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THQ Inc. (THQI)

F4Q06 Earnings Conference Call

May 5, 2006 11:00 a.m. EST

Executives

Julie MacMedan - Director, IR

Brian Farrell - President, CEO

Ed Zinser - EVP, CFO

Analysts

Tony Gikas - Piper Jaffray

Edward Williams - Harris Nesbitt

Jeetil Patel - Deutsche Bank Securities

Heath Terry - Credit Suisse

Justin Post - Merrill Lynch

Mike Wallace - UBS

John Taylor - Arcadia

Liz Osur - Citigroup

Arvind Bhatia - Sterne Agee

Brendan McCabe - CIBC World Markets

Lowell Singer - Cowen and Company

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2006 THQ Inc. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Ms. Julie MacMedan, Director of Investor Relations. Ma'am, please proceed.

Julie MacMedan

Thank you. Good morning everyone. Welcome to THQ's conference call for the fourth quarter and fiscal year ended March 31, 2006. I'd like to remind everyone that statements and projections made during this conference call regarding our expectations, estimates, and predictions of the future are forward-looking statements. These statements about our business are based in part on assumptions made by management and are not guarantees of future performance. Therefore, actual results may differ materially from today's forward-looking statements due to several risk factors which are described in our March 31, 2005 Form 10-K. A copy of this filing may be obtained from our website. The forward-looking statements made on today's call are as a May 5, 2006 and we disclaim any duty to update them.

On today's call Brian Farrell, THQ's President and Chief Executive Officer, will review our fiscal 2006 accomplishments and will then turn the call over to Ed Zinser, our Chief Financial Officer who will review the Company's operating results and financial outlook. Brian will then close with a discussion of our plans for fiscal 2007, and long-term growth. We will then conduct a question-and-answer session following prepared remarks. I would now like to introduce Brian Farrell, our President and Chief Executive Officer.

Brian Farrell

Thanks, Julie, and good morning everyone. We'd like you to take three things away from today's call:

  1. . THQ executed very well in a tough environment last fiscal year;
  2. We have a solid lineup of both current and next gen titles that give us confidence in the short-term;
  3. We positioned THQ very well for growth in the long term.

Fiscal 2006 marked our 11th consecutive year of revenue growth as we grew net sales 7% in a tough market environment. We posted net sales of $807 million and net income of $0.52 per share.

Our focus on driving more units per title paid off. We shipped 10 titles of more than 1 million units each in fiscal 2006, up from six a year ago. While the ongoing industry transition and our investments in product development affected our bottom line results in fiscal 2006, we are proud of our achievements during the year and how we positioned THQ for the future.

In calendar 2005, THQ gained share in all our key markets. North America, Europe, and Australia. In fact, we now generate nearly 40% of our revenues outside of North America and view international markets as a continuing growth opportunity over the next cycle.

Our record fiscal 2006 net sales were driven by the strength of our proven mass market brands and the establishment of two new franchises for core gamers, Juiced and Destroy All Humans!. We believe THQ has a significant opportunity for continued market share gains over this cycle as we roll our more products targeted to the core gamer and we continue to leverage our long-term licensed brands. We encourage you to visit our booth at the E3 trade show next week to get a first-hand look at our games.

In order to support our strategy of developing more franchises in-house and to build more owned original properties we continue to grow our studio system which now includes 1,200 people located in 14 studios.

We are excited about our internally developed product pipeline targeted to core gamers including upcoming title Saints Row and Company of Heroes and fiscal 2008 title Front Lines: Fuel of War.

THQ's handheld leadership continued to drive our gains in fiscal 2006. Consistent with our strategy of releasing games for the new handheld platform as the install base ramps, we significantly increased our share on both the Nintendo DS and Sony PSP. We shipped more than 500,000 units of our first PSP title, WWE SmackDown vs. Raw 2006, and brought internal franchise MX vs. ATV to that device. We are focused on extending our handheld leadership over the cycle.

Let's talk for a few minutes about some other growth opportunities for THQ. We grew our wireless revenues and began to attack two important emerging revenue opportunities: In-game advertising and downloadable content. Our revenues on the wireless platform grew nearly 50% to $36 million, from $25 million a year ago. While we have work to do to build that part of our business, we continue to view the wireless platform as an exciting growth driver over the long term.

We also plan to pursue in-game advertising on future PC and next gen console games and entered into agreements with Massive and Double Fusion to support those efforts. We view downloadable content and micro transactions as a key component of our next gen development efforts. We'll start with downloadable maps for The Outfit later this month and plan to offer downloadable content for Saints Row as well.

In short we have laid the groundwork for continued share gains not only in fiscal 2007, but over the next several years. Now, Ed Zinser our Chief Financial Officer will review our fiscal 2006 operating results, and forecasts for fiscal 2007.

Ed Zinser

Thank you, Brian. Good morning. Today I will recap our full year fiscal 2006 results and review our Q4 financial results. In addition, I'll provide guidance for full year fiscal 2007 and for the upcoming June quarter.

THQ gained market share both domestically and internationally in the fiscal year ended March 31, 2006 and posted net revenue of $807 million. 7% growth over the prior year. Net revenue was fueled by 10, 1 million unit-plus titles which included both licensed and new original intellectual properties.

Earnings, however, declined to $0.52 per share from $1.04 in prior year. The prior year earnings per share included a $0.13 research and development tax benefit claimed for prior years. A significant decline in earnings per share and operating margin was planned for this fiscal year due primarily to next generation product development spending.

Now, turning to our financial results for the fourth quarter. Net sales for the fourth quarter of fiscal 2006 were $148.1 million with a $0.12 loss per share which was consistent with our updated guidance. This is down from $171.9 million in net sales and $0.16 in earnings per share in the prior-year period.

The top-selling titles in the quarter were The Outfit, WWE SmackDown vs. Raw 2006, Nicktoons Unite, and MX vs. ATV Unleashed. In addition we posted strong sales of SpongeBob titles in our catalog.

