動視暴雪 (ATVI) 2005 Q3 法說會逐字稿

Good day, everyone, and welcome to this Activision third 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 Ms. Kristin Southey. Please go ahead.

Thank you. Good afternoon and thank you all for joining us today for Activision's third 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, and maintenance of relationships with key personnel, vendors and third-party developers, international economic and political conditions, and 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 changes 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 here of, or to reflect the occurrence of unanticipated events.

I would also like to highlight 2 items. First that our remarks today include the non-GAAP financial measures, free cash flow, and return on invested capital. A reconciliation of these non-GAAP financial measures to the most comparable GAAP financial measure may be found at the end of our earnings release. And second, that our outlook for fiscal 2006 earnings per share does not include the impact of adopting FASB 123(R) which relates to expressing of stock options and other share-based payments.

And now, I'd like to introduce Bobby Kotick, our Chairman and CEO.

Thank you, Kristin. Our actual results for the quarter and 9 months were better than anticipated due to our especially strong overall performance in December. For both the quarter and first 9 months of the fiscal year, we posted the highest revenue and earnings in our history. We exceeded our financial expectations, and of equal importance, we increased the strength of the intellectual property franchises we control and our global distribution reach.

Our incredibly talented team succeeded in achieving all of the key goals we have articulated to you throughout the fiscal year. For the first 3 quarters of this fiscal year, revenues are greater than all of last year. In fact, over 27 percent greater, marking our 13th consecutive year of revenue growth. For the first 9 months of the fiscal year, our operating margin increased to a record 15.6 percent, up 220 basis points versus the same period last year. For the trailing 12 months, free cash flow was $107 million and return on invested capital increased to 46 percent. We ended the quarter with over $710 million in net cash and short-term investments, another record.

Our financial results are the measure of our performance against our strategic objectives. We achieved our goal of 10 titles selling in excess of 1 million units, and 4 franchise titles exceeding the multi-million unit mark. We set out to build Call of Duty into one of the most successful new video game franchises and we have. You can expect many more sequels and products leveraging the Call of Duty brand, which has become one of our highest operating margin contributors.

Our studio resources were further strengthened with our purchase of Vicarious Visions, the studio behind our number 1 third party Nintendo DS title Spider-Man and the upcoming DOOM 3 for the Xbox. Vicarious had a history of high-quality product creation and they control proprietary middle ware technology, which will help enhance Activision's operating model over the long term.

Over the past year we've successfully expanded our product portfolio, increased our global presence, and improved our competitive position. In calendar 2004, our products were top sellers worldwide across every platform. Spider-Man 2 was the number 1 selling movie game in both the U.S. and Europe, driving this year's sales of the Spider-Man franchise over the 7 million unit mark. Tony Hawk's Underground 2 was fifth consecutive Tony Hawk title to make the U.S. annual top 10 list ,and the brand had another strong year selling over 6 million units worldwide.

Call of Duty was the number 1 best selling franchise based on new intellectual property, selling over 4.5 million units worldwide. Shrek 2 was the number 1 children's game in the U.S. and in 2004 Shrek games sold in excess of 4 million units worldwide. For the launch of the Nintendo DS, we took the leadership position with Spider-Man 2, the number 1 selling third-party title. In fact, Spider-Man 2 outsold the next 2 third-party titles combined, clearly illustrating our ability to optimize platform introduction opportunities.

On the PC, we achieved an all-time high 10 percent market share in the U.S. for the year, and we were the only publisher to have 3 top 10 titles. Our success in building and exploiting our exclusive franchises worldwide is the key to expanding our operating margins and increasing our return on invested capital. We have well thought through programs for operating margin expansion and our results are a clear indication that these programs are working.

In fiscal '06 we're commit to delivering another year of record revenues, operating margin, and earnings. The coming year should be our best ever. The product slate is our strongest. In fact, in fiscal '06 we expect to have 12 big propositions, which will launch across more gaming platforms than ever before.

Our '06 slate is anchored by games based on all of our top-selling franchises. These are all internally developed titles and have never been released in the same fiscal year. For the first time, we'll have a new Tony Hawk, Spider-Man, Shrek, Call of Duty, and True Crime titles across all key platforms. Our catalog in fiscal '06 will be driven by the 10 successful titles we launched in fiscal '05 versus only 3 titles in the prior year.

