動視暴雪 (ATVI) 2005 Q2 法說會逐字稿

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Good day everyone and welcome to Activision second quarter fiscal 2005 earnings 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 Salvy. Please go ahead, ma'am.

Good afternoon and thank you all for your patience and joining us today for our second quarter fiscal 2005 conference call. My name is Kristin Salvy, Vice-president Investor Relations. I will start today's call with a review of our Safe Harbor disclosure, followed by comments by Bob Kotick, Chairman and CEO, and Ron Doornink, our President, after which we will take your questions.

With regard to Safe Harbor disclosure I like to remind everyone that statements made during the 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, projection 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 10K and quarterly report on form 10Q.

The Company maintains its intentions, belief or expectation 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 any anticipated events. Now, I would like to introduce Bob Kotick our Chairman and CEO.

As you can see from our results business continues to be strong for Activision. We substantially outperformed our expectations this quarter, because many of the initiatives we shared with you are working. Our product quality is industry leading, in market execution is getting even better and we continue to see the benefits of our operating margin expansion programs. A few of the highlights from the quarter reflect the success of these initiatives. We posted the highest non-holiday quarterly revenues in earnings in our history and for the trailing 12-month revenues exceeded $1 billion. To date 5 of our recently released titles have exceeded the million unit mark and three achieved multi unit status.

Our balance sheet and operating metrics continue to strengthen. We ended the quarter with over $600 million in cash in short term investments and for the trailing 12 months free cash flow with 122 million dollars and return on invested capital increased to 42%. We continue to expand and strengthen our global presence and competitive position.

During the quarter, we achieved record in market performance worldwide. In July we were the #1 overall publisher in the UK, in August we were the #1 PC publisher in North America, the #1 publisher overall in the UK, #1 publisher overall in Germany and #2 publisher overall in France. Each of these accomplishments are firsts for Activision. Earlier in the year we said one of the reasons our marketing and selling expense would be higher was to reflect investments we're making to expand their international presence. These investments are paying dividends sooner than we would have expected.

European expansion continues to represent a major opportunity for Activision. A one we'll pursue aggressively. We'll continue to add infrastructure and leverage our development and marketing expenses across a number of new territories. Overall our success in building and exploiting franchises world-wide is the key to expanding our operating margins and increasing our returns upon invested capital. Our record results world-wide were driven by the release of high quality titles.

Over the past year we have seen significant improvements in our game quality reflected in third party game ranking and in consumer satisfaction. This is further strengthening many of the powerful game franchises we control and providing even greater opportunities to leverage these franchises over the long-term. We believe Tony Hawk, Spider-Man, X-men, Shrek, Capelas, True Crime, Call of Duty, Doom, Total War, Wolfenstein and Quake will continue to provide the Company with predictable revenue streams for years to come.

We're committed to delivering another record year in term of revenues, margin expansion and earnings. The achievement of our fiscal '05 operating plan would result in our 13th executive year of record growth and our 5th consecutive year of operating margin expansion and highest return on invested capital in our history. As we look at fiscal '06, our product release schedule is strong and growing. We have great product visibility with sequels to all our all-time best-selling franchises, many of which are in far stages of development, including True Crime, Tony Hawk, Call of Duty and Spider-Man which collectively have generated over a billion and a half dollars in revenues.

Number of new product introductions in November, in fact, will mark the beginning of a new era we believe in portable gaming. We expect an entirely new generation of hardware will for the first time, appeal to a new generation of consumers. Until now, Gameboy has been primarily purchased by 6 to 11 year olds or their parents, and we think that the new Nintendo DS and Sony PST will appeal to older gamers and those older gamers represent more than half the total market for video games.

The next-generation handhelds, including Nintendo DS and PSP, and even emerging wireless devices have the potential to expand the handheld market overall. By the time the next generation consoles are introduced the handheld markets should a solid and growing installed base of new consumers. We believe we're well positioned to successfully exploit all of these new devices. With games capturing greater percentages of leisure time we're also planning for opportunities to add advertising and sponsorship revenue. Several months ago, we announced our advertising initiative with Nielsen, we remain excited about the prospects of expanding margins through integration of advertisers and sponsors and looking for ways to reach the 18 to 34-year-olds in a measurable more targeted fashion. The research to date indicates that last year, young men in the U.S. spent over 30 billion hours playing games. When advertisers spent relatively small amounts in games compared to the $8 billion Nielsen believes they spent to reach the take consumers via television.

