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Activision Blizzard (NASDAQ:ATVI)

Q2 2014 Earnings Call

August 05, 2014 4:30 pm ET

Executives

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

Analysts

A. Justin Post - BofA Merrill Lynch, Research Division

Brian J. Pitz - Jefferies LLC, Research Division

Daniel Ernst - Hudson Square Research, Inc.

Michael Hickey - The Benchmark Company, LLC, Research Division

Stephen Ju - Crédit Suisse AG, Research Division

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

Michael J. Olson - Piper Jaffray Companies, Research Division

Neil A. Doshi - CRT Capital Group LLC, Research Division

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

Operator

Good day, and welcome to the Activision Blizzard's Quarter 2 2014 Results Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to 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 2014 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 risks and uncertainties.

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, including the factors discussed in the Risk Factors section of our SEC filings, including our 2013 Annual Report on Form 10-K, which is on file with the SEC, and those indicated on the slide that is showing.

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, they ultimately may prove to be incorrect. The company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after today, August 5, 2014, or to reflect the occurrence of unanticipated events.

I would 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, the amortization of intangible assets, expenses related to the purchase transaction and related debt financing and the associated tax benefits. Please refer to our earnings release, which is posted on www.activisionblizzard.com 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 financial overview highlighting both GAAP and non-GAAP results in a 1-page summary sheet.

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. I'm pleased to report that Activision Blizzard delivered better-than-expected Q2 results. On a non-GAAP basis, we generated $658 million in revenues, with a record 73% from digital channels and earnings per share of $0.06.

For the first half of the year, we generated strong earnings and cash flow, we repaid $375 million of principal to reduce our term loan and we paid our highest ever dividend of $0.20 per share.

Based on our strong results this quarter and better visibility for the balance of the calendar year, we're raising our full-year outlook and expect to grow our non-GAAP revenues year-over-year and deliver record non-GAAP earnings per share this year.

We control some of the most valuable and iconic entertainment franchises, and we maintain some of the largest and most engaged online communities in the world, including Call of Duty, Skylanders, World of Warcraft, Diablo, StarCraft, and now, Hearthstone. And all of these franchises are leaders in their respective categories.

Our teams continue to be among the very best in the world at innovating within our known franchises and creating exciting new franchises like Hearthstone and Destiny. We're seeing more opportunities to create great content for new platforms, new higher-margin business models and new geographies. And we're embracing these opportunities for growth with the same commitment to excellence we have demonstrated over the last 20 years.

As the world's most successful interactive entertainment company, we'll remain focused on the creation of the most compelling, engaging games for our dedicated committed audiences and providing superior returns for our shareholders, as we have for more than 2 decades.

I'm grateful for the continued determination and extraordinary efforts of our employees around the world and the continued support of our audiences and shareholders. And now, Dennis will share the results of our second quarter and provide an update on our view with the balance of 2014, which is shaping up to be an extraordinary year for Activision Blizzard.

Dennis Durkin

Thanks, Bobby. Good afternoon, everyone. Today, I'll review our better-than-expected Q2 financial results and then our outlook for Q3 and our increased outlook for 2014.

Starting with our financial results. Please refer to our earnings release for full non-GAAP to GAAP reconciliations. Also the numbers I'll be quoting are compared to the prior year, unless otherwise noted.

For the quarter, on a GAAP basis, we generated better-than-expected revenues of $970 million, and operating margin of 32% and EPS of $0.28. On a non-GAAP basis for the quarter, we generated revenues of $658 million, including a record 73% from digital channels, which drove an overall operating margin of 17% and EPS of $0.06.

Our strong performance was driven by 5 distinct franchises, which highlights the increasing breadth and depth of our expanding portfolio. Blizzard Entertainment's strong results were driven by World of Warcraft subscriptions, Warlords of Draenor prepurchases and paid character boost, Diablo III: Reaper of Souls expansion pack sales and sales of Hearthstone cards.

