Activision Blizzard (ATVI) Robert A. Kotick on Q3 2015 Results - Earnings Call Transcript

Activision Blizzard, Inc. (NASDAQ:ATVI) Q3 2015 Earnings Call November 3, 2015 8:00 AM ET

Executives

Amrita Ahuja - Sr. Vice President, Investor Relations

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

Thomas Tippl - Chief Operating Officer

Riccardo Zacconi - CEO and Co-Founder, King Digital Entertainment

Dennis M. Durkin - Chief Financial Officer

Eric Hirshberg - President and Chief Executive Officer, Activision Publishing, Inc.

Michael Morhaime - Chief Executive Officer of Blizzard Entertainment, Activision Blizzard, Inc.

Analysts

Chris Merwin - Barclays Capital, Inc.

Douglas L. Creutz - Cowen and Company

Neil A. Doshi - Mizuho Securities USA, Inc.

Arvind Bhatia - Sterne Agee CRT

Eric J. Sheridan - UBS Securities LLC

Ben Schachter - Macquarie Capital (USA), Inc.

Brian J. Pitz - Jefferies LLC

Drew E. Crum - Stifel, Nicolaus & Co., Inc.

Operator

Good morning, ladies and gentlemen. Welcome to the conference. Today's presentation is being recorded. I would now like to turn the call over to Amrita Ahuja, Senior VP of Relations.

Amrita Ahuja - Sr. Vice President, Investor Relations

Good morning and thank you for joining today's call. We have a lot of exciting news to share with you. First, our proposed acquisition of King. Then Activision Blizzard Third Quarter Earnings Results, followed by Q&A.

I'd 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. These forward-looking statements include comments about our plans and expectations regarding Activision Blizzard's pending acquisition of King Digital Entertainment as well as our comments about our outlook and other future plans and expectations that we'll provide during the earnings report portion of this call.

A number of important factors could cause actual future results and other future circumstances to differ materially from those expressed in any forward-looking statements, including the factors indicated on the slide that is showing and those discussed in the Risk Factors section of Activision Blizzard's and King Digital Entertainment's SEC filings.

In particular, all of our statements with respect to the expected impact of the acquisition are subject to the risk that the acquisition may not be completed, or may not be completed on the expected timeline. The forward-looking statements in this presentation are based on information available to Activision Blizzard and King Digital Entertainment as of the date of this presentation. And while we believe them to be true, they may ultimately prove to be incorrect.

The companies undertake no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after today, November 3, 2015, or to reflect the occurrence of unanticipated events.

I would like to note that Activision Blizzard prepares its financial information in accordance with U.S. GAAP and King Digital Entertainment prepares its financial information in accordance with IFRS as issued by the IASB. Certain numbers we will be presenting today will be made on a non-GAAP basis for Activision Blizzard and on a non-IFRS basis for King Digital Entertainment. We refer to these measures as non-GAAP measures. Please refer to our Rule 2.5 announcement which is available at Activisionblizzard.acquisitionoffer.com and Activision Blizzard's Earning Release which is posted on Activisionblizzard.com for the applicable reconciliations of these non-GAAP measures and further explanation.

There are also two PowerPoint overviews, one with respect to the deal and one with respect to Activision Blizzard's Q3 results which you can access with the webcast and which will be posted to the websites following the call. In addition, we will also be posting a financial overview highlighting both GAAP and non-GAAP results in a one-page summary.

Please note because this an Irish public company deal, there are certain limits on what we can say, specifically our statements must be limited to matters disclosed in the Rule 2.5 announcement which was released last night, and we won't be able to go beyond what is presented in that document. Irish law also places certain limitations on what are deemed to be profit forecasts, so we are more limited in what we can say about future prospects.

Now speaking on the call today will be Bobby Kotick, our CEO; Thomas Tippl, our COO; Dennis Durkin, our CFO; and Riccardo Zacconi, CEO and Co-Founder of King Digital Entertainment. Later we will be joined by Eric Hirshberg and Mike Morhaime to review Activision Blizzard's quarterly overperformance. And now, I would like to introduce our CEO Bobby Kotick.

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

Thanks, Amrita. Over the last 25 years, we've demonstrated a consistent ability to identify opportunities to serve and support our audiences and deliver superior value to our shareholders. We're disciplined, deliberate and methodical whether in the development of new franchises, entering new segments and geographies and, perhaps most importantly, identifying transactions with great opportunity for shareholder value creation.

With respect to the latter, we've had very positive results and track records over the last 25 years because we care deeply about how we allocate our capital and prioritize our opportunities. The way we considered King is consistent with our proven history of evaluating acquisition opportunities. King operates in a rapidly-growing segment. They have a truly world-class management team, exceptional game development talent and great commercial instincts. The transaction is accretive, brings new audiences, and the King Corporate DNA is oriented towards great game making with commercial potential.

When we merged with Blizzard Entertainment, we found the right partner with extraordinary leadership. And when others dismissed the sustainability of Blizzard's incredible capacity for innovation, we were certain patience would be rewarded. And it has. We see a lot of the same characteristics today in King. We think now is the right time to enter mobile gaming in a meaningful way. Widespread mobile access around the world has opened up significant demand for engaging, fun content that players can enjoy anytime, anywhere.

By acquiring King, which has a proven ability to turn its games into iconic franchises, we will be a participant in the fastest-growing segment in gaming, a category that today is estimated to be $36 billion. It's still extremely fragmented and we believe has great promise for the future. We also believe King's management team, including Riccardo, Sebastian and Stephane, are some of the most talented executives in the game industry.

We've long admired their talents and after spending a lot of time over the last three years getting to know the King team, we realized how truly special their company is. They have over 1,600 incredibly talented people committed to a community of more than 450 million monthly active users. Acquiring King will solidify Activision Blizzard's position as the world leader in interactive entertainment, positioning the combined company for growth across platforms, audiences, genres and business models.

