Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Activision, Inc. (ATVI)

Q4 2006 Earnings Conference Call

May 05, 2006, 4:30 p.m. EST

Executives

Kristin Southey, Vice President of Investor Relations

Robert Kotick, Chairman and Chief Executive Officer

Thomas Tippl, Chief Financial Officer

Michael Griffith, President and Chief Executive Officer of Activision Publishing

Analysts

Mike Wallace - UBS

Anthony Gikas - Piper Jaffray

Ed Williams - Harris Nesbitt

Lowell Singer - Cowen & Co

Ralph Schackart - William Blair

Evan Wilson - Pacific Crest Securities

Helen Fleming - Merrill Lynch

Azeem Ibrahmin - Deutsche Bank

Daniel Ernst - Hudson Square Research

Presentation

Operator

Good day everyone and welcome to the Activision Fourth Quarter and Full Year 2006 Earnings Conference. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Kristin Southey. Please go ahead Kristin.

Kristin Southey

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

With regards 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 subjects to risks and uncertainties. The company cautions that a number of important factors could cause Activision’s actual future results to differ materially from those expressed in any such forward-looking statements. Such factors include, without limitation, sales of the company’s titles during fiscal year 2007, 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, law suits and maintenance of relationships with key personnel, vendors and third-party developers, international economic and political conditions, an integration of recently acquired subsidiaries and identification of suitable future acquisition opportunities.

These important factors and other factors that potentially could affect the company’s financial results are described in our filings with the SEC, including the company’s most recent Annual Report on Form 10-K and quarterly reports on Form 10-Q. The company may change its intentions, beliefs or expectation at any time and without notice, based upon any changes in such factors in the company’s assumptions or otherwise. The company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. And now, I would like to introduce Bobby Kotick our chairman and CEO.

Robert Kotick

Thank you Kristin, net revenues and earnings for the fourth quarter were higher then our outlook driven by continued success of our titles for the Xbox 360 and generally better then expected performance of our product across other platforms. Net revenues for the fiscal year were the highest in Activision’s history marching our 14th consecutive year of growth. We ended the fiscal year as the #2 publisher overall with the strong balance sheet to pursue the many opportunities that lie ahead.

With almost $1 billion in net cash and short term investments and $1.2 billion in shareholders equity, we have the financial strength to capitalize on the market growth like we do occur for many years to come. Over the past five years our shareholders equity has increased from a $181 million to $1.2 billion, a 46% rate compounded annually. We remain focused on building shareholder value. Towards this objective, this past fiscal year, we once again strengthened our industry leadership position. Specifically, we grew the number of multimillion unit sellers in our portfolio. We increased our international revenues by deeper country penetration in territorial expansion and we expanded our handheld presence with products for PSP, DS and Game Boy and we created the #1 new IP for the third year in the row.

And, we achieved market share leadership for the first time on a next generation platform with the #1 title Xbox 360, Call of Duty 2. This year we were successful in growing share and increasing brand awareness although as we said on our last call our operating results for significantly impacted by the challenges of the console transition. Overall, we exited fiscal 2006 a substantially improved company. The barriers to entry in the video game business continue to rise and today include limited access to intellectual property rights, the ability to successfully create new franchises owning proprietary development resources and having broad distribution capabilities. Activision’s possession of these difficult to duplicate assets coupled with its proven ability to leverage them should lead to continued margin expansion and higher returns on the invested capital over time.

We remain focused on expanding our balance franchise portfolio strengthening our next generation development leadership furthering our initiatives to reduce development expense through organizational efficiencies and expanding our distribution reach. While increasing production cost and the volatility of transitioning to new devices remains a challenge, there is much to be excited about as the install base of new platform grows. The investments we have made over the last 16 years and the discipline focused on institutionalizing our business combined with our substantial capital position provides us with a great competitive advantage in the creation of long-term shareholder value. We continue to evaluate the best users of our capital and over the last few months, we have extended many of our important licenses and secured the rights to some important new properties.

True to our commitment towards expanding our collection of proven franchises, we announced the acquisition of the long-term rights to develop and publish games based on the James Bond Universe through 2014. To-date, approximately 30 million units of video games based on James Bond have been sold. Bond is one of the most successful film franchisee within history having crossed over $3.6 billion and we have a proven track record of success, leveraging movie-supported properties such as Spider-Man and Shrek. The Bond RAN will be helpful as we continue to expand internationally as only the first franchisee in our history likely to generate the majority of its revenue from outside of North America.

Consistent with our other licensing arrangements, we have secured these rights with the attributes of ownership that allow for proper franchisee planning. We have long-term control, flexibility to use the movie and non-movie universes, and attractive royalty rates and a partner in MGM that recognizes that how valuable video games can be in building equity in an underlying intellectual property, finally, the great addition to our growing brand portfolio.

The composition of the franchisee portfolio is also an important asset for our future. Because each of the new platforms is more distinct than the device differences we saw in prior generation. Having properties that can take advantage of the unique attribute to each device will create more opportunities for exploitation than in prior generation. As we attempted to find these differences, development cost will remain higher than usual. However the differences whether in the online support, 360 market place provides the incredibly high production values capable on the PS3 are the unique means for interaction within end of innovative controller will attract new consumers and expand the market and the opportunities for long-term margin expansion.

