Edgar Filing: Activision Blizzard, Inc.

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

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

For the Quarterly Period Ended September 30, 2015

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

For the transition period from to

Commission File Number 1-15839

ACTIVISION BLIZZARD, INC.

(Exact name of registrant as specified in its charter)

Delaware		95-4803544

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

3100 Ocean Park Boulevard, Santa Monica, CA		90405

(Address of principal executive offices)		(Zip Code)

(310) 255-2000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer x		Accelerated Filer o

Non-accelerated filer o		Smaller reporting company o

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The number of shares of the registrant’s Common Stock outstanding at November 3, 2015 was 731,183,860.

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

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	Cautionary Statement	3

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Balance Sheets at September 30, 2015 and December 31, 2014	4

	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2015 and September 30, 2014	5

	Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015 and September 30, 2014	6

	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and September 30, 2014	7

	Condensed Consolidated Statement of Changes in Shareholders’ Equity for the nine months ended September 30, 2015	8

	Notes to Condensed Consolidated Financial Statements	9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	48

Item 4.	Controls and Procedures	49

PART II.	OTHER INFORMATION	50

Item 1.	Legal Proceedings	50

Item 1A.	Risk Factors	50

Item 6.	Exhibits	50

SIGNATURE		51

EXHIBIT INDEX		52

CERTIFICATIONS

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CAUTIONARY STATEMENT

This Quarterly Report on Form 10-Q contains, or incorporates by reference, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements consist of any statement other than a recitation of historical facts and include, but are not limited to: (1) projections of revenues, expenses, income or loss, earnings or loss per share, cash flow or other financial items; (2) statements of our plans and objectives, including those relating to product releases; (3) statements of future financial or operating performance; (4) statements relating to our proposed acquisition of King Digital Entertainment plc (the “Acquisition”); (5) statements relating to the outcome or impact of pending or threatened litigation; and (6) statements of assumptions underlying such statements. Activision Blizzard, Inc. (“Activision Blizzard”) generally uses words such as “outlook,” “forecast,” “will,” “could,” “should,” “would,” “to be,” “plan,” “plans,” “believes,” “may,” “might,” “expects,” “intends,” “intends as,” “anticipates,” “estimate,” “future,” “positioned,” “potential,” “project,” “remain,” “scheduled,” “set to,” “subject to,” “upcoming” and other similar expressions to help identify forward-looking statements. Forward-looking statements are subject to business and economic risk, reflect management’s current expectations, estimates and projections about our business, and are inherently uncertain and difficult to predict. Our actual results could differ materially. Risks and uncertainties that may affect our future results include, but are not limited to: sales levels of our titles; increasing concentration of revenues among a small number of titles; our ability to predict consumer preferences, including interest in specific genres, such as first-person action, massively multiplayer online, “toys to life” and music-based games, and preferences among hardware platforms; the amount of our debt and the limitations imposed by the covenants in the agreements governing our debt; the adoption rate and availability of new hardware (including peripherals) and related software, particularly during console transitions; counterparty risks relating to customers, licensees, licensors and manufacturers; maintenance of relationships with key personnel, customers, financing providers, licensees, licensors, manufacturers, vendors, and third-party developers, including the ability to attract, retain and develop key personnel and developers that can create high quality titles; changing business models, including digital delivery of content and the increased prevalence of free-to-play games; product delays or defects; competition, including from used games and other forms of entertainment; rapid changes in technology and industry standards; possible declines in software pricing; product returns and price protection; the identification of suitable future acquisition opportunities and potential challenges associated with geographic expansion; the seasonal and cyclical nature of the interactive entertainment market; litigation risks and associated costs; protection of proprietary rights; shifts in consumer spending trends; capital market risks; applicable regulations; domestic and international economic, financial and political conditions and policies; tax rates and foreign exchange rates; the impact of the current macroeconomic environment; uncertainties as to the timing of the Acquisition; uncertainties as to whether we will be able to consummate the Acquisition; the integration of King Digital Entertainment plc being more difficult, time-consuming or costly than expected; the possibility that we may be unable to achieve expected synergies and operating efficiencies in connection with the Acquisition within the expected time-frames or at all; and the other factors identified in “Risk Factors” included in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2014 or in “Cautionary Statement Regarding Forward-Looking Statements” from our Current Report on Form 8-K filed on November 3, 2015. The forward-looking statements contained herein are based upon information available to us as of the date of this Quarterly Report on Form 10-Q and we assume no obligation to update any such forward-looking statements. Although these forward-looking statements are believed to be true when made, they may ultimately prove to be incorrect. These statements are not guarantees of our future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and may cause actual results to differ materially from current expectations.

Activision Blizzard, Inc.’s names, abbreviations thereof, logos, and product and service designators are all either the registered or unregistered trademarks or trade names of Activision Blizzard. All other product or service names are the property of their respective owners.

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Part I. Financial Information

Item 1. Financial Statements

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Amounts in millions, except share data)

	At September 30, 2015		At December 31, 2014
Assets
Current assets:
Cash and cash equivalents	$	4,365	$	4,848
Short-term investments	154		10
Accounts receivable, net of allowances of $216 and $383, at September 30, 2015 and December 31, 2014, respectively	503		659
Inventories, net	238		123
Software development	342		452
Intellectual property licenses	27		5
Deferred income taxes, net	373		368
Other current assets	307		444
Total current assets	6,309		6,909
Long-term investments	9		9
Software development	73		20
Intellectual property licenses	—		18
Property and equipment, net	200		157
Other assets	171		85
Intangible assets, net	24		29
Trademark and trade names	433		433
Goodwill	7,083		7,086
Total assets	$	14,302	$	14,746

Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	309	$	325
Deferred revenues	907		1,797
Accrued expenses and other liabilities	394		592
Total current liabilities	1,610		2,714
Long-term debt, net	4,078		4,324
Deferred income taxes, net	110		114
Other liabilities	515		361
Total liabilities	6,313		7,513
Commitments and contingencies (Note 12)

Shareholders’ equity:
Common stock, $0.000001 par value, 2,400,000,000 shares authorized, 1,159,620,225 and 1,150,605,926 shares issued at September 30, 2015 and December 31, 2014, respectively	—		—
Additional paid-in capital	10,209		9,924
Less: Treasury stock, at cost, 428,676,471 shares at September 30, 2015 and December 31, 2014	(5,613)		(5,762)
Retained earnings	3,937		3,374
Accumulated other comprehensive loss	(544)		(303)
Total shareholders’ equity	7,989		7,233
Total liabilities and shareholders’ equity	$	14,302	$	14,746

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

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Amounts in millions, except per share data)

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2015		2014		2015		2014
Net revenues
Product sales	$	425	$	337	$	1,736	$	1,693
Subscription, licensing and other revenues	565		416		1,576		1,140
Total net revenues	990		753		3,312		2,833

Costs and expenses
Cost of sales - product costs	195		156		560		568
Cost of sales - online	56		56		161		170
Cost of sales - software royalties and amortization	81		34		314		136
Cost of sales - intellectual property licenses	5		7		12		20
Product development	159		131		453		387
Sales and marketing	189		221		445		465
General and administrative	109		140		297		342
Total costs and expenses	794		745		2,242		2,088

Operating income	196		8		1,070		745

Interest and other expense, net	51		51		151		152

Income (loss) before income tax expense (benefit)	145		(43)		919		593

Income tax expense (benefit)	18		(20)		186		119

Net income (loss)	$	127	$	(23)	$	733	$	474

Earnings (loss) per common share
Basic	$	0.17	$	(0.03)	$	0.99	$	0.65
Diluted	$	0.17	$	(0.03)	$	0.98	$	0.64

Weighted-average number of shares outstanding
Basic	730		718		727		714
Diluted	739		718		736		725

Dividends per common share	$	—	$	—	$	0.23	$	0.20

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

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Amounts in millions)

