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Activision Inc. (ATVI)

F4Q07 Earnings Call

May 31, 2007 4:30 pm ET

Executives

Kristin Southey - Vice President, Investor Relations

Bobby Kotick - Chairman and CEO

Thomas Tippl - CFO

Mike Griffith - President and CEO of Activision Publishing.

Analysts

David Joseph - Morgan Stanley

Ben Schachter - UBS Securities

Jeetil Patel - Deutsche Bank

Heath Terry - Credit Suisse

Ralph Schackart - William Blair

John Taylor - Arcadia Investments

Tony Gikas - Piper Jaffray

Daniel Ernst - Hudson Square

Arvind Bhatia - Sterne, Agee & Leach

John Mcpeake - Prudential

Presentation

Operator

Good day everyone, and welcome to this Activision Fourth Quarter and Fiscal Year-end 2007 Financial Results Conference Call. Today's call is being recorded. And now at this time for opening remarks and introductions, I'd like to turn today's call over to Vice President of Investor Relations, Kristin Southey. Please go ahead, Kristin.

Kristin Southey

Good afternoon and thank you for joining us today for Activision's Q4 and fiscal '07 year-end conference call. 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 statements made during this call are not historical facts in our forward-looking statements. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties.

The company cautions, that a number of important factors could cause Activision's actual future results and other future circumstances to differ materially from those expressed in any such forward-looking statements.

Such factors include without limitations further action by the NASDAQ Listing and Hearing Review Council relating to the continuation of the listing of Activision's common stock; the completion of work by Activision’s management and Activision's outside auditors on the restatement of Activision's financial statements in response to the special findings of a special sub-committee of independent directors established in July 2006 to review our historical stock option granting practices; the completion and filing of overdue quarterly reports, and amendments to our previously filed quarterly report with the SEC.

The further implementation, acceptance and effectiveness of the remedial measures recommended or adopted by the special sub-committee, the Board and Activision. The outcome of the informal inquiry opened by the SEC and the derivative litigation filed against certain current and former directors and officers with Activision. The possibility that additional claims and proceedings will be commenced, other option related litigation, sales of the company's titles, shifts in consumer spending trends, the seasonal and cyclical nature of the interactive game market, Activision's ability to predict consumer preferences among competing hardware platforms, including next-generation hardware, declines in software pricing, product returns and price protection, product delays, retail acceptance of our products, adoption rate and availability of new hardware and related software, industry competition, rapid changes in the technology and industry standards, protection of proprietary rights, maintenance of relationship with key personnels, customers, vendors and third-party developers, international economic and political conditions, natural disasters, integration of recently acquired subsidiaries, and identification of suitable future acquisition opportunities, limitations on our ability to issue stock and options, and foreign exchange rate changes.

These important factors and other factors that potentially could effect the company's financial results are described in our filings with the SEC, including the company’s most recent 10-K, and the recent Form 8-K and the cautionary statements there in and the exhibits there to.

The company may change its intentions, belief or expectation at any time and without notice based upon any changes in such factors in the company’s assumptions or otherwise. The company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances or other changes after the date hereof or to reflect the occurrence of unanticipated events.

Before getting started, I would like to highlight a couple of items. First on May 25, 2007 Activision filed an amended annual report on Form 10-K/A for the fiscal year ended March 31, 2006 consistent with the estimate release for Activision on May 3, 2007 the Form 10-K is filed lastly [with report] to a total of $66.7 million in additional pretax and $45.4 million after non-tax cash equity based compensation expense, as a result of the stock option inquiry over the 13 year period from April 1, 1993 through March 31, 2006.

Investors are urged to carefully read the Form 10-K/A for the fiscal year ended March 31, 2006. Second, please note that any comments made during this call with reference to our fiscal '07 results or future outlook, exclude any adjustments that may be required by the occurrence of events subsequent to this call that affects the estimates inherent in the process of preparing these results and should be considered preliminary until Activision files all required periodic, quarterly and annual reports for fiscal '07 with the SEC.

Finally, certain financial commentary in this call will be made excluding the impact of equity-based compensation, and therefore certain financial measures discussed in this call will not be in accordance with GAAP. Please refer to our earnings release for a full reconciliation of these non-GAAP financial measures to GAAP measures.

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

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Bobby Kotick

Thank you, Kristin. Today, we are pleased to share with you our record results for the fourth quarter and the fiscal year ended 2007. Net earnings revenues and earnings for the fourth quarter were higher than our previous outlook, driven by the continued success of our tittles for the next generation platforms, and strong sales which we targeted to on the PS2. Net revenues for the fiscal year were a record $1.5 billion, significantly higher than our outlook at the beginning of the year, and the highest in Activision's history marking our 15th consecutive year of growth. We ended the fiscal year as the number two, third party publisher with four of the top 15 titles. We also extended our next generation leadership as the only company to be a top three publisher for both in Nintendo Wii and the PS3. Our results for the fiscal year were driven by our focused line up of proven franchises Call of Duty, Tony Hawk, our newest Marvel property Ultimate Alliance and Guitar Hero. Our increasing scale provides cost leverage across our global infrastructure, and we're beginning to see the benefits of this leverage reflected in our operating results.

Our strong cash position of almost $1 billion affords us the ability to seize investment opportunities like expanding our intellectual property portfolio or adding key development talent. As an organization we remain focused on building shareholder value through margin expansion and cash flow generation. Over the past five years, our shareholders equity has increased from $436 million to $1.4 billion, a 27% rate compounded annually.

