Activision F2Q08 (Qtr End 9/30/07) Earnings Call Transcript

| About: Activision Blizzard, (ATVI)
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Activision, Inc. (NASDAQ:ATVI) F2Q08 Earnings Call November 5, 2007 4:30 PM ET


Kristin Southey - Vice President, Investor Relations andTreasurer

Robert A. Kotick - Chairman of theBoard, Chief Executive Officer

Thomas Tippl - Chief Financial Officer

Michael J. Griffith - President & Chief ExecutiveOfficer of Publishing Unit


Tony Gikas - Piper Jaffray

Michael Savner - Banc of America Securities

Mark Wienkes - Goldman Sachs

Brent Thill - Citigroup

Ben Schachter - UBS Securities

Shawn Milne - Oppenheimer

Heath Terry - Credit Suisse

Jeetil Patel - Deutsche Bank

Ralph Schackart - William Blair


Good day, everyone, and welcome to this Activision secondquarter 2008 financial results conference call. Today’s call is being recorded.At this time, for opening remarks and introductions, I would like to turntoday’s call over to the Vice President of Investor Relations, Kristin Southey.Please go ahead, Madam.

Kristin Southey

Good afternoon and thank you for joining us today forActivision's Q2 fiscal 2008 conference call. As always, I’ll start today’s callwith a review of our Safe Harbor disclosure, followed by comments from BobbyKotick, Chairman and CEO; Thomas Tippl, Chief Financial Officer; and MikeGriffith, President and CEO of Activision Publishing.

With regard to our Safe Harbor disclosure, I would like toremind everyone that statements will be made during this call that are nothistorical facts and are forward-looking statements. These forward-lookingstatements are based on current expectations and assumptions and are subject torisk and uncertainty. The company cautions that a number of important factorscould Activision's actual future results and other future circumstances todiffer materially from those expressed in any such forward-looking statement.

Such factors include without limitation sales of thecompany’s titles during fiscal year 2008, shifts in consumer spending trends,the seasonal and cyclical nature of the interactive game market, the company’s abilityto predict consumer preferences among competing hardware platforms, includingnext-generation hardware, declines in software pricing, product returns andprice protection, product delays, retail acceptance of our products, adoptionrate and availability of new hardware and related software, industrycompetition, rapid changes in technology and industry standards, protection ofproprietary rights, maintenance of relationships with key personnel, customers,vendors and third-party developers, international economic and politicalconditions, integration of recent acquisitions and the identification ofsuitable future acquisition opportunities and foreign exchange rates.

Other such factors include the further implementation,acceptance and effectiveness of the remedial measures recommended or adopted bythe special sub-committee of independent directors established in July 2006 toreview our historical stock option grant practices, by the Board and byActivision, the outcome of the SEC's formal investigation and derivativelitigation filed in July 2006 against certain current and former directors andofficers of Activision relating to Activision's stock option granting practices,and the possibility that additional claims and proceedings will be commenced,including additional action by the SEC and/or other regulatory agencies, andother litigation unrelated to stock option granting practices.

These important factors and other factors that potentiallycould affect the company’s financial results are described in the company’s mostrecent annual report on Form 10-K and the cautionary statements therein and theexhibits thereto. The company may change its intentions or expectations at anytime and without notice based upon any changes in such factors in the company’sassumptions or otherwise. The company undertakes no obligation to releasepublicly any revisions to any forward-looking statements to reflect events orcircumstances after the date hereof, or to reflect the occurrence ofunanticipated events.

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

Robert A. Kotick

Thank you, Kristen and thank you all for joining us today.We are pleased to share with your our record second quarter results, a previewof our third quarter, which we expect to be our first billion-dollar quarter,and our increased outlook for the fiscal year.

In the second quarter, net revenues and earnings exceededour expectations and grew significantly over the prior year, driven by theGuitar Hero franchise and our newest intellectual property, Transformers.

For the first half of the fiscal year, we delivered recordrevenues and earnings, driven by strong market conditions and the success ofour balanced franchise portfolio, both in the U.S. as well as Europe.

For the quarter, Guitar Hero was the number three franchiseoverall and remains the number one videogame franchise in North America for allof calendar ’07. Transformers was the number two third-party title in Europeand the number one third-party handheld title worldwide. To date, we haveshipped more than 3 million units of Transformers worldwide.

In North America, our console and handheld market shareincreased from 5% to 10% over the prior year. For the quarter, internationalpublishing net revenues grew 80% over last year and are up 145% for the firsthalf of the year, due to better execution in our largest markets.

Strategically, we continue to make the organizational infrastructuralchanges necessary to ensure our long-term leadership. Our institutionalizedprocesses and thoughtful approach to our business has fueled growth anddiversified our franchise portfolio. We continue to identify new marketopportunities and reinvent our core brands through innovative game play that wevalidate through our consumer testing and support services with the veryhighest quality development resources we believe in our industry.

In September, we acquired Bizarre Creations, one of the preeminentU.K. baseddevelopment studios. They have over 160 employees, a strong track record ofsuccess, and the acquisition will bolster our development resources and enableActivision to enter the $1.4 billion global racing genre, which is the largestgenre that we currently don’t participate in.

With almost $1 billion of cash, we’ll continue to makestrategic investments that will expand our intellectual property portfolio,extend our next generation development leadership, and strengthen our globalmarketing and distribution footprint.

We continue to reap the benefits of the investments we havemade over the past few years, which this holiday we expect will result in ourfirst billion-dollar quarter and $2 billion of revenues for the fiscal year.

As of tomorrow, we will have launched all of our majorholiday titles in North America well in advance of the Thanksgiving sellingseason.

