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2010 ANNUAL REPORT

Table of contents

  • Page 1
    2 010 A N N UA L R E P ORT

  • Page 2
    ... Year PROV EN BR A NDS, GLOBA L R E ACH, A ND ONLINE LE A DER SHIP First Operating margin* Earnings per share* Billion in operating cash flow Billion in total cash and investments, no debt ever cash dividend * Non-GAAP-For a full reconciliation see tables at the end of the annual report...

  • Page 3
    ...L CH A NNELS* $ %+ Growth .B+ Revenues Operating Margin %+    *Represents Non-GAAP revenues from subscriptions and licensing royalties, value added services, downloadable content, digitally distributed products, and wireless devices. 

  • Page 4

  • Page 5
    ...Blizzard Entertainment's World of Warcraft is the #1 subscription-based Massively Multiplayer Online Role-Playing Game Worldwide* 12M+ Subscribers 3/2005 11/2005 7/2007 10/2008 10/2010 *# ranking and chart based on internal company records, public data, and/or reports from key distribution...

  • Page 6

  • Page 7
    ... of all time* $ .B + Revenues         *# ranking in $s, based on NPD, GFK-Charttrack; graph based on internal company records and/or reports from key distribution partners. 

  • Page 8
    2010 A N NUA L R EPORT Another Record Year PROV EN BR A NDS, GLOBA L R E ACH, A ND ONLINE LE A DER SHIP #1 publisher overall, all time highest retail share (1) Biggest year ever in Asia Pacific ® Largest entertainment launch in history (2) ® #1 Best-selling video game of all time (3) ...

  • Page 9
    ... our products and services to new markets around the world. Yet, we are generating more cash than we can find good uses for. As a result, in 2010, we became the first company in our industry to issue a dividend and we repurchased nearly $1 billion of our stock, bringing our two-year share buyback...

  • Page 10
    ... and interests of our audiences. Over time, our ability to do so has been reflected in our shareholder returns. Since 1991, when the company was insolvent and Brian Kelly and I bought control of Activision, we have kept our plan simple and our focus sharp. Over the last 20 years, we have doubled our...

  • Page 11
    ...9 million units of full-game retail sales and online downloads, with each posting record launch sales figures. In 2010, Blizzard Entertainment's World of Warcraft, remained the #1 subscription-based massively multiplayer online role-playing game, with over 12 million subscribers worldwide. Last year...

  • Page 12
    .... Activision Publishing's slate includes a new Call of Duty game and the long-anticipated digital platform, the highly innovative Skylanders Spyro's Adventureâ„¢, which will be released on multiple platforms, and a project from Bungie. Blizzard Entertainment has been hard at work developing new...

  • Page 13
    ... license agreements, game engines and internally developed franchise intangible assets, respectively. Stock Split-In July 2008, the Board of Directors approved a two-for-one split of our outstanding shares of common stock effected in the form of a stock dividend ("the split"). The stock dividend was...

  • Page 14
    ... devices. Our Activision business involves the development, marketing, and sale of products through retail channels or digital downloads, by license, or from our affiliate label program with certain third-party publishers. Blizzard Entertainment, Inc. Blizzard Entertainment, Inc. ("Blizzard") is...

  • Page 15
    ... include downloadable games and content, massively multiplayer online subscriptions and value-added services, and mobile and social games in our estimates of revenues from this digital channel. Business Results and Highlights Notwithstanding the above-mentioned industry dynamics, Activision Blizzard...

  • Page 16
    In April 2010, Bungie, a developer of successful game franchises, and Activision announced an exclusive 10-year alliance to bring Bungie's next big action game universe to market. On February 3, 2011, our Board of Directors authorized a new stock repurchase program under which we may repurchase up ...

  • Page 17
    ... downloadable content and add-ons to our products (e.g., new multi-player map packs and additional songs). Digital online-delivered content is generally offered to consumers for a one-time fee. Our subscription based services are digitally delivered and hosted by Blizzard Entertainment's proprietary...

  • Page 18
    ... reviews segment performance exclusive of the impact of the change in deferred net revenues and related cost of sales with respect to certain of our online-enabled games, stock-based compensation expense, restructuring expense, amortization of intangible assets and purchase price accounting related...

  • Page 19
    ...these game titles over the estimated service periods. The product life may range from a minimum of five months to a maximum of less than a year. The related cost of sales is deferred and recognized to match revenues. In the table above, we present the amount of net revenues and related cost of sales...

  • Page 20
    ... sales of games in the music and casual genres. In 2010, Activision released twelve key titles compared to the release of sixteen key titles in 2009; and Blur and Singularity, two new intellectual properties that were released in the second quarter of 2010, had only limited market success. While...

