Activision Blizzard's CEO Discusses Q3 2011 Results - Earnings Call Transcript

| About: Activision Blizzard, (ATVI)
This article is now exclusive for PRO subscribers.

Activision Blizzard (NASDAQ:ATVI) Q3 2011 Earnings Call November 8, 2011 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

Kristin Mulvihill Southey - Former Vice President of Investor Relations

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

Eric Hirshberg - Chief Executive Officer of Publishing Unit


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

Douglas Creutz - Cowen and Company, LLC, Research Division

Jeetil J. Patel - Deutsche Bank AG, Research Division

Neil A. Doshi - Citigroup Inc, Research Division

Brian J. Pitz - UBS Investment Bank, Research Division


Good day, and welcome to the Activision Blizzard's Third Quarter 2011 Earnings Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn today's call over to Ms. Kristin Southey. Please go ahead.

Kristin Mulvihill Southey

Good afternoon, and thank you all for joining us today. With me today are Bobby Kotick, CEO of Activision Blizzard; Thomas Tippl, COO and 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 forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties. As indicated in the slide that is showing, a number of important factors could cause the company's actual future results and other future circumstances to differ materially from those expressed in any forward-looking statements.

Such factors include, without limitation, the sales levels; increasing concentration of titles; shifts in consumer spending trends; current macroeconomic and industry conditions and conditions within the video game industry; our ability to predict consumer preferences among competing genres and hardware platforms; the seasonal and cyclical nature of our industry; changing business models, including digital delivery of content, competition, including from used games; possible declines in pricing, product returns, price protection, and product delays; adoption rate and availability of new hardware and related software; rapid changes in technology and industry standards; litigation and associated costs; 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, 2010, and in the company's other SEC filings. The company may change its intentions, beliefs or expectations made at anytime and without notice, based upon any changes in such factors in the company's assumptions or otherwise. The company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after today, November 8, 2011, 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 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 share-based payments, expenses related to the restructuring of our Activision Publishing operations, the amortization of intangibles and impairments of intangible assets and the associated tax benefit. Please refer to our earnings release, which is posted at for a full GAAP to non-GAAP reconciliation and further explanation.

There's also a PowerPoint overview, which you can access with the webcast and which will be posted to the website following the call. In addition, we will also be posting a 12-quarter financial overview highlighting both GAAP and non-GAAP results.

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

Robert A. Kotick

Thank you, Kristin, and thank you all for joining us today. As you can see from our quarterly results and our updated outlook, Activision Blizzard is having a year of many records. While we have powerful franchises, fantastic brand recognition and some of the industry's finest technologies and marketing skills, what enables us to achieve records every year -- the highest game rankings, record-setting sales, standout marketing programs or stellar financial results, what enables these accomplishments is a team of people around the world committed to excellence.

Our conference call is focused on our financial statement, but our balance sheet doesn't reflect the incredibly talented, driven, enthusiastic people who come to work at Activision Blizzard every day. We're one of the world's best entertainment companies because of the dedication and hard work of an extraordinarily accounted group of people, who are the driving force behind our superior financial performance. The passion and dedication that our teams around the globe bring to each and every project is truly remarkable.

As we assess our success this year, we're entering rarefied territory. Life-to-date sales for World of Warcraft and Call of Duty now rank with worldwide box office sales for Star Wars and Harry Potter, 2 of the most successful entertainment franchises of all time. And our industry-leading capability to develop original, globally-appealing innovative intellectual property, which we do exceptionally well, continues with Skylanders.

For the third quarter, Activision Blizzard delivered better-than-expected results driven by record revenues from online channels and the continued strength of our online-enabled franchises. Today, we're raising our 2011 revenue and EPS outlook and now expect to deliver record operating margins and earnings per share, reflecting the strength of our business and confidence in our ability to engage audiences with our uniquely immersive experiences.

We remain the largest, most profitable independent interactive entertainment company. For the past 3 consecutive years, we've delivered record operating margins and earnings per share, something few companies have been able to achieve, especially in a volatile economic environment. Our consistency and success are driven by 2 things: our collaborative corporate culture, which attracts the industry's most talented, creative and capable people; and our focus on our long-term objectives, which are: a commitment to our audiences to build successful franchises through innovation, strengthening our global execution capabilities, selectively developing new intellectual property and emphasizing financial discipline across all levels of the organization that provide superior shareholder returns.

These core tenets have served us well for more than 20 years and allowed us to successfully leverage the changes in entertainment driven by technology advancements. Through many platform and business model transitions, we've emerged the stronger, more capable leader. And today, we are better positioned than ever before to capitalize on the opportunities afforded by the expanding digital entertainment landscape. By delivering rich content and engaging persistent online experiences, we have developed some largest, most dedicated communities in the world. Our scale, expertise and strong balance sheet provide us with a competitive advantage and allow is to invest heavily in our service platforms to deliver 24/7 entertainment experiences to our audiences around the world.

