Activision Blizzard, Inc.
Q4 2016 Earnings Call Transcript

Published: 10 Feb 2017

[Operator:]

Good day, and welcome to the Activision Blizzard's Q4 2016 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 2016 conference call. With us are Bobby Kotick, CEO; Thomas Tippl, COO; Dennis Durkin, CFO. And for Q&A, 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 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 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 9, 2017. We will present both GAAP and non-GAAP financial measures during the call. However, as discussed on our July 29 conference call, due to updated compliance and disclosure interpretations issued by the SEC staff on May 2016, we are no longer able to present non-GAAP financial measures excluding the impact of (1

[Robert A. Kotick:]

Thank you, Amrita, and thank you all for joining us today. Our performance in 2016 further strengthened our position as the world's leading stand-alone interactive entertainment company. We achieved record results in 2016, delivering all-time high revenues of $6.6 billion, and record non-GAAP EPS of $2.18, up 42% and 68% respectively over last year. We also delivered record non-GAAP operating margins of 35%. We over-performed our plan for the quarter delivering record revenues of $2 billion and record non-GAAP earnings per share of $0.65, up 49%, and 160% respectively over last year. We also delivered our strongest annual operating cash flow in history at $2.2 billion, up 71% over last year. Our success continues to be driven by our two greatest assets

[Thomas Tippl:]

Thank you, Bobby. Due to our portfolio strength and digital momentum, we far exceeded our plans in 2016. We surpassed our initial revenue guidance by $0.5 billion and our initial non-GAAP EPS guidance by more than $0.40. And we also outperformed expectations for the holiday quarter. In driving our record-setting year, and as we look ahead, we remain focused on our three strategic pillars

[Dennis M. Durkin:]

Great. Thanks, Thomas. Q4 was another great quarter, capping off a record setting year. For the full year for the first time, we had over $1.5 billion in revenues on three different interactive platforms

[Operator:]

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

[Timothy L. O'Shea:]

Yes, hi. Thank you for taking my question. So looking at Call of Duty, I'm curious what the plan is for content this year, and whether for the Q4 release you intend to tweak anything based on the reaction to last year's version of the game. Thank you.

[Eric Hirshberg:]

Hey, Tim. Thanks. It's Eric. So the first thing I'll say is just that I think the most important thing is remember, the Call of Duty ecosystem is strong, and we continue to see very strong MAUs, and that this is the first time we'll have three active games with three different player communities at scale with Infinite Warfare, Modern Warfare Remastered, and Black Ops III. And the plan is we're going to be driving engagement for all of those titles with great content throughout the year. As far as the second part of your question, as I've said many times before, with any longstanding franchise like Call of Duty, there's a balancing act we need to strike between staying true to the things that people love about the franchise and also the need to never become complacent and to keep pushing for innovations to keep the franchise fresh and vital. I would argue, over a period of many years now, we've managed that balance on Call of Duty better than just about any longstanding franchise in any medium. Last year I don't think we got that balance right. Infinite Warfare had a ton of great gameplay innovations that many of our fans appreciated and loved, but it also had a setting that didn't appeal to all of our fans. The good news is, is that I'm excited to say that in 2017 we think we have this balance in perfect harmony with a game that our teams are incredibly passionate about, with a lot of great innovations, but that also has the traditional combat that we know our fans are going to love. The game is being made by Sledgehammer, as Thomas mentioned. They're a proven team that's passionate about this title. We green-lit it over two years ago now, and they've been hard at work at it ever since, and we can't wait to unveil it to the world soon. And without discussing too much about what else we've got in the Call of Duty pipeline, I can also tell you that we're confident our fans are going to love those games as well, and we've never be more excited either creatively or commercially about our three-year Call of Duty slate.

[Timothy L. O'Shea:]

Great. Thanks, Eric, and congrats on the quarter.

[Eric Hirshberg:]

Thank you.

[Robert A. Kotick:]

Thank you.

