動視暴雪 (ATVI) 2006 Q3 法說會逐字稿

Good day, everyone. Welcome to the Activision third quarter fiscal 2006 earnings conference. Today's call is being recorded. At this time for opening remarks and introductions I would like the turn the call over to the Vice President of Investor Relations, Kristen Southey. Please go ahead.

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

With regard too our Safe Harbor disclosure, I would like to remind everyone the statements made during this call not historical facts are forward-looking statements. These forward-looking statements are based on current expectations and assumptions that are subject to risk 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, sales of the Company's titles during the remainder of fiscal 2006, consumer spending trends, the seasonal and cyclical nature of the interactive game market, the Company's ability to predict consumer preferences among competing hardware platforms, including next generation hardware, software pricing, product returns and price protection, product delays, retail acceptance of our products, delays in hardware launches, 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.

These important factors and other factors that potentially could affect the Company's financial results are described in our filing 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 expectation innocent and without notice based on any changes in such factors in the Company's assumptions or otherwise. The Company undertakes in obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

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

Thank you, Kristin. First a word of gratitude. As many of you may know, Kristin gave birth late last week to a very healthy baby girl and did not miss a beat working the entire weekend to prepare for our call today. Kristin, thank you.

For the quarter, net revenues and for the first nine months of fiscal year were the highest in our history. For the quarter, we finished as the number two publisher overall as measured by MPD and with $765 million in cash and $1.2 billion in shareholder's equity our financial position remains exceptionally strong.

As we said throughout last year if the pricing environment deteriorated dramatically, and titles like True Crime performed substantially below our expectations, earnings would suffer. The combination of the rapid decline line in pricing and consumption, some key titles performing below expectations, and the lack of 360 hardware to mitigate these negative market factors contributed to lower results than we planned for.

In addition, we increased our variable selling and marketing spending to unusually high levels in an effort to mitigate these negative market conditions which magnified costs beyond historical levels. While this spending likely resulted in better brand awareness for our franchises, it didn't help the quarter's operating results. Lower overall sell through resulted in a significantly increased provision for price protection and returns, and higher product creation costs which further impacted our margins. On balance, however, for the quarter, and the year-to-date, we substantially improved our competitive position.

We finished the year as the clear number two publisher overall as measured by MPD, and perhaps most importantly, we are the number one market share publisher of next generation software with a 32% share of the XBox 360 market. This was accomplished through a focused strategy of a small number of high quality releases with Call of Duty capturing the number one position on the platform.

We also achieved a number of other important successes during the quarter. We had eight titles selling in excess of 1 million units each. Three of the top 10 titles overall, the number one new intellectual property for the third year in a row. The number two overall PC title, the number one XBox 360 title and as I mentioned we're the number one market share publisher for XBox 360.

This quarter the Tony Hawk franchise surpassed the billion dollar market and Tony Hawk's American Wasteland became the seventh consecutive title to make the holiday top 10. We extended the long-term rights to three of our most important franchises, Spiderman, X-Men and Shrek. In November we entered into a long-term agreement to extend all rights to the Spiderman and X-Men franchises through 2017. Having the long-term rights to our strongest brands gives us a significant competitive advantage in terms of planning, development and profitability for the long-term.

We also announced a new multi-year multi-property licensing agreement with DreamWorks Animation. The deal extends the rights to the valuable Shrek franchise, and gives us the rights to four additional DreamWorks animated films. To date we shipped over 13 million units of DreamWorks licensed titles, including over 3 million copies of Madagascar this year alone. We're focused on leveraging our next generation leadership and we've adjusted our product development investments and release strategies to capitalize on the opportunities these new platforms will afford us over the next few years.

While this year and next are likely to be volatile, the opportunities presented by the launch of the various new consoles and handheld platforms, the new Vista operating system, which is likely to energize PC gaming much like windows 95 did ten years ago, the emergence of new revenue sources, like in-game advertising, online gaming, and the host of wireless markets developing we find ourselves in a strong position to leverage our competitive strengths over the next few years.

To truly take advantage of the strong market fundamentals of the future will require investment and focus today. We intend to use our deep management strengths and our strong balance sheet to enhance our opportunities for the future. Mike will share the implications of these investments on fiscal '07 and the benefits that are likely to accrue in fiscal '08 and beyond, but first Thomas will provide a review of operating results for the quarter.

