Activision Blizzard, Inc.
Q1 2018 Earnings Call Transcript

Published: 4 May 2018

[Operator:]

Good day, everyone. Welcome to Activision Blizzard's Q1 2018 earnings conference 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 first quarter 2018 conference call. Before we start the call, we want to share with you an extraordinary error that was made by The Wall Street Journal earlier today, which caused trading volatility in our stock. The Wall Street Journal made a mistake and prematurely released a completely inaccurate headline, reporting our Q1 revenues as $1.7 billion instead of our actual Q1 2018 GAAP revenues of a record $1.97 billion. Not only did they report inaccurately, they did so in violation of our written embargo agreement. They have since issued an apology. Our actual results are now clarified and reflect our strong performance and plans for growth, including a record first quarter well ahead of our outlook and consensus and increased guidance for 2018. So today to review those results, we have with us

[Robert A. Kotick:]

Thanks, Amrita, and thank you all for joining us today. This was another record quarter for Activision Blizzard, with GAAP revenues of $1.97 billion, driven by record quarterly digital, in-game, and mobile net bookings. We also achieved an all-quarter record non-GAAP EPS of $0.78, surpassing our prior outlook by $0.13. And we generated record Q1 operating cash flow of $529 million, up nearly 30% year over year. Our continued ability to set new records speaks to the breadth and enduring nature of our portfolio of franchises against the backdrop of a large and growing interactive industry. Gaming is constantly evolving and innovating, which often expands the marketplace, and the success of Fortnite is no exception. This game is attracting new players of all ages and gender and it is helping gaming become even more mainstream entertainment. Our biggest franchises are anchored by communities of tens of millions of players. And while many of our players try new games, they always come back to the franchises that are the foundation of the communities that they are a part of. World of Warcraft, Call of Duty, and Candy Crush are great examples. These longstanding franchises are driving innovation into games at a regular pace with new in-game content, social features, and regular updates added to their ever-evolving rich game universes. World of Warcraft is on a very positive trajectory, with strong presales for the upcoming expansion content. And Candy Crush is demonstrating growth, holding both the number one and two grossing mobile spots in the U.S. for the second quarter in a row. We see strength across the whole portfolio, including Overwatch, where total franchise engagement is up, and Call of Duty, where the digital season and reach have been strongly ahead of last year. And of course, we're all very excited about the highly anticipated Black Ops 4 release. Gaming remains the most engaging form of entertainment, and it's projected to grow faster than any form of media except messaging, even faster than social media in terms of time spent. We estimate that the interactive entertainment industry exceeded $120 billion in total revenues last year and grew at 20% year over year. We are the largest standalone interactive entertainment company, and yet we represent less than 10% of this rapidly growing industry, which illustrates the sizable opportunity we see ahead. Our core games business has always been our growth engine in terms of results and intellectual property creation. That will only get stronger as we focus on two especially large opportunities ahead of us. First, mobile gaming, which represents a unique opportunity for us to dramatically expand our reach to new and existing players, and we're leveraging our powerful franchises across the company in the creation of our new mobile franchises and titles. Second, we have room to grow our high-margin and recurring in-game revenue streams through a persistent focus on continuing to add value to all of our players' experiences. We continue to be the leading innovators in professional esports. The inaugural regular season of the Overwatch League is progressing well, with millions of viewers each week and average viewing time of over an hour, which provides our multiple global broadcast partners and sponsors with access to a highly engaged and hard-to-reach audience. The Overwatch League continues to thrive, and our players are getting even broader recognition of their incredible talents in mainstream media. We see even greater opportunity with the playoffs and Grand Finals still to come. And we've begun sales of our next round of Overwatch League teams. And over time, we believe our esports initiatives could rival traditional sports for audience interest, advertiser interest, sponsors, ticket sales, and merchandise sales, both virtual and physical. Our five-year growth plan is in its earliest innings, and our greatest challenge remains prioritization of opportunity, which is an enviable challenge to have. We have the finest talent in our industry, and we continue to attract the very best and brightest people, drawn to the excitement, opportunity, and rewards our company provides. We have a very exciting remainder of this year, and we thank you, our shareholders, as well our talented driven teams around the world for all of your support. Now Coddy will review the highlights of our operations of this record quarter.

