Gaming company Activision (NASDAQ:ATVI) reports fiscal Q1 2007 earnings results tomorrow. Want to know what Wall Street expects to see? Read on. Want to know what really matters? Read on a bit more.

What analysts say:

  • Buy, sell, or waffle? 26 analysts still play Activision, and it's only gotten more popular since last quarter. Twenty-one of them now rate it a buy, and only five a hold.
  • Revenues. Which isn't to say tomorrow will be pretty. Analysts collectively think the firm's sales tumbled 38% in the quarter, to $150.2 million.
  • Earnings. They also generally agree that losses increased to $0.10 per share.

What management says:
Don't be too sure that the analysts know what they're talking about, though. After all, as fellow Fool Jeremy MacNealy described back in May, they got caught flat-footed when Activision announced its fiscal Q4 2006 sales came in not at the predicted $131 million -- but 44% higher. What's more, the company projects $1 billion in 2007 sales and 60% more -- $1.6 billion -- in 2008. (Read all about it here.) Subsequent news from management has been less promising, however. For example, last week came word that the company has become one of the latest participants in the ongoing story on stock options backdating. The news of the SEC investigation followed by only days an announcement that an Activision shareholder is suing management in a derivative lawsuit (that's when a shareholder sues someone on the company's behalf -- and whoever loses, the lawyers will win).

What management does:
Now take a look at the margins that Activision has been earning from its revenues. As you do so, keep in mind that the gaming industry is cyclical and tied to the introduction of new gaming platforms every five years or so. Here you can see that rolling operating and net margins have both been declining for the last 18 months. Gross margins, in contrast, have begun to turn around.

Margins %

12/04

3/05

6/05

9/05

12/05

3/06

Gross

40.8

39.9

37.4

36.7

37.3

37.5

Op.

14.1

13.1

10.8

7

4.4

2.8

Net

10.4

9.8

8.6

6.2

3.7

2.9

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Activision's blowout sales quarter three months ago didn't fail to capture the attention of Fool co-founder David Gardner, who noted that the greater economies of scale provided by the better-than-expected sales helped to trim Activision's losses for the quarter. David twice recommended the stock in the wee hours of the last gaming console upgrade cycle (in 2002 and 2003.)

Will Activision's recent success earn it a third recommendation? If history is any guide, it wouldn't surprise me. 2002 and 2003 in the last console cycle equate to 2007 and 2008 in this one. Sales in 2002 and 2003 last time around were a bit less than $800 million and $900 million, respectively. And on those revenues, Activision earned annual margins of 6.6% and 7.7%, respectively. If all things remain equal (sadly, they rarely do), it would seem not unreasonable to expect net margins of 8% and 9%, or thereabouts, in 2007 and 2008. So, perhaps as much as $80 million in 2007 and $144 million in 2008 -- 80% year-over-year growth. I bet that would get a lot of people's attention.

Competitors:

  • Atari (NASDAQ:ATAR)
  • Electronic Arts (NASDAQ:ERTS)
  • JAKKS Pacific (NASDAQ:JAKK)
  • Microsoft (NASDAQ:MSFT)
  • Midway Games (NYSE:MWY)
  • Take-Two Interactive (NASDAQ:TTWO)

Activision and Electronic Arts are Motley Fool Stock Advisor picks, while Microsoft is a Motley Fool Inside Value selection.

That's all well and good for 2007, but 2007 is months away! What does David recommend that you buy today? Found out in the August issue of Motley Fool Stock Advisor. It's hot off the presses as we speak -- and if you'll give our service a tryout, we'll let you read it for free. Just click here.

Fool contributor Rich Smith does not own shares of any company named above.