Good day, everyone and welcome to today’s Activision Blizzard’s first quarter ending March ’09 earnings conference call. Today’s conference is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Vice President of Investor Relations, Ms. Kristin Southey. Please go ahead.
Good afternoon and thank you for joining us today for Activision Blizzard's March quarter calendar ’09 conference call. As always, I will start today’s call with a review of our Safe Harbor disclosure, followed by comments from Bobby Kotick, CEO; Thomas Tippl, Chief Corporate Officer and CFO; Mike Griffith, President and CEO of Activision Publishing; and Mike Morhaime, Chief Executive Officer of Blizzard Entertainment.
I would like to remind everyone that statements will be made during this call that are not historical facts are forward-looking statements. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties. The company cautions that a number of important factors could cause Activision Blizzard's actual future results and other future circumstances to differ materially from those expressed in any such forward-looking statements.
Such factors include without limitation sales levels of the company’s titles, shifts in consumer spending trends, the impact of the current macroeconomic environment, the seasonal and cyclical nature of the interactive game market, any complications related to the transition of World of Warcraft in China from the current licensee to NetEase, the company’s ability to predict consumer preferences among competing hardware platforms, declines in software pricing, product returns and price protection, product delays, retail acceptance of our products, adoption rate and availability of new hardware and related software, industry competition, rapid changes in technology and industry standards, protection of proprietary rights, litigation, maintenance of relationships with key personnel, customers, vendors, licensees, licensors, and third-party developers, counter-party risks, domestic and international economic, financial, and political conditions and policies, foreign exchange rates, the integration of recent acquisitions and the identification of suitable future acquisition opportunities, our success in completing the integration of the operations of Activision and Vivendi games in a timely manner, or at all, and our ability to realize the anticipated benefits and synergies of this transaction to the extent or in the timeframe anticipated.
These important factors and other factors that potentially could affect the company’s financial results are described in the company’s annual report on Form 10-K for the period ended December 31, 2008. The company may change its intentions, beliefs, or expectations any time and without notice, based upon any changes in such factors in the company assumptions or otherwise.
The company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after today, May 7, 2009, or to reflect the occurrence of unanticipated events.
I would also like to note that certain numbers we will be presenting today, including net revenues, operating income, earnings per share, manufacturing and distribution costs, product creation costs, sales and marketing expense, and G&A spending, inventory, catalog software, and intellectual property will be made on a non-GAAP basis excluding the impact of the change in deferred net revenue and related cost of sales. Expenses related to equity-based compensation costs, the operating results of products and operations from the historical Vivendi Games business that the company has exited or is winding down, one-time costs related to the business combination with Activision and Vivendi Games, the amortization of intangibles and the changing cost of sales resulting from purchase price accounting adjustments and the associated tax benefits.
Please refer to our earnings release for a full GAAP to non-GAAP reconciliation. In addition, due to the fact that our business combination was accounted for as a reverse acquisition, we will be presenting additional non-GAAP information that includes Activision standalone results for the period prior to July 9th, which we refer to as a non-GAAP comparable basis.
I would also like to highlight that for your convenience, we are now including some additional information in our reporting. In today’s release we have added non-GAAP net revenue tables by platform and geography. Please refer to our earnings release, which is posted on our website, at www.activisionblizzard.com for reconciliations and further explanations.
And now, I would like to introduce our CEO, Bobby Kotick.
Robert A. Kotick
Thank you, Kristen, and thank you for joining us today. I am pleased to report that our March quarter results significantly exceeded our prior outlook. We believe this success is the result of the competitive advantages inherent to our business strategy. These competitive advantages allowed us to deliver record non-GAAP revenues and profits last year and now enable us to raise our outlook for calendar 2009 and raise our confidence in our overall outlook for the future, as you will hear in more detail later in this call.
I want to reiterate the four key advantages that allow us to continue our growth as the world’s number one third-party publisher.
First, we focus on the select number of proven franchises and genres where we have leading development expertise, and we ensure the titles are high quality with broad appeal across multiple platforms and geographies.
Second, we support strong retail oriented marketing and sales programs and intend to strengthen those relationships over the next few years. Our retailers are our most important partners. We also find ways to broaden the footprint of our franchises through innovative business models like subscription based online gaming.
Third, we execute with industry-leading operational capability and the most talented group of employees in our sector.
And finally, we have an exceptional balance sheet, which is the result of our continued focus on margin expansion, operational excellence, rigorous cost control, and an unwavering conviction to providing superior shareholder returns.
It has taken 18 years to create these competitive advantages but taken together, they position us better than any of our competitors to capitalize on the dynamic and growing interactive entertainment market and to continue to drive long-term value to our shareholders as we have over the last 18 years.
Every major strategic activity we undertake is based around expanding those competitive advantages over the long-term. This includes the development talent we acquire or invest in, the long-term licenses we pursue, the acquisitions we make, the segments of the market we enter, the partners with which we align ourselves, and the additions we make to our management team.
In fact, this quarter we strengthened our business for the long-term with a number of key announcements in these areas. We expanded the depth in our management team with the addition of Dan Rosensweig as President and CEO of the Guitar Hero business. Dan brings more than 25 years of industry experience from Ziff Davis to Yahoo!, where Dan served as Chief Operating Office, and I experienced his leadership ability and good judgment and operational excellence there first hand.
I would also like to thank Bruce [Hack], who stepped down this spring from his role as Chief Corporate Officer. On behalf of everyone at Activision Blizzard, I want to extend my sincere appreciation to Bruce for his vision to merge Activision and Blizzard and his leadership during the integration of these two great companies. Thomas Tippl, our Chief Financial Officer, has now assumed the added responsibilities of Chief Corporate Officer.
In addition to strengthening our management team, we made a strategic change in China that should positively impact our long-term growth objectives with Blizzard Entertainment’s announcement that it will transition its relation for World of Warcraft to NetEase. We are focused on [inaudible] a smooth transition but as you know, transitions inherently come with some risk. Our dedication is to the long-term and we look forward to building our long-term relationship with NetEase, who is the premier China based videogame company and has an unmatched consumer service and operational excellent reputation.
