動視暴雪 (ATVI) 2005 Q1 法說會逐字稿

Good day, everyone, and welcome to this Activision first-quarter earnings release conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn today's call over to the Vice President of Investor Relations, Kristin Southey. Please go ahead, Kristin.

Good afternoon and thank you all for joining us today for our first-quarter fiscal 2005 conference call. My name is Kristin Southey, Vice President of Investor Relations.

I will start today's call with a review of our Safe Harbor disclosure, followed by comments from Bobby Kotick, Chairman and CEO, and Ron Doornink our President, after which we will take your questions.

With regard to our Safe Harbor disclosure, I would like to remind everyone that the statements made during this call that are not historical facts are forward-looking statements. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties. The Company cautions that a number of important factors could cause Activision's actual future results to differ materially from those expressed in any such forward-looking statements. Such factors include, without limitation, product delays, retail acceptance of our products, industry competition, rapid changes in technology and industry standards, protection of proprietary rights, maintenance of relationships with key personnel, vendors and third-party developers, international, economic and political conditions, integration of recently acquired subsidiaries and identification of suitable future acquisition opportunities. These important factors and other factors that potentially could affect the Company's financial results are described in our filings with the SEC, including the Company's most recent annual report on Form 10-K and quarterly report on Form 10-Q.

The Company may change its intentions, beliefs or expectations at any time and without notice, based upon any changes in such factors in the Company's assumptions or otherwise. The company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Now, I would like to introduce Bobby Kotick, our Chairman and CEO.

Thank you, Kristin. June was another great quarter. Solid execution worldwide resulted in the highest first-quarter net revenues in our company's history. The success of Spider-Man 2 and Shrek 2 provide even greater confidence for the remainder of the fiscal year and the future of both these important franchises.

We continue to increase our scale and strengthen our global competitive position. Our leadership can best be measured in the numbers -- 12 years of consecutive revenue growth, the last four years with expanding operating margins, over $0.5 billion of cash and for the trailing 12 months, a 30 percent return on invested capital.

We also measure the strength of our business by the power of our product portfolio, which has never been stronger. Over the past few years, we strengthened our slate of reputable franchises with global appeal. These include Tony Hawk, Spider-Man, True Crime, Call of Duty and Shrek.

In the last nine months, all five of our internally developed titles have shipped over one million units with 3 shipping over 3 million units. Equally important, two of the five are new, wholly-owned franchises assigned as a collaboration between our studios and our brand-management organization is working exceptionally well.

Leadership in our industry and superior financial results come from a portfolio of intellectual properties and the consistent ability to develop high-quality games based on these properties so as to generate meaningful revenues and profits every year. Activision continues to demonstrate that ability. We continue to grow our franchise portfolio and our game ratings reflect the continued focus on developing high-quality game play.

In the first quarter, we focused our efforts and resources against two important franchises, Shrek 2 and Spider-Man 2, with the goal of expanding worldwide consumer awareness and consumption for these products. We were successful in driving incremental sales of these titles by utilizing the large-scale focus retail and consumer approach. Today, we announced that our wholly-owned studios and the marketing teams that capitalize on these power franchises are already hard at work on sequels, and we expect these franchises to contribute meaningfully to our scale and profitability for many years to come.

Driven by our strong lineup and the ever-growing worldwide install base of hardware, we have greater confidence in the fiscal year financial results as well as our future financial results. Later in the call, Ron will share the specifics of our increased financial outlook with you.

Our slate for the balance of the year is impressive and includes DOOM 3, Shark Tale, Call of Duty and Tony Hawk's Underground II, and of course, continued sales of Shrek and Spider-Man.

Given the strength of our slate, we expect another record year of revenue, margin expansion and record earnings. The achievements of our fiscal '05 operating plan would result in our 13th consecutive year of revenue growth and our fifth consecutive year of operating margin expansion, which as you know is a Company-wide focus.

As we look to fiscal '06, our release schedule is strong and growing. We have great product visibility with sequels to our all-time best-selling franchises, including True Crime, Call of Duty, Tony Hawk, Spider-Man, Quake, Shrek and Cabela's. We also have three exciting movie-supported releases, Marvel's Fantastic Four and Iron Man, and DreamWorks Madagascar. As our Spider-Man success demonstrated, our organization did exceptionally strong in the execution of creating highly-rated games based on Blockbuster movies and leveraging the marketing programs of our movie studio partners and in particular, our friends and partners at Marvel.

Our market is expanding -- in addition to our already strong fiscal '06 slate, today we are announcing a new original property we are developing in our wholly-owned studio, Neversoft. Neversoft, as you might know, is the creator of our Tony Hawk franchise. In the last five years, we have released six titles from this studio, each of which has sold in excess of 2 million units. Neversoft is recognized as one of the world's best development teams and the new title, which has been in development for some time and will be released in fiscal '06, is likely to become another important franchises for us to leverage far into the future.

Our continued success in building and exploiting our franchises is the key to expanding our operating margin and increasing our return on invested capital. Another area of focus that should provide operating model improvement is expanding our international publishing reach to ensure greater realization against our fixed product investments. The European market represents a major growth opportunity for us and with the globally appealing portfolio of franchises we have, we are increasing our emphasis on European growth, adding staff and resources in countries that today are served only by third-party distributors.

