Soldiers in combat within "Call of Duty" game

Call of Duty is going back to its roots. Image source: Activision Blizzard. 

On its latest conference call, Activision Blizzard (NASDAQ:ATVI) confirmed that Call of Duty: Infinite Warfare fell short of expectations, yet the company turned in a great quarter. The top video game publisher posted growth in revenue and earnings, and increased its annual dividend by 15%.

What happened

Reports surfaced in December that Activision Blizzard's latest Call of Duty installment -- Infinite Warfare -- was underperforming the year-ago title by as much as 50%. Those reports proved accurate, although we don't know exactly how many units Infinite Warfare sold because the company doesn't disclose that information. On the conference call, however, management explained that the new science fiction genre for the game's setting didn't resonate with the player base.

"Sales underperformed our expectations, and it's clear that for a portion of our audience, the space setting just didn't resonate. We had a passionate, experienced studio, deeply committed to this direction, and despite the risks we saw, we believe it is important to consider the passions of our game teams in deciding what content to create. ... Providing an environment that recommends passion is a critical component of our success, and the process to learn from our mistakes is what makes our company special," said Chief Operating Officer Thomas Tippl.

Call of Duty became popular making games with a historical setting like World War II or other 20th century conflicts. Each subsequent iteration of the game over the last 10 to 15 years progressed up to modern-day combat settings. Recent Call of Duty games have taken a look at the future of combat, and considering the history of the game's development, it makes sense that the next logical step was a very futuristic, sci-fi take like Infinite Warfare.

However, gamers have made it clear to the company that a futuristic setting is not the game's identity. Management has heard that message and is planning the next Call of Duty game to return to its roots with a modern-day combat setting.

One out of seven

I like management's explanation for the game's disappointment on the conference call. Executives knew a science fiction setting was a risk, but it was a risk they were willing to take. Management's approach to game development is to let talented developers pursue their passion, and this is the same process that has led to other hits in the company's portfolio, like Destiny, Overwatch, and Skylanders.

Activision Blizzard has seven franchises with $1 billion or more in life-to-date revenue. All of these games are designed to build a mass audience and then sell that audience a steady stream of additional in-game content that enhances the gameplay experience or lengthens the life of the game altogether. It's similar to a razor-and-blades business model.

Management has been gradually implementing a strategy in recent years to use this in-game content to build a year-round revenue stream and lessen the dependence on single game hits.

If there is one quarter that demonstrated the strength of Activision's business model, it was the 2016 fourth quarter. Despite Infinite Warfare's underperformance, the Call of Duty franchise still managed to be the top-selling console title for the eighth consecutive year. All in all, player engagement in the Call of Duty franchise remained stable in the fourth quarter, while other franchises from the Blizzard side of the company saw growth in monthly active users.

Activision's publishing segment revenue was down 23% in the fourth quarter, but Blizzard revenue grew 46%, helping to offset most of the poor performance of Call of Duty: Infinite Warfare. Excluding the acquisition of King Digital Entertainment, total segment revenue was $1.8 billion compared to $1.9 billion in 2015.

Looking ahead

Activision Blizzard has a light slate of game releases planned for 2017. However, there will be a Destiny sequel, which management expects to broaden the player base. Activision also has a great opportunity in 2017 to drive higher in-game content revenue with three Call of Duty titles that each have enough of a player community for the company to benefit. Management is planning to steadily release additional in-game content for these Call of Duty games throughout the year. Because in-game content purchases carry a higher margin than game sales, 2017 could be the company's biggest year yet for digital revenue growth within Call of Duty.

Management is guiding up for the fourth quarter in 2017, as the next Call of Duty game in the fall is expected to deliver what fans expect and should have much better appeal than Infinite Warfare. If gamers want more of the same from the last decade, that's a great sign of the franchise's brand strength and longevity.

At the end of the day, the problem with Infinite Warfare wasn't quality, but the setting, and that is easily fixable.