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

Activision (ATVI)

Q3 2006 Earnings Conference Call

February 6th 2006, 4:30 PM.

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:

Elizabeth Osur, Citigroup

Michael Wallace, UBS

Brian Pitz, Morgan Stanley

Heath Terry, Credit Suisse

Edwards Williams, Harris Nesbitt

Anthony Gikas, Piper Jaffray

Jeetil Patel, Deutsche Bank

Justin Post, Merrill Lynch

Operator

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

Kristin Southey, Vice President of Investor Relations

Thank you, good afternoon and thank you all for joining us today for Activision’s third quarter 2006 conference call. As always I will start with today’s call with a review of our Safe Harbor disclosure followed by comments from Bobby Kotick, Chairman and CEO; Thomas Tippl, our 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 there are number of important factors could cause Activision’s actual future results to differ materially from those expressed in any such forward-looking statements. Such factors include, without limitation, sales of the company's titles during the remainder of fiscal year 2006 consumer spending trends, the seasonal and cyclical nature of the interactive game market, the company's ability to predict consumer preferences among competing hardware platforms including next-generation hardware, software pricing, product returns and price protection, product delays, retail acceptance of our products, delays in hardware launches, industry competition, rapid changes in technology and industry standards, protection of proprietary rights and maintenance of relationships with key personnel vendors and third-party developers, international economic and political conditions, integration of recently acquired subsidiaries and identification of suitable future acquisition opportunities. These important factors and other factors that potentially could affect the company's financial results are described in our 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 intention, belief or expectation at any time and without notice, based upon any changes in such factors in the company's assumptions or otherwise. The company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. And now, I would like to introduce Bobby Kotick our chairman and CEO

Robert Kotick, Chairman and Chief Executive Officer

Thank you Kristin, and first a word of gratitude as many of you may know Kristin gave birth last week to very healthy baby girl, and she did not missed a beat-working the entire weekend to prepare for our call today. So Kristin, thank you.

For the quarter, net revenues in for the first 9 months for the fiscal year were the highest in our history. For the quarter we finished as the #2 publisher overall as measured by NPD. And we had $765 million in cash and 1.2 billion in shareholders equity, our financial position remains exceptionally strong. As we said throughout last year, if the pricing environment deteriorated dramatically and titles like True Crime performs substantially below our expectation, earnings with software. The combination of the rapid decline in pricing and consumption, some key titles performing below expectations and the lack of 360 hardware to mitigate these negative markets factors, contributed to lower results than we planned for. In addition, we increased our variable selling and marketing spending to unusually high levels and an effort to mitigate these negative market conditions, which magnified costs beyond historical levels. While this spending likely resulted in better brand awareness for our franchises, it didn’t help the quarter’s operating results.

Lower overall sell-through resulted in a significantly increased provision for price protection and returns and higher product raise in costs which further impacted our margins, on balance however for the quarter and the year-to-date we substantially improved our competitive position. We finished the year at the clear #2 publisher overall as measured by NPD and perhaps most importantly we are the #1 market share publisher of Next Generation software, we have 32% share of the Xbox 360 market. This was accomplished to a focus strategy of a small number of high quality releases with Call of Duty capturing the #1 position on the platform. We also achieved a number of other important successes during the quarter, we had 8 title selling in excess of 1 million units each, 3 of the top 10 titles overall, the #1 new intellectual property for the 3rd year in a row, the number #2 overall PC title, the #1 Xbox 360 title, as I mentioned we are the #1 market share publisher for Xbox 360. This quarter, the Tony Hawk franchise surpassed the $1 billion mark and Tony Hawk’s American Wasteland became the 7th consecutive title in the franchise’s history to make to holiday top 10.

We extended the long-term right to 3 of our most important franchises Spider-Man, X-Men and Shrek. In November, we entered into a long-term agreement to expand all rights to the Spider-Man and X-Men franchises through 2017. Having the long-term rights to our strongest brands gives us a significant competitive advantage in terms of planning, development and profitability for the long-term. We also announced the new multiyear, multi-property licensing agreement with The DreamWorks Animation. The deal extends the rights to the valuable Shrek franchise and gives us the rights to 4 additional DreamWorks animated films. To-date, we’ve shipped over 13 million units of DreamWorks licensed titles including over 3 million copies of Madagascar this year alone.

