Activision Blizzard Q2 2010 Earnings Call Transcript

| About: Activision Blizzard, (ATVI)

Activision Blizzard (NASDAQ:ATVI)

Q2 2010 Earnings Call

August 05, 2010 4:30 pm ET


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

Thomas Tippl - Chief Operating Officer and Chief Financial Officer

Robert Kotick - Chief Executive Officer, President and Director

Kristin Southey -


Shawn Milne - Janney Montgomery Scott LLC

Brian Pitz - UBS Investment Bank

Heath Terry - FBR Capital Markets & Co.

Jess Lubert - Wells Fargo Securities, LLC

Colin Sebastian - Lazard Capital Markets LLC

Edward Williams - BMO Capital Markets U.S.

Justin Post - BofA Merrill Lynch

Jeetil Patel - Deutsche Bank AG


Good day, everyone, and welcome to Activision Blizzard's Second Quarter Current Year 2010 Earnings Conference. [Operator Instructions] At this time for opening remarks and introductions, I would like to turn today's call over to Ms. Kristin Southey. Please go ahead, Kristin.

Kristin Southey

Good afternoon, and thank you for joining us today for Activision Blizzard's Second Quarter Calendar 2010 Conference Call. With me today are Bobby Kotick, Chief Executive Officer of Activision Blizzard; Thomas Tippl, Chief Operating Officer and Chief Financial Officer of Activision Blizzard; and Mike Morhaime, Chief Executive Officer of Blizzard Entertainment.

I would like to remind everyone that we will be making statements that are not historical facts. These forward-looking statements are based on current expectations and assumptions that are subject to risk and uncertainties. As indicated in the slides, they're 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 statement. Such factors include, without limitation: Sales level; increasing concentration of titles; shifting consumer spending trends; current macroeconomic and industry conditions and conditions within the video game market; the seasonal and cyclical nature of our market; difficulties related to World of Warcraft in China; our ability to predict consumer preferences among competing hardware platforms; declines in pricing; product returns; price reception; product delays; retail acceptance of our products; adoption rate and availability of new hardware and related software; competition, litigation and associated cost throughout the changes in technology; industry standards; business models, including online and youth games and consumer preferences; protection of proprietary rights; maintenance of key relationships, including the ability to attract, retain and develop key personnel and developers that can create high-quality hit titles; counterparty risk; economic, financial and political conditions and policies; foreign exchange and tax rates; identification of acquisition opportunities; and potential challenges associated with geographic expansion.

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, 2009. The company may change its intentions, views, or expectations at anytime and without notice based upon any changes in such factors in the company's assumptions or otherwise. The company undertakes no obligations to release publicly any revisions to any forward-looking statements to reflect events or circumstances after today, August 5, 2010, or to reflect the occurrence of unanticipated events.

I would also like to note that certain numbers we will be presenting today will be made in 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 share-based payment, the operating results of products and operations from the historical of any gains that the physical company has exited or substantially wound down. Costs related to the business culmination between Activision and the vendor games, the amortization of intangibles and impairment of intangible assets and an associated tax benefit. Please refer to our earnings release, which is posted at for a full GAAP to non-GAAP reconciliation and further explanation. Found there is a PowerPoint overview which you can access with the webcast and which will be posted in the website following the call. And now, I would like to introduce our CEO, Bobby Kotick.

Robert Kotick

Thank you, Kristin, and thank you, all, for joining us today. We are quite pleased to announce that we outperformed our EPS outlook for the quarter, and we're reaffirming our calendar year revenue and EPS expectations, which would result in the most profitable year in our history and our highest operating margins to date.

Our results this period once again affirmed our business strategy and superior worldwide execution. Our focus on the largest and most profitable opportunities and our ability to extend our leadership in the fast-growing online segments continue to provide us with a competitive advantage and recurring profitability that is unmatched in our industry.

In addition to our second quarter results, you'll hear more today about our blockbuster lineup for the balance of the year, including a recap of our first major launch of 2010 Blizzard Entertainment StarCraft II, which was released worldwide in July 27. The game is off to a superb start and with the relaunch of players around the world are enjoying a significantly enhanced online experience. StarCraft is one of the highest quality, and it's further confirmation of the unique talent that is embedded in Blizzard. This will again become clear with the launch of Cataclysm later this year.

Our unrelenting commitment to quality, our resources and our proven skills in providing compelling content for gamers provide a unique competitive advantage. Our success continues to reflect the early and thoughtful way our management team anticipated, recognized and reacted to significant shifts taking place in audience needs and how we adapted to deliver more compelling games for our players.

As a result, we continue to see a shift to the high-margin digital side of our business, which yields faster growth, better returns on invested capital and reduces our exposure to the volatility that has historically characterized video game companies. In fact, this is the first quarter that our sales from online channels outweighed our retail sales.

Our continued successful results reaffirm our strategy. Clearly, leading franchises are strengthening. However, this only happens where there is great innovation, and StarCraft II is certainly confirmation of this. Today, players and retailers alike are more selective than ever before and are choosing to concentrate their entertainment spending on fewer higher-quality experiences. This is a trend not just in video games but across all media, where we continue to see the largest and most successful properties, when superbly executed, gain disproportionate share of audience attention.

Online technologies like voice over IP and video over IP, as well as new motion-sensing technologies like Move and Kinect, are offering players exciting new ways to interact. These new experiences are more immersive than prior technologies, and games that capitalize on these innovations are optimally positioned to attract much, much larger audiences.

With gaming becoming one of the most popular uses of the Internet, more gamers in far broader demographics than we have ever seen before are emerging as new consumers. This will drive growth and will reward companies like ours that have deep expertise and understanding in making surely interactive entertainment.