We recently announced the next phase of our partnership with Nielsen Entertainment and also announced Daimler-Chrysler will be the first advertisers to take part in the test to track consumer interaction with the Jeep brand, utilizing proprietary technology developed by Nielsen and Activision. In this test, an inaudible audio signal will identify how long and how often players are exposed to the Jeep brand while playing Tony Hawk's Underground 2. The test is a milestone in our efforts to take video games to a new level as the mainstream advertising media.

We look forward to sharing with you the results of this study in the next few quarters. Our performance for the first half of the fiscal year clearly demonstrates Activision is expanding its scale in competitive advantages, the barriers to entry in our business are higher than they have ever 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 video game system.

Our market is expanding, thanks to the ever increasing installed base of hardware, new portable devices, sales increasing outside of the U.S., improvements in on-line gaming, and overall improvement in production values. We believe our margins will continue to expand as a result of annualizing and growing our strong franchises, the measured introduction of new franchises, greater international penetration and the overall operating model leverage that comes from a growing revenue base. There also is additional opportunity for margin expansion from some of the new initiatives we discussed. While we are very enthusiastic, this is a business with many risks. Product market acceptance, the challenges associated with the introduction of new hardware, pricing pressures, new untested business models and aggressive competition all influence our success and all have the potential to disrupt our financial and strategic plan.

That said, Activision has never been in a better position to capitalize on the long term opportunities our industry offers. Ron will now share with you the results of operations this quarter and his predictions for the winter in each battleground state.

Thank you, Bobby, I'll take a respectful pass on the second part of that. I'll be delighted to go over the results of the last quarter. For the quarter ending September 30, net revenues were $311 million, up 193 million versus last year. Net revenues were the highest of any non-holiday quarter in our history, surpassing the record we just set last quarter. Earnings per share were a record 17 cents, compared to a loss per share of 8 cents last year. Our record breaking performance was driven by our publishing business both at home and abroad.

For the quarter North American publishing revenue increased 240% versus last year and year-to-date is up 119%. Also during the quarter international publishing revenue increased 329% versus the prior year, a year-to-date is up 155%. You're just starting to see the benefits of combined focus on big propositions and international expansion.

For the quarter our top-selling title overall was Spider-Man 2, the #1 selling game in the U.S. and UK for the month of July. Spider-Man 2 has outsold its predecessor worldwide on a comparable basis. Also driving the quarter were the North American launches of Dreamworks, Shark Tale and X-men Legends. Shark Tale was the second of five Dreamworks titles we will release over the next few years. Shark Tale was launched at a premium price and to date has already shipped over a million units. The game has received some of the all time highest ratings for a children's title and continues to benefit from the movie's momentum. The great success we had with Shrek 2 and Shark Tale gives us more confidence the potential for future Dreamworks releases.

The success of X-men legends developed by our own Raven Studios was also significant due in part because it was not supported by a big budget movie. The title has received critical acclaim and has been successful in attracting the mass consumer rather than just hard core RPG gamer. X-men legends is already on track to be the best selling game in the franchise's history, it's performance is an excellent gauge of the strength and long term viability of the franchise.

Turning to the PC business, this has been an area of focus for us, this quarter marked the best performance in our history, driven by some of the highest quality products we've ever released. In Q2 we released three high-quality PC titles, starting with this year's highly anticipated Doom 3. Doom 3 was released in August, making the biggest--making it the biggest PC launch in Activision history. It launched at highest wholesale price ever and sales quickly surpassed the million and a half unit mark. In its first month of release, Doom 3 dominated retail sell-through charts world-wide taking the #1 spot in the U.S., UK and Germany and to date is a #1 selling PC title in the U.S. for the calendar year. During the quarter we also launched Rome Total War which is currently the highest rated PC game in Activision history and selling very well world-wide. Additionally we released Call of Duty, United offensive, an expansion pack which has showing a very strong attach rate to last year's #1 PC title during the holiday season with sales exceeding our expectations. Other highlights for the quarter include strong sales from our Cabela's hunting franchise, and our new Rapala fishing brand, and some as solid catalog sales for some of the Companies strongest franchises, including Shrek, Tony Hawk and True Crime.

Turning to the financial results in the September quarter, manufacturing and distribution expense was 40% of net revenues, significantly below the 62% in the prior year, due to improved revenue mix. Operating expenses for the quarter excluding manufacturing and distribution expense were 49% of net revenues, improvement of 360 basis points versus the prior year due mainly to lower product development expense offset by higher royalties and marketing cost.