In fiscal '07, we delivered against all of our financial and strategic objectives. We entered the fiscal year with tempered expectations, as we released fewer titles with a focus on increasing revenues and profitability against our most important franchises. This resulted in driving revenues per title to an all time high. A year ago, we outlined our cost optimization plans, we ended the fiscal year well ahead of our expectation and achieving these plans without sacrificing consumer awareness or gain quality.

Strategically, we remain focus on expanding our balance franchise portfolio, expanding our next generation development leadership and expanding our global marketing and distribution footprint. To that end, we acquired the long-term rights to the James Bond franchise one of the most internationally appealing franchises in video games.

We are currently in development of a new James Bond game which will be released in conjunction with the feature film next year. We also acquired the Guitar Hero franchise. Since the acquisition we've executed best in class retail marketing programs and re-engineered the supply chain. In less than a year our PS2 share from Guitar Hero are almost equal to the size of the entire football ground on the PS2.

We have very thoughtful plans for this franchise as we expect it to be the fastest growing franchise in Activision's history. We continue to strengthen our development resources for the recent acquisition of DemonWare which we believe provides a meaning competitive advantage as console gaming moves to more of online model and as multiplayer match up becomes a more important part of the console experience.

Our organization is firing on all cylinders, we continue to remain focus on long-term shareholder value creation as we have for the last seventeen years. Our results for this past fiscal year are our testament to the discipline and commitment shown by our extraordinary team. The outlook we are providing today for fiscal '08 demonstrates that the investment we have made in intellectual property, development resources and our human capital as well as our focus on margin expansion are continuing to provide superior financial results for our stakeholders. Our performance will continue to be driven by expanding our balance franchise portfolio, strengthening our next generation development leadership and furthering our initiative to reduce development expense through organizational efficiencies.

In today's market we have more opportunities to grow our franchises and increase our revenue and profitability per title through a variety of new activities than we've ever had before. The Internet connectivity of the new consoles continues to provide us with exciting new sources of margin expansion to such offerings as downloadable content, in-game advertising, social networking, prize play and eventually even online sweepstakes.

We've just entered the most exciting time in our industry's history and Activision has never been stronger.

Later in the call, Mike will share some more details of our plans for the next fiscal year. But now, Thomas will provide a review of our operations during the last quarter and the fiscal year. Thomas?

Thomas Tippl

Thank you, Bobby. Today, we announced operating results for the first three quarters of fiscal 2007. As a result of updating our financial charges related to the review of historical stock option grant practices and subsequent demand adjustments primarily related to changes in the effective tax rate, the company's updated nine month earnings per diluted share, excluding equity-based compensation increased from $0.33 to $0.37. A full update by quarter can be found on our earnings release.

We expect that we will shortly be in a position to file an amended quarterly report on Form 10-Q/A for the quarter ended in June 30, 2006 and quarterly reports on Form 10-Q for the quarters on September 30 and December 31, 2006. The completion of these filings will bring the company current in its periodic reporting obligation and will restore company's compliance with NASDAQ listing requirements.

We also intend to file the company's annual report on Form 10-K for the fiscal year ended on March 31, 2007, almost on or before June 14 and to that end we filed yesterday for an automatic 15-day extension of the deadline for that filing to June 14.

Additionally, today we announce results for the fourth quarter and fiscal year 2007 which I will recap.

For the March quarter, net revenues were a record $313 million as and anticipated and $124 million rest of the prior driven by the strength of our holiday suite particularly Call of Duty and Guitar Hero and the European launch of the PS3.

Before I continue with our financial review, I would like to note that certain numbers I will be giving you including operating income, earnings and loss per share, for updation cost, sales and marketing expense and G&A spending will be made excluding the impact of expenses relating to equity-based compensation and are not in accordance with GAAP. Please refer to our earnings release for a full reconciliation.

For the March quarter, we had a loss per share of $0.04, this was better than our outlook driven by the overall performance of our [apparels] and then more favorable tax rate offset partially by expenses rates related to the stock option review.

In the March quarter, manufacturing and distribution expense was 58% of net revenues versus 63% in the prior year due to improved targets.

Product creation cost for the quarter were 25% of revenues versus 23% in the prior year, we define product creation cost at the sum of cost, software royalties and amortization. Cost of sales in financial property licenses and product development expense. The increase was due in part for product launches greater than the prior year.

Sales and marketing expense for the quarter was 12% of revenues, roughly inline with the prior year. G&A as a percentage of revenues were 12% impacted by linear professional fees related to the stock option review as well as intangible amortization related to the RedOctane acquisition.

We generated higher investment income for the quarter due to higher cash balances and rising interest rates. Our effective tax rate for the quarter was 22%. This is lower than our previous outlook as a result of improved profitability leading to utilization of net operating loss carry forward and in turn a reduction in valuation allowances related to R&D tax credits.

Now moving on to the fiscal year end results. For the fiscal year, net revenues reached $1.5 billion through the multi-platform releases of Call of Duty 3, Tony Hawk's Project 8 and Marvel: Ultimate Alliance as well as we target on the PS2 and growth in our distribution business.

For the year, earnings per share was $0.33, significantly higher than the prior year and our outlook going into a fiscal year. This is due mainly, to strong product performance, better than expected market conditions and improved returns on our sales and marketing investments.

For the fiscal year manufacturing and distribution expense was 53% of revenues, which was 50% in the prior year due in part to strength in our distribution business. Operating expenses for the fiscal year excluding manufacturing and distribution expense were 41% of net revenues. This is down significantly versus the prior year due to the previously mentioned strength in our distribution business and progress we made against our cost efficiency of changes.

