Activision Blizzard, Inc.
Q3 2016 Earnings Call Transcript

Published: 4 Nov 2016

[Operator:]

Good day, and welcome to the Activision Blizzard Q3 2016 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Colin Roussil. Please go ahead, sir.

[Colin Roussil:]

Good afternoon, and thank you for joining us today for Activision Blizzard's third quarter 2016 conference call. With us 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'll 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 also may prove to be incorrect. A number of important factors could cause the company's actual future results and other future circumstances to differ materially from those expressed in any forward-looking statements, including the factors discussed in the risk factors section of our SEC filings including our 2015 Annual Report on Form 10-K, which is on file with the SEC and those indicated on the slides 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 3, 2016. We will present both GAAP and non-GAAP financial measures during this call, however, as discussed on our July 29 conference call, due to updated compliance and disclosure interpretations issued by the SEC staff on May 17, 2016, we are no longer able to present non-GAAP financial measures excluding the impact of deferrals. On this call and in the future, we will continue to provide non-GAAP financial measures which exclude the impact of expenses, related 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 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 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, Colin. Many of you may notice that the voice reading you this safe harbor is a different voice than usual, and that's because Amrita is out on maternity leave and we're happy to say, she had a beautiful baby a few weeks ago and she's doing well, but we're looking forward to her being back to accompany Colin on the next call. We delivered another record quarter, and we continue to focus on building enduring franchises for our nearly 500 million monthly players around the world. Continuous innovation within existing franchises and the creation of new franchises like Overwatch helps broaden our audiences, deepen engagement and increase player investment. We believe gaming is the most engaging form of media and players spend tens of billions of hours a year with our franchises. In fact, this quarter alone, our players spent over 10 billion hours playing our games. This strong engagement and the social experiences that are such an important part of game-playing have been the catalyst for our new opportunities in enhanced game monetization, expansion of our franchises into linear media and consumer products, and greater involvement in advertising supported spectator gaming like we have with MLG. It's estimated that as many as 225 million people are now watching organized gaming competitions. Competition between videogame players is becoming as thrilling to watch as traditional professional sports. With the launch of professional global leagues, we believe games spectating will grow significantly as an opportunity for us and for our players. The increased popularity of spectator gaming will enable us to celebrate and reward our players and recognize their accomplishments. Professional gamers will eventually be as celebrated, honored and recognized as professional athletes. Professional gamers will be the role models and goodwill ambassadors of the digital generation and we believe great new business opportunities are emerging throughout the esports ecosystem which we helped pioneer more than a decade ago with games like StarCraft. In May, Blizzard released Overwatch, which in about four months has already eclipsed 20 million registered players making it Blizzard's fastest, new intellectual property to reach that mark. And Overwatch was specifically designed to be the definitive competitive game. We're uniquely positioned to realize the full potential of esports. We have some of the most successful iconic franchises in gaming and direct relationships with nearly 0.5 billion monthly active users, a powerful combination that distinguishes us from the rest of our competitors. And we have unmatched commercial capabilities that have served our shareholders extremely well over the last 25 years. Before I hand off the call, I want to take this opportunity to thank the talented people who drive the success at our company every day. They are our greatest asset, inspiring play, competition and community by creating the most engaging entertainment in the world. Thomas and Dennis will now share the details of our record quarter.

[Thomas Tippl:]

Thank you, Bobby. Thanks to the efforts of our creative and commercial teams, 2016 has continued to be a record-setting year. We over-performed our plan delivering record third quarter revenues, up almost 60%, and EPS more than doubling year-over-year on a non-GAAP basis. On the back of this strong momentum, we are raising our full-year guidance once again. As we've discussed before, our 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 investment. Let's start with audience reach which was nearly 0.5 billion monthly active players this quarter. In Q3, Blizzard had its highest MAUs in history, up 50% year-over-year and 25% over the previous record in Q2. This increase was driven in particular by Overwatch and World of Warcraft. Blizzard's MAUs have more than doubled from two years ago, thanks to compelling new content and the broadening of the portfolio to new franchises and new platforms, including mobile. World of Warcraft

[Dennis M. Durkin:]