It is now my pleasure to introduce our new CFO, Thomas Tippl, who will share the quarterly results and the balance of the outlook of the fiscal year with you.

Thank you, Bobby.

For the December quarter, net revenues were a record $816 million up $136 million or 20% over the prior year due to our large holiday lineup. Our revenue performance of the driven by the multi-platform releases of Call of Duty 2, Tony Hawk's American Wasteland, Call of Duty 2 Big Red One, GUN, Shrek, True Crime and Quake. Also contributing to the quarter were our catalog titles, Ultimate Spiderman, X-Men Legends 2, and Madagascar.

For the quarter ended December 31, we had diluted earnings per share of $0.23 versus $0.35 in the prior year. Earnings were lower than the prior year in the November outlook due mainly to challenging market conditions, creation costs, and increased sales and marketing spend. In the December quarter manufacturing and distribution expense was 45% of net revenues, down versus 47% in the prior year due to improved mix as we had higher publishing revenue. This was partly offset by inventory write downs and higher price protection return reserves due to weakened market conditions.

Product creation costs for the quarter were 23% of revenues versus 16% in the prior year. We define product creation costs as the sum of cost of sales software royalties and amortization, cost of sales intellectual property licenses, and product development expense. The increase was due in part to higher development costs per title, driven mainly by the addition of next gen SKUs, delayed capitalization of next gen development costs and fleet revisions.

During the quarter we made the decision not to release several of our franchise titles in fiscal '07 but to release them in fiscal '08 and beyond to better align the portfolio with the expected market growth. In addition, we canceled the movies slated for the console in fiscal '07 due to under performance on the PC and the Iron Man SKUs in development as we reverted those rights to Marvel.

Sales and marketing expense for the quarter was 19% of revenues, up from 16% in the prior year. Sales and marketing spend was significant in the quarter due to our large lineup as well as our attempt to drive demand given weak market conditions and competitive pricing actions. The high level of trade and consumer activity increased revenues although the standing did not drive proportionate expected sales volumes. Over the past two years, sales and marketing spend has been growing rapidly to increase brand awareness of our franchises and this will be a focus of future efficiency improvement.

G&A as a percentage of revenues was up modestly versus the prior year due to infrastructure investments to support territory expansion and costs related to management team additions. Investment income for the quarter was higher than the prior year, mainly due to the sale of partial stake in the developer. Our effective tax rate for the quarter was 27% versus 31% last year. The reduction is primarily due to tax credits accounting for a larger portion of pre-tax income. This completes the year-over-year P&L comparison.

I would also like to provide some perspective on the variance on the outlook we provided in November. Manufacturing and distribution costs came in higher than expected by about 5 percentage points of revenue, as a result of negative product mix, the previously mentioned provision for inventory and higher than anticipated requirements for price protection returns reserves. The causes of higher operating expenses are principally the same as those that drove the year-over-year increase.

Now turning to the balance sheet, on December 31 we had $765 million in cash and short term investments, an increase of $51 million versus last year. Cash and short term investments were also up $14 million versus last quarter including up from payments for our new license agreements. As of December 31, we had 941 million of working capital, an increase of 40 million versus last year and up 36 million versus September 30. The accounts receivable balance was 414 million, up 70 million versus the prior year due to higher revenues. Day sales outstanding were 47 days and in line with the prior year. The accounts receivable reserve of 175 million was 30% of gross receivables, up versus the prior year as a result of previously discussed requirements to higher price protection and return reserves.

Inventories were $85 million, up $43 million versus last year driven by weaker than expected reorders of certain titles. On December 31st, inventory for the publishing business was $63 million and $22 million for the distribution business. Capital Ex software development costs were $36 million, a decrease of $39 million versus last year and down $87 million versus last quarter. The sequential reduction reflects a normal seasonal pattern, given the amortization of our large Q3 lineup. Capitalized intellectual property costs were $85 million, up $54 million versus the prior year and $56 million versus September 30. Due to the recently announced long-term licensing arrangements with Marvel and DreamWorks.