Most these conference calls provide a financial update of the quarter and the fiscal year. While many of the participants on the call today are familiar with our industry and many the opportunities that lie ahead, there are a growing number of new investors who are not. We thought it would be useful to provide a glimpse into the future and share our enthusiasm for the growth and increasing financial returns we believe lie ahead. We about to begin a new cycle of opportunity, driven by the introduction of hardware devices like the Sony PSP and the Nintendo DS.

While the Game Boy dominated portable market has been lucrative, it has never captured an older demographic. A high percentage of our console and PC revenues come from that older demographic and yet these gamers have been absent as portable consumers. We believe the production values, features and designs of these new handheld systems are likely to expand the portable gaming market significantly. Our franchises and our development expertise will allow us to capitalize on these new market opportunities.

Likewise, as wireless devices become more capable of delivering rich media entertainment, games based on the franchises we control are likely to fuel significant increases in usage for wireless carriers around the world. Within the next few years, new console systems from Sony, Microsoft and Nintendo will energize the business. The real-time rendering capabilities of these devices blur the lines between television, film and games and the planned online features will allow players to interact with each other around the world. Eventually, they will be able to hear and see each other, chat with each other through integrated instant messaging, compete in tournaments, win prizes and be recognized for their gaming skills. As gaming evolves from primarily a solitary form of entertainment to a much more social one, we will see growth in the user base and we will profit from it.

With games capturing greater percentage of the leisure time, the opportunities to add advertising and sponsorship revenues will also grow. Several months ago, we announced our advertising initiative with Nielsen. Needless to say, we are excited about the prospects of further expanding our operating margin through the integration of advertisers and sponsors looking for ways to reach the elusive 18 to 35 year-old in a measurable, targeted fashion. Last year, young men in the U.S. spent over 30 billion hours playing games. Advertisers, however, spent relatively small amounts of money in games compared to the $8 billion Nielsen estimates they spent to reach the same consumers via television. We expect, over the next few years, to be able to capitalize on the opportunities that will arise from advertising and sponsorship and having a measurement system that Nielsen provides in a language that advertisers understand.

To our stakeholders' benefit, Activision's protective mote is widening. The barriers to entry in our business are higher than they have been. Whether it be the capacity to develop great games, having control over important franchises, or the ability to successfully market and sell games around the world, there are few companies better positioned than Activision to take advantage of the positive fundamentals of the videogame business.

Our market continues to expand thanks to this every-increasing install base, these new portable devices, sales increasing outside of the U.S., the improvements we expect in online gaming and the overall improvements in production values. We believe our margins will continue to expand as a result of our franchise strength, the continued introduction of new franchises, greater international penetration and the overall operating model leverage that comes from scale. Additional margin expansion is likely to come from the initiatives, like the advertising and sponsorship initiatives we just talked about.

The June quarter financial results, while impressive, highlight the financial opportunities we have today and are a great indicator of the continued financial performance we expect in the future.

Ron will now share with you highlights of the quarter and provide an increased revenue and earnings outlook for the balance of the fiscal year.

Thank you, Bobby. For the quarter ending June 30, net revenues increased 33 percent year-over-year to $211 million. Our net revenues were the highest of any non-holiday quarter in our history. We had earnings per share of 8 cents compared to earnings per share of 3 cents last year.

Our revenues for the quarter were driven by the record-breaking performance of both the publishing and distribution sides of the Company. Top-selling titles through the quarter were our big proposition -- Shrek 2 and Spider-Man 2 across all platforms.

Since its launch in May, Shrek 2 has been selling well worldwide. Domestically, it was the Number One selling title in May across all platforms and in June, it was the Number Two best-selling title across all platforms, second only to Spider-Man 2 (indiscernible) NPD.

For comparison purposes, during the quarter, Shrek 2 outsold the most recent successful animated E-rated movie title by 50 percent for the comparable U.S. release period despite the higher wholesale price. Shrek 2 has also topped charts internationally, ranking as high as the Number Three overall franchise in the UK per chart track. Shrek 2: The Movie already ranks as the fifth-highest grossing U.S. movie of all time and should continue to fuel excitement and awareness for our products well into the holiday season, as well as extend the life of their property long into the future.

Spider-Man 2 the game was released on June 29 here in the U.S., one day before the theatrical release. The movie is of high-quality and to date is on track to outperform the original. The game is also of high-quality and to date is on track to significantly outperform the original. In terms of game quality, Spider-Man 2 currently ranks as the highest-rated PS/2 movie game of all time, surpassing our own Spider-Man 1, which had previously held that record.

In terms of performance, in the first 8 days of release, we have shipped more than 2 million units of the Spider-Man 2 game in North America alone and we estimate that more than half of these units sold through in the first three weeks. We project that Spider-Man 2 has outsold Spider-Man 1 almost two-to-one in North America for the comparable release period.

In the month of June, with only five days of sell-through, Spider-Man 2 ranked as the Number One selling title across all platforms as measured by NPD.

Internationally, the title has just begun selling and already hit the Number One spot on the UK and Australian charts. Overall, the end market results for Shrek 2 and Spider-Man 2 continue to confirm that our single-minded focus on big propositions is working.

Turning to the financial results, in the June quarter, our manufacturing and distribution expense was 42 percent of net revenues, an improvement of 600 basis points versus last year, due to revenue mix differences. Operating expenses for the quarter, excluding manufacturing and distribution expense, were 50 percent of net revenues, roughly in line with prior year. Product creation costs, which includes software and IP costs and development expense as percentage of revenue, were in line with last year. Sales and marketing expenses in the quarter were significantly higher than the prior year, as we are putting more marketing muscle behind our big propositions. In this quarter, we did just that for Shrek 2 and Spider-Man 2. We believe this will help to ensure continued success of these franchises through the remainder of the fiscal year, and it helps set up the success of their sequels, Shrek 3 and Spider-Man 3.