On October 28th, we launched in North America Guitar Hero 3on multiple platforms, including the long-awaited debut of Guitar Hero on thePS3 and the Nintendo Wii. Week one consumer sales of Guitar Hero 3 have alreadyexceeded $100 million. The Guitar Hero franchise is one of the most successfulentertainment properties in any medium -- film, television, music, orvideogames, and Guitar Hero 3 is by far the most successful product launch inActivision's history.

Additionally, the multi-platform release also ranked as thelargest hardware unit launch this cycle and is likely the largest hardwarelaunch in the history of videogames.

Competitively, we expect the Guitar Hero franchise to be thewinner at retail this holiday. We have huge, early consumer response wellbefore the heavy selling periods of Thanksgiving or Christmas. We have anunprecedented amount of global supply, the product is available now on allconsole platforms, we have more than 30 million demonstration kiosks that willdrive consumer awareness and purchase intent, and in the international markets,this is the only game of its genre available.

While we have worked hard to increase our global supply,given the exceptionally strong early consumer response, there is a probabilitythat this holiday, we won’t be able to satisfy all the demand for everyplatform, but we will have millions of Guitar Heroes around the world.

Tomorrow, we’ll launch one of our remaining third quarterrelease, Call of Duty 4: Modern Warfare, in North America,and Call of Duty 4 is extremely anticipated, it’s already receiving ravereviews from the gaming press, including a perfect 10 from the official X-BoxMagazine.

The team has done an incredible job delivering a productwith production values and game play that truly capture the best of nextgeneration videogames. The combination of our record first half results, ourstrong holiday lineup, and the increased visibility that comes with launchingall of our major holiday titles well before Thanksgiving has enabled us toincrease our full year revenues and earnings outlook.

Our global leadership position continues to strengthen andour competitive advantage is derived from our focus on expanding our balancedfranchise portfolio into opportunistic genres, leveraging our strong portfoliowith best-in-class marketing programs, the exploitation of emerging marketgrowth, and by ongoing initiatives to reduce expenses through organizationalefficiencies.

All of these efforts should lead to continued marginexpansion and higher returns on invested capital in the future. We believe overthe long term, we can continue to provide superior returns to our shareholders,as we have over the past 17 years.

Later in the call, Mike will share more details on our Q3titles and the remainder of this fiscal year and provide a look at fiscal ’09.Now, Thomas will provide a brief review of our operations during the lastquarter. Thomas.

Thomas Tippl

Thank you, Bobby, and good afternoon. For the Septemberquarter, net revenues were $318 million. This is $68 million higher than ourprior outlook and up $130 million versus the prior year, due to the strongperformance of premium-priced Guitar Hero Rocks the 80s and the European launchof Transformers, in addition to continued sales of our first quarter launches.

Before I continue with our financial review, I would like tonote that certain numbers I’ll be giving you will not be in accordance withGAAP. Please refer to our earnings release for a full reconciliation. I wouldalso like to remind everyone that after the beginning of this call, some of thenumbers I will be sharing with you, particularly the outlook for Q3, Q4, andthe full fiscal year 2008 and beyond, are forward-looking statements and nothistorical facts and are based oncurrent expectations and assumptions that are subject to risks anduncertainties identified at the outset of this, in our press release, and inour most recent annual report on Form 10-K.

So for the September quarter on a GAAP basis, we deliveredbreak-even earnings per share as compared to a loss per share of $0.09 in thesame period of the prior year. Excluding the impact of equity-basedcompensation, we delivered earnings per share of $0.02. This is higher thananticipated and a significant improvement versus the prior year quarterly lossof $0.08. The main drivers were strong title performance and operatingleverage.

Manufacturing and distribution expense for the quarter was48% of revenues, down significantly from 68% in the prior year, due to improvedmix and higher price realization, as consumers continue to trade up to nextgeneration platforms.

Product creation costs for the quarter on a GAAP basis were27% of revenues and excluding the impact of equity-based compensation, were 26%of revenues. We define product creation costs as the sum of total sales,software royalties and amortization, cost of sales intellectual propertylicenses, and product development expenses. Product creation costs were higherthan the prior year due mainly to a higher mix of licensed properties.

Sales and marketing expense for the quarter on a GAAP andnon-GAAP basis were 16% of revenues, an improvement of more than 100 basispoints versus a year ago. G&A as a percentage of revenues on a GAAP basiswas 12% and excluding equity-based comp was approximately 11%, an improvementover 140 basis points over last year. We continue to make good year-over-yearprogress; however, the numbers still reflect the impact of higher legal andprofessional fees, intangible amortization related to the Red Octane andDemonware acquisitions.

We generated high investment income for the quarter due tohigher cash balances and higher interest rates versus the prior year.

Our effective tax rate for the quarter was 73%. Our tax ratethis quarter was higher than expected due to a tax law change in the U.K.However, we still expect our full-year tax rate to be around 34% to 35%.

Turning to the balance sheet, on September 30, we had $962million in cash and short-term investments. This is in line with the lastquarter and more than $210 million higher than last year, due to strongoperating performance.

The accounts receivable balance was $110 million. This isdown $88 million versus the prior quarter due to collections of first quarterrevenues. The accounts receivable reserve as a percentage of trailingnine-month revenues was 9%.

Inventory was $189 million, up $97 million versus lastquarter. As noted on our last call, we expected inventories to be substantiallyhigher as we prepared for the multi-platform launch of Guitar Hero 3. OnSeptember 30, inventory was $155 million for the publishing business and $34million for the distribution business.

Capitalized software development costs were $132 million, anincrease of $25 million versus the prior quarter due to the large number oftitles releasing in Q3. Capitalized intellectual property costs were $82million, in line with the prior quarter.

In summary, we finished the quarter well ahead of therevenue and earnings outlook we provided and based on our strong businessmomentum and increased visibility, we are raising our fiscal ’08 outlook.

