Activision Blizzard Inc. (ATVI - Snapshot Report) reported earnings of 22 cents in the third quarter of 2014, which convincingly beat the Zacks Consensus Estimate of 9 cents. Earnings (including stock-based compensation but excluding one-time items) increased from 7 cents reported in the year-ago quarter. The year-over-year increase was primarily attributable to robust revenue growth exhibited by the company in the reported quarter.

Quarter Details  

Revenues increased 78.1% year over year to $1.17 billion. Revenues also beat the Zacks Consensus Estimate of $992 million.

The launch of Destiny as well as the robust performance of Diablo III and Hearthstone: Heroes of Warcraft helped revenues to surpass the consensus mark.

Product sales revenues were up 1.5% on a year-over-year basis to $337 million in the reported quarter. Subscription, licensing and other revenues were up 15.9% from the year-ago quarter to $416 million.

Activision reported retail sales of $587 million (up 190.6% year over year) and digital online revenues of $505 million (up 26.6% from the year-ago quarter), which comprised 93.3% of revenues in the quarter.

On a geographical basis, revenues from North America increased 82% while the same from Europe and Asia Pacific increased 70% and 94%, respectively, on a year-over-year basis.

Total operating expenses (including stock-based compensation but excluding amortization and net effect of deferrals) as a percentage of revenues declined 2050 basis points (bps) on a year-over-year basis to 37.9% in the reported quarter. The significant decline was due to lower product development (down 1010 bps), lower sales & marketing expense (down 300 bps) and lower general & administrative expense (down 730 bps) in the quarter.

Operating margin increased 460 bps to 20.3% in the quarter. Net income was $159 million or 22 cents per share versus $74 million or 9 cents per share in the year-ago quarter.

Activision Blizzard, Inc - Earnings Surprise | FindTheBest

Balance Sheet & Cash Flow

Activision exited the third quarter with $3.80 billion in cash and short-term investments versus $4.20 billion in the previous quarter. Long-term debt stands at $4.32 billion.

Operating cash flow was $1 billion in the reported quarter on a trailing-12 month basis. The company generated free cash flow of $81.0 million in the third quarter.

Future Plan

Over the upcoming months, the company expects to launch World of Warcraft: Warlords of Draenor, the newest expansion in the epic franchise, which has already been pre-purchased by over 1.5 million subscribers.

Moreover, Activision also plans to launch The Dark Below, the first expansion to Destiny, for Sony’s PlayStation 3 & PlayStation 4 consoles as well as Microsoft’s (MSFT - Analyst Report) Xbox One and Xbox 360 consoles in the fourth quarter.

Activision intends to launch two new free-to-play franchises next year. The two new franchises are Blizzard's Heroes of the Storm and Activision's Call of Duty Online.

Outlook

For the fourth quarter, Activision expects non-GAAP revenues of $2.20 billion, lower than the Zacks Consensus Estimate of $2.32 billion. Earnings are expected to be 86 cents per share, which is lower than the Zacks Consensus Estimate of 90 cents.

The company raised its full year revenue guidance to $4.80 billion (from the prior outlook of $4.70 billion) based on strong performance from its major franchises, strong product pipeline and expected higher consumer spending on new consoles going forward.

For full year 2014, Activision expects earnings of $1.35 per share while the Zacks Consensus Estimate is pegged at $1.21 per share. The company remains positive on 2014 as it plans to release a number of new gaming titles based on Call of Duty, Destiny and Diablo franchises.

Our Take

We believe that Activision is well positioned to gain from the upcoming releases on new consoles 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.

The previous version of Call of Duty released during the holiday season last year lifted quarterly results. A similar scenario is expected this year following the release of Call of Duty: Advanced Warfare. Another factor that needs to be taken into consideration is the reported absence of competition from Electronic Arts’ Battlefield series. Last year, EA released Battlefield 4 during the holiday season.

Reportedly, both EA and Take-Two Interactive have postponed the launch of their much-anticipated games Battlefield and Evolve, respectively to 2015. So less competitive pressure in the first person and third person video shooter game categories should work in favor of Activision this year.

Also, Activision’s latest release, Destiny garnered more than $325 million globally in the first five days, per Chart-track and the company’s internal estimates. This should positively impact the top line.

However, 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).