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Activision Blizzard Inc. (ATVI - Snapshot Report) reported robust fourth quarter non-GAAP earnings of 78 cents, which increased 25.8% from the year-ago quarter. Including stock-based compensation of 3 cents, earnings of 75 cents handily beat the Zacks Consensus Estimate of 69 cents.

Revenues 

Revenues on a non-GAAP basis jumped 7.8% from the year-ago quarter to $2.59 billion. Reported revenues were significantly ahead of management’s guidance of $2.41 billion and also surpassed the Zacks Consensus Estimate of $2.44 billion. The better-than-expected revenue growth was primarily attributed to solid performance from the Call of Duty and Skylanders franchises.

The quarterly revenues were also positively impacted by strong retail (up 10% year over year) as well as digital online revenues (up 22% year over year), which more than offset the lower revenues from the distribution segment (down 31% year over year).

Segment wise, revenues from Activision Publishing increased 11% from the year-ago quarter to $2.15 billion. Blizzard Entertainment and its subsidiaries’ revenues increased 12% from the prior-year quarter to $310 million.

On a geographical basis, revenues from North America, Europe and Asia Pacific reported year-over-year increase of 11%, 2% and 19%, respectively.

Operating Results

Total costs and expenses on a non-GAAP basis (excluding stock-based compensation and amortization and net effect of deferrals) decreased 5.1% year over year to $1.44 billion, primarily due to 17.6% decrease in sales and marketing expenses and 3.6% drop in the product development expenses.

Operating income on a non-GAAP basis (excluding stock-based compensation and amortization and net effect of deferrals) spiked 29.7% to $1.15 billion from the year-ago quarter. Operating margin expanded 760 basis points (“bps”) from the previous-year quarter to 44.5%, driven by favorable product mix and productivity improvements.

However, including stock-based compensation, operating income came in at $1.11 billion while operating margin was 42.9%.

Net income on a non-GAAP basis (excluding stock-based compensation and amortization and net effect of deferrals) was $891 million in the quarter compared with $725 million in the year-ago quarter. Including stock based compensation, net income stood at $853 million.

Balance Sheet

Activision exited the fourth quarter with $4.38 billion in cash and cash equivalents and short-term investments versus $3.36 billion in the previous quarter. The company did not have any long-term debt in its balance sheet.

Outlook

For the first quarter of 2013, Activision expects non-GAAP earnings of 10 cents per share on revenues of $690 million. For fiscal 2013, Activision Blizzard expects to generate non-GAAP revenues of $4.175 billion and earn 80 cents per share.

The company plans to launch StarCraft II: Heart of the Swarm on Mar 12. Moreover, the company expects its product line to be based on its four franchise - Call of Duty, Skylanders, World of Warcraft and StarCraft. Apart from these, Activision expects to invest in new IPs and develop Bungie’s new universe.

However, the company remains cautious regarding fiscal 2013 due to volatile macro economic environment coupled with uncertainly related to the console transition and tough year-over-year comparisons.

Recommendation

We believe that Activision’s product portfolio will boost top-line growth over the long term. Activision’s expansion in China to offer Call of Duty online bodes well with the company’s long-term prospects. Moreover, the company’s product pipe line remains strong with new installments from the Skylanders franchise and Call of Duty expansion packs. Moreover, Blizzard Entertainment is expected to come up with an all new MMO game in 2013.

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 (EA - Analyst Report), Take-Two Interactive Software (TTWO - Snapshot Report) and Sony (SNE - Snapshot Report) are the major headwinds going forward. Moreover, continued investments in new products are expected to hurt margins in the near term.

Currently, Activision Blizzard has a Zacks Rank #4 (Sell).

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