As in-home broadband penetration increases globally, Internet-connected televisions become a reality and the ubiquity and capability of portable devices is rising. We should continue to see dramatic extensions in the reach and functionality of today's leading entertainment content as a result. Game quality will obviously be crucial for long-term success, and for us, quality begins with focus and talent.

Our decision last February to organize a separate business unit focused on Call of Duty was an example of a recognition of the need to dedicate the best resources towards the tens of millions of players who are playing Call of Duty games.

In Call of Duty: Black Ops, which is due out this November, we are raising the bar to extraordinary levels. The game is one of the best we have ever created. There isn't anything quite like it. The features in multiplayer technology, for example, will make this latest Call of Duty experience easier to jump in and enjoyed than ever before, while at the same time offering a personalized depth of experience for our core consumers.

The value of having the most talented people and the deepest resources applied against the most important projects has never been higher. We believe our competitors, and there are many, are beginning to realize the gaps that they must bridge. Within the last year, and even the past few weeks, our competitors and industry partners have been moving to try and reposition themselves in light of these new requirements for success.

There is an industry-wide urgency to invest in online games and game companies. We, fortunately, saw the changes taking place a number of years ago, and as a result, our competitive lead is significant. Our history of investing in our people, our brand, our platforms and our communities has allowed us to develop unmatched knowledge and execution capabilities in this area as well as the financial strength to invest prudently in key resources. As a result, we are uniquely positioned to continue offering immediate online experiences that deliver incredible entertainment to gamers, while providing superior returns to our shareholders.

I've often applied the metaphor the broad and deep moats that surround our core franchises. The convergence of changing consumer demand, new technologies offering more immersive and sustainable engagement with entertainment and our methodical alignment of the absolute best talent, best assets and the recognition of our obligations to our shareholders have only made these moats deeper and more difficult for many of our competitors to navigate. At the same time, the core franchises our moats protect are also growing and becoming more attractive through our audiences.

The relaunch of is a perfect example of how we are rolling out the next generation of services and online environment to our audiences, while others are just beginning their complicated and costly explorations of where to begin. The combination of technical capability and tangible benefits Blizzard is delivering to its StarCraft audience represents the next evolution in the arenas of gaming, social networking, online commerce and customer service. is perhaps best example of how we are forging a new connection between content creators and content consumers that will yield advances in the game experience and quality of service that we can uniquely deliver.

We continue to follow those three basic tenets to guide our business that we've talked about many times in the past. Our commitment to create the most exciting and innovative games for gamers, operating a best-in-class independent studio model and publishing organization that inspires creativity and fosters innovation and focus on providing superior shareholder returns for the long term. In fact, over the last 10 years, shareholder value has grown at a compounded annual rate of over 30%. Our continued focus on the largest and most profitable opportunity provides us not only the ability to deliver the work of our talented teams to the broadest possible audiences but also allows for greater predictability in our multi-year planning and reflect our emphasis on shareholder value creation.

Recognizing how important inspired creativity is for continuing our success, we have recently added Eric Hirschberg to our management team as CEO of Activision Publishing. Eric has a deep understanding of the video game business, subscription-based businesses, mobile devices and an incredibly deep understanding of how to convert consumer insight into inspired, creative content. In his new role, he will oversee Activision Publishing's operational management, including its studios, product development functions and consumer marketing activities reporting directly to Tom.

Today, we're uniquely positioned to take advantage of the growing interest in gaming and the trends that are resulting in the shift in the way broad audiences spend their leisure time. And as a result, we have never been better positioned to capitalize on the growth and opportunity that exists in interactive entertainment.

Thomas will now share with you the results of another quarter of profitable success and our plans for the balance of the year. Thomas?

Thomas Tippl

Thank you, Bobby. Today, I'll begin with a recap of the June quarter results followed by a review of our outlook for the third quarter and calendar 2010 and will close with a review of the Activision business before handing it over to Mike Morhaime, who will discuss Blizzard's performance and plans.

For your reference, in our press release, there are schedules which provide non-GAAP comparable by business segment, and this will be the numbers I'll refer to unless otherwise noted. Also please refer to our earnings release for a GAAP to non-GAAP reconciliation.

For the second quarter, GAAP net revenues were $967 million, GAAP operating income was $300 million and earnings per share was $0.17, $0.06 ahead of our prior outlook primarily due to lower revenue deferrals and equity expense. On a non-GAAP basis, June quarter net revenues were $683 million, non-GAAP operating income was $101 million and non-GAAP EPS came in at $0.06, $0.02 ahead of our prior outlook.

The quarter was driven by Blizzard Entertainment's World of Warcraft and Activision's Call of Duty. In addition, we also released Shrek, Singularity, Blur and Transformers. As expected, non-GAAP revenues and earnings were down as of the prior year due to a smaller release slate and continued weakness at retail in the Casual and Music genres. As compared to our prior outlook, non-GAAP revenues were slightly lower due to the negative impact of foreign exchange and lower sales of our new releases, which were largely offset by the continued momentum of our core franchises Call of Duty and World of Warcraft.

Non-GAAP EPS looked higher than our outlook driven by the strength of our core franchises, specifically, by the, strong, continued digital revenue performance over the Call of Duty Map Packs and Blizzard's value-added services both of which have helped deliver year-to-date non-GAAP operating margin expansion of 100 basis points.

With respect to the P&L line items, in the June quarter, GAAP product costs were 30% of revenues. And GAAP operating expenses, including royalties, was 39% of revenues. Our GAAP tax rate was 27%. In the June quarter, non-GAAP product costs were 32% in line with our outlook. Non-GAAP operating expenses came in better than expected at about 54% due mainly to lower G&A expenses related to better-than-expected realization of savings of our March quarter organizational realignment. Finally, our non-GAAP tax rate was 29%.

