動視暴雪 (ATVI) 2012 Q2 法說會逐字稿

Ladies and gentlemen, good day. Welcome to Activision Blizzard's Q2 2012 conference call. Please note, today's conference is being recorded. At this time, for opening remarks and introductions, I would like to turn today's call over to Ms. Kristen Southey. Please go ahead.

Good afternoon, and thank you for joining us today for Activision Blizzard's second quarter 2012 conference call. With me today are Bobby Kotick, CEO of Activision Blizzard Thomas Tippl, COO of Activision Blizzard; Dennis Durkin, CFO of Activision Blizzard; Eric Hirshberg, CEO of Activision Publishing; and Michael Morhaime, CEO of Blizzard Entertainment. I would like to remind everyone that during this call, we will be making statements that are not historical facts. These are forward looking statements and based on our current expectations and assumptions and 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, 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 hardware platforms and the seasonal and cyclical nature of our industry, changing business models, including digital delivery of content, competition, including product returns and price protection, 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 and relationships with key personnel and developers, economic, financial, and global conditions and policies, foreign exchange and tax rates and the identification of suitable future acquisitions opportunities and potential challenges associated with geographic expansion.

These important factors and other factors that could affect the Company's results are described in the company's annual report on Form 10-K for the period ended December 31, 2011 The Company may change its intentions, beliefs or expectations at any time and without notice, based upon changes in such factors in the Company's assumptions or otherwise. The forward-looking statements in the presentation are based on information available to the Company as of the date of this presentation, and, while believed to be true, may ultimately prove to be incorrect. The company undertakes no obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after today, August 2, 2012, or reflecting current or anticipated events. I would like to note that certain numbers we will be presenting today will be made on a non-GAAP basis, excluding the impact of changes (inaudible) of net revenue and related cost of sales with respect to certain of our online games -- (inaudible) -- the amortization of intangibles and associated tax benefits. Please refer to our earnings release as posted at www.Activisionblizzard.com for a full GAAP to non-GAAP reconciliation and further explanation. There is also a Power Point overview which you can access with the webcast and which will be posted to the website following the call. In addition, we also will be posting a 12-quarter financial overview highlighting both GAAP and non-GAAP results on a one-page summary sheet.

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

Thank you, Kristen, and thank you all for joining us today. We once again delivered better than expected quarterly results. On a non-GAAP basis, we achieved record Q2 and first half net revenues, operating income, and earnings. For the first six months of 2012, we had the top three best selling games in North America and Europe, Skylander's Spyros Adventure and Call of Duty Modern Warfare 3, and, of course, Diablo 3. Having the top three games is an important milestone for Activision Blizzard. Our performance for the first half of the year was driven by the remarkable talent and dedication of our employees around the world, and I want to thank them for their continued commitment to excellence, which fuels our strong results. We continue to build and enhance our diversified portfolio of great franchises. So far this year, Activision publishing Skylander's Spyros Adventure, a franchise that didn't exist 12 months ago was the number one best selling game, including toys for the first half of 2012.

Additionally, Skylanders toys outsold the number one action figure line in the US and Europe year-to-date. On October 19, we plan to release Skylander's Giants, which we believe will build on the momentum with a great new game and expanded lineup of characters and a significantly greater retail presence than we had last year. Skylanders has been Activision publishing's most successful new IP, and we have the opportunity to grow this unique franchise across both the $80 billion worldwide toy market and the $55 billion worldwide video game market. In addition to Black Ops 2 this year, we plan to broaden the global reach of Call of Duty, through our recent agreement with Tencent to bring a new free-to-play micro-transaction game to China, one of the largest and fastest growing game markets in the world. Tencent is the ideal partner for Call of Duty, and we're delighted to have Tencent and also NetEase as our partners in China. Diablo 3 marks Blizzard's 14th number one PC game launch, an astonishing record. Diablo 3 set a new launch record for PC games with more than 6.3 million players in its first week alone, and as Mike will tell you later in the call, there's a lot more from Blizzard this year. In fact, next up is World of Warcraft's Mist of Pandaria, expected to launch in the US and Europe on September 25. And, although we've seen some declines in the player base over the past year, Mist is expected to deliver past and present World of Warcraft players a tremendous amount of new content, including story lines, levels, and game modes.

