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Executives

Julie MacMedan - VP, IR and Corporate Communications

Brian Farrell - Chairman, President and CEO

Paul Pucino - EVP and CFO

Rasmus Van Der Colff - Interim CFO and VP

Analysts

Tony Gikas - Piper Jaffray

John Taylor - Arcadia Investment

Tom Andrews - BMO Capital Markets

Benjamin Schachter - UBS

Colin Sebastian - Lazard Capital Markets

Leeg Shagatson- Sterne Agee and Leach

Justin Post - Merrill Lynch

Mark Wienkes - Goldman Sachs

Brent Thill - Citigroup

Douglas Creutz - Cowen & Company

Heath Terry - FBR Capital Markets

THQ, Inc. (THQI) F3Q09 (Qtr End 12/31/08) Earnings Call February 4, 2009 5:00 PM ET

Operator

Good afternoon. My name is Richard and I will be your conference operator today. At this time, I would like to welcome everyone to the THQ, Inc. Fiscal 2009 Third Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions). Thank you.

I would now like to turn the call over to Julie MacMedan, Vice President of Investor Relations and Corporate Communications. You may begin your conference.

Julie MacMedan

Thank you good afternoon everyone. On today's call, management will make forward-looking statements and projections regarding our expectations, estimates and predictions of the future. These statements are based in part management beliefs and certain 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 the risk factors and cautionary statements that are described in our March 31, 2008 Form 10-K and subsequent filings with the SEC. A copy of these filings may be obtained from our website. THQ disclaims any obligation to update its view on any such risks or uncertainties after the date they are made.

In describing THQ's financial performance, we will discuss non-GAAP measures including net sales and EPS. These non-GAAP measures include the following: stock-based compensation expense, the impact of deferred revenue and related cost, business realignment expense, goodwill impairment charges, the other than temporary write-down of investments and mark-to-market on auction rate securities.

The non-cash valuation allowance for deferred tax assets, and the related income tax effects for each of these items. Please refer to the reconciliation of these measures to GAAP results in the tables provided in today's results release.

Now, on today's call Brian Farrell, THQ's President and Chief Executive Officer, will review trends in our business and our strategic plans and we'll then turn the call over to Paul Pucino our Executive Vice President and Chief Financial Officer to discuss THQ's results for fiscal 2009 third quarter. Brian will then provide closing remarks before we conduct a question-and-answer session.

I would now like to introduce Brian Farrell, our President and Chief Executive Officer. Brian?

Brian Farrell

Thank you, Julie, and good afternoon, everyone. On today's call, I will review our third quarter results. More importantly, I will update you on the strong actions we are taking to reposition our organization and cost structure in order to maximize the potential of our more focused product strategy. Following today's financial review, I will give an overview and update of our upcoming product slate.

Earlier today we announced our third quarter results with net sales below plan and a net loss versus expected net income.

Clearly this was one of the most challenging holiday retail environments that I have experienced in my 18 years at THQ. We fell short of our third quarter sales goals due to retail tight inventory management and some products not performing to expectations.

On the bottom line we did not achieve our profitability goal in the quarter to primarily to unanticipated accelerated software amortization and bad debt expense from Circuit City and EUK bankruptcies.

Unquestionably this is challenging time for THQ. The video game sector as a whole grew in 2008 and clearly we did not participate fully in that growth. Recognizing this in November we announced our updated product strategy and business realignment plan.

And now I will reiterate our five point strategy to return to profitability.

First, we are focusing on delivering one to two high quality titles targeted to the core gamer each year. Today we have shifted more than 2.6 million units of Saints Row 2 posting sales in excess of $100 million on this title.

Saints Row 2 achieved a medic credit rating of 82 and we marketed the game aggressively. The conclusion, when we focus make a great game and market it aggressively we succeed.

We intend to apply these three steps to the upcoming launch of game like Red Faction: Guerrilla and Darksiders. Our goal with each of these titles is to launch high quality games, market it aggressively into windows where we can win.

Second, we are the leaders in the fighting category and we are looking to expand this in two ways. We look into these new games based on the WWE brand and our first games spends on the ultimate fighting championship this spring.

Specifically in March we look forward to launching a new game WWE Legends of Wrestlemania in conjunction with WWE's Wrestlemania 25 event.

In UFC we have one of the most exciting new brands and we are delivering a fun, high quality game that truly captures the mixed martial arts sword.

Third we are reconfigurating our kids portfolio with new games based on Marvel Super Hero Squad and DreamWorks Master Minds. We still expect significant revenues from games based on our Disney/Pixar and Nickelodeon brands, we are pleased with augmented our portfolio with these new properties.

Because units for kids titles are down across the board, we will be aggressively managing our development and marketing costs to improve profitability in this category.

Fourth, we plan to build on our already profitable causal game franchises, targeted to consumers on Nintendo platforms such as DeBlob, Drawn to Life, Paws & Claws and Big Beach Sports. Our revenues on the WII were 72% in the first nine months of fiscal 2009 versus a year ago driven by the success of these games.

On the WII we launched an innovative new title Blob which achieved a medic credit score of 82 and shipped approximately 700,000 units at full price line. We also focused on the more casual budget category on V shipping for the 1.2 million units of our new game, Big Beach Sports.

On the Nintendo DS we shipped more than 1.5 million units of games from our innovative to underlying franchise. We also have Paws & Claws which has shipped more than 2.3 million to date.

Going forward with the WII DS, we intend to leverage these proven franchises, introduce new games at both full and budget price points. And continue to maximize our key licensed franchisers.

Fifth, we view the PC online gaming market as a solid long term opportunity for THQ. We plan to extend our brands online first with Company of Heroes online, in conjunction with.