Looking at the balance sheet on September 30, we had $606 million in cash and short-term investments, an increase of $195 million versus last year, and up $67 million versus last quarter. As of September 30, we had $739 million of working capital, an increase of 240 million or 48% versus last year. The accounts receivable balance on September 30 was $139 million, up 109 million versus last year, due to the number and timing of late quarter releases. The accounts receivable reserve of $62 million was up 14 million versus June 30, and as a percent of gross receivables is 31%. DSO's were 41 days.

Inventory on September 30 came in at 64 million, up 24 million versus June 30. Our publishing inventory temporarily increased due to the timing of several key launches including the early October release of one of our biggest titles, Thug 2. Overall we feel very good about our inventory position both at warehouse and retail knowing our titles are selling well. Capitalized software development costs on September 30 were $100 million, up 3 million versus last quarter. Capitalized intellectual property costs were 36 million, also up 3 million versus last quarter.

Now, I would like to share our thoughts on the overall market, beginning with our hardware estimates. At the end of September, the install base in North America for current generation systems including handheld was 65.8 million units. For calendar year end 2004 we have not changed our projection that the installed base of hardware including handhelds will grow to 73 million units. Looking at each system individually the Playstation 2 ended the month of September with installed base of 24.9 million units, and we believe this hardware will end the calendar year at about 28 million units. Microsoft's X box, the fastest selling console this year, ended the month of September with installed base of 9.8 million units, and we're projecting it will grow to about 11 million units by calendar year end. We believe that the game cube will grow from 7.9 million units the end of September, to 9 million by the end of this year.

At the end of the quarter, the Game boy Advance had a U.S. installed base of 23.2 million units and we expect this installed base including the Nintendo DS to hit 25 million units by calendar year end.

As we announced earlier this month, we're committed to and excited about the upcoming launch of Nintendo DS. This is a great piece of hardware and one that has potential to expand the current handheld demographic. In conclusion the installed base of current generation hardware is significant and growing and for the balance of the calendar year, our expectations do not assume any additional hardware price cuts.

Moving to software, we defined the software 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 markets for current gen consoles, handheld and PC, to be up about 8%. Looking at the market segments we're projecting growth of 10% for the total current gen console market, which is defined as software for the Playstation 2, the X box and the Game Cube. The combined software growth rate for the current gen console and handheld market we project to be about 8 to 9%, and add a PC market that we expect to grow about 5% in the combined growth rate for current gen console, handheld and PC video game software is roughly 8%.

With respect to software pricing to date, premium pricing for triple A launch titles has helped. For the balance of fiscal '05, we are planning that our slate of console products will maintain launch pricing of 49.99.

Strategically our performance this year continues to 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 2, Rome Total War, X-men legends and Lemony Snickets. 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 can 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. For the fiscal year we're raising our revenue outlook by $50 million and expect revenues of 1 billion, 150 million, up a strong 21% versus last year. In fiscal '05 we expect to increase operating income by 45%. Translating into a record 13.8% operating margin, an increase of 50 basis points versus our prior guidance. For the fiscal year we expect EPS of 75 cents, up 6 cents versus our prior guidance, and up 39% versus last year, a year in which we grew EPS a strong 26%.

For fiscal '05 we expect manufacturing and distribution costs of 43% of net revenues with operating expenses including royalties of 43%. Operating expenses will be higher than in fiscal '04 due to increased selling and marketing expense. For the full year we project interest income of 0.9%, a tax rate of 32%, which should be consistent throughout the year, and a fully diluted share count of 154.4 million. For the third quarter we expect revenues of $500 million, $500 million, and EPS of 49 cents. This is somewhat lower than our prior guidance, primarily due to better than expected performance of our Q2 titles which accelerated reorders into Q2, and a movement of Doom 3 for the X-box into the March quarter.

For the quarter, we expect manufacturing and distribution costs at 43% of net revenues with operating expenses, including royalties of 35.5%. We project interest income of 0.7% and fully diluted share count of 153.3 million. Drive titles for the holiday quarter include Tony Hawk's Underground 2 which shift in early October to critical acclaim and retail enthusiasm, making this year's initial launch even bigger than last year's. In November we will release Call of Duty, Finest hour, for the consoles, Lemony Snickets, A series of unfortunate events on 5 platforms and for the PC, we have Vampire Masquerade blood lines. For the launch of the Nintendo DS, we will release an all-new Spider-Man game which we think will be a top selling game given that it looks great and it really takes advantage of the dual screen functionality. The competitive environment is favorable given we expect there will be only 6 or 7 titles available at launch in comparison to the 20 or so that were available for the launch of the GBA.

