Activision Blizzard, Inc.
Q4 2017 Earnings Call Transcript

Published: 9 Feb 2018

[Operator:]

Good day, and welcome to the Activision Blizzard Q4 2017 Earnings Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Amrita Ahuja, Senior Vice President of Investor Relations. Please go ahead.

[Amrita Ahuja:]

Good afternoon and thank you for joining us today for Activision Blizzard’s fourth quarter 2017 conference call. With us are Bobby Kotick, CEO; Coddy Johnson, President and 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, February 8, 2018. 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, 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 of these excluded items along with significant discreet tax related items such as those results from the Tax Cuts and Jobs Act enacted in December 2017. 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 can 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. Starting this quarter, we are introducing a new operating metric, net bookings. Net bookings is defined as the net amount of products and services sold digitally or sold-in physically in the period and is equal to revenues plus the impacts from deferrals. And now, I’d like to introduce our CEO, Bobby Kotick.

[Bobby Kotick:]

Thanks, Amrita, and thank you all for joining us today. This was a record quarter and record year for Activision Blizzard. We delivered record quarterly net bookings of $2.6 billion and record annual net bookings of $7.2 billion. We delivered record segment operating income of $2.4 billion and record non-GAAP EPS of $2.21 per share, above our initial February outlook of $1.70. And we also delivered record annual operating cash flow of $2.2 billion. Each part of our business reached new milestones and demonstrated the durable and enduring nature of our franchises. Activision celebrated strong Call of Duty momentum and their best operating income year ever. Blizzard delivered their highest operating income ever for year with no major game releases. And King returned to growth with the Candy Crush franchise stronger than ever. 2017 was also an important year for us for preparation of our future growth initiatives. We invested in new services, features, content and experiences to connect and engage audiences all across our franchises. One example is the launch of the Overwatch League. Witnessing the passion of players at the opening matches of Blizzard Arena and the millions of spectators connecting via live stream from around the world was a thrilling moment in our history and a milestone in esports growth. Watching fans road trip across the country, spectators in the stands wearing team jerseys, gears in the game wearing team skins, audiences leaping to their feet after daily play and viewing parties around the world; these were awesome moments that created incredibly rewarding experience and demonstrated the emergence of professional competition as a way to celebrate our players. Launching a professional league is an ambitious undertaking and our teams executed on countless fronts, attracting 12 world-class team owners representing cities in Asia, Europe and North America, signing numerous league and team level sponsors, brining esports spectating and production values to new heights, and forming a media strategy that provides broad reach and fair value for our premium content while also preserving distribution on own platforms. Overwatch League matches are broadcast live on our MLG and Twitch, and will be available on other broadcast outlets throughout the world. In its first week, the league reached 10 million unique viewers and had more than 280,000 average viewers on a per minute basis, in the week since we’ve seen sustained levels of viewership globally with new spectators joining each week as the excitement continues to grow. Of course, we are building this league for the long term, and we’re pleased with the early strong momentum that we have which has created value for players, spectators, team owners, partners and sponsors. Our efforts have already led to increased global demand for expansion teams, which we expect to start selling later this year. We also believe in the growth potential of each new opportunity we are pursuing whether in-game advertising, consumer products, cinematic productions or esports, all of these support our communities and help to drive engagement with our franchises. Each new experience we provide that enables our players to demonstrate their passion, creates a virtuous cycle of engagement, investment and growth. It’s still early days for many of these efforts but making progress in these strategic growth areas will be an important focus for us in 2018 and beyond. I have the privilege to lead one of the best teams in the entire business world. And as I begin my 28th year at helm, I have never been more energized to pursue with focus and determination the great growth opportunities that lie ahead. Also, this quarter, we announced that Reveta Bowers joined our Board of Directors, Reveta brings an immense amount of experience and leadership from education and media institutions such as Common Sense Media where she chairs the National Board of Directors and from The Walt Disney Company where she served as a director for 10 years. We’re thrilled to have her as our newest Board member. And now, here is Coddy, to review the highlights of our operations this quarter.