For the first time, new sources of margin expansion are starting to materialize. Commercially viable digital download of game add-ons is becoming more feasible. First parties are increasingly validating the opportunities for in-game advertising and sponsorship and new rich media wireless devices should all contribute to profit growth over time.

And, volatility and uncertainty comes great opportunity. We have never been better prepared to take advantage of the many opportunities that lie ahead. Later in the call, Mike will share some more details of our plans for the next few fiscal years but now Thomas will provide a review of our operations during the last quarter and the last fiscal year. Tom?

Thomas Tippl

Thank you, Bobby. For the March quarter, net revenues were $188 million, this is higher than anticipated driven by the Call of Duty franchisee and our other previously released Q3 titles. Quarterly revenues were down $16 million versus the prior year, as we had no new releases versus two new PSP titles last year. For the quarter, we had a loss per share of $0.03 versus earnings per share $0.01 in the prior year. Earnings were lower than the prior year due mainly to challenging market conditions, higher product creation G&A expenses.

In the March quarter, manufacturing and distribution expense were 63% of net revenues down versus 64% in the prior year due to improved mix. Product creation costs for the quarter were 23% of revenues versus 16% in the prior year. We define product creation cost as the sum of cost of sales, software royalties and amortization, cost of sales intellectual property licenses and part development expense. The increase year-over-year was due mainly to had next-gen development cost. Sales and marketing expense for the quarter was 13% of revenues, down versus 15% in the prior year as we had no new releases. G&A as a percent of revenues was 15% up from 7% in the prior year driven by higher separation and leading costs. We generated high investment income for the quarter due to higher cash balances and raising interest rates.

For the fiscal year, revenues reached a record $1.47 billion driven by the multiplatform releases of Call of duty, Tony Hawk’s American Wasteland, Madagascar, Fantastic Four, Ultimate Spider-Man, X-Men Legends II, DOOM, Shrek, True Crime and QUAKE. Consistent with our updated goals, we were successful in increasing our international publishing revenue 18% versus the prior year. The increase in our international publishing business was driven in part by our successful expansion effort into new territories and strong affiliate out performance. Our continued focus to improve our handheld market position resulted in 16% year-over-year publishing revenue growth for this segment. For the year, earnings per share was $0.14, lower than the prior year due mainly to challenging market conditions, have for our creation costs and increased sales and marketing spend. For the fiscal year, manufacturing and distribution expense was 50% of net revenues, up versus 47% in the prior year, given part to mix shift and price erosion of current-gen software.

Operating expenses for the fiscal year, excluding manufacturing and distribution expense were 49% of net revenues, up significantly versus the prior year; due mainly to have product development expense and marketing costs. Our effective tax rate for the year was 14% versus 30% last year. The reduction is primarily due to tax credit representing a larger portion of pretax income.

Now turning to the balance sheet, on March 31, we had $945 million in cash and short term investments, an increase $104 million versus last year and an increase of $180 million versus the prior quarter, due to Q3 receivables collection. The accounts receivable balance was $29 million, down $80 million versus the prior year, due in part to lower revenues in the quarter and higher reserves of price potential returns, as a result of difficult market conditions in higher channel inventories. Activision inventories were $61 million, an improvement of $23 million versus last quarter. On March 31st, inventory for the publishing business was $44 million and $17 million for the distribution business. Capitalized software development cost were $61 million, a decrease of $31 million versus last year and up $24 million versus last quarter. The sequential increase reflects more next-gen titles going into development for future slates.

Capitalized intellectual property costs were $87 million, up $51 million versus the prior year and up slightly versus December 31. The year-over-year increase was primarily due to the new long-term licensing arrangements with Marvel and DreamWorks. In summary, we ended the quarter ahead of plan 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 views as of today and there are number of internal and external factors that could cause our actual results to differ materially. I refer you to our financial filings with the SEC for full review of our risk factors.

Now to Q1, our first major release is DreamWorks Over the Hedge, which will hit store shells in advance of the May 19th movie opening. We will launch Over the Hedge on the PS2, Xbox, GameCube, NDS, GBA and the PC. This is our 4th DreamWorks movie-supported title and last year’s hit Madagascar shipped over 3 million units and ranked as the #1 children’s movie title in 2005. Also launching in May is X-Men: The Official Game, in front of the May 26th movie premiere. X-Men will launch on the PS2, Xbox GameCube, NDS, GBA, PC and the Xbox 360. X-Men: The Official Game will be our first super hero title to launch on the next-gen consoles.

As for our financial outlook for the first quarter, we expect revenues of approximately $145 million and including the impact of adopting FAS 123R which relates to the expensing of stock options and other share-based payments. We expect the loss per share of approximately $0.11. The company’s loss per share outlook, excluding the impact of FAS 123R is approximately $0.10. This is down versus the prior year, due to few releases and lower current-gen pricing. This year, we have only 2 major releases in the quarter as compared to last year when we released DOOM 3 for the Xbox, Madagascar and Fantastic Four. In terms of pricing, our 2 major releases this quarter, we launched on the current-gen consoles at $39.99 as compared to last year when we launched DOOM 3 at $59.99 for the collective addition and $49.99 for the base SKU and as you may recall the collective addition of sold base SKU. Fantastic Four, also launched at the higher retail price of $49.99 last year.