Company of Heroes online won a top ten most wanted award and the China Joy Video game show last fall. Our other initiatives include our WWE online game being developed in Asia and our Warhammer 40,000 MMO game being developed at our Vigil Studio.

We think the popular Warhammer 40,000 Sci-fi universe is a great fit for PC MMO gaming.

In addition to executing on our product strategy we are taking actions to align our organization and cost structure.

During the third quarter we executed on our previously announced plan to reduce our fiscal 2002 forecasted annual spending by $120 million. Given continued economic weakness and our cautious outlook we now plan to reduce costs by and additional $100 million.

Specifically we plan to reduce product development spending by an additional $70 million to studio dispositions and other project and headcount reductions. We also intend to reduce sales, marketing and corporate expenses globally though headcount and other cost reductions with targeted savings of an additional $30 million annually.

Some of these actions have already taken place. Last week we downsized our THQ wireless operations by approximately 100 people and now on our focus to publish games only for high end hand held devices.

In total with the two cost reduction actions combined we expect to reduce total spending by $220 million and company wide headcount by approximately 600 people or 24% of our workforce.

With the combination of more focused and competitive product line and a more efficient cost structure, our goal for next year is to return to profitability and to generate cash.

As we announced earlier today, Paul Pucino has been appointed THQ new Executive Vice President and CFO replacing Colin Slade who remains on a indefinite medical leave of absence.

Paul, brings a tremendous amount of experience to THQ having been CFO of public technology companies Digital Insight and Tekelac. Before Paul reviews our financial results, I would like to thank Rasmus Van Der Colff for stepping in to the role of Interim CFO over the past few months. Rasmus is on the call today and will continue on as our Chief Accounting Officer and Controller. Paul?

Paul Pucino

Thank you, Brian and good afternoon. First of all, let me say how pleased I am to be here at THQ. The company certainly has strong franchisees and a solid strategy. I am looking forward to working with Brian and the team as we execute on our plan to achieve profitability.

Today I will review Q3 financial results in more detail and focus my remarks primarily on the year-over-year quarterly comparison. In addition I will comment on March quarter.

As I discussed our financial performance in more detail or use non-GAAP results which are comparative to previous quarter's non-GAAP results. There were several adjustments to GAAP reporting, to get to non-GAAP reporting. Please refer to our press release issued earlier today for a detailed explanation of our non-GAAP adjustments and a reconciliation of our GAAP results to our non-GAAP results.

As Brian mentioned our third quarter results were below our expectations. Net sales for the third quarter of fiscal 2009 were $385.6 million. This represented a 24% decline versus the previous year quarter and was below the low end of our expectations of $400 million.

Key titles during the third quarter were WWE SmackDown vs. RAW 2009 and Saints Row 2. Catalog was 10% on net sales. The decrease in our net sales versus the prior year quarter was primarily due to lower average net selling prices per unit primarily on leap and lower unit sales.

Lower unit sales were driven by lower sales of WWE SmackDown vs. RAW 2009 in the current quarter as compared with WWE SmackDown vs. RAW 2008 in the prior year quarter as well as a decrease in the number of new releases in the current quarter as compared to the prior year quarter.

On a year-over-year basis, foreign currency exchange rates negatively impacted net sales by approximately $31 million or 8%.

Turning to cost of sales, our product cost at 37% of net sales were up 3 points versus the prior year quarter. This increase is primarily the result of lower average net selling prices per unit primarily on the way as compared to the prior year quarter.

Software amortization and royalties at 28% of net sales was 4 points above the prior year's fiscal third quarter. This increase was primarily the result of accelerated amortization recorded during the quarter due to the impact of lower gross sales.

License amortization and royalty costs of 9% of net sales decreased by approximately 60 basis points compared to the third quarter of last fiscal year due primarily to product mix. Venture partner expense declined on a dollar basis due to lower sales of WWE products year-over-year.

As a result of higher product costs and higher software development amortization as a percentage of net sales, the gross margin was 22% versus 28% in the prior year quarter.

Product development expenses of $23.8 million were down $16.3 million compared to the prior year quarter. This decrease was primarily due to cost savings resulting from the closures of certain studios and the cancellation of certain titles as part of our business realignment process.

Selling and administrative, selling and marketing expenses were $67.6 million up from $64.9 million in the prior year quarter.

This increase on a dollar basis is primarily a result of the increase in marketing spend to support the launch of our key releases in the quarter such as Saints Row 2 which did not have a comparable title in the prior year and WWE SmackDown vs. Raw 2009.

G&A expenses were $20.1 million up from $15.1 million in the prior year quarter. This increase is due to an increase in our bad debt expense of $6 million resulting primarily from the bankruptcy of certain of our customers offset somewhat our cost reduction items.

Interest and other income for the quarter was $2.2 million down $1.2 million from the prior year, primarily as a result of lower average yields on lower average investment balances and the net impact of foreign currency rates.

Our non-GAAP net tax benefit of $13.3 million for the quarter included approximately $4.4 million of benefit from the R&D tax credit that was retroactively renewed by Congress in October.

Our net loss for the third quarter was $9.6 million or $0.14 per share compared to net income in last year's third quarter of $19.6 million or $0.29 per diluted share.

In summary, sales at $385.6 million were below the low end of our guidance. A lower gross margin in unforeseen bad debt expense partially offset by cost control efforts and favorable tax benefit resulting in a loss of $0.14 per share which was below our guided range.

Before I discuss the balance sheet in more detail, let me give a quick update on realignment initiatives. During the fiscal third quarter, we executed on our previously announced real-time initiatives and reduced our fiscal 2010 forecasted annual spending by $12 million.

As a result, we recorded $30.8 million in non-cash impairment charges related to the cancellation of titles and long-lived assets associated with the studio closures and $9.6 million and other cost including severance and other employee-related costs and lease and contract termination cost.