Today, our online platforms, and Call of Duty Elite supports millions and millions of unique users and allow us to deliver content and capabilities directly to them. As a result, we continue to build stronger relationships with our audiences than ever before. We're pleased to announce that at 12:01 this morning, we launched Call of Duty: Modern Warfare 3 and Call of Duty Elite.

First, I'd like to thank the immensely talented teams at Infinity Ward and Sledgehammer Games, who have delivered Modern Warfare 3, which deems on track to be the most successful Call of Duty game ever. Preorders for Modern Warfare 3 set a new industry record, and were well ahead of last year's record-setting Black Ops, which went on to become the best-selling video game of all time.

The launch of Modern Warfare 3 was the largest in Activision Blizzard's history, and our global organization remains laser-focused on delivering the largest entertainment launch of all time for the third consecutive year, and to exceed the record set by Black Ops life-to-date. I'd also like to thank our Beachhead and Demonware teams who built the innovative online platform Call of Duty Elite from the ground up. Elite represents the next step in social connectivity and should set a new standard for online entertainment.

Also, with respect to industry firsts, I want to thank everyone at our wonderful studio, Toys for Bob, for all their inspired work on Skylanders. The game has received outstanding critical response, and although it's early in the quarter, so far Skylanders is performing ahead for our expectations.

Modern Warfare 3, Call of Duty Elite and Skylanders are all extraordinary examples of how we continue to redefine entertainment around the world. 2011 is turning out to be another year of records and looking ahead to 2012, we expect to deliver profitable growth based on the strength of our content and our services.

And for the future we expect and for the future, we expect great things from strong portfolio of online-enabled properties, our service platform capabilities, new business models and increased revenues from casual, social and mobile entertainment. We remain well positioned for the many opportunities we believe lie ahead, and we'll pursue them with the most talented, passionate people in our industry.

Now I'd like to turn the call over to Thomas.

Thomas Tippl

Thank you, Bobby. I'll begin with a recap of our third quarter and year-to-date results, followed by a review of our increased outlook for the fourth quarter and full year and provide some initial comments for 2012. For your reference in the press release, there's a set of schedules that provide non-GAAP comparables, and these will be the numbers I'm referring to unless otherwise noted. Please refer to our earnings release for a full GAAP to non-GAAP reconciliation. Also note that the numbers I'll be quoting are compared to the prior year, unless otherwise noted.

For the third quarter, on a GAAP basis, we generated revenues of $754 million and record earnings per share of $0.13. For the third quarter, on a non-GAAP basis, we generated revenues of $627 million and EPS of $0.07, representing our 13th consecutive quarter of non-GAAP EPS generation. As expected, our results were below prior year due to the fewer large scale launches, but were well ahead of expectations as revenues from digital channels increased to a new third quarter record of $386 million

Our strong performance for the quarter and year-to-date has been driven by our products with online integrations and digital revenue streams, including Blizzard's World of Warcraft and Activision's Call of Duty. For the first 9 months, GAAP revenues from digital channels, including subscriptions, value-added services, downloadable content and full game downloads, increased 25% over the prior year and accounted for 38% of total revenues, driving a record 39% operating margin and a record EPS, which increased 62% over the prior year. On a non-GAAP basis, year-to-date revenues from digital channels increased 16% over the prior year and accounted for 60% of total revenues, driving a record 23% operating margin and record earnings per share, which were up 15% over the prior year.

Turning to the P&L line items for the third quarter. Please note that all percentages are based on net revenues, except the tax rate. For GAAP, product costs were 26%; operating expenses were 52%; and our tax rate was 11%. Non-GAAP product costs were 30%. This is down from our prior outlook due to digital overperformance. Non-GAAP operating expenses were 57%, significantly lower than our prior outlook, due mainly to operating leverage from strong digital top line performance and term movement of expenses from Q3 to Q4. Also, our tax rate came in lower due to discrete benefit items resulting from the September filing of our 2010 tax returns. This benefit amounted to about $0.01 of EPS.

Turning to the balance sheet. On September 30, we had no debt and approximately $2.9 billion in cash and investments, roughly in line with the prior quarter. Our receivables balance was $139 million, down $107 million versus the prior year due mainly to fewer releases.

Inventories of $207 million increased sequentially ahead of the Skylanders launch, but was down $51 million versus the prior year due to a reduction of peripheral inventory. Capitalized software development costs were $254 million, a decrease of $21 million versus the prior year, also due to fewer titles in 2011.

With respect to cash flow, for the trailing 12 months, our operating cash flow and free cash flow were over $1 billion, despite significant investments in the most robust pipeline of new products and services Activision Blizzard has ever had. Our ability to not only invest but also generate returns on investments is what continues to set us apart from most of our competitors.

So let me now move on to our outlook. As we have said, this year, we are focused on 3 initiatives to drive operating margin expansion and long-term growth. So let me quickly recap our progress. First, we continue to focus on our high margin digital business and online-enabled franchises.