Specifically for Q3, we are expecting net revenues ofapproximately $1.05 billion. For the third quarter, on a GAAP basis, thecompany expects manufacturing and distribution costs of approximately 43% ofrevenues and operating expenses, including royalties, of about 35%. We projecta tax rate of about 34% to 35% that can be used throughout the fiscal year, anda diluted share count of about 316 million.

Finally, we expect earnings per share of approximately$0.51.

For the third quarter, excluding the impact of equity-basedcompensation, we expect operating expenses including royalties of 33% andearnings per share of approximately $0.55. All other line items are the same,as I mentioned a moment ago.

For the fiscal fourth quarter, on a GAAP basis we expect aloss per share of $0.05; excluding the impact of equity-based compensation, weexpect a loss per share of $0.03.

For the second half of the fiscal year, we expect theacquisition Bizarre Creations will be dilutive to earnings by approximately$0.02 to $0.03, and this is incorporated in the outlook I just provided.

As for the full fiscal year, we are increasing our outlookand we now expect net revenues of approximately $2.7 billion. On a GAAP basis,we expect manufacturing and distribution costs of approximately 44% of revenuesand we expect operating expenses, including royalties, of about 45%.

We project a diluted share count of about 316 million.

Finally, we expect earnings of approximately $0.55 pershare.

For the fiscal year excluding the impact of equity-basedcompensation, we expect operating expenses, including royalties, of about 43%and earnings per share of approximately $0.65.

The last item I wanted to touch on was our balance sheetphilosophy, since this is a topic frequently brought up at our investor andanalyst meetings. Our strong cash position enables us to continue makingstrategic investments in the future, like we recently did with Red Octane,Transformers, Demonware, and Bizarre Creations. We are sharply focused oninvestment opportunities that expand our intellectual property portfolio,expand our next generation development leadership, strengthen our globalmarketing and distribution footprint, and most importantly create long-termshareholder value.

Our track record over the past few years has been strong inthis area, especially with respect to return on invested capital. Ouracquisition process is thoughtful and rigorous, with a very strict set ofcriteria that must be satisfied.

At a minimum, we require that our investments provide scaleacross geographies and platforms, the ability to generate an annual revenuestream, and matched with a proven development solution and strong financialreturns based on proven benchmarks. It is this institutionalized process thathas kept us from justifying speculative investment in unproven business modelsand rewarded our shareholders with superior returns over many years.

We see more opportunities that fit this approach and we planto continue to capitalize on them with the help of our strong balance sheet andoperating performance, and this brings me back to the near-term.

We expect that fiscal 2008 will be by far the largest andmost profitable year in Activision's history. This year, we will more thandouble our operating income and expect to deliver industry-leading operatingmargins and net income, all while still in the early phase of the cycle.

I will now turn things to Mike Griffith, President and CEOof Activision Publishing, who will provide his thoughts on the balance offiscal ’08 and fiscal ’09.

Michael J. Griffith

Thank you, Thomas. Today, my comments will focus on where wesee the hardware and software markets for the balance of the year, our marketposition as we enter this holiday season, and our initial thoughts on fiscal2009.

Overall, industry fundamentals are very strong and we expectthey’ll continue to improve. On September 30th, the installed base of hardwarein North America for current and next generation systems, including handhelds,was approximately 137 million units. The large installed base of the PS2,combined with the growing installed base for all three of the next gen systemsplus handhelds continues to provide an attractive market dynamic. And recenthardware price reductions on next gen platforms are further buildingopportunity.

With respect to hardware, the hardware market in total as oftoday, we expect the following increases in North America during the calendaryear. We are estimating PS2 will be up by 4 million to 5 million units and weare anticipating 3 million units of PS3.

We expect X-Box 360 growth of 4 million to 5 million units.We also expect about 5 million to 6 million units from Nintendo's Wii, andfinally, we expect handhelds will grow approximately 12 million to 13 millionunits.

Moving to software, we define our market to include allmajor platforms in North America and Europe. For calendar 2007, we expect acombined North American and European software markets for current and next-genconsoles, handheld and PCs, to grow in excess of 15%, driven in part by a stronginstalled base of hardware. The overall market growth has been broad-basedacross platforms and across geographies, and even if you exclude the stronggrowth of the Nintendo consoles year over year, the software market would stillbe growing at a double-digit pace.

With respect to software pricing, to date we continue to bepleased by the consumer and retail acceptance of the higher next gen pricingand we expect that traditional software launch pricing for the X-Box 360 andPS3 will continue to hold at $59.99 and for the Wii at $49.99.

Of course, pricing decisions for front line current genconsole titles will be made on a title-by-title basis, based on quality andother factors, and as always, we intend to monitor pricing conditions veryclosely this holiday and remain mindful of competitive practices.

Turning now to the balance of fiscal 2008, our Q3performance will be driven by our slate and strong commercial execution, bothin the U.S. and internationally. Our emphasis on consumer marketing, retailcategory management, and in-store execution against our largest markets andlargest customers continues to be our focus.

This quarter, we’re bringing an exceptionally strong gamelineup to a marketplace that’s poised to reward companies with well-establishedbrands. Our slate is anchored by high quality games based on our mostsuccessful franchises, including Tony Hawk, Spider-man, Call of Duty, andGuitar Hero, as well as Enemy Territory, QUAKE Wars, and a game based onDreamworks’ new Bee Movie.

On October 16th, we launched our first Q3 title, Tony Hawk’sproving ground. The game builds on the core assets associate with Tony Hawk anddeeper customization of the features most appreciated by the mass consumer.

Tony Hawk is still the only skateboarder with mass marketappeal and the Proving Ground game is targeted squarely at the broad holidayaudience, with strong merchandising and advertising throughout the season.