  • Page 21
    ... from Operations Activision Activision's operating income decreased in 2010 as compared to 2009, primarily due to the following Release of fewer key titles in 2010 than in 2009 and weaker sales of games in the music and casual genres; Limited market success of two new intellectual properties, Blur...

  • Page 22
    ... shift in the sales mix to higher-margin digital products; Lower sales and marketing expenses as a result of fewer releases; and Savings realized from headcount reductions within certain administrative functions in the first quarter of 2010. Activision's operating income increased in 2009 as...

  • Page 23
    ... to pro forma consolidated operating income (loss): Net effect from deferral of net revenues and related cost of sales ...Stock-based compensation expense ...Restructuring...Amortization of intangible assets and purchase price accounting related adjustments ...Impairment of intangible assets...

  • Page 24
    ...Duty downloadable content. Pro Forma Activision Segment Income from Operations Activision's operating income decreased in 2010 as compared to 2009, primarily due to the Release of fewer key titles in 2010 than in 2009 and weaker sales of games in the music and casual genres; Limited market success...

  • Page 25
    ...unvested stock awards at the closing date of the Business Combination ($59 million for the year ended December 31, 2008). Pro forma adjustments are shown net of tax using an assumed combined federal and state statutory tax rate of 39.4%. Represents Non-Core activities, which are legacy Vivendi Games...

  • Page 26
    ... growth with the successful launch of World of Warcraft: Wrath of the Lich King in China in August 2010. The increase in consolidated net revenues for North America was partially offset by the impact of fewer titles released in 2010 and the weaker sales of games in the music and casual genres...

  • Page 27
    ... sales of games in the music and casual genres in 2009. Foreign Exchange Impact Changes in foreign exchange rates had a negative impact of approximately $54 million and $71 million on Activision Blizzard's net revenues in 2010 and 2009, respectively. The change is primarily due to the year-over-year...

  • Page 28
    ... platform given the aging lifecycle of the Sony PlayStation 2 platform as consumers are now almost fully transitioned to the current-generation platforms. Net revenues from Nintendo Wii decreased in 2010 as compared to 2009, primarily due to the weakness in the sales in casual and music genres. Net...

  • Page 29
    ...change in business mix for products with fewer hardware peripherals, and accordingly lower product costs; A greater share of revenues generated by the Blizzard segment, which has a lower overall cost of sales; and Lower intellectual property license expenses due to weaker sales of games in the music...

  • Page 30
    ... due to the write off of capitalized software development costs of cancelled titles, primarily a Guitar Hero title that had been planned for 2011 and True Crime: Hong Kong. This increase in product development expense was partially offset by lower stock-based compensation expense and the benefits...

  • Page 31
    ... and $250 million to license agreements, game engines and internally developed franchises intangible assets, respectively, for 2010 within our Activision segment. See Note 12 of the Notes to Consolidated Financial Statements included in this Annual Report for additional information regarding the...

  • Page 32
    ... receivables generated by the sale of our products and digital and subscription revenues, partially offset by payments to vendors for the manufacture, distribution and marketing of our products, payments to third-party developers and intellectual property holders, tax liabilities, and payments to...

  • Page 33
    ... development, production, marketing and sale of new products, to finance the acquisition of intellectual property rights for future products from third parties, to fund a new stock repurchase program and to pay the dividends declared on February 9 to our shareholders. On April 29, 2008, Activision...

  • Page 34
    ..., or capital resources. Financial Disclosure We maintain internal control over financial reporting, which generally includes 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...

  • Page 35
    ... 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 relevant information. These quarterly reports are reviewed by certain key corporate...

  • Page 36
    ... and/or future invoices. The conditions our customers must meet to be granted the right to return products or price protection include, among other things, compliance with applicable trading and payment terms, and consistent return of inventory and delivery of sell-through reports to us. We may also...

  • Page 37
    ... and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation, or the completed and tested product design and working model. Significant management judgments and estimates are utilized in the...

  • Page 38
    ... 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...

  • Page 39
    ... consolidated financial statements. In October 2009, the FASB issued an update to Software-Certain Revenue Arrangements That Include Software Elements. This update changes the accounting model for revenue arrangements that include both tangible products and software elements that are "essential to...

  • Page 40
    ... of $2 million for the years ended 2010 and 2009, respectively, resulted from the foreign exchange contracts and swaps with Vivendi and were recognized in the consolidated statements of operations. Revenues and related expenses generated from our international operations are generally denominated in...