Currency exchange rates decreased our net sales during the quarter by $5 million or 3%. Gross margin for the quarter was 62% down 4 points from the prior year primarily due to greater price protection for Full Spectrum Warrior: Ten Hammers and to product mix.

License amortization and royalty costs were 10% of net sales consistent with last year's rate. Software development amortization of 24% of net sales increased from 9% of net sales in the prior year quarter. Five points of the increase was due to the cessation of internal product development for wrestling games as we discussed in our April 20 press release. In addition, Full Spectrum Warrior: Ten Hammers and to a lesser extent, The Outfit, accounted for the majority of the remaining rate increase.

Product development expenses of $19.9 million decreased by $3.5 million versus the prior year quarter. The greater number of next generation titles in development that have now reached technical feasibility and as a result are no longer expensed, drove the decline.

Selling and marketing expenses were 14% of net sales down from 17% in the prior year quarter which included television advertising for the launches of The Punisher and MX vs. ATV Unleashed. The current year quarter had two key new releases, The Outfit and the Full Spectrum Warrior the Sequel. G&A expenses were $17 million essentially flat versus the prior year quarter.

Now let's turn to the balance sheet. THQ ended the year with $372 million or $5.84 per diluted share in cash and short-term investments. This represents an increase of $41 million versus the March 2005 balance of $331 million. Net accounts receivable increased to $79 million from $74 million at March 31, 2005 due to the late quarter releases of our key titles this year as compared to the prior year quarter. This timing also impacted our days sales outstanding which was 48 days compared to 39 days in the prior year period.

Accounts receivable reserves were $58 million at year end, unchanged versus March 31, 2005. The coverage on a trailing nine months of sales basis was 8% versus 7% the prior year. Inventory was $29 million, an increase from the $24 million at March 31, 2005 on a rolling 12-month basis inventory turns were 11, the same as a year ago.

Our investment in licenses of $81 million decreased by $7 million from the $88 million balance on March 31, 2005 as amortization expense exceeded additions this year. Capitalized software development increased to $109 million at March 2006 year-end from $65 million a year ago, and from $96 million at December 31, 2005.

The largest additions to the prior year balance were for Saints Row and Cars, which accounted for nearly half of the net increase. Company of Heroes, Supreme Commander, and the Sopranos also had significant capitalized development costs.

The increase in property, plant, and equipment of $11 million was due to leasehold improvements, development kits, and information systems software. The goodwill increase of $7 million was primarily due to the acquisition of the Juice Games Studio.

Total current liabilities were $148 million, up $27 million compared to the March 31, 2005 balance. The increase reflected the growth in the business, and greater accrued royalties. The Company's current ration was 4:1 with working capital of $464 million. Operating cash flow was $43 million, down from the prior year of $60 million due to lower net income and our higher spending for software development, partially offset by lower cash spending for licenses.

Return on invested capital on a rolling 12-month basis was 13%, down from 28% in the prior year due primarily to lower net income. We had no borrowings at quarter end, total stockholders' equity was $631 million.

That concludes the financial results for the fourth quarter of fiscal 2006. Before I discuss THQ's financial projections for the full year of fiscal 2007, and for the first quarter, I'd like to review some of our assumptions.

There are a number of variables that will impact our industry this year which make it difficult to predict market performance, particularly in a transition year where software pricing and hardware installed base forecasts are subject to even greater uncertainty.

Nonetheless, our software dollar growth expectations for calendar 2006 call for flat to down 5% for North America and Europe, generally consistent with industry expectations. We expect continued current generation software dollar declines with an offsetting increase in Microsoft Xbox 360, Sony PS3 and PSP, Nintendo Wii and DS software sales.

With regards to pricing, we expect to continue downward pricing pressure on current generation software. We expect that select titles on next generation platforms will continue to achieve a premium price.

Our calendar 2006 unit hardware forecasts in North America for each platform are as follows: PlayStation 2, 4.5 million to 5 million; Xbox up to 300,000; Game Cube 0.5 million to 1 million; GBA, 2.5 million to 3 million; PSP, 5 million to 5.5 million; DS, 3 million to 3.5 million; Xbox 360, 5 million to 5.5 million; PS3, 1 million to 1.5 million; and Nintendo Wii, 1 million to 1.5 million.

Our calendar 2006 unit hardware forecasts in Europe and the other power territories for each platform are as follows: PlayStation 2, 3.5 million to 4 million; Xbox, 0.5 million; Game Cube, up to 300,000; GBA, 1 million to 1.5 million; PSP, 4 million to 4.5 million; DS, 3 million to 3.5 million; Xbox 360, 2 million to 2.5 million; PS3, 1 million; and Nintendo Wii 0.5 million to 1 million.

Turning to THQ's fiscal year 2007, our sales and profit projections remain unchanged from our February call. We are projecting net revenue of approximately $900 million to $950 million which is 12% to 18% growth versus fiscal 2006. As Brian will discuss, our revenue will be driven by a strong product lineup which starts with Disney/Pixar's Cars and will also include Saints Row and Xbox 360, and WWE SmackDown vs. Raw 2007, on current and next generation platforms. We also plan to release a full Nickelodeon line up and PC titles, such as Company of Heroes and Supreme Commander.

Net income is projected at approximately $0.90 to $1 per share excluding the impact of equity-based compensation expense. For fiscal 2007, this has been forecasted at $0.16 per share.

Our SKU count is expected to increase to approximately 70 from 66 due primarily to the next generation console platforms. Our title count is expected to be relatively flat versus fiscal 2006.

Catalog is planned at approximately 25% of the sales mix, down somewhat from fiscal 2006. Our international revenues are expected to increase slightly to approximately 41% of the mix. Wireless revenues are expected to show modest growth of approximately 10% as we execute against a more focused casual gaming product line which leverages THQ's strong portfolio of owned and licensed properties.