All of these developments in our March quarter, including the financial initiatives that Thomas will discuss later in the call, and the ongoing progress of our share repurchase program, were undertaken to increase our key competitive advantages for the long-term. As we look ahead to this year and to the next three to five years, we believe our competitive advantages leave us well-positioned to take advantage of numerous emerging opportunities.
There are many lucrative and exciting catalysts for growth in margin expansion over the coming years in interactive entertainment. With our focus, talented employees, the unique franchises and development expertise we possess, our deep capital resources and an 18-year track record of successfully navigating the volatility and risks of a rapidly changing industry, we have never been better positioned to capitalize on those catalysts and the audience expanding changes we expect.
Later this month we will be hosting analysts and investors for a webcast presentation in which we will share in much more detail our views of the future growth of our company and the industry as a whole. You are of course all invited to join us.
Now I would like to turn the call over to Thomas Tippl who will provide a review of Activision Blizzard's financial results for the quarter and a review of our outlook for 2009. Thomas.
Thank you, Bob. Today I will begin with a review of Activision Blizzard's March quarter results and then I will review our outlook for the second quarter and calendar 2009.
Before I get into the numbers, I would like to remind everyone that due to reverse merger accounting, our historical GAAP financials are those of Vivendi Games only. Activision’s results are only included as of the date of the merger, July 9, 2008. in order to help you with year-over-year comparisons, as we did the last few quarters, we have included in our press release a set of schedules which provide non-GAAP comparables by business segment, and these will be the numbers that I will refer to unless otherwise noted. Also, please refer to our earnings release for a GAAP to non-GAAP reconciliation.
Focusing on the core business, for the quarter, GAAP net revenues were $981 million. GAAP operating income was $179 million and earnings per share were $0.14. As expected, GAAP results for the quarter are ahead of our non-GAAP results as revenues and costs that were deferred from online enabled games in the December quarter were recognized this quarter.
On a non-GAAP comparable basis, March quarter net revenues were $724 million, non-GAAP operating income was $119 million, and non-GAAP EPS was $0.08, $0.05 ahead of our outlook.
Our over-performance was primarily driven by continued sales momentum of our three wholly-owned franchises, World of Warcraft, Guitar Hero, and Call of Duty. In addition, we benefited [inaudible] operating expenses due in part to the cost containment strategies we implemented and tax efficiencies generated from our European restructuring.
As anticipated, our quarterly results were lower than the prior year due to tougher market conditions, a stronger dollar, incremental investments made by Blizzard for product development and customer service initiatives, and a strong base period on Guitar Hero where last year during the March quarter, we were still catching up with demand and building channel inventory.
With respect to the specific line items for the core business, I will refer only to non-GAAP numbers. In the March quarter, non-GAAP product costs, including cost of sales for MMOGs, was 40% of net revenues, [inaudible] our outlook due in part to better performance in our distribution business, which carries a lower gross margin.
Non-GAAP product creation costs, which include software royalties and amortization, intellectual property licenses, and product development were 23% of net revenues.
Non-GAAP -- excuse me, non-GAAP sales and marketing expense was 11% of net revenues and non-GAAP G&A was 10%.
In total for the quarter, non-GAAP operating expenses came in at 44%, approximately 10 percentage points lower than expected. The favorability was due to operating leverage from higher revenues, business mix, and cost management strategies that we implemented, including travel limitations, delayed pay increases, and the deferral of non-development related new hires.
During the quarter, we generated $10 million in investment income, $8 million less than last quarter as yields continue to decline because our investments are held in government backed shorter term securities to limit credit exposure and provide flexibility to deploy capital.
Our effective non-GAAP tax rate was 14%. This is lower than anticipated as we released valuation allowances on foreign NOLs and benefited from lower taxes on foreign income, both resulting from our successful European integration and restructuring.
Now turning to the balance sheet, on March 31st, we had no debt and approximately $3.1 billion in cash and investments, which is in line with the prior quarter. This quarter we repurchased 32 million shares. As of quarter end, we were about halfway through our $1 billion buy-back program, as we have purchased 45 million shares for $439 million at an average price of $9.76 per share.
Now let met turn to our other key balance sheet positions -- the accounts receivable balance was $185 million. This is a decrease of about $1 billion versus the prior quarter end, due to continued holiday collections. Inventories were $230 million, down $32 million from the December 31st. Overall inventory levels as a percentage of trailing 12 months publishing revenues remain in line with our historical averages.
For the quarter, capitalized software development costs were $251 million, an increase of $15 million versus the prior quarter end. Of the $251 million, approximately $45 million is related to deferrals for online enabled games.
Capitalized intellectual property costs were $40 million, in line with the balance on December 31st.
And last but not least, we generated $317 million of free cash flow in the quarter.
So in summary, our strong financial position and cash flow performance provide us with a significant competitive advantage, particularly in this market environment, and we are leveraging it to invest for future growth, as well as return cash to shareholders.
Before turning to our financial outlook, I would like to highlight a few items -- due to current macroeconomic conditions, our outlook is subject to significant risks and uncertainties, including declines in demand for the company’s products, fluctuations in foreign exchange rates and counter-party risks relating to [inaudible], licensors, and manufacturers.
Our outlook is also based on assumptions about sell-through rates for the company’s products, the new slate of products, and associated market pricing. As a result of these and other factors, including any complications related to the transition of World of Warcraft in China from the current licensee to NetEase, actual results may deviate materially from the outlook presented today.
So now to the company’s outlook -- for 2009, we are taking a reasonably prudent approach, as we always do, and we continue to monitor the retail and consumer environment carefully and remain cautious, despite the strength of our franchises, the quality of our slate, and the best-in-class execution we are bringing to the distribution of our titles, both online and offline.
Having said that, our long-term company-wide focus on profitability is still expected to yield another year of operating margin expansion and EPS growth. For calendar 2009, we are increasing our GAAP net revenue outlook by $100 million to $4.3 billion, and increasing non-GAAP also by $100 million to $4.8 billion.
On a constant currency basis, we expect non-GAAP net revenues to be up year over year.
For calendar 2009, we are raising our GAAP EPS to $0.24 and we are also raising our non-GAAP EPS outlook to $0.63.
