Activision Blizzard, Inc.
Q1 2010 Earnings Call Transcript

Published: 7 May 2010

[Operator:]

Good day, and welcome to the Activision Blizzard's First Quarter CY 2010 Earnings Conference Call. [Operator Instructions] At this time, for opening remarks and introductions, I'd like to turn the call over to today's Senior Vice President of Investor Relation, Ms. Kristin Southey. Please go ahead.

[Kristin Southey:]

Good afternoon, and thank you for joining us today for Activision Blizzard's First Quarter Calendar Year 2010 Conference Call. With me today are Bobby Kotick, Chief Executive Officer of Activision Blizzard; Thomas Tippl, Chief Operating Officer and Chief Financial Officer of Activision Blizzard; and Mike Morhaime, Chief Executive Officer of Blizzard Entertainment. I would like to remind everyone that we will be making statements that are not historical facts. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainty. As indicated in the slide that is now showing, 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. Such factors include, without limitation, sales levels, shifts in consumer spending trends, current macroeconomic conditions, the seasonal and cyclical nature of our market, difficulties related to World of Warcraft in China, our ability to predict consumer preferences among computing hardware platforms, decline in prices, product returns, price protection, product delays, retail acceptance of our products, adoption rate and availability of new hardware and related software, competition, litigation and associated costs, rapid changes in technology, industry standards, business models, including online and used games, and consumer preferences, protection of proprietary rights, maintenance of key relationships, including the ability to attract, retain and develop key personnel and developers that can create high quality "hit" titles, counterparty risks, economic, financial and political conditions and policies, foreign exchange and tax rates, identification of acquisition opportunities and potential challenges associated with geographic expansion. These important factors and other factors that potentially could affect the company's financial results are described in the company's annual report on Form 10-K, for the period ended December 31, 2009. The company may change its intentions, belief or expectations, at any time and without notice, based upon any changes in such factors, in the company's assumptions or otherwise. The company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after today, May 6, 2010, or to reflect the occurrence of unanticipated events. I'd also like to note that certain numbers we will be presenting today will be made on a non-GAAP basis, excluding the impact of the changes in deferred net revenues and related costs of sales, expenses related to equity-based compensation costs, the operating results of products and operations from the historical Vivendi Games businesses that the company has exited or substantially wind down, cost related to the business combination between Activision and Vivendi Games, the amortization of intangibles and the impairment of intangible assets and the associated tax benefits. Please refer to our earnings release for a full GAAP to non-GAAP reconciliation. Please refer to our earning release, which is posted on our website at www.activisionblizzard.com for reconciliations and further explanations. Also given that we are in litigation related to Infinity Ward's past and present employees, we will be limited in what we can say with regards to the human resources issue. Finally, there's also a PowerPoint overview, which you can access with the webcast and which will be posted to the website following the call. And now, I would like to introduce our CEO, Bobby Kotick.

[Robert Kotick:]