In calendar '04 Halo 2 and GTA, San Andreas absorbed enormous retailer and consumer resources. The competitive landscape in calendar '05 is likely to be less concentrated, which should provide a great opportunity for many of our strong titles. And the market keeps expanding, particularly as a result of the introduction of DS and the impending introduction in the U.S. of Sony's PSP.

The global barriers to entry in our business are higher than ever before, whether it be the capacity to develop great games, control important franchises, or the ability to successfully market and sell our games around the world, there are few companies better positioned than Activision to take advantage of the positive fundamentals of the video game business. The successful execution of our fiscal '06 operating plan would mark our 14th consecutive year of revenue growth, our sixth consecutive year of operating margin expansion, and another record year for earnings.

Operating margin expansion will remain the financial focus of the Company, and we believe growth will continue through -- the annualization and increasing revenues from our franchises; the measured introduction of new franchises; greater international penetration; a refocus on the hand-held market, which this year will represent our fastest growth segment; and the overall operating model leverage that comes from a growing revenue base. There's also an opportunity for additional margin expansion from new initiatives like wireless gaming, on-line gaming, and in-game advertising and sponsorship.

Activision has never been in a better position to capitalize on our strong industry fundamentals. Fiscal '06 should prove to be a rewarding year. And as we look out even further, fiscal '07 is likely to offer the greatest opportunities for overall industry growth we have ever experienced. Ron will now share with you the strong results of our operations this quarter and an overview of our fiscal '06 operating plan.

Thanks, Bobby. For the quarter ending December 31st, net revenues increased 34 percent to a record $680 million, up $172 million versus last year. Earnings per share rose 19 percent to a record $0.63 compared to earnings per share of $0.53 last year. Year-to-date earnings per share were $0.87 cents, up 78 percent versus the same period last year. Our record-breaking performance was driven by our worldwide publishing business.

For the quarter, North American Publishing revenue increased 37 percent versus last year and year-to-date is up 64 percent. Also during the quarter, International Publishing revenue increased 30 percent versus the prior year and year-to-date is up 68 percent. As we said last quarter, we are starting to see the benefits of our combined focus on big propositions and international expansion.

Our top-selling title in the quarter was Tony Hawk's Underground 2 which surpassed a multi-million unit mark and ranked us the number 5 title in the U.S. for the December quarter. The Tony Hawk franchise has generated now over $1 billion in retail sales over the last 6 years. The brand's continued success clearly demonstrates the strategic value of franchise annualization.

Also surpassing the multi-million unit mark was Call of Duty, Finest Hour. The brand launched in mid-November on the consoles and quickly became one of the fastest selling titles in Activision's history. Call of Duty has established itself as a new large-scale franchise for the Company in the same league as Tony Hawk, Spider-Man, Shrek, True Crime, DOOM, and Cabela's. At looking ahead, it has the potential to become our largest and most profitable franchise.

Given the title's success and consistent with our strategic principle of franchise annualization, we're pleased to announce that in fiscal '06 we will launch 2 new Call of Duty products, one for the PC, and one for the consoles. During the quarter we also launched Lemony Snicket's, A Series of Unfortunate Events. Even though the movie was released in late December, the title has already crossed the million unit mark.

In November, Nintendo successfully launched the Nintendo DS and we were there with Spider-Man 2, the number 1 selling third party title. The launch of this title is important as it demonstrates the execution of our next-gen product strategy, which is to optimize market performance at the launch of each new system. Also contributing to our performance during the quarter were strong sales from the Company's previously released titles including Spider-Man 2, Shrek 2, X-Men legends, Rome Total War, DOOM 3 and Cabela's.

Turning to the financial results of the December quarter, our manufacturing and distribution expense was 46.5 percent of net revenues in line with the prior year as a percentage. Operating expenses for the quarter, excluding manufacturing and distribution expense, were 33 percent of net revenues, an expected increase versus the prior year due mainly to lower product development expense offset by higher royalties and marketing costs.

Looking at the balance sheet on December 31st, we had $713 million in cash and short-term investments, an increase of $162 million versus last year and up 107 million versus last quarter. As of December 31st, we had $901 million of working capital, an increase of 251 million, or 39 percent versus last year. The accounts receivable balance on December 31st was $345 million, up 103 million versus last year due to increased revenues. The EAR reserve of $83 million was up 14 million versus the prior year, and as a percent of gross receivables is 19 percent. DSOs were 47 days.

Inventories on December 31st were $42 million, down 22 million versus September 30. Overall we feel very good about our inventory position both in the warehouse and at retail with no single title representing over 10 percent of the inventory. Capitalized software development costs on December 31st were $75 million, down 25 million versus last quarter. Capitalized intellectual property costs were 32 million, down 4 million versus last quarter.