For the fourth quarter we expect revenues of $128 million and EPS of 1 cent. Our revenue expectation is slightly higher than our prior guidance as we're moving Doom 3 for the X-box into the quarter, but impact is not that significant as we already had a certain amount of reorders from the late Q3 release, factored into our prior expectations. We project Q4 manufacturing and distribution costs of 54.5% of net revenues with operating expenses including royalties of 45%. We project interest income of 2.0% and fully diluted share count of 156.2 million.

For the fourth quarter for planning purposes only, we are assuming the release of Doom 3 for the X box, but as you know its software makes the decision of when the game will ship, not Activision. Also for the fourth quarter for planning purposes only we are assuming the release of Doom 3, resurrection of evil, expansion pack for the #1 PC title in the U.S., but again its software makes that decision on when the title ships, not Activision. This title was included by the way, in our prior expectations but the product was only just announced by ID, that is last week. With respect to Sony PSB, pardon me, we plan to launch with the platform launch games based on the Spider-man 2 and Tony Hawk franchises. We are very excited about this new handheld and its long term potential but from conservatism we model financial results to be minor in Q4.

As we've looked to fiscal '06 and beyond, our strategy for growth is tied directly to execution and expansion. Our fiscal '06 slate continues to grow, game quality continues to improve and selling and marketing capabilities continue to expand allowing us to realize even greater returns on our product investments. While we are expanding our international publishing capabilities to date, we have our own staff in only seven European countries. We recently set up operations in 2 new countries and we're targeting 5 additional countries for expansion next year.

As we look ahead to the introduction of next generation console and portable hardware we see significant opportunity. We were successful in growing during the last console introductions and our goal for the next transition is no different. Our strategy is two-pronged. First, it is to maximize potential of the large installed base of hardware current generation systems for as long as this yields superior financial results. Second, we will ensure that Activision has a meaningful launch presence for 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 capability, or sales and marketing expertise.

We continue to get deeper into development programs for the next generation systems and I'm very excited as we see step change improvements in technology, which show major potential to drive long-term market growth. Our slate in fiscal '06 combines the most proven predictable brands with the very best product development resources we control. Expect sequels to True Crime, Call of Duty, Tony Hawk, Spider-Man, Shrek, Quake and Cabelas, and add to that the sequel to X-men legends which we just announced last week.

Complimenting these proven video game franchises are major theatrical event supported releases based on Marvel's fantastic 4 and Madagascar from Dreamworks. Titles based on new IP include the movies, and the title in development by our Neversoft team, a title which we plan to support heavily in order to maximize potential to become a top-selling title.

Our release schedule which will capitalize on current generation hardware, new hardware introductions, and our expanded international publishing capability is designed to execute against our stated goal of continued growth during the period of new hardware introductions. We have elevated our competitive position and our financial results continue to distinguish Activision from its competitors year after year. We thank you for your the opportunity to share our continued success and plans for the future. Now I'll open the call up for your questions. Thank you very much.

Operator?

Thank you, sir. At this time, ladies and gentlemen, if you would like to ask a question, press the star key followed by the digit one on your touch tone telephone. If you use a speaker phone for today's conference, make sure your mute function is turned off in order for your signal to reach our equipment. If you want to ask a question, press star-1. We'll take today's first question from Mike Wallace with UBS.

Hi, couple questions: First, the Doom expansion pack and Doom for the X box, you assuming those early in the March quarter or are those late in March? Is there a preliminary timetable you have for those?

We're assuming them in the plan for pretty late, Mike.

Okay. Second question, I know you're not giving guidance for fiscal '06 yet, but what sort of market you expect and hard console sales up or down during the year, average selling prices, if you think most of the stuff will in fact hold the $50 price point for a while, and just maybe in general terms what, you know, you're going to be doing on the R&D side. I know there will be a lot of platforms to support but do you think the new hand-helds will offset that on the revenue side.

We're not in today's call do a lot of speculating on next year. We did in the prepared remarks talk about the fact that we expect our console launch pricing to hold at $49.99 through the end of this fiscal year. When we get to the next call in January, we'll have lot more visibility to what of course happens in this Christmas season we'll factor that in and at that point be prepared to give you some initial perspective on expectations in the market in general next year.

Okay. So basically nothing on '05. As far as the products for this Christmas and I know previously you talked about, I forget, but maybe it was 10 products doing a million copies, do you still think you're on track for that. Is Call of Duty the most new important console you have for Christmas?