Thank you, Kristin. We once again significantly outperformed both our quarterly revenue and EPS expectations, and we've raised our EPS outlook for the year. We continue to accomplish industry-leading financial performance as a result of the over 7,200 exceptionally talented people at Activision Blizzard whose dedication and commitment enable our consistent performance, growth and margin expansion. We begun the fiscal year with great momentum in both Blizzard Entertainment and Activision have extraordinary product year. As always, we'll provide detailed reviews of the quarter and our updated expectations for the balance of the year later in the call. I want to focus on Activision's strategy for the Call of Duty brand, and our commitment to maintaining and supporting the best development talent in the industry, including the addition of Bungie to our team. I want to start by affirming four points, each of which I'll discuss in more detail. First, we're focused on growing our Call of Duty franchise, broadening its reach, using its lead technical innovation in our industry and providing greater entertainment value than ever before to all of our audiences. We have long-term well-fostered plans in place, and we are fully resourced to continue to lead the industry with this important franchise. Obviously, studios like Infinity Ward remain an important part of this process. And we continue to invest in its growth and support the talented developers there who are working hard on the next title. Next, we expect to launch a groundbreaking Call of Duty retail title in 2011, in addition to our expanded digital content strategy for the brand. And finally, we couldn't be more excited about our new 10-year alliance with Bungie, which is one of our next big things. Over the last 20 years, one of our key goals has been to broaden the audiences for our franchises while selectively adding new franchises with the potential to be billion-dollar properties. Our actions over the past few months demonstrate our commitment to this objective. Call of Duty, as an overarching franchise, is perhaps the best example of how to focus on the taste and interest of an audience. In this case, an audience that numbers in the many tens of millions of players and use audience insight to shape future product plans. There's nothing accidental about the continued success we are having with the Call of Duty brand. The driving factor of Call of Duty success is our ability to consistently execute a three-pronged strategy to elevate the franchise to greater levels of audience satisfaction through superb execution with our retail partners, delivery of innovative gameplay through online tools and distribution capabilities and by driving greater interest in the franchise in new geographies. Through our multi-platform, multi-developer approach, we continue to build an enormous player base. While our direct-to-consumer Digital business is growing, our continued success will come only with the tremendous support of our fantastic retail partners. Last year, we successfully mobilized our logistics, supply chain and sales teams to partner with great retailers around the world, and leverage social media and great quality advertising to create the largest retail video game launch in history. We have every intention of doing this again this year with Call of Duty

[Thomas Tippl:]

Thank you, Bobby. Today, I'll begin with a recap of our March quarter result and provide our outlook for the June quarter and calendar 2010. And then I will review the Activision Publishing business before heading over to Mike, who will cover the Blizzard business. For your reference, in our press release, our set of schedules which provide non-GAAP measures by business segment, and these will be the numbers that I will refer to unless otherwise noted. Also please refer to our earnings release for a GAAP to non-GAAP reconciliation. For the quarter, GAAP net revenues were $1.3 billion and GAAP earnings per share were $0.30. On a non-GAAP basis, net revenues for the quarter were $714 million and non-GAAP earnings per share were $0.09. Earnings per share were above the prior year and ahead of the outlook we provided in February. The March quarter was driven by the continued performance of Blizzard Entertainment's World of Warcarft and Activision's Call of Duty. Beyond strength in catalog sales for Call of Duty in retail, we also benefited from the launch of the Call of Duty

[Michael Morhaime:]

Thanks, Thomas. I'll start off with the review of our performance for the first quarter and then discuss what's in store for Blizzard Entertainment for the rest of 2010. Q1 2010 was another dream [ph](47

[Kristin Southey:]

Thank you, Mike. And operator, we'd like to open it up for questions. I'd just again, want to remind everyone that given that we are in litigation related to Infinity Ward past and present employees that we will be limited in what we can say with regard to the circumstances. So operator, with that, we can start your questions.

[Operator:]

[Operator Instructions] We'll take our first question from Heath Terry with FBR Capital Markets.

[Heath Terry:]

Thomas, you mentioned that World of Warcarft was better than expected in the quarter. Can you give us a sense of what that means from a subscriber standpoint, since we've generally seen subscribers flat for the last year or so? Or was this simply higher ARPU per subscriber that you were referring to?

[Thomas Tippl:]

Yes, I think the subscriber trends have been healthy. We continue to make great progress and probably slightly better than we had even expected, particularly in China, since we entered the relationship with NetEase, and NetEase has been doing a fantastic job, growing the World of Warcraft community in China. So that's tracking very well. And then in addition, as Mike mentioned in his earlier remarks, there's a lot of traction for the additional services that Blizzard has started to offer their gamers, and those have been selling very well as well.

[Heath Terry:]

So it's safe to say and say that we're still at 11.5 million subscribers?

[Thomas Tippl:]

Safe to say that we have not yet reached a new milestone that we will be ready to announce.

