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ACTIVISION BLIZZARD, INC. - 10-K/A - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) Business Overview
The Company's Formation and Business Combination
Activision, Inc. was originally incorporated in California in 1979 and was
reincorporated in Delaware in December 1992. On July 9, 2008, a business
combination (the "Business Combination") by and among Activision, Inc., Sego
Merger Corporation, a wholly-owned subsidiary of Activision, Inc., Vivendi S.A.
("Vivendi"), VGAC LLC, a wholly-owned subsidiary of Vivendi , and Vivendi
Games, Inc. ("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. Activision Blizzard is a
public company traded on the NASDAQ under the ticker symbol "ATVI."
Activision Blizzard, Inc. is a worldwide online, personal computer ("PC"),
video game console, tablet, handheld, and mobile game publisher. The terms
"Activision Blizzard," the "Company," "we," "us," and "our" are used to refer
collectively to Activision Blizzard, Inc. and its subsidiaries. Based upon our
organizational structure, we conduct our business through three operating
segments as follows:
Activision Publishing, Inc.
Activision Publishing, Inc. ("Activision") is a leading international
developer and publisher of interactive software products and content. Activision
develops games based on both internally-developed and licensed intellectual
property. Activision markets and sells games we develop and, through our
affiliate label program, games developed by certain third-party publishers. We
sell games both through retail channels and by digital download. Activision
currently offers games that operate on the Sony Computer Entertainment, Inc.
("Sony") PlayStation 3 ("PS3"), Nintendo Co. Ltd. ("Nintendo") Wii ("Wii") and
Nintendo Wii U ("Wii U"), and Microsoft Corporation ("Microsoft") Xbox 360
("Xbox 360") console systems; the Nintendo Dual Screen ("DS") and Nintendo 3DS
("3DS") handheld game systems; the PC; and other handheld and mobile devices.
Blizzard Entertainment, Inc.
Blizzard Entertainment, Inc. ("Blizzard") is a leader in the
subscription-based massively multi-player online role-playing game ("MMORPG")
category in terms of both subscriber base and revenues generated through its
World of Warcraft® franchise, which it develops, hosts and supports. Blizzard
also develops, markets, and sells role-playing action and strategy PC-based
computer games, including games in the multiple-award winning Diablo® and
StarCraft® franchises. In addition, Blizzard maintains a proprietary online-game
related service, Battle.net®. Blizzard distributes its products and generates
revenues worldwide through various means, including: subscriptions (which
consist of fees from individuals playing World of Warcraft®, sales of prepaid
subscription cards, and revenue from value-added services such as realm
transfers, faction changes and other character customizations within the World
of Warcraft gameplay); retail sales of physical "boxed" products; online
download sales of PC products; and licensing of software to third-party or
related party companies that distribute World of Warcraft, Diablo® III and
StarCraft® II products.
Activision Blizzard Distribution
Activision Blizzard Distribution ("Distribution") consists of operations in
Europe that provide warehousing, logistical and sales distribution services to
third-party publishers of interactive entertainment software, our own publishing
operations, and manufacturers of interactive entertainment hardware.
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Business Results and Highlights
In 2012, Activision Blizzard's consolidated net revenues were $4.9 billion
and consolidated net income was $1.1 billion, resulting in diluted earnings per
common share of $1.01. The Company grew net revenues, operating income, and
earnings per share as compared to 2011. We also generated $1.3 billion in cash
from operating activities in 2012.
Also, according to The NPD Group with respect to North America, GfK
Chart-Track with respect to Europe, and Activision Blizzard internal estimates,
during 2012:
º •
º In North America and Europe combined, including toys and accessories,
Activision Publishing was the #1 console and handheld publisher for
the calendar year with the #1 and #3 best-selling franchises-Call of
Duty® and Skylanders.
º • º Activision Blizzard reported record digital revenues for the calendar
year and was the #1 third-party interactive entertainment Western
digital publisher.
º •
º For the calendar year, in aggregate across all platforms in the U.S. and Europe, Activision Publishing's Call of Duty: Black Ops II was the
#1 best-selling title in dollars and Call of Duty: Modern Warfare® 3
was the #9 best-selling title in dollars.
º •
º In both North America and Europe, including toys and accessories,
Skylanders Giants™ was the #1 best-selling kids' title in dollars for
the fourth quarter. Additionally, for the calendar year, in North
America and Europe combined, including toys and accessories,
Skylanders Giants was the #5 best-selling game in dollars, and
Skylanders Spyro's Adventure® was the #4 best-selling game in dollars.
º •
º For the calendar year, Blizzard Entertainment had two top-10 PC games
in North America and Europe. Diablo III was the #1 best-selling PC
game at retail, breaking PC-game sales records with more than
12 million copies sold worldwide through December 31, 2012, and World
of Warcraft: Mists of Pandaria® was the #3 best-selling PC game at
retail.
Product Release Highlights
The following games and content packs, among other titles, were released
during the year ended December 31, 2012:
• •
007™ Legends Family Guy: Back to the Multiverse
• •
Angry Birds™ Trilogy Ice Age™ Continental Drift Arctic Games
• •
Battleship® Men In Black: Alien Crisis™
• •
Cabela's® Dangerous Hunts 2013 Prototype® 2
• •
Cabela's Hunting Expeditions Skylanders Giants
• •
Call of Duty: Black Ops II The Amazing Spider-Man™
• •
Call of Duty Modern Warfare 3 Transformers™: Fall of Cybertron™
Content Collection #1
• •
Call of Duty: Modern Warfare 3 Transformers Prime™
Content Collection #2
• •
Call of Duty: Modern Warfare 3 Wipeout 3
Content Collection #3
• •
Call of Duty: Modern Warfare 3 World of Warcraft: Mists of Pandaria
Content Collection #4
•
Diablo III
On January 29, 2013, Activision released Revolution, the first downloadable
map pack for Call of Duty: Black Ops II, ("Revolution") on the Xbox 360.
Revolution is expected to be available on other platforms during the first
quarter of 2013.
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StarCraft II: Heart of the Swarm™, the first expansion to Blizzard's
real-time strategy game StarCraft II: Wings of Liberty®, is expected to be
available in stores and online beginning March 12, 2013.
International Operations
International sales are a fundamental part of our business. Net revenues
from international sales accounted for approximately 50%, 50%, and 46% of our
total consolidated net revenues for the years ended December 31, 2012, 2011 and
2010, respectively. We maintain significant operations in the United States
("U.S."), Canada, the United Kingdom ("U.K."), France, Germany, Ireland, Italy,
Sweden, Spain, the Netherlands, Australia, South Korea and China. An important
element of our international strategy is to develop content that is specifically
directed toward local cultures and customs. Our international business is
subject to risks typical of an international business, including, but not
limited to, foreign currency exchange rate volatility and changes in local
economies. Accordingly, our future results could be materially and adversely
affected by changes in foreign currency exchange rates and changes in local
economies.
Management's Overview of Business Trends
Online Content and Digital Downloads
We provide our products through both retail channels and digital online
delivery methods. Many of our video games that are available through retailers
as physical "boxed" software products, such as DVDs, are also available by
direct digital download over the Internet (both from websites that we own and
from others owned by third parties). In addition, we offer players downloadable
content as add-ons to our products (e.g., new multi-player content packs),
generally for a one-time fee. We also offer subscription-based services for
World of Warcraft, which are digitally delivered and hosted by Blizzard's
proprietary online-game related service, Battle.net. In 2011, Activision
launched Call of Duty Elite, a digital service that provides both free and paid
subscription-based content and features for Call of Duty: Modern Warfare 3. In
conjunction with the release of Call of Duty: Black Ops II, all of the Call of
Duty Elite service features for that game were made available for free. This
free service does not include downloadable map packs, which are sold separately,
either a la carte as individual map packs or as part of a discounted season pass
bundle. Existing Call of Duty Elite premium members will continue to enjoy the
Call of Duty Elite premium membership features for Call of Duty: Modern Warfare
3 through the end of their subscription period. Digital revenues remain an
important part of our business, and we continue to focus on and develop products
that can be delivered via digital online channels. The amount of our digital
revenues in any period may fluctuate depending, in part, on the timing and
nature of our specific product releases.
We currently define digital online channel-related sales as revenues from
subscriptions and memberships, licensing royalties, value-added services,
downloadable content, and digitally distributed products. This definition may
differ from that used by our competitors or other companies.
For the year ended December 31, 2012, our sales through the digital online
channels decreased by approximately $100 million, as compared to 2011, and our
net revenues from digital online channels represented 32% of our total
consolidated net revenues in 2012 as compared to 34% in 2011. These decreases
were mainly attributable to the deferral of revenues due to the timing of the
releases of Diablo III and World of Warcraft: Mists of Pandaria. On a non-GAAP
basis, our sales through the digital online channels increased by $40 million,
as compared to 2011, and our net revenues from digital online channels
represented 32% of our total consolidated net revenues in 2012 as compared to
35% in 2011. This increase in sales from the digital online channels was
primarily due to the releases of Diablo III and World of Warcraft: Mists of
Pandaria.
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Please refer to the reconciliation between GAAP and non-GAAP financial
measures later in this document for further discussions of retail and digital
online channels.
Current Generation of Game Consoles
The current generation of game consoles began with Microsoft's launch of the
Xbox 360 in November 2005, and continued in 2006 when Sony and Nintendo launched
the PS3 and the Wii, respectively. The installed base of current generation
hardware (i.e. Xbox 360, PS3 and Wii) in the U.S. and Europe was approximately
183 million units as of December 31, 2012, as compared to 166 million units at
December 31, 2011, according to The NPD Group, with respect to North America,
and GfK Chart-Track, with respect to Europe, representing an increase of 11% in
units year-over-year. The installed base of PS3 and Xbox 360 hardware units
increased 15% year-over-year, while the installed base of Wii hardware units
increased 5% year-over-year. During the 2012 year-end holiday season, Nintendo
released a new "next-generation" high-definition version console, the Wii U. On
February 20, 2013, Sony announced that it intends to launch PlayStation 4, its
next-generation computer entertainment system, by the 2013 year-end holiday
buying season.
We continually monitor console hardware sales, as well as the development of
"next-generation" consoles. We manage our product delivery on each current and
future platform in a manner we believe to be most effective to maximize our
revenue opportunities and achieve the desired return on our investments in
product development.
Conditions in the Retail Distribution Channels
Conditions in the retail channels of the interactive entertainment industry
remained challenging through 2012. In North America and Europe, retail sales
within the industry experienced a combined overall decrease of approximately 21%
in 2012, as compared to 2011, according to The NPD Group and GfK Chart-Track.