For the quarter, we expect manufacturing and distribution cost of approximately 55% of net revenues. We expect operating expenses including royalties and the impact FAS 123R of approximately 81%, projected tax rate of 31% that can be used throughout the fiscal year in the basic share count of about 278 million shares. For the quarter, excluding the impact of FAS 123R, we expect operating expenses including royalties of about 78% all other line items are the same as I mentioned a moment ago.

For modeling purposes, Q2 will also be down versus the prior year as we have only one new release, Quake Enemy Territory for the PC versus a number of multiplatform releases last year including Spider-Man and X-Men. Today, there are still uncertainty with regard to the market software pricing and first party hardware plans from current and next-gen. But we believe revenues in fiscal ’07 will be approximately $1.25 billion and earnings per share including the impact of FAS 123R, I expect it to come in at $0.10. The company’s earnings per share outlook excluding the impact of FAS 123R is a approximately $0.15.

For the fiscal year, we expect manufacturing and distribution cost of approximately 49% of net revenues. We expect operating expenses, including royalties and the impact of FAS 123R of approximately 49% in a diluted share count of about 302 million shares. For the fiscal year, excluding the impact of FAS 123R, we expect operating expenses including royalties of approximately 47%, all other line items are the same as I just mentioned.

Now I would like to turn it over to Mike Griffith, president and CEO of Activision Publishing who will provide his thoughts on the balance of fiscal ’07 and fiscal ’08.

Michael Griffith

Thank you Thomas, today my comments will focus on two main areas. First our market expectations and second what we planned to deliver in fiscal 2007 and 2008. Looking at the overall market on March 31, the install base of hardware in North America for current and next generation systems including handheld exceeded the 100 million unit mark. We expect the install base over the next few years will accelerate driven by strong and growing consumer demand for the Xbox 360, Sony play station 3 and the Nintendo E in addition to continued growth in handheld platforms and lower price current-gen hardware.

With respect to the hardware market, even though we have more information from the first party than we did at the last call, there is still risk in the short-term, primarily surrounding next generation launch dates and quantities in current generation hardware pricing and support. But for now, we still expect the following hardware increases in North America during the calendar year. We are expecting PS2, up 4 million to 5 million units which include the impact of the recently announced $129 price point. And, we are anticipating approximately 1 million units from Play Station 3. We expect regular Xbox of 500,000 units while the Xbox 360 grows 545 million units. We anticipate GameCube up by 800,000 units. And, we expect less then a 1 million units from the launch of Nintendo E. Finally, we expect handhelds which includes GBA, DS and PSP will grow by approximately 10 million units.

Moving to software, we define our market to include all major platforms in North America and Europe. For calendar 2006, we expect to combine North American and European software markets for current-gen and next-gen consoles, handhelds and PCs will decline by up to 5%. With respect to software pricing, this still remains one of the major risks to operating plans. We expect that software launch pricing for frontline current generation console prices will be made on the title-by-title basis between $39 and $49 and that launch pricing for the Xbox 360 and Play Station 3 will be $59.

Turning now to our to our fiscal 2007, as we said on our last call, this fiscal year we’ve planned to launce a more focused slate then in fiscal ’06 which should align well with the challenging current generation environment and slow ramp up of the next generation hardware. The real benefit is that we are able to allocate more development resources against our large and growing fiscal ’08 and fiscal ’09 lineup when market condition should be significantly more favorable. Earlier, Tom has highlighted a product release schedule for the first half of the fiscal year and I’ll review our lineup for the balance of the year. Also I want to highlight some of the steps we are taking to expand the depth and breadth of our franchise portfolio which as you know, is our top priority at Activision.

Yesterday, we further strengthened our balance portfolio with the acquisition of the long-term rights of the James Bond license as Bobby mentioned. This franchise is perfect fit in our product portfolio for number of reasons. First, it’s already a proven video game franchise with over 30 million units sold and it’s a genres fits well with our development capability. Second, this franchisee has a particularly strong built-in European consumer base which will help drive our international expansion efforts. And third, we have track record of success leveraging mass market movie title like Spider-Man and Shrek driven by the release of high quality software. As in the organization, we are excited to by the opportunity this new franchise presents and we look forward to taking it to a whole new level in the years to come. So, along with the recently acquired transformer rights, we had a real depth to our portfolio. In addition, and in the near-term during the fiscal ’07, we are focused on adding important breadth to three of our largest franchises.

Starting with Tony Hawk, our goal is to capture a wider, broader demographic. We’ll first target the core Tony Hawk consumer with the release of the new Tony Hawk game. This is our traditional Tony game completely rebuilt for the next generation consoles. Next, we will target on more casual gamer with the launch of Tony Hawk’s Downhill Jam, a friendly Downhill raising game in a new direction for the Tony Hawk franchise. This dual launch strategy is slimmer to be approach, we used this past year with Call of Duty 2 and Call of Duty Big Red One which gave us tremendous leverage with respect to our marketing dollars and was without a doubt are most successful franchise in fiscal ’06.

