well as proceeds available fromavailability under our international credit facilities, to finance our operational requirements for at least the next twelve months, including purchases of inventory and equipment, the funding of the development, production, marketing and sale of new products, to finance the acquisition of intellectual property rights for future products from third parties, the restructuring activities, and to fund the completionstock repurchase program we announced on November 5, 2008.
On November 5, 2008, we announced that our Board of Directors authorized a stock repurchase program under which we may repurchase up to $1 billion of our common stock. Under this program, we may repurchase our common stock from time to time on the tender offeropen market or in connection withprivate transactions, including structured or accelerated transactions. We will determine the combination with Vivendi Games.timing and amount of repurchases based on our evaluation of market conditions and other factors. The repurchase program may be suspended or discontinued by the Company at any time. We purchased 13 million shares for $126 million in the fourth quarter of 2008, leaving approximately $874 million available for purchases under the program at December 31, 2008.
Cash Flows from Operating Activities
The primary sourcedrivers of cash flows provided byfrom operating activities have typically have included the collection of customer receivables generated by the sale of our products and our subscription revenues, offset by
payments to vendors for the manufacture, distribution and marketing of our products, third-party developers and intellectual property holders and to our own employees. For the years ended March 31, 2008 and 2007, cash flows from operating activities were $573.5 million and $27.2 million, respectively. The principal components comprising cash flows from operating activities for the year ended March 31, 2008 included an increase in amounts collected from customers due to increased net revenues, an increase in accounts payable, accrued expenses and other liabilities partially offset by the increase in inventory and accounts receivables. See an analysis of the change in key balance sheet accounts below in "Key Balance Sheet Accounts." We expect that a primary source of future liquidity, both short-term and long-term, will be the result of cash flows from continuing operations.
A significant operating use of our cash relates to our continued investment in software development and intellectual property licenses. We spent approximately $168.8 million and $166.1 million for the years ended March 31, 2008 and 2007, respectively, in connection with the acquisition of publishing or distribution rights for products being developed by third parties, the execution of new license agreements granting us long-term rights to intellectual property of third parties, as well as the capitalization of product development costs relating to internally developed products. We expect that we will continue to make significant expenditures relating to our investment in software development and intellectual property licenses. Our future cash commitments relating to these investments are detailed below in "Commitments." Cash flows from operations are affected by our abilityNote 18 of the Notes to release highly successful or "hit" titles. Though many of these titles have substantial production or acquisition costs and marketing expenditures, once a title recoups these costs, incremental net revenues typically will directly and positively impact cash flows.Consolidated Financial Statements.
Cash Flows from Investing Activities
The primary sourcedrivers of cash flows used in investing activities have typically have included capital expenditures, acquisitions of privately held interactive software development companies and publishing companies and the net effect of purchases and sales/maturities of short-term investment vehicles.investments. The goal of our investments is to maximize returnminimize risk and maintain liquidity while minimizing risk, maintaining liquidity, coordinating withmaximizing returns, funding anticipated working capital needs, and providing for prudent investment diversification.
For the yearsyear ended MarchDecember 31, 2008, and 2007, cash flows provided by and used in investing activities were $326.3 million and $35.2 million, respectively. For the year ended March 31, 2008, cash
flows provided by investing activities were primarily the result of proceeds from sales and maturitiesthe reverse acquisition of investments, asActivision, Inc., partially offset by cash paid for business acquisitions, capital expenditures, and purchasesthe acquisitions of short-term investments. The increase in cash flows provided by investing activities versus the prior year was primarily related to our investment activities as we had a bigger net proceeds from salesFreestyle Games, Ltd. and maturities of investments, particularly in the fourth quarter fiscal 2008 as compared to that of fiscal 2007. Such activities were carried out in anticipation of the close of the BCA with Vivendi and the related tender offer (see Note 20 of the Notes to Consolidated Financial Statements included in Item 8), and are part of the reason for the substantial increase in cash and cash equivalents of approximately $1 billion. We have historically financed our acquisitions through the issuance of shares of common stock or a combination of common stock and cash.Budcat Creations, LLC.