We are focused on leveraging our next generation leadership and we’ve adjusted our product development investments in release strategy to capitalize on the opportunity these new platforms will afford us over the next few years. While this year and next are likely to be volatile, the opportunities presented by the launch of the various new consoles and handheld platforms, the new Vista operating system which is likely to energize PC gaming much like Windows 95, did 10 years ago. The emergences of new revenue sources like in-game advertising, online gaming and the host of wireless markets developing, we find ourselves in the strong position to leverage our competitive strengths over the next few years. We truly take advantage of the strong market fundamentals of the future; we’ll require investment and focus today. We intend to use our deep management strengths and our strong balance sheet to enhance our opportunities for the future. Michael shared the implications of these investments on fiscal ’07 and the benefits that are likely to accrue in fiscal ’08 and beyond. But first, Thomas will provide a review of the operating results for the quarter. It’s now my pleasure to introduce our new CFO, Thomas Tippl, who will share the quarterly results and outlook for the balance of the fiscal year review.

Thomas Tippl, Chief Financial Officer

Thank you Bobby, for the December quarter net revenues were record $860 million, up 136 million or 20% over the prior year due to our large holiday lineup. Our revenue performance was driven by the market platform releases of Call of Duty 2, Tony Hawk’s American Wasteland, Call of Duty 2: Big Red One, GUN, Shrek, True Crime and Quake. Also contributing to the quarter were our catalog titles Ultimate Spider-Man, X-Men Legends II and Madagascar.

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

Product creation cost for the quarter was 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 product development expense. This increase was due in part to have development cost per title, driven mainly by the addition of next-gen SKUs, the slate capitalization of next-gen development cost and for slate revisions. During the quarter, we made the decision not to release several of our franchise titles in fiscal ’07, but to release them in fiscal ’08 and beyond to better our line our portfolio with the expected market growth. In addition, we cancelled the movies slated for the console in fiscal ’07 due to under performance on the PCs and the aim in SKUs in development as we’ve reverted those rights to model.

Sales and marketing expense for the quarter was 19% of revenues, up from 16% in the prior year. Sales and marketing spend were significant in the quarter due to our large line up, as well as our plans to drive demand given big market conditions and competitive pricing actions. The high levels of trade and consumer activity increased revenues although the spending did not raise proportionate expected sales volumes. Over the past 2 years, sales and marketing spend has been growing rapidly to increase brand awareness of our franchises and this will be a focus of future efficiency improvement.

G&A as a percentage of revenues was up modesty versus the prior year due to the infrastructure investments, to support territory expansion and cost-related to management team additions. Investment income for the quarter was higher than the prior year mainly due to the sales of the cautions taken to development. Our effective tax rate for the quarter was 27% versus 31% last year, the reduction is primarily due to tax credit accounting for a larger portion of pretax income. This completes the year-over-year P&L comparison.

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

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

Inventories were $85 million, up 43 million versus last year driven by weaken unexpected reorders of certain titles. On December 31, inventory for the publishing business was $63 million and $22 million for the distribution business. Capitalized software development cost were 36 million, a decrease of $39 million versus last year and down $87 million versus last quarter. The sequential reduction reflects a normal seasonal pattern given the amortization of our large Q3 lineup.

Capitalized intellectual property cost were 85 million, up 54 million versus the prior year and 56 million versus September 30, due to the recently announced long-term licensing arrangements with Marvel and DreamWorks. In summary, we ended the quarter with a strong cash position and financial base, which gives us the flexibility to invest and leverage the many opportunities that the next few years will yield. Before turning to our financial outlook, I would like to begin by saying that our outlook represents our users of today, and 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 a full review of our risk factors.

