Activision Blizzard Management Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 1.13 | About: Activision Blizzard, (ATVI)

Activision Blizzard (NASDAQ:ATVI)

Q2 2013 Earnings Call

August 01, 2013 4:30 pm ET


Kristin Mulvihill Southey - Former Vice President of Investor Relations

Robert A. Kotick - Chief Executive Officer, President and Director

Dennis Durkin - Chief Financial Officer

Eric Hirshberg - Chief Executive Officer of Activision Publishing, Inc

Michael Morhaime - Chief Executive Officer of Blizzard Entertainment, Inc and President Blizzard Entertainment, Inc


Brian J. Pitz - Jefferies LLC, Research Division

Colin A. Sebastian - Robert W. Baird & Co. Incorporated, Research Division

Arvind Bhatia - Sterne Agee & Leach Inc., Research Division

Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division

Edward S. Williams - BMO Capital Markets U.S.

Daniel Ernst - Hudson Square Research, Inc.

Douglas Creutz - Cowen and Company, LLC, Research Division


Good day, and welcome to Activision Blizzard's Second Quarter 2013 Results Conference. Today's call is being recorded.

And at this time, for opening remarks and introductions, I would like to turn today's call over to the Senior Vice President of Investor Relations and Treasurer, Ms. Kristin Southey. Please go ahead.

Kristin Mulvihill Southey

Good afternoon, and thank you for joining us today for Activision Blizzard's second quarter 2013 conference call.

With me today are Bobby Kotick, CEO of Activision Blizzard; Thomas Tippl, COO of Activision Blizzard; Dennis Durkin, CFO of Activision Blizzard; Eric Hirshberg, CEO of Activision Publishing; and Mike Morhaime, CEO of Blizzard Entertainment.

I would like to remind everyone that during this call, we will be making statements that are not historical facts. These are forward-looking statements that are based on current expectations and assumptions that are subject to risk and uncertainty. As indicated in the slide that is showing, a number of important factors could cause the company's actual future results and other future circumstances to differ materially from those expressed in any forward-looking statements.

Such factors include, without limitation, sales levels; current macroeconomic conditions; increasing concentration of titles; shifts in consumer spending trends; our ability to predict consumer preferences among competing genres and hardware platforms; maintenance of key relationships, including the ability to attract, retain and develop key personnel and developers that can create high-quality hit titles; the seasonal and cyclical nature of our industry; changing business models, including digital delivery of content; competition, including from used games; possible declines in prices; product returns; price protection; product delays; the adoption rate and availability of new hardware and related software, particularly during the console transition; the rapid changes in technology and industry standards; the current regulatory environment; litigation and associated costs; protection of proprietary rights; counterparty risks; economic, financial and political conditions and policies; foreign exchange and tax rates; potential changes associated with geographic expansion; capital market risk; the possibility of expected benefits related to the recently announced transaction may not materialize as expected and the transactions not being timely completed, if completed at all. These important factors and other factors that potentially could affect the company's financial results are described in the company's most recent Annual Report on Form 10-K, our quarterly report on Form 10-Q for the period and the company's other SEC filings. The company may change its intentions, beliefs or expectations made at any time and without notice based upon any changes in such factors in the company's assumptions or otherwise.

The forward-looking statements in this presentation are based on information available to the company as of the date of this presentation and while we believe them to be true, may ultimately prove to be incorrect. The company undertakes no obligation to release publicly any revision to any forward-looking statements to reflect events or circumstances after today, August 1, 2013, or to reflect the occurrence of unanticipated events.

I'd like to note that certain numbers we will be presenting today will be made on a non-GAAP basis, excluding the impact of the change in deferred net revenues and related cost of sales with respect to certain of our online-enabled games; expenses related to stock-based compensation; expenses related to restructuring; the amortization of intangibles and impairment of intangible assets and goodwill; and the associated tax benefit. Please refer to our earnings release which is posted at for a full GAAP to non-GAAP reconciliation and further explanation.

There's also a PowerPoint overview, which you can access with the webcast and which will be posted to the website following the call. In addition, we will also be posting a 12-quarter financial overview, highlighting both GAAP and non-GAAP results on a one-page summary sheet. Further, you can find the PowerPoint overview of the recently announced transaction on our website.

And now, I'd like to introduce our CEO, Bobby Kotick.

Robert A. Kotick

Thank you, Kristin, and thank you, all, for joining us today. As you know, on July 25, we announced that we reached an agreement with Vivendi that will, upon closing of the transaction, make us an independent company again. We believe that the transactions described last Thursday represent a tremendous opportunity for our company and all of our shareholders.