Due to uncertainties surrounding the timing of liquidation of our auction rate securities ("ARS"), which are comprised of AAA-rated student-loan-backed taxable securities,debt obligations secured by higher education student loans, all our investments in such securities were classified as long-term investments in our consolidated balance sheets as of MarchConsolidated Balance Sheets at December 31, 2008. Liquidity for these auction rate securities is typically provided by an auction process which allows holders to sell their notes and resets the applicable interest rate at pre-determined intervals, usually every 7 to 35 days. On an industry-wide basis, many auctions have failed, and there is, as yet, no meaningful secondary market for these instruments. Each of the auction rate securities in our investment portfolio as of Marchat December 31, 2008 has experienced a failed auction and there is no assurance that future auctions for these securities will succeed. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. In the event that there is a failed auction, the indenture governing the security requires the issuer to pay interest at a contractually defined rate that is generally above market rates for other types of similar short-term instruments. The securities for which auctions have failed will continue to earn interest at the contractual rate and be auctioned every 7 to 35 days until the auction succeeds, the issuer calls the securities, or they mature. As a result, our ability to liquidate and fully recover the carrying value of our auction rate securities in the near term may be limited or not exist. In August 2008, certain affiliates of Citigroup, Inc. ("Citi") and UBS through which we own our auction rate securities, announced agreements in principle with various state regulatory agencies and the SEC, to address their clients' liquidity issues arising from the auction failures. On August 7, 2008, Citi announced that it would use its best efforts to provide liquidity solutions to its institutional investor client who invested in auction rate securities by the end of 2009.
As there On November 14, 2008, we accepted an offer from UBS, providing us with rights related to our ARS held through UBS (the "Rights"). The Rights permit us to require UBS to purchase our ARS held through UBS at par value, which is not yetdefined as the price equal to the liquidation preference of the ARS plus accrued but unpaid dividends or interest, at any meaningful secondary market for these securities, quoted market pricestime during the period of June 30, 2010 through July 2, 2012. Conversely, UBS has the right, in its discretion, to purchase or sell our ARS at any time until July 2, 2012, so long as we receive payment at par value upon any sale or disposition. If auctions continue to fail, we expect to sell our ARS under the Rights. However, if the Rights are not available. We estimatedexercised before July 2, 2012 they will expire and UBS will have no further rights or obligation to buy our ARS. So long as we hold our ARS, they will continue to accrue interest as determined by the fair market value using valuation models, which take into account both observable market data and non-observable factors, including credit quality, duration, insurance wraps, collateral composition, maximum rate formulas, comparable trading instruments, and likelihoodauction process or the terms of redemption. Accordingly, we consider the values generated by such valuation models to represent management's best estimateARS if the auction process fails.
Table of fair value for the purposes of applying the Statement of Financial Accounting Standards No. 115Accounting for Certain Investments in Debt and Equity Securities.Contents
UBS's obligations under the Rights are not secured by its assets and do not require UBS to obtain any financing to support its performance obligations under the Rights. UBS has disclaimed any assurance that it will have sufficient financial resources to satisfy its obligations under the Rights.
The change in fair value of the auction rate securities of $4.3through UBS and Citi totaled $55 million was recorded as a component of comprehensive income (loss) in the Consolidated Statement of Changes in Shareholders' Equity for the year ended Marchand $23 million, respectively, at December 31, 2008, as the decline in fair value is not considered to be "other-than-temporary." We have the intent and ability to hold these securities for a period of time sufficient for a recovery of fair value up to (or beyond) the initial cost of the investment.2008.
Based on our other available cash and expected operating cash flows and financing, we do not anticipate that the potential lack of liquidity on these investments will affect our ability to execute our current business plan or to consummate the proposed post-closing tender offer described in Note 20 of the Notes to Consolidated Financial Statements included in Item 8. Additionally we have received indications from certain lenders that we may borrow against the par value of the securities at competitive rates.plan.
Cash Flows from Financing Activities
The primary sourcedrivers of cash fromflows provided by financing activities has beenhave historically related to transactions involving our common stock, including the issuance of shares ofour common stock to employees.employees and the public and the purchase of treasury shares. We have not utilized debt
financing as a significant source of cash flows. However, if needed, we do have available at certain of our international locations,may access and utilize the credit facilities whichthat are described below in "Credit Facilities," that can be utilized if needed.
For the years ended March 31, 2008 and 2007, cash flows provided by financing activities were $105.2 million and $28.0 million, respectively. The increaseFacilities" in cash provided by financing activities for the year ended March 31, 2008 was the result of the issuance of common stock related to employee equity incentive and stock purchase plans. The increase in stock option exercises was primarily due to the performance of our share price and the release in June 2007 of the suspension of stock option exercises implemented while we were not current with the filings we are required to make pursuant to the Exchange Act.