As Brian mentioned in response to the continuing uncertainty in the market today, we announced additional cost reduction actions. We expect to reduce planned fiscal 2010 spending by an additional $100 million. This will reduce our aggregate plan spending by $220 million and headcount reduction by approximately 600 people or 24% of our work force.

We expect to incur significant changes as part of the additional cost reduction actions which will be excluded from the non-GAAP results. We expect most of the additional charges to be recognized in the remainder of fiscal 2009.

Now let's turn to the balance sheet, THQ ended the quarter with $181 million, or $2.70 per share in cash and investments including $36 million in long-term investments. This balance was down sequentially by $20 million from the prior quarter, and primarily reflects the net use of cash on operation in holiday quarter. During the third fiscal quarter, we entered to agreements with two of our banks which provided us with the ability to borrow against our auction rate securities.

As of December 31, 2008, we had borrowed a total of $26 million under these agreements. Net accounts receivable of $145.5 million decreased from $217.7 million at December 31, 2007. The decrease is primarily due to lower net sales in the quarter as well as the launch of MX versus ATV late in the prior year quarter.

DSO of 34 days improved by 14 days versus the prior year Q3, primarily due to the timing of sales and collection within the quarter. Accounts receivable reserves were $124.5 million at quarter end. The coverage ratio on a trailing nine months on net sales basis was 13%, up slightly from 12% in the prior year quarter.

Inventory was $40 million, an increase from $38 million at the prior fiscal year end, but down from the prior year balance of $44 million. Inventory turns were 8, down 2 from 10 in the prior year quarter.

Our investment in licenses was $104 million, up from $87 million at the prior fiscal year end. This primarily reflects the timing of payments for new licenses entered into during the current fiscal year including DreamWorks and Marvel, as well as existing licenses.

Capitalized software development increased to $204 million at the end of the current quarter, up from $181 million at the prior fiscal year end. This growth reflects the investment in key titles, including UFC 2009 Undisputed, Red Faction: Guerrilla and Darksiders.

With respect to goodwill, in the latter half of our third quarter, our stock price experienced a significant decline, resulting from a market capitalization below the carrying value of our net asset.

In connection with the preparation of our third quarter financial statements, we performed an interim goodwill impairment test, as of December 31, 2008. As a result, we recognized impairment charges of $118.1 million, representing the entire amount of the previous recorded goodwill. The goodwill impairment charges were excluded from our current quarter non-GAAP results.

Total current liabilities were $344 million, up from $300 million at the end of the prior fiscal year. The change is primarily due to the $26 million we borrowed during the current quarter under lines of credit secured by certain of our auction rate securities.

This balance includes $53 million for the preferred return to JAKKS Pacific under our joint-venture, which has been accrued at the payment rate that expired in 2006. We are currently engaged in arbitration with JAKKS to determine the new rate, which we expect to be significantly lower.

Until the new rate is established and any amount determined to be due JAKKS are paid this accrual will continue to grow. Other long-term liabilities were $12 million from the previous fiscal year to $32 million primarily reflecting payment to license orders. Stockholders' equity was $403 million. And that concludes the financial result for the current quarter.

Now turning to our fiscal fourth quarter. As Brian mentioned, the macroeconomic environment created a great degree of uncertainty in the second half of our fiscal year. Due to economic uncertainty and limited visibility, we are not providing revenue and EPS guidance for our fiscal 2009 fourth quarter.

We will however share with you some context about how we are thinking about the drivers of our business. We continue to experience a cautious retail and consumer environment with lower initial order quantities and tight inventory management by retail.

As a result, we expect fourth quarter results to be significantly below our previous expectations. We plan to release a total of nine SKUs in Q4. key new releases driving Q4 are Warhammer 40000, Dawn of War II on PC. Initial shipment of WWE Legends on Xbox 360 and PS3, 50 Cent: Blood on the Sand and Deadly Creatures on Wii. We also expect continued sales of holiday titles such as WWE SmackDown versus Raw 2009 and Saints Row 2 among others during the quarter.

Once again as Bryan mentioned, we are diligently focused on returning to THQ to profitability in fiscal 2010. I refer to working with him and the rest of the team of the team as we execute against this plan.

Now I will turn the call to Brian.

Brian Farrell

Thank you, Paul. Earlier on the call, I provided an update on our strategic plan. Now I will get a little more specific on how that strategy translates into our upcoming product line. As I stated, we are focused on five key product areas.

First, core gamer titles. With our previously announced phased green light process, we are putting fewer core gamer titles into full production, concentrating our investments in our biggest franchise opportunities.

We are looking forward to the launch of three strong core gamer titles over the next several months. Warhammer 40000, Dawn of War 2 is scheduled to ship latter this month. This is a very successful PC franchise for our Wellex studio known for their high quality award winning games. We have already shipped more than $4 million units of games on Madonna 4 franchise, all on a PC.

In the first quarter of fiscal '10, we are looking forward to the return of one of our owned Intellectual properties with the release of Red Faction: Guerrilla. As I mentioned earlier with Red Faction: Guerrilla, we are focused on delivering our highly rated and compelling game based on the successful franchise featuring lots of actions and strong online multiplayer game play.

Darksiders an ambitious and promising franchise for THQ is scheduled for the second quarter of fiscal 2010. Cinemax quality of this game is outstanding. And we believe Darksiders has the potential to be a top title in the action adventure genre.

Later in the year, we plan to release our latest installment and our successful MX versus ATV off road racing franchise. We have shipped more than 7 million units of this franchise like to-date.

Second with respect to the fighting at the end of March, we plan to ship WWE Legends of WrestleMania to coincide with WrestleMania 25. Legends features some of the most popular WWE wrestlers of all time including Hulk Hogan and Andre the Giant and a new arcade style game play that differentiates it from the SmackDown versus Raw brand. And of course, we plan to bring our flagship WWE SmackDown versus Raw at this holiday.