Proving Ground will also be available on more platforms thanany other skateboarding game and it will be the only game of its kind on thePS2 platform with the largest installed based.

Next, we continue to diversify our superhero portfolio andbroaden our leadership in the category with the release of our new Marveltitle, Spider-man: Friend or Foe, which is targeted toward a youngerdemographic and is a perfect title for the holiday season. This game is off toa strong start and is likely to benefit from the momentum and advertising spendcreated by the recent DVD launch of Spider-man 3.

Beyond providing a positive environment for Spider-man:Friend or Foe, this should also benefit continued sales of the Spider-man 3game, which was launched initially in Q1.

On October 29th, we released the Bee Movie game, based onthe Dreamworks film that stars Jerry Seinfeld and opened this past weekend. BeeMovie is our first full console title to come from our internal studio inCanada where we’ve been building capability to help match costs withopportunities. For this title, we were able to significantly lower the cost ofthe development spending and early reviews are strong.

Next, as Bobby mentioned, tomorrow will mark the highlyanticipated launch of Call of Duty 4: Modern Warfare. The Call of Dutyfranchise was our largest selling in fiscal 2007 and this title marks thefourth consecutive annual release. This is a wholly-owned, internally developedtitle and we are very pleased with the exceptional reviews it’s been receiving.

We are also encouraged the introduction of the modern dayelement to this franchise significantly increases future opportunity for theCall of Duty brand with a new leg on the stool.

With game quality and reviews comparable to Halo 3, consumerinterest is very high and preorders are up significantly versus the prior yearand set a new company pre-sell record, although only briefly as it wassurpassed by Guitar Hero 3 preorders, which I’ll discuss in a minute.

We also plan to continue to drive momentum on Call of Dutythrough the holiday and into next calendar year with a variety of downloadablecontent available in the months ahead.

Finally, October 28th marked the largest product launch inActivision history with Guitar Hero 3: Legends of Rock. Guitar Hero is another internally developed,wholly-owned franchise that continues to build the genre it created.Sell-through to consumers topped $100 million in its first week, setting a newcompany record.

As youknow, we’ve been working vigorously for the last nine months to increase ourguitar manufacturing capacity. We’ve put an experienced product supplyorganization in place with on-the-ground resources in North America, Europe andChina to manage the complex logistics.

And thanksto the hard work of this group around the world, we were able to increase ourproduction significantly to launch across four different console platforms withan unprecedented level of supply and significantly more units than a year ago.

A week ago,we would have told you we had adequate supply in place. But given initialconsumer demand, it’s possible the demand will outstrip supply on certainplatforms before Christmas.

Thestrength of this product has resulted in extraordinary interests from ourretailers, the media, and consumes. To help ensure we continue our momentum, wehave over 30,000 in-store kiosks worldwide where consumers can demo the game,and this is more than triple the number of kiosks we had last year.

Guitar Hero3 offers tremendous value with over 70 songs available at purchase. The gamefeatures a strong soundtrack, including master tracks by such artists asAerosmith, Sex Pistols, Metallica, Guns ‘n Roses, the Rolling Stones, BeastieBoys, and Pearl Jam, as well as new original songs by Slash and Tom Morello.

Guitar Hero3 will also offer a robust slate of new downloadable content for the X-Box 360and the PS3. The game builds on its signature easy-to-play butdifficult-to-master game play, and adds new features including boss battles,where players can challenge Slash and Tom Morello in side-by-side, head-to-headplay. And finally, the all new wireless guitar controllers are available forall platforms.

We areequally excited about the upcoming launch of Guitar Hero 3 in Europe later this month. The largeand growing European market offers us tremendous opportunity and Guitar Hero 3will for the first time provide localized song content with music from aselection of popular European bands in addition to being the only game of itskind available this holiday season.

As youknow, one of our core tenets to achieving sustainable growth in marginexpansion is driving our independent studio model as a long-term competitiveadvantage, and our execution this holiday reaffirms our strategic choice.

A primeexample of the strength of our model was the seamless transition of bringingGuitar Hero development in-house. The team at Neversoft has done an exceptionaljob bringing innovation to the franchise while keeping the game true to whathas made it part of pop culture, all in a relatively short period of time.

Anotherexample of our studio strength is that our large Q3 product lineup wascompleted early this year, giving us additional sell-through potential andmaking us the only independent publisher who did not delay a holiday release.

In terms ofexpertise, our studios are executing at a high level on the PS3, a technicallychallenging platform where many are struggling. To understand the significanceof this, play Call of Duty 4 on the PS3 and compare the experience to other PS3games.

Finally,the acquisition of Bizarre Creations significantly [inaudible] our internaldevelopment expertise and bolsters our development resources. The 160developers are working on two major properties, including one new intellectualproperty for the large and profitable racing genre.

So insummary, our fiscal 2008 lineup is the strongest in the company’s history andwith our improved visibility and strong execution, we are once again increasingour fiscal 2008 outlook, marking our first $2 billion year and our 16thconsecutive year of growth.

Beyond this,fiscal 2009 already looks robust. The market conditions are expected to improvefurther and we intend to have a broad lineup of titles for both movie andnon-movie games.

Movie gameswill include the new upcoming James Bond, which has been significantlyrevitalized by Casino Royale; Dreamworks’ Kung Fu Panda, which we are expectingto be the next Shrek-sized franchise; Madagascar 2; and the newly addedMonsters Versus Aliens late in the fiscal year.

Next yearwe’ll also focus on driving Guitar Hero further globally, as it’s likely we’llstill be trying to catch up with consumer demand, and we have a number of newexciting dimensions for the franchise. We’ll also broaden our core franchises,like Call of Duty with a new title across more platforms next year than thisyear, and Tony Hawk.

Inaddition, we’ll be supporting our leadership position in the superhero categorywith two new releases, and of course we expect to have an especially strongcatalogue coming from our fiscal 2008 lineup.