Second, we will capitalize further on a success Call of Duty 2, in addition to releasing at all new Call of Duty title, we’ll offer 7 downloadable multiplayer maps for a fee Xbox 360, that will feature exciting new World War II locations. This way of continuing to add breadth to our Call of Duty franchise, is our first step in exploiting the revenue potential of online and extend in shelf play for our games.

Third, we’ll broaden our super hero slate and category leadership with the release of Marvel ultimate alliance. And all new RPG game, where one can play as 20 different super hero characters including Spider-Man and Captain America. So in total, with these three franchises and the balance of our portfolio, we remain committed to maintaining a leadership position on next generation hardware in fiscal ’07 and we will release 5 PSP titles, 4 Xbox 360 titles, 3 Play Station 3 launch titles and 3 Nintendo E launch titles.

While we are committed to driving high quality next generation titles; we are also committed to driving product development efficiencies over time. As expected, in absolute dollars, product development expenses for next generation hardware are raising. In anticipating this we’re pursuing a number of strategies that will help us leverage key learning and development cost across our global organization. In fiscal 2007, all of our next generation titles will utilize a number of proprietary tools that enable our artist to utilize character rendering and shading techniques across multiple platforms and more easily simulate a variety of game effects. In addition to shared technologies, we are increasing our development schedules to facilitate longer preproduction phase and more predictable workflow time that produce a double benefit of higher quality output and more efficient use of manpower.

And finally, we are outsourcing areas of game development like outwork to other parts of the world such as Asia. Use of just few other things that we’re currently working on that in addition to leveraging the next generation learning curve, would help bring product creation cost inline with our historical levels over the course of the cycle. Fiscal 2007 will be a year of caution in investment, as we manage to the remainder of the transition and focus resources to prepare for accelerated growth in the next few years. In fiscal ’08, we’ll begin to read the benefits of leveraging next generation development, a larger install base of hardware and a growing deeper and broader franchise portfolio.

We will start the first quarter of the year with two of our strongest movie-supported franchises, Spider-Man 3 and Shrek 3. The prequels of these two movies generated $1.7 billion and worldwide box office sales and collectively the franchises have sold an excess of 33 million game units to-date. There is also an added benefit to releasing well-known movie-supported franchises early in the year, as you get additional revenue opportunities during the holiday season. Also anchoring our slate, will be strong new titles from the number of our largest franchises Tony Hawk, Call of Duty and X-Men. And we’ll release new movie-supported properties based on the DreamWorks Bee Movie, and the Transformers Movie which are both scheduled to launch early in our fiscal year.

Our four fiscal ’08 lineup is one of our strongest ever and we will share with you the specifics of our full lineup on future calls. But as of today, we expect that fiscal ’08 revenues will preliminarily exceed $1.6 billion. Our growth in fiscal 2008 were driven by double digit market growth, our expanding balance franchise portfolio, greater international publishing realization, benefits of the more efficient cost structure and continued successful focus on winning bid with winning customers.

And we thank you for your time and the opportunity to share our initiatives for the future with you and I’ll now open up the call for your questions. Thank you.

Question and Answer Session

Operator

Thank you. (Operator's Instructions).

We will take our fist question from Mike Wallace with UBS.

Mike Wallace - UBS

Hi, couple of questions. Let me since, what happened with the year, Tony Hawk’s occurred with the cost issue, if you look at this cycle compared with last one with R&D cost higher, is it going to be slower ramp up in terms of your operating margins? Or, looking up the jump in sales in ’07, do you think it follows a similar pattern, in other words, the path on a margin side, going to be a couple of years out further then it would have because the R&D cost are so high?

Robert Kotick

Let me first say that margin expansion continues to be a key focus area for the company. And, while near-term margins will remain under pressures, we navigate through the counsel transition; we are focused on balancing short-term cost control with the investment necessary to drive significant growth, late and beyond when market should improve. So, the drivers behind the long-term margin expansion that we see really remain unchanged from what we’ve seen so far and that is, as Mike described building depths and breadths of the franchise portfolio and leverage that against market growth and international expansion and participating in the growth of in margin enhancing business model that are emerging such as online, wireless and in-game advertising. And then obviously, continuing to optimize our cost structure. So, in ’08 while that’s still early in the cycle, we still feel that as we hit certain revenue milestones, we can go operating margins to the 15% to 18% range over the next couple of years that we talked about previously.

Mike Wallace - UBS

And one of the things that you had talked about was the online markets, do you have any plans in the multiplayer genres is that something you’re working on or exploring first description type games?

Michael Griffith

Yes in fact, we’re a little known fact. We are the largest online game in the industry in Quake, so we had a fair number amount of experience of this in the past. But in terms of generating revenue online and micro transactions, we’re pretty bullish on the scenario of the revenue expansion and margin expansion over time. Although, we think that it’s obviously, a gradual ramp up with the capabilities of next generation hardware in the install base. But we are learning and committed to take leadership position on that we are going to make available beginning with these three, seven new maps available via live on Xbox 360 for our Call Duty franchise. A usual retail between $5 and $11 in the margin accretive way, so while the revenue will be quite small, we think it’s an important test and we are very interested in the learning about the area.

Robert Kotick

And, as far as like a massively multiplayer persisted base product Mike, with a subscription revenue model, that’s not something we are investing in presently.