Now I'd like to share with you our thoughts on the overall market, beginning with our hardware estimates. At calendar year-end 2004 the installed base in North America for current generation systems, including hand-held, was 76.5 million units. As we enter calendar 2005, the outlook for the hardware market is positive. Starting with the current generation systems, there's still a large and growing install base of hardware. The console shortages that retailers experienced during the holidays demonstrate that there are still considerable demands at the $149 price point.

The outlook for the next-gen systems is equally exciting. During the calendar year we will have 2 additional handhelds in the marketplace, both of which have the potential to broaden the demographic and expand the software market. By year-end, we could even see the introduction of the first-gen console system -- first next-gen console system, but because that has not yet been confirmed by one of the first parties, we have not included the impact of this in our projections.

For the calendar year our hardware forecast for the U.S. assumes that the PlayStation 2 will grow between 4 and 4.5 million units, that the Xbox will increase by 3 to 3.5 million units, the GameCube to sell approximately 1.5 million units, and that handhelds, which include the GBA, Nintendo DS and Sony PSP, will grow between 12 and 13 million units.

Moving to software, we define our market to include all major platforms in North America and Europe. For calendar 2005, we expect that the combined North American and European software markets for current gen consoles, handheld and PC, could grow as much as 5 percent. Looking at the market segments, in calendar 2005, we are projecting that the total current gen console market, which is defined as software for PlayStation 2, Xbox, and the GameCube, will be flat to down 5 percent.

We expect the handheld market to grow significantly driven by the 2 new hardware introductions. We project a combined software growth rate for the current gen console market and the handheld market will be a positive 3 to 5 percent. We expect the PC market to come in flat to down 5 percent, with the combined growth rate for current gen console, hand-held and PC video game software to grow in a range of 0 to plus 5 percent. Again, keep in mind that our projections do not include the introduction of a new console system, and if announced, it could positively impact our numbers.

With respect to software pricing, with the exception of children's titles, premium pricing for AAA-launched titles has held and we are planning that this will continue through the holidays. Our reserves protect against continued price erosion, but if large pricing for AAA titles drops abruptly before the holidays then we have exposure.

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. Strategically, our performance this year has been driven by focusing our time, energy, and capital on the global execution of our big propositions.

As Bobby mentioned earlier, we have exceeded our goal for this fiscal of having 10 titles sell in excess of 1 million units with 4 exceeding the multi-million unit mark. Successful titles like Shrek 2, Spider-Man 2, Call of Duty, Tony Hawk's Underground 2, DOOM 3, Shark Tale, X-Men Legends, and Lemony Snicket will continue to generate sales not only this fiscal year but well into the next.

Today we are increasing our outlook for fiscal 2005. We are raising our fiscal year revenue outlook by $87 million and expect revenues of 1 billion 352 million, up a strong 43 percent versus last year. In fiscal '05 we expect to increase operating income by 69 percent, translating into a record 13.7 percent operating margin, an increase of 210 basis points versus the prior year. For the fiscal year, we expect EPS of $0.87, up $0.06 versus our prior guidance and up 61 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 45 percent of net revenues with operating expenses including royalties of 41 percent. For the full year we project interest income of 0.8 percent, a tax rate of 32 percent and a fully diluted share count of 155.6 million. For the fourth quarter, we are raising our revenue outlook to $150 million and expect earnings per share of $0.01, even though the launch of DOOM 3 for the Xbox and the DOOM PC expansion pack have both moved into the first quarter of fiscal '06.

We expect manufacturing and distribution costs of 56 percent of net revenues with operating expenses including royalties of 45 percent. We project interest income of 2 percent, a tax rate of 31.5 percent, and a fully diluted share count of 116 million shares.

Our drive title for the quarter leveraged a North American launch of the Sony PSP. We plan to release with the platform launch all new games based on Spider-Man and Tony Hawk. Naturally, we're excited given the success of Spider-Man on the Nintendo DS. We look forward to release of this new handheld and its long-term potential.

As we look to fiscal '06 and beyond, our strategy for growth is tied directly to the continued investment in annualization of our existing franchises, selective but heavily supported launches of new concepts and continued expansion of our international publishing operation. Our fiscal 2006 slate continues to grow in-depth and breadth, and our worldwide selling and marketing capabilities continue to expand allowing us to realize even greater returns on our product investments.

