Mission Accomplished - Level #100 #23

So that's mission accomplished on my leveling plans for Draenor.  I'm pretty happy with having got through all that, and will likely continue the garrison gold making charge as well as leveling a 3rd hunter and maybe a 3rd mage, at least until the pre-expansion patch comes out.  I'm guessing that's still at least a month out at this point.

The garrison gold making continues to go pretty well, average something over 60,000g per week using the techniques that I've outlined here.

My last two max level toons I've passed on fully building out their garrisons because I don't believe there will be time to recoup the cost between now and when garrisons get nerfed.

This toon was a monk, so I was heavily leveraging the xp boost that comes from the monk dailies on this one, so he ended up with a total played time from 1-100 of right at 1 day, 15 hours.

Cheers,

Joar

Review of Activision-Blizzard's First Quarter Form 10-Q

So for those of you that aren't dedicated public reporting and accounting geeks and were wondering about my title, a Form 10-Q is the quarterly document that public companies registered in the U.S. file with the Securities and Exchange Commission.  The document itself contains some of the same information that companies typically include in the press releases but can often have other valuable information worth reviewing.  For large public companies, the document is due 40 days after the end of the quarter (so for a calendar year-end company, that would be today for Q1)

The first section of the document is the financial statements and footnotes themselves.  The second section is called "Management's Discussion and Analysis of Financial Condition and Results of Operations", which you'll sometimes see referred to as MD&A.  This is where the company explains all the things that caused changes in their financial results for the quarter.  There's also a portion of this section that is dedicated to discussions of liquidity - how much cash the company has, how much debt and what the terms of that debt is and how they plan to manage all of that.

The final few sections are more specific and technical and may include information on significant legal cases as well as a discussion of any changes or issues with the company's internal controls.

So that's the background.  There are a couple of places you can usually find this document.  Most companies will have a copy of it on the Investor Relations section of their website (usually under SEC Filings).  You can also get it directly off the SEC's website at www.sec.gov, and click the button on the top right that says "Company Filings".

So, couple of things from the Activision-Blizzard (ATVI) 10-Q that I wanted to go through today:  Segment Reporting, the Candy Crush Transaction, Monthly Active User disclosures and nuggets from MD&A.

Segment Reporting

The way the accounting disclosure rules work, a company determines their segments based on the way they provide information to top management for decision making and based on how they think about resource allocation.  Traditionally, ATVI has disclosed two segments - Activision and Blizzard.  Typically, when you do a major acquisition like the King deal, it gives you the chance to reevaluate whether that continues to be how you'd like to look at things.  In this case, it looks like the company decided to continue with business as usual, but of course with adding King as a third segment.  They also report a fourth category of "Other" which are things that aren't yet large enough to merit reporting as a separate segment.  Those include things like eSports, the studio and their distribution business.

The Candy Crush Transaction

So when you acquire a company like King, you're required to record all of the assets and liabilities of that company at their current fair value, including intangible assets that might not have been on the books of that company when you acquired it.  Then, to the extent that the amount that you paid is more than the value of those net assets, the difference gets recorded as goodwill.  Because technology companies and gaming companies don't typically have a lot of hard identifiable assets, this goodwill number can end up being quite large.

So the purchase price for King was approximately $5.8 billion.  And here is how they allocated that:

So you see a few interesting things here under intangible assets - a value for King's internally-developed franchises at $845 million, a separate value for the software itself at $580 million and then a value for their existing customer base at $609 million.  These things will all be amortized to expense over the periods in the right hand column, reducing King's profitability for those periods.

They also added $2.7 billion of goodwill related to King bringing the total goodwill on the books of ATVI as a whole to $9.8 billion.

Monthly Active User Disclosures

So in their MD&A, we got a little bit more detail on their monthly active users by segment than what they had put in the earnings call information.  Below is their disclosure by quarter, for the past year.

So looking at the Blizzard line, there is a pretty significant spike in Q2 of 2015, which likely relates to the Hearthstone expansion and the full release of Heroes of the Storm during that period.

The decline in MAU's for King is also pretty interesting.

MD&A Nuggets

So reading through their MD&A, you see some pretty interesting detail.  For the quarter, they disclose that revenue for Blizzard as a whole was down because of declines in Warcraft, related to lower subscriber numbers, and also because of declines in Heroes of the Storm, because the comparable period in 2015 contained a one-time revenue boost from the sales of Founders' Packs.  However, this was offset by increases in revenue for Hearthstone, which was released on iPhone and Android smartphones beginning in Q2 of 2015.

Finally, they disclose for Blizzard that their profitability as a whole as impacted by the same factors, and also by increased sales and marketing costs being incurred to support future releases.