Our effective tax rate for the year was 22% versus 12% last year. The rate is lower than our previous outlook for the same reasons I mentioned earlier in the Q4 discussion. The increase versus prior year is due to the improved profitability and as a result R&D tax credits accounting for a small portion of taxable income.

Now turning to the balance sheet. On March 31st, we had 955 in cash and short-term investments, an increase of $10 million versus the prior year end and up $150 million versus the prior quarter due to collection of holiday quarter receivables. The accounts receivable balance was $149 million, up $120 million versus the prior year due to higher revenues in the quarter including the PS3 release in Europe.

Inventories were $91 million, an increase of $6 million versus last quarter and higher than normal due to the inventory build for the early April release of Guitar Hero II on the Xbox 360. On March 31st, inventory for the publishing business was $66 million and $25 million for the distribution business.

Capitalized software development costs were $131 million, an increase of $70 million versus last year, and up $29 million versus last quarter. The increases reflect more multi-platform to next-gen titles in development.

Capitalized intellectual property costs were $100 million, up $13 million versus the prior year. The year-over-year increase was primarily due to the new long-term licensing arrangements with the James Bond franchise.

In summary, in fiscal '07, we executed well against our stated financial goals. We also finished the year well ahead of the revenue and earnings outlook we provided to you in each of the year, ended the year with a healthy cash position and strong financial base, which will continue to give us the flexibility to invest and leverage the increasing strong base of global hardware.

In addition, we made significant progress against our cost reduction programs. We improved sales and marketing return on investment by over 40%, [obtained] rising product development costs and successfully executed our workforce realignment.

Finally, we continue to profitably grow our franchise portfolio through the immediately accretive acquisition of Guitar Hero.

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 a number of internal and external factors that could cause our actual results to differ materially. I refer you to our financial filings with the SEC for a full review of our risk factors.

Now to Q1. Quarter-to-date, we have already successfully launched four products into the marketplace. Our first release of the quarter was Guitar Hero II for the Xbox 360, which largely involves the US and Europe in early April. Demand for this product at that time has outstripped on increased production capabilities. In the US, Guitar Hero is the number one franchise in the marketplace to-date in calendar 2007, and it has only been launched on two platforms. In Europe, the title continues to gain awareness with the Xbox 360 SKU taking the number one spot in a host of countries.

Our second major release was Spider-Man 3 the movie game, which launched concurrent with the theatrical release on May 5th. Spider-Man 3 achieved the highest pre-sell activity in our company's history and the box office results have been excellent. To-date, we are pleased with the title's performance and believe the launch has set the foundation for another very strong year for the Spider-Man franchise.

In May, we also launched DreamWorks Shrek the Third on multiple platforms in advance of the May 18th movie opening. This is our fifth DreamWorks movie supported title and today the DreamWorks partnership has yielded over 20 million units. The demand started growing for this title and Shrek the Third pre-orders were three times greater than Shrek 2. The US launch has been a success and we look forward to the upcoming international launches tied with the movie release.

This quarter we also launched Tony Hawk's Downhill Jam on the PS2, leveraging the continued strength of the PS2 software market and the development investment we have already made for the 2006 holiday release on the Nintendo platform.

Finally in the last few days of the quarter, we will begin shipping Transformers to US Retail for the July 4th movie release. The movie looks great and the excitement continues to build. This game will ship on multiple platforms including two unique SKUs for the Nintendo DS. The European launch will ship in the second quarter concurrent with the movie launches in those geographies.

In Q1 we made one more change to our release schedule as we moved the launch of Enemy Territory Quake Wars for the PC to the second quarter. But as you know, ID also makes the final decision on the release date.

As for financial outlook, for the first quarter we expect record net revenues of approximately $425 million, driven by our large lineup. Including FAS 123R, which relates to the expensing of stock options and other share based payment; we expect earning per share of approximately $0.03. The company's earnings per share outlook excluding the impact of 123R is approximately $0.05.

For the quarter, we expect manufacturing and distribution cost of approximately 22% of net revenues that resulted increase in gross profit versus the prior year, due to positive mix on increased publishing revenue. We expect operating expenses including royalties and the impact of FAS 123R of approximately 57%. The projected tax rate of 33% that can be used throughout the fiscal year, and a diluted share count of about 310 million shares. For the quarter, excluding the impact of 123R, we expect operating expenses including royalties of about 55%, while other line items were the same as I mentioned a moment ago.

For modeling purposes, second quarter net revenues and operating performance will be better than the prior year. However, given the limited release schedule, we will still expect a loss in the third quarter.

As for OpEx for the full year, we are increasing our revenue outlook and today we believe net revenues in fiscal '08 will be approximately $1.8 billion. We expect operating income excluding FAS 123R will be in excess of $200 million, doubling year-over-year.

In fiscal '08, earnings per share, including FAS 123R is expected to be $0.45 and company's earnings per share also excluding the impact of FAS 123R is approximately $0.55.

For the fiscal year, we expect manufacturing and distribution costs of approximately 44% of net revenues. This reflects improved mix versus the prior year, to a half percentage of revenues coming from our publishing business, and within publishing a higher mix of PC and Next-Gen products sharing higher gross margins. We expect operating expenses including royalties and impact of FAS 123R of approximately 46% and a diluted share count of about $316 million.

For the fiscal year excluding the impact of 123R,we expect operating expenses including royalties of approximately 44%. This is higher versus the prior year, as we highlighted on our last call, due to increased publishing business mix, higher growth associated with our larger and growing fleet and our anticipation of a more competitive environment.

Starting with sales and marketing expense; as a percentage of revenue, we expect it will be up versus the prior year due to the fact, as I just highlighted. However, we did go forward in our previously announced target range of 14% to 16%.