In the first quarter of fiscal 2010, we plan to launch our first games based on the ultimate fighting championship. We are encouraged by the momentum behind the UFC league and we are excited about the variety of mixed martial arts fighting styles in our upcoming UFC 2009 Undisputed game.

I would like to take this opportunity to thank Dana White in the entire UFC organization for their support in launching this exciting new video game franchise. Third, our kids lineup. In fiscal 2010, we will have our first games based on Marvel Entertainment's Super Hero Squad, Disney, Pixar, title is up and SpongeBob's 10th anniversary event.

As I mentioned earlier, our goal is to enhance profitability in this segment of our business by moderating spending in, both product development and marketing to size the spend with anticipated revenue.

Fourth, we will release several casual games for the Nintendo Wii and PS that will be announced over the next several months. Our lineup includes innovative new titles and the return of some of our proven brands that capitalize on the broad demographic of gamers on the Nintendo platforms.

Fifth, we currently have two fiscal '10 online initiatives. We are working with leading Chinese game operators Shanda to adapt Company of Heroes online to the free-to-play micro transaction model for the Chinese market. We look forward to launching this title in the coming months and we plan to roll the game out to other Asian territories later in fiscal 2010. We also plan to capitalize on the growing casual MMO market in North America with the launch of Dragonica to our joint venture with ICE entertainment in fiscal 2010.

In summary, we have a strong fiscal line up that reflects our focus product strategy. Combined with our aggressive cost reduction actions we have positioned a company to return to profitability and generate cash in fiscal 2010. Obviously this is a time of great uncertainty and we do not have visibility into when the economy in retail and consumer spending will turnaround.

However, we do see continued relative strength in the video game market. We have made it difficult but necessary decisions to reposition THQ to effectively navigate the current environment and meet the demands of the board range of today's gamers.

We look forward to executing on our strategy with strong franchisees, a solid plan to return THQ to profitability and the support and commitment for our dedicated and hard working employees.

With that I would like to ask the operator to open up the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Tony Gikas with Piper Jaffray.

Tony Gikas - Piper Jaffray

Hi, good afternoon, guys. Couple of questions, maybe you can just start by talking about your expectations for growth and the industry during calendar 2009. Do you expect to take share during the year? And then as it relates to the cost cutting measures, how many SKU's do you plan to cut in the current plan? And then I have a quick follow-up?

Brian Farrell

Tony, this is Brian. With respect to industry growth, we are in the mid-single digit growth for next year in software dollars in our relevant markets, which are obviously North America, Europe and then the Asia-Pac regions. With respect to taking share, I am not prepared to comment yet because our focus really and the message we wanted to deliver on this call is the most important thing to us right now is profitability.

Clearly, we are not pleased with the reduction in our share over the last few year's, but we are very committed to this focused product line and we think overtime that will result in a profitable growth that sort of has defined this company over the previous thirteen years. With respect to the number of titles for next year, only one of the titles that we reduced in this most current round was scheduled for fiscal 2010, the other were unannounced titles, somewhat earlier in development for fiscal '11 and beyond.

Tony Gikas - Piper Jaffray

Okay. And then do you expect that the sales and marketing spend is going to remain at elevated levels through 2009 and then just a quick housekeeping, I am not sure if you said this, did you give a launch quarter for UFC title?

Brian Farrell

Let’s take your last one first. The UFC we will launch in the June quarter. And the previous part of your quarter was?

Tony Gikas - Piper Jaffray

Do you expect that sales and marketing spend will remain at elevated levels through calendar '09?

Brian Farrell

Well here what we are thinking about sales and marketing generally and you have to breakdown the different market segments that we are in. Certainly, with respect to core gamers the aggregate spending will come down because the number of core gamer titles we were launching is coming down. The idea is to focus, focus, focus, but we will compete aggressively when we launch both Red Faction: Guerrilla and Darksiders and things like UFC. When we launch those we will be very aggressive about those but there are fewer of those so the aggregate spend will come down.

In the budget and casual business, those tend to be a lot more sales driven if you will so those don’t require large marketing spends. And then with respect to our kids business as we said, that will be coming down too as we size the spend on those titles when we perceive the market opportunity to be.

Tony Gikas - Piper Jaffray

Okay. And then just a last question if you don’t mind. How much risk does the consumer presents account for 2009 in this category.

Brian Farrell

I was going to ask you. It’s hard to say I mean we won't it is a mix bag out there. Yeah we did hit our numbers and for the fiscal third quarter there were some titles in a different environment I think we would have gotten reorders on based on how low retail was running. And so the good news is we ended the calendar year in pretty good shape with inventory and retail. And the post-holiday sell-through I think has been reasonably good. And so consumers still are buying video games, I want to be very clear about that. How they react longer term again I don’t think we are prepared to make that prognostication. The other thing I would point out, we have not yet released any of our big titles for our fiscal Q4. So, to watch here is we are being very cautious in this environment, we are tying to be as cautious and as smart about this as possible.

Tony Gikas - Piper Jaffray

Okay, thanks guys. Good luck.

Operator

Your next question comes from the line of John Taylor with Arcadia Investment.

John Taylor - Arcadia Investment

Hi. I have got a couple of questions, the accelerated software amortization in the December quarter, was that the $29 million that came off of capital software development somewhere on the balance sheet from previously, did I get that right?

Brian Farrell

Well, I think the 29 million that came off the balance sheet as a combination of number of thing JT, obviously we added some things during the quarter, amortized some in the normal course of business. And then the accelerate amortization, I think the guys are looking for the number, Rasmus do you have it.

