動視暴雪 (ATVI) 2004 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Activision second-quarter earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at time period (CALLER INSTRUCTIONS) As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Ms. Kristin Southey.

Good afternoon and thank you all for joining us today for our second-quarter fiscal 2004 conference call. My name is Kristin Southey, Vice President of Investor Relations. I will start by reviewing our Safe Harbor disclosure and reminding everyone that the statements made during this call that are not historical facts are forward-looking statements. Although the Company believes that its plans, intentions, and expectations reflected in such forward-looking statements are reasonable, a number of factors could cause our actual future results to differ materially from those expressed in any such forward-looking statements. These important factors and other factors that potentially could affect our financial results are described in our filings with the SEC, including form 10-K for the year ended March 31, 2003. Now I would like to introduce Bobby Kotick, our Chairman and CEO.

Thank you, Kristin. As you can see, we had a light release schedule for the second-quarter, but our catalog titles performed well. The balance sheet remains strong and we ended the quarter with $411 million in cash and short-term investments, low DSOs, and $664 million in shareholders' equity. Our focus on product quality and enhancing are studio resources continued in the quarter. We added to our studios with our acquisition of Infinity Ward. Infinity Ward created Call of Duty for the PC, which shipped recently and has been highly acclaimed. This is a superb development group with a great track record and we're happy to have them as a part of our studio team.

As we enter the holiday selling season, our product lineup represents some of the strongest, most innovative games we've ever created. The third-quarter will be driven by titles like Call of Duty, True Crime, and Tony Hawk's Underground, all of which have been released into the marketplace and so far are performing very well. Accordingly, we're raising our revenue outlook for the December quarter and the full fiscal year, even though we're moving DOOM 3 into fiscal '05 for planning purposes. Our EPS outlook, however, will be impacted by a onetime charge resulting from the elimination of certain projects we had in development.

As we look at fiscal '05 and beyond, we'll continue to focus our time and our energy and our capital on the many big propositions we have in development. By eliminating properties with low potential, we can efficiently reallocate our resources to our high-priority projects, as we did this year with our very focused holiday lineup. We have a great deal of confidence in our upcoming slate, and we saw no reason to continue with projects that don't have high-volume potential, especially when we have so many titles we believe have great potential for high financial returns.

By eliminating projects with lower likely returns, we can focus and increase our development and marketing resources on our big propositions. In fact, the opportunity costs that inevitably come from the distraction of lower performing titles could compromise the success we expect to have with these big propositions. In the fiscal '05, the worldwide install base would be bigger than ever before and we have a strong product slate. Spider-Man 2, Shrek 2, DOOM 3, Lemony Snicket, A Shark’s Tale, Call of Duty - Finest Hour, Rome - Total War, and The Movies, all titles we believe will be strong performers. And if our recently released titles succeed, our catalog business should be healthy as well. Ron will now share with you the highlights of our performance this quarter and provide an outlook on the future of our business.

Thank you, Bobby. For the quarter ending September 30, net revenues were $118 million, versus 169 million last year. We had a loss per share of 11 cents in the quarter versus earnings-per-share of 8 cents last year. Last year's quarterly results were driven by a number of multi platform releases in addition to very strong catalog sales of our Spider-Man franchise. This year our quarterly results were driven by a light release schedule including Disney's Extreme Skate Adventure, Cabela's Deer Hunt, and LucasArts’ Jedi Knight: Jedi Academy, which we develop and publish in Europe.

Catalog sales were the Company's strongest franchises including Spider-Man, Tony Hawk, and Return to Castle Wolfenstein, were solid. During the September quarter our manufacturing and distribution expense was 62 percent of net revenues, in line with our expectation. Operating expenses, excluding manufacturing and distribution expense, were about 53 percent of net revenues, also roughly in line with our expectation.

Turning to our balance sheet, on September 30 we had $411 million in cash and short-term investments versus 390 million last quarter. As of September 30, we had $499 million of working capital, an increase of 49 million versus June 30. During the quarter we entered into $11 million of new structured repurchase agreements while we had 46 million in structured repurchase agreements mature for cash. As you may recall, these transactions may be settled in cash or stock based on the market price of our common stock on the date of settlement. For more information, please refer to our form 10-K for the fiscal year ending March 31, 2003.