Now turning to the balance sheet. On June 30, we had no debt and approximately $2.9 billion in cash and investment. This quarter, we repurchased $242 million worth of stock, bringing this year's total purchases under the $1 billion authorization to approximately 31 million shares worth $334 million. And we also paid our first-ever dividend of $187 million.

Now let me turn to our other key balance sheet positions as of June 30. The accounts receivable balance was $190 million, an increase of $56 million worth at the prior quarter end. The increase was primarily due to the late quarter releases of Transformers and Singularity.

Inventories were $157 million, down $37 million versus the prior quarter and down $41 million worth at the prior year due mainly to a reduction in Guitar Hero inventory. Our Guitar Hero inventory and total inventory's position represents our lowest inventory level in years.

Capitalized software development cost was $249 million, an increase of $28 million worth at the prior quarter due to upcoming releases. Of the $229 million, approximately $38 million is related to deferrals for online-enabled games.

Capitalized intellectual property cost were $59 million. Excluding deferrals, capitalized intellectual property costs were $54 million, $5 million above the year ago due in part to cost related to upcoming license releases. And to cash flow for the trailing 12 months, we have generated approximately $1.2 billion in operating cash flow. So in summary, our financial position remains very strong and puts us in an excellent position to capitalize on invested opportunities both internally and externally for long-term growth.

Before turning to our financial outlook, I'd like to highlight a couple of items. We continue to focus on a few key building blocks, to drive earnings growth and operating margins. And I will take a minute to review those building blocks and remark on our progress to date.

First, we are heading into the strength of our 2010 lineup. For our financial perspective the key drivers of our calendar year 2010 results remain Blizzard StarCraft II, which launched last week, and World of Warcraft: Cataclysm, as well as Activision's Guitar Hero: Warriors of Rock and Call of Duty: Black Ops, all of which remain on schedule and look great at this point.

Second, we expect significant growth in our Digital Online business, the majority of which will come from Blizzard. In the June quarter, we again realized strong performance from two of our largest online business components: Blizzard Entertainment's World of Warcraft and Activision's Call of Duty: Modern Warfare 2 Map Packs. During the quarter, sales from online channels grew 120% year-over-year, to reach an all-time high and for the first time, accounted for the majority of sales for the quarter.

Third, we expect to increase operating income contribution of our Music business and today, we remain on track to hit that objective despite a significantly lower fault line for this part of our business. And finally, we'll continue our productivity improvement efforts to expand operating margins, while investing in top broadband lines. Our four-focused approach, use of lower operating expenses in the June quarter and we will continue our stringent expense management as we move forward.

In summary, for the first two quarters of the year, we continue to execute against each of these goals, as outpaced our earnings outlook and expanded our operating margins and return over $500 million of cash we transferred in the form of share repurchases and dividends.

So now, off to the company's outlook. Our outlook is subject to significant risks and uncertainties, including those mentioned at the beginning of this call, and the risk highlighted in the company's annual report on Form 10-K for the period ended December 31, 2009. As a result of these and other factors, actual results may deviate materially from the outlook presented today.

First, I would like to highlight that we have made the decision to move True Crime: Hong Kong into 2011, which I'll discuss in my review of the Activision publishing business. Despite moving True Crime, our outlook for calendar 2010 remains unchanged due mainly to an increase in our expectations for the Call of Duty franchise in Q4, which is shaping up great.

For the year, we will still expect GAAP net revenues of $4.2 billion and GAAP EPS of $0.49 and non-GAAP net revenues of $4.4 billion and non-GAAP EPS of $0.72. For the calendar year, we expect GAAP product cost of approximately 31% of net revenues and operating expenses of about 49% of net revenues. We projected GAAP-protected tax rate of about 27% and a diluted share count of about $1.25 billion.

On a non-GAAP basis, we expect product cost of 32%, gross manufacturing margins I expected to expand meaningfully year-over-year as a result of strong digital revenue generation from Call of Duty and Blizzard's high-margin flanks. We expect non-GAAP operating expenses, including royalties of over 39% of net revenues. This is higher than a year ago due to our larger slate. Also, Blizzard is continuing with increased investments in product development and customer service to drive long-term growth.

For the calendar year, we expect a non-GAAP record operating margin of about 29%. We expect to achieve our margin expansion targets by focusing on the core consumer and retail combined with a continued emphasis in our higher margin online businesses and product lines. We expect our effective non-GAAP tax rate to be about 29% which can be used for the remaining quarters and expect the diluted share count of $1.25 billion.

Now moving to the September quarter. This quarter, our new releases include StarCraft II and the late four releases of Guitar Hero: Warriors of Rock and Spider-Man: Shattered Dimensions. For the quarter, we expect GAAP net revenues of $600 million. We expect GAAP product cost of 30%, operating expenses of about 71% and break even GAAP EPS.

We expect non-GAAP net revenue of $725 million for the quarter. Non-GAAP net revenues will be relatively in line with the prior year as revenues of StarCraft II are expected to offset negative effects, a smaller publishing slate and lower license revenues. Expected third quarter non-GAAP EPS is $0.08. We expect non-GAAP EPS to double versus the prior year due mainly to a mix shift to higher-margin PC platform revenues offset somewhat by an increase in operating expenses due to the larger Fed half late [ph] this year. We expect non-GAAP product cost of 29%, non-GAAP operating expenses of 51% and a non-GAAP effective tax rate of 29%. We also project a diluted share count of 1.25 billion.

In summary, we believe our combined company strengths and the Retail and Online segments, our continued cost containment efforts and our significant financial strength position us to drive another year of record non-GAAP operating margins and earnings per share, which should drive shareholder value creation.

