Activision Blizzard, Inc.
Q4 2014 Earnings Call Transcript

Published: 6 Feb 2015

[Operator:]

Good day, and welcome to the Activision Blizzard's Fourth Quarter 2014 Earnings Conference Call. Today's conference is being recorded. At this time, for opening remarks and introductions, I would like to turn today's call over to Ms. Kristin Southey. Please go ahead, Kristin.

[Kristin Mulvihill Southey:]

Good afternoon, and thank you for joining us today for Activision Blizzard's Fourth Quarter 2014 Conference Call. Speaking on the call today will be Bobby Kotick, CEO of Activision Blizzard; Dennis Durkin, CFO of Activision Blizzard; Eric Hirshberg, CEO of Activision Publishing; Mike Morhaime, CEO of Blizzard Entertainment; and Thomas Tippl, COO of Activision Blizzard. 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 2013 annual report on Form 10-K, which is on file with the SEC, and those indicated on the slide that is showing. The forward-looking statements in the 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 revisions to any forward-looking statements to reflect events or circumstances after today, February 5, 2015, or to reflect the occurrence of unanticipated 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 intangible assets; expenses including legal fees, costs, expenses and accruals related to the purchase transaction; and related debt financing and the associated tax benefits. Please refer to our earnings release, which is posted on 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 financial overview highlighting both GAAP and non-GAAP results in a 1-page summary sheet. And now, I'd like to introduce our CEO, Bobby Kotick.

[Robert A. Kotick:]

Thank you, Kristin. 15 years ago, our investors had very little interest in video games or video game companies. In fact, at that time, the Internet was creating great amounts of wealth, in fact, what we would consider more wealth creation than we've seen in modern commerce. And companies without page views and click-throughs were very out of favor. We thought it'd be a good time to start an Investor Relations program, but we had a very difficult time finding anybody that actually wanted to run it. And so we told the recruiter to start looking for out-of-favor industries, industries that were as out-of-favor as video games, and they couldn't find any anymore out-of-favor industry than tobacco. So fortunately, for our shareholders, we were able to pry away from Philip Morris Kristin Southey, who thought it would be more fun to extol the virtues of video games than investing in tobacco. When Kristin joined in March 2000, the company had a market value of $337 million. During her tenure, the stock has grown at a compound annual rate of 23% versus the S&P at 4%, and at a rate that's greater than the rate of growth at Berkshire Hathaway, which, as you know, is our benchmark for almost everything. Kristin has protected our treasury, she has collected our receivables with the smallest rate of bad debt writeoffs of any major company in the video game industry, and for me, she's always been a fantastic professional, great partner and a pleasure to work with. Kristin has decided to take some time off, something that her work ethic never allowed her to do during her 15 years that she's been with the company. Both Brian and I are very incredibly grateful for all her contributions and I'll miss her greatly. She has assured me, however, that purely for our own personal enjoyment, she continues -- she will continue to keep all of you analysts in line, especially Michael Pachter. She's handing the reigns over to someone terrific and we're confident that Amrita will make Kristin proud as she leads our IR program and protect the legacy Kristin has created as one of the world's great IR efforts. So everyone in the room welcome Amrita, and thank you, Kristin, for all of your great contributions, for your extraordinary service, for your unyielding effort and for your incredible commitment to the principles of creating true stakeholder value. Thank you. And now, I get to share of our record results. So of course, we'll be reviewing in detail in a moment our record results, but we had another incredibly successful year. We had record results across a number of different areas. We introduced new franchises with outstanding game play. We expanded on new higher-margin business models. We continued investing in some of the world's most important entertainment franchises, and we continued to attract extraordinarily talented people to our company. In terms of results, on a non-GAAP basis, we delivered record earnings per share, which increased more than 50% from the previous year, double-digit revenue growth and higher-margin record digital revenues that represents an all-time high of 46% of total revenues. And we produced more great content in 2014 than ever before. Call of Duty

[Dennis Durkin:]

Thanks, Bobby. Good afternoon, everyone. Today, I will review our Q4 and full year 2014 financial results, and then I will review our outlook for 2015. 2014 was a very important year that delivered strong financial results that exceeded our outlook, while setting the stage for growth in the years to come. In 2014, on a non-GAAP basis, we generated double-digit revenue growth, record digital revenues, a 32% operating margin, a record EPS, which is up more than 50% year-over-year and operating cash flow of approximately $1.3 billion. From a capital perspective, we strengthened our balance sheet, paid a record dividend to shareholder, repaid $375 million of our debt and continued to invest in the strongest pipeline of new opportunities with high-margin potential in our history. Our financial performance was driven by our strong diversified product portfolio. This year, our top franchise has maintained their leadership positions, and we successfully expanded our portfolio of IP with Destiny and Hearthstone, which drove more than $850 million in combined non-GAAP revenue. Turning to our financial results. Please refer to our earnings release for full non-GAAP to GAAP reconciliation. Also, the numbers I will be quoting are compared to the year prior, unless otherwise noted. Please also note that all percentages are based on revenues, except for the tax rate. Our Q4 results exceeded our outlook and were driven by Activision Publishing's Call of Duty

[Eric Hirshberg:]

Thanks, Dennis. Activision Publishing had another record-breaking and industry-leading year. The North America and Europe combined, Activision Publishing was the #1 retail publisher and had 3 of the top 5 best-selling new releases of 2014. With #1 Call of Duty

[Michael Morhaime:]

Thank you, Eric. Thanks to the efforts of our dedicated and talented employees around the world. Blizzard Entertainment delivered one of our most successful years ever. In 2014, we released award-winning expansions, World of Warcraft

[Thomas Tippl:]

Thanks, Mike. Before we open the call to questions, I'll take a moment to summarize the 3 key takeaways from today's call. First, from a financial perspective, 2014 was an excellent year for Activision Blizzard

[Operator:]

[Operator Instructions] And we'll take our first question from Brian Pitz with Jefferies.

[Brian J. Pitz:]

Our question on Hearthstone monetization. The game is already a big hit. We continue to be impressed with the size of Twitch audiences, suggesting basically off-the-charts engagement. We're wondering if you take the average Hearthstone player, could you give a sense for the trend of their in-game spending over time, especially as the recent expansion like Goblins and, I guess, Gnomes are launched? How should we be thinking about the expansion packs? Is that a new source of spikes at the beginning when we launch them?

[Michael Morhaime:]

Thanks for the question. Well, we're definitely -- we've definitely been thrilled with the engagement levels of Hearthstone throughout the year. I think you're correct when you think about their spending behavior. They certainly start out building their decks, and then their engagement and spending patterns certainly follow the release of new content throughout the year. So and that is what we saw, and so I think that drove our record Hearthstone engagement and revenue quarter in the fourth quarter of the year.

[Operator:]

We'll take our next question from Daniel Ernst with Hudson Square.

[Daniel Ernst:]

Eric, you touched on this a little bit, but Call of Duty, still the #1 title on console. But clearly, the unit volumes are down year-on-year and down from the peak of where they had been. Can you talk about some of the drivers of that, was that -- is it game-specific, is it cycle-specific, is it the franchise actually weakening or as people fear? And what are the prospects for regrowing the franchise going forward?

[Eric Hirshberg:]

Yes, I don't think it's franchise-oriented, and just to level set here, it was the #1 game for the sixth consecutive year in North American, and we're now well past $1 billion in sell-through. And as we've just announced, we're off to a great start with our DLC season on Advanced Warfare, which is up double digits both on Season Pass and on a la carte DLC sales and engagement is higher than it was a year ago. Also, Advanced Warfare is a great game. It was really well received by both critics and fans, and it created a lot of positive buzz for the franchise. And we attach at franchise high-levels to the next-gen consoles which I think is what matters most when we're looking towards the future. So I actually think the franchise ended the year in a great place, and we entered 2015 with a lot of momentum. 2014 was the height of the console transition. So I think to compare it to years when we were selling -- when Call of Duty was able to sell to a much larger and more stable installed base is not an apples-to-apples comparison. Our 2015 guidance on Call of Duty's new release is flat year-over-year, but we still have a fairly conservative planning assumption. We have Treyarch developing the game. We'll have a larger installed base of next-gen hardware to sell into, and we believe our Q4 new release can be one of our best games yet. So we think the future is bright.

[Operator:]

We'll go next to Arvind Bhatia with Sterne Agee.

[Arvind Bhatia:]

First, as someone who has covered the company for a long time and worked with Kristin from the very beginning, I would like to echo the positive comments. She has set the bar pretty high for IR programs. My question is for Mike on the Blizzard side, thanks for the update on Heroes of the Storm. Wanted to just see if you could provide some color on maybe the timing of the release and what the feedback has been from the beta? The Founder's Pack, how is that done, et cetera? Just how should we think about kind of the revenue opportunity in say '15 and '16?

[Michael Morhaime:]

Okay, thanks for the question. So at this point, we're at the closed beta phase. We entered closed beta last month in January. We're very pleased with the response from our beta testers. The feedback that we've been receiving has been very positive. We are going to continue increasing the invites and concurrency as we test out the infrastructure for our game and drive towards open beta. We don't have any dates to announce on that. I think that's going to really be determined by how the testing goes, but we're eager to get the game into the hands of as many people as possible and drive towards our official commercial launch.

[Operator:]

We'll go next to Colin Sebastian with Robert Baird & Co.

[Colin A. Sebastian:]

And I'll echo everyone's comments. Kristin, good luck and keep in touch. My question, though, I think, is for Eric. I guess looking back at the performance of Skylanders, the commentary was generally positive, although we certainly see more competition in the space. As the originator of this type of experience, how should we think about the ability of the Skylanders team to evolve the experience? And in particular, remain relevant with what's a fairly fickle audience base?

[Eric Hirshberg:]

Well, that fairly fickle audience base has made Skylanders the #1 console game globally with kids for the fourth year in a row. So I think that our relevance remains very high and our momentum is strong with the audience. It's also very true and inarguable that we continue to see more and more competition entering the category. But we believe we have 3 important advantages in relation to that competition. One is what, I think, at this point needs to be seen as our proven ability to out-innovate competitors. Critics and fans have both acclaimed our recent titles to that end, and we believe that the most important reason we've been able to stay on top of the category is that we've had the best games in the category, and we plan to continue that trend in 2015. Number two is that we're not constrained by the limitations of existing intellectual property or characters or anyone else's release slate. We only have to answer one question each and every time we design a game, which is what do we think will be the most fun experience for our fans to have? And three, while there's more competition, I also think it's notable that we are able to grow our annual revenue per user this year through new game play innovation like the introduction of Traps, and we plan to continue to do similar things like that in the future.

[Operator:]

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

[Christopher Merwin:]

Kristin, it's great to work with you and all the best in the future. So how did digital downloads trends on new-gen consoles in the 4Q as compared to last year? Are you seeing an uplift in downloads on new gen or is that happening on old gen also? And would you mind just telling us directionally how digital sales trended for Call of Duty this year versus last? And then Dennis, just a quick follow-up. You mentioned that the $0.08 drag on non-GAAP earnings this year, I think, was mostly from tax rate, but I also noticed that share count you're forecasting is up year-on-year, so just curious if that includes the impact of buybacks?

[Dennis Durkin:]

Yes, just to be clear, the $0.08 does include our increased share count in our model of $0.01, and we don't have any buybacks included in that number. So to just sort of bring that point to roost. The second part -- or the first part of your question, though, on digital downloads, yes, obviously, very positive momentum in terms of digital download on consoles. In Q4 year-over-year, as the next-gen installed base grew, we did see a doubling effectively on Call of Duty in terms of our digital downloads year-over-year. So that's very, very nice. We're now seeing sort of mix percentages. We talked about high teens on the last call. It kind of remained in sort of the teams area in terms of total overall mix, and that'll sort of move a little bit throughout the year as you have different sort of retail pushes, et cetera. But overall, we've seen just great demand for digital on both next-gen systems as well as on past gen systems. So it's a pretty consistent trend that we're seeing.

[Operator:]

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

[Douglas Creutz:]

Eric, could you talk a little more about Call of Duty online. It has been now in open release for a month. So you have some idea, you mentioned that the anticipation of the game was very high. So I think that you must have a lot of players in the game. And then is there anything that we should be looking at as analysts to try and assess how the game is doing that you can think of? That would be helpful as well.

[Eric Hirshberg:]

Thanks. We think the game is going to be great and our partners at Tencent do, too. As I mentioned in my comments, the Baidu Index puts Call of Duty Online on par with the rollout of League of Legends in terms of consumer interest, which is a great start. It's been just over 3 weeks since we launched and we're still an open beta, so as I said, it's too early for us to share any financial metrics, but we're optimistic. In terms of 2015 guidance, we assume modest contributions from Call of Duty Online but that's simply because, even with the most successful free-to-play games in the market, they've taken time to build revenue to expand their audiences. So we feel fortunate that Tencent has the strongest track record in that market, and I think you can look to games like Crossfire or League of Legends to see how the early ramp up occurs for large successful games in the Chinese market. That's a ramp that takes time to build up, but one that is ultimately significant and worth it.

[Operator:]

We'll next go to Drew Crum with Stifle.

[Andrew E. Crum:]

As it relates to Destiny, Eric, can you comment on your retail position exiting 2014? What does the channel inventory look like? And then talk about the puts and takes for the franchise when you compare '15 to '14 from a top and bottom line perspective?

[Dennis Durkin:]

Okay, well, maybe I'll take that one actually, and maybe, Eric, if there's any follow-up commentary you want to have just on the content pipeline. This is Dennis. Obviously, we don't talk about specific channel levels by franchise, but overall, we're comfortable with the channel levels that we have across our various portfolio and ended the year in a very good position relative to that. I would make one comment relative to overall channel inventory levels that was the move to digital. I'd say retailers are managing their channel inventories very closely, so the overall channel is down versus previous years, and we expect this trend to continue as the transition to digital continues over the coming years. Relative to the puts and takes for Destiny and sort of comparing '14 and '15, obviously, last year was a major launch with Destiny 1 and we won't have a comparable launch this year, although we do have content, as I mentioned and Eric mentioned, in the back half of the year. On the flip side, though, on the cost side, there was significant amortization of Destiny's development costs that came through in 2014, that will not be in 2015. So even though the revenue will be down based on the new content pipeline and a smaller release, effectively, we do expect actual profits to be up for the franchise.

[Eric Hirshberg:]

And the 2 things I would add, I think the 2 most important things to think about in relation to Destiny as we look forward now that the launch is behind us, first is just a record-breaking size of the launch and the amount of players we brought into the top of that funnel. And then the second is the remarkable ongoing engagement that we're seeing. That's obviously the combination you want as you strive to build a 10-year franchise. We have a massive audience and they're averaging over 3 hours of play per day. So both of those things speak to the fact that Destiny is a great game. As I mentioned, we have a second expansion pack on the way and a major content release coming in the fall and a very robust pipeline planned after that. Beyond that, whenever you have a large and highly engaged community, there are obviously opportunities for us to deliver a lot of different kinds of content that we think that player base would find valuable and appreciate and that's what we're planning on doing.

[Operator:]

And we'll take our last question from Eric Handler with MKM Partners.

[Eric O. Handler:]

Wonder if you can talk a little bit about your cash and capital allocation. You got about 25% of your cash onshore. Is there -- what are your plans or how can you use some of the offshore cash maybe to pay down debt? Or what are your plans for some of that offshore cash? And then as you think about, you have -- you're paying down some of your debt, what's your long-term view of the debt? It was 7-year debt when you originally issued those notes. Is that something you want to keep paying down? Or just you want to -- do you want to sustain a certain amount of debt? And then last, as you think about the remaining Vivendi shares that could come to market, possibly your view of those shares as a possible buyback opportunity?

[Dennis Durkin:]

Sure. Thanks for the question, Eric. We've obviously talked about capital allocation in the past, I think you see some of the priorities relative to that highlighted in the capital allocation choices we made today. In general, we're trying to balance the various needs of our stakeholders while maintaining flexibility over the long term to invest in the business and take advantage of opportunities that may arise and really strong cash flows and a strong balance sheet help us support that objective. We've said in the past we're very comfortable with sort of capital structure that we have today. We're continuing to pay down as we pointed out today with the $250 million buy down of our Term Loan B. We're in a net cash position when you sort of do the puts and takes of our debt versus our cash. We're very -- we feel like we're in a very flexible position and that allows us to make the capital allocation choices that we did today regarding the dividend and obviously the authorization of the buyback. The last part of your question I think was relating to Vivendi, we don't really have anything to announce relative to that, we don't know their intentions, we are in their window period that does open up, but you'd have to ask them about their intentions relative to that. And then, I guess, the first part of your question related to euro cash, and we do have a sizable, obviously, overseas cash balance that is, for our financial statement, permanently invested abroad, and we think that will be used to fund our international options and opportunities going forward, so that's our plan for that. So thanks, Eric, for your call.

[Kristin Mulvihill Southey:]

Okay, I would like to thank everyone for their time and interest today. I'd like to thank Bobby and everyone for their super great comments, and all of you, it's been a great 15 years. So thank you, all.

[Robert A. Kotick:]

Thank you, Kristin.

[Operator:]

This concludes today's conference. Thank you for your participation.