[Operator:]

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

[Drew Crum:]

Okay, thanks. Good afternoon, everyone. So for Overwatch, would you be willing to provide any additional detail on plans for content in 2017 and beyond? You made reference to live ops, but any additional detail there? And as far as the Overwatch League, any additional color on what you have in store for that? Thanks.

[Michael Morhaime:]

Sure. Thanks for the question. This is Mike. First, we're very pleased with the launch of Overwatch and the player response to the content. We've entered 2017 with strong momentum. The game passed the 25-million-player mark last month. And each seasonal event that we run has set a record for engagement. Our plan is to continue evolving Overwatch with new hero and map content, new game modes, and additional events. We've seen very strong engagement in digital sales from these efforts last year. Looking into the future, we also see opportunities in areas like linear media and consumer product. We think that this will help deepen connections with the franchise and also expose Overwatch to new audiences. In addition, we want to create new ways for players to engage with the franchise through the Overwatch League. Esports is growing, but the ecosystem isn't always easy to navigate for players, viewers, or teams. So with the Overwatch League, we're working very hard to address those challenges. Our focus is on creating stability and participation for teams and owners, and accessibility of the content for fans. We'll have global city-based teams with a standardized annual schedule, creating professional, high quality content and guaranteed league slots for the teams. This is all built on a game that's easy to understand, with short matches, and great action. The core experience is very fun to watch, and there's already a sizable audience for it around the world. Based on this, we think that we'll see significant new business and engagement opportunities. We're going to start identifying team owners soon. That's our next step. And we're looking forward to holding our first combine and kicking off the League later this year. So with all of that said, we're very excited about Overwatch's future.

[Drew Crum:]

Great. Thanks, Mike.

[Michael Morhaime:]

Yeah.

[Operator:]

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

[Mike J. Olson:]

Hey, good afternoon. For King advertising, can you fill in some detail on the testing so far and when we should expect that you get to a full rollout across the games and the player base? Thanks.

[Riccardo Zacconi:]

Hi, Mike. Here's Riccardo.

[Mike J. Olson:]

Sure.

[Riccardo Zacconi:]

So, first of all, we have a large user base, but more importantly, it's a very engaged user base. You've heard earlier Thomas saying that we have more than half an hour of gameplay per player per day, and we think this is an attractive opportunity, a very attractive opportunity for advertisers. It's a very engaged user base. So at the last earnings call I said that we are very careful and protective of the user experience, and so we've been testing and we are testing several ad formats. We've been testing with very high quality consumer brands like Nestle or Fox in our key games. We've been testing in Candy and we've been testing in Candy Crush Soda Saga. And we are testing integrated ad formats, which are integrated in the gameplay and are supportive of the gameplay. And so far, the results have been very positive. They've been positive both for the players, with an increase in gameplay and an increase in ad spend, and they've been positive for advertisers. So we have seen completion rates, which are above industry benchmarks, and we define completion rates as when the player really starts a video ad and finishes the video ad. And further on, we have engaged third parties through third-party research to analyze the impact on players, and the result was that our ads stand out more when they are presented and shown on our platform, on our games than when they are shown on other platforms. So we are very pleased with the results so far. So we are continuing on our plan, and the plan for this year is, first of all, to continue to invest in building the technical infrastructure, and to continue building out the team. Secondly, we will continue to test various ad formats, and as we do so, we will also ramp up the inventory. So our expectation for this year is to have a positive contribution to the bottom line, and we expect to scale the impact on the bottom line in 2018.

[Mike J. Olson:]

Thank you.

[Operator:]

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

[Brian Nowak:]

Thanks for taking my question. Appreciate all the color on the digital revenue strength. I guess I'd be curious to hear about where you finished on full game download mix for consoles for the year and what are you expecting for 2017? Thanks.