The $30 million accounts receivable balance on September 30 was down significantly versus the same period last year due to our light release schedule. The accounts receivable reserve of $15 million was down 4 million versus last year. As we said at our last call, the effect of lower receivables and higher reserves had caused the AR reserve to look out of the ordinary, specifically, the AR reserve as a percent of gross receivables equaled 63 percent, well above the 48 percent average for the past eight quarters. In the future we expect this metric to move closer to its historical average.

DSOs for the quarter were at 23 days. Inventories at the end of the quarter were $21 million, down 4 million versus last year. Of the 21 million, only 8 million relates to our publishing business and 13 million relates to our European distribution business. Going into the holiday season, we feel very good about our inventory position both in the warehouse and at retail.

Capitalized software development costs on September 30 were 87 million, up 15 million versus June 30. Importantly, less than 5 percent of our current capitalized software development balance relates to products that have already been released. Next quarter you will see a reduction in this balance based on the impact of the onetime charge and the amortization of the software expense related to our Q3 titles. On September 30, capitalized intellectual property licenses were 42 million, down 3 million versus June 30.

Now I'd like to share our thoughts on the overall market, beginning with our hardware estimates. As of September, 2003, the install base in North America for current generation systems, including handheld, has grown to 45.6 million units, an 87 percent increase over last year. For calendar year end 2003, we expect the install base of hardware, including handheld, to grow to about 56 million units, slightly ahead of our previous outlook. Looking at each system individually, at the end of September the PlayStation2 had an install base of 19.2 million units in North America. We believe that without a price cut the install base of the PlayStation2 hardware will end the calendar year at about 24 million units. That's down 1 million units from our last call.

As of September 30, driven by a well-received price cut to $99, the GameCube had an install base of about 4.7 million units. We believe that the GameCube is selling well at this new price point, and that the install base will grow to more than 6 million units by year-end.

Microsoft's Xbox ended the month of September with an install base of about 6 million units. We project the install base of this console to grow to about 8 million by the end of this calendar year. At the end of September, the GameBoy Advance had a US install base of 15.7 million units. We now expect the install base of the GameBoy Advance to hit 18 million units by calendar year end as a result of the success of the SP.

In conclusion, the install base of current generation hardware is significant and growing. Today the install base is more than 100 percent larger than at the same point in the last console cycle, despite the higher average price point for the current systems. The lack of further hardware price cuts in this holiday season by the first parties does give us reason to believe that calendar 2004 should be a stronger than previously expected year for hardware.

Moving to software now, we define our market to include all major platforms in North America and Europe and we exclude Japan. Since our call, demand for software has somewhat weakened and we're reducing our expected growth rate for the North America and European software markets combined to about 8 percent for this calendar year.

Looking at the market segments, we're projecting growth of 10 percent for the total console market, including software for both the past and current platforms. This is down primarily due to the lack of hardware price cuts by Sony and Microsoft. The combined growth rate for the console and handheld market is also projected to be 10 percent and, adding a flat PC market, the expected combined growth rate for the console, handheld, and PC videogame software markets becomes 8 percent.

With respect to software pricing, it's still a risk factor. While we expect AAA console product launch pricing to hold at $49.99 through the holidays, we're concerned about price declines for second-tier or underperforming titles. However, our operating plan is designed to provide for that scenario.

Looking to our fiscal '04 outlook, we're increasing our revenue expectation by $30 million to $780 million. This increase is driven by the revenue over performance in Q2 and an increase in revenue expectation for our Q3 lineup, partially offset by the movement of DOOM 3 into fiscal '05.

Turning to the bottom line for fiscal '04, we would have raised our EPS outlook had we not made the decision to eliminate a number of low potential propositions in development for fiscal '05 and '06. This decision will result in a onetime pretax charge of $23 million or 16 cents per share on an after-tax basis. We've also adjusted our numbers to reflect the movement of DOOM 3 into fiscal '05 and now expect EPS of 34 cents for fiscal '04, which includes the after-tax effect of the onetime charge.

We are executing a realignment of our project portfolio, driven in part by the evolution of the videogame market and the increasing dominance of big propositions driven by strong brands backed by high-quality products and marketing campaigns. In view of this market scenario, we recently completed a comprehensive review of our product portfolio in which we evaluated each project on a number of criteria including the strength of the franchise, the projected product quality, the potential responsiveness of the project to aggressive marketing support, and the financial downside in case of project failure.

