Activision Blizzard, Inc.
Q1 2019 Earnings Call Transcript

Published: 2 May 2019

[Operator:]

Good day, and welcome to the Activision Blizzard Q1 2019 Earnings Conference Call. At this time, I'd like to turn the conference over to Mr. Chris Hickey, Senior Vice President of Investor Relations. Please go ahead, sir.

[Christopher Hickey:]

Thank you. Good afternoon and thank you for joining us today for Activision Blizzard's first quarter 2019 conference call. With us are Bobby Kotick, CEO; Coddy Johnson, President and COO; and Dennis Durkin, Company CFO and President of Emerging Businesses. And for Q&A Rob Kostich, President of Activision; J. Allen Brack, President of Blizzard; and Humam Sakhnini, President of King will also join us. I'd like to remind everyone that during this call, we be making statements that are not historical facts. The forward-looking statements in this presentation are based on information available for the Company as of the date of this presentation. And while we believe them to be true, they ultimately may prove to be incorrect. A number of factors could cause the Company's actual future results and other future circumstances to differ materially from those expressed in any forward-looking statements. These include the risk factors discussed in our SEC filings, including our 2018 Annual Report on Form 10-K and those on the slide that is showing. The Company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after today May 2, 2019. We will present both GAAP and non-GAAP financial measures during this call. We provide non-GAAP financial measures which exclude the impact of expenses related to stock-based compensation; the amortization of intangible assets and expenses related to acquisitions including legal fees costs expenses and accruals; expenses related to debt financings and refinancings; restructuring and related charges; and the associated tax benefit of these excluded items. These non-GAAP measures are not intended to be considered in isolation from as a substitute for or superior to our GAAP results. We encourage investors to consider all measures before making an investment decision. Please refer to our earnings release, which is posted on www.activisionblizzard.com for a full GAAP to non-GAAP reconciliation and further explanation with respect to our non-GAAP measures. There's also an earnings presentation which you can access with the webcast and which will be posted to the website following the call. In addition, we will also be posting financial overview highlighting both GAAP and non-GAAP results. And now, I'd like to introduce our CEO, Bobby Kotick.

[Robert Kotick:]

Thank you, Chris, and thank you all for joining us today. Our first quarter results exceeded our prior outlook reflecting strong operating discipline. We are refocusing our resources on our biggest franchises to deliver the operational excellence for which we are known. As we outlined last quarter, we are increasing our focus and investment on our biggest franchises in order to better execute and unlock their great potential.

[Collister Johnson:]

Thank you, Bobby. Focus and operating discipline enabled Activision Blizzard to outperform our first quarter outlook. Strong performance for Candy Crush, better than expected sales for Sekiro and favorable cost timing were key factors driving upside. We also continue to reposition the business to take advantage of our future growth opportunities. So before diving into the specifics of our quarterly results, I'd like to update you on some of the most important steps, we've been taking since our last call. As a reminder, we have four key long-term strategic growth drivers

[Dennis Durkin:]

Thanks, Coddy. Today, I will review our better than expected Q1 2019 results as well as our outlook for Q2, and the full-year. To review the quarter, I'll start with our segment results. Activision revenue of $317 million, increased 2% year-over-year. Key quarterly contributors were Call of Duty in-game and catalog net bookings, and the successful launch of Sekiro. Operating income was $73 million with an operating margin of 23%, which was lower year-over-year primarily due to mix effects. Blizzard revenue of $344 million was in line with our expectation. Operating income was $55 million lower year-over-year due to a decline for in-game revenues, partially offset by lower cost. Blizzard's operating margin was 16%. King revenue of $529 million was roughly flat year-over-year. Candy Crush net bookings grew year-over-year with the ads business more than doubling over the same period. Operating income was $178 million with an operating margin of 34% down 2 percentage points year-over-year due to investment in marketing for Candy Crush Friends. Now let's turn to our consolidated results. Unless otherwise indicated, I will be referencing non-GAAP figures. Please refer to our earnings release for a full GAAP to non-GAAP reconciliations. For the quarter, we generated Q1 GAAP revenues of $1.83 billion, $110 million above our February outlook. This includes the net recognition of deferrals of $567 million. Net bookings of $1.26 billion were $83 million above our February guidance. We incurred a GAAP only restructuring charge of $57 million and generated Q1 GAAP EPS of $0.58 and Q1 non-GAAP EPS of $0.78, which was $0.15 above guidance. These figures include the net recognition of deferrals of $0.47. In terms of cash flow and the balance sheet, in Q1 we generated operating cash flow of $450 million and ended the quarter with approximately $4.8 billion in cash and investments, and a net cash position of over $2.1 billion. Now let's turn to our slate and outlook for Q2 and for the full-year. In Q2, Activision will continue to support Call of Duty

[Operator:]

Thank you. We'll take our first question from Alexia Quadrani with JPMorgan.