Turning to the expected full year income statement next year, we expect gross margins to improve versus the fiscal 2006 level. License, amortization, and royalties should decrease in fiscal 2007 reflecting more original properties in our mix.

Our product creation costs, which include both software amortization and development expense, are expected to increase by more than 20%. We anticipate marketing and selling expenses to remain consistent with fiscal year 2006 as a percent of net sales and G&A to decrease as a percent of net sales. As a result, our operating margin is expected to improve to 8 to 9% of sales.

Our effective tax rate for 2007 is planned at 30%. This is subject to change due to geographical profit mix and other factors. The fully diluted share count is planned at approximately 68 million.

Consistent with our normal pattern, we'll now provide initial guidance for the 2007 fiscal first quarter. We expect net sales of approximately $125 million and a net loss of about $0.21 per share, excluding the impact of equity-based compensation expense. This has been forecasted at $0.04 per share.

The June quarter has three significant new releases planned, Cars on seven platforms in North America, Titan Quest on PC, and Motor GP on Xbox 360.

In the first half of the fiscal year compared to the prior year we expect net revenue growth with a greater loss on the bottom line.

In summary, in fiscal year 2007, we plan to generate $900 million to $950 million in net revenue and earnings per share of $0.90 to $1, excluding the impact of equity-based compensation expense.

I would now like to turn the call back to Brian.

Brian Farrell

Thanks, Ed. THQ is well-positioned to execute effectively through this hardware transition and to gain share over the next cycle. We are very confident in our line up for fiscal 2007, and in the robust pipeline of innovative new products we are building at THQ. We have a strong and diversified fiscal 2007 product portfolio that is expected to drive THQ's above-market growth during a transition year for the industry.

We intend to achieve this growth with strong contributions from games based on Disney/Pixar's Cars, WWE SmackDown vs. Raw 2007, Saints Row, a full Nickelodeon lineup and high end PC titles Company of Heroes and Supreme Commander.

We plan to start fiscal 2007 with the launch of games based on Disney/Pixar's Cars on seven platforms. The games are scheduled to be on shelf in advance of the theatrical release which is expected to begin in North America on June 9, and then roll out to other territories over the following months.

We are extremely pleased with the performance of our games based on the first tow titles under our long-term agreement with Disney/Pixar, Finding Nemo and The Incredibles. Live to date, we have shipped over 8.5 million games on Finding Nemo and more than 7.5 million units of games based on The Incredibles. Cars is an outstanding movie from the great creative team over at Pixar and we believe our games based on Cars have the potential to outperform their predecessors. Rounding out our first quarter line-up, we plan to release Titan Quest on PC and Moto GP 2006 on Xbox 360.

In the September quarter we plan to launch our innovative and critically acclaimed Xbox 360 title Saints Row developed by our Volition Studio. In addition to Saints Row we expect to release the highly anticipated PC game Company of Heroes created by our Relic Entertainment Studio which took best strategy game honors at last year's E3. We also plan to launch games based on the Monster House and Barnyard movies in conjunction with their theatrical release.

For the second half of 2007 we plan to release the sequel to Destroy All Humans!, the recently announced Sopranos game, and our popular mass market titles for holiday. We plan to publish WWE SmackDown vs. Raw 2007 on Xbox 360, PS2, and PSP for holiday and to follow with the PS3 version in the launch window.

In addition to releasing games on current gen platforms based on our popular Nickelodeon brands, including SpongeBob SquarePants, Avatar, Danny Phantom, and Nicktoons, we plan to bring SpongeBob and Avatar to the new Nintendo Wii console. We also expect strong sales of our Cars game at holiday enhanced by the launch of this title on the Xbox 360 and Nintendo Wii platforms. We round out the holiday lineup with a sequel to our Bratz brand which shipped more than 1 million units in fiscal 2006.

During our fourth quarter we plan to deliver new titles to the core gamer including two new high end PC titles Supreme Commander and STALKER: Shadow of Chernobyl along with our recently announced GTR racing title for Xbox 360.

While we are pleased that THQ is poised to outperform the market in fiscal 2007, our main focus is to position THQ to capitalize on industry growth and to make further market share gains over the cycle. As we've discussed previously we have a solid pipeline of next gen titles from both our internal studios and from leading external studios. In addition to next gen console titles, our product pipeline includes a growing number of titles for the Sony PSP and Nintendo DS to support our continued leadership on handheld platforms.

With respect to industry growth over the next five years, according to independent research firm IDG, the market for video game software including PC in North America and Europe is expected to surpass $17 billion in 2010, up from $14 billion in 2005. For calendar 2007, IDG expects video game software dollar growth of more than 14% in North America and Europe. Note that the IDG figures do not include emerging opportunities in wireless, in-game advertising. and micro transactions. We think this environment provides THQ with an excellent opportunity to grow our business over the next five years.

We've already built a substantial line-up of games to take advantage of the accelerating market growth in calendar 2007. In fiscal 2008, we plan to release new games based on the next Disney/Pixar film and our World Wrestling Entertainment and Nickelodeon franchises.

With respect to original properties, we've announced Front Lines: Fuel War from our Kaos Studio on PS3 and Xbox 36O. In addition, we plan to release a new next gen original title from our Concrete Games Studio, as well as sequels to established original titles developed by our Juiced Games, Rainbow, and Volition Studios, all exclusively on next generation platforms.

We expect owned intellectual properties to approach 40% of net sales in fiscal 2008. We are also targeting north of 50% of fiscal 2008 net sales to come from products developed by our internal studios. Our goal is to grow at or above the market in fiscal 2008 and 2009.

We remain bullish on the growth opportunity in the wireless market and our ability to leverage THQ's content on to the wireless platform. We expect THQ wireless growth to accelerate starting in fiscal 2008.