Mike Wallace - UBS

Okay, and then just one more question with what Nintendo is doing with the controller, are you going to do more Nintendo-supported games this time around the different GameCube and are you going to do more exclusive subtitles that are only on their platform?

Robert Kotick

You know we haven’t commented on what would be exclusive and what wouldn’t, we are really excited about the platform, I think it is a really well differentiated product, it will appeal to that younger consumer to the more casual consumer and you get to see it in full force next week. But there will be so many competitors in the platform, who are very committed to it and I think you will see a level of support that is more than what we did with GameCube.

Mike Wallace - UBS

Okay, thank you.

Operator

Next we’ll go to Anthony Gikas of Piper Jaffray.

Anthony Gikas - Piper Jaffray

Hi good afternoon guys, couple of questions, do you know is it just kind of going back to the product development expense, is it clear at this point, if you’ll actually be able to port, from the Play Station 3 to the 360 or vice versa. Second question, could you characterize the market opportunity a little bit more for, in-game advertising and these, console downloads, can they reach maybe together 10% of the market over the next 3 to 5 years and maybe you could just touch on what the revenue model looks on the downloads, the transactions you are referring to on Call of Duty and I have a follow up as well.

Michael Griffith

But that’s a lot of questions for a follow up queue, but let me start with the, the product development question that you asked. I think, no surprise we are seeing cost increased with the new generation of hardware, and you are right that there are differences between platforms Play Station 3 and Xbox 360, and we are climbing the learning curve on it, and I think while early in the platform, transition causing porting between the platforms is more challenging than we’ve seen on the previous platforms, this is an area that we are learning day-by-day and getting more efficient, we are building engines and tools and developing assets and experience all of which are going to help us develop more efficiently and port more efficiently across platforms. So we are, we think we are about where we would expect to be at this stage of the platform and we think we are going to be able to develop much more efficiently over time and get to that area of prospect on quoting as you say, as with experience of this transition.

Robert Kotick

As far as in-game advertising Tony, we are seeing a level of interesting commitment on the part of the first parties that we’ve always said it’s critical to establish from the standards in pricing and in measurement. And, you are not going to see move the dial this fiscal year, probably not even next fiscal year. But, its starting the attraction we have a lot of interest on the part of advertisers and I think once you do see a decent size install base of next generation hardware, some serious opportunities will emerge, as far as the digital downloads, again its early days I think, this is a good experiment for us, you are going to need a much bigger install base first to be meaningful, could it eventually be 10% of revenues, we’d like to look at the PC model and you look at our more successful PC franchises where we have add-on packs. In the console, in our history of console exploitations, add-on pack is not really been economically feasible for variety of reasons. But I think, this is going to be that supplement, so we’ve had add-on packs and have sold in excess of 25% or 30% of the install base of the PC product, and I think that the opportunity exist to do that on the console.

Michael Griffith

And you just see this with the, the way Xbox live downloads work it, ends up being a margin accretive part of the business model.

Anthony Gikas - Piper Jaffray

Do you know what those downloads are going to cost, I mean are these 199 transactions or 999 transactions?

Michael Griffith

Well they are, they are between $5 and $11 per transaction.

Anthony Gikas - Piper Jaffray

Okay and then last question, can you comment on how long you’ve had development kits for the PS3, and what are the games looking like, at this point, in the development process?

Robert Kotick

Yeah, we obviously can see when we receive development systems, but we’ve been working on them for a long time and, the multiprocessor architecture, holographic capability, the hardware spectacular, the throughput is beyond what I think we would have expected in terms of the original design, its great product and it really is a meaningful difference generation-over-generation.

Anthony Gikas - Piper Jaffray

Okay, good job thanks guys.

Robert Kotick

Thank you.

Michael Griffith

Thank you.

Operator

Next we’ll go to Ed Williams with Harris Nesbitt.

Ed Williams - Harris Nesbitt

Good afternoon, just a couple of quick questions for you, looking first of all at your studios, can you just remind us what you did in fiscal ’06 and your revenues from internal studios and where the number has been in the recent past and what your target is as far as getting into the heart of the next generation cycle?

Robert Kotick

It was very consistent with prior years, we were about 2/3 of the revenues, publishing revenue generated from internal studios and we don’t expect that to change much early for fiscal ’07 either.

Ed Williams - Harris Nesbitt

Okay, but looking into, do you have a goal that you can kind of elaborate us to where you hope to get that number getting into the rest of the platform cycle, or is it 2/3 for your comfortable?

Robert Kotick

Generally speaking Ed, I think one of the things you are finding is as production expense is increasing and the requirement for using centralized tools and technologies is getting greater, it becomes more difficult for us to use third parties because they just don’t have the capabilities that will meet for next generation, but I would say when you look at the non-strategic platforms like Game Boy or some of the other things that we are using up our developers for, that number is not likely to change this fiscal year, and maybe it’d increases slightly in favor of internal development in fiscal ’08.

Ed Williams - Harris Nesbitt

Okay, and then can you just elaborate a little bit about the steps that you’ve guys have taken to gain some leverage on the cost of developing games, you mentioned, Mike I think you just mentioned about outsourcing more in terms of our work in the lake, can you elaborate a little bit more on that?