As for product creation costs, we expect it will be up versus the prior year due to the largest leg of next-gen product and increase in license property.

In our publishing business, if you exclude the cost of licensing, our projected product development cost as a percent of revenue continues to improve year-over-year. And looking ahead, we shall see a better realization against our product reassessment, as we continue to ramp the next-gen learning curve and increase the amount of game development that has been also obsolete and who are offshored to lower cost locations.

Finally with respect to G&A expense, we expect to see a meaningful improvement year-over-year and believe the line to come in around at top end of our 4% to 6% target range. The year-over-year improvement will be driven by a few expenses associated with the RedOctane acquisition and legal fees and professional fees.

In summary, we expect that fiscal 2008 will be the largest and most profitable year in the Activision history. Our substantial increase in operating income will mark a significant step forward towards achieving our peak operating margin target of 15% to 18% for the cycle.

I would like to turn things over to Mike Griffith, President and CEO of Activision Publishing, who will direct his thoughts on fiscal '08 and beyond.

Mike Griffith

Thanks Thomas. Today, I'm going to touch on three areas that'll be key to our future performance. First, I'd like to underscore the key strategic choices we believe will drive sustainable growth in market expansion over the long term. Next, how we see the hardware and software markets for the year ahead, and finally, how we’re looking at fiscal ‘08 and beyond.

As we began a new fiscal year, its a good time to affirm the choices we've made, and where we’re focusing our time, effort and resources to drive sustained growth. First, and this should be no surprise. We’re committed to building brand franchises that resonates with consumers.

We built industry leading capabilities to understand what our consumers want and are turning these insights into a strong portfolio of games and effective marketing programs. We are focused on leveraging this capability to add depth and breadth to the intellectual property we own or control through the annualization of key properties by extending our IP into new opportunities and by building ancillary revenue streams.

As an example, beyond annualizing our core IP last year, we also successfully extended the Tony Hawk franchise and delivered year-over-year revenue for the brand with the release Tony Hawk’s Downhill Jam.

We expanded our leadership in the superhero category with the successful launch of Marvel, Ultimate Alliance, extending our Spider-Man and X-Men franchises. We also added incremental revenues and operating income to Call of Duty and Guitar Hero franchises through in-game advertising and popular downloadable content offerings.

And finally, we continue to broaden our portfolio with new licensed opportunities like James Bond and new wholly-owned internal IP which is currently under development.

Next, we’re focusing on driving our independent studio model as a long-term competitive advantage. This model allows each studio to maintain its own unique creative culture and identity, which gives us an important edge in attracting and retaining key talent, and is also consistent within environment that fosters great creativity. We also think we found the right balance between our autonomous studio culture and centralized processes which drives scale.

Our central technology organization facilitates the sharing of tools and technology and provides studios who needed support, while an acquisition like DemonWare offers scalable capabilities across our studios. And because our studios are rewarded based on the operating profit of their gains and central resources are provided on a service pricing model. There is a healthy attention to deliver a creatively attractive gain at commercially attractive cost.

Our Call of Duty franchise is a great example of the strength of our studio model. Today, we have two fully qualified studios that develop the Call of Duty franchise and this share of technology will (leap frog) in the annual development. The advantage is that each studio gets an 18 to 24 month development cycle required for this gain, while allowing us to meet the annual demand of consumer's desire. Following on a very successful Call of Duty 3 last fall we expect Call of Duty 4 to set a new bar for the franchise.

Another example of the strength of our model was the seamless transition of Guitar Hero development to Neversoft, who is bringing even stronger innovation to the franchise and I think you will be pleased with the success this fall.

And third, for an in market sales perspective we are focused where it matters most. We are placing more resources against our top markets and top customers than ever before. We still have significant room to grow in our most development market and with our largest customers.

Despite growing broadly in fiscal '07, we still experienced our greatest absolute dollar growth from our strongest markets and our strongest customers. Our focus on consumer marketing, retail category management, in-store execution against our largest markets and customers is paying off and will continue to be a key focus for the company.

In total, we think our choices and capabilities in these three important areas will continue to provide us the distinctive foundation for growth and margin expansions throughout the cycle.

Moving now to hardware and software markets, overall industry fundamentals continue to improve and on April 30th the installed base of hardware in North America for current and next generation systems, including handheld was approximately 128 million units, which is significantly higher than where the installed base was at this point in the last cycle.

The large installed base at the PS2 combined with the growing installed base for all three of the next-gen systems bodes well for our performance this year. We believe growth will also be fueled by continued strength in handheld platforms and eventually, lower-priced current-gen hardware.

With respect to the hardware market, in aggregate we now expect the installed base of hardware by year-end to be higher than previously expected. As of today, we expect the following hardware increases in North America during the calendar year.

We are estimating PS2 will be up 4 million units and we are anticipating 4 million PS3 units. We expect Xbox 360 growth of 5 million units and we also expect about 5 million units from Nintendo’s Wii. Finally, we expect handhelds, which include the GBA, PSP will grow by approximately 11 million to 12 million units.

Moving to software and we define our market to include all major platforms in North America and Europe. For calendar 2007, we expect a combined North America and European software market for current and next-gen consoles, handheld and PC to now grow in excess of 12% driven in part by a larger installed base of hardware.

With respect to software pricing, today we are pleased by the consumer and retail acceptance of the higher next-gen pricing. We expect that software launch pricing for the Xbox 360 and PlayStation 3 will hold at $59, and for the Wii $49.

Pricing decisions for front line current gen console titles will remain on a title-by-title basis based on quality and other factors, having said that, software pricing still remains one of the major risk to our operating plans, due to the potential impact of competitive pricing actions.