What we found was that we have an extensive slate of high potential properties in development, including Spider-Man 2, Shrek 2, and DreamWorks’ A Shark’s Tale. However, we also found that certain projects had a lower likelihood of achieving exceptional levels of operating performance and that continued pursuit of these projects would create a substantial opportunity cost as it relates to our slate of high potential projects.

Accordingly, we have cancelled the development of 10 projects, which include the previously announced titles -- Trinity, Shaun Palmer's Pro Snowboarder II, and Street Hoops II. The resulting onetime charge of $23 million consists predominantly of capitalized software expense, all of which will be charged in the third quarter. We have a lot of confidence in our upcoming slate and the project realignment will enable us to focus and increase our resources, both financial and personnel, on projects with the highest probability for success and the highest levels of return. We also believe this reduces the risk and increases the potential for upside associated with our strong slate of future products.

Our decision was reinforced by the positive response we have received from consumers and retailers to our current holiday lineup consisting of a few high-quality titles backed by aggressive marketing programs. Now for fiscal '04 we expect manufacturing and distribution costs of 51.1 percent of new revenues, with operating expenses, including royalties, and a special charge of 43 percent. We project interest income of 0.6 percent. The fiscal '04 tax rate should be 35 percent, which will hold constant for each of the quarters, and our fully diluted share count will be 96.3 million.

For the third quarter of fiscal 2004, we're increasing our revenue outlook by $30 million to $390 million, making it the biggest quarter in the company's history. We're also adjusting our EPS outlook to 45 cents to include increased expectations from the holiday lineup and the impact of the 16 cents onetime charge.

Quarter to date we're pretty enthusiastic about our recent product launches, however we remain cautious given the mid quarter change in retailer inventory management we experienced last year. As you may recall, last year there was a fair amount of optimism early in the quarter which proved to be short-lived as retailers pulled back on the replenishment of many titles, sometimes not even reordering top-selling titles. We're not saying that this is going to happen again this year, but we still have a lot of product to sell between now and the end of the quarter.

Going into this year's holiday season, we do feel more confident about the quality of our product lineup and the marketing opportunities we will have available to us. Almost a year ago, we outlined our plan to improve product quality, and you are starting to see the benefit of that focus. In terms of marketing, we're supporting our big propositions with high impact marketing programs, which include massive in-store promotion of our entire holiday lineup, and heavy national TV and in-cinema advertising.

Our first release this quarter was Empires: Dawn of the Modern World, a state-of-the-art real-time strategy game for the PC that launched to solid reviews on October 21st. Next out of the gate was the all new totally redesigned Tony Hawk's Underground. Prior to launch it was a bit difficult to gauge the acceptance level off the game's new direction, but initial reviews suggest that Tony Hawk will remain one of the highest-rated franchises of all time. We are aggressively supporting the franchise with the largest marketing program in Activision's history. We have high expectations for Tony Hawk and expect it will be one of the holiday's best-selling franchises, both domestically and abroad.

On October 29th, we launched Call of Duty for the PC created by our recently acquired studio, Infinity Ward. The title has been getting the highest accolades from the gaming community. The game was recently featured on the cover of the coveted December issue of PC Gamer magazine, which characterized the game as the year's best shooter and awarded it a 93 rating. All this bodes well for the console version of the brand, Call of Duty - Finest Hour, which is a completely new game, not a port, and is scheduled to release next fiscal year.

On Tuesday, this week, we launched our final product offering for this holiday season, True Crime - Streets of L.A. We put a lot of time and effort into this title, and we were very pleased by pre launched interest it has received. In fact, True Crime had the highest retail presell numbers in our company's history. It's very difficult to establish new franchises. But with True Crime and Call of Duty, we might have the opportunity to do so and we're going after it with big marketing programs. This also means that we have significant expectations for these propositions and, as a result, they remain our biggest risk factors for the quarter.

To finish with our outlook for the third quarter, we expect manufacturing distribution costs of 48 percent of net revenues with operating expenses, including royalties and a charge, of 35 percent. We project interest income of 0.3 percent and a fully diluted share count of 96.6 million. For the fourth quarter, there is no impact from the onetime charge and we now expect revenues of $114 million and a loss per share of 5 cents. This is lower than our previous outlook as a result of the movement of DOOM 3 for planning purposes now in fiscal '05, and this is partly offset by increased catalog expectations.