Activision Blizzard will acquire approximately 429 million shares and certain tax attributes from Vivendi, in exchange for $5.8 billion in cash, or approximately $13.60 per share, before taking into account any benefit to the company from this tax attributes.

Separately, in a related transaction, an investor group led by Brian Kelly and me will acquire approximately 172 million shares from Vivendi for $2.3 billion in cash. Brian and I are personally investigating a combined $100 million of our own money to purchase company shares from Vivendi through the investor group.

Following completion of the transaction, the majority of shares will be held by public shareholders. The shares purchased by the company will no longer be outstanding, which will deliver meaningful accretion for our shareholders. We expect to emerge from these transactions even stronger than we are today, an independent company, with a best-in-class franchise portfolio and the focus and flexibility to drive long-term shareholder value and expand our leadership position as one of the world's most important entertainment companies. Later in the call, Dennis will provide more detail about the transaction and its expected benefits to Activision Blizzard shareholders.

Turning now to our second quarter results. We're, of course, pleased to announce that Activision Blizzard delivered another quarter and first half of strong financial results. For the first 6 months of the year, Activision Blizzard was the #1 video game publisher in North America and Europe, combined, including toys and accessories. Skylanders was the #1 video game title in North America and Europe, including toys and accessories, and Call of Duty: Black Ops II was the #2 video game title in North America and Europe, combined. Additionally, Blizzard Entertainment's World of Warcraft remains the largest subscription-based MMORPG in the world, ending the quarter with approximately 7.7 million subscribers.

Our remarkably talented and dedicated employees drove our success this quarter as they have in each of the other quarters. They continue to develop and build the great franchises that attract our highly engaged communities and deliver great entertainment to our audiences around the world.

While we had a solid first half, we do expect the remainder of the year to have its challenges for many of the reasons we've highlighted previously and a few I'll share with you now. As excited as we are about our holiday launches, we face a more crowded competitive landscape than we have in the past. We face titles that compete more directly with our offerings and past offerings, including highly anticipated, heavily marketed games launching around our launch dates. To address the effects of this competition, we'll likely further increase our sales and marketing investments this year.

Also, while the transition to new consoles should bring great long-term opportunities, it creates risks in the short term. Both Sony and Microsoft are planning to release very advanced new game systems, but launch dates, promotional plans and launch quantities remain uncertain. Furthermore, console transitions can create purchase hesitation and otherwise affect consumer spending.

Our concern about competition, macroeconomic effects and the console transition period heading into the back half of the year will not change the basic strategy that has served us very well in the past, to continue to prudently invest in our established franchises and selectively invest in new opportunities like Skylanders or Destiny that have the potential to become established franchises, while always managing our costs very carefully.

Regardless of near-term risks, our focused and disciplined approach has served as well for over 20 years and we expect it to continue to deliver superior shareholder returns over the long term. We're optimistic that our leadership position, scale, infrastructure and talent will allow us to take advantage of the positive long-term fundamentals of our industry.

Looking ahead over that longer-term time horizon, we see many exciting opportunities, including new platforms, new geographies and new business models. We're continuing to invest against these opportunities. And while near-term there are challenges, particularly those related to the console transition that are real, they are not unique. We face similar challenges many times in the past. Our product pipeline and go-to-market plans, both for the remainder of the year and for the future, are strong; our strategy is sound; and our talent is unmatched. All of which gives us confidence in our future now as an independent company with a very heavily invested management team.

Now I'd like to turn the call over to our Chief Financial Officer, Dennis Durkin, who will review the transaction and our Q2 financial performance and our outlook for the remainder of the year. Dennis?

Dennis Durkin

Thanks, Bobby. Good afternoon, everyone. Today, I will start with a brief recap of the Vivendi transaction we announced last week, followed by a review of our June quarter results and our outlook both pre- and post-transaction for Q3 and for the remainder of the year.

The transaction, which was unanimously approved by the special community of the Board of Directors for Activision Blizzard, as well as our overall board, is expected to close by the end of September 2013, subject to customary closing conditions. Following the closing of the transaction, Activision Blizzard will no longer have a controlling shareholder, as approximately 63% of our outstanding shares will be owned by public shareholders, 24.9% will be held by an investor group led by Bobby and Brian and 12% will be held by Vivendi.

As part of the transaction, Activision Blizzard will buy back approximately 429 million shares or approximately 38% of our outstanding shares for $13.60 per share or a 10% discount to our preannounced price or a 24% discount to yesterday's closing price.

Activision Blizzard will fund the deal, including estimated transaction fees and upfront interest, with approximately $1.2 billion of balance sheet cash and $4.75 billion of newly issued debt. In addition, we also expect to establish a $250 million revolving credit facility, which will be undrawn at closing. We've already received committed financing for the transaction from Bank of America Merrill Lynch and JPMorgan.