In summary, we ended the quarter with a strong cash position and financial base which gives us the flexibility to invest and leverage the many opportunities that the next few years will yield. Before turning to our financial outlook, I would like to begin by saying that our outlook represents our users of today and number of internal and external factors that could cause our actual results to differ materially. I refer to our financial filings with the SEC for a full review of our risk factors.

Now to Q4. As said in November, we have no new titles slated for release. And since our last conference call weakened market conditions and limited supply of next gen hardware has led us to significantly reduce our prior performance expectations. For the quarter, we expect revenues of between 125 and $135 million and a loss per share between $0.07 and $0.09.

For the quarter we expect manufacturing and distribution costs between 60 and 65% of net revenues with operating expenses, including royalties, of between 63 and 66%. Projected tax rate of about 23% and a basic share count about 278 million. For the full fiscal year, we expect revenues in the range of $1.405 billion and $1.415 billion, and earnings per share between $0.09 and $0.11. Now I would like to turn things over to Mike Griffith, President and CEO of Activision Publishing who will provide his thoughts on fiscal year '06 earnings and our outlook for fiscal '07 and beyond.

Thanks, Thomas.

Today I will focus my comments in three areas: first our Q3 learning, second, what we'll do differently in the future, and three, what we plan to deliver in fiscal 2007 and 2008. From a competitive position we were very pleased with our performance in Q3. International publishing revenues increased significantly during the quarter, and in North America we were decisively the number two publisher overall with the largest market share gain of any publisher. Additionally our average game ratings improved year-over-year and Call of Duty for the XBox 360 was the highest rated title overall.

While not every title exceeded our expectations our commitment to quality product development helped drive a number of our titles to a leadership position in respective categories as Bobby highlighted earlier. The market environment this quarter turned out tougher than we expected. We underestimated that the decline in current generation software sales as the transition came on sooner and harder than expected, and the supply of XBox 360 in the market was lower than anticipated. As a result of the softness, we saw more pricing pressure than we expected.

We also aggressively supported our franchises although we didn't see the incremental revenues needed to provide an adequate return. In fact, the additional investment in brands had a compounding effect on the reduction operating margins. Looking ahead, we plan to better aline our sales and marketing spend with expected market conditions. In fiscal '07, we'll adjust sales and marketing dollars versus the prior year, reflecting a smaller slate, and to be consistent with our plan to return to our historical and proven investment levels.

Finally, two major releases underperformed our expectations, GUN and True Crime. However, we're guessed Gun ranked as the number one intellectual property in North America. By market standards this title would be considered a success. It didn't achieve our own return on investment targets, as we spent significant development and marketing dollars against the launch of this brand. Even though we missed our internal expectations, make no mistake, we're very excited about the future of this property, and we'll update you in the future on our plans.

Turning now to our thoughts on the overall market, beginning with our hardware estimates. On December 31, the install base in North America for current generation systems, including handheld was 97 million units. The install base over the next few years will be driven by lower price current generation hardware, the new handhelds, the XBox 360, and the launch of Sony PlayStation 3 and Nintendo Revolution.

With respect to the hardware market, there is still risk in the short term with regard to first party plans, including next generation launch date and quantities, year-end install dates estimates, and reductions in current gen hardware pricing and support. So now, we expect the following hardware increases in North America during the calendar year: PS2 up approximately 4 to 5 million units, XBox up about 500,000 units, XBox 360 up 4 to 5 million units, GameCube 800,000 units, handhelds which include GBA, Nintendo DS and PSP will grow approximately 10 million units. PS3 approximately 1 million units and Nintendo Revolution less than a million units.

Moving to software, we define our market to include all major platforms in North America and Europe. For calendar 2005, the combined North America and European software markets for current gen and next gen console, handheld and PCs declined 4%, well below our beginning of the year expectations of flat to up 5%. For calendar 2006, we expect the combined North American and European software markets for current generation and next generation consoles, handheld and PC will decline approximately 0 to negative 5% in line with 2005.

With respect to software pricing, this still remains one of the major risks to our operating plans. We expect that software pricing for frontline console titles will continue to be under pressure in calendar 2006, but the next generation software launch pricing will remain at 59.99.