[Michael Morhaime:]

Well we can't confirm we are over 11.5 million so. I just want to add a couple of points because we have a couple of reasons for optimism about the future this year as being a big year for World of Warcarft. And I just want to call out two of those reasons. One is, of course, the launch of Cataclysm, which we're very excited about. Historically, we've always seen a nice bump of returning players, as well as new players when we've launched expansions. And also we've seen great momentum for the game in China despite the fact that we haven't launched Wrath of the Lich King yet. And we also expect that when we do receive approval to launch Wrath of the Lich King, that will also drive interest for the game in China.

[Operator:]

Next, we'll go to Brian Pitz with UBS.

[Brian Pitz:]

With respect to Map Packs for Call of Duty, should we expect at least two additional releases for Modern Warfare 2 this year? And also is that $15 ESP sustainable? And just a quick on regarding Blizzard, is it likely that we can see two or more releases annually from the studio going forward?

[Thomas Tippl:]

So with regard to the Map Pack, I think they've been selling incredibly well. As you know, we've expanded the number of maps that we are providing as part of that release. And therefore, the $15 price point has still provided a fantastic value to gamers and is also evidenced by the billions of hours that people are playing the game online. So we think that has worked. We have currently the second Map Pack in development at Infinity Ward. So we expect this to be launch sometime later this year. And we haven't made any comment beyond that at this point. And I'll let Mike handle the question on the Blizzard release schedule.

[Michael Morhaime:]

I'll just say that we have a great pipeline of products in developments, and we'll continue creating content for our games. We've already announced that we'll be creating two expansions for StarCraft II after launch, but we haven't announced any details about the new release schedule.

[Operator:]

Next we'll go to Collis Boyce with Morgan Stanley.

[Collis Boyce:]

One question just around mobile. I know that historically, you guys have licensed your franchises, and now that iPhone's and iTouch's are about 86 million for an installed base, the iPad already has 1 million units. So I was wondering if that still your strategy going forward or if there's any change to how you think of mobile?

[Thomas Tippl:]

When we settled along that, prioritization of opportunities is always our greatest challenge when you have lots of growth opportunities. As the installed base of the mobile devices gets bigger. If we can -- we have a number of products that are on those platforms today that are performing well, but I think one of the challenges for us is really figuring out how do you have a profitable business on those platforms. And they generate a modest amount of profitability. I will say this, I think over the course of the next couple of years, that iPhone and mobile, generally will present opportunities for growth and margin expansion that we haven't seen in the past. So we're getting more excited about the opportunities there.

[Operator:]

Next, we'll go to Edward Williams with BMO Capital Markets.

[Edward Williams:]

Quick question for you Bobby. As you look at Call of Duty, can you give us an idea as to what you're seeing with the ARPU given -- kind of what's the uptick rate like for the expansion packs? And how much have you been able to expand ARPU above and beyond what the retail prices?

[Robert Kotick:]

We don't really look at ARPU per se. I think what we're really focused on is how can we deliver value-added experiences to our customers that are worth paying for. And I think that we clearly looking at the amount of consumption. We're doing that. I think that we're going to continue to invest against the opportunities that downloadable content provide. As long as we see that the collections of what's included in the Map Pack is really going to deliver delight, surprise, enthuse our audiences, we'll continue to do that. But I can't say that we really look at it from a sheer ARPU perspective.

[Edward Williams:]

And can you comment a little bit about what steps you may be taking with that particular franchise going forward and integration, if any of that could come in to the Battle.net platform?

[Robert Kotick:]

We haven't said anything about integrating it with Battle.net. I think that Blizzard is focused on using Battle.net as a principal tool for StarCraft II. And I'll let Mike answer that question. But from our perspective, what we're focused on right now is enhancing the multiplayer experience. And I will say this, that what we're delivering in Call of Duty

[Michael Morhaime:]

On the Battle.net question, I just would say that our focus right now is developing Battle.net to support those Entertainment games. I don't have any announcements to make at this time regarding integrating the service with any non-Blizzard games.

