Activision Blizzard, Inc.
Q1 2017 Earnings Call Transcript

Published: 4 May 2017

[Operator:]

Good day, and welcome to the Activision Blizzard's Q1 2017 Earnings Call. Today's call is being recorded, and at this time I would like to turn the conference over to Amrita Ahuja, SVP of Investor Relations. Please go ahead.

[Amrita Ahuja:]

Good afternoon and thank you for joining us today for Activision Blizzard first quarter 2017 conference call. With us are Bobby Kotick, CEO; Thomas Tippl, COO; and Dennis Durkin, CFO. And for Q&A, Mike Morhaime, CEO of Blizzard; Eric Hirshberg, CEO of Activision; and Riccardo Zacconi, CEO of King will also join us. I would like to remind everyone that during this call we will be making statements that are not historical facts. The forward-looking statements given in this presentation are based on information available to 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 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, including the factors discussed in the risk factor section of our SEC filings, including our 2016 annual report on Form 10-K, which is on file with the SEC and those indicated on the slide that is showing. The company undertakes no obligation to release publicly any revision to any forward-looking statements to reflect events or circumstances after today, May 4, 2017. We will present both GAAP and non-GAAP financial measures during this call. However, as discussed on our July 29, 2016 conference call, due to updated compliance and disclosure interpretations issued by the SEC staff in May 2016, we are no longer able to present non-GAAP financial measures excluding the impact of deferrals. On this call and in the future, we will continue to provide non-GAAP financial measures which exclude the impact of expenses related to stock based compensation, the amortization of intangible assets, expenses including legal fees, costs, expenses, and accruals related to acquisitions, including the acquisition of King Digital Entertainment, expenses related to debt financing and refinancing, restructuring charges, and the associated tax benefits. 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 our full GAAP to non-GAAP reconciliation and further explanation with respect to our non-GAAP measures. There's also a PowerPoint overview, which you can access with the webcast and which will be posted on the website following the call. In addition we will also be posting a financial overview highlighting both GAAP and non-GAAP results in a one-page summary. And now I'd like to introduce our CEO, Bobby Kotick.

[Robert A. Kotick:]

Thank you, Amrita. And thank you for joining us today. This quarter we achieved record revenues, earnings per share, and cash flow, and over-performed our prior guidance. The size and engagement of our community remains strong. We continue to invest in both in-game growth opportunities, as well as adjacent opportunities, like consumer products, advertising, and esports. One of our big priorities is to unlock the full potential of professional esports by opening the sale of teams and media rights of our leagues. Over the years, we've become a leader in creating world class competitive experiences, sustainable franchises that engage hundreds of millions of people around the world, through gameplay competition and connecting players and communities. This success is driven by our ability to tap into the timeless power of communities, anchored through organized competition. Throughout history, sports has helped bring communities together. City and country loyalties form the basis for spectator enthusiasm, generations of engaged audiences and traditions anchored in scheduled competitions. Until the 20th century though, sports like football, baseball and basketball were still hobbies for gifted amateurs. Then professional leagues emerged like the Premier League, the NFL, or the NBA. The value of sports in our everyday lives has grown exponentially, and so have the commercial opportunities that we see in sports. We actually believe the same opportunity to further professionalize esports now exists, and we think the impact can be as significant as the traditional sports we know and love. The franchises we've built over the years deliver competitive experiences as enduring as traditional sports, but with unique strength and value for brands. Our players are digital natives competing in almost every country in the world. The esports audience includes some of the hardest to reach and most sought-after demographics for marketers and advertisers, with the share of millennials two to three times higher than any of the big four U.S. sports. We're incredibly excited to launch the Overwatch League later this year. We believe by celebrating and rewarding our players, and recognizing their accomplishments, our professional players will become the role model and inspired competitors of the 21st century. The competitions we're creating around the world will attract sponsors and advertisers resulting in broadcast revenues, licensing, sponsorship and ticket sales, and most importantly, amazing spectator experiences. Through MLG, we're building the first dedicated global channel for esports, the over the top ESPN of video games. To put the Overwatch League opportunity in context, around 240 million people today watch approximately 7 billion hours of NFL content annually. This drives $12 billion in revenues including more than $6 billion in media rights revenues. The NBA today has roughly 175 million viewers watching around 2 billion hours total with more than $5 billion in revenues and a $1.8 billion of those from media rights. With hundreds of millions of people already watching esports and playing our games, over the long term our goal is to create opportunities that we believe could be of a similar scale. We're also going to combine delivery of our spectator content with unique advertising opportunities that includes the ability for advertisers to have better targeting and analytics, much more so than what you would see in traditional forms of broadcast advertising today. And with over 400 million MAUs and extremely high levels of engagement, our potential to generate meaningful advertising revenue is substantial. In particular, we believe our initiatives for advertising in King mobile games is a large and untapped opportunity and we're continuing to make progress with our testing and development of our ads platform, Ad King. Our results this past quarter demonstrate our ability to execute successfully against the many opportunities for shareholder value creation we have and as we have done for 26 years. And now Thomas will share the details on the quarter with you.

