動視暴雪 (ATVI) 2006 Q2 法說會逐字稿

Thank you for standing by and welcome to today's Activision second quarter fiscal 2006 earnings conference call. [OPERATOR INSTRUCTIONS]. At this time, I'd like to turn the conference over to the Vice President of Investor Relations, Kristin Southey, Ms. Southey, please go ahead.

Good afternoon and thank you all for joining us today for Activision's second quarter 2006 conference call. As always, I will start today's call with a review of our Safe Harbor disclosure, followed by comments from Bob Kotick, Chairman and CEO and Mike Griffith, President of and CEO of Activision Publishing.

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 our 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, integration of recently acquired subsidiaries and identification of suitable future acquisition opportunities.

Such important factors and other factors that could potentially affect the Company's financial results are described in our filings with the SEC, including the Company's most recent annual report on form 10-K and quarterly report on form 10-Q. The Company may change its intentions, beliefs, or expectations at any time, and without notice, based upon any changes in such factors and the Company's assumptions or otherwise.

The Company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events. In addition, I would like to highlight that our numbers have been adjusted to reflect our four for three stock split that was payable on October 24, 2005.

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

Thank you, Kristin, and thank you all for joining us today. Today I will share our results and provide an outlook for the back half of the fiscal year.

But before my comments on the quarter, I wanted to acknowledge the contributions made by Bill Chardavoyne, our CFO during the last six years. I speak for everyone at Activision when I thank Bill for his and unyielding commitment to our stakeholders. Bill will be handing the reins and some big boots to Thomas Tippl, who was appointed CFO of Activation Publishing in September. Thomas joins us from Procter & Gamble where he held senior positions in operational finance, treasury, investor relations, M&A, investments and a variety of international assignments including Japan, China and Europe. Thomas and Mike Griffith worked together throughout their long association at P&G and we're grateful Thomas will be joining the management team.

Turning to our financial results, revenues and earnings for the quarter exceeded our prior outlook. Our balance sheet and financial position remains strong, we ended the quarter with $750 million in cash and $1.1 billion in shareholders equity. We remain focused on our core strengths: Branding, product innovation and world class selling and marketing. As an organization, we continue to execute against our articulated goals and financial objectives.

To date, seven of our titles released this fiscal year have exceeded the 1 million unit mark and we remain on track to achieve our goal of 12 million unit sellers. We remain committed to consistently delivering high quality interactive entertainment. Our product lineup for the remainder of the year is strong and balanced and our institutionalized product development process has yielded some of the most innovative games we have ever created, All of which are expected to launch before Thanksgiving.

In Q3, we will launch eight titles across more gaming platforms than ever before. Seven of the eight titles were developed by our own internal studios. Six of the titles are based on our proven predictable top selling franchises. One is our own widely anticipated new intellectual property, Gun. Our launch lineup for the XBox 360 is the strongest ever for the new platform, consistent with our goal of having a meaningful launch presence for all new hardware.

Our products and our marketing plans are our strongest ever, and we are enthusiastic about our prospects for the balance of the fiscal year. That said, we remain cautious of the many variables that can still affect industry fundamentals and our own market performance. There is still significant pricing risk, macro-economic risk and the acceptance by consumers of our products given the many choices they will have this holiday season.

Early indications, in fact, show some market weakness. Possibly the result of the hurricanes, fuel prices or the consumer waiting for the launch of the new XBox 360. Retailers seem to be placing lower initial orders followed by faster replenishment as product demonstrate sell through strength. We are closely monitoring industry conditions and product sell through and will adjust research allocations as necessary, a true benefit of having a balanced portfolio of products in the marketplace and a highly organized operational and logistics capability.

Operating margin remains an area of financial concentration. We are focussed on increasing and annualizing revenues and profits from our franchises, the measured introduction of new potential franchises, broader and deeper financial participation, greater participation in the hand held market and early introduction of high quality next generation titles.

With respect to the market, the successful global launch of the new handheld is behind us. We have more clarity on first-party console hardware plans and better visibility into the changes required for next generation development. Longer term, the market should expand driven by technical innovation, broader demographics, and greater international hardware penetration.

As an organization, our long term strategies, investments and operational actions are all designed to leverage the positive market fundamentals and to deliver operating margin expansion, greater free cash flow, and a continued higher return on our invested capital.

