Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Julie MacMedan - VP, IR and Corporate Communications

Brian Farrell - Chairman, President and CEO

Paul J. Pucino - EVP and CFO

Analysts

Tony Gikas - Piper Jaffray

Colin Sebastian - Lazard Capital Markets

Arvind Bhatia - Sterne Agee & Leach

Heath Terry - FBR Capital Markets

John Taylor - Arcadia Investment

Edward Williams - BMO Capital Markets

Douglas Creutz - Cowen & Company

Justin Post - Banc of America

Todd Mitchell - Kaufmann Brothers

Eric Handler - MKM Partners

Jeetil Patel - Deutsche Bank

THQ Inc. (THQI) F4Q09 Earnings Call May 6, 2009 5:00 PM ET

Operator

Good afternoon. My name is Brittany and I will be your conference operator today. At this time, I would like to welcome everyone to the THQ Inc. Fiscal 2009 fourth quarter and year-end results conference call. (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 on management’s 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 costs, 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.

On today's call, Brian Farrell, our President and Chief Executive Officer, will review our strategic initiatives and will then turn the call over to Paul Pucino, our Executive Vice President and Chief Financial Officer, to discuss THQ's results for our fiscal 2009 fourth quarter and full year. 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. Clearly fiscal 2009 was a disappointing year with our net sales and operating results down significantly. Important, we have taken swift and aggressive actions to address the issues affecting our business and to right-size our cost structure.

We have emerged from a challenging fiscal 2009 with a more streamlined organization, a more focused product strategy, with many promising game launches coming up, and a demonstrated track record of delivering quality games.

We recently completed a significant realignment of our business to position THQ for profitability and positive cash flow in fiscal 2010. We took decisive actions to achieve our cost-saving objectives and have eliminated $220 million in planned expenditures from our fiscal ’10 budget.

In line with our focused product strategy, we will invest in the brands and products with the highest potential to drive THQ's long-term profitable growth. Our studio systems remains a key driver of future growth, with more than 1,200 people and eight internal studios creating a strong pipeline of games.

And our product quality initiatives are working. In fiscal 2009, we delivered on our product quality promise with strong metacritic ratings of 80-plus for Saints Row 2, WWE Smackdown Versus Raw 2009, The Blob, Warhammer 40,000: Dawn of War II, and other titles.

Our upcoming product pipeline continues to emphasize our commitment to delivering high quality entertainment for gamers. We were looking forward to the launch this quarter of our first games based on the popular ultimate fighting championship, and the first open world version of our Red Faction franchise. And later in the year, we plan to release MX versus ATV, Darksiders, and WWE Smackdown Versus Raw 2010.

Our strong studio system and our product quality success give us confidence in executing on our five point strategy, which I would now like to update you on.

First, our strategy is to launch one to two titles targeted to the core gamer each year. Our Saints Row and Warhammer 40,000 franchises provide key pillars of our core gamer portfolio and we plan to sequel and extend these franchises for many years to come. To date we have shipped nearly 5 million units of our Saints Row franchise and more than 4.5 million units of our Warhammer 40,000 franchise. These results demonstrate than when we focus, build quality games, market them aggressively and launch them in appropriate windows, we are successful. We are looking forward to building on our portfolio of owned intellectual properties with Red Faction and Gorilla and Darksiders, in fiscal ’10.

In addition, we look forward to unveiling some of our core gamer titles for fiscal ’11 at the E3 trade show next month. We will be featuring these titles at our investor event at E3, and we look forward to seeing you there.

Second, we are the leaders in the fighting category and we are actively expanding this industry leadership. Our $1 billion WWE franchise continues to be a multi-million unit seller for THQ. In fiscal 2009, we shipped more than 4.5 million units of our WWE Smackdown versus Raw 2009 title. In March, we launched a new brand extension, WWE Legends of Wrestlemania, and we are pleased with sales to date of this title.

We are also very excited about the addition of the UFC franchise to our portfolio. In two weeks, we are scheduled to launch UFC 2009 Undisputed. We’ve built an outstanding game that captures all of the action of this extremely popular sport and we expect our UFC games to be a key driver of net sales for many years to come.

Third, in addition to our Disney Pixar and Nickelodeon games, we are reinvigorating our kids portfolio with plans to launch new games, this year with Marvel Superhero Squad and next year with DreamWorks Animation’s Mastermind. Our first games based on Marvel Superhero Squad are scheduled to ship this holiday season and we expect this to be an annual franchise for several years to come.

We will also be aggressively managing our development and marketing costs to improve profitability in this category.

Fourth, we plan to build on our already profitable mass appeal and family game franchises. We are excited to launch MX versus ATV in this fiscal year. This franchise has sold more than 7.5 million units to date. In addition, we have several strong franchises targeted at consumers on the Nintendo platforms. Our fiscal 2009 revenues on the Wii nearly doubled as a percent of net sales to 17% from 9% a year ago, driven largely by the success of casual budget games, such as big beach sports, and full priced innovative games like The Blob.

