Activision Blizzard, Inc.
Q2 2019 Earnings Call Transcript

Published: 8 Aug 2019

[Operator:]

Good day, and welcome to the Activision Blizzard Q2 2019 Earnings Conference Call. Please note today's call is being recorded. At this time, I would like to turn the conference over to Christopher Hickey, Senior Vice President of Investor Relations. Please go ahead.

[Christopher Hickey:]

Good afternoon and thank you for joining us today for Activision Blizzard's second quarter 2019 conference call. With us are Bobby Kotick, CEO; Coddy Johnson, COO; and Dennis Durkin, Company's 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.

[Bobby Kotick:]

Thank you, Chris, and thank you all for joining us today. Our second quarter results exceeded our prior outlook for both revenue and earnings per share. In the first half of 2019 we prioritized investments in our key franchises and we expect to expand reach, deepen engagement, and drive player investment as a result. We're very encouraged by the early results of this renewed focus.

[Coddy Johnson:]

Thank you, Bobby. Activision Blizzard exceeded its second quarter outlook with strong, creative, and commercial execution and with top line performance at Activision and favorable cost timing driving operational upside. In our recent earnings calls I've shared how we’re increasing investment in our key franchises this year across Call of Duty, Candy Crush, Warcraft, Hearthstone, Overwatch, and Diablo, we're expanding our development teams and resources so that we can accelerate the delivery of content in our pipeline and pursue new business models, broaden our communities, and delight our players. These expanded teams are working on innovative new content across console, PC, and mobile for both in-game content and for new releases. Most of the work underway will set us up for future growth, but we also saw encouraging early progress in several of our flagship franchises, in particular new in-game content for Call of Duty, Hearthstone and World of Warcraft reinvigorated those communities and drove improved Q2 fans. At Black Ops 4 we saw market improvement in daily engagement trends since the introduction of a new Alcatraz Blackout Map in April and more frequent events throughout the quarter. And our ongoing work to offer even more compelling in-game experiences delivered strong year-over-year growth for net bookings from in-game items versus World War II. In Hearthstone a great response to the rise of Rise of Shadows expansion and the substantial new single player content led to net bookings growth versus the prior quarter and versus the Q4 expansions and World of Warcraft saw growth in subscribers in the second half of the quarter driven by both the Rise of Azshara major update late in the quarter and by building excitement on the imminent launch of World of Warcraft Classic.

[Dennis Durkin:]

Thanks Coddy. Today I will review our better than expected Q2 2019 results, as well as our outlook for Q3 and the full-year. Q2 GAAP and non-got EPS were ahead of our prior outlook. Key factors included business over performance and favorable cost timing, as well as an equity investment gain and a lower tax rate. To review the quarter, I'll start with our segment results Activision revenue was $268 million, down year-over-year against a comparable that included Destiny. Key quarterly contributors were Call of Duty in-game revenues and the successful launch of Crash Team Racing, Nitro Refueled. Our operating income was $55 million with an operating margin of 21%, which was 4 percentage points lower year-over-year due to lower revenue and mix effects. Blizzard revenue was $384 million, lower year-over-year due to a decline in in-game revenues. Operating income was $75 million with the revenue decline partially offset by lower costs. Blizzard's operating margin was 20%. King revenue of $499 million was roughly flat year-over-year and modestly higher in constant currency. Candy Crush net bookings grew year-over-year with the ads business doubling over the same period. Operating income was $171 million and an operating margin of 34% which is consistent sequentially and year-over-year. 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 full GAAP to non-GAAP reconciliations. For the quarter we generated Q2 GAAP revenues of $1.4 billion, $81 million above our May guidance. This includes the net recognition of deferrals of $189 million. Net bookings of $1.21 billion were $57 million above our May outlook. We incurred a GAAP only restructuring charge of $22 million. We recognized an unrealized gain on an equity investment of $38 million which is included in our GAAP to non-GAAP EPS and we generated Q2 GAAP EPS of $0.43 and Q2 non-GAAP EPS $0.43 and Q2 non-GAAP EPS of $0.53 which was $0.18 above guidance. These figures include the net recognition of deferrals of $0.15. From a cash flow and capital structure perspective, Q2 operating cash flow of $154 million grew strongly year-over-year due to working capital timing. We paid a cash dividend of $0.37 per common share which was up 9% year-over-year for a total of $283 million in aggregate to shareholders of record as of March 30, 2019. Our cash investments at the end of June was approximately $4.7 billion and we ended the quarter with a net cash position of approximately $2 billion. Now let's turn to our slate and outlook for the second half of 2019. Blizzard released Hearthstone's latest expansion Saviors of Uldum this week and is launching World of WarcraftClassic globally on August 27. The team will continue to support Overwatch with new content and events and is preparing for the release of Warcraft III

[Operator:]

Certainly. And we'll go first to Matthew Thornton of SunTrust.