[Collister Johnson:]

Thank you, Bobby. As Bobby said, Activision Blizzard had another record quarter, growing year over year and setting top and bottom line records. We were able to deliver these results because of our incredible teams with some of the world's best creative, technical, and operational talent, because of our passionate communities and strong franchises, which have some of the world's most dedicated and engaged players, spectators, and fans. And because our teams continue to find more and more ways to serve our communities in those franchises with ongoing year-round streams of content, features, and services, so that even in quarters without large content releases, we can deliver records. Before diving into the specifics of the quarter, it's worth building on what Bobby shared about one of the genres where we already have some of the world's largest franchises and communities, the shooter genre. The new battle-round modes that have recently entered the space have compelling survivor mechanics and large in-game player pools. They have also brought tens of millions of completely new players into gaming, both on traditional platforms like console and PC, but also on newer platforms for the genre like mobile. We are very, very encouraged by this. The shooter genre was already one of the largest and growing. We are already one of the largest players in that space. New modes that attract new players bring us new opportunities to expand our own communities and to benefit from the significant pipeline of innovation that we have planned for our franchises. As you saw this quarter, many of our franchises delivered records, with continued success across our three strategic pillars of reach, engagement, and player investment. On reach, the company had 374 million monthly active users this quarter. And for the second quarter in a row, King stabilized its player base of overall monthly active users just slightly down from last quarter and overall engagement remaining strong, with King's daily time spent per user at record levels. Importantly, the largest part of King's audience, Candy Crush monthly active users on mobile, grew for the second quarter in a row. And King plans to grow its network even further with new game launches planned for later this year and beyond. Activision's successful 2017 launches for Call of Duty, Destiny, and Crash Bandicoot continue to draw large audiences, with 51 million monthly active users this quarter, up 7% over last year. Call of Duty grew year over year with players engaging across the franchise, including in Call of Duty

[Spencer Adam Neumann:]

Thanks, Coddy. Today I'll review our better than expected Q1 2018 results as well as our outlook for the full year. Once again, we outperformed our guidance thanks to our incredibly talented teams, our strong global portfolio of owned intellectual property, our compelling offerings of year-round content, and our commitment to relentless prioritization and fiscal discipline. Now turning to the specifics of the quarter, I'll start with our segment results, where revenue and operating income grew by double-digit percentages year over year, setting a new Q1 operating income record while we continued to invest in new capabilities. This performance was primarily driven by our in-game content, with net bookings growing by double-digit percentage year over year for all three segments. King grew segment revenue by 13% year over year and operating income by 15%. Margins also improved year over year, with segment operating margin at 36%. The King teams focused on continually investing and innovating in its live titles resulted in the Candy Crush franchise achieving its highest net bookings since Q4 2013. Activision grew segment revenue and operating income substantially year over year on the strength of Call of Duty

[Operator:]

Thank you. We'll hear first from Eric Sheridan with UBS.

[Eric J. Sheridan:]

Thanks for taking the question. Maybe going back to Fortnite, I wanted to know if we can get any color on any impact on either engagement or monetization across some of your key titles. And what are the key learnings you have as a management team from what you've seen from Fortnite that you might apply to your own titles? Thanks so much.