Turning now to our fiscal 2007 preliminary outlook. In fiscal 2007 we plan to launch a more focused slate than in fiscal 2006, which should align well with the challenging current generation environment and slow ramp up of next generation hardware. This will importantly enable us to allocate more development resources against our large and growing fiscal '08 lineup when market conditions should be substantially more favorable.

We'll kick off fiscal 2007 in Q1 with the release of two very exciting titles that will launch in conjunction with feature films. Dreamworks' Over the Hedge and X-Men 3 from Fox Marvel Studios. We'll launch Over the Hedge, on the PS2, XBox, GameCube, NDS, GBA and the PC and X3 on all the same platforms as well as an Xbox 360 SKU. For the balance of the year we're planning new console releases on our largest and proven franchises Tony Hawk and Call of Duty. Additionally we'll release Quake Enemy Territory for the PC and Marvel Legends, a new superhero RPG slated for consoles. Throughout the year we'll also continue to support current Call of Duty Two for the Xbox 360 as if it were a newly launched title in fiscal '07, given the small but growing hardware penetration and our number one title status.

In terms of new intellectual property we're excited about a title testing well and targets the younger consumer. The game is an extension of the Tony Hawk brand called Tony Hawk's Downhill Jam designed to reach a different audience, similar to our approach this year on Call of Duty 2 and Call of Duty Big Red One, which gave us tremendous leverage with respect to our marketing dollars and was arguably our most successful program this year. So this will be a strong title in the absolute, but also complementary with our main lane Tony Hawk launch.

In fiscal 2007 we'll also remain committed to maintaining a leadership position on next generation platforms, and we plan to release five PSP titles, four XBox 360 titles, three PSP launch titles and one Revolution launch title. Given our limited visibility with regard to the market, software pricing and first party hardware plans for current and next generation, we'll be in a better position to give more detail on our fiscal year guidance on our next call, but preliminarily, we believe revenues will slightly exceed $1 billion and diluted earnings per share, excluding the impact of stock options, will be up modestly year-over-year despite the reduction in revenues.

Fiscal 2007 will be a year of caution and investment as we manage through the remainder of the transition and focus resources to prepare for accelerated growth in the next cycle. We're focused on driving the breadth and quality of our slate, while at the same time driving efficiencies in our business model.

Looking ahead, our performance over the next few years will be driven by directing our global resources and capital allocation toward: one building the breadth and depth of our pipeline while fully exploiting our strong IP stable. two, expanding the strength in Europe and Asia, three, operating with a more efficient cost structure, four, winning big with winning customers.

First, we're focused on building and strengthening our product portfolio. We plan to accomplish this by continually reinventing our core brands through superior game play innovation and selectively acquiring and creating high quality intellectual property as we've successfully done over the past few years. We made major progress in this area as we re-signed a long-term rights to three of our most important license franchises: Spiderman, X-Men and Shrek, and also remain focused on geographic expansion with particular emphasis on Europe. We have a lot of opportunity in Europe we are just beginning to capture. We've had tremendous success this year in Italy, Spain and Benelux, the three newest geographies we transitioned to our direct selling model.

We continue to look for similar opportunities and in the short term we see Portugal and Nordic as additional geographies where we will increase our direct selling capabilities this fiscal year. We're committed to operating with an efficient cost structure. Going forward you will see a real focus on aligning our costs with market expectations and expected product performance, especially in the areas of overhead and sales and marketing. We'll look to leverage the synergies that a global organization can offer. For example, we recently restructured a European business. Previously we had eight reporting segments and have streamlined them into four, a similar structure that other multinational corporations utilize.

Finally, we're relentlessly focused on winning with the customer. We're committed to leading best in class industry practices that improve our customers and Activision's performance together. So in summary, we continue to position ourselves for the long-term and the growth that should follow the new hardware. In fiscal '08, we plan to leverage our large and growing slate against the strong industry growth that's expected. Our slate leverages major movie launches, core franchises and new intellectual property.

We'll enter fiscal 2008 with two major movie supported releases, Spiderman 3 and Shrek 3. The preqels of these two movies generated $.7 billion in worldwide box office sales, and we've sold in excess of 25 million Spiderman units and 7.5 million Shrek units to date. With more platforms and territories to exploit, longer lead times for development, closer links with movie marketing partners and sponsors, and the biggest theatrical launches in the history of both Dreamworks and Sony, Spiderman 3 and Shrek 3 will likely be the biggest launches in our history.