On closing, we expect to pay Vivendi approximately $5.83 billion for their shares, which would leave us with more than $3 billion in cash on hand, most of which is foreign cash and all of which help secure future financial stability. Going forward, we believe that our free cash flow generation will support the debt we are taking on, while also allowing us the flexibility to continue to invest in our business and drive value for our shareholders over time. Following the closing of the transaction, Activision Blizzard will have a new capital structure which reduces our weighted average cost of capital and nearly doubles our return on equity.

Now turning to our better-than-expected Q2 results, which we announced on a preliminary basis last week. Please refer to our earnings release for full GAAP to non-GAAP reconciliations. For the quarter on a GAAP basis, we generated revenues of $1.05 billion, record Q2 operating margins of 41% and EPS of $0.28. On a non-GAAP basis for the quarter, we generated revenues of $608 million and operating margin of 20% and EPS of $0.08.

Our Q2 revenues and earnings were lower than in the prior year, as expected, because we didn't have a comparable to the record-setting launch of Diablo III in May of last year. During the quarter, revenues were driven by Call of Duty, Skylanders and Blizzard's World of Warcraft. Digital channels generated a record 63% of total Q2 non-GAAP revenues, led by World of Warcraft and Call of Duty.

Turning to the specific P&L items. Please note that all percentages are based on revenues. For GAAP in Q2, product costs were 22% and total operating expenses were 37%, both better than our outlook due to the product mix and timing of expenses. For non-GAAP in Q2, product costs were 26% and total operating expenses were 55%, again, favorable to our outlook due to product mix and expense timing.

In terms of cash flow, we generated Q2 operating cash flow of $109 million and free cash flow of $90 million. And for the first 6 months, we generated record operating cash flow of $434 million and record free cash flow of $398 million. During the second quarter, we also paid $216 million to shareholders via the $0.19 per share dividend we distributed in May.

From a balance sheet prospective, as of June 30, we ended the quarter with no debt and $4.6 billion in cash and investments or nearly $4 per fully diluted share. Of that amount, approximately 60% was held outside the U.S.

Now moving to our outlook. We have had a solid first half and a good start to the year. But as we've been saying since last November, we believe that the back of this year will be challenging due to a more crowded competitive slate and continuing uncertainties relating to the console transitions that are still in front of us. While these factors continue to keep us cautious, we are raising our GAAP full year outlook as the vast majority of our GAAP revenues and earnings occurred in the first half of the year and are now behind us. Inversely, for non-GAAP, where the majority of our revenues and earnings are still in front of us in the second half the year, we are maintaining and affirming our full year outlook, given the risks I just mentioned.

Now on to the numbers. First, on a pre-transaction basis. Starting with the third quarter. Our guidance reflects the launch of Activision Publishing's third and fourth the DLC Map Packs for Black Ops II and the September 3rd launch of Blizzard Entertainment's Diablo III for PS3 and Xbox 360.

For the September quarter on a GAAP basis, we expect net revenues of $635 million, product cost of 23%, operating expenses of 68%, a tax rate of 26% and a fully diluted weighted average share count of $1.17 billion (sic) [1.17 billion], which can be used for both GAAP and non-GAAP in Q3 and Q4. Finally, we expect GAAP EPS of $0.03. On a non-GAAP basis, we expect net revenues of $585 million, product costs of 25%, operating expenses of 66%, a tax rate of 27% and non-GAAP EPS of $0.03.

For the December quarter, we expect GAAP net revenues of $1.3 billion and GAAP earnings per share of $0.06. On a non-GAAP basis, we expect net revenues of $2.25 billion and EPS of $0.54.

For the full year on a GAAP basis, we expect net revenues of $4.31 billion, product costs of 24%, operating expenses of 48% and a tax rate of 26% for the full year. For 2013, fully diluted weighted average share count is expected to be 1.16 billion for both GAAP and non-GAAP and GAAP EPS is expected to be $0.77.

On a non-GAAP basis, we expect net revenues of $4.25 billion with product costs of 26%, operating expenses of 44%, a tax rate of 27% and EPS of $0.82. Again, all the numbers I just referenced are on a pre-transaction basis, consistent with how we have reported and forecast in the past.

Now let's look at the numbers in a post-transaction basis, as we expect they will be reported in our financials for the balance of the year. As we said, we expect the transaction to close in late September and today we are also providing a post-transaction outlook as it will be reported with only 1 quarter of accretion. To keep the modeling simple, we've assumed that our new capital structure will be in place at the start of the fourth quarter. Any Q3 impacts are expected to be relatively immaterial to the Q3 outlook I just provided.