  • Page 41
    ... under the Exchange Act. Our management, with the participation of our principal executive officer and principal financial officer, conducted an evaluation of the effectiveness, as of December 31, 2010, of our internal control over financial reporting using the criteria set forth by the Committee of...

  • Page 42
    ... on these financial statements, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform...

  • Page 43
    ...: Cash and cash equivalents ...Short-term investments ...Accounts receivable, net of allowances of $377 million and $317 million at December 31, 2010 and 2009, respectively ...Inventories ...Software development ...Intellectual property licenses ...Deferred income taxes, net ...Other current assets...

  • Page 44
    ... share data) For the Years Ended December 31, 2009 2008 2010 Net revenues Product sales ...Subscription, licensing, and other revenues ...Total net revenues ...Costs and expenses Cost of sales-product costs ...Cost of sales-massively multi-player online role-playing game ("MMORPG") ...Cost of sales...

  • Page 45
    ... ...Stock-based compensation expense related to employee stock options and restricted stock rights ...Return of capital to Vivendi related to taxes (see Note 16) ...Dividends ($0.15 per common share)...Shares repurchased (see Note 20) ...Balance at December 31, 2010 ... Common Stock Shares Amount...

  • Page 46
    ... additional common stock related to the Business Combination...Repurchase of common stock ...Settlement of payable to Vivendi ...Dividends paid ...Excess tax benefits from stock option exercises ...Net cash provided by (used in) financing activities ...Effect of foreign exchange rate changes on cash...

  • Page 47
    ...devices. Our Activision business involves the development, marketing, and sale of products through retail channels or digital downloads, by license, or from our affiliate label program with certain third-party publishers. (ii) Blizzard Entertainment, Inc. Blizzard Entertainment, Inc. ("Blizzard") is...

  • Page 48
    ... been prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in...

  • Page 49
    ... market prices of financial instruments with similar characteristics. Both short-term and long-term ARS are carried at fair value, with fair values estimated using an income-approach model (specifically, a discounted cashflow analysis). We carry derivative instruments, primarily foreign exchange...

  • Page 50
    ... net revenues. 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...

  • Page 51
    ... 31, 2010, the Company's reporting units consisted of Activision, Blizzard, and Distribution. We test goodwill for possible impairment by first determining the fair value of the related reporting unit and comparing this value to the recorded net assets of the reporting unit, including goodwill...

  • Page 52
    ... and $373 million to license agreements, game engines and internally developed franchises intangible assets, respectively. (See Note 12 of the notes to consolidated financial statements) Revenue Recognition Product Sales We recognize revenue from the sale of our products upon the transfer of title...

  • Page 53
    ... the first month of free usage that is included with the World of Warcraft boxed software, the World of Warcraft end user may enter into a subscription agreement for additional future access. Revenues associated with the sale of subscriptions via packaged software and prepaid subscription cards, as...

  • Page 54
    ... are sufficient to meet the demand from the retail markets, but at the same time are controlled to prevent excess inventory in the channel. We benchmark units to be shipped to our customers using historical and industry data. We may permit product returns from, or grant price protection to, our...

  • Page 55
    ... time the related ad is run. Advertising expenses for the years ended December 31, 2010, 2009, and 2008 were $332 million, $366 million, and $241 million, respectively, and are included in sales and marketing expense in the consolidated statements of operations. Income Taxes We account for income...

  • Page 56
    ... awards include stock appreciation rights and restricted stock units granted both by Vivendi and under the Blizzard Equity Plan ("BEP"). The Company records a liability and recognizes changes in fair value of the liability that occur during the period as compensation cost over the requisite service...

  • Page 57
    ...Developed software ...Game engines ...Internally developed franchises ...Retail customer relationships ...Favorable leases ...Distribution agreements...Activision trade name ...Goodwill ...Long term liabilities ...Deferred tax liability ...Total consideration ... 3 - 10 years 1 - 2 years 2 - 5 years...

  • Page 58
    ... (loss) on trading securities ...Unrealized gain (loss) on ARS rights from UBS...Net realized gain on investments ...Change in fair value of other financial liability ...Net realized and unrealized gain (loss) on foreign exchange contracts with Vivendi ...Investment and other income, net ...5. Cash...

  • Page 59
    ... to accepting the UBS offer (see Note 2 of the notes to consolidated financial statements), we classified our investment in ARS held through UBS as available-for-sale. We recorded unrealized gains and losses on our available-forsale securities, net of tax, in accumulated other comprehensive income...

