Activision Blizzard, Inc.
Q4 2013 Earnings Call Transcript

Published: 7 Feb 2014

[Operator:]

Good day, and welcome to the Activision Blizzard Quarter Four 2013 Results Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn today's call over to Kristin Southey. Please go ahead, Kristin.

[Kristin Southey:]

Good afternoon, and thank you for joining us today for Activision Blizzard's fourth 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. And 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 most recent quarterly report on Form 10-Q will define filing with the SEC and those 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 revision to any forward-looking statements to reflect events or circumstances as of today, February 6, 2014 or to reflect the occurrence of unanticipated events. I'd like to note that certain numbers we'll be presenting today will be made on the 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 intangible assets; expenses relating to the purchase transaction and related debt financing; 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 is 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 and a one-page summary sheet. This quarter, we have also added a number of EBITDA metrics to our earnings release and slides for our new debt investors and analysts. And now I'd like to introduce our CEO, Bobby Kotick.

[Robert Kotick:]

Thank you, Kristin, and thank you for joining us today. 2013 was a transformational year for Activision Blizzard, and for our industry. On October 11, Activision Blizzard became an independent company once again. The majority of our shares are in the hands of public shareholders, many of whom are long-term committed investors, including our Chairman, Brian Kelly and me. Our transaction with Vivendi delivered immediate benefits to our public shareholders in the form of significant earnings per share accretion. Even more importantly, this transaction gives the company new focus and flexibility. Our combination with Blizzard five years ago brought together in one company the two most creative talented groups of employees in our industry and a collection of some of the most valuable intellectual property in all of entertainment. The merger also came with the majority shareholders, whose interests understandably were not always aligned with the interest of Activision Blizzard. The challenges and constraints that came from being a controlled company have all been eliminated, and we believe as an independent company we can generate strong returns for all of our stakeholders as we have for over 20 years. For the full fiscal 2013, Activision Blizzard delivered better than expected financial results, based on the continued success of our games. On a non-GAAP basis, we generated over $4.3 billion in revenues, 31% operating margin, earnings per share of $0.94 and operating cash flow of over $1.26 billion. Our Board of Directors authorized an increase in our annual cash dividend to $0.20 per share and an accelerated debt repayment of $375 million based on our strong cash flows. Over the past five years alone, we have returned almost $10 billion to our shareholders in the form of dividends and share repurchases. This maybe more valued in the enterprise value of most of our major competitors combined. Our great result this year and every year are due to the remarkable talent and relentless commitment to excellence of our employees around the world. Their efforts aligned with our long-term strategy and operating discipline continue to produce industry-leading creative and commercial results. We're once again the number one independent console and handheld publisher in Northern America and Europe combined, including toys and accessories. We have the most (successful base) MMORPG of all time, and we continue to lead our industry in our ability to generate free cash flow from operations. Here are some of the highlights from 2013, which we'll be hearing more about later in the call. Activision Publishing's Call of Duty

[Dennis Durkin:]

Thanks, Bobby. Good afternoon, everyone. Today I will review our better than expected Q4 and full year 2013 financial results. And then I will review our outlook for growth in 2014. From nearly every perspective, 2013 was an important year for Activision Blizzard. We have been talking about the risks and volatility associated with the console transition for more than a year now. As expected, these risks materialize in Q4. A strong next-gen demand was enabled to offset the decline in current-gen software. We also saw a significant amount of consumer spending shift from software to hardware with the new console launches. Despite the volatility and uncertainty of this transition, Activision Blizzard still produce better than expected financial results, achieved a non-GAAP operating margin of 31% and generated operating cash flow of more than $1.26 billion. In addition, this year we return to independence and improved our capital structure in a highly accretive way via our 429 million share repurchase from Vivendi. We also paid out over $215 million in dividends. Operationally, we were the number one Western publisher and established a leadership position on next-gen consoles. We also continue to invest our capital in the strongest pipeline of new opportunities in our history. In summary, 2013 was an important year that delivered solid financial results and challenging backdrop, while setting the stage for portfolio expansion, revenue growth and record EPS in 2014. Turning to our financial results, please refer to our earnings release for full non-GAAP to GAAP reconciliations. Also the numbers that I will be quoting are compared to the prior year, unless otherwise noted. Our Q4 results were better than expected with revenues in the quarter driven by Activision Publishing's Call of Duty

[Eric Hirshberg:]

Thanks, Dennis. 2013 was another year of industry-leading performance for Activision Publishing. We were the number one console and handheld publisher in North America and Europe combined. We delivered non-GAAP operating income of nearly $1 billion despite significant headwinds from the ongoing console transition. Our performance is driven by our two blockbuster franchises, Call of Duty and Skylanders, which including toys and accessories were two of the top three franchises in North America and Europe combined. We also had four of the top 10 games of the year in both North America and Europe. Additionally, Call of Duty

[Michael Morhaime:]

Thanks, Eric. Hello, everyone. 2013 ends on a strong note with our most successful BlizzCon yet. More than 4.5 million viewers around the world tuned into the show where we gave you two news games, Heroes of the Storm and the next expansion for World of Warcraft

[Kristin Southey:]

Thanks, Mike. And we'll start with the questions. Operator?

[Operator:]

Thank you. (Operator Instructions) We'll take our first question from Edward Williams. Please go ahead sir.

[Edward Williams:]

Just looking at a couple of things, if I could quickly, you guys continue to generate quite a bit of cash. Can you give us a sense to how you prioritize dividends and stock buybacks, debt reduction and M&A activity? And then secondly, you alluded to it little bit, but can you give us a sense of the console transition, where we should look for demand for legacy software, adoption of new software from new systems and kind of what you're seeing at current retail inventory levels?

[Dennis Durkin:]

Okay. Hey, Ed, it's Dennis. Thanks for the question. I'll start with the first one, and then maybe I'll hand over to Eric to talk about some of the console transition trends. Obviously our priorities with our new capital structure are around debt repayments and debt servicing. We're very comfortable with the sort of the leverage ratios that you see inside of our capital structure, it's very modest. We obviously are committed to making sure that we're delivering value to all of our stakeholders. You'll see that by the dividend today. We currently don't have a share repurchase authorized by the Board currently, but like all things whether it's M&A or other activities, we're going to be opportunistic relative to new opportunities, whether it would be inorganic opportunities, but with the same discipline that we've always used in terms of evaluating those and making sure that they're going to be accretive to the things that we do as a company. I think those are larger priorities relative to our cash.

[Eric Hirshberg:]

And as for the second part of your question, I'll take that. The console transition is really no surprise here for us. We've discussed consistently on previous calls that we expected the console transition to create some headwinds and it has. The good news is that the next-gen is off to a great start better than expected. The demand for current-gen software is down perhaps a bit more than expected. And for those reasons, we do have supply in the channel, but we ultimately have great retail plans and proper funding in place to sell this inventory through.

[Edward Williams:]

Okay, great. Thank you.

[Operator:]

And we will take our next question with Brian Pitz from Jefferies.

[Brian Pitz:]

Thanks. Question is for Michael or maybe Dennis. Heroes of the Storm is going after a big market opportunity and game looks great so far from what we've seen. Given that Heroes though is a trickier free-to-play model, how should we think about the impact? How many users would really be required to deem it successful? And then quickly on the level 90 boost for Warlords, what impact could this follow the seat change essentially have on the WOW sublevels longer term? Thank you so much.

[Michael Morhaime:]

Okay. Well, on the Hero side from my perspective, I think it's too early to tell. Our focus right now is just getting the game right. On the level 90 boost and its impacts of long-term sustainability to the game, I think actually we view this as a positive. I think on the one hand, I think it really helps with winning back players and making it easier for them to catch-up to their friends. And also from a content creation standpoint it allows the developers to really focus on the endgame, which is where most players are anyway and making out most fun.

[Dennis Durkin:]

I would just maybe add two comments on top of Mike's to build on that. On the Heroes side, obviously that's a huge market opportunity and we like to go after very large market opportunities. And we feel like we have a great IP to go after that. It is about building a great game for that market. And so, that's the key to that. As I mentioned in my remarks, it's not in our guidance for the full year. And then the second one on the level 90 boost, just to add on to Mike's comments, another big factor and this is making it easier for returning players to come to the game, which we think is obviously very important for those players who have lapsed out of the ecosystem. So we think that's obviously positive as well.

[Brian Pitz:]

Just real quick, as a follow-on, any sense for potential pushback from the community on the level 90 boost for the guy who haven't left the franchise?

[Michael Morhaime:]

Well, we announced the plans for this at BlizzCon. And I'd say the community reaction was very supportive.

[Brian Pitz:]

Great, thank you.

[Operator:]

And our next question comes from Colin Sebastian with Robert Baird & Company. Please go ahead, sir.

[Colin Sebastian:]

Thanks. One question, first off on Destiny, just given how important that new franchise is in terms of the growth this year. How secure should we feel with respect to the release timing? And ultimately who makes that decision, if there are any changes necessary at the publisher level or developer level? And then secondly, in terms of World of Warcraft, Mike, the user-base, any chance you can provide a split or release some indication around the trend line of users in Western markets versus the lower value markets. I'm assuming given the higher online subscription revenues that this growth came from the West. Thank you.

[Eric Hirshberg:]

So, this is Eric. I will take the first question on Destiny. The best way for me to answer the question about the release date is that we have a very strong history of meeting our dates once they are announced and we have every confidence of the game. The game looks great, and it's on track and we will deliver that -- we're planning on delivering that date. As far as the second question, as of everything we do on Destiny is a partnership. The partners of Bungie are interestingly completed aligned and we're building this as a ten-year franchise and we need the best game possible. So, we will make any decisions as we have in the past with the partnership.

[Michael Morhaime:]

Okay. And the other part of the question was on the East-West split. So, in Q4 we were slightly down in the East and slightly up in the West.

[Colin Sebastian:]

Thanks, guys.

[Eric Hirshberg:]

Thanks, Colin.

[Operator:]

And our next question comes from Doug Creutz with Cowen.

[Doug Creutz:]

Yes, thanks. Sort of we can talk about Call of Duty a little bit. I think you acknowledged a little earlier in the call that you did add some inventory in the channel. Does that imply that the game maybe underperform where you're expecting going into the launch? And given that and given the competition the shooter genre are coming into 2014, how should we think about your expectations for performance this year? Thank you.

[Eric Hirshberg:]

I think that I addressed at the last question about the channel inventory and the fact that there is really nu surprise there. We expected the console transition to create some headwinds. And they happened in the ways that I described. We think that we are properly funded to sell that inventory through. Looking forward to 2014, as both Bobby and I said, we think we have a superlative game in the works and that we have some new approaches this year that we think are going to be very positive, with the three-year development cycle with the injection as a lucrative leadership from some very intelligent folks at Sledgehammer games. And that we think the 2014 game is going to be one of it's not the best Call of Duty game ever.

[Doug Creutz:]

Okay, thank you.

[Operator:]

And our next question comes from Eric Handler with MKM Partners.

[Eric Handler:]

Yes. Thanks for taking my question. It's been reported in the media that Chinese Ministry of Culture approved the Call of Duty online back on December 4. I'm just curious, what's holding back the official launch of that game and same goes for Hearthstone as well. And then secondly with Hearthstone, how much of your financial contribution do you expect to come from Asia versus the rest of world? And what type of financial or what percentage of people do you expect might be paying for the game?

[Eric Hirshberg:]

So, on Call of Duty online, it's great to have the government's approval early in the process and that will lose a potential obstacle later. But that's very separate from the game development process and making sure that we have a great game which is what's driving our launch schedule. And so, we are approaching, this is a sizable long-term opportunity for the company. And we're taking the time to polish the game and make sure that its right before we launch it. So, then on Hearthstone question, Mike, do you want to start with that?

[Michael Morhaime:]

Yes. So we do have approval from the government to release Hearthstone, which allowed us to go live with the open beta in China concurrent with the rest of the world. With respect to financial contribution, we don't provide that type of guidance, but what I can say is we're seeing a similar trend globally in terms of a very healthy engagement and monetization.

[Eric Handler:]

Great, thank you.

[Operator:]

And our next question comes from Andrew Crum with Stifel.

[Andrew Crum:]

Okay, thanks. Good afternoon everyone. So I want to ask about Skylanders, just give us your thoughts on the competitive landscape in 2013, what you're anticipating for 2014, and any changes that might be brought to the game play? And then separate from that, Dennis, if you could comment on the timing and recognition of the NOLs you require as part of the Vivendi transaction, any of that contemplate in your guidance for 2014? Thanks.

[Eric Hirshberg:]

Sure. And I'll take the first part of Skylanders. As far as the competitive landscape, again there is really nothing new for us here. We always had competition in every category, we operate and that's nothing new. Actually what was new was not having competition for a brief spell on the Skylanders franchise because we invented the category. But as we've said a number of times, it was only a matter of time before competition entered the category-based, given the success of Skylanders. I think that the important thing to know is that we're able to grow the business in 2013 despite both the console transition and new competition for the first time. We grew and the category grew. We think that also shows the same power of the playback. And we were able to outsell our competition from their launch forward and from my launch forward. As for in the future if any game play changes, as I said, we're not reviewing that just yet, but we remain focused on the thing that got us here which is breakthrough creativity and breakthrough innovations and Toys for Bob is back at the home this year. And all I can tell you is that we have a great game in the works that we're very excited about.

[Dennis Durkin:]

And then on the second question related to the NOLs, as you may recall from our comments last summer and then again in the fall, the $200 million tax benefit from the NOLs and the related indemnity from Vivendi are large. We're going to have a balance sheet impact and not a P&L impact. So, they will effectively lower our cash tax payments over the course of next four years when they're utilized. And essentially that will offset the purchase price per share that was paid. So, lowering the 13.60 per share amount in equity on a go-forward basis, our tax rate, including the interest tax shield from the depth that we now have for from the transaction is expected to be 25% of -- I mentioned in my prepared remarks.

[Andrew Crum:]

Thanks, guys.

[Dennis Durkin:]

Thank you.

[Operator:]

Thank you. And our final question of the day will come from Neil Doshi with CRT Capital. Please go ahead sir.

[Neil Doshi:]

All right, thanks guys. Mike, I wanted to know if you could maybe talk about Diablo III

[Michael Morhaime:]

We're very excited about the upcoming expansion of Diablo. There is a lot of excitement in the community about new Diablo content. We don't provide forecast in terms of how we think it will perform. But I guess if you want to compare to previous expansion releases, Diablo does have a very large base and it is larger than the Wings of Liberty base at the time launched Heart of the Swarm last year. In terms of World of Warcraft, we think that the ongoing engagement in the game really is just dependent on ongoing content, and we're continuing to invest in growing the World of Warcraft development team and creating new content. And really looking towards getting into beta on Warlords of Draenor, we think there are a lot of great features that will drive engagement with the game and hopefully bring players back to the game.

[Neil Doshi:]

Thank you.

[Kristin Southey:]

Great. Okay. On behalf of everyone at Activision Blizzard, we want to thank you for your time and consideration. And we look forward to speaking with you soon.

[Operator:]

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