For GAAP, we expect Q4 EPS of between $0.01 and $0.04 depending on our final financing costs based on a fully diluted weighted average share count of 743 million shares, which can be used for GAAP and non-GAAP. For the full year, we expect GAAP EPS of $0.80 to $0.82 based on a fully diluted weighted average share count of 1.05 billion, which can be used again for both GAAP and non-GAAP.

On a non-GAAP basis, we expect Q4 EPS of between $0.76 and $0.79, again, depending upon our final financing costs. For the full year, we expect non-GAAP EPS of $0.85 to $0.87. Keep in mind the full year reported EPS is based on full year net income divided by the time weighted average shares outstanding in the year, not the sum of the quarters.

Given the reported numbers, we will only show the lower share count in Q4, as well as the corresponding interest payments in that period. The pro forma full year EPS may give a better sense of our earnings' trends, particularly as you look to future periods.

So let's take a look at the numbers on a pro forma basis, assuming the transaction took effect January 1, 2013. In that case our GAAP EPS outlook would be $0.91 to $0.99 and our non-GAAP EPS outlook would be $1.01 to $1.09, reflecting as much as 29% and 33%% accretion on a GAAP and non-GAAP basis, respectively. The significant accretion reflects the 38% reduction in shares outstanding at closing, partly offset by approximately 150 million to 225 million in incremental after-tax interest expense associated with the new debt. These accretion trends may be useful in thinking about our 2014 outlook, which we will provide more detail on in future calls.

So in summary, although we had a solid Q2 and first half of the year, we remain cautious about the short term and back half of 2013. Longer term, we are excited about the future for our company and industry and committed to continuing the strategy that have successfully guided us through many difficult market transitions in the past. Notably, focus on doing a few things exceptionally well, managing our costs very carefully and delivering superior long-term value to both our customers and our shareholders. Our new ownership structure should make it easier to stay true to this mission.

With all that said, let me now hand the call over to Eric to discuss our Activision Publishing business.

Eric Hirshberg

Thanks, Dennis. I'm pleased to report that in Q2 Activision Publishing delivered another record quarter with record digital revenues and operating income. This follows a record Q1 and record years in operating income in 2011 and 2012. We currently have the industry's #1 and #2 titles year-to-date, including toys and accessories with Skylanders Giants and Call of Duty: Black Ops II. This made Activision Publishing the #1 video game publisher in North America and Europe combined in both Q2 and year-to-date. Such remarkable success would not be possible without the talent and passion of our employees and support of our partners around the world.

Year-to-date, Skylanders was the #1 title in North American and Europe. Since its launch, Giants software and toys units are up significantly over Skylanders: Spyro's Adventure in the prior year. The franchise continues to break new ground and create new revenue streams. In fact during Q2, Skylanders was named the best overall -- license -- Overall Best Licensing Program of the Year in 2013 by the Licensing Industry Merchandiser's Association. A remarkable achievement for a franchise that is still less than 2 years old.

Skylanders' continuing success is based on sustained innovation and superior game play. The team has delivered outstanding execution and inspired creativity in all aspects of the game, which have helped the franchise shatter records, generating over $1.5 billion in retail sales through July 31 since launching October 1 -- October 2011.

On October 13, Skylanders SWAP Force will introduce an all new play pattern with dynamics swapability which creates all new play options. SWAP Force will be our deepest and most immersive Skylanders world yet. Both the characters and the game looked great at E3. The press had been incredibly positive and retailers have committed over 25% more space than last year.

While this genre we've created will face more direct competition than ever before, every indicator tells us that Skylanders' franchise is solidly on the rise and has both the culture momentum and the product innovation to keep it that way.

Now let's turn to Call of Duty, which is one the world's largest entertainment franchises and which grew strongly in Q2 and in the first half of this year. During the quarter, the scale of our online community and online play both set records. The level of engagement drives digital sales, which in turn drives more engagement in a virtuous cycle.

In Q2, Call of Duty digital sales records, which grew over 100% year-on-year. And at retail, Black Ops II sales exceeded Modern Warfare 3 sales in the prior year. And later this year we expect to launch Call of Duty: Ghosts on the Xbox 360, PlayStation 3, Xbox One, PlayStation 4, PC and Wii U. Call of Duty: Ghosts is a new sub-brand developed by Infinity Ward, the studio that created the original Call of Duty and the seminal Call of Duty: Modern Warfare series and features an all new world, story, characters and experiences all powered by a new next-gen engine.

As one might expect in this console transition year, pre-orders for Call of Duty: Ghosts are well below the record-setting pace set by Call of Duty: Black Ops II last year. However, our quantitative consumer research indicates that hesitation amongst past club preorders is primarily due to not knowing which platform they will be playing on, which is natural at this time in the console transition.