In summary, THQ executed very well in a tough environment last fiscal year. We have a solid line-up of both current and next gen titles to give us confidence in the short term and we have positioned THQ very well for growth in the long term. We now look forward to responding to your questions. Operator, please open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Tony Gikas of Piper Jaffray, please proceed.

Tony Gikas - Piper Jaffray

Good morning, guys.

Brian Farrell

Good morning, Tony.

Tony Gikas - Piper Jaffray

A couple questions. Q1 looks a little light in light of the launch of Cars, how might that launch look, does it look any different materially compared to Incredibles or Nemo?

Second question the wireless business, it looks like the growth rate there is tempered a little bit from some expectations. Is that due to deck space, product flow, or handset sales? Then I have a quick follow-up.

Brian Farrell

Let's start with Cars, maybe Ed has something to add. We expect Cars to be a bit like Nemo where we'll get several bites of the apple. As we've been saying all along, Cars will launch here in North America in the June quarter, June 9, is the movie date, so we'll have the month of June to sell games based on Cars.

Then the movie will roll out around the world so we expect a pretty strong Q2 and Q3 on that, when we add the Nintendo Wii and the Xbox 360 version of Cars. As you know, the other products have had very, very long shelf lives so these kinds of products tend to have a long shelf life, it's not all in one quarter.

Ed Zinser

Tony, as far as how to think about it for calendarization of the quarters for fiscal '07, you might want to think about it as a 30/30/30/10 kind of a split. You'll have a little bit less in Q3 than you do in Q1 and Q2 but that's probably a way to think about it.

Tony Gikas - Piper Jaffray

Okay.

Brian Farrell

Then on wireless, as we discussed in our last call, being one of the early leaders on the wireless platform we put a lot of products out there to find out what works and what doesn't and then we've trimmed back the product line. We did that before the last call which sort of muted our expected growth this year, which is about 10%. But we expect that to accelerate next year now that we have more of those products in the pipeline.

What our strategy there is to just to reiterate, we've got a lot of the great licensed brands that work for us like WWE and SpongeBob have worked very well. Some of our original products, like Destroy All Humans! and Juiced have done very, very well, and some of the more casual products seem to do well.

We're just in a bit of a reset from a product line standpoint in this fiscal year, but we do expect the growth to accelerate next year.

Tony Gikas - Piper Jaffray

Could you just provide a little bit more info on the Sopranos rollout? The timing, how many games, what's the frequency over the longer term that you expect to exploit that brand?

Brian Farrell

We're really looking forward to the launch of the game on multiple platforms. PS2, 360 this fall. It's a great series, we think it has a long life and longevity in it. But for right now we're really focused on getting out high quality products that truly reflect the world and the characters and the feelings of the Sopranos. The big focus right now is on these holiday launches, after that, we'll think about what the future is.

Tony Gikas - Piper Jaffray

Great, good job, thanks guys.

Operator

Your next question comes from Edward Williams of Harris Nesbitt. Please proceed.

Edward Williams - Harris Nesbitt

Good morning guys, just a couple questions. First of all, looking at your thoughts on the development side, where do you see your head count going with studios as the year progresses? What sort of steps are you taking at this point to lower the cost of bringing a game to market through outsourcing?

If you could just kind of give us some idea as to what percentage of revenues are coming from your internal studios at this point and what your longer term goal is for that?

Ed Zinser

Sure, I'll take the first part of that, Ed. In terms of our head count we are expecting to continue to grow out our studio system. As you know, we added the Juiced Studio just recently, which obviously was added to our head count, but you're looking at something north of 20% in terms of head count additions to our studio system this fiscal year.

Brian Farrell

Then with respect to how we think about managing the costs on a strategic basis, we've done several things. One of the things we've announced, I think this quarter, was an internal group called XDG whose job is to be the central repository of all of our outsourcing.

They've actually worked now with 150 external vendors or contractors to help us with our outsourcing efforts. It's not all about outsourcing. Obviously we built an amazing studio system over the last six or seven years. Part of the thinking behind that was to have the ability to share tools, technologies, assets across studios and across products.

Then the last thing is you've got to think about your product line strategically. Yes, at the very highest end, if you want to compete at the very highest end of the market, the products are quite expensive. But there are a number of products or product lines which you don't have to spend that much money on. You can reuse tools and technologies.

So those are the three things we're thinking about. One is outsourcing, the other is sharing tools and technologies across studios and the last thing is to have a balanced product line where every product in the portfolio is not the biggest bet ever.

Edward Williams - Harris Nesbitt

Then your thoughts as far as revenue coming from internal studios?

Brian Farrell

I believe we said in our prepared remarks we think it's going to be around 50% or north of 50% next year.

Edward Williams - Harris Nesbitt

Is that your long-term goal as well?

Brian Farrell

We've always said we want to balance, Ed, where it's going to fluctuate based on product release, but you can think of us as somewhere north of that 50% going forward.

Ed Zinser

Just to make sure we're clear, the 50% is what we had targeted for fiscal '08 as Brian said in his prepared remarks. For fiscal '07, we're looking at about 40%.

Edward Williams - Harris Nesbitt

Looking at the wireless business for a moment, how many carriers are you working with at this point? Are any of the 1,200 development studios personnel that you have working on wireless or is that all outsourced currently?

Brian Farrell

All of our wireless development is outsourced currently. With respect to carriers, we have carrier relationships, that's one of the real advantages we have in our wireless group, we're over 100 worldwide, all major markets, including China. So we are in a number of wireless markets. That's one of the strategic advantages and competitive advantages we think we have in that market. We have a great portfolio of products, we have great carrier relationships, now the thing we need to do is make sure we augment the product line to take advantage of that potential growth.

Edward Williams - Harris Nesbitt

Okay, good. Thank you very much.

Operator

Your next question comes from Jeetil Patel of Deutsche Bank Securities

Jeetil Patel - Deutsche Bank Securities

Three questions, actually. First of all, can you just give us a sense of what you think the top five titles this year for you will be? I assume Cars is in that list, but just the other four?