Now to Q4, as I said in November, we have no new title slated for release since our last conference call, weakened market conditions and limited supply of next-gen hardware that laid up to significantly reduce our product performance expectations. For the quarter, we expect revenues of between $125 million and $135 million and a loss per share between $0.07 and $0.09. For the quarter, we expect manufacturing and distribution cost of between 60% and 65% of net revenues with operating expanses including royalties of between 63% and 66%. We project the tax rate of about 23% and a basic share count of about 278 million. For the full fiscal year, we expect revenues in the range of $1.405 billion and $1.415 billion and earnings per share between $0.09 and $0.11. Now, I would like to turn things over to Mike Griffith, President and CEO of Activision Publishing who will provide his talks on fiscal year ’06 earnings and our outlook for fiscal ’07 and beyond.

Michael Griffith, President and Chief Executive Officer of Activision Publishing

Thanks Thomas. Today I am going to focus my comment in three areas. First, our Q3 earning; second, what we will do differently in the future; and three, what we plan to deliver in fiscal 2007 and 2008. From a competitive position, we are very pleased with our performance in Q3. International publishing revenues increased significantly during the quarter, and in North America, we were decisively the #2 publisher overall with a largest market share gain of any publisher. Additionally, our average game ratings improved year-over-year, and Call of Duty for the Xbox 360 was the highest rated title overall. Well, not every title exceeded our expectations. Our commitment to quality product development help drive a number of our titles to a leadership position in their respective categories as Bobby highlighted earlier.

The market environment this quarter turned out tougher than we expected. We underestimated the decline in current generation software sales as the transition came on sooner and harder than expected and the supply of Xbox 360s in the market was lower than anticipated. So, a result of the softness, we saw more pricing pressure than we expected. We also aggressively supported our franchises although we didn’t see the incremental revenues needed to provide an adequate return. In fact, the additional investment in brands had a compounding effect on the reduction of operating margins. Looking ahead, we plan to better align our sales and marketing spend with expected market conditions. In fiscal ’07, we will adjust sales and marketing dollars versus the prior year, reflecting a smaller slate and to be consistent with our plan to return to our historical and proven investment levels.

Finally, two major releases underperformed our expectations, GUN and True Crime. However, we were pleased that GUN reined as the #1 new intellectual property in North America. So by market standards, this title would be considered a success. But it didn’t achieved our own return on investment targets as we spend significant development and marketing dollars against the launch of this brand. Even though we missed our internal expectations, make no mistake we were very excited about the future of this property and we’ll update you in the future on our plans.

Turning now to our box on the overall market, beginning with our hardware estimates. On December 31, the install base in North America for current generation systems including handheld was 97 million units. The install base over the next few years will be driven by lower price generation, current generation hardware, the new handhelds, the Xbox 360 and the launch of Sony PlayStation 3 and Nintendo revolution. With respect for the hardware market, there is still risk in the short-term with regard to first party plan, including next generation launch date enquiries, yearend install base estimates and reductions in current-gen hardware pricing and support.

For now, we expect the following hardware increases in North America during the calendar year. PS2, up approximately 4 million to 5 million units, Xbox up about 500,000 units, Xbox 360 up 4 million to 5 million units, GameCube, 800,000 units, handhelds which include GBA, Nintendo DS and PSP will grow approximately 10 million units, PS3 approximately 1 million units and Nintendo Revolution less than a million units.

Moving to software. We define our market to include all major platforms in North America and Europe. For calendar 2005, the combined North America and European software markets for current-gen and next-gen consoles, handhelds and PCs declined 4%, well below our beginning of the year expectations of flat to up 5%. For calendar 2006, we expect to combine North America and European software markets for current generation and next generation consoles, handheld and PC will decline approximately 0% to negative 5%, inline with 2005. With respect to software pricing, this still remains one of the major risk to our operating plans. We expect the software pricing for topline console titles will continue to be under pressure in calendar 2006, but the next generation software launch pricing will remain at 59-99.