In fiscal '06 it's our goal to have 12 or more titles sell in excess of 1 million units with 5 to 6 reaching multi-million unit status. In the coming year we will also continue to focus on expanding our international publishing capabilities. In fiscal '06 we expect to increase our direct selling efforts in 5 countries, and materially expand our international marketing efforts. In fiscal '05 we've seen the benefits of these initiatives and next year we will be even more aggressive in further strengthening our international competitive position.

As we look ahead to the introduction of next-generation console and handheld 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. You can expect Activision to have a meaningful launch presence for all new hardware systems. We demonstrated our ability to execute against this strategy with the launch of Spider-Man 2 on the Nintendo DS.

Our portfolio of annualized and long-lasting franchises gives us a clear advantage in resource allocation and planning for the next generation. Today we are deep in development for the next-gen systems and are 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 our most proven predictable brands with the very best product development resources we control. As we see it, there are a number of risks in the marketplace, but from an Activision perspective, we have never been better prepared to execute.

In fiscal '06 we plan to launch 12 big propositions across more gaming platforms than ever before. 6 of the propositions are new versions of our top 6 selling titles in fiscal '05, which represent a majority of our fiscal '05 publishing revenues. Tony Hawk, Spider-Man, Shrek, Call of Duty, DOOM, and X-Men. All of these titles will be released on the consoles including Call of Duty, which I mentioned earlier will have a console and a PC sequel in fiscal 2006.

Additionally, we will have 2 more proven properties slated for release. The multi-platform sequel to one of our all-time best sellers, True Crime, and on the PC its software's Quake 4. Complimenting these proven video game franchises are 2 major theatrical event supported releases based on Marvel's Fantastic Four and Madagascar from DreamWorks. We also expect to release the movies from Lionhead onto PC and our own new IP with a multi-platform title in development by the Neversoft team, a title which we have said we plan to invest heavily against to maximize its potential to become a top-selling franchise for years to come.

In fiscal 2006, we have more big propositions than the prior year and our SKU count will rise as we add the 2 new handhelds to our multi-platform strategy. The introduction of the 2 -- of the new handheld devices represents an opportunity for margin expansion in the coming fiscal year, and we plan to leverage our major growth in fiscal '05 into a leadership position in fiscal '06.

In fiscal 2005, we tripled the percentage of revenues coming from the handhelds versus the prior year, driven in part by the strong launch of Spider-Man on the Nintendo DS. In fiscal '06, we plan to significantly increase our position in the category and by year-end we expect to have 8 titles in the marketplace for the Nintendo DS and the Sony PSP combined.

In fiscal '06, the Company will have its strongest catalog lineup ever. We have 10 proven properties from fiscal '05 that we will continue to invest consumer and trade marketing dollars against. In addition, most of these titles will benefit from the significant infusion of marketing dollars that we expect to spend on their sequels.

In summary, in fiscal '06 we will launch our largest slate of big propositions across more gaming platforms than ever before, as well as our strongest catalog lineup ever. Our release schedule, which will capitalize on the largest installed base of current generation hardware, new hardware introductions, and our expanded international publishing capabilities, is designed to execute against our stated goal of continued growth during the period of new hardware introductions.

We are still in the process of finalizing our fiscal '06 operating plan and product release calendar, and we'll give detailed quarterly guidance on our next call. But as of today, we're expecting revenues in fiscal '06 to hit a record $1 billion 430 million which would be our 14th year of consecutive revenue growth. We also expect earnings per share to hit a record $0.91, which translates into a record 14.4 percent operating margin, which would be our sixth consecutive year of operating margin expansion.

For fiscal '06, we expect manufacturing and distribution costs of about 42 percent of net revenues with operating expenses, including royalties, of 43.5 percent. Operating expenses are expected to be higher than in fiscal '05 due to increased selling and marketing expense. However, product creation costs, which include developer and intellectual property royalties and product development expense are not expected to increase as a percentage of revenue as compared to the prior year, and are projected to stay in line with the annual percentage for the previous 5 years of approximately 21 percent of revenues.

For the year, we expect interest income of 1.5 percent, the tax rate of 34.5 percent, which is higher than fiscal ' 05 due to the phasing out of certain international tax benefits. We also expect a fully-diluted share count of 165.4 million. We will kick off the first quarter of the new fiscal year with the launch of DOOM 3 for the Xbox and the DOOM 3 expansion pack for the PC. In addition, we have 2 movie supported releases, Marvel's Fantastic Four, which will be launched on 5 platforms, and DreamWorks' Madagascar which will be released on 6 platforms including Nintendo DS.