Thanks, Thomas. Q3 was another great quarter as we continue to see strong performance across our broad portfolio of leading franchises. Before we go into results, as we mentioned on our Q2 call, we've made changes to how we report non-GAAP financials. As a reminder, our non-GAAP results no longer exclude the impact of deferrals. If you would like to calculate metrics as we used to report them, you would add the impact of deferrals to our non-GAAP – our non-GAAP as redefined figures. Our segment results, however, are still presented excluding the impact of deferrals like they always have been. This aligns with how Bobby, our management team and our board continues to review the business and our overall performance. With that backdrop, I'd like to first start with our segments, as they are the engine behind our consolidated financial results. Starting with Activision, on the back of strong Call of Duty engagement and the successful launch of Destiny's Rise of Iron in September, Activision delivered record Q3 operating income of $123 million and also achieved record year-to-date operating income of $309 million, up 27% versus last year. Blizzard delivered Q3 segment revenues of $727 million, which were nearly double last year's Q3 performance. This also helped fuel record third quarter segment operating income of $321 million, which is up 2.5 times versus Q3 of last year. And year-to-date Blizzard segment revenue of $1.8 billion is up 59% versus last year, and operating income of $740 million is up 93% versus last year. I wanted to pause here for a second and mention that just the Activision and Blizzard segments, so excluding King, also set a Q3 and year-to-date record for combined segment revenue and operating income. Notably, this performance drove year-over-year organic growth for Activision and Blizzard segments of 15% for the quarter and 22% year-to-date. Operating income grew even faster year-over-year, increasing 78% for the quarter and 67% year-to-date. Turning to King, as expected, revenues were down slightly quarter-over-quarter and year-over-year, but as Thomas noted, importantly the Candy Crush franchise and mobile overall performed well with bookings growth year-over-year. King's operating income was down this quarter, mainly due to marketing costs related to the launch of Farm Heroes Super Saga, as well as investments we are making in our promising Advertising business. Let's now turn to our consolidated results and raised outlook for the full year of 2016. Unless otherwise indicated, I will be referencing non-GAAP as redefined measures. Please refer to our earnings release for a full GAAP to non-GAAP reconciliations. For the quarter, we generated record Q3 GAAP revenues of $1.57 billion, $78 million above our August guidance and $578 million or 58% above Q3 last year. The net effective deferred revenue was $62 million for the quarter and also above guidance of $45 million. We generated GAAP EPS of $0.26. That is $0.20 above guidance, of which $0.10 is related to the timing of our call premium, which I will discuss in more detail later when I cover the balance sheet. We generated record Q3 non-GAAP as redefined EPS of $0.49, $0.10 above guidance and more than double the $0.20 we generated in Q3 of last year. The impact of deferrals on non-GAAP as redefined, EPS was $0.03 and above guidance of $0.01. The over-performance in the quarter versus guidance was driven by multiple factors, including Overwatch full game sales and in-game content, the strong performance of the World of Warcraft

[Operator:]

Thank you. We'll take a first question for Mike Olson from Piper Jaffray.

[Michael J. Olson:]

All right. Good afternoon, and thanks for taking my question. Activision is obviously evolving. It appears to be positioned to add several incremental categories of revenue over the next few years, each of which you touched on a bit in your prepared remarks. Between esports, King Advertising and consumer products and content, which category would you say you're most excited about? And which could you have the most impact on your results in the next couple of years? Thanks.

[Dennis M. Durkin:]

Yeah, thanks, Mike. Great question. You hit on one of the hardest things in our business right now, which is really the prioritization of all the great opportunities we have in front of us. And first, I'd probably add one thing to your list, which is probably the biggest near-term opportunity, which is additional in-game content. As you've seen in our numbers, we've seen incredible growth in this area over the past several years, but we really think we're still only in the early stages here. And if we can do it right and not only drive additional player investment, it can also drive additional engagement as you deliver content to fans more frequently and consistently, as we saw in Q3. So this is really an enormous opportunity just based on the current engagement that we have across our portfolio. And we're also excited about many of the new opportunities that you mentioned. We are making good progress in our Advertising business with King. And as Thomas mentioned earlier, we expect it to contribute next year and scale up in 2018. We're off to a very good start with our first TV show, Skylanders Academy, which just launched last weekend on Netflix, extremely high-quality and it's nice progress in that initiative. And as you heard Bobby say at the beginning of the call, we're incredibly excited about esports and the opportunities we have in this space, given our strong and owned IP portfolio. You only have to look as far as BlizzCon this weekend to sort of see that in action, and this longer term is an enormous opportunity for the company. So across all these areas, we'll continue to manage our investments with the same discipline and prudence that we do in all parts of our business, but undoubtedly more opportunity in front of us than we've ever had before.