During fiscal 2003, our Board of Directors authorized a buyback program under which we can repurchase up to $350.0 million of our common stock. Under the program, shares may be purchased as determined by management and within certain guidelines, from time to time, in the open market or in privately negotiated transactions, including privately negotiated structured stock repurchase transactions and through transactions in the options markets. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time to time without prior notice. As of March 31, 2008, we had approximately $226.2 million available for utilization under the buyback program. We actively manage our capital structure as a component of our overall business strategy. Accordingly, in the future, when we determine that market conditions are appropriate, we may seek to achieve long term value for the shareholders through, among other things, new debt or equity financings or refinancings, share repurchases, and other transactions involving our equity or debt securities.
Key Balance Sheet Accounts
Accounts Receivable
| March 31, 2008 | March 31, 2007 | Increase/ (Decrease) | ||||||
---|---|---|---|---|---|---|---|---|---|
| (amounts in thousands) | ||||||||
Gross accounts receivable | $ | 332,831 | $ | 240,112 | $ | 92,719 | |||
Net accounts receivable | 203,420 | 148,694 | 54,726 |
The increase in gross accounts receivable was primarily the result of increased sales volume in the fourth quarter fiscal 2008 of our successful titlesCall of Duty 4: Modern Warfare andGuitar Hero III: Legends of Rock leading to higher net revenues for the fourth quarter fiscal 2008 of $602.5 million compared to $312.5 million for the fourth quarter fiscal 2007.
Reserves for returns, price protection and bad debt increased from $91.4 million at March 31, 2007 to $129.4 million at March 31, 2008 whereas reserves as a percentage of gross receivables increased from 38% to 39% at March 31, 2007 and 2008, respectively. This was the result of increases in revenues during the fourth quarter fiscal 2008 as compared to the fourth quarter fiscal 2007. Reserves for returns and price protection are a function of the number of units and pricing of titles in retail inventory, which has been consistently applied. (see description ofAllowances for Returns, Price Protection, Doubtful Accounts, and Inventory Obsolescence in Item 7:Critical Accounting Policies and Estimates).
Inventories
| March 31, 2008 | March 31, 2007 | Increase/ (Decrease) | ||||||
---|---|---|---|---|---|---|---|---|---|
| (amounts in thousands) | ||||||||
Inventories | $ | 146,874 | $ | 91,231 | $ | 55,643 |
The increase in inventories at March 31, 2008 compared to March 31, 2007 is primarily the result of the expanding Guitar Hero franchise, and larger slate of titles when compared to fiscal 2007 across all console platforms and our continued international business growth.
Software Development
| March 31, 2008 | March 31, 2007 | Increase/ (Decrease) | |||||||
---|---|---|---|---|---|---|---|---|---|---|
| (amounts in thousands) | |||||||||
Software development | $ | 109,786 | $ | 130,922 | $ | (21,136 | ) |
Software development decreased from $130.9 million at March 31, 2007 to $109.8 million at March 31, 2008. The decrease in software development was primarily the result of an increase in amortization related to the increase in the number of titles released in fiscal 2008 and stock option expenses for the year ended March 31, 2008, partially offset by our continued investment in Activision's future product slate of titles.
Intellectual Property Licenses
| March 31, 2008 | March 31, 2007 | Increase/ (Decrease) | |||||||
---|---|---|---|---|---|---|---|---|---|---|
| (amounts in thousands) | |||||||||
Intellectual Property Licenses | $ | 83,551 | $ | 100,274 | $ | (16,723 | ) |
Intellectual property licenses decreased from $100.3 million at March 31, 2007 to $83.6 million at March 31, 2008. The decrease in intellectual property licenses primarily resulted from the amortization of intellectual property licenses upon releases of titles during fiscal 2008.
Accounts Payable
| March 31, 2008 | March 31, 2007 | Increase/ (Decrease) | |||||||
---|---|---|---|---|---|---|---|---|---|---|
| (amounts in thousands) | |||||||||
Accounts payable | $ | 129,896 | $ | 136,517 | $ | (6,621 | ) |
The slight decrease in accounts payable of $6.6 million from March 31, 2007 to March 31, 2008 primarily reflects the timing of the payment of several items.
Accrued Expenses and Other Liabilities
| March 31, 2008 | March 31, 2007 | Increase/ (Decrease) | ||||||
---|---|---|---|---|---|---|---|---|---|
| (amounts in thousands) | ||||||||
Accrued expenses and other liabilities | $ | 426,175 | $ | 204,652 | $ | 221,523 |
The increase in accrued expenses and other liabilities was primarily driven by:
See Note 918 of the Notes to Consolidated Financial Statements included in Item 8 for details of accrued expenses and other liabilities.Statements.
Capital Requirements
For the fiscal year ending MarchDecember 31, 2009, we anticipate total capital expenditures of approximately $35.6$118 million. Capital expenditures will be primarily for computer hardware and software purchases and various corporate projects.