For the full year, we are passing on only a portion of the March quarter over-performance due to the one-time near-term financial impact of the World of Warcraft transition in China, and the later-than-anticipated launch of Wrath of the Lich King in China. Additionally, we continue to take a conservative approach to the remainder of our fiscal year as we still have in front of us the vast majority of our major releases, including all of our new intellectual property introductions.
For the calendar year, we expect GAAP product costs, including cost of sales for MMOGS of approximately 34% of net revenues, and operating expenses, including royalties, of about 57% of net revenues.
We project the GAAP effective tax rate of 23% and a diluted share count of about 1.32 billion.
On a non-GAAP basis, we expect product costs, including costs of sales for MMOGs of 35%, which is significant -- which is a significant improvement over the prior year, driven by cost reductions for Guitar Hero hardware and mix shift to software for the franchise.
Gross manufacturing margins will also expand due to revenue declines in the distribution and co-publishing businesses, which carry a much higher cost of goods.
We expect non-GAAP operating expenses, including royalties of almost 40% of net revenues. This is above a year ago as a result of our larger publishing slate, which includes three new intellectual properties resulting in higher product creation costs and higher sales and marketing expense year over year.
Also, as we mentioned on our last call, Blizzard is increasing [inaudible] in product development and customer service.
For the calendar year, we now expect an effective non-GAAP tax rate in the range of 31% to 32%, which as I mentioned earlier is being positively impacted by the completion of our European restructuring.
We expect the diluted share count of 1.32 billion. Please note that our share count could be different depending on the amount of repurchase activities executed in the remainder of the year.
Now moving on to the June quarter -- we have a number of major releases this quarter, most of which will launch in the month of June. Our new releases, combined with the continued momentum on catalog sales, are expected to generate GAAP net revenues of approximately $1 billion, as we are still recognizing revenues from online enabled games that were deferred in the December quarter.
We expect GAAP product costs, including cost of sales for MMOGs of approximately 35% of net revenues and operating expenses, including royalties, of about 49% of net revenues. We project a GAAP effective tax rate of 21%, diluted share count of about 1.31 billion, and GAAP earnings per share of $0.10.
We expect non-GAAP net revenues of $775 million. This is below year ago as a result of the anticipated near-term impact of the World of Warcraft transition in China, a continued conservative approach by our retail customers with regard to channel inventories, and a significant negative FX impact.
For the June quarter, operating income will also be down year over year for the reasons I just mentioned, and the fact that we will begin to significantly increase our marketing spend to support our very large lineup in the back-half of the year. For perspective, this year we have 11 major releases in the back half as compared to eight last year.
We expect non-GAAP product costs, including cost of sales for MMOGs, of 35%, non-GAAP operating expenses, including royalties, of 49% of net revenues, and a non-GAAP effective tax rate of 31% to 32%.
We also project a diluted share count of 1.31 billion and non-GAAP earnings per share of $0.06.
So in closing, we made good progress during the March quarter, strengthening our business model for the long-term through the establishment of new relationships that create long-term value, and by improving our earnings per share realization through efficient tax planning and share repurchases.
This combined with having the strongest lineup of proven properties in the industry gives us confidence that we can deliver another year of record operating margins and EPS.
So I will now turn things over to Mike Griffith, President and CEO of Activision Publishing, who will provide his thoughts on the coming quarters.
Michael J. Griffith
Thank you, Thomas. Today I will focus my comments on our projections for the hardware and software market, the strategies that drove Activision Publishing’s over-performance in the first quarter, and the key drivers for the balance of calendar 2009.
Starting with a review of the market, on March 31st, the installed base of hardware in North America and Europe for current gen systems, including handheld, was 170 million units, an increase of 63% year over year, providing a strong foundation for the industry’s future.
Building on this, during the quarter Sony announced a price cut on the PS2 to $99, making it the most affordable platform in the market, and Nintendo introduced the new DSI handheld, which had strong first week sales of approximately 435,000 units in the U.S.
For calendar 2009, our hardware projections remain unchanged from our last call, as we expect the installed base of current gen consoles and handhelds to grow by more than 53 million units during the year.
In terms of software, we expect the combined North America and European retail software markets to show low- to mid-single-digit growth this year. The retail environment continues to be balanced. We are finding retailers generally bullish on the category and overall we expect category space in store to be expanded this year at the expense of other entertainment segments. We also expect triple A launch pricing to continue to hold, as we have seen in the last quarter. But we also see retailers taking a conservative approach to inventories, consistent with their behavior over the past several months. And while channel inventories are down from the beginning of the year, we see continued retail conservatism in their initial buy decisions preferring to chase successful titles.
This is an environment that continues to favor the large proven properties at the expense of smaller titles.
So turning now to Activision, according to NPD, for the first quarter Activision Publishing was the number one third-party console and handheld publisher in North America, and the number one third-party publisher for the Wii platform worldwide. And according to NPD, Chart Track, and GTK, Guitar Hero and Call of Duty remained in the top five selling franchises for both the U.S. and Europe.
Our focus on delivering sustained long-term growth will be driven by three core strategies. First, selectively expanding our balanced franchise portfolio with IP that offers innovative entertainment experiences; second, strengthening our development capabilities; and third, allocating our resources disproportionately to the top customers, the top markets, and against our top properties.
During the quarter, we made progress in each of these areas. First, we added a new property, Bakugan, to our product portfolio and will bring the breakout Pokemon style hit toy and popular action animated television series to videogames. In February, Bakugan won three awards from the toy industry association, including overall toy of the year.
In addition, we further strengthened our Call of Duty World at War offering through a new downloadable map pack, which sold more than 1 million maps in the first seven days and to date has already surpassed the 2 million mark, exceeding results from our previous map pack.
Beyond direct accretive revenue generation, this extends our shelf life, helping to insulate us from the used game market and in turn allowing us to hold pricing longer.
On the development front, we strengthened our capabilities with the addition of seven studios, which has experienced developing music-based games. Overall, our independent studio model continues to be a long-term competitive advantage as it fosters creativity and innovation and enables us to attract and retain the industry’s strongest studio talent.
Lastly, we continue to focus our global resources disproportionately against the top markets on our top customers and against our top titles. With this focus, we built share in our core music and shooter genres in four of our top five countries in the March quarter, including in the U.S., and led to our overall over-performance in Q1.