[Dennis M. Durkin:]

Yeah, hey, Brian. Thanks. It's Dennis. Yeah, digital tailwinds have obviously been a huge and important factor across all of our businesses, and thankfully we have the diversity of being across multiple platforms. So having huge success on mobile, which is almost all digital, on PC which has over time become almost all digital, and then the last real holdout is really on console where full game download mix is still the minority of player purchases. In general, it varies based on title and region and audience type. So for a game in big and mass market as Call of Duty, you see a slightly lower percentage mix of digital just because it is so mass market. But it's now in the low to mid 20s, and that's up from zero three or four years ago. But in games like Destiny and Overwatch, we see in the mid 30s. And that trend is continuing every year where we see 5-plus percentage points of mix moving every year in terms of overall business mix. So it should be a nice tailwind for us and for others in the industry over the next few years as well. Thanks.

[Brian Nowak:]

Great, thanks.

[Operator:]

And we'll take our next question from Doug Creutz with Cowen.

[Doug Creutz:]

Hey, thanks. I think you got 300,000 Redditers to breathe a huge sigh of relief when you confirmed Destiny 2 for this year. Could you give any indication whether you expect that in Q3 or Q4? And then could you talk about what you and Bungie learned from Destiny 1 that's informing the design process for Destiny 2 and your plans for post-launch content? Thanks.

[Eric Hirshberg:]

Hey, Doug, it's Eric. Yeah, I think the best thing we can say about Destiny is that the development is going great, and it is indeed on track for release this fall. As for the particulars, we've got a big reveal planned. I'm going to let the game do most of the talking, but I'll give you some broad strokes. I think that our team and our great partners at Bungie are doing a very nice job on two fronts. One is if you're one of the millions of players who really invested in Destiny 1 and have put a lot of hours and passion into that game, you're going to love this game, and there's a lot more of what you love here. For anyone who either hasn't yet tried Destiny or hasn't played it in a while, we think we've made a game with the sequel that's going to have a lot for them to love, too. The cornerstone of that is a great cinematic story. That's been a real focus with a great cast of memorable, relatable characters, coupled with some very nice ways to make the game more accessible to a casual player, without losing anything that our core players love. We've made it more accessible to someone who just wants to have a great more casual first-person action experience. We're also going to introduce Destiny to a number of new people by going to some international markets that we haven't been in before. So I'm going to leave the rest for the reveal, but we're very excited about the game, and it'll be coming this fall.

[Doug Creutz:]

As am I. Thanks.

[Operator:]

And we'll take our next question from Chris Merwin with Barclays.

[Christopher Merwin:]

Okay, thank you. I just have one for Riccardo. If you don't mind just updating us on the game pipeline for King. I think you said in the past that you're mostly focused on developing King IP for the time being, but at some point does it make sense to take one of your established IPs from Blizzard or Activision Publishing and create a mobile version of that game that the King team can develop? Thanks.

[Riccardo Zacconi:]

Hi, Chris. Here's Riccardo. So over the past year, we have taken a much more focused approach on what content we develop and release. So this is in line with our goal to continuously raise the bar on innovation. Innovation is a major word for us. It is a major focus point. So talking about the King team, first and foremost we're focusing on the existing King franchises. So we have proven last year that our focus on live games, creating new content in the forms of live ops and new features has paid off, and pays off, and we've seen this in the growth of the Candy Crush franchise year-on-year on mobile. So we are continuing to invest in live games. Secondly, we are working on sister titles and sequels for our existing successful King franchises. We have launched recently, in mid-January, we have launched Bubble Witch 3, and we are extremely pleased not only with the quality of the game, but also with the response from the players and the acceptance from the players. And we are looking forward to scaling further this game in the year. We are also working on titles with much higher level of innovation for the long-term growth of the franchise, and we believe innovation is key for the long-term success. We're also working for the future on additional IPs in new genres with franchise potential, and here it's great to be part of the Activision Blizzard family, and we are very excited about the opportunities coming from working together on bringing established Activision Blizzard IP to mobile. And we're currently working on this, and the work is at prototype stage. We're also working with the Activision Blizzard team on marketing existing Activision Blizzard mobile IP on mobile devices, and that's where we can leverage the experience we have made on mobile, and the technique and infrastructure. So in summary, our resources are more focused than ever, on the long-term growth of our business.

[Christopher Merwin:]

Okay. Thank you.