On the Activision Publishing side, performance was driven by Call of Duty: Ghosts, and Skylanders SWAP Force.

Turning to specific P&L items. Please note, all percentages are based on revenues except for the tax rate. For Q2, GAAP product costs were 25%, operating expenses were 43%, and operating margin was 32%, above our outlook, driven by higher-than-expected revenues and the timing of expenses. GAAP and non-GAAP interest expense was $52 million and our GAAP tax rate was 22%. Our GAAP and non-GAAP weighted average share count was 725 million, and for EPS purposes, we also include 16 million of participating securities for a total of 741 million fully diluted shares.

On a non-GAAP basis for the quarter, product costs were 27%, slightly higher than expected due to over performance in our low-margin distribution business. Operating expenses were 56%, better than expected, and operating margin was 17%, above our outlook for the same reasons I mentioned for GAAP.

Our adjusted EBITDA margin was 20%, and our non-GAAP tax rate was 29%.

In terms of EBITDA and cash flow, in Q2, we generated non-GAAP adjusted EBITDA of $131 million, which we define as non-GAAP operating income and then add back depreciation, as well as strong operating and free cash flow of $106 million and $81 million, respectively.

On a trailing 12-month basis, we generated nearly $1.1 billion of operating cash flow. We also paid out approximately $147 million related to our $0.20 per share dividend in May.

Turning to the balance sheet. As of June 30, we had $4.2 billion in cash and investments, of which over $650 million was held domestically. With total debt of $4.4 billion, our net debt was approximately $150 million.

Now let's turn to our slate and our outlook for Q3 and for full year 2014.

For Q3, Blizzard launched the first content pack for Hearthstone, Curse of Naxxramas, for PC, Mac and iPad in July, and expects to launch Diablo III: Ultimate Evil Edition later this month for consoles. In September, Activision Publishing plans to release Destiny, which we believe will be one of the biggest selling titles of the year, and will establish yet another iconic franchise in the Activision Blizzard portfolio.

Turning to the numbers. In Q3, on a GAAP basis, we expect net revenues of $650 million, product costs of 27%, and operating expenses of 76%. We expect GAAP and non-GAAP interest expense of $52 million, a GAAP tax rate of 30%. And with significant GAAP revenue deferrals in the future periods, we're expecting a GAAP loss of $0.07 in the quarter.

Note, we are using basic weighted average share count of 719 million shares for GAAP EPS. We expect a GAAP loss in the quarter. For Q3, on a non-GAAP basis, we expect record revenues of $975 million, product cost of 25%, and operating expenses of 60%. Note this includes heavy launch marketing costs for Destiny, as well as marketing expenses for our large Q4 lineup.

In addition, there will also be significant amortization of capitalized software development expenses for Destiny in both Q3 and Q4.

Finally, we expect a non-GAAP tax rate of approximately 19%, a non-GAAP fully diluted share count of 745 million and non-GAAP EPS of $0.11.

In Q4, we expect to launch Skylanders: Trap Team on October 5, and Call of Duty: Advanced Warfare on November 4. And for planning purposes, our outlook assumes a Q4 launch of the World of Warcraft: Warlords of Draenor expansion.

Now to our full year 2014 numbers.

On a GAAP basis, we expect increased revenues of $4.24 billion, product costs of 28% and operating expenses of 47%. For both GAAP and non-GAAP, we expect interest expense of $208 million. Our GAAP tax rate is expected to be 22%. We expect $750 million fully diluted shares, both for GAAP and non-GAAP, and GAAP EPS of $0.91. For 2014, on a non-GAAP basis, we expect increased revenues of $4.7 billion, representing 8% revenue growth year-over-year, product costs of 26%, operating expenses of 43%, operating margin of 32% and a non-GAAP tax rate of 25%. Today, we are raising our full year non-GAAP EPS outlook by $0.02 to a record $1.29, representing 37% reported EPS growth year-over-year.

