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Activision Blizzard Inc. (ATVI - Free Report) reported better-than-expected second quarter 2012 earnings, which surpassed the Zacks Consensus Estimate by a dime. The quarterly revenues were well ahead of the Zacks Consensus Estimate of $893.0 million.

Quarter Details

Revenues on non-GAAP basis (excluding revenues from deferral and related cost of sales) surged 50.8% year over year to $1.05 billion and comfortably exceeded the company’s guidance of $805.0 million. The significant year-over-year growth was driven by strong performances from Diablo III, Skylanders, World of Warcraft and Call of Duty franchises.

The quarterly revenues were also positively impacted by strong retail (up 141% year over year) as well as digital online revenues (up 17% year over year), which more than offset the decline in revenue from the distribution segment (down 25% year over year).

On operating basis, revenues from Activision Publishing increased 15.0% from the previous-year quarter to $373.0 million. Blizzard Entertainment and its subsidiaries’ revenue jumped a staggering 103.0% from the prior-year quarter to $634.0 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 46.0%, 38.0% and 116.0%, respectively.

Total costs and expenses on non-GAAP basis escalated 41.2% year over year basis to $754.0 million, due to 32.4% rise in the product development cost coupled with 51.7% increase in sales and marketing expenses and 44.8% jump 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 81.8% to $300.0 million from the year-ago quarter. Operating margin expanded 490 basis points (“bps”) annually to 28.5%, driven by productivity improvements.

However, stock-based compensation of $31.0 million dragged down operating income to $269.0 million in the quarter. Operating margin improved 480 bps to 25.5%.

Net income on non-GAAP basis (excluding stock based compensation and amortization and net effect of deferrals) was $224 million or 20 cents per share in the quarter, up from $116 million or 10 cents per share in the prior-year quarter.

However, including stock-based compensation of $21.0 million net income was $203.0 million or 18 cents compared with $103.0 million or 9 cents in the year-ago quarter.

Activision exited the second quarter with $3.19 billion in cash and cash equivalents and short-term investments, versus $3.48 billion in the previous quarter. The company did not have any long-term debt in its balance sheet. During the quarter Activision generated $92.0 million. During the quarter, Activision repurchased 4.4 million shares for an estimated price of $204.0 million.


For the third quarter, Activision expects non-GAAP earnings of 7 cents per share on revenues of $690 million. For fiscal 2012, Activision raised its non-GAAP revenues and earnings estimate. Activision now expects to earn 99 cents (up from 95 cents) on total revenues of $4.63 billion (up from $4.53 billion) for the full year.

Management expects the availability of Transformers: Fall of Cybertron, Call of Duty: Modern Warfare 3 Content Collection #3 and Call of Duty: Modern Warfare 3 Content Collection #4 to positively impact the upcoming quarter results. Moreover, the expected release of Ice Age Continental Drift — Arctic Games, Wipeout 3 and Angry Birds Trilogy will be beneficial for the company’s top line.

In addition, aided by the continued strong performance of the Skylanders franchise, Activision expects to simultaneously gain traction in both the toy market and video game market. Activision’s expansion plans in China will also be incrementally beneficial for the company over the long term.  


We believe that Activision is focusing on expanding its product portfolio by developing new games in partnership with Bungie. Moreover, the company is reviving its popular old franchises such as StarCraft, in order to drive customer engagement going forward. We believe that portfolio expansion will reduce Activision’s dependency on Call of Duty and World of Warcraft for top-line growth over the long term.

Activision recently entered into a partnership with Tencent to run Call of Duty Online in China. We believe that Activision has strong growth potentials in China due to the significant presence of Tencent. We also believe that Activision’s foray into the mobile gaming market is expected to be a long-term positive.

Meanwhile, Activision continues to strengthen its World of Warcraft, Call of Duty and Skylanders franchises through the launch of new versions and content packs, which are expected to boost top-line growth in the near term.

However, softness in the video game industry and Activision’s limited presence in the online gaming market coupled with significant competition from Electronic Arts Inc. (EA - Free Report) and Take-Two Interactive Software Inc. (TTWO - Free Report) are the major headwinds going forward. Moreover, increasing investment related to new product developments may hurt profitability in the near term.

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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