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2015		2014		2015		2014
Net income (loss)	$	127	$	(23)	$	733	$	474

Other comprehensive income (loss):
Foreign currency translation adjustment	5		(206)		(240)		(230)
Unrealized gains (losses) on forward contracts designated as hedges, net of deferred income taxes of $0 million for the periods ended September 30, 2015 and 2014	(3)		5		3		5
Unrealized losses on investments, net of deferred income taxes of $0 million for the periods ended September 30, 2015 and 2014	(1)		—		(4)		—
Total other comprehensive income (loss)	$	1	$	(201)	$	(241)	$	(225)

Comprehensive income (loss)	$	128	$	(224)	$	492	$	249

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

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Amounts in millions)

	For the Nine Months Ended September 30,
	2015		2014
Cash flows from operating activities:
Net income	$	733	$	474
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes	(22)		(57)
Provision for inventories	16		33
Depreciation and amortization	65		61
Amortization of capitalized software development costs and intellectual property licenses1	303		131
Amortization of debt discount and debt financing costs	5		5
Stock-based compensation expense2	71		74
Excess tax benefits from stock awards	(33)		(29)
Changes in operating assets and liabilities:
Accounts receivable, net	142		(193)
Inventories	(135)		(90)
Software development and intellectual property licenses	(249)		(253)
Other assets	158		59
Deferred revenues	(833)		(54)
Accounts payable	(7)		(83)
Accrued expenses and other liabilities	(51)		19
Net cash provided by operating activities	163		97

Cash flows from investing activities:
Proceeds from maturities of available-for-sale investments	15		21
Purchases of available-for-sale investments	(144)		—
Capital expenditures	(95)		(90)
Increase in restricted cash	(15)		(11)
Net cash used in investing activities	(239)		(80)

Cash flows from financing activities:
Proceeds from issuance of common stock to employees	82		160
Tax payment related to net share settlements on restricted stock rights	(36)		(41)
Excess tax benefits from stock awards	33		29
Dividends paid	(170)		(147)
Repayment of long-term debt	(250)		(375)
Proceeds received from shareholder lawsuit settlement	202		—
Net cash used in financing activities	(139)		(374)
Effect of foreign exchange rate changes on cash and cash equivalents	(268)		(248)
Net decrease in cash and cash equivalents	(483)		(605)
Cash and cash equivalents at beginning of period	4,848		4,410
Cash and cash equivalents at end of period	$	4,365	$	3,805

1 Excludes deferral and amortization of stock-based compensation expense.

2 Includes the net effects of capitalization, deferral, and amortization of stock-based compensation expense.

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

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2015

(Unaudited)

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

	Common Stock			Treasury Stock			Additional Paid-In		Retained		Accumulated Other Comprehensive		Total Shareholders’
	Shares	Amount		Shares	Amount		Capital		Earnings		Income (Loss)		Equity
Balance at December 31, 2014	1,151	$	—	(429)	$	(5,762)	$	9,924	$	3,374	$	(303)	$	7,233

Components of comprehensive income:
Net income	—	—		—	—		—		733		—		733
Other comprehensive income (loss)	—	—		—	—		—		—		(241)		(241)
Issuance of common stock pursuant to employee stock options	6	—		—	—		82		—		—		82
Issuance of common stock pursuant to restricted stock rights	4	—		—	—		—		—		—		—
Restricted stock surrendered for employees’ tax liability	(1)	—		—	—		(36)		—		—		(36)
Tax benefit associated with employee stock awards	—	—		—	—		31		—		—		31
Stock-based compensation expense related to employee stock options and restricted stock rights	—	—		—	—		73		—		—		73
Dividends ($0.23 per common share)	—	—		—	—		—		(170)		—		(170)
Indemnity on tax attributes assumed in connection with the Purchase Transaction (see Note 9)	—	—		—	82		—		—		—		82
Shareholder lawsuit settlement in connection with the Purchase Transaction (see Note 12)	—	—		—	67		135		—		—		202

Balance at September 30, 2015	1,160	$	—	(429)	$	(5,613)	$	10,209	$	3,937	$	(544)	$	7,989

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

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Description of Business and Basis of Consolidation and Presentation

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

The Business Combination and Share Repurchase

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

On October 11, 2013, we repurchased approximately 429 million shares of our common stock, pursuant to a stock purchase agreement (the “Stock Purchase Agreement”) we entered into with Vivendi and ASAC II LP (“ASAC”), an exempted limited partnership established under the laws of the Cayman Islands, acting by its general partner, ASAC II LLC. Pursuant to the terms of the Stock Purchase Agreement, we acquired all of the capital stock of Amber Holding Subsidiary Co., a Delaware corporation and wholly-owned subsidiary of Vivendi (“New VH”), which was the direct owner of approximately 429 million shares of our common stock, for a cash payment of $5.83 billion, or $13.60 per share, before taking into account the benefit to the Company of certain tax attributes of New VH assumed in the transaction (collectively, the “Purchase Transaction”). Immediately following the completion of the Purchase Transaction, ASAC purchased from Vivendi 172 million shares of our common stock, pursuant to the Stock Purchase Agreement, for a cash payment of $2.34 billion, or $13.60 per share (the “Private Sale”). Robert A. Kotick, our Chief Executive Officer, and Brian G. Kelly, Chairman of our Board of Directors, are affiliates of ASAC II LLC. Refer to Note 6 of the Notes to Condensed Consolidated Financial Statements for information regarding the financing of the Purchase Transaction.

On May 28, 2014, Vivendi sold approximately 41 million shares, or approximately 50% of its then-current holdings, of our common stock in a registered public offering. Vivendi received proceeds of approximately $850 million from that sale; the Company did not receive any proceeds.

As of September 30, 2015, we had approximately 731 million shares of common stock issued and outstanding. At that date: (i) Vivendi held 41 million shares, or approximately 6% of the outstanding shares of our common stock; (ii) ASAC held 172 million shares, or approximately 24% of the outstanding shares of our common stock; and (iii) our other stockholders held approximately 70% of the outstanding shares of our common stock. The common stock of Activision Blizzard is traded on The NASDAQ Stock Market under the ticker symbol “ATVI.”

Operating Segments

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

(i) Activision Publishing, Inc.

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

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(ii) Blizzard Entertainment, Inc.

Blizzard Entertainment, Inc. (“Blizzard”) is a leader in the subscription-based massively multi-player online role-playing game category in terms of both subscriber base and revenues generated through its World of Warcraft® franchise, which it develops, hosts and supports. Blizzard also develops, markets, and sells role-playing action and strategy games for the PC, console, mobile and tablet platforms, including games in the multiple-award winning Diablo®, StarCraft®, and Hearthstone®: Heroes of Warcraft™ 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; sales of prepaid subscription cards; value-added services, such as in-game purchases and services; retail sales of physical “boxed” products; online download sales of PC products; purchases and downloads via third-party console, mobile and tablet platforms; and licensing of software to third-party or related-party companies that distribute World of Warcraft, Diablo, StarCraft and Hearthstone: Heroes of Warcraft products. In addition, Blizzard is the creator of Heroes of the Storm™, a free-to-play online hero brawler released on June 2, 2015.

(iii) Activision Blizzard Distribution

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

Basis of Consolidation and Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) and accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim reporting. Accordingly, certain notes or other information that are normally required by U.S. GAAP have been condensed or omitted if they substantially duplicate the disclosures contained in the annual audited consolidated financial statements. The year-end condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2014.

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

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

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

Supplemental Cash Flow Information: Non-cash investing activities

As of September 30, 2015 and 2014, the Company had accrued capital expenditures of $16 million and $4 million, respectively, recorded within “Accounts Payable” and “Accrued expenses and other liabilities.”