It's worth mentioning that Ghosts preorders are over double those of Call of Duty: Black Ops, which is the last time we launched a new sub-brand for the franchise. It's also worth mentioning that our other key engagement metrics from the number of people playing per month to the number of people playing daily to DLC sales, to video views, to community engagement are all significantly ahead of past years. We also have in place the most aggressive marketing retail and digital programs in the history of the franchise. We've made substantial investments to make Ghosts a showcase for the next-gen consoles and also the best current-gen Call of Duty title ever.

Looking to 2014 and beyond, in addition to our portfolio of annualized titles, as you know, we are developing Call of Duty Online with Tencent for the massive Chinese online gaming audience, although we have nothing new to announce today. And as many of you saw at E3, we have been working with Bungie on Destiny, the breakthrough game the brings first-person action gamers together in a shared persistent online world. The game is on track for a 2014 launch. The research of E3 was nothing short of inspiring, with Destiny receiving over 50 awards, including 20 Best of Show Accolades. We strongly believe that we are on pace to set the all-time preorder records for a new IP. Based on what we've seen, we believe Destiny has the potential to become the third active billion-dollar franchise in the Activision Publishing portfolio.

While we're excited about our fall pipeline and feel good about our go-to-market plans, the rest of this year will be competitive. We expect more direct competition for Skylanders and Ghosts for launching to an even more crowded holiday slate than previously expected. In addition to the uncertainties brought about by new consoles, the new consoles themselves will be competing for our fans' time, attention and dollars.

So in summary, our record results in Q2 affirm our focused strategy in delivering the best AAA titles in the industry, which drive year-round engagement and monetization. This strategy built Call of Duty and Skylanders and is the cornerstone of our pipeline of new intellectual properties. It has served us well in the past and we expect it to help us expand our leadership in the future.

And now, I'll turn it over to Mike Morhaime.

Michael Morhaime

Thanks, Eric. Q2 was a relatively quiet quarter when compared against last quarter which included the StarCraft II: Heart of the Swarm launch and Q2 2012 when we launched Diablo III. We've been making great progress on Diablo III console and Hearthstone along with other ongoing projects, which I'll discuss shortly.

Starting off with World of Warcraft, we ended the quarter with about 7.7 million subscribers worldwide, with the declines split about evenly between East and West. The most recent content update in late May has had a positive impact on stabilizing the churn rate in both regions.

Our next major content update, Siege of Orgrimmar, is currently in the public testing phase. This update includes a massive new raid dungeon and new questing area, as well as some new features. Proving grounds is a way for players to learn the skills they need for in-game contents and flexible raids allows groups of varying sizes to enjoy in-game rating. This will make it easier for players to experience compelling in-game contents with their friends. In addition to sustaining engagement for existing players, we believe these features can help make the transition back to the game more compelling for returning players as well. We look forward to releasing this update in the coming weeks.

Before I get into the other game updates, I want to say a few words about our unannounced project, codename Titan. We're in the process of selecting a new direction for the project and re-envisioning what we want the game to be. And while we can't talk about the details yet, it is unlikely to be a subscription-based MMORPG. I also want to reiterate that there has not been an official announced or projected release date. What I can say is that the commitment's quality has always been at the core of Blizzard values. And we've gone through this type of iterative development process several times in the past on the way to creating genre-defining games. As we continue our assessment, we have shifted some of the resources from the team to our other franchises, including World of Warcraft and Blizzard All-Stars, which we believe will add immense value to those projects.

On the Diablo III side, we announced a September 3 date for the Xbox 360 and PlayStation 3 versions to the game. Our showing at E3 was a great opportunity to reinsure ourselves to the console gaming audience. The development team has done a lot of work to tailor Diablo III for a living room experience and these subtle changes have been very well-received by the press. We'll be sharing more Diablo-related news at Gamescom later this month.

Moving on to StarCraft II. We just launched Heart of the Swarm in China a couple of weeks ago and in these early stages have seen a jump in concurrency in the region. In addition, our year-long StarCraft II World Championship Series is currently in its second season with the season finals taking place later this month at Gamescom in Germany.

We've also been putting a lot of focus on Blizzard All-Stars, our upcoming free-to-play online game. Action RTS games have become increasingly popular over the years. As we have in the past with games like World of Warcraft and the original Diablo, we're looking to put our own spin on this genre and challenge some of the existing design paradigms. We've reached a significant internal milestone with Blizzard All-Stars going into wider internal testing and we'll have more to say about the game later this year.