Michael Griffith

Sure, well as I said we are not surprised to see the cost pressure increase at this stage of the development cycle and as we talk about our product development cost or product creation cost, we include intellectual property in there and traditionally it’s been above of 20% of net revenue. And as Tom has mentioned, in fiscal ’06 we saw that climbed 23% we think it will stay about there in fiscal ’07, but we have a clear priority to improve our efficiency in product creation cost process and we are finding efficiencies and plans for efficiencies broadly without sacrificing game quality or innovation, and its really on the development and application of tools that can be developed and used and applied centrally to build efficiencies across platforms across studios, we’re reconfiguring our quality assurance program that move more resources upstream, indoor studio process where we’ve got a double benefit of being more efficient and more effective. And as I mentioned before, we are sourcing more of our out development offshore. So again, not particularly unexpected for this stage of the cycle, but we are confident we’ve got the right program in place to drive that to our historical levels of cost on our base percent in our revenue time.

Robert Kotick

Hey Ed, as one other area of specifics is the movement of quality assurance to India and its something that we’ve been experimenting with and we’ve had some pretty good success in our first phase of testing. So, when you look at QA, both up streaming some of the production testing to the studios themselves and moving offshore on like things like in Indian testing, is really actually been something that we think is going to pay dividends for the next couple of years.

Ed Williams - Harris Nesbitt

Okay, and then it’s the last question, as you look towards the next platform cycle, where do you expect most of the growth to be coming from, is it through in the North American market or is it in the European market and do you envision the household penetration of game consoles to expand, or do you expect MMO games to have an impact on the market as a whole and possibly negatively affecting the console games?

Michael Griffith

Well I think, first of all, we are seeing market growth potentials in both North America and Europe, so we’ve got an expectation over the course of the cycle that will be helped by market growth broadly, if you look at where our business is today, between North America and Europe, we’ve got more upside potential in Europe, just because we are less developed there, its about last time, building the business than in North America, and so that continues to be a major focus for growth and in terms of console penetration or game platform penetration, yeah, we think its going to up, but we are also seeing more multiplatform ownership in homes which, at least providing additional revenue opportunities.

Robert Kotick

The other thing I would say Ed is, when you look at the next generation devices and you look at things like Blu-ray, the first hi-depth DVD devices that will be in the marketplace, are going to be the Play Station 3, I think you are going to see a lot of mass market consumer interest in Play Station 3 as a video player. I think when you look at how compelling it is to play online with the multiplayer, in a multiplayer experience with tournaments, and ladders, and organize competition and the benefited intermitted instant messaging and audio with the headset on the 360. And then the really unique characteristic of the Nintendo which is absolutely going to peal to much broader audiences than we’ve seen in prior generations of hardware, that, I think what you see is there, will be a broadening of the audience for the console here and in international markets. And well the MMOPG business is an interesting one it’s likely to remain a much more of an inch business, focused on the PC until you have a much larger install base with more capable next generation hardware out there. So we are going to stay focused on the retail distribution of our products as the primary means of distribution and we definitely think that you will see broader audience emerge.

Ed Williams - Harris Nesbitt

Okay great thank you.

Operator

Next we go to Lowell Singer with Cowen & Co.

Lowell Singer - Cowen & Co

Thank, good afternoon. Just a couple of questions, Bobby can you help out on this question of game development cost by offering, for a generic title some perspective on what it cost you to develop games for essentially four platforms back in 2002 for the last cycle. And where you all think that t comparable game development cost will be for, 3 consoles and 3 rental handhold in 2007. So essentially what’s the delta where you sit today before you start building in all the efficiencies? And second Thomas a question for you, can you provide some, some of the assumptions that underlie the $1.6 billion revenue forecasting fiscal ’08, but some of your, hardware and software category assumptions are in sort of your specific company title assumptions. Thanks.

Robert Kotick

Okay so, I really can’t give you the specifics on title development. But we now have 5 next generation 360 products under our belt, they have been wide ranges in production expense, we’ve also been developing these cross plat forming tool and our centralized technology group has increased considerably. And it is still early days on Play Station 3 and on the Nintendo, so I don’t think we have a really good handle. But I guess overall is that when you, I mean step back when you think about the cost increases we’ve seen in prior generations, typically what we saw it in the first couple of years is about a 25% to 30% cycle-on-cycle increase in production expense. In some cases that’s been higher now, but I think ultimately we will get, remember, we are actually operating today with a $10 higher wholesale price which has been a pretty good offset, to some of the increased production expense. But we are going to need to get through the balance of this fiscal year, and get products out on Play Station 3, and the new Nintendo to really note exactly which tools are going to be affective for us, and how much control we can have over production expense. But I would say that couple of other things that we are doing kind of giving us more control. Our studios are bonused and rewarded on their ability to achieve operating margin targets. And one of the things that we are finding is that, we are improving the allocation process by putting things like production testing into the studio, they are more control over testing as an extents, we are really and powering our studio executives to get deeper into the details at our production budget, and were rewarded performance in the reduction of those production budgets and so there are lot of systemic things that we are doing as well. But we really want have a great handle on differences in the cost until we get through this fiscal year.