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2. Inventories, Net

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

	At September 30, 2015		At December 31, 2014
Finished goods	$	174	$	112
Purchased parts and components	64		11
Inventories, net	$	238	$	123

At September 30, 2015 and December 31, 2014, inventory reserves were $41 million and $52 million, respectively.

3. Software Development and Intellectual Property Licenses

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

	At September 30, 2015		At December 31, 2014
Internally-developed software costs	$	249	$	262
Payments made to third-party software developers	166		210
Total software development costs	$	415	$	472

Intellectual property licenses	$	27	$	23

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

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2015		2014		2015		2014
Amortization of capitalized software development costs and intellectual property licenses	$	80	$	35	$	312	$	143

4. Intangible Assets, Net

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

	At September 30, 2015

	Estimated useful lives	Gross carrying amount		Accumulated amortization		Net carrying amount
Acquired definite-lived intangible assets:
License agreements and other	3 - 10 years	$	98	$	(93)	$	5
Internally-developed franchises	11 - 12 years	309		(290)		19
Total definite-lived intangible assets		$	407	$	(383)	$	24

Acquired indefinite-lived intangible assets:
Activision trademark	Indefinite					386
Acquired trade names	Indefinite					47
Total indefinite-lived intangible assets						$	433

	At December 31, 2014

	Estimated useful lives	Gross carrying amount		Accumulated amortization		Net carrying amount

Acquired definite-lived intangible assets:
License agreements and other	3 - 10 years	$	98	$	(92)	$	6
Internally-developed franchises	11 - 12 years	309		(286)		23
Total definite-lived intangible assets		$	407	$	(378)	$	29

Acquired indefinite-lived intangible assets:
Activision trademark	Indefinite					386
Acquired trade names	Indefinite					47
Total indefinite-lived intangible assets						$	433

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Amortization expense of intangible assets was $2 million and $5 million for the three and nine months ended September 30, 2015, respectively. Amortization expense of intangible assets was $2 million and $5 million for the three and nine months ended September 30, 2014, respectively.

At September 30, 2015, future amortization of definite-lived intangible assets is estimated as follows (amounts in millions):

2015 (remaining three months)	$	7
2016	8
2017	4
2018	3
2019	2
Total	$	24

5. Fair Value Measurements

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

• Level 1—Quoted prices in active markets for identical assets or liabilities;

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

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

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Fair Value Measurements on a Recurring Basis

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

			Fair Value Measurements at September 30, 2015 Using
	As of September 30, 2015		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance Sheet Classification
Financial Assets:
Recurring fair value measurements:
Money market funds	$	4,229	$	4,229	$	—	$	—	Cash and cash equivalents
Foreign government treasury bills	31		31		—		—		Cash and cash equivalents
U.S. treasuries and government agency securities	129		129		—		—		Short-term investments
Foreign currency forward contracts designated as hedges	3		—		3		—		Other current assets
Auction rate securities (“ARS”)	9		—		—		9		Long-term investments
Total recurring fair value measurements	$	4,401	$	4,389	$	3	$	9

			Fair Value Measurements at December 31, 2014 Using
	As of December 31, 2014		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance Sheet Classification
Recurring fair value measurements:
Money market funds	$	4,475	$	4,475	$	—	$	—	Cash and cash equivalents
Foreign government treasury bills	40		40		—		—		Cash and cash equivalents
ARS	9		—		—		9		Long-term investments
Total recurring fair value measurements	$	4,524	$	4,515	$	—	$	9

The following tables provide a reconciliation of the beginning and ending balances of our financial assets classified as Level 3 by major categories (amounts in millions) at September 30, 2015 and 2014, respectively:

	Level 3
	ARS (a)		Total financial assets at fair value
Balance at December 31, 2014	$	9	$	9
Total unrealized gains included in other comprehensive income	—		—
Balance at September 30, 2015	$	9	$	9

	Level 3
	ARS (a)		Total financial assets at fair value
Balance at December 31, 2013	$	9	$	9
Total unrealized gains included in other comprehensive income	—		—
Balance at September 30, 2014	$	9	$	9

(a) Fair value measurements have been estimated using an income-approach model. When estimating the fair value, we consider both observable market data and non-observable factors, including credit quality, duration, insurance wraps, collateral composition, maximum rate formulas, comparable trading instruments, and the likelihood of redemption. Significant assumptions used in the analysis include estimates for interest rates, spreads, cash flow timing and amounts, and holding periods of the securities. At September 30, 2015, assets measured at fair value using significant unobservable inputs (Level 3), all of which were ARS, represent less than 1% of our financial assets measured at fair value on a recurring basis.

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Foreign Currency Forward Contracts

The Company transacts business in various foreign currencies and has significant international sales and expenses denominated in foreign currencies, subjecting us to foreign currency risk. In addition, the Company transacts intercompany business in various foreign currencies other than its functional currency, subjecting us to variability in the functional currency-equivalent cash flows. To mitigate our foreign currency risk resulting from our foreign currency-denominated monetary assets, liabilities and earnings and our foreign currency risk related to functional currency-equivalent cash flows resulting from our intercompany transactions, we periodically enter into currency derivative contracts, principally forward contracts. We report the fair value of these contracts within “Other current assets,” “Accrued expense and other liabilities,” “Other assets,” or “Other liabilities,” as applicable, in our condensed consolidated balance sheets based on the prevailing exchange rates of the various hedged currencies as of the end of the relevant period.

We do not hold or purchase any foreign currency forward contracts for trading or speculative purposes.

Foreign Currency Forward Contracts Not Designated as Hedges

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

At September 30, 2015 there were no outstanding foreign currency forward contracts not designated as hedges. At December 31, 2014, there was one outstanding foreign currency forward contract not designated as a hedge; the notional amount of that foreign currency forward contract was $11 million and the fair value was not material. For the three and nine months ended September 30, 2015 and 2014, pre-tax net losses related to these forward contracts were not material.

Foreign Currency Forward Contracts Designated as Hedges

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

The gross notional amount of all outstanding foreign currency forward contracts designated as cash flow hedges was approximately $336 million at September 30, 2015 and $78 million at September 30, 2014. At December 31, 2014, there were no outstanding foreign currency forward contracts designated as cash flow hedges. These foreign currency forward contracts have remaining maturities of 15 months or less. During the three and nine months ended September 30, 2015 and 2014, there was no ineffectiveness relating to these hedges. At September 30, 2015, $3 million of net unrealized gains related to these contracts are expected to be reclassified into earnings within the next twelve months.

Fair Value Measurements on a Non-Recurring Basis

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

For the three and nine months ended September 30, 2015 and 2014, there were no impairment charges related to assets that are measured on a non-recurring basis.

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6. Debt

The proceeds from the credit facilities and the unsecured senior notes, as described below, were used to fund the Purchase Transaction disclosed in Note 1 of the Notes to Condensed Consolidated Financial Statements.

Credit Facilities

On October 11, 2013, in connection and simultaneously with the Purchase Transaction, we entered into a credit agreement (the “Credit Agreement”) for a $2.5 billion secured term loan facility maturing in October 2020 (the “Term Loan”), and a $250 million secured revolving credit facility maturing in October 2018 (the “Revolver” and, together with the Term Loan, the “Credit Facilities”). A portion of the Revolver can be used to issue letters of credit of up to $50 million, subject to the availability of the Revolver. To date, we have not drawn on the Revolver and there were no letters of credit issued and outstanding under the Revolver at either September 30, 2015 or December 31, 2014.

Borrowings under the Term Loan and the Revolver bear interest, payable on a quarterly basis, at an annual rate equal to an applicable margin plus, at our option, (A) a base rate determined by reference to the highest of (a) the interest rate in effect determined by the administrative agent as its “prime rate,” (b) the federal funds rate plus 0.5%, and (c) the London InterBank Offered Rate (“LIBOR”) for an interest period of one month plus 1.00%, or (B) LIBOR. LIBOR borrowings under the Term Loan are subject to a LIBOR floor of 0.75%. At September 30, 2015, the Credit Facilities bore interest at 3.25%. In certain circumstances, our applicable interest rate under the Credit Facilities will increase.