In summary, Activision Blizzard's expanding portfolio of industry-leading franchises delivered better than expected financial results during the first half of the year, and in the back half, we expect to deliver what we believe to be the strongest lineup in our history.

Today, we have more opportunities than ever before to increase our portfolio of premium content and to continue growing our large, socially connected communities worldwide by expanding our reach to new consumers, platforms and geographies. We also remain laser-focused on execution, while keeping a keen eye on cost, all of which should deliver long-term growth, strong margins and cash flows for our various stakeholders.

Now I will turn the call over to Eric Hirshberg to discuss Activision Publishing.

Eric Hirshberg

Thanks, Dennis. In Q2 Activision Publishing had the #1 selling title left to date on the next-generation consoles with Call of Duty: Ghosts, and the #2 title in the industry year-to-date with Skylanders SWAP Force. We believe our blockbuster launch this fall with Destiny, Skylanders and Call of Duty could deliver the largest second half revenues in Activision Publishing's history.

First up is Destiny, which we plan to launch on September 9, and the game is looking great. Our beta test attracted over 4.6 million players and the feedback was almost universally positive.

With that great consumer response, strong first-party support from Sony, very strong demand from our retail and digital distribution partners and a strong future pipeline of digital content, we believe more than ever that Destiny will become the biggest new IP launch in video game history, and over time, Activision's next billion-dollar franchise.

Preorders continue at a record pace for new intellectual property and other leading indicators like purchase intent and awareness are showing strength as well. On October 5, we plan to release Skylanders: Trap Team, a great game from our wholly-owned studio, Toys for Bob, the originators of both the franchise and the toys-to-life genre. In Trap Team, we're not only letting kids bring their toys to life, as we have in past games, we're also letting them bring life to their toys. This time, when you defeat bad guys, you can capture them in a crystal trap and make them fight for you, bringing yet another breakthrough innovation to the toys-to-life genre.

I think, this is our most magical Skylanders game yet. Since we revealed Trap Team, we have seen a 50% increase in our Skylanders YouTube channel views compared to last year. And while we have strong competition, we also have breakthrough innovation, a new lineup that has more price points and options for the consumer and unprecedented support from both first and third-parties, including Nintendo, General Mills and McDonald's.

We therefore expect Skylanders to continue to lead the toys-to-life category this fall and determining one of the most successful kids entertainment franchises in the world.

On November 4, we intend to launch Call of Duty: Advanced Warfare, our incredibly talented wholly-owned studios, Sledgehammer Games, is delivering a truly extraordinary experience, with innovation across every game mode. Our best graphics ever and a campaign anchored by great story, as well as two-time Oscar winner, Kevin Spacey.

We also have an open launch window and we're taking full advantage of this with strong first-party support from Microsoft, highly engaged distribution partners and some of most our focused and we expect effective marketing programs ever.

Adding to this momentum is an active Call of Duty player community that has actually grown since our last earnings call. This is an unusual trend at this time of the year, which typically sees declining active player count.

This speaks to the continued strength of the Call of Duty franchise and healthy appetite for Call of Duty content as we head into Advanced Warfare's launch. And according to YouTube, our reveal trailer was the most viewed entertainment trailer in the second quarter, ahead of not only every other game, but also every movie and television show in North America. We expect Call of Duty to be the most pre-ordered game of the year and we're currently seeing strong purchase intent, in line with our past top-performing titles.

Finally, our development for Call of Duty Online in China is going great and gaining momentum. This is our first major free-to-play initiative and has just entered large scale testing, which means hundreds of thousands of gamers in China will be playing a closed beta over the coming months. This is part of our rollout strategically with Tencent, which is by far the largest gaming community in China. Call of Duty online is a major opportunity to expand our reach and to bring the franchise to a massive new player community.

So in closing, Activision Publishing had a strong second quarter and looks forward to delivering what could be our biggest second half ever. We expect our AAA launches to materially expand our portfolio and our reach, both this fall and in the future, with top line growth and increasing margins as the next-gen consoles continue to grow and expand our opportunities to drive high-margin digital revenues.