[Alexia Quadrani:]

Thank you very much. Just circling back to your comments on the Overwatch League, how is it performing versus your expectations? And how is that translating to sort of player engagement or monetization of the game? And I guess any further color you can give on the Call of Duty city-based league.

[Robert Kotick:]

Sure. This is Bobby. As I've said, we continue to lead the way in professional eSports. For us the most important thing always was being able to celebrate professional players who make the commitment to our games and inspire our players every day. But I think what we found is that as a result of our eSports initiatives, we're creating a lot more enduring appeal in these franchises. When you think about sports and sports teams, they are the ultimate examples of everlasting franchises. And the reason that we've created this city-based global league is to be able to attract that same passion and affinity that only city-based teams can really foster as we grow the fan base and as we want to deepen the engagement that our players have with our franchises. I would say lastly, we've seen a tremendous opportunity to create value for our shareholders through our eSports initiatives. If you think about the last couple of years, the results that our team focused on eSports has achieved is remarkable. If you look at the amount of time it would've taken in traditional sports to sell over $0.5 billion worth of teams, I don't think there's any example of being able to do that in a couple of year period of time. Viewership continues to grow on the Overwatch League and we're now generating much more substantial revenues from the broadcast rights and from sponsors and licensees. So from a commercial perspective, the league is doing really well. Between Overwatch League and now the five Call of Duty teams that we've sold, we have over 25 teams that have generated that $0.5 billion of revenues, and the prices for the Call of Duty teams were well ahead of what the initial prices were for the Overwatch League teams. So we've got great owners. We've got a lot of commercial momentum. I think we've got a great season that we're off to this year for Overwatch League with viewership up substantially. And overall, I think we continue to lead in our initiatives of professional eSports. And with respect to the gaming, I'll leave to Jay you can answer the gaming question.

[J. Allen Brack:]

Yes. I think the game sentiment, the player sentiment for the game remains positive. We continue to have an active player base even though we're approaching our 30th anniversary. The teams are continuing to add features for content and for support engagement. Last week, we released Overwatch workshop on the public test realm. This is a mode that allows players to really be very flexible and very creative and really build their own game modes giving some of the power that the developers have to the players. Early reaction has been positive, and I think we're excited to see what players are able to create. Over the rest of the year, we'll continue to add new heroes and new maps and new experiences. And last quarter I talked about how we have very large ambitions for the Overwatch universe and how it can develop over time. And for us it's going to be a balance of working on the existing game as well as the team focusing on other work that they have. Overwatch is a huge tentpole franchise for Blizzard and we're continuing to dedicate the resources and the attention, so that we can continue to grow the community and the franchise over time.

[Robert Kotick:]

Thanks, Alexia. Operator, can we have the next question, please?

[Operator:]

Absolutely. We'll take our next question from Colin Sebastian with Baird.

[Colin Sebastian:]

Great. Thanks. Just want to follow-up on the comments on free-to-play and given the success in the market for free-to-play title and battle royale as well, I wonder if you could provide a little more of an update on the company's strategy to take advantage of these trends? Thank you.