Looking at the balance sheet, on June 30, we had $539 million in cash and short-term investments, an increase of $149 million versus last year and down 49 million versus the prior quarter. The decrease versus the prior quarter was due mainly to the June 29th release of Spider-Man 2, which pushed up our receivable and inventory balances. If you exclude the changes in receivables and inventories, our cash balance for the quarter would have increased by $25 million.

As of June 30, we had $705 million of working capital, an increase of $256 million, or 57 percent versus last year. The Accounts Receivable balance on June 30 was $123 million, up 90 million versus last year, due to the timing of releases. The AR reserve of $48 million was up $1 million versus March 31st. The AR reserve as a percent of gross receivables equals 28 percent, which is lower than the last quarter due to the high AR balance -- again caused by a concentration of sales at the end of the quarter. For the same reason, this quarter's DSOs of 53 days were higher than our previous four-quarter average of 30 days. Over the next few quarters, we would expect DSOs to trend back closer to our four-quarter average.

Inventories on June 30 were $40 million, up 14 million versus March 31st. Of the 40 million, less than 50 percent, or 18 million, relates to our publishing business with 22 million of inventory relating to our distribution business. Our publishing inventory is up due to the timing of several key releases and we feel very good about our inventory position, both in the warehouse and at retail, knowing that these titles are selling very well.

Capitalized software development costs on June 30 were $97 million, up $11 million versus last quarter as expected, given that we are getting deeper into development with our strong fiscal '06 slate. On June 30, capitalized intellectual property licenses were $33 million, down $16 million versus last year, which relates to the release of both Shrek 2 and Spider-Man 2.

Now, I would like to share our thoughts of the overall market, beginning with our hardware estimates. At the end of June, the install base in North America for current-generation systems, including handheld, was 62.9 million units. For calendar year end 2004, we have not changed our projection at the install base of hardware, including handheld, will grow to 73 million units.

Looking at each system individually, the PlayStation 2 ended the month of June with an install base -- I'm sorry, 24.2 million units. We believe it will end the calendar year with an install base of about 28 million units.

Microsoft's Xbox ended the month of June with an install base of 9.2 million units, and we are expecting it will grow to 11 million units by calendar year end.

We believe that the GameCube will grow from 7.6 million units at the end of June to 9 million units by year end.

At the end of the quarter, the Game Boy Advance had a U.S. install base of 22 million units, and we expect the install base of the handheld market to hit 25 million units by calendar year end.

We are currently in development for the Nintendo dual-screen and the Sony PSP platform, which are expected to launch in late 2004 and early 2005, respectively. As of now, we have very modest expectations in our fiscal '05 financial projections for these devices. Longer-term, however, we do see them becoming significant contributors.

In conclusion, the install base of current-generation hardware is significant and growing. This year, both Sony and Microsoft implemented price reductions and our installed base expectations do not assume any additional hardware price cuts in this calendar year.

Moving to software, we define our market to include all major platforms in North America and Europe, and we exclude Japan. For calendar 2004, we have not changed our outlook and expect a combined North American and European software market for current gen consoles, handheld and PC to be up by about 8 percent.

Looking at the market segments, we are projecting growth of about 10 percent for the total current generation console market, which is defined as the PS/2, the Xbox and the GameCube. The combined software growth rate for the current gen consoles market and the handheld market is projected to be about 8 to 9 percent. When you add a PC market that we expect to grow modestly, the combined growth rate for current gen console, handheld and PC videogame software is roughly 8 percent.

With respect to software pricing, to date, premium pricing for AAA launched titles has helped. In terms of our pricing assumptions for the balance of fiscal '05, we are planning that our slate of console product will have launch pricing of $49.99 through the holiday season. Our plan provides for reserves against a certain amount of price erosion.

Turning now to a review of our key strategic initiatives, as I've mentioned our last call, our fiscal '05 operating plan centers around one key theme, execution. Our performance this year will be driven by focusing our time, energy and capital on the global execution of our big propositions, including Shrek 2, Spider-Man 2, DOOM 3, Call of Duty, Shark Tale, Tony Hawk's Underground II, Rome Total War and X-Men Legends.

Our goal is to end the year with more than ten titles having sold at least 1 million units with four or more reaching multimillion unit selling status. In the first quarter alone, we are off to a great start by achieving multimillion-unit seller status with both Shrek 2 and Spider-Man 2.

Our long-term goals remain the same, increase our scale to expand our operating margin and return on invested capital, as we have done successfully for the past twelve years. Our ability to continue that trend is tied directly to execution and expansion.

As we look to fiscal '06 and beyond, our strategy for growth includes the following areas of concentration -- first and foremost, we will be leveraging our growing stable of established, repeatable franchises such as Tony Hawk, Spider-Man, Shrek, Call of Duty, Wolfenstein, True Crime Quake and Cabela's.

In addition to maximizing our portfolio of proven franchises, we will very selectively invest in the development of one or two new brands each year with franchise potential, as we did successfully with True Crime and Call of Duty last year.

With respect to this particular initiative, we are very pleased to announce today that our own Neversoft Studio has been working for some time now on an all-new game based on original IP. Neversoft is the developer behind one of the industry's highest-rated and most popular brands, Tony Hawk. It also created a great Spider-Man classic title which won Sony's PlayStation Game of the Year in the year 2000.