Turing now to our fiscal 2007 preliminary outlook, in fiscal 2007 we plan to launch a more focused slate than in fiscal 2006, which should align well with the challenging current generation environment and slow ramp-up of next generation hardware. This will informally enable us to allocate more development resources against our large and growing fiscal ’08 line-up, when market conditions should be substantially more favorable. We will kick-off fiscal 2007 in Q1 with the release of two very exciting titles that will launch in conjunction with feature films. DreamWorks’s Over the Hedge and X-Men 3 from Fox Marvel Studios. We will launch Over the Hedge on the PS2, Xbox, GameCube, NDS, GBA and the PC and X3 on all the same platforms as well as in Xbox 360 SKU.

For the balance of the year, we are planning new console releases on our largest and proven franchises: Tony Hawk and Call of Duty. Additionally we will release, Quake Enemy Territory for the PC and Marvel Legends, a new super hero RPG slated for consoles. And throughout the year, we will also continue to support current Call of Duty 2 for the Xbox 360, order new launch title in fiscal ’07, given the small but growing hardware penetration and our #1 title status.

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

In fiscal 2007, we will also remain committed to maintaining a leadership position on next generation platforms and we planned to release 5 PSP titles, 4 Xbox 360 titles, 3 PS3 launch titles and 1 Revolution launch title. Given our limited visibility with regard to the market, software pricing and first party hardware plans for current and next generation, we will be in better position to give more detail on our fiscal year guidance on our next call. But preliminarily, we believe revenues will slightly exceed $1 billion dollars, and diluted earnings per share excluding the impact of stock options, will be up modestly year-over-year despite the reduction in revenues. Fiscal 2007 will be a year of caution and investment as we manage through the remainder of the transition and focus resources to prepare for accelerated growth in the next cycle. We are focused on driving the breadth and quality of our slate, while at the same time, driving efficiencies in our business model.

Looking ahead, our performance over the next few years will be driven by directing our global resources and capital allocation for 1) building the breadth and depth of our pipeline more fully exploiting our strong IP status. 2) Expanding the strength in Europe and Asia, 3) operating with a more efficient cost structure, 4) wining bid with winning customers. First, we are focused on building and strengthening our product portfolio. We planned to accomplish this by continually reinventing our core brands through superior game play innovation and selectively acquiring, creating high quality intellectual property as we’ve successfully done over the past few years.

We make major progress in this area, as we re-sign the long-term rights, the 3 of our most important licensed franchises: Spider-Man, X-Men and Shrek. We will also remain focused on geographic expansion with particular emphasis on Europe. We have a lot of opportunity in Europe that we are just beginning to capture. We’ve had tremendous success this year in Italy, Spain and Netherlands, the 3 newest geographies we transitioned to our direct selling model. We continue to look for similar opportunities and in the short-term we see Portugal and Nordic as additional geographies where we will increase our direct selling capabilities this fiscal year. We are committed to operating with an efficient cost structure. Going forward, you will see a real focus on aligning our cost with market expectations and expected product performance especially in the areas of overhead and sales and marketing.

We will look to leverage the synergies that a global organization can offer. For example, we recently restructured a European business; previously we had 8 reporting segments and have streamlined them into 4, a similar structure that other multinational corporations utilize. Finally, we are relentlessly focused on winning with the customer, we are committed to leading best-in-class industry practices that improve our customers and Activision’s performance together.

So in summary, we continue to position ourselves for the long-term and the growth that should follow the new hardware. In fiscal ’08, we plan to leverage our large and growing slate against the strong industry growth that’s expected. Our slate leverages major movie launches, core franchises and new intellectual property. We will enter fiscal 2008 with two major movie supported releases: Spider-Man 3 and Shrek 3. The prequel of these 2 movies generated 1.7 billion in worldwide Box-Office sales and we sold in excess of 25 million Spider-Man units and 7.5 million Shrek units to-date. With more platforms and territories to exploit long release stance for development, closer links with movie marketing partners and sponsors and the biggest theatrical launches in the history of both DreamWorks and Sony. Spider-Man 3 and Shrek 3 will likely be in the biggest launches in our history.

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

Finally, we’ll launch our own internally developed intellectual property, our fiscal 2008 slate will exploit a greater percentage of next generation games as we move up the learning curve. It’s still early, but we expect that fiscal 2008 will be the biggest year in Activision history, with revenues expected preliminarily to exceed $1.6 billion with a sustainable plan for growth over the next few years.