It's my great pleasure to introduce Mike Griffith and Mike will share with you our quarterly results and provide an update to our Fiscal '06 operating plans and financial outlook.

Thanks, Bobby.

First, I would like to start with the highlight of our Q2 results specifically, and then I will preview in what we see in Q3 and the balance of the fiscal year, and finally I will step back to review the market and our focus and direction for future growth into the next hardware era.

Let me start with Q2. For the quarter ending September 30, net revenues were $223 million with the loss per share of $0.05. Our results exceeded our prior year outlook driven by solid execution and as expected, we are down versus prior year.

Year-over-year, we faced tough comparables due to last year's unusually strong Q2 lineup which included Spiderman 2, Doom 3, Shark Tale and X Men Legends. In the second quarter of this year we had no worldwide releases in the months of July and August. Our quarterly performance was driven by the late-September U.S.- only launches of Ultimate Spiderman and X-men Legends Two. To date, both titles have exceeded the million-unit mark, driven in part by some of the highest game rankings in the super hero history.

This quarter we also launched World Series of Poker Worldwide, and Tony Hawk's Remix and Spiderman 2 in Europe with the successful launch of our PSP hardware. Also contributing to the quarter was catalog performance of two movie-supported release, Marvel's Fantastic Four and Dreamworks' Madagascar. Both titles have exceeded the million-unit mark, with Madagascar already exceeding 2 million units. In addition our distribution business was positively impacted by the successful launch of PSP in Europe, where we distribute both hardware and software.

Turning more specifically to the financial results in the September quarter, our manufacturing and distribution expense was 51% of nef revenue, in line with prior expectations and up 40% from last year due primarily to product mix. In the publishing business, we had lower percent of net revenue come from the PC this year which has no associated first party royalties. And then the distribution business, we had a higher percentage of revenue coming from hardware, which is the higher cost of goods.

Operating expenses for the quarter excluding manufacturing and distribution expense were approximately 61% of net revenues, up versus 49% in the prior year driven by our growth initiatives including an increase in the number of titles of development and addition of global infrastructure to support our European growth. Our effective tax rate for the quarter was 34.5% versus 31.5% last year, higher due primarily to a international benefit we had in the prior year.

Turning to the balance sheet, on September 30, we had $750 million in cash and short-term investments, a significant increase of $144 million versus last year, and down $36 million versus last quarter, due to the seasonality and the timing of payments and expenses. As of September 30, we had $906 million of working capital, an increase of $167 million or 23% versus last year.

The accounts receivable balance on September 30 was $117 million, up $22 million versus the prior quarter, due mainly to the late September launches of Spiderman and X-Men. The accounts receivable reserve of $79 million was up $2 million versus the prior quarter and as a percent of gross receivables is 40%.

Days sales outstanding were 48 days. Inventories on September 30 were $52 million, up $7 million versus June 30, again driven by our heavy Q3 release schedule. On September 30, inventory for publishing business was $35 million and $17 million for the distribution business.

Capitalized software development costs on September 30 were $123 million, up $15 million versus last quarter, and up $22 million versus last year, reflecting the growth of our product slate. Capitalized intellectual property costs were $29 million, down $6 million versus last quarter and last year. In summary, we ended the first half of the fiscal year ahead of our outlook and with a strong balance sheet and solid financial position.

Our performance for the remainder of the year will be driven by the achievement of best-in-class global execution of our slate. Our release schedule for the holiday quarter is ambitious and represents the most innovative games we ever produced, all of which will be supported by the strongest selling and marketing effort in our history.

Now, before moving to Q3, I would like to share our thoughts on the overall market beginning with the hardware estimates. On September 30, the installed base in North America for current generation systems including hand held was just over 87 million units. The outlook for the hardware market is positive.

For calendar year 2005, we expect approximately 22 million units will be added to the installed base so the addressable install base of hardware for the current gen systems is large and growing. The next gen install base for 2005 will be driven by new hand helds and the much anticipated launch of XBox 360 which is now just around the corner.

Specifically we expect the following increases. We expect PS2 up by 4.5 million units. Xbox and XBox 360 combined up between 3 and 3.5 million units. GameCube up 1.5 million units and hand helds including GBA, DF and PSP all up 12 to 13 million units.