Moredetails of our fiscal year 2009 slate will be announced on a later call, but infiscal 2009 we see the market continuing to expand at a double-digit rate, seeour portfolio of brands continue to grow and continue to find upsideopportunity on our largest franchises, see increasing revenues from emergingmarkets, and lastly, we’ll continue to focus on shareholder value creationthrough operational discipline.

With that,thank you very much for listening and the opportunity to share our initiativeswith you for the future, and I’ll now open up the call for your questions.Thank you.



(Operator Instructions) We will take our first question fromTony Gikas with Piper Jaffray.

Tony Gikas - PiperJaffray

Good afternoon, guys. Congratulations on a good quarter. Acouple of questions; given that you continue to exceed sales estimates, couldyou give us a little update on your outlook for operating margin prospects andwhat line items do you see the most leverage on? Is that R&D?

And then the second question, retail sell-through on GuitarHero 3, could you break that down or give us some visibility on the platform,platform breakdown?

Thomas Tippl

I’ll take the first one and then Mike is going to speak toGuitar Hero. Our plan for margin expansion hasn’t changed. We are supremelyfocused on it. To date, we are tracking ahead of the plans we set originally.There is a good chance that this year is going to be a year of record marginsfor us, higher than in the previous peak and we are early in the cycle. We’veset a goal for 15% to 18% for the peak of this cycle and obviously the factthat our strategies so far are tracking ahead are giving us confidence that wecan get there.

In terms of where that expansion is coming from, it’s reallycoming from all line items. So we are expanding gross margins with a couple ofdrivers. The first one being that our publishing business, which is highermargin, is growing faster than our distribution business. Within publishing,the shift, the trading up of consumers to next generation consoles gives usfurther gross margin expansion because we are selling those at a 20% pricepremium, as you know.

And then lastly, we’ve also started to tackle the supplychain in order to optimize it and get efficiencies from there and we’ve donethat in most of our business except Guitar Hero, where we are so far extremelyfocused on expanding capacity, so that’s going to be a priority for thatfranchise next year.

Product creation costs, we’ve made good progress. I thinkwe’ve explained on previous occasions that we are very deliberate with that,qualifying every step of the way the interventions that we are making and Mikementioned the Bee Movie success we have seen with off-shoring a complete game.So all of this is going in the right direction but because that’s the life ofthe company, we’re taking very [inaudible] approach.

And then lastly, you have already seen the efficiencyimprovement in trade and marketing spending and we would expect to continue tosee scale leverage on the G&A line as the top line is growing at adouble-digit pace.

Michael J. Griffith

Tony, on your Guitar Hero question, as we said, we arepleased that we sold through more than $100 million in the first week. But Ican tell you it’s broad-based across platforms and proportional. We started thefranchise on the PS2 and then migrated it to the X-Box 360 last March. We’venow franchise life to date sold more than 7 million units through to theconsumer and I think our initial experience with Guitar Hero 3 across allplatforms reinforces that it’s a proposition that plays wells across allplatforms on which it is offered.

Tony Gikas - PiperJaffray

Just a quick follow-up then; are there any key markets thatGuitar Hero 3 will not launch in that might come next year?

Robert A. Kotick

In terms of geographies, you mean?

Tony Gikas - PiperJaffray


Michael J. Griffith

No, it’s going to launch in all of our key Activisiongeographies. It has launched first in North America. It launches across all ourEuropean geographies in late November, and then will also be available inAsia-Pacific, although we expect most of the business there to be our moretraditional market, such as Australia.

Robert A. Kotick

But as we’ve pointed out, Tony, there may be some supplyconstraints as we get into the balance of the year.

Tony Gikas - PiperJaffray

Okay. Great job, guys. Thanks.


We’ll take our next question from Michael Savner with Bancof America Securities.

Michael Savner - Bancof America Securities

Thanks very much. If I could also follow up on the marginquestion, in light of Thomas’ comments, even after adjusting for the Bizarreacquisition, I would have expected maybe a little bit more flow-through ofearnings from that revenue upside, given that presumably your increasedoptimism on revenue is coming from success of higher margin titles like GuitarHero and Call of Duty, so is there something that could be offsetting? Is therepricing weakness away from the core titles that could offset or are you justbeing conservative? Because if I do the math correctly for the adjustment, it’sa little bit over 100 basis points of incremental op margin that you areforecasting, so how should we think about that flow through?

Thomas Tippl

I think first of all, [inaudible] in the holiday season, soI don’t think there is any reason to get ahead of ourselves for the whole year.I think this is very much in line with the philosophy that we have employedover the last couple of years.

Second, part of the revenue gain and increase in guidance isalso related due to the weaker dollar and the strength of the Pound the Eurospecifically, and of course that’s revenue increases that just falls through tothe bottom line because the costs that are associated with those revenues go upmore or less at the same ratio, since we are producing the product in Europeand we are marketing them in Europe and people in Europe are paid in Pounds andEuros.

Michael Savner - Bancof America Securities

Great, that’s helpful, thanks. And then one follow-up; as wethink about Guitar Hero in ’09, and I know you are obviously very happy withthe success here and don’t want to get ahead of yourselves, but as we thinkabout what the opportunity is in ’09, is there anything that would prohibit youfrom adding new functionality, like additional instruments to a version furtherdown the road? And can you talk a little bit about the -- how the economics ofthe game have changed at all as you’ve gone to master tracks, if at all?

Michael J. Griffith

I think on Guitar Hero, as we’ve said before, we are blessedwith a title that has an awful lot of opportunity and different directions thatyou could go and our key challenge is prioritizing those for the broadestappeal, so we are looking at a number of exciting new vectors and directions totake the franchise for next fiscal and as Bobby had said, we’re adding capacityquickly to take full advantage of international markets.