Titles slated for release in the fourth quarter are Pitfall, on multiple platforms, Tenchu for the Xbox, and our motocross game, MTX - Mototrax. MTX is an exciting fast-paced game that you can preview by a playable demo on Tony Hawk's Underground for the PlayStation2, which should create a lot of awareness for the title. For the fourth quarter, we expect manufacturing and distribution costs of 55 percent of net revenues, with operating expenses, including royalties, of 52 percent. We project interest income of 0.6 percent and a basic share count of 90 million.

In conclusion, fiscal '04 can be characterized as a year of improving our processes and realigning our project portfolio and resources with the key factors for success in the videogame market as we see them evolve in the years ahead.

Looking now to fiscal '05, we believe we have a slate in development with outstanding potential. As a result of the steps announced today, we'll be able to focus our time, energy, and marketing dollars on big propositions such as Spider-Man 2, Shrek 2, A Shark's Tale, Lemony Snicket, DOOM 3, Call of Duty for the console, Rome - Total War, and Peter Molyneux's The Movies. We look forward to updating you on our progress and outlining our plans for fiscal '05 in greater detail on our next conference call. Thank you all for joining us. Operator, we will now open the call up for questions.

(CALLER INSTRUCTIONS) Anthony Gikas of Piper Jaffray.

A couple questions. Could you give us a little bit more color on what you're hearing from retailers for the holiday season here coming up? And then also, looking to next year, do you expect that sales and marketing expenses should increase materially as well as product development as you start development for new handheld and forward-looking platforms? And then I have a follow-up.

Let me start with the retail color commentary you asked for. I'd say a couple of things. In the US the September/October market was a bit slow, but store traffic does seem to be picking up in recent weeks. Customers seem cautiously optimistic about the holiday season in general. However, they're also I would say unanimously concerned about the difficulty of comping last year with the success of Vice City. All customers seem to be managing their inventories quite carefully at this point going into the season, not everybody did that last year. That caused some problems. But I'd say that if November releases perform well, we shouldn't see the kind of problems that we saw last year. On the other hand, if the November releases do not perform, then we could see a repeat of some of the issues we had last year. So we're moving into a very critical number of weeks.

How would you characterize your conservatism going into the quarter to avoid what happened last year?

We always try to be appropriately conservative. We feel that we've done that again. But it is up period of the year that's very difficult to forecast.

Okay. And then the sales and marketing and product development looking forward -- ?

It's too early for us to comment on that now; we're going to discuss our fiscal '05 plan in the next call.

Okay, thanks.

Edward Williams of Harris Nesbitt Girard.

A couple questions for you. First of all, can you tell us what you're expecting your cap software number to be at December 31, given the $23 million charge your expected amortization and what you expect to add to the balance?

Ed, we would like to answer that on the basis of the end of the fiscal year, March 31st. We're going into a part of the year where we typically see amortization exceed the capitalization rate because of the release schedule. But we also have a fairly light schedule in Q4. So what we're expecting, including the charge, is that we will end the fiscal year at about the number that we are on September 30, and that's 87 billion.

Okay, and can you also comment a little bit about how much capital you've currently committed to your structured buyback program?

Let me get a piece of paper on that here. Yes, we have about 36 million outstanding at this point.

36 total?

That's the structured repurchase deals that are outstanding.

Okay, and then one final question. The Infinity Ward transaction, can you quantify what you paid for it, either in cash or stock?

We are not going to, because we don't have to, disclose the amount that we paid. It was a good deal for the company. I also think it was a good deal for Infinity Ward. We're very pleased with the acquisition and I believe that feeling is mutual. They've obviously delivered a fantastic game in Call of Duty, launching a new franchise with us that we hope to successfully take on to the console. So we're delighted with the acquisition.

Can you tell us if it was a cash transaction or stock?

We're not going to disclose that.

Okay, thanks.

Heath Terry of CSFB.

Can you talk a little more specifically about the process that you're going through in determining which products get cut, which ones are going to stay in development? You've obviously reduced the SKU count. It sounds like you're reducing the SKU count for the second year in a row. What do you think the right number for the company on a run rate basis is going to be? And is there a plan to grown internally versus externally, if indeed you are going to grow it?