Turning to fiscal 2008, Thomas touched on Q1 and this quarter set the stage for the balance of the year. Our Q1 movie launches will be supported with strong DVD programs in Q3 and our expectation is that both Spider-man and Shrek will set new revenue records for their respective franchises in the fiscal year.

For the second quarter, we will continue to support the late Q1 launch of Transformers worldwide across multiple platforms supported by the movie launch beginning on July 4th in the US and in UK. And the anticipation for this movie is strong as is our last program for the title.

Additionally for the PC, we will release Enemy Territory Quake Wars, and for Guitar Hero, we will launch the 80 Encore pack for the PlayStation 2. Our research shows that PS2 consumers want more content and they will get it with 30 new songs for Guitar Hero.

Looking to Q3, we will come to market with an exceptionally strong line up. We will start by leveraging the theatrical marketing promotions surrounding the DVD releases of our movie based tittles. In addition our holiday line up will be anchored by a high quality slate of proven properties based on our most successful franchises including Tony Hawk, Call of Duty and Guitar Hero.

Starting with Tony Hawk, our goal is to once again capture a wider, broader demographic and this year, we will launch Tony Hawk's Proving Ground. Last year, we grew the franchise and we were excited about this new tittle, which will launch across multiple platforms this fall.

Next, we'll look to further capitalize on the success of the Call of Duty franchise, with Call of Duty 4 modern day. The Call of Duty franchise is one of our largest sellers in fiscal 2007 and this game marks the fourth consecutive annual release. This game is designed to take through advantage of next generation technology and the release on the X-Box 360, PlayStation 3 and the PC. The title will come with the variety of downloadable content it has been characterized by early press coverage as the best shooter out.

Third, we'll continue to broaden our leadership in the super hero category with the release of a new Marvel title. This title will benefit from the momentum and advertising created by the theatrical release and DVD launch of Spider-man 3.

During the holiday season, we'll also launch the Guitar Hero 3 worldwide on multiple next-gen platforms. Guitar Hero is currently the number one franchise in the marketplace and the title is only been released on the PlayStation 2 and X-Box 360. We've significantly increased our capacity for Guitar production and will be ready for the demand this holiday season.

We are also planning to expand the depth and breadth of the franchise through continued emphasis on Guitar Hero 1 and Guitar Hero 2. In addition, we'll offer a full selection at downloadable content.

In terms of new intellectual property, we'll release Bee Movie our next DreamWorks' movie based title, which will coincide with the holiday theatrical release, starring Jerry Seinfeld.

In summary, our fiscal '08 line up is strongest in the company's history. Today, we are significantly increasing our fiscal '08 net revenue guidances to 1.8 billion as Thomas said, marking our 16th consecutive year of growth.

In fiscal '08, we'll more than double our operating income and expect record earnings per share. Beyond this fiscal '09 is shaping up nicely for continued growth behind a number of titles including blockbuster movie games such as James Bond, and DreamWorks Kung Fu Panda, and Madagascar 2. We will also focus on driving the Guitar Hero and broadening our core franchises like Tony Hawk, Call of Duty in addition to supporting our leadership position in the superhero category.

So over the next few years, our performance will be driven by double-digit market growth, expanding the breadth and depth of our franchise portfolio and development resources, realizing the benefits of a more efficient cost structure and winning bids, winning customers around the world.

So, thank you very much for your time and opportunity to share our initiatives for the future with you. And I'd now like to open up the call for your questions. Thank you.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. We’ll go first to David Joseph, Morgan Stanley.

David Joseph - Morgan Stanley

Yeah, hi, guys. Thanks for taking my question. Just two questions. One, you talked a little bit about the software industry and expectations of pricing, and I’m wondering what your expectations are as they’ve been adjusted at all for pricing on the hardware in the second half of the year. It seems that there are expectations for price movements perhaps on the PS3 and Xbox, especially in light of the PS3 not really seeing their share creep along, especially here in the US, I’m wondering if you might be able to speak a little bit, and how any kind of price movements might impact your business? Also, I’m wondering if you might be able to give us a little bit more color on how the PS3 did or is doing in Europe?

Bobby Kotick

Sure. I think in terms of pricing, we certainly expect our current gen pricing to come down at some point. We heard the rumors in the marketplace like you do. We really don't have visibility to specific pricing plans. I think it's really up to the first parties to decide and communicate that. So, we based our plans to the best extent we can on current marketplace pricing dynamics. In terms of PS3 in Europe, it continues to build. PlayStation business, of course, has a very strong leadership share in Europe, and we expect that they will continue to expand their installed base through the course of the year.

David Joseph - Morgan Stanley

Great. Thank you.

Bobby Kotick

Certainly, David.

Operator

We will go next to Ben Schachter, UBS Securities.

Ben Schachter - UBS Securities

Hey guys. Congratulations on a great year. I was wondering if you could talk about PS2 for a second and how important that is for fiscal '08 and may be even to fiscal '09, and how long you think that cycle can really stick around? And then also in China, I was wondering if there are any models that you are seeing over there that you think you are particularly interesting to Activision for models that might actually begin the impact here in the US later in the cycle? Thanks.

Bobby Kotick

Well, PlayStation 2, I think we've all been encouraged to see the vitality at PlayStation 2 really in the last holiday season and continuing on into this calendar year, and it looks like it may have a stronger and longer leg than we at one time anticipated. So, as we develop our titles against multiple platforms, we are certainly taking that into account and we've got a strong PlayStation 2 lineup this fiscal year to take advantage of it, and we'll continue to PlayStation 2 just as long as it's a viable platform.