Thanks. And I'll now turn the call over to Mike to talk about Blizzard.

Michael Morhaime

Thanks, Eric. Blizzard had a busy second quarter, reaching milestones on a number of projects. This includes the start of beta testing on World of Warcraft: Warlords of Draenor, the release of Hearthstone on iPad, and ongoing testing of new content for Diablo III, and our unreleased team brawler, Heroes of the Storm.

Starting off with World of Warcraft. The franchise remains healthy with revenues up year-over-year. This is due in part to ongoing interest in Warlords of Draenor presales, which now exceed 1.5 million, and the character boost, which suggests strong support for the expansion by the community.

As we mentioned on the previous call, we anticipated fluctuation in subscribership due to seasonality and the fact that the current game content is at the end of its life cycle. And as expected, we did see a decline in subscribers, which mostly came out of the East. This pattern is right in line, percentage-wise, with the drops that we saw at Cataclysm's cycle in Q2 2012. That drop in 2012 was followed by an uptick in subscribers just ahead of Mists of Pandaria's launch. So we're hoping to see players return once we draw closer to the release of Warlords of Draenor later this year.

On the development side for World of Warcraft, we did begin beta testing for Warlords of Draenor in Q2. Q2 was also a big quarter for Hearthstone with the iPad version of the game launching in April. That version has been popular, bringing millions of new players into the Battle.net ecosystem, and building on momentum from Q1's PC launch. Hearthstone has also been growing in popularity on the e-sports side, with a number of big tournament events taking place around the globe. We also announced our year-long Hearthstone competition, which will collect competitors from around the world to compete at a yearend tournament at BlizzCon for a $250,000 prize pool. A few weeks ago, we launched Curse of Naxxramas, our first adventure mode content for Hearthstone, and it's now available around the world on Windows, Mac and iPad. The content is split into 5 parts released over 5-week period, and it includes single player challenges, as well as cards that players can use in head-to-head competition. Players can purchase the weekly content à la carte for in-game gold or real money or as a bundle for real money. The community has responded with enthusiasm to Curse of Naxxramas, fueling Hearthstone's biggest week ever in terms of both engagement and revenue. We're pleased with the results and we look forward to continuing our support for Hearthstone going forward.

Moving on to Diablo III. We're pleased to show that the game has reached more than 20 million in unit sales, including digital. This figure includes the base Diablo III game on PC and console, and the Reaper of Souls PC expansion pack. We're looking forward to delivering the expansion content to players on next and current-gen consoles with the release of the Diablo III Ultimate Evil Edition, which we expect to ship on August 19. In addition to the Reaper of Souls content, the Ultimate Evil Edition includes all of the updates that we made to the core Diablo III experience on PC, as well as some console-exclusive features that make it even easier and more rewarding for friends to play together.

And lastly, we just announced plans with NetEase to bring Diablo III to Mainland China.

Rounding out our game update for this call is Heroes of the Storm, our upcoming hero brawler. Alpha testing continued in Q2 and was expanded to include players from other regions around the world. We're incredibly excited about the prospects for Heroes of the Storm. As we head back into the back half of 2014, we're looking to close out the year strong with BlizzCon and the release of Warlords of Draenor, in addition to the ongoing content that we're in the process of adding to Hearthstone, Diablo III and Heroes of the Storm.

We're proud to be offering more gaming options that appeal to a wide range of players across more platforms than ever before.

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

Kristin Mulvihill Southey

Thanks, Mike. And I think, we'll open up the call for questions now. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Justin Post of Merrill Lynch.

A. Justin Post - BofA Merrill Lynch, Research Division

Looks like you're guiding 3Q above the Street. And what can you tell us about Destiny preorders and anything you could tell us about the units there? And then, as you think about as the unit sale gets sold in this quarter, what does that mean for the digital opportunity as you look forward?