In summary, we remain focused on the right priorities and believe that our strategic initiatives will enable us to deliver our long-term financial goals.
Now, I would like to turn to our release schedule for the balance of the year, starting with the June quarter. This quarter, we have three games inspired by theatrical motion pictures -- X-Men: Origins, Transformers, and Ice Age, all of which are expected to be blockbuster films this spring. And on May 1st, we release our X-Men game in conjunction with the theatrical release, which was by far the highest grossing film at the box office and to date, we’ve already received retailer re-orders for the game.
Additionally in June, we will release Prototype, a new third person open world action game. The press and pre-orders on this title have been very positive and we are excited about its entry into the market. We will also release Guitar Hero Smash Hits, a compilation of the most popular songs from previous Guitar Hero games for band play, and a second map pack for Call of Duty World at War.
Now I would like to discuss our planned releases for the back half of the year.
First, let me touch on an overview of the Guitar Hero business by highlighting the strengths of the franchise and our long-term growth strategy. This quarter, we further extended our advantage for the Guitar Hero franchise. We ended the quarter with a 55% share of all rhythm and music based games in North America and Europe, up 10 full points from the prior year, as we took share from Rock Band in both North America and Europe.
For the quarter, the music category overall was down due to a tough base period comparison. However, Guitar Hero well outperformed the music category and as a result of our significant share gains, performed in line with the overall software market for the quarter.
In the U.S. and Europe, the Guitar Hero franchise was the number one best-selling third party franchise overall and Guitar Hero World Tour was the number one best-selling third-party title overall.
In Europe, where expansion of the franchise remains a strategic priority, quarterly sell-through was up over 80% year over year, with Guitar Hero outselling Rock Band by 10 to one. Our competitive position should further improve next month when we launch Guitar Hero Metallica in Europe.
We attribute our share growth to first launching more frequent and meaningful retail titles, driving loyalty among our current installed base; second, superior consumer marketing to drive Guitar Hero’s cultural icon status; and third, superior in-store presence. And on this point, while trade inventories are higher than year ago when we had hardware shortages, the channel is cleaner than three months ago and we have strong plans in place with retailer support to drive both catalog and new releases through the year. This is a genre retailers continue to disproportionately support.
Looking ahead, we are well-positioned for the balance of the year and beyond. We are especially pleased to have brought Dan Rosensweig on board as our new President and CEO of the Guitar Hero business. As Bobby said, Dan was the former Chief Operating Officer of Yahoo! and his experience and knowledge of how consumers can be entertained online is directly applicable to building our business model through both traditional and new channels.
Overall, our strategy for growing the Guitar Hero franchise is focused on three vectors -- satisfying and expanding our audience, building international sales further, and improving operating margins.
Satisfying and expanding our audience works two ways -- first, we have an installed base of more than 15 million unique households who own Guitar Hero hardware and who are primed to experience music interactively through our titles as we provide compelling new content. And second, we’ll build this consumer base further against the opportunity of the 170 million installed base of current generation hardware by broadening the experience with new genres and new segments to appeal to new users. This year, our music slate will offer the widest variety of genres, artists, and innovation to the entertainment category since the initial launch and we’ll continue to change how people experience music by strengthening the relationship between music and videogames.
First, we will continue to deliver exciting expansion titles, starting with the first half releases of Guitar Hero Metallica and Guitar Hero Smash Hits. Then, in the back half, we plan to release Guitar Hero Van Halen, which will deliver the ultimate rock experience centered around the best guitar riffs of all time.
Second, we plan to release our next tent-pole title for the Guitar Hero franchise with Guitar Hero 5, which will establish the next major game play innovation in the franchise behind a broad collection of rock music.
Like its Guitar Hero World Tour predecessor, Guitar Hero 5 can be enjoyed with a single guitar or played with a group using guitars, drums, and microphones. This title brings additional innovation and a broadly appealing and compelling song list to our core franchise, meeting consumers’ interest in music variety and fun game play.
Third, we plan to introduce two exciting extensions to our franchise -- designed to broaden our audience well beyond just rock. First, we will launch DJ Hero, which uses a turntable and can be optionally supplemented with a guitar. DJ Hero is an all new, groundbreaking interactive music experience that allows gamers to rule the party as only a DJ can, delivering unique remixes and mash-ups created by professional DJs exclusively for the game. DJ Hero has unprecedented music content that spans such genres as hip hop, electronica, R&B, and dance. We are excited about this new music experience, as our research shows that 50% of likely buyers for DJ Hero are consumers who are not currently Guitar Hero owners.
And additionally, we’ll release Band Hero, our first E rated collection of top 40 music to penetrate a broader family audience and provide an additional genre experience with fun-to-play pop music hits.
Both DJ Hero and Band Hero will broaden our reach to those who own consoles but not Guitar Hero, and with the exception of the turntable, which will be unique to DJ Hero, all instruments will be fully operational and cross-compatible with all our hero games for maximum flexibility and value.
So along with our core Guitar Hero franchise, this will give us three vehicles to further broaden our consumer base. There’s no doubt that this is the most exciting lineup in the history of this franchise.
As our second Guitar Hero growth vector, Europe will continue to be a core focus for us. Our product line is well-positioned this year to continue the strong growth we established last year. Our first offering will be this quarter’s launch of Metallica, a band which is very popular across Europe and in fact going on tour in the summer. Additionally, we are very excited about the launch of DJ Hero as the club dance genre is among the most popular in Europe and not yet addressed. DJ Hero is being developed by a European team and will offer more localized content and talent than any other game in the franchise’s history, which should continue to broaden our appeal.
And finally, we continue to focus on expanding our operating margins as we develop further scale and make significant progress from last year designing and sourcing our hardware.
Longer term, we will continue to invest in new extensions and innovations that will take the category to the next level against these growth vectors, and in addition, we’ll expect to leverage complementary online growth channels that have yet to be utilized by the gaming industry.
Our research shows that almost 50% of Guitar Hero owners now prefer interacting with music through Guitar Hero than other ways of experiencing music, and more than 30% of users have purchased music that they have been exposed to for the first time when playing Guitar Hero games.
To put this into perspective, we have already sold more than 3 million units and to date, more than 40 million professional songs have been downloaded for Guitar Hero. At the same time, on GH Tunes, user generated songs have been downloaded more than 14 million times. All of these opportunities provide us with long-term expansion possibilities we’re working against for our music games.