So we think the only limitation right now is upside on the PS2 platform, hardware wise, is Sony's ability to manufacture the hardware. So, if Sony can manufacture greater quantities than what they have given in their last forecast, that should be exciting for the market.

As far as China, lot of exciting developments there over the last few years, we opened an office in Shanghai this past year. And you really are starting to see mainstream gaming, it's mainly online, but we view that as a long-term expansion opportunity for the company.

Ben Schachter - UBS Securities

Okay. Thanks.

Operator

We'll go next to Jeetil Patel, Deutsche Bank.

Jeetil Patel - Deutsche Bank

Yeah, hey guys.

Bobby Kotick

Hey Jeetil.

Jeetil Patel - Deutsche Bank

A couple of questions, first of all your percentage of revenues from proven IP that you've historically been working with versus new IP for fiscal '08, what do you think that mix looks like in terms of what you've already historically executed upon? And second, what do you think is the right time to test new IP in the marketplace as we are still in the ramp up phase of the next-gen? And then I have a quick follow-up.

Mike Griffith

Sure, let me start with me the new IP in the marketplace. As you know our approach is really a portfolio approach and we think that has stood at the test of time and we are pretty committed to it. And as a portfolio across both licensed and wholly owned IP, like Call of Duty and Guitar Hero, which obviously are growing strongly for us. But we think it's important to be represented across both licensed and internally owned and we're actively interested in expanding both parts of our portfolio. We are constantly looking and evaluating our own internal IP development ideas and we have a couple of things in early stages in various stages of production. But it's really a portfolio of products that we are taking on this.

Bobby Kotick

And I think that we like the predictability that comes from using proven IPs and leveraging proven IP, Having said that, this is the fiscal year we just entered, there are three new properties, Transformers, Bee Movie, and then next day you'll see things like Kung Fu Panda. So there are some of these newer, little bit more risky propositions. But we think they are really safe, that's when you consider the amount of marketing support that's coming from the studios against those propositions.

Jeetil Patel - Deutsche Bank

Got it. And I guess and you had concerns on overall software pricing holding up at 60 and retail on next-gen versus 50 on the Wii and less on the PS2. I guess do you think the risk is coming from the pricing of the hardware first party publishing pricing, or is it a marquee titles or other industry leaders and their pricing strategies for the upcoming year?

Mike Griffith

I think if there is risk it will be driven by competitive software actions. We don't see any evidence of that today. We are encourage that the $59 for 360 and PS3 price points and $49 for Wii is holding. And if you look at the comp store file, what we think our competitors have, it would tend to add credibility to that continuing to hold. So we don't think if we -- if there risk, we don't think it would be driven really by the hardware side of things. It would really be driven by competitive behavior.

Jeetil Patel - Deutsche Bank

But I think competitors going at reorg or restructure of their businesses, that would be a bit of a concern?

Bobby Kotick

Absolutely I think that's the biggest risk that we faced this calendar year, it is what happens with that premium pricing. Now and that we are insulated in certain categories like Guitar Hero, where we control essentially that market and there's a little bit less pricing risk there. We've actually raised prices on some of the hardware and not seen any shortage in demands, but I think pricing generally is the big risk for the calendar year.

Jeetil Patel - Deutsche Bank

Thanks.

Operator

We'll go next to Heath Terry, Credit Suisse.

Heath Terry - Credit Suisse

Right, thank you. I was wondering if first you could quantify or attempt to quantify the impact that the options investigation had on the legal and professional expenses in the quarter, and what the profitability would have looked like without that?

Thomas Tippl

Yeah, the impact of [divisional] cost where a couple of [hanging] on the quarter and as well as couple of [hanging] on the year.

Heath Terry - Credit Suisse

Okay. And then the degree to which those will continue to carry forward into this current fiscal year, I know you've mentioned that you are in 14th filing date. Should we expect that those cost start to roll off pretty quickly after that?

Thomas Tippl

Yeah, my expectation will be that the bulk of the cost that we still have to carry for fiscal '08 will hit the first quarter.

Heath Terry - Credit Suisse

Okay, great. And then just finally, can you talk about the attach rate that you are seeing for the down loadable expansion packs or additional songs on the 360 version of Guitar Hero. How does it match up to what you've seen in your other downloadable content offerings and your expectations?

Mike Griffith

I think downloadable content for Guitar Hero has been strong, there's been strong consumer appeal and acceptance of it. We continue to get more experience overall with downloadable content, micro-transactions to be clear. This continues also to be a small part of the revenue model, but it is growing. Last year, for example, we generated less than $10 million in revenue; this year we should double that up to $20 million. On the high side, Guitar Hero will be a major contributor to that, as will be the Call of Duty, Modern Warfare. So in Q1 we had about 200,000 downloads for Guitar Hero.

Thomas Tippl

So far.

Heath Terry - Credit Suisse

Great. Thank you.

Operator

We'll go next to Ralph Schackart, William Blair.

Ralph Schackart - William Blair

Hi good afternoon, I was wondering if you could give us perhaps a little bit more color on Transformers, specifically the reaction from the retailers at this point and may be a little bit more color on the pre-sale activities?

Mike Griffith

Yeah we feel good about Transformers. The movie itself has had strong buzz. We got good retailer acceptance to our programs, and we expect strong start as we begin shipping it towards the end of this quarter. And then in the next quarter in terms of most of Europe. So we think the movie is strong, we think the game will be well accepted, and its got a very strong program behind it.

Ralph Schackart - William Blair

Great thank you.