[Matthew Thornton:]

Hey, good afternoon and thanks for taking the question. Maybe just on World of Warcraft, can you just talk a little bit about just the lit you're seeing from the introduction of the classic mode as well as the recent patch Rise of Azshara and just how sustainable you think that is here into the second half from an engagement standpoint? Thanks.

[J. Allen Brack:]

Hi, this is J, first on World of Warcraft more broadly, the team is always looking for ways to meet the demand for more content between expansions recognizing the kind of sort of the deep love that players have of the game and the value of new experiences. The recent update, Rise of Azshara is a good representation of how we think about large updates for the game. While Classic is also part of our effort to increase available content, players have shown a lot of support for both Classic and Rise of Azshara. Regarding Classic specifically, for many years we've really heard from players their desire to play the original version of the game and it was a great experience for me personally to announce the start of that effort at BlizzCon. Overall, this has been a pretty significant undertaking. There has been a lot of technology challenges, but I think the team has really fed a lot off of the excitement that they've seen from the community from the overall player base. We're really proud of the work that has gone into creating the game and we're also really excited for the launch on August 27. If you are a subscriber, while Classic is automagically included with your subscription, so it's greatly increasing the available content to players and is really a good way to maintain our connection to the game. We've had over 100 million players experience wow and that's a global number. So it's a great opportunity for many players who were once part of the community to return and re-experience the game as they, as it once was. Now to your specific question, there is a lot of excitement around Classic and it's really exceeded our expectations already, but it's really difficult to predict sustained engagement post launch. We have seen a lot of strong interest, and we'll see, you'll see us continue to work to drive awareness around the launch in the coming weeks. I thank you for the question. I really appreciate it. Classic is something that's really close to my heart.

[Christopher Hickey:]

Operator, can we have the next question please?

[Operator:]

Yes. And that will come from Brian Nowak of Morgan Stanley.

[Unidentified Analyst:]

Hi, it's on Matt on for Brian. Thanks for taking the questions. So first one is just looking at the King business, can you go over sort of the key drivers and vectors for growth from here? And then turning to the core, how should we think about MAU and sort of in-game monetization trends heading into the second half? Thanks.

[Humam Sakhnini:]

Hey, it's Humam. Thank you for the question. So after a couple of quarters of MAU sequential growth, overall King MAUs fell a bit to 258 million in Q2 and I mentioned on the last call that we tried to be quite disciplined on user acquisition and we spent less in marketing in Q2 compared to Q1 and so MAU as well have been slow over the quarters. But with the headline MAU figure you don't necessarily see the important underlying trends. One of the most important ones that look at is for Candy Crush, our largest franchise which were up year-on-year and with Candy and mobile continuing to represent the larger share of our mix versus web and smaller titles in the portfolio, the overall year-on-year and the new trends have been improving. And then specifically on your question on monetization Candy Crush bookings grew year-on-year in Q2, and to me that - those are the growth story for the franchise that has started happening in 2017 and 2018 and I saw it again in Q2. And these long-term trends are really kind of about what we're doing in the franchise and how we continue to invest in content and new features for our players. So, we know that content drives player engagement and you heard we just released 5,000 level in the original Candy Crush, great milestone for the game. But content is much more than just adding levels. We're adding innovative features and life ops that creates many different ways for our players to enjoy our games, and that means that we offer fresh ways for everybody in the titles - to engage with our titles whether are just starting or where they are at level 5,000. So, and on top of all of this, we're adding new features, which drive monetization. So as I look forward, we have a pretty strong pipeline of these features planned for the coming quarters and they will continue to deliver these features to our players to drive engagement and also monetization.

[Christopher Hickey:]

Operator, can we have the next question please?

[Operator:]

Of course and that question will come from Mike Ng of Goldman Sachs.