Eric Hirshberg

Sure. This is Eric, I'll take those in order. Well, first of all, as I mentioned in our prepared comments, Destiny preorders are on track to be the largest ever for new IP in the industry. But it's important to note that preorders are just one data point that we look at when determining the momentum of a franchise like this. We also look at our quantitative studies surrounding things like purchase intent and awareness and we're seeing strength in those areas as well. It's also important to just sort of reset expectations as it relates to preorders overall. You guys can see the same thing we see industry-wide, that there's been sort of a secular downturn as it relates to preorders. We think that's happening due to a number of factors, things like increased digital consumption, particularly on the next-gen consoles, titles being widely available on day 1 and the decline overall for demand on previous-gen consoles. So given that trend, even more important to us is that preorders are the quantitative metrics that I mentioned, so I'll just share a few highlights from those. Destiny's awareness is at an all-time high and climbing when compared to any other new game intellectual property this distance from launch. Purchase intent is similarly at an all-time high and rising when compared to any other new IP, and we had 4.6 million players in the beta with almost universally positive sentiment. So all of those add to our sense of momentum for the launch. Overall, we're really pleased with the performance of the Destiny beta. We're pleased with the broad range of metrics that we look at to gauge momentum and our chances for success. As for your second question about digital, obviously, our strategy here is to build as large an installed base as possible so a big launch is key to that and getting momentum early is key to that. We have a robust plan for follow-on digital content to provide to our players, which we think will be highly relevant. And we've already announced 2 expansions that are coming.

Operator

We'll take our next question from Brian Pitz of Jefferies.

Brian J. Pitz - Jefferies LLC, Research Division

Quick question on Hearthstone. Can you give us an idea for the type of engagement you're seeing out of the Naxx expansion? And longer term, any commentary on your belief in having a really new long-term revenue stream? Finally, just a quick question on Call of Duty. Any sense on how preorders are progressing at this point, especially relative to previous years?

Michael Morhaime

So we're very pleased with the engagement that we've seen out of Naxxramas, and I think that it really bodes very well for the engagement that we'll be able to drive in the future with additional content for the game. And so, I think, we'll learn more as time goes on, but the fact that last week was our strongest week ever for Hearthstone in terms of both revenue and engagement, I think, is a really strong sign. It's important to note that we still have yet to bring the game to the Android and iPhone devices. And if you look at the response we got from bringing Hearthstone to the iPad, which brought in millions of new accounts on Battle.net, I think, there's a lot of engagement and opportunity around those platforms as well.

Eric Hirshberg

On Call of Duty preorders, my answer will be fairly similar to what I said on Destiny in that you see the secular downturn across the industry as it relates to preorders, and Call of Duty is not immune to that. However, within that context, we still expect the Call of Duty to lead the industry in preorders once again this year. And also, like with Destiny, we also look at other metrics as well and we're seeing a lot of strength in those metrics, particularly, we have an internal quantitative consumer study and we're seeing purchase intent for Advanced Warfare to be significantly above that which we saw in Ghost, and actually in line with our past top-performing titles. And I think, it's also important to remember that we're still a ways from our launch and we have yet to reveal some of the most important elements of the game to the community who tends to like multiplayer and some of our best preorders are yet to come.

Operator

We'll take our next question from Daniel Ernst of Hudson Square.

Daniel Ernst - Hudson Square Research, Inc.

Kind of a 2-part question, if I might, on Destiny. Clearly, the beta went well and it looked great at E3, and as you said, the intent for it is quite high and it sounds like you're seeing a similar thing for Call of Duty. So I was wondering if you could, big picture, discuss how much demand is there for big games like that, given that they play all year round. When you have 2 of those big tent poles, but industry-wide, how many games like Destiny and Call of Duty can the industry demand support throughout the year? And then, sort of the second part of that question on Destiny, you previously discussed being a little bit concerned about the early profitability of the game. Obviously, a lot of development cost borne this year for a multiyear game, you have to do it on 4 consoles, obviously a big marketing portion. I wonder if you could talk some about what you're seeing on profitability for Destiny now, what your thoughts are for now and a little bit in the future as you no longer have to support 4 consoles and you've pushed past the launch cost.