Combining Activision Blizzard's portfolio of some of the very best interactive entertainment franchises on the console and PC with King's leading mobile titles will create a world-class portfolio of games with strong endearing appeal to a wide range of demographics and audiences along with leadership positions across key platforms. The number one console franchise was Call of Duty, the number one PC franchise was World of Warcraft, and now two of the top five highest-grossing mobile games.

We'll have one of the largest entertainment networks in the world, with over 0.5 billion monthly active users, immediately opening up meaningful opportunities to grow and cross-promote content to provide enhanced offerings to our collective players while expanding into untapped geographies. The combined company will have diversified capabilities across business models, like subscription, up-front purchase, free-to-play and micro transaction.

Through our world-class properties and enhanced capabilities across segments and business models, we'll be able to diversify our revenue streams, enhancing our position as the most profitable interactive entertainment company in the world. The result is a transaction that will be accretive to estimated 2016 non-GAAP EPS estimates by approximately 30%. I couldn't be more excited to welcome King into the Activision Blizzard family.

And now Thomas will share with you the specifics of the transaction.

Thomas Tippl - Chief Operating Officer

Thanks, Bobby. Under the proposed transaction, Activision Blizzard will acquire all of the outstanding shares of King for $18 in cash per share for a total equity value of $5.9 billion or an enterprise value of $5 billion, representing a multiple of approximately 6.4 times King's estimated 2015 adjusted EBITDA. This transaction will be financed through a mix of offshore cash and fully committed debt financing. This will enable us to maintain a strong balance sheet and conservative leverage.

Following today's announcement, our path to completion is subject to approval by the Irish High Court, the U.S., EU and other antitrust regulators as well as other customary closing conditions. In addition, the transaction is subject to a vote by King's shareholders. Apax and key management shareholders have committed to voting their shares in favor of the transaction. All in all, we expect the transaction to close by spring 2016.

Once the transaction closes, King will operate as an independent operating unit of Activision Blizzard, similar to how Blizzard Entertainment operates. We have an excellent track record of integrating with minimal disruption and in a way that maintains the organization's culture, creative independence and ability to really thrive. As Bobby said earlier, King's management team has been integral to their success. Riccardo, Sebastian and Stephane will continue to lead the business and they've all signed long-term contractual commitments.

We think this acquisition is an exciting opportunity for everyone connected to Activision Blizzard and to King. This is a very compelling transaction from a financial perspective. Together, we'll have more diversified and recurring revenues, a strong balance sheet and strong liquidity. King's shareholders will also be getting a 20% plus premium to the recent share price and liquidity. And we'll be able to speed up our ability to capitalize on meaningful long-term growth opportunities. We'll reach more players across more audiences and expand our presence in fast-growing regions, such as Asia.

One of the most exciting things about this deal is what it means for our communities of players. By putting these two companies together, we'll have greater capabilities and expertise to enrich the player experience, an expanded network to reach players in virtually every country across the world and more resources to amaze and delight our players. We want to be wherever our players are, whether they are at home on consoles or PCs or out on their smartphones and tablets, and this deal enhances our ability to do just that.

I also want to talk to you about employee culture. It's something that's incredibly important at Activision Blizzard and something we really think sets us apart. We have a track record of attracting and retaining top talent. This is incredibly important in the entertainment and technology industries. And one of the reasons we are able to do this is because we have deep respect for the creative process. We are the destination for the best talent in the business. Activision Blizzard's commitment to innovation, talent development and the creative process is 100% mirrored in King's culture.

For Activision Blizzard debt holders, this transaction accelerates the promising path we are already on to build out our diverse portfolio, grow our predicable recurring revenue streams and generate strong cash flows while maintaining strong liquidity. This financial profile puts us on the path for near-term deleveraging and further supports our already investment grade financial profile. In fact, last night Moody's upgraded the company's debt ratings to investment grade upon announcement of the deal. King and Activision Blizzard are a great fit for all stakeholders and we're excited about what we'll be able to accomplish together.

As Bobby mentioned earlier, our long-term strategy has been focused on innovating on new high-growth platforms, expanding our franchise portfolio with captivating and original new intellectual property and building our capabilities to create compelling offerings to our diverse player base across genres, platforms, business models and geographies. You will hear more during the second half of this call about our strong results, which are further evidence that our strategy is working.

And this transaction meaningfully accelerates that growth strategy by providing Activision Blizzard with a leadership position in mobile gaming, the largest and fastest-growing segment of interactive entertainment, which is expected to grow by more than 50% from $36 billion in 2015 to $55 billion by 2019. Mobile franchises are now reaching results similar to established console franchises. King in particular has shown repeat success with multiple titles, and the leading franchises demonstrate a track record of continued success.

The combined company will have a world-class portfolio with some of the world's most iconic franchises in the entertainment industry across key platforms. Activision Blizzard knows how to create, develop and sustain a portfolio of titles and turn them into iconic franchises with long-lasting appeal and deep engagement. The names you see on this slide are some of the most successful interactive entertainment franchises in the world.

What attracted us to King is that, in similar ways to us, they have a proven ability to extend the success of their core titles, developing them into proven franchises. Together we'll be able to apply our highly complementary strengths, assets and operational expertise to drive deep year-round engagement and digital revenue streams and build upon our proven development models to bring new content to more audiences across genres.

Our combined audience will have more than half a billion monthly active users, making it one of the largest entertainment networks in the world. Our audience includes a broad diversity of demographics in almost every country around the globe. The ability to cross-promote our industry-leading franchises across this highly engaged network is incredibly exciting.

As part of our growth strategy, not only do we have some of the leading owned intellectual property in interactive entertainment, but we've been building capabilities across platforms, genres, business models and geographies.

It is clear that our acquisition of King provides important, highly complementary capabilities in key areas: in mobile, free-to-play and the ability to reach casual gamers in emerging geographies. Our capabilities in infrastructure have never been better, and we've never been in such a great position to deliver content to any audience on any platform. That is an exciting prospect for not only our fans, but for our employees and for our shareholders as well.

Now let me introduce Riccardo, who will walk you through King's business.