[Spencer Adam Neumann:]

Sure, Eric. This is Spence, I'll take this one. So as Bobby and Coddy mentioned earlier, the Battle Royale mode, it's contributing to the innovation and expansion we're seeing in the industry. It's not only bringing the younger audiences and millions of new gamers that both Coddy and Bobby mentioned into the shooter genre, where we're already a leader in the space, but importantly, it's also highlighting the ability to successfully bring immersive gaming experiences like Battle Royale to mobile in both Western and Eastern audiences, or markets I guess. And that's really encouraging as we think about our future mobile opportunities and our growth opportunities generally as gaming becomes increasingly mainstream. So yes, we've seen some near-term impact from Battle Royale. But as you heard on the call today, our business continues to perform at record levels. We've got one of the broadest and most diverse portfolios of successful franchises across genres, across platforms, and across business models. And we're continuously innovating within those existing franchises, and we've got a really exciting future development pipeline. So when you put all that together, we feel great about where we're positioned and our ability to continue to deliver on our growth plans going forward.

[Robert A. Kotick:]

And, Eric, this is Bobby. I would just add the long history of our company. When we see people innovate in an interesting and impactful way, we are very quick to figure out how to capture inspiration from innovation. And so we as a company, in our DNA, in our culture, when we see things that appeal to our audiences, we are very good at being inspired by those.

[Eric J. Sheridan:]

Thanks so much.

[Operator:]

We'll hear next from Evan Wingren with KeyBanc.

[Evan Wingren:]

Thanks. Coming to Black Ops, how do you anticipate this edition of Black Ops will differ from historical Call of Duty games that you guys have released?

[Collister Johnson:]

Thanks, Evan. This is Coddy. I'll take that one, and glad to. As I said in prepared remarks, Black Ops for us is going to be an awesome game, given the community, really just an incredible experience for us, gameplay features and modes. And we think not just for existing community members, but also for a significant number of new players that are coming into the shooter genre. There is a number of reasons for the strength of our belief. First is it's just Black Ops. It's the most played Call of Duty sub-franchise to date, and that's saying something in a franchise like Call of Duty, which had the success it's had. The Black Ops III iterations so far over eight years have drawn in 200 million players and billions and billions of hours of gameplay. And by the way, that's still ongoing. As we speak, there is millions of people playing in the Black Ops franchise right now. And it leads to the second advantage, which is what we see from those billions of hours of gameplay, where we get to see in depth and real time what really engages our players. Black Ops 4 builds on that and on everything Treyarch has learned about what players love to play. And so that's the third main area, is the confidence we have in Treyarch and their ability to execute on their creative vision. It's an incredible developer with a deep understanding of the community and the first-person genre, but also a real proven track record of innovation, including Zombies and multiple multi-player innovations that have really transformed the industry. And it's a most important last point, which is that this is a game that's not going to just build on our strengths. It will continue to push the envelope in innovation. You'll see that in the core game itself, where we have a number of new exciting developments to roll out very soon, but also in the game's appeal on growth platforms like PC, where we've invested significant dedicated resources and design time to make sure we can deliver a great PC game to serve that community. So very soon, May 17, we'll have a lot more to say at the Black Ops 4 global reveal, and I hope you tune in. You should.

[Evan Wingren:]

Thank you.

[Operator:]

We'll hear next from Chris Merwin with Goldman Sachs.

[Christopher Merwin:]

Okay, thanks for taking my question. I was wondering if you could talk about how Overwatch League viewership has been trending relative your expectations so far. I think in the prepared remarks, you mentioned that you started a second round of team sales already, so maybe you could comment about how that's going and how we should be thinking about the value of the new teams you might sell. Thanks.

[Robert A. Kotick:]

So this is Bobby.

[Michael Morhaime:]

Go ahead, Bob.

[Robert A. Kotick:]

Sorry, you go first, Mike.