So this franchise presents tremendous opportunity to continue building the breadth and strength of our business this year and into the future.
And looking at the back half of the year, Guitar Hero is just part of the largest and most diverse lineup in the company’s history. This year, we will have more titles represented on the Wii and Nintendo DS than ever before. Our performance on these platforms last year reinforces our commitment to maintaining our leadership position this year. Beyond Guitar Hero, which was the number one third-party game on the Wii, we have a number of franchises that have been developed with the Wii and DS in mind, including Transformers, Ice Age, and our back half releases, Bakugan and Tony Hawk, which I will touch on in just a moment.
Our back half release schedule is balanced between the company’s most successful proven franchises and a select few new exciting intellectual properties. In the back half, we plan to release Marvel Ultimate Alliance 2, which features the largest army of superheroes and villains, including Spider-man, Hulk, and Iron Man. Additionally, we have Wolfenstein, which will build on ID Software’s well-established videogame franchise.
We also plan to launch our new wholly-owned first person action game, singularity. The game is set in a mysterious sci-fi environment and is already receiving strong interest from the media.
Next, we have Bakugan, the new IP I discussed earlier. The Bakugan television and toy phenomena continues to grow. Retailers are very excited about this property. It has a Pokemon like following and feel and perfect for the holidays.
Additionally, we expect to release our highly anticipated racing game Blur from Bizarre Creations. From a business perspective, we are targeting Blur to do for racing what Call of Duty did for shooters, and that was the goal when we originally acquired Bizarre Creations to make this game.
Blur brings real innovation to the racing category and is looking very strong. You will all get a chance to see this game first-hand at E3, but suffice it to say, we are excited to be entering this genre with this game.
We are also planning to release our reinvention of Tony Hawk with a very innovative and interactive game that lets consumers experience the thrill of skateboarding like never before. Our goal from the start was to reinvent this franchise back to its roots where we engaged a broad, mass market consumer, and we feel good about what this game can do. We will also unveil specifics at E3.
Last but not least, we plan to release what we expect will be the must-have title of the year, Infinity Ward’s highly anticipated Call of Duty Modern Warfare 2 on November 10th. When the original Modern Warfare was introduced two years ago, it set a new bar for first person action games. Catalog sales for this game continue to be strong and to date, we’ve sold more than 13 million units worldwide.
In fact, we recently launched the teaser trailer announcing the November 10th ship date, and it’s received over 5.5 million trailer views already, with over 1.3 million in the first 24 hours.
So as you can see, our back half lineup is very broad, based on big propositions and spans across many demographics and genres. You will have the opportunity to see many of these titles first hand at the upcoming E3 show.
And now I would like to turn the call over to Mike Morhaime, who will provide an update on Blizzard Entertainment. Mike.
Thank you, Mike. On today’s call, I would like to talk about our performance for the March quarter and highlight some of the milestones we are looking forward to this year.
As you know, back in November we launched the second World of Warcraft expansion, Wrath of the Lich King, which achieved record-breaking sales. As mentioned on the last call, Wrath of the Lich King sold more than 2.8 million copies in its first 24 hours, to become the fastest selling PC game of all time.
We followed up on that success in the first quarter with strong sales of World of Warcraft and both expansions. According to NPD, Wrath of the Lich King was the best-selling PC game for the first quarter and six of the top 20 best-selling PC games through March were Blizzard games. This includes every World of Warcraft title as well as our Warcraft 3 and Diablo Battlechest.
More than 11.5 million paying subscribers around the world continue to play World of Warcraft, which is a significant increase compared to the same quarter last year.
The continued success of World of Warcraft fueled a strong March quarter for us, despite the week economy. This highlights the incredible entertainment value and longevity of the game.
Our financial performance for the quarter was better than expected, both on the top and bottom line. We were successful in growing revenues year over year and as expected, operating income was down due to a stronger dollar and the significant investments we are making in customer service and product development to better position us for the long-term.
Like many other companies right now, we are reducing operating costs where possible, but investing and improving in these key areas should help us emerge from the current economic situation with an even stronger position and product slate.
On the customer service front, we’ve been actively reevaluating and upgrading our tools and procedures. As part of this effort, our regional teams have been working to implement local best practices globally. We’ve also engaged customer service leaders in other industries to discuss new ways of taking Blizzard’s service to the next level.
In terms of our overall business, we are pleased with our results this year so far and we still have a lot to look forward to. We believe there continues to be growth potential for World of Warcraft in all regions but especially in China.
Our first expansion, The Burning Crusade, launched in China about eight months after its initial release and it was very well-received by new, existing, and returning players there. We are looking forward to a similar response when Wrath of the Lich King launches in China.
Another significant growth factor for World of Warcraft is the ongoing release of new content. In April, we launched Secrets of Ulduar, one of our biggest content updates ever, which added a ton of new material for hardcore and casual players to explore.
Like our expansions, these content updates generate a lot of excitement around the global World of Warcraft community.
We generally see a good number of players sign up or reactivate their subscriptions around the time of these updates to connect with friends and try out the new content. It’s a bit early to gauge the impact of the April update, but we are anticipating a positive effect on our subscribership.
We are already hard at work on the next update and we plan to continue evolving and enhancing the game in this way for many years to come.
Now I would like to briefly discuss our expanded relationship with NetEase in China. Last month, we announced that Blizzard will be transitioning the operation of World of Warcraft in China to NetEase, who we are already working with for Starcraft 2, Battlenet, and Warcraft 3. This is a great development for us and for our players, as NetEase has years of experience and a proven track record as an outstanding developer and online game operator.
Consolidating our activities in China with a single company will help us maintain a consistent level of quality for all Blizzard entertainment games included in the relationship. It will also help us to operate more efficiently as well as put us in an even better position to capture the growth in this market.
In the short-term, we have a lot of work ahead of us for the transition, including re-establishing the hardware and support infrastructure. However, our expanded collaboration with NetEase represents a strong future for Blizzard Entertainment in China and we are looking forward to working with them to bring World of Warcraft to even more players.
As I am sure you can understand, we will not be in a position to answer any questions with regard to NetEase until all of the specifics about the transition have been finalized, and we look forward to sharing additional details with you shortly.