Credit Facilities
We have revolving credit facilities with our Centresoft subsidiary located in the UK (the "UK Facility") and our NBG subsidiary located in Germany (the "German Facility."Facility")
. The UK Facility providedprovides Centresoft with the ability to borrow up to GBP 12.012 million Great British Pound Sterling ("GBP") ($23.918 million), including issuing letters of credit, on a revolving basis as of March 31, 2008. Furthermore, under the UK Facility, Centresoft provided a GBP 0.6 million ($1.2 million) guarantee for the benefit of our CD Contact subsidiary as of Marchat December 31, 2008. The UK Facility bore interest at LIBOR plus 2.0% as of March 31, 2008, is collateralized by substantially all of the assets of the subsidiary and expires in March 2009. The UK Facility also contains various covenants that require the subsidiary to maintain specified financial ratios related to, among others, fixed charges. As of March 31, 2008, we were in compliance with these covenants.
The German Facility providedprovides for revolving loans up to EUR 0.51 million Euro ("EUR") ($0.81 million) as of Marchat December 31, 2008, bore interest at a Eurocurrency rate plus 2.5%, is collateralized by certain of the subsidiary's property and equipment and has no expiration date.2008. No borrowings were outstanding against the UK Facility or the German Facility as of Marchat December 31, 2008.
As of MarchAt December 31, 2008, we maintained a $10.0$35 million irrevocable standby letter of credit. The standby letter of credit is required by one of our inventory manufacturers to qualify for payment terms on our inventory purchases. Under the terms of this arrangement, we are required to maintain on deposit with the bank a compensating balance, restricted as to use, of not less than the sum of the available amount of theThe letter of credit plus the aggregate amount of any drawings under the letter of credit that have been honored thereunder but not reimbursed. At March 31, 2008, the $10.0 million deposit is included in short-term investments as restricted cash. No borrowings were outstanding as of Marchwas undrawn at December 31, 2008.
As of MarchAt December 31, 2008, our publishing subsidiary located in the UK maintained a EUR 7.025 million ($11.035 million) irrevocable standby letter of credit. The standby letter of credit is required by one of our inventory manufacturers to qualify for payment terms on our inventory purchases. The standby letter of credit does not require a compensating balance, and is collateralized by substantially all of the assets of the subsidiary and expires in February 2009. No borrowings were outstanding asat December 31, 2008.
On April 29, 2008, Activision, Inc. entered a senior unsecured credit agreement with Vivendi (as lender). At December 31, 2008, the credit agreement provides for a revolving credit facility of Marchup to $475 million. No borrowings were outstanding at December 31, 2008.
Commitments
In the normal course of business, we enter into contractual arrangements with third partiesthird-parties for non-cancelable operating lease agreements for our offices, for the development of products, as well asand for the rights to intellectual property.property ("IP"). Under these agreements, we commit to provide specified payments to a lessor, developer or intellectual property holder, as the case may be, based upon
contractual arrangements. Typically, theThe payments to third-party developers are generally conditioned upon the achievement by the developers of contractually specified development milestones. TheseFurther, these payments to third-party developers and intellectual property holders typically are deemed to be advances and are recoupable against future royalties earned by the developer or intellectual property holder based on the sale of the related game. Additionally, in connection with certain intellectual property rightrights acquisitions and development agreements, we will commit to spend specified amounts for marketing support for the related game(s) which is to be developed or in which the intellectual property will be utilized. Additionally, we lease certain of our
facilities and equipment under non-cancelable operating lease agreements. Assuming all contractual provisions are met, the total future minimum commitments for these and other contractual arrangements in place as of Marchat December 31, 2008 are scheduled to be paid as follows (amounts in thousands)millions):
| Contractual Obligations(1) | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Facility & Equipment Leases | Developer & IP | Marketing | Total | ||||||||||
Fiscal years ending March 31, | ||||||||||||||
2009 | $ | 19,343 | $ | 110,771 | $ | 41,401 | $ | 171,515 | ||||||
2010 | 17,028 | 31,041 | 22,100 | 70,169 | ||||||||||
2011 | 14,553 | 34,086 | 13,100 | 61,739 | ||||||||||
2012 | 10,256 | 16,586 | — | 26,842 | ||||||||||
2013 | 8,791 | 21,586 | — | 30,377 | ||||||||||
Thereafter | 31,201 | 26,001 | — | 57,202 | ||||||||||
Total | $ | 101,172 | $ | 240,071 | $ | 76,601 | $ | 417,844 | ||||||
| Contractual Obligations(1) | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Facility and equipment leases | Developer and IP | Marketing | Total | |||||||||||
For the year ending December 31, | |||||||||||||||
2009 | $ | 38 | $ | 111 | $ | 45 | $ | 194 | |||||||
2010 | 33 | 46 | 14 | 93 | |||||||||||
2011 | 21 | 17 | 13 | 51 | |||||||||||
2012 | 19 | 22 | — | 41 | |||||||||||
2013 | 15 | 16 | — | 31 | |||||||||||
Thereafter | 42 | 22 | — | 64 | |||||||||||
Total | $ | 168 | $ | 234 | $ | 72 | $ | 474 | |||||||
Off BalanceOff-Balance Sheet Arrangements
As of MarchAt December 31, 2008 and 2007, we did not have anyActivision Blizzard had no relationships with unconsolidated entities or financial parties, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we do notpurposes, that have any off balance sheet arrangements andor are not exposedreasonably likely to any financing,have a material future effect on our financial condition, changes in financial condition, revenues or expenses, results of operation, liquidity, market,capital expenditure, or credit risk that could arise if we had engaged in such relationships.capital resources.