[Michael Morhaime:]

Okay. I wanted to say we're extremely happy with both the launch and how the inaugural season for Overwatch League has been going so far. The league is definitely outperforming our expectations, starting with viewership. Viewership has been very strong and consistent each week. We've had millions of fans tuning in, and our average viewer spends about an hour – over an hour of watching each day. Our broadcast partners like Twitch and MLG and our partners in China have been great. We've also been introducing some exciting new engagement programs that are unique to esports. We have partnered with some great sponsors as well like HP, Intel, Toyota, T-Mobile, and Sour Patch Kids, and these sponsors now have access to a highly engaged and hard-to-reach audience. We've been adding to our esports team. We've recently added professionals with strong sports marketing and broadcast expertise. And so we think that overall this has been a great success. We think it's good for the whole ecosystem. It's good for owners, our owners who have partnered with us on this exciting new venture. It's great for the players, who have increased stability as well as a great venue to showcase their talent. And it's great for the Overwatch franchise, which has benefited from increased total engagement.

[Robert A. Kotick:]

Sorry, Mike. Go ahead.

[Michael Morhaime:]

Okay. With respect to team sales, we are currently in process. We've been meeting with potential new owners in new geographies. Demand has been really strong globally. We don't have an update on exact timing, but we do expect to add new teams to the league this year. And so looking ahead, we're heading towards the end of our inaugural season. We'll be holding our playoffs, Grand Finals, and an All Star game this summer. And so we've got a lot of great stuff planned. We're very excited. And I'll turn it over to Bobby.

[Robert A. Kotick:]

You said most of what I was going to say and probably better than I could have said it. But the only thing that I was going to point out is that for our almost 40 million players, what I think the league has really done is it's reinforced that the thing that they spend hours and hours a day playing is something that they feel like is now being validated in a way that it never has before in a video game. And so all of our players in almost 190 countries around the world feel like this is truly a recognition of the sense of belonging that they get playing the game and the sense of accomplishment they feel playing the game. And I think more than anything, that's been an enormous benefit as a result of the creation of the league.

[Christopher Merwin:]

Okay, thank you.

[Operator:]

And from Sanford Bernstein, we'll hear from Todd Juenger.

[Todd Michael Juenger:]

Hi, thanks for taking the question. I'd like to ask about King, if I could, so probably for Riccardo. So, Riccardo, I'd love to hear what you can share with us about what you're continuing to do to drive the reach of King, and just any other general insights you have to share with us on current trends you're seeing in your space. Thanks.

[Riccardo Zacconi:]

Hi, Todd. This is Riccardo. So first of all, I would like to say that to grow again the reach is a key priority for us. So in Q1, we had 285 million monthly active users. This is slightly down sequentially, but we stabilized the active user base over the last several quarters, which I believe is a very important achievement. And if I look at the other metrics, these are also very encouraging. Daily active users were stable across the network. And specifically, daily active users in the Candy franchise increased slightly. Now we have achieved this focusing primarily on the player experience in the live games. In live games, we have increased the pace of releasing fresh content. So we have released more levels. We have released live operations. We have released new features, and we will do more of this. Further on, we believe there is an opportunity to grow the reach, not only innovating in the game, but also innovating in the marketing. Now, to change the trend more meaningfully requires major new game launches. Our best teams are at work building a great pipeline, and we have as we speak games at various stages of development. We have games at the conceptual level. We have game prototypes, and we have games in production. And we have games that we will release, as you heard earlier, this year.

[Todd Michael Juenger:]

Fantastic, thank you.

[Operator:]

Next we'll hear from Brian Nowak with Morgan Stanley.

[Brian Nowak:]

Thanks for taking my question. I'm curious for an update on Destiny. Maybe talk about some of the challenges you've seen on it over the course of the last six months. And what are the biggest steps you think you need to implement in Destiny to fix it, bring back the users, and drive monetization higher?