In addition to new content for each of this year's four major franchises, our future program also includes Call of Duty online to China, as I mentioned, a new IP from Bungee, who created the Halo franchise, as well as Blizzard' StarCraft 2 Heart of the Swarm, Blizzard All-Stars, and an all new MMORPG in the future. All of these games are deep in the development process. We're pleased with our performance for the first half of the year, and we're very excited about our titles for the back half of the year. And, while we're increasing our financial outlook for 2012, we do remain cautious, given macroeconomic uncertainty, risks to consumer spending, especially during the holiday season, and the recognition that the majority of our earnings will be generated in the last six months of the year. We'll continue to face a rapidly changing landscape in our industry, and, as we have said many times before, our success comes from focusing on opportunities that offer the greatest long-term growth, expansion of our global reach, and our focus on cost management. This strategy has served us well in the past and should position us well for the future. One last note, over the past few months, there's been much speculation regarding Vivendi's intentions with respect to its stake in Activision Blizzard. While we're unable to comment on Vivendi's behalf, we continue to remain focused on strong execution, the delivery of great games, and the provision of superior shareholder returns, as we have for over 20 years. That strategy has served us very well in the past and will position us very well for the future.

Now, I would like to turn the call over to Dennis, who will review our financial performance.

Thanks, Bobby. Good afternoon, everyone. Today, I'll begin with a recap of our better than expected second quarter and first half results, and I'll then cover our increased outlook for 2012. Let's start with our results. Please refer to our earnings release for full GAAP to non-GAAP reconciliations. For the second quarter, on a GAAP basis, strong consumer demand for our premium content and services drove better than expected results with revenues of $1.08 billion and EPS of $0.16. For the second quarter, on a non-GAAP basis, revenues increased 51% versus the prior year to a record $1.05 billion. Digital revenues hit an all-time high of $497 million, and operating margin increased 480 basis points to a record 28.5%, while EPS increased 100% over the prior year to a record $0.20. Our record performance this quarter was driven by our four mega franchises, including record-setting Diablo 3, our newest IP Skylanders, as well as World of Warcraft and Call of Duty.

During the quarter, we had the top three titles at retail, which underscores our ongoing commitment to our retail partners. We also had the largest subscription based MMORPG and strong digital sales of Diablo 3, which drove record digital revenue. Turning to the specific P&L items, please note all percentages are based on revenues except for the tax rate. For the quarter, GAAP product costs were 27%, just below our outlook due to product mix. GAAP operating expenses were 52%, slightly higher than our outlook, due mainly to higher G&A expenses for Activision Publishing. Finally, our GAAP tax rate was 19%. Non-GAAP product costs were 22%, below our outlook due to revenue over-performance and product mix. Operating expenses were 50%, also below our outlook due to revenue out-performance, offset somewhat by higher G&A expenses. And our non-GAAP tax rate was 26%. It was a strong first half for our business on multiple fronts, and the record performance of Skylanders and Diablo more than offset subscription declines inside of World of Warcraft, lower ala carte DLC sales for Call of Duty and weaker performance in our mid-market and catalog business. Our teams are very focused on addressing each of these areas, and you'll hear from both Eric and Mike about some of the trends in our approach going forward.