Riccardo Zacconi - CEO and Co-Founder, King Digital Entertainment

Thank you, Thomas. I would like to share a little about King, especially for those who are (15:14) company. King is a leader in mobile gaming and has been developing games since 2003. We have created a strong organization with 12 studios in Europe, Asia and the U.S. that are driven by dedicated world-class talent. King has a portfolio of best-in-class franchises that include the top grossing games within their sub-genres. Our four franchises, Candy Crush, Farm Heroes, Pet Rescue and Bubble Witch, are category-leading brands. We operate them as a live service and continually give our players new, highly-engaging content by adding new levels, time-based live ops and extensions with innovative modes of play.

We also launched new games within our existing franchises. Candy Crush Soda Saga is our highly successful sister title to the original hit, Candy Crush Saga. We have seen that these efforts have transformed our games into true game franchises. In third quarter 2015, more than three years after the original launch of Candy Crush Saga, an average of 92 million people played Candy Crush games every day.

The popularity of our games and success of our monetization and franchise strategy have translated to a leading position in the mobile gaming business. We have had two of the top five grossing games on the Apple App Store and Google Play Store in the U.S. for three consecutive quarters, and at least three of the top 15 grossing games for seven consecutive quarters.

We have built one of the largest networks of mobile game players, with 474 million monthly active users in Q3 who played 1.4 billion games per day. Our network is a key asset for launching new games through cross-promotion.

We are excited about what we bring to the combined company. We have a strong pipeline which includes new franchise games and other new games to diversify our portfolio into new genres, which we have just begun with our first non-casual game launch.

Since our company already has a strong presence globally, we see meaningful opportunities in key Asian markets. Our strength as a company is reflected in our robust financial profile, with significant scale and profitability. In the 12 months ended September 30, we generated $2.2 billion of gross bookings and $875 million of adjusted EBITDA for a 42% adjusted EBITDA margin. We have a highly cash-generative business with $920 million of cash on our balance sheet.

We think we can have the combined company win in mobile. We have one of the largest networks, not just for a gaming company, but across the mobile sector with 474 million monthly active users and 133 million daily active users in Q3. We have a portfolio of best-in-class game franchises on mobile, which are top-grossing in their respective sub-genres, and a multi-year plan to operate our franchises with three new games planned for launch by the end of 2016.

In addition to our focus on our franchise business, our strategy is to leverage our reach and capabilities to answer new genres. We recently launched our first resource management game and expect to release our first mid-core title in 2016. Through this transaction, I think that both King and Activision Blizzard will be able to better serve our players by leveraging our complementary strengths, assets and operational expertise.

We also will have the ability to cross-promote games, providing our players more opportunities to engage with our content. Activision Blizzard has a long history of building, maintaining and growing what I think are iconic and successful franchises, and I believe we can benefit from their experience.

Our third quarter performance reflects the continued strength of our business. Our preliminary third quarter 2015 results include gross bookings of $502 million, which exceeded the high end of our guidance range. Adjusted EBITDA for the period was $180 million for a 38% adjusted EBITDA margin.

Our player metrics for the quarter, 474 million monthly active users, 330 million monthly unique users, and 133 million daily active users underscore our massive player network. Built on the timing of game releases and recent trends, King expects gross bookings in the fourth quarter to be between $475 million and $500 million. We look forward to sharing more with you about our third quarter performance during our earnings call tomorrow.

In closing, I think this deal makes sense because it makes us stronger in the industry, it brings together two world-class teams, and it gives our shareholders an attractive liquidity event. And we look forward to working together with Activision Blizzard and I'm very excited.

Dennis M. Durkin - Chief Financial Officer

Thanks, Riccardo. As Bobby, Thomas and Riccardo have mentioned, we're incredibly excited to be combining the capabilities and portfolios of our companies together. This transaction enhances Activision Blizzard's current position as the most profitable standalone interactive entertainment company.

We expect accretion to 2016 estimated non-GAAP revenues and earnings per share of approximately 30% based on IBES Consensus estimates. The transaction is also significantly accretive to 2016 estimated free cash flow per share.

We'll be combining Activision Blizzard's trailing 12-month non-GAAP revenues of $4.7 billion with King's trailing 12-month adjusted revenues of $2.1 billion, and combining Activision Blizzard's adjusted EBITDA of $1.6 billion with King's $0.9 billion over the same period. Importantly, the accretion figures detailed in this presentation do not include potential synergies that could come from cross-promotion and shared capabilities for the combined company.

Activision Blizzard's business today generates the bulk of its revenues from its high-performing Console and PC businesses, which, as we will discuss during our Q3 earnings report, continue to perform very well and are increasingly shifting to higher margin digital channels with increasingly long tails of player engagement and monetization.

King generates virtually all of its revenue from high-margin digital platforms, with the vast majority of it on mobile. The industrial logic of combining these businesses, bringing leadership in gaming across PCs, consoles and mobile platforms, is highlighted by the balanced post-deal revenue mix of roughly one-third coming from each of these platforms. In addition, the combined company will be an online services business with roughly two-thirds of the combined revenue being delivered digitally.

One of the things we've learned from our Blizzard merger is that a broader IP portfolio across more platforms creates a diversified and highly profitable financial profile, which in turn provides us with more capital to reinvest in innovation and to deliver the great content that our fans expect. And with the acquisition of King, we will now have some of the world's leading interactive entertainment franchises, not only on PC and console, but mobile as well.

Now let's turn to balance sheet and look at the sources and uses of capital as well as the combined capitalization of the company. As mentioned earlier, the acquisition of King is an accretive use of Activision Blizzard's offshore cash. The transaction will be funded with $3.4 billion in offshore cash from our balance sheet along with $2.3 billion coming from a fully-committed term loan financing led by Bank of America Meryl Lynch and Goldman Sachs and around $200 million of rollover unvested equity awards. The combined company's capitalization will also maintain a conservative balance sheet with strong liquidity.