We are already deep in development with this new property and what we are disclosing today is that the game is slated for release in fiscal '06, alongside a new Tony Hawk game also created by Neversoft. It will bring Neversoft's world-renowned development prowess to a new genre. We believe that the concept behind this game has huge potential and will be exceptionally compelling to video gamers around the world. We intend to invest our capital and energy into this product as if it can be the biggest game of next year.

Our fiscal '06 slate continues to grow. Game quality continues to improve and our worldwide selling and marketing capabilities continue to expand, allowing us to realize even greater returns on our product investments. While most of our forecasted operating profit in fiscal '05 and '06 is derived from proven franchises, we believe that the new title from Neversoft, as well as the movies, a new title from Peter Molyneux, both have strong, new franchise potential.

While we are expanding our international publishing capabilities, today we have our own staff in only seven European countries. We are targeting ten additional countries for expansion over the next few years.

As we look ahead to the introduction of next-generation console and portable hardware, we see enormous opportunity. We were successful in growing our revenues during the last console introductions and our goal for the next transition is no different. Our strategy is two-pronged. First is to maximize the potential of the large install base of hardware of current-generation systems for as long as this yields superior financial returns. Second, we will ensure that Activision has a meaningful launch presence on all new hardware systems with a goal of gaining market share on each system. This is different from prior hardware introductions, as we did not have the same breadth of franchises, product development capabilities, or sales and marketing expertise.

Consistent with our next-gen launch strategy, we have already announced a number of projects with the objective of having one or more proven franchise-based titles at each launch for the Nintendo DS and Sony PSP. Our goal for these launch titles is to focus on top-five potential.

With respect to the new consoles, while we have development efforts underway, we are not disclosing the specific details today but you should know that we plan to have an important launch presence on each of the new console systems.

Before turning to our current financial outlook, I'd like to reiterate that our outlook represents our views as of today and there are a number of internal and external factors that could cause our actual results to differ materially. I refer you to our financial filings with the SEC for a full review of our risk factors.

Today, we are increasing our outlook for fiscal '05, driven by better visibility and confidence in our upcoming lineup. For the fiscal year, we expect revenues of $1.1 billion, up $50 million versus our prior guidance and up a strong 16 percent versus last year. In fiscal '05, we expect to increase operating income by 33 percent, translating into a record 13-plus percent operating margin. For the fiscal year, we expect EPS of 69 cents, up 5 cents versus our prior guidance and up 28 percent versus last year, a year in which we grew EPS a strong 26 percent.

For fiscal 2005, we expect manufacturing and distribution costs of 43.5 percent of net revenues with operating expenses, including royalties, of 43 percent. Operating expenses will be higher than in fiscal '04 mainly due to increased selling and marketing expense.

For the full year, we project interest income of 1.2 percent, a tax rate of 33 percent, which should be consistent throughout the year, and a fully diluted share count of 156.1 million, which is higher than our previous outlook, as we have modified our share count assumptions for the year.

Moving to the second quarter, we are raising our outlook and now expect revenues of $254 million and earnings per share of 8 cents. We expect manufacturing and distribution costs of 42 percent of net revenues with operating expenses, including royalties, of 52 percent. We project interest income of 1.4 percent and a fully diluted share count of 154.9 million.

In Q2, we will release three high quality PC games starting with this year's most anticipated title, DOOM 3. DOOM 3 is set to release the week of August 2 and it will go out at a premium price. The game is of exceptional quality and recently received a 94 rating from PC Gamer magazine. Retailers are anxiously awaiting shipment of Doom and we expect it will be one of the best-selling PC tiles of the year.

With respect to the DOOM 3 Xbox SKU, Activision, for modeling purposes, is assuming that this SKU will be released in the December quarter. However, as you know, its (ph) software makes the actual decision when this title is release, not Activision.

Also due in Q2 is Rome Total War, a real-time strategy game for the PC which is the latest edition in Creative Assembly's award-winning total war series.

During the quarter, we will also release Call of Duty: United Offensive, the expansion pack for the best-selling, critically acclaimed PC title, Call of Duty. The fans of Call of Duty will get ten new levels, which should extend the appeal of the Call of Duty brand.

In late Q2, we will release two console titles. First, DreamWorks' Shark Tale will release in North America approximately one week in advance of the October 1 theatrical release with international shipments planned for Q3. The movie and the game look terrific and DreamWorks has an extraordinary marketing program planned.

The second late-quarter release will be X-Men Legends being developed by our own Raven Studios. X-Men Legends is the first 3-D action role-playing game featuring many of the best-known characters in this very popular Marvel universe. The game will now ship domestically in late Q2 and like Shark Tale, it will ship internationally early in Q3.

On our last call, we offered an outlook for the back half of the fiscal year for modeling purposes and now, with more visibility, I will provide some additional detail. For the third quarter, we expect revenues of $515 million and EPS of 52 cents. We expect manufacturing and distribution costs of 43 percent of net revenues with operating expenses, including royalties, of 34.5 percent. We project interest income of 0.9 percent and a fully diluted share count of 156.6 million.

Drive titles for the holiday quarter include Tony Hawk's Underground II, sequel to the 2003 smash hit, Tony Hawk's Underground, which is slated for release in mid-October. Now, with a five consecutive season track record, over $800 million of cumulative sales, Tony Hawk has proven to be one of the most valuable franchises in the videogame industry. This franchise continues to capture the heart of popular culture. We expect the Tony Hawk brand to approach $1 billion in cumulative revenues this fiscal year.