So we’re not ready to talk to specific plans for Guitar Heroon ’09, but suffice it to say that it will continue to have a broad-basedlaunch across platforms and across geographies, and certainly working activelytoward adding additional functionality to the brand.

Michael Savner - Bancof America Securities

And the part about the economics on master tracks?

Michael J. Griffith

The economics are pretty solid across versions of the brandand we really don’t anticipate a significant change in the economics. There are-- while today we are focusing largely on increasing our capacity, we’ve alsofound some logistics efficiencies along the way. We think over time we aregoing to find substantially more efficiencies on the supply side of thisfranchise, and so while master tracks are a little bit more expensive thanre-records and we have a blend of those in our game, they are not substantiallymore and thus far we’ve been successful offsetting them.

Robert A. Kotick

Michael, remember we have a higher price, wholesale price onvirtually all of the products that have just been released in Guitar Hero 3 andI think when you see -- next year, we’d like to provide more insight into thedetails for next year but there is no shortage of opportunity on thisfranchise. As Mike pointed out, it’s prioritization of opportunity thatcontinues to be the challenge.

Michael Savner - Bancof America Securities

Thanks, Bobby.


We’ll take our next question from Mark Wienkes with GoldmanSachs.

Mark Wienkes -Goldman Sachs

Thanks. Good afternoon. First, I was wondering, can youshare your thoughts on any divergences you are seeing in the retailerpositioning for the holiday period, meaning the big box retailers versus -- youknow, are they on the same page as the specific game retailers? Any differencesthere?

And then, any prospect on pricing? And then on Skate versusTony Hawk at retail specifically, any surprises versus your expectations, andhow are those sales trending?

Michael J. Griffith

Could you just give me a little more clarification on yourretailer positioning question?

Mark Wienkes -Goldman Sachs

As far as retailers are seeing some tough times right now, Iguess from a square footage allocation perspective, have you seen them increasethe square footage making available for videogames this holiday season?

Michael J. Griffith

I got it. Thank you. We’re seeing across all geographiesvery strong retailer support to the videogame space in general and certainly toour titles. The one trend that continues from previous years is that retailersare certainly focusing disproportionately on the largest opportunities, so Ithink that publishers with disproportionately, well-established slates aregoing to continue to see disproportional benefit from retailers. But in total,we’re seeing strong support across all retailer formats this year.

On your second question on Tony Hawk, no, I don’t think it’sanything that we haven’t expected here. Obviously it’s a competitive year forTony Hawk and I think in the near-term, having an additional title out there isgoing to help drive awareness to the total segment, which is still a relativelysmall percentage of total videogames.

So while near term, I think we’re probably sharing some ofthe hardcore and early adapters, longer term we think the market has expansivepotential in this. Tony has always been a mass market oriented game and it’salways skewed late in the quarter. It’s really a December title. It’s a goodgame. This year, we’ve got very strong merchandising and marketing set upreally through the quarter and thanksgiving and on to December.

We’ve got a broader number of platforms available than thecompetitive title and we expect strong performance on Tony through the balanceof the quarter. But like always, Tony is going to be a back end quarter game.

Mark Wienkes -Goldman Sachs

Right, thanks. Just one quick follow-up, if I could; usingyour new targets for 2Q, 3Q, implied revenue for 4Q is roughly a little over$200 million, or two-thirds of fourth quarter a year ago. Is that a reflectionfor an expectation for the increased competition from some of the other titlesfrom publishers that have pushed them out into the March quarter, or just lessvisibility that far out?

Thomas Tippl

I think we -- let’s don’t forget last year we had the launchof the PS3 in Europe, so that’s in the -- we don’t have that this year. We aregetting all the PS3 titles out in all geographies already in Q3. That’sprobably the bigger factor here.

Mark Wienkes -Goldman Sachs

Okay. Thanks very much.


We’ll take our next question from Brent Thill with Citi.

Brent Thill -Citigroup

Thanks. Tom, I was just curious if you had a percent ofrevenue as it relates to Guitar Hero in the quarter and how you are thinkingabout that for the year?

Robert A. Kotick

You’re asking for Q3?

Brent Thill -Citigroup

For Q2.

Thomas Tippl

Guitar Hero, we don’t provide the revenue numbers for aspecific title but it was in the -- between roughly 30% range, so notsurprising, it was the one title that had a new launch this quarter with Rock the80s on the PS2 and that performed very well. Guitar Hero downloads, all of thesong packs continue to perform very well, so it is one -- it is our leadingfranchise at this point.

Brent Thill -Citigroup

And just as it relates to the European rollout, anydifferent dynamic that you expect as it rolls out there?

Thomas Tippl

As we said, in Europe, the way we look at the business is weare one year behind with establishing the brand in Europe because initially, wewere supply constrained and focused on North America. This is really the firstyear where we are providing our international markets the tools to besuccessful as we have been in the U.S. We have much more supply available. Wehave for the first time localized content available with European bands, whichallowed us to establish the same kind of marketing and promotional programsthat we have executed over the last two years in North America, and of courseretailers in Europe are watching what’s happening over here in the States andare now getting fully behind the product. And over the original spaceconstraints that we faced maybe back a year ago, so we are very bullish aboutthe prospects we have in Europe. Music is a universal genre. From ourperspective, there is really no reason why this business can’t be successful inEurope and you’ve already seen this in other parts of the music genre with SonySingStar being extremely successful in Europe. So we think we are going to makemajor progress there not only this year but even more so the next year.

Brent Thill -Citigroup



We’ll hear from Ben Schachter with UBS Securities.