Having a strong balance sheet with deep capital resources is very important to us, and the transaction further diversifies and reinforces our financial profile. And as Thomas mentioned, just last night, Moody's upgraded all of our debt rating to investment grade upon announcement of the deal, which is obviously great recognition for the progress we have made in the past two years since we raised debt for the first time.

So in summary, Activision Blizzard's acquisition of King solidifies us as a world leader in interactive entertainment and positions us well for future growth opportunities. The transaction accelerates our current growth strategy as it provides us with a leadership position in mobile gaming, the largest and fastest-growing gaming segment, and it adds to our portfolio of iconic interactive entertainment franchises. It is also highly accretive to earnings and free cash flow per share while still providing King's shareholders with the premium and liquidity. And most importantly for the long-term growth prospects of our business, our acquisition of King brings with it a committed management team with a proven track record and talented employees with aligned objectives to drive innovation to better serve our player communities. So we couldn't be more excited than we are now to have Riccardo, Sebastien, Stephan and the entire King team as part of the Activision Blizzard family.

I will now turn the call back to Thomas to kick off our Q3 results discussion.

Thomas Tippl - Chief Operating Officer

Thank you, Dennis. I will now turn to Activision Blizzard's earnings results for the third quarter of 2015. Our strong results reflect our strategic focus on expanding our franchise portfolio with innovative new intellectual property, broadening our reach by expanding out to new platforms and geographies and driving deeper engagement through regular content updates that delight our audiences.

We outperformed our Q3 targets on revenues, digital growth and earnings per share and we are raising our full-year outlook yet again. We project year-over-year revenue and EPS growth at constant FX. We will continue to invest in our franchises through the holidays to build our install base, given the increasing opportunity of back-end revenues. This investment sets us up for continued organic growth in 2016 and beyond. And of course the addition of King to our portfolio presents additional opportunities for growth ahead.

As we successfully transition from a launch to a year-round engagement model, our audience base and the total amount of time people spend with our franchises continue to grow. In the third quarter, our monthly active users grew by 27% year over year, and the amount of time our communities spent playing Activision Blizzard games grew by 23% year-over-year. Our audiences yet again logged nearly 3.5 billion hours of game play in the quarter, not including rapidly growing hours spent spectating. You will hear more about our strategic initiatives at Investor Day later this week at BlizzCon, where you will also get to see some of the industry's most exciting eSports Championships. We look forward to seeing you there.

And now I will turn the call over to Eric to discuss Activision Publishing results.

Eric Hirshberg - President and Chief Executive Officer, Activision Publishing, Inc.

Thanks, Thomas. Activision Publishing delivered another record quarter with record non-GAAP operating income, which at constant FX was up by over 50% versus last year's Q3 performance. We also drove monthly active users up by 17% year-over-year, continued to have three of the top-five next generation games life to-date and had the largest digital revenues in our history both in Q3 and year-to-date. Our results are due to our proven ability to turn great games into long-term franchises with large passionate communities. We strategically and methodically expanded our portfolio to include three such industry-leading franchises, each of which gamers enjoy playing year-round.

We've also just relaunched what we hope could become our fourth major franchise with Guitar Hero Live. We are only two weeks in, but early reception from fans and critics has been very positive. While sell-through comparisons to prior games from five years ago aren't exactly apples-to-apples, our current sell-through is significantly up versus each of the prior two Guitar Hero titles. As you know, unlike past games, we also designed Guitar Hero Live to be a living platform to keep players engaged, and so far, people are responding well, with average engagement per player reaching nearly two hours per day. The game has also been featured in a wide array of the most influential must-have holiday toy lists. All that said, it's still very early and we anticipate that this title will ramp towards the holiday, which is why we have over half of our marketing investment this year still yet to come.

Moving onto Destiny, we launched The Taken King in September with our partners at Bungie to an extremely positive reception from fans and critics. Day one downloads broke Sony PS4 records, day one engagements saw the highest number of active players in Destiny's history. Daily player engagement is now well north of three hours per day, and the Destiny community has now over 20 million registered players – 25 million registered players.

For new players, The Taken King Legendary Edition gives new players the original Destiny game, both expansion packs and The Taken King all for the same price as a regular console game. We've also successfully introduced great new content into the game which allows our players to express themselves and personalize their experience, which is available via in-game purchases and has caused a number of Thriller dances in-game to increase dramatically.

On to Skylanders, which launched at the end of September with Skylanders Superchargers, our first game featuring both vehicle and character toys. I said in our last call that we expect the competition to continue to increase in the toy select category which we invented. And it has. I also said we will continue to lead because we deliver the best games and the biggest innovations. And we are, with Skylanders remaining the biggest franchise in the toy select category year-to-date.

Superchargers and the addition of vehicles into Skylanders have been positively received by both critics and fans. It's also one of our most engaging Skylanders games ever, with more choice per player than last year. But even though Supercharger sell-through is down year-on-year due to increased competition, we are investing in the holiday to maintain our leadership position, and we're optimistic that we'll see category expansion in the holiday. The full game will once again be available on tablet and for the first time on iPhone and Apple TV as well.

As I mentioned on our last call, we are in development on a major new mobile initiative called Skylanders Battlecast which brings cards to life in a free-to-play card battle game. The game is looking great and we expect it to launch in 2016.

Last, but not least, Call of Duty. The year so far has been phenomenal for the franchise, with revenues up double-digit percentages both this quarter and year-to-date. The over-performance has been driven by: 1) higher advanced warfare selling; 2) deeper engagement from our community, driving up performance on season pass, DLC and the new consumable micro-transaction feature Supply Drops; and 3) strong catalogue sales of Black Ops which have ramped with consumer anticipation for Black Ops III.

In fact, monthly active users for Black Ops II grew quarter-over-quarter again to a new record of nearly 12 million monthly active users. And on today's level of engagement for a game, that is now three years old, and only available on Old Gen.