[Collister Johnson:]

Sure. This is Coddy. Thanks Colin. No specific update today, but I think you’re right to ask how we think about the broader context of it. And as you highlighted, there's a lot of dynamic growth happening in this industry today. I think it's first worth stepping back and talking about broadly how we see that growth because it speaks to why we reposition the company that we have. But we see real growth taking place in in-game revenues, in mobile, in Asia, in free-to-play and in eSports, I just mentioned and in in-game advertising. And so for us the repositioning is really about setting up the right resources to be able to dedicated to those growth initiatives and take advantage of them as we head into the coming years. I specifically know about one of those growth areas in the industry where you see Battle Royale free-to-play coming together. And as we mentioned, we did see some reach impact in our franchises from competitors, who combined that approach in the space. But I think just as importantly, we see real opportunity for our franchises, where we can expand the reach of our ability to go to consumers as we look at that opportunity across our portfolio. I need to start, though. Our north star is always compelling content and great engaging gameplay. It has to start there. It is why we have multiple business models in the company because different gameplay lands itself to different kinds of monetization, and what we're always trying to do is to make sure we have a growing ecosystem of a great player experience in the ecosystem of reach, engagement and monetization. But we are constantly re-examining these ecosystems. If you just look at Call of Duty for instance, over the last decade, we've done multiple things to really evolve that model with evolving player interest from different upfront pricing, to different passes, to different post-launch content approaches and offerings, and we continue to consistently examine those ecosystems. And part of coming to this year and the repositioning of our resources to make sure we had enough available not only to do what we've traditionally done, but to be able to test new approaches to look at the data, to understand what consumers really want and to be able to take advantage of some of those growth opportunities. I do want to make one thing clear that just in closing, which is – we know that the upfront content that we sell for a premium has significant appeal to players, and that they're very pleased by the AAA experiences we can provide as an upfront sale. So we will continue that model. But our additional resources allow us to really look at a number of additional opportunities to take advantage of these kinds of growth areas.

[Robert Kotick:]

Thanks. Operator, can we have a next question please.

[Operator:]

Absolutely. We'll take our next question from Kunaal Malde with Atlantic Equities.

[Kunaal Malde:]

I want to ask about King MAUs, because we've now seen two quarters of sequential growth. So how are you thinking about the outlook for the King Player base going forward?

[Humam Sakhnini:]

Yes. Hey, Kunaal. It's Humam. Let me take that one. So as you saw, we had monthly active users of 272 million across King network this quarter, and it's kind of worth just remarking I think of how strong that network is and I'm really pleased to see that we have two quarters of sequential growth. It's really the first time we saw that since Q1, 2015, which was the quarter after we launched Soda. And I'm equally pleased that that growth didn't come at the expense of average engagement. As you heard, we had record time spent for daily active user. Now it's about 38 minutes. You might have heard us last year we talked about that we're going to put more focus on our reach initiatives, and clearly we're seeing some of that pay off. And as I think about we also had some really strong marketing opportunities that we've been able to capitalize on, you should bear in mind we're a very, disciplined marketer. So we're always looking at positive ROI user acquisition opportunities and those do vary from quarter-to-quarter. But within that framework, what we do is, look at ways that we can always unlock more marketing investments and we do that by introducing new features in our pipeline, which drive engagement and monetization and that now includes advertising, which then enables us to invest more in user acquisition and feed the network. And as an aside, we saw strong momentum in advertising in Q1. So overall, really happy to see that stabilization and we're going to continue to be disciplined in how we balance reach and user acquisition cost in the coming quarters.

[Robert Kotick:]

Thanks Kunaal. Can we have a next question please?

[Operator:]

Thank you. We'll take the next question from Michael Ng from Goldman Sachs.

[Michael Ng:]

Thank you so much for the question. I just have one on Hearthstone. It seems like that's a property where bookings may have been declining for several quarters now. Is there anything specific to point to that's been driving that weakness, whether that's been competition in digital collectible cards or just a normal revenue curve for a game that's been very successful over five years? And are you assuming any sort of inflection in the Hearthstone trajectory following the launch of Rise of Shadows in April? Thank you.

[J. Allen Brack:]

Hi, this is J. I just wanted to kind of say that Hearthstone is a great franchise for us. The game launched a little over five years ago and it's got over 100 million players. We also feel really proud that the game has such a large global appeal. For engagement in the game it's moved around from year-to-year depending on where the Meta game – the Meta of the game that set at being one-time. How the latest expansion is landing and sort of resonating with the community. And what sort of new features are have been introduced in the game. We do think that Hearthstone can be larger in the future. We have a lot of confidence in the team in both, leadership of the team and in the kind of direction they're taking for the game. We're adding more developers in the Hearthstone to create more of a content that the community really wants. And we also have some ideas for innovation that we want to accelerate. You mentioned Rise of Shadows. We launched that in April. And we're really happy that it drove engagement above the previous two expansions. Throughout the rest of the year you'll continue to see different things that we add into the game. The next thing up is our highly re-playable venture. That's going to come out this month. And it has substantially more content than we released in any previous P2P experience. And so overall we feel great about the surprises that that the team have and everything in some of sort of large player community.