Also anchoring our slate will be the return of a number of our largest franchises including Tony Hawk Call of Duty and X-Men. Additionally, we'll have new movie supported properties like DreamWorks B movies and we've just finalized a new multi-year agreement with Hasbro to support the Transformer line which will launch with a major motion picture in summer 2007, our Q2 of fiscal 2008.

Finally, we'll launch our own internally developed intellectual property. Our fiscal 2008 slate will exploit a greater percentage of next generation games as we move up the learning curve. It is still early. We expect fiscal 2008 will be the biggest year in Activision history with revenues expected preliminarily to exceed $1.6 billion, with a sustainable plan for growth over the next few years. We thank you for your time and the opportunity to share our initiatives with you for the future, and I'll now open up the call for your questions. Thank you.

[OPERATOR INSTRUCTIONS]. Our first question of the day will come from Elizabeth Osur with Citigroup.

Just a couple quick questions. I am only hearing in your product release slate one new IP and not until fiscal '08. am I understanding that correctly, and can you talk a little bit about what your goal is for new intellectual property introductions and whether we can expect to see sequels of the True Crime and GUN franchises over the next few years.

I think we have first of all been consistent our goal is to launch 1 to 2 new intellectual properties a year, and we're consistent with that over the next couple of years. In fiscal 2007 we consider the extension of Tony Hawk, Tony Hawk Downhill Jam, to be an important new IP for us and an extension of that franchise.

Again, very similar to how we operated this year with Call of Duty 2 and Call of Duty Big Red One which gave us substantial synergies in a number of areas that allowed us to reach different audiences. Tony Hawk Downhill Jam proves to extend this Tony Hawk, our successful Tony Hawk franchise to a new and younger audience. In fiscal 2008, while it is too early for us to announce our plans in this area, we do expect to have a new intellectual property.

Okay. Thanks. If I could ask a follow up, then, could you maybe walk us through the revenue growth between a billion in fiscal '07 and 1.6 in fiscal '08 and how much of that is coming from market growth assumptions and how much is coming from the two additional movie properties and touch on how many quote unquote big propositions there are in each of those years.

The growth that we'll experience between 2007 and 2008 will be largely slate driven against an environment of more installed next generation hardware units. If you look at our 2007 plans compared to 2008 plans, the number of SKUs we'll put into the market will be up about 50%.

Okay. Thanks. Just final question, and I will let someone else get going. Distribution revenues for next year, can you give us an idea, should we be thinking about that in terms of something similar to market growth forecast or is the impact of hardware significantly altering the way we should think about that?

No. Distribution this year is about 20% of our revenues, which is pretty much in line with where we've been. We expect that to be about the case for next year as well.

Thanks a lot.

Next question will come from Mike Wallace with UBS.

Hi. A couple questions. Looks like calendar '06 is a wash, not even worth talking about. EA seems to be getting a free pass for it. So let's assume everybody does and we'll fast forward to '07.

Looking at your operating margins you kind of had a steady ramp of percentage point each year in the last cycle. How quickly do you think you get your margins back up to double digits? In other words, in '07 with, let's assume more growth 25% you have big movies coming out, and can grow fast in the market on the top line, what kind of impact should we see on the bottom line? Is this going to be a situation where it is kind of high single digits and you move up or you think you will start this cycle in calendar '07 in low double digits and where do you think you can take those margins going through '09 or '10?

This is Thomas. Let me take that one. As you know we have provided some outlook on the top line on fiscal year '08, given how far away we are, at this point we have not provided any bottom line guidance. I think as revenues pick up, you will obviously see margin expansion from the levels that we are at. It is simply too early to put down a number for that.

Okay. What about the use of cash in terms of M&A, you saw EA get in the wireless business pretty big way. You're seeing the online business ramp in other territories. What's your thought on doing something with the money and getting into some of these other areas or is it a matter of sitting back and waiting for those markets to emerge a little more before you get into it?