Rounding out our announced game projects is Hearthstone, our new free-to-play digital collectible card game. Hearthstone will launch initially on Windows and Mac PC followed by iPad soon after. We've made great progress polishing the game through internal testing and will be reaching the external test phase very soon. Our promotions in the last quarter, which included several live streamed game-play demos have generated great budge for the game since we revealed it at PAX East in March. Not only will this be our first game on iPad, it will also be the first time in a very long time that we have announced a game and launched it within the same year. This reflects the philosophy behind a small team of Blizzard veterans developing Hearthstone to create Blizzard-quality games on a smaller scale.

Looking ahead, we have BlizzCon coming up on November 8 and 9 at the Anaheim Convention Center. The show will be a good one with the latest Blizzard news, hands on with games and development and of course, the global finals for our StarCraft II World Championship Series. We hope to see you there or following along via the online stream or on a DirecTV.

As we enter the back half of 2013, what we're showing at Blizzard is a broadening of our gaming portfolio. Just 3 years ago, we had 1 active game. Moving into the rest of 2013 and beyond, we will have several active and vibrant games across 3 major franchises on multiple platforms and with different business models. We'll continue to work hard on creating epic game experiences for our players and look forward to delivering those experiences in a variety of ways.

Thanks, and I'll turn the call back over to Kristin.

Kristin Mulvihill Southey

Thanks, Mike. Operator, we'll go ahead and open it up for questions.

Question-and-Answer Session


[Operator Instructions] We'll take our first question from Brian Pitz with Jefferies.

Brian J. Pitz - Jefferies LLC, Research Division

With respect to holiday competition, can you give us your latest thought on marketing efforts for the holidays? Will there be a new strategy here? Should we expect marketing dollars to be up or down? Or you just going to spend smarter dollars rather than more dollars? And with respect to the wild sub declines, I think last quarter was more Asia based, now it seems to be ramping up more on the West. Can you just give us a little more color there on the split?

Eric Hirshberg

I'll take the marketing portion of the question, this is Eric. As Bobby mentioned I believe in his comments, we expect that marketing cost might well be up year-over-year. That said, we do have extremely strong plans already in place. And I think we've shown best-in-class marketing efforts in our ability to make our launches into real cultural events and make them unignorable. And that's what we plan on doing this year.

Michael Morhaime

[indiscernible] on the wild sub decline, in aggregate in Q2, we did see a smaller decline than we saw in Q1. And I think it's very important to note the impact that our content updates have had since the most recent update, mid-May. We have seen a very positive impact on the churn rate. And that's across both regions.

Brian J. Pitz - Jefferies LLC, Research Division

Got it. And just one more follow-up on WoW. There's kind of been rumors in and out of the press on a potential movie set with the WoW theme. Any updates there?

Michael Morhaime

I don't have any updates other than to say that we are continuing to work with Legendary Pictures. Duncan Jones has been selected as the writer/director, who has been actively working on the movie. And we continue to be very excited about it.


We'll take our next question from Colin Sebastian with Robert W. Baird & Co.

Colin A. Sebastian - Robert W. Baird & Co. Incorporated, Research Division

I just have a question and one follow-up. I guess first, Mike, in the scenario that WoW were to continue declining, I'm wondering whether your priority, ultimately, would be to protect profitability of the franchise or to continue spending on potential growth initiatives? And then on the strategic priorities following the buyback, Bobby, you mentioned before perhaps acquisitions as one opportunity. I wondered if you care to provide any profile of what you might be looking for and maybe rank some of the strategic options as well.

Michael Morhaime

So on the World of Warcraft side, our priority is to continue delivering great content to our players. We feel the WoW continues to be the top most compelling, actually, multiplayer online role-playing game available. And we think it still has a very long life ahead of itself. We think that, over time, we have seen players come and go and return to World of Warcraft. And we recognize that there's a lot that we can do to make the experience of coming back to World of Warcraft and the transition back into the game and meeting up with your friends much easier than it currently is. And so I think that's a big opportunity for us.

Robert A. Kotick

And no, I can't comment on future acquisition plans.


We'll take our next question from Arvind Bhatia with Sterne Agee.

Arvind Bhatia - Sterne Agee & Leach Inc., Research Division

Actually just to kind of following up on the last one. I want to give another shot. On the margin side for Blizzard, you've seen, obviously, a lot of fluctuation depending on the mix of product and you had the best margins last year, close to 60%. And this quarter, because of the mix, have been closer to the high 20s. Where do you feel comfortable -- I think, historically, it's been in the high 30s, low 40s. Again, sort of the balance between growth and profitability. Can you give us some ballpark of how you guys are thinking about margins?

Michael Morhaime

So I'll just answer that from my perspective. Dennis can jump in if he wants. I think that the margins are very much influenced by our release schedule. And so, of course, World of Warcraft has much more stable margins but when we release something like Diablo III, that's going to have a huge impact to the margins in that quarter.