Now I'd like to move on to a discussion of Activision publishing. To date, I'll focus my comments on three areas. First, I will recap our outlook for hardware, software and digital content. Second, I will highlight our core strategies and execution year-to-date. And finally, I will cover Activision's key drivers for the remainder of 2010.

Let's start with a review of Hardware and Software. On June 30, the installed base of Hardware in North America and Europe for current-gen systems, including handheld, was 235 million units, an increase of 31% over the prior year. Overall, our 2010 aggregate hardware installed base forecast remained unchanged and we expect to end the year with a massive installed base of about 265 million units of consoles and handhelds.

With respect to software in the U.S. and Europe, as we said, we expected Nintendo and legacy platforms to decline this year. Importantly, we expect that the core gamer platforms, where we generate the majority of our revenues, including the PS3, Xbox 360 and PC, collectively will be up high single digits this year and then online sales will be up double digit.

Overall, we expect a combined retail and digital software market to be up in single digits. Within that, our portfolio products is well aligned with the backdrop of the industry, and our performance continues to illustrate the contribution and importance of our core franchises and depth in digital.

This quarter, our performance was driven primarily by the sustained retail and online strength of Call of Duty. During the quarter, in the U.S. and Europe, Call of Duty ranks as the number 3 franchise overall. In addition, the brand's continued digital expansion is creating player values deeper into the product life cycle than ever before.

In May, we released the Call of Duty: Modern Warfare 2 stimulus package Map Pack on the PS3 and the resurgence back on the 360, which collectively sold more than 5 million copies during the quarter alone. In fact, for the first half of the year, Call of Duty Map Packs has generated enough revenue to rank among the top five retail releases in the U.S. and Europe thus far in 2010. And if you take catalog sales of Modern Warfare 2, and Map Pack sales for the first half of the year, they have generated more revenues than the number one selling title of 2010.

Lastly, during the quarter, live to date Call of Duty Map Pack sales exceeded the 20 million mark. These products not only drive meaningful levels of high-margin revenue, they also help generate a deeper loyalty among the fan base, drive increased stickiness to the physical product, which encourages gamers to keep their copies rather then reselling them and opens up new opportunities for the future as more and more players evolve their engagement with the brands.

During the quarter, we also launched four titles, two new IPs in Singularity and Blur, and on the License side, Shrek and Transformers. Singularity fell short of meeting what is not an exceptionally high bar within the Shooter genre. Fortunately, Call of Duty was the title that raised that bar and shortfall of Singularity was offset by Call of Duty's catalog and DLC performance.

Additionally, Blur was not able to break out in what turned out to be a relatively soft Racing genre despite the number of high-quality releases. Importantly, the game broke new ground in creating innovative, social and multiplayer features, including functionality, enables our unique online and back-end platforms that will play an increasing role in driving value in the future.

With respect to our license properties, both Shrek and Transformers achieved the highest ever game ratings in the franchise's history. Transformers particularly is selling well taking, taking the top 10 spot in June for NPD despite the late June release. We have retail and consumer programs planned for the remainder of the year to drive sales of our June quarter releases well into the holiday where the majority of the consumer spending occurs.

Looking ahead, all of our major releases in 2010, are in the back half of the year. In the September quarter, Activision launched two titles. Spider-Man: Shattered Dimensions in early September and Guitar Hero: Warriors of Rock at the end of September. This year's Spider-Man release offers players an original storyline combining four dramatically different universes with a distinct Spider-Man for each, armed with unique skills and strength. The game generated a significant amount of buzz at the recent Comic-Con where we revealed the fourth and final dimension.

Next up will be Guitar Hero: Warriors of Rock. Year-to-date, the music category has been relatively quiet due in part to lack of new releases. Warriors of Rock will be our only Guitar Hero release this year, and given its game quality and our full lineup of marketing activities should generate consumer and retail excitement. This year's game will introduce for the first time a deep story mode with more challenges than ever before, rock-inspired new hardware, the ability to use your existing Guitar Hero music library and an authentic set list featuring 95 songs, and the first million units of Warriors of Rock will be bundled and simultaneously launched with the first new Soundgarden album released in over 10 years.

As we count down to the September 28th release, I'd like to take this opportunity to thank Microsoft for the right leadership they've been providing for the franchise, selling nearly 40 million units live to date, and maintaining an incredibly high level of quality over the past few years despite a one-year development cycle, something rarely accomplished in this industry.

Before turning to our Q4 lineup, as I mentioned earlier, we've made the decision to move two clients into 2011. Now it gives the Development team more time to deliver the exceptional entertainment experience they envision. We are excited about the game, and we are putting additional investment into two clients in order to provide an outstanding experience as well as the full breadth of content players expect in an open-world game.

Now for our expected Q4 lineup, which is our largest ever and 100% focused on proven franchises delivering exciting new content and experiences to further broaden our advance. And as always, we plan to launch all of our major releases before Thanksgiving. Our exciting lineup includes Tony Hawk: SHRED, which will for the first time also involve [ph] skateboarding and snowboarding gameplay utilizing its highly acclaimed four peripherals and improved control system. DJ Hero 2, the sequel to last year's number one new IP, which gives you the ability to play with two turntables and a microphone, and a set list of original DJ mixes worth buying on its own. We have two James Bond titles, a remake of the timeless GoldenEye, exclusively under Wii, which sold over 4 million units on the N64 alone, and Blood Stone, written by legendary Bond screen writer Bruce Feirstein, which will be available for all other key platforms. We'll also launch an all-new Bakugan, which was a major success for our past holiday. And finally, on November 9, we will release what we expect to be the most sophisticated game of 2010 and, by far, our largest title of the year: Call of Duty: Black Ops. This year's Black Ops will release on more platforms than ever before and continues to pace ahead of last year's record-setting Modern Warfare 2 in terms of pre-sales, buys [ph] and all other consumer-awareness metrics.