This brings me to our most anticipated launch of the year, Call of Duty Black Ops III. We couldn't be more excited about the launch this Friday. We have strong momentum indicated by a number of factors, but just to name a few, the growing engagement around the past Black Ops titles, the significantly year-on-year lift in pre-orders, consumer sentiment around our marketing assets which is more positive for Black Ops III than any Call of Duty title on record, a great partnership with Sony across consumer, trade and custom PS4 bundles, and our ranking as Neilson's Number One Most Anticipated Title of the Year.

Even more importantly, we've got the game. It is simply awesome. With innovations across single-player, multi-player and of course, zombies, Black Ops III has more content and more surprises packed inside than any game we've made to-date.

So in closing, we've had a great first three quarters built on innovative games that engage our passionate fans and the stage is set for a strong Q4. I look forward to seeing you and sharing more at Investor Day this Friday.

And now, I'll turn the call over to my good friend, Mike, to discuss Blizzard.

Michael Morhaime - Chief Executive Officer of Blizzard Entertainment, Activision Blizzard, Inc.

Thank you, Eric. Q3 was another strong quarter for Blizzard. We had significant activity across our franchises and our MAUs for the quarter were up 50% year-over-year. Blizzard continues to be well positioned for growth. We're operating more franchises on more platforms and in more regions than ever before. We have an exciting upcoming content of late. And we're continuing to foster powerful connections with our community, online, through our pro and amateur eSports programs and at live events like BlizzCon.

Hearthstone in particular had another great quarter, driven by the launch of The Grand Tournament expansion. Along with continued strength on mobile and continued strong performance in all markets, the new expansion helped push engagement for Hearthstone even higher in Q3 than in Q2. Year-over-year engagement was up 77%, leading to Hearthstone's highest ever quarterly revenue. In addition, we recently launched a fully localized version of Hearthstone in Japan. The game already had an established audience in Japan, but we were pleased to provide them, as well as new players, with a version that makes access even easier.

Activity around Hearthstone eSports is also continuing to grow and drive excitement. Over the past few months, we concluded several tournaments feeding into the World Championship at BlizzCon. For World of Warcraft this quarter, we released a key update, which helped maintain stability in the subscriber base, and we're currently at work on the next update. We also had very exciting news at Gamescom, with the announcement of World of Warcraft Legion, our next expansion. Players responded very positively, not only to the new features coming with the expansion, but to the care we're putting into the content. In addition to hosting the World of Warcraft Arena Championship, we'll have more to share on Legion at BlizzCon this week.

On the StarCraft II front, excitement for Legacy of the Void, which will be sold as a standalone product launching on November 10, remains strong. In fact, pre-purchases for Legacy of the Void have continued to outpace those for the previous release, Heart of the Swarm. At the professional level, the StarCraft II World Championship Series competition has been intense and extremely fun to follow. I encourage everyone to tune in at BlizzCon or online for the final round. It's amazing to see some of the most skilled pro gamers in the world in action.

As for Diablo III, we were pleased that it continued to bring in new players in Q3. And in China, it passed the 2 million sales milestone. We released a huge well-received content update in the quarter. All together, we've added a ton of post-launch content to Diablo III, and this reflects our strong commitment to the game and to the community.

Heroes of the Storm also brought in more players in Q3, driven in part by our Diablo-themed content series. While we are still in the early days for the game, it's been great to see the ongoing enthusiasm and support from players as the community continues to come together. We held the regional championships for our Road to BlizzCon series, including the Americas Championship in Las Vegas and the European Championship in Prague over the past few months. These events featured teams with international followings across multiple games, which is exciting for the Heroes of the Storm community and for eSports as a whole. We're looking forward to seeing the winners of the regional championships face off at BlizzCon for the World Championship title.

There is also a lot of ongoing excitement around Overwatch, which just started its beta test last week. We've already had more than seven million players sign up to participate, and that's not including China. We're keeping access limited in order to focus feedback, but we plan to periodically run stress test weekends around the world that will allow many more players to join in. We'll be sharing the latest Overwatch news at BlizzCon, so I hope you will tune in.

As you can tell, we're very excited about BlizzCon and all the eSports action taking place there this week. BlizzCon represents the depth and breadth of our portfolio and the height of eSports competition in our games. It's a massive undertaking and it wouldn't exist without the super-passionate, highly-engaged audience of Blizzard gamers around the world. Tickets again sold out very quickly and we're using more of the Anaheim Convention Center than ever before to host the 25,000-plus live attendees.

The BlizzCon Virtual Ticket is again available this year and viewers will have multiple channels for catching as much of the show as possible. We'll be broadcasting the opening ceremony and all the eSports events for free globally and we're expecting the total audience to again number in the millions. You can tune in via BlizzCon.com.

Duncan Jones will be there to talk about the Warcraft movie and he'll debut the commercial trailer during our opening ceremony. We're also happy to have Wil Wheaton hosting our community contests, and Linkin Park will help close out the show on Saturday night. I look forward to seeing those of you who will be attending, and I encourage everyone else to follow the action online.

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

Dennis M. Durkin - Chief Financial Officer

Thanks, Mike. I will now review our better-than-expected Q3 financial results and our raised outlook for Q4 and the full year 2015. Unless otherwise indicated, I will be referencing non-GAAP measures, so please refer to our earnings release for full non-GAAP to GAAP reconciliations.

For the quarter, on a GAAP basis we generated revenues of $990 million, up 31% year-over-year, and operating margin of 20% and GAAP EPS of $0.17, up $0.09 versus our August guidance. For the quarter, on a non-GAAP basis we generated revenues of $1.04 billion and operating margin of 24%, up 190 basis points year-over-year, and EPS of $0.21. We outperformed our August guidance by $110 million on revenue and $0.07 on EPS. At constant FX, our year-to-date revenues are up 5% ahead of last year and EPS is 35% ahead of last year despite the tougher comp with last year's Diablo III expansion and Destiny's full game launch.

Importantly, total digital revenues grew 38% year-over-year or 50% at constant FX to an all-time quarterly record of $697 million. A significant driver of that growth was sales from digital add-on content, which grew 60% year-over-year or 75% at constant FX. Our digital full-game downloads also grew 39% year-over-year or 48% at constant FX, largely driven by the Destiny expansion launch.