Eric Hirshberg

I'll take the first part and I'll let Dennis speak to the profitability question. On how many games the industry can support, and particularly the first-person action genre, I think, we've seen in the past that the first-person action genre in particular is broadly appealing to accommodate more than one blockbuster hit. There have been other good performing players in that genre and that hasn't ever kept Call of Duty from delivering incredible results. So we think that there's room for more than one blockbuster hit and we're just intent on having 2 of them. That said, we do think that the games are very different from one another. Call of Duty, as you know, is a gritty, authentic military shooter, and Destiny is a far future sci-fi action-adventure game with lot of RPG characteristics. So in fact, when you look at the people who participated in the Destiny beta, we actually think Destiny has the capability to appeal not only to the first-person action fan, but also to bring new fans into our portfolio since the game also appeals to fans of RPG and action-adventure games. So net-net, the answer is that we believe industry can and will support both, and I think, history has shown that whenever publishers have shown up with breakthrough great content with great experiences for fans, that those have tend to find a market. Dennis?

Dennis Durkin

Sure. And then, just relating to the Destiny kind of profitability point, Dan, and you know, we don't provide franchise-level details on profitability, but obviously, the biggest driver of profitability is the scale of the franchise, and we expect both to achieve high scale and deliver substantial profitability from our investment over time. That's based on Bungie's track record as a marquee developer, having developed Halo on a single platform and selling more than 50 million units lifetime and billions in sales. So that track record and the ability to bring the franchise cost platform represents a very big profit opportunity for the company. Relating to our guidance though, our guidance does assume that Destiny will be marginally profitable this year, given the significant marketing investments for launch, as well as the amortization of development expenses to build the game and the game engine and tools. And long-term, obviously, we think that's going to be a profitable franchise and foundation for us to build off of.

Operator

Our next question comes from Mike Hickey of The Benchmark Company.

Michael Hickey - The Benchmark Company, LLC, Research Division

Just a couple of questions on Call of Duty Online. Looks like you're getting close to closed beta. Just curious, any feedback you may have gotten from the alpha testing and getting in some optimism for the beta launch here shortly? And then, obviously, China is a competitive for first-person shooters, and I guess, in particular, CrossFire, fairly entrenched. Just wondering how you'd best position that game to the market there for success?

Eric Hirshberg

Sure. As I mentioned in my comments earlier, development is going very well and it's actually gaining some momentum. We have, as you know, I think, some of our best development talent working on this opportunity, both from our core Call of Duty studios in the West, as well as our best-in-class back end technology gurus at DemonWare and our team in Shanghai. We also have, I think, the best partner in the market with Tencent, who has built with us a detailed development rollout plan that we're now in the midst of executing. So the indicators so far are really positive across numerous player engagement and tracking metrics that both we and they are using and seeing as positive. So we're entering the large scale close beta testing now. There'll be hundreds of thousands of Chinese gamers playing soon and so we'll know more after that. As far as breaking through the marketplace with an entrenched competitor, we think that our best efforts are making a breakthrough game that will be something that the market hasn't seen that level of quality before. And making sure that we take the time to get it right and to build something that's going to be sticky and is built for the long term. We think that we have that in motion, and if we do, obviously, the market is a huge market and a huge opportunity for us.

Operator

We'll take our next question from Stephen Ju of Crédit Suisse.

Stephen Ju - Crédit Suisse AG, Research Division

So Eric or Dennis, some of your competitors have seen 12% to 15% of new release sales coming from full game digital downloads. Is this pretty consistent with what you've been seeing or should we be thinking about it differently? And further, what is your expectation for the mix of Destiny full game downloads?