Financial Disclosure
We maintain internal control over financial reporting, which generally includeincludes those controls relating to the preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America.U.S. GAAP. We also are focused on our "disclosure controls and procedures," which as defined by the Securities and Exchange CommissionSEC are generally those controls and procedures designed to ensure that financial and non-financial information required to be disclosed in our reports filed with the Securities and Exchange CommissionSEC is reported within the time periods specified in the Securities and Exchange Commission'sSEC's rules and forms, and that such information is communicated to management, including our Chief Executive Officersprincipal executive and our Chief Financial Officer,financial officers, as appropriate, to allow timely decisions regarding required disclosure.
Our Disclosure Committee, which operates under the Board approvedof Directors-approved Disclosure Committee Charter and Disclosure Controls & Procedures Policy, includes senior management representatives and assists executive management in its oversight of the accuracy and timeliness of our disclosures, as well as in implementing and evaluating our overall disclosure process. As part of our
disclosure process, senior finance and operational representatives from all of our corporate divisions and business units prepare quarterly reports regarding their current quarter operational performance, future trends, subsequent events, internal controls, changes in internal controls, and other accounting and disclosure-
relevantdisclosure-relevant information. These quarterly reports are reviewed by certain key corporate finance representatives.executives. These corporate finance representatives also conduct quarterly interviews on a rotating basis with the preparers of selected quarterly reports. The results of the quarterly reports and related interviews are reviewed by the Disclosure Committee. Finance representatives also conduct reviews with our senior management team, our internal and external counsel and other appropriate personnel involved in the disclosure process, as appropriate. Additionally, senior finance and operational representatives provide internal certifications regarding the accuracy of information they provide that is utilized in the preparation of our periodic public reports filed with the Securities and Exchange Commission.SEC. Financial results and other financial information also are reviewed with the Audit Committee of the Board of Directors on a quarterly basis. As required by applicable regulatory requirements, the Chief Executive Officersprincipal executive and the Chief Financial Officerfinancial officers review and make various certifications regarding the accuracy of our periodic public reports filed with the Securities and Exchange Commission,SEC, our disclosure controls and procedures, and our internal control over financial reporting. With the assistance of the Disclosure Committee, we will continue to assess and monitor, and make refinements to, our disclosure controls and procedures and our internal control over financial reporting, and will make refinements as necessary.reporting.
Recently Issued Accounting Standards
In December 2007, the FASBFinancial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141(R)141 (revised 2007),Business Combinations "Business Combinations" ("SFAS No. 141(R).") This Statement provides greater consistency in. SFAS No. 141(R) expands the accounting and financial reportingdefinition of business combinations. It requires the acquiring entity in a business combination and requires acquisitions to recognize all assetsbe accounted for at fair value. These fair value provisions will be applied to contingent consideration, in-process research and development and acquisition contingencies. Purchase accounting adjustments will be reflected during the period in which an acquisition was originally recorded. Additionally, the new standard requires transaction costs and restructuring charges to be expensed. Furthermore, to the extent the Company has changes to its uncertain tax positions associated with any subsidiaries acquired and liabilities assumedin previous business combinations for which goodwill exists subsequent to December 31, 2008, such changes to the uncertain tax positions will be recorded in the transaction, establishesCompany's Consolidated Statements of Operations rather than as a reduction in goodwill, which was the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed, and requires the acquireraccounting treatment in place prior to disclose the nature and financial effect of the business combination. Also in December 2007, the FASB issued Statement No. 160.Non-controlling Interests in Consolidated Financial Statements ("SFAS No. 160.") This Statement amends Accounting Research Bulletin No. 51,Consolidated Financial Statements, to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 141(R) and SFAS No. 160 are required to be adopted simultaneously and are effective for the first annual reporting period beginning on or after December 15, 2008 with earlier adoption being prohibited. We do not currently have any non-controlling interests in our subsidiaries, and accordingly the adoption of SFAS No. 160 is not expected to have a material impact on our financial statements. We are currently evaluating the impact from the adoption of141(R). SFAS No. 141R on our Consolidated Financial Statements.