Now I would like to provide an update on the development of Starcraft 2, which continues to be a major focus for us this year. This summer, we will be opening up external beta testing and while we haven’t announced a release date yet, this phase will signal the final stretch of development.
During the Starcraft 2 beta test, we will also begin external testing of our newly revamped Battlenet online service, including some features that are designed to connect all future Blizzard games. This includes new tools that will make it easier for players to communicate with each other between games. We are also introducing a centralized account system that will let players manage all of their Blizzard Entertainment games including World of Warcraft and future games in one place without having to remember multiple sets of login information.
Even after Starcraft 2 ships, the new Battlenet service will continue to evolve and grow. I look forward to going into more detail on our plans for Battlenet on future calls.
As for our long-term plans for the Starcraft franchise, after the launch of Starcraft 2, we will support the PC and Macintosh platforms. We plan to release two expansions following the initial launch. The core game will offer substantial single player and multi-player components. While the two expansions will continue the storyline and add additional multi-player content, our priority now is completing the core game. Once that’s complete, the focus will shift heavily to production on the expansions.
To put this opportunity in perspective, the last Starcraft and Diablo games released 11 and eight years ago, were both on NPD’s domestic top 20 list for March. This is a great indication that demand remains high for the next chapters in both of these series.
To date, the Starcraft series has sold more than 11 million copies and the Diablo series has sold more than 20 million copies. In addition to the appeal of our upcoming games, the customer service improvements I touched on before will continue to set us apart and help us retain and grow our player base in 2009 and beyond.
We are also preparing for our fourth Blizz-con convention, which will take place on August 21st and 22nd in Anaheim, California. Last year’s Blizz-con sold out in about 15 minutes and was attended by over 20,000 people. Because demand was so great last year, we are expanding the show to a fourth hall to give us more room for an even larger crowd this year.
Blizz-con gives us the chance to meet some of our most passionate players and share the latest news about our games with them. It’s also a great opportunity for the public to play our games before they are released, and to watch some of the top professional gamers in the world compete in a variety of tournaments.
As we recently announced, we are also expanding our collaboration with DIRECTV to include an Internet stream of Blizz-con coverage that players anywhere in the world can purchase.
Despite increasing the space and the number of tickets for the previous two Blizz-cons, we were never able to fully meet player demand. Offering an exclusive stream of coverage this year will help us to ensure that anyone who is unable to buy a ticket or travel to Anaheim will still have the opportunity to experience the show.
In closing, we are excited about the future of the industry and we believe Blizzard Entertainment is well-positioned for continued growth. World of Warcraft remains strong and continues to offer great entertainment value.
By constantly making changes and improvements, we will be able to extend the longevity of the game around the world. We also have an unmatched lineup of highly anticipated upcoming games with Starcraft 2 and Diablo 3.
Thank you, everybody, and now I would like to turn the call back over to Kristen.
Thanks, Mike. Operator, we would now like to open up for questions, but I want to highlight that because of the large number of people and the length of the call, we ask that you limit your questions to one per caller. Operator.
(Operator Instructions) And our first question will come from Ralph Schackart with William Blair.
Ralph Schackart - William Blair
Good afternoon. Congrats on another good quarter. Just one broad question -- just curious how the sales have trended in April so far, just given the continued transition and the macro outlook. And has there been any major changes in the purchasing activity that you have seen at the retailers, either positive or negative, since last call? Thanks.
Robert A. Kotick
Okay, Ralph, sure. Being in April, obviously it’s a tough year-over-year comparison because GTA was out in the year-ago period but we find retailers continuing to be bullish on the category, particularly the top titles, and they are very active planning, merchandising and promotional programming with us for the current quarter, and looking forward into the months ahead.
I would say if anything, we’d see a slight strengthening of the retailer mood in April. But I think it’s going to be a gradual process.
Ralph Schackart - William Blair
Okay. Thank you.
Our next question comes from the line of Jeetil Patel with Deutsche Bank.
Jeetil Patel - Deutsche Bank
Great. Thank you. A couple of things -- I know it’s probably hard to kind of dig into this particular issue and isolate it but just curious -- as you look at this year, what type of impact are you kind of looking at on a sub basis or expense basis as you look at the transition in China? In general, kind of what are you assuming in terms of the impact? Is it that you have no sub growth this year in China or -- and then expense wise?
And then second, as you look at the music category for 2009, obviously we’ve got a pretty exciting slate out. I guess can you maybe just give a sense of how you feel today versus back in January, the last earnings call, in terms of the appetite for consumption in the music category. Thank you.
I will take the first part, which is related to the transition of World of Warcraft in China. Our focus is to bring the best experience to our players and so we are committed to making sure that the transition is as smooth as possible. We are working closely with our partners to work on ensuring that that is what happens. There are elements of risk in that transition and our efforts are completely focused to minimize those areas of risk.
Robert A. Kotick
Let me pick up on the music business -- you know, we are much more focused on our own business than the overall market because we can’t really control what happens with the other titles, such as Rock Band, where we have seen a rather precipitous fall-off of that franchise. But we feel very good about our holiday slate and intermediate titles as we launch Guitar Hero. The Guitar Hero franchise in fact this quarter surpassed the $2 billion mark and was only the third franchise in the history of gaming beside Super Mario and Madden to ever achieve that milestone. So it’s got a strong foundation -- number one title, third-party title in the March quarter and we built 10 share points. Metallica is off to a good start against 15 million unique households who have Guitar Hero as an installed base and are looking for the right kinds of expansion opportunities to enjoy additional music. Certainly Metallica, which is launching next month in Europe, and the band will be touring in Europe, we’ll be sponsoring that tour as part of our promotion activities. We think that’s going to be a very positive addition.
Smash hits, which I think is going to be a highly anticipated title where it’s the best of previous Guitar Hero games but recoded so its available for full band play, and then the triad that we’ve got in the holiday between Guitar Hero 5, DJ Hero and Band Hero we think will not only serve the current user base but also provide additional -- significant additional expansion opportunity to new genres so that we can start tapping into the significant number of households that are part of the 170 million installed base of hardware but haven’t yet engaged with Guitar Hero.