[Robert A. Kotick:]

Thanks for the question, Mike.

[Operator:]

Thank you. We will now take our next question from Brian Nowak with Morgan Stanley.

[Brian Nowak:]

Thanks for taking my question. I have two. The first one on World of Warcraft

[Michael Morhaime:]

Okay. Thanks for the question. This is Mike. First, we're very happy with the Legion launch. We worked very hard to make Legion our best expansion, and we're pleased and gratified by the player reaction so far. We no longer report subscribers, but as Thomas mentioned, our MAUs were up 30% quarter-over-quarter, and that built on the momentum we saw earlier in the year. In terms of Legion performance, it has matched or exceeded our prior expansions launch performance across metrics like sales, player base, and participation in value-added services. So we're very excited to see how players are reacting and engaging in the new content, including our new Legion mobile companion app. We're seeing players spend their time across a whole variety of activities, and with all of the content that's available to them, we're hopeful they'll have a lot to do for a long time. It is a big priority for us to continue to provide new content to Legion players. Last week, we released our first content Patch for Legion less than two months after the launch. This is the fastest that we've added a new major Patch to a World of Warcraft expansion in the game's history, and it's also bigger than the initial content Patch that we released for the last few expansions. Our players have reacted very positively so far, and we're looking forward to furthering the momentum that Legion has generated into BlizzCon, the holidays and beyond, and following up with more content next year.

[Brian Nowak:]

Great. Thanks. And I have one follow-up. 2017 ramp, (34

[Eric Hirshberg:]

Hey, Brian. Thanks for the question. So, as we mentioned, we're on track and really excited about what we think is going to be an awesome sequel for Destiny in 2017. No announcements today on timing just yet. But what I will say is, that sequel is designed to both excite our highly-engaged current players, but also to broaden the appeal even further, bringing in new fans and bringing back lapsed fans, as well. So that's our primary focus right now. Beyond that, in the past, I've mentioned that the incredible demand for Destiny content has somewhat outpaced our ability to deliver upon that demand. And going forward, along with our partners at Bungie, we've put together what we believe is a very smart approach that will allow us to deliver that steady stream of great content to keep our players engaged and keep the universe live and growing in the wake of that sequel.

[Operator:]

Thank you. We'll now move on to our next question from Chris Hickey with Atlantic Equities.

[Chris P. Hickey:]

Thank you, and congratulations on the quarter. I had a question about King. MAUs were down slightly this quarter, but you said that time spent per user was up and it's obviously good to hear the mobile business continues to grow. What are you seeing in terms of overall engagement there and how should we be thinking about MAUs from here?

[Riccardo Zacconi:]

Hey, Chris, it's Riccardo. Well, first of all, I think in terms of strategy, I think that we see that our focus on the top franchises is really paying off. And as you noted, while we see that – we see a slight decline in MAUs quarter-over-quarter, the mobile gross bookings have grown or we managed to grow gross bookings year-on-year. And very importantly, the Candy Crush Saga franchise overall gross bookings also grew year-on-year. This is the result of hard work from the teams in the end of life (37

[Operator:]

Thank you. We'll now take our next question from Brian Fitzgerald with Jefferies.

[Brian P. Fitzgerald:]

Thanks, guys. We know it's very early, but how are Call of Duty sales trending this year relative to last? Overall, should we think about Call of Duty user levels, revenue and profitability in 2016 as up, flat or down? Thanks.