For the first quarter, we expect revenues of $215 million and EPS of $0.02. We're projecting revenue growth for the quarter against a tough comparable. As you may recall, last year in Q1 released Shrek 2 and Spider-Man 2, which turned out to be 2 of our biggest products for the year. For the quarter, we expect manufacturing and distribution costs of 45 percent of net revenues with operating expenses including royalties of 55 percent. We project interest income of 2 percent, a tax rate of 34.5 percent, and a fully diluted share count of 162.1 million.

For modeling purposes, Q2 of fiscal '06 will most likely be smaller than the previous year's Q2, and the third quarter of fiscal '06 will likely be significantly larger than the previous year due to the timing of releases. In fiscal '05 we had more Q2 releases due in part to the competitive lineup that was expected in the holiday quarter. On our next conference call we will give more detail on our product release timing and our quarterly guidance.

We have a long track record of growing revenues ahead of the market and our goal for next year is no different. Fiscal '06 represents another year of great opportunity for Activision driven by our own slate with more proven properties, more SKUs, less competition with fewer high-profile titles, the introduction of 2 to 3 new platforms, a direct sales force in 5 additional countries, our marketing excellence, our very strong balance sheet, and our incredible people and their ability to consistently deliver.

We look forward to the coming year as we're building for the future and the long-term value creation that comes from increasing the breadth and depth of our proven product portfolio, expanding our high-quality product development resources and improving our international penetration. We thank you for the opportunity to share our continued success and growth initiatives for the future.

We will now open the call to your questions. Thank you very much. And, operator, over to you.

Thank you. (Operator Instructions). And we go first to Edward Williams with Harris Nesbitt.

Good afternoon. A couple questions for you guys. First of all, looking at pricing, can you give us some color as to what your expectations are for the percent of SKUs slated to launch in FY '05 that will launch at the premium price, and how that will change compared to when looking at FY "06?

Okay. We -- as I indicated in the prepared remarks, we believe that pricing will hold through the holidays for AAA products on the console, and that's $49.99 retail, with the exception of products for kids. We have only a couple of kids products in our portfolio next year, so the majority of our titles are expected to be released at that premium price point.

Okay. So we'll see an increase on a percentage basis of the SKUs?

Because you have the PSP and DS titles, yes, you will. Those prices are going to be up as compared to Game Boy, so overall I think you'll see a higher number of SKUs at higher prices.

Okay. Then, Bobby, if you can comment a little about in-game advertising. When do you think this is something that will have a material impact on the Activision income statement?

What we've said all along is that once we have a rate card established and the measurement tools to really provide advertisers with appropriate measurement of the value of the media, then we'll disclose more details of our programs, so you can expect that sometime in the next 6 to 8 months.

Okay. And then just 2 housekeeping questions. Catalog revenues for the quarter, if you could let us know what they were? Then headcount in R&D at this point?

Yes, the catalog number for the quarter, about 30 percent of net revenues. R&D headcount, about 750 people internally, and externally you could add another 300 or 400 to that.

And the 750 includes the recent acquisition?

It does.

Okay. Then one last question. The 5 countries that you alluded to are you going to elaborate as to which ones those are?

Denmark, Switzerland, Austria, Portugal and Norway.

Great. Thank you very much.

You're welcome.

We go next to Heath Terry from CSFB.

Could you give us an idea to what extent, if any, the hardware shortage is impacted, particularly your European distribution business? And then if you could also kind of give us an idea, you talked about product development as a percentage of sales being relatively flat going into the next cycle. If you were to include the change in the capitalized software expense over that period, would we -- what kind of increase would we see? I guess what I'm trying to get at is the total dollars that are being spent on product development beyond just what's going to be shown on the income statement, what kind of an increase should we be looking for there?

Heath, on the hardware shortage, we've certainly heard a lot about that and it seemed to be more of an issue in Europe in terms of having an effect on the business than here in North America. And inside of our European organization, yes, there was an impact on our distribution business that was felt, but there were also some significant offsetting factors. We had a really strong year, both on the distribution side and the publishing side over in Europe driven by our own slate and also in the distribution business. The slate of third-party publishers performing well.

On the PD front, yes, we're seeing an increase in total spending on product development simply because we continue to buildout our slate, not only for fiscal '06, but also significant work is underway for fiscal '07. We expect that slate to be even bigger than in fiscal '06. So it's a rising number, but we continue to go back to the fact that over the last 4 or 5 years, as a percentage of net revenues, that number has been pretty constant in the 20, 21 percent range.