Yeah, we have that stated goal of having 10-plus titles this fiscal year that exceed a million units and inside of that, four were better doing more than two million units, and we like where we are, considering the fact that we're going into the, you know, the biggest half of the fiscal year, with five titles that have gone over a million units, and three of those five have actually exceeded two million. As far as the second half, big titles, yes, Call of Duty, along with Thug 2, are big titles for us, as we, you know, we will market them accordingly.

Okay. Last question: You dodged Bobby's challenge on the election, Ron. Who do you think will take part in Florida? .

I'll answer Florida. I think Wal-Mart going to win in Florida. They have 200 stores, they'll probably do well although the Gamestop and EB is giving them a run for the money in the state,

All right, everybody is ducking all the questions. Thanks. (laughter)

We'll take our next question from Heath Terry with CSFB.

Just wondering, Ron, if you can give us an idea, without going too deeply into next year because I know you're not ready to do that, in terms of planning for next generation hiring on the R&D side, looking at where product development spending is going to go, as you prepare for the transition, are we kind of 80% to where you think the peak is going to be? Maybe even closer to 90%? How much more expansion are going to be internal development do you want to see where you want to be for next cycle.

Let me address the general question that I think you asked about product development costs and where that's headed. For clarity, the way that we would like to discuss that is in terms of total creation costs which includes software and IP royalties, as well as product develop costs. If you look at our P & L the last two years, that item as a percent of net revenues has been pretty stable around 20, 21, 22%. Now, the fact is, if you look back over that period, the costs of creating a game has definitely not been steady. Since back on substantially over that period of time. But the reason that in our P & L's it has not gone up as a percentage of net revenues is that we have deployed a number of strategies that effectively offset those rising costs. Those strategies include; increase in number of big brands in our portfolio, developing more products internally, aggressively exploiting grants across all viable platforms and expanding our international marketing capabilities. There is a pretty broad consensus in the industry that as we move into this transition that product development costs are going to continue to go up on the per-game basis and we would agree with that. However, we're not at all convinced that this will translate into a material change in the percent of net revenues spent on product creation. The reason for that is that we see plenty of room left in the strategies that we've used effectively to offset the rising costs of making video games, and we'll continue to stay focused on those. That as I say we're cautiously optimistic we can offset rising game development costs in the years ahead much like we have in the past three or four years.

If you were to look back at the period of time when PS2 and X box were first introduced those were periods of time we saw operating margin leverage and expansion and so we feel fairly confident that we'll be able to continue to do that.

Sure, sure. Thanks Bobby. One other kind of question, and you touched on this a little bit, but can you give us an idea of more than a general level of the perception that you guys have in talking to your retail partners, where the level of kind of enthusiasm, optimism is this Christmas relative to the past couple of Christmases we've seen, not just for your own products but for the industry as a whole.

I would say this: Overall there are a good number of factors that seem to point to a pretty healthy market for this Christmas right now. For example, we see good momentum in the market, September MPD results were certainly strong. As an industry we're going into the holiday season with a very strong slate. Probably, arguably, one of the strongest ever. Price points for Triple A console products holding at 49.99. That's a good thing. I'll point to Europe being quite strong. Year to date the European software market is up 26%, and showing really no signs of slowing down. And then there is new hardware on the way for this Christmas, not only Nintendo DS, but also after pretty much running the channel dry over the summer, Sony is finally back into the hardware business with full force with what we think is an exciting Playstation 2.

You know, you have to kind of weigh that against other factors, that could put pressure on the market however, and that includes all companies I think, pressures like overall geopolitical and economical conditions that are, you know, difficult to predict, and the strength of this year's Christmas season overall, as far as retail activity is something that we don't know that much about. . And specific to our market the highly competitive conditions which are definitely, you know, the case with some major releases in the weeks ahead. On balance we're taking a--we take a conservative stance on the market right now. Favorable factors beat out the unfavorable ones then that should spell out some potential for upside.

Great, Thanks a lot, Ron. .

We'll take our next question from Jeetil Patel with Deutsche Bank.

Hey, guys, couple of questions. First of all, Ron, you talked about how, you know, (audio skip) -- the distribution strategy and you're still expanding in the European market and potential Asia-PAC. I guess if you kind of-- Is there any way to quantify how much opportunity is there kind of just to give us a sense of the scope of expansion.