The game continues to gain momentum, and based on the traction we have already established through trial partners around the world, we expect that Black Ops will yet again drive Call of Duty to be the entertainment event of the year. We are incredibly excited about this release as Black Ops is expected to deliver a high level of game quality and new game features especially in the online multiplayer experience, which we believe will raise the bar for the whole genre yet again.

Additionally, with up-screen Map Pack development, which will offer the gaming community more fresh, high quality content than ever before. Over the next few months, you'll be hearing more about new Black Ops games features and the exciting plans we have to launch begin globally.

Looking ahead, the Call of Duty brand represents once of our largest long-term opportunities as the brand is one of the largest entertainment properties and is well-aligned with the fastest growing entertainment sectors, including online gaming. These factors give us the confidence to redouble our investment in the brand, which should offer more opportunities for organic long-term growth than ever before.

As Bobby mentioned, we have and will continue to strengthen our Call of Duty Studios with additional talent and financial resources. Year-to-date, we have received approximately 5,000 applications for positions at our Infinity Ward and Sledgehammer Studios alone. And out of that incredible pool, we've selected approximately 60 extremely talented individuals to join our teams. These additions have been important, and we've been very pleased with the game development you've seen from both studios to date.

In addition to Black Ops, we had developments on a number of new initiatives, each of which are being specifically designed to expand and improve the Call of Duty single player and online experience, including our next first person shooter, which is expected to launch next year. Additional online content and our entry into Asia where the brand already enjoys considerable awareness, but has yet to launch.

By establishing a standalone Call of Duty business unit, we have been able to focus our resources against this large and growing franchise. In just a few months, we have already realized significant synergies and benefits which were never before possible, including better communication and greater collaborations among our studios, all of which should benefit the launch of Black Ops and future Call of Duty initiatives, and most importantly, will provide our highly engaged Call of Duty community with an improved and seamless player experience.

In addition to our internal investments, we are very disciplined and selective when it comes to investors in excellent growth opportunities. It must be accretive to our business model. Our partnership with Bungie, is an extraordinary addition to our franchise portfolio and a perfect example of the thoughtful approach we take to use our shareholders' capital. Bungie's in development on a groundbreaking new game universe, which also aligns well against the growth in online gaming. And today, we are happy to report that the majority of the Bungie team is settling to its new space and is now focused on new crafting their new universe.

The new universe will be a substantial addition to our portfolio and an opportunity that should drive Activision's growth well into the next decade.

So in summary, we remain focused and dedicated to providing the best entertainment value for all of our players around the world. We have well thought through [indiscernible] plans and actions and are fully resourced to continue to lead the industry with our largest franchises. We look forward to sharing more details about our plans for the Call of Duty franchise and our other products with you on future calls.

With that, I'll now turn the call over to Mike Morhaime, who will provide an update on Blizzard Entertainment.

Michael Morhaime

Thanks, Thomas. With two games shipping in the same year for the first time since 1998, 2010 is shaping up to be Blizzard Entertainment's biggest year yet. Two quarters in, we have much to look forward to and anticipate a strong finish to the back half of the year.

To start things off, I'll discuss our performance in Q2 before talking about specific areas such as StarCraft II, World of Warcraft and BlizzCon. Blizzard has shown continued strength in the second quarter of 2010. Worldwide subscription numbers for World of Warcraft are holding steady at more than 11.5 million players despite the struggling economy and pressure on European currencies through the first half of the year. We were still able to grow our business year-over-year both in terms of revenue and profit. As a reminder, the results from Q2 don't include sales from StarCraft II, which was just launched a week ago.

Star Craft II is currently one of the highlights of our year with the game launching across five different continents and in 11 languages. The response by both players and press from around the world has been outstanding. As a matter fact, Metacritic's currently rate StarCraft II a 94 out of a possible 100, making it one of the top scoring games of all time.

Preliminary sales numbers have begun to roll in, and I'm pleased to say that StarCraft II is already the fastest-selling strategy game of all time. We sold more than 1.5 million copies worldwide in the first two days of release, making StarCraft II the best-selling PC game so far this year.

Just to put that number in perspective, if we compare the day one sales of StarCraft II in North America and Europe combined, the day one sales of World of Warcraft in those two regions combined, StarCraft II more than doubled the sales of World of Warcraft. We are very pleased with the StarCraft II's retail sell-through to date.

What's more, the excitement over StarCraft II has actually driven consumer interest in our other games. Amazon's North American PC sales data for the week of July 29 shows that the top five was a clean sweep for Blizzard: StarCraft II, StarCraft II Collector's Edition, StarCraft I Battle Chest, World of Warcraft Burning Crusade [World of Warcraft: The Burning Crusade] and World of Warcraft occupied the entire top of the Amazon PC sales chart for North America that week.

I do want to point out that StarCraft II is currently in a free open beta period in Taiwan and Korea. This is a standard practice for game launches in Asia to allow players to play the game for free for a short period of time before moving into commercial launch. Since players in Korea and Taiwan can play StarCraft II for free right now, sales numbers from those regions are not meaningful yet. In addition to the high quality of the game, several promotions have helped drive global awareness for StarCraft II leading in to the launch. In the week prior, we debuted an extended trailer for the game on YouTube, that generated more than 2 million views in just two days and more than 4 million views in a week. The popularity of the trailer made it the number one video on YouTube for that week.