And that's the total product creation cost number that I think you were sort of alluding to with your capitalized software.

And the reason that is flat is that we're implementing and are continuing to implement strategies that sort of counter balance the rising costs of game development. Some of those strategies are, focusing on increasing number of big brands in our portfolio, developing big brands internally across platform exploitation, international expansion, and so forth, all of those help balance out the increasing costs of developing games.

Great. Just one last question, Bobby, if you could, can you talk about kind of your view on this whole consolidation debate that seems to be going on in the press and certainly something that the media companies seem to enjoy talking about. Does it make sense to you? Do you see it as being a direction that the industry is headed in? And how do you win, assuming that these opportunities have come up, how does Activision evaluate those kind of offers?

No, Heath, we're going to refrain from making any comments on consolidation today.

Okay. Thanks.

We go next to Jeetil Patel from Deutsche Bank Securities.

I had 3 questions. First of all, if you look at fiscal '06, the growth rate, can you just give us a sense of how much will be driven by some of the new hardware releases in fiscal '06? Namely, distribution growth versus the publishing business growth as you look at the upcoming year. Second question. Can you just give us a sense of how many SKU releases that does imply if you're releasing about 12 major products in the next year? And then third question is, probably just more strategically, but what does the appetite to do just content deals or intellectual license, intellectual property look like today from the major studios? Is it changing any? Are they kind of holding some of these licenses close to their vest at this point as they evaluate build or buy decisions in the marketplace?

Let me start with your first question about -- I think it was about the growth rate between publishing and distribution in '06. We actually expect our distribution business to be down a little bit year-over-year. That's typical for that time in the cycle. And at the same time we expect for that reason all the growth to occur on the publishing side.

That's even with some of the new console launches expected next year as it relates to international?

Remember our distribution business is primarily in Europe and we're focused on the Sony distribution.

Okay.

The number of SKUs next year is around -- call it 52. Which is up 10 or so versus this year. And then in terms of IP content opportunities, those consistently have come our way over the years and are continuing to. We evaluate them on a case-by-case basis for the fit with our skill set, what we're good at in terms of upgrading products and marketing products, and importantly, of course, financial compatibility with our operating model. And being the second largest independent publishers, we're getting exposed to a lot of those opportunities, but we're very selective. Frankly, we think we're long on good IP and our focus is on maximizing return on the IP that we have.

I think you'll continue to see the focus on taking IP that we own and expanding the opportunities with that and with those intellectual property rights and that will continue to be the focus of the Company.

So we shouldn't expect like one deal a year or anything like that?

No, we're always participating in the evaluation, as Ron said, and as long as they meet our financial requirements, allow us to continue to grow our operating model, come with exclusivity, then we take a look.

Thank you.

We now go to John Taylor from Arcadia Investment Corporation.

Hi. I've got a couple of questions as well. First, could you maybe blue sky a little bit about the deployment of the alchemy that you picked up with the Vicarious Visions acquisition? And I don't know how broadly you're going to use that in your studio system, but maybe talk in general terms about standardized technology and how you're approaching that. That's the first question. Second question is, maybe talk a little bit about the advertising spending, sales and marketing spend in the December quarter, it went up quite a bit. What did you spend it on? What you got out of it? What you were happy with, what you weren't? And then the third question is PSP retail pricing, sounds like Sony is going at $39.99. Have you guys chosen where you're going to start yet? Thanks.

Yes, about the middleware technology that came with the Vicarious Visions acquisition, that's a really positive part of the acquisition. It is middleware that facilitates quick and efficient development of next-generation games. We've already worked with it. X-Men Legends, for example, was built on the alchemy engine and also some of our handheld games are built with that technology. As I said, it's a strong part of the acquisition. We will use that technology within the Company and other places. It won't necessarily be a mandatory technology, but it will be encouraged on other projects. So it's a big plus for the Company.

Secondly, your question about the advertising spend, yes, we were pretty aggressive during the Christmas season, and stepping back, overall we feel it worked very well, and as we move into fiscal '06 -- '06, we plan to capitalize on the learning and put all the good things to even greater effect in the program for next year. So it's definitely something that we feel was quite effective for the Company.

May I follow up on that real quick?

Yes.

So was that -- was the biggest bump there to media, or in-store, or pricing, rebating? I mean, can you talk a little bit about about where the oomph was?