In addition to paying interest on outstanding principal balances under the Credit Facilities, we are required to pay the lenders a commitment fee on unused commitments under the Revolver. Commitment fees are recorded within “Interest and other expense, net” on the condensed consolidated statement of operations. We are also required to pay customary letter of credit fees, if any, and agency fees.

The terms of the Credit Agreement require quarterly principal repayments of 0.25% of the Term Loan’s original principal amount, with the balance due on the maturity date. On February 11, 2014, we made a voluntary repayment of $375 million on our Term Loan. This repayment satisfied the required quarterly principal repayments for the entire term of the Credit Agreement. On February 11, 2015, we made an additional voluntary repayment of $250 million on our Term Loan.

The Credit Facilities are guaranteed by certain of the Company’s U.S. subsidiaries, whose assets represent approximately 69% of our consolidated assets. The Credit Agreement contains customary covenants that place restrictions in certain circumstances on, among other things, the incurrence of debt, granting of liens, payment of dividends, sales of assets and mergers and acquisitions. If our obligations under the Revolver exceed 15% of the total facility amount as of the end of any fiscal quarter (subject to certain exclusions for letters of credit), we are also subject to certain financial covenants. A violation of any of these covenants could result in an event of default under the Credit Agreement. Upon the occurrence of such event of default or certain other customary events of default, payment of any outstanding amounts under the Credit Agreement may be accelerated, and the lenders’ commitments to extend credit under the Credit Agreement may be terminated. In addition, an event of default under the Credit Agreement could, under certain circumstances, permit the holders of other outstanding unsecured debt, including the debt holders described below, to accelerate the repayment of such obligations. The Company was in compliance with the terms of the Credit Facilities as of September 30, 2015.

Unsecured Senior Notes

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

The Notes are general senior obligations of the Company and rank pari passu in right of payment to all of the Company’s existing and future senior indebtedness, including the Credit Facilities described above. The Notes are guaranteed on a senior basis by certain of our U.S. subsidiaries. The Notes and related guarantees are not secured and are effectively subordinated to any of the Company’s existing and future indebtedness that is secured, including the Credit Facilities. The Notes contain customary covenants that place restrictions in certain circumstances on, among other things, the incurrence of debt, granting of liens, payment of dividends, sales of assets and mergers and acquisitions. The Company was in compliance with the terms of the Notes as of September 30, 2015.

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Interest on the Notes is payable semi-annually in arrears on March 15 and September 15 of each year. As of September 30, 2015 and December 31, 2014, we had interest payable of $5 million and $38 million, respectively, related to the Notes, recorded within “Accrued expenses and other liabilities” in our condensed consolidated balance sheet.

We may redeem the 2021 Notes on or after September 15, 2016 and the 2023 Notes on or after September 15, 2018, in whole or in part on any one or more occasions, at specified redemption prices, plus accrued and unpaid interest. At any time prior to September 15, 2016, with respect to the 2021 Notes, and at any time prior to September 15, 2018, with respect to the 2023 Notes, we may also redeem some or all of the Notes by paying a “make-whole premium,” plus accrued and unpaid interest. Further, upon the occurrence of one or more qualified equity offerings, we may also redeem up to 35% of the aggregate principal amount of each of the 2021 Notes and 2023 Notes outstanding with the net cash proceeds from such offerings. The Notes are repayable, in whole or in part and at the option of the holders, upon the occurrence of a change in control and a ratings downgrade, at a purchase price equal to 101% of principal, plus accrued and unpaid interest. These redemption options are considered clearly and closely related to the Notes and are not accounted for separately upon issuance.

Fees associated with the closing of the Term Loan and the Notes are recorded as debt discount, which reduce the carrying value of the Term Loan and the Notes. The debt discount is amortized over the respective terms of the Term Loan and the Notes. Amortization expense related to the debt discount is recorded within “Interest and other expense, net” in our condensed consolidated statement of operations.

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

	At September 30, 2015
	Gross Carrying Amount		Unamortized Discount		Net Carrying Amount
Term Loan	$	1,869	$	(9)	$	1,860
2021 Notes	1,500		(21)		1,479
2023 Notes	750		(11)		739
Total long-term debt	$	4,119	$	(41)	$	4,078

	At December 31, 2014
	Gross Carrying Amount		Unamortized Discount		Net Carrying Amount
Term Loan	$	2,119	$	(10)	$	2,109
2021 Notes	1,500		(23)		1,477
2023 Notes	750		(12)		738
Total long-term debt	$	4,369	$	(45)	$	4,324

For the three and nine months ended September 30, 2015, interest expense was $48 million and $145 million, respectively, amortization of the debt discount for the Credit Facilities and Notes was $1 million and $4 million, respectively, and commitment fees for the Revolver were not material. For the three and nine months ended September 30, 2014, interest expense was $50 million and $150 million, respectively, amortization of the debt discount for the Credit Facilities and Notes was $1 million and $4 million, respectively, and commitment fees for the Revolver were not material.

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As of September 30, 2015, the scheduled maturities and contractual principal repayments of our debt for each of the five succeeding years are as follows (amounts in millions):

For the year ending December 31,
2015 (remaining three months)	$	—
2016	—
2017	—
2018	—
2019	—
Thereafter	4,119
Total	$	4,119

As of September 30, 2015 and December 31, 2014, the carrying value of the Term Loan approximates the fair value, based on Level 2 inputs (observable market prices in less than active markets), as the interest rate is variable over the selected interest period and is similar to current rates at which we can borrow funds. Based on Level 2 inputs, the fair values of the 2021 Notes and 2023 Notes were $1,579 million and $799 million, respectively, as of September 30, 2015 and $1,586 million and $810 million, respectively, as of December 31, 2014.

Deferred Financing Costs

Costs incurred to obtain our long-term debt are recorded as deferred financing costs within “Other assets — non-current” in our condensed consolidated balance sheets and are amortized over the terms of the respective debt agreements using a straight-line basis for costs related to the Revolver and the interest earned method for costs related to the Term Loan and the Notes. Amortization expense related to the deferred financing costs is recorded within “Interest and other investment income (expense), net” in our condensed consolidated statements of operations. For the three and nine months ended September 30, 2015 and 2014, this amount was not material.

7. Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss) at September 30, 2015 and 2014, were as follows (amounts in millions):

	For the Nine Months Ended September 30, 2015
	Foreign currency translation adjustments		Unrealized gain (loss) on forward contracts		Unrealized gain (loss) on available- for-sale securities		Total
Balance at December 31, 2014	$	(304)	$	—	$	1	$	(303)
Other comprehensive income (loss) before reclassifications	(240)		8		(4)		(236)
Amounts reclassified from accumulated other comprehensive income (loss)	—		(5)		—		(5)
Balance at September 30, 2015	$	(544)	$	3	$	(3)	$	(544)

	For the Nine Months Ended September 30, 2014
	Foreign currency translation adjustments		Unrealized gain (loss) on forward contracts		Unrealized gain on available-for-sale securities		Total
Balance at December 31, 2013	$	67	$	—	$	1	$	68
Other comprehensive income (loss) before reclassifications	(230)		7		—		(223)
Amounts reclassified from accumulated other comprehensive income (loss)	—		(2)		—		(2)
Balance at September 30, 2014	$	(163)	$	5	$	1	$	(157)

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

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8. Operating Segments and Geographic Region

Our operating segments are consistent with our internal organizational structure, the manner in which our operations are reviewed and managed by our Chief Executive Officer, who is our Chief Operating Decision Maker (“CODM”), the manner in which we assess operating performance and allocate resources, and the availability of separate financial information. Currently, we conduct our business through three operating segments: Activision, Blizzard and Distribution (see Note 1 of the Notes to Condensed Consolidated Financial Statements). We do not aggregate operating segments.