Moving to software, we define our market to include all major platforms in North America and Europe. For calendar 2005, consistent with our prior outlook, we continue to expect the combined North America and European software markets for current gen and next gen consoles, hand held and PC, will grow modestly in the range of flat to up 5%.

With respect to software pricing, we plan to launch our XBox 360 titles at a premium surprise of $59.99, with the exception of children's titles, we expect launch pricing for all AAA titles to hold through the holidays. This appears to be market pricing for quality franchises.

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

As we look forward to Q3 in the full year, let me say that our strong lineup has more depth, breadth and balance than any slate in our history. We continue to improve and expand our worldwide selling and marketing capabilities putting us in a better position to leverage our franchises for greater, long-term return on investment.

There still remain a number of significant risks in the marketplace, but from an Activision perspective, we have never been in a better competitive position. First, for the full year, we are increasing our revenue outlook to $1.48 billion, which if achieved would mark our 14th consecutive year of revenue growth. We continue to expect earnings per share of $0.52. Operating margin is expected to improve by 70 basis points over the prior year.

For fiscal '06, we expect manufacturing and distribution costs of 45.1% of net revenues with operating expenses including royalties of 41.1%. Other expenses are expected to be higher than in fiscal year '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 percent of revenues as compared to the prior year.

For the year, we expect interest income of approximately 2% and a tax rate of 34.3%. Our tax rate is up versus the prior year mainly because of lower R&D credits and no prior-year true ups. We expect a fully diluted share count of 296 million.

Now on to the December quarter. In Q3 we are launching eight big titles across more gaming platforms than ever before. Seven of these titles are internally developed. Six of these are based on our all time best selling franchises, including Tony Hawk's American Wasteland. Shrek Super Slam, Call of Duty 2, True Crime New York City. Quake 4, and Call of Duty 2: Big Red One.

Complimenting these proven video game franchises are new IP, the movies on the PC and Gun. We have been getting very strong consumer and retail interest in Gun and we are investing heavily against this title to maximize its potential to become a top selling franchise.

In addition, our commitment to next gen development and our intent to have a high quality presence at the launch of XBox 360 is on track. We are launching Tony hawk's America's Wasteland, Gun, Quake 4 and Call of Duty 2 all with the hardware. In fact, Call of Duty 2 was the first XBox 360 title to be approved by Microsoft. And the game's early previews have been exceptional.

Notably, every title we are targeting for the all-important holiday season is launching in Q3. This is a testament to the Activision institutionalized product development process which enables us to manage a large portfolio of global products while providing better consistency with regard to launch dates and product quality.

So in total, for the third quarter we still expect revenues of $790 million and earnings per share of $0.52. We expect manufacturing and distribution costs of 40% of net revenues with operating expenses including royalties of 31%. We project interest income of .8%, a tax rate of 34.5%, and a diluted share count of 298.1 million.

In terms of risks to our plan, I would like to highlight that our reserves protect against continued gradual price erosion, but if launch pricing for triple-A titles drop abruptly market-wide or the performance of our portfolio products are substantially below our expectation then we have exposure and you are well aware that the launch of new intellectual properties like Gun always come with a higher degree of risk.

We feel good about our launch schedule. Our game quality, marketing support and retail execution. And while the overall retail environment is beyond our control, we were actively monitoring demand and are prepared as necessary to adjust our plans, particularly to chase the winners as the quarter unfolds.

Moving to the fourth quarter, we expect revenues of $226 million and EPS of $0.05. This is slightly lower to our smaller outlook due in part to a PSP title which was on the cusp into Fiscal '07. We expect manufacturing distribution costs of 45% of net revenues, with operating expenses including royalties, of 48.5%. We project interest income of 4%, a tax rate of 34.5%, and a diluted share count of 301.9 million.

In summary, fiscal '06 represents a year of opportunity for Activision. Now, looking ahead to fiscal '07, we are in the process of finalizing our product slate and our annual operating plan but we will update you in our future. But you can expect many of our best selling franchises to return.

In addition, we will kick off the year with the release of two titles we are very excited about, Lost in conjunction with feature films, Dreamworks, Over the Hedge and X Three from Fox Marvel Studios. Although we will update you in greater detail on Fiscal 2007 on our next conference call, I do want to provide a sense of the key building blocks we will remain focused on in order to capitalize on the positive long term industry fundamentals.

