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Activision Blizzard Inc. (ATVI - Snapshot Report) reported earnings of 76 cents in the fourth quarter of 2013, which comfortably beat the Zacks Consensus Estimate by 6 cents. Earnings (including stock-based compensation but excluding one-time items) improved 1.3% from the year-ago quarter.

Quarter Details  

Revenues (excluding net-effect of deferred revenues) decreased 12.4% year over year to $2.27 billion. However, revenues managed to beat both the management’s guidance and the Zacks Consensus Estimate of $2.2 billion.

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 down 16.0% from the year-ago quarter to $1.8 billion. Blizzard Entertainment and its subsidiaries’ revenues slumped 7.0% year over year to $287.0 million. Revenues from Activision’s Distribution segment increased 29.0% from the year-ago quarter to $180.0 million.

Activision reported retail sales of $1.7 billion (down 16.3% year over year) and digital online revenues of $353.0 million (down 6.6% from the year-ago quarter), which comprised 92.0% of the revenues in the quarter.

On a geographical basis, revenues from North America, Europe and Asia-Pacific declined 13.0%, 12.0% and 11.0%, 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 480 basis points (bps) on a year over year basis to 54.3% in the last quarter.

The modest increase was due to higher product development (up 10 bps), sales & marketing (up 160 bps) and general & administrative expenses (up 60 bps) in the quarter.

As a result, operating margin declined a modest 30 bps in the quarter. Net income margin was 26.3% compared with 32.9% in the year-ago quarter.

Activision exited the fourth quarter with $4.44 billion in cash and short-term investments versus $6.82 billion in the previous quarter. The long-term debt amount stands at $4.67 billion versus no debt in the year-ago quarter. Operating cash flow was $880.0 million in the reported quarter compared to capital usage of $50.0 million in the prior quarter.

Outlook

For the first quarter, Activision expects non-GAAP revenues of $675.0 million (down from the prior outlook of $2.22 billion). Earnings are expected to be 9 cents per share as against the Zacks Consensus Estimate which is pegged at 8 cents per share.

The company raised its full year revenue guidance to $4.60 billion (from the prior outlook of $4.29 billion) based on strong performance from its major franchises, strong sales of Call of Duty: Black Ops, strong product pipeline and expected higher consumer spending on new consoles during the holiday season.

For full year 2014, Activision expects earnings of $1.26, while the Zacks Consensus Estimate is pegged at $1.20 per share. 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), Take-Two Interactive (TTWO - Snapshot Report) and Glu Mobile Inc (GLUU - Snapshot Report). However, management’s cautious approach is commendable due to volatility associated with the console transition cycle.

In 2014, the company plans to launch Hearthstone on tablets and smartphones. In many countries, the mobile Internet is the fastest growing interactive entertainment platform and we firmly believe that Hearthstone is well positioned for success.

We believe that the new games have the potential to be among the largest and most profitable in their respective spheres and would enhance profitability going forward.

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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