Activision Blizzard, Inc.
Q1 2013 Earnings Call Transcript

Published: 8 May 2013

[Operator:]

Good day, and welcome to the Activision Blizzard's First Quarter 2013 Results Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to the Senior Vice President of Investor Relations, Ms. Kristin Southey. Please go ahead, Kristin.

[Kristin Mulvihill Southey:]

Good afternoon, and thank you for joining us today for Activision Blizzard's First Quarter 2013 Conference Call. With me today are Bobby Kotick, CEO of Activision Blizzard; Thomas Tippl, COO of Activision Blizzard; Dennis Durkin, CFO of Activision Blizzard; Eric Hirshberg, CEO of Activision Publishing; and Mike Morhaime, CEO of Blizzard Entertainment. 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 risk and uncertainty. As indicated in the slide that is 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; current macroeconomic conditions; increasing concentration of titles; shifts in consumer spending trends; our ability to predict consumer preferences among competing genres and hardware platforms; maintenance of key relationships, including the ability to attract, retain and develop key personnel and developers that can create high-quality hit titles; the seasonal and cyclical nature of our industry; changing business models, including digital delivery of content; competition, including from used games; possible declines in prices; product returns; price protection; product delays; adoption rate and availability of new hardware and related software, particularly during the expected console transition; rapid changes in technology and industry standards; the current regulatory environment; litigation and associated cost; protection of proprietary rights; counterparty risks; economic, financial and political conditions and policies; foreign exchange and tax rates; and potential changes 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 most recent Annual Report on Form 10-K for the period and in the company's other SEC filings. The company may change its intentions, beliefs or expectations made at any time and without notice based upon any changes in such factors in the company's assumptions or otherwise. 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, may ultimately prove to be incorrect. The company undertakes no obligation to release publicly any revision to any forward-looking statements to reflect events or circumstances after today, May 8, 2013, or to reflect the occurrence of anticipated events. I'd like to note that certain numbers we will be presenting today will be made on a non-GAAP basis, excluding the impact of the change in deferred net revenues and related cost of sales with respect to certain of our online-enabled games, expenses related to stock-based compensation, the amortization of intangibles from purchase price accounting and the associated tax benefit. Please refer to our earnings release which is posted at www.activisionblizzard.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 12-quarter financial overview highlighting both GAAP and non-GAAP results on a one-page summary sheet. And now, I'd like to introduce our CEO, Bobby Kotick.

[Robert A. Kotick:]

Thank you, Kristin, and thank you, all, for joining us today. For the quarter, we generated non-GAAP revenues of $804 million, non-GAAP EPS of $0.17 and $325 million of operating cash flow. Our results demonstrate our continued ability to build and sustain great game franchises that support highly engaged communities around the world. This proven ability, combined with our long-term strategy, rigorous planning, best-in-class execution and incredibly talented employees are the core strengths of our company. Activision Publishing's Skylanders was the leading video game franchise in both North America and Europe, including toys and accessories. Call of Duty was the #2 franchise in North America and Europe combined. Blizzard's World of Warcraft remains the largest subscription-based MMORPG in the world. However, during the quarter, subscribership declined by approximately 1.3 million subscribers, roughly 14%, and we ended the quarter with approximately 8.3 million subscribers. Though the majority of our subscriber declines occurred in the East, where we have more subscribers and lower revenue per subscriber, we saw declines in the West as well. And while we do believe further declines are likely and we expect to have fewer subscribers at year end than we do today, World of Warcraft remains one of the most successful franchises in the history of entertainment. It's important to note that the nature of online games has changed, and with the environment becoming far more competitive, especially with free-to-play games. To address this, we're working to release new content more frequently to keep our players engaged longer and make it easier for lapsed players to come back into the game. We believe in the long-term value of this franchise and will continue to commit substantial resources to World of Warcraft. During the quarter, Blizzard also launched its expansion to the long-standing StarCraft franchise, with StarCraft II

[Dennis Durkin:]

Thanks, Bobby. Good afternoon, everyone. Today, I will start with a recap of our March quarter results. Followed by a review of our outlook for Q2 and for the full year. Beginning with our Q1 results. Please refer to our earnings release for full GAAP to non-GAAP reconciliations. For the quarter, on a GAAP basis, we generated revenues of $1.3 billion, an operating margin of 44% and EPS of $0.40. On a non-GAAP basis for the quarter, we generated revenues of $804 million, an operating margin of 31% and EPS of $0.17. Our revenues in the quarter were driven by Call of Duty, both catalog and digital; Skylanders; Blizzard's World of Warcraft and the recently released StarCraft II

[Eric Hirshberg:]

Thanks, Dennis. I'm pleased to announce that in Q1 Activision Publishing delivered another strong quarter. None of our success would be possible without the talent, passion and commitment of the best team of employees in the entertainment industry and the commitment of our retail and digital partners around the world. Through March 31, in North America and Europe combined, Activision Publishing had the #1 and #2 video game franchises, including toys and accessories. Let's start with Skylanders. Skylanders, including toys and accessories, moved into the #1 spot as the biggest franchise year-to-date and Skylanders Giants delivered year-on-year growth compared to Skylanders

[Michael Morhaime:]

Thanks, Eric. On the product side, Q1 was an exciting time for Blizzard as we announced 2 new games

[Kristin Mulvihill Southey:]

Thank you, Mike. Operator, this will open it up for questions.

[Operator:]

[Operator Instructions] We'll go first to Mike Olson with Piper Jaffray.

[Michael J. Olson:]

So you mentioned that your focus is doing a few things exceptionally well, and as we enter the next cycle, depending on how you would define major franchises, you'll have 4 or so major franchises that generate the majority of your profits. What are your expectations for what that number will be during the middle innings of the next cycle? And then if I can kind of sneak in other one, the Wii has historically been relatively important for -- platform for Skylanders. Is there potential for Skylanders to face some headwinds versus last year, due to the weakness of Wii U?

[Dennis Durkin:]

I guess I can take this. We aren't going to give specific guidance on new launches outside of the ones that we've talked about in our overall disclosure and what's in the investment portfolio inside Activision Publishing and inside of Blizzard. So I think -- but when you look -- so we do concentrate on a few things and making sure those scale and that's driven the margin structure that we have inside the business, which is really, really great. But I would say, when we look at new investments, we aren't looking to do new investments unless they provide the kind of -- same kind of scale and investment return that we have in our existing businesses. So I think, even as you look to next-generation, we'll still be very focused in terms of the investments we're making regarding new franchises. Eric, why don't you take the second one relative to the Skylanders and the Wii platform?

[Eric Hirshberg:]

The main thing to look at is first -- we've been receiving similar questions about the weakness of the Wii since the beginning of the Skylanders franchise. And Skylanders has done great both before the Wii U and has done great after the Wii U. Obviously, a growing installed base of family friendly consoles would be a benefit. And console prices and sales are one of the risks and one of the issues that we articulated for the fourth quarter. That said, we've done well despite weaknesses for both the Wii and the Wii U and seeing the Wii U take off would be great, but remains to be seen.

[Operator:]

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

[Douglas Creutz:]

Thus far, your approach to emerging game platforms, and I'm specifically thinking about mobile, has been somewhat cautious as you said, you don't want to throw money at unproven business models. It feels to me like we've seen a bit of an inflection in the mobile business in the last 6 to 9 months where you're starting to see some games generate some real sustainable revenues. I wonder if your prioritization of mobile has changed recently? And if so, what are you doing about it?

[Robert A. Kotick:]

I think we've always said, we're constantly exploring all different platforms for opportunities. But, I don't think we would exactly share your view that 3 months suggests they're sustainable franchises. And if you look at the last 4 or 5 years, you've seen changes in the top 10 almost every year, they're significant. And nothing that's really driven any sizable amount of operating profit and while we are going to continue to look at it and we think that over the long term, there'll be opportunities, right now we just don't see anything that would suggest that changing the way that we're approaching investing against mobile would be a good idea.

[Operator:]

[Operator Instructions] We'll go next to Justin Post with Merrill Lynch.

[A. Justin Post:]

Appreciate your help with the outlook for the back half. Maybe you could just help us a little bit more with what's kind of changed over the last 3 months. Have you seen some things with the title slates getting more crowded and competitive? Or some things with console pricing that may be concern you? Or is it just really the Wii that's starting to slow -- that's incorporating your guidance? I'm talking more about the cycle -- I'm sorry, the console side of your business, of course, versus the World of Warcraft side.

[Dennis Durkin:]

Yes, no problem. So -- thanks, Justin. Yes, I mean, a couple of things. As we said in our last call and we've sort of said repeatedly since November, obviously that's the console transition year and those years bring significant volatility just as you have the lead off, there's a lot of noise in the market and a lot of other factors that just kind of contribute to the fact that there's more volatility. You only have to go back to the last generational change to see that. So that's one of the biggest things. And we've been talking about that since the beginning. But what we've really seen since then is obviously a little bit of a decline in our WoW business. And then there has been several large titles that have moved from the front half of the business -- front half of the year to the back half of the year, which has driven more competition into that slate. And against some of our main line franchise -- we have 3 large competitors, who are coming directly at us in the back half of the year. And so I think, for us, from a prudent prospective, we need to be able to meet that head on relative to those competitive entrants. And as you know in the past, platform transitions are really opportunities for people to reestablish franchises. So we really need to defend in this window. In light of all that though, like we do in -- across all of our spending decisions, we're going to be very, very prudent and only spend money when it's -- we have a solid return on that investment. So we'd like to build the firepower into our plan, but of course, we're going to be prudent as we get closer and making sure that we're spending that wisely.

[Operator:]

We'll go next to Ben Schachter with Macquarie.

[Benjamin A. Schachter:]

A couple of questions. First on WoW, in China, was there any meaningful change to the promotional activity around the game in the quarter? And will that change going out for the back half the year? And then, Bobby, if you could just talk about the potential for any new business models that might be enabled by the new consoles? Should we expect more meaningful microtransactions, et cetera?

[Michael Morhaime:]

So on the promotional activity in China, we're constantly running various promotional efforts, so I would say no meaningful impact. And we are busy planning with the local teams there and [indiscernible] to plan out our efforts for the balance of the year. But we're continuing to actively promote the game.

[Robert A. Kotick:]

And then with respect to new business models, I can't comment specifically on the next-generation consoles. But our general view is we approach new business models skeptically. And we take our time. And we look for those that will turn out to be something that is sustainable for a long term. I think we're seeing there are a lot of exciting new ways to allow customers to pay for their experiences, there are a lot of new ways [ph] for us to monetize our content. But I can't say that you're going to see any dramatic shifts in the way that we monetize on the console.

[Operator:]

We'll go next to James Hardiman with Longbow Research.

[James Hardiman:]

So if I think about your guidance, you beat by $0.07 in the first quarter, you raised guidance by $0.02. On the top line you beat by I think $114 million, you raised by $75 million. I guess the point I'm getting at, it seems like more of the sales beat is flowing through to the full year than the earnings beat. Obviously it's difficult to anticipate. But should we take that to think that -- you still think you're going to be able to capture your fair share of sales with your key games, but it's going to cost you a little bit more and what does that say, if anything, about your outlook for transition-related costs, versus sort of how you were thinking about things 3 months ago?

[Dennis Durkin:]

Sure. Let me just take the outlook question. Yes, I think -- you're reading the right feedback relative to our guidance that there is more competition in the second half of the year and we're going to have to probably spend a little bit more in order to achieve some of those results. And that's sort of -- that's what's baked into our numbers. But we feel very comfortable with what's inside those numbers. So I don't think that there's anything different relative to that. I don't know, Eric, do you have anything that you'd like to add about marketing in the second half of the year?

[Eric Hirshberg:]

Just seconding what Dennis said, we're going to keep our ability to defend our market share vigorously and there are also all the risks that Bobby and others mentioned in their prepared comments today, just related to the console transition overall.

[Operator:]

[Operator Instructions] We'll go next to Colin Sebastian with Robert Baird & Co.

[Colin A. Sebastian:]

I guess, first, just comparing your comments from last quarter on uses of cash, we noticed in the 10-Q you still have the language around potential substantial buybacks, that's not included in the earnings press release. So just hoping you could confirm if there's been any change in plans around capital allocation? And then just as a follow-up regarding World of Warcraft subscribers, Mike, I'm just curious what you think precipitated the latest decline, if there was a specific competitive title or other factor that you'd care to point out?

[Dennis Durkin:]

Thanks, Colin. I'll take your first one regarding the language in disclosure. The disclosure language is exactly the same that's inside of our 10-Q and there's no change relative to that. And we're not going to be speaking about any other capital allocation related matters on this call.

[Michael Morhaime:]

Okay. And in terms of whether there was anything specific. I don't really think there was anything specific. We are seeing competitive titles releasing all the time. I do think that there has been an increasing competition, especially with free-to-play games out in Asia. And what we're seeing over time is an evolution of player behavior, both to consume content quickly, as well as to come and go as we release new content, so that's why I think it's really important that we continue down the path of creating more frequent content updates and also looking to innovate in terms of the design and creating more innovative content.

[Operator:]

And our final question will come from Edward Williams with BMO Capital Markets.

[Edward S. Williams:]

Just kind of following up on Colin's and James' questions. Mike, if you can give us a little bit of color to as to what you think happened in the first quarter with regards to the WoW subscriber numbers? And what we should be able to kind of look for over the course of the balance of the year? I mean, obviously, I think you pointed out that about $0.05 of the delta or the lower sub-numbers about a $0.05 contribution to reduction in your guidance? But what steps do you think you can take to kind of reverse that trend?

[Michael Morhaime:]

I'll let Dennis comment on the $0.05 number.

[Dennis Durkin:]

Yes, so maybe I could just talk -- I could start with that. Just to clarify the $0.05, when you think about, we were up $0.07 in Q1, we passed on $0.02 in terms of raising our guidance for the year going from $0.80 to $0.82. Of that $0.05 what's factored into that is really a couple of things

[Michael Morhaime:]

So on the decline side, as we mentioned, most of the decline did come from the East. And by the East, since the -- a large percentage of our subscriber base in the East is out of China. I can confirm that most of the decline did come from China. What we've seen is there has been a decrease in especially casual player engagement in the games, the amount of time the casual players are spending in the game. We do have a content update coming out later this month. It's currently being tested. And we'll continue working on a frequent content update to keep the community engaged. With Mists of Pandaria, we've provided some new types of game play experiences. We'll continue to explore new ways of innovating on our design. I think that, that's really important. I think that it's also really important that we spend some time easing the transition when players come back to the game. If you think about player could be gone for a week, they could be gone for several months and when they come back, it can be a very disorienting experience and I think that there's a lot that we can do to make that better. So that when players do come back, we have a better chance of retaining them longer.

[Kristin Mulvihill Southey:]

Okay, operator? I just want to say, on behalf of everyone at Activision Blizzard, we want to thank you for your time and consideration. And we look forward to seeing some of you at E3. Thank you.

[Operator:]

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