  • Page 60
    ... in millions): At December 31, 2010 At December 31, 2009 Internally developed software costs ...Payments made to third-party software developers ...Total software development costs ...Intellectual property licenses ... $142 60 $202 $73 $182 52 $234 $83 Amortization, write-offs and impairments of...

  • Page 61
    ...2011, the Board of Directors of the Company approved a restructuring plan involving a focus on the development and publication of a reduced slate of titles on a going-forward basis, including the discontinuation of the development of all music-based games and the closure of the related business unit...

  • Page 62
    ... did exceed the fair value of those options, the tax benefit is credited to accumulated paid in capital. At December 31, 2010, 2009 and 2008, the gross goodwill and accumulated impairment losses by reporting unit are as follows: Activision Blizzard's core operations Balance at December 31, 2008...

  • Page 63
    ...definite-lived intangible assets: License agreements ...Game engines...Internally developed franchises ...Favorable leases ...Distribution agreements ...Acquired indefinite-lived intangible assets: Activision trademark...Acquired trade names ...Total ... Net carrying amount 3 - 10 years 2 - 5 years...

  • Page 64
    ... historical experience and our internal business plans and applied an appropriate discount rate. Based on this analysis, we recorded impairment charges of $67 million, $9 million and $250 million to license agreements, game engines and internally developed franchises intangible assets, respectively...

  • Page 65
    ... reviews segment performance exclusive of the impact of the change in deferred net revenues and related cost of sales with respect to certain of our online-enabled games, stock-based compensation expense, restructuring expense, amortization of intangible assets and purchase price accounting related...

  • Page 66
    ...or dividend equivalents during the contractual period of the award. Since the unvested restricted stock rights are considered participating securities, we are required to use the two-class method in our computation of basic and diluted earnings per common share. For the years ended December 31, 2010...

  • Page 67
    ... tax rate) for each of the years are as follows: 2010 For the Years Ended December 31, 2009 2008 Federal income tax provision at statutory rate ...State taxes, net of federal benefit ...Research and development credits ...Domestic production activity deduction ...Foreign rate differential ...Change...

  • Page 68
    ......Stock-based compensation ...Foreign deferred assets ...Other ...Deferred tax assets...Deferred tax assets, net of valuation allowance...Deferred tax liabilities: Intangibles ...Prepaid royalties ...Capitalized software development expenses ...State taxes ...Deferred tax liabilities ...Net...

  • Page 69
    ... Vivendi for any tax liability imposed on Vivendi (or any of its subsidiaries) due to Activision Blizzard's failure to pay any taxes it owes under the Tax Sharing Agreement. Prior to the Business Combination, Vivendi Games' income taxes are presented in the financial statements as if Vivendi Games...

  • Page 70
    ... the measurement date (amounts in millions): Fair Value Measurements at December 31, 2010 Using Quoted Prices in Active Markets for Significant Identical Other Significant Financial Observable Unobservable Instruments Inputs Inputs (Level 1) (Level 2) (Level 3) Financial assets: Money market funds...

  • Page 71
    ...or (losses) (realized/unrealized) included in investment and other income, net...Purchases or acquired sales, issuances and settlements ...Balance at December 31, 2010 ... ARS (a) $77 ARS rights from UBS (b) $7 $84 Other financial liabilities $(23) 23 - $- 7 (61) $23 (7) - $- - (61) $23 59

  • Page 72
    ... our Activision operating segment. The write down resulted in impairment charges of $67 million, $9 million and $250 million to license agreements, game engines and internally developed franchises intangible assets, respectively (see Note 12 of the notes to the consolidated financial statements for...

  • Page 73
    ...does not require a compensating balance and expires in July 2011. No amounts were outstanding at December 31, 2010 and 2009. On April 29, 2008, Activision, Inc. entered into a senior unsecured credit agreement with Vivendi, as lender. Borrowings under the agreement became available upon consummation...

  • Page 74
    ... place at December 31, 2010 are scheduled to be paid as follows (amounts in millions): Facility and Equipment Leases Contractual Obligations(1) Developer and Intellectual Properties Marketing For the years ending December 31, 2011 ...2012 ...2013 ...2014 ...2015 ...Thereafter ...Total ...(1) Total...

  • Page 75
    ...with shareholder approval on June 3, 2010 (as so amended and restated, the "2008 Plan"). The 2008 Plan authorizes the Compensation Committee of our Board of Directors to provide stock-based compensation in the form of stock options, share appreciation rights, restricted stock, restricted stock units...

  • Page 76
    ... amount in cash eighteen months after the closing upon the terms and subject to the conditions set forth in the BEP and in the Business Combination Agreement, including continued employment through the payment date. The determination of the value of Blizzard shares upon a change in control was equal...