The CODM reviews segment performance exclusive of the impact of the change in deferred revenues and related cost of sales with respect to certain of our online-enabled games, stock-based compensation expense, amortization of intangible assets as a result of purchase price accounting, and fees and other expenses (including legal fees, costs, expenses and accruals) related to the Purchase Transaction and related debt financings. The CODM does not review any information regarding total assets on an operating segment basis, and accordingly, no disclosure is made with respect thereto. Information on the operating segments and reconciliations of total net revenues and total segment operating income to consolidated net revenues from external customers and consolidated income before income tax expense for the three and nine months ended September 30, 2015 and 2014 are presented below (amounts in millions):

	Three Months Ended September 30,
	2015		2014		2015		2014
	Net revenues				Income (loss) from operations before income tax expense (benefit)
Activision	$	591	$	704	$	122	$	95
Blizzard	369		388		128		164
Distribution	80		78		1		1
Operating segments total	1,040		1,170		251		260

Reconciliation to consolidated net revenues / consolidated income (loss) before income tax expense (benefit):
Net effect from deferral of net revenues and related cost of sales	(50)		(417)		(26)		(180)
Stock-based compensation expense	—		—		(28)		(22)
Amortization of intangible assets	—		—		(1)		(2)
Fees and other expenses related to the Purchase Transaction and related debt financings	—		—		—		(48)
Consolidated net revenues / operating income	$	990	$	753	$	196	$	8
Interest and other expense, net					51		51
Consolidated income (loss) before income tax expense (benefit)					$	145	$	(43)

	Nine Months Ended September 30,
	2015		2014		2015		2014
	Net revenues				Income from operations before income tax expense
Activision	$	1,208	$	1,193	$	244	$	66
Blizzard	1,106		1,189		383		548
Distribution	189		218		—		(1)
Operating segments total	2,503		2,600		627		613

Reconciliation to consolidated net revenues / consolidated income before income tax expense:
Net effect from deferral of net revenues and related cost of sales	809		233		517		260
Stock-based compensation expense	—		—		(70)		(76)
Amortization of intangible assets	—		—		(4)		(4)
Fees and other expenses related to the Purchase Transaction and related debt financings	—		—		—		(48)
Consolidated net revenues / operating income	$	3,312	$	2,833	$	1,070	$	745
Interest and other expense, net					151		152
Consolidated income before income tax expense					$	919	$	593

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Geographic information presented below for the three and nine months ended September 30, 2015 and 2014 is based on the location of the selling entity. Net revenues from external customers by geographic region were as follows (amounts in millions):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
Net revenues by geographic region:
North America	$	495	$	350	$	1,750	$	1,384
Europe	367		316		1,219		1,172
Asia Pacific	128		87		343		277
Total consolidated net revenues	$	990	$	753	$	3,312	$	2,833

The Company’s net revenues in the U.S. were 46% and 45% of consolidated net revenues for the three months ended September 30, 2015 and 2014, respectively. The Company’s net revenues in the U.K. were 13% and 14% of consolidated net revenues for the three months ended September 30, 2015 and 2014, respectively. The Company’s net revenues in France were 7% and 19% of consolidated net revenues for the three months ended September 30, 2015 and 2014, respectively. No other country’s net revenues exceeded 10% of consolidated net revenues for the three months ended September 30, 2015 and 2014.

The Company’s net revenues in the U.S. were 50% and 46% of consolidated net revenues for the nine months ended September 30, 2015 and 2014, respectively. The Company’s net revenues in the U.K. were 13% and 14% of consolidated net revenues for the nine months ended September 30, 2015 and 2014, respectively. The Company’s net revenues in France were 8% and 16% of consolidated net revenues for the nine months ended September 30, 2015 and 2014, respectively. No other country’s net revenues exceeded 10% of consolidated net revenues for the nine months ended September 30, 2015 and 2014.

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
Net revenues by platform:
Console	$	420	$	270	$	1,737	$	1,402
Online1	195		205		687		601
PC	164		165		427		447
Mobile and other2	131		35		272		165
Total Activision Blizzard net revenues	910		675		3,123		2,615
Distribution	80		78		189		218
Total consolidated net revenues	$	990	$	753	$	3,312	$	2,833

1 Revenues from online consist of revenues from all World of Warcraft products, including subscriptions, boxed products, expansion packs, licensing royalties, and value-added services.

2 Revenues from mobile and other include revenues from handheld, mobile and tablet devices, as well as non-platform specific game related revenues such as standalone sales of toys and accessories products from the Skylanders franchise and other physical merchandise and accessories.

Long-lived assets by geographic region at September 30, 2015 and December 31, 2014 were as follows (amounts in millions):

	At September 30, 2015		At December 31, 2014
Long-lived assets1 by geographic region:
North America	$	153	$	122
Europe	38		29
Asia Pacific	9		6
Total long-lived assets by geographic region	$	200	$	157

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

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9. Income Taxes

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

The income tax expense of $18 million for the three months ended September 30, 2015 reflects an effective tax rate of 13%, which is lower than the effective tax rate of 46% for the three months ended September 30, 2014. This decrease is primarily due to an incremental tax benefit included in the three months ended September 30, 2014, from a lower estimated effective annual tax rate in 2015 due to the mix of foreign earnings taxed at relatively lower statutory rates as compared to domestic earnings, partially offset by certain non-tax benefited costs incurred during the prior year quarter.

The income tax expense of $186 million for the nine months ended September 30, 2015 reflects an effective tax rate of 20%, which is comparable to the effective tax rate of 20% for the nine months ended September 30, 2014.

The effective tax rates of 13% and 20% for the three and nine months ended September 30, 2015, respectively, differed from the U.S. statutory rate of 35%, primarily due to the tax benefit from foreign earnings taxed at relatively lower statutory rates, recognition of California research and development credits, federal domestic production deductions and favorable return to provision adjustments, partially offset by increases to the Company’s reserve for uncertain tax positions.

The overall effective income tax rate for the year could be different from the effective tax rate for the three and nine months ended September 30, 2015 and will be dependent, in part, on our profitability for the remainder of the year, as well as the other factors described above.

The Internal Revenue Service (“IRS”) is currently examining Activision Blizzard’s federal tax returns for the 2008 through 2011 tax years. During the second quarter of 2015, the Company transitioned the review of its transfer pricing methodology from the advanced pricing agreement review process to the IRS examination team. Their review could result in a different allocation of profits and losses under the Company’s transfer pricing agreements. Such allocation could have a positive or negative impact on our provision for uncertain tax positions for the period in which such a determination is reached and the relevant periods thereafter.

In addition, Vivendi Games’ tax return for the 2008 tax year is under examination by the IRS and several state taxing authorities. While Vivendi Games’ results for the period January 1, 2008 through July 9, 2008 are included in the consolidated federal and certain foreign, state and local income tax returns filed by Vivendi or its affiliates, 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. Additionally, the Company has several state and non-U.S. audits pending.

The final resolution of the Company’s global tax disputes is uncertain. There is significant judgment required in the analysis of disputes, including the probability determination and estimation of the potential exposure. Based on current information, in the opinion of the Company’s management, the ultimate resolution of these matters are not expected to 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.