In September 2006, the FASB issued Statement No. 157 ("SFAS No. 157"),Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. SFAS No. 157141(R) is effective for fiscal years beginning after November 15, 2007the Company for financial assetsacquisitions closing during and liabilities and is effective for fiscal years beginning after November 15, 2008 for non-financial assets and liabilities. The adoptionsubsequent to the first quarter of SFAS No. 157 is not expected to have a material effect on our financial position or results of operations.
In February 2007, the FASB issued Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 ("SFAS No. 159.") SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The provisions of SFAS No. 159 are effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 159 is not expected to have a material effect on our financial position or results of operations.
In June 2007, the FASB ratified the Emerging Issues Task Force's ("EITF") consensus conclusion on EITF 07-03,Accounting "Accounting for Advance Payments for Goods or Services to Be Used in Future Research and Development.Development." EITF 07-03 addresses the diversity which exists with respect to the accounting for the non-refundable portion of a payment made by a research and development entity for future research and development activities. Under this conclusion, an entity is required to defer and capitalize non-refundable advance payments made for research and development activities until the related goods are delivered or the related services are performed. EITF 07-03 is effective for interim or annual reporting periods in fiscal years beginning after December 15, 2007 and requires prospective application for new contracts entered into after the effective date. The adoption of EITF 07-03 isdid not expected to have a material impact on our Consolidated Financial Statements.
In March 2008, the FASB issued Statement No. 161,Disclosures "Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133133" ("SFAS No. 161."161") SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an
entity's financial position, financial performance, and cash flows. The guidance in SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. SFAS No. 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. We are currently assessing the impactThe adoption of SFAS No. 161.161 did not have a material impact on our Consolidated Financial Statements.
In April 2008, the FASB issued FASB Staff Positions ("FSP") SFAS No. 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP FAS 142-3"). FSP FAS 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under SFAS No. 142, "Goodwill and Other Intangible Assets" This guidance for determining the useful life of a recognized intangible asset applies prospectively to intangible assets acquired individually or with a group of other assets in either an asset acquisition or business combination. FSP FAS 142-3 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008, and early adoption is prohibited. The adoption of FSP FAS 142-3 did not have a material impact on our Consolidated Financial Statements.
Inflation
Our management currently believes that inflation has not had a material impact on continuing operations.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the potential loss arising from fluctuations in market rates and prices. Our market risk exposures primarily include fluctuations in interest rates, currency exchange rates, and market prices. Our market risk sensitive instruments are classified as instruments entered into for purposes "other than trading." Our views on market risk are not necessarily indicative of actual results that may occur and do not represent the maximum possible gains and losses that may occur, since actual gains and losses will differ from those estimated, based upon actual fluctuations in interest rates, currency exchange rates, market prices, and the timing of transactions.
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments to manage interest rate risk in our investment portfolio. We manage our interest rate risk by maintaining anOur investment portfolio consistingconsists primarily of debt instruments with high credit quality and relatively short average maturities. We also manage ourmaturities and money market funds that invest in such securities. Because short-term securities mature relatively quickly and must be reinvested at the then current market rates, interest rate risk by maintaining sufficientincome on a portfolio consisting of cash, and cash equivalent balancesequivalents, or short-term securities is more subject to market fluctuations than a portfolio of longer term securities. Conversely, the fair value of such that we are typically ablea portfolio is less sensitive to hold our investments to maturity. Asmarket fluctuations than a portfolio of Marchlonger term securities. At December 31, 2008, our cash and cash equivalents, and short-term investments included debtmoney market funds and mortgage-backed securities of $1,171.4 million. Also, as of March 31, 2008, we classified our investments$2,609 million and $7 million, respectively. We have $78 million in auction rate securities of $91.2 millionat fair value, which are classified as long-term investments, (see Note 1 of the Notes to Consolidated Financial Statements included in Item 8 for summary of significant accounting policies.)
The following table presents the amounts and related weighted average interest ratesat December 31, 2008. Most of our investment portfolio asis invested in short-term or variable rate securities. Accordingly, we believe that a sharp change in interest rates would not have a material effect on our short-term investment portfolio.