Back in June, we also began a

terrific relationship with Korean Air. As part of this marketing partnership, Korean Air has wrapped a pair of passenger jets in StarCraft II artwork. Both planes are already in service around the world and will continue to serve as vibrant mobile billboards for StarCraft II for the rest of the year.

Thousands of people came out to support a dozen official launch events in countries around the world for StarCraft II. The local event here in Orange County and the event in Singapore each drew more than 1,000 people. The Taiwan launch drew nearly 1,000. Events in Paris, Berlin and Brisbane drew an excess of 2,000. And the events in Moscow and Seoul each had more than 3,000 attending. In addition to these official launch events, more than 8,000 stores around the world had their doors open at midnight to celebrate the release and welcome players.

The launch of StarCraft II was also the debut of the new The revamped platform was successfully launched around the world, which was a major technical achievement. The integration between World of Warcraft and StarCraft II was a success and players are using the service to compete and communicate with their friends. We're already working on additional features to the service to respond to player demand, such as private chat channels and tournament functionality.

With regard to the World of Warcraft, the Cataclysm Beta launched in June, and the early results of the testing have been very positive. There are currently tens of thousands of players participating in the beta test, and we're planning to add more in the coming months. Additionally, more than 200,000 gamers and media will have the opportunity to play Cataclysm later this month at GamesCom's in Germany.

Excitement around Cataclysm continues to build as players are eager to revisit the altered landscape of Azeroth. In the six years since World of Warcraft's first launch, our developers have gained a wealth of expertise in creating MMO content. Cataclysm leverages all the experience we gained over the last six years as we overhaul existing content in the game and add additional content to satisfy both new and current players. We believe this strategy will not only help us retain players but make us more effective at attracting new players in making the game more appealing again for players who may have left.

Also I'd like to point the release of Cataclysm being our best expansion yet for World of Warcraft. Although an exact release date has not yet been announced, we are on track to launch the expansion by the end of the year. As with all Blizzard games though, we won't release until it's ready.

As far as serving current World of Warcraft players, the Remote Auction House is a service we've introduced recently, allowing any player to view the in-game auction house for free using the web and iPhone or Android phone. Players can also subscribe to an optional service for $2.99 a month, which gives them additional auction-related functionality from their browser or smartphone. We've included the ability to buy or sell items for in-game currency.

Before I move on, I have some great news to share about what World of Warcraft in China. Our partner, NetEase, has received official written approval from JPP for Wrath of the Lich King. There is one remaining regulatory approval needed before the expansion can launch, but this is a positive sign for bringing our latest content to Chinese players. As always, we look forward to celebrating the different Blizzard game universes and their global communities with all of the attendees at BlizzCon 2010. Two batches of tickets for the event went on sale in June, and both effectively sold out the moment they went live. If you weren't in the queue to buy tickets within one second, you didn't get a ticket.

Fortunately, if you wanted to attend BlizzCon but were not able to purchase one of the 20,000 tickets, you won't be left out in the cold. For the second straight year, we're partnering with DirecTV to make it possible for players around the world to enjoy the BlizzCon experience from their homes. Several exciting changes have been made to the service, including the ability for viewers to customize their experience by selecting from multiple channels. The Internet stream will also include enhanced video-on-demand and DVR functionality.

In summary, we view 2010 as the single most exciting year in Blizzard Entertainment history. With StarCraft II, we have already achieved a record-breaking game launch, we had exciting developments in China and Cataclysm is still on track for the final half of the year. So we expect that by the end of 2010, more people will be playing Blizzard games than ever before.

I look forward to joining our growing community at BlizzCon this October, and I hope to see some of you there as well. Thanks, and I'll turn things back over to Kristin.

Kristin Southey

Operator, we can open up for questions.

Question-and-Answer Session


[Operator Instructions] And your first question will come from Jeetil Patel with Deutsche Securities.

Jeetil Patel - Deutsche Bank AG

Can you first talk about StarCraft? It's launched in the U.S. and U.K. market predominantly. There's probably some purchases out of Korea, but can you talk about how many are in beta today and maybe the timing of when that goes into open sale as opposed in beta? Second, it looked like in the quarter, you cut back marketing on Blur and Singularity. Do you think that was more a function of trying to manage earnings? Or kind of what was the strategy rational behind that? Lastly, do you need cut back your software product line up further and focus on your bigger titles since that seems to be the theme in the industry of driving profitability and gearing everything towards the holiday season?

Michael Morhaime

This is Mike. So first I'd like to clarify that the StarCraft II launch was a worldwide launch. It wasn't just U.S. and U.K. Actually, we launched throughout Europe, we launched in Latin America and in Southeast Asia as well. The places that are in open beta right now are Taiwan and Korea, and we have not announced an ending date for the open beta yet, but typically, these things last for a few weeks.

Thomas Tippl

And then, with regards to your question, we have made a very significant investment behind the establishment of Blur as a new IP. So I think the marketing plans was very strong, probably stronger than for most of our franchises. Unfortunately, the racing genre was not particularly responsive, at least so far this year, despite the number of good releases. On Singularity, the bar in the shooter genre these days is very high. I think we made the right size investment against this opportunity, and that's how we expect to continue to look at the amount of marketing support we put behind all of our launches. With regards to the lineup, certainly making fewer games there, but bigger has been our strategy for a long time now. I think it's what the market has been rewarding, and we constantly evaluate our plate as part of our three-year planning process and decide which market segment we want to participate in, where do we have consumer-proven concept, great development talent that can deliver those concepts. And as a result, our slate, if you look into the future, is likely going to continue to grow.


Your next question will come from Heath Terry from FBR Capital Markets.

Heath Terry - FBR Capital Markets & Co.

