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Activision Blizzard Inc. (ATVI - Snapshot Report) reported earnings of 7 cents in the third quarter of 2013, which comfortably beat the Zacks Consensus Estimate of a penny. However, earnings (including stock based compensation but excluding one-time items) declined a massive 50.0% from the year-ago quarter primarily due to lower revenues.

Quarter Details  

Revenues (excluding net-effect of deferred revenues) decreased 12.5% year over year to $657.0 million. However, revenues were much better than management’s guidance of $585.0 million and also beat the Zacks Consensus Estimate of $593.0 million.

Tough year-over-year comparable sales, primarily due to robust sales of Diablo III in the year-ago period and the launch of World of Warcraft: Mists of Pandaria expansion pack, were the reasons for the decline in revenues.

Robust performance from Call of Duty, Skylanders, World of Warcraft and the launch of Diablo III on consoles helped revenues to surpass the consensus mark and management’s guidance.

Segment wise, revenues from Activision Publishing were up 13.1% from the year-ago quarter to $319.0 million. Blizzard Entertainment and its subsidiaries’ revenues slumped 31.9% year over year to $282.0 million. Revenues from Activision’s Distribution segment increased 3.7% from the year-ago quarter to $56.0 million.

Activision reported retail sales of $202.0 million (down 25.2% year over year) and digital online revenues of $399.0 million (down 6.6% from the year-ago quarter), which comprised 60.7% of the revenues in the quarter.

On a geographical basis, revenues from North America, Europe and Asia-Pacific declined 3.0%, 18.0% and 33.0%, respectively, on a year-over-year basis.

Total costs and expenses (including stock-based compensation but excluding amortization and net effect of deferrals) as a percentage of revenues increased 50 basis points (bps) to 84.3% in the last quarter.

The modest increase was due to higher product development (up 470 bps) and sales & marketing (up 450 bps), which fully offset declines in cost of sales (down 770 bps) and general & administrative expenses (90 bps) in the quarter.

As a result operating margin declined a modest 30 bps in the quarter. Net income margin was 11.3% compared with 19.3% in the year-ago quarter.

Activision exited the third quarter with $6.82 billion in cash and short-term investments (including $2.28 billion in escrow) versus $4.55 billion in the previous quarter. In October, Activision completed the acquisition of approximately 429 million company shares from Vivendi for approximately $5.83 billion in cash.

Outlook

For the fourth quarter, Activision expects non-GAAP revenues of $2.22 billion (down from the prior outlook of $2.25 billion). Earnings are expected to be 72 cents (down from the prior outlook range of 76 to 79 cents).

In November, both Sony (SNE - Snapshot Report) and Microsoft (MSFT - Analyst Report) are set to launch their new consoles after a gap of 7 years.

Although the recent releases of Call of Duty: Ghosts, Skylanders SWAP Force, Cabela’s African Safari, and Wipeout Crash and Burn, SpongeBob SquarePants, Plankton’s Robotic Revenge and Teenage Mutant Ninja Turtles are expected to boost  the top line, the decline in revenue outlook reflects the negative effects console transition and digital distribution.

However, the company has raised its full year revenue guidance to $4.29 billion (from prior outlook of $4.25 billion) based on strong performance from its major franchises, strong sales of Call of Duty, strong product pipeline and expected higher consumer spending on new consoles during the holiday season.

For full year 2013, Activision expects earnings of 89 cents, higher than prior outlook of 85 to 87 cents. The company remains positive on 2014 as it plans to release a number of new gaming titles based on Call of Duty, Skylanders, Destiny, and Diablo franchises.

Our Take

We believe that Activision is well positioned to gain from the upcoming console releases due to its superior product offering compared to rivals such as Electronic Arts (EA - Analyst Report). However, management’s cautious approach is commendable due to volatility associated with the console transition cycle.

Additionally, Activision’s limited presence in the mobile gaming segment, higher adoption of free-to-play games and significant competition are the major headwinds in the near term.

Currently, Activision Blizzard has a Zacks Rank #3 (Hold).

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