The declines in the North America and European retail channels were impacted by
fewer releases and catalog sales in 2012 as compared to 2011, as well as price
declines over the prior year. In addition, the decline in sales to the retail
channels continue to be more pronounced for casual titles on the Nintendo Wii
and handheld platforms (down over 35% year-over-year), than titles on
high-definition platforms (i.e., Xbox 360 and PS3).
Despite the 21% decrease in retail sales for the overall industry, according
to The NPD Group, GfK Chart-Track and the Company's internal estimates, the
sales of the industry's top five titles (including accessory packs and figures)
grew 1% in 2012, as compared to 2011. This has resulted in the further
concentration of revenues in the top titles, particularly for high-definition
platforms, which experienced year-over-year growth, while non-premier titles
experienced declines. The Company's results have been less impacted by the
general declining trends in retail compared to our competitors because of our
greater focus on premier top titles and a more focused overall slate of titles.
Concentration of Top Titles
The concentration of retail revenues among key core titles has continued as
a trend in the overall interactive software industry. According to The NPD
Group, the top 10 titles accounted for 30% of the sales in the U.S. video game
industry in 2012 as compared to 26% in 2011. Similarly, a significant portion of
our revenues has historically been derived from video games based on a few
popular franchises and these video games are responsible for a
disproportionately high percentage of our profits. For example, our four largest
franchises in 2012-Call of Duty, Diablo, Skylanders and World of
Warcraft-accounted for approximately 83% of our net revenues, and a
significantly higher percentage of our operating income, for the year.
We expect that a limited number of popular franchises will continue to
produce a disproportionately high percentage of the industry and our revenues
and profits.
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Seasonality
The interactive entertainment industry is highly seasonal. We have
historically experienced our highest sales volume in the year-end holiday buying
season, which occurs in the fourth quarter. We defer the recognition of a
significant amount of net revenue related to our software titles containing
online functionality that constitutes a more-than-inconsequential separate
service deliverable over an extended period of time (i.e., typically five months
to less than a year). As a result, the quarter in which we generate the highest
sales volume may be different than the quarter in which we recognize the highest
amount of net revenue. Our results can also vary based on a number of factors
including, but not limited to, title release date, consumer demand, market
conditions and shipment schedule.
Outlook
Looking forward, the above discussed factors, such as the ongoing console
transition, increasing concentration of top titles in the interactive
entertainment industry, and a continuingly challenged global economy, might
negatively impact our short-term results. In addition, 2013 compared to 2012
will be a difficult year-over-year comparison due to the highly successful
launch of Diablo III in May 2012. We will continue to invest in our established
franchises, as well as new titles we think have the potential to drive our
growth over the long-term.
Consolidated Statements of Operations Data
The following table sets forth consolidated statements of operations data
for the periods indicated in dollars and as a percentage of total net revenues
(amounts in millions):
For the Years Ended December 31,
2012 2011 2010
Net revenues:
Product sales $ 3,620 75 % $ 3,257 68 % $ 3,087 69 %
Subscription, licensing, and other
revenues 1,236 25 1,498 32 1,360 31
Total net revenues 4,856 100 4,755 100 4,447 100
Costs and expenses:
Cost of sales-product costs 1,116 23 1,134 24 1,350 31
Cost of sales-online subscriptions 263 5 255 5 250 5
Cost of sales-software royalties and
amortization 194 4 218 5 338 8
Cost of sales-intellectual property
licenses 89 2 165 3 197 4
Product development 604 12 629 14 626 14
Sales and marketing 578 12 545 11 516 12
General and administrative 561 12 456 10 375 8
Impairment of intangible assets - - - - 326 7
Restructuring - - 25 - - -
Total costs and expenses 3,405 70 3,427 72 3,978 89
Operating income 1,451 30 1,328 28 469 11
Investment and other income (expense), net 7 - 3 - 23 1
Income before income tax expense 1,458 30 1,331 28 492 12
Income tax expense 309 6 246 5 74 2
Net income $ 1,149 24 % $ 1,085 23 % $ 418 10 %
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Operating Segment Results
Our operating segments are consistent with our internal organizational
structure, the manner in which our operations are reviewed and managed by our
Chief Executive Officer, who is our Chief Operating Decision Maker ("CODM"), the
manner in which we assess operating performance and allocate resources, and the
availability of separate financial information. We do not aggregate operating
segments.
The CODM reviews segment performance exclusive of the impact of the change
in deferred net revenues and related cost of sales with respect to certain of
our online-enabled games, stock-based compensation expense, restructuring
expense, amortization of intangible assets, and impairment of intangible assets
and goodwill. The CODM does not review any information regarding total assets on
an operating segment basis, and accordingly, no disclosure is made with respect
thereto. Information on the operating segments and reconciliations of total
segment net revenues and total segment operating income to consolidated net
revenues and income before income tax expense from external customers and
consolidated income before income tax expense for the years ended December 31,
2012, 2011, and 2010 are presented in the table below (amounts in millions):
For the Years Ended December 31,
Increase/ Increase/
(decrease) (decrease)
2012 2011 2010 2012 v 2011 2011 v 2010
Segment net revenues:
Activision $ 3,072 $ 2,828 $ 2,769 $ 244 $ 59
Blizzard 1,609 1,243 1,656 366 (413 )
Distribution 306 418 378 (112 ) 40
Operating segment net revenue
total 4,987 4,489 4,803 498 (314 )
Reconciliation to consolidated
net revenues:
Net effect from changes in the
deferral of net revenues (131 ) 266 (356 ) (397 ) 622
Consolidated net revenues $ 4,856 $ 4,755 $ 4,447 $ 101 $ 308
Segment income from operations:
Activision $ 970 $ 851 $ 511 $ 119 $ 340
Blizzard 717 496 850 221 (354 )
Distribution 11 11 10 - 1
Operating segment income from
operations total 1,698 1,358 1,371 340 (13 )
Reconciliation to consolidated
operating income and
consolidated income before
income tax expense:
Net effect from changes in the
deferral of net revenues and
related cost of sales (91 ) 183 (319 ) (274 ) 502
Stock-based compensation expense (126 ) (103 ) (131 ) (23 ) 28
Restructuring - (26 ) (3 ) 26 (23 )
Amortization of intangible
assets (30 ) (72 ) (123 ) 42 51
Impairment of
goodwill/intangible assets - (12 ) (326 ) 12 314
Consolidated operating income 1,451 1,328 469 123 859
Investment and other income
(expense), net 7 3 23 4 (20 )
Consolidated income before
income tax expense $ 1,458 $ 1,331 $ 492 $ 127 $ 839
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For better understanding of the differences in presentation between our
segment results and the consolidated results, the following explains the nature
of each reconciling item.
Net Effect from Deferral of Net Revenues and Related Cost of Sales
We have determined that some of our game's online functionality represents
an essential component of gameplay and as a result a more-than-inconsequential
separate deliverable. As such, we are required to recognize the revenues of
these game titles over the estimated service periods, which 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 as the related revenues are recognized. In the
table on the previous page, we present the amount of net revenues and related
cost of sales separately for each period as a result of this accounting
treatment.
Stock-Based Compensation Expense
We expense our stock-based awards using the grant date fair value over the
vesting periods of the stock awards. In the case of liability awards, the
liability is subject to revaluation based on the stock price at the end of the
relevant period. Included within stock-based compensation are the net effects of
capitalization, deferral, and amortization.
Restructuring
On February 3, 2011, the Company's Board of Directors authorized a
restructuring plan (the "2011 Restructuring") involving a focus on the
development and publication of a reduced slate of titles on a going-forward
basis. The 2011 Restructuring included the discontinuation of the development of
music-based games, the closure of the related business unit and the cancellation
of other titles then in production, along with a related reduction in studio
headcount and corporate overhead. The costs related to the 2011 Restructuring
activities included severance costs, facility exit costs, and exit costs from
the cancellation of projects. The 2011 Restructuring charges for the year ended
December 31, 2011 were $25 million, which is reflected in a separate caption
"Restructuring expenses" on our consolidated statement of operations. The 2011
Restructuring was completed as of December 31, 2011 and we do not expect to
incur significant additional restructuring expenses relating thereto.
In 2008, we implemented an organizational restructuring plan as a result of
the Business Combination. This organizational restructuring was to integrate
different operations and to streamline the combined Activision Blizzard
organization. The costs related to the restructuring activities included
severance costs, facility exit costs, write-offs of assets and liabilities and
exit costs from the cancellation of projects. For the year ended December 31,
2011, expense related to the organizational restructuring was $1 million and has
been reflected in the "General and administrative expense" in the consolidated
statement of operations. The organizational restructuring activities as a result
of the Business Combination were completed as of December 31, 2011 and we do not
expect to incur additional restructuring expenses relating thereto.
Amortization of Intangible Assets
All of our intangible assets are the result of the Business Combination and
other acquisitions. We amortize the intangible assets over their estimated
useful lives based on the pattern of consumption of the underlying economic
benefits. The amount presented in the table represents the effect of the
amortization of intangible assets as well as other purchase price accounting
adjustments, where applicable, in our consolidated statements of operations.
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Impairment of Goodwill/Intangible Assets
We recorded a non-cash charge of $12 million related to the impairment of
goodwill of our Distribution reporting unit for the year ended December 31,
2011, reflecting a continuing shift in the distribution of interactive
entertainment software from retail distribution channels to digital distribution
channels. Furthermore, we recorded a non-cash impairment charge on
definite-lived intangible assets of $326 million for the year ended December 31,
2010, reflecting a continuing weaker environment for the casual game and music
genres.
Segment Net Revenues
Activision
Activision's net revenues increased for 2012 as compared to 2011, primarily
due to revenues from the Skylanders franchise (both from the launch of
Skylanders Giants in the fourth quarter of 2012 and the full-year revenues from
Skylanders Spyro's Adventure, which was launched in the fourth quarter of 2011).
The increase was partially offset by lower revenues from the Call of Duty
franchise primarily from lower catalog sales and lower revenues from
downloadable content packs for Call of Duty: Modern Warfare 3, though these
decreases were partially mitigated by the strong performance from Call of Duty:
Black Ops II which launched in the fourth quarter of 2012.
For 2011, net revenues from the Activision segment increased as compared to
2010 primarily due to: the strong performance of Call of Duty: Modern Warfare 3
and the strong digital revenue performance from the franchise; revenues from
Skylanders Spyro's Adventure which successfully launched as a new intellectual
property in the fourth quarter of 2011; the release of Lego Star Wars III, which
we published on behalf of Lucas Arts in Europe and certain countries in Asia
Pacific; and benefits from foreign exchange as compared to the prior year. The
increase was partially offset by a more focused release schedule in 2011 than in
2010, and lower catalog sales of games in the music and casual games genre.