Thomas Tippl

And regard to your question, how the 1.6 builds up, I think we’ve in the last call talked about some of the slates, I am going to go back into that for a minute. And lot of our, big seller, as they go into the beyond the slate in ‘08 we are going to start very strongly with movie supported titles of Spider-Man: The Movie 3, and Shrek 3 two of our best performing titles ever. And a lot of our proven franchisees are back on the slate Call of Duty will be there, Tony will be there. We have about, if you added a lot, we haven’t announced all the titles, but from an SKU point of view we are going to about 50% of robust fiscal ’07. Then apart from the slate we expect the market to come back significantly in ’08, we expect double digit market growth as Mike mentioned early on in his comments, we continue to make good progress internationally and that leads to higher realization, higher penetration of international markets, some of those we already in but we are expanding our percentage of business that we sell direct to. And at the end of the day, there will be some contribution from the new markets and business models that are starting to emerge although its not going to be huge at that stage.

Lowell Singer - Cowen & Co

Okay thanks a lot.

Thomas Tippl

Sure.

Operator

Next we will go to Ralph Schackart from William Blair.

Ralph Schackart - William Blair

Good afternoon good to see you are standing by the, the long-term guidance. Can you sort of walk us through your fiscal ’06 guidance and sort of help us understand how that maybe actually little bit higher than what you put out there and what potentially could be the biggest risk to that? In additionally, can you just give us an update have you seen any up tick in sales especially on that catalogs since PS2 price that has second place? Thanks.

Thomas Tippl

I think, first of all, we’ve given ’08 revenue guidance earlier than we would usually do and at this stage we are not yet providing earnings per share guidance for ’08. So, with the regard to how the revenues build up, I think, I have just been, just gone through that, so I don’t know I have not much to add, from that perspective. And so, what was your second question?

Ralph Schackart - William Blair

The PlayStation 2 price card, I know it’s early but have you seen any up tick in sales especially from the catalog sales?

Michael Griffith

Well it’s really too early to see an increase in sales based on the Play Station price catalog. The 129 price point is really just now being reflected at retail in North America and as you know they’ve not made a similar move yet in Europe. So, its really just getting established, we have built that expectation into our plans, in the fiscal ’07 plans and guidance that we’ve already provided, but I will say that, given that price point on the Play Station and the robust slate we put into the market and fiscal ’06 and continued growth in the Xbox 360 penetration, we do expect our catalog business as a percent of revenue to be up slightly in ’07 compared to ’06.

Robert Kotick

And we did see the catalog in the fourth quarter performed better than we expected.

Ralph Schackart - William Blair

Great thank you okay.

Operator

Next we will go to Evan Wilson with Pacific Crest Securities.

Evan Wilson - Pacific Crest Securities

Hi there, and thanks for taking the question. Three I’ve got three, but first when should we expect to see the first Bond game, the second on the new Call of Duty announced for this Christmas what execution we expect there is that a PC title, well it roll across for the consoles as well, and then the third and probably the hardest, only the intellectual property versus licenses business, licenses you’ve been signing are definitely helping this to move out the transition but now company you definitely a company that’s traditionally focused more than others owned IP. Any sense on what owned IP versus outside IP will represent fiscal 2007 if you have any sense on fiscal 2008 that would be helpful? Thanks.

Michael Griffith

All right, first of all, let me answer your Bond question; we are in the early days obviously working with MGM and understanding the movie slate that they have in mind. And talking about various scenarios, so we have not made any decisions and certainly not any announcements about when the first Bond game will come into the market. This is, as Bobby mentioned, a very important long term franchise for us. So it’s very important that we do it right and naturally we focused on doing on Bond. For Call of Duty, this year it’s a broad based title. And, we think it’s going to be a very successful follow-up on Call of Duty 2, and will launch in our third quarter. It’s not a PC product, it’s a console product. And it’s all next-gen.

Evan Wilson - Pacific Crest Securities

All right.

Michael Griffith

And in terms of your intellectual property question, we are focused on a balanced portfolio of across different genres different platform and across owned and licensed intellectual property, there is a lot of good reasons to be pursuing both licensed and wholly owned and we have a combination of that. And we think that our split is going to stay pretty constant in the near-term. In ’07, our major wholly owned property is Call of Duty.

Evan Wilson - Pacific Crest Securities

Could you give us any sense of the previous fiscal year what own versus external was?

Robert Kotick

Yeah, it was, internally it is above, the third of our revenues are owned versus licensed.

Evan Wilson - Pacific Crest Securities

Thanks.

Operator

Next we’ll go to Justin Post with Merrill Lynch.

Helen Fleming - Merrill Lynch

Hi this is Helen Fleming for Justin. I just was wondering if you could discuss a little bit how your are going to use the $1 billion cash you said, its good opportunity in to invest are you looking more, more aggressively at mobile or online gaming now so that you could review acquisition strategy?

Robert kotick

Yeah we’ve had some great success in the last few months in extending our intellectual property agreement for very long-term. So that’s been one good user of our capital, we had good success last year in the acquisition of development resource and that will continue to be a focus of our capital usage. And so, I would say those would be the two things over the last six months through year that we’ve got the benefit of that capital.

Helen Fleming - Merrill Lynch

Then you’re looking forward, are you looking to be more aggressive in other areas?

Robert Kotick

No, we’re still remained opportunistic, but focused on what was well for us in the last few years.

Helen Fleming - Merrill Lynch

All right thank you.