Also planned for release is the console game Call of Duty: Finest Hour, a new installment of our popular brand. Finest Hour is a completely new game designed to maximize the Call of Duty experience on the console. Based on the early feedback, Call of Duty: Finest Hour has the potential to be one of our most successful fiscal '05 titles and will further enhance the strength and leadership position we occupy in this genre.

Later in the holiday quarter, we will release "Lemony Snicket's A Series of Unfortunate Events" based on the Nickelodeon movie. The movie is scheduled for release in December and we plan to ship the game before Thanksgiving.

We also expect strong sales in the quarter from Shrek 2 and Spider-Man 2. Both titles will benefit from massive DVD marketing campaigns. These two titles will vie for biggest DVD releases of all time, and we will certainly benefit from the overwhelming retail presence these two titles will have this Christmas.

We will also release Vampire Bloodlines, an action RPG for the PC that's being built using some of today's most advanced and exciting technology.

For the fourth quarter, we expect revenues of $120 million and EPS of 1 cent. We expect manufacturing and distribution costs of 53 percent of net revenues with operating expenses, including royalties, of 47 percent. We project interest income of 2.7 percent and a fully diluted share count of 159.8 million.

With respect to the Nintendo DS and the Sony PSP hardware launches, we expect to have at least one title ready for the launch of the Nintendo DS and two titles ready for the launch of the PSP. For conservatism, we are modeling the impact to our financial results to be minor in fiscal '05.

As we break the billion dollar revenue barrier for the first time in fiscal '05, we are seeing the results of many years of focus on building processes that enable the identification of market opportunities and the ability to translate those opportunities into highly rated, commercially successful games. We have institutionalized these processes and the momentum we create in fiscal '05 should continue into fiscal '06 and beyond. Our slate in fiscal '06 has more forward visibility than we have ever had and consists of the most proven, predictable brands married to the very best product development resources we control. Expect sequels to True Crime, Call of Duty, Tony Hawk, Quake, Spider-Man, Shrek and Cabela's.

Complementing these proven videogame franchises are major theatrical event-supported releases based on Marvel's Iron Man and Fantastic Four, as well as Madagascar from DreamWorks. Titles based on new IP include the movies and the new Neversoft title we announced today. Our release schedule, which will capitalize on the largest installed base of current-generation hardware, new hardware introductions and our expanded international publishing capabilities, will help us execute against our stated goal of growth.

While this is an early snapshot for future fiscal years, earlier than we have ever provided, it is the confidence in our franchises, the development efforts underway and our success in executing industry-leading selling and marketing programs that provides the enthusiasm for the future. We have truly elevated our competitive position and our financial results continue to distinguish Activision from its competitors.

We thank you for the opportunity to share our continued success and plans for the future. Now, operator, we will open the call for your questions. Thank you very much.

Thank you. (OPERATOR INSTRUCTIONS). Mike Wallace with UBS.

A couple of questions -- first, the one that I seem to be getting the most is regarding the December quarter with Halo and GTA, so maybe I can get your thoughts on what you think the retail environment is going to be like. Two years ago, a lot of people had problems, in part because of the last GTA. Do you think that and Halo are going to suck up a lot of dollars? What do you think the outlook is going to be for you guys?

The second question -- it looks like you have a lot for '06 and I'm not going to ask you to give guidance, but do you think it's possible to grow your business in fiscal '06 relative to '05?

Let's start with the December quarter. We are excited about the December quarter. It's great to go into the quarter with a lot of momentum that we feel we have that, especially with Shrek 2 and Spider-Man 2. We hope to have that as well with DOOM 3 and some of the other titles that are going out in the second quarter. So, we don't have a tremendous amount -- everything riding on that one Christmas quarter.

We have a great slate also for the third quarter and you know, we are, I guess, boosted by the experience we have with Tony Hawk IV, which went out virtually on top of Vice City and performed very well. It was the second best-selling franchise in the industry in that particular quarter, so we are not afraid of a little competition. We think, in general, we are looking at a second half that looks strong because of a number of great titles. Fortunately, we have a good fair share of those.

As far as fiscal '06 is concerned, we definitely are looking to grow year-over-year. We have grown revenues for twelve consecutive quarters years and it will be our goal for next year as well. It's simply our focus on a number of things that we believe can get us there.

I will mention quickly six key sort of drivers that we have concentrated on. One, we're going to continue to leverage our growing portfolio of established, repeatable franchises. Secondly, we will selectively invest in games based on major movie releases, and we have a nice number of them next year already. Third, we will selectively develop games based on new IP as we did successfully last year with True Crime and Call of Duty, and we've made some announcements about that today. We will expand our international publishing operation. As I mentioned, we identified ten additional countries targeted for expansion. We plan to have a meaningful launch presence on all viable new hardware platforms with the objective to grow our market share, and we're very focused on that. Finally, we're very focused on executing with excellence. I hope you've seen that in our execution of Shrek 2 and Spider-Man in terms of both product quality and timeliness, as well as the marketing execution. Those are the six areas that we focus on in pursuit of our goal to continue to grow the business year-over-year.

I would add, Mike, a couple of things. One is we are in July and I would say, for the first time in twelve years, we are actually having a conversation about the succeeding fiscal year, which ordinarily we wouldn't begin to do until January or February of next year. So, between the control of the franchises and our observations of the products we have in production for fiscal '06, we have a lot more confidence in fiscal '06 than we've ever had in a succeeding fiscal year.