To put our strength in perspective, for the trailing 12 months, we generated $1.7 billion in digital revenues, up more than 22% versus the prior 12 months. Importantly, these digital revenues generated operating margins in excess of 50%. Our digital scale and operating income generation is also well ahead of anyone in our industry, and looking ahead, we have more online product and services in development than ever before.

Our second initiative to drive operating margin this year is to streamline the Activision Publishing business for higher profitability and online expansion. And this year, Activision Publishing alone is projected to generate record digital revenues and a record operating margin of more than 26%. And as I mentioned a minute ago, we are investing for the future to build our pipeline, extend our digital leadership and expand our core brands.

We continue to allocate the vast majority of our internal investments to our bigger franchises and online product and service capabilities, including Call of Duty and the Elite online service, the new Call of Duty micro-transaction game for China, Bungie's new gaming universe, World of Warcraft, StarCraft, Blizzard's next-generation MMO, and Diablo III, with its new real money option house model and our social and mobile initiatives.

So in summary, we continue to execute against each of our stated goals, and our strong execution this year has enabled us to increase our financial outlook for the third time this year. So now, on to the specifics of our outlook.

In terms of our 2011 GAAP outlook, we now expect revenues of $4.33 billion, up $150 million from our prior outlook and EPS of $0.76, up $0.08 from our prior outlook. For the calendar year, we expect GAAP product cost of 25% and operating expenses of 48%. We project a GAAP effective tax rate of about 25% and a diluted share count of about 1.2 billion.

On a non-GAAP basis, we are increasing our revenue outlook to $4.25 billion, up $200 million from our prior outlook. And we are increasing our non-GAAP EPS outlook to $0.85, up $0.08 from our prior outlook. Since February, when we gave our initial calendar year outlook, we have increased our earnings per share expectation by more than 20%, and are now on track towards another year of record EPS even without a single Blizzard frontline release.

2011 is expected to mark the third year in a row, since our merger, that we have generated record earnings despite the economic downturn. For the year, on a non-GAAP basis, we expect product cost of 28%, resulting in the highest gross profit margin in our history, driven by our continued transition to digital products and services. We also expect operating expenses of about 41%, and projecting an effective tax rate of 26%, and a diluted share count of about 1.2 billion.

For the calendar year, we continue to expect the combination of our strong online-enabled franchises and the streamlining of our Activision Publishing business to produce a record GAAP operating margin of 27% and a record non-GAAP operating margin of 31% for the combined company. And we see more opportunity for future margin expansion as we continue growing our share of digital revenue, which, for us, generates significantly higher margins than our corporate average.

Now moving to the December quarter. On a GAAP basis, we expect revenues of $980 million, product cost of 27% and operating expenses of 86%. We project an effective tax rate of 24% and a basic share count of 1.2 billion and a GAAP loss per share of $0.08 due to revenue deferrals.

In terms of non-GAAP, we expect revenues of $2.17 billion, product cost of 26% and operating expenses of 34%. We project an effective tax rate of 27%, which is in line with the prior year and a diluted share count of 1.2 billion. We expect EPS of $0.55, which reflect our increased product expectations, offset somewhat by the movement of expenses from the third to the fourth quarter.

In summary, the year is progressing with great momentum and this gives us further confidence that the growth objectives we presented at our recent analyst day are achievable. In fact, with our increased outlook for the year, we are generating shareholder value even faster than anticipated. And the early look at how our 2012 slate is coming together suggest another year of profitable growth, and record EPS is ahead of us. As always, we look forward to sharing with you the details of our 2012 annual operating plan on our February call.

So now, let me hand it over to Eric to discuss our Activision Publishing business.

Eric Hirshberg

Thanks, Thomas. Today, I'm going start with some high-level comments on the industry, and then I'll discuss Activision Publishing's performance in Q3 and year-to-date and provides some commentary around our recent launches, the groundbreaking Skylanders: Spyro's Adventure, our best-in-class digital platform, Call of Duty Elite and what is, by just about any metric, the most anticipated game of all time, Call of Duty: Modern Warfare 3.

Starting with the industry. The biggest and best titles continue to grow fueled by the expanding HD console installs base, which accounts for a larger share of the industries revenues and profits than ever before. Gamers increasingly prefer online multiplayer games, which is one of the reasons the games that do the best job igniting connected communities of gamers continue to get bigger. We're seeing more and more gamers' time and dollars invested in the true must-have games. These trends underpin our strategy of focusing more of our creative talent and capital on our biggest and best franchises, and our performance continues to validate this strategy.

Now, let's talk about hardware. We ended the third quarter with an installed base of 291 million current gen systems in North America and Europe, and we expect to end the year at 312 million units, the highest ever and up 16% over the prior year. Within that, we expect the installed base of online-enabled consoles, specifically Xbox 360s and PS3s, to increase even faster, by 24% to 92 million.