Dennis Durkin

Sure. Thanks, Stephen. Dennis here. Yes, obviously, increasing digital downloads on consoles have been very positive margin-accretive tailwind for our industry and one that we expect to benefit from for the foreseeable future. But while day and day frontline digital distribution has only recently come to consoles with the launch of the next-gen systems last fall, we have a unique position of having seen the progression of digital sales with Blizzard products over the last decade, selling directly to consumers via Battle.net. And over that period, today, we now see the vast majority of Blizzard sales are digital. So we know that's a trend that's likely to be followed over the long term in the console space. Last fall, as you point out, digital mix was, on frontline, was in the single-digits as a percentage of our sales mix. And in the first half of this year, we have seen with some of the smaller launches and in catalog titles, that mix climbed into the teens as a percentage of revenue mix. Keep in mind though, when you fast-forward into the fall and into this holiday, our titles are some of the biggest in the industry and attracts some of the broadest audiences. So are likely to have smaller percentages, I'd say, of the total revenue mix, although over time as I said, based on the Blizzard experience, we expect that to continue to trend upward.

Operator

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

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

One follow-up on Destiny. Eric, is there any more takeaways from the beta, for instance, what sort of tweaks are you making to the game from the user feedback? And were you satisfied with the nuts and bolts of the performance around server stability? And then, a quick one for Mike on Warlord, should we assume the uptick in users around that release will be weighted towards the western markets, and thus, be more favorable in terms monetization or would it be more balanced between East and west?

Eric Hirshberg

On the Destiny beta, thanks for the question, on a while, it was certainly a very successful beta, both creatively and technologically. It was the biggest beta of this generation of consoles and the biggest beta ever for a new IP, so we were able to test everything at scale and everything held up well. I don't think it's an overstatement to say that feedback was nearly universally positive. That said, as you might imagine, we learned a lot by watching players engage with the game and hearing their feedback and Bungie is now making tweaks to optimize the game and they actually did so after the alpha as well, so that's going to be, I think, an ongoing process to make it a better experience and nothing is more important to us or to Bungie than delivering a great experience to our community and the beta certainly helped us do that. But I would describe these as tweaks and not major changes as we saw the fundamentals of the game to be very strong. And the good news is because we've got 4.6 million players into the beta, we were able to test the back end at scale and the system performed really well and stably. And we think we're ready for a great launch with a great partner in Bungie.

Michael Morhaime

Colin, thanks for the World of Warcraft question. We would expect World of Warcraft subscribership to bounce back, both in the East and the West. I don't have a prediction on the ratio of that but it's important to note that when you look at the prepurchase of Warlords, that 1.5 million is all in the West. I think, it's also important to note that if you look at the overall sort of health and size of Blizzard's Battle.net community, we're up 40% year-over-year just looking at monthly actives at the end of Q2. So we have a healthy community. I think, the community is ready for new content, and so far, into the beta of Warlords, the feedback has been very positive.

Operator

We'll take our next question from Mike Olson of Piper Jaffray.

Michael J. Olson - Piper Jaffray Companies, Research Division

Turning out to be a big year for Blizzard, and I was just wondering if you could talk about the potential for Heroes of the Storm, and any indication of a more specific timing, and just in general, how we should think about how big of a title this could be? And then, separately, on Call of Duty, to what you attribute the increase in active player count for Call of Duty during this seasonally slower time? And as you said, kind of contradicting the normal Q2 decline, is it a function of interest in the game from those that are purchasing next-gen hardware or do you think it's something else?

Michael Morhaime

So it's still too early to make any kind of projections in terms of the size of the opportunity. We think we have a very strong game and we know that the genre is very large and continues to grow. We think that our spin on the genre is unique and combined with Blizzard's recognizable characters, our design philosophy, which is really trying to create a very approachable team-based game, kind of sets us a little bit apart from some of the competition. We're encouraged by the fact that millions have signed up to test the game and we'll have additional information about timing later in the year.