Second, Brian, I think you mentioned something like the industry growth from $14 billion to $17 billion, it looks like a little over 4.5% growth from a CAGR standpoint. I guess can you give us an idea of what kind of impact some of the newer opportunities like in-game advertising, digital content, what have you, could actually do to kind of stimulate, add to that growth rate? How big could that 4.5% CAGR look like as we go through the upcoming cycle?

And I have a quick follow-up.

Brian Farrell

With respect to the first part of your question on the top titles, the top ones to really focus on this year clearly are Cars. That's a great movie, it's another just amazing film from Pixar. They continue to impress us just amazingly. We have a lot of optimism about Saints Row. As you might know, that product's getting a lot of buzz online and in the marketplace. We think that's going to be a top title for us as well. WWE on multiple platforms will clearly be a top title for us.

The way to think about the rest of it would be the Nickelodeon business between Avatar and SpongeBob. So those would be the titles to be watching, but Cars, Saints Row, and WWE are really the ones to watch.

With respect to the compound annual growth, we've heard the debate, we've heard the debate a lot, we've heard everyone else's conference calls, and we're reading what all you guys are writing, I think the answer is there's a lot of things we just don't know yet.

There are growth opportunities. We're just starting out, again, we launched the downloadable maps for The Outfit here in a few days. We like the opportunity for some of the downloadable content we're doing on Saints Row. The answer is these are new markets. What can they add to the growth rates? I'll let you guys run your own numbers.

But in addition to that, some of the things that we like in terms of just the growth of the business is as we've built out our business in Western Europe, moving more into Eastern Europe, we've been looking very, very strong over in Asia, we're now direct in Japan. We're spending a lot of time in China.

So before we get these models locked down, let's get all the platforms launched, let's look at all the opportunities, but I think we're going to look back in five years and say boy here's where it came from. I don't think the models predicting that are going to be very accurate today.

Jeetil Patel - Deutsche Bank Securities

Got it. Can you give us a sense of what the mix of business looks like between current gen and next gen for fiscal '07 and fiscal '08?

Ed Zinser

Obviously it's going to continue to increase for next gen in '07 you'll see a greater contribution of next gen even in '08. In terms of absolute percentages, I don't really have the number in front of me, but I think you're obviously going to see significantly more in current gen in fiscal '07, certainly well north of half as we really are just starting to roll out our 360 offerings really with a couple of key properties coming this year. You'll see a much more significant number in fiscal '08 and in fiscal '09.

Jeetil Patel - Deutsche Bank Securities

So it's probably safe to assume 50%, more than 50% for current gen in '07 and less than 50% in fiscal '08?

Ed Zinser

I'd certainly say well north of 50% in fiscal '07 on current gen. As we get into the following year, it's a little premature given we're really not sure what we're going to look at for installed bases for PS3 and so forth. So we're really not going to speculate too much on our '08 revenue yet.

Jeetil Patel - Deutsche Bank Securities

Thank you.

Operator

Your next question comes from Heath Terry of Credit Suisse.

Heath Terry - Credit Suisse

I was wondering if you could just talk a little bit about what you're seeing at retail right now, particularly post the PlayStation 2 price cut and the increase in Xbox 360 volume? What kind of impact, to what degree are you actually seeing the hardware flow improvements? But then also what kind of impact is it having on your software business?

If you could just give us an idea on Cars, when you look at the progression or what you expect to be the progression of retail sales or shipments for the title, should we expect that it generally follows the Nemo pattern or is there anything here that maybe we might not be thinking about?

Brian Farrell

Well, to answer the first part of your question, Heath, this is all anecdotal, we haven't seen any data yet, but speaking with our retail partners with respect to the PS2 cut, we've heard numbers like a 20% to 30% lift in hardware based on the price cut from the widely anticipated price cut from $149 to $129. Again, anecdotally we're hearing a lot better things from both retail and Microsoft themselves about the flow of 360 hardware not just here in the U.S. but also in Europe.

So those are two, what I would call not net but sort of marginal positives. The way I would describe it right now is this is the seasonally weakest time of year in the May/June timeframe, May/June/July. So it's hard to separate the seasonal weakness from the transitional weakness, but it's our expectation that we'll see a lot more activity at retail, I think most of our competitors would agree with this.

As we get deeper into the year, we get the buzz around the PS3 and the Wii launches, you get closer to holiday for 360 and PS2. I think it's sort of playing out as one would have expected so far in this transition year. Nothing has really has surprised us.

With respect to Cars, yes, I would say that Cars being a racing game probably gets us a little more excited than Nemo did certainly as a game with fish versus cars. So it's hard to say how that progression is going to be. Suffice it to say, I think Ed said we're thinking about 30/30/30/10 in terms of the quarters this year. I don't remember exactly how Nemo played out.

The thing we know about the Pixar titles is, they have very, very, very long legs on the shelf. We'll get the roll out around the world this year, we'll get the DVD at holiday, we'll get the two new platforms at holiday, we'll go greatest hits next year. We love these products because they have a very, very long life.

Heath Terry - Credit Suisse

Thank you.

Operator

And your next question comes from Justin Post of Merrill Lynch.

Justin Post - Merrill Lynch

Yes, can you talk a little bit more about Saints Row? I know it's a big title for you, maybe some lessons you learned from The Outfit. Have you resolved any of the issues regarding multiplayer game on that with different levels?

Brian Farrell

The multiplayer on Saints Row?

Justin Post - Merrill Lynch

On Saints Row, yes.

Brian Farrell

Yes, Saints Row is a title that we're feeling very, very good about here. We're really going to be hands-on at E3 with that, I encourage you all to come play the game. I have a lot of confidence in this title.

The things we like about it is it's just a lot of fun to play. It's the first, and I think we'll have a bit of an open field in terms of this open world genre on the 360, I think we'll be one of the first and I think by far the best open world game in that genre.