[Coddy Johnson:]

Thank you, Bobby. Activision Blizzard had a record year. And throughout 2017, we broke records and posted strong results each quarter by providing an ongoing year-round scheme of content, services, features and events, both large and small, to our passionate and deeply engaged communities. While achieving these records, we also made important investments to drive future growth. We invested in marketing, to grow our franchise reach, and used services and features to enable more audience engagement and player investment and in new growth verticals to celebrate our fans. Let’s dive into our first strategic pillar, audience reach, which was 385 million monthly active users this quarter, up from 384 million in Q3. Starting with King. On our last call, we discussed a number of initiatives underway to stabilize King’s user base. Those ongoing efforts include releasing fresh and compelling features, events and content into the live games, ROI positive marketing to attract and engage new players, and a strong pipeline of new titles to expand the network. Several of these initiatives enabled King to finish Q4 with 290 million monthly active users and to grow time spent per user to a record of 37 minutes. The Candy Crush franchise in particular was up in monthly active users quarter-over-quarter, while also driving increased engagement with higher daily active users and higher time spent per player. Activision had the top grossing console game releases in North America and two of the top five worldwide, getting at 55 million monthly active users in Q4, up double digits quarter-over-quarter and matching the prior quarterly record. Call of Duty

[Spencer Neumann:]

Thanks, Coddy. So, today, I’ll our review our Q4 and 2017 results as well as our outlook for 2018. Q4 was another strong quarter capping off a record-setting year, with record quarterly and annual revenues driven by record annual digital revenues as our business is now 78% digital and record in-game revenues consistent with our entertainment as a service model. With an increasingly diversified business, we generated for the first time over $2 billion in annual revenues on each of three interactive platforms, console, PC, and mobile, and with record profits, record annual non-GAAP operating income and earnings per share, and record cash flows. Each of Activision Blizzard and King contributed to our over-performance for the year, delivering record annual total segment revenues and operating income. And as Bobby noted, this was without the benefit of a new full game release from Blizzard, underscoring the strength of our continuous engagement model. Activision had an impressive fourth quarter, capping off their best year ever with segment records for operating income of over $1 billion and operating margin of over 38%. Activision’s performance was driven primarily by the resurgence of the Call of Duty franchise with the successful launch of Call of Duty

[Operator:]

[Operator Instructions] Our first question comes from Chris Merwin with Goldman Sachs.

[Chris Merwin:]

So, this one is for Riccardo. We’ve seen some pretty impressive growth for King, lately. You’ve invested in some more frequent content updates and we’ve seen improved player engagement as a result. But beyond, I guess, the improvements and monetization for King, can you talk a bit more about the pipeline and the two or more new releases in 2018 that you mentioned in the prepared remarks?

[Riccardo Zacconi:]

So, we have several teams working on new games, first of all. And those are games using the existing franchise IP as well as new IP. So, we are creating also new IP. And these games are at various stages of production, and it’s a multiyear pipeline. So, as you heard before, in 2018, we plan to release at least two new games including social casino in partnership with PlayStudios. I would like to highlight that we set ourselves a very high bar for new game launches. We will only launch games of the highest quality and we’ll only launch them when they’re ready. When we think about games pipeline, it’s not just about new games, it’s also new content for our existing live games where we develop new features and live ops. In 2017, we focused this development on increasing engagement and increasing monetization, and this has allowed us to hit several mobile bookings milestones. As you heard earlier, we had in Q3, our highest-ever mobile bookings quarter, and in Q4, we hit our highest ever mobile booking week. In 2018, we will continue focusing on engagement and monetization, but we will also focus these new features on rich initiatives. So, we expect to continue to drive positive engagement and monetization as well as we expect to attract new users. So, if I think about it, we exited 2017 with a strong momentum. And I believe that we have a great pipeline, both of new titles and new content for our live games.

[Operator:]

We’ll take our next question from Laura Martin with Needham.

[Laura Martin:]

Let’s talk about the Overwatch League. It sounds like everything is going great. Could you sort of give us an update on how it did benchmark against your expectations and what surprised you, both on the upside and downside? And then, on the monetization, as we’re modeling 2018, you said you’re going to sell more teams. Could you talk about monetization generally and then where do you think the teams will sell for more than the first 12 teams?

