Activision Blizzard, Inc.
Q1 2016 Earnings Call Transcript

Published: 6 May 2016

[Operator:]

Good day and welcome to the Activision Blizzard Q1 2016 Earnings Call. Today's conference is being recorded. At this time, for opening remarks and introductions I would like to turn today's call 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 2016 Conference Call. With us today are Bobby Kotick, CEO; Thomas Tippl, COO; and Dennis Durkin, CFO. And for Q&A, Eric Hirshberg, CEO of Activision; Mike Morhaime, CEO of Blizzard; 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. These are forward-looking statements that are based on current expectations and assumptions that are subject to risks and uncertainties. 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 factors section of our SEC filings, including our 2016 Annual Report on Form 10-K which is on file with the SEC and as indicated on the slide that is showing. 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. The company undertakes no obligation to release publicly any revisions to any forward-looking statement to reflect events or circumstances after today, May 5, 2016. Unless otherwise indicated, our speakers will be referencing non-GAAP measures, which exclude the impact of the change in deferred net revenues and related cost of sales with respect of certain of our online enabled games, 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, the related debt financings, and the associated tax benefit. Please refer to our earnings release, which is posted on www.activisonblizzard.com for a full GAAP to non-GAAP reconciliation and further explanation. 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 and a one-page summary sheet. And now I'd like to introduce our CEO, Bobby Kotick.

[Robert A. Kotick:]

Thank you, Amrita. And thank you all for joining us this afternoon. This year the global market for interactive entertainment is expected to reach $94 billion. With more than $6 billion of revenues forecasted for this year, Activision Blizzard is clearly the world's most successful standalone interactive entertainment company, yet we only have a 7% participation. These forecasts don't really contemplate the growth in eSports or the introduction of advertising into games and they certainly don't contemplate the introduction of prize and cash play into games, all of which are emerging and potentially significant opportunities for the company. eSports has unique meaning to our audiences. Frank Pearce, one of the founders of Blizzard captured what makes our games and the organized competitions we host so special to our players. He said our players feel a unique sense of belonging from their engagement with our content. Their social experiences are shaped by the communities they're a part of, and the investments our players make in our games is rewarded by being part of a community that celebrates their play and recognizes their accomplishments. Our audiences spent 42 billion hours playing and watching our games in the past 12 months, similar to the number of hours people spent watching Netflix, and greater than the number of hours people consumed video on Facebook. But because these are principally social and truly interactive experiences, the commitment to our franchises is deeper and much more personal than other forms of entertainment. One special example is that of a high schooler whose father was deployed in Afghanistan. The son and the father stayed connected by regularly playing World of Warcraft throughout his deployment. The shared experiences and high engagement required to play our games creates a unique bond and a special sense of belonging for the players. A great multigenerational example is an 84-year-old grandfather who, for 10 years now, has played WoW with both his son and grandson. And another example of a life-changing experience is our most recent Heroes of the Dorm competition. The result changed the lives of five players when they won the collegiate championships and had their college tuitions entirely paid for. There isn't any other form of entertainment that generates the passion, engagement, and commitment that game players experience and we're at the very beginning stages of providing opportunities to celebrate and reward our audience commitment. This year, our franchises will provide over $10 million in prize money for players and shout-casters and commentators are earning real revenues and yet we're barely in the first inning of opportunity for games as organized sport. Today, collectively, eSports' viewer-ship is greater than the individual audiences for NHL, Major League Baseball or the NBA. In the future, Call of Duty, Hearthstone and Overwatch could each have audiences in excess of any of the most well-known sports leagues. Advertising and subscription revenues for eSports events are dwarfed by major league sports and yet the passion of a Call of Duty player is no less than the passion of the most ardent NFL fan. My friend, Robert Kraft, the owner of the New England Patriots paid a little less than $180 million for the Patriots in the early 1990s and he told me it was the best investment he ever made. 15 to 20 years from now, pro-team owners of our major franchises will likely be sharing similar sentiments. Our network itself has over 0.5 billion users each month. Only Facebook, YouTube and WeChat have bigger audiences, and we continue to transform our business to franchise focused, frequent content delivered directly to our 0.5 billion audience members in 196 countries around the world. Value is delivered through a variety of player investment models, all providing flexibility to our audiences, and as we introduce new player investment opportunities like advertising, and we start seeing our eSports events command their fair share of broadcasting revenues, our players will have their efforts recognized and their achievement rewarded and their sense of belonging to their communities will only deepen. Because of our uniquely talented 9,000 employees around the world, we're better positioned than any other entertainment company to take advantage of the sizable opportunities ahead. Our challenge, the challenge of prosperity, is the prioritization of these many opportunities and our 25 years of disciplined careful execution is what will enable us to pursue these opportunities with success as we have for 25 years. Since I joined the company, I haven't felt more excitement for our prospects and now Thomas will discuss the key drivers of our overall performance at our operating units and Dennis will review our financial results. Thomas?