[Collister Johnson:]

Sure, thanks. This is Coddy. I'll take that one. I guess the first thing, one of the best parts about Destiny is just how passionate and engaged that community is. And the bright side of that is it gives us the chance to really build and iterate upon the feedback. As I said in the prepared remarks, the three things that we know we're going to do and that the community is looking for is make the player more powerful, provide more rewards, and make the endgame more meaningful. As we look ahead, we have a chance to continue to build on that, particularly in feedback that really engages the community. And so maybe just as an example to share, Bungie recently hosted a large cohort of the top worldwide Destiny players onsite up at their studio in Seattle. And they walked through the roadmap of features and updates they're planning, but they also gave hands-on with not just Warmind, the expansion coming out shortly, but also with a part of the big fall release planned for later this fall, and it was a very positive response to the three things I just mentioned, the power and the rewards and the need for endgame. But even more of what's coming this fall into the innovations and gameplay there, including to what we think will be an incredibly engaging new mode, one that introduces a whole new style of play for first-person shooter gaming generally and certainly for the shooter space that Destiny created. It's a really exciting development. It's one of the things that we feel really speak to the community when it comes out in the fall, and we're really excited to share more about that. We won't do that until E3. So as to this next expansion, head over to E3. We hope we'll you see there and be able to talk more about it.

[Brian Nowak:]

Okay, great. Thanks.

[Operator:]

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

[Michael J. Olson:]

Hey, good afternoon, maybe back to Riccardo on King. Riccardo, could you update the expected timeline for more material King ad revenue? And can you talk about some of your findings during this testing period? And how extensive should we expect the raw to be as far as how much of the King portfolio is ready for advertising? And then lastly, will advertising change any game design or gameplay mechanics? Thank you.

[Riccardo Zacconi:]

Hi, Mike, Riccardo here. Thank you for your questions. Let me start first giving an update on how the business is going. So I'm pleased, I'm very pleased with the progress that our ad business has made in Q1. We hit an internal milestone. The business is still relatively small but was modestly profitable this quarter. So the goal is to build a strong long-term business, and we will ramp up further the investments during the year. And the other thing we've done is, a key priority is to build a strong team, and we have continued to build out our leadership team and our capabilities in this area. We have made some key hires in product development, in B2B marketing, and in measurement and insights. And we have also continued to work on our ads product offering. We have introduced new placements and new times where ads appear in the player journey. As Coddy mentioned earlier, our ad products perform well. Players are completing our reader views more than 90% of the time, and our ad recall rates are much higher than industry norm. Our ad teams are working very closely with the game teams to create ad experiences that are supportive of the gameplay. So for example, you can get a booster watching an ad, and that can help you in the game. And in regards to the rollout of our ad business, currently ads are live in certain games, including the Candy Crush franchise, but we have not turned yet on ads for all the players in these games. We are taking a measured approach where we AB test before showing ads to new segments of players. So we expect the ad business to ramp throughout the year, particularly in the second half, as we serve more players.

[Michael J. Olson:]

Thank you.

[Amrita Ahuja:]

Operator?

[Operator:]

We'll go now to Jefferies' Tim O'Shea.

[Timothy O'Shea:]

Yes, thank you for taking my question. So there are some other big markets like China, like mobile, where free-to-play is the dominant business model already. So I'm just wondering if Fortnite's success, if it changes how you think about the $60 full-price business model for console games going forward. Thanks.

[Collister Johnson:]

Sure. Hey Tim, this is Coddy. Thanks for the question. I'd say broadly we think in a growing industry like ours that there's room for multiple business models to succeed in parallel. We see this just in our own portfolio across Activision Blizzard. Right now, today, we have a full range of business models, free-to-play, subscription, upfront payments, downloadable content packs, ongoing micro transactions, all of these succeeding at scale. And so it's like there's no one in a better position to see the nature of how you think about bringing a value proposition to consumers. We think it's true of our industry broadly as well, where that direct ongoing interactive connection with players and audiences, it allows an enormous amount of iteration and innovation on how to provide the most satisfying avenues for investment. We get to see that real time in the loop that we create and the things that we roll out. But not just in interactive, we think there's a number of areas across broader entertainment that prove this out as well, where multiple business models work at the same time. Just in linear viewership, you have Netflix and YouTube, both coexisting, both growing, both with their own kind of value propositions. And for us, that's really the most important piece is the value proposition, the North Star. And for us, that is deeply compelling and engaging gameplay. When we get that right and we find the fun and deliver that rich, meaningful, ongoing experience for players, we think we have the ability to deliver the right business model that supports and adds to the experience. We do think $60 games will continue to be an important part of that equation. And we believe the level of investment in content, in features, and in services that we provide will continue to make that a very attractive proposition for players.