[Michael Ng:]

Hi, thank you very much for the question. I was just wondering if you could talk a little bit more about the future of the Call of Duty franchise. Specifically, it seems that with the focus toward Call of Duty titles that might have the potential to sustain over multiple years. We may be going toward a business model that doesn't necessarily involve annual releases but instead a few franchises that are perpetual live service games. Would that be consistent with what's your vision for the future of Call of Duty looks like? Thanks.

[Robert Kostich:]

Mike, it's Rob. Thanks for the question and it's a good one at that because we're taking some important steps to grow the franchise overall, and there's probably a few things I mentioned here. Now obviously Call of Duty mobile, it's going to be an ongoing live services title. We're building a huge stream of content and events, keep our players around the globe having fun for the long haul on this one. But if I look overall on the console and PC side, we do still see new launches as a critical part of our future. These new releases are, have been and continue to be a huge engagement drivers for our community because they bring a robust set of new experiences to our fan. So that said, obviously we want to also build player engagement here over time as well. We're very committed on this front. You're going to start seeing that in a few ways, first with modern warfare. We're going to have cross platform play as Coddy mentioned and we're also not having a season pass. Now this is important and we're doing this because we want to build one massive community where everyone can come together and have fun each and every day and to support that community as we go forward. We're investing significant resources post launch content events and new ways to play that we think fans are going to really love. So what I'd say is, we're really looking forward to the launch of modern warfare, it is a great game. And we believe it's the beginning of an incredible journey for our community. Thanks.

[Coddy Johnson:]

Hey, Mike. It's Coddy. If I might just jump on to the question, just to talk more broadly, not just Call of Duty, but also the rest of the franchises in our portfolio, because I think the question is broader really about how we think about live services. And we recognize that the key to player engagement is really great ongoing and content coupled with like core game play features and services that really keep the players engaged. And you've heard that today, the investment that we're putting against that initiative and the resources we're bringing to bear and earlier results we're seeing are really meant to think about our franchises as live services. That said, we do see across many of our franchises major upfront launches as a very effective and important way to refresh the franchise, to drive innovation, to reach out to new players, to expand the community and so in the resources there are putting into our franchises. As you see in the additional investment, we think we can get the best of both worlds. We can get live services an ongoing way and then major upfront launches to really drive innovation and to refresh the franchise and expand the community. So you'll see, you'll continue to see big launches from us, and we're looking forward to telling you more about those in due course.

[Christopher Hickey:]

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

[Operator:]

Next question will come from Kunaal Malde of Atlantic Equities.

[Kunaal Malde:]

Hi, thank you. Could you expand on your comments about the Overwatch League performance in the quarter and also kind of talk about what effect do you expect the home-and-away format of games to have next year? Thanks.

[Dennis Durkin:]

Hey. You bet. Hi, Kunnal it's Dennis. I'll take this one. It's a great question, obviously because viewership is a great indicator of the health of any league any sports league - like the Overwatch League, and I know from the outside, because we are -- we have some great streaming partners and we're also on TV, it's sometimes hard to get the specific date on that. You heard in Bobby and Coddy's comments that when we looked at the two OWL stages that were held in Q2 the average minute audience which is the best, probably the best what measure of viewership was up strongly and when you look at the season-to-date average minute audience is up 15%, with the U.S. actually up over 30%, so encouraging trends there. And then demographically, when we kind of parse through that even more importantly is that we're seeing growth in our younger U.S. audience as well and that's in a year when nearly every other major traditional sport is seeing viewership decline in those audience segments. So I think this really highlights how the expanded roster this year is driving more interest in more places for the league, and that also the work that we've done to enhance the viewing experience is really starting to help deliver some results. Now that's not to say we're done on that journey. There's still a lot of room for further improvement in the viewing experience and this is a key focus area for us as we think it's critical to continuing to make the broadcast not only compelling but easily digestible for mass market audiences. On the second part of your question around the home-and-away format, yes we're excited for next year. We think it will be a big driver of not only for local fan interest in many of our markets, but also broader viewership as well. We did see some early indicators of solid progress on that this quarter with the Dallas and Atlanta home stands that brought thousands of spectators to the home arenas in those respective areas and obviously the atmosphere in those arena is actually I think translated well into the broadcast. So I think that bodes well for as we roll out format out next year across the league, both not only for the Overwatch league, but for the Call of Duty league as well. So, yes, it's still early innings to use a sports analogy and there's still plenty of work to do, but early signs are very encouraging.

[Christopher Hickey:]

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

[Operator:]

And that will come from Ray Stochel of Consumer Edge Research.