[Thomas Tippl:]

Thank you, Bobby, and good afternoon, everyone. 2016 is off to a great start. We over-performed our plan for the first quarter, delivered year-over-year growth, achieved record digital revenues and raised our full year guidance. These results are driven by focus and execution against our three strategic pillars. First, expanding our audiences; second, deepening engagement; and third, providing opportunities for more player investments. Let's start with our progress in growing our audience reach which grew to 544 million monthly active players this quarter. With the close of the King acquisition, we massively expanded our audience reach. King brought a diverse network of 463 million global players to the Activision Blizzard family. The acquisition also provides us with significant audience expansion opportunities going forward, as mobile is the fastest-growing platform and has the greatest global reach. The team at King continues to execute with excellence, as they grew monthly active users 3% over a large base last quarter. King's growth was driven by the release of Candy Crush Jelly Saga, which became a top 10 grossing game on the iPhone in the U.S. and Google Play worldwide. This, combined with continued strong performance of the first two Candy Crush games, which are regularly updated with new content, features and live ops, returned the Candy Crush franchise to sequential growth. This further demonstrates that continued investment in innovation of existing franchises drives longevity. We have also seen strong organic audience expansion in the Activision and Blizzard businesses. Both divisions set new all-time records with quarterly MAUs up 10% year-over-year for Activision and 23% for Blizzard. Activision's audience expansion was driven by Call of Duty, which, on the back of high-quality DLC, set the new franchise record for MAUs in the quarter, impressively growing its MAUs to exceed that of the holiday quarter. With the number-one title on both next-gen platforms live to-date and with two other titles in the top-10 list, Call of Duty is the preferred choice on next-gen. In fact, about 85% of all PS4 buyers in North America this quarter opted for the Black Ops III Bundle, an amazing statistic which bodes well for the franchises' engagement and in-game play investment continued to expand rapidly. On top of the Black Ops III momentum, Activision plans to build upon the community with an innovative new release this holiday, Call of Duty

[Dennis M. Durkin:]

Thanks, Thomas. Good afternoon, everyone. Today, I will review our better than expected Q1 financial results, our outlook for Q2 and our increased outlook for 2016. Q1 was a great start to the year that included the close of the King transaction and strong trends in our year-round franchises. We over performed our non-GAAP February guidance by $108 million on revenue and $0.12 on EPS. Our results grew year-over-year by 29%, or $205 million on non-GAAP revenues, and by 44% or $0.07 on EPS. This increase is largely due to the inclusion of King in our results, since the closing date of the acquisition, February 23rd. Excluding King, non-GAAP revenues and EPS were relatively flat to Q1 of last year. Reflecting on some highlights by segment, Activision exceeded plans and last year's results on revenues and profit, with record Q1 digital revenues that were up 54% year-over-year. Activision also continued its next-gen leadership with four of the top 10 titles on PS4 and Xbox One life-to-date, including the number one spot with Call of Duty

[Operator:]

Thank you. We'll go first to Neil Doshi with Mizuho.

[Neil A. Doshi:]

Great. Thanks, guys. A quick question on Overwatch. It seems like the beta has been quite successful. Just wondering how we should think about units for the quarter when it's released and then as well as for the year. It seems like there's a much bigger audience than there is for Diablo, so any thoughts or color on that front would be very helpful. Thanks.

[Dennis M. Durkin:]

Well, we're very excited about the open beta, so we're less than 24 hours in but the game is now live and freely accessible to players around the world including China. We've already seen millions of players try out the game in open beta. The feedback has been extremely positive. This is our first global simultaneous multiplatform launch and so we're on PS4, Xbox, PC across all of our regions. We don't project out specific unit numbers but like Thomas mentioned, we do expect this to be our biggest launch since Diablo 3 which was heavily anticipated and the Diablo franchise was something that has been loved for many years. This is a brand-new IP. We're doing a ton to expose players to the richness of this world that we've created but it is a new IP in a very popular genre.

[Neil A. Doshi:]

Great. Thanks.

[Operator:]

We'll go next to Chris Merwin with Barclays.

[Christopher David Merwin:]

Hi. Great. Thank you. So now that the King acquisition is closed, I was wondering if you could just update us on the strategic plans for King. At what point does King start to plan for the development of some of Activision's IP and maybe given the size of King's user base does it make sense to integrate some third-party advertising into the mix? And if so, what would the ramp look like there? Thanks.