[Thomas Tippl:]

Thank you, Bobby. We're off to a very strong start this year. We delivered record Q1 revenues of $1.7 billion and record digital revenues of $1.4 billion. We grew year-over-year, over-performed our guidance for the quarter, and are raising our guidance for the full year. Our results continue to be driven by focus and execution against our three strategic pillars. First, expanding our audiences, second deepening engagement, and third providing more opportunities for player investment. Let's start with audience reach, which was 431 million monthly active users this quarter. Blizzard had 41 million MAUs for the quarter, up 58% versus last year and relatively stable versus the prior quarter, despite no new full-game releases. Blizzard's fastest growing new IP ever, Overwatch, continues to grow from an MAU perspective, setting another high water mark this quarter. In less than a year since launch, Overwatch has 30 million registered players and has become Activision's eighth $1 billion franchise. Hearthstone continues to attract new players as well, reaching 70 million registered players life-to-date. MAUs also grew year-over-year and quarter-over-quarter despite no new content in Q1. Activision had 48 million MAUs for the quarter, down year-over-year due to weakness in last holiday's Infinite Warfare release as discussed on our Q4 call. However, Call of Duty continues to have a large and active community of players across Infinite Warfare, Modern Warfare Remastered and Black Ops III. And we expect the community to grow with the next game in the series, Call of Duty

[Dennis M. Durkin:]

Thanks, Thomas. Today I will review our better than expected Q1 results, our outlook for Q2, and our raised outlook for the full year. Once again, we outperformed our guidance thanks to the strength of our global portfolio of owned IP, which delivered record Q1 revenues, digital revenues, earnings per share, and cash flow. To review the quarter, I'd like to first start with our segment results. As a reminder, our segment results, unlike our consolidated results, are still presented excluding the impact of deferrals as they always have been. At an aggregate level, combined segment operating income was up 41% year-over-year on an as reported basis. Operating income also grew on a pro forma basis, when including a full quarter of King last year. This is despite expected Call of Duty headwinds and shows the strength and broad diversity of our portfolio. As anticipated, Activision Publishing's Q1 results were down due to lower in-game digital sales. As mentioned on our Q4 call, we expect Activision to have a back-end loaded year with the two exciting releases in the second half of Destiny 2 and Call of Duty

[Operator:]

Thank you. And at this time, we'll take a question from Tim O'Shea with Jefferies.

[Timothy L. O'Shea:]

Yes, so first congratulations on the quarter, and thank you for taking my question. So I was just wondering if you could provide more detail on the Call of Duty

[Robert A. Kotick:]

Hey, thanks, Tim. Maybe the easiest way to answer the question is to go a little deeper into the data that Thomas started to share on our prepared remarks. Preorders, as Thomas said, are off to a very strong start. But we also track a number of other softer measures to indicate strong positive interest in the game and we're off to a great start with most of those as well. The reveal trailer has become the most liked video in Call of Duty history, and also now has the most organic views of any Call of Duty reveal trailer we've ever made. We also set a new high watermark with the views of the live stream. That's both for Call of Duty and for Activision overall. And the livestream also was extremely positively received, with a 95% like to dislike ratio. And then probably equally important as the positive indicators is the – that the negative social media sentiment, which you know we – was an issue last year, has virtually evaporated at about 0.2% at reveal. So, I think, we're going to have a great game. And I think we have the right game at the right time. Obviously there's a lot of thirst from the community to go back to boots on the ground, but we didn't stop there. We're also going to be bringing some real innovations to the game which are obviously designed to keep it fresh and make it even more appealing for more different types of players, and those are going to be on display when we bring hands on multiplayer to E3 next month, and that's only the second time in our history that we've done that. And for context, the other time was Black Ops III. So obviously we have a lot of confidence in what we're going to be showing. So early days, obviously, but we're off to a strong start. And while we're obviously only talking today about Call of Duty

[Operator:]

And this time we'll take a question from Colin Sebastian with Robert Baird.