Now, turning to the balance sheet, on June 30, we had no debt and $3.2 billion in cash and investments, or $2.71 per share. This is lower than the prior quarter, due in part to the return of approximately $260 million to shareholders through dividends and stock repurchases. For the first six months of the year, we generated a record $245 million of operating cash flow, and, after capital expenditures, we generated record free cash flow of 219 million. The strength of our balance sheet and cash flows are major competitive advantages for us, particularly in this challenging economic climate. Specifically, they afford us the ability to invest for future growth in internal opportunities with the highest return on invested capital, like Skylanders, Call of Duty online in China and Blizzard's new MMO, invest for future growth through attractive external opportunities, such as our 10-year exclusive arrangement with Bungee, and return value to shareholders in the form of dividends and share repurchases. As you know, the retail market for interactive entertainment has declined and macroeconomic concerns and weakening consumer buying patterns are making our markets more competitive than ever. With this as a backdrop, focus has never been more important.

For Activision Blizzard, our three key priorities for 2012 remain unchanged, and we are diligently focused on driving execution against the plan we laid out at the beginning of the year. To reiterate that plan, first, we expect growth from Blizzard, driven by the expected launch of at least two title this year, namely Diablo 3 and Mists of Pandaria. Second, Activision Publishing is focused on this year's new Call of Duty title, Black Ops 2, on drawing on-line engagement and modernization, and on continuing to expand and scale the Skylanders franchise. And finally, we plan to continue expanding operating margins, revenue mix and productivity improvement initiatives across multiple areas of operating expenses. Because of our focused execution for calendar 2012, on a GAAP basis, we are again raising our outlook and expect net revenues of $4.33 billion. We expect product costs of 27% and operating expenses of 48%. We expect a tax rate of 25%, a diluted share count of about 1.15 billion that can be used in all quarters, and GAAP EPS of $0.69. For 2012, we now expect non-GAAP net revenues of $4.63 billion, a $100 million increase from our prior outlook, and up versus the prior year. We expect non-GAAP product costs of 26%, and operating expenses of about 41%. We expect a tax rate of 26% and a diluted share count of about 1.15 billion, both of which can be used in each of the remaining quarters.

We now expect non-GAAP EPS of $0.99, a new record. Now, moving on to the September quarter, on a GAAP basis, we expect net revenues of $740 million, product costs of 26%, and operating expenses of 62%. We expect a GAAP tax rate of 25% and earnings per share of $0.06. For the September quarter, on a non-GAAP basis, we expect net revenues of $690 million, an increased over prior year driven by our lineup including the very late quarter launch of World of Warcraft Mists of Pandaria. We expect non-GAAP product costs for the quarter of 25% and operating expenses of 59%. OpEx is up versus the prior year driven by higher sales and marketing expenses primarily for Mists of Pandaria. For the quarter, we expect non-GAAP EPS of $0.07. EPS is in line with the prior year as our tax rate was very low last year, due to discreet one-time items in the quarter. So, in summary, despite a challenging macroeconomic and consumer environment, Activision Blizzard completed the first half of the year strongly. Although we still have the majority of our major product launches in front of us, we will continue our strategy of focusing on doing a few things really well, driving quality into our game slate, building upon our strength in retail and digital, and keeping a relentless focus on cost containment. The combination of these things should position us for another record year of record non-GAAP margins and EPS in 2012.

And with that, I'll turn the call over to Eric Hirshberg, who will discuss Activision Publishing.

Thanks, Dennis, and hello, everyone. Today, I'll start with a brief overview of our product, performance and recent strategic initiatives, and then I'll go into our pipeline. Year-to-date, the industry has seen a decline in overall retail sales. However, the top games at retail continue to grow. For the first six months of this year, sales of the top five games in North America and Europe are up 15% collectively including accessories. The top five games were also up strongly in 2011 and, in fact, since 2007, top five games have grown revenues an average of 11% per year. And this growth does not include digital sales. So while retail is down overall, the story is much more positive for the top selling titles and Activision Publishing continues to drive this trend. As Bobby said, the first six months of 2012 Activision Blizzard had the three best selling games in North America and Europe, and Activision Publishing's Skylander's Spyros Adventure and Call of Duty Modern Warfare 3 were two of them.