Rasmus Van Der Colff

We are just looking here for second.

John Taylor - Arcadia Investment

Yes, so the one I am looking for as actually kind of how much you took off at September capitalized number that we weren't able to accrue at normal rates.

Brian Farrell

Yes, we will have to take that offline JT, we don’t have that in front of us.

John Taylor - Arcadia Investment

Okay, great.

Rasmus Van Der Colff

If you are doing three moving parts in that number as you know, we added some, I amortized some in the normal course of business. But the important point is because our future forecast went down against some of these, we had to accelerate amortization.

John Taylor - Arcadia Investment

Yes. Okay. Because there is no [C reads] it looks like its getting at that number but I guess not quite.

Brian Farrell

I don’t think it was that big.

John Taylor - Arcadia Investment

Yes. And I wondered if you could talk a little bit about this the lower cost deferred. So, is there a way if you sort of push back from the table and put your hands behind your head and think about this. What’s the delta in average go-to-market cost, if you add development cost and marketing cost for the key segments, the key product segments you are talking about? Is there any delta that you are kind of driving towards for core gamer, kids, whatever?

Brian Farrell

I am not sure what you meant by delta. So let me answer the question this way and come back at me. Obviously in a core gamer things, things like Red Faction: Guerrilla, Darksiders those are significant development budget because we are attempting to compete at the highest levels of that market. As you know that takes a significant marketing spend, as well although, we are going to be a lot smarter about how we are spending a lot of our marketing dollars. We have this terrific new connected marketing group, a lot more viral. So, its not just big TV spends, although, we will spend some there.

So, these are big budgets. It's not about cutting those budgets back. It's about spending the money very smart and those things. The kids is where there is the biggest delta, and the way to think about that is sort of directionally. Obviously, back when we were doing 8 million to 10 million units of Pixar titles that would support a very large marketing budget. We are expecting next year's Disney/Pixar title up to be off from current, even WALL-E numbers. So, we have got to assign the investments accordingly. And that’s where you are going to see the lower deltas in that kid segment of the business.

John Taylor - Arcadia Investment

I guess, what I am driving towards here, I am trying to pin it down is, it seems like the single biggest problem, people are wrestling with is that unit volumes just are not big enough to justify the budgets required to build the games, and get them out there in front of people. So is there kind of a percentage, we would like to achieve, 30% lower average go-to-market cost for one of these titles then we did under our previous thinking or is there any way you can help me on that?

Brian Farrell

Yes. Overtime, a lot of our product development reductions come from more outsourcing, we think we have some reuse technology, we know we have been leaders in that, again, especially we have been in production for a while, like Red Faction: Guerrilla and Darksiders. Those games are pretty much locked and loaded. What we are not doing to answer your question, now that I understand it better, is yes. We want to be able to make money on unit volumes that we think are very achievable and then drive upside. And so, for example, a way to think about this to answer your question a little more specifically is, yes, we have done 2.6 million units of Saints Row 2 so far. We are not planning either Darksiders or Red Faction: Guerrilla at those levels. So, based on conservative assumptions we think we can hit our target ROIs and it's not about trying to assume big unit volume if that's your question.

John Taylor - Arcadia Investment

Okay. Good. And then what's your cash product development budget whether you run through the R&D line and P&L or whether you are capitalizing it but whether that looks like in 2010 versus 2009?

Brian Farrell

Well, the way to think about it as we talked about on the last call. We expected our product development spend in this year and this is a good way to get everyone context to what we are thinking about. On our last call we said that we got our total PD spend in fiscal '09 would be about $365 million and that the reductions we made in November or just subsequent to November reduced that number by about $30 million and now we reduced by an additional $70 million. So think of it in that $250 million to $260 million range.

John Taylor - Arcadia Investment

Okay. Great. That's really helpful. And then obviously last one, so I wonder if you could post cut and so on, how many studios are you carrying forward and roughly what's the population of it?

Brian Farrell

I don’t have the specifics in front of me. We have 11 studios now. We have announced that we will reduce that number of studios and headcount within those studios, but we don’t want to give any more specific at this time.

John Taylor - Arcadia Investment

Okay. Thank you.

Operator

Your next question comes from the line of Edward William with BMO Capital Markets.

Tom Andrews - BMO Capital Markets

Good afternoon, it's Tom Andrews standing in for Edward. Just a couple of questions if I could? Are you targeting a certain portion of your development to outsource, and also do you have any plans to establish development in a lower cost territories. And also looking at the kids segment what’s driving the weakness there is currently macroeconomic environment or do you see something else have an effect there?

Brian Farrell

Taking those things in order, Tom. Yes, we don’t target, we do it by product, we figure our what can be outsourced by specific products so there is no across the board, everyone must outsource the certain percent. Some of that are more than others based on the type of product that they are, but again I will remind you, we were one of the leaders in this segment. We formed our XTG outsourcing groups several years ago, so I think we were ahead of the curve on this one.

On lower cost territories, that’s why we invested early on in both Canada and Australia and we do have our THQ China office now as well. So in lower cost territories is one thing, you have to watch what happens with the dollar because it can go both ways.

Finally with respect to the kids business, macroeconomic weakness hard to separate out from the other trends that we have identified before which are, there is a lot more kids animated movie titles now, live action on TV has become a bigger part. So I think the market has just spread across more titles. Also kids are playing a lot more games, casual games on the Wii which why we are making games like the Blob and Big Beach Sports and things like that. So there is several trends in the kids business and also I mentioned the fact that Nintendo does dominate the very kid friendly Wii, so we think all of those factors are contributing to the weakness on the kids business.

Tom Andrews - BMO Capital Markets

Thank you.

Operator

Your next question comes from the line of Ben Schachter with UBS.