Our performance over the next few years will be driven by directing our global resources and capital allocation toward making our big brands bigger through innovation and marketing excellence, building structural advantage through leveraging scale, and winning at retail with superior execution at the front line.

First, we are squarely focused on a branding strategy. Driving and continually reinventing our core brands through superior innovation and marketing. We purposely built capability to do this and we believe it will continue to be the very foundation of our growth. To be clear, we expect to selectively develop and introduce new IP as we were this year with Gun, but with the full intention of being selective so that we can get it right absorb the appropriate investment and with the intention of building it into a sustainable franchise to add to our portfolio.

Second, we are committed to structural margin improvement through building and leveraging our scale. One way we are doing this is by developing across multiple platforms simultaneously. Another, through spreading our costs across more geographies. During this hardware transition cycle, we are fully supporting current generation hardware as long as economically attractive, while simultaneously establishing a leadership role supporting the new generation.

This is something we couldn't do during the last transition, and is helping us tremendously to maximize use of our development and marketing resources. For example, we are experiencing marketing synergy by launching Call of Duty 2 for PC and XBox 360, while simultaneously launching Call of Duty 2: Big Red One for current gen.

We will continue to be very focussed on geographic expansion with particular emphasis on Europe. This year we are pleased with our performance and our well-established businesses in the U.K., Germany and France as well as new territories Italy and Spain. When Italy launched Madagascar earlier this year, for example, our corporate market share in that country rose to a leadership level. And in Spain, we were the number two publisher for the quarter. We have a lot more opportunity in Europe and we're focussed on it.

Finally we were relentlessly focusing on superior in-store execution at the front line. Over the past six months we completed the transition of our selling structure to a multi-functional customer teams. These teams have partnered with individual customers and provide a new level of analysis to understand where our trade marketing is most effectively spent. We were starting to see the benefit of this beginning this quarter.

Circular support and display activity overall and on a per title basis are up significantly year-over-year in both the U.S. and Europe. And while we are pleased with our customer plans, we are beginning to see the long-term benefit of this direction to more actively partner with retailers.

In summary, we believe this fiscal year we are firing on all cylinders of our strategy. We are proud of the products we are launching and the execution behind them. Looking ahead, we expect to be well positioned as we start a new hardware era.

Thank you for the opportunity to share our continued success and initiatives for the future and I will now open up the call for your questions. Thank you.

[OPERATOR INSTRUCTIONS]. We will go with Elizabeth Osur with Citigroup.

Thanks. Great quarter guys. I know you don't want to give too much detail on the product release slate for next year, but could you give us a sense of whether or not we can expect more titles or fewer or just to comment on whether or not we can expect you to grow revenues every year through the cycle? Just something to give us a big picture idea?

Well, I think for starters we are not going to get into the specifics of our titles and launch plans. We will be at a better position to do that on our next call. But certainly you can expect, based on our strategy, that our strongest franchises will return and will focus on building them in the future.

Okay, and if I could ask one other question, in terms of retail trends we've heard a lot about some weaker trends in the U.S. Are you as your competitor mentioned yesterday, are you seeing stronger trends in Europe as well and feeling like there is somewhat of a divergence between the two markets and the consumer trends?

Well, as we step back on our Q3 slate and plans, we are entering the quarter with a very robust portfolio and a very strong execution in both the U.S. and Europe. It's really the strongest execution the Company's had in its history.

We are launching, all together, 13 main line titles, 54 SKUs, double the number of titles in Q3 than we had a year ago. Not a single title that we had planned for Q3 has been delayed. We are very pleased with the quality. We have the strongest marketing program behind our titles that we ever had that the advertising and programs have been well vetted or data tested. We feel like we got very good reception from the trade in both Europe and the U.S. As I said, we have seen plans in Q3 for very strong year-over-year increases in circular support and display activity.

But that being said, as Bobby mentioned earlier, and as I mentioned on the call, we are seeing signs of a cautious retailer environment and it is bridging between North America and Europe. There are many macro issues that are on the minds of retailers that are impacting both geographies. Some specific to each geography. But it is hard to say how much the hurricane, the gas prices, the console pricing are all impacting the macro-economic trends, but we have seen in Europe and North America, general pressure on channel inventory. Seen a stronger mentality on the retailers to reduce initial order quantities. And then expect to chase reorders faster as the titles sell through.