In addition to our product performance, we've also been strengthening our online capabilities starting with our move into China. We've announced a long-term relationship with Tencent to bring an all new free to play micro-transaction game, Call of Duty Online, to the Chinese market. China is one of the most exciting places in the world for us to grow our business. The online game market in China is estimated at $8 billion and is expected to grow at a 17% compounded annual growth rate through 2016. Today, Tencent's QQ network has over 750 million accounts. They have a terrific track record and obviously have deep market knowledge, which -- both of which will be invaluable to us. Second, we see long-term potential for premium games on smartphones and tablets. Our recent agreements with Flurry and Swerve and the creation of our own mobile studio, The Blast Furnace, which is built around some of the industry's best hand-held development talent, are building blocks of our broader strategy. You'll see us develop and release premium titles to expand and strengthen our core brands. You'll see us launch a series of free-to-play games from our rich portfolio of existing intellectual properties, and you'll see us publish third party independent titles that build and engage community and launch new innovative IP. We look forward to telling you more as this strategy unfolds.

Now, let's move to our fall lineup, which is anchored by two of the most popular franchises in all of entertainment, Call of Duty and Skylanders. Call of Duty is one of the biggest entertainment franchises of all time, and player engagement with the brand continues to set new records. In preparation for the launch of this year's game, our team at Trefis has been working tirelessly to bring our highly engaged community Call Of Duty Black Ops 2. The game has several meaningful innovations and firsts for the franchise. It strikes a great balance between taking the franchise to new places, while retaining the core appeal of all Call of Duty games. The game has already generated tremendous buzz, and pre-orders continue to track ahead of Modern Warfare 3. We're working incredibly hard with all of our partners around the world to make Black Ops 2 the biggest entertainment launch of all time for the fourth consecutive year. Call of Duty Elite will also be supporting the multi-player experience in black ops 2. With Call of Duty Elite, we've had historic successes, combined with some important learning. Elite's 2.3 million premium members and over 12 million registered users are remarkable achievements. When taken in combination with the record engagement of the Call of Duty franchise overall, there's strong evidence of tremendous continued engagement with the franchise. That said, we still feel we have a long way to go.

Elite has introduced a lot of changes in behavior for our fans. One consequence is the fact that ala carte DLC sales have not performed as well as in years past. Our over-arching goal is to provide all of our players with the best possible community platform. With that goal in mind, we are always evaluating ways to improve and optimize the service to create the best experience for our fans and the best return on our investment. We look forward to sharing more details on this with you in the future. Finally, I'm pleased to say that Call of Duty Black Ops 2 will give us the biggest and best zombies experience ever. We are very pleased with the game's development, and we expect to have many more announcements to share with you before the November 13 launch. In addition to Call of Duty, we're also focused on driving momentum for Skylander's Spyros Adventure and bringing Skylander's Giants to market. For the first half of 2012, including accessories, Skylander's Spyros adventure was the number one best selling console and handheld game. In addition to that, our stand-alone toy sales also made Skylanders the number one selling action figure in the US and Europe. Skylanders has now succeeded in both the toy industry and the interactive entertainment industry, and, with the combined scale of over $130 billion, there's still plenty of room for us to grow.

We believe that Skylanders has the potential to be our next billion dollar franchise. Over the past few months, we've increased capacity and believe that we will be in a better position to meet consumer demand this year. On October 19, we will release Skylanders Giants. Giants will have significantly higher brand awareness and a significantly larger retail presence than we had for the launch of Skylander's Spyros Adventure. At top retailers, we expect Giants to have more than 100,000 linear feet of shelf space, which will give the title one of the biggest and best in-store presences of any video game. In addition to significantly more retail presence for the game itself, Skylanders will also be present throughout stores this holiday due to our significant licensing partnerships, which we think will both be accretive to the brand and to the bottom line. It will be a huge launch. The game itself will feature eight giants, which are almost double the size of regular Skylanders, eight light course Skylanders that light up in the game and in the real world, eight all new Skylanders, and 24 updated characters from Skylanders Spyros adventure. And the good news for parents and kids is that all of the characters from the original game are compatible with Giants with their abilities and upgrades intact.