There are a few key franchise drivers worth highlighting. Hearthstone had its highest revenue quarter yet with the launch of its expansion, The Grand Tournament, in August. Destiny's operating income grew by a double-digit percentage year-to-date on the back of the launch of The Taken King in September. Skylanders SuperChargers launched to great fan and critical reception, though into a more competitive landscape. Activision's Call of Duty and Blizzard's Diablo III and Heroes of the Storm continued to perform well and attract new players. And World of Warcraft subscribers stabilized at 5.5 million subs in the quarter. And note that this is the last quarter that we plan to provide the subscriber number as there are other metrics that are better indicators of the overall Blizzard business performance.

In terms of EBITDA, in Q3, we generated non-GAAP adjusted EBITDA of $275 million and $1.63 billion on a trailing 12-month basis. Operating cash flow on a trailing 12-month basis was $1.36 billion, up 39% year-over-year, and free cash flow was $1.25 billion, up 43% year-over-year.

Turning to the balance sheet. As of September 30, we had approximately $4.5 billion in cash and investments, of which approximately $870 million was held domestically. We had total debt of $4.12 billion and net cash of approximately $400 million. We had no share repurchases in the quarter.

Turning to FX, please note that as discussed on our prior earnings calls, the strong dollar has and will continue to be a headwind this year as our international revenues are translated at lower rates than last year. In Q3, the year-over-year impact of the strengthening of the dollar was $85 million on revenue and $0.05 on EPS. Year-to-date, the year-over-year FX impact was $239 million on revenue and $0.16 on EPS.

Now let's turn to our outlook for Q4 and full-year 2015. First for Q4, on a GAAP basis we expect net revenues of $1.22 billion, product costs of 30% and operating expenses of 57%. We expect GAAP and non-GAAP interest expense of $51 million, a GAAP tax rate of 39%, a GAAP and non-GAAP share count of 753 million and EPS of $0.09.

For Q4 on a non-GAAP basis, we expect revenues of $2.15 billion, product costs of 25% and operating expenses of 35%. We expect a non-GAAP tax rate of approximately 24% and non-GAAP EPS of $0.82. Note that our guidance is at FX spot rates, as laid out in the accompanying slides on our IR website.

Now to our full-year 2015 numbers. For 2015 on a GAAP basis, we expect revenues of $4.53 billion, product costs of 24%, operating expenses of 49% and GAAP and non-GAAP interest expense of $201 million. Our GAAP tax rate is expected to be 22%. We expect GAAP and non-GAAP fully diluted shares of 750 million and GAAP EPS is expected to be $1.07. For 2015, on a non-GAAP basis, we expect revenues of $4.65 billion, $50 million higher than our August guidance, product costs of 24%, operating expenses of 44% and an operating margin of 32%. Our non-GAAP tax rate is expected to be 24%.

Once again, we are raising our full-year EPS guidance now to $1.31. We are not fully passing through the entire $0.07 Q3 over-performance largely due to three factors: the first, revenue pull-forward on Destiny and Skylanders from Q4 to Q3 which had an impact of approximately $0.02, cost saving and timing of expenses which pushed into Q4 from Q3, which also was worth $0.02 and additional investments we will be making in Q4 to build the installed base of players across our portfolio, which accounts for the other $0.02.

With the strong back-end monetization we are seeing across our portfolio, we think these investments set us up well heading into next year. Importantly, we expect to end the year with more than half of our revenues coming from digital channels, up double-digit percentage points in aggregate from last year. So in summary, strong engagement and recurring digital monetization trends continue to drive our financial results.

Along with these positive digital tailwinds, our strategic investments in new franchises, platforms and geographies are paying off as shown by our year-to-date results. And going forward, with King's franchises in our portfolio, we feel that our strategic growth opportunities across platforms, genres, business models, audience demographics and geographies are more promising than ever. We couldn't be more excited to welcome King and their talented employees into the fold and look forward to taking advantage of the great mutual opportunities we have in front of us.

Lastly, we look forward to seeing many of you in person this Friday at Investor Day at the start of BlizzCon to tell you more about the exciting times ahead. And for those of you who can't attend in person, you can watch the livestream from our IR website.

Thanks again, and now we'll open up the call for questions.

Amrita Ahuja - Sr. Vice President, Investor Relations

Operator?

Question-and-Answer Session

Operator

Thank you. And we'll go to our first question from Chris Merwin of Barclays.

Chris Merwin - Barclays Capital, Inc.

Hi, great. Thank you. And congrats to everyone on the deal. In the last couple years, the revenue mix for Activision has been evolving more towards a predictable model with free-to-play games and we've seen very good improvements in engagements for console and PC games. And then mobile as a category historically has had different characteristics in terms of the life of games and engagement.

So can you talk about the plan for creating even more predictable revenue streams on mobile and how you can drive consistent engagement and monetization with those mobile games, much as you've done very successfully on other platforms? Thanks.

Dennis M. Durkin - Chief Financial Officer

Well, I think I'll let Riccardo get into more details, but I think you've got to recognize King has already a fantastic track record of continuing engagement. Riccardo mentioned some of the incredible number of games people play every day, almost 100 million people coming to King to play their games every day.

I think they have a tremendous track record, and we really only got full appreciation of that as we spent a lot of time over the last few months going with Riccardo and his team through their business, the analytics that they built and the sophistication that their game developments have built in order to make the games fun to play, engaging, rewarding for players, and that is why you see the strong performance that they have put on. And we don't see any reason for that to change. If anything, we think there's opportunity for that to continue to grow and expand, as the teams get stronger and as we will be able to share our very complementary expertise that we have built over decades of being in this business.

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

I think one of the things you realize from the combination is that with now over 0.5 billion players in our network, there's an insatiable demand for great content. And so, now the model is going to start to shift across all of the categories to be able to deliver continuous content, and that should be helpful for more consistent monetization.

Chris Merwin - Barclays Capital, Inc.