All right, let's start with the question about the process we went through in doing this strategic project realignment. We really decided to realign our project portfolio because the videogame market is increasingly dominated by big propositions involving big franchises, high-quality products and massive marketing programs. And, as we move into the later years of this hardware cycle, we expect the domination of big propositions frankly to strengthen. And recognizing that, we evaluated the entire product portfolio. The company assessed the likelihood of each project achieving acceptable returns.

We did that through a comprehensive process that used a lot of different criteria. Some of those were criteria like -- does the project involve a big franchise? How strongly to we feel about that franchise? Will the project result in a top-quality product? Does the project's scope merit aggressive marketing support? What's the financial downside of the title? And so forth. So to comprehensive process, we feel good about having done that in that it showed us that we have some very strong high potential titles in our portfolio, but it also showed that we had some that were not high potential and we've taken the steps that we've announced today with those.

Your question about the right number of SKUs, this action, after taking these titles out of our slate, means next year we are currently looking at about 50 titles going out and we feel that's a good number. It's more about quality than it is about quantity. And we've certainly experienced that in this holiday season, given the very positive reaction that we've gotten to our focused slate, only a few titles. I forget your last --.

It was just whether or not the focus is going to be -- to what degree the focus is going to be on internal development?

Our strategy in that area is generally that we'd like to see about two-thirds of our revenues being generated by internally developed products, and we think that mixes the benefits of internal versus external well, so we will continue to follow that strategy.

Great, thanks.

Jeff Goverman of Pacific Crest.

Can you give a little bit more color on DOOM 3 and (indiscernible) in there? And is Quake IV still next year?

DOOM 3, really we've given you all the information that we can give. It's, for planning purposes, no longer in the fourth quarter, which is what we indicated at our last call. We're now assuming that it's going to launch in our next fiscal year. At our next call we'll probably tell you which quarter, but we're at this point simply indicating that we expect it to be in the next fiscal year. And its software makes the launch decision; we're simply trying to plan for what we think will happen.

Quake IV is an unannounced release date, and we have no news on that. We will give you an update on the entire slate for next year in the January call, but we've really given you most of titles already in the summary that we listed.

Okay, thanks.

Arvind Bhatia of Southwest Securities.

I guess the 10 games that have been canceled and the charge that you took, about 22 million, can you remind us what the charge was for the -- I believe it was 20 games that you talked about canceling earlier in the year? Was the charge -- can you talk about what the charge was at point?

There's no charge. We did, as a matter of general course, cancel some games in the past. The number 20, I don't know where you get that. There's no such thing. So this -- we had a charge 3.5 years ago where we did a mid (ph) restructuring of the company and since then have not had the charge.

And I'm going back to your January conference call, I think you had cut down your SKUs at that point. So at that point did the expense for that go through your income statement or was that a charge?

There was no charge at that time. We moved some titles out and we also had a couple of smaller cancellations, but we did not have a special onetime charge that was associated with that.

Okay. And then you talked about the marketing budget for Tony Hawk being one of the biggest. Can you quantify that? And then, can you also talk about True Crime and what sort of marketing spend you're doing there vis-a-vis the Tony Hawk marketing spend? Is it larger than that or his it less or about the same?

We indicated that the Tony Hawk marketing campaign is the biggest marketing campaign ever fielded by Activision, and that's about all we can say about it for competitive reasons. We don't want to disclose more details than that, but we're excited about the program and think it's not only the biggest but also the best program that we've ever fielded. On the True Crime side, you can infer from what I said about Tony Hawk that the spending there is less than what we're spending on Tony Hawk, but it's still a very sizable marketing campaign. And again, we feel that it's a great campaign and are excited about it. We like the commercials. We like the program overall.

So the SKU count this year looks like it should be about 40, is that right?

That's correct.

So you're going from 40 to 50 next year is what you're saying?

Yes.

And you mentioned several brands coming out, I think, if I wrote down all these correctly, about six or seven of those. So we should assume that most of these are going to be on multiple platforms then?

Yes.

The titles that we mentioned, those will be multiplatform (indiscernible).

And of course some PC titles.

And some PC titles. And for planning purposes next year would you expect distribution business to be any different than what you're seeing in this year? As (multiple speakers) as your total?