[Timothy O'Shea:]

Thanks, Coddy.

[Operator:]

And our final question today will be from Colin Sebastian with Robert Baird.

[Colin Alan Sebastian:]

Great, thanks. My question is related to World of Warcraft, including higher engagement that you're seeing with the title. And in particular, I'm wondering what we should expect then in terms of WoW usage and engagement leading up to and following the launch of Azeroth this summer. Thank you.

[Michael Morhaime:]

Hi, Colin. This is Mike. Thanks for the question. Before I go into the expansion, I just want to quickly thank the World of Warcraft team for their amazing work in delivering great content for that community. Over the last couple of years, they have really shifted their pipelines and invested in not only the expansions, but also creating ongoing and an increasingly steady stream of content in between expansions, which is really important to keep people engaged all the way from one expansion to the next. Battle for Azeroth is our next expansion. And at Blizzard, we're really excited about this expansion. It's coming along great. And it looks like our players are also very excited about it. As Coddy mentioned, our presales are ahead of plan. As always, this expansion features some exciting new features. I'm just going to mention a couple of them that we're particularly excited about. Island Expeditions, where players will explore unchartered islands that include randomly generated elements, we've built AI that will give players a different experience every time they visit an island, and that's to create a highly dynamic experience. And Warfront, where players will join large groups and get the feeling of being part of a massive battle with different objectives. Warfront is a throwback to Warcraft real-time strategy roots, and we think that players, veterans and new players will really enjoy it. We designed these new features with our players in mind. We think they should get increased engagement as well as more replayable content, so that's really important with a game as massive as World of Warcraft. This is some really exciting stuff that we're adding. We just entered wider beta testing. Player feedback has been excellent so far. So when the expansion launches in August, we are looking forward to millions more joining us in World of Warcraft.

[Colin Alan Sebastian:]

Thanks, Mike.

[Operator:]

And it's time for closing remarks. I'd like to turn things over to our CFO, Spencer Neumann.

[Spencer Adam Neumann:]

Thank you, I'll make this quick. I have a happy organizational announcement to make and I'll do while we have everybody on the call. So first, I want to congratulate Amrita, our fearless leader in Investor Relations, on a promotion. Amrita is going to become the next CFO of Blizzard, which we're ecstatic about. I hope you guys have all gained an appreciation for Amrita and her skills and capabilities over the years in her three years leading Investor Relations, as the company has been on a tremendous growth curve. We've exceeded performance of all kinds of indices during that three-year period, and we really appreciate all of her efforts along the way. And she's a star in the organization and we're looking forward to the next chapter for her. And I'm excited to announce, even though we've got very big shoes to fill, that we're thrilled with our new head of Investor Relations that is coming onboard next week. His name is Chris Hickey. Chris is someone who many of you on the phone or on the call may know. He comes from Atlantic Equities, where he's not only an equity analyst, he's a co-founder of the firm, so he's really an entrepreneur at heart as well, and we couldn't be more happy to have him join our team. Chris knows our company well. He knows our industry. He's covered a number of industries across not just gaming, but technology, payments, and services. So he'll be joining officially on May 14. Amrita, since she's not going far, will ensure a smooth transition as well as Colin and Jason and the team have done a terrific job supporting all of us, especially as Amrita has been transitioning down to Blizzard. So hopefully you all welcome Chris to the team. We're really happy to have him be part of the Activision Blizzard family, and I'm sure you'll get to know a lot more of him in the coming months and years ahead. So thank you.

[Operator:]

And that will conclude today's conference. We do thank you all for joining us. You may now disconnect.