Operator

We'll go next John Taylor, Arcadia Investments

John Taylor - Arcadia Investments

Hi, I got a couple of questions. Let's see first the housekeeping one; can you give us the accounts receivable reserve please at the end of March.

Thomas Tippl

Yeah, accounts receivable reserve as a percentage of gross receivables were 38% at the end of March.

John Taylor - Arcadia Investments

Of gross. Okay, great. And then in your 1.8 billion forecast, I wonder if you could give us a break down, a range or something of how you expect that to be split up by format or SKU scan or anything like that?

Thomas Tippl

We continue to see an increasing percentage on the next-gen for two-thirds of that, as we expect it to that about two-thirds of the business.

John Taylor - Arcadia Investments

I guess I am looking --

Bobby Kotick

And from SKU perspective I think we have about 45 SKUs major SKUs in '07 and we expect that to increase about 65 probably.

John Taylor - Arcadia Investments

So 45 goes to 55. So, I wonder if you could give us a sense of what the Wii business or the Nintendo format business is going to look like as a percent of '08 versus '07?

Bobby Kotick

We expect that we obviously based on the momentum that it has in the marketplace to continue to grow as a share of our business and we expect it will be at least double of where we were in '07.

John Taylor - Arcadia Investments

Great, and then let's talk about the economic challenges of porting a game across multiple platforms because the architectures are so different, I am wondering if you guys are feeling that had an impact on Q4 numbers at all with getting the Spider-Man and Shrek items out and whether sort of learning curve is going to help produce that challenge as you go through '08?

Thomas Tippl

Yeah first of all I think on Spider-Man and Shrek, we have produced old titles for the first time on the next-gen, so I will definitely say that the production costs reflect the early stages on the learning curve for those properties. We built New York City for Spider-Man for the first time on the next-gen, that was a real significant investment that went into that. We would expect to see efficiency as we go into the next iteration on those properties, so there's no doubt about that. With regards to efficiency across platform, regarding efficiency because we are doing co-development with the Xbox 360 as well as the PS3 and we are leveraging some of our development networks between the PS2 and Wii development. I think what we are seeing overtime though is, you wanted to be fully competitive which is our intention on the Wii, I think we still have more potential to make better use of the unique features that the Nintendo platforms offer. So, there will some specific investment going into against that as we look forward.

Bobby Kotick

But we are getting the benefit of things like the offshore development and from outsourcing and as I'm sure you noticed we had lot less learning's in the quarter.

John Taylor - Arcadia Investments

I appreciate it. Heath asked about the legal costs, so I wonder if you could help us quantify what you expect that to look like in the first quarter and fiscal '08. And then or there any other sort of non-recurring or if not non-recurring sort of things you might want to call out in terms of cancelled product cost, that might have been observed in the fourth quarter because the revenue number was up pretty nicely and the earnings number I think are the contribution on that higher revenue number was maybe a little lower than what I would have thought. So maybe, was there someone else that maybe have taking care of the other things?

Thomas Tippl

No, we didn’t know write-offs on the development side, I think we have managed through this year, so our processes failing diligently that doesn’t mean we'll never have a write-off again, but '07 was a successful year, very successful year in that regard. The key items that impacted Q4 was the legal and professional fees related to the option review as well as significant amount of rate of attending tangible amortization which we also will still have some of in '08, but we will have finished with that by the time fiscal '08, '08 is done and is moving on to expense of fiscal '09.

Mike Griffith

And if you remember we said, we had a little bit more of the revenue of the performance in the quarter coming from the shipments of PlayStation 3 hardware through the distribution company in the UK.

John Taylor - Arcadia Investments

Okay. Thank you.

Operator

Moving on next to Tony Gikas with Piper Jaffray.

Tony Gikas - Piper Jaffray

Hi good afternoon guys. Couple of questions, could you give us a little update on your plans for the Guitar Hero trend by platform and media and may be your thoughts on what other instruments you might have coming, what are the platforms this is coming on and then your thoughts on competitive product that's coming out later this year?

Bobby Kotick

Sure. Well, we are very excited about the potential of Guitar Hero --

Kristin Southey

(inaudible).

Bobby Kotick

I am sorry guys. All right thank you. As I said, we are excited about Guitar Hero. We feel like we are just getting started. Consumers obviously have responded very enthusiastically to the brand they seem to have an insatiable appetite for more songs whether that is through additional games or downloadable content. This fall, will be our first full multi-platform launch of the game. So, we expect to accelerate this franchise even beyond where it is. I think, in terms of your competitive thought, we take all competition seriously obviously and it's not surprising that our success with this title has attracted some imitators.

But our focus is 100% on making sure consumers have an excellent experience with Guitar Hero and give them no reason to switch and that's really what we focused on. We've got a number of significant competitive advantages on our side for this title that we are fully exploiting.

First, we've got strong brand recognition, strong commercial momentum, consumers are very satisfied as they say looking for more.

Second, we've got strong retailer commitment to the franchise and we stays at a premium, that's a significant advantage, particularly as we launch multiple SKUs.

Three, it will not be underestimated, we've got an established supply chain between multiple hardware producers in China and delivery worldwide, and plenty of hardware lined up to support our Guitar Hero 3 demand. And we are innovating the hardware and the software together, and that's overtime going to be a very important advantage.

So, we continue to see a lot of enthusiasm from both consumers and retailers. We are adding some geographic specific song content to help accelerate this business in Europe and other countries. But we think the segments continuing to expand our opportunities, our expenses and we feel very good about the program this year.

Tony Gikas - Piper Jaffray

Okay. Thanks.

Bobby Kotick

Thanks a lot, Tony.

Operator

We'll go next to Daniel Ernst, Hudson Square.