Our team at Toys For Bob has done an amazing job. The game is looking great. Looking beyond this year, we're very excited about releasing new content for the Skylanders and Call of Duty franchises bringing Call Of Duty Online to China, continuing to grow our mobile business and launching Bungee's new game and universe, just to name a few. Overall, Activision Publishing continues to focus on our biggest and most promising growth opportunities and, as Dennis said, doing a handful of things exceptionally well. I'm looking forward to sharing more with you as the year progresses.

And now I'll turn it over to Mike Morhaime, who will update you on Blizzard Entertainment.

Thanks, Eric. We've been very busy at Blizzard since the last call. Q2 2012 was Blizzard's best quarter ever, from both a revenue and a profit standpoint. Much of that success was fueled by the record-breaking launch of Diablo 3, and we're excited to welcome so many new players to the Blizzard community. As a matter of fact, about 16.9 million players logged into Battle.net during the past month to play Diablo 3, StarCraft 2, or World of Warcraft. The Diablo 3 launch shattered PC Games sales records, including fastest selling PC game ever. To date, more than 10 million copies have been sold, including the 1.2 million copies sold through the WOW annual pass. While Diablo 3 is our 14th number one seller, we did experience some challenges. Due to the unprecedented influx of players, a number of service issues arose that we needed to work around the clock to address. The vast majority of these issues were ironed out within a couple weeks of launch.

As I mentioned in a letter to players recently, we're not satisfied with just breaking launch records. We want people to play and enjoy Diablo 3 for a long time. We've already made a number of fixes and updates, including the activation of the auction house, which provides a convenient way for players to trade items with each other. The Diablo team has also been working on improvements to end game rewards and adding a player versus player mode, which we hope will enhance the value and longevity of the game. On the World of Warcraft front, we ended Q2 at about 9.1 million subscribers worldwide. This figure is down from the 10.2 million we reported at the end of Q1, with the majority of the declines at the quarter coming from the east. Historically, we have seen usage decline towards the end of an expansion cycle. We saw similar drop in subscribers in the months before Cataclysm, followed by substantial number of returning players around the Cataclysm launch. We're also seeing that a number of players took a break from World of Warcraft to play Diablo 3. As I have mentioned in the past, continuing to deliver compelling new content is critical for long-term engagement with an MMO like World of Warcraft. We are very excited to have recently announced that Mists of Pandaria, our next expansion, will be released on September 25.

In addition to the World of Warcraft players that have been eagerly awaiting the release of this upcoming expansion, there are a surprising number of Diablo players that have never tried World of Warcraft. We believe that Mists of Pandaria includes some of the highest quality content that we've ever created for World of Warcraft. Between the new areas to explore, player race, character class, dungeons, and game modes, we believe that Mists of Pandaria can appeal not only to players looking for more content, but also to those who are looking for different ways to enjoy the game. The new scenario mode offers a pickup and play feel for small groups who want more casual ways to adventure together. Challenge mode offers a great deal of re-playability for hard core competitive players, and pet battles should appeal to players who enjoy collecting pets with some lighthearted competitive elements added on. Another thing I wanted to point out is that we're offering a new digital deluxe version of Mists of Pandaria. This new option will give players who want the mount, pet and other digital goodies from the collectors edition and chance to get those items and still enjoy the convenience of direct download. The Collector's Edition will remain available exclusively at retail.

We'll continue building excitement for Mists of Pandaria in the coming weeks, as we work hard toward a successful launch. Pre-orders are off to a good start in this very early stage, and the ongoing beta test has yielded positive valuable feedback that we're using to tune and polish the game as we head into release. We're also hoping to make a splash at the Gamescom show in Germany later this month, where we will debut the opening cinematic to Mists of Pandaria. In addition to Mists, we'll also be showing the multiplayer version of StarCraft 2 Heart of the Swarm at Gamescom. Back in June, we showed the expansion at major league gaming's spring championship in Anaheim, which was the largest E sport event ever in North America. More than 20,000 spectators came to the event and had a chance to try out Heart of the Swarm. Another 4.7 million unique viewers tuned in to the event via MLG's online broadcast where we showed off some exclusive trailers for Heart of the Swarm. We received tremendous feedback from that event, and we're looking to head into beta very soon. Aside from working on the expansion, the development team just released the arcade update for StarCraft 2.