We thank you for your time and the opportunity to share our initiatives with you for the future. And will now open up the call for your questions. Thank you.

Questions-and-Answer Session

Operator

Thank you very much, question and answer session will be conducted electronically, if you would like to ask a question today, you can do so by pressing “*” “1” on your telephone keypad. Once again that is “*” “1” to ask a question, as a remainder if you are using a speakerphone please make sure that your mute function is turned off so, we can receive your signal. We’ll pause one moment as we assemble our roster.

Our first question today will come from Elizabeth Osur with Citigroup.

Q - Elizabeth Osur

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

A - Robert Kotick

Well I think we have first of all, been consistent that our goal is to launch one to two new intellectual properties a year and we are consistent with that over the next couple of years. In fiscal 2007, we consider the extension of Tony Hawk, Tony Hawk: Downhill Jam to be an important new IP for us and an extension of that franchise. Again, very similar to how we operated this year with Call of Duty 2 and Call of Duty: Big Red One, which gave us substantial synergies in a number of areas, and allowed us to reach different audiences, Tony Hawk: Downhill Jam proves to extend this Tony Hawk, our successful Tony Hawk franchise to a new and younger audience. In fiscal 2008, while it’s too early for us to announce our plans in this area, we do expect to have a new intellectual property.

Q - Elizabeth Osur

Okay, thanks, if I can just ask a follow-up then, could you maybe walk us through the revenue growth between a billion in fiscal ’07 and 1.6 in fiscal ’08 and how much of that is coming from your market growth assumptions and how much of that is coming from two additional movies properties, and maybe just touch on how many current update propositions are in each of those years?

A - Robert Kotick

Sure, the growth that we’ll experience between 2007 and 2008, will be largely slate revenue against an environment of more install next generation hardware units. So if you look at our 2007 plans compared to 2008 plans the number of SKUs we’ve put it into market will be up about 50%.

Q - Elizabeth Osur

Okay thanks, and just final question and I’ll let someone get going but, distribution revenues for next year, can you just give us an idea, should we be thinking about that in terms of something similar to your market growth forecast, or is the impact of hardware significantly, alternatively maybe we should think about that?

A - Robert Kotick

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

Q - Elizabeth Osur

Okay, thanks a lot.

Operator

Our next question will come from Michael Wallace with UBS.

Q - Michael Wallace

Hi, couple of questions, it looks like calendar ’06 is a wash, if not, we are talking about EA seems to be getting a free passport, so lets just assume everybody does and we’ll fast forward to ’07. Looking at your operating margins, you kind of had a steady ramp of percentage point each year in the last cycle. How quickly do you think you get your margins back up to double digits, in other words in ’07 with, but assume there’s more growth to 25%, you have some big movies coming here and you can grow fast in the margin on the topline. What kind of impact should we see on the bottomline, is this going to be a situation where its kind of, high single digits and then you move up, are you thinking you are going to start this cycle in calendar ’07 and low double digits and where do you think you can take those margins going through ’09 or ’10?

A - Thomas Tippl

And this is Thomas, let me take that one. As you know, we’ve provided some outlook on the topline on fiscal year ’08, but given how far where we are at this point, we have not provided any bottomline guidance, I think as our revenues pickup, you will obviously see margin expansion from the levels that we are at, but its simply too early to put down a number for that.

Q - Michael Wallace

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

A - Robert Kotick

Mike I think, we are going to continue to stay focused on the principles that have worked well for us in the past, with respect to acquisition strategies. So, we are seeing 4 or 5 things like proving history in terms of an intellectual property or process, all the capability, good management history of good profitable operation, generally non-diluted transactions, things that compliments that you can speak to what we’ve done in the past and those are the things that we’ve stay focused on in the future.

