Activision Blizzard, Inc.
Q3 2017 Earnings Call Transcript

Published: 3 Nov 2017

[Operator:]

Good day, and welcome to the Activision Blizzard's Third Quarter 2017 Earnings Conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Amrita Ahuja. Please go ahead.

[Amrita Ahuja:]

Good afternoon and thank you for joining us today for Activision Blizzard's third quarter 2017 conference call. With us are Bobby Kotick, CEO; Coddy Johnson, COO; and Spencer Neumann, CFO. And for Q&A, Dennis Durkin, Chief Corporate Officer; 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 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 things 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 2016 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, November 2, 2017. We will present both GAAP and non-GAAP financial measures during this call. We also 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 financings and refinancings; 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 a full GAAP to non-GAAP reconciliation and further explanation with respect to our non-GAAP measures. There's also a PowerPoint overview, which you could access with the webcast and which will be posted to 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 sheet. And now I'd like to introduce our CEO, Bobby Kotick.

[Robert A. Kotick:]

Thanks, Amrita. This was another strong quarter. We delivered record results and exceeded our prior outlook. Our audience is among the largest of any platform and this quarter, we achieved a new milestone for daily time spent per user of over 50 minutes, which is in line with some of the most engaging online connected platforms in the world. We remained focused on building enduring franchises over the long term and helping to grow strong and highly engaged communities around them. When we focus on serving our communities and investing in new ways to help people connect with our franchises and each other across many different types of content and platforms, we create opportunities for delivering growth across reach, engagement and player investment. A great example of this is BlizzCon. Tomorrow, the 11th celebration of the Blizzard community kicks off in Anaheim, California. This is one of the highlights of the year for the company as BlizzCon exemplifies how our games bring people together from all walks of life and all parts of the world. Gaming through events like BlizzCon provides players with a true sense of belonging and a recognition that through our games we can help break down the barriers that seem to be dividing much of the world. Over the next couple of days, over 30,000 people will join us from around the globe, with millions more joining virtually including via the live stream and our virtual ticket. The attendance and viewership are great examples of the incredible passion of the Blizzard community, whether hosting esports championships, unveiling epic cinematics, offering compelling new game play experiences and consumer products, or simply providing a space for players to connect. BlizzCon reflects the scale and diversity of the broader opportunities open to the company today. We remain excited about our growth prospects, many of which are progressing quickly. The launch of the Overwatch League begins with regular season play on January 10, and we believe 2018 will be the year that esports becomes even more broad in its appeal. This morning, we announced large Overwatch League sponsorship deals with both Hewlett-Packard and Intel. And these are two great examples of forward-thinking initiatives by two important companies that will help us deliver a great experience for the community and invest in the future of the League. Our employees across Activision Blizzard and King continue to be recognized for their commitments to excellence and execution. We were named to the Fortune 500, Fortune 100 Best Companies to Work For and Fortune's Most Admired companies. This quarter, we're proud to have been recognized in the top 10 of Fortune's first-ever Future 50 list, which recognize the world's most innovative and forward-looking companies. Marrying vision and creativity with consistent execution over the long term has always been the blueprint for our success. And we're going to keep working hard to approach our future with the same discipline. We're very grateful for the support of all our employees, our player communities, our partners and our stakeholders and shareholders in this effort. And now, here's Coddy to review the highlights of our operations this quarter.

[Collister Johnson:]