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In connection with the Purchase Transaction, we assumed certain tax attributes of New VH, generally consisting of New VH’s net operating loss (“NOL”) carryforwards of approximately $760 million, which represent a potential future tax benefit of approximately $266 million. The utilization of such NOL carryforwards will be subject to certain annual limitations and will begin to expire in 2021. The Company also obtained indemnification from Vivendi against losses attributable to the disallowance of claimed utilization of such NOL carryforwards of up to $200 million in unrealized tax benefits in the aggregate, limited to taxable years ending on or prior to December 31, 2016. No benefit for these tax attributes or indemnification was recorded upon the close of the Purchase Transaction, as the benefit from these tax attributes did not meet the “more-likely-than-not” standard. For the nine months ended September 30, 2015, we utilized $248 million of the NOL, which resulted in a tax benefit of $87 million, reduced by $5 million for return to provision adjustments, and a corresponding reserve of $82 million was established as the position did not meet the “more-likely-than-not” standard. As of September 30, 2015, an indemnification asset of $149 million has been recorded in “Other Assets,” and, correspondingly, the same amount has been recorded as a reduction to the consideration paid for the shares repurchased in “Treasury Stock” (see Note 1 of the Notes to Condensed Consolidated Financial Statements for details about the share repurchase).

10. Computation of Basic/Diluted Earnings Per Common Share

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

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2015		2014		2015		2014
Numerator:
Consolidated net income (loss)	$	127	$	(23)	$	733	$	474
Less: Distributed earnings to unvested stock-based awards that participate in earnings	—		—		(4)		(5)
Less: Undistributed earnings allocated to unvested stock-based awards that participate in earnings	(2)		—		(6)		(7)
Numerator for basic and diluted earnings (loss) per common share — income (loss) available to common shareholders	$	125	$	(23)	$	723	$	462

Denominator:
Denominator for basic earnings per common share - weighted-average common shares outstanding	730		718		727		714
Effect of potential dilutive common shares under the treasury stock method:
Employee stock options and awards	9		—		9		11
Denominator for diluted earnings per common share - weighted-average common shares outstanding plus dilutive common shares under the treasury stock method	739		718		736		725

Basic earnings (loss) per common share	$	0.17	$	(0.03)	$	0.99	$	0.65

Diluted earnings (loss) per common share	$	0.17	$	(0.03)	$	0.98	$	0.64

Certain of our unvested restricted stock rights (including certain restricted stock units, restricted stock awards and performance shares) met the definition of participating securities as they participate in earnings based on their rights to dividends or dividend equivalents. Therefore, we are required to use the two-class method in our computation of basic and diluted earnings per common share. For the three and nine months ended September 30, 2015, on a weighted-average basis, we had outstanding unvested restricted stock rights with respect to 8 million and 9 million shares of common stock, respectively, that are participating in earnings. For the three and nine months ended September 30, 2014, on a weighted-average basis, we had outstanding unvested restricted stock rights with respect to 14 million and 16 million shares of common stock, respectively, that are participating in earnings.

Certain of our employee-related restricted stock rights are contingently issuable upon the satisfaction of pre-defined performance measures. These shares are included in the weighted-average dilutive common shares only if the performance measures are met as of the end of the reporting period. Approximately 4 million shares are not included in the computation of diluted earnings per share for the three and nine months ended September 30, 2015 as their respective performance measures had not yet been met. Approximately 5 million and 4 million shares are not included in the computation of diluted earnings per share for the three and nine months ended September 30, 2014 as their respective performance measures had not yet been met.

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Potential common shares are not included in the denominator of the diluted earnings per common share calculation when the inclusion of such shares would be anti-dilutive, such as in a period in which a net loss is recorded. Therefore, options to acquire 1 million shares of common stock were not included in the calculation of diluted earnings per common share for the three and nine months ended September 30, 2015 and options to acquire 10 million and 1 million shares of common stock were not included in the calculation of diluted earnings per common share for the three and nine months ended September 30, 2014, as the effect of their inclusion would be anti-dilutive.

11. Capital Transactions

Repurchase Program

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

Dividends

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

On February 6, 2014, our Board of Directors declared a cash dividend of $0.20 per common share, payable on May 14, 2014, to shareholders of record at the close of business on March 19, 2014. On May 14, 2014, we made an aggregate cash dividend payment of $143 million to such shareholders, and on May 30, 2014, we made related dividend equivalent payments of $4 million to certain holders of restricted stock rights.

12. Commitments and Contingencies

Legal Proceedings

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

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

Purchase Transaction Matters

In prior periods, the Company reported on litigation related to the Purchase Transaction. During the period ended June 30, 2015, the cases were resolved and dismissed with prejudice. As part of the resolution of the claims, we received a settlement payment of $202 million in July 2015 from Vivendi, ASAC, and our insurers. We recorded the settlement within “Shareholders’ equity” in our condensed consolidated balance sheet as of September 30, 2015.

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Other Matters

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

13. Related Party Transactions

Transactions with Vivendi and Its Affiliates

As part of the Business Combination in 2008, we entered into various transactions and agreements, including cash management services agreements, a tax sharing agreement and an investor agreement, with Vivendi and its subsidiaries. In connection with the consummation of the Purchase Transaction, we terminated the cash management arrangements with Vivendi and amended our investor agreement with them. We are also party to a number of agreements with subsidiaries and other affiliates of Vivendi, including music licensing and distribution arrangements and promotional arrangements, none of which were impacted by the Purchase Transaction. None of these services, transactions and agreements with Vivendi and its affiliates were material, either individually or in the aggregate, to the consolidated financial statements as a whole. As discussed in Note 1 of the Notes to Condensed Consolidated Financial Statements, on May 28, 2014, Vivendi sold 41 million shares, reducing its ownership interest below 10%, and is no longer considered a related party.

Transactions with ASAC’s Affiliates

Pursuant to the Stock Purchase Agreement, the Company and each of Mr. Kotick, the Company’s Chief Executive Officer, and Mr. Kelly, the Company’s Chairman of the Board of Directors, entered into waiver and acknowledgment letters (together, the “Waivers”), which provide, among other things, (i) that the Purchase Transaction, Private Sale, any public offerings by Vivendi and restructurings by Vivendi and its subsidiaries contemplated by the Stock Purchase Agreement and other transaction documents, shall not (or shall be deemed not to) constitute a “change in control” (or similar term) under their respective employment arrangements, including their employment agreements with the Company, the Company’s 2008 Incentive Plan or any award agreements in respect of awards granted thereunder, or any Other Benefit Plans and Arrangements (as defined in the Waivers), (ii) (A) that the shares of our common stock acquired by ASAC and held or controlled by the ASAC Investors (as defined in the Waivers) in connection with the Transactions (as defined in the Waivers) will not be included in or count toward, (B) that the ASAC Investors will not be deemed to be a group for purposes of, and (C) any changes in the composition in the Board of Directors of the Company, in connection with or during the one-year period following the consummation of the Transactions will not contribute towards, a determination that a “change in control” or similar term has occurred with respect to Messrs. Kotick and Kelly’s employment arrangements with the Company, and (iii) for the waiver by Messrs. Kotick and Kelly of their rights to change in control payments or benefits under their employment agreements with the Company, the Company’s 2008 Incentive Plan or any award agreements in respect of awards granted thereunder, and any Other Benefit Plans and Arrangements (in each case, with respect to all current and future grants, awards, benefits or entitlements) in connection with or as a consequence of the Transactions.

Also pursuant to the Stock Purchase Agreement, on October 11, 2013, we, ASAC and, for the limited purposes set forth therein, Messrs. Kotick and Kelly entered into the Stockholders Agreement. The Stockholders Agreement contains various agreements among the parties regarding voting rights, transfer rights, and a standstill agreement, among other things. In connection with the settlement of the litigation related to the Purchase Transaction, the parties to the Stockholders Agreement amended that agreement on May 28, 2015.

14. Recently issued accounting pronouncements

Revenue recognition

In May 2014, the FASB issued new accounting guidance related to revenue recognition. The new standard will replace all current U.S. GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. This guidance will be effective beginning January 1, 2018 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. We are evaluating the adoption method as well as the impact of this new accounting guidance on our financial statements.