[Operator:]

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

[Douglas Creutz:]

I was wondering if you can maybe go into a little bit what the economic structure is for StarCraft II in Korea, given they have sort of a unique PC café market there? Is it still kind of a stray unit model or is there some sort of a revenue share deal that you have with the PC cafés?

[Michael Morhaime:]

We have not yet announced the details about our IGR model in Korea. What we have said is that players will be able to purchase access to StarCraft II. We've announced the pricing of 69,000 Korean won. And we have announced that there will be alternative pricing options available, as well as pricing for current WOW players that we're going to be announcing later. But for competitive reasons, we're not ready to get into additional detail right now.

[Operator:]

Next we have Ben Schachter with Broadpoint AmTech.

[Benjamin Schachter:]

When you look at Korea, just what percentage of revenue do you think will come from Korea for StarCraft in the first year? And then if you could tell us what does the StarCraft brand mean in China and when we might expect to see it there? And then finally on StarCraft, how many of these worldwide do you expect to sell direct through Battle.net? Is that going to be very different from your past relationships selling it through retail?

[Michael Morhaime:]

Starting with the last part, for a competitive reasons, we can't go into our anticipated breakdown for digital versus retail and how many players might opt to download the game this release from the Blizzard store versus how many might get a boxed copy from retail. But we are committed to providing different distribution options and payment options in various regions for players that want to play StarCraft II. And the objective, of course, is to reach the widest possible audience. Regarding the breakdown of revenues by region, that's not something that we break down. I can say that the StarCraft brand is extremely strong in Korea, as you know. And the Blizzard brand is extremely strong throughout Asia and in China. And so Warcarft III happens to be more popular in China than StarCraft was. But that really, I think, is a product of the timing of the release and just that as the market in China evolved since Warcraft III came out later, we were able to attract more players to play it. But throughout Asia, StarCraft is still a very strong franchise. And we expect there's a lot of buzz and a lot of anticipation in China. And so we expect to have success in China similar to other regions. In terms of the timing of the launch in China, I don't have any forecast for you other than to say that our desire is to launch the game in China as soon as possible, and we'll work with the relevant government authorities and with our local partner to ensure that we can do that.

[Benjamin Schachter:]

And Thomas, just quickly, excluding music and excluding COD, will Activision Publishing be up or down year-over-year?

[Thomas Tippl:]

Excluding music and Call of Duty, we'll probably be up year-over-year.

[Operator:]

Next we have Justin Post with Bank of America Merrill Lynch.

[Justin Post:]

Just want to clarify Call of Duty for next year. It sounds like there could be a Sledgehammer version and an Infinity Ward version. Can you just talk about that and are you at all worried about diluting the brand value of the franchise by having so much content out there next year?

[Thomas Tippl:]

Our standards for the content that we are willing to put up under the Call of Duty franchise banner is extremely high. We have built a very enthusiastic and loyal fan base over years that have very high quality expectations. And the last thing we would ever do is put a product out that doesn't live up to the standard. In fact, what we're trying to do with every product is raising the bar. And the good news about having such a large community that's banking so many hours playing the game, and now also the online connectivity and all the data that we are gathering on our back end, allows us to see what parts of the game player appreciate the most. It also had a vocal fan base, the let us know the kinds of gameplay mode, services, et cetera, that they would love to have but they're not having yet. And all of that fit into our development process. So we are extremely well-positioned on Call of Duty because of the consumer interest that we have and because of the fact that we have a very developed, very talented developers working on the franchise. And in fact, we never had more talented developers working on this franchise than we have right now. We've added, Sledgehammer, which is a super-talented team. There's still a large group of extremely talented individuals at Infinity Ward that we're going to supplement and Treyarch has gotten better and better every year. And I think you will all be surprised by the quality of Call of Duty

[Justin Post:]

And is there an Infinity Ward shooter version coming out for next year? Can you confirm that at this point?