We also plan to build on our popular Drawn to Life and Paws and Clause franchises. Going forward, for the Wii and DS, we intend to leverage these proven franchises and introduce new casual games at both full and budget price points.

Fifth, we view the emerging online gaming market as a solid long-term opportunity for THQ. We plan to extend our key franchises online, first with Company of Heroes online, in conjunction with Shanda. The game is continuing to test well in China and we look forward to its commercial release later this fiscal year.

Other brand extension 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 extending our current franchises online, we are exploring new online game concepts and models, such as our new casual MMO, Dragonica, which is scheduled for release in North America this fall.

In summary, we are making strong progress in our five key product areas that we expect will drive THQ's net sales for years to come. With the combination of a more focused and competitive product line, and a more efficient cost structure, we have positioned THQ to return to profitability and to generate cash in fiscal ’10. As a result, we are confident that our strategy is working and that we are taking the right actions to increase shareholder value.

With that, I would like to turn the call over to Paul Pucino, our Executive Vice President and CFO. Paul.

Paul J. Pucino

Thank you, Brian and good afternoon. Today I’ll recap our full year fiscal 2009 results and review our Q4 financial results. In addition, I will discuss our future business outlook. As I discuss our financial performance in more detail, I will use non-GAAP results, which are comparative to prior periods’ 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.

First I would like to briefly recap the fiscal year. For the full fiscal year ended March 31, 2009, THQ reported net sales of $813 million, down 23% from last year’s $1.1 billion. This decrease is primarily attributable to three factors -- one, net sales of our kids business decreased by 38%; two, net sales of our WWE franchise decreased by 25%; and three, unfavorable changes in foreign currency rates reduce net sales by $41 million.

With respect to our license kids business, we have announced our strategy to improve profitability and refresh our portfolio with new brands, such as Marvel and DreamWorks Animation.

With respect to the fighting category, in addition to the WWE, we are adding games based on the Ultimate Fighting Championship to enhance our fighting category revenue.

Our product cost as a percent of net sales increased 3.9 percentage points due to lower average selling prices due to mix and higher sales returns and allowances. In addition, software amortization as a percentage of net sales was higher by 4.3 percentage points, due to lower net sales on products that were released in fiscal 2009, as well as increased impairments for games yet to be released due to lower expected future sales.

Selling and marketing expenses as a percentage of net sales were 3.1 percentage points higher due primarily to lower net sales.

G&A was up $6.9 million, due primarily to bad debt expense. These increases were partially offset by lower product development expenses, due primarily to studio closures under our business realignment and more focused R&D spend on future projects.

As a result, we generated an operating loss for the fiscal year of $165 million. This compares with an operating loss of $55 million for the prior year.

Turning next to the fourth quarter, net sales for the fourth quarter of fiscal 2009 were $154 million. Fourth quarter net sales were driven primarily by new releases, WWE Legends of Wrestlemania, and Warhammer 40,000 Dawn of War 2. This compares with net sales of $218 million in the fourth quarter of fiscal 2008, which were drive by new release, Frontlines Fuel of War, and strong carry-through of holiday releases, such as MX versus ATV Untamed, and WWE Smackdown versus Raw 2008.

Unfavorable currency exchange rates decreased our fourth quarter net sales by $18 million year over year. Software amortization at 37.8% of net sales was 7.3 percentage points above the prior year quarter, due to lower net sales of new releases compared to last year.

License, amortization, and royalty costs of 8.6% of net sales increased by 2.5 points compared to the fourth quarter of last fiscal year, due primarily to the greater sales mix of licensed properties this year.

Product development expense of $22 million decreased by approximately $11 million compared to the prior year period, primarily due to the closure of seven studios under our business realignment plan.

Selling and marketing expenses were $20 million, or 13% of net sales, down significantly from $39 million, or 18% in the prior year quarter. The decrease is due to the substantial advertising spend last year to launch new original IP front liners Fuel of War. In addition, fiscal 2009 Q4 employee expenses decreased under our business realignment plan.

G&A expenses were $15 million, down slightly from $16 million in the prior year quarter. The benefits from our business realignment plan were partially offset by roughly $3 million of bad debt expense in Europe. We are currently negotiating with our insurance carrier to recoup a large portion of this expense; however, we have recognized the full amount in Q4.

As a result, we reported a fiscal 2009 Q4 operating loss of $42 million, which was slightly better than the operating loss of $43 million we reported in the prior year. Interest and other income of $80,000 declined from $2 million a year ago, due to lower interest rates earned on a lower investment balance.

During the 2009 fourth quarter, we reported an income tax benefit of $5 million. This benefit reflects our year-end true-ups, resulting in an annual effective tax rate of 34%, which is slightly below the high 30s rate we had expected, due to additional foreign taxes and a reduction in R&D credits. In the same quarter last year, we reported an income tax benefit of $16 million.

The net loss for the fourth quarter was $36.4 million, or $0.54 per diluted share. This compared with a net loss of $24.8 million, or $0.37 per diluted share in the prior year quarter.