Ben Schachter - UBSSecurities

Congratulations on a nice quarter. Bobby, for as long as Ican remember, you’ve been talking about the idea of having more concentrationamong the top tier publishers. And if you look at some of the NPD data, therehave been months where 80% plus of revenues have come from the first party andthe top five. How much more concentrated can that really get? How do youposition yourself there to continue to gain share against some of the other bigguys?

Separately, there’s been a lot of activity in Asia, capitalmarkets, looking at that, and the margins over there are just spectacularcompared to what you get with Europe, for business models. How does Activisionpotentially play in that space? Thanks.

Robert A. Kotick

Well, as we’ve said, share gains are going to be somethingthat you see concentrated in the top tier publishers and that’s happening. Weare probably the best example of that this year, but when you look out over thenext few years, we continue to see franchise consolidation, developer resourceconsolidation, retail distribution consolidation to only the very, very toptier companies. You will see the benefit of that at retail and with theconsumer, with our product line this year or next year.

As far as what’s happening in Asia, we are looking at itvery carefully. You are starting to see some great dynamics. The great news forus is that in the markets like the U.S., the U.K., France and Germany, there isstill a lot of upside for us to grow our business, especially in Europe. And sowe are going to capitalize on that for the next few years, but we are startingto see some great opportunities emerge in Korea and in China and we are goingto be looking actively at those markets for the long term for growth.

Does that answer your question, Ben?

Ben Schachter - UBSSecurities

Yes, thanks. One quick follow-up; just how important aresome of the ancillary hardware pieces for Guitar Hero? You see all the guitarface plates and all that kind of stuff all over the stores at Best Buy, etcetera.

Robert A. Kotick

You know, when you have a popular cultural phenomenon likethis, all of these things are additive and they demonstrate the investment theconsumers are making into the brand and we are seeing Guitar Hero is beingintegrated into TV shows now, like Gossip Girls and it’s just -- it’s aphenomenon that we haven’t seen before where it’s one of these few videogame propertiesthat has really infiltrated popular culture. And when we talk about theprioritization of opportunity, you are really seeing the strength of thisbrand, the power of this franchise and it’s one of those things where how muchis up? When you look at the opportunities for downloadable content, when youlook at some of the opportunities we’re pursuing in new categories that relateto new types of experiences with the guitar for next year, it really is one ofthe -- it’s a great problem of prosperity to have, but prioritization ofopportunity is the great challenge.

When you think about $100 million of revenues in the firstweek generated by this product, it’s now -- you start to see this is a propertythat has transcended videogames and it is now one of the most valuablefranchises in entertainment.

Ben Schachter - UBSSecurities



We’ll take our next question from Shawn Milne withOppenheimer.

Shawn Milne -Oppenheimer

Thank you. Good afternoon. Just a couple of quick questions;one on the Bizarre Creations acquisition -- when you made that acquisition, Ibelieve there was no specific time for the racing title, and actually I thinkit was in the release, you said it wasn’t in fiscal ’09. Can you update us onthat?

And then Bobby, can you just talk a little bit more aboutGuitar Hero on the supply side? Are you feeding North American retailhand-to-mouth? Or are you building inventory along the supply chain? Just morecolor on to the extent that you think you may see stock-outs. I mean clearly,we’re seeing some on our checks already but it obviously got a very big pushout the door. Anymore color there?

Thomas Tippl

Let me start with the answer on Bizarre. These guys havebeen historically on a two-year development cycle and that has worked well forthem. That is how they consistently launched 90-rated games and that’s why wesaid when we announced the acquisition that the first title coming in theracing genre will be after FY09. So that hasn’t changed.

Robert A. Kotick

And as far as the supply chain is concerned, without gettinginto too much detail, we think we’ve got a very good handle. As Mike pointedout, we’ve got a terrific team on the ground here, in Europe, in Asia. We areworking really hard at managing both the cost of goods and our ability tosecure inventories to supply to the demand, and so -- as compared to last year,we were able to launch millions of units around the U.S. in every retailer andwe had some fantastic trade marketing and consumer marketing programs. I wouldsay they were probably the best in the history of the company.

So we are continuing to manage through the supply and Iguess the good news here is that even we didn’t anticipate the popularity ofthe product in the first week.

Shawn Milne - Oppenheimer

Thomas, can you break out Guitar Hero as a percent ofinventory?

Thomas Tippl

That increase that you saw from the end of the first quarterto the end of the second quarter was driven by Guitar Hero.

Shawn Milne -Oppenheimer

Thank you.

Thomas Tippl

And just to be clear, we are on a continuous manufacturingprocess here, so we keep cranking out new guitars for all platforms every week,so we will be able to continue to supply the retail channel with additionalunits during this holiday season and in Q4.


Moving on, we will hear from Heath Terry with Credit Suisse.

Heath Terry - CreditSuisse

Forgive me if this sounds like I’m harping on the issue butI was wondering if you could give us an idea of what kind of tie ratio you haveseen for the guitar, for extra guitars? So what percentage of users are buyingmultiple guitars, and to what degree you feel like there is still a significantgap between supply and demand? This is the third year of you -- or the thirditeration of Guitar Hero and it seems like really from nearly from the start,there hasn’t been a consistent supply of the extra guitars on shelves atretail. So we’ll just trying to get an idea how much pent-up demand is outthere for you ultimately to be able to fill as you are able to get hardware toconsumers.

Thomas Tippl

It’s in our interest to drive the installed base of the gameand therefore, during the period of time there were supply constraints, ourpriority was to use the guitar supply in bundled products in order to get theproduct in the hands of as many consumers as we possibly could. And that’s whatyou are also seeing still with Guitar Hero 3. It was the mass majority ofproduct being sold is a bundled product.

As we catch up with demand, we will see the percentage ofstandalone guitars also increase, but there is no doubt that there is at thispoint probably some pent-up demand there, although we will have to see how wecome out of the Guitar Hero 3 launch. This is an opportunity for people thatbought Guitar Hero 2 on the X-Box 360 to buy another bundle and that way get totheir second guitar, and we are going to monitor and read this carefullythroughout the holiday season.