[Robert Kotick:]

Thanks Mike. Operator, can we have the next question please?

[Operator:]

Thank you. We will hear now from Tim O'Shea with Jefferies.

[Tim O'Shea:]

Yes. Thank you for taking my question. With Dennis returning to the CFOC, I just thought it made sense to hear if there's going to be any changes in terms of the philosophy around M&A and capital returns. Thank you.

[Dennis Durkin:]

All right, Hey! Tim. Thanks. I appreciate the question. This is Dennis. Well, you covered us for a long time so you obviously know we have a long track record of trying to be balanced, and disciplined in how we allocate capital across investing in the business strategic M&A or returning capital to shareholders via buybacks and dividends. And the core component of that is always ensuring. We have a strong balance sheet. And we for a long time viewed that as a really strategic asset for the company and that gives you a tremendous flexibility as you think about making big bets. And when we find those compelling opportunities, we're not afraid to follow-up on them. You've seen the benefits of that approach over time in both our Vivendi buyback in 2013 and also when we acquired King in 2016. In both cases we were able to deploy balance sheet cash and borrow in a disciplined fashion while we moved our way up the investment-grade credit rating grid. And with rapid change in our industry, we think it's really important to maintain this kind of strategic flexibility and be disciplined about what's best for the company for the long-term. So yes, nothing has changed in terms of how we think about capital allocation philosophy and you should expect a continuation of our disciplined balanced approach going forward.

[Robert Kotick:]

Yes, and I'll just add Tim because I'm off to Omaha for I don't know probably the 20 time for the Berkshire Annual Meeting that as you think about it's worth well for us as a philosophy over 29 years, we're going to always be the guys that wait for that – pitch. And when you think about that it's baseball analogy, we're not going to veer from the discipline that we had for that as a guiding philosophy. Operator, can we have the next question, please?

[Operator:]

Thank you. We'll now hear now from Mike Olson with Piper Jaffray.

[Michael Olson:]

Hey, good afternoon. And thanks for taking my question. I was wondering, how you're feeling about the upcoming version of Call of Duty that's coming this fall. And also what's the latest you can share related to the prospects and potentially timing for Call of Duty mobile? Thanks.

[Robert Kotick:]

Hey, Mike, it's Rob. Thanks for the question. So we continue to feel incredibly good about this year's game coming from Infinity Ward. The game's going to be revealed later this quarter. I think it's going to be really clear then why we're really so excited about the release. On the mobile part of your question, obviously, we see significant potential for Call of Duty. We're starting to see first-person action games on the platform to attract really substantial audiences and we feel that with Call of Duty's global appeal, we can obviously see some powerful results. Now as we've discussed before now approaching the mobile opportunity in two ways really, both through internally developed content and through partnerships. And in the case of what we recently announced the Call of Duty mobile, we're working with Timi one of Tencent's top studios. And Tencent's putting a ton of resource behind the game and it continues to shape up really, really well. The results from all the regional tests that we've had have been really encouraging as is the interest in the community. And after we announced the Call of Duty mobile is coming to region outside of China, we saw over 10 million pre-registrations on Google Play for the game, which is a really strong and significant result for a new title. We're also pretty encouraged by the resumption of approval in China, but we're not taking anything for granted here. As stated you can assume we're planning particularly prudently for that country and mobile overall. And to sum it up honestly, we feel just really good about the games that we have in the pipeline for the Call of Duty franchise this year and we're excited for their prospects. Thanks for the question. Operator, can we have the next question, please.

[Operator:]

Thank you. We'll now move on to Matthew Thornton with SunTrust.

[Matthew Thornton:]

Hey, good afternoon, everyone. Thanks for taking the question. Maybe coming back to King and Candy Crush in particular, you talked in the past about how the franchise grew through some of the network disruptions last year. And my question here is, is that growth sustainable than we've seen recently? And can we expect some acceleration as we look forward here as we start to comp some of those network disruption issues? Thanks, guys.