Thank you.

Operator

And we'll go to our next question from Doug Creutz of Cowen & Company.

Douglas L. Creutz - Cowen and Company

Hey, thanks and congratulations, everybody involved. In your comments, you said you're not assuming any synergies from the deal, but maybe could you talk about what opportunities you think there might be for synergies? Thanks. Especially on the cost side.

Dennis M. Durkin - Chief Financial Officer

Yeah. So I think from a financial perspective, obviously the deal is already very attractive, but without the assumption of any synergies delivering 30% accretion, and that was an assumption of the deal, only closing by spring. So on a full-year basis, that would be even better.

Now we do think there are obviously opportunities. We talked a lot about already how complementary our relative skill sets are and Bobby just mentioned the incredibly large size of the network overall and, therefore, we're broadening our audience reach, which I think will give all of our franchises a broader access to more people in more geographies, particularly in some of the fastest geographies like Asia.

And I think the same is true vice versa. I think we have a lot of experience in how to build franchises and grow franchises over time and I think some of those skills will be helpful as King continues to grow and mature as a leader in mobile gaming.

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

I think one of the other things that we obviously are not reflecting in our discussions today, but is an important point, if you look at the history of Activision Blizzard, we go back to our founding in 1979, whether it's Infocom, Dynamix, Sierra, Activision, Imagic, we have the largest library of intellectual property in games that exists from any company. And a lot of that intellectual property, you look back in its history, there are tens of millions of players who have experienced those franchises.

With mobile, we now have the opportunity to reach new players in 196 countries around the world and take a lot of that great content that we've built over 35 years and create new content or leverage that content against this new opportunity.

Douglas L. Creutz - Cowen and Company

Okay. Thank you.

Operator

And we'll hear next from Neil Doshi of Mizuho.

Neil A. Doshi - Mizuho Securities USA, Inc.

Great. Thank you very much, guys, and congrats. Bobby, will you guys be investing in King or will King be primarily responsible for funding its own initiatives?

And then, Mike, can you provide any update on Overwatch? It looks like the game will lend itself well for eSports. So if you can provide any color on the eSports front for Overwatch and then how we should be thinking about the distribution strategy going forward, that'd be great.

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

From an investment perspective, King will, like Activision and Blizzard, operate as an independent unit. And so they'll generate their own capital, that capital will be available to them to invest against their business opportunities.

One of the big benefits I think they'll get is plugging into the great framework that we've created for long-term strategic planning, and that includes capital allocation. Remember, King generates a lot of operating profit, in fact, more operating profit than virtually any other gaming company that has ever existed. And so they'll be able to continue to generate that operating profit and invest that cash flow in new opportunities.

Michael Morhaime - Chief Executive Officer of Blizzard Entertainment, Activision Blizzard, Inc.

Okay. And on the Overwatch questions, we just entered beta. Feedback from the beta has been extremely positive. On the eSports question, I think that Overwatch has a lot of potential with eSports. We've done some experimenting internally at Blizzard with our own show matches internally at the company. It's very fun to watch. But in terms of announcements about business model or distribution, we're not ready to talk about that today. We'll have more information about Overwatch at BlizzCon.

Neil A. Doshi - Mizuho Securities USA, Inc.

Great. Thanks, Bobby. Thanks, Mike.

Operator

And moving on, we will go to a question from Arvind Bhatia of Sterne, Agee.

Arvind Bhatia - Sterne Agee CRT

Thank you very much. And I'd like to add my congratulations as well. My question is on Guitar Hero. I appreciate the color and the comparison to the first two franchises in the game's history. If you could maybe refresh our memory on the size of the performance of the original game in the first few years and then just maybe any quantification if possible at retail for Guitar Hero, the new one that's just come out? Thank you.

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

Obviously, the prior games were the first to reach $1 billion of any video game franchise, so the performance was very strong commercially at its apex. And as I said, the new game's sell-through in week one is up significantly versus the last two games. But as I mentioned, those are five-year old comparisons so not exactly apples-to-apples.

I think the more relevant factors right now are the fact that we've designed this game, the first time for a Guitar Hero game to really have a long tail of engagement with Guitar Hero TV, the world's first playable music video network. We're seeing two hours per day engagement from players who've already purchased the game. And it's going to be a holiday-centric title and we expect to see it ramp during the holiday. And we've got over half of our marketing budget yet to go for the year because of that.

Arvind Bhatia - Sterne Agee CRT

Great. And good luck.

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

Thanks, Arvind.

Operator

And we will hear next from Eric Sheridan of UBS.

Eric J. Sheridan - UBS Securities LLC

Thanks for taking the question. Maybe a bigger picture question for Bobby and the team around capital allocation going forward. With so many choices now between the various divisions as well as the debt holder and equity holder desire to get capital back with deleveraging, maybe just think bigger picture about where capital incrementally is going to get allocated 2016 and beyond and just rank order those opportunities.

Dennis M. Durkin - Chief Financial Officer

Sure. Thanks, Eric. Obviously having a strong balance sheet and having access to capital has been a critical and important part of our strategic plan and our process. We've always tried to be very balanced regarding capital allocation. We have significant capital to be able to invest in our business and invest in new opportunities, whether that be inside the Activision business, the Blizzard business or in the future in the King business. And really the greatest governor in that investment is usually related to great development talent and great ideas. And then we try and be disciplined about how we put that investment against those ideas internally.

As it relates to other capital allocation, now obviously taking on a little bit more debt, our near-term priority will be on deleveraging in line with our investment grade profile. Our dividend payout is expected to be largely consistent with our historical approach. And in the short term, the $750 million share buyback authorization will likely not be utilized under current plans. So we feel like we have significant capital resources to be able to invest in our business and still return capital and balance the needs of our various stakeholders.

Amrita Ahuja - Sr. Vice President, Investor Relations

Operator?

Operator

And did you have anything further, Mr. Sheridan?

Eric J. Sheridan - UBS Securities LLC

No. Thank you very much for that color.