Mike, I think we're going to continue to stay focused on the principles that have worked well for us in the past with respect to acquisition strategies, so those same four or five things like proven history in terms of intellectual property or product development capability, good management history of good profitable operation, generally non-dilutive transactions, things that are complements strategically to what we've done in the past and those are the things we stay focused on in the future.

And just one more question, Bobby, if you look at the 360 Microsoft had a window of opportunity here, and it looks like at least in my opinion, they probably blew it in the near term. If you had to gauge the next cycle with the PS3 coming and the blue ray capabilities, how would you stack those two against each other, especially if there is no Halo coming out this Christmas?

We are very firm believers that Microsoft delivered is an excellent product. They obviously had challenges like everyone, this is high technology, and I think you can expect there always to be obstacles in the introduction of new platforms. Having said that, I think both of these devices are the most significant changes we've seen, whether it is in providing realtime internet access, whether it is in the elevation of production values and we still remain confident that the introduction will likely grow the overall install base and I think that you can expect that new users will continue to come into the marketplace and we'll be able to capitalize on it.

Okay. Thanks.

Brian Pitz from Morgan Stanley has a question.

Can you talk more specifically about Call of Duty 2, what percentage of your shares on the 360 is represented by Call of Duty both in the U.S. and Europe, and also the potentially the potential to increase your catalog sales better than expected, obviously there is only 1.5 million 360's out there. As we go closer to 5.5 to 10 million unit penetration over the course of the next year, what the opportunity to monetize that is? Thanks.

I think, Brian, on Call of Duty 2 on the XBox 360, is obviously a phenomenal success capturing the number one title on that platform, and was disproportionately important of course in our share of the overall platform. I think on the issue of catalog sales, this one is -- has to be looked at a bit differently because the hardware penetration is still relatively small and growing, and as I said, a major focus in 2007 for us is to drive the current Call of Duty 2 title as the XBox 360 penetration grows, so on a catalog basis, certainly on a Call of Duty-specific basis we would expect to see very large catalog percentages for this title.

Can you give us any more specifics in Europe, what the share looked like on the console for that title?

Very similar, to be honest. We've had a very strong success with this franchise in all geographies.

And just an unrelated question, can you talk about anything that's out there in terms of IP that you may have your eye on in terms of acquisition, or do you think we should assume that there probably be none of that over the course of the next 6 to 12 months?

We're always looking and nothing that we can comment on other than the Transformers we announced today and the extension of the rights that we control.

Okay. Thanks.

Sure.

Next question is from Heath Terry with Credit Suisse.

You mentioned moving some products out of 2007 to 2008. Can you give us an idea how many products were actually moved and were there any products in this process that were actually cancelled so games that you were accruing for on the balance sheet that you've decided aren't going to be put out?

Yeah, let me start with how we approached 2007 and our thinking on 2008. The most important thing we elected to do was to focus our resources and investments to maximize growth for the next generation cycle as it begins. And in addition, to reflect the learning that we've had in Q3 and as this current transition obviously is underway.

So it really all began with what we could do to maximize '08, and looking in that, we obviously in 2007 aren't going to come forward with a GUN or True Crime sequel although we are examining those franchises carefully for their future potential. We're also -- we also learned this year that children's titles without a major movie launch was challenging in the context of transition environment. So we've elected to put our focus on Shrek 3 coming out in early 2008, as well as Spiderman 3, also coming out in [2003] so it is really a reallocation of resources for those to be launched and successful as we think they can be.

And can you talk a little bit about the increase we saw in sales and marketing? You mentioned some of it was channel related, some of it was advertising. Can you talk about the break down, how much of it went to channel support and to the extent that there was any product markdown support?

Well, we had -- an increase as we said in our sales and marketing support for 2006, and we learned that in the challenging transition environment, while Bobby said, it certainly made an investment in our brands in terms of the awareness and registration or the benefits of those brands, it didn't deliver substantial or enough additional revenue to make sense for that increase. It was a balance between consumer directed marketing and trade directed marketing, and we're committed to getting into the future with a level of sales and marketing support that's in line with proven success in the past.

Great. Thank you.

Edward Williams with Harris Nesbitt has the next question.

Good afternoon. A couple questions, first of all, looking at your studios, could you remind us as to where you are with head count at this point, and also what your expectations are for the percent of revenues of your publishing revenues coming from your internal studios and I have a couple of questions after that.

