Activision Blizzard Inc. (ATVI)reported fourth quarter 2010 results that beat the Zacks Consensus Estimate. Management pointed out that the quarter represented the largest and the most profitable quarter in the company’s history. However, shares fell as a result of a disappointing first quarter and full year 2011 guidance.
Operating Performance
Earnings, including stock-based compensation but excluding one-time items, of 52 cents were up from 48 cents reported in the prior-year quarter. This was above Activision’s earnings guidance of 47 cents per share as well as the Zacks Consensus Estimate of 49 cents.
Total costs and expenses on a non-GAAP basis were $1.65 billion in the fourth quarter, up 2.2% from $1.61 billion in the prior-year quarter. Operating margin came in at 35.4%, flat from the prior-year quarter.
Revenue
Revenue on a non-GAAP basis (excluding revenues from deferral and related cost of sales) was $2.55 billion, up 2.1% year over year from $2.50 billion. This was above Activision’s guidance of $2.20 billion and the Zacks Consensus Estimate of $2.35 billion.
The year-over-year growth was primarily driven by increased sales from the PC (up 2.0% year over year) and MMORPG games (up 69.0% year over year) segment, which fully offset weak results from Distribution (down 13.0% year over year), Consoles (down 7.0% year over year) and Handheld devices (down 22.0% year over year). However, revenues from digital channels (30% of total revenue) for the quarter were more than $470 million, an increase of 40% year over year.
Activision was the #1 publisher overall in North America and Europe for fiscal 2010. During the quarter, strong performance from Activision Publishing’s Call of Duty: Black Ops and Blizzard Entertainment’s World of Warcraft: Cataclysm attracted more gamers, which contributed significantly to revenue growth.
As of February 2, 2011, more than 27 million gamers played Call of Duty games online. For the quarter, in North America and Europe, Call of Duty: Black Ops was the #1 best-selling console title and the Call of Duty franchise was the #1 franchise overall. To date, the game has achieved more than $1 billion in retail sales worldwide.
As of December 31, 2010, more than 12 million gamers worldwide have subscribed to playing Blizzard Entertainment’s World of Warcraft. World of Warcraft: Cataclysm was launched on December 7, 2010 and sold more than 3.3 million copies within 24 hours of its release, making it the fastest-selling PC game of all time. It continued to sell through more than 4.7 million copies in its first month.
On a geographic basis, revenues from North America (53.0% of total revenue) increased 6.0% year over year to $1.36 billion while revenues from Europe (41.0% of total revenue) were down 4.0% year over year to $1.04 billion. Although the Asia-Pacific region contributed only 6.0% to total revenue, revenues from the region leaped 16.0% on a year-over-year basis to $147.0 million in the quarter.
Balance Sheet & Cash Flow
As of December 31, 2010, Activision had no debt on its balance sheet. Cash and short-term investments were $3.53 billion compared with $2.85 billion at the end of September 30, 2010. The company generated $993 million in cash from operations. Over the last four quarters, Activision generated $1.28 billion in free cash flow.
Share Repurchase & Dividend
Activision announced that its board of directors has authorized a new repurchase program, under which the company can repurchase shares upto $1.5 billion. This program replaces the company’s existing $1 billion repurchase plan authorized in February 2010, which expired on December 31, 2010. As of December 31, 2010, Activision had purchased an aggregate of 86 million shares for approximately $966 million under the 2010 program.
The company also declared a cash dividend of 16.5 cents per share payable on May 11, 2011 to shareholders of record as of March 16, 2011. This is the company’s second-ever cash dividend and represents a 10% increase over 2010.
Outlook
Activision provided a conservative outlook given the continued uncertainty related to the macroeconomic and retail environment. For the first quarter of 2011, Activision forecasts non-GAAP net revenues of $640 million and earnings of 7 cents per share. In the quarter, the company plans to release only Call of Duty: Black Ops – First Strike, the first add-on content pack.
For full year 2011, Activision anticipates non-GAAP revenue to be $3.90 billion and earnings per share of 70 cents. Wall Street expected 2011 revenue of $4.69 billion and earnings of 83 cents per share.
The outlook does not include any new game from Blizzard in 2011. Revenues are expected to be down year over year due to the negative foreign exchange impact and the exit of low-margin business. Management expects no new music or skateboarding games and anticipates distribution and affiliate businesses to decline in 2011. In case the company does not release a major title this year, management plans to launch only two Blizzard titles in 2012.
Activision plans to reduce its exposure to low-margin and low-potential businesses, helping it to grow over the long term and enable it to continue expanding its position as the largest digital publisher. However, management expects growth from high-margin Digital business going forward.
Given the continued decline in the music genre, the company plans to spin off its Publishing’s Guitar Hero business unit that has witnessed slow growth in the last two years and will discontinue development on its Guitar Hero game for 2011. The company also will stop development on True Crime: Hong Kong.
Activision faces stiff competition from Electronic Arts Inc. (ERTS) and Take-Two Interactive Software Inc. (TTWO).
We maintain a Neutral rating on the shares over the long term (6-12 months). Currently, Activision has a Zacks #3 Rank, which implies a Hold rating on a short-term basis (1-3 months).
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