[Thomas Tippl:]

We have not yet confirmed the individual plans for next year. We usually don't do that at this time. They're very focused on our communication right now about the release from this year. What we have said is that Infinity Ward is working on the Call of Duty title. And you'll hear more details as we advance through the year.

[Michael Morhaime:]

Remember, Justin, and this is a history that we have. We are laser focused right now. We don't want any distraction from the continued success, for the amount of work [ph](69

[Justin Post:]

How is the retail reception? And what are you hearing about Black Ops? Any way of quantifying it all versus last year, which was just obviously, an unparalleled success?

[Thomas Tippl:]

Retail is very excited about the new game, and we again, I think, set up for another blockbuster launch that's going to be supported with great advertising, a major marketing campaign and tremendous retail support.

[Robert Kotick:]

And it is an extraordinary multiplayer product.

[Operator:]

And we do have time for one more question. We'll take the question from Jeetil Patell with Deutsche Bank Securities.

[Jeetil Patel:]

I guess it's been obviously quite a bit of controversy in the markets about the Activision in different things. I guess can you discuss maybe 2011 broadly qualitatively? Do you think earnings grow in 2011? And second, question around StarCraft II. I know a lot of folks have asked questions on this but it seems like a hybrid business model has software and subscription/royalties. I guess when you look at the opportunity for a game like StarCraft II and I guess it's still played after 10 years. I guess if you look at over the next five or 10 years, what percent of the opportunity or revenue opportunity comes in the form of the traditional software model versus maybe what we're not thinking about, which is subscriptions and royalties and licensing and all the other ancillary pieces of the equation you weren't able to monetize or capture here on the past decade with number one? Can you go through those? That would be great.

[Robert Kotick:]

I'll take the first part of your question, Jeetil, but we have a 20-year history of growing earnings and expanding margins. And while we don't give outlooks for next year, this year, I think you know what our commitment is to growing our margins and expanding our business. And I think Mike will be best equipped to handle the second part of your question.

[Michael Morhaime:]

I think initially, the StarCraft II launch will probably look very similar to previous launches with the model being driven by the sale of the unlimited client, either at retail or digitally. But as I mentioned, we plan to tailor the business model in each region in a way that makes sense for individuals in each region. So I think that, that will have the impact of basically extending out the life of the game. I think it will also create additional accessibility for markets that really don't support a full retail price point, like the United States and Europe. I just want to call out as an example, I'm going to give Russia as an example. The way that it will work is we're going to offer two retail packages in that region. One would sell for the equivalent of about $33 and will include one year of play. Another would sell for the equivalent of about $16.50, and that would include four months of play. Players would then have the option of purchasing additional time for a fee or even upgrading their account to unlimited play. And we think that giving players in these regions more options on how to pay for StarCraft II, that will attract a wider audience and also minimize piracy.

[Jeetil Patel:]

I guess do you look at any particular model out there in media or in general that may be a good proxy for us to look at, just as a concept to think about StarCraft II? And second, I guess, is the StarCraft II model that you're looking at broadly, maybe a blueprint for how you look at online in general as you look at some of the other franchises and this integration of client versus online?

[Michael Morhaime:]

As far as the model goes, our perspective on that is we always design our games first and tailor the model to what's appropriate to both the game and to individual region and how we expect people to play the games. And in terms of predicting what the breakdown might look like, I think I'm going to leave that up to you.

[Operator:]

And that does conclude today's question-and-answer session. I'd like to turn the call back over to Kristin Southey for any additional comment or closing statements.

[Kristin Southey:]

Well, thank you. On behalf of everyone in Activision, everyone, I thank you for your time and your support.

[Operator:]

That does conclude today's conference, and we thank you for participating.