We have about 1300 people in our studios across the company about, about two-thirds of our titles are generated from our internal studios.

Okay. And I am assuming that as far as the year progresses the studio head count number is more likely to stay flat or go up than go down much it is not necessarily a source of improving your operating expenses?

There are a lot of things that go into the product development costs, as you know, Ed, and so while head count may remain the same, we are committed to finding ways to improve efficiencies within the studio.

Okay. And then when as we look to new revenue opportunities such as in-game advertising, when do you expect to have that have an impact on your top line? Is it something we could see in FY '08, that you've included with this 1.6 number, that still is just out there and not necessarily included?

It is not included yet, and our feeling is until you have a sizable enough installed base of next generation hardware and we're still moving rapidly towards building a rate card and a measurement system, but it is not included in our first pass plans for the guidance we provided for '08, but it is something we'll have a lot more visibility on towards the end of the year.

And looking at your publishing revenue between the North American market and the European market, what sort of differences do you expect in the growth rates between those two areas going into '07 as well as going into '08?

We're looking at the software market as growing about the same between Europe and North America. If you look totally at our split of revenues, it is about 50/50 North America and international. When you look at Europe specifically, you will see our focus in the year in the year and years ahead to aggressively drive our expansion in Europe so that the percent of our business accounted for by Europe should increase overtime as we think we're under developed relative to the market there.

There is no way our expectation is right now while it is 50/50 a big component to that is our distribution business in the U.K., and we really should see 50/50 publishing split between here and Europe. We're not going to get that in '08, but we'll make a lot of progress towards that.

Great. Thank you very much.

Next we'll hear from Tony Gikas with Piper Jaffray.

Good afternoon, guys. Thanks for taking my questions. Is looks like you're more a victim of the industry here with some of your peers and not really related to product quality or execution, and I am wondering what your long-term outlook is on the industry, because we've done a lot of the industry modeling work and as you go back from 2000 to 2005 total software sales growth according to MPD was only up about 4.6%, and if it grows to 11 billion in 2010 that's only about 7% growth over the course of the next cycle. Is there reason to think that it can be better than that? I will stop there and I have one follow up.

Generally, Tony, what we're likely to see as a result of changes in the hardware especially, I think, the multi-player advancement you're seeing, increase in production values, things like Blue Ray, introductions of portables that are appealing to the consumer, the opportunities will emerge from online gaming for new ways for distribution and billing, our expectation is over the next five years you're going to see growth rates that are at least consistent and likely in excess of what we've seen over the last five years. Also, I think one of the things we always like to point is is when you look at the top four or five publishers, take the third parties out, and EA, we only account for collectively about 60% of total industry revenues so there is a lot of share gain that's available, and that consolidation is largely taking place through the acquisition of new franchises, or development capacity, but I think a combination of long-term share gains plus what we see as new hardware likely to expand the market should allow for pretty attractive growth rates over the next five years.

A couple quick follow-up's. Do you think the higher price points in hardware and software will be any kind of deterrent to consumer purchases over the course of the next few years and how have PlayStation Portable sales tracked post holidays? We've heard they've softened up a little bit. Any comment on that?

I think first of all on the software pricing, if you look at history over the last generation of hardware and examine what the pricing or how the pricing has held up, it has been pretty encouraging in this cycle. We're certainly seeing as new generation software on consoles launches at $59, the experience we've had over the this holiday season would suggest plenty of demand there, as obviously the hardware has been well received by the consumers and we've had tremendous success with the software platforms in that regard. On the handhelds, PSP, the new generation of handhelds again we've had tremendous success with stronger price points on that, and while I think that we'll see some variability of the sales rates of that hardware over time, I think we consider PSP a very strong success.

Okay. Thank you.

Jeetil Patel with Deutsche Bank is next.

Couple questions. First of all, Michael, is there any way you can go through the next gen cycle? I know it is broad, but the future returns of the next cycle, do they look just as compelling, similarly compelling, less compelling, or what are the big variances that drive your returns in that business from a -- as you look at over the next three years to five years and the next cycle and how much does pricing or the ASP being a $60 influence that and second, I have a quick follow up for Bobby.