Heath Terry at CS First Boston.

Hi. I was wondering and I realized this is probably not going to be able to get into a lot of specifics here, but if you could kind of give us an idea in terms of the level of development spending that you're going to need for Next Generation, how far along are you? Are we kind of 50 percent below peak levels? 80 percent?

Then in terms of the development spending that is ongoing now, what part of the development organization would you say is devoted to next-gen versus your part of the development organization that's still working on the current platforms?

In terms of PD (ph) expense, Heath, we gave guidance earlier about the current fiscal year, in that we would (indiscernible) current fiscal are expecting PD (ph) expense to be pretty close as a percentage of net revenues, so what it was last year.

Yes, I'm actually not -- I've got that on the actual product development line. I'm thinking more on the amount of cash that's going out, so it's including that amount that's being capitalized on the balance sheet.

I would say, in terms of the balance sheet between now and end of the fiscal, total product creation costs, with the two components being IT and capitalized software, we don't expect it to change much. That can change, of course, as new developments could arise but for now, things being what they are, we don't expect those balances on June 30 to be much different versus the projection for March 31 of next year.

Okay. Then kind of the breakdown in terms of those product creation costs in terms of what's going towards next-gen and what's going to the current platforms?

We said, during the call, we're not really planning on getting into much detail on the next-gen. It's a hot topic, we know, but we have so much of other stuff to cover and for competitive reasons, we kind of want to keep that under wraps for now.

I guess could you talk just a little bit about the environment in Europe right now, given the size of your distribution business over there? How would you characterize it relative to the U.S.? Is it healthier, not as healthy, more in need of a price cut? Less?

It is real strong, we feel. It's stronger than the U.S. You can see that in the year-to-date trends here. We accumulate the equivalent of the NPD data for each of the countries and kind of do an aggregate roll-up of that. That gives us a -- not a very precise feeling for what goes on but a real good directional sense for what's going on.

I will give you a couple of statistics. Year-to-date, the market for Next Gen console software in Europe -- we estimate it being up about 27 percent. When you look at the handheld market, we estimate that to be up about 32 percent. Even the PC market, which has not been strong here in the U.S., is up in the aggregate of the European markets, so we would describe Europe as being in good shape. Of course, having both a publishing and a distribution business there, we are benefiting from that significantly.

With William Blair & Company, we have David Farina.

Good afternoon. You saw your two markets as opportunities, handheld and portables down the road. The problem with markets historical has been they are not -- well, (indiscernible) the portable market -- I mean the handheld market and the wireless market but -- is there any margin in these businesses long-term, I mean especially the wireless side? I just don't see -- I see revenue but not huge margin opportunities. Can you talk a little bit about how you think those markets will evolve in terms of profitability?

The handheld market has been a good and profitable market for us and we have participated in that for quite awhile and have made good money, and we don't see that change in the years ahead. In fact, with the new devices coming out, especially the PSP but also Nintendo DS, it's a good chance that the handheld market will continue to grow and offer additional opportunity for our content.

As far as wireless, it is still an emerging market in our opinion. We have participated. We published, for example, the Shrek 2 wireless game ourselves, but it is still sort of exploratory work. It's too early, not significant enough yet for us to invest major resources. Again, we're watching it and when the time comes, we will be ready to make a move in that direction that will -- if it's financially attractive -- be accretive to the Company.

I would make one other point. When you look at PSP operating model, historically handheld has actually been less development expense and more cost of goods expense. What we are starting to see is with PSP you have a shift where you're going to have elevated production values, the product will appeal to a different consumer than Game Boy has in the past, and it's actually, we think, going to be a more lucrative operating model.

One more comment about the wireless opportunity -- those are longer-term opportunities and until you get to the point that data transfer rates are reasonable, which are happening, and the handset manufacturers are starting to provide game-control capabilities, you won't see a near-term data opportunity but we think, over the long term, it's an interesting opportunity to leverage our content.

Tony Gikas of Piper Jaffray.

A couple of quick questions for you -- could you give us a little bit more color on the handheld market over the next cycle? Is this a market that you think sales could increase 50 percent over the next five years, or is this a market that potentially could double over the course of the next cycle?

Second question -- based on all the hardware estimates that you've given us for calendar '04 or for this year, what do you project -- do you have an early projection on what industry sales could be for calendar '05? Are they down or do they manage to be flat or a little up next year? I would love to know your thoughts on that.

Third question -- is it possible that, next year, you could do another Shrek or Spider-Man game even if there isn't a movie property out?

I would say, just to start -- to answer your question about a little color, I would say the color is going to be decidedly green. We see that from the portable opportunities. I will let Ron get into a little bit more of the detail on the portable opportunity, but we did say earlier that, yes, in fact we will have a Spider-Man and we will have Shrek and we are planning to have both of those for next fiscal year.

Yes, Tony, you also asked about our market forecast for '05. We're going to stay away from that; we want to see this year's market play out. There's so much still that has to happen between now and end of the year, so we've traditionally waited until that unfolds a little bit more before we start getting into that. But as Bobby quickly mentioned, we have two games in development, one based on Shrek and one based on Spider-Man. I point to the fact that, especially in the case of Spider-Man, there has been a number of non-movie-based games that have been best sellers. We referenced the one that was made by Neversoft and it sold over 2 million units, was quite successful. It's a great franchise and we believe the same about Shrek. Those games are well in development, we've seen them a number of times in terms of their progress and are very excited about them.

Edward Williams at Harris Nesbitt.