[Colin Alan Sebastian:]

Thanks, guys. My question for Bobby or Mike around Overwatch, and you must be encouraged by the pace of growth with the user base. I'm wondering just how large of a market opportunity you think there is for this game, how you plan on maintaining that pace of growth, and on a related note if you could provide an update on the progress of the Overwatch League, including timing of league sales and kick off of the league. Thanks.

[Michael Morhaime:]

Hi, Colin. Thanks for the question. This is Mike. So right now we're heading towards Overwatch's launch anniversary later this month, and we're incredibly happy with the community that's developed around the game, how many people have already tried the game and how they're staying with us nearly a year after the launch. Our first quarter MAUs were higher than we've seen all of last year, so that's great. We've seen new players come into the game when we release new types of gameplay through our seasonal events. And we have a lot of opportunities to continue doing that. We're also pleased with how successful Overwatch has been globally across the Americas, Europe, and Asia as well as our strong presence on both PC and Console. But we're tapping into the biggest genre in the world, so we think there's still a lot of room for growth across both regions and platforms. We think the Overwatch IP is incredibly strong and has potential across a number of different mediums. Our out of game linear media via comics and animated shorts has been really successful in fueling passion for the game's lore. And we think there's an ongoing opportunity there as well. Our existing esports community is really strong and it's growing. The Overwatch League is poised to accelerate that even more. So we're early in Overwatch's story with many growth opportunities still ahead. As far as the Overwatch League timing, we are working to launch the league later this year. You'll hear more about that in the coming months and I can turn it over to Bobby to talk a little bit more about how the team sales process is going.

[Robert A. Kotick:]

Yeah, as far as the team selling process is concerned, Colin, if you look back at the history of when we started this, it was really building a structure that would allow us to celebrate, recognize, and reward our players, and that was our principal priority. What we've come to realize is there's a big commercial opportunity potentially as well. So we've got a great team assembled with people from places like ESPN, Fox Sports, the NFL, the NBA. We've been out meeting with prospective team owners, both endemic teams as well as professional sports team owners, and the reception has been terrific. We'll be announcing our key city sometime later this year and give a little bit more detail into what the play schedule will be. But not for another few months.

[Operator:]

Let us now move to San Phan with Mizuho.

[San Q. Phan:]

Hi. This question is for Riccardo. Can you tell us a bit more about King engagement, what you're focused on at this point? And how you think by driving that business, you're growing engagement.

[Riccardo Zacconi:]

Hi Phan. It is Riccardo. So engagement has always been and continues to be a key priority for the company. And as you've seen from what Thomas was saying earlier, we have very positive trends and we are very happy about these positive trends. The average time played per player in last quarter was around 35 minutes per day. And this has been an increase both towards the last quarter and also versus the same quarter of the previous year. So, great results. And it's also great result that create engagement, it translates into how you're monetization. And we have seen here that bookings per pay year have gone up for the seventh consecutive quarter. So we have reached a new record level. Now what do we do to drive engagement? We do a few things. First of all, we release new fresh content in the live games, and we do – we call it live operations, which basically means this content is temporary, limited in time, and only available for a specific timeframe. And this makes it particularly attractive. And what we also do then, we also release features, which are permanent. So that they are impacting the gameplay for the long term. And both of those – the content releases are in the live games. What we also do is we then leverage the network of games we have by cross promoting players from one game to the next game. And by doing so, retaining and increasing the engagement, not only in the single game but at network level. And then of course we release new games and we have released Bubble Witch Saga 3 in January of this year. And the launch went very well. We are very pleased with the results of the launch, and we're very pleased with the high quality of the game. And as you have heard earlier, Thomas, we have now – we're also entering a new genre of games with the partnership with PlayStudios, which will go live towards the ends of the year.

[San Q. Phan:]

Great. Thank you.

[Operator:]

At this time, we'll take a question from Evan Wingren with Pacific Crest Securities.

[Evan Wingren:]

Thanks. So given Blizzard's slate this year, with less full games being released, just curious how you think about the content to help keep the community engaged throughout the year and how you think about the monetization of that engagement?

[Michael Morhaime:]

Hi, Evan, this is Mike. So, yeah, this year for Blizzard represents a new type of pipeline, one that's not necessarily based on full game launches, but instead on delivering new content updates for our games. This quarter, we have meaningful new content for every franchise in our portfolio. In fact, a few weeks ago we set a new DAU record on the back of these new content updates. This reflects the evolution of our business from focusing primarily on full game releases to also providing a consistent stream of content for our players. Even without any full game launches this year, we're continuing to add to the depths of our games to serve a very highly engaged community with more content across our portfolio than we ever have before.