The multiplayer has come along incredibly on that title. The best thing I could say on that, come see it at E3 because it's really come together in a way that we're proud of.

It's really unfair to compare that to The Outfit, very different genres. The Outfit was a bit of an innovation trying to bring strategy to the action genre early in the cycle. Very, very different genre. Saints Row's a very, very different game. We are extremely proud of it and we're looking forward to launching it in late August.

Justin Post - Merrill Lynch

Second question, on the PlayStation Portable and Dual Screen, do you see your handheld revenues growing significantly as a percentage of total revenues for those platforms?

Brian Farrell

Our DA and PSP businesses are growing very rapidly. We've been pretty clear about rolling out new titles as we have as the installed base ramps. I think that the handheld market is playing out very much as we have predicted all along where PSP is tending to go to the older audience, DS is in the mid-range, GBA is tending to be young.

So the real question there is when does the DS really take over the Game Boy Advance's business overall? But we'll let Nintendo answer that question. We've got Cars coming on PSP and DS, Juiced coming on PSP, WWE coming on both those platforms. So handheld's going to be around 20% of our revenues just on PSP and DS as we look forward into fiscal '07.

Operator

Your next question comes from Mike Wallace of UBS. Please proceed.

Mike Wallace - UBS

Hey, Brian a couple questions. First, could you talk about what you're doing for the Nintendo Wii, what kind of things you're going to be doing with the controller and what titles?

Second question, the Sopranos game, how long have you been working on that? Is that internal? What sort of expectation should we have given that the Godfather was disappointing? I assume it's a similar title.

The third question is PS2 support, I don't know if it's too early to talk about platform mix as we get into calendar '07, but do you anticipate doing more PS2 titles than the past?

Brian Farrell

Let's start with the Wii question. We showed in a press event recently, a SpongeBob game, using the Nintendo Wii, and a Nintendo Wii controller, and standing there watching very jaded game journalists hoot and holler on a Sponge Bob game was actually quite relieving. In fact, in Nintendo's booth you can see our SpongeBob Wii game, we have a Cars and Avatar Wii game in development as well.

One of the things we like about that platform is the development costs back to Edward's question, development costs on the Wii are nowhere near what they are on the PS3 and Xbox 360. That's something that's quite encouraging.

As you probably know, our portfolio maps very, very well to what we think the Wii demographic is going to be. We think we have a bit of a competitive advantage on that platform because our product lineup matches so well to what we think the Nintendo Wii demographic is going to be. Again, Cars, Sponge Bob Avatar, pretty cool stuff. We like that platform a lot.

Your second question was about Sopranos. When we look at the Godfather, you've got to think about what the expectations were. We think Sopranos is a lot more relevant maybe to today's consumer. I actually got a lot of e-mails yesterday congratulating us on the deal.

It's been in development for about a year. So we love the series, we're really excited about launching the game. But let's keep expectations just muted for the time being until we launch it. And the last part of your question, Mike was?

Mike Wallace - UBS

The PS2 supports you get in '07. Do you think it's mostly new stuff? There's going to be a fair amount of PS2 games that you're looking at, just do you have any idea what the mix between new and old stuff will be?

Brian Farrell

We don't want to talk too much about calendar '07 yet, but there will be some new PS2 development. Again, you can look at our portfolio. Clearly the next Pixar film, things like that, Nickelodeon things clearly belong on PS2, things we can get to multiplatform easily. You get more selective.

One of the things we've created here, as you know is a great catalog, the question is always is new development justified? Do you just keep reaping the catalog on some of the older titles? That's something we did very well in the last half of the last cycle. Yes, we will have some new PS2 titles, it will be based on our biggest mass market, but we'll also mine our catalog very aggressively as well.

Mike Wallace - UBS

Thanks.

Operator

And your next question comes from John Taylor of Arcadia. Please proceed.

John Taylor - Arcadia

Hi, I've got a couple of housekeeping questions, then maybe a bigger one. Is there any capitalized software development cost for The Outfit still on the balance sheet as of the end of March?

Brian Farrell

Is it a multipart question? Or do you want me to start answering?

John Taylor - Arcadia

Okay, so that's the first one. The second one is, I'm wondering what engine you guys are going to be using for Soprano.

Then I think you mentioned 60/40 split between licensed owned as an objective for '08. Maybe give us a sense of what you think that might look like in '07?

Then, Brian, maybe talk a little bit about the casual game site that you're setting up, and kind of how that fits into or how you're going to integrate that into the larger picture in terms of cross pollination or what you're going to be able to leverage with that. Thank you.

Ed Zinser

In terms of cap software, essentially all of The Outfit was written off, cap software was expensed through the P&L in our fiscal fourth quarter.

Brian Farrell

On the Sopranos that's being developed externally, J.T., I can't tell you which engine it is, but it's being developed by an external partner.

With respect to casual games, yes, there was something written about a beta site we have under development. I don't think it's a great stretch to say we're interested in the casual games market. Our ValuSoft division has been very, very successful. In fact, they're probably the leader in the casual game markets in the boxed product world. To migrate a lot of that content over to the online world is a very natural extension, but it's a little early to talk about what our whole strategy is there.

We think there may be some real potential for crossover between online casual and wireless devices, but again I think it's premature until we get finished with our research and experimentation. I'd rather roll out a very comprehensive strategy, but just to give you a little insight into our thinking, we think there's some opportunities to grow some business based on some expertise we already have.

Ed Zinser

In terms of our owned IP for fiscal '07, about 20% to 25% will be owned and the balance will be licensed obviously, we're looking for pretty strong performance out of Disney/Pixar's title Cars and the WWE. We'll be between about 20% and 25%, we figure, for owned.

John Taylor - Arcadia

Great. Brian, let me follow up on that casual game thing for a minute. So do your license agreements with Nick and with Pixar and so on, are those transferable over to online casual games or flash games, that kind of thing?