[Riccardo Zacconi:]

Hi, Chris. It's Riccardo here. First of all, it's nice to talk to you again and thank you for the question. So before I answer the first part of your question on the strategic plans, as part of Activision Blizzard, I would like to highlight that the integration went extremely smoothly and it's effectively complete. King has been part of the Activision business family as you know now for two months and we have retained our key talents and have remained focused on driving the business and executing on our existing plan. As you have heard in Q1, we had delivered both top line and profit growth by growing our player and payer networks as well as the investment per player. We're first of all focused on executing on our strategy and we have a strong pipeline across our franchises and we're working on new titles within these franchises. We're also developing additional new IPs within our studios. In addition to developing the new titles, we're also continuing to invest in our existing franchise games with new content, new features, and with live ops. Live ops as a brief reminder are the time-limited events. And all of this content is driving engagement, retention, and investment per player. Now as part of the Activision business family, beyond existing plans, we have now new opportunities to create even greater games for our massive player network by combining Activision Blizzard's top-performing IPs on console and PC with our mobile expertise. The deal, as you know, closed two months ago and we have started conversations with both Activision and Blizzard to explore those opportunities. In regard to the second part of your question regarding advertising, I want to say that first and foremost we are focused on retaining our players and we are focused on providing a great player experience and we will not compromise on this point. That said, given our massive network, we do believe that advertising could be a meaningful revenue stream for King in the long term. We have 463 million monthly active users, and with that it's one of the largest untapped audiences for advertisers in the world. But it's early days and we've just begun experimenting with that in two of our games, so we do not expect any impact to this year's results from ad sales.

[Christopher David Merwin:]

Thanks, Riccardo.

[Operator:]

We'll go next to Doug Creutz with Cowen and Company.

[Douglas L. Creutz:]

Thanks. You mentioned on the call that you got some good re-engagement at Destiny around the April update, I just wonder if you could maybe kind of size how engagement is trending relative to the peak you hit back in September around The Taken King launch? Thanks.

[Eric Hirshberg:]

Hey, Doug. It's Eric. So Destiny has nearly 30 million registered players now and our April content successfully reengaged the community and was very well received. We think engagement has remained remarkably strong, even after the release of some competitive games in this genre. But it's clear that our fans are hungry for more content than we've been able to create and that passion and loyalty from our fans is something that we don't take for granted, which is why we're working side-by-side with Bungie to make sure that in the future, we're able to deliver a more consistent stream of great content and drive even more engagement.

[Douglas L. Creutz:]

Great. Thanks.

[Operator:]

We'll go next to Eric Handler with MKM Partners.

[Eric O. Handler:]

Thank you very much. A question for Mike regarding Hearthstone. Mike, so users are now, you said, they are at 50 million. I think it's up from about 40 million players in November, so big increase there. Can you talk about user monetization trends for the game, and are the newest players spending as much, less or more than those that have been playing longer?

[Michael Morhaime:]

We don't publicly discuss specific monetization trends, but we're very happy with the continued strong performance we're seeing from Hearthstone. As Thomas mentioned, we are very excited that engagement both in terms of daily players and hours per player rose with the Old Gods' launch. Hearthstone revenues were also up 20% year-over-year in the first quarter, so in general we're very pleased.

[Eric O. Handler:]

Thanks.

[Operator:]

We'll go next to Arvind Bhatia with CRT Capital.

[Arvind Bhatia:]

Great. Thank you. Congratulations on another good quarter. I've got a two part question, first, if you could maybe touch a little bit more on the Call of Duty

[Eric Hirshberg:]

Thanks, Arvind. It's Eric. Black Ops III is performing very well, but before I address our digital performance specifically, I think it's important to take a step back and first talk about overall engagement. We've made a great game that our fans love and that's demonstrated by the fact that our monthly active users are at all-time highs. And as a result of that, our digital business is also operating at Q1 all-time highs and is up significantly year-over-year. Season Pass is at an all-time high and, in fact, we expect to deliver the most map packs ever to players with Black Ops III. So the most important thing for us is that we're delivering all this performance, while seeing record engagement with the game. On the second part of your question related to Infinite Warfare, first of all you got to love the passion of gamers, this is an industry like no other, and a fan base like no other and we love that our fans treat this franchise like it's their own and have such strong points of view about it. There just aren't many entertainment franchises on Earth that can generate the kind of passion that Call of Duty can and that's a good thing. Secondly, of course we know that there are people in our community who are nostalgic for the boots on the ground style gameplay, and that's why we made Modern Warfare Remastered. But we also have millions of people in our community who want to have new innovative experiences in the game each year and Infinite Warfare is going to deliver that. And the good news is this year we found a way to deliver both in one package while keeping our community together. And while of course we see the passionate opinions online, we also look at other measurements. And the fact is, while it's very early, preorders are off to a very strong start. Views of the reveal trailer that you referred to are up and, in fact, the number of likes per view on the Infinite Warfare reveal trailer are also the highest we've ever seen. We've seen this in the franchise before. The reveal trailer for Black Ops II, which took the franchise into the future for the first time, had the most dislikes of any reveal trailer we had ever made at that time. And that, of course, went on to become our most successful game ever. And right now, the franchise has never been stronger. We have more people playing Black Ops III, a game that takes place in the future with boost jumps and fictitious weapons and all the rest, than any game in our history. So what we know for sure is that if we always just did what worked in the past and never took any creative risks, we wouldn't have a franchise. The day to worry is the day we stop trying new things.