So I think we are feeling that we’ve got a very strong program in the year ahead and we are bullish on the music category.
Our next question comes from the line of Tony Gikas with Piper Jaffray.
Tony Gikas - Piper Jaffray
Good afternoon, guys. A couple of questions, just back to Guitar Hero -- you talked a little bit about growing margins on that franchise. Could you just give us an idea of where those margins are today, how you plan to grow them, and is it an above or below average publishing margin?
As you know, we don’t provide margin information by a specific franchise but I can give you some color on the margin program and where it is trending. At this point, as you know, we are still -- our primary titles that we are selling right now are still Guitar Hero World Tour where as we talked on the last call, margins have been compressed as a result of the hardware costs related, particularly to the band product. So what we expect to see is that margins will improve as we get into the latter part of the year, where we will have new hardware out that’s not only better and innovative but also cost optimized. So that’s the first driver.
And we have made good progress. We have reasonably good visibility at this point because most of the new contracts we’ve locked in -- you know, freight rate has come down, fuel prices are down, so good progress on that end.
The second driver for margin expansion as we go through the year is going to be the additional content that we are launching and as a result, a mix shift of the business to more software, which is carrying higher margins. So you combine that, and then as always, you know, we leverage our overall cost optimization programs as we, in our go to market operations, as we have delivered the synergy savings, or over-delivered, I should say, the synergy savings, which will benefit all businesses, including Guitar Hero.
Tony Gikas - Piper Jaffray
Can you tell us if the Guitar Hero business is an above or below average publishing margin?
No, as I said, I won’t get into that level of detail on a franchise basis.
Tony Gikas - Piper Jaffray
Okay. Thanks a lot. Great job.
Our next question comes from the line of Mark Wienkes with Goldman Sachs.
Mark Wienkes - Goldman Sachs
Thank you. Just wondering, regarding the commentary earlier on about the retailer behavior and the pricing for the fall, how are you thinking about balancing the price points around what should be some of the premium selling titles for this holiday season.
Robert A. Kotick
Well, as I said, we expect the triple A launch prices to hold. The retailer environment I think, as I characterized earlier, we’d say it’s balanced. The retailers are bullish on the category, a number of initiatives at retail to expand the space of videogames at the expense of other segments, particularly the other entertainment segments. But at the same time, there is some caution on the initial buy-in due to the trade initiatives broadly to try to control inventory levels and preferring to chase the titles rather than to stock them.
But on the triple A titles, on the big propositions, this is an environment, as I said before, where the trade will disproportionately support those titles, potentially at the expense of smaller titles. And our expectation and our plans are based on the triple A pricing holding as we launch through the balance of the year. So that was, you know, not one of my larger concerns this year.
Mark Wienkes - Goldman Sachs
I guess I was actually wondering more specifically, is there an opportunity to even add a -- to increase the price? Because it seems like the retailers, some of them have commented that all of the limited edition product that’s out there seems to fly off the shelves.
Robert A. Kotick
Yeah, well I think we saw that last holiday where the average price in the December quarter was actually higher than year ago and it was driven in part by collector’s editions, added premium content, and in part by premium SKUs, like Guitar Hero, and I think that trend will continue. You know, it’s certainly our expectation that we will put emphasis on premium content SKUs as we get into the holiday season.
But we think it’s a good suggestion, Mark.
Mark Wienkes - Goldman Sachs
Our next question comes from the line of Colin Sebastien with Lazard.
Colin Sebastien - Lazard Capital Markets
Thanks for taking my questions and congratulations on the quarter. Mike Morhaime, just a clarification on one of the prior questions on World of Warcraft transition -- should we expect a temporary dip there in the subscriber accounts? Or maybe better said -- how do you make sure to keep those subscribers on board if there is any service disruption?
And then Bobby, in terms of the acquisition opportunities that you guys have talked about before, I was curious if you are still in the market for that and perhaps if you care to provide any color on the size or profile of companies that may be under consideration? Thanks.
Okay. Thanks for asking that question. Heading into the transition, we are very happy with the solid performance of World of Warcraft in China. It remains very, very strong with a lot of support from players. And this is without the launch of Wrath of the Lich King, so I think that -- you know, knowing that we still have this huge amount of content out there, we are eager to get that in the hand of players as soon as possible, I think we are in a really strong position to basically be able to continue having the top massively multi-player game in the region.
Robert A. Kotick
As far as M&A is concerned, we never comment on M&A and right now, we think the best use of our capital is investing in our business and that’s the combination of investing in intellectual property development and development talent and in the repurchase of our own securities, so I would say that’s our focus right now.
Colin Sebastien - Lazard Capital Markets
Our next question comes from the line of Shawn Milne with Janney Montgomery.
Shawn Milne - Janney Montgomery
Thank you. Good afternoon. Thanks for taking my questions. With the upside in the quarter, Thomas, and then looking at the second quarter revenue guidance, you are still looking at a bit of growth in the second half of the year in terms of revenue. Maybe if you could just give us a little bit more color around what you would think which big franchises would be driving the growth? And in that context, given what we have seen and certainly in the music category, again do you still think that Guitar Hero, are you expecting it to be up year over year in the second half? And any clarity behind that? Thank you.
I think we’ve laid out a slate on a couple of occasions and I think the back half slate is by far the strongest we’ve ever had -- 11 major releases instead of eight, there are a number of franchises coming back this holiday season that we really didn’t have last year, like Tony Hawk, for example. We also are entering the $1.5 billion racing genre with a very strong proposition this year, and we have by far our strongest Guitar Hero slate from a content perspective, and we are bringing in with DJ Hero a whole new audience, we hope, with the launch because it’s a different style of music, different style of game play. And we continue to see good momentum in the international geographies -- in particular, as Mike said, the March quarter sales were up 80% year over year. That’s very healthy, particularly in light of the economic climate.
So we believe we have a very strong arsenal of games and we believe we have strong execution plans that are reflected in our back half guidance.
Robert A. Kotick
And I would just echo, Shawn, when you think about our release schedules -- A, as compared to any of our competitors but in comparison with our own history, you are looking at what we think is the most aligned to the consumer marketplace, whether you look at Starcraft, Modern Warfare 2, Band Hero, Guitar Hero 5, DJ Hero, our new Tony Hawk product, Bakugan -- we have the strongest release schedule we think by far of anybody in the industry and really great execution plans against it.
