Activision Beats on Q1 Earnings, Revs - Analyst Blog

Activision Blizzard Inc. ATVI reported earnings of 16 cents in the first quarter of 2014, which comfortably beat the Zacks Consensus Estimate by 9 cents. Earnings (including stock-based compensation but excluding one-time items) improved 4.6% from the year-ago quarter.

Quarter Details  

Revenues (excluding net-effect of deferred revenues) decreased 23.1% year over year to $772.0 million. However, revenues managed to beat management's guidance and the Zacks Consensus Estimate of $675.0 million and $689.0 million, respectively. The strong performance was driven by 5 distinct franchises, highlighting the increasing breadth and depth of the company's product portfolio.

Segment wise, revenues from Activision & Blizzard were down 18.5% from the year-ago quarter to $1.04 billion. Revenues from Activision's Distribution segment increased 43.1% from the year-ago quarter to $73.0 million in the reported quarter.

Activision reported retail sales of $659.0 million (down 26.5% year over year) and digital online revenues of $379.0 million (up 0.5% from the year-ago quarter), which comprised 93.4% of the revenues in the reported quarter.

On a geographical basis, revenues from North America declined 18.9%. Europe and Asia Pacific increased 10.0% and 75.0%, respectively on a year-over-year basis.

In the reported quarter, in North America and Europe combined, Activision Publishing had #1 and #2 best selling titles in the form of Skylanders SWAP Force and Call of Duty: Ghosts, respectively.

In the first quarter, Blizzard Entertainment had the #1 PC title in North America and Europe combined in the form of Diablo III: Reaper of Souls. In the first week after its launch, it sold more than 2.7 million copies worldwide.

During the quarter, Blizzard launched its new free-to-play game Hearthstone: Heroes of Warcraft. Hearthstone already has over 10.0 million registered PC players across all regions with strong engagement and monetization. Thus, Hearthstone is all set to become Blizzard's first new franchise since World of Warcraft.

During the quarter, Blizzard generated robust revenues through Battle.net with the launch of Hearthstone on iPads.

Moreover, as of Mar 31, 2014, Blizzard Entertainment's World of Warcraft remained the #1 subscription-based MMORPG with approximately 7.6 million subscribers worldwide.

Total costs and expenses (including stock-based compensation but excluding amortization and net effect of deferrals) as a percentage of revenues increased 1470 basis points (bps) on a year over year basis to 72.8% in the quarter.

The modest increase in total costs ad expenses was due to higher product development (up 600 bps) and general & administrative expenses (up 340 bps) in the quarter.

As a result, operating margin declined 51.0% in the quarter to $210.0 million. Net income margin was 15.9% compared with 18.0% in the year-ago quarter.

Balance Sheet & Cash Flow

Activision exited the first quarter with $4.3 billion in cash and short-term investments versus $4.4 billion in the previous quarter. Long-term debt stands at $4.37 billion versus $4.67 billion reported in the prior quarter.

Operating cash flow was $136.0 million in the reported quarter compared to capital usage of $880.0 million in the prior quarter. The company generated a free cash flow of $99.0 million in the quarter.

Further, the company has decided to pay a cash dividend of 20 cents per common share on May 14, 2014.

Future Plan

Activision in partnership with Tencent is all set to bring Call of Duty to China in a format especially designed for the market both on the PC and as a free-to-play-game.

The company plans to make 4 additions to its franchise portfolio in the near future. However, no major game release is planned for the second quarter of 2014.

In the third quarter of 2014, the company expects to release Destiny which is believed to be the biggest video-game IP launch in history. However, since its marketing will involve enormous expenditure, operating income in the quarter is expected to be subdued.

The fourth quarter of 2014 will witness the launch of Skylanders: Trap Team and Call of Duty: Advanced Warfare.

Outlook

For the second quarter, Activision expects non-GAAP revenues of $600.0 million while the Zacks Consensus Estimate for the same is pegged at $577.0 million.

Earnings are expected to be a penny versus the Zacks Consensus Estimate of $0.03 per share. Operating margin for the second quarter is projected to be 10.0%. Product cost and operating expenses are expected to be 26.0% and 45.0% respectively.

The company provided full year 2014 revenue guidance of $4.68 billion based on strong performance from its major franchises, higher sales of Call of Duty: Black Ops, a strong product pipeline and expected higher consumer spending on new consoles. The management guidance happens to be higher than the Zacks Consensus Estimate of $4.64 billion.

For full year 2014, Activision expects earnings of $1.27 per share while the Zacks Consensus Estimate is pegged at $1.20 per share. Non-GAAP operating margin is expected to be 32.0%.

The company remains positive on 2014 as it plans to release a number of new gaming titles based on the 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, Take-Two Interactive TTWO and Glu Mobile Inc GLUU. However, management's cautious approach is commendable due to volatility associated with the console transition cycle.

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).