[Raymond Stochel:]

Great, thanks for taking my question. One on Blizzard, so how do you balance Blizzard Polish, as you guys call it, an increasing demands from consumers around the speed and pace of content? Thanks.

[J. Allen Brack:]

This is Jay, this is a question that the teams really spend a lot of time considering on how to be successful and it’s a priority for me personally. There is a high demand of Blizzard game content and it's a challenge we faced for a long time. I think we have made some headway over the years. At the same time, I think it's very clear that we could be doing better, and that was one of the driving reasons for us increasing the amount of developer talent at the company as well as really focusing on our priorities this year. Having more people in place to support the various initiatives that we have and the various features is really critical. It's the -- the process of iteration that we feel is really critical to us reaching the right quality levels. It's going to take some time to further ramp up on content delivery across our franchises, but we're happy with the early progress. We've seen significant new content for Hearthstone and for World of Warcraft just this quarter, and those are both very positively received by both communities. And ultimately, that's how we're thinking about Blizzard quality. Internally, we talk about craftsmanship, and to us that's about meeting our expectations as well as the player expectations and both in terms of frequency of content and in the level of polish. And so when we say that we're aiming to release more Blizzard game content for our players, it means that they can start to look forward to not just more Blizzard games, but more Blizzard quality game experiences across the board.

[Christopher Hickey:]

Right. Operator, can we have the next question please?

[Operator:]

And that will come from Alex Giaimo of Jefferies.

[Alex Giaimo:]

Great, thanks for taking the question. I was just hoping to get an overall update on the advertising opportunity at King and whether you're still confident in the ability to scale that business over time?

[Humam Sakhnini:]

Hey, Alex. Thanks for the question. It's Humam. So we have a lot of momentum in advertising right now and I still see a substantial opportunity for ongoing growth. I'm going to give you a little bit of color on that. So on the demand side, the -- ad product is in safe premium environment and that's differentiated proposition for the advertisers. And we're seeing both new and returning brands recognize this and as we are seeing this, we are continuing to build our sales capabilities. So we have a number of strong partnerships as well around that with ad platforms that help fill the engine -- we're making available. And on the supply side, we recently introduced ads into Candy Friends our newest Candy title and we are working on putting ads into Candy Crush Jelly Saga and at rescue saga in the back half of the year. So we've made good progress on both supply and demand, and we're continuing to increase impressions. As you heard ad net bookings doubled year-on-year again in Q2. And we're well on track to exceed the 100 million mark that I talked about. And as I look ahead, we're planning to continue to grow within the King that work and educate more brands and partners about the strength of this value proposition.

[Coddy Johnson:]

Hey, Alex. It's Coddy, I may jump in as well. Here, just stepping back for a moment, because it's to king's credit that they've built a really tremendous ad platform and set of capabilities that are delivering the results that we talked about today and that Humam just gave some more color on. We also have the opportunity now to bring this capability elsewhere in the business. We are actively working on this including looking at certain new mobile experiences and also at esports and we think there's a lot of potential to deploy what we've learned across the rest of the company where it makes sense, and so overall there's there is momentum for us, not just in the existing ads business inside King, but we think plenty potential for further growth across the rest of the business.

[Christopher Hickey:]

Thanks, Alex. Operator, we have the next question please?

[Operator:]

And the next question will come from Mike Hickey of The Benchmark Company.

[Mike Hickey:]

Hey, Bobby, Coddy, Dennis, Chris, nice quarter, guys, thanks for taking my questions. Just curious, perhaps in your Activision re-masters opportunity obviously you have a huge library of IP, there to work with. So I guess just how meaningful is re-Masters business and what the opportunity for further re-Masters in the future? Thank you.

[Robert Kotick:]

Hi Mike, it's Rob, I'll take that one. So at Activision we have seen great results from re-mastering some of these beloved games over the last couple of years. If you look at Crash and Sane Trilogy, Spyro Reignited Trilogy and Crash Team Racing, they are all credible games and our teams have done a really great job in modernizing them for today's platform. Now the player response due to these have been fantastic. And I'd say, for example, if you look at Crash and Sane Trilogy; that one sold through over 10 million copies. So they are obviously having a big impact on our bottom line and a real impact there, but I'd say what's really important is that it's reaffirming the enduring nature of these franchises for us. And as you mentioned, when you look at our IP library, we think there's a lot of IP in there the fans are going to want to experience again. So now what I'd say stay tuned for some future announcements. But just beyond pure re-masters are also a lot of opportunities now to innovate and think about totally new content within these IPs. So as we think about it, there is a lot of growth opportunities for the business over time within Activision, based on our library of IP and frankly more broadly across the company, where the company did collectively have the ton of great IP.