A couple of quick comments for you or questions for you -- international sales in the first quarter, what were they? Then what are you expecting them to be over the course of the year? First of all, start with that.

International sales, first you have to put it in the context of the fact that we released Shrek internationally late in the quarter. We didn't release Spider-Man until recently, i.e. in the second quarter, so the split between domestic and international was a little different than what we have traditionally seen -- 60/40, yes. But that's simply a timing issue. The international part of the publishing company has done well, is seeing good results early on in Shrek and Spider-Man as well.

What would you expect the mix to be over the course of year? What would you expect the mix to be international versus North American as the year progresses?

I don't have that number in front of me.

It's 50-50.

It's about 50-50 when you add in the distribution business.

Can you characterize what your headcount is currently in the international markets and then give us a percentage basis as to what you expect -- how you expect that to change?

We've not given international headcount. Total headcount for the Company is 1,400.

Okay. How about, while we are on that topic, headcount in the studios?

It's about a little over half of the 1,400.

As we come out of this fiscal year, how do you think the headcount in the studios will be?

Probably going up. We are continuing to expand geographically; we are expanding our portfolio of products, those that are in development. We have been steadily adding people, which we see as a good sign, considering that we've -- while we did so, continue to grow. (multiple speakers).

We're adding folks primarily in the studio but we're really seeing the leverage is on our selling and marketing and G&A infrastructure, where we are really not adding much headcount and we are getting the benefit of the extra revenues, and that will contribute to the operating margin expansion.

Okay. Just a couple of housekeeping questions -- cash (indiscernible) from operations in the quarter as well as catalog sales in the June quarter?

The catalog sales were about 10 percent. Consolidated revenues and cash flow from operations, about negative 52, 52 million.

Okay, and then one final question, probably for Bobby -- giving the success that you guys have had with your movie-based properties as well as some of your competitors with some relatively large licenses, as you look out over the next couple of years, what do you see happening with the cost of the licenses? More specifically, do you think that the increased -- assuming that there will be an increased cost with it -- will be felt on a higher royalty, or will it be more of an increase in the prepaid arena?

If I would say, firstly, we're not really actively looking for a lot of new intellectual properties. We are very long IP (ph) right about and very satisfied that we can continue to generate growth and operating margin expansion on the intellectual property portfolio that we control.

You know, we are out looking selectively at a small number of things and we do that from time to time. Generally speaking, I would say that royalty rates have remained about the same, that there is definitely a shift on the part of intellectual property owners. They realize the value that a great videogame should bring to building overall value in an intellectual property -- (technical difficulty). I think with greater scrutiny they are looking at who their partners are and what their partners will bring to the table in terms of high-quality game development. So, that is a big consideration and, generally speaking, I would say guarantees are going up bit but the most important thing that intellectual property owners are looking for is high-quality production capability, and royalty rates have stayed about the same.

Karen Maseo (ph) at Merrill Lynch.

Hi. I just had a couple of quick questions. One of them -- obviously (indiscernible) did a great job with Spider-Man 2. I didn't hear you guys mentioned Dead Rush at all out of this year or next. Is that still a project in the works?

It's not. We gave an opportunity (indiscernible) and evaluated it subsequently. In the context of our focus on big propositions for success that we are experiencing with those, Dead Rush did not meet the standards that we have for big propositions so we are focusing the resources involved in that project on projects with bigger probability to become a very significant contributor to the Company.

Okay. Then just on the PSP or the NDS, do you guys have any more sense of what the pricing is going to look like on the games for those?

We do not.

Arvind Bhatia at Southwest Securities.

Good afternoon, guys. A quick question on the operating margin expansion -- I know you spent a lot of time on operating margins continuing to expand. As I look at the last cycle, during the transition, even though the top line was up during that year, your operating margins actually declined from 8.4 to 6.7 percent, if I'm looking at it correctly. What's different this time that makes you feel -- is it the pricing is holding up better at this point? What's the assumption? What are the assumptions going into -- your assumption that operating margins would keep growing from here?

We see plenty of opportunity for operating margin growth. I can start with a simple comparison to, I will call it competitor A, who is obviously bigger than we are and is putting last year at 26 percent operating margin up, which is more than double what our target is for this year.

We're going after a bigger operating margin simply by expanding the scale of this company's operations in terms of the number of brands that are multimillion-unit sellers. We made really good progress against that and we see plenty of opportunity left to continue that.

We are also seeing plenty of opportunity, for example, in building out our operating model overseas. I mentioned the additional countries that we are targeting for expansion. The new platforms offer additional opportunities, particularly if we can exploit them while we also continue to exploit the existing install base, which is huge. So, we see that synergy as a potential opportunity for market expansion. So, those are just a few reasons why we are optimistic that we can continue to expand our operating margin as we continue to add scale to this company.

Just to follow on Ron's point, when you look at Competitor A, when Competitor A was at roughly $1 billion in revenues, they had a 9 percent operating margin. When they hit 2 billion, they got to an 18 percent property margin and at roughly 3 billion, it went to 26 percent. There's not a lot of magic there. As you continue to build scale, you stay focused on the franchises; you get greater realization in the international markets; you do see, as we have seen, the operating margin expand. So, a lot of what we've seen with some of our competitors we see as likely benefits to our Company over time.