Thank you, Bobby. 2017 continues to be a record-setting year. We surpassed last year's high watermark for year-to-date revenues and earnings per share, we delivered record revenues in Q3 and we outperformed our guidance by more than $200 million on revenue and by $0.13 on non-GAAP EPS. Given this over-performance and the confidence we have in our plans, we are raising our outlook again, for the year. Our performance is made possible by our incredible teams whose commitment to delivering creative and commercial excellence, engages our communities and enables our company to grow. I want to highlight, in particular, that in Q3, our teams demonstrated two important aspects of our strategy. First, the ability to serve our communities with a broad range of experiences, large and small across full games, expansions, content drops, features and services. And second, the ability to drive meaningful results from those investments. We saw this from Activision and Bungie with launch of Destiny 2, a major new game for the franchise, which is now the biggest console release for the year in the U.S. We also saw see this from Blizzard with Hearthstone's Knights of the Frozen Throne expansion, built upon iconic characters and lore, which became a franchise's best-performing expansion to-date. And we saw this from King with Candy Crush where continuous ongoing feature and content updates allowed this franchise to have its largest quarter since 2013 and return to the number one position in the U.S. app store. King's Q3 performance is worth underscoring for a moment. They reclaimed their number one mobile publishers spot in the U.S., they grew revenues for the third sequential quarter to the highest level seen in 10 quarters, and they achieved record mobile gross bookings. King did all of this by focusing on the player experience and the live titles and by increasing the pace and success with which they release content, services and feature updates. Let's now dive deeper into our first strategic pillar, audience reach, which was 384 million monthly active users this quarter. Activision MAUs were a Q3 record of $49 million driven by launch of Destiny 2 and continued strong performance by the Call of Duty franchise, which helped Activision achieved record Q3 segment revenue and record Q3 operating income. Destiny 2 is off to a strong start and after the PC launch is now ahead of Destiny 1 on total consumer spend, on time spent per player, attach rate to the expansion packs and average revenue per user. Destiny 2 also achieved a new high watermark in digital full game downloads at over 50% of console sell-through. And last week, we introduced Destiny to PC gamers for the first time, opening up the franchise to new global audiences and future growth opportunities. We were thrilled to launch on Blizzard's Battle.net platform where we have an end-to-end connection with consumer and can drive enhanced player experiences, better insights and better company economics. The Call of Duty franchise had a record Q3 MAUs providing even more momentum around tomorrow's highly anticipated release of Call of Duty

[Spencer Adam Neumann:]

Thanks, Coddy. Today, I'll our review our better-than-expected Q3 results as well as our outlook for Q4 and our raised outlook for the full year. I'll start with our Q3 segment results. We delivered record Q3 segment revenue and operating income, up 16% and 10%, respectively, and record year-to-date performance. Importantly, we saw strength across all of our segments with each of Activision Blizzard and King contributing to our over performance for the quarter compared to guidance. By focusing on our strategic pillars of reach, engagement and player investment across our breadth of leading franchises, we were able to outperform our outlook, deliver strong results in the quarter and prudently invest in long-term growth initiatives. King had a great quarter. The business delivered segment revenues of $528 million, up 15% year-over-year; operating income of $208 million, up 51% year-over-year; and operating margin of 39%, which was up 9 percentage points year-over-year, and all of which also meaningfully over performed prior quarter. As Coddy mentioned, King's revenues have now grown for the third sequential quarter to the highest they've been since the first quarter of 2015 and mobile gross bookings grew to an all-time record. This is the result of really strong execution by the King team and their commitment to continuous community engagement, data-driven platform insights and capabilities and consistent delivery of new, impactful game features. Following the King acquisition early last year, the team further prioritized resources on Candy Crush and live franchised tiles. We're seeing the benefits of this discipline and focus. Activision had a record third quarter, including segment revenues of $759 million; operating income of $261 million; and operating margin of 34%, driven by the successful launch of Destiny 2, the ongoing engagement of Call of Duty community and continued contribution from our library with Crash Bandicoot. Activision doubled revenues and more than doubled operating income year-over-year, leading to record Q3 and record year-to-date financial performance. Blizzard's $531 million in segment revenues and $168 million of operating income were driven by the strength of the World of Warcraft, Hearthstone and Overwatch franchises. Performance was down year-over-year as expected, given the difficult comp to last year's Q3, which featured both a World of Warcraft expansion and the first full quarter following Overwatch's release. Now let's turn to our consolidated results. Unless otherwise indicated, I'll be referencing non-GAAP figures, which include the impact of deferrals. Please refer to our earnings release for full GAAP to non-GAAP reconciliations. So for the quarter, we generated GAAP revenues of $1.62 billion, which was $233 million above our August guidance. This includes the net deferral of revenues of $284 million. We generated GAAP EPS of $0.25 and non-GAAP EPS of $0.47 in Q3, which were $0.16 and $0.13 above guidance, respectively. These figures include net deferrals of $0.13. For the year-to-date on a GAAP basis, we generated record revenues of $4.97 billion, up 8% year-over-year and EPS of $1.12, up 19% year-over-year. On a non-GAAP basis, we generated operating margin of 37% and record EPS of $1.73. Looking at cash flow and capital structure; we delivered Q3 operating cash flow of $379 million, finishing the quarter with approximately $3.7 billion in cash and investments, about one-third of which is held domestically. And we ended the quarter with approximately $4.4 billion of aggregate debt outstanding for a net debt position of roughly $800 million. So now let's turn to our Q4 outlook. In Q4, we'll continue our strategy of delivering a steady stream of content and services to our community, including updates for Blizzard's Hearthstone and Overwatch franchises and execution against a robust slate of features and live ops across King's titles. As you know, Activision released Destiny 2 on PC on October 24 and we have plans to release our first expansion and add-on content for that franchise on December 5. And of course, Activision releases the much anticipated Call of Duty

[Operator:]

Thank you. And we'll take our first question from Colin Sebastian with Robert W. Baird. Your line is open.

[Colin Alan Sebastian:]

Thanks, guys and congrats on another strong quarter. I have two questions. The first one is how are you thinking about driving further improvements in bookings at King based on what we've seen for the quarter and year-to-date thus far? Thank you.

[Riccardo Zacconi:]

Hi, Colin. It's Riccardo here. Maybe before I answer your question just want to highlight that 2017 has been a great year for gross booking growth. And this quarter has been the third quarter of sequential gross booking growth and Candy regains the number one slot in the U.S. app store, and we are now the leading developer in the U.S. and this has also been, as you heard before, the highest ever quarter in mobile gross bookings. So I think we're very proud of that. And I'm very proud of what the team has achieved. Now, we have achieved these results by executing on our strategy. We used our proven system to deliver content and features that our players love, and we also focused more resources on live operations to increase the cadence of our updates. If you think of our network and of the size of our network and the experience over the years, we have a unique opportunity to better understand really what players like, what players want. And so we developed a portfolio of features and content and we test these features and content with our players. And when we get these right, we add to the player experience and this converts into higher player engagement and greater player investment. We can see the results of this virtuous loop in our Q3 results. However, I would like to point out that this quarter, our system delivered an exceptional hit rate, and this has led to a greater amortization growth than usual. So over time, while we don't expect the same level of increase every quarter, we remain confident in our long-term ability to deliver innovation and growth with this rigorous process.

[Colin Alan Sebastian:]

Great. And may be as a follow-up – sorry, the follow-up was just mentioning some of the reach initiatives for King that you first talked about on the last call, if you could expand on those as well? Thank you.

[Riccardo Zacconi:]

Sure. Sure. So reach is a key priority for us and we have two approaches to stabilize and then grow the reach. We are focusing on marketing and we're focusing on product. On the marketing side, the goal is to drive new installs and to regain less players. Here we're focused on innovating how we market our live titles. So as an example of innovation is the partnership with CBS and Lionsgate in the U.S. for the Candy Crush TV show. On the product side, here we focus on the live games, and we're working on new content and new features to drive greater player retention. So the teams are now prioritizing this initiative alongside our monetization and engagement initiatives and that as you heard earlier, have been so successful in driving gross bookings. On top of these initiatives, we're also working on new game launches. New game launches have always been proven as driving reach and having a positive impact on reach. And our development teams are now working really hard on prototyping and developing new titles for the coming years. I would like to point out that reach is everyone's problem. We're all focused on reach and changing the reach trajectory, however, will take time. We have the team, and we have the focus to do it.