[Christopher Hickey:]

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

[Operator:]

And that will come from Mike Olson of Piper Jaffray.

[Michael Olson:]

Hey, good afternoon. Speaking of great IP, you guys have a great track record of creating new IP but we know how difficult that is to do. And just wondering, can you talk about new IP development and how you're thinking about the opportunity there in general? Thanks.

[Coddy Johnson:]

Sure. Thanks, Mike. Thanks for the question. This is Coddy. Happy to talk about new IP initiatives, but first I do want to just pause and emphasize that we feel fortunate to already have a number of large established franchises with global recognition and passionate communities and it's worth pausing there because we do feel strongly and see result around thinking of those as beachheads that we can build on where there is tremendous scope to innovate inside of them. And we do feel the execute on that potential, the company should be and will be substantially larger than it is today, and we think this is not just true for ourselves, but broadly in gaming and entertainment where large established franchises really do give you a significant competitive advantage and we're leaning into that. That said, it doesn't mean we're only focused on the existing portfolio franchises. We have new IP projects underway across each of the businesses. And as you mentioned, we've had a -- we think one of the best or when a top track records of putting out new IP and part of the reason for that is that we have a very rigorous screen like process through which we put new ideas. We're looking at creative, at commercial, at design at every stage of development from prototyping all the way through the build and testing and it's a high bar. And honestly many and maybe most ideas don't make it through. But we think this like that rigorous approach is the right one because of the demands of the fans and of the industry are increasingly significant. You have to be disciplined about the process, not just because it's the launch of the IP, but it's about sustaining it and growing it over time. That's by far the best experience for the players when you can launch in sustaining grow. It's also by the way, by far the best business model and it's what really drives the returns. And so, that's what we look for, and that high bar means that it takes time for us to bring games to bear and it also means we don't talk about our plans too early. But I want you to be rest assured we have new IP initiatives underway and given our track record, we feel pretty confident about our ability to have success here over the future.

[Christopher Hickey:]

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

[Operator:]

And that last question will come from Ryan of Bank of America.

[Unidentified Analyst:]

Hey, good afternoon. Thanks for taking the questions. Just two quick ones, if I may. First regarding the soft launch testing you're doing for Call of Duty on mobile, can you maybe share some of the early feedback you're getting from the players there? And whether there is anything in the data suggesting, hey this game could be top 10 or top 20 grossing on mobile? And then along the lines of mobile, can you talk briefly on what you and your partners over in China are seeing regarding the approval process there for games like Call of Duty and Diablo? Thanks.

[Robert Kotick:]

Hey, Ryan, it's Rob. So yes, Call of Duty mobile now has been in soft launch in Canada and Australia, the last few weeks and the early indicators, so far, very promising and we're seeing very strong and very strong results across all key metrics, including installs and retention. Players are reacting to and I think loving the authentic Call of Duty game play, the characters and the setting and obviously an ability to play across a wide variety of fun modes and when we look at the pre-registrations for the game to us it suggests a real high anticipation and organic demand for the game globally. So like I said, I do think the early signs are encouraging and now as we think about mobile, there is another interesting thing for us, which is the opportunity here for tens of millions of people to experience Call of Duty for the first time. Now, if we get that right, this could be a step change for us in the franchise's reach. As you know, there are several mobile action games right now that are generating significant reach in revenue. So this game does have potential to be meaningful to us. All that being said, this is a new initiative and we are always particularly careful not to get ahead of ourselves when it comes to forecasting these things, but as I mentioned, we do feel very good about what we're seeing so far. Now you asked about China and, as you'd expect, we're planning very prudently there and working through the process, but we're not going to wait for China to launch this game elsewhere. We've been keen to get this game into the community's hands as soon as it's ready and they shouldn't have to wait too much longer. Thanks for the question.

[Christopher Hickey:]

All right, thanks everyone for joining us today. We greatly appreciate your interest and support and we look forward to seeing many of you in-game this fall and hopefully in person at BlizzCon towards the end of October. Thanks again.

[Operator:]

And with that, ladies and gentlemen, that does conclude today's call. We would like to thank you again for your participation. You may now disconnect.