[Arvind Bhatia:]

Very helpful. Thank you.

[Operator:]

We'll go next to Brian Pitz with Jefferies.

[Brian J. Pitz:]

Thanks. A question on Overwatch marketing. Maybe you could discuss how you build Overwatch into a true trans-media franchise including the types of media, such as eSports, movies, cartoons, comic books, et cetera, as well as merchandising opportunities we might see over time if the game is successful. And basically is it fair to compare it to, say, you're building essentially your own version of the Marvel Universe here? Thanks.

[Michael Morhaime:]

Thanks for the question. I think it's a great question. We see a ton of opportunity here. We put a lot of work into creating a game universe with awesome characters and a deep backstory. We think there's a big opportunity for Overwatch to thrive across all sorts of media. The game itself is vibrant and rich with personality. We've seen an overwhelming positive response to our animated shorts and comics and we're working on more of those. We think that there's a lot of potential to go even further in the future. When it comes to eSports, we feel Overwatch has huge potential. We put a lot of focus on the viewing experience and making sure the action is fun to watch. We designed the game with eSports in mind and we have big plans in this area, which we'll talk more about later this year.

[Brian J. Pitz:]

Thanks, Mike.

[Operator:]

We'll go next to Colin Sebastian with Robert Baird.

[Colin A. Sebastian:]

Thanks. I guess as a follow-up to an earlier question on the mobile business in King, hope you can talk in a little more detail about Jelly Saga's performance since launch in terms of usage and monetization and then also how you view the prospects for the performance of the Candy Crush franchise as a whole through the balance of the year, especially as we consider promotion across the network. Thank you.

[Riccardo Zacconi:]

Hi, Colin. It's Riccardo. Thanks for the question, first of all. The overall Candy Crush franchise is very healthy. It continues to produce strong performance, growing sequentially in Q1, as you have seen. And this validates our franchise-focused strategy. We continue to execute on our four-pronged approach to creating enduring franchises by, number one, adding new content, implementing live ops, delivering extensions in our existing games as well as offering players new sister or sequel titles. This approach has led to continued strong performance by the Candy Crush franchise. In fact, the original game, the Candy Crush Saga, is already four years old and it continues to lead the casual game category and was the number three top grossing game in the U.S. in Q1. In regards to your question on Candy Crush Jelly Saga, we launched the game in January of this year and it's a sister title to Candy Crush Saga. It has the same star ratings as Candy Crush Saga and our players are clearly enjoying the game. It's our third largest title and a top 10 grossing game in the U.S. on iPhone and it's also a worldwide top 10 grossing game on Google Play. The game brought new players to King's network in Q1 and has returned the franchise to growth. When you look across the entire franchise, all three Candy Crush titles were top 15 grossing games in the U.S. in Q1, which demonstrates the longevity and strength of the brand. So we believe we have an enduring franchise with Candy Crush and we are executing to keep innovating for our players.

[Colin A. Sebastian:]

Great. Thanks. And maybe I could sneak in another follow-up around eSports, more specifically around monetization in eSports longer-term beyond the loyalty and improving the brand Halo around certain titles. Thank you.

[Robert A. Kotick:]

Our first priority has been the opportunity to celebrate our players. And when you think about the commitment that our players make to our games, by providing them with the recognition, the organized competitive experiences, highlighting their accomplishments, being able to provide higher levels of prize play than we ever have, these are all in the service of enhancing engagement and building value in the equity of our properties. I think when you look at the untapped opportunities though that enable you to do a lot of those things, we have this very virtuous cycle. People pay to participate, sponsors are willing to finance events, those events then become the content that is broadcast on our network or on other networks, those events then lead to having the ability to have regional events, national events, international events; all of these things have the opportunity for us to expand broadcast rights, licensing and merchandising, ticket sales, local sponsorships, national sponsorships, and these are all things that we're very actively engaged in, not to mention all the opportunities to sell our professional teams for our professional leagues. And so over the long term, we view this as a tremendous opportunity to both celebrate our players and to create a lot of value for our shareholders.

[Colin A. Sebastian:]

Thanks, Bobby.

[Operator:]

That was our final question. So at this time, I'll turn the call over to Dennis Durkin for any additional or closing remarks.

[Dennis M. Durkin:]

All right. Thank you, everyone. We appreciate your dialing in and participating on this call and we look forward to seeing you on next quarter's call in early August. Thank you.

[Operator:]

That does conclude today's conference. We thank you for your participation.