Q - Michael Wallace

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

A - Robert Kotick

We are very firm believers that, what Microsoft has delivered is an excellent product, they obviously had some challenges like everyone, this is high technology and now I think you can expect or used to be some obstacles in the introduction in new platforms. Having said that, I think these, both these devices are the most significant changes we’ve seen whether its in providing real-time internet access, whether its in the organization of production values and we still remain confident that the introduction of these new devices would likely grow the overall install base, and I think that you can expect that new users will continue to come into the marketplace and we’ll be able to capitalize them.

Q - Michael Wallace

Okay, thanks.

A - Robert Kotick

Okay.

Operator

Brian Pitz, Morgan Stanley has a question.

Q - Brian Pitz

Thanks. Can you talk a little bit more specifically about Call of Duty 2 maybe what percentage of your share on that 360 is represented by Call of Duty both in the US and Europe and also potentially, the potential to increase your catalog sales better than expected. Obviously, there’s only 1.5 million 360s out there as we get close to the 5.5 million to 10 million unit penetration over the course of the next year, what the opportunity to monetize that is? Thanks

A - Robert Kotick

Well, I think Brian; on Call of Duty 2 on the Xbox 360 is obviously a phenomenal success capturing the #1 title on that platform and was disproportionately important of course in our share of the overall platform. And I think on the issue of catalog sales, this one is, it has to be looked at a bit differently because the hardware penetration is still relatively small and growing and as I’ve said a major focus in 2007 for us is to drive the current Call of Duty 2 title as the Xbox 360 penetration grows. So, on a catalog basis, certainly on a Call of Duty specific basis, we would expect to see very large catalog percentages for this title.

Q - Brian Pitz

Can you give us anymore specifics in Europe with what the share looks like on the console, for that title?

A - Robert Kotick

Very similar, to be honest. So, we had very strong success with this franchise in all geographies.

Q - Brian Pitz

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

A - Robert Kotick

All we’ve looking Brian are nothing that we can comment on other than the transformers that we announced today and the expansion of price that we control.

Q - Brian Pitz

Okay, thanks.

A - Robert Kotick

Sure.

Operator

Our next question will come from Heath Terry with Credit Suisse.

Q - Heath Terry

You mentioned moving some products out of 2007 to 2008; can you give us an idea of how many products were actually moved? And then, were there any products in this process that were actually cancelled so, games that you’re occurring for the on the balance sheet that were that you’ve decided to part kind of, be put out?

A - Robert Kotick

Yeah, let me start with how we approached 2007 and in 2008, well, the most important we elected to do was to focus our resources and investments to maximize growth for the next generation cycle as it begins. And in addition to reflect the learning that we’ve had in Q3 and as this current transition obviously is underway. So it really all began with what we can do to maximize our weight and looking in that, we obviously in 2007 aren’t going to come forward with a Gun or True Crime sequel, although we are examining those franchises carefully for their future potential. We also learned this year that children’s titles without a major movie launch was challenging in the context of transition environment. So, we’ve elected to put our focus on Shrek 3 coming out early 2008 as well as Spider-Man 3 also coming out in 2008. So, it’s really a reallocation of our resources to ensure that those were going to be as large and successful as we think they can be.

Q - Heath Terry

Okay. And, can you also talk a little about the increase that we’ve saw in sales and marketing you’d mentioned that some of it was channel-related, some of that was advertising, can you talk about the breakdown, how much of it went to channel support and to the extent that there was any product markdown support?

A - Robert Kotick

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

Q - Heath Terry

Okay, great thank you.

Operator

Edwards Williams with Harris Nesbitt has our next question.

Q - Edwards Williams

Good afternoon. Now just a couple of questions, first of all, looking at your studios, could you just remind us to where you are with your headcount at this point. And also what your expectations are for the present revenues of your publishing revenues coming from your internal studios? And then I have a couple of questions after that.

A - Robert Kotick

All right, we’ve got about 1300 people in our studios, across the company. About 2/3 of our titles are generated from our internal studios.

Q - Edwards Williams

Okay, and I am assuming that as far as the year progresses, your studio headcount number is more likely to stay flat or go up and to go down, so its not necessarily a source of improving your operating expenses?