Dennis Durkin

Yes, I think in the past you've seen that it is very release dependent. Like all of our businesses, content ends up being a stimulus for the installed base. But we're going to continue to invest to drive growth within the community and making sure we're kind of balancing the customer experience and the player experience with our profitability goals. And we think we can do those 2 things hand-in-hand.


We'll take our next question from Drew Crum with Stifel.

Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division

So one for Dennis. I just wanted to get your thoughts on securing interest rates on your debt below the 5% to 7% range you suggested last week. And then for Eric, maybe you can talk how your outlook has changed on Skylanders for the holidays amid some of the movement around timing for the Disney product?

Dennis Durkin

Sure. This is Dennis. Just with regards to your first question on sort of financing costs. I think that range is the appropriate one based on how you should think about what the potential could be. We're obviously going to do our best to maximize and optimize towards the low end of that range and try and build as much flexibility to our financing package as we can. And we're moving as quickly as we can to try and market the deal and get the deal completed. Obviously, we're in an interest rate environment that has some volatility in it, although it's stabilized over the last 60 days. So we'll be watching that closely and moving as quickly as we can. But that's essentially the range that we're expecting to end up in.

Eric Hirshberg

On Skylanders. Frankly, our outlook hasn't changed. The competition launching closer to our window is neither here nor there for us. We're focused on delivering what we think will be the best Skylanders game we've delivered yet with another breakthrough play mechanic, with swapability, and the strongest marketing and retail support yet. Just when we thought we couldn't get any bigger after last year's retail presence, we've increased it by 25% again this year. So for all those reasons, our financial outlook hasn't changed.


Our next question comes from Edward Williams from BMO Capital Markets.

Edward S. Williams - BMO Capital Markets U.S.

Eric, just -- I want to go to Call of Duty Online for a moment. What are the steps that we should be looking for next before that product actually gets a commercial release? And then as we kind of think about it, I guess the key thing for me is trying to get a sense as to the size of what that could be and when the contribution can really kick in?

Eric Hirshberg

In terms of the next steps, we are still solidly in the development process and focusing on creating a great game. And we're taking the time as necessary to make sure that we deliver that. As for the next steps, Tencent is a great partner. They are the ones who will really be leading the path to commercialization, through governmental approvals, through the beta, through that sort of thing. So we're going to rely upon them to guide us through that process. Our priority is getting the quality right. And we feel that the production is going well.

Robert A. Kotick

I would add that, I think, Tencent's investment in the company was a recognition of the enthusiasm that they have for the opportunity.


We'll hear next from Daniel Ernst with Hudson Square Research.

Daniel Ernst - Hudson Square Research, Inc.

Question for Bobby and Mike. In the 5 years since you guys joined forces in the sort of the Vivendi transaction the first time around, there was a lot of hope and anticipation for synergies between the 2 companies. I wondered if you could comment on the things that you have accomplished over those 5 years together that you couldn't have done separately? And then your comment on what you think you might be able to do in the next 5 years in working together now that you're an independent company without Vivendi? And then, Bobby, on the console transition. As we move past the uncertainty and the timing and the launch quantities, what is your perspective longer term about the size of this coming cycle with so many different other options out there in gaming? Do you think this cycle could be bigger, smaller, the same size as the cycle that we're finishing now?

Robert A. Kotick

Good questions. So we'll start with my perspective of the synergies. I think -- remember that part of the original thinking behind the merger was that there were categories of business that Blizzard operated in that Activision didn't. And so rather than us spending $1.5 billion like other competitors have investing in MMOs, as an example, without any success and we view the merger would give us the opportunity to get insight and understanding about areas like And the impact of things like the insights we developed from are really profound on Call of Duty. But we largely wanted to keep the culture of the company, the operations of the business independent. The things that were easy and obvious were corporate functions, worldwide retail execution, which has been in the benefit of having a single-focused worldwide retail distribution organization has been hugely helpful. There were process improvements that we made across the company that got implemented both within Activision Publishing and in Blizzard. There's been talent moving between the businesses. I think one of the great benefits and insights that we developed as a combined company was the opportunity in China. When we started out, Blizzard was successful in China, but probably one of the most successful Western entertainment companies in China. And I think that, to put that in perspective, I'm not just saying game company. I think when you look at the success that Blizzard just had in China, it's probably the most successful Western entertainment company in China. And that insight has been hugely helpful in shaping the combined company thinking about how to address China. Obviously, then, on things like purchasing, scale and leverage on servers and data centers and negotiating all the things that relate to the back-end products like Call of Duty or World of Warcraft. And I think you'll continue to see -- the first few years were really focused on just continuing to operate and execute, the next few years we had the benefit of really starting to understand synergies. And I think the next 5 years, you're going to see a lot of the benefits of the combination. In this year, in particular, we'll launch for the first time of a Blizzard console game as an example. But I think when you think about the relationships that we have with first parties, it certainly benefited Blizzard. And that we've probably spent the conference call talking about all of the benefits that we've seen in the way that we did manage our talent development process and evaluate performance in establishing metrics for evaluating performance and rewarding performance. But I think you'll see the next 5 years a lot of the benefits of the synergies that we've really explored over the last year.