[Operator:]

At this time we'll move to Michael Olson with Piper Jaffray.

[Michael Olson:]

Thanks, good afternoon. Looks like King has posted some developer job openings for Call of Duty mobile game. Can you provide us with any more detail on the game and your plans with that going forward?

[Eric Hirshberg:]

Sure, I'll start. Riccardo, then maybe you can jump in. So, yeah, Thomas mentioned King and Activision are teaming up to build a Call of Duty mobile game from the ground up. And the goal is to take a brand that tens of millions of people know and love and reinterpret it in a way that is appealing to the mass mobile audience. And we think it's a big opportunity. With King's experience making massively accessible and engaging games for that platform, and Activision's experience building one of the most enduring and appealing and engaging gaming franchises ever, we think we have the right combination of skills to pull it off. But obviously it's very early days. But that's the goal. Riccardo?

[Riccardo Zacconi:]

Hi, Mike. So I believe if I may I will add a couple things to what Eric just said. First of all, and most importantly, and I'm talking here for the entire King's team. I'm super excited about this incredible opportunity, and to work together with the incredible team at Activision Publishing. One of the things which really excited us when we joined the Activision Blizzard family was the strength of the team on one side and the incredible quality and depth of their portfolio of games. And now we have the opportunity to work together on one of the jewels in this portfolio. So, this is super exciting. Of course, as Eric was saying, it's still early days. We are just at the beginning of this process and of the development, and it will take many iterations, as we know well, to create a game of incredible quality. But we are super focused on it. We put amazing people on this task. The target is to develop a game of broad appeal and to combine in doing it the experience of King of creating mobile games of broad appeal with the great experience in the genre and in the shooter genre of Activision Publishing and the experience of creating a franchise which has been around for a very long time. And so I believe that this is a really significant future opportunity, and I'm very excited to work together.

[Operator:]

We'll now move to Doug Creutz with Cowen.

[Doug Creutz:]

Yeah, I wonder if you could give as much update as you can on when you expect to rollout advertising to the King user base, and maybe talk about what some of the gating items are to do that? Thank you.

[Riccardo Zacconi:]

Hi, Doug. So advertising is still in beta. In Q1 of this year, we've been doing further testing. We've built the internal capabilities, and we've built the team and are continuing to build the team. Currently, we are testing in seven titles, including some of our largest titles, with Candy, Candy Soda, and Farm Heroes. And we're testing different ad formats to ensure that we have the best possible player experience and also to ensure that we have the best possible return for our advertisers. We're seeing that in the market there's incredible demand for high quality mobile video ad symmetry, and we continue to be very excited about this opportunity, because we think we are in a very strong position both because of the size of the network and as you've heard before, because of the engagement of our players. So as we said earlier this year in – at our last earnings call in February, we expect to become profitable with this business line, with advertising this year, and to scale up the business in 2018.

[Operator:]

Our final question today will be from Brian Nowak with Morgan Stanley.

[Brian Nowak:]

Great. Thanks. A question on Destiny. Can you just talk a little bit about your expectations for Destiny in the new guidance given the dual platform, console and PC release? And then talk a little more about the digital and the MTX innovation you see coming with the title and what type of contribution you expect in that? Thanks.

[Eric Hirshberg:]

Thanks, Brian. Well, the community's reception to the reveal was obviously awesome. And after four weeks, Destiny 2 pre-orders are tracking amongst the top in Activision Publishing's history. So the most important thing for this franchise beyond delivering a great game, which Destiny 2 is definitely going to do, as we talked about in the past, is getting the content pipeline right. Destiny's engagement has been the best in Activision's history. And we now have a lot of confidence that we're going to be able to keep up with demand with that steady stream of great content to sort of keep pace with our player's engagement post the release of Destiny 2. So as you know from our past comments on previous calls on – with Destiny 2's content, we're coupling Bungie's great visionary leadership with multiple AAA developers that have a proven track record here at Activision to help us make sure that we have just one great piece of new content after another to keep the community engaged. And that's the most important answer to the second part of your question. We've shown that when we have great engagement, great business follows. So with respect to PC, which you asked about, we're committed to delivering meaningful features that are bespoke for the PC community and I'm really excited about what we have to show for them. But I'm going to leave the details of those for our gameplay premiere event which is happening on May 18. And we'll have some additional, obviously, exciting announcements on the game overall at that time as well.

[Robert A. Kotick:]

All right. Thanks, Brian, and thanks everyone for joining us today. We'll look forward to seeing many of you at E3 or on our earnings call this summer. So thank you.

[Operator:]

And again, that does conclude today's conference call. Thank you all for your participation.