Blizzard
Blizzard's net revenues increased for 2012 as compared to 2011, primarily
due to the release of Diablo III in May 2012 and World of Warcraft: Mists of
Pandaria in September 2012. The increase in net revenues was partially offset by
lower subscription revenues from World of Warcraft due to a lower subscriber
base.
At December 31, 2012, the worldwide subscriber* base for World of Warcraft
was approximately 9.6 million, down from a base of more than 10 million
subscribers at September 30, 2012, and approximately 10.2 million subscribers at
December 31, 2011, with the majority of the decline from the East (where the
"East" includes China, Taiwan, and Korea, and the "West" includes North America,
Europe and Latin America). With the launch of World of Warcraft: Cataclysm®, in
the fourth quarter of 2010, the subscriber base reached a new peak at more than
12 million subscribers at December 31, 2010. Since that time, the subscriber
base has trended downward. Looking forward, Blizzard Entertainment expects to
continue to deliver new game content in all regions that is intended to further
appeal to the gaming community.
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º *
º World of Warcraft subscribers include individuals who have paid a
subscription fee or have an active prepaid card to play World of Warcraft,
as well as those who have purchased the game and are within their free
month of access. Internet Game Room players who have accessed the game over
the last thirty days are also counted as subscribers. The above definition
excludes all players under free promotional subscriptions, expired or
cancelled subscriptions, and expired prepaid cards. Subscribers in
licensees' territories are defined along the same rules.
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Blizzard's net revenues decreased for 2011 as compared to 2010 primarily as
a result of no new titles released in 2011 as compared to 2010, when StarCraft
II: Wings of Liberty was released in the third quarter and World of Warcraft:
Cataclysm was released in the fourth quarter; and as a result of a decline in
World of Warcraft's subscriber base during 2011. These decreases were partially
offset by benefits from foreign exchange as compared to the prior year.
Distribution
Distribution's net revenues decreased in 2012 as compared to 2011, primarily
due to a weaker U.K. market.
Distribution's net revenues increased in 2011 as compared to 2010, primarily
due to additional customer sales opportunities in the U.K. and benefits from
foreign exchange as compared to prior year.
Segment Income from Operations
Activision
Activision's operating income increased in 2012 as compared to 2011,
primarily due to higher net revenues as described above, and lower sales and
marketing costs. The increase was partially offset by higher cost of sales as a
result of higher net revenues, higher product development costs, and higher
general and administrative costs, primarily resulting from legal-related
expenses (including legal-related accruals, settlements and fees) and additional
accrued bonuses reflecting our strong 2012 financial performance.
Activision's operating income increased in 2011 as compared to 2010,
primarily due to a more focused release of products that delivered higher
operating margins; increased digital sales of Call of Duty's digital content,
resulting in high operating margins; and reduction of operating expenses
resulting from the 2011 Restructuring. These positive impacts on operating
income were partially offset by an increase in sales and marketing expenses to
support the launch of Skylanders Spyro's Adventure, Call of Duty: Modern Warfare
3 and Call of Duty Elite and additional litigation activities and settlement of
lawsuits.
Blizzard
Blizzard's operating income increased in 2012 as compared to 2011, primarily
due to higher revenues as described above. The increase was partially offset by
higher cost of sales as a result of higher net revenues, higher sales and
marketing costs to support the launch of Diablo III and World of Warcraft: Mists
of Pandaria, and higher general and administrative costs from additional accrued
bonuses reflecting our strong 2012 financial performance.
Blizzard's operating income decreased in 2011 as compared to 2010, primarily
due to lower revenues as discussed above. These negative impacts on operating
income were partially offset by a decrease in sales and marketing expenses, as
higher sales and marketing expenses were incurred in 2010 to support the release
of StarCraft II: Wings of Liberty in the third quarter and World of Warcraft:
Cataclysm in the fourth quarter; and lower customer support costs incurred.
Non-GAAP Financial Measures
The analysis of revenues by distribution channel is presented both on a GAAP
(including the impact from change in deferred revenues) and non-GAAP (excluding
the impact from change in deferred revenues) basis. We use this non-GAAP measure
internally when evaluating our operating performance, when planning, forecasting
and analyzing future periods, and when assessing the performance of our
management team. We believe this is appropriate because this non-GAAP measure
enables an analysis of performance based on the timing of actual transactions
with our customers,
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which is consistent with the way the Company is measured by investment analysts
and industry data sources, and facilitates comparison of operating performance
between periods. In addition, excluding the impact from change in deferred net
revenue provides a much more timely indication of trends in our sales and other
operating results. While we believe that this non-GAAP measure is useful in
evaluating our business, this information should be considered as supplemental
in nature and is not meant to be considered in isolation from, as a substitute
for, or as more important than, the related financial information prepared in
accordance with GAAP. In addition, this non-GAAP financial measure may not be
the same as any non-GAAP measure presented by another company. This non-GAAP
financial measure has limitations in that it does not reflect all of the items
associated with our GAAP revenues. We compensate for the limitations resulting
from the exclusion of the change in deferred revenues by considering the impact
of that item separately and by considering our GAAP, as well as non-GAAP,
revenues.
Results of Operations-Years Ended December 31, 2012, 2011, and 2010
Non-GAAP Financial Measures
The following table provides reconciliation between GAAP and non-GAAP net
revenues by distribution channel for the years ended December 31, 2012, 2011,
and 2010 (amounts in millions):
For the Years Ended December 31,
Increase/ Increase/
(decrease) (decrease) % Change % Change
2012 2011 2010 2012 v 2011 2011 v 2010 2012 v 2011 2011 v 2010
GAAP net
revenues by
distribution
channel
Retail
channels $ 3,013 $ 2,697 $ 2,629 $ 316 $ 68 12 % 3 %
Digital
online
channels(1) 1,537 1,640 1,440 (103 ) 200 (6 ) 14
Total
Activision
and Blizzard 4,550 4,337 4,069 213 268 5 7
Distribution 306 418 378 (112 ) 40 (27 ) 11
Total
consolidated
GAAP net
revenues 4,856 4,755 4,447 101 308 2 7
Change in
deferred net
revenues(2)
Retail
channels 69 (185 ) 251 254 (436 ) (137 ) (174 )
Digital
online
channels(1) 62 (81 ) 105 143 (186 ) (177 ) (177 )
Total
changes in
deferred net
revenues 131 (266 ) 356 397 (622 ) (149 ) (175 )
Non-GAAP net
revenues by
distribution
channel
Retail
channels 3,082 2,512 2,880 570 (368 ) 23 (13 )
Digital
online
channels(1) 1,599 1,559 1,545 40 14 3 1
Total
Activision
and Blizzard 4,681 4,071 4,425 610 (354 ) 15 (8 )
Distribution 306 418 378 (112 ) 40 (27 ) 11
Totalnon-GAAP net
revenues(3) $ 4,987 $ 4,489 $ 4,803 $ 498 $ (314 )
11 % (7 )%
--------------------------------------------------------------------------------
º (1)
º We currently define revenues from digital online channels as revenues from
subscriptions and memberships, licensing royalties, value-added services,
downloadable content, and digitally distributed products.
º (2)
º We have determined that some of our game's online functionality represents
an essential component of gameplay and as a result a
more-than-inconsequential separate deliverable. As such, we are required to
recognize the revenues of these game titles over the estimated service
periods, which may range from a minimum of five months to a maximum of less
than a year. In the table above, we present the amount of net revenues for
each period as a result of this accounting treatment.
º (3)
º Total non-GAAP net revenues presented also represents our total operating
segment net revenues.
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The increase in GAAP net revenues from retail channels for 2012 as compared
to 2011 was the result of sales from the Skylanders franchise (both from the
launch of Skylanders Giants in the fourth quarter of 2012 and the full-year
revenues from Skylanders Spyro's Adventure, which was launched in the fourth
quarter of 2011) and revenues from Diablo III and World of Warcraft: Mists of
Pandaria. The increase was partially offset by lower catalog sales of Call of
Duty and other titles, and lower catalog revenues generated from World of
Warcraft: Cataclysm and Starcraft II: Wings of Liberty, which were released in
2010.
The increase in GAAP net revenues from retail channels for 2011 as compared
to 2010 was the result of the strong performance of the Call of Duty franchise,
recognition of deferred revenues from the 2010 launches of StarCraft II: Wings
of Liberty and World of Warcraft: Cataclysm, and revenues generated from the
launch of Skylanders Spyro's Adventure, partially offset by the release of fewer
key titles.
The decrease in GAAP net revenues from digital online channels for 2012 as
compared to 2011 was primarily due to lower revenues from World of Warcraft
subscriptions and lower net revenues from Call of Duty downloadable content
packs released in 2012 for Call of Duty: Modern Warfare 3, in comparison to
downloadable content packs released in 2011 for Call of Duty®: Black Ops. The
decrease was partially offset by the full game download sales of Diablo III and
World of Warcraft: Mists of Pandaria, and revenues from Call of Duty Elite
memberships.
The increase in GAAP net revenues from digital online channels for 2011 as
compared to 2010 was primarily due to the stronger performance and greater
number of downloadable content packs for Call of Duty: Black Ops, which was
released in 2011, as compared to the downloadable content packs for Call of
Duty: Modern Warfare® 2 released in the prior year, and a higher number of full
game downloads from the Call of Duty catalog titles. In addition, revenues
generated from the World of Warcraft franchise, particularly from the digital
release of World of Warcraft: Cataclysm in December 2010, as well as the digital
release of StarCraft II: Wings of Liberty in July 2010, resulted in more
deferred revenues recognized in 2011 as compared to 2010.
The increase in non-GAAP net revenues from retail channels for 2012 as
compared to 2011 was the result of sales from the Skylanders franchise (both
from the launch of Skylanders Giants in the fourth quarter of 2012 and the
full-year revenues from Skylanders Spyro's Adventure, which was launched in the
fourth quarter of 2011), Diablo III and World of Warcraft: Mists of Pandaria.
The increase was partially offset by lower catalog sales of Call of Duty titles
as well as other titles, and lower catalog revenues generated from World of
Warcraft: Cataclysm and Starcraft II: Wings of Liberty, which were released in
2010.
The decrease in non-GAAP net revenues from retail channels for 2011 as
compared to 2010 was the result of our more focused slate, with the release of
fewer key titles, and lower revenues generated from the casual "value" titles.