This is the biggest update we've made to StarCraft 2 since the game launched, and it includes improvements to the user Interface, the custom game editor, and the entire custom game system on Battle.net. Historically, the custom games that the community has created with our game editors have contributed greatly to the longevity of our strategy games. We are hoping that the new arcade update will result in more awesome community-created games on our platform. Before I finish, I want to briefly comment on eSports, specifically our StarCraft 2 World Championship Series. With the help of our partners, we've been running StarCraft 2 eSports events in 28 different countries and regions around the world over the past few months. The best players will compete at the Battle.net world championship event in Shanghai in November. This event will be an eSports Olympics, with talented players representing multiple countries around the world. Our hope is that excitement around eSports can help drive continued interest in our games. In summary, the record-breaking launch of Diablo 3 has given us great momentum into the back half of 2012. We still have a lot of work ahead of ourselves, as we continue to support our Diablo players, get ready for the Heart of the Swarm beta, and prepare for the launch of Mists of Pandaria. With all of our major franchises finally together on Battle.net and great new games in the pipeline -- great new games in the pipeline, the rest of the year and beyond is looking very exciting at Blizzard.

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

Thank you. Operator, we can now open it up for questions.

(Operator Instructions)

James Hardiman, Longbow Research.

Just a quick question on the guidance here. You beat the second quarter, your own internal expectations by $0.10. You're only raising the year by $0.04. Similarly, on the top line, I think you beat by, you know, $200 million-plus, you only raised by about $100 million. How should I think about the guidance for the back half of the year, were there's some shifts in some of your assumptions as we work our way through the year?

Sure. This is Dennis speaking. Thanks for that question. I think, you know, as you heard in my remarks, in this market environment, we think being prudent is the best path, and I think that's what we've done with our guidance, and we've done that for many years as a Company. There are obviously some head winds that we've seen in terms of FX and those are things that we're trying to put inside of our guidance. But, overall, we feel good about our lineup, but obviously, it's a very choppy market with a lot of uncertainty in it, and we're just focused on executing and delivering the great titles that we have in the plan.

Thanks. Just quick follow-up, if I may, just from an industry perspective, obviously, given your small number of high quality titles, you guys probably have less general industry exposure than most of your competitors. But can you give us an idea of what you're assuming for packaged good sales for the year and how that compares to your previous expectations?

Yes, we don't give specific guidance relative to the packaged goods market. I think what you've seen overall, as Eric alluded to in his markets, that more share is going to the biggest titles. What you see -- and so that's just kind of the general trend, which has obviously benefited us because we have some of those largest titles. I think when you also look at that, we are late in the console lifecycle, and so you've seen year-over-year declines, particularly at retail. Digital, as you've seen inside of our numbers, are still very, very strong. So consumers are still consuming in whatever way they find to be the most convenient. Our experience, though, is that if you build great, high quality experiences that consumers will show up. I think Diablo 3 was the perfect example of that.

And the thing that we are seeing, the retailers are putting the most sport behind our titles and the biggest titles generally.

Perfect. Thanks, guys. I'll hop back in the queue. Congrats on a great quarter.

Thank you.

Colin Sebastian, Robert Baird & Company.

Thanks for taking my question. I guess, Mike, maybe could you talk a little bit more in detail about the marketing and advertising program for Mists of Pandaria? Is that going to be broad based, focused maybe a little bit more on Asia and is that mostly online, or are you going to look at traditional channels as well? Thanks.

I think that what you'll see is similar to our past expansions, where we really have gone big and broad, so you'll see both online and television. We think that there's a big opportunity both in the east and the west, and so we're really looking to make this a big global event.