So we think we are very well positioned. But it's prudent to watch it closely. We are working this with every major retailer in Europe and North America. But in both continents, we are focusing heavily on what we control. One thing we've got that we feel good about in Q3 is a very broad portfolio. And we feel very good about the quality of the games and the marketing support.

But we're in a position from both the consumer marketing and a trade marketing view to reallocate our resources as we get more data and go through the quarter. So that we focus on feeding the strong. To the degree as strong as possible. We think that this is a real benefit and a advantage we will have with the breadth of our portfolio. We are watching it very closely.

Thanks a lot.

Our next question is from Brian Pitz from Morgan Stanley.

Congratulations on a good quarter. Couple questions here. Can you give us any more color on the XBox/XBox 360 breakout to 3 to 3.5 million. Is it safe to assume that's a 50/50 split or weighted one way or another or maybe a little color on your China opportunity you recently talked about releasing titles in China. Maybe more color on that and your thoughts on piracy in that market. Thanks.

All right. Well, let me take the XBox/XBox 306 one. I think your best guidance on that will come from Microsoft. We have been staying close to their projections just like you and others. And we are very bullish on the new platform.

The good news that we have been hearing consistently from Microsoft is regardless of the exact week of the execution, they have very robust plans to ramp up 360 in the weeks and months ahead. We think it will be a major platform which of course, is why we are supporting it so heavily at the beginning.

In terms of China, I would say this broadly, we were interested in distributing our titles around the world, in many cases through distribution agreements. And we haven't announced anything in China specifically, but in general we are very interested in distributing our products and. and amortizing our product creation costs over more geographies.

Certainly, piracy is an issue in China. Having lived in Asia myself, I understand that and that's something we have to be very cautious of and make sure that we are stepping in there with our toes before we jump all the way in.

Our next question is from Jeetil Patel with Deutsche Bank.

Couple of questions. Michael, first of all, you have been there for some time now and have had a chance to really dig into the operations. Can you talk about I guess some of positives and kind of areas of opportunity that you see at Activision as you had a chance to settle in and see how the development process all the way to the marketing and selling process looks? Give us a sense of where you think the strengths were when you were surprised positively and where there is still opportunity inside to improve upon.

Second, you talked about lower initial orders. Anyway to give us a sense of what kind of percentage lower orders you initially saw as you kind of progressed through October?

Well, let me start, with your first question. I did my due diligence on Activision. No doubt about that. And first of all I am here because I believe in the basic premise that competitive advantage can be built in this industry through superior innovation and marketing just as it can in classical consumer products businesses. And I am really drawn to the belief in that model here at the Company.

I believe that deep understanding of what gamers really want can be codified into the games they want to play. And that disciplined business processes to support this can built shareholder value. That is my premise for joining this company. So our focus is really quite simple. First, you will see continued and increased emphasis on building brands. Starting with a better understanding of -- understanding of gamers leading to innovation that delights them and ending up driving our big brands to be bigger. It's a very basic tenet of what has driven the success of this company over the past several years and I believe in it.

Of course, as I said, we will also broaden the portfolio over time. This year introducing Gun as we have in the past with Call of Duty and True Crime. So in that way, we will develop these into big brands as well. But in no way is that going to distract us from continually breathing new life and reinventing our existing franchises.

So second, we really got to get better and continue to emphasize leveraging our scale into stronger operating margins. Again, a belief in the company that I buy into, support and will accelerate. Focusing on the big proposition certainly helps, geographic expansion will continue to be critical. But we will drive more rigor into our processes to be sure we capture the opportunity fully.

And lastly I would say we will build our leadership on the front line in the store. We have seen the success of this in many industries. As I said, we have been restructuring our selling organization against a customer team focus and already seeing results of that in terms of stronger in-store support, stronger merchandising support. But there is a lot more opportunity from full partnerships that we are going after with retailers. And we will be Focusing on and delivering on that.

So I feel particularly blessed to be joining the Company at a time where it has momentum, at a time where we are going into a hardware transition, but also at a time where we see how these basic tenets can drive us much further. So that may be a little bit more than you wanted on that point but I feel passionately about it.