No, we'll really get into the details in next year's plan at the next call, Arvind.

Got it. And did you guys mention the reserves for the quarter?

Yes.

Yes, we did.

I'll go back and look at it. What was the cash flow from operations?

It was a --.

A negative 28 million for the quarter.

And last question on -- Shrek, Spider-Man 2 as well, are these games coming out day on date with the movies or do you think Spider-Man will come out maybe a little bit before the launch of the movie?

That's still subject to discussion with the studios involved. We don't know yet. But obviously the objective is to be there right with the launch of the movie and in some cases we'll try to be there a little earlier.

Got it. Thank you.

Ian Corydon of B. Riley & Co.

Looking at the '05 slate, is there a chance that you could see some games movie into '05? Specifically I'm thinking about Fantastic Four and maybe the next Tony Hawk title.

We've given you all the information on our slate that we can at this point, so we're going to give you more detail, more color on the slate for next year at the next call.

Alright. And when could we expect sequels to, say, True Crime and Call of Duty, beyond obviously the Call of Duty for the console that we're seeing in '05?

Same answer. At this point we just launched these titles and we're still learning a lot about how people react to them and, of course, how well they're performing in the marketplace. So it's premature to get into a discussion about sequels on them.

Do you have sequels in development?

As I said, it's premature to get into discussions about sequels on them.

Okay, and then what was catalog for the second quarter and what do expect it to be for the third-quarter?

Catalog for the second quarter was about a third, 33 percent of consolidated net revenues. That should be substantially lower in the third-quarter, more in the mid teens as we're launching lots more bigger, new products.

All right, last question. What was cash spend on software development and IP?

Do you have that, Bill?

For the second quarter? It's $25 million for software development.

Thank you.

Keith Gay of Thomas Weisel.

Call of Duty on console, you mentioned it's not at port. Does that indicate there's still some significant development left? It sounds like you've got a very solid PC title. Does that mean you're just working on added features at this point? Can you give us a little sense of that?

It's (indiscernible) completely different game, so it's not a port. It's not a version of the PC title; it's a completely different game with a different storyline.

Different development team

Difference development team, all of that.

On the games canceled, as you go through that decision-making process, do you feel like you're sacrificing anything that was out there in the farm system or does this indicate that you may have more development in reserve, if you will?

Not sure I follow the question.

Well, the fact that you are sacrificing some of these titles for next year, does that indicate that you have some development in reserve, given that you've got a pretty strong lineup now going into fiscal '05 already?

We feel we had a big lineup, and that was one of the reasons why we took such a close look at the portfolio, thinking that perhaps it was too big and that we were spreading ourselves too thin and potentially setting ourselves up for the risk of getting distracted by secondary propositions when we had such big propositions that, if we execute those well, should perform very well for us next year. So we feel that even after this reduction of our slate next year, we're still looking at 50 very promising titles that we think now we can execute better and focus on more.

Okay. And can you give us -- what's your latest thinking on PS/2 price cut timing? And also, can you discuss what efforts you have with respect to PSP and what your expectations might be there for next year?

I think generally people are expecting a price cut on the PlayStation2 around 83 (ph). We'd be above them. As far as the PSP is concerned, we're heavily into evaluating our participation on that platform. We will very likely participate on it. But we also still want to complete the evaluation process and the planning process before we publicly commit ourselves in that area.

So you haven't started any real development effort there yet?

We're still evaluating.

Thank you.

Stewart Halpern of RBC Capital Markets.

A clarification on your guidance, and then I've got a follow-up on the write-down. Based on your comments, is it fair to assume that your guidance for the December quarter assumes substantial reorders of True Crime and (indiscernible) from what you've shipped in already?

Well, we said that we still have a lot of business to do between now and the end of the quarter. So you can infer from that we are expecting reorders across the floor on all the titles that we shipped.

Okay. And then just following-up on the break down, a couple of things first. So, the 23 million specifically relates to 10 products and 10 products alone, right? It's no more than the 10?

It's just products.

And so none of those titles will ever see the light of day, they're all canceled?

That's correct.

Okay. And then just finally, just out of curiosity, (technical difficulty) doing the writedown in the third quarter as opposed to the second quarter, could you just help us understand better the accounting principle that leads you to do it in Q3 versus having done it when you closed your books for Q2?