It's really across the marketing spectrum. TV was up, trade activity in-store, display programming from gen [ph] was up. And it was an across-the-board increase in our investment in that area, which as I indicated, we feel really paid off.

Was there anything in particular that worked well, do you think?

If I had the answer I wouldn't tell you.

Okay.

On the PSP, you asked about pricing. We're going to go out at 49.99. Recall we were $10 ahead of the first-party price point on the DS, and it worked fine. We think that's a very good strategy, and if you go back to previous hardware launches, like the GBA, for example, we were also $10 ahead of the first-party price point at that point in time and that, too, worked well, so that's our strategy.

Okay. Do you guys have a thesis as to how many PSPs are going to be available in the market when Sony finally releases on the 24th or whenever?

Sony went out and talked about a million units.

Manufactured.

Right.

Do you have any sense of how much is going to be available at retail?

That's all we know, JT.

Thank you.

We go next to Tony Gikas from Piper Jaffray.

Good afternoon, guys. Great job in the quarter. Couple of questions for you. Do you have a preliminary idea of what the impact will be when you do start expensing options and maybe could you give us a heads-up on the timing of that.

Second question, some publishers were talking about supporting the current generation platforms longer into the out years once the next-gen had been launched, and it sounds like you guys are trying to maximize product launches at the start or the front end of the hardware cycle now. Maybe you can tell us if there's been a change there. And hand in hand with that, as it relates to the next generation of consoles from Microsoft, if they do launch later this year, how many titles do you expect you would be at that launch time with?

Then the fourth question, I mean, you guys can execute like mad. I congratulate you in that regard. What's gone wrong with guidance? You guys have been way off base with guidance, particularly if we rewind the calendar 3, 4 months ago, and even from the guidance you gave us a month ago. Not sure how to look at guidance right now.

All right, Tony. Let's leave that last one for last. First, on option expensing, we're going to begin that in the second quarter of next fiscal year. It is too early for us to give you any color commentary on that. We're still learning about the binomial model and what that all means, so please be patient. We'll probably give you a more specific update at the next call.

In terms of the support for the current generation hardware, and is there a change in our strategy? Yes, there is a change in our strategy. It's not as it relates to support for the current-gen hardware, but rather we're complimenting continued support for the current-gen hardware with the strategy that establishes Activision in a meaningful way at the launch of new hardware. If you go back to the last generation of hardware that's what we did not do, and that's what we're setting out to change. But we're not changing our commitment to the current-gen hardware. We'll continue to support that for a long time to come.

In terms of the -- if there is a new Xbox later this fall, how many titles will we have? We're going refrain from giving you a specific number, but we will tell you that it will be our goal to put out enough titles so we have a significant meaningful presence at launch.

And finally, what's wrong with our guidance, we don't think there's anything wrong with our guidance, Tony. We are conservative. We feel that, for example, in the last case in mid-December, there was still a lot of information not known about the month of December. Even though we provided guidance in the middle of December, you prepare that in early December. International information, which is a big part of our Company, on the month of December at the time was very limited, and historically, the last few weeks in December can make a huge difference in your quarterly results. Fortunately, we had a very strong 3 weeks in the end of the quarter and that made for a big difference, but that's not anything wrong with our guidance. That's simply the results coming in better than we conservatively forecasted at that time.

Tony, if you remember, the impact of the hardware shortages provided some uncertainty at that time, and generally what we found is that if we're planning conservatively and there is upside, especially unexpected upside, we get a great benefit as a result.

Okay. Great job, guys. Thanks.

Thank you.

Our next question comes from Elizabeth Osser from Smith Barney.

I guess a couple of quick questions. I wanted to follow up on the line Tony was going down. How often do you guys get reports from your European retailers? What's the kind of communication channel there, such that you can fill in and come up with such an incredible earnings surprise?

Yes, we have more real-time information here in North America than we do in Europe. In North America we're hooked into most of our major customers as far as their systems are concerned, and within a few days, are updated on where they are from a sell-through standpoint on our titles. It's not that way in Europe. It takes longer, generally at least a couple weeks for us to be able to contact all the retailers and get a good feeling for where they are, keeping in mind there are many more customers that we deal with in all the different countries in Europe than the dozen or so that we deal with directly here in the U.S.

Okay. And 2 more quick ones. One, in terms of new original intellectual property, do you think it would be fair to look for something like 1 game per year?