  • Page 77
    ...of stock-based payment awards at the grant date depends upon the accuracy of the model and our ability to accurately forecast model inputs as long as ten years into the future. These inputs include, but are not limited to, expected stock price volatility, risk-free rate, dividend yield, and employee...

  • Page 78
    ...of 1.6 years. Income tax benefit from stock option exercises was $36 million, $85 million, and $22 million for the years ended December 31, 2010, 2009, and 2008, respectively. Non-Plan Employee Stock Options Granted to Executives In connection with prior employment agreements between Activision, Inc...

  • Page 79
    ... 31, 2010 2009 2008 Cost of sales-software royalties and amortization ...Product development ...Sales and marketing...General and administrative ...Restructuring ...Stock-based compensation expense before income taxes...Income tax benefit ...Total stock-based compensation expense, net of income tax...

  • Page 80
    ... 22, 2010, the Company made dividend equivalent payments of $2 million related to this cash dividend to the holders of restricted stock units. On February 9, 2011, our Board of Directors approved a cash dividend of $0.165 per share to be paid on May 11, 2011 to shareholders of record at the close of...

  • Page 81
    ... cash to Vivendi. Others Activision Blizzard has entered into various transactions and agreements, including cash management services, investor agreement, tax sharing agreement, and music royalty agreements with Vivendi and its subsidiaries and affiliates. Effective July 23, 2010, we terminated...

  • Page 82
    ...Board of Directors to discontinue the repurchase program. Cash Dividend. On February 9, 2011, our Board of Directors approved a cash dividend of $0.165 per common share to be paid on May 11, 2011 to shareholders of record at the close of business on March 16, 2011. 26. Quarterly Financial and Market...

  • Page 83
    Net revenues ...Cost of sales ...Operating (loss) income ...Net (loss) income ...Basic (loss) earnings per share...Diluted (loss) earnings per share... For the Quarters Ended December 31, September 30, June 30, March 31, 2009 2009 2009 2009 (Amounts in millions, except per share data) $1,557 1,012 ...

  • Page 84
    ... be incorporated by reference into any filing of Activision Blizzard Inc. under the Exchange Act or the Securities Act of 1933, as amended. The graph below matches the cumulative 69-month total return of holders of our common stock with the cumulative total returns of the NASDAQ Composite index and...

  • Page 85
    ... by our Board of Directors. There can be no assurances that dividends will be declared in the future. Return of capital to Vivendi related to settlement of pre-Business Combination taxes Prior to the Business Combination, Vivendi Games' income taxes are presented in the financial statements as if...

  • Page 86
    ...repurchase in December 2010 pursuant to that stock repurchase program. On February 3, 2011, our Board of Directors approved a stock repurchase program pursuant to which we may repurchase up to $1.5 billion of the Company's common stock from time to time on the open market or in private transactions...

  • Page 87
    ...which are beyond our control and may cause actual results to differ materially from current expectations. Activision Blizzard's names, abbreviations thereof, logos, and product and service designators are all either the registered or unregistered trademarks or trade names of Activision Blizzard. 75

  • Page 88
    ... Channel Retail channel Digital online channel* Total Activision and Blizzard Distribution Total consolidated GAAP net revenues Change in Deferred Net Revenues1 Retail channel Digital online channel* Total changes in deferred net revenues Non-GAAP Net Revenues by Distribution Channel Retail channel...

  • Page 89
    ... segment total Reconciliation to consolidated operating income (loss): Net effect from deferral of net revenues and related cost of sales Stock-based compensation expense Restructuring Amortization of intangible assets and purchase price accounting related adjustments Impairment of intangible assets...

  • Page 90
    ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES RECONCILIATION OF GAAP NET INCOME TO NON-GAAP MEASURES (Amounts in millions, except earnings per share data) Year Ended December 31, 2010 GAAP Measurement Less: Net effect from deferral in net revenues and related cost of sales Less: Stock-based ...

  • Page 91
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  • Page 93
    ... Policy Officer, Activision Blizzard Austin, Texas Carlsbad, California Dallas, Texas Eagan, Minnesota Eden Prairie, Minnesota El Segundo, California Encino, California Fayetteville, Arkansas Foster City, California Fresno, California Irvine, California Los Angeles, California Menands, New York...

  • Page 94
    3100 OCEAN PARK BOULEVARD SANTA MONICA, CALIFORNIA 90405 TELEPHONE: (310) 255-2000 FAX: (310) 255-2100 WWW.ACTIVISIONBLIZZARD.COM