Robert Kotick

Yeah, and I think, if you look at the financial discipline that we have exercised in our acquisition process we stayed true to generally speaking yields that are coming with some proprietary technology or franchise a history of profitable operation they are margin accretive for the long-term generally non-dilutive, and come with good management. And so when they meet all of those requirements we usually get interested.

Helen Fleming - Merrill Lynch

All right thank you.

Operator

Next we’ll go to Colin Sebastian with Lazard Capital Market.

Robert Kotick

Okay, hi Colin, go ahead; want to go to the next question.

Kristin Southey

Operator?

Operator

We’ll take our next question from Azeem Ibrahmin with Deutsche Bank.

Azeem Ibrahmin - Deutsche Bank

Hey thanks taking my question. When you guys look at the when you launch your games in the sort of first quarter, second quarter, third quarter, fourth quarter looking not into the next cycle. You typically you’ve said you had, your movie release games coming on the first quarter, third quarter is always been a sort of a big quarter for pushing out a bunch of titles. When you look into the next cycle, do you think that maybe more prudent to say launch games throughout all the four quarters. Or do you think we are still going to kind of see the third quarter being big weighted quarter. And I ask that question in the context of, there is been some sort of skeptics, there is been some claims that perhaps games may cannibalize or compete against each other when they were all dumped into third quarter. That’s the first question. And the second question, could you just, pretty simply sort of characterize your discussions with MGM over the James Bond franchise. Do you think it was a sort of discussion based on, you wanted it on a quality issue or it was a price issue, and may be MGM were sort of looking to just refresh the whole franchise especially given that the movie itself is undergoing a sort of a refreshment right now, could you sort of give us a characterization of why you think you are able to get that franchise? Thank you.

Robert Kotick

Well let me, start by addressing your quarter-by-quarter launch strategy question. They were clearly for movie support titles we need to launch the games concurrent with the movie, that is a the way to maximize revenue, and for those movies that launch outside of the holiday window in Q1 let say, those are important opportunity because they give us than a chance to double depth. Again during the holidays as often not just seasonality, but the DVD releases. So movie supported titles will really be driven by the release schedule of the movies. Beyond that, I think we will continue to see the third quarter that the October, December quarter be the most important just in terms of overall consumer demand, we have seen our slate vary as a percent of the year released in that quarter over time. And I think we will continue to see that based on a number of factors. But clearly from a seasonality view that’s going to continue to be the most important quarter, in terms of the Bond, I got to tell you we, we’re delighted with MGM we’ve had with many very productive discussions I think we are, we are seeing this franchise alike very similarly its getting well into our strategic priorities, and I really can’t comment much beyond that.

Azeem Ibrahmin - Deutsche Bank

Okay thank you.

Operator

Our last question will come from Daniel Ernst with Hudson Square Research.

Daniel Ernst - Hudson Square Research

Yes thanks to you thanks for taking the call. Just I think 2, I hopefully quick ones. One, on your plans for the, for the PS3 launch, are you planning to launch those, the sort of day and day or within the near term of the launch of the console in November. And then secondly, maybe a different tried at the cost putting any title not spends above of the marketing costs. What do you think the sales and marketing costs has been your revenue you are going to trend to that always been up significantly over the last 2 years is kind of revenue, did you see it stabilizing here or was it going to cleave up whole further here in a competitive and hitched in an environment? Thanks.

Michael Griffith

Well, I think first of all on the Play Station 3 launch, as we said we’re committed to supporting that launch, we’ve got 3 launch titles that will come out, in very near proximity to the hardware launch. In terms of the variable for the sales and marketing expenses, as I said we’ve, we increased our sales and marketing expenses quite considerably in fiscal ’06, we try to offset weaker market conditions, we found that it didn’t work, as well as we accepted. So we’ve gone back and analyze line-by-line, what’s working and what’s not working as well from our marketing expenses. We are committed to returning to proven historical levels of marketing support, we know how to do that, it’s pretty straightforward and we’re on path to do that over the next 1, 2 years.

Daniel Ernst - Hudson Square Research

I understand and as a follow up that, is there an opportunity to create some synergies on your multiplatform console, i.e., I can market Tony Hawk for the PS3, and PSP at the same time, and I guess, about that day and day kind of synergies, is that an opportunity or do you have to market them separately?

Robert Kotick

No, it’s absolutely an opportunity and that if I can take you back to the year we’ve just closed, we think one of our most successful programs was a simultaneous launch of Call of Duty 2 and Call of Duty: Big Red One which were on different platforms. And, we realize significant marketing efficiencies across that. So that was a very successful program and we will reapply that learning on the Tony Hawk franchise this year and more beyond.

Daniel Ernst - Hudson Square Research

Great thanks look forward to see next week as well.

Robert Kotick

All right thanks very much.

Operator

And at this time that concludes today’s question and answer session. I’d like to turn the conference back to Ms. Southey for additional or closing remarks.

Kristin Southey

Okay, thank you on behalf of everyone at Activision, we thank you for your time and consideration and we hope to see you all next week’s E3. Thank you.

Operator

And that does concludes today’s teleconference I’d like to thank you for your participation and have a great afternoon and you may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Activision, Inc. Q4 2006 Earnings Conference Call Transcript (ATVI)
This Transcript
All Transcripts