Daniel Ernst - Hudson Square

Yes, good evening. Thanks for taking the call. Two quick ones I might. First, on the target model, the 15% to 18%, can you talk a little bit about the weavers that would push lower to 15% or higher to 18%. Is it the next-gen front line pricing? Is it the downloadable content? Is it a efficiency on making cross platform games?

And then secondly, can you talk a little bit about geographic expansion, you mentioned a little bit about China, but certain areas of Asia. I was wondering, do your current licenses for where your licensing franchises allow you the flexibility to enter some markets in different ways, for instance what EA has done with FIFA Online in Korea and where else might do you expand in the Asia region? Thanks.

Thomas Tippl

Yeah, with regards to the key drivers, I have fully understood your math. But our expectation is that we are going to open those franchises over the year.

Kristin Southey

Operator?

Bobby Kotick

I think we can do one more.

Operator

We'll go next to Arvind Bhatia, Sterne Agee.

Arvind Bhatia - Sterne, Agee & Leach

Good afternoon. First question is on Spider-Man and Shrek. I was wondering if could provide some color on how the units would breakdown by quarter? Particularly in the December quarter, what sort of percentage of the overall franchise shipments we should expect there? And then, a housekeeping question, what was catalog during the quarter?

Mike Griffith

Let me start with the catalog piece. The catalog on the quarter was about two-thirds of our revenue

Arvind Bhatia - Sterne, Agee & Leach

Okay.

Mike Griffith

And to get to your Shrek in Spider-Man question, Q1 this year really is underpinned with three big movie launches, Shrek and Spider-Man being two of them and then also including Transformers. The one thing we like about the way our business is projected this year, is that these have strong launch programs during the first quarter. But also very a strong theatrical follow-up program including DVD launch in Q3. So, we expect a long entail on these properties as we progress through the fiscal year.

We are pleased with the start on Spider-Man and Shrek and expect to be pleased to with the start on Transformers the way things are shaping up. We think that we'll continue to have strong performance throughout the year coming back at another by added as we have lot of game programming behind the DVD launch during the holiday season. Transformers is the first time that we've launched the game with that property, but we expect both our Spiderman and Shrek franchises to set new revenue and unit records this year.

Bobby Kotick

I think one of the big bounces, we get Arvind is that for Sony in particular, Spiderman is really important part of their overall Blu-Ray video strategy for holiday. So they are spending an enormous amount of money to built awareness. They think it's going to be one of the most important DVD launches that they've ever had. And DreamWorks feels the same way about Shrek. So we will get the unusual benefit of the new video formats, as well as a bigger commitment than ever, looked forward by both of those studios in their retail and consumer marketing in holiday.

Arvind Bhatia - Sterne, Agee & Leach

So an even spread throughout the fiscal year, would be fair? I mean with the first two quarters?

Bobby Kotick

No, we typically don't comment of that. But, , I think Mike made an important point which is we expect both of those franchises to be record performers for the year.

Arvind Bhatia - Sterne, Agee & Leach

Let me ask one quick one if I could. Your revenue guidance obviously went up, I was wondering is it fair to say most of that increase came from increased expectations on the publishing side, given your discussions on the distribution side of the business a few minutes ago?

Mike Griffith

Yes, I think that's fair.

Arvind Bhatia - Sterne, Agee & Leach

Okay. Thanks guys.

Operator

We do have time for one final question. We'll go next to John Mcpeake.

John Mcpeake - Prudential

Thanks very much for squeaking me in there. There has been some concern in the marketplace that as well as Nintendo has been doing shipment target that they put out there over the cycle, is pretty substantial with respect to prior cycles. And third party publishers historically haven't done as well on that platform. And I just wanted to get what you guys thought about the targets that they've set. I can't remember the exact number, but it's over 50 million to the peak, and how that either expands the market or takes share and if that's a concern for you over this cycle.

Bobby Kotick

I'll make few observations about Nintendo, because there seems to be a continues misconception about first party versus third party opportunities. In the last cycle because the Nintendo hardware is not especially well differentiated and didn't actually have the level of success that I think they aspired to, it really became a non- strategic platform for us. And most of our development effort was focused on straight forth, at low cost to leverage our franchises.

If you look back historically lets say over the last 17 years, what you've seen on Nintendo platform is that in the past they actually had an unusual advantage in the development of software. And for a few generations Nintendo software was better than third party software. When you look at where we are today with accessed intellectual property, the amount of resources we actually develop products across multiple platforms, with a better concept we get with things like centralized technology. We think we are actually in the best condition and probably in most cases better than first party to leverage our development dollars to provide high quality software.

And so now that Nintendo has achieved that level of success as Thomas pointed out earlier in the call and as Mike mentioned, we are reinvesting against the Nintendo platform in a way that in the last cycle we will able to get [enough]. And probably most importantly, when you look at what happened with physical interface and certainly Nintendo has led the way from a broad perspective. But look at what's happening with physical interface to the product like Guitar Hero, it probably is no better product to take advantage of the capabilities of the Wii that Guitar Hero. And so, I think you'll see when we release Guitar Hero on the Wii that we have the potential to capture significant share because it is the first product from the third party that leverages the physical interface that way. So, we are excited about the Nintendo prospects overall. We don't really think if there is any reason to get concern that you can't generate returns on investment against that platform that could be any difference that you can on the platform.

John Mcpeake - Prudential

Nice one. Thank you.

Kristin Southey

Okay. Well, thank you operator and thank you everyone. On behalf of everyone at Activision, we thank you for your time and consideration.

Operator

That will conclude our teleconference for today. Thank you all for your participation. Have a wonderful afternoon.

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