Maybe as a follow-up, the real money auction house, any more detail you can provide on sort of the progress and velocity? Seems like that's potentially another good platform opportunity for you guys. Thank you.

What I can say about that is that, in terms of usage, it is in line with our expectations, in terms of how that is performing. Players are definitely making use of it. We'll continue supporting it and making updates to make sure that it continues meeting their needs. We aren't going to be providing projections or forecasts regarding that specific segment of the business, though.

Thank you. Yep.

Doug Creutz, Cowen & Company.

Mike, I wondered, if I look at the subscription revenue number, and I adjust for Call of Duty Elite and this $11 million accounting issue, it looks like that the ARPU on Warcraft was down substantially more than the subloss, which is a little confusing given you just said most of the sublosses were in the east where the ARPU was lower. Wondered if you could help me reconcile those two things.

I'll let Dennis you take that one.

Sure. When you unpack essentially the -- I think you're referring to the sequential quarter-over-quarter decline in subscription revenues. I think you need to unpack it just a little bit, where about half of it does come from the subscriber decline. I think the other half relates to several other things, which I'll list right now. One is the $11 million that you mentioned, which is one-time non-cash adjustment, accounting adjustment. The second is in Q1, we had some value-added services and a mount that we didn't have in Q2. So, again, stripping that piece out, and there was a little bit of a modest impact for new annual pass members who joined during the quarter. So when you strip out kind of those last three things, the actual subscriber -- subscription revenue decline is actually more in line with the subscriber decline.

Okay, thank you.

Daniel Ernst, Hudson Square Research.

Two questions, if I might, but they are related, so forgive me. Bobby, big picture, the gaming industry is down 30-something percent in the first half of the year. Clearly, you're not, you're actually up 13%, benefiting from that trend of gamers going towards the best titles out there. But I wonder if you could comment as someone who has been through pretty much every home console cycle, what you think is driving it. Is it simply that we're in the seventh year of the cycle? Or are we seeing any signs of gamers leaving as a hobby and moving to other things? And then a related question, where -- in the current cycle where the Wii brought in a lot of gamers who hadn't been there before, my in-laws -- people were playing Wii games and Tiger Woods golf and it was just fun and everyone was doing it, and people have left that. The industry then chased after Facebook gaming, which is now under significant pressure that we've seen from Zinga and EA acknowledging that and everyone's now sort of pushing towards mobile as the place where you can go capture gamers who aren't really gamers and might spend a little bit of money with you. Is that sort of a false hope, do you think? Or do you think there's still an opportunity to expand the market beyond the people, like kids that love Skylanders and hard core gamers that love World of Warcraft and Call of Duty? Thank you.

I think it's all your in-laws' fault. (laughter) I would say couple of observations. First of all, you have a very difficult macroeconomic environment. If you look at the things that we look at that could have an influence on the consumption of entertainment generally, unemployment data is very concerning and you look at what's happening in Europe, and there are a lot of challenges that we see that are going to continue to affect the macroeconomic outlook. I think that we are at the late end of a cycle and the late end of a console cycle is always going to have its share of difficulties. I think you have had, unfortunately, a stream of products that are less than adequate from some of our competitors, and I think the demands and the expectations in the marketplace for great quality product, and if you look at the success that we're having, it validates that there is an opportunity for great quality products. But I think where we are in the console cycle makes it more challenging for anything other than great quality products. I think there's a lot of competition for entertainment dollars. You look at mobile games, and you see what's happening there and where pricing is there, that's had an impact. And I think the other thing that we've seen is games like Call of Duty, a lot of the other games that we may play are multiplayer games that offer a lot of replayability. And when you have the opportunity for replayability in an economic environment like we're in, you're going to spend more time playing the games that you have that give you, an unending amount of replayability. So I think there are a whole host of factors that can contribute. I will say this, when you look out over the next five years, there's a lot of -- there's a lot of reason to be hopeful and enthusiastic, but in the next few years, they are going to be challenging.

Thanks for the color, sir.