That's not our strategy. It has worked out that way, and it's worked out that way really well with '03 True Crime being a big success and '04 Call of Duty being a big success for us. This year we have on tap a new title coming from the Neversoft development organization that we're very bullish on and expect to support aggressively, but we don't have a 1-a-year strategy. It just happens to work out that way, or has happened to work out that way. We have an ongoing process of screening new ideas and sometimes we have quite a few, and other times we're a little leaner in that department. So there's no 1-a-year strategy, but it has worked out that way, and it seems to have worked quite well.

Okay. Finally, just from a strategic perspective, you talk far less about the opportunities on the mobile side and in Asia than some of your competitors. Could you just speak to when you think that might become a more significant part of your business?

On mobile gaming, I'll tell you that Activision tends to be a leading publisher of the mobile gaming space with a market share equal to greater than our market share of the console, hand-held and PC markets. For those of you less familiar with it, worldwide mobile games are generating industry revenues of an estimated billion, billion and a half in 2004, and that number is expected to grow quite a bit by 2007. So I'm estimating as much as much as 5 billion. We've positioned ourselves to take full advantage of that opportunity. In fact, in the last few years 19 mobile game titles were released based on Activision's brand portfolio, some with very significant success. Our current strategy is to publish our wireless games via several partnerships with dedicated wireless publishers, as well as direct relationships with the carriers and the handset makers. Bottom line, that's our model for today. In 1999, in fact, Activision was one of the first major publishers to move into the wireless space and we intend to be a major player as that market matures.

Thank you.

Thank you.

And our final question today comes from Bill Lennan from WR Hambrecht.

I have 3, I'll try and make them fast here. Could you give us an idea, I'm talking only about consoles now, excluding handhelds, how much do you think the installed base grows in the next generation? And related to that question, what do you think the ceiling is on household penetration of consoles? That's part 1. Part 2 is, what's your confidence in the DOOM SKUs for Q1? Are we on a quarter-to-quarter, we'll see it -- we'll believe it when we see it kind of thing or do you have higher confidence? Finally, on the 5 countries question, what percentage of your trailing 12-month revs do they represent now and what percentage of the market opportunity do you think they represent? That's it for me. Thanks.

So on the installed base question, as far as the next-generation hardware and what its impact is likely to be over a long period of time, I think we're comfortable giving the guidance that we gave you today on what calendar '05 will look like. Beyond that, I think one of the nice things about the changes that are taking place with technology generally is that as the browser does become an opportunity to deliver gaming experience, as these products have more capabilities like a blue ray or the ability to provide other networking capabilities in the living room, you're likely to see the penetrations continue to grow of games to users that in the past have not really participated in gaming. That said, probably don't want to get into speculation on anything other than the numbers that we gave you for the year.

On the DOOM SKU question, our confidence level is very high that those SKUs will be released in April. And on the 5 country question, we, for competitive reasons, cannot give out the percentages that you asked for. What I will tell you is that in our experience with other countries, there's been a substantial increase in our performance, both top line and bottom line in that particular country. Order of magnitude, as much as 100% increase on the net revenue line as we've taken those type of territories from the old model to the direct model.

Just 1 quick follow-up, then, for the guidance, then, does it assume that you realized any of that potential in those 5 countries or are you leaving that progress all for upside?

We're being pretty conservative in that area knowing that it takes a little time to ramp up operations in those type of countries, but, yes, there is some element of that built into our guidance.

Thank you.

And I do apologize, it does look like we have time for 1 more question and that will come from Mike Wallace.

Hi, guys. First, the handheld outlook you gave, what do you think the split is between PSP and the Game Boy and DS? Do you think Sony is going to take significant share this year? Second question is regarding market growth, if you look at calendar '06, I know you don't want to give guidance out that far, but if you see flat to up in European software, do you see something similar the following year? Do you think you get growth? And along those lines, do you think the PS3 is early '06 or late '06?

Let me answer the second question first. We're looking at '06 as kind of the lowest growth year in the 5-year cycle or so ahead. So we're expecting '07 to be a significant growth year, outperforming '06.

That's fiscal '06.

Yes. And on the NDS versus the PSP race, we're calling it a little ahead for the DS simply because they have an earlier start and Nintendo's well established strength in that area, but we do expect the PSP to come pretty close in threatening the DS numbers.

And we don't want to make any comments on the delivery date of PS3.

Thanks.

You're welcome.

Okay. Well, thank you all for joining us today, and for those of you who have any questions after the call, please contact me directly. And on behalf of everyone at Activision, we appreciate your time today. Thank you.

And that does conclude today's conference call. We appreciate your attendance today and have a great day.