Eric Hirshberg

On Call of Duty, I think, all we can attribute it to is a strong interest in the franchise and strong activity and strong as ever Call of Duty content. Because of the console transition, we probably have more players engaged in 2 titles at once right now with both Ghost and Black Ops II for those who haven't made the transition yet, so that could be a contributor. But mostly, we just see lot of anticipation for Advanced Warfare, which could lead to increased playtime as well and a strong healthy desire for Call of Duty content to set the stage well for our launch with Advanced Warfare. And we think that, in general, the Call of Duty delivers the best online gaming experience and we're doing so currently and we'll certainly aim to continue to do so with Advanced Warfare.

Operator

We'll take our next question from Neil Doshi of CRT Capital.

Neil A. Doshi - CRT Capital Group LLC, Research Division

Do you think we could see Activision create an online subscription plan where players can access older catalog titles and get early access to new titles? And then, on the Hearthstone game itself, I think, in the past, you guys have said that it was on track to exceed $100 million in revenue. As you launched the iPad and then consider that the broader market with iPhone and Android yet to come, how should we think about that overall number?

Eric Hirshberg

I'll take your first question. This is Eric. As you know, we have a very focused strategy as a company and we tend to focus our resources and our people on the biggest and best creative and commercial opportunities. And right now, I think, we have our strongest slate ever and we're broadening that slate. So we have a lot of focus on and do not make sure we get right in the coming months to keep our temple franchises driving and establishing new ones as well. And we think everything will work and has huge potential. So of course, we're always looking at new opportunities to better serve our players and our communities and we're always evaluating new business models. And once those models are proven, we'll pursue them if we think it makes sense for our players and for our business. But right now, we're continuing to focus on the things we discussed on our call, which include a wide range of business and monetization models and all of which will deliver, we think, the best experience for our fans and a great return for our shareholders.

Michael Morhaime

And on the Hearthstone question, Hearthstone has been exceeding all of our expectations. We're not ready to provide a new specific number but we're very excited about the long-term prospects, especially when you consider further platform expansion to smartphones and a strong multiyear content pipeline that we have planned.

Operator

And we'll take our final question from Arvind Bhatia of Stern Agee.

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

As Eric just mentioned, you guys have a fantastic lineup this year, Diablo III, Destiny, Hearthstone, World of Warcraft expansion pack, one might wonder if this sets up a high watermark for you guys that might be difficult to surpass? Hypothetically, I'm wondering if you can maybe discuss some longer-term trends for you guys, the growth potential of your portfolio beyond 2014.

Robert A. Kotick

Sure Arvind, great question. We obviously have spent a lot of time investing against not just this year but for the next few years and I think we have a great roadmap for opportunity. I think, you know we're very good at prioritizing those opportunities. And I think, among the things that we're the most excited about are the opportunities for new geographies that are getting the benefit of more sophisticated technology like smartphones. When you think about the population of smartphones in places like China, that would be something like 500 million smartphones sold between now and 2020 in China. And when you look at geographies in the past that have been inaccessible to us as a company, whether it's Eastern Europe or Brazil, Indonesia, Vietnam, these are all market opportunities that we're seeing for the first time. I think, when you look at the opportunities for us to provide new services, things like virtual item sales, you look at the changing business models, like we've adopted with games like Hearthstone, we see over the next 3 to 5 years the opportunity to serve greater audiences with deeper, richer experiences. And the pathways that we have for the franchises that we've invested in over a very long time, we spent a lot of time and a lot of resources planning against future opportunities. And so, I think, we feel very good about not just what we have for this year and next year but over the next 5 to 10 years, we see lots of opportunities that have never been available to the company before.

Kristin Mulvihill Southey

Okay. Well, I want to thank you, all, and everyone at Activision Blizzard for your time and consideration and we look forward to talking to you soon.

Operator

This concludes today's conference. Thank you for your participation.

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Source: Activision Blizzard's (ATVI) CEO Bob Kotick on Q2 2014 Results - Earnings Call Transcript
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