Stock-based compensation

In June 2014, the FASB issued new guidance related to stock compensation. The new standard requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which the requisite service has already been rendered. The new standard is effective for fiscal years beginning after December 15, 2015 and can be applied either prospectively or retrospectively to all awards outstanding as of the beginning of the earliest annual period presented as an adjustment to opening retained earnings. Early adoption is permitted. The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

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Consolidations

In February 2015, the FASB issued new guidance related to consolidations. The new standard amends certain requirements for determining whether a variable interest entity must be consolidated. The new standard is effective for fiscal years beginning after December 15, 2015. Early adoption is permitted. We are evaluating the impact, if any, of adopting this new accounting guidance on our financial statements.

Debt Issuance Costs

In April 2015, the FASB issued new guidance related to the presentation of debt issuance costs in financial statements. The new standard requires an entity to present such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. It is effective for annual reporting periods beginning after December 15, 2015. The new guidance will be applied retrospectively to each prior period presented. The adoption of this guidance will not have a material impact on our financial statements.

Internal-Use Software

In April 2015, the FASB issued new guidance related to internal-use software. The new standard relates to a customer’s accounting for fees paid in cloud computing arrangements. The amendment provides guidance for customers to determine whether such arrangements include software licenses. If a cloud arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The new standard is effective for fiscal years beginning after December 15, 2015. Early adoption is permitted. We are evaluating the impact, if any, of adopting this new accounting guidance on our financial statements.

Inventory

In July 2015, the FASB issued new guidance related to the measurement of inventory which requires inventory within the scope of the guidance to be measured at the lower of cost and net realizable value. Net realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The new standard is effective for fiscal years beginning after December 15, 2016 and should be applied prospectively. Early adoption is permitted. We are evaluating the impact, if any, of adopting this new accounting guidance on our financial statements.

15. Subsequent events

The Acquisition

On November 2, 2015, we and King Digital Entertainment plc, a leading interactive mobile entertainment company incorporated under the laws of Ireland (“King”), entered into a Transaction Agreement (the “Transaction Agreement”) under the terms of which we will acquire King (the “Acquisition”) and King will become a wholly-owned subsidiary of the Company. At the effective time of the Acquisition, King shareholders will become entitled to receive $18.00 in cash in exchange for each King share they then hold. We expect to transfer approximately $5.9 billion in consideration to the existing King shareholders and share based award holders through a combination of the net proceeds from $2.3 billion of committed incremental term loans, our offshore cash, and approximately $200 million of our share based awards for the replacement of share based awards held by current employees and directors of King.

The transaction is subject to customary closing conditions, including the approval by King’s shareholders, Irish High Court sanctioning, as well as certain regulatory approvals, and is expected to close by Spring of calendar year 2016.

Amendment to Credit Agreement

In conjunction with the Acquisition, the Company entered into a First Amendment (the “Amendment”), which amends the Credit Agreement, dated as of October 11, 2013. The Amendment, among other things, provides for Incremental Term Loans in the form of Tranche B-2 Term Loans in an aggregate principal amount of approximately $2.3 billion. The proceeds of the Tranche B-2 Term Loans will be used to fund the Acquisition.

The Tranche B-2 Term Loans will mature on the date that is seven years and six months after the date of the initial funding of the Tranche B-2 Term Loans and will bear interest, at an annual rate equal to an applicable interest margin plus, at our option, (A) a base rate determined by reference to the highest of (a) the interest rate in effect determined by the administrative agent as its “prime rate,” (b) the federal funds rate plus 0.5%, and (c) the London InterBank Offered Rate (“LIBOR”) rate for an interest period of one month plus 1.00%, or (B) LIBOR. LIBOR borrowings under the Tranche B-2 Term Loan will be subject to a LIBOR floor of 0.75% and base rate will be subject to a floor of 1.75%. The applicable interest margin for Tranche B-2 Term Loans will be 3.00% for LIBOR borrowings and 2.00% for base rate borrowings. Voluntary prepayments of the Tranche B-2 Term Loans are permitted at any time, in minimum principal amounts, without premium or penalty, subject to a 1.00% premium payable in connection with certain repricing transactions within the first six months after the date of the initial funding of the Tranche B-2 Term Loans. The Tranche B-2 Term Loans will be secured by the same collateral and guaranteed by the same guarantors as the existing Term Loan. The other terms of the Tranche B-2 Term Loans are also generally the same as the terms of the existing Term Loan.

Commitment Letter

In conjunction with the Acquisition, the Company also entered into a commitment letter (the “Commitment Letter”) with Bank of America, N.A. and Goldman Sachs Bank USA (the “Debt Financing Sources”). Pursuant to the Commitment Letter, subject to customary conditions, the Debt Financing Sources committed to provide the Company with the Tranche B-2 Term Loans on such modified terms as set forth therein (Tranche B-2 Term Loans as so modified, the “Tranche A Term Loans”) in the same aggregate principal amount and for the same purpose as the original Tranche B-2 Term Loans. The Tranche A Term Loans will be effected via, and subject to the passing of, a second amendment to the Credit Agreement and will mature on October 11, 2020.

Cash Confirmation

Under the Irish Takeover Rules, no financing condition to the Acquisition is permitted. As is customary, we have executed and delivered a cash confirmation representation letter to our financial advisor, in which we have given various representations, warranties and undertakings in relation to the sources and availability of the funding. In conjunction with the representation letter the Company has segregated $3.56 billion in cash in separate bank accounts, where the cash is not accessible to the Company for operating cash needs, as its use has been administratively restricted for use in the consummation of the Acquisition.

All information included in the accompanying unaudited Condensed Consolidated Financial Statements and notes to Condensed Consolidated Financial Statements in this report reflects only our results, and does not reflect any impact of the proposed Acquisition, Amendment to the Credit Agreement, Commitment Letter, or Cash Confirmation.

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

Business Overview

Activision Blizzard, Inc. is a leading global developer and publisher of interactive entertainment. The terms “Activision Blizzard,” the “Company,” “we,” “us,” and “our” are used to refer collectively to Activision Blizzard, Inc. and its subsidiaries.

Operating Segments

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

(i) Activision Publishing, Inc.

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

(ii) Blizzard Entertainment, Inc.

Blizzard Entertainment, Inc. (“Blizzard”) is a leader in the subscription-based massively multi-player online role-playing game category in terms of both subscriber base and revenues generated through its World of Warcraft® franchise, which it develops, hosts and supports. Blizzard also develops, markets, and sells role-playing action and strategy games for the PC, console, mobile and tablet platforms, including games in the multiple-award winning Diablo®, StarCraft®, and Hearthstone®: Heroes of Warcraft™ 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; sales of prepaid subscription cards; value-added services, such as in-game purchases and services; retail sales of physical “boxed” products; online download sales of PC products; purchases and downloads via third-party console, mobile and tablet platforms; and licensing of software to third-party or related-party companies that distribute World of Warcraft, Diablo and StarCraft products. In addition, Blizzard is the creator of Heroes of the Storm™, a free-to-play online hero brawler released on June 2, 2015.

(iii) Activision Blizzard Distribution

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

Business Highlights

For the three months ended September 30, 2015, Activision Blizzard had net revenues of $990 million, as compared to net revenues of $753 million for the same period in 2014. For the three months ended September 30, 2015, Activision Blizzard had earnings per diluted share of $0.17, as compared to loss per diluted share of $(0.03) for the same period in 2014.

For the nine months ended September 30, 2015, Activision Blizzard had net revenues of $3.3 billion, as compared to net revenues of $2.8 billion for the same period in 2014. For the nine months ended September 30, 2015, Activision Blizzard had earnings per diluted share of $0.98, as compared to earnings per diluted share of $0.64 for the same period in 2014.

For the three and nine months ended September 30, 2015, digital online channel revenues were 64% and 54%, respectively, of consolidated net revenues, as compared to 67% and 48% for the three and nine months ended September 30, 2014, respectively.