Second, on the IP side, I know there has been some talk here of late with traditional media and entertainment companies looking at the video game landscape. What kind of impact or--anything interesting you've seen on the IP front that says, hey, we may actually look to do something different and unique with this IP as you go talk to some of the studios out of the marketplace other parties on the IP side?

On the first part of your question , the quantifying the expansion plan, just a couple of comments: One, when we go into a territory that we're currently not in, in terms of Activision people on the ground, there is a couple of things we're trying to do. One is to grow our revenue base by being the direct--calling directly on retailers and secondly improve our profitability by effectively taking out the middle man, distributor that up to that point covered the market. So those are compounding benefits of expanding geographically in the countries that we're going into. Long-term we expect that to be significantly positive in terms of adding revenue and profitability, but it is a little difficult to give you a simple percentage to help you quantify that, as much as I would like you to do that. For the reasons I articulated, we feel it is a significantly accretive element in our growth plan.

What kind of margin enhancement do you see in terms of basis points when you go from distribution to kind of direct, or feet on the street?

Well, typically distributors can get 15, 20 points, you know, so when we move in, we try to--we capture that and then offset that partially with the cost of the people on the ground. So it depends on the territory and the size of the business. So there is not a simple answer to your question.

Other thing we have found, Jeetil, as we get into these markets, we're getting better opportunities for generating revenue as we develop closer relations to retailers, we can participate with more thoughtfully in trade marketing promotions, and so what we're seeing is sort of this double benefit of taking out the margin of the middle man but also actually getting incremental revenue from having people paying attention to only to your own product line.

Yeah.. And then the second question on just IP. (audio difficulties)

Your question in terms of are we talking to the studios about doing some things with our IP other than what we're doing ourselves? ?

No, more of a question of I guess everyone seems to be thinking about video games in terms of market expansion. Have you seen any sort of movement of, you know, IP owners looking to hold on to IP longer, trying to reevaluate any movement that would indicate that, hey, they're getting more serious or looking at alternative strategies to get into, the video game and interactive entertainment markets.

We're long IP here at the Company, so I can't say that we've been that active about looking for new IP. We're really much more focused again as part of the strategy of expanding the operating margin as leveraging the intellectual properties that we control.

Great.

We'll take our next question from David Farina with William Blair.

Good afternoon, last year you guys did a great job of developing new franchises, Call of Duty and Tony Hawk Underground. Do you see that same potential this year, not to be critical, but I don't see the those kind of titles that have the same extendibility. Couple of movie titles have done well, but--.

Well, first of all we did a good job with Call of Duty on the (QC) last year, but we're bent on doing an even better job of Call of Duty on the console. It is truly a multi platform proposition. That's an extension of success. It is not new in the sense that we're creating the brand from the ground up but we're establishing with the launch on the console hopefully very successful multi platform proposition that we can go back to for a long time to come and we've also announced the development of a new IP game coming out of Neversoft. We're very excited about that. We're going to give you details on that later on. But in terms of being committed to the creation of new IP, those are two examples of things that are coming your way.

I would say this, David, my answer to the last question, is all of the products that we're releasing this year are franchises that we own or control for the very long term, and the strategy is focused on maximizing the revenues that we can generate on the franchises that we control. So we're--while we're always interested in the measure of using new IP the real focus is on maximizing the franchises that we currently control.

We expect like one to two new years a year or do they happen as they happen?

That's very possible, but we're not running it on that basis. We're simply doing an ongoing job of evaluating ideas and concepts and sometimes it could produce two or three games in a fairly short time frame in terms of new IP development.

Thank you.

We'll take our next question from Karen Maseo with Merrill Lynch.

Couple questions. First in terms of you mentioned you were coming out with some new IP, do you have anything on Deadrush game which you cancelled, can we expect anything new out of that group other than the Spider-Man game?

I can't really discuss it at this call. We'll probably tell you about it later. But they are our Spider-Man organization, they worked on that successfully with the movie and also working on the ultimate Spider-Man game. It is a talented organization and we're likely going to get other titles out of them in the future.

Generally speaking our strategy is to keep studios focused on franchises, so if you look at all of the studios we control, they're generally attached to a particular genre or franchise, and that will continue to be the strategy, is to become the leaders in the genre, specialized and focused on a franchise. .

Okay. And then just one more question. Are you guys any closer to being confident at the timing on the next gen consoles at this point.

I would say there seems to be pretty broad market speculation that there will be a console launch next Christmas. I certainly want to acknowledge that but we really can't say more much about that, because we're under specific restrictions, but that seems to be the consensus out there, I want to acknowledge that. We did mention that we are deeper into our development of games for next generation hardware, and that's quite exciting to us. We're starting to see actual game play and beginning to see the capabilities of the next generation hardware and it's quite promising, in our opinion.

