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Activision Blizzard Inc. (ATVI - Snapshot Report) reported better-than-expected third quarter 2012 results, beating the Zacks Consensus Estimate by a nickel. Further, quarterly revenues were well ahead of the Zacks Consensus Estimate of $708 million.

Quarter Details

Revenues on non-GAAP basis (excluding revenues from deferral and related cost of sales) jumped 20% year over year to $751 million and comfortably exceeded the company’s guidance of $690 million.

The year-over-year growth was primarily driven by robust performance from the World of Warcraft: Mists of Pandaria and Skylanders (life to date revenue of $500 million). Moreover, continued strong performance from Diablo III (year to date 10 million copies sold) and the Call of Duty franchise were also responsible for the top-line expansion.

The quarterly revenues were also positively impacted by strong retail (up 65% year over year) as well as digital online revenues (up 11% year over year), which more than offset the decline in revenue from the distribution segment (down 30% year over year).

On operating basis, revenues from Activision Publishing increased 12% from the previous-year quarter to $283 million. Blizzard Entertainment and its subsidiaries’ revenue increased 39% from the prior-year quarter to $414 million, primarily driven by Diablo III’s strong performance.

On a geographical basis, revenues from North America, Europe and Asia Pacific reported yearly increase of 23%, 17% and 20%, respectively.

Total costs and expenses on non-GAAP basis (excluding stock based compensation and amortization and net effect of deferrals) increased 10.1% year over year to $597 million, due to 14.2% increase in sales and marketing expenses and 2.2% increase in the general and administrative expenses.

Operating income on a non-GAAP basis (excluding stock based compensation and amortization and net effect of deferrals) soared 81.2% to $154 million from the year-ago quarter. Operating margin expanded 690 basis points (“bps”) from the previous-year quarter to 20.5%, driven by productivity improvements.

However, including stock-based compensation, operating income came at $120 million while operating margin was 16%.

Net income on non-GAAP basis (excluding stock based compensation and amortization and net effect of deferrals) was $168 million or 15 cents per share in the quarter, up from $87 million or 7 cents per share in the prior-year quarter.

Including stock-based compensation, net income was $145 million or 12 cents compared with $74 million or 6 cents in the year-ago quarter.

Activision exited the third quarter with $3.36 billion in cash and cash equivalents and short-term investments, versus $3.19 billion in the previous quarter. The company did not have any long-term debt in its balance sheet.

Outlook

For the fourth quarter, Activision expects non-GAAP earnings of 70 cents per share on revenues of $2.41 billion. Moreover, Activision raised its fiscal 2012 outlook buoyed by the strong third quarter results. Activision now expects to earn $1.10 per share (up from 99 cents) on total revenues of $4.81 billion (up from $4.63 billion) for the full year.

Activision expects its new title releases in October, namely 007 Legends, Skylanders Giants, Cabela’s Dangerous Hunts 2013, Cabela’s Hunting Expeditions and Transformers Prime to drive the results in the next quarter. Moreover, the expected release of Call of Duty: Black Ops II coupled with Wipeout 3 and Family Guy: Back to the Multiverse in November would be incrementally beneficial for the company to achieve its forecasted results.

However, Activision’s 2013 outlook was a cautious one owing to the ongoing sluggish macroeconomic scenario and a tough year-over-year comparison due to the robust sales of Diablo III. Management expects to focus on the growing retail segment and to remain cost effective.

Recommendation   

We believe that Activision’s expanding product portfolio will boost top-line growth over the long term. The company is in the process of reviving its popular old franchises such as StarCraft, which are expected to drive customer engagement going forward.

Moreover, Activision’s partnership with Tencent in China to offer Call of Duty online bodes well with the company’s long-term prospects. The company has a strong product pipeline for the upcoming holiday season, which would expectedly drive the top line in the near term.

However, continued softness in the video game industry, limited presence in the mobile gaming segment, higher adoption of free-to-play games and significant competition from Electronic Arts Inc. (EA - Analyst Report) and Take-Two Interactive Software Inc. (TTWO - Snapshot Report) are the major headwinds going forward.

We prefer to remain on the sidelines due to these concerns and maintain our Neutral recommendation over the long term (6-12 months). Currently, Activision Blizzard has a Zacks #3 Rank, which implies a Hold rating in the short term.

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