Benjamin Schachter - UBS

Hi guys, a couple of question and then I want to follow-up. Can you talk about where you expect cash to end up at the end of this year and next and also what does the cash look like in terms of what's domiciled here in the US versus international. And then just some clarification around the OpEx run rate some of the numbers gets a little confusing in terms of where you are starting cost savings at. If you can give us an idea of where the total OpEx number should be for the end of this year and then how you are thinking about next year and then a follow-up, thanks.

Paul Pucino

To start-off this is Paul. I will address your question about our cash balances. We are not giving guidance at this point with respect to where our cash balance is going to be at the end of the fiscal year which is the end of March. We did give some guidance during the last call. And obviously our Q3 results have come in lower than we anticipated and as we discussed today on the call our Q4 results are going to come in lower than we anticipated as well. So, the guidance that we gave last quarter at this point in time we do expect to come in somewhat lower than the number we had given during the last call.

Having said that, as Brian mentioned during his prepared remarks, we are in a process of putting together a plan internally that will call for us generating cash in fiscal 2010. So at this point in time we fell comfortable that we have enough cash on our balance sheet and given the plan that is going to be put place that we are going to generate cash that for fiscal 2010 our cash needs are sufficient as they stand at this point in time.

Having said that, we continue to monitor and we will continue to monitor closely our cash balance, and if for some reason our balances appeared to be getting too low, there is number of alternatives that we can obviously pursue whether it's going after private money or public money or equity markets or debt markets we will explorer any and all of those alternatives at the point in time we feel necessary. And in fact, we continue to look at those alternatives as well just to know where they are in such that we are positioned well if we feel we need to tap one of those markets.

Benjamin Schachter - UBS

And how much cash do you have in the US versus international right now?

Rasmus van der Colff

This is Rasmus. At the end of December we had about $53 million internationally and the rest was all in the US.

Benjamin Schachter - UBS

Okay, and then another question on the operating expenses?

Rasmus van der Colff

Yes, with respect to, here is a way to think about it Benny, you are trying to put your model. It is always very complicated. We just gave guidance to JT's question. Our guidance I should say input on our product development spend. So some of that $250 million to $260 million will go to the income statement and some more depending on the cap software issue.

And then the rest of operating expenses we cut total as you have seen in the two releases the total of $50 million in other operating expenses, not including also the previous question about how you are thinking about marketing expenses. So, variable marketing expenses will also go down and you could think of those as going down as a percentage of total revenues just based on the remarks I made before.

Benjamin Schachter - UBS

And then, Brian what are the goals for the company, one of your personal goals to remain independent or are you open to possible mergers or acquisitions. And can give us any clarity on for the change of control provisions are around WWE and the UFC?

Brian Farrell

Our goal is to make money Ben.

Benjamin Schachter - UBS

Okay

Operator

Your next question comes from the line of Colin Sebastian with Lazard Capital Markets.

Colin Sebastian - Lazard Capital Markets

Thanks and good afternoon and congratulations Paul on the appointment.

Paul Pucino

Thank you.

Colin Sebastian - Lazard Capital Markets

Brian this is for you. Based on the changing mix of your product portfolio and the cost alignment, where would you approximate a breakeven level of revenues once you get through the restructuring process?

And then secondly, just looking at the strength you have historically in product development, there obviously been some consistency with your key licenses such as WWE and some of the more casual and handheld products, but it’s been a little more challenging to get ROI from some of the wholly-owned core game properties. So I wonder what are your thoughts internally about maybe sticking to where you have some established expertise maybe taking a pass on some of the higher costs of the hardcore games? Thanks.

Brian Farrell

Let me take the later part of the question first and whether we have some tremendous expertise and a great track record on the core gaming side. So you make a good point that those titles are now without risk, but again when you get a ride like we did as we pointed out in our prepared remarks 2.6 million units, like today which puts Saints Row as a franchise approaching the 5 million unit mark, big win, The War Hammer, franchise 4 million units, MX versus ATV we are the market leader there. So we have a lot of expertise in that particular category and some terrific development talent organized around that. So again our view is focus, we were doing too many of those titles, lots of focus, spreading on investment across too many titles is we think is more of the issue than being in that business because when you get that business right can't make a lot of money. The other thing I would say is the kids business I mentioned, a moment ago, that's where we have seen some leakage that we got to fix as well. So just saying we go to return to what we are used to do, to us it's a little broader than that which means.

Getting the core gamer right continuing on the casual side where we are good but we've got to make sure that we return to profitability, solid profitability in that kids business in size, the investment to the overall opportunity.

Colin Sebastian - Lazard Capital Markets

And the other question on that break even level of revenue.

Brian Farrell

Yeah that's something; it's a work in process right now. Obviously we are targeting as Paul said we are in a process and we are deep in the process right now of our fiscal '10 budget. So since we are not giving any forward guidance on the decline that they talk about what that revenue level might be. But you can see from the very strong actions that we are taking, that we are getting the business right sized to where we think the revenue is going to be and we will give you as much as update as we can on our next call.

Colin Sebastian - Lazard Capital Markets

Right. Thanks Brian.

Operator

Your next question comes from the line of Arvind Bhatia with Sterne Agee.

Leeg Shagatson- Sterne Agee and Leach

Yeah this is actually [Leeg Shagatson] for Arvind. Can you just comment on your expectations for UFC relatively to WWE and then I guess on your assumptions for your pricing in calendar year '09?

Brian Farrell

Yeah with respect to you as you remember, this is the initial launch of this really exciting brand and I think we are all very excited here about when we see the momentum, we see at UFC as a brand in their live events and their paper view. There are some very good data points there. But that being said, UFC is on 360 PS3 we are not exploiting the older platforms like we did on we do with WWE, and UFC is not yet as mature internationally as WWE which provides us a great growth opportunity over the longer term.