Robert A. Kotick

I will say, Heath, I think we’ve been surprised at thesell-through in the first week and I think that there is an enormous amount ofpent-up demand, especially that the product is now available for the first timeon platforms like the Wii, so while we didn’t accurately anticipate the demandon launch, I think over the next year or so, we’ll get production in line andstart to be able to deliver more to the demand.

Heath Terry - CreditSuisse

Great, but not to try and nail you down to a number, but isthere a sense that you have of what percentage of those Guitar Hero -- of thatGuitar Hero installed base that is out there actually has been able to buymultiple guitars?

Robert A. Kotick

It’s a very small percentage today.

Heath Terry - CreditSuisse

Thank you.


Moving on, we will take our next question from Jeetil Patelwith Deutsche Securities.

Jeetil Patel -Deutsche Bank

Hey, guys, a couple of questions; I guess from a platformdevelopment standpoint, it’s probably early thinking right now but do you haveto now start to make decisions on which platforms you are going to besupporting with your entire lineup as you look at calendar 2008, fiscal ’09? Iguess relating specifically to the PlayStation 3, given the lower installedbase there, or is it too early to tell?

And then second, can you talk about in fiscal ’09, obviouslythere’s still another good growth here coming for the industry as a whole. Doyou think that the overall year will be characterized as more of a marginexpansion type of opportunity or a market share gain type of opportunity interms of how you prioritize your product lineup and your targets as you look atthe upcoming year?

Michael J. Griffith

Let me tell you first on the platforms as we makedevelopment decisions going forward. Our strategy is to support all viableplatforms and we really don’t see that changing. We think all platforms thatare out there now continue to be viable through fiscal ’09. We are seeingencouraging growth from the PlayStation 3, particularly as they’ve started toimplement their price reductions in Europe. We think Sony across both the PS3and the PSP will continue to be a major factor, so our development strategy isbroad-based against all of the viable platforms.

I think in terms of fiscal ’09 specifically, we are planningon year-over-year growth, just as we have every year. We’ve got a robust slateshaping up, anchored by a strong movie schedule with Kung Fu Panda, which as Isaid earlier we think will be one of the larger Dreamworks offerings.

Madagascar 2 -- Madagascar 1 performed very well for us, sowe are encouraged by that. We’ve got another Dreamworks film, Monsters VersusAliens, coming late in the year and we’ve got James Bond, which as you know isa revitalized franchise.

We’ve talked already about upside on Guitar Hero and Call ofDuty, which will be a major focus for ’09 and a number of other titles, ofcourse, including Tony Hawk and more superheroes.

I think the slate, along with increasingly attractivefundamentals in the market and a foundation of strong catalog titles that weare launching now for next year will really put us in a very attractiveposition to continue our growth and margin expansion into fiscal ’09.

Jeetil Patel -Deutsche Bank

Got it. And a quick follow-up just on Ben’s question, but itseems like Guitar Hero has obviously quite a -- a big social phenomenon, almostresembles what Audition is doing in the Asia-Pac region between Korea andincreasingly China, but have you thought about porting that title into more ofthe MMO space for Asia? How fast can you do that if you were to go intoAsia-Pac with that type of a product offering?

Robert A. Kotick

We probably don’t want to get into too much of the productplans for next year now, but obviously we said that we think that there’s agreat strategic opportunity for certain kinds of products in the Asian market,particularly in Korea and China, and remember this is a category of productthat has had some success, even in Japan. So when we look out at all of theprioritization of opportunity that we need to do, clearly those are things thatfall into the realm of opportunity for us for the future.


Mr. Patel, do you have anything further?

Jeetil Patel -Deutsche Bank

I’m set. Thanks.


We have time for one more question. This comes from RalphSchackart with William Blair.

Ralph Schackart -William Blair

Good afternoon. Congrats on another good quarter. Youtouched on it briefly about the catalogue sales of Spidey 3. Just curious ifyou could give us a little bit more color on your thoughts of the catalog forSpidey 3, Shrek, and Transformers for the holiday quarter with the DVDreleases. Thanks.

Michael J. Griffith

I think if you go back to the beginning of the year, we arepleased that between Shrek, Spider-man movie 3, and Transformers, we had aleading share -- in fact, a majority share of all the movie related games thusfar this year. And all three of these games are supported by DVD launches in Q3-- Shrek, Spidey, and Transformers.

As we also mentioned earlier, Spider-man: Friend or Foelaunches as well as Shrek: Ogres and Donkeys. Both of these, besidesopportunities in and of themselves, combined with the DVD launches and give usa real umbrella merchandising opportunity to continue to sell the cataloguefrom the Q1 movie titles. And we are focused on strong programs throughout thegift-giving holiday season on that.

Transformers, as we said, is really a breakout title for us.It’s already shipped more than 3 million units and we fully expect bothSpider-man and Shrek franchises to grow year over year as well.

Robert A. Kotick

And Ralph, we have really -- I’ll tell you, being sodominant at retail right now and having what we believe is probably thebest-selling organization in video games, we are finding that the opportunitiesto tie into trade marketing programs on the DVD, having now had so many yearsof expertise and experience doing it, this is where you really get the benefitof the combined trade marketing expertise of the studios, DVD organizations,and our selling organization. So we are getting a great benefit there.


This does conclude the question-and-answer session. At thistime, I will turn it back over to Kristin Southey for any additional or closingremarks.

Kristin Southey

I would like to say we would like to thank you all for yourtime and the opportunity to share our initiatives for the future. Thank youvery much.


Once again, this does conclude today’s call. Thank you forjoining us and have a great day.

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