[Mike Morhaime:]

This Mike from Blizzard. First off, I want to take a moment to thank everyone on the Overwatch League team for the amazing job they’ve done. Overwatch League was an ambitious undertaking, it required supported collaboration across Activision Blizzard starting from the Overwatch game team although up to Bobby who as you know has been a strong supporter of the league from the beginning, as well as from a host of stakeholders and the communities. I want to especially thank all the pro players who compete, the team owners who really got behind our vision for the league, our partners over at Twitch and our sponsors who believed in what we were building. I want to also thank the viewers who tune in especially those people who are coming to the studio and bringing their passion and energy and filling up the stands. They’re an inspiration to everyone who works on Overwatch League. It’s really been wonderful to see how everything has worked out so far. We’re very pleased with the high-quality that we have been able to enjoy every week. The games have been exciting to watch and the reception from our viewers has been really spectacular. So, so far everything has either met or exceeded our expectations. We made a landmark two-year media rights deal with Twitch and more than 10 million people tuned in to week one, worldwide. We had an impressive audience per minute of over 400,000 on opening day. We’ve also been very happy that several major brands have partnered with Overwatch League including Intel, HP, Toyota, T-Mobile, and Sour Patch Kids. While we’re pleased, it’s important to note that this is only the beginning. Our focus is going to be on continued growth of the audience through improvements to the broadcast and the live viewer experience. In the mid to long term, we think the audience growth is the key to seeing impact both to the bottom line results and to the Company as a whole, and I think also to drive popularity in the game as well. In terms of selling expansion teams, we are very excited with the reaction and the interest in expansion teams. I’m pretty confident to say that the price is going to go up.

[Operator:]

We will take our next question from Matthew Thornton with SunTrust.

[Matthew Thornton:]

Maybe one for Eric on Destiny 2. Can you kind of give us little more color just on the trends you are seeing around player engagements, in-game monetization, and then, again, little more color just about how you are thinking about the game and the plans for 2018?

[Eric Hirshberg:]

Yes, absolutely, Matt. Happy to talk about Destiny 2. And I want to start just by putting it all in context because we did have a very successful launch of the game. As Coddy mentioned, it was the number two game in North America, the number four game globally, and it was also very well received, it had an A7 rating, that was the full 10 points of improvement over Destiny 1 and it received a 120 awards and nominations. And on top of that we saw a very positive sentiment and new franchise high levels of engagement for the first couple of months post launch. Now after that meaning after players report a significant amount of hours already into the game, we have definitely seen some real sentiment issues surface in a couple of areas, and we got plans to address those. For example, one of the things we wanted to do with Destiny 2 was to make the game a little bit less of a grind based on feedback we heard and we also wanted to provide players with more direct pass to getting the game’s best rewards. And that actually allowed our core players to consume the content faster than we anticipated. And that has led to an increase in players calling for more challenges and better rewards in the ongoing game. Now, this is a live game, and responding to player feedback is a part of the process in this game and any live game. And we feel we have the right plans in place to address the concern. Last week, Bungie posted a detailed roadmap of the changes that we have coming over the next several months. And thus far, those plans have been very well received as have the changes that we’ve already put into the game itself already and the sentiment is already starting to shift. And also, remember that we have a great expansion coming in May and a major expansion coming at the end of the year. And those events have always been opportunities for us to reengage our community and win back people who have churned out. This is an incredibly passionate group of players and that passion is a good thing, even when the sentiment is critical because it shows how deeply people care about the game. And we think that’s one of the thing that makes us a great franchise. And we are fully committed to listening to and communicating with our community more frequently and more transparently than ever and making the right changes to improve the experience. And we think we have the right path forward.

[Operator:]

We’ll take our next question from Tim O’Shea with Jefferies.

[TimO’Shea:]

So, Coddy touched on this in the opening remarks, but I wanted to get a better sense for where Call of Duty finished the year in terms of full game downloads. And then, maybe if you could give us little color on what your expectations are going forward?

[Spencer Neumann:]

See, as you’ll recall, I mentioned last quarter that we’re seeing a consumer-led shift to full game downloads in our console business. It’s similar to what we’ve already experienced in the games business on PC platforms, and of course digital transition is not unique to gaming; it’s impacting pretty much every form of entertainment consumption. So, the good news for us is, as I also discussed last call that it’s good for our business; it brings us closer to our consumer and with better economics. So, with that context, Call of Duty finished the year at 30% digital mix. And we mentioned last year that our digital mix was about 20% to 25% on Call of Duty. So, this year’s performance -- it’s essentially in line actually, a bit of an acceleration in that historical 5 percentage-point increase we’ve been seeing the past few years. And I should underscore that these are big absolute numbers, when we’re talking about Call of Duty because it’s such a mass market game. As Coddy mentioned, Call of Duty

[Operator:]

Up next, we have Mike Olson with Piper Jaffray.

[Mike Olson:]

I just have one. You talked about the opportunity for the actual league. But, could you talk about the Overwatch League impact on Overwatch, the game itself, as it relates to engagement, monetization and/or core game sales?

[Mike Morhaime:]

The Overwatch League has increased overall engagement with the franchise, between viewership and game play. When you consider the hundreds of thousands of fans watching each match and average watch time of over an hour each night, we’re tapping into a whole new avenue for players to express their passion for Overwatch. Of course, there are other positives for the game overall. The Overwatch League has driven a ton of buzz and awareness for the game. And so as that increases, our players have new ways to customize their playing experience with in-game digital skins as well as physical merchandise. And we’ve seen our players respond well to both of those. We’re also looking forward to launching additional initiatives to tie the viewing experience better with the play experience. We think that over the long term, the league will bring in new players as people see the excitement around the league and may even start to train to become the next pro player. Outside of league, we have additional plans to keep Overwatch fresh and players engaged. We already released a new map called Blizzard World in January. We have the Lunar New Year event launching today and there’s additional plans later this year for new heroes and seasonal events to come out. That’s all.

[Operator:]

Our next question comes from Brian Nowak with Morgan Stanley.

[Brandon Hoffman:]

Hi. This is Brandon Hoffman on for Brian Nowak. So, you had strong performance from Call of Duty

[Bobby Kotick:]

Absolutely, the CoD pipeline is one of my favorite topics. Before we talk about World War II, I think it’s worth stepping back and talking about how pleased we’re with the Call of Duty franchise overall. Obviously, Call of Duty

[Operator:]

Our next question comes from Eric Sheridan with UBS.

[Eric Sheridan:]

I wondered if you could talk a little bit about some of the moves you’ve made, whether it would be investments, acquisitions to position the Company for the advertising opportunity across King. And then, maybe the second one would be how do you think about extending those capabilities or assets across other brands or platforms of the Company in the coming years?

[Riccardo Zacconi:]

Advertising for us is a strategic focus given the opportunity we have with our large and engaged audience. So, we are prioritizing investments across multiple areas. First of all, we are building a world-class team and we are investing in our teams on several dimensions on the ad product, in engineering, in sales and in analytics. And we have already people in place. And this year, we plan to scale these teams further. Second, we are investing in creating great ad products. And by that I mean ad experiences that resonate with our highly engaged players and that are well-integrated into the game play, and also deliver real value to our advertisers. So, to get these right, we have embedded the X [ph] teams within our game teams including in Candy. So, third, we are investing in our own ad tech infrastructure. In 2017, we’ve seen early success with a dozen of global brands buying advertising across a number of territories in five different games. And we have seen repeat buys as a result of the strong completion and viability metrics. In 2018, as you heard Spence earlier, we’re expecting only a modest bottom line contribution from ads as we plan to ramp individual ads opportunity, and as we continue to invest in the significant opportunity for the long term. For the second part of the question, I will hand over to Coddy.

[Coddy Johnson:]

I think first, just to step back, and you know that we have several key initiatives underway. We’re building our capability in one area of the business, enables flexibility and option value to bring that capability to other areas of the business over time. Overwatch League could be a great example of this. So, the focus now is completely and solely on Overwatch success. But over time, the professional city-based league approach, infrastructure, the knowhow, the team, the processes, the support structure could logically go on to support other franchises that have strong esports momentum. And broadly, the way to think about this, Eric, advertising we think is another good example of this. And perhaps specifically, we have the opportunity probably in a couple of areas that are impacting. The first and foremost one is the opportunity that Riccardo just spoke to. Ads for the key mobile network is our primary focus right now. It’s the first step in building our internal ad products, tech deck, team and infrastructure. The second, we do have a near-term opportunity to bring relevant advertising to our esports audiences. We are already off to a good start there with Overwatch League, media rights, sponsorships, advertiser interest, but we see further opportunity in our owned MLG platform. And over time, third, there could be opportunities in other areas of the Company, particularly as we explore ad-based experiences across new games that are suited to that form of media. If you then just step a little bit back, we have over 50 minutes of engagement per day in our games right now, and that’s not yet including all the time spent watching games in our franchises. So, we think there’s a pretty compelling opportunity to do what you said, which is to be able to bring advertising to other brands and platforms across our network.

[Operator:]

Our next question comes from Evan Wingren with KeyBanc.

[Evan Wingren:]

This is for Mike. Just wondering, what are your expectations for World of Warcraft

[Mike Morhaime:]

So, at Blizzard, we always get excited about new launches. And we in addition to our players are very excited about Battle for Azeroth’s features, which include new Allied Races, to give players even more character customization options, players who preordered the expansion have been enjoying early access to some of the Allied Races already, and that has helped drive early preorders. We’re very pleased with the results so far. Battle for Azeroth also includes two huge continents for players to explore as well as some new game play modes. Warfronts is a new cooperative mode where players will band together in massive battles inspired by Warcraft’s RTS roots. And the Island Expeditions mode will include randomized elements for small groups to enjoy with great replayability which is very important in the game like Global Warcraft. Content always drives engagement. So, just like we did with Legion, we are planning a steady stream of content after launch to maintain engagement. As for what’s ahead in 2018 with Battle for Azeroth, we’re looking forward to sharing more in the months to come and releasing expansion this summer. There’s a ton of buzz right now in the community and at Blizzard. The team is very excited about this expansion.

[Operator:]

And our last question comes from Colin Sebastian with Robert Baird.

[Colin Sebastian:]

I guess, I just wanted some clarification on where development stands for some of the new mobile titles in the pipeline, not only in King, which I think was already addressed but across Blizzard and Activision following up on some of the announcements on personal, last year perhaps.

[Coddy Johnson:]

So, you are right. I’d probably break them, mobile efforts and new games into two buckets. The first you mentioned which is the ongoing efforts at King on their mobile pipeline. It’s just worth highlighting and they’re taking a very focused approach to development. And as mentioned, expect to have two or more new releases during the year, in addition to the ongoing updates inside their existing live games, which really are just in the live games initiatives in and of themselves that drive new players and bring in new audiences. So, there is as you know and as we speak to a lot, there is real focus there. But the second opportunity is to take our very successful PC and console franchises and extend them to mobile. And we think this is the time to do it and it’s an exciting opportunity for few reasons. First, mobile gaming is of course not very much at scale, large and growing with billions of people around the world who essentially have a mini console or PC in a pocket. And kind of the second reason that the technology we feel has advanced to a point where we feel the mobile platform now that can fulfill the requirements of our core IP. There is also for us we think a really important opportunity in Asia where we already have some of the most successful non-mobile franchises. And as you know, many of the top mobile games there now are based on existing console or PC IP. That was their roots in console and PC and they moved to mobile. And we think there is an opportunity for us as well over time to explore our IP on mobile in that region. We obviously want to get this right, we want to do it well at super high quality for our players and audiences who matter a great deal to us. So, it takes the investment and time. But we do plan to see some early results there this year from our mobile investments and we expect more meaningful impact in 2019 and beyond. So, we’re working hard in the pipeline and we will let more news to share down the road.

[Bobby Kotick:]

Okay. I think that was the last question. Right? So, well, thank you all for joining the call today. We appreciate it. We appreciate your time. And we look forward to seeing or speaking with you -- and speaking with you over the next few weeks and months. Thanks.

[Operator:]

And that does conclude today’s conference. We thank you for your participation.