And probably the other thing that is really important is we are not, like some of our competitors, focused on restructuring and laying off employees and making new investments in new potential intellectual properties. We are focused on franchises that we know, that we are very comfortable who the audience is and how to reach them, and we can focus 100% of our attention on execution.
Shawn Milne - Janney Montgomery
Great. That’s helpful. Thank you.
Our next question comes from the line of Arvind Bhatia with Sterne, Agee & Leach.
Arvind Bhatia - Sterne, Agee & Leach
Thank you. A couple of big picture questions for you, Bobby -- you talked about some of the catalysts coming up in the years ahead of us. Can you maybe talk a little bit more in detail there, and touch on the cycle length that you see at this point? And then maybe the state of the European market perhaps?
Robert A. Kotick
Sure. So -- well, remember, Arvind, I think it’s important to recognize that our company, unlike many other companies in our business, more than half of the company’s operating profit does not come from the console marketplace. So when you look at how the cycles for the consoles affect us as compared to our competition, we just don’t have the same volatility in our results.
As far as the consoles themselves, I think that you have hardware that was in some respects was over-invested against but I think that there’s a lot of runway for all of these devices. I think that you can expect, when you look at PS2, a decade of opportunity on the PS2 and you look how capable Xbox 360, PlayStation, the Wii are -- you look at DSi being introduced. I think that we’ve got a long way to go before you get to price points that truly take advantage of all of this hardware. I think from a geography standpoint, we still have a long way to go before these products have really penetrated every single geography, so we don’t really anticipate there are going to be material changes to the console landscape anytime soon.
Arvind Bhatia - Sterne, Agee & Leach
Michael J. Griffith
As far as Europe, you know, we’ve said this -- that we continue to invest against the European opportunity, there’s a lot more upside for us as a publisher there. As we start to get more localized content, as we start to have in each one of the genres content that is more appropriate to those markets, we are continuing to invest against it from a management depth perspective, so we think there’s a lot of upside still in Europe.
Robert A. Kotick
The only thing I would add to the European comment is that, as we reported earlier, our Guitar Hero franchise has historically been under-developed in Europe, but with the strong growth that we’ve experienced here over the last six months and almost 2X in the March quarter from year ago, we feel like we are getting to the tipping point in Europe on this franchise. And along with DJ Hero and our other offerings coming out, and Metallica, which lends itself very well to the European marketplace, we feel we’ve got some real upside in front of us on that franchise as well.
Arvind Bhatia - Sterne, Agee & Leach
And nothing unusual going on in that market right now?
Michael J. Griffith
Do you think there’s anything unusual, is that the question?
Arvind Bhatia - Sterne, Agee & Leach
Well, meaning the U.S. market, by some measure, could be considered a little bit softer or -- I wonder if Europe in comparison to the U.S. market is any weaker or stronger. I know your products are obviously positioned a little different but just what you are hearing from retail over there.
Robert A. Kotick
I think the retail story is actually quite similar in Europe compared to the U.S., is what we are hearing. This is still this overall focus by retailers to reduce inventory levels and to focus disproportionately on the top titles. But again, I think the strongest retailers are seeing that the future in gaming is a growth vector for them -- reallocating their capital and their resources toward the genre, so again, I would characterize it as balance but disproportionately supportive of the top titles, again with the growth that we saw on Guitar Hero where we have outsold Rock Band 10 to one in Europe but also the receptivity to the Call of Duty franchise and others.
So you know, I think we are seeing the retail environment in Europe fairly closely mirror in attitude that of North America but we are getting strong support on our major titles.
Operator, can you put on the next question?
(Operator Instructions) Our next question comes from the line of Heath Terry with FBR Capital.
Heath Terry - FBR Capital
Great. Thank you. Mike, I guess just a quick question of what the transition over to the NetEase relationship in China is going to look like from a consumer perspective -- will they see any kind interruption? Is there anything there that is going to be required of them in this process?
And then Bobby, I know you mentioned that unlike your competitors, you are not relying on new intellectual properties for this year, but to the extent that you do have some new intellectual property in the pipeline, like Singularity and Bakugan, are there any there that you are particularly enthusiastic about contributing this year?
As I mentioned, our priority is to ensure a smooth transition. It is a complicated transition and some down time may be necessary for a limited time as we set up the game with the new partner. We are going to do our best to keep any service disruption to a minimum. We are working very hard on transition planning. We’ve got a website set up in China, a transition website for players to keep them informed about all the details you are asking about -- the url is wow.163.com. You can go there. You probably will need to learn Chinese, though. And as we nail down some of these details, we will be making announcements to players. I don’t have any details to announce on the call.
Robert A. Kotick
And from a new IP perspective, Heath, we’ve got -- you know, typically our strategy has been at the most one or two new IPs that have sequel potential, that are annualizable, that can be exploited across all platforms and in all geographies, and so the products that we have coming into the marketplace this year are no exception. You know, we’ve always said that if we are going to do new IP, it’s got to be with development talent that has experience in the genre, and they have to be genres that actually can move the dial for us as a $4 billion-plus company.
So to ask me which ones I favor would be a little like saying which of my children is my favorite, but I will say this -- that when you look at products like Blur, we have we think a unique opportunity in the racing genre with Bizarre Creations, one of the great developers of racing product, and we are especially excited about entering what has been historically one of the biggest categories of videogames that we have not been in before, and as Mike said, we expect to do in that category over time what we did in the first person action category with Call of Duty, so that would be one area that I would be particularly excited about
Our next question comes from the line of Eric Handler with MKM Partners.
Eric Handler - MKM Partners
Just looking at your guidance, tell me if I am looking at this correctly -- it seems like going from a tax rate of 34% to 32% pretty much gets you to an incremental $0.02, so is there anything operationally that I am missing here, or is that the correct way to think about it?
That’s the correct way to think about it.
Eric Handler - MKM Partners
Operator? Okay. We are going to close out the call, so on behalf of everyone at Activision Blizzard, we thank you for your time and consideration today. We look forward to seeing you all at the upcoming E3 trade show. Thank you.
Again, that does conclude today’s conference call. Thank you for your participation.
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