I was wondering if you could give us, now that the game is out and you're up and running and Korea, a little bit more of the sense of what you expect the breakdown on users in Korea to look like between the packaged good, between the cafe side of things? And just give us a little bit more of a sense on what the business model is going to look like in those markets relative to the U.S.

Michael Morhaime

So while we don't disclose specific breakdown and haven't in the past for World of Warcraft, we do expect the usage patterns to be fairly similar to what they have been for our previous games. So you'll see a fair number of players playing the game from home as well as people playing from the IGRs [Internet Gaming Room]. Since we are still in open beta, it's too early to get a sort of indication of the number of people that will choose to go out and purchase the game versus just playing in the IGRs. One thing I'll point out, so the model, the way it works in Korea, players have a lot of choices. So they can purchase the game digitally for the same price as we're offering in the U.S. It comes to be about 69,000 Korean won. They also have the option of purchasing a digital subscription for either one day or 30 days, or they can go to a game room and play. And if they play in the game rooms, we actually bill the game rooms for usage time and the model with the game room is actually very common for games in Korea, and our pricing is competitive.

Heath Terry - FBR Capital Markets & Co.

And then just, Mike, can you give us a sense -- I know you've released kind of first 48-hour numbers. Can you give a sense of kind of what -- how things are trending since then relative to your expectations, not just from a pure sales standpoint but also the reaction that you're getting from the community and from usage levels that you're seeing as you had at

Michael Morhaime

The reaction has been very positive for the game. Players around the world really appreciate the game. Players in Korea, the response has been very positive. One thing we're seeing is that StarCraft I remains very popular in Korea, and I think we're going to see a transition period because right now, you're still seeing a lot of StarCraft I pro tournaments broadcast on live TV. Our partner in Korea made an announcement yesterday about the StarCraft II leads that they'll be running through the end of this year, which was received extremely positive by players not only in Korea but around the world. So there's a lot of excitement about this, and I think that the broadcast of StarCraft II tournaments and seeing their favorite pro players playing StarCraft II is really going to drive a lot of interest. But there will be a transition period.


From UBS, we'll hear from Brian Pitz.

Brian Pitz - UBS Investment Bank

Actually does another follow up on StarCraft on Heath's question. Is there any impact regarding the lack of LAN availability for the game in places like North America and Europe among the hard core players? And then, maybe you could just touch upon some of the earlier comments in the call, where you mentioned both the casual and music genres kind of weaker in the second quarter. What kind of assumptions are you playing out in Q3, Q4 for those genres?

Michael Morhaime

We really haven't seen any impact to sales. As we mentioned, StarCraft II is selling faster than any of our previous real-time strategy games. And even comparing it to the original World of Warcraft box, we're still selling much faster. The reviewers have been universally positive on the game. And I think most players, when they sit down and play the game, they find that the multiplayer support on is actually quite good. So no, I would say we haven't really seen any impact.

Thomas Tippl

And on the casual and music genre, the first half of the year, there were zero new releases coming out from our end and as a result, there were [indiscernible] catalogs. And obviously, the numbers as a result were down year-over-year. And as we move into the back half of the year, we made a number of adjustments to our plans, and we expect that retail and higher price points, games as peripherals, will continue to face some headwinds. And so that's baked into our plans.


We'll hear from Edward Williams with BMO Capital Markets.

Edward Williams - BMO Capital Markets U.S.

First of all, just looking at the $20 million Call of Duty map pack sales, can you give us some color as to what each succeeding map pack did? So what the uptick was like as you progress through them? And also, if you can provide a little bit of color as to what the reaction has been to the pricing, specially with more recent releases?

Thomas Tippl

Starting with the last part of your question, obviously the success of the map pack speaks for the value that we are providing to the gamers is incredible, new contents coming out and millions of hours played on that content so the value creation we provide to players is great. And as a result, we've been selling a ton of them. Modern Warfare 2 map packs are on a very good trajectory, and they have not yet crossed the number of map packs we have sold with World of Warcraft, but that's probably going to happen within the next couple of weeks. It's going extremely well. We couldn't be more pleased.

Michael Morhaime

I think one of the things I'd add also that's important, we have gotten an incredible amount of benefit from this very, very large installed base of players and the way people are reacting to the downloadable content. And a lot of that learning has now been incorporated into what you'll see in a lot of the functionality of Black Ops. And one of the things that we've really done is improve the quality of the multiplayer beyond anything that any customers have ever seen. And partly why we're so enthusiastic about our prospects for the back half of this year, but Black Ops is turning out to be one of the best products that we've ever created.

Edward Williams - BMO Capital Markets U.S.

Can you describe a little bit as to what you're thinking right now in terms of the potential lifetime revenue you may be able to get out of the map pack type of sales or additional content sales on the console side? I'm not sure what it would be, but what's your percentage of overall sales may come from that? Or how critical it is it to the future of those games?

Thomas Tippl

I think continued content delivery is going to be very critical for many reasons. One, it generates higher margin revenue, but more importantly, it makes our brands even stickier. It gives our fan base no reason to go play different games, or other brands. And as a result, we have today more resources than ever dedicated to creating additional content for Call of Duty, whether that's map packs, whether that's game modes and the whole host of new features that we're going to talk about when we get close to the launch of Black Ops.


Your next question will come from Justin Post with Bank of America.

Justin Post - BofA Merrill Lynch

Just thinking about the shape of the quarters, I think you did $0.06 this quarter and you have what is a very high margin PC title launching in 3Q. Maybe talk about why EPS is only $0.02 better on kind of a higher level basis? And then Bobby, over the years, you've really been able to innovate and kind of build new franchises that you didn't have, say, five years ago, how is that looking now with the industry changing? Is it already about building the franchises you already have? Or can you still create and come up with new things that kind of replace some of the franchises that are declining over time?