A - Robert Kotick

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

Q - Edwards Williams

Okay and then, as you look out to new revenue opportunities such as in-game advertising, when do you expect to have that to have an impact on your topline, if sooner, we could see in FY ’08 that you’ve included with this 1.6 number as that demand flow is just out there and not necessarily included?

A - Robert Kotick

Yes that’s not included yet, our feeling is that until you have a sizable on a consolidate basis with next generation hardware, and we’re still moving rapidly towards building a rate card in the measurement system but, its not included in our first half plans for the guidance that we’ve provided for ’08, but it’s something that we’ll have a lot more visibility on towards the end of the year.

Q - Edwards Williams

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

A - Robert Kotick

Well, we are looking at the software market as growing about the same between Europe and North America. If you look totally at our split of revenue that’s about 50-50 North America and International. But when you look at Europe specifically, you’ll see our focus in the year and years ahead to aggressively drive our expansion in Europe, so that the percent of our business accounted for by Europe should increase overtime and as we think we’re underdeveloped relative to the market there.

A - Thomas Tippl

And in ’08, our expectation is, rough right now while it is 50-50, a big component of that is our distribution business up in the UK and we really should see 50-50 publishing split between here and Europe, we’re not going to get that in ’08, but we’ll make a lot of progress towards that.

Q - Edwards Williams

Okay, great thank you very much.

Operator

And next we’ll hear from Anthony Gikas from Piper Jaffray.

Q - Anthony Gikas

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

A - Robert Kotick

I think generally, Anthony, what we are likely to see as a result of changes in the hardware especially I think the multiplayer advancements you’re seeing, increase in production values, things like Blu-ray, the introduction of portables that are appealing to all the consumers. The opportunities will emerge from online gaming as new ways for both distribution and billing. Our expectation is that over the next 5 years, you are going to see growth rate that are at least consistent and likely in excess of what we’ve seen over the last 5 years. Also, I think one of things we’ve always like to point out is that when you look at the top 4 or 5 publishers, take the third parties us and EA that we only account for collectively about 60% of total industry revenue. So, there is lot of share gains that’s available and that consolidation has largely taken place through the acquisition of new franchises, our development capacity. But I think the combination of long-term share gains plus what we see is new hardware likely to expand the market should allow for us to pretty attractive growth rate over the next 5 years.

Q - Anthony Gikas

Okay, and just a couple of quick follow-ups, do you think that the higher price points in hardware and software will be any kind of an deterrent to consumer purchases over the course of the next few years? And how have PlayStation Portable sales attracted post holidays that’s we’ve heard that they have softened up a little bit, any comment on that?

A - Robert Kotick

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

A - Anthony Gikas

Okay thank you.

Operator

Jeetil Patel with Deutsche Bank is next.

Q - Jeetil Patel

Thanks. Couple of questions first of all, my question is we can kind of go through next-gen cycle, I know its broad but just kind of the future returns of the next cycle, do they look just as compelling, similarly compelling, less compelling or what are the big variances that drive your returns in that business from, as you look at over the next 3 years to 5 years in the next cycle. And how much does pricing or the ASP being at $60 influenced that? And second I have a quick follow-up for Bobby?

A - Thomas Tippl

All right, well I think, we’re very bullish on the potential for growth and returns in the next generation cycle for a couple of reasons. One is, we think it provides a real market opportunity as Bobby just talked about earlier. But also we’ve learned a lot about how to operate more efficiently and as we go into this next cycle with larger scale than we had at this time during the previous cycle, more countries, more platforms, more development efforts, we are able to take advantage of that scale and drive operating efficiencies that I think, we’ve only begun to really uncover and enjoy. So, we think this next cycle is really going to be a balanced approach for us with growth on the topline. But also improve the efficiency in margin expansion to compliment that as well, so, we’ve gone to a model that is pretty bullish about it.