The other comment that I found interesting in MD&A was under Product Development expense where they disclosed that development costs actually decreased for Blizzard because of the timing of cost capitalizations.***

One additional item that I wanted to highlight from the 10-Q is from the cash flow statement, where they showed operating cash flow of $309 million, up from $209 million for the same quarter in the prior year, so they are continuing to show strong cash flow generation.

Last item that was a little bit interesting was in Part II, Item 1 of the 10-Q which is the section related to legal proceedings where they disclose that there is a class action lawsuit out there against King arising from their IPO.   They include the fairly standard language around believing the claims are without merit and intending to defend it vigorously, but it may merit monitoring in case they end up incurring lots of costs from a defense standpoint.

Cheers!

***  I was asked a follow up question on Twitter about what this means exactly.  Unfortunately, it's probably too detailed to fit into a 140 character response, so I'm updating it here instead.  The accounting policy note in their 10-K explains their accounting for software development costs as follows:

 Software development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products. Software development costs are capitalized once technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation, or the completed and tested product design and working model. Significant management judgments and estimates are utilized in the assessment of when technological feasibility is established. For products where proven technology exists, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product basis. 

So prior to establishing "technological feasibility", the costs related to that particular game or piece of software are expensed under Product Development expense.  So what that means in general is the timing of a game getting to the point that they can call in technologically feasible so they can start capitalizing costs instead of expensing them can have a significant impact on the expense recognized for the period in this particular category.  What that would seem to imply is that something just hit that technological feasibility threshold recently, so costs are now being capitalized instead of expensed (or possibly they had a few things that were just short of that point last year).

An Analysis of Blizzard's First Quarter Earnings Release

So this quarter's earnings release was probably more notable for the changes in format than for the specific information about Warcraft that was available.  Most notably, we no longer have specific revenue information related to World of Warcraft being publicly disclosed by Activision-Blizzard ("ATVI").

So here is the table from the Q4 earnings release where they break-out the World of Warcraft information:

And here is that same schedule now.  Note the footnote at the bottom where they explain that the stuff that used to be broken out and separately identified as World of Warcraft has now been lumped in with all the other PC based stuff.

So this is coming on the heels of separate subscriber numbers no longer being disclosed after Q3 of last year.

But here is something we are getting that is new this time around, and that is overall Monthly Active Users for Blizzard as a whole.  Below is a really cool slide from Activision-Blizzard's earnings call presentation that talks about their total audience reach across all three segments.

So we have totals for Blizzard now, which was 26 million monthly active users, and was the fastest growing of ATVI's segments, growing 23% year over year.  But keep in mind, that includes all of Blizzard's franchises - Warcraft, Diablo, Starcraft, Hearthstone and Heroes of the Storm (and maybe even Overwatch - they didn't really say).  While it was the fastest growing, it's really interesting to see how much smaller it is than Activision and King on a relative basis.

So, now for the numbers.  For ATVI as a whole, they had a strong quarter.  GAAP revenues increased about 14% for the quarter to $1.455 billion and non-GAAP revenue increased 29% for the quarter to $908 million.  Note that Q1 is typically a very slow time for the Company from a non-GAAP standpoint, particular without any notable new releases typically occuring during that time.

For Blizzard specifically, their non-GAAP revenue story was not nearly as good, declining 16% to $294 million for the quarter.  So while their monthly active users are up 23% year over year, that's not necessarily translating the revenue increases, at least at this point.

In terms of actual operating income, the decline at Blizzard was even larger, with a drop of 38% to $86 million for the quarter compared to $139 million in 2016.  There should be more detail explaining these particular changes in their Form 10-Q filing with the Securities and Exchange Commission, but unlike previous quarters, they didn't file their 10-Q on the same day as their earnings release.

From a cash flow standpoint, we'll also have to wait until that 10-Q gets filed to see the details on their cash flow for the quarter, but they did disclose on the call that they generated something north of $300 million of operating cash flow for the quarter, which would be a significant improvement over the $209 million of operating cash flow from the first quarter of last year.

As you may recall from previous posts, they took on an additional $2.3 billion of new debt in connection with the King acquisition, and they also disclosed on the call that they had already repaid $500 million of that new debt.  Lastly, they also disclosed that they had received approval from their board to repay an additional $1 billion of debt over the rest of the year.  So as of 3/31, the Company had $2.9 billion of cash on hand, compared to $5.9 billion of gross debt, or net debt of around $3 billion.  This compares to $1.3 billion of net cash (total cash minus total debt) on hand at year-end.

Only planning to use $1 billion of the $2.9 billion of cash that they have currently on hand to repay debt over the remainder of the year might create some interesting speculation around what plans they might have for that remaining $1.9 billion, plus the cash they will generate over the rest of the year.