Brian Farrell

I don't want to speak to various contract terms because frankly I don't recall all of them. Some probably do, J.T., some don't. But we're not thinking about that as just a license opportunity. I think it's a broader opportunity than that. So to the extent we can include licensed content where we do have those rights, that will certainly be part of our thinking but I think it's a little broader opportunity than just licensed content.

John Taylor - Arcadia

Okay. Thank you.

Operator

Your next question comes from Liz Osur of Citigroup. Please proceed.

Liz Osur - Citigroup

Thanks, we have heard a lot in the last week from some of you're competitors about development costs on next gen and just development time on next gen taking longer than some people had planned. Can you give us a sense of any surprises you've seen in development and when you think the real porting and R&D cost reductions will begin on next gen development?

Brian Farrell

Well, yes, we're not going to argue with the fact that it's hard and it takes a long time, and it is a bit more complex in this generation. But I think the important thing to do, I think one of THQ's competitive advantages is the more balanced approach we take to the market, a huge part of the market isn't that more mass market area, and again we won't see development costs rise that dramatically in that segment of the market.

We talked about Nintendo Wii, that is not a high-cost development platform. We think they have an opportunity to gain significant share. We don't know how big it's going to be but we think it's going to have real opportunity to gain some share.

So the other thing we've always seen historically to counter that is even though development costs, we don't have to spend as much as we get deeper into the cycle and we have our cross-platform tools, people, including THQ tend to start raising the bar.

I think the dynamic you're going to see as a continuation of the dynamic we've seen in the recent generation, which is it's going to be a trend toward the bigger titles and the biggest brands, the B title will no longer be produced, or if it is, it will not be profitable.

It's going to be a stiff competition at the high end, there will be a great opportunity for licensed brands that aren't development cost driven, and then again, there are other markets like micro transactions and in-game advertising where you hopefully are reaping more profits not just recouping your costs.

You've got to take a balanced approach to the market. Handheld, again, for instance, the handheld costs are nowhere near what they are on the next generation consoles. So if you look at the way we map out against the market, yes we do have some high-cost big bets, but we have a very balanced approach to the market that I think mitigates some of the risk in that.

Ed Zinser

With respect to porting, Liz, obviously not having launched the first PS3 title, you won't see any real benefit from more efficient porting tech until we obviously are further into development on PS3 and actually have launched some titles. So you won't start to see any real benefits of that until next fiscal year and after that.

Liz Osur - Citigroup

If I could just ask a follow-up on the maps for The Outfit, can you tell us where those are priced and what kind of expectations you have for sales either as a percentage of the installed base of the game or the percentage of users on Xbox Live?

Brian Farrell

My recollection is that there will be about 500 live points, roughly five bucks per map. One of the great things about The Outfit it's been lauded for its online play. But as you know the installed base of both the 360 and The Outfit specifically are pretty limited.

We don't have great expectations for that title from a financial perspective. The point we're trying to make here is we're trying to establish a leadership position in some of these new paradigms, and we think we can figure it out as fast if not faster than our competitors and start exploiting those opportunities.

So there's a near-term very small financial opportunity but we think we're going to learn a lot about consumer behavior patterns, consumer preferences, and what works and what doesn't and that's going to be an advantage as we move further into the generation.

Liz Osur - Citigroup

If I could just ask one final question, on your mobile relationships with mobile carriers, do you see any change in negotiations with them or anything else since the acquisition of Jammed Up by EA?

Brian Farrell

We look at wireless just like we look at any platform, which is the best content wins. The deck is shelf space, and you better have great content that commands shelf pace. The stuff that sells to the ultimate consumer wins. It's no different on wireless than it is on any other platform.

Liz Osur - Citigroup

Okay, thanks.

Operator

Your next question comes from Arvind Bhatia from Sterne Agee. Please proceed.

Arvind Bhatia - Sterne Agee

Good morning, guys.

Brian Farrell

Good morning.

Arvind Bhatia - Sterne Agee

A couple of big picture conceptual questions. Brian, have you looked at any recent numbers in market penetration from a U.S. or European market penetration of consoles standpoint? And what sort of expectations would you have for the next cycle? What I'm trying to get to is can we expect similar growth rates all said and done, whether it's including all the new opportunities that you mentioned in there and then I have a follow-up.

Brian Farrell

That's a raging debate now, and again having been through five platform transitions, I've sat here many times hearing the world is about to end if penetration can't get higher, people are doing other things before, they were going on line, they were going to PCs. Again, I'm not going to sit here and say that none of those things are true in this generation.

The way we look at it is there's a lot of growth in other areas, not just in North America but in places around the world that are new markets that are just starting to grow. The bigger thing for THQ is if you put market growth aside, and we do think there's going to be significant market growth in this round, is THQ specifically, we think we're in really good shape to gain share given the fallout of some of the smaller competitors, the way we own the mass market and we're really ramping up against the core gamer, the fact we've had great launches on handheld just ramping up on high end PCs. So I think the big picture is the markets going to grow whatever it's going to grow, but for THQ specifically, I think given the way we positioned the Company we're positioned to gain share regardless of the market growth.

Arvind Bhatia - Sterne Agee

Do you have any market share penetration numbers? I mean market penetration numbers?

Brian Farrell

In terms of market share objectives for us, is that your question?

Arvind Bhatia - Sterne Agee

Actually more so in terms of what is to date in the U.S. and Europe your best estimate of how penetrated those markets are, household standpoint?

Brian Farrell

We have that data, we just don't have it in front of us right now.

Arvind Bhatia - Sterne Agee

Got it. Also, for Cars, I know you mentioned you're really excited about it, this round you could do better than even finding Nemo. For modeling purposes, I know you tend to be more conservative, can you give us some flavor for where you are in terms of for the percentage of sales, what Cars could be so we know what that might be roughly?