Okay. And then I just have one more quick question in terms of sales and marketing. It actually came in a little bit lighter in the quarter than I had been looking for. Do you think we'll see more of a significant pickup in the December quarter.

We expect the quarter to be competitive and prepared with our products to participate hopefully successfully in that, so it is going to be a competitive quarter. We're certainly going to market with a significant amount of marketing spending behind the titles. Both catalog and new launches. .

All right. Thanks a lot. Great job on the quarter.

Next question from Anthony Gikas with Piper Jaffray. .

Good job on the quarter. Couple questions. I'll start with a light one in the event I'm missing something here. Does the video game sector benefit from a Republican or Democratic president? You talked about being early to the next generation of platforms. Maybe you want to expand on that a little bit, sounds like there was a little bit of change with respect to being early on these platforms and maybe just talk about the percentage of sales early on. Also, as we move into 2005 and '06 as we start to trail down this current cycle, what's your acquisition strategy? It has typically been at a time when we've seen some companies get active, whether it is IP or studios and do you have any interest in moving into new territory and typical follow-ups after that.

Bobby , what is the answer to your question about democratic versus republican president.

No, I really don't.

New platforms, you know, you remember in the last platform transition we virtually had no presence in the first year of the Playstation 2, and the very limited presence on the X box, and at the time we didn't have the breadth of resources to continue to support the existing installed base of the Playstation 1, the M64, and also allocate resources in both Q and in capital, to the next generation hardware. This time we're in a very different position. We have the bandwidth to do it. We're committed to doing it. We think that that will be, you know, a good thing for the Company and will set us up to go after expanded market share early on in the next cycle, while continuing to support the existing installed base of the existing current gen hardware. That is our strategy, we won't leave the existing platforms behind. In fact, we will fully support it for as long as financial returns are positive on that.

But at the same time we will be ready to have a significant presence on every major new piece of hardware, as evidenced by the launch of the Spider-Man title for Nintendo DS, we also have a couple of titles in development for the Sony PSP we've announced. So we're committed to that strategy and think that is the right balance between supporting existing and future platforms. And then you asked about our acquisition strategy, but we prefer not to discuss our acquisition strategy in a conference call. Or any other. .

How about a couple housekeeping. Should we expect that sales and marketing will trend relatively flat next year as a percentage of sales, or could that increase in the later part of the cycle? And what are your thoughts on share repurchase?

The marketing spending and plans for next year is really premature for us to get into that. We promised that we would start discussing that starting with our January call. So I have to pass on that one. Your question about the share repurchase program, the Company authorized 350 million, we've bought back about 125 million, so we've got 225 million left under that authorized plan.

Have you been active recently?

We have not.

Okay. Thanks, guys.

You're welcome.

We'll take our next question from Edward Williams with Harris Nesbitt.

Good afternoon. Couple questions for you. Could you give us an update on what you're R&D head count is at the end of the September quarter?

Somewhere around 700.

700? And what are your thoughts as to what that number will look like say over the course of, if you can, over the course of next year, or maybe the end of the current fiscal year.

It's been a growing number for the Company for the last five years and we expect it to continue to grow as the Company grows.

Okay. Any percentage goals or targets?

No.

What about looking at percentage of revenues that come from your internal studios, what is that number is on a trailing 12- month basis, a directional number?

Better than two-thirds. Revenues coming from internal studios.

And then going forward is that when the key components as far as operating margin expansion is concerned.

It is one of the components, yes.

We can look at that number going up towards say three-quarters or thereabouts, or higher?

It's possible.

Okay. And then looking at your development efforts for new consoles, can you talk about the business model for the DS and PSP, how that compares to the Game Boy Advance or should we really look at say the console business as a better point of comparison for the business model?

The--I would say the DS is more comparable to the GBA, where the PSP starts to be sort of midpoint between the GBA and a console.

Okay. And then the difference here really is the cost of the goods sold?

That and the cost of developing the game.

Okay. What is the delta just on a multiple basis if you can relative to GBA for developing the game?

I think because of our non-disclosure agreements with Nintendo and Sony probably best not to get too specific, but both are more attractive operating models than what we have today.

Okay. Looking at the next gen of hardware, are you expecting the--what are you expecting to the cost to be to bring a game to develop a game for the next generation of hardware? Is it, you know, a percentage increase over the current, say, cost of the Playstation 2 or is it a, you know, as much as multiple increase?