One thing that comes to mind is your focus on bigger propositions. Could that be part of the reason as well? In other words, fewer franchises are much bigger and the incremental margins on the bigger franchises obviously -- that incremental margins tends to be high. Is that part of it? Because again, you were getting the scale even last time. You know, your revenues were growing between fiscal 2000 and 2001 but again, the operating margin declined, so I guess I don't know if I'm answering my question myself, but is it mostly related to the bigger franchise focus?

Yes, it is. You hit the nail on the head.

Also, if you look at what happened since 2000, we've doubled the size of our Company and doubled our operating margin.

Okay. A couple of other quick follow-ups -- for planning purposes for next year, would you be assuming Iron Man in there or at this point, you would not (indiscernible) Fantastic Four would be part of that. Would that be fair?

We have both Iron Man and Fantastic four planned in our fiscal '06 slate.

I got it. Let's see. The spidey (ph) 2 launch internationally happening in the beginning of this quarter, was that something you guys had planned at the beginning of the quarter, or was it more of a decision you took as the quarter progressed?

It was simply tied to the release date of the movie. The movie released later internationally than it did in North America. Because the game was so closely tied to the movie, in terms of its content -- and revealed certain things about the movie -- we were releasing the game right next to the release of the movie. That's the reason why there was a different in timing.

So that was always part of the plan?

Yes.

Okay, and then reorders for Shrek 2, I know you had given an initial shipment number of a million units but the reorders during the quarter?

Let me just say that we're very pleased with Shrek. It has performed really well and we're very optimistic that, given the success of the movie, the DVD release this holiday season, that it will continue to sell well and with that come reorders.

Okay. Final question -- on the distribution side of your business, over the next couple of years, as we introduce the new handheld platforms, would you see your distribution business growing, or just give us a directional sense of how you see that business?

The distribution business -- (technical difficulty) -- really well, particularly early on in a new cycle because it sells hardware, primarily Sony hardware. With the PSP coming out pretty soon, that will be a very positive factor for the distribution business. Then the PlayStation 3 will be, again, a source of growth for the distribution business. But our distribution business has also been growing by simply attracting more clients, publishers. We've invested in the infrastructure, built a new warehouse, expanded the management team and that company has done a great job of servicing the UK market and has attracted, as I said, additional publishers and also retailers to which it provides products exclusively. Our financial team in that operation is optimistic that they can continue those kinds of trends in the years ahead.

You know, this is providing a lot of strategic value in terms of the ability of our publishing unit to get their fulfillment logistics, credit and collection all managed by world-class operators. You know, if you're look at sort of the scheme of financial investments that our Company has made, the roughly $40 million we invested to acquire control of that business has probably already yielded twice that in operating income and the amount of capital that that business uses is a relatively small amount of capital, so the return on invested capital in that business is as good is it gets.

You really don't have to invest a lot in new technology like RFID (ph) or stuff like that just to keep that business growing?

No, because it's mainly focused on the independent channel, the specialty channel in the UK, which is roughly 20 percent of that market.

One more question, if I could? On that Neversoft property for fiscal '06, is it fair to assume that it's multiplatform property? Could you give us any indication of what genre that property might be in?

It will be a multiplatform release, and it will not be a sport's game.

Bill Lennan with WR Hambrecht.

Thanks a lot. The first question is about Europe. The ten countries that -- if we just add them all together and think of them as one monstrous opportunity -- would you characterize the opportunity as either Scenario A or Scenario B? Scenario A is these countries have a hardware installed based that's on par with Italy, Germany, France and the UK and we simply need to exploit an existing opportunity? Or Scenario B is the hardware is not there yet and we need to be there ahead of the hardware penetration? That's the first part of the question.

The second party is, if you succeed in these countries, how much does it increase your addressable market opportunity?

Yes, it is closer to your Scenario A where there is a significant market in those countries that now, with our ongoing scale, our portfolio of brands, it has expanded pretty dramatically in the last few years. Now, it represents opportunities that a few years back were financially -- (technical difficulty) -- opportunities are now attractive opportunities. So it's primarily about established brands where the scale of the Company now allows us to go after them.

Any guess as to how big that makes your market increase, how much it increases your market?

We are optimistic that it can add significantly to our international operation, but we prefer not to give out a specific number at this point.

On a related note, housekeeping item, could you tell us what foreign exchange gains were in the quarter?

Yes, it was about --.

$7 million.

7 million on the revenue line and a fraction of a penny.

Okay, I also wanted to talk about your market forecast of 8 percent for this year. If you add together Wall Street expectations for all the publicly traded companies in America and then throw in IDOS, Vendi and UbaSoft (ph), it looks like these companies and/or the Street are expecting 17 percent publishing growth in 2004. So, would you say your 8 percent is conservative, or would you say that the 17 percent that other people are expecting (indiscernible) included in that number is aggressive?

We think we have a pretty good handle on the market and the forecast that we gave you seems to be pretty close to at least what has happened year-to-date. I think, you know, everybody defines the market a little differently, so you've got to watch out, but the way we define it and have explained it in the call, year-to-date that market is up 9 percent. For the year, we're calling it 8 percent. So, we feel that we are about right on with our expectation.

But we haven't really taken the time to look at a lot of other people's forecasts. We are focused on our own, so it would probably not really be appropriate for us to comment on anybody else's forecasts.

Okay, and two fast questions -- does your forecast include foreign exchange?

It does, yes.

Finally, we're all dying to know, who is Competitor A?

(LAUGHTER). It's EA.

Thank you.

We would like to thank you all for joining us today and if you have any questions, you can call my office directly at 310-255-2635. Thank you for your time.

That does conclude today's conference call. Thank you all for your participation.