Michael Morhaime

So just a couple of points that Bobby may not have mentioned. I think that when we first did the merger, I think we all recognize that there were certain complementary areas of expertise that Blizzard had and that Activision had. And I think that there is definitely an ongoing benefit even if we're not contributing directly on each other's products, there's some really good knowledge sharing that's happening between the 2 companies, the 2 divisions, in sort of giving each other advice and sharing the lessons that we've learned in various aspects of game-making. And so I think that, that's helping us on the console side of the business. And I think that there are things that as we move into different business models, Activision and Blizzard both have complementary experience dealing with different types of games that potentially could be applied or at least help us navigate new space.

Robert A. Kotick

But at the end of the day, they are separate business operations with separate management, separate strategies, separate business plans. And we view that as a big benefit. One thing to point out is when we did the original merger, it was with Vivendi Games. And there was whole Vivendi Game operation independent of Blizzard that needed to be dismantled, projects that needed to be terminated, canceled or sold. And so there was a fair amount of synergy getting that just came from eliminating unproductive investments that have been made in the Vivendi game side of the business.

Daniel Ernst - Hudson Square Research, Inc.

Got it. Then, the new cycle?

Robert A. Kotick

What was the second question?

Daniel Ernst - Hudson Square Research, Inc.

The new cycle, your thoughts on the scale of the coming cycle, whether it could be bigger, smaller, same size?

Robert A. Kotick

I mean, if you look back in history, what you've seen is that every new cycle has been larger than the prior cycle. I don't know that we've had the same number of competing platforms or opportunities to deliver interactive entertainment. But I will say this, I think, that most manufacturers are delivering on the promise of excellent hardware. We have much more visibility today than we even did 3 months ago. And I think they both made great progress. I think they're going to put more marketing money against the launches than ever before. I think they have both learned a lot about how to improve and enhance supply chain and manufacturing efficiencies. I think when you look at all of these new benefits that will come from direct digital distribution, the ability to have an always-on device, I think there's a lot that you look at in terms of future and capabilities, whether it's social gaming, whether it's some of the enhancements, improvements you see in graphics processing or the efficiencies, in Sony's case, in reducing all of these parallel processing devices to much more clean architecture. But my sense is that I think consumers are going to be excited about this hardware. And I think that, over the long term, they probably be, if not as long as what we've seen in the current cycle, roughly the same amount of time. And I think that you're going to see new kinds of software that has not been available in this current generation. I'm just seeing the things that we're working on and the things that we're developing, things that we've never been able to do before, that I think will excite audiences in ways that we haven't seen before.


And our final question will come from Doug Creutz with Cowen and Company.

Douglas Creutz - Cowen and Company, LLC, Research Division

One for Dennis. Could you just confirm, the share count you're giving for the back half of the year seemed a little higher than what I expected. Is that just due to some additional dilution created by the rising of stock price? And then for Eric. You said that the fall window is going to be even more competitive than you had -- sort of were projecting. What's changed in the last 3 months to sort of alter your view on that?

Dennis Durkin

Yes, thanks, Doug. I'll handle the first one and hand it over to Eric. Yes, since our guidance, with the stock price move, we have more diluted shares, as well as, as you go through the year, we're granting more shares to employees. So you just want to make sure you're comparing the right periods in there. When you look on the slide in our deck here that has sort of the different pre-transaction, post-transaction, the Q4 number is really probably the closest because that's the weighted average for that Q4 post-transaction number, the 743 million number. That's probably the best number to use when you start thinking about next year as a fully diluted number. And it is as the results of the increased share price and all the other things that have happened during the course of the year.

Eric Hirshberg

As far as the competition in Q4, the relative statement was versus last year. And also there have been some key competitors that have moved into the fall quarter -- of the Q4, closer to our launch, that's what I was referring to.


And I'd like to turn the conference back over to Kristin Southey for any additional or closing remarks.

Kristin Mulvihill Southey

Thank you. On behalf of everyone at Activision Blizzard, we want to thank you for your time and consideration. And we look forward to speaking to you in the future. Thank you.


Again, this does conclude today's conference. We thank you, all, for your participation.

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