Table of March 31, 2008 (amounts in thousands):
| Average Interest Rate | Amortized Cost | Fair Value | ||||||
---|---|---|---|---|---|---|---|---|---|
Cash equivalents: | |||||||||
Variable rate | 3.09 | % | $ | 1,129,980 | $ | 1,129,980 | |||
Short-term investments: | |||||||||
Fixed rate | 5.21 | % | $ | 41,619 | $ | 41,411 | |||
Long-term investments: | |||||||||
Variable rate | 6.09 | % | $ | 95,538 | $ | 91,215 |
Our short-term investments generally mature between three months and thirty months.Contents
Currency Exchange Rate Risk
We transact business in many different foreign currencies and may be exposed to financial market risk resulting from fluctuations in foreign currency exchange rates, particularly EUR, GBP, and AUD. Therates. Currency volatility of EUR, GBP, and AUD (and all other applicable currencies) will beis monitored frequently throughout the coming year. When appropriate, we enter into hedging transactions in order toTo mitigate our risk from foreign currency fluctuations.fluctuations we enter into currency forward contracts with Vivendi, generally with maturities of twelve months or less. . We willexpect to continue to use hedgingeconomic hedge programs in the future and may use, in addition to currency forward contracts, currency options, and/or other derivative financial instruments commonly utilizedsuch as currency options to reduce financial market risks if it is determined that such hedging activities are appropriate to reduce risk. We do not hold or purchase any foreign currency contracts for trading or speculative purposes. AsThe following procedures are designed to prohibit speculative transactions:
In addition, Activision Blizzard may hedge foreign currency exposure resulting from foreign currency denominated financial assets and liabilities, consisting primarily of Marchintercompany receivables and payables, and earnings.
At December 31, 2008 we had no outstanding exchange forward contracts. As of Marchand December 31, 2007, accrued expenses included approximately $90,000the net notional amount of outstanding forward foreign exchange contracts was $126 million and $14 million, respectively. A pre-tax net unrealized lossesgain of $3 million for the estimated fair value of outstanding currency exchange forward contracts.
Market Price Risk
With regard to the structured stock repurchase transactions described in Note 15 of the Notes to Consolidated Financial Statements included in Item 8, at those times when we have structured stock repurchase transactions outstanding, it is possible that at settlement we could take delivery of shares at an effective repurchase price higher than the then market price. As of Marchyear ended December 31, 2008 we had no structured stock repurchase transactions outstanding.and a pre-tax net unrealized loss of $2 million for the year ended December 31, 2007 resulted from the forward foreign exchange contracts with Vivendi and were recognized in the Consolidated Statement of Operations.
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reports of Independent Registered Public Accounting | F-1 | |
Consolidated Balance Sheets | ||
Consolidated Statements of Operations for the Years Ended | ||
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended | ||
Consolidated Statements of Cash Flows for the Years Ended | ||
Notes to Consolidated Financial Statements | ||
Schedule II—Valuation and Qualifying Accounts | ||
Other financial statement schedules are omitted because the information called for is not applicable or is shown either in the consolidated financial statementsConsolidated Financial Statements or the notesNotes thereto.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
Item 9A. CONTROLS AND PROCEDURES
1) Definition and Limitations of Disclosure Controls and Procedures.
Our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to reasonably assureensure that information required to be disclosed in our reports filed under the Exchange Act is (i) recorded, processed, summarized, and reported
within the time periods specified in the Securities and Exchange Commission'sSEC's rules and forms and (ii) accumulated and communicated to management, including our Chief Executive Officersprincipal executive officer and Chief Financial Officer,principal financial officer, as appropriate to allow timely decisions regarding required disclosures. A control system, no matter how well designed and operated, can provide only reasonable not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in our periodic reports. Inherent limitations to any system of disclosure controls and procedures include, but are not limited to, the possibility of human error and the circumvention or overriding of such controls by one or more persons. In addition, we have designed our system of controls based on certain assumptions, which we believe are reasonable, about the likelihood of future events, and our system of controls may therefore not achieve its desired objectives under all possible future events.
2) Evaluation of Disclosure Controls and Procedures.
Our management, with the participation of the Chief Executive Officersour principal executive officer and Chief Financial Officer,principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures asat December 31, 2008, the end of March 31, 2008.the period covered by this report. Based on this controls evaluation, and subject to the limitations described above, the Chief Executive Officersprincipal executive officer and Chief Financial Officerprincipal financial officer concluded that, as of the end of the period covered by this report,at December 31, 2008, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized, and reported on a timely basis.basis, and (ii) accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures.
3) Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act Rule 13a-15(f).Act. Our management, with the participation of our Chief Executive Officersprincipal executive officer and Chief Financial Officer,principal financial officer, conducted an evaluation of the effectiveness, as of MarchDecember 31, 2008, of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control—Integrated Framework. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of MarchDecember 31, 2008.
Management excluded the internal control over financial reporting of Vivendi Games, Inc., which was acquired by the Company during 2008 in a purchase business combination, from its assessment of the Company's internal control over financial reporting as of December 31, 2008. The acquired Vivendi Games, Inc. businesses, which includes Vivendi Games' subsidiary Blizzard Entertainment, Inc., and business units and divisions that the Company has exited or is winding down such as Sierra Online and Vivendi Games Mobile, represented approximately 4% of the Company's consolidated total assets as of December 31, 2008 and 46% of its consolidated net revenues for the year then ended.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
The effectiveness of our internal control over financial reporting as of MarchDecember 31, 2008 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report included in this annual report on Form 10-K.
4) Changes in Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial reporting during the most recent fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
5) Other Information
As noted above and described in more detail in Note 1 to the Consolidated Financial Statements, during the year ended December 31, 2008, the Company completed its Business Combination with Vivendi Games.
Prior to the consummation of the Business Combination on July 9, 2008, Vivendi Games was a wholly owned subsidiary of Vivendi S.A. As a wholly owned subsidiary operating as a business unit within the Vivendi S.A. group, Vivendi Games had not historically prepared financial statements for separate stand-alone purposes, had its taxable income processed within the Vivendi U.S. tax returns and did not maintain an external financial reporting group or tax group. Internal controls were determined to be adequate to comply with Vivendi S.A.'s internal reporting requirements under International Financial Reporting Standards. For purposes of inclusion in Activision's proxy statement related to the Business Combination, Vivendi Games prepared U.S. GAAP stand-alone financial statements for the fiscal years ended December 31, 2007 and 2006, and these stand-alone financial statements were issued after the announcement of the transaction. As previously disclosed, it was determined that the following matters constituted material weaknesses as it related to those stand-alone financial statements. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis.
As previously disclosed, in connection with the preparation of its financial statements, on a stand-alone U.S. GAAP basis, for the fiscal years ended December 31, 2007 and 2006, Vivendi Games did not properly design and/or operate effective controls to detect certain errors in the preparation, classification and disclosure of its financial statements; additionally, Vivendi Games did not properly design and/or operate effective controls to detect certain errors in the preparation of the stand-alone tax provision and related tax disclosures in its financial statements for the fiscal year ended December 31, 2007.
Subsequent to the consummation of the Business Combination on July 9, 2008, Activision Blizzard management became responsible for establishing and maintaining the combined Company's internal control over financial reporting, including financial statement preparation and reporting and tax provision preparation and reporting.
None.
Item 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The information required by this Item is incorporated by reference to the sections of our definitive Proxy Statement for our 20082009 Annual Meeting of Shareholders, entitled "Proposal 1—Election of Directors," "Executive Officers and Key Employees," "Section 16(a) Beneficial Ownership Reporting Compliance," "Corporate Governance Matters—Code of Ethics for Senior Executive and Senior Financial Officers" and "Corporate Governance Matters—Board of Directors and Committees—Audit Committee" to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K.Commission.
Item 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the sections of our definitive Proxy Statement for our 20082009 Annual Meeting of Shareholders, entitled "Executive Compensation," "Director Compensation"Compensation," and "Compensation Committee Report" to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K.Commission.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information required by this Item is incorporated by reference to the sections of our definitive Proxy Statement for our 20082009 Annual Meeting of Shareholders, entitled "Equity Compensation Plan Information" and "Security Ownership of Certain Beneficial Owners and Management" to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K.Commission.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated by reference to the sections of our definitive Proxy Statement for our 20082009 Annual Meeting of Shareholders, entitled "Certain Relationships and Related Transactions" and "Corporate Governance Matters—Board of Directors and Committees—Director Independence" to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K.Commission.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated by reference to the sections of our definitive Proxy Statement for our 20082009 Annual Meeting of Shareholders, entitled "Independent Registered Public Accounting Firm's Fees" to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K.Commission.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE
(a) | 1. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
2. | Financial Statement ScheduleThe following financial statement schedule of Activision | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Schedule II—Valuation and Qualifying Accounts | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other financial statement schedules are omitted because the information called for is not applicable or is shown either in the | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
3. | The exhibits listed on the accompanying index to exhibits immediately following the financial statements are filed as part of, or
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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