In addition to seeing growth in online-enabled console games at retail, digital sales remain the fastest-growing most profitable part of the industry. We estimate that in the U.S. and Europe, sales of digital content grew double digits in the third quarter, and we continue to expect similar rate of growth for the full year.

Today, more consumers than ever before are engaging in interactive entertainment, driven by the largest hardware installed base ever of current gen systems and the tremendous installed base of browser-based devices. The proliferation of all these platforms continue to create significant worldwide opportunities for the best games with the most passionate audiences, especially online-enabled franchises, such as Call of Duty.

Year-to-date, Call of Duty: Black Ops has been a driving force behind both retail and digital sales. For the first 9 months of the year, Black Ops has remained #1 title in U.S. and Europe, generating more revenue than any new major console release. In addition to retail sales, Call of Duty: Black Ops has sold more than 20 million Map Packs. The revenues generated from Map Packs alone would make it the third largest console title of the year.

In the September quarter, we released a fourth Map Pack, something we've never done before. And not only did it positively impact our quarterly results, but it further demonstrates that there is continued consumer interest in the content even 11 months after the launch, making playing Call of Duty truly a year-round activity for millions of our fans. This should bode well for Call of Duty Elite, a key feature of which is providing a constant stream of new digital playable content to our fans throughout the year

Now I want to spend a few moments talking about our largest launches of the year, as they exemplify the approach we're taking to our business. First, we continue to focus on growing our proven franchises to investment in innovation and second, we selectively develop new intellectual property, which we believe has unique, differentiating and breakthrough appeal to gamers, as well as having long-term franchise potential.

We think we have found such a franchise with Skylanders: Spyro's Adventure, which launched on October 16. It's a great example of how we're approaching new innovative online-enabled IP. Obviously, we put a tremendous amount of passion, imagination and innovation to the creation of Skylanders and the result is the world's first truly cross-platform game, which brings the world of toys, video games and the Web and mobile together like never before.

Separately, the market for toys and games each represent big opportunities. In fact, in the West, the markets for toys is actually bigger than the market for video games. So franchises like Skylanders, which brings these 2 audiences together, represents a significant opportunities.

In terms of creating awareness and excitement, Skylanders is already on many of the most influential lists for the top toys of the holidays including the Toys "R" Us Holiday Hot Toy List, the Toy Insider "Hot 20 List" and Time to Play's "Power Ups" holiday toy list.

We'll also be supporting the game with our largest marketing campaign ever for a new property, which includes a heavy TV campaign in the U.S. and Europe and extensive mall and home tours to generate hands-on trial, as well as a 2-minute 3D trailer in theaters, which runs in front of a number of holiday movies, including Puss in Boots, Happy Feet Two and The Muppets.

Even though it's a new intellectual property, our retail partners have embraced Skylanders as though we're an established franchise, giving us unprecedented shelf space and store presence. This includes thousands of powered interactive kiosks where kids can take any toy off the peg, place them on the floor while still in their packaging and bring them to life right in the store. This is a critical feature for a game were our most powerful form of marketing is demonstration.

So what are we seeing since the launch? Well, the gamers reviews have been incredibly strong, especially for a kids title. Gamers received an average 87 ranking across 5 platforms according to And my favorite are some of the reviews from the hard-core gamer press who really seem to love it. In addition, we've heard some incredible stories of how the toys are sparking kids imaginations and how parents are embracing the game, not only as a game for their kids, but to play with their kids.

And while it's still very early in the holiday selling season, the game is performing ahead of our expectations in both starter pack sales and the sale of individual toys. As of today, there are already millions of toys in the hands of children around the world. Of the 30-plus characters, some are already very hard to find, and we've already seen Skylanders characters sell for as much as $70 on eBay.

Finally, after only a few weeks in the market, literally all of our major retail partners across all territories have already placed reorders.

We've talked about Skylanders' many innovations and the warm critical receptions received, but I want to take a moment to talk about its value. For $69.99, kids get 3 toys, the portable power, a video game with a 30 level single player mode, coop game play and endless hours in battle mode. It also comes with a vast connected web world at no extra charge, as well as poster and trading cards. When you consider the 3 average toys with no interactive capabilities whatsoever and an average new video game would cost you more than the Skylanders starter pack, I think it's fair to say that it's an exacting value proposition for the holidays.

And as excited as we are about the games performance to date, like any new IP, Skylanders will take time to reach its full potential. We have momentum growing into the peak holiday selling season and have strong brands to continue building awareness and demand for the game. I look forward to updating you on our holiday performance and the growth of Skylanders in coming quarters.

Now, I'd like to spend the rest of my time today discussing today's launch of the most successful -- of one of the most successful entertainment franchises ever and the only entertainment properties to set launch records for 2 and hopefully 3 consecutive years, Call of Duty. By all metrics, the hours of engagement, digital content sales, purchase intent and most recently, record-shattering preorders, Call of Duty franchise continues to grow.