[Humam Sakhnini:]

Hey, it's Humam again. We've had a really strong quarter for Candy franchise as you heard. And yes, the network disruption in Q2 last year did cause a step-down in reach and monetization. So when you think about the year-on-year net bookings growth it really illustrates the durability over the long-term of the franchise. I will say that since that disruption, we stepped up our internal initiatives to build more direct connections with our players. But on the durability point, I just want to highlight how evergreen the franchise is that we've created there. The Candy franchise bookings grew year-on-year in 2017, again in 2018, and now continued into Q1. Shows kind of the strength of this franchise, which first launched in 2012. And ever since Soda was launched in 2014, Candy has had two of the top 10 grossing titles, and the U.S. app stores. In my mind it comes down to our ability to do a few things here within the franchise, first is successfully developing market new titles within the franchise. So we launched Candy Crush Friends in 2018 – October 2018, and the retention and monetization trends on that continue to remain strong. And we prudently invest in our marketing opportunities to bring in former players and new players, and I discussed that earlier. We take a very disciplined ROI approach to that. And third, we constantly innovate within our live titles and deliver players fresh new content and features. And we really think very thoughtfully about those pieces of content that we're putting in our live titles. So, I feel really good about our ability to continue executing in these areas and to deliver ongoing growth in the Candy franchise as a result of that.

[Robert Kotick:]

Thanks, Matt. Can we have the next question please, operator?

[Operator:]

Thank you. We'll take our next question from Mike Hickey with The Benchmark Company.

[Michael Hickey:]

Hey, guys. Thanks for taking my question and congrats on a strong Q1, good start of the year. I guess I was just hopeful that you could provide some additional color or maybe some – a little bit more visibility within your Blizzard pipeline. Thank you.

[J. Allen Brack:]

Hi. This is J. Thanks for the question. This is an important topic for everyone, and it's super important to me personally. I said consistently that the Blizzard pipeline is larger and richer than ever before. It includes PC and console releases. It includes ongoing content for World of Warcraft, Overwatch, Hearthstone and a couple of mobile initiatives. It's critical that all these products meet the Blizzard quality that we're known for. We want to give the teams the space to really create excellence and release games at a better and more consistent kids. We're pretty impatient to get all those content in front of the community and it's a reason that we have significantly increased our developer head count as we talked about last quarter. The teams are highly motivated. We feel we've got a lot to prove, both to our players and to ourselves. And lastly, we just talk about – Coddy talked about earlier announcing BlizzCon and the show is returning November 1 and 2 to the Anaheim convention center and working really hard to make it great event.

[Robert Kotick:]

Thanks. Operator, we have time for one last question.

[Operator:]

Thank you. We'll take our last question from Brian Nowak with Morgan Stanley.

[Matthew Costa:]

Hi. This is Matthew Costa on for Brian. Thanks for taking the question. Just on the cloud gaming opportunity, there's obviously been a large number – number of large payers going into the space between Stadia from Google and now Microsoft with Project X cloud. Can you contextualize that opportunity in your view and give any thoughts on those new platform entrants? Thank you.

[Robert Kotick:]

Yes. Thanks for the question. It's Bobby. When you own 30 years of IP like we do, there's probably never been a better time to be in the games business. And when these big well-funded companies are building out platforms that they have limited amounts of content to actually serve up to customers. I'd say that there's a great opportunity for a company like ours. I think for starters they will all try to broaden the audience for gaming and make big investments and commitments in doing so. And that's just helpful for a growing market. But in each case none of these platforms can succeed without great content. And truthfully, they don't really know how to make it. So, when you think about what will be required it will be support from us to allow them to actually build audience. And I think that we have a better opportunity than most to capitalize on all these new platforms that will be there. In addition, to the fact that we have almost 350 million direct relationships with our own customers today and so distribution is evolving and changing in the way that we actually connect with our own customers. So the net, I would say as you think about the next five to 10 years, there will be more ways and places to engage players and that serves us better than almost any other company.

[Christopher Hickey:]

All right, thank you everyone for joining us today. And we look forward to seeing many of you I guess in L.A. for E3 perhaps next month then if not then see you on the call next quarter. Thanks for the time.

[Operator:]

Thank you. That does conclude today's conference. Thank you all for participation. You may now disconnect.