Profit Sinks at Activision

Updated from 4:35 p.m. EST

The cyclical nature of the video-game market is finally catching up with Activision (ATVI Quote).

In its earnings report Monday, executives at the video-game software publisher predicted essentially flat sales this fiscal year and an outright sales decline in the coming one. Should those forecasts come to pass, they would mark a big change for a company that has prided itself on consistently growing its top line year to year for some 13 years.

That time period encompassed two different console transitions -- the periodic replacement of video-game hardware and software with updated versions. Industrywide, such transitions have typically led to slumping sales and increased costs.

Although Activision was able to weather those past cyclical changes without taking a hit to its top line, it won't be able to escape unharmed the current one that began with the launch last fall of Microsoft's (MSFT Quote) Xbox 360 console, company officials said.

But the problem for Activision could be bigger than failing to hit a numeric target -- the forecast has called into question the company's basic strategy of frequently updating an ever-increasing number of franchise games.

The first signs of the transition's impact on Activision came to light in the company's just-completed holiday quarter. Although sales actually came in better than expected in the period, it's a misleading picture. The company's costs in the quarter soared as it upped advertising expenses and raised its reserves to protect against price cuts to move games. As a result, profit plunged much lower than analysts expected.

In the just-completed quarter, "The market environment was tougher than we expected," said Michael Griffith, CEO of Activision's publishing division, on a conference call. "The console transition came on sooner and harder than we expected."