Brian Farrell

Flavor like chocolate, vanilla, or strawberry? It's going to be good, let's launch the product, as soon as we get sales reads around the world we'll update our thinking on this. We've given you the numbers to date for Nemo and Incredibles, and we've given you a way to think about Cars in terms of quarterly rollout. I think that's as far as we want to go.

Arvind Bhatia - Sterne Agee

Last question, pricing. We're all expecting it to come down this year but do you have any sense of what that number might look like as you look at it?

Brian Farrell

Well, again, remember, we say this every time, you've got to look at pricing as the way you segment the market. We have a number of titles at a premium price, we'll have a number of high-end, full-price PC titles. We have some very compelling PS2 launches that will be at full price. We have an awesome catalog that will be at greatest hits pricing. So I actually push back pretty hard when people say pricing will come down this year. We'll have more titles at $59.99 this year than maybe any year in our history so you're going to have a mix of prices.

The real question to ask someone is what is your mix of titles at the various price points. And if you look at our portfolio, you can see we have a pretty broad mix. But I think just to say pricing comes down this year is not a true statement.

Arvind Bhatia - Sterne Agee

Got it. Thanks guys.

Operator

Your next question comes from Brendan McCabe of CIBC World Markets. Please proceed.

Brendan McCabe - CIBC World Markets

Two quick questions. There's an argument that due to a younger end user base that you guys naturally would be a late cycle player. I was wondering if you believe in this argument? If you do, do you foresee any console transition issues that other publishers are digesting now happening a little later down the line?

My second question would be with 1Q guidance full expectation, it seems like the back three quarters are doing a lot of the work with '07 guidance being held intact, qualitatively, how much of your guidance is dependent upon successful launch of next gen games. Could underperformance of any one of those titles impact that 900 to 950 number?

Brian Farrell

With respect to the late cycle play, I always kind of bristle at that one, too, just because we built this amazing portfolio between the Nickelodeon and Pixar stuff that plays very well in the late cycle, we're very pleased with that. We outperformed the industry last year and we're poised to outperform the industry this year.

I think we've also been pretty clear on our strategic objectives of building our share against the core gamer. Couple of proof points there, if you look at Juiced and Destroy all Humans! on console last year, even a product we don't talk about as much as we should, Dawn of War from our Relic Studio, a PC title now with a couple of expansion packs is well over a million units.

So we think we've positioned the Company that way and we think one of the reasons there's significant potential upside in THQ is that we think there are some questions, can THQ really compete against the core gamer. And I guess the only thing I can say to that is come to E3, look at Saints Row, look at Company of Heroes, look at Supreme Commander. I think we can compete with everyone. So the answer to your question is do you think something happens to us later in the transition, the answer is absolutely not. Second part of the question?

Ed Zinser

As far as our '07 forecast in terms of what we're expecting from next gen titles, obviously it's not a huge piece of our revenue in fiscal '07 based upon the product lineup and what we've disclosed as far as what our 360 titles are, so, again, the bulk of our revenue is going to come from current gen plus handheld obviously DS and PSP are out from last year and those will make a nice contribution.

So when you look at our year and if you're trying to size up risk or where the bets are, as Brian had said earlier, we certainly would expect Cars to do very well, WWE to do very well. We are looking for Saints Row to perform well. But we don't have a significant amount of revenue planned for next gen consoles working in our '07 numbers yet. I'd answer that question differently in fiscal '08 certainly.

Brendan McCabe - CIBC World Markets

Great, thanks.

Julie MacMedan

We have time for one more.

Operator

Your next question comes from Lowell Singer of Cowen and Company.

Lowell Singer - Cowen and Company

A couple of quick questions. Brian you had alluded to the development cost differential with the Wii being much less expensive than the 360 or the PS3. Can you give us some sense of the magnitude of that differential? Or at least what you've seen thus far?

Second, you also suggested that Wii might be in a position to gain share for Nintendo in the cycle. I'm wondering if you think that is the console that people might be most wowed by once they have all three of them out in the market?

Finally, I know it's early, but can you give us some sense of where you are in terms of the development of the next Pixar game, which I guess would come out in a year from now, is Ratatouille.

Brian Farrell

With respect to the last part of that question, we can't, we're not going to comment on anything that our partners at Disney and Pixar have not yet commented on. But just suffice it to say we will be prepared to launch our games when the movies are in development.

Let me be really clear, yes, the Nintendo Wii in terms of the development environment, it was very close, as I understand it, I'm not the development professional here, but as I understand it, the development is much akin to the GameCube environment, certainly a faster processor and things like that, but it wasn't a whole new programming environment. So we had a lot of tools and tech. that work in that environment. So those costs. Again, I hate these broad generalizations but they could be as little as a third of the high end next gen titles on Nintendo Wii. Maybe the range is a quarter to a half.

What I said with their ability to gain share, again you've got to realize that we're going to continue to allocate our capital to platforms on an economic basis and we're not going to cheerlead for any one of them. I think the thing if you look at the Nintendo WWE it's positioned very differently than the PS3 or the 360. The PS3 and 360 are clearly the living room going after the high end set-top box next to your TV in the living room. Nintendo's taking a different approach, lower price point, much more mass market.

We look at that and say could that really be the second platform in households with two? The other thing you've got to say is Nintendo is probably going to get their core demographic that they've always been very good against, that's the 6 to 16-year-olds. All we're trying to say is we think there's a market opportunity that plays very well against our portfolio there at cost that makes sense to us from a development standpoint.

Lowell Singer - Cowen and Company

Thank you.

Julie MacMedan

That concludes our fourth quarter call, we would like to thank you for joining us today and look forward to seeing you next week at E3.

Operator

Thank you for your participation in today's conference, this concludes the presentation. You may now disconnect. Good day.

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Source: THQ Inc. F4Q06 (Year ended Mar 31, 2006) Earnings Conference Call Transcript (THQI)
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