In terms of the inventory or the retailer orders that they are bringing in, generally seeing it different by retailer, but it is not uncommon for the retailer to be bringing in a 3 to 4 weeks of inventory and then coming back with reorders.

Great. And on that point, a margin expansion and international expansion as part of it. I guess do you think that it can be done using the partnership approach on licensing IP? Or do you think you need to look at still building IP from internal such as Gun, such as True Crime? Or do you take the partnership approach in terms of IP and licensing?

Think for all practical purposes it will be a blend. If you look at the model, each way, by licensing IP you wouldn't license it unless you believed in the strength of the equity that you were bringing in to the model. For internally developed IP, there will be a requirement of stronger marketing establishment early on. And I think as we look at our portfolio and how we balance the slate and the returns over time, it is clearly going to be a blend of both.

Great, thanks.

Next question is from Gary Cooper of Banc of America Securities.

Couple of questions. First, can you give us an idea how Tony Hawk is performing since the release versus last year and whether it's one of these 1 million sellers. And secondly, the sales and marketing line, it's up to 25% of quarterly sales.

I'm wondering if you could break that line out to say TV advertising and in-store costs and I guess specifically what I'm driving at there is I'm wondering if you spent money on in-store costs in Q2 that you benefit in Q3. Could you name the PSP title that was pushed?

Yeah, the first of all on Tony, this is an exceptional title. As I look at the game and we look at how reviewers are responding to it and marketing program we have behind it, we feel that Tony Hawk America Wasteland has taken the franchise to a new level. It is one of our million unit sellers already. Despite just being launched. So we are very bullish on it.

That said, you know, it comes with all the Q3 risks that we outlined before. But we feel very good about our execution. The PSP title, by the way, was Gun, that was just on the cusp of being in or out of our fiscal year. We had a stretch objective to bring it into the year based on the enthusiasm of Gun franchise and reception it's receiving. But we made the call to just make sure we have got a game that we feel very good about and so we will put it into Q1. And I can't remember your second question.

Marketing, variable selling marketing.

We aren't going to break that out for you. We are a believer in a marketing contribution to the business and to building our equities. But we don't want to get into the specific line item breakouts.

I would say those investments are likely to pay dividends for the third quarter.

Thank you.

Our next question comes from Edward Williams from Harris Nesbitt.

A couple of questions. First -- your development videos, could you let us know what the head count is at this point and how you expect that to change in the next couple of quarters. In addition to that, what steps you have taken to drive down the cost or at least to temper the rate of increase as you move to next generation of hardware? And then secondly, as we look to the next console cycle and geographic basis, how do you see your revenue breaking down between North America, Europe and places such as Asia.

Starters, you have got 1200 people in the studios. We expect that will go up by another 2 to 300 by year end. On steps we are taking on our product creation costs, we really think of product creation costs holistically including software and IP royalties as well as the specific development expenses as a true cost of making a game. That's really the number we are focussed on and the number we want to see efficiencies build, over time, behind.

Historically we have seen that hold to about 20% of our net revenues over a long period of time, despite the fact that hardware complexity is increased. In fact, our past three year average on product creation cost is just about exactly 20%. Really too early to tell how the new generation hardware is going to impact development costs.

No doubt the hardware is becoming more complex, but we were also getting more sophisticated at developing it at the same time. We will focus very seriously at improving our processes as well as our efficiencies and so regardless, continuing to focus on amortizing those development costs, over more platforms, over more geographies across internal -- developing more games with our internal studios and all of those things will help us.

We are very focussed on driving the efficiency of that. We think we have a number of vectors to address it against.

And then looking at the geographic base for your revenue on a going forward basis.

Our geographic is about 50/50 in terms of total company.

If we are looking at publishing, how do you see that shaking out as Europe expands? Obviously you are looking to expand fairly rapidly in the European market.

One way to look at it is today we are kind of two-thirds/one-third publishing U.S. to Europe. But if you look at where the software market is, it's closer to 50/50. There's no reason over time we shouldn't have our business in line with the software market.

Thank you.

Next question is from Heath Terry with Credit Suisse bank.

Just first I guess to follow up a little bit on Ed's question. As we go into this new cycle and get a few years into it, what kind of opportunities do you see the new technologies creating in Asia for Activision?

And then I want come looking out beyond this holiday season, one of the things that you talked a bit about is the advertising opportunity. Wondering if maybe you could talk about your perspective on that and how you see that potentially playing out as an opportunity for the company.

You know our focus right now, Heath, is still to expand our opportunities within Europe and we are starting to make modest investments in the Asian markets. I think as the next generation consoles emerge and we have content more appropriate to license in those markets, we will start to explore them. But the next two or three years you will see the low hanging fruit for us to take the products we currently have in the pipeline is to expand our presence in Europe.

What was your second question?

And then the other question was just kind of current perspective on the advertising opportunity for the company.

Advertising in terms of what?

In game advertising.

In game advertising? Well, we think in game advertising holds a lot of promise over a long period of time. And something that we are actively staying close to, experimenting with, and so forth. It, of course, now when we expect for the near term is going to have a very small potential for us and the industry, but as it matures and as a business model develops that looks viable, we will certainly be there.

Great, thank you.

Next question comes from Mike Wallace, UBS.

Hi, a couple things. First, when do you think pricing starts to come down? Is it early next year? Mid next year, not until the PS3 comes out. I'm talking about the software pricing of the PS2 holding $50.

Second question: could you give us a list of the new titles being released in the March quarter. Third question regarding retail and nervousness and everything there, back Christmas '02, what happened in a lot of cases, some retailers even if they were selling products just stopped buying all together.

Maybe, Bobby, you can gauge the level of nervousness you are seeing so far. Can you see a chance where we are seeing a repeat there where even top selling games people aren't buying. Do you think they are more anxious because the 360 is coming out? How would you gauge the environment?

Seems similar and there are a lot of differences as far as product quality. I think you look at the relative strength of the bigger companies in the category . Mike talked a lot about what we have been doing in terms of retail shelf presence. I can't even say this is a concept that's isolated to just '02.

Almost every single year we hear the retailer at around this time saying that they want to cut their early inventories. That they want to move to a more of a sell through model. Everybody recognizes the reality of long lead times from manufacturing. And it's too early to tell, but I can't say that things are dissimilar to what we experienced in other periods.

The question of pricing, we are planning on pricing holding at least through the holidays, the launch pricing. We are -- we don't have new titles planned for Q4. So we got to see how we will get through the holiday season and then we will make an assessment on where we think pricing will be longer term.

So the March quarter there is nothing new, it's all catalog, is that what you said?

It will be, yes.

Thanks.

Our next question will come from Justin Post with Merrill Lynch.

Can you talk about the fourth quarter -- I know you brought down the number a little bit and if it's a title pushout. There is anything related to a competitor really pushing a lot of titles that quarter and trying to be prudent about competition that quarter?

And second question, X-Men Legends; has it exceeded your expectations and does it mean anything for the movie release next summer, how bullish are you on that?

I think in terms of Q4, it was nothing in the competitive landscape that motivated our actions. And as we did a bottom up calculation of what we expect to deliver in Q4 based on pretty robust catalog program.

The percent of our business that will end up being Q4 this year will be about the same as it has been historically and last year, at about 15%. So we feel pretty good about where we stand in that regard.

In terms of X-Men, yeah, this is one where we feel is a real potential annualizable platform for us and we are very much looking forward to the movie.

I think when you look at our Q4, a lot of this success in Q4 will be dependent on our success in Q3 and we have a really strong slate for Q3, but we need carry over for Q4.

And one quick follow-up. On taxes, you are at 34%. Can you get that number under 30 as you grow internationally, and is that a long-term margin opportunity for you?

Well, I think it's certainly going to be a focus on driving the cash rate down over time. I can't tell you exactly where we will get you, but we aren't happy with it going up.

Thank you.

Our next question comes from Tony Gikas with Piper Jaffray.

Good afternoon, guys. Two questions. How quickly do you plan on ramping your on-line initiatives on the next gen and then maybe characterize how many of the games over the next 12 months or so will be coming out for the XBox and the PS3 will have on-line opportunities like micro transactions?

Second question, has it become a challenge to maintain margins in the distribution business? Maybe at historical levels as industries trends flow a little bit and hardware is a greater portion of overall of sales? Third question, any opportunity to bring the mobile video game business in-house? Is that market big enough yet?