The decrease was partially offset by the strong performance of the Call of Duty
franchise and revenues generated from Skylanders Spyro's Adventure.
The increase in non-GAAP net revenues from digital online channels for 2012
as compared to 2011 was attributable to sales of full game digital downloads
from the launches of World of Warcraft: Mists of Pandaria and Diablo III (which
were launched in 2012) and memberships revenues from Call of Duty Elite (which
was launched in late November 2011). The increase was partially offset by lower
revenues from World of Warcraft subscriptions and lower net revenues from Call
of Duty downloadable content packs.
The increase in non-GAAP net revenues from digital online channels for 2011
as compared to 2010 was attributable to the stronger performance and greater
number of downloadable content packs released in 2011 for Call of Duty: Black
Ops, versus downloadable map packs released in the prior year for Call of Duty:
Modern Warfare 2, and a higher number of full game downloads from the Call of
Duty
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catalog titles. This increase was partially offset by the unfavorable impact of
the decrease in World of Warcraft's subscriber base, the decrease of full game
downloads of World of Warcraft: Cataclysm, which was released in December 2010,
and StarCraft II: Wings of Liberty, which was released in July 2010.
Consolidated Results
Net Revenues by Geographic Region
The following table details our consolidated net revenues by geographic
region for the years ended December 31, 2012, 2011, and 2010 (amounts in
millions):
For the Years ended December 31,
Increase/ Increase/
(decrease) (decrease) % Change % Change
2012 2011 2010 2012 v 2011 2011 v 2010 2012 v 2011 2011 v 2010
Geographic
region net
revenues:
North
America $ 2,436 $ 2,405 $ 2,409 $ 31 $ (4 ) 1 % - %
Europe 1,968 1,990 1,743 (22 ) 247 (1 ) 14
Asia Pacific 452 360 295 92 65 26 22
Consolidated
net revenues $ 4,856 $ 4,755 $ 4,447 $ 101 $ 308
2 7
The increase/(decrease) in deferred revenues recognized by geographic region
for the years ended December 31, 2012, 2011, and 2010 was as follows (amounts in
millions):
For the Years Ended December 31,
Increase/ Increase/
(Decrease) (Decrease)
2012 2011 2010 2012 v 2011 2011 v 2010
Deferred revenues recognized
by geographic region:
North America $ (78 ) $ 154 $ (166 ) $ (232 ) $ 320
Europe (28 ) 104 (159 ) (132 ) 263
Asia Pacific (25 ) 8 (31 ) (33 ) 39
Total impact on consolidated
net revenues (131 ) 266 (356 ) (397 ) 622
Consolidated net revenues from North America and Asia Pacific increased in
2012 as compared to 2011, primarily due to sales from the Skylanders franchise
(both from the launch of Skylanders Giants in the fourth quarter of 2012, and
the full-year revenues from Skylanders Spyro's Adventure, which was launched in
the fourth quarter of 2011), Diablo III and World of Warcraft: Mists of
Pandaria. Sales of Diablo III accounted for the majority of the year-over-year
increase in net revenues for the Asia Pacific region. The increase in
consolidated net revenues from North America and Asia Pacific was partially
offset by lower subscriptions revenues from World of Warcraft, lower catalog
sales of Call of Duty titles as well as other titles, and lower catalog revenues
generated from World of Warcraft: Cataclysm and Starcraft II: Wings of Liberty,
which were released in 2010.
Consolidated net revenues from Europe decreased slightly in 2012 as compared
to 2011, primarily due to lower subscriptions revenues from World of Warcraft,
lower catalog sales of Call of Duty titles as well as other titles, and lower
catalog revenues generated from World of Warcraft: Cataclysm and from Starcraft
II: Wings of Liberty, which were released in 2010, and lower revenues from our
Distribution segment. The decrease was partially offset by sales from the
Skylanders franchise (both from the launch of Skylanders Giants in the fourth
quarter of 2012 and the full-year revenues from Skylanders Spyro's Adventure,
which was launched in the fourth quarter of 2011), Diablo III and World of
Warcraft: Mists of Pandaria.
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Further, in Europe and certain countries in Asia Pacific, net revenues were
also negatively impacted due to the fact that we published titles for Lucas Arts
in 2011, such as Lego Star Wars III, while no comparable title was published in
2012.
The decrease in deferred revenues recognized in all regions for the year
ended December 31, 2012 as compared to 2011 was primarily attributable to lower
World of Warcraft subscription revenues, lower sales of Call of Duty digital
downloadable content packs and catalogs titles, and lower catalog sales of World
of Warcraft: Cataclysm and Starcraft II: Wings of Liberty, as well as an
increase in revenues deferred due to the launch of both Diablo III and World of
Warcraft: Mists of Pandaria. The decrease was partially offset by the
recognition of the deferred revenues from Call of Duty: Modern Warfare 3.
Consolidated net revenues from Europe and Asia Pacific increased in 2011 as
compared to 2010, primarily due to the success of Call of Duty catalog titles,
stronger performance of downloadable content packs for Call of Duty: Black Ops
and the release of World of Warcraft: Cataclysm and StarCraft II: Wings of
Liberty in 2010, all of which resulted in increased revenues recognized in 2011
as compared to 2010. Further, the launch of Skylanders Spyro's Adventure and the
increase in Distribution segment revenues in Europe contributed to the increase
in consolidated net revenues. These increases were partially offset by the
additional deferral of revenues as a result of greater sales from the launch of
Call of Duty: Modern Warfare 3 in November 2011.
Consolidated net revenues from North America decreased slightly in 2011 as
compared to 2010, primarily due to the decrease in net revenues from music and
casual titles and the greater sales from the launch of Call of Duty: Modern
Warfare 3 which resulted in additional deferral of revenues. These decreases
were almost entirely offset by the success of Call of Duty catalog titles,
stronger performance of downloadable content packs for Call of Duty: Black Ops,
the releases of World of Warcraft: Cataclysm and StarCraft II: Wings of Liberty
in 2010, and the launch of Skylanders Spyro's Adventure, all of which resulted
in increased revenues recognized in 2011 as compared to 2010.
The releases of Call of Duty: Black Ops, World of Warcraft: Cataclysm and
StarCraft II: Wings of Liberty in 2010 were the primary reason why more deferred
revenues were recognized during 2011 as compared to 2010 across all regions.
This increase in the recognition of deferred revenues was partially offset by
greater revenues deferred in 2011 as a result of the higher sales from the
initial launch of Call of Duty: Modern Warfare 3 as compared to Call of Duty:
Black Ops.
Foreign Exchange Impact
Changes in foreign exchange rates had a negative impact of approximately
$114 million and a positive impact of approximately $100 million on Activision
Blizzard's net revenues in 2012 and 2011, respectively. The change is primarily
due to the year-over-year movements of the British pound, Euro and Australian
dollar average rates relative to the U.S. dollar.
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Net Revenues by Platform
The following table details our net revenues by platform and as a percentage
of total consolidated net revenues for the years ended December 31, 2012, 2011,
and 2010 (amounts in millions):
Year % of Year % of Year % of Increase/ Increase/
Ended total Ended total Ended total (decrease) (decrease)
December 31, consolidated December 31, consolidated December 31, consolidated 2012 v 2011 v
2012 net revs. 2011 net revs. 2010 net revs. 2011 2010
Platform net
revenues:
Online
subscriptions(1) $ 986 20 % $ 1,357 29 % $ 1,230 28 % $ (371 ) $ 127
PC and other(2) 1,214 25 374 8 325 7 840 49
Console
Sony PlayStation
3 876 18 948 20 889 20 (72 ) 59
Microsoft
Xbox 360 1,019 21 1,140 24 1,033 23 (121 ) 107
Nintendo Wii and
Wii U 291 6 351 7 408 9 (60 ) (57 )
Total console 2,186 45 2,439 51 2,330 52 (253 ) 109
Handheld 164 4 167 3 184 4 (3 ) (17 )
Total platform
net revenues 4,550 94 4,337 91 4,069 91 213 268
Distribution 306 6 418 9 378 9 (112 ) 40
Total
consolidated net
revenues $ 4,856 100 % $ 4,755 100 % $ 4,447 100 % $ 101 $ 308
The increase/(decrease) in deferred revenues recognized by platform for the
years ended December 31, 2012, 2011, and 2010 was as follows (amounts in
millions):
Years Ended December 31,
Increase/ Increase/
(Decrease) (Decrease)
2012 2011 2010 2012 v 2011 2011 v 2010
Increase/(decrease) in deferred
revenues recognized by platform:
Online subscriptions(1) $ (85 ) $ 202 $ (191 ) $ (287 ) $ 393
PC and other(2) (36 ) 75 (81 ) (111 ) 156
Console
Sony PlayStation 3 (30 ) (36 ) (77 ) 6 41
Microsoft Xbox 360 3 (43 ) (15 ) 46 (28 )
Nintendo Wii and Wii U 12 66 16 (54 ) 50
Total console (15 ) (13 ) (76 ) (2 ) 63
Nintendo 3DS and DS 5 2 (8 ) 3 10
Total impact on consolidated net
revenues $ (131 ) $ 266 $ (356 ) $ (397 ) $ 622
--------------------------------------------------------------------------------
º (1)
º Revenues from online subscriptions consists of revenue from all World of
Warcraft products, including subscriptions, boxed products, expansion
packs, licensing royalties, value-added services, and revenues from Call of
Duty Elite memberships.
º (2)
º Revenues from PC and other consists of net revenues from the sale of PC
boxed products, Skylanders franchise standalone toys products, mobile sales
and other physical merchandise and accessories.
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Net revenues from online subscriptions decreased in 2012 as compared to
2011, primarily as a result of lower World of Warcraft subscription revenues,
and lower Blizzard catalog sales from World of Warcraft: Cataclysm, which was
released in December 2010. The decrease was partially offset by revenues from
Call of Duty Elite memberships and World of Warcraft: Mists of Pandaria. Net
revenues from online subscriptions increased in 2011 as compared to 2010,
primarily driven by the recognition of deferred revenues from the release of
World of Warcraft: Cataclysm in December 2010 and from the sales of World of
Warcraft's value-added services, partially offset by the unfavorable impact of
World of Warcraft's declining subscriber base.