[Operator:]

And we'll take our next question from Mike Olson with Piper Jaffray. Please go ahead.

[Mike J. Olson:]

Thanks. Good afternoon and congrats on a strong quarter. You've talked about esports as an investment in the near-term without material profits. Can you help quantify near-term milestones and other benefits that having the leagues can offer such as the marketing for Overwatch and other titles? And what are the plans for additional leagues beyond the Overwatch League? Thank you.

[Robert A. Kotick:]

Thanks, Mike. It's Bobby, I'll answer that. In fact, today, we're having our first owners meeting for the Overwatch League, and we view that as a major growth initiative and a very sizable standalone opportunity for the company. We're building the league for the long-term and, in our view, the opportunity, rivals, what you see in professional sports for a lot of perspectives but starting with the demographics to the audience. The first season is really about building a solid foundation, delivering world-class viewing experience, distributing the content as broadly as we can to our audiences around the world, making sure that we have that strong and growing global fan base and really building the league revenues in the key three areas that we've outlined in the past. And today was a great announcement in that regard in sponsorships, in the sale of broadcasting media rights and in licensing. And we've got a really great group of owners who I just came from. We've got some of the great entrepreneurs in sports, some of the great entrepreneurs of the endemic esports businesses. And they are all focused on driving local marketing campaigns to build out their fan bases in the markets that they serve. I think we're off to a very good start in the sponsorship front with the announcements that we've made today. And we'll continue to deliver new news and information as we get closer to our January 10 launch date. So it will clearly benefit the franchise from a marketing perspective, but it is a great business opportunity in and of itself. As far as other leagues – right now, we are so focused on executing Overwatch League as best as we can that we're not really planning on announcing anything else right now. And look, I would say, that the greatest single benefit that we get from celebrating our professional players is that these are people who make an incredible investment and commitment into our games and we have the opportunity to really celebrate and recognize and reward them in an exceptional way. And we think that that has the most tremendous value to our players and to the company.

[Michael Morhaime:]

This is Mike. I just want to add, we're incredibly excited about the launch of the league on January 10. We really view this as sort of building a foundation for this league that we don't expect will scale overnight. Sports leagues take time to build. But with the foundation that we're building, we're really excited about what the future will hold, and we think it will benefit players, teams, fans and have a really long-term potential for the Overwatch League. In terms of how the league might benefit the franchise overall, we really view that as being tied – what is good for the league is good for the Overwatch game as well. So, incredibly excited about the inaugural season.

[Operator:]

We'll take our next question from Evan Wingren with KeyBanc Capital Markets.

[Evan Wingren:]

Thanks. And appreciate the clarity on the Destiny digital data. Just wondering, how has the total engagement trended for Destiny 2 to-date, may be compared to Destiny 1 over that same timeframe on a like-for-like basis?

[Eric Hirshberg:]

Hey, thanks, Evan. It's Eric. We're very happy with the performance of Destiny 2 thus far. With just a month of sales, it's already, as Coddy mentioned, the bestselling console game of the year-to-date in the United States. But beyond that we've also improved on pretty much all the other important metrics that we look at. We're now ahead of Destiny 1 in total consumer spend. Hours per player reached a new franchise record and average revenue per user was up as well. We also have a very strong attach rate to the Expansion Pass, which we think is a great indication of our fans' ongoing commitment to engagement with the franchise. So we know our fans wanted a game with a great engaging story, with great characters and a more accessible experience overall. And we think we lived up to their high expectations on those measures. And we also know that our fans are already hungry for more. And as I've said on past calls, we now have not just Bungie but multiple AAA teams developing content for Destiny and we're planning on having more content than ever before to support Destiny 2, starting with the first expansion that's coming on December 5. And also, we launched Destiny on PC, which we expect to open up new geographies where we think Destiny is going to be really well received. So we've got events coming, we've got compelling in-game content coming, we've got strong marketing and events planned through the holidays, so we've got good momentum there.

[Operator:]

And we'll take our next question from Tim O'Shea with Jefferies. Please go ahead.

[Timothy O'Shea:]

Yes. Hi. Thank you for taking my question. So, look, very impressive with Destiny 2's digital mix accounting for over 50% of sell-through. So it does seem like full game downloads are picking up steam in the console business and I thought you might update us on where you see this trend heading in the next year? Thank you.

[Spencer Adam Neumann:]

Thanks, Tim. This is Spence. I'll take this one. Let me first underscore that we've got great retail partners. Retail is going to continue to be important for us on console for some time to come, but, that said, this consumer trend that we're seeing and the shift to full game digital downloads, it's real, it's a strong tailwind for our business, and it's a good thing. That digital connection, it brings us closer to our consumer and it creates better economics. It's roughly $10 of direct profit improvement and then there's also indirect savings and margin benefit and even some working capital benefits. But I guess, getting back to your question on the trends, I believe we mentioned last year that our historical digital mix was about 20% to 25% for Call of Duty and more in the 30% to 40% range for Destiny and Overwatch on console. And historically, we've been seeing that digital mix increase at about 5 points a year. As you point out, with Destiny 2 digital at over 50% console sell-through so far, we believe we're seeing some acceleration in that digital shift. And while that's consumer-led move, I'd be remiss if I don't point out just for a moment that our team put together some really compelling digital premium packages and drove a lot of credit for creating packages that clearly resonated with Destiny's community and delivered a lot of value. So as we look to the kind of finish out the year and into the back half of Q4, we'd expect retail actually to gain some share as we reach a broader audience. But we do still expect to end the year well ahead of the original Destiny digital mix. I guess, I should point out that when you look at a franchise like Call of Duty, there's different dynamics there. So it's not like-for-like. Call of Duty, as you know, is a more mass-market game and the more mass you get, the higher the retail share. So while we're seeing higher digital preorders as well on World War II relative to any prior Call of Duty title, that digital mix is still well below what we're seeing for Destiny 2. So with CoD, we may still also see that acceleration from the 5 point historical rate, but again, it's a consumer-led shift predominantly, and we'll have to wait and just see how the quarter lands. Overall, though, this is a good news for our business, it's a nice trend. There's a lots of runway to go to expand that digital full game sales footprint and grow that connection with our players.

[Timothy O'Shea:]

Great. Thanks, Spence, and congratulations on the quarter.

[Spencer Adam Neumann:]

Thanks.

[Operator:]

And we'll take our next question from Matthew Thornton with SunTrust.

[Matthew C. Thornton:]

Yeah. Hey, good afternoon. Thanks for taking the question guys. Maybe just following up on the prior comments on Call of Duty, I know there's a bunch of leading indicators that you guys track versus prior releases, including total preorders and preorder mix. Can you just walk us through where we stand on all those leading indicators that you think are relevant? Thanks.

[Eric Hirshberg:]

Sure, Matt. This is Eric. I'll take that one. The good news is all indications are very strong. We've got preorders that are strong, awareness and purchase intent which, of course, we also track at the top of the scale. And anticipation amongst our community is at a fever pitch that we're very excited about. The other thing that sets us up well is the fact that we had our Monthly Active Users on the Call of Duty franchise at a record high in Q3, and it's always great for our new content launches when we have people hyper engaged with the franchise. So as Coddy mentioned, Call of Duty has been the number one console franchise worldwide, seven of the last eight years. We expect to extend that streak this year. And obviously, our community is excited that we're returning to the sort of grittier, boots-on-the-ground authentic military setting that the franchise's roots, but we didn't – it's also important to know that we didn't just do that. I think that's the headline, but we didn't rest on those laurels. We're also bringing a bunch of really cool innovations like an entirely new way to play multiplayer called War Mode which is more team-based and collaborative than any mode we've had before. That was a huge hit in the beta that we did as well as Sledgehammer's take on Call of Duty

[Operator:]

And we'll take our next question from Drew Crum with Stifel.