Let me lump your first and third question together. Which is really what the opportunity for mobile gaming and what the opportunity for micro transactions, and other on-line, both of these areas that are very small opportunities today in the industry on a percent of total revenue basis. And the business models are still evolving. We are involved in and experimenting with both. Involved in all key areas of the business that may develop over time.

But we are focussed on solidifying the business model, Focusing on where we know we have got the greatest leverage on the current consoles, current platforms. We are going to keep monitoring these things as they become more attractive. These are, in many ways particularly mobile is like another platform and it will be content-driven.

We are focussed on delivering top quality content and as it becomes worthwhile to continue to extend into those areas, we will certainly do it in the most attractive way. On our distribution business, it's been a stable business for us. While it's got some tough year-over-year comparables, so that we aren't seeing a lot of growth out of it at this point, what it's delivering is very stable.

And we always said that the -- the operating margins are slightly lower than with a we have in our publishing business. The return on invested capital is very significant. Distribution businesses in Europe have always provided with us overall advantages in those markets and they are great businesses.

Just a couple of add-on comments, with respect to next generation software and on-line enhancements, virtually every one of the product has some form of on-line play, Tony, and as we get more visibility from Microsoft and Sony how to how micro transactions will actually work, to the extent there is an opportunity those won't be difficult ones for us to take advantage of.

On the wireless front, there is always some confusion about our participation of business because it's a small business today. We have over 20 titles that we've developed or published. In some cases they're self-published and other cases they are licensed. The direction is to move toward a self-publishing model in that area. And largely that is driven by our desire to take intellectual properties that we own or control and leverage them across the broadest possible platform.

We view both of those as opportunities for long-term margin expansion. And dedicated resources Focusing on them.

Thanks. Great job.

Thanks.

Our next question will come from Arvind Bhatia with Southwest Securities.

Hi. First question is on the catalog side, can you give us the number for that quarter and the expectation for the next quarter?

My second question is I think you mentioned Madagascar sold or shipped 2 million unit. Can you tell us if that was evenly spread out between this quarter and the last one?

Yeah, I think first of all on the catalog business, it was about just over 25% of our business this quarter. We think that is about where we will end the year. Somewhere just north of 25%. Pretty typical range for us.

In terms of Madagascar, it has been a hugely successful title for us. It has shipped well. In Q1 and Q2 as well. Like all titles, it tends to ship more in the beginning than in later months. But it is one of our 2 million plus unit sellers this year.

One last question, if I could. The [catalyzed] software side, can you tell us what percentage is on the balance sheet that relates to the product that is in the marketplace already?

13, roughly 13%.

Thanks, guys.

We have time for one more question at this time. It is from Shawn Milne with Friedman, Billings Ramsey.

Thanks a lot. Mike, wondering if you could talk a little bit about the G&A line in the quarter was up a little higher than I expected. Is that infrastructure built out in Europe and a number we can use going forward?

And then, Bobby, I wanted to beat the dead horse one more time. We heard a lot about the lower initial orders this week. It's a trend that seems to me is happening for the past couple of years. Are you suggesting today that the titles that you just released into the marketplace are not selling through as well as you expected? Are you commenting on initial order quantities, thank you.

To start with your first question on G&A, you hit it right on the head. It is exactly infrastructure build out for expanding our operations. And we are right on track with our expectations in that regard.

And all I was saying was there is a general trend that we have seen it continue that retailers continue to focus on whether it's buyer compensation or the way they are measuring their own performance and able to turn their inventories and that trend continues and I think Mike alluded to it earlier, that people are moving towards three to four weeks supply of inventory. That wasn't meant to be anything other than a general comment on the marketplace.

But I would add on to that again, looking at what we control as we go into the third quarter with the broadest portfolio in the Company's history and if you look at the ratings that these titles have been delivering, they are exceptionally strong. Our programs in terms of marketing and planned merchandising support are exceptionally strong. So we feel on the execution side, we are really feel very good about where we are.

Thank you. Good luck.

I would like to turn the conference back to the speakers for additional or closing remarks.

On behalf of everyone at Activision, we thank you for your time and consideration today. And we look forward to speaking with you in the future.

And with that, that does conclude today's conference call. We would like to wish everyone --