Amrita Ahuja - Sr. Vice President, Investor Relations

Thank you.

Dennis M. Durkin - Chief Financial Officer

Thanks, Eric.

Operator

And so, we'll go to our next question from Ben Schachter of Macquarie.

Ben Schachter - Macquarie Capital (USA), Inc.

Congrats. A few questions, one, are there particular new franchises in the King pipeline that you think are important drivers? Or just more about the long-term value of the current franchises? And then, Bobby, can you just talk about how the success of Hearthstone on mobile may have influenced this deal and your overall thinking of mobile gaming? Thanks.

Riccardo Zacconi - CEO and Co-Founder, King Digital Entertainment

Sure. So it's both. We're having our earnings call tomorrow, so we'll give more details tomorrow, but fundamentally, what we have announced in the past is that we are working on all the key franchises we have, with basically sequels and sister titles. And we announced that by the end of 2016, we will see at least three new titles coming out. And of course at the same time, most of our people are working on new things. So, the target is also to over time crystallize new franchises.

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

So, I think the thing that always drives us, Ben, is can we really creatively and in an inspired way figure out new opportunities to delight and engage our audiences? And mobile is allowing us to do that. I think certainly Hearthstone's success, which has been extraordinary, was a catalyst for us to think about the opportunities differently.

And when you look at 196 countries being served by King's footprint and a network of over 400 million players, our intellectual property that goes back to 1980, we really thought that there was a great opportunity. And you're now seeing mobile as a $36 billion market that's growing faster than almost any category. I think the most important thing, though, was that we thought that creatively, we could see sustained franchises that would have perpetual value, where we could continuously put our best creative foot forward.

Operator

And did you have anything further, Mr. Schachter? At this time, we'll go to our next question from Brian Pitz of Jefferies.

Brian J. Pitz - Jefferies LLC

Great. Thanks for the questions. In the prepared remarks, you mentioned the cross-promotional opportunity. Any additional color on that point? What games might be candidates near term to promote into King's network? And then separately, any comments on the need to acquire versus build a mobile studio? Clearly, you guys have a great development team, but just want to hear your thoughts on thinking through that decision longer term. Thanks.

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

Riccardo will take the second part of the question, they've built the best mobile company in the world. And with that network, with hundreds of millions of people, the incredible expertise with inspired, creative talent in all of their studios, as much as we could invest on our own, we couldn't, as quickly or probably in that quality, get to the place that Riccardo and his team have gotten to. So it's a perfect complement to what we do already so well in the categories that we operate in.

Riccardo Zacconi - CEO and Co-Founder, King Digital Entertainment

And it's something in terms of the network composition, if you look at the composition of our network on the free playing side, it's about 60% female, 40% male. But if you then look at the paying side, it's much more accentuated towards a female audience, and this is where one of the big opportunities here is to not only retain better, but in particular market better to our audience, and continue to build out further our network with games which have more focus on males, and that's where I think the opportunities are to tap into the amazing IP portfolio of the Activision business.

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

And, with 0.5 billion players now in our network, or audience members as we like to think of them, there's a lot of opportunity to distribute content to that 0.5 billion player network. And we haven't really announced a lot of the future plans, but some of the things that we've announced recently, you'll see tied very well into what the opportunity is to look at that network and continuously deliver new content to players around the world.

Dennis M. Durkin - Chief Financial Officer

Thanks, Brian.

Amrita Ahuja - Sr. Vice President, Investor Relations

Operator?

Operator

And we will go to our last question from Drew Crum of Stifel.

Drew E. Crum - Stifel, Nicolaus & Co., Inc.

Okay. Thanks. Good morning, everyone. So, want to follow up on an earlier question on King. Just can you talk about plans to accelerate the rate of content or game output going forward? And then separately, I think there's been some discussion around Destiny favoring micro transactions going forward. Based on the experience you had with The Taken King, can you talk about the strategy with DLC going forward? And can it, along with micro transactions, coexist with this franchise? Thanks.

Riccardo Zacconi - CEO and Co-Founder, King Digital Entertainment

In terms of – as I said, I think tomorrow you will hear more details, but overall, I think we have a big pipeline of games lined up. A large focus of this pipeline is focused on our franchises with sequels and sister titles for our franchises, and this is a multiyear plan. And then at the same time, we announced in our last earnings call that we are focusing on leveraging the massive network we have to enter new genres.

So we have launched our first title in resource management, Paradise Bay, and you will hear more details tomorrow on its performance. And we have also announced that next year, we're going to launch our first mid-core title. And then beyond that in terms of what can we do with the new portfolio of ideas, I think that the work we started on the deal is closed with the team sitting together and going through the opportunities which this presents.

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

And on Destiny, Drew, I think they're already coexisting. We had a full year of expansions to the game that have been very well received and sold quite well. And more recently, you've seen us introduce smaller in-game purchases that allow people to customize their experience and express themselves. And those have been very well received and have sold well also. So I think we've already shown in those things that micro-transactions can exist and that our community is hungry for more great content.

As far as any shifts in strategy, I don't have any announcements today, but I think we have a lot of options at our disposal. And the reason for that of course is that we have such great engagement with this game. As I said, we're seeing average player times of three hours per day, which is really an astounding figure. And beyond that, we're also bringing in new players. And I think our Legendary Edition going into the holiday gives players the best time ever to jump into the Destiny universe, because you've got the original Destiny game, both the expansion packs and The Taken King for the price of a regular console game. So this has already brought a lot of new players in, and we hope to see even more as we head into the holiday.

Dennis M. Durkin - Chief Financial Officer

Great. So thanks, Drew, and thanks, everyone, for joining us this morning. We're obviously very excited about the new announcements today, and welcome the whole King organization inside of Activision Blizzard, and we look forward to seeing many of you and hopefully speaking to many of you online this Friday at our Investor Day, which will be Friday morning Pacific Time, right before the opening ceremony of BlizzCon. So thanks, everyone, for joining us today.

Operator

And that does conclude this call. We would like to thank everyone for their participation today.