So we are currently planning UFC to be fairly well below what WWE has achieved recently. But again our job is to drive the upside. With respect to pricing, we still see that strong premier titles, like Saints Row can we retain that 59-99 price point going forward, I think consumers have voted with their pocket books that when you deliver a compelling game with strong entertainment value they'll pay their 59.99 for it.

What we have seen is very quick price erosion on products that do not reach that sort of top-tier status which is why, we are committed to when we bring out one of the games in those [John Rose] that we do bring out a top title and retain that price point.

Leeg Shagatson- Sterne Agee and Leach

Okay. Thanks, and then real quick on the JAKKS arbitration when do you think, we share something next on that?

Brian Farrell

That’s always been a tough question for the last three something years since this stuff has been going on. The update is that, there is an arbitration scheduled finally as you know we had to sue to compel that arbitration so we are very anxious to get to that arbitration because we believe strongly based on the facts and circumstances that I think we know and probably all of you know that rate should come down considerably but when that all gets resolved based on imagination that have happened I just can not promise.

Leeg Shagatson- Sterne Agee and Leach

Okay. Thank you.

Operator

Your next question comes from the line of Justin Post with Merrill Lynch.

Justin Post - Merrill Lynch

One quick business model question, and a balance sheet question. On the business model, can you talk about the two Wii games, the DeBlob and Big Beach Sports and how much kind of developments go into those type of games and how profitable they are and then maybe a balance sheet question.

Brian Farrell

Yes. Good question because there are two very different Wii products, DeBlob, again 82 critic very, very strong game from our internal studio down in Australia. For a Wii game I would rather speak in ranges that was more in a $4 million to $6 million range, if I remember correctly. So, in the mid price, a mid-range, of a Wii title, but a very strong title. But we priced at a full price point Big Beach Sports was a made for budget title which was a very strong category as you might know on a Nintendo Wii. Our development costs are well below DeBlob, but given that very high volume at a low price point, very, very profitable.

Justin Post - Merrill Lynch

Okay. And then, on the balance sheet, it looks like accrues and other current liabilities are up from the March quarter balance any way. And its about, yeah that with the payables, its about $300 million. Just wondering is that stuff really going to come through in the March quarter, and how do you feel about using your receivables and the inventory and cash, what's going to kind of offset that if that stuff is really kind of current at this point?

Brian Farrell

We do not give the JAKKS payment, coming off in the March quarter for sure.

Justin Post - Merrill Lynch

Okay. So that's in their groups right now?

Brian Farrell

There are other guys waiting to.

Justin Post - Merrill Lynch

Okay. So the JAKKS payment is all on the accrues, is that where that is?

Brian Farrell

That’s correct.

Justin Post - Merrill Lynch

Okay. So that’s kind of a longer term. Okay. Good to know. And then lastly, how are you seeing overall console sales right now? How are you going to capitalize on the relative Wii's growth and do you really see that as a big opportunity as you look out over the next say 12 or 18 months?

Brian Farrell

I think couple of things we know. Nintendo has been very dominant on the Wii both here and in Europe, but Nintendo themselves will tell you and has said that they expect third party software to grow as a percentage of total Wii software over the next couple of years. And I think we can participate in that.

As I mentioned in my prepared remarks there are three ways we are attacking the Wii. One is the sort of high end titles like DeBlob where you do something very innovative that takes very good advantage of the Wii play pattern and price of the full price point. We have other titles be announced that are consistent with those kind of themes.

We also like the budget categories like Big Beach Sports and we also have several other budget titles like that and we will be announcing some of those as we get later into our year. And then finally all of our big license franchises Pixar, Nickelodeon, WWE also should improve overtime on the Wii so that's how we are thinking about the Wii.

Justin Post - Merrill Lynch

In aggregate can you make enough on that platform to really move the needle on the bottom line for THQ over the next couple of years?

Brian Farrell

Yes.

Justin Post - Merrill Lynch

All right. Thanks.

Brian Farrell

I mean we will also add the DS I mean both digital platforms provide significant opportunities for us.

Justin Post - Merrill Lynch

Thank you.

Operator

Your next question comes from the line of Mark Wienkes with Goldman Sachs.

Mark Wienkes - Goldman Sachs

Thank you. I was just going to ask about DS I guess with respect to the DSI, I guess could you help us think about any expectations for DSI. And then as you relate Warhammer 40,000, can you help us the frame the economics of that game how to think about the profitability profile at different subscriber levels?

Brian Farrell

Yeah, Mark first on the DSI, we think its got a nice new innovative feature set on it with the camera et cetera, our studios are working on products with the DSI. As you know there is pretty strong backward compatibility. So we don’t have to give either or on that one, so our strategy there is to migrate our brands over, overtime just like any others would have platform transition with Nintendo's we have done with past where the operating system is very, very similar.

With respect to Warhammer 40K I presume you are talking about the MMO and not the PC game we are launching this month.

Mark Wienkes - Goldman Sachs

Yes.

Brian Farrell

So to talk about the subscriber levels? Yeah, the way we are thinking about that is we think we have a great franchise there. We have a team of professionals and both these kinds of games down on our Visual Studio, we think we are making the might right product development investment and what we have done is we think at relatively modest subscriber bases that we can very profitable on this franchise.

I think we have very bundled up business model with respect to that, that particular franchise based on how we are developing the game and the knowledge and the expertise that we are leveraging. But until we get closer launch, I don't want to get any specific subscriber levels but that's one, if you look at all the things we have done with respect to reducing products. That was a keeper because we liked the long-term business model there and we think that franchise because it had the similar play pattern but very different universe in which the player is a great point of difference that we like for that.