[Operator:]

And next we have Eric Sheridan with UBS.

[Eric J. Sheridan:]

Thank you for taking the question. We saw the announcement of the consumer products division. We've certainly seen other companies like Disney turn large IP libraries into big consumer product businesses. Why now in terms of the consumer product launch? How should we think about that opportunity? And what should we be watching for over the next couple of years as that business rolls out? Thank you.

[Robert A. Kotick:]

Great question, Eric. It's Bobby. I think Disney is a great example. They've figured out probably better than any entertainment company how to turn consumer products into a multi-billion dollar business, but also to increase the touch points for their franchises around the world. And so we've elevated consumer products to a new strategic pillar for the company. We hired Tim Kilpin who is a veteran of both Disney and Mattel, and we think that consumer products can accelerate growth by leveraging our IP and creating new ways for people to connect with our franchises, especially as we're launching our e-sports leagues. If you think about consumer products as they relate to the NFL or the NBA, these are billions of dollars of revenues for the leagues, and we think they'll be great opportunities for league and team merchandise. That'll be important components of what we do in the consumer products business. Generally, we think creating more consumer touch points in a low capital investment, high-return way, adds tremendous value to the franchises. So we think this is a great opportunity for the company, and we're really looking forward to expanding what we do in consumer products with Tim Kilpin.

[Eric J. Sheridan:]

Great. Thank you.

[Operator:]

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

[Colin Alan Sebastian:]

Great, thanks. And this is a follow up question for Mike. I was hoping you could tell us a little bit more about the Blizzard pipeline as well, both in terms of full new releases and online expansions. And then any sense for the linearity of release timing would be helpful as well. Thanks.

[Dennis M. Durkin:]

Hi, Colin, thanks for the question. Well, last year was a really epic and important year for us, in addition to celebrating our 25th anniversary, we posted record results and have more people playing Blizzard games than ever before. We're very grateful for the passion and support of our players, and our commitment to delivering awesome content to them has never been stronger. So with that in mind, we've put in a significant effort into being able to support the type of longer-term engagement that Blizzard games have always delivered, but doing so now across more games on more platforms and in more regions. So we've really had to scale up our organizational capabilities to do that. This year, we'll have compelling new content across all of our franchises, as well as continuing to expand beyond the games with things like comics, animated shorts and more. In addition, we're always thinking about new game ideas, and we have several in the prototype phase, but not able to talk about those right now. As I mentioned before the Overwatch League also represents new business and engagement opportunities for us this year and beyond, and that's going to be a big focus for us as well.

[Colin Alan Sebastian:]

Great. Thanks.

[Operator:]

We have time for one more question. We will now hear from Eric Handler with MKM Partners.

[Eric O. Handler:]

Yes. Thanks for taking my question. Bobby, question for you. With League of Legends recently signing a $50 million year streaming deal with BAMTech, I'm curious, how do you perceive the value for your e-sports properties?

[Robert A. Kotick:]

Great question, Eric. I actually think it was a very important milestone for e-sports. It's a large-scale broadcast commitment, and I think it really demonstrates how valuable our content can be as spectator content. I think when we look at what the opportunity is for professionally-produced content, and as Mike pointed out, city-based competition around the world, which there really isn't an analog to, we think that if you look at where advertisers want to spend their capital, where sponsors want to spend their capital, it is very difficult to reach 18 to 35-year-old males today, and this programming is incredibly compelling. People are watching it largely as user generated content today. But we think the professionally produced content will have tremendous value, and we think this is going to be a big area of opportunity, again, to strengthen our franchises, but probably most importantly to really celebrate our players. Because if you think about the player investment that our players make, the time, the commitment, there's a great opportunity for us to showcase and celebrate our professional players, and we think there's going to be larger audiences and large numbers of advertisers willing to support those efforts.

[Eric O. Handler:]

Thanks, Bobby.

[Dennis M. Durkin:]

All right. Thank you everyone for joining us today and we'll look forward to talking to you again in early May.

[Operator:]

And that concludes today's presentation. We thank you all for your participation. And you may now disconnect.