Net revenues from PC and other significantly increased in 2012 as compared
to 2011, primarily as a result of the sale of standalone toys and accessories
from the Skylanders franchise (both from the launch of Skylanders Giants in the
fourth quarter of 2012 and Skylanders Spyro's Adventure, which was launched in
the fourth quarter of 2011), and from sales of Diablo III. The increase was
partially offset by the decrease in revenues from Starcraft II: Wings of
Liberty, which was released in July 2010. Net revenues from PC and other
increased in 2011 as compared to 2010, primarily due to the sale of standalone
toys and accessories for Skylanders Spyro's Adventure, and the success of the
Call of Duty franchise titles. The increase was partially offset by lower
revenues from music and causal titles and no major release for PC and other in
2011 as compared to 2010, when StarCraft II: Wings of Liberty was released.
Net revenues from PS3 and Xbox 360 decreased in 2012 as compared to 2011,
primarily due to lower revenues from Call of Duty downloadable content packs and
catalog sales, partially offset by sales from the Skylanders franchise. Net
revenues from PS3 and Xbox 360 increased in 2011 as compared to 2010, primarily
due to the launch of Skylanders Spyro's Adventure, the success of the Call of
Duty franchise, and downloadable content packs for Call of Duty: Black Ops as
compared to the downloadable content packs for Call of Duty: Modern Warfare 2.
The increase was partially offset by the strong consumer demand at launch in
November 2011 for Call of Duty: Modern Warfare 3, which resulted in additional
deferral of revenues.
Net revenues from Nintendo Wii and Wii U decreased in 2012 as compared to
2011, primarily due to overall weaker catalog sales and fewer comparable
releases, partially offset by additional revenues from titles associated with
the launch of the Wii U. Net revenues from the Nintendo Wii and handheld systems
decreased in 2011 as compared to 2010 due to the release of fewer key titles
than in 2010, and lower catalog sales of games in the music and casual games
genres.
The deferred revenues recognized for online subscriptions decreased in 2012
as compared to 2011, primarily due to revenues deferred from World of Warcraft:
Mists of Pandaria, which launched on September 25, 2012, and lower revenues
recognized from World of Warcraft: Cataclysm, which was released in December
2010, and was partially offset by additional revenues recognized from Call of
Duty Elite memberships in 2012. The deferred revenues recognized for online
subscriptions increased in 2011 as compared to 2010, primarily driven by the
recognition of deferred revenues from the release of World of Warcraft:
Cataclysm in December 2010 and from the sales of World of Warcraft's value-added
services, partially offset by the unfavorable impact of World of Warcraft's
declining subscriber base.
The decrease in deferred revenues recognized for PC and other in 2012 as
compared to 2011 was primarily related to revenues deferred from the successful
launch of Diablo III on May 15, 2012 and a decrease in revenues recognized from
catalog sales of StarCraft II: Wings of Liberty, which was released in July
2010. The deferred revenues recognized for PC and other increased in 2011 as
compared to 2010, primarily related to the recognition of revenues of StarCraft
II: Wings of Liberty, which was released in July 2010.
The increase in deferred revenue recognized for Xbox 360 in 2012 as compared
to 2011 was primarily due to less revenue deferred from Call of Duty: Black Ops
II. The decrease in deferred revenue recognized for Xbox 360 in 2011 as compared
to 2010, was primarily due to the revenues
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deferral from Call of Duty: Modern Warfare 3. The decreases in deferred revenues
recognized for Nintendo Wii in 2012 as compared to 2011, primarily relate to
overall weaker catalog sales and fewer comparable releases, and were partially
offset by additional Wii U deferred revenues recognized. The increases in
deferred revenues recognized for Nintendo Wii in 2011 as compared to 2010,
primarily relate to recognition of revenues of our catalog sales of games in the
music and casual games genres.
Costs and Expenses
Cost of Sales (amounts in millions)
The following table details the components of cost of sales in dollars and
as a percentage of total consolidated net revenues for the years ended
December 31, 2012, 2011, and 2010 (amounts in millions):
Increase Increase
Year Ended % of Year Ended % of Year Ended % of (Decrease) (Decrease)
December 31, consolidated December 31, consolidated December 31, consolidated 2012 v 2011 v
2012 net revs. 2011 net revs. 2010 net revs. 2011 2010
Product costs $ 1,116 23 % $ 1,134 24 % $ 1,350 31 % $ (18 ) $ (216 )
Online
subscriptions 263 5 255 5 250 5 8 5
Software
royalties and
amortization 194 4 218 5 338 8 (24 ) (120 )
Intellectual
property
licenses 89 2 165 3 197 4 (76 ) (32 )
Total cost of sales decreased in 2012 as compared to 2011, primarily due to
a decrease in amortization of capitalized software development and intellectual
property license costs as we had fewer titles released during 2012; a decrease
in amortization of intangible assets due to decreasing intangible assets
balances year-over-year; and lower product costs from our Distribution segment
due to lower revenues. These decreases in cost of sales were partially offset by
higher product costs from our Publishing and Blizzard segments due to higher
revenues.
Total cost of sales decreased in 2011 as compared to 2010, primarily due to
the continued change in mix for products with fewer hardware peripherals, and
accordingly lower product costs; an increasing number of products distributed
through digital online channels; a decrease in inventory obsolescence charges,
as the prior year included higher inventory obsolescence charges relating to
peripherals; a decrease in amortization of capitalized software development and
intellectual property license costs as we had fewer titles released during 2011;
and a decrease in amortization of intangible assets. These decreases in cost of
sales were partially offset by more deferred costs recognized, consistent with
more deferred revenues recognized, during 2011 as compared to 2010; and higher
product costs from our Distribution segment revenues associated with higher
revenues.
Product Development (amounts in millions)
Increase Increase
Year Ended % of Year Ended % of Year Ended % of (Decrease) (Decrease)
December 31, consolidated December 31, consolidated December 31, consolidated 2012 v 2011 v
2012 net revs. 2011 net revs. 2010 net revs. 2011 2010
Product
development $ 604 12 % $ 629 14 % $ 626 14 % $ (25 ) $ 3
For 2012, product development costs decreased as compared to 2011,
principally due to higher capitalization in 2012 of our overall product
development costs related to future titles and the timing at which these titles
reached technical feasibility and lower stock option expenses. Additionally,
product development costs in 2011 included larger amounts written off, due to
the cancellation of games under development, than in 2012. The decrease was
partially offset by higher studio-related bonuses reflecting our strong 2012
financial performance.
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For 2011, product development costs increased slightly as compared to 2010,
principally due to lower capitalization of our overall product development costs
related to future titles and higher accrued studio-related bonuses. This
increase in product development expense was partially offset by the benefits
realized from our 2011 Restructuring, which involved a focus on reducing the
number of titles in development and publication, including the discontinuation
of the development of music-based games. Additionally, product development costs
in 2011 included amounts written off due to the cancellation of a future game
under development; however, the write-off of capitalized software development
was slightly less than in 2010.
Sales and Marketing (amounts in millions)
Increase Increase
Year Ended % of Year Ended % of Year Ended % of (Decrease) (Decrease)
December 31, consolidated December 31, consolidated December 31, consolidated net 2012 v 2011 v
2012 net revs. 2011 net revs. 2010 revs. 2011 2010
Sales and
marketing $ 578 12 % $ 545 11 % $ 516 12 % $ 33 $ 29
Sales and marketing expenses increased in 2012 as compared to 2011,
primarily due to increased spending on sales and marketing activities to support
the launches of Diablo III and World of Warcraft: Mists of Pandaria, as well as
continued investments in our Skylanders franchise.
Sales and marketing expenses increased in 2011 as compared to 2010,
primarily due to increased spending on sales and marketing activities to support
the launch of Skylanders Spyro's Adventure, Call of Duty: Modern Warfare 3 and
Call of Duty Elite in the fourth quarter of 2011.
General and Administrative (amounts in millions)
Increase Increase
Year Ended % of Year Ended % of Year Ended % of (Decrease) (Decrease)
December 31, consolidated December 31, consolidated December 31, consolidated 2012 v 2011 v
2012 net revs. 2011 netrevs. 2010 net revs. 2011 2010
General and
administrative $ 561 12 % $ 456 10 % $ 375 8 % $ 105 $ 81
General and administrative expenses increased in 2012 as compared to 2011,
primarily due to higher legal-related expenses (including legal-related
accruals, settlements and fees), stock-based compensation expenses and
additional accrued bonuses reflecting our strong 2012 financial performance.
General and administrative expenses increased in 2011 as compared to 2010,
primarily due to higher legal expenses incurred from additional litigation
activities and settlement of lawsuits, the impairment of our Distribution
segment's goodwill and higher depreciation expense and facilities costs.
Impairment of Intangible Assets (amounts in millions)
Increase Increase
Year Ended % of Year Ended % of Year Ended % of (Decrease) (Decrease)
December 31, consolidated December 31, consolidated December 31, consolidated 2012 v 2011 v
2012 net revs. 2011 net revs. 2010 net revs. 2011 2010
Impairment
of
intangible
assets $ - - % $ - - % $ 326 7 % $ - $ (326 )
There was no impairment of intangible assets for the years ended
December 31, 2012 and 2011.
In the fourth quarter of 2010, as a result of the franchise and industry
results of the holiday season, we significantly revised our outlook for the
retail sales of software. Further, with the impact of the continued economic
downturn on our industry in 2010 and the change in the buying habits of casual
consumers, we reassessed our overall expectations with respect to our future
sales of certain
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games titles. We considered these economic changes during our planning process
for 2011 that we conducted during the months of November and December, 2010,
which resulted in a strategy change to, among other things, focus on fewer title
releases in the casual and music genres. As a result, we updated our future
projected revenue streams for our franchises in the casual and music genres. We
performed recoverability and, where applicable, impairment tests on the related
intangible assets in accordance with ASC Subtopic 360-10. Based on the analysis
performed, we recorded impairment charges of $67 million, $9 million and
$250 million to license agreements, game engines and internally developed
franchises intangible assets, respectively, for 2010 within our Activision
segment. See Note 11 of the Notes to Consolidated Financial Statements included
in Item 8 of this Annual Report on Form 10-K for additional information
regarding the determination of the impairment charges recorded for the year
ended December 31, 2010.
Restructuring (amounts in millions)
Increase Increase
Year Ended % of Year Ended % of Year Ended % of (Decrease) (Decrease)
December 31, consolidated December 31, consolidated December 31, consolidated 2012 v 2011 v
2012 net revs. 2011 net revs. 2010 net revs. 2011 2010
Restructuring $ - - % $ 25 - % $ - - % $ (25 ) $ 25
There were no material restructuring expenses for the year ended
December 31, 2012.