Robert Kotick

We have sort of a dual responsibility. You have to have incredibly compelling innovation in the franchises that we own and control, and that's critically important. We've always known that. I think what we've been able to do is elevate the level of innovation in products beyond what we've been ever able to do before. We've talked a lot about the seven different pillars of success that we expect over the course of the next few years. And remember, we have two enormous investments: one in Bungie and the other in another project at Blizzard that we haven't given a lot of visibility to. Those are going to be entirely new intellectual properties. But with the recognition that the way to build them is take long amounts of time, lots of capable talent, an enormous amount of capital and you have to have a real roadmap for innovation and creativity. And I think that those are going to be two very good examples from the ground up original ideas.

Thomas Tippl

Justin, on the quarter-over-quarter EPS progression, yes, obviously Blizzard's contribution to Q3 is going to be higher than its contribution to Q2. At the same time, we have no new Call of Duty map packs in Q3. And as I just talked about, they've been extremely successful for us in the June quarter. So net-net, we are delivering 100% EPS growth in the September quarter year-over-year, and this is something that we feel pretty good about.


Next, we'll hear from Colin Sebastian at Lazard.

Colin Sebastian - Lazard Capital Markets LLC

I guess turning back to Call of Duty, the shooter and war genres are going to be a little bit more competitive this fall. And I know you've generally been pretty prudent there about in terms of financial expectations. You're suddenly a little bit more optimistic on this call and just curious how you're approaching the merchandising or the retail plans for Black Ops differently than, say, last year when there was a bit more of an open field?

Robert Kotick

This across the board, the biggest investment that we've ever made in a launch of a title. And I think when audiences see the product, they'll see why we're doing it this way. But the market opportunity is bigger than it's ever been. The installed base of hardware is bigger than it's ever been. The product has incredibly broad appeal, but it also has a whole host of functions that are going to be unique to the core consumer. And from that perspective, we feel like it's the most appropriate Activision product to put these kinds of resources behind. And I think there's a lot of competition, not just from games but from a whole host of other things that you can do with your leisure times. And this is something that we think has the potential to break through and appeal to a much broader consumer base than ever before.

Colin Sebastian - Lazard Capital Markets LLC

And then I guess, Thomas, just quickly one housekeeping, if you could quantify the impact on this currency on the top line for the quarter versus your original expectation?

Thomas Tippl

It's about $20 million.

Colin Sebastian - Lazard Capital Markets LLC

$20 million?

Thomas Tippl



Next question will come from Jess Lubert with Wells Fargo Securities.

Jess Lubert - Wells Fargo Securities, LLC

First, I was hoping you could discuss some of the trends that caused the sequential decline in the Blizzard subscription revenue, and should we expect sequential growth there through the second half of the year? And then second, can you give us an update on your efforts to target the Used-Games business? This is something you'd alluded to at E3. Many of your competitors have implemented single-use codes. Any help there would be appreciated.

Thomas Tippl

When you look at our platform breakout, and those are GAAP numbers so it's impacted by deferrals from a year ago. If you go back, we had to ramp up the Lich King expansion pack launch. And then, the following six months, benefited from the deferred revenue that was coming in. If you look at Blizzard, that's a segment revenue in the June quarter, and remember, our StarCraft is shipped in the third quarter. But there's no retail release in the second quarter. Blizzard has been growing our revenue and operating income as a result this very healthy subscriber trends, as well as strong performance in value-added services. So this is very healthy, subscriber numbers are very healthy, concurrency has been very strong. And this one thing that I don't think Mike has mentioned earlier, but we continue to see very strong concurrency numbers ever since the launch of the StarCraft, which is very encouraging.

Jess Lubert - Wells Fargo Securities, LLC

And then on the Used-Games business?

Thomas Tippl

Can you repeat your question on the Used Games business?

Jess Lubert - Wells Fargo Securities, LLC

At E3, you had mentioned that you're looking to target Used-Games business and capture that opportunity. Can you give an update on your plans there?

Thomas Tippl

We are still evaluating various possibilities for greater participation in the Used-Games business. What's been working the best so far is providing additional content and therefore limiting the supply to used games. So that's a proven strategy that we will continue. And any other initiatives, we will be talking about when we get closer to it.


And we do have time for one more question. Your final question will come from Shawn Milne from Janney Capital Markets.

Shawn Milne - Janney Montgomery Scott LLC

I just wanted to go back to the question about just the third quarter earnings outlook. I think when you had moved StarCraft II before, you talk about $0.05 in terms of profitability. So all things being equal, you'd be looking at $0.05 over the prior period a year ago. Is there something else going on in third quarter? I think you mentioned maybe a little bit more investment on the Blizzard side in terms of customer experience. Is there some incremental spending there? And then, Mike, you touched upon it briefly, just on I know it's very early, but any other signs in terms of usage or hours or what you're seeing early on with the relaunch of

Thomas Tippl

First of all, I don't think we have ever provided a guidance for our outlook number on StarCraft. I'm not quite sure where your $0.05 are coming from. So product performance is strong. I think it makes a significant contribution to Q3, but we also expect the product will have some significant lags in sales for many quarters to come.

Michael Morhaime

Well, as Thomas mentioned, we've been watching World of Warcraft usage since the StarCraft launch and really haven't seen a big impact to the World of Warcraft usage, which is a great sign. And we're seeing StarCraft usage continuing to increase since launch. So it's all looking very great from our perspective.

Kristin Southey

On behalf of everyone at Activision Blizzard, we thank you, all, for your time and consideration. And we look forward to talking to you later.


Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!