Mark Wienkes - Goldman Sachs

Right and just a quick follow-up or two on the inventory destocking we saw across, over the holiday period. Yes, when you expect to see that cycle through is can you still seeing every retailer, elected retailers, or just no visibility yet?

Brian Farrell

Yeah it was pretty much across the board at the holiday, some were even more sever than others. Again, I think some retailers and us, and I think I speak for our competitors too did loose some sales from some of these actions.

I don't think there is going to be any lead up in the retailers, how they manage their inventories very tightly as we move through this economic cycle. I just don't think there is any reason for them to do that. So we are planning our business as if these tight turns are going to continue.

Mark Wienkes - Goldman Sachs

Okay, just a follow-up on the cash question. What was the approximate amount of cash associated with the first $120 million of cost savings, and is that a good proxy with respect to the next $100 million, or about how much was the cash portion of the charges be with respect to the next $100 million cost cuts?

Brian Farrell

I think directionally very similar.

Mark Wienkes - Goldman Sachs

Proportionately, you mean?

Brian Farrell

Yes.

Mark Wienkes - Goldman Sachs

Okay. And the cash portion of the first 120?

Julie MacMedan

It was 9.

Brian Farrell

Yeah, just under $10 million, Mark.

Mark Wienkes - Goldman Sachs

10 million? Okay, got it. Thank you very much.

Brian Farrell

You are welcome.

Operator

Your next question comes from the line of Brent Thill with Citigroup.

Brent Thill - Citigroup

Thanks, just a quick follow-up on the cash. You mentioned the credit line you drew, I think $26 million in the quarter, do you anticipate drawing further against that in the fourth quarter?

Brian Farrell

Well, just to be clear. That was not credit line, or certainly not a typical credit line. We were able to borrow against the action rate securities that we hold. And this is a program that has been very well chronicled in the press over the past several months or so. But the banks, basically lent us a portion of the money associated with the ASRs that we had.

Auction rate securities that we had on our books, and it was effectively, practically zero base borrowing for us. The interest rate charged to us equal the interest rate that the auction rate securities were paying. So that was the borrowing associated with $26 million. To be clear, we do not have at the present time a credit line in place.

Brent Thill - Citigroup

Okay, thanks.

Rasmus Van Der Colff

Although it certainly seems in this market it would be a prudent thing to do, so it's one of the things that we are exploring at this point.

Brent Thill - Citigroup

Okay, thanks for clarification. And for Brian, I know you mentioned you are not giving guidance for 2010, but can you just gives us a sense of when you look at the lineup and you measure it, wholly owned versus license, the profitability of some of these titles coming in 2010 when you compare it to 2009, or perhaps years, how do we put that in the context?

Brian Farrell

The first thing I would say is, the trend is going to continue toward wholly owned. We are pleased I think year-to-date, I think the numbers goes something like this, we have gone from about 27% wholly owned to something over 30% or well over 30% wholly owned, so the trend continues in the direction that we have been planning.

As we look into '10, again, this is directionally now when we think about things like the movie UP from Disney/Pixar, we were planning that down from the levels. So we think the license portion of our business will continue to decline year-over-year, particularly with strong brands like Red Faction: Guerilla and Darksiders.

Now that being said it will be offset by U.S.C, which we expect very strong results from and that's a license titled. So directionally, we hope to continue to elevate the percentage coming from owned IP, but again the offsetting factor that's going to be just how well does UFC do?

Brent Thill - Citigroup

Thank you.

Operator

Your next question comes from the line of Douglas Creutz with Cowen & Company.

Douglas Creutz - Cowen & Company

Thanks. We have a pretty idea, what your fiscal plans looks like and includes a few titles that got pushed from fiscal '09. I think you said that in your last round of cost cutting most of the titles that you killed were post-fiscal '10 titles. So how should we think about fiscal '11 enfold in terms of the numbers of users you are releasing relative to fiscal '10.

Brian Farrell

I think again directionally the way to think about this is fewer SKU's and more concentrated. That’s the nature of the business now, so I don’t think there is going to be significant trend upward/downward in SKU's from what we are seeing right now, maybe a slight increase as we get into 11 and 12 but again give us time to put those plans together and we will be sharing those with you when we (inaudible).

Douglas Creutz - Cowen & Company

Okay, thanks.

Julie MacMedan

Operator, this is Julie. Do you we have time for one more question, please?

Operator

Okay. Your final question comes from the line of Heath Terry with FBR Capital Markets

Heath Terry - FBR Capital Markets

Great, thank you. Brian, I was just wondering you touched a little bit on the restructuring or the restrateging that you are doing towards the kids business. How much of your current performance in the kids business would you attribute to the gain in share that we have seen for the Wii and Nintendo's dominance on that platform versus the high hardware prices that we have had to-date in this quarter and to what extent are those problems that you can address on your own?

Brian Farrell

As I said earlier Heath, the kids markets there are a lot of things affecting that. As you mentioned, the dominance of Nintendo on the platform, I think even up till now the music genre has taken a slice of that business. Again there are lot more animated films each year and more live action TV shows, the market has become more diluted. So the big thing is we are going to control what we can control and we are now going to size what we are spending against what we think the revenue opportunity is. I think you are also making the point is, do kids migrate to 360 and PS3 as those prices points come down?

Historically I think the answer is yes. And so overtime we will migrate our kids brands on those platforms. But right now the opportunity for kid’s games on 360 and PS3, there is an opportunity there but is very small one.

Heath Terry - FBR Capital Markets

Great, thank you.

Julie MacMedan

Great, well thank you for your questions. That concludes our call for the third quarter fiscal 2009. Thank you.

Operator

Ladies and gentlemen, that does conclude today’s conference call. You may now disconnect.

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Source: THQ, Inc. F3Q09 (Qtr End 12/31/08) Earnings Call Transcript
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