On February 3, 2011, the Company's Board of Directors authorized the 2011
Restructuring. The 2011 Restructuring focused on the development and publication
of a reduced slate of titles on a going-forward basis, including the
discontinuation of the development of music-based games, the closure of the
related business unit and the cancellation of other titles then in production,
along with a related reduction in studio headcount and corporate overhead. The
costs related to the 2011 Restructuring activities included severance costs,
facility exit costs, and exit costs from the cancellation of projects. The 2011
Restructuring was completed as of December 31, 2011 and we do not expect to
incur additional restructuring expenses relating thereto. See Note 7 of the
Notes to Consolidated Financial Statements included in Item 8 of this Annual
Report on Form 10-K for more detail and a roll forward of the restructuring
liability that includes the beginning and ending liability, costs incurred, cash
payments and non-cash write downs.
In 2008, we implemented an organizational restructuring plan as a result of
the Business Combination. This organizational restructuring was to integrate
different operations and to streamline the combined Activision Blizzard
organization. The restructuring activities included severance costs, facility
exit costs, write offs of assets and liabilities and exit costs from the
cancellation of projects. At December 31, 2010, we had completed our
organizational restructuring activities as a result of the Business Combination.
Restructuring expenses during year ended December 31, 2011 and 2010 associated
to this plan were immaterial and were recorded within the "General and
administrative expense" in our consolidated statements of operations.
Investment and Other Income (Expense), Net (amounts in millions)
Increase Increase
Year Ended % of Year Ended % of Year Ended % of (Decrease) (Decrease)
December 31, consolidated December 31, consolidated December 31, consolidated 2012 v 2011 v
2012 net revs. 2011 net revs. 2010 net revs. 2011 2010
Investment
and other
income
(expense),
net $ 7 - % $ 3 - % $ 23 1 % $ 4 $ (20 )
Investment and other income (expense), net, increased in 2012 as compared to
2011. The increase is primarily due to the net realized gain on our foreign
exchange contracts of $2 million in 2012 as
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compared to a $7 million loss in 2011. However, during 2012, we experienced
lower yields on our investments, which partially offset the increase.
Investment and other income (expense), net, decreased in 2011 as compared to
2010. During 2011, we recorded higher yields generated from our cash and
investment balances, which was partially offset by a higher realized loss from
foreign exchange contracts, as compared to 2010. Further, the majority of
Investment and other income (expense), net, in 2010 related to the reduction in
fair value of a financial liability relating to a contingent earn-out liability
from a previous acquisition and there was no such item during 2011.
Income Tax Expense (Benefit) (amounts in millions)
Increase Increase
Year Ended % of Year Ended % of Year Ended % of (Decrease) (Decrease)
December 31, Pretax December 31, Pretax December 31, Pretax 2012 v 2011 v
2012 income 2011 income 2010 income 2011 2010
Income
tax
expense $ 309 21.2 % $ 246 18.5 % $ 74 15.0 % $ 63 $ 172
For 2012, the Company's income before income tax expense was $1.46 billion.
Our income tax expense of $309 million resulted in an effective tax rate of
21.2%. The difference between our effective tax rate and the U.S. statutory tax
rate of 35% is due to earnings taxed at relatively lower rates in foreign
jurisdictions, recognition of California research and development credits, the
federal domestic production deduction, and a tax benefit resulting from a
federal income tax audit settlement allocated to us by a subsidiary of
Vivendi S.A. ("Vivendi"), as further discussed below.
For 2011, the Company's income before income tax expense was $1.3 billion.
Our income tax expense of $246 million resulted in an effective tax rate of
18.5%. The difference between our effective tax rate and the U.S. statutory tax
rate of 35% is due to earnings taxed at relatively lower rates in foreign
jurisdictions, recognition of federal and California research and development
credits, the federal domestic production deduction and a favorable impact from
discrete items recognized in connection with the filing of our 2010 tax returns.
In 2012 and 2011, our U.S. income before income tax expense was $668 million
and $623 million, respectively, and comprised 46% and 47%, respectively, of our
consolidated income before income tax expense. In 2012 and 2011, the foreign
income before income tax expense was $790 million and $708 million,
respectively, and comprised 54% and 53%, respectively, of our consolidated
income before income tax expense. In 2012 and 2011, the impact of earnings taxed
at lower rates in foreign jurisdictions versus our U.S. federal statutory tax
rate was 17% and 15%, respectively.
As previously disclosed, on July 9, 2008, the Business Combination occurred
among Vivendi, the Company and certain of their respective subsidiaries pursuant
to which Vivendi Games, then a member of the consolidated U.S. tax group of
Vivendi's subsidiary, Vivendi Holdings I Corp. ("VHI"), became a subsidiary of
the Company. As a result of the business combination, the favorable tax
attributes of Vivendi Games carried forward to the Company. In late August 2012,
VHI settled a federal income tax audit with the Internal Revenue Service ("IRS")
for the tax years ended December 31, 2002, 2003, and 2004. In connection with
the settlement agreement, VHI's consolidated federal net operating loss
carryovers were adjusted and allocated to various companies that were part of
its consolidated group during the relevant periods. This allocation resulted in
a $132 million federal net operating loss allocation to Vivendi Games. In
September 2012, the Company filed an amended tax return for its December 31,
2008 tax year to utilize these additional federal net operating losses allocated
as a result of the aforementioned settlement, resulting in the recording of a
one-time tax benefit of $46 million. Prior to the settlement, and given the
uncertainty of the VHI audit, the Company had insufficient information to allow
it to record or disclose any information related to the audit until the quarter
ended September 30, 2012, as disclosed in the Company's Form 10-Q for that
period.
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Vivendi Games results for the period January 1, 2008 through July 2009 are
included in the consolidated federal and certain foreign state and local income
tax returns files by Vivendi or its affiliates while Vivendi Games results for
the period July 10, 2008 through December 31, 2008 are included in the
consolidated federal and certain foreign, state and local income tax returns
filed by Activision Blizzard. Vivendi Games tax years 2005 through 2008 remain
open to examination by the major taxing authorities. The IRS is currently
examining Vivendi Games tax returns for the 2005 through 2008 tax years.
Activision Blizzard's tax years 2008 through 2011 remain open to examination
by the major taxing jurisdictions to which we are subject. The IRS is currently
examining the Company's federal tax returns for the 2008 and 2009 tax years. The
Company also has several state and non-U.S. audits pending.
Although the final resolution of the Company's global tax disputes is
uncertain, based on current information, in the opinion of our management, the
ultimate resolution of these matters will not have a material adverse effect on
the Company's consolidated financial position, liquidity or results of
operations. However, an unfavorable resolution of the Company's global tax
disputes could have a material adverse effect on our business and results of
operations in the period in which the matters are ultimately resolved.
On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into
law by the President of the United States. Under the provisions of the American
Taxpayer Relief Act of 2012, the research and development ("R&D") tax credit
that had expired December 31, 2011, was reinstated retroactively to January 1,
2012, and is now scheduled to expire on December 31, 2013. The Company will
record the impact of the extension of the R&D tax credit related to the tax year
ended December 31, 2012, as a discrete item the first quarter of 2013. The
impact of the extension of the R&D tax credit is expected to result in a tax
benefit of approximately $11 million related to the tax year ended December 31,
2012.
The overall effective income tax rate in future periods will depend on a
variety of factors, such as changes in the mix of income by tax jurisdiction,
applicable accounting rules, applicable tax laws and regulations, and rulings
and interpretations thereof, developments in tax audits and other matters, and
variations in the estimated and actual level of annual pretax income or loss.
Further, the effective tax rate could fluctuate significantly on a quarterly
basis and could be adversely affected by the extent that income (loss) before
income tax expenses (benefit) is lower than anticipated in foreign regions where
taxes are levied at relatively lower statutory rates and/or higher than
anticipated in the United States where taxes are levied at relatively higher
statutory rates.
A more detailed analysis of the differences between the U.S. federal
statutory rate and the consolidated effective tax rate, as well as other
information about our income taxes, is provided in Note 15 of the Notes to
Consolidated Financial Statements included in Item 8 of this Annual Report on
Form 10-K.
Foreign Exchange Impact
Changes in foreign exchange rates had a negative impact of $67 million and a
positive impact of $49 million on Activision Blizzard's consolidated operating
income in 2012 and 2011, respectively. The change is primarily due to the
strengthening of the British pound, Euro and Australian dollar average rates
relative to the U.S. dollar.
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Liquidity and Capital Resources
Sources of Liquidity (amounts in millions)
For the Years Ended December 31,
Increase
(Decrease)
2012 2011 2012 v 2011
Cash and cash equivalents $ 3,959 $ 3,165 $ 794
Short-term investments 416 360 56
$ 4,375 $ 3,525 $ 850
Percentage of total assets 31 % 27 %
For the Years Ended December 31,
Increase Increase
(Decrease) (Decrease)
2012 2011 2010 2012 v 2011 2011 v 2010
Cash flows provided by
operating activities $ 1,345 $ 952 $ 1,376 $ 393 $ (424 )
Cash flows provided by (used
in) investing activities (124 ) 266 (312 ) (390 ) 578
Cash flows used in financing
activities (497 ) (808 ) (1,053 ) 311 245
Effect of foreign exchange rate
changes 70 (57 ) 33 127 (90 )
Net increase in cash and cash
equivalents $ 794 $ 353 $ 44 $ 441 $ 309
Cash Flows Provided by Operating Activities
The primary drivers of cash flows provided by operating activities included
the collection of customer receivables generated by the sale of our products and
digital and subscription revenues, partially offset by payments to vendors for
the manufacturing, distribution and marketing of our products, payments to
third-party developers and intellectual property holders, tax liabilities, and
payments to our workforce. A significant operating use of our cash relates to
our continued focus on customer service for our subscribers and investment in
software development and intellectual property licenses.
Cash flows provided by operating activities were higher for 2012 as compared
to 2011, and were lower for 2011 as compared to 2010. Our source of cash inflow
varies with our release schedule. For example, Blizzard's major releases of
StarCraft II and World of Warcraft: Cataclysm during 2010, and Blizzard's major
releases of Diablo III and World of Warcraft: Mist of Pandaria during 2012
contributed to the higher cash inflows for 2010 and 2012 as compared to 2011,
when there were no major releases from Blizzard. Additionally, the strong
performance of Activision's Skylanders franchise and Call of Duty: Black Ops II
contributed to strong operating cash flows in 2012.
Cash Flows Provided by (Used in) Investing Activities
The primary drivers of cash flows used in investing activities have
typically included capital expenditures, acquisitions and the net effect of
purchases and sales/maturities of short-term investments.