All right. I think we're very bullish on the potential for growth and returns in the next generation cycle. For a couple of reasons. One is we think it provides a real market opportunity, as Bobby just talked about earlier. Also we've learned a lot about how to operate more efficiently.

As we go into this next cycle with larger scale than we had at this time during the previous cycle, more countries, more platforms, more development efforts, we're able to take advantage of that scale and drive operating efficiencies that I think we've only begun to really uncover and enjoy. We think this next cycle is really going to be a balanced approach for us with growth on the top line, but also improved efficiency and margin expansion to complement that as well. So as we've gone through and modeled it, pretty bullish about it.

Do the margins still get to higher than where you were with a $50 price point if you progress through the cycle and Bobby, just if you go back over the history of Activision and where you are today, I guess can you just give us a characterization of just the industry cycle and the industry transition, how does it fare relative to year's past, is it worse, better? Can you just give us a characterization there? Thanks.

Sure. You know, from my perspective, Jeetil, I think that general, not too dissimilar from the points I made earlier, but you're seeing new hardware devices that have broader appeal from companies that have broader reach. I think when you look at the amount of money that Microsoft will spend to continue to promote the 360, when you see what PlayStation means to Sony, not just in terms of videogaming but in terms of the establishment of blue ray as a DVD standard, when you see the opportunities as he emerge with a PSP to address an audience for portable gaming that we haven't seen before, when you see the benefits that come from a truly always on internet connection on these devices that offers the opportunity for content enhancement, micro transactioning, all sorts of multi-play experiences that really transform gaming from this very solitary experience between an audience and a hardware device to a much more social experience, I think you're likely to see more consumption in more places than ever before.

And I think that the entry points to get into the business are, the barriers to entry are higher than they've ever been, whether it is in product development cost or talent or resources or access to distribution channels, so the barriers to entry are larger than they've ever been which I think bodes very well for companies like ours that have big distribution foot prints, that have well developed product making capabilities, that control intellectual properties of value and have the ability to create new intellectual properties of value, so when I look out at the next five years as in terms of where we are and where we've been, I think the greatest opportunities for our company are yet to come.

We are a much more stable, much more professionally managed, much more strategically thoughtful company today than we've ever been. When you think about all the growth likely to come from the marketplace, we're in a much better position to capture that growth over the long-term.

Does that answer your question?

It helps. Thanks.

Now take our final question from Justin Post, Merrill Lynch.

Imagine that fiscal '08 margin expectations are all over the map. Can you help us a little about that, just talk maybe about the development costs on PlayStation 3 and the XBox 360 relative to the last cycle, and how you're seeing the trend and licensing, I know you signed a couple deals you can't comment on specifically. How do you see the licensing costs going for Activision?

Justin, , we're not giving specific guidance now as has always been the case margin expansion for us is one of the most important things we're focused on. That won't change. I think right now we recognize we need to invest in our product slate, expand our international distribution reach, make some changes to the cost structure that will allow for more efficiencies but always with the intention of getting to those industry leading margins.

We're not really going to give any guidance on where that is likely to be in '08. We typically don't give the kind of guidance even on the revenue line we're giving for the following fiscal year. We're only doing it because we have confidence in the product we have in production and I think as we get towards the middle of this coming fiscal year we'll be able to give you more visibility on what that margin structure should look like.

True Crime what did you learn from that and I don't know if you were able to comment in your prepared remarks on the future of that franchise?

Well, I think we certainly learned a lot about True Crime, as we did our broad slate, but on True Crime in particular it fell short on our expectations for a couple of reasons. One of them is that it fell short in terms of our quality expectations. While our game ratings, as we mentioned, was up significantly, year-over-year, and Call of Duty 2 was the highest ranked title in the holiday season, number one, on the XBox 360 platform, we fell short on our own delivery of quality standards on True Crime, so we have a lot to contemplate on that franchise. We're doing a lot of research with consumers to understand what the specific issues were, and what the vie ability of that franchise is going forward, and we're going to make some very thoughtful considerations in the weeks ahead in terms of where we'll go with that.

Thank you.

Yes.

That does conclude our question and answer session. I will turn the conference back over to Kristin Southey for closing or additional remarks.

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

Thank you.

That does conclude our conference call. Thank you for joining us today.