Q - Jeetil Patel

So do the margins still get to higher than where you were with even a $50 price point, if you progress to the cycle? And then Bobby, just if you go back over the kind of history of Activision and where you are today, I guess, can you just give us a characterization of just the industry cycle and the industry transition, how does it fair relative to years past in terms of transition, is it worse/better, can you just give us a characterization of it? Thanks

A - Robert Kotick

Sure, from my perspective Jeetil, I think that again not to be similar from the point I made earlier, but you are seeing new hardware devices that have broader appeal from companies that have broader reach and I think when you look at the amount of money that Microsoft will spend and continue to promote 360, when you see what PlayStation 3 means to Sony, not just in terms of Video gaming but in terms of the establishment the Blu-ray as a DVD standard, when you see the opportunities that would emerge with PSP to addressing audience for portable gaming that we haven’t seen before, when you see the benefits that come from truly, always on internet connection on these devices that offers the opportunity for content enhancement micro transaction, all sorts of multi-play experiences that really transform gaming from this very solitary experience between an audience and a hardware device to a much more social experience. I think you are likely to see more consumption in more places than ever before. And, I think that the entry point to get into the business, the barriers of entry as higher than they have ever been whether its in product development cost or talent or resources or access the distribution channels. Thus, the barriers to entry are larger than they’ve ever been, which I think worked very well for companies like ours that have big distribution footprint that has a well-developed card making capabilities that control intellectual properties of value, hence have the ability to create new intellectual properties of value. So, when I look at it terms of the next 5 years as in terms of where we are and where we’ve been. I think the greatest opportunities for our company are yet to come, and we are a much more stable, much more professionally managed, much more strategically profitable company today than we’ve ever been. So when you think about all the growth that’s likely to come from the marketplace, we are in a much better position to capture that growth over the long-term. Does that answer your question?

Q - Jeetil Patel

It helps, thanks.

Operator

We will now take our final question from Justin Post, Merrill Lynch.

Q - Justin Post

Yeah, imagine that fiscal ‘08 margin expectations are going to be all over the math, can you help us a little bit with that, just talk maybe about the development cost in the PlayStation 3 and Xbox 360 relative to the last cycle, how you are seeing that trend and then licensing, I know you’ve signed a couple of deals, you can comment among specifically, but how do you see the licensing cost going for Activision?

A - Robert Kotick

Hi Justin, we are not giving specific guidance right now. But I could tell you, as has always been the case; margin expansion for us is one of the most important things that we are focused on. And that won’t change, I think right now we recognize we need to invest in our product slate, expand our international distribution reach, state some changes to the cost structure that will allow for more efficiencies. But, always with the intention of getting to those industry leading markets, we are not really going to give any guidance on we are likely to be in ’08. And we typically don’t give the kind of guidance even on the revenue line that we’re giving for the following fiscal year. And we’re only doing it because we have confidence in the product that we have in production and I think as we get towards the middle of this fiscal, coming fiscal year we will be out to give you more visibility on what that margin structure should look like.

Q - Justin Post

Okay and then one quick follow-up, True Crime what did you learned from that and I don’t know if you were able to comment in your prepared remarks on the future of that franchise?

A - Robert Kotick

Well, I think we truly learned a lot about True Crime, as we did our broad slate, but on True Crime in particular, its still short on our expectations for a couple of reasons, but one of them is that it fell short in terms of our quality expectations. Well our team ratings as we mentioned was up significantly year-over-year. And Call of Duty 2 was the highest ranked title in the holiday season, #1 on the Xbox 360 platform, but we fell short on our own delivery of the quality standards on True Crime, so we have a lot to contemplate on that franchise, we are doing a lot of research with consumers to understand what the specific issues were and what the viability of that franchise is going forward and we’re going to make some very thoughtful considerations in the weeks ahead in terms of where we’ll go with that.

Q - Justin Post

Thank you.

Operator

And that thus concludes our question and answer session, I will now turn the conference back over to Kristin Southey for any closing or additional remarks.

Kristin Southey, Vice President of Investor Relations

Well on behalf of everyone in Activision, we thank you for your time and consideration and we look for speaking with you in the future. Good afternoon.

Robert Kotick, Chairman and Chief Executive Officer

Thank you.

Operator

And that thus conclude our conference call. Thank you for joining us today.

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 F3Q06 (Qtr Ending Dec 31, 2005) Earnings Conference Call Transcript (ATVI)
This Transcript
All Transcripts