Cash flows provided by investing activities were lower for 2012 as compared
to 2011, primarily due to decreased proceeds from the maturity of investments,
partially offset by higher purchases of short-term investments. In 2012,
proceeds from the maturity of investments were $444 million, the majority of
which consisted of U.S. treasury and other government agency securities, while
the purchase of short-term investments totaled $503 million. Further, capital
expenditures, primarily related to property and equipment, were $73 million.
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Cash flows provided by investing activities were higher for 2011 as compared
to 2010, primarily due to increased proceeds from the maturity of investments,
decreased purchases of short-term investments and lower capital expenditures.
Proceeds from the maturity of investments were $740 million, the majority of
which consisted of U.S. treasury and other government agency securities, while
the purchase of short-term investments totaled $417 million and capital
expenditures, primarily related to property and equipment, were $72 million.
Cash Flows Used in Financing Activities
The primary drivers of cash flows used in financing activities have
historically related to transactions involving our common stock, including the
issuance of shares of common stock to employees, payment of dividends and the
repurchase of our common stock. We have not historically utilized debt financing
as a source of cash flows although we may do so in the future.
Cash flows used in financing activities were lower for 2012 as compared to
2011, primarily due to decreased share repurchase activities. Cash flows used in
financing activities for the year ended December 31, 2012 primarily reflected an
aggregate cash payment of $204 million to holders of our common stock and
restricted stock units in connection with our annual dividend. In addition, cash
flows used in financing activities for the year ended December 31, 2012 reflect
the repurchase of $315 million of our common stock and the payment of
$16 million in taxes relating to the vesting of employees' restricted stock
rights. The repurchases and dividend payments were partially offset by
$33 million of proceeds from the issuance of shares of our common stock to
employees in connection with stock option exercises.
Cash flows used in financing activities were lower for 2011 as compared to
2010, primarily due to decreased share repurchase activities. Cash flows used in
financing activities for the year ended December 31, 2011 primarily reflected an
aggregate cash payment of $194 million to holders of our common stock and
restricted stock units in connection with our annual dividend. In addition, cash
flows used in financing activities for the year ended December 31, 2011 reflect
the repurchase of $692 million of our common stock, as compared to the
repurchase of $959 million for the year ended December 31, 2010.
Other Liquidity and Capital Resources
Our primary sources of liquidity are cash and cash equivalents and
investments and cash flows provided by operating activities. With our cash and
cash equivalents and investments of $4.4 billion and expected cash flows
provided by operating activities, we believe that we have sufficient liquidity
to meet daily operations for the foreseeable future. We also believe that we
have sufficient working capital ($3.6 billion at December 31, 2012) to finance
our operational requirements for at least the next twelve months, including
purchases of inventory and equipment, the development, production, marketing and
sale of new products, the provision of customer service for our subscribers, the
acquisition of intellectual property rights for future products from third
parties, and to fund our stock repurchase program and dividends.
As of December 31, 2012, the amount of cash and cash equivalents held
outside of the U.S. by our foreign subsidiaries was $2.6 billion, compared with
$1.6 billion as of December 31, 2011. If these funds are needed in the future
for our operations in the U.S., we would accrue and pay the required U.S. taxes
to repatriate these funds. However, our intent is to permanently reinvest these
funds outside of the U.S. and our current plans do not demonstrate a need to
repatriate them to fund our U.S. operations.
We are considering, or may consider during 2013, substantial stock
repurchases, dividends, acquisitions, licensing or other non-ordinary course
transactions, and significant debt financings relating thereto.
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Capital Expenditures
We made capital expenditures of $73 million in 2012, as compared to
$72 million in 2011. In 2013, we anticipate total capital expenditures of
approximately $85 million. Capital expenditures are expected to be primarily for
computer hardware and software purchases.
Commitments
In the normal course of business, we enter into contractual arrangements
with third-parties for non-cancelable operating lease agreements for our
offices, for the development of products, and for the rights to intellectual
property. 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. The payments to third-party developers are
generally conditioned upon the achievement by the developers of contractually
specified development milestones. Further, 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 rights
acquisitions and development agreements, we 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. Assuming all contractual
provisions are met, the total future minimum commitments for these and other
contractual arrangements in place at December 31, 2012 are scheduled to be paid
as follows (amounts in millions):
Contractual Obligations(1)
Facility and Developer
equipment leases and IP Marketing Total
For the year ending
December 31,
2013 33 119 58 210
2014 31 5 51 87
2015 22 1 - 23
2016 18 - 6 24
2017 17 - 6 23
Thereafter 52 3 - 55
Total 173 128 121 422
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º (1)
º We have omitted uncertain income tax liabilities from this table due to the
inherent uncertainty regarding the timing of potential issue resolution.
Specifically, either the underlying positions have not been fully developed
enough under audit to quantify at this time or the years relating to the
issues for certain jurisdictions are not currently under audit. At
December 31, 2012, we had $207 million of unrecognized tax benefits, of
which $197 million was included in "Other Liabilities" and $10 million was included in "Accrued Expenses and Other Liabilities" in the consolidated
balance sheets.
Off-balance Sheet Arrangements
At December 31, 2012 and 2011, Activision Blizzard had no significant
relationships with unconsolidated entities or financial parties, 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, that have or are reasonably
likely to have a material future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operation, liquidity,
capital expenditures, or capital resources.
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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"). We also are focused on our "disclosure controls and
procedures," which as defined by the Securities and Exchange Commission (the
"SEC"), 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 SEC is reported within the time periods specified in the SEC's
rules and forms, and that such information is communicated to management,
including our principal executive and financial officers, as appropriate, to
allow timely decisions regarding required disclosure.
Our Disclosure Committee, which operates under the Board-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
relevant information. These quarterly reports are reviewed by certain key
corporate finance 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 legal 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 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 principal executive and financial officers review
and make various certifications regarding the accuracy of our periodic public
reports filed with the 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.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with 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 and assumptions. 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. The estimates and assumptions 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 and assumptions about the effect of
matters that are inherently uncertain. Specific risks for these critical
accounting estimates and assumptions are described in the following paragraphs.
Revenue Recognition including Revenue Arrangements with Multiple Deliverables
On January 1, 2011, we adopted amendments to an accounting standard related
to revenue recognition for arrangements with multiple deliverables (which
standard, as amended, is referred to
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herein as the "new accounting principles"). The new accounting principles
establish a selling price hierarchy for determining the selling price of a
deliverable and require the application of the relative selling price method to
allocate the consideration received for an arrangement to each deliverable in a
multiple deliverables revenue arrangement. Certain of our revenue arrangements
have multiple deliverables and, as such, are accounted for under the new
accounting principles. These revenue arrangements include product sales
consisting of both software and hardware deliverables (such as peripherals or
other ancillary collectors' items sold together with physical "boxed" software)
and our sales of World of Warcraft boxed products, expansion packs and
value-added services, each of which is considered with the related subscription
services for these purposes. Our assessment of deliverables and units of
accounting does not change under the new accounting principles.
Pursuant to the guidance of ASU 2009-13, when a revenue arrangement contains
multiple elements, such as hardware and software products, licenses and/or
services, we allocate revenue to each element based on a selling price
hierarchy. The selling price for a deliverable is based on its
vendor-specific-objective-evidence ("VSOE") if it is available, third-party
evidence ("TPE") if VSOE is not available, or best estimated selling price
("BESP") if neither VSOE nor TPE is available. In multiple element arrangements
where more-than-incidental software deliverables are included, revenue is
allocated to each separate unit of accounting for each of the non-software
deliverables and to the software deliverables as a group using the relative
selling prices of each of the deliverables in the arrangement based on the
aforementioned selling price hierarchy. If the arrangement contains more than
one software deliverable, the arrangement consideration allocated to the
software deliverables as a group is then allocated to each software deliverable
using the guidance for recognizing software revenue.
As noted above, when neither VSOE nor TPE is available for a deliverable, we
use BESP. We do not have significant revenue arrangements that require BESP for
the years ended December 31, 2012 and 2011. The inputs we use to determine the
selling price of our significant deliverables include the actual price charged
by the Company for a deliverable that the Company sells separately, which
represents the VSOE, and the wholesale prices of the same or similar products,
which represents TPE. The pattern and timing of revenue recognition for
deliverables and allocation of the arrangement consideration did not change upon
the adoption of the new accounting principles. Also, the adoption of the new
accounting standard has not had a material impact on our financial statements.
Overall, 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" (i.e., 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
date the product is sold to our customer. Revenue from product sales is
recognized after deducting the estimated allowance for returns and price
protection.
For our software products with online functionality, we evaluate whether
those features or functionality are more than an inconsequential separate
deliverable in addition to the software product. This evaluation is performed
for each software product and any online transaction, such as a digital download
of a title with product add-ons, when it is released.
When we determine that a software title contains online functionality that
constitutes a more-than-inconsequential separate service deliverable in addition
to the product, which, when we do, is principally because of its importance to
gameplay, we consider our performance obligations for this title to extend
beyond the sale of the game. VSOE of fair value does not exist for the online
functionality of some products, as we do not separately charge for this
component of every title. As a result, we recognize all of the software-related
revenue from the sale of any such title ratably over the estimated service
period of such title. In addition, we initially defer the costs of sales for the
title (excluding intangible asset amortization), and recognize the costs of
sales as the related revenues are
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recognized. Cost of sales includes manufacturing costs, software royalties and
amortization, and intellectual property licenses.
Determining whether the online functionality for a particular game
constitutes more than an inconsequential deliverable, as well as the estimated
service periods and product life over which to recognize the revenue and related
costs of sales, is subjective and require management's judgment.
We recognize revenues from World of Warcraft boxed product, expansion packs
and value-added services, in each case with the related subscription service
revenue, ratably over the estimated service period beginning upon activation of
the software and delivery of the related services. Revenues attributed to the
sale of World of Warcraft boxed software and related expansion packs are
classified as "Product sales," whereas revenues attributable to subscriptions
and other value-added services are classified as "Subscription, licensing, and
other revenues."
Revenue for software products with more than inconsequential separate
service deliverables and World of Warcraft products are recognized over the
estimated service periods, which range from a minimum of five months to a
maximum of less than a year.
For our software products with features we consider to be incidental to the
overall product offering and an inconsequential deliverable, such as products
which provide limited online features at no additional cost to the consumer, we
recognize the related revenue from them upon the transfer of title and risk of
loss of the product to our customer.