[Andrew Edward Crum:]

Okay. Thanks. Good afternoon, everyone. Can you discuss in a little more detail recent performance and trends you're seeing across World of Warcraft and Hearthstone? And how you're thinking about the pace of investments for these franchises going forward? Thanks.

[Michael Morhaime:]

Hi. This is Mike. Thanks for the question. So we continue to be very happy with both of those – with the strength of both of those franchises. And I'd tell you on the World of Warcraft side, we are investing more than ever. The team has been hard at work delivering on our commitment to the community to deliver more content, more consistently between expansions, that's been going really well. Since Legion was launched in August of last year, we had – we've added multiple content updates and the updates have been really well received by the community. We've seen engagement up versus last year, when you look at time spent per player and also frequency of play. On the Hearthstone side, Hearthstone's continuing to do really well. Engagement has been really strong throughout the year driven by our successful content launches and our innovative event specifically, with the last expansion, Knights of the Frozen Throne. As you heard, it's had a franchise record for expansion sales and also drove strong engagement with time spent, up double-digit percentage year-over-year and MAUs were also up year-over-year as well.

[Operator:]

And we'll take our next question from Brian Nowak with Morgan Stanley.

[Brian Nowak:]

Thank you. My question Happy Call of Duty Eve! one of the question on King. Could you just talk to sort of the biggest learnings on the King advertising side, kind of what drives the business from here? And what are some of the big milestones you're looking for on the advertising business into 2018?

[Riccardo Zacconi:]

Hey, Brian. This is Riccardo. So the advertising business, the first priority in the advertising business has been to build a strong ad team, and we now have industry-proven leadership onboard and we are making great progress in filling other key roles in the team as we grow the advertising organization. Our vision for the business is to deliver great experiences for the players that also drive results for the marketeers. And we have made progress on several dimensions. We have, first of all, been developing several ad formats with a particular focus on those that are supportive of the gameplay. So an example of such an ad format is rewarded video ads where players receive an in-game benefit for initiating and for viewing an ad. And in this respect, I'm encouraged by what I'm seeing. We're steadily enabling more of our player cohorts to see ads as a consequence of that. We're also growing traction with advertisers from a range of industries. For example, entertainment, tech, banking, and we're seeing traction in key markets, in the U.S. and in the U.K. As a result of this, the team has started increasing the volume of impressions. On the sales side, we're seeing traction in the direct sales, and we're also continuing to make resource and partnership investments to build on this momentum we are seeing in programmatic buying. Looking forward, we will continue to develop the business with a focus on aligning the experience of our players with the delivery of key metrics for the advertisers. You heard Coddy earlier and, basically, we expect to ramp up the advertising business during 2018. So if I have to summarize, in short, I'm very excited about the opportunity that advertising provides for King, for our players, and for advertisers.

[Brian Nowak:]

Okay. Thanks.

[Operator:]

And we'll take our final question from Scott Krasik with Buckingham Research. Please go ahead.

[Scott D. Krasik:]

Hey, everyone. Thanks for taking my question. Great quarter. I'm not sure who's more excited for the new Blizzard content, gamers or investors. But for those who have not gone to BlizzCon, is there a way for you to tease any of the upcoming announcements? Thanks.

[Michael Morhaime:]

Well, first, we're going to have to get you to BlizzCon one of these days, but it's just an amazing community event. And getting to see the passion of our players and the amazing skill of the pro-players in-person is pretty incredible. But even if you're not there in person, you can still watch the opening ceremonies for free at BlizzCon.com. That starts at 11

[Scott D. Krasik:]

Okay. Thanks.

[Spencer Adam Neumann:]

Okay.

[Amrita Ahuja:]

I think that was the last question?

[Spencer Adam Neumann:]

That's the last question?

[Amrita Ahuja:]

Yeah.

[Spencer Adam Neumann:]

Okay. All right. Well, I want to thank everyone for joining the call today, and we look forward to speaking with you next quarter. Thanks.