Percentage increase, I would say the combination of higher pricing, which we expect for our next generation software, and more leverage across all of our franchises, you know, having more platforms and more opportunity like a PSP and Game Boy. We are talking about percentage increases.

Okay. As far as the lead time of creating a game? ? For the next generation of hardware, that is still going to be comparable to the Play station 2. Are we talking about increase in head count creating the game?

I think it is too early to give you a conclusive answer on that.

Okay. All right. That's it for me.

Thank you. .

We'll take our next question from Jennifer Jordan with Wells Fargo.

Yes, congratulations gentlemen on the great quarter here. Couple questions and some of these maybe have been answered a bit. My first question has to relate to pricing. You mentioned that you expect, as you have seen already that the $49 price point for premium games should hold. Do you expect to see there could be any negative impacts from what is going on in the sports related titles between EA and Take 2 on the other broader category of titles? And also have you gotten any push-back or indications from the retailers about what type of holiday selling fees they're anticipating and how discount hungry they might be?

Yeah, is there a pricing impact from the sports battles? If there is, we haven't seen it up to this point in terms of our brands. I would say, no, and we hope it stays that way. As as far as --

We're generally focussed on exclusive intellectual properties that we own or control and that is an important part of our strategy.

--and retail questions, I indicated earlier in the call, when somebody else asked a similar question, that, you know, number of factors seem to point to pretty healthy market conditions right now, but at the same time there are factors that could cause the market--that could pressure the market and its participants and I went over those. For example, the overall geopolitical and economical conditions or the strength of this year's Christmas season in total at retail, and the fact that the market in terms of title launches is quite competitive this year. So it's, you know, and in my mind--it is prudent to take a good conservative stance as a Company, as we go into the Christmas season.

Okay. And then to follow up on that, two related questions, one, if you were to see holiday pricing pressure, do you think it would tag into the coming year or would you be able to get back to premium pricing for the new IP that you bring out? And, secondly, it seems to me, and I think you alluded to that, that this is a cycle where because of the breadth of existing hardware consoles out there in the market place, that as next gen comes in, you should be able to keep your general premium pricing today longer and price even above that with the next gen console.

We're committed to--we think the products we put together are great values and is worth the price that they're being launched at. And arguably, and I think some of our competitors demonstrated they agree, some of the products out there actually are capable of commanding a higher price than $49.99, and that is good for business, we believe, and as we look to the next generation of hardware, in the titles that we go to make for that, we will explore every opportunity to see if we can get higher prices for those titles because we believe that they are worth it.

I think if you look back, you know, from the early '90s to today, you see what has happened to pricing, there really hasn't been much of a change and yet you've seen a meaningful increase in amount of hours of entertainment we're providing, quality of production values, and I think that we haven't really been able to take advantage of the opportunity, when you look on a dollar per hour cost of entertainment, this is still one of the most attractive forms of leisure time that is available to consumers today.

All right. And finally you were successful already in doing this with the Shrek title taking a kid's price title to a premium price point this quarter. Do you see any other titles in what you're bringing out that have that possibility, will Lemony be at a 49.99 price point or somewhat lower.

49.99

And Shark Tale came out at 49.99, as well.

We'll take today's final question from Mike Wallace with UBS.

Hi, just one more, I want to ask about the distribution business. What are your expectations for distribution sales this year? Is it down slightly? And things like the DS and PSP, how do those impact the distribution business and maybe offset, you know, some of the slow-down on the software side next year?

Distribution business is focused on Sony hardware, that's where the historical relationship resides, so with the PS2 coming on, that's been a good thing for distribution companies, and they've taken their numbers a little bit for the third quarter, that was offset by some of the other changes we talked about today. But it's a healthy business for us, it is operating well, and it tends to do well early on in a new cycle when it is driving new hardware into the independent channels, so we're looking forward to that beginning.

So, then, you won't have any DS then? But you will have PSP?

We will have DS but it will be in modest quantities.

And PSP will be the focal point of that company's efforts and they're very enthusiastic about the product.

Okay. But for the year, the guidance you gave, I know you didn't split it up but should we still assume distribution is still down a little bit from last year.

It is about the same, yes.

About flat. All right. Thanks. .

Okay. Well, thank you all for joining us today. And on behalf of everybody at Activision we appreciate your time and consideration. Thank you. .

Once again this concludes today's conference. Thank you for your participation. You may now disconnect.