In summary, we generated a similar year-over-year fourth quarter operating loss on lower net sales, driven by lower product development and selling and marketing expenses, partially offset by higher software amortization and bad debt expense. In addition, our net loss reflected lower tax benefit versus the prior year.

Now let’s turn to the balance sheet -- THQ ended the year with $141 million, or $2.10 per share in cash and short-term investments. This compares with $144 million at the end of Q3. Excluding the impact of roughly $4 million of cash charges from business realignment actions during the fourth quarter, our cash balance was essentially unchanged since the end of Q3. Obviously we are pleased that we stabilized our cash balance.

In addition, we had $11 million in long-term investments net of borrowings on our auction rate securities.

Net accounts receivable of $60 million decreased from $113 million at the prior year-end. This decrease is primarily due to lower net sales in the fiscal 2009 fourth quarter versus a year ago.

Accounts receivable reserves of $101 million at quarter end compared to $113 million at the prior fiscal year-end. The coverage ratio on the trailing nine months of net sales basis was 11%, up slightly from 10% in the prior year-end quarter. Inventory was $26 million, down from $38 million at the prior fiscal year-end, due to tighter inventory management.

Capitalized software development decreased to $162 million at year-end from $181 million at the prior fiscal year-end. This decrease reflects net amortization and impairments discussed previously as well as $63 million for projects cancelled under our business realignment.

The March 2009 balance includes our investment in key Q1 releases, such as UFC 2009 Undisputed, Red Faction Gorilla, and UP.

Total current liabilities of $190 million includes $57 million related to our joint venture with Jack Specific, which has been accrued at the payment rate that expired in June 2006. We are currently engaged in arbitration with Jack’s to determine the new rate, which we expect to be significantly lower. Until the new rate is established and any amounts determined to be due Jack’s are paid, the accrual balance will continue to grow.

In addition, approximately $21 million of current liabilities relate to $14 million of deferred revenue. That is no impact on cash -- as well as $7 million of employee expenses that are not incremental to our cash spend.

Our total stockholders equity was $307 million.

And that concludes the financial results for the fourth quarter of fiscal 2009.

Now I would like to share with you our outlook and perspective on our business for fiscal 2010.

We expect our fiscal 2010 net sales to be similar to those reported in fiscal 2009. Our fiscal 2010 net sales will reflect a more focused product portfolio covering each of our strategic segments -- core, fighting, kids, mass appeal, and online.

Directionally, with respect to quarterly revenues throughout the year, we expect Q1 to be up year over year, Q2 to be down, and Q3 and Q4 to be similar to the prior year. We remain keenly focused on returning to profitability and generating cash flow that is significantly higher than the operating income in fiscal 2010.

Our goal to return to profitability is driven by four primary factors. First, we have achieved our targeted $50 million in annual savings from selling, general, and administrative expenses.

Second, we expect our product development expense to be lower in fiscal ’10, as reflected in the run-rate you saw in Q4 of fiscal 2009.

Third, we expect lower software amortization in fiscal ’10 versus the prior year, due to a lower starting balance and lower total spend during the year, and fourth, we expect to significantly improve our fiscal ’10 gross margin after product costs, due to our expectation to ship fewer units at a higher average selling price. This is due to a greater mix of sales expected from higher priced titles, including UFC 2009 Undisputed, Red Faction Gorilla, Darksiders, and MX Versus ATV.

In addition, we expect price protection to decline in fiscal ’10, given our stronger product slate and tighter inventory management by both us and retail.

With respect to cash, we expect our fiscal ’10 year-end cash balance to increase by at least $50 million versus our balance at March 31, 2009.

Our cash flow forecast reflects that $170 million in savings from our business realignment, plus lower cash spend on product purchases and licensed payments. I want to be clear that this does not include any amounts now accrued to Jack Specific

It is important to note that despite this increase in cash by the end of fiscal ’10, consistent with our historical seasonality, we expect our cash balance to decline in the June and September quarters, and then to rebound significant in December as we collect cash from holiday sales.

Earlier today we announced a commitment with Banc of America for a new $35 million credit facility. We expect to complete this process with Banc of America by July 5th.

While we do not currently plan to access this line, in this economic environment we thought it was prudent to have a line in place as a back-up measure.

Now I would like to spend a few minutes talking taxes. Beginning in fiscal 2010 for non-GAAP purposes, we have determined to adopt the fixed five-year projected tax rate to evaluate our operating performance, as well as to forecast, plan, and analyze future periods.

Based on our current five-year projections, we expect to apply a 15% tax rate to our non-GAAP operating results, starting in fiscal ’10. This rate has been determined based on a combination of factors. We expect to report various AMT and state and local taxes in the U.S., as well as tax on income from foreign operations, offset by the utilization of NOLs and R&D tax credits.

From a GAAP perspective, we expect to report $5 million to $10 million in tax expense per year for the next several years, with fiscal ’10 coming in at the low end of that range. This amount represents expense incurred and cash paid, primarily on foreign operations.

Now looking forward to the 2010 fiscal first quarter, while we are not providing specