Activision Blizzard (ATVI) Q1 2018 Results - Earnings Call Transcript

May 03, 2018 8:37 PM ETActivision Blizzard, Inc. (ATVI)10 Comments3 Likes
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Activision Blizzard, Inc. (NASDAQ:ATVI) Q1 2018 Earnings Call May 3, 2018 4:30 PM ET

Executives

Amrita Ahuja - Activision Blizzard, Inc.

Robert A. Kotick - Activision Blizzard, Inc.

Collister Johnson - Activision Blizzard, Inc.

Spencer Adam Neumann - Activision Blizzard, Inc.

Michael Morhaime - Activision Blizzard, Inc.

Riccardo Zacconi - Activision Blizzard, Inc.

Analysts

Eric J. Sheridan - UBS Securities LLC

Evan Wingren - KeyBanc Capital Markets, Inc.

Christopher Merwin - Goldman Sachs & Co. LLC

Todd Michael Juenger - Sanford C. Bernstein & Co. LLC

Brian Nowak - Morgan Stanley & Co. LLC

Michael J. Olson - Piper Jaffray & Co.

Timothy O'Shea - Jefferies LLC

Colin Alan Sebastian - Robert W. Baird & Co., Inc.

Operator

Good day, everyone. Welcome to Activision Blizzard's Q1 2018 earnings conference 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 - Activision Blizzard, Inc.

Good afternoon and thank you for joining us today for Activision Blizzard's first quarter 2018 conference call.

Before we start the call, we want to share with you an extraordinary error that was made by The Wall Street Journal earlier today, which caused trading volatility in our stock. The Wall Street Journal made a mistake and prematurely released a completely inaccurate headline, reporting our Q1 revenues as $1.7 billion instead of our actual Q1 2018 GAAP revenues of a record $1.97 billion. Not only did they report inaccurately, they did so in violation of our written embargo agreement. They have since issued an apology.

Our actual results are now clarified and reflect our strong performance and plans for growth, including a record first quarter well ahead of our outlook and consensus and increased guidance for 2018.

So today to review those results, we have with us: Bobby Kotick, CEO; Coddy Johnson, COO; and Spencer Neumann, CFO. And for Q&A Dennis Durkin, Chief Corporate Officer; Mike Morhaime, CEO of Blizzard; 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 things could cause the company's actual future results and other future circumstances to differ materially from those expressed in any forward-looking statements. These include the risk factors discussed in our SEC filings, including our 2017 Annual Report on Form 10-K and those on the slide that is showing. The company undertakes no obligation to release publicly any revision to any forward-looking statement to reflect events or circumstances after today, May 3, 2018.

We will present both GAAP and non-GAAP financial measures during this call. We also provide non-GAAP financial measures, which exclude the impact of expenses related to stock-based compensation, the amortization of intangible assets, expenses including legal fees, costs, expenses, and accruals related to acquisitions, including the acquisition of King Digital Entertainment; expenses related to debt financings and refinancings; restructuring charges and the associated tax benefits.

These non-GAAP measures are not intended to be considered in isolation from, as a substitute for, or superior to our GAAP results. We encourage investors to consider all measures before making an investment decision. Please refer to our earnings release, which is posted on www.activisionblizzard.com, for a full GAAP to non-GAAP reconciliation and further explanation with respect to our non-GAAP measures.

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 and a one-page summary sheet.

And now I'd like to introduce our CEO, Bobby Kotick.

Robert A. Kotick - Activision Blizzard, Inc.

Thanks, Amrita, and thank you all for joining us today. This was another record quarter for Activision Blizzard, with GAAP revenues of $1.97 billion, driven by record quarterly digital, in-game, and mobile net bookings. We also achieved an all-quarter record non-GAAP EPS of $0.78, surpassing our prior outlook by $0.13. And we generated record Q1 operating cash flow of $529 million, up nearly 30% year over year.

Our continued ability to set new records speaks to the breadth and enduring nature of our portfolio of franchises against the backdrop of a large and growing interactive industry.

Gaming is constantly evolving and innovating, which often expands the marketplace, and the success of Fortnite is no exception. This game is attracting new players of all ages and gender and it is helping gaming become even more mainstream entertainment.

Our biggest franchises are anchored by communities of tens of millions of players. And while many of our players try new games, they always come back to the franchises that are the foundation of the communities that they are a part of.

World of Warcraft, Call of Duty, and Candy Crush are great examples. These longstanding franchises are driving innovation into games at a regular pace with new in-game content, social features, and regular updates added to their ever-evolving rich game universes. World of Warcraft is on a very positive trajectory, with strong presales for the upcoming expansion content. And Candy Crush is demonstrating growth, holding both the number one and two grossing mobile spots in the U.S. for the second quarter in a row.

We see strength across the whole portfolio, including Overwatch, where total franchise engagement is up, and Call of Duty, where the digital season and reach have been strongly ahead of last year. And of course, we're all very excited about the highly anticipated Black Ops 4 release.

Gaming remains the most engaging form of entertainment, and it's projected to grow faster than any form of media except messaging, even faster than social media in terms of time spent. We estimate that the interactive entertainment industry exceeded $120 billion in total revenues last year and grew at 20% year over year. We are the largest standalone interactive entertainment company, and yet we represent less than 10% of this rapidly growing industry, which illustrates the sizable opportunity we see ahead.

Our core games business has always been our growth engine in terms of results and intellectual property creation. That will only get stronger as we focus on two especially large opportunities ahead of us. First, mobile gaming, which represents a unique opportunity for us to dramatically expand our reach to new and existing players, and we're leveraging our powerful franchises across the company in the creation of our new mobile franchises and titles. Second, we have room to grow our high-margin and recurring in-game revenue streams through a persistent focus on continuing to add value to all of our players' experiences.

We continue to be the leading innovators in professional esports. The inaugural regular season of the Overwatch League is progressing well, with millions of viewers each week and average viewing time of over an hour, which provides our multiple global broadcast partners and sponsors with access to a highly engaged and hard-to-reach audience.

The Overwatch League continues to thrive, and our players are getting even broader recognition of their incredible talents in mainstream media. We see even greater opportunity with the playoffs and Grand Finals still to come. And we've begun sales of our next round of Overwatch League teams. And over time, we believe our esports initiatives could rival traditional sports for audience interest, advertiser interest, sponsors, ticket sales, and merchandise sales, both virtual and physical.

Our five-year growth plan is in its earliest innings, and our greatest challenge remains prioritization of opportunity, which is an enviable challenge to have. We have the finest talent in our industry, and we continue to attract the very best and brightest people, drawn to the excitement, opportunity, and rewards our company provides.

We have a very exciting remainder of this year, and we thank you, our shareholders, as well our talented driven teams around the world for all of your support.

Now Coddy will review the highlights of our operations of this record quarter.

Collister Johnson - Activision Blizzard, Inc.

Thank you, Bobby. As Bobby said, Activision Blizzard had another record quarter, growing year over year and setting top and bottom line records. We were able to deliver these results because of our incredible teams with some of the world's best creative, technical, and operational talent, because of our passionate communities and strong franchises, which have some of the world's most dedicated and engaged players, spectators, and fans. And because our teams continue to find more and more ways to serve our communities in those franchises with ongoing year-round streams of content, features, and services, so that even in quarters without large content releases, we can deliver records.

Before diving into the specifics of the quarter, it's worth building on what Bobby shared about one of the genres where we already have some of the world's largest franchises and communities, the shooter genre. The new battle-round modes that have recently entered the space have compelling survivor mechanics and large in-game player pools. They have also brought tens of millions of completely new players into gaming, both on traditional platforms like console and PC, but also on newer platforms for the genre like mobile. We are very, very encouraged by this.

The shooter genre was already one of the largest and growing. We are already one of the largest players in that space. New modes that attract new players bring us new opportunities to expand our own communities and to benefit from the significant pipeline of innovation that we have planned for our franchises.

As you saw this quarter, many of our franchises delivered records, with continued success across our three strategic pillars of reach, engagement, and player investment. On reach, the company had 374 million monthly active users this quarter. And for the second quarter in a row, King stabilized its player base of overall monthly active users just slightly down from last quarter and overall engagement remaining strong, with King's daily time spent per user at record levels. Importantly, the largest part of King's audience, Candy Crush monthly active users on mobile, grew for the second quarter in a row. And King plans to grow its network even further with new game launches planned for later this year and beyond.

Activision's successful 2017 launches for Call of Duty, Destiny, and Crash Bandicoot continue to draw large audiences, with 51 million monthly active users this quarter, up 7% over last year. Call of Duty grew year over year with players engaging across the franchise, including in Call of Duty: World War II. And as we look ahead to the fall, Activision plans to again be number one globally with Call of Duty: Black Ops 4.

The studio behind the Black Ops franchise is Treyarch, known for innovation and highly engaging games, with Black Ops sub-franchise drawing over 200 million players and 15 billion hours played to date. Treyarch is now hard at work to deliver yet another amazing game. And everything about it will be community and engagement first, giving players more of the gameplay features and modes that they love and bringing all of it to players earlier than ever before in October. Tune in on May 17 when Activision will share more at the Black Ops 4 global reveal.

Now on our last call, we talked about the Destiny 2 sentiment issues and the plan to address them. The next step in that plan is the launch of Destiny 2's second expansion, Warmind, set for next week, featuring fresh updates and new content from our partner Bungie that make the gameplay more rewarding and the endgame more fulfilling. Bungie has a number of additional updates planned for the remainder of the year as well as a large expansion in the fall.

Activision continues to bring its rich library of owned IP back to some of the world's most passionate fans. Crash Bandicoot's launch on Facebook last year was a phenomenal success. And Activision plans to bring Crash to new audiences this summer on additional platforms like PC, Xbox One, and Switch. And then in September, Activision will release a new remastered collection of Spyro the Dragon on PlayStation and Xbox. Like Crash, it will be three games in one, the Spyro Reignited Trilogy. And what we know is that when we bring back our beloved IP in the right way, the community responds. And the Spyro reveal trailer has already had tens of millions of views, and preorders are well ahead of expectations.

Blizzard continues to engage audiences across platforms with 38 million monthly active users this quarter. World of Warcraft is releasing more content more regularly than ever before, leading to higher engagement sequentially, over-performance versus the prior expansion at this point in time, and strong community participation with in-game purchases. The next expansion, Battle for Azeroth, launches worldwide on August 14 and is already off to a great start, with preorders ahead of plan.

Hearthstone continued to reach and engage its large global audience last quarter, first with a novel promotion of under the Year of the Mammoth, which offered new and existing players a chance to expand their decks and gameplay at a great value. Blizzard also recently released a new player versus environment mode, Monster Hunts, on the back of the most recent expansion, and engagement has been great so far.

Overwatch continues to grow its community and engagement remains strong, with the most recent seasonal event, Retribution, having the highest participation rate to date. Now Overwatch's performance is driven by a commitment to the player community. And with its ongoing stream of seasonal events, maps, and heroes, Overwatch was recently recognized as the world's best evolving game.

To that end, Overwatch has now added new and innovative links between the game and the spectating experience for Overwatch League, which brings me to our second pillar, deepening engagement. Esports is, as you know and as Bobby said, a priority for the company. It's where we celebrate player achievement and community passion and provide awesome spectating experiences for a rapidly growing number of esports fans, nowhere more so than Overwatch League, which continues to reach millions each week.

We are seeing increased engagement for the franchise overall, with the hours combined spent playing and watching Overwatch growing quarter over quarter. And as Bobby said, this is even before the playoffs and Grand Finals later this summer. Overwatch League and its partners also introduced new engagement programs like token drops, cheermotes, and the new Twitch league pass, which deliver even better viewing experiences and new revenue opportunities.

And given all this progress, there is very strong demand for Overwatch League expansion teams. The league will therefore be highly selective in this approach, adding just a handful of teams in key strategic markets by end of year. More broadly, building out the Overwatch League allowed the company to develop a unique set of capabilities and infrastructure, and we plan to begin applying them to other franchises in the near future, including to Call of Duty. To that end, Call of Duty's 2018 World League completed its first phase in mid-April and continues to have strong viewership, with cumulative hours watched doubling year over year.

Turning last to our third strategic pillar, player investment, in-game content features and services continue to both engage our fans and contribute significantly to our results, delivering a Q1 record of $1 billion of in-game net bookings. King continues to drive player investment and had its highest net bookings quarter since Q1 of 2015, with 3% sequential growth and 13% growth year over year. And for its core business on mobile, King had its highest net bookings quarter ever.

Just as importantly, the absolute number of paying players increased quarter over quarter. And for over four years, King has had two of the top 10 games in U.S. app stores. And now, for the second quarter in a row, King had the top two games with Candy Crush Saga and Candy Crush Soda Saga, once again showing the remarkable durability of this franchise. King is also ramping up its advertising business. Supported by industry-leading viewability, completion, and ad recall rates, King continues to attract new advertisers and importantly has repeat advertises now coming across multiple industries.

Finally, on player investment, Call of Duty's strong launch last year led to growth year on year for in-game net bookings with World War II 's Q1 second only to that of Black Ops III. And there's more on horizon for Call of Duty fans this digital season, including additional in-game content and seasonal events.

So looking back, we had a great quarter that was a result of strong franchises with incredible teams innovating on behalf of passionate and growing communities. Looking ahead, we have a growth path that builds on these strengths and, as Bobby said, over time increasingly includes mobile as a primary building block that expands our player and spectator communities. We are investing in our core franchises on mobile. And as I said on the last call, we hope to see early results later this year with more meaningful impact in future years.

In summary, our franchises are as strong as ever. We are investing and building internal capabilities for the future with mobile, esports, advertising, and other forms of content and all the while delivering record results.

Spencer now will review those numbers in more detail.

Spencer Adam Neumann - Activision Blizzard, Inc.

Thanks, Coddy. Today I'll review our better than expected Q1 2018 results as well as our outlook for the full year. Once again, we outperformed our guidance thanks to our incredibly talented teams, our strong global portfolio of owned intellectual property, our compelling offerings of year-round content, and our commitment to relentless prioritization and fiscal discipline.

Now turning to the specifics of the quarter, I'll start with our segment results, where revenue and operating income grew by double-digit percentages year over year, setting a new Q1 operating income record while we continued to invest in new capabilities. This performance was primarily driven by our in-game content, with net bookings growing by double-digit percentage year over year for all three segments.

King grew segment revenue by 13% year over year and operating income by 15%. Margins also improved year over year, with segment operating margin at 36%. The King teams focused on continually investing and innovating in its live titles resulted in the Candy Crush franchise achieving its highest net bookings since Q4 2013.

Activision grew segment revenue and operating income substantially year over year on the strength of Call of Duty: World War II. Growth in the Call of Duty digital season in particular drove a Q1 record for segment operating margin. Blizzard grew segment revenue to a new Q1 record, driven by in-game content across their portfolio of franchises, strong World of Warcraft presales, and the launch of the Overwatch League.

Margins decreased year over year, as Blizzard continues to invest in key growth initiatives, including the Overwatch League, MLG Network, Battle.net, and mobile incubation efforts. We expect these strategic investments to pay off in the coming years.

Now let's turn to our consolidated results. Before I continue, I wanted to quickly review ASC 606, the new accounting standard for revenue recognition. We've now adopted the new standard, which is reflected in our Q1 results. The prior-period results have not been restated. While ASC 606 affects our GAAP revenue recognition and some quarterly timing, it's not expected to materially impact our annual segment results, cash flows, or financial performance as reviewed for internal management purposes. Please refer to our 10-Q for more information.

Also, unless otherwise indicated, I'll be referencing non-GAAP figures, so please refer to our earnings release for full GAAP to non-GAAP reconciliations.

For the quarter, we generated record Q1 GAAP revenues of $1.97 billion, $145 million above our February guidance. This includes the net recognition of deferrals of $581 million. Net bookings were also a Q1 record of $1.38 billion, which is $104 million above our February guidance. We generated an all-quarter record GAAP EPS of $0.65 and an all-quarter record non-GAAP EPS of $0.78, which was $0.13 above guidance. These figures include the net recognition of deferrals of $0.40.

Now from a cash and capital structure perspective, our business performance continues to deliver strong cash flow, with record Q1 operating cash flow of $529 million, an increase of 29% over last year. We finished the quarter with approximately $5.3 billion in cash and investments, $4.4 billion in aggregate debt outstanding, and a net cash position of roughly $860 million.

Looking ahead, we're maintaining our balanced approach to capital allocation, with board authorization to pay down as much as $1.8 billion of debt this year and plan to pay a cash dividend on May 9 of $0.34 per common share, which is a 13% increase over 2017.

We also recently had positive credit rating developments, receiving an upgrade from both Moody's and S&P. Each agency has now upgraded our rating three times in about 2.5 years, as we continue to demonstrate the strength, diversity, and recurring nature of our business.

Before I turn to the specifics of our upcoming slate and outlook, I'd like to provide some context. Based on the strength of our Q1 beat and our confidence in our franchises and pipeline, we are raising our full-year outlook modestly. As I said on our last call, we expect revenues and operating income for 2018 to be more back-end loaded than 2017 given the timing of our content slate relative to the prior year.

For example in Q2 of last year, we had Black Ops III, Zombies remastered maps, the Crash launch, and the Diablo Necromancer update. While we don't have those launches in Q2 this year, we do have an amazing full-year lineup as well as a continuous stream of content, features, and services throughout Q2 and the year, as I'll discuss in a moment. In addition, the back half of this year features not only an exciting Call of Duty: Black Ops 4 but also another major release for the year with Blizzard's World of Warcraft expansion.

Now let's turn to the specifics of our slate and outlook for 2018. In terms of slate for Q2, for Activision, Call of Duty's digital season will continue with additional map packs, content, and events. Destiny 2 will release its second expansion along with other content and feature updates, and Crash will be released on additional platforms.

Earlier this month, Blizzard released a new Hearthstone expansion and Overwatch seasonal event. Blizzard also plans to release more content and features across its portfolio, including a second anniversary event for Overwatch. And of course, King will continue to deliver innovative live ops across its portfolio. In addition, marketing spend will begin to ramp in Q2 to support the heavy back-half release schedule.

So for Q2 on a GAAP basis, we expect: net revenues of $1.555 billion, including the net recognition of deferrals of $205 million; product cost and game operations and distribution expenses of 22%; and operating expenses, including software amortization, of 57%. We expect GAAP net interest expense of $68 million, a GAAP tax rate of 23%, GAAP and non-GAAP share count of 771 million, and GAAP EPS of $0.26.

For Q2 on a non-GAAP basis, we expect: product costs and game operations and distribution expenses of 22%; operating expenses, including software amortization, of 48%. We expect non-GAAP net interest expense of $30 million, a tax rate of 20%, and non-GAAP EPS of $0.46, including the net recognition of deferrals of $0.15.

Now turning to the 2018 full-year outlook, our strong Q3-Q4 release slate includes not only Blizzard World of Warcraft expansion, Battle for Azeroth, and Call of Duty: Black Ops 4, but also Spyro the Dragon Reignited Trilogy, Destiny's major expansion, King's new launches, as well as the continued ramp of growth initiatives such as advertising.

Q1 over-performance benefited in part from timing, and we still have a lot to deliver in the year. Still, as I just mentioned, we feel great about the remainder of the year, and we're modestly raising our full-year outlook.

On a GAAP basis, we expect full-year revenues of $7.355 billion, including deferrals of $120 million; product costs and game operations and distribution expenses of 22% and operating expenses including software amortization of 53%. Our GAAP net interest expense is expected to be $135 million, and our GAAP tax rate is expected to be 18%. We expect 775 million fully diluted shares both for GAAP and non-GAAP, and GAAP EPS is expected to be $1.79.

For 2017 on a non-GAAP basis, we expect product costs and game operations and distribution expenses of 22% and operating expenses including software amortization of 44%. We expect non-GAAP net interest expense of $94 million, a tax rate of 20%, and non-GAAP EPS of $2.46, including deferrals of $0.05.

In summary, our results this quarter once again illustrate the power of our franchises. We expect them to continue to consistently deliver into the future while we invest prudently in exciting new businesses. And as always, we'll focus on fiscal discipline and operational excellence across the company.

Now I welcome Dennis, Mike, and Riccardo as they join us for the Q&A portion of the call. Operator?

Question-and-Answer Session

Operator

Thank you. We'll hear first from Eric Sheridan with UBS.

Eric J. Sheridan - UBS Securities LLC

Thanks for taking the question. Maybe going back to Fortnite, I wanted to know if we can get any color on any impact on either engagement or monetization across some of your key titles. And what are the key learnings you have as a management team from what you've seen from Fortnite that you might apply to your own titles? Thanks so much.

Spencer Adam Neumann - Activision Blizzard, Inc.

Sure, Eric. This is Spence, I'll take this one. So as Bobby and Coddy mentioned earlier, the Battle Royale mode, it's contributing to the innovation and expansion we're seeing in the industry. It's not only bringing the younger audiences and millions of new gamers that both Coddy and Bobby mentioned into the shooter genre, where we're already a leader in the space, but importantly, it's also highlighting the ability to successfully bring immersive gaming experiences like Battle Royale to mobile in both Western and Eastern audiences, or markets I guess. And that's really encouraging as we think about our future mobile opportunities and our growth opportunities generally as gaming becomes increasingly mainstream.

So yes, we've seen some near-term impact from Battle Royale. But as you heard on the call today, our business continues to perform at record levels. We've got one of the broadest and most diverse portfolios of successful franchises across genres, across platforms, and across business models. And we're continuously innovating within those existing franchises, and we've got a really exciting future development pipeline. So when you put all that together, we feel great about where we're positioned and our ability to continue to deliver on our growth plans going forward.

Robert A. Kotick - Activision Blizzard, Inc.

And, Eric, this is Bobby. I would just add the long history of our company. When we see people innovate in an interesting and impactful way, we are very quick to figure out how to capture inspiration from innovation. And so we as a company, in our DNA, in our culture, when we see things that appeal to our audiences, we are very good at being inspired by those.

Eric J. Sheridan - UBS Securities LLC

Thanks so much.

Operator

We'll hear next from Evan Wingren with KeyBanc.

Evan Wingren - KeyBanc Capital Markets, Inc.

Thanks. Coming to Black Ops, how do you anticipate this edition of Black Ops will differ from historical Call of Duty games that you guys have released?

Collister Johnson - Activision Blizzard, Inc.

Thanks, Evan. This is Coddy. I'll take that one, and glad to. As I said in prepared remarks, Black Ops for us is going to be an awesome game, given the community, really just an incredible experience for us, gameplay features and modes. And we think not just for existing community members, but also for a significant number of new players that are coming into the shooter genre. There is a number of reasons for the strength of our belief. First is it's just Black Ops. It's the most played Call of Duty sub-franchise to date, and that's saying something in a franchise like Call of Duty, which had the success it's had.

The Black Ops III iterations so far over eight years have drawn in 200 million players and billions and billions of hours of gameplay. And by the way, that's still ongoing. As we speak, there is millions of people playing in the Black Ops franchise right now. And it leads to the second advantage, which is what we see from those billions of hours of gameplay, where we get to see in depth and real time what really engages our players. Black Ops 4 builds on that and on everything Treyarch has learned about what players love to play.

And so that's the third main area, is the confidence we have in Treyarch and their ability to execute on their creative vision. It's an incredible developer with a deep understanding of the community and the first-person genre, but also a real proven track record of innovation, including Zombies and multiple multi-player innovations that have really transformed the industry.

And it's a most important last point, which is that this is a game that's not going to just build on our strengths. It will continue to push the envelope in innovation. You'll see that in the core game itself, where we have a number of new exciting developments to roll out very soon, but also in the game's appeal on growth platforms like PC, where we've invested significant dedicated resources and design time to make sure we can deliver a great PC game to serve that community. So very soon, May 17, we'll have a lot more to say at the Black Ops 4 global reveal, and I hope you tune in. You should.

Evan Wingren - KeyBanc Capital Markets, Inc.

Thank you.

Operator

We'll hear next from Chris Merwin with Goldman Sachs.

Christopher Merwin - Goldman Sachs & Co. LLC

Okay, thanks for taking my question. I was wondering if you could talk about how Overwatch League viewership has been trending relative your expectations so far. I think in the prepared remarks, you mentioned that you started a second round of team sales already, so maybe you could comment about how that's going and how we should be thinking about the value of the new teams you might sell. Thanks.

Robert A. Kotick - Activision Blizzard, Inc.

So this is Bobby.

Michael Morhaime - Activision Blizzard, Inc.

Go ahead, Bob.

Robert A. Kotick - Activision Blizzard, Inc.

Sorry, you go first, Mike.

Michael Morhaime - Activision Blizzard, Inc.

Okay. I wanted to say we're extremely happy with both the launch and how the inaugural season for Overwatch League has been going so far. The league is definitely outperforming our expectations, starting with viewership. Viewership has been very strong and consistent each week. We've had millions of fans tuning in, and our average viewer spends about an hour – over an hour of watching each day. Our broadcast partners like Twitch and MLG and our partners in China have been great.

We've also been introducing some exciting new engagement programs that are unique to esports. We have partnered with some great sponsors as well like HP, Intel, Toyota, T-Mobile, and Sour Patch Kids, and these sponsors now have access to a highly engaged and hard-to-reach audience. We've been adding to our esports team. We've recently added professionals with strong sports marketing and broadcast expertise. And so we think that overall this has been a great success. We think it's good for the whole ecosystem. It's good for owners, our owners who have partnered with us on this exciting new venture. It's great for the players, who have increased stability as well as a great venue to showcase their talent. And it's great for the Overwatch franchise, which has benefited from increased total engagement.

Robert A. Kotick - Activision Blizzard, Inc.

Sorry, Mike. Go ahead.

Michael Morhaime - Activision Blizzard, Inc.

Okay. With respect to team sales, we are currently in process. We've been meeting with potential new owners in new geographies. Demand has been really strong globally. We don't have an update on exact timing, but we do expect to add new teams to the league this year. And so looking ahead, we're heading towards the end of our inaugural season. We'll be holding our playoffs, Grand Finals, and an All Star game this summer. And so we've got a lot of great stuff planned. We're very excited. And I'll turn it over to Bobby.

Robert A. Kotick - Activision Blizzard, Inc.

You said most of what I was going to say and probably better than I could have said it. But the only thing that I was going to point out is that for our almost 40 million players, what I think the league has really done is it's reinforced that the thing that they spend hours and hours a day playing is something that they feel like is now being validated in a way that it never has before in a video game.

And so all of our players in almost 190 countries around the world feel like this is truly a recognition of the sense of belonging that they get playing the game and the sense of accomplishment they feel playing the game. And I think more than anything, that's been an enormous benefit as a result of the creation of the league.

Christopher Merwin - Goldman Sachs & Co. LLC

Okay, thank you.

Operator

And from Sanford Bernstein, we'll hear from Todd Juenger.

Todd Michael Juenger - Sanford C. Bernstein & Co. LLC

Hi, thanks for taking the question. I'd like to ask about King, if I could, so probably for Riccardo. So, Riccardo, I'd love to hear what you can share with us about what you're continuing to do to drive the reach of King, and just any other general insights you have to share with us on current trends you're seeing in your space. Thanks.

Riccardo Zacconi - Activision Blizzard, Inc.

Hi, Todd. This is Riccardo. So first of all, I would like to say that to grow again the reach is a key priority for us. So in Q1, we had 285 million monthly active users. This is slightly down sequentially, but we stabilized the active user base over the last several quarters, which I believe is a very important achievement. And if I look at the other metrics, these are also very encouraging. Daily active users were stable across the network. And specifically, daily active users in the Candy franchise increased slightly.

Now we have achieved this focusing primarily on the player experience in the live games. In live games, we have increased the pace of releasing fresh content. So we have released more levels. We have released live operations. We have released new features, and we will do more of this. Further on, we believe there is an opportunity to grow the reach, not only innovating in the game, but also innovating in the marketing.

Now, to change the trend more meaningfully requires major new game launches. Our best teams are at work building a great pipeline, and we have as we speak games at various stages of development. We have games at the conceptual level. We have game prototypes, and we have games in production. And we have games that we will release, as you heard earlier, this year.

Todd Michael Juenger - Sanford C. Bernstein & Co. LLC

Fantastic, thank you.

Operator

Next we'll hear from Brian Nowak with Morgan Stanley.

Brian Nowak - Morgan Stanley & Co. LLC

Thanks for taking my question. I'm curious for an update on Destiny. Maybe talk about some of the challenges you've seen on it over the course of the last six months. And what are the biggest steps you think you need to implement in Destiny to fix it, bring back the users, and drive monetization higher?

Collister Johnson - Activision Blizzard, Inc.

Sure, thanks. This is Coddy. I'll take that one. I guess the first thing, one of the best parts about Destiny is just how passionate and engaged that community is. And the bright side of that is it gives us the chance to really build and iterate upon the feedback. As I said in the prepared remarks, the three things that we know we're going to do and that the community is looking for is make the player more powerful, provide more rewards, and make the endgame more meaningful. As we look ahead, we have a chance to continue to build on that, particularly in feedback that really engages the community.

And so maybe just as an example to share, Bungie recently hosted a large cohort of the top worldwide Destiny players onsite up at their studio in Seattle. And they walked through the roadmap of features and updates they're planning, but they also gave hands-on with not just Warmind, the expansion coming out shortly, but also with a part of the big fall release planned for later this fall, and it was a very positive response to the three things I just mentioned, the power and the rewards and the need for endgame.

But even more of what's coming this fall into the innovations and gameplay there, including to what we think will be an incredibly engaging new mode, one that introduces a whole new style of play for first-person shooter gaming generally and certainly for the shooter space that Destiny created. It's a really exciting development. It's one of the things that we feel really speak to the community when it comes out in the fall, and we're really excited to share more about that. We won't do that until E3. So as to this next expansion, head over to E3. We hope we'll you see there and be able to talk more about it.

Brian Nowak - Morgan Stanley & Co. LLC

Okay, great. Thanks.

Operator

We'll hear now from Mike Olson with Piper Jaffray.

Michael J. Olson - Piper Jaffray & Co.

Hey, good afternoon, maybe back to Riccardo on King. Riccardo, could you update the expected timeline for more material King ad revenue? And can you talk about some of your findings during this testing period? And how extensive should we expect the raw to be as far as how much of the King portfolio is ready for advertising? And then lastly, will advertising change any game design or gameplay mechanics? Thank you.

Riccardo Zacconi - Activision Blizzard, Inc.

Hi, Mike, Riccardo here. Thank you for your questions. Let me start first giving an update on how the business is going. So I'm pleased, I'm very pleased with the progress that our ad business has made in Q1. We hit an internal milestone. The business is still relatively small but was modestly profitable this quarter. So the goal is to build a strong long-term business, and we will ramp up further the investments during the year.

And the other thing we've done is, a key priority is to build a strong team, and we have continued to build out our leadership team and our capabilities in this area. We have made some key hires in product development, in B2B marketing, and in measurement and insights. And we have also continued to work on our ads product offering. We have introduced new placements and new times where ads appear in the player journey.

As Coddy mentioned earlier, our ad products perform well. Players are completing our reader views more than 90% of the time, and our ad recall rates are much higher than industry norm. Our ad teams are working very closely with the game teams to create ad experiences that are supportive of the gameplay. So for example, you can get a booster watching an ad, and that can help you in the game.

And in regards to the rollout of our ad business, currently ads are live in certain games, including the Candy Crush franchise, but we have not turned yet on ads for all the players in these games. We are taking a measured approach where we AB test before showing ads to new segments of players. So we expect the ad business to ramp throughout the year, particularly in the second half, as we serve more players.

Michael J. Olson - Piper Jaffray & Co.

Thank you.

Amrita Ahuja - Activision Blizzard, Inc.

Operator?

Operator

We'll go now to Jefferies' Tim O'Shea.

Timothy O'Shea - Jefferies LLC

Yes, thank you for taking my question. So there are some other big markets like China, like mobile, where free-to-play is the dominant business model already. So I'm just wondering if Fortnite's success, if it changes how you think about the $60 full-price business model for console games going forward. Thanks.

Collister Johnson - Activision Blizzard, Inc.

Sure. Hey Tim, this is Coddy. Thanks for the question. I'd say broadly we think in a growing industry like ours that there's room for multiple business models to succeed in parallel. We see this just in our own portfolio across Activision Blizzard. Right now, today, we have a full range of business models, free-to-play, subscription, upfront payments, downloadable content packs, ongoing micro transactions, all of these succeeding at scale. And so it's like there's no one in a better position to see the nature of how you think about bringing a value proposition to consumers.

We think it's true of our industry broadly as well, where that direct ongoing interactive connection with players and audiences, it allows an enormous amount of iteration and innovation on how to provide the most satisfying avenues for investment. We get to see that real time in the loop that we create and the things that we roll out.

But not just in interactive, we think there's a number of areas across broader entertainment that prove this out as well, where multiple business models work at the same time. Just in linear viewership, you have Netflix and YouTube, both coexisting, both growing, both with their own kind of value propositions. And for us, that's really the most important piece is the value proposition, the North Star. And for us, that is deeply compelling and engaging gameplay. When we get that right and we find the fun and deliver that rich, meaningful, ongoing experience for players, we think we have the ability to deliver the right business model that supports and adds to the experience. We do think $60 games will continue to be an important part of that equation. And we believe the level of investment in content, in features, and in services that we provide will continue to make that a very attractive proposition for players.

Timothy O'Shea - Jefferies LLC

Thanks, Coddy.

Operator

And our final question today will be from Colin Sebastian with Robert Baird.

Colin Alan Sebastian - Robert W. Baird & Co., Inc.

Great, thanks. My question is related to World of Warcraft, including higher engagement that you're seeing with the title. And in particular, I'm wondering what we should expect then in terms of WoW usage and engagement leading up to and following the launch of Azeroth this summer. Thank you.

Michael Morhaime - Activision Blizzard, Inc.

Hi, Colin. This is Mike. Thanks for the question. Before I go into the expansion, I just want to quickly thank the World of Warcraft team for their amazing work in delivering great content for that community. Over the last couple of years, they have really shifted their pipelines and invested in not only the expansions, but also creating ongoing and an increasingly steady stream of content in between expansions, which is really important to keep people engaged all the way from one expansion to the next.

Battle for Azeroth is our next expansion. And at Blizzard, we're really excited about this expansion. It's coming along great. And it looks like our players are also very excited about it. As Coddy mentioned, our presales are ahead of plan. As always, this expansion features some exciting new features. I'm just going to mention a couple of them that we're particularly excited about. Island Expeditions, where players will explore unchartered islands that include randomly generated elements, we've built AI that will give players a different experience every time they visit an island, and that's to create a highly dynamic experience.

And Warfront, where players will join large groups and get the feeling of being part of a massive battle with different objectives. Warfront is a throwback to Warcraft real-time strategy roots, and we think that players, veterans and new players will really enjoy it. We designed these new features with our players in mind. We think they should get increased engagement as well as more replayable content, so that's really important with a game as massive as World of Warcraft.

This is some really exciting stuff that we're adding. We just entered wider beta testing. Player feedback has been excellent so far. So when the expansion launches in August, we are looking forward to millions more joining us in World of Warcraft.

Colin Alan Sebastian - Robert W. Baird & Co., Inc.

Thanks, Mike.

Operator

And it's time for closing remarks. I'd like to turn things over to our CFO, Spencer Neumann.

Spencer Adam Neumann - Activision Blizzard, Inc.

Thank you, I'll make this quick. I have a happy organizational announcement to make and I'll do while we have everybody on the call. So first, I want to congratulate Amrita, our fearless leader in Investor Relations, on a promotion. Amrita is going to become the next CFO of Blizzard, which we're ecstatic about. I hope you guys have all gained an appreciation for Amrita and her skills and capabilities over the years in her three years leading Investor Relations, as the company has been on a tremendous growth curve. We've exceeded performance of all kinds of indices during that three-year period, and we really appreciate all of her efforts along the way. And she's a star in the organization and we're looking forward to the next chapter for her.

And I'm excited to announce, even though we've got very big shoes to fill, that we're thrilled with our new head of Investor Relations that is coming onboard next week. His name is Chris Hickey. Chris is someone who many of you on the phone or on the call may know. He comes from Atlantic Equities, where he's not only an equity analyst, he's a co-founder of the firm, so he's really an entrepreneur at heart as well, and we couldn't be more happy to have him join our team. Chris knows our company well. He knows our industry. He's covered a number of industries across not just gaming, but technology, payments, and services. So he'll be joining officially on May 14.

Amrita, since she's not going far, will ensure a smooth transition as well as Colin and Jason and the team have done a terrific job supporting all of us, especially as Amrita has been transitioning down to Blizzard. So hopefully you all welcome Chris to the team. We're really happy to have him be part of the Activision Blizzard family, and I'm sure you'll get to know a lot more of him in the coming months and years ahead. So thank you.

Operator

And that will conclude today's conference. We do thank you all for joining us. You may now disconnect.

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