For the three and nine months ended September 30, 2015, non-GAAP digital online channel revenues were 67% and 74%, respectively, of consolidated net revenues, as compared to 43% and 58% for the three and nine months ended September 30, 2014, respectively.

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

Activision Blizzard 2015 and Upcoming Product Releases

We have recently released the following titles and games, among other titles:

· On January 11, 2015, Activision entered open beta for Call of Duty Online, a free-to-play game available in China.

· Activision released Call of Duty: Advanced Warfare Havoc (“Havoc”), the first downloadable content pack for Call of Duty: Advanced Warfare on the Xbox One and Xbox 360 platforms on January 27, 2015 and on other platforms on February 26, 2015.

• Activision released Call of Duty: Advanced Warfare Ascendance (“Ascendance”), the second downloadable content pack for Call of Duty: Advanced Warfare on the Xbox One and Xbox 360 platforms on March 31, 2015 and on other platforms on April 30, 2015.

· On April 2, 2015, Blizzard released Blackrock Mountain™, an addition to Hearthstone: Heroes of Warcraft content and on April 14, 2015, Hearthstone: Heroes of Warcraft was released on iOS and Android smartphones.

· On April 7, 2015, Blizzard launched the WoW™ Token System, which enables World of Warcraft players to exchange game-time tokens, purchased at $20, to other players for in-game gold, which provides players with a secure method for purchasing gold in-game.

· On April 23, 2015, Blizzard released the action role-playing game Diablo III: Reaper of Souls™ in China.

· On May 19, 2015, Activision released House of Wolves, the second expansion to Destiny.

· On June 2, 2015, Blizzard released Heroes of the Storm, its free-to-play online team brawler.

· Activision released Call of Duty: Advanced Warfare Supremacy (“Supremacy”), the third downloadable content pack for Call of Duty: Advanced Warfare on the Xbox One and Xbox 360 platforms on June 2, 2015 and on other platforms on July 2, 2015.

· Activision released Call of Duty: Advanced Warfare Reckoning (“Reckoning”), the fourth downloadable content pack for Call of Duty: Advanced Warfare on the Xbox One and Xbox 360 platforms on August 4, 2015 and on other platforms on September 3, 2015.

· On August 24, 2015, Blizzard released The Grand Tournament™, the latest expansion to Hearthstone: Heroes of Warcraft.

· On September 15, 2015, Activision released The Taken King, the third expansion to Destiny.

· On September 20, 2015, Activision released Skylanders Superchargers, the latest title in the Skylanders franchise.

· On October 20, 2015, Activision released Guitar Hero Live, bringing back the franchise that had previously reached over 40 million players in North America and Europe.

· On October 27, 2015, Blizzard began closed beta testing for Overwatch™, its upcoming team-based first-person shooter.

· On November 6, 2015, Activision released Call of Duty: Black Ops III, the latest in the Call of Duty franchise series.

· In November 2015, Blizzard expects to release Starcraft II: Legacy of the Void™, the third installment of the real-team strategy game.

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Management’s Overview of Business Trends

Console Platform Transition

In November 2013, Sony released the PS4 and Microsoft released the Xbox One, their respective next-generation game consoles and entertainment systems. According to The NPD Group and GfK Chart-Track in North America and Europe, as of September 30, 2015, the combined installed base of PS4 and Xbox One hardware was approximately 32 million units, representing growth of approximately 118% over the combined installed base of approximately 15 million as of September 30, 2014. While the combined installed base of PS3 and Xbox 360 hardware was approximately 123 million units as of September 30, 2015, at the comparable point in their release cycle, the prior-generation platforms had only 22 million units installed.

When new console platforms are announced or introduced into the market, consumers reduce their purchases of game console software products for prior-generation console platforms in anticipation of new platforms becoming available. During these periods, sales of the game console software products we publish slow or even decline until the new platforms introduced achieve wide consumer acceptance, which we believe will have largely occurred with respect to the next-generation platforms by the end of 2015. In prior cycles, as the next-generation installed base grew, software sales declines abated and software sales grew.

During platform transitions, we simultaneously incur costs to develop and market new titles for prior-generation video game platforms and to develop and market products for next-generation platforms. We continually monitor console hardware sales and manage our product delivery on each of the prior- and next-generation platforms 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.

Digital Online Channel Revenues

We provide our products through both retail and digital distribution channels. Many of our video games that are available through retailers as physical “boxed” software products are also available digitally (from our websites and from websites and digital distribution channels owned by third parties). In addition, we offer players digital downloadable content as add-ons to our products (e.g., new multi-player content packs), subscription-based services, value-added services and micro-transactions across our various video games. We have also introduced games based on some of our most successful franchises which operate online on a free-to-play model with micro-transactions.

We currently define sales via digital online channels as revenues from digitally distributed subscriptions, licensing royalties, value-added services, downloadable content, micro-transactions, and products. This definition may differ from that used by our competitors or other companies.

According to Activision Blizzard internal estimates, overall industry digital gaming revenues for the nine months ended September 30, 2015 increased by approximately 21% as compared to the same period in 2014. The primary drivers of the increase in digital gaming revenues were increases in micro-transactions and consumer purchases of full games via digital channels. Digital revenues are an important part of our business, and we continue to focus on and develop products, such as downloadable content, 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. Our sales of digital downloadable content are driven in part by sales of, and engagement by players in, our retail products. As such, lower revenues in our retail distribution channels in the current year may impact our revenues through digital online channels in the subsequent year.

For the three months ended September 30, 2015, revenues through digital online channels increased by $125 million, as compared to the same period in 2014, and represented 64% of our total consolidated net revenues, as compared to 67% for the same period in 2014. On a non-GAAP basis (which excludes the impact of deferred revenues), revenues through digital online channels for the three months ended September 30, 2015 increased by $192 million, as compared to the same period in 2014, and represented 67% of our total non-GAAP net revenues, as compared to 43% for the same period in 2014.

For the nine months ended September 30, 2015, revenues through digital online channels increased by $421 million, as compared to the same period in 2014, and represented 54% of our total consolidated net revenues, as compared to 48% for the same period in 2014. On a non-GAAP basis (which excludes the impact of deferred revenues), revenues through digital online channels for the nine months ended September 30, 2015 increased by $333 million, as compared to the same period in 2014, and represented 74% of our total non-GAAP net revenues, as compared to 58% for the same period in 2014.

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Conditions in the Retail Distribution Channels

Conditions in the retail distribution channels of the interactive entertainment industry continued to be challenging during the first nine months of 2015. In North America and Europe, retail sales of video games declined by 8%, as compared to the same period in 2014, according to The NPD Group and GfK Chart-Track. However, the increase in digitally distributed games, including full-game downloads, add-on content, and free-to-play games, has offset the negative trends in the retail distribution channels.

Additionally, the toys-to-life game category has seen increasing competition from new market participants.

Please refer to the reconciliation between GAAP and non-GAAP financial measures later in this document for further discussions of digital and retail online channels.

The Business Combination and Share Repurchase

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Consolidated Statements of Operations Data

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
Net revenues
Product sales	$	425	43%	$	337	45%	$	1,736	52%	$	1,693	60%
Subscription, licensing and other revenues	565		57	416		55	1,576		48	1,140		40
Total net revenues	990		100	753		100	3,312		100	2,833		100

Costs and expenses
Cost of sales - product costs	195		20	156		21	560		17	568		20
Cost of sales - online	56		6	56		7	161		5	170		6
Cost of sales - software royalties and amortization	81		8	34		5	314		10	136		5
Cost of sales - intellectual property licenses	5		—	7		1	12		—	20		1
Product development	159		16	131		17	453		14	387		14
Sales and marketing	189		19	221		29	445		13	465		16
General and administrative	109		11	140		19	297		9	342		12
Total costs and expenses	794		80	745		99