We had not made these decisions by the end of the second quarter, so therefore you cannot book it in the second quarter.

It is in the past couple of weeks that you made the decision, then?

Correct.

Jeetil Patel of Deutsche Bank.

A couple of questions. First of all, with the focus to product quality -- which I think is the right approach -- can you characterize the quality of the lineup for fiscal 2005, compared to what you have out there for the current December quarter? Do you think it is as high a quality, slightly lower, given you've got a larger slate, higher quality? How would you characterize it?

Secondly, can you talk about with this shift towards quality, do you think that you could get operating margins back up into the 20 to 25 percent range as you execute on the strategy over the long haul? And then I have a follow-up to that.

First about fiscal '05 quality, I would say we have learned a lot in the last year. We are applying that learning to creation of the games for next fiscal year. We see the potential in the slate, the potential to deliver high-quality games, but there is a tremendous amount of work that goes into creating the kind of quality that you're seeing in our slate for this holiday season. And I think it is something that we still have to prove to ourselves before starting to say that we are sure that we can do that next year.

So you will get updates on that along the way, but it is a significant challenge. As far as the operating margin is concerned, you used some fairly stratospheric numbers. We have never been in the 20 to 25 percent range. Excluding the charge this year, we are at about 9 percent. We would like to get back to about 12.5 percent in the next 2 to 3 years, and that is our focus.

As a follow-up, it looks like you are increasing titles by about 25 percent from fiscal '04 to fiscal '05, and given the shift that you are making from quantity to quality and the transition you have been through over the past couple quarters, would you characterize a 25 percent title growth to translate into a 25 percent unit growth, given a higher quality lineup out there?

And second, just as a follow up, as you look at quality, what should we look as in terms of sell-through with a specific title that indicates success? Is there a unit threshold we should consider, 200,000 unit, 400,000 units, or 100,000 that we could point to as a successful franchise for you that you can build off of?

I would say on your first question if we have 50 titles next year and 40 this year, does that imply a 25 percent growth rate? The answer is it is too simple a model. There's too many things floating around. For example, next year we have a significantly large number of GBA titles. They tend to be smaller then full-console titles, so I would not go to that conclusion. I would actually give us some time until January to give you more of a precise breakdown and our own outlook in terms of what we expect next year.

Your second question, is there a unit threshold? We do not really use one. Again, it comes out to the same thing of talking about PC or console. The financial dynamics are very different. So we are really looking at it on a title-by-title basis, and internally owned IP obviously very different from a licensed IP. So there is no simple answer to your question.

Mike Wallace of UBS.

A couple of questions. First, the charge. Is that 10 games or 10 SKUs?

Games.

And how come this is classified as a onetime charge? Last year when you had some inventory issues it was just the cost of doing business. Is it because these games have not actually shipped yet?

They have not actually shipped, and it is also, in our view, a very strategic intervention that is being done to set the company up to be more successful in the future. And it is an order of magnitude bigger than anything we did in previous quarters.

How much is left in the buyback? And did you buy any stock in the quarter?

We did not buy any stock in the quarter. 191 left.

191, Okay. And I know you don't want to give guidance next year. Maybe we can talk about the market. If it is high-single-digit software growth this year, what is your thinking about the market next year? Can we get some flat, or is it slightly down?

We're going to give you our opinion in January on that, too. We would like to see how this Christmas season falls in the way of hardware, and then see what happens on the pricing front, too. But theoretically the fact that now more likely we will see price cuts next year should help the hardware market versus our previous set of numbers. But before giving you more specific answer, we would like to see this Christmas season play out.

Just one more question. You probably won't be able to answer. What is your confidence level in the PSP actually getting out on time? I think originally they were talking about dev kits going out in September. Do you have any feel when those actually show up and can this thing get out next fall?

Which title were you asking for?

PSP.

Oh, the PSP. We're still getting a lot of information on it, Mike. We're still evaluating our level of participation on the platform. We will likely participate, but like you, still some questions here about those kinds of things. So we're still learning and do not have the answer to your question

Okay, thank you.

Thank you all for joining us today. We look forward to talking to you after we get through our holiday season, and we will give you an update on next year in late January. Thank you.

Ladies and gentlemen, thank you for your participation and this concludes your conference for today. You may disconnect at this time, and have a good day.