[Eric Hirshberg:]

Hey, Brian. Well, let's see, how do I answer that? First of all, I think it's obviously too early to make any comments on our annual release, which hasn't released yet with Infinite Warfare. But I think that it is important that we think about Call of Duty as a year-round business, which is designed to have a steady stream of content throughout the year to keep our players engaged, and obviously our annual release is a huge part of that engagement-driving strategy. But when we do our jobs right on this franchise, we manage to keep people engaged year-round. And this year we definitely achieved that with record operating income, which Thomas mentioned, for the franchise year-to-date. And I think probably the best news is that's been accompanied with also a record in monthly active users, so in this case engagement and the business are going hand-in-hand and helping one another. So on the annual release, as you know, we've modeled Infinite Warfare, which is a new sub-brand, down versus Black Ops III, which is our best established sub-brand, and that only makes sense given our historical patterns. But we think that we have delivered a great game that we think is going to do great over the holiday quarter. And it's got huge innovation for our fans, and as you know, keeping a franchise that's been on top for as long as Call of Duty has fresh every year is no easy task, and Infinity Ward has definitely done that with Infinite Warfare, which has a ton of new experiences and gameplay mechanics for our fans while also feeling – giving that classic Call of Duty feel that our fans love. Second, Thomas mentioned we think it's the most complete entertainment package in the industry. It's got a full campaign. The multiplayer builds upon. One of the stickiest and most played multiplayer games in the world. And it's the first time that we've had a full Zombies mode on the disk of the main release in a Treyarch (40

[Operator:]

Thank you. We'll now take our next question from Colin Sebastian with Robert W. Baird.

[Colin Alan Sebastian:]

Okay. Thanks, guys. And maybe just as a follow-up on King, I was hoping you could provide a little more detail on the ad testing, specifically how monetization and engagement is tracking with paying and non-paying users in those tests? And then at what point in the next year should we expect those ads to roll out more broadly and contribute to revenues? Thank you.

[Robert A. Kotick:]

Hey, Colin.

[Riccardo Zacconi:]

Let me give you an update on the ad business. So we have been testing various ad units over the past several months, and we have tested these ad units in two Candy Crush games. And our plan is to increase inventory by adding additional cohorts of players through the end of the year with these ad units. As I said in the past, we believe that advertising is an attractive opportunity to monetize non-paying players, and we see that because of the size of the network, and also because the players are so engaged on our network, that the interest from high-quality brand advertisers is very strong. So we want to take this opportunity, and there's a lot to do to take this opportunity. And the teams are working hard as we speak; on one side, on building the inventory; and on the other side, we are building the team and the infrastructure required to take this opportunity. So, regarding the second part of your question, we believe that advertising will begin to contribute to bottom line, as Dennis was saying before, in 2017 and that we will be able to scale it in 2018.

[Operator:]

Thank you. We'll now take our final question from Chris Merwin with Barclays.

[Christopher David Merwin:]

All right. Thanks for taking my question. So for Overwatch, can you just talk a bit about what your plans are around new content next year just to keep your users engaged? Is your hope to have some sort of new content out every year whether it'd be an expansion or a full re-release of the game? Thanks.

[Michael Morhaime:]

Thanks for the question. We're very pleased with the launch of Overwatch. As Thomas mentioned, it's our fastest IP in Blizzard's history to achieve 20 million players, and we're happy to see our players reacting favorably to the new content and new experiences that we've been adding to Overwatch so far. We think Overwatch will achieve record launch-year revenue for Blizzard game this year. We've already had several new content releases since launch and player participation continues to build momentum. As Thomas said, engagement and participation in the Halloween event in October exceeded the one for the Summer Games event in August. So, so far we've released a new hero, new map, competitive play mode, and we have more content in development. We're very excited about player reaction to the Overwatch shorts and the plans we have for Overwatch in esports which we will discuss more at BlizzCon tomorrow. It's too early for me to discuss our plans for 2017, but what I can say is that the two events that we've had so far have shown us we have a great model for follow-on content. We've found that it stimulates our audience and drives record engagement. So you should expect to see more events like Summer Games and Halloween, and additional content, which we'll discuss in more detail later. So as the community continues to grow and our player base continues to react positively to the content we're creating, we're very excited about the prospects for the future.

[Dennis M. Durkin:]

All right. On that note, Mike, thanks for the BlizzCon tease for this weekend. We look forward to seeing you all – many of you this weekend at BlizzCon in Anaheim and we look forward to talking to you all next quarter on our conference call in early February. So thanks for your time today.

[Operator:]

And that does conclude today's conference. Thank you all for your participation, and you may now disconnect.