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, market
conditions, and the anticipated timing of other releases to assess future demand
of current and upcoming titles. Initial volumes shipped upon title launch and
subsequent reorders are evaluated with the goal of ensuring that quantities 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
customers under certain conditions. In general, price protection refers to the
circumstances in which we elect to decrease, on a short or longer term basis,
the wholesale price of a product by a certain amount and, when granted and
applicable, allow 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
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 consider other factors, including the facilitation of
slow-moving inventory and other market factors.
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 on 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;
historical performance of the hardware platform; historical performance of the
franchise; console hardware life cycle; sales force and retail customer
feedback; industry pricing; future pricing assumptions; weeks of on-hand retail
channel inventory; absolute quantity of on-hand retail channel inventory; our
warehouse on-hand inventory levels; the title's recent sell-through history (if
available); marketing trade programs;
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and performance of competing titles. The relative importance of these factors
varies among titles depending upon, among other items, genre, platform,
seasonality, and sales strategy.
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 December 31, 2012 allowance for sales returns, price
protection and other allowances would have impacted net revenues by
approximately $3 million.
Similarly, management must make estimates as to the collectability 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 regularly review inventory quantities on-hand and in the retail channels.
We write down inventory based on excess or obsolete inventories determined
primarily by future anticipated demand for our products. Inventory write-downs
are measured as the difference between the cost of the inventory and net
realizable value, based upon assumptions about future demand, which are
inherently difficult to assess and dependent on market conditions. At the point
of loss recognition, a new, lower cost basis for that inventory is established,
and subsequent changes in facts and circumstances do not result in the
restoration or increase in that newly established basis.
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 the Financial
Accounting Standards Board ("FASB") guidance for the costs of computer software
to be sold, leased, or otherwise marketed ("Accounting Standards Codification
("ASC") Subtopic 985-20"). Software development costs are capitalized once
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, 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 if and
when we believe such amounts are not recoverable. Capitalized costs for those
products that are cancelled or expected to be 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
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proprietary rights in the development of our products. Depending upon the
agreement with the rights holder, we may obtain the right to use the
intellectual property in multiple products over a number of 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
expected to be 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, recoverability 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; market performance of comparable titles; orders for
the product prior to its release; general market conditions; and, for any sequel
product, estimated performance based on the performance of the product on which
the sequel is based. Further, as many of our capitalized 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 assessing 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 the originally
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. Material differences may result in
the amount and timing of expense for any period if management makes different
judgments or utilizes different estimates in evaluating these qualitative
factors.
Income Taxes
We record a tax provision for the anticipated tax consequences of the
reported results of operations. In accordance with FASB income tax guidance
("ASC Topic 740"), 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. The effect on
deferred tax assets and liabilities due to a change in tax rates is recognized
in income in the period that includes the enactment date. We evaluate deferred
tax assets each period for recoverability. For those assets that do not meet the
threshold of "more likely than not" that they will be realized in the future, a
valuation allowance is recorded.
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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 tax expenses in the period such determination is made. The
calculation of tax liabilities involves significant judgment in estimating the
impact of uncertainties in the application of ASC Topic 740 and other complex
tax laws. Resolution of these uncertainties in a manner inconsistent with
management's expectations could have a material impact on our business and
results of operations in an interim period in which the uncertainties are
ultimately resolved.
Significant judgment is required in evaluating our uncertain tax positions
and determining our provision for income taxes. Although we believe our reserves
are reasonable, no assurance can be given that the final tax outcome of these
matters will not be different from that which is reflected in our historical
income tax provisions and accruals. We adjust these reserves in light of
changing facts and circumstances, such as the closing of a tax audit or the
refinement of an estimate. To the extent that the final tax outcome of these
matters is different than the amounts recorded, such differences will impact the
provision for income taxes in the period in which such determination is made.
The provision for income taxes includes the impact of reserve provisions and
changes to reserves that are considered appropriate, as well as the related net
interest and penalties.
Our provision for income taxes is subject to volatility and could be
adversely impacted by earnings being lower than anticipated in foreign regions
where taxes are levied at relatively lower statutory rates and/or higher than
anticipated in the United States where taxes are levied at relatively higher
statutory rates; by changes in the valuation of our deferred tax assets and
liabilities; by expiration of or lapses in the R&D tax credit laws; by tax
effects of nondeductible compensation; by tax costs related to intercompany
realignments; by differences between amounts included in our tax filings and the
estimate of such amounts included in our tax expenses; by changes in accounting
principles; or by changes in tax laws and regulations including possible U.S.
changes to the taxation of earnings of our foreign subsidiaries, the
deductibility of expenses attributable to foreign income, or the foreign tax
credit rules. Significant judgment is required to determine the recognition and
measurement attributes prescribed in the accounting guidance for uncertainty in
income taxes. The accounting guidance for uncertainty in income taxes applies to
all income tax positions, including the potential recovery of previously paid
taxes, which if settled unfavorably could adversely impact our provision for
income taxes or additional paid-in capital. In addition, we are subject to the
continuous examination of our income tax returns by the Internal Revenue Service
("IRS") and other tax authorities. We regularly assess the likelihood of adverse
outcomes resulting from these examinations to determine the adequacy of our
provision for income taxes. There can be no assurance that the outcomes from
these continuous examinations will not have an adverse impact on our operating
results and financial condition.
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
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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 (that is, the risk premium). Determining these cash flow estimates is
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 FASB literature related to accounting for the impairment or disposal of
long-lived assets within ASC Subtopic 360-10, 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, other than indefinite-lived
intangible assets, may not be recoverable including, but 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 whether 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.
During 2010, we recorded an impairment charge of $326 million to our
definite-lived intangible assets. See Note 11 of the Notes to Consolidated
Financial Statements included in Item 8 of this Annual Report on Form 10-K for
additional information regarding the determination of the impairment charges
recorded for the year ended December 31, 2010. We did not record an impairment
charge to our definite-lived intangible assets as of December 31, 2012 and 2011.
FASB literature related to the accounting for goodwill and other intangibles
within ASC Topic 350 provides companies an option to first perform a qualitative
assessment to determine whether it is more likely than not that the fair value
of a reporting unit is less than its carrying value before performing 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. ASC Topic 350 requires that the impairment test be performed at
least annually by applying a fair-value-based test. The qualitative assessment
is optional. The first step
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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, and 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.
Fair value of our reporting units is determined using an income approach
based on discounted cash flow models. In determining the fair value of our
reporting units, we assumed a discount rate of approximately 10.5%. The
estimated fair value of the Activision Publishing reporting unit exceeded its
carrying value by approximately $3 billion or at least 25% as of December 31,
2012. The estimated fair value of the Blizzard reporting unit substantially
exceeded its carrying value as of December 31, 2012. However, changes in our
assumptions underlying our estimates of fair value, which will be a function of
our future financial performance, and changes in economic conditions could
result in future impairment charges.
We test acquired trade names for possible impairment by using a discounted
cash flow model to estimate fair value. We have determined that no impairment
has occurred at December 31, 2012 and 2011 based upon a set of assumptions
regarding discounted future cash flows, which represent our best estimate of
future performance at this time. In determining the fair value of our trade
names, we assumed a discount rate of 10.5%, and royalty saving rates of
approximately 1.5%. A one percentage point increase in the discount rate would
not yield an impairment charge to our trade names. Changes in our assumptions
underlying our estimates of fair value, which will be a function of our future
financial performance and changes in economic conditions, could result in future
impairment charges.
Stock-Based Compensation
Stock-based compensation expense is recognized during the requisite service
periods (that is, the period for which the employee is being compensated) and is
based on the value of stock-based payment awards after a reduction for estimated
forfeitures. Forfeitures are estimated at the time of grant and are revised, if
necessary, in subsequent periods if actual forfeitures differ from those
estimates.
We estimate the value of stock-based payment awards on the measurement date
using a binomial-lattice model. Our determination of fair value of stock-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.
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We generally determine the fair value of restricted stock rights (including
restricted stock units, restricted stock awards and performance shares) based on
the closing market price of the Company's common stock on the date of grant.
Certain restricted stock rights granted to our employees and senior management
vest based on the achievement of pre-established performance or market goals. We
estimate the fair value of performance-based restricted stock rights at the
closing market price of the Company's common stock on the date of grant. Each
quarter, we update our assessment of the probability that the specified
performance criteria will be achieved. We amortize the fair values of
performance-based restricted stock rights over the requisite service period
adjusted for estimated forfeitures for each separately vesting tranche of the
award. We estimate the fair value of market-based restricted stock rights at the
date of grant using a Monte Carlo valuation methodology and amortize those fair
values over the requisite service period adjusted for estimated forfeitures for
each separately vesting tranche of the award. The Monte Carlo methodology that
we use to estimate the fair value of market-based restricted stock rights at the
date of grant incorporates into the valuation the possibility that the market
condition may not be satisfied. Provided that the requisite service is rendered,
the total fair value of the market-based restricted stock rights at the date of
grant must be recognized as compensation expense even if the market condition is
not achieved. However, the number of shares that ultimately vest can vary
significantly with the performance of the specified market criteria.
For a detailed discussion of the application of these and other accounting
policies see Note 2 of the Notes to Consolidated Financial Statements included
in Item 8 of this Annual Report on Form 10-K.
Recently Issued Accounting Pronouncements
Indefinite-lived intangible assets impairment
In July 2012, the FASB issued an update to the authoritative guidance
related to testing indefinite-lived intangible assets for impairment. This
update gives an entity the option to first consider certain qualitative factors
to determine whether the existence of events and circumstances indicates that it
is more likely than not that the fair value of an indefinite-lived intangible
asset is less than its carrying amount as a basis for determining whether it is
necessary to perform the quantitative impairment test. This update is effective
for the indefinite-lived intangible asset impairment test performed for fiscal
years beginning after September 15, 2012. Early adoption is permitted. The
adoption of this guidance does not have a material impact on our consolidated
financial statements.
Balance sheet offsetting disclosures
In December 2011, the FASB issued authoritative guidance on the disclosure
of financial instruments and derivative instruments that are either offset or
subject to an enforceable master netting arrangement or similar agreement and
should be applied retrospectively for all comparative periods presented for
annual periods beginning on or after January 1, 2013 and interim periods within
those annual periods. The adoption of this guidance does not have a material
impact on our consolidated financial statements.
Reclassification of accumulated other comprehensive loss
In February 2013, the FASB issued an accounting standards update requiring
new disclosures about reclassifications from accumulated other comprehensive
loss to net income. These disclosures may be presented on the face of the
statements or in the notes to the consolidated financial statements. The
standards update is effective for fiscal years beginning after December 15,
2012. The adoption of this guidance does not have a material impact on our
consolidated financial statements.
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