Eric Handler, MKM Partners.

First, on World of Warcraft, are you projecting that we could see a release of Mists of Pandaria in China in the third quarter, or is that more likely a fourth quarter event? And then also, do you think you could talk quickly about the tail for Diablo 3 and as it competes with users for the new Mists of Pandaria update, how you're thinking about continuing to monetize that game?

Okay. So with respect to China, our goal is to launch Mists of Pandaria in China as soon as possible and really close the gap between the launch in the rest of the world and the launch in China. Of course we still don't have approval, so I can't provide a release date at this point, but, hopefully that's going to be a much smaller gap than we've seen in the past. That probably still moves it out of Q3. With respect to Diablo, I think that, you know, what we've seen in the past with blizzard games is that they tend to have very long shelf life and we hope to continue supporting and selling that game for a very long time. I think that there is an opportunity created by bringing new players into the Blizzard community, and we hope to -- that some of those players will try out other blizzard games in World of Warcraft.

Thank you.

Edward Williams, BMO Capital Markets.

Good afternoon. Just a quick question looking at Call of Duty in China. Can you give us a little bit of color, Eric, maybe on what steps we have to get through from here to there, in terms of between now and the release of it? And then also, how should we kind of think about this product in terms of what the potential economics of it might be in terms of, maybe some visibility on a revenue split or just some kind of context around the potential economic impact of it.

Well, in terms of the steps between here and the launch, very similar to what Mike just mapped out on Blizzard titles. We obviously are still in development. We made our announcement, but we're still developing the game. Then we still have to gain the approval of the government to release it and we're going to be doing a beta as well. There's still several steps between now and release. In terms of the economics, we can't discuss any particulars in terms of the agreement. However, you know, as I said in my comments, we're partnered with a leading company in China in this segment. They have a tremendously strong track record. We have I think a game that will be very differentiated for what the Chinese gaming community has experienced in the most popular segment being first person shooter. So, we're very bullish about the opportunity.

Okay, great.

Brian Karimzad, Goldman Sachs.

Two quickly, actually. So on Call of Duty China, that's set and in place. But how about the idea or the process of a microtransaction based Call of Duty in other regions in the west? What's the decision tree there, and kind of what are the milestones you need to get to before that becomes a possibility? Then I have a follow-up for Dennis.

Well, I think we, I think we look at, you know, the Call of Duty online game in China on its own merits, as a great opportunity. That's not to say that we won't gain learnings about how it works in a micro transaction-based format for the game, and there are a few other regions where that would be very relevant. But we certainly are not ready to announce any plans in that regard.

Okay, and then, Dennis, from a cash flow perspective, free cash flow perspective, this Company is more like one of the global media companies than it is like a traditional video game publisher, and the capital return to shareholders has also been more like that than a traditional video game publisher. I guess the missing element is leverage, which is present on those. And I know there are some constraints with your parents, but if you kind of back that out and you just think about your view of where the business itself fundamentally will be over the next three years or so, what's your sense of comfort with leverage?

Well, you know, I don't think we're going to go into a hypothetical exercise about how the company might be restructured or anything relative to balance sheet. I think when you look at the past and you allude to the fact that this has been a very shareholder-friendly company in terms of returning capital to shareholders, buybacks and dividends. And it's our goal to continue to drive a lot of cash flow inside the business, which will give us the flexibility to do other things, both returning capital to shareholder and thinking about other investments that we can make inside the business. As we've said, we think that strong balance sheet is a very strategic asset for us, and we're going to continue trying to make it as strong as we possibly can.

And Brian, I would say just one comment on comparing us to traditional media companies, I don't know of any traditional media companies that have our operating margins or return on invested capital.

Fair enough. I was using it as a [complementary], but you're right, absolutely. (laughter)

Okay. Well, on behalf of everyone at Activision Blizzard, we want to thank you for your time and consideration, and we look forward to speaking with you soon.

Ladies and gentlemen, this now concludes today's conference call. Thank you very much for your participation.