Preorders for Call of Duty: Modern Warfare 3 outpaced preorders for Call of Duty: Black Ops by a wide margin, setting a new industry record in making it the most preordered game of all time. In fact, we have more than 1.5 million people stay up and stand in line at thousands of midnight events at stores worldwide to be the first to buy the game.

The momentum of the franchise over the last 2 months has been unprecedented, even in the face of a number of aggressive, competitive launches. Not only did our preorders of Call of Duty: Modern Warfare 3 continue their record-setting pace during the last 2 months, but remarkably, before, during and since our competitors' launches, Call of Duty: Black Ops maintained its status as the most played game on Xbox LIVE, and Call of Duty: Modern Warfare 2 remained the second most played game on Xbox LIVE. This is pretty incredible given that these titles are 12 and 24 months old, respectively, and are still ranked ahead of several much hyped titles launched this year. That, combined with the record-setting presales of Call of Duty: Modern Warfare 3, should serve to demonstrate that our fan base is more engaged than ever, the strength of the Call of Duty brand is stronger than ever and in fact, is still on the rise.

Which brings us to the next chapter in this great franchise, Call of Duty: Modern Warfare 3. MW3 offers gamers the complete package. It offers the most epic, cinematic, adrenaline pumping single player yet, the most refined balanced and innovative multiplayer yet, a dramatic reimproved coop mode with spec ops and an all new survival mode. And with the addition of Call of Duty Elite, we have now added one more key pillar, which is to help of all of our players at every level play together better.

We believe that the free Elite service is the best free service in the industry and dramatically increase the value of buying the game for all of our players. And the premium subscription for Elite quite simply resets the bar for multiplayer experience, with several industry firsts in innovations and services. And although it's still extremely early, we've been very pleased with the attach rate of the purchase of Call of Duty Elite premium subscription with the preorder of Modern Warfare 3 when available.

In terms of establishing expectations for an unproven model like this, it's very hard to forecast. But if you look at companies with a similar fee-based subscriber model like Xbox LIVE or Netflix, it took each of them at least a year to reach 1 million paid subscribers. And based on our Elite preorders alone, we expect to meet that milestone a lot sooner.

It's also important to note that those players who still prefer to purchase the downloadable content a la carte at their discretion throughout the year will still be able to do so. We have taken nothing away from our players. We have added a tremendous amount to the value of the game with the free service and the premium service will deliver a new level of social connectivity for Call of Duty gamers around the world.

We've already had an incredible response to Call of Duty Elite from the moment it went live. Player registration request for our new live services have exceeded even our most optimistic expectations, which have created some bottlenecks in the registration process. We've already registered over 1 million players, and we've been working round-the-clock to increase registration capacity as quickly as possible. Keep in mind these issues have no impact on players' ability to play Call of Duty: Modern Warfare 3.

The record number of preorders from Modern Warfare 3 drove the largest Day 1 shipments in our history and in the industry's history. In addition, we kicked off the launch of 12:01 this morning with more than 13,000 retail events around the world, making it the largest retail release in Activision's history and in the industry's history

And finally, we cannot be more pleased with the global game reviews, which punctuate the amazing job that our incredible teams at Infinity Ward, Sledgehammer and Raven have done. But don't take my word for it, as of this morning, Call of Duty: Modern Warfare 3 already had 11 perfect scores posted and has received an average 90 rating from both Metacritic and

Specifically, IGN says, "The multiplayer is hands-down the best it has ever been with more features, more modes and a ton of new levels and ways to interact via Call of Duty Elite " Joystiq says, "the Modern Warfare franchise has twice set the bar for what this kind of blockbuster shooter should be, and Modern Warfare 3 doesn't break the streak."

The U.K. Telegraphs says, the game not only to lives up to the hype but exceeds it. And Planet Xbox 360 said, "If you have only $60 to spend this holiday season, it should be on the best Call of Duty game ever created, and that game is Modern Warfare 3." I really hope people listen to that one.

So in summary, this year, we have delivered innovation with both Skylanders and Call of Duty: Modern Warfare 3 and Call of Duty Elite, which are firsts for the industry. We also expect to generate the highest operating margins in Activision Publishing's history, which shows that our strategy of focusing our time, investment and creativity against our highest potential opportunities is working.

We're excited about our pipeline of online-enabled properties and services and remain committed to providing the very best interactive entertainment to our players around the world. I'm looking forward to updating you on our holiday performance on the next call.

And now, I'd like to turn it over to Mike Morhaime to update you on Blizzard Entertainment.

Michael Morhaime

Thank you, Eric. So Blizzard just enjoyed another successful BlizzCon a few weeks ago, sharing exciting news with 26,000 live attendees and more than 1 million online viewers from 144 countries around the world. We made several big announcements. These included the world premiere of our new World of Warcraft expansion, Mists of Pandaria and a showcase of the multiplayer side of our StarCraft II expansion, Heart of the Swarm.

We also featured our upcoming Blizzard DOTA free-to-play online game and generated even more excitement for Diablo III. We hosted packs of crowds for our most exciting e-sports tournaments yet. And finally, we announced our World of Warcraft annual pass. I will go into more detail on everything in a moment, but first, I want to touch on our results for the past quarter.

Our revenues for the third quarter 2011 are down versus last year, which included the record-setting launch of StarCraft II. World of Warcraft finished the quarter with 10.3 million active subscribers worldwide, which is down from the previous quarter. While the majority of these declines are coming from the East, World of Warcraft continues to be one of the most popular online games in China and remains by far the most popular subscription-based MMO in the world.

That said, we know there are improvements that we can make in gaming content. The level-up content in Cataclysm is some of our best works. But it was consumed quickly compared to our past expansions set, Wrath of the Lich King. Once players reached max level, the end-game content in Cataclysm is more difficult. Balancing this content for our diverse player base can be very challenging.

Our development team is constantly analyzing the game, and we're continuing to explore ways that we can adjust the game to better satisfy both hard-core and casual players. To that end, our next free major content update for World of Warcraft is already in testing and will be available for players in the coming weeks.

This is our largest update since Cataclysm launch. It will include our biggest and best rated content ever, featuring the iconic dragon Deathwing, as well as a new raid finder feature. The raid finder will make it easier than ever for casual players to experience end-game content, and it will open up a big part of the World of Warcraft to more of our players.

Looking beyond our next content update, the development team is already hard at work on our next expansion set, Mists of Pandaria. We introduced the Pandarian race to the Warcraft universe with Warcraft III, and players have already been -- always been eager to see them introduced to World of Warcraft. We're finally making them a playable race in Mists of Pandaria.

And the announcement trailer has already collected more than 3 million views on YouTube. We'll be introducing a number of new features to World of Warcraft this expansion set. But one that's gotten a lot of positive buzz from players and press is our new pet battle system, which we believe will be very appealing to casual players. For hard-core players, we have plans to focus the story heavily on the Horde alliance conflict. Combined with some new PVP features, we believe the new expansion will have a lot of appeal for our diverse audience.

Aside from the new expansion set, we made another exciting announcement at BlizzCon, the World of Warcraft annual pass. The annual pass is an initiative we created to reward the loyalty of our current subscribers, as well as welcome back lapsed players. The deal is pretty simple, if you make a 12-month commitment to World of Warcraft, we give you Diablo III for free, along with an invitation to the next World of Warcraft beta and an exclusive in-game mount.

This is a limited time offer that's only available to players who had already created a World of Warcraft account as of October 18. We have received a tremendous response to this promotion, and we believe it's a great way for us to leverage the size and passion of our World of Warcraft player-base to drive even more momentum around Blizzard games.

We have other aggressive marketing plans in the coming months for World of Warcraft, but we're not ready to share details yet.

Closing out our discussion on World of Warcraft, we have recently announced that a new localized version of the game will hit the Brazilian market on December 6. As we mentioned in the past, Brazil is one of the fastest-growing markets in terms of online connectivity and is already in the top 10 countries in terms of broadband users. We're looking forward to seeing how our expansion into Brazil, our new content updates and other initiatives contribute to the growth of World of Warcraft.

Moving on to StarCraft II. We showed off the multiplayer aspect of Heart of the Swarm at BlizzCon for the first time. Players were very excited to try out the new units, and the game has generated a ton of buzz. The new sizzle trailer that we released for the game has also gotten a lot of press and attention with more than 1 million views on YouTube.

In addition to Heart of the Swarm, the StarCraft development team has been hard at work on a new free-to-play online game, Blizzard DOTA. This game was created by our development team using the StarCraft II engine, and we debuted a new version of it at BlizzCon. Blizzard DOTA drew a lot of positive interest from press who attended the show and will be our entry into an increasingly popular genre of online games. Similar games in the market operate on a free-to-play basis with micro-transaction elements. With that in mind, we're currently exploring what type of business model will work best for Blizzard DOTA, and look forward to sharing more information about the game in the near future.

On the Diablo III front, we are still targeting an early 2012 launch. We've been collecting great feedback from our ongoing beta test and BlizzCon, and the team is using that feedback to continue polishing and improving the game. We've also been testing the gold auction house functionality through the Beta and are gearing up to test the real mining systems very soon.

We have very high expectations for Diablo III. The buzz surrounding the game continues to the tremendous, and our debut of a new trailer for the game at BlizzCon was one of the highlights of the show.

In closing, 2012 is shaping up to be one of the busiest and most exciting years in Blizzard's history. We plan on having at least 2 major releases, and as BlizzCon demonstrated, we have a lot of great games coming down the pipeline. We continue to invest in development and customer service to support long-term growth. But for now, the company is focused on execution and getting these great games out for our players.

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

Kristin Mulvihill Southey

Okay, operator, we're going ready to take questions.

Question-and-Answer Session


[Operator Instructions] And at this time, we will go to Brian Pitz with UBS.

Brian J. Pitz - UBS Investment Bank, Research Division

Can you give us some additional color on what's happening to engagement and subscriber levels for World of Warcraft, particularly following that big expansion pack announcement? Where do you think the subscribers are actually going? And I've got a quick follow-up.

Michael Morhaime

Okay. Well, as you know, we don't provide a forecast on subscribership levels. What I'll say is that the announcements at BlizzCon were incredibly well received. There's a lot of excitement around the expansion and the upcoming content in the next patch, which will be introduced in the next couple of weeks. It is currently in test on our public test realm, and we're very excited about that content. I guess, I can say this, the majority of the declines were in the East. China still represents more than half of our global player base and historically, December has been a very good month for subscriber trends. We have a number of initiatives planned. We plan to be very aggressive in terms of our marketing promotions, and we're looking forward to the end of the year.

Brian J. Pitz - UBS Investment Bank, Research Division

Great. And maybe this is a question for Thomas, as well. How should we think about the Diablo III promotional offer that's being provided with the annual subscription option?

Thomas Tippl

From our perspective, the reception to the offer has been phenomenal. As you would expect, I think, it's a tremendous value offer for existing and lapsed players. So we're not surprised. And I think it's going to continue to help broaden and deepen the engagement of the Blizzard community overall, and I think that's particularly desirable to us because as we look into the future, I think we recognize there's more competition heading into the MMO genre overall because it's a very attractive genre. And so we want to make sure we continue to offer our players, not only the best content but also the best value.

Brian J. Pitz - UBS Investment Bank, Research Division

And should we assume that's a margin-neutral event for the most part?

Michael Morhaime

Well, we think that it is -- the more interest that we drive towards Diablo III, we think the more interest our players will continue helping to drive for us Diablo III.

Thomas Tippl

And I think from a margin perspective, I think that it still remains to be seen. As you know, Diablo III launches with a real money auction house. So it provides an opportunity to potentially generate high-margin revenues from additional Diablo players which we might not otherwise get to. But I think obviously, that's still early days, and we'll find out about that once we use the product in the market.


Moving along, we will go to Neil Doshi with Citi.

Neil A. Doshi - Citigroup Inc, Research Division

Thomas, I had a question about the Blizzard operating margins. It looks like margins have been coming down from the traditionally high 50% range to now kind of 40%. How would you think about margins going forward? And would we continue to see continued pressure on Blizzard margins? Or has most of the development been done there, and we can hope to expect margins get back in that 50% range?

Thomas Tippl

I don't think it's a surprise that this year the margins are down because we are developing a whole host of products within Blizzard. Effectively, we have 5 products in development, none of which has launched this year. So you got all of the development costs and none of the revenue. So next year, we are seeing at Blizzard, as Mike mentioned earlier, a minimum of 2 releases. So I think with that kind of additional leverage on the top line, I think you will see those trends reversing.

Robert A. Kotick

And things like the auction house, where it's still -- we haven't shared a lot of detail about what the margin strategy looks like, but obviously, it's a very high-margin component of the overall franchise.

Michael Morhaime

Yes, I think it's a difficult comparison this year because if you look at last year, we had 2 major launches. This year, 0.

Neil A. Doshi - Citigroup Inc, Research Division

I understand. Okay. And then Mike, on the Diablo beta, what learnings have you found so far from the players' community and how's the auction house testing going relative to your expectations?

Michael Morhaime

Feedback and testing have been extremely positive in the beta. Keep in mind, the amount of content that we're exposing to players is very limited because we do want to save the vast majority of that content for the actual release. But even within that small amount of content, people are playing it over and over, experiencing with the various characters, and we've been reading the feedback and talking to people at BlizzCon. One of the most common questions that I got asked at BlizzCon was just, hey, they want to get their friends into the beta, how do they do that? Of course, it's very difficult to do.


Next up, we'll hear from Conor Irvine with Deutsche Bank.

Jeetil J. Patel - Deutsche Bank AG, Research Division

It's Jeetil Patel. A couple of questions. One, as you look at the Diablo, Warcraft bundling strategy, I guess, the idea behind that is to get as many users on Diablo and the real opportunity from a modernization standpoint will be auction house in terms of the transactional flow there. I'm curious. How much do you think there'll be in terms of the cannibalizations of the pre-packet offer sale through the bundling strategy? And then second, on Warcraft, 10.3 million subs, what's your best guess as to where that number kind of settles in at as we look out over the next 12 months or so?

Thomas Tippl

All right. First, Jeetil, on Diablo, I think that benefits that we see from the Diablo are really two-fold. I think one, it's going to -- because it requires a 12-month subscription to World of Warcraft, it's going to extend the subscriber life. And as a result, it's going to generate more revenues, more high-margin revenues at World of Warcraft. And in addition, as Mike and Bob had mentioned earlier, we also think that the larger the Diablo community is and the larger the marketplace around Diablo's real money transaction auction house is, the greater the opportunity to also generate income and have a long tail behind Diablo. And then on the subscribers, Mike mentioned earlier, we're not providing any subscriber forecast. We haven't done so in the past. We're not starting right now. I think we're providing you a financial forecast, which includes, as always, prudent proven assumptions around all of our variables that go into our financial plan.

Jeetil J. Patel - Deutsche Bank AG, Research Division

Maybe if you look at Auction House going backwards to the prior Diablo or maybe what you're seeing in early testing, can you talk about how many transactions the average player typically does in a given month? Is there a way -- any way to quantify that?

Thomas Tippl

There isn't really because the experience that we are going to offer is going to be so much better than anything players were able to see in the past on Diablo. So where we are really looking is -- so that's number one. Number two, I think, the general acceptance of gamers for our different types of business models existing in the past in terms of more micro-transaction base has increased substantially over time. So we are really looking more for benchmarks really outside of currently relevant micro-transaction games. And as you know, those trends have been very encouraging. But for us, we'll have to see until we get into the marketplace. I mean, if we didn't think it's a significant opportunity, we won't be doing it.

Michael Morhaime

So let me just add to that. It's really impossible to extrapolate behaviors from the limited beta experience we're offering to the more open-ended ultimate Diablo III experience. But if you look at Diablo II and even Diablo I player behaviors, there was a big need to trade items between players, and we found that a lot of our players were going to third-party sites to perform that trading. And the main reason that we're doing this is to provide them a safe and secure environment to perform this trading. We think it's going to make for a better game. We think it's going to lead to longer engagement with the game. But in terms of the volume, I think it's very difficult to predict.


Moving forward, we will go to Eric Handler with MKM Partners.

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

Just out of curiosity, when you've had big patches before with World of Warcraft, what type of subscriber uplift do you typically see? And then going to an alternative question with Skylanders, I'm just curious what type of attach rates you're seeing with the action figures with the game purchase.

Michael Morhaime

Well, historically, with the content updates that we've done, it's really not intended to go out and drive new user acquisition, that's a whole other strategy. But it does drive engagement with the game, and so that will impact churn, if we do it successfully and eventually will drive win back, as players tell each other about the content they're enjoying. We'll hopefully see a lift in our ability to win back players that may have already churned.

Eric Hirshberg

And in terms of Skylanders, we're not going to discuss exact attach rates but it is -- we can say that it is higher than we expected.

Thomas Tippl

It's surprising this early in the game because people are going in the store and they're not just buying a starter pack, but because of the attractiveness of the toys and the value proposition of the toys itself, we are seeing a lot of initial purchases including already toys beyond the starter pack.


And moving forward, we will go with Doug Creutz with Cowen and Company.

Douglas Creutz - Cowen and Company, LLC, Research Division

I was wondering if you could talk a little bit about where you are in terms of your plans to expand Call of Duty to China?

Eric Hirshberg

What we can say is that the development process is going exceedingly well. We already have possible versions of the game on the proper technology, and it translates beautifully to that market. We've built a micro-transaction engine, and it looks -- the game, I think, looks regulatory compared to what is currently available in the genre in the market. So development goes very, very well, and our plans are ahead of schedule.


And the final question today will be from Edward Williams with BMO Capital Markets.

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

Just a quick question. Eric. If you can just give us a little bit more color on Call of Duty Elite. What -- how significant is that -- Thomas, maybe this is more directed for you, but how significant it is in the current quarter? And then Eric, how should we think about it going into calendar '12 where I imagine the impact is considerably larger?

Thomas Tippl

Well, I think -- in the short-term I don't think it's going to move the needle significantly on our December quarter results, and that's largely driven by the fact that we are going to amortize the 12-month membership over the 12-month period. But there's just not enough time left to really move the needle dramatically into the December quarter. But obviously, we are setting up very fast [ph] to generate revenues particularly for 2012.

Eric Hirshberg

And in terms of how to think about it going forward, I think a lot of depends on the adoption rate. I think at the very least, we wanted to significantly expand the value proposition around the franchise and create greater value for every player, which we've done with the free service significantly. And depending on the adoption rate, it could really fundamentally change the way the community plays the game, which is our hope because it's the best way for us to deliver continuous content throughout the year, and to do some of the innovative things we're doing like manage community-wide competitions for real prizes. The greater the adoption rate, the greater the potential it has to change the game.

Robert A. Kotick

I can tell you, Ed, it is a key strategic priority for the company, and there are a lot of resources focused on it. And we're very enthusiastically supporting it.

Kristin Mulvihill Southey

Okay. Well, thank you, all. And on behalf of everyone at Activision Blizzard, we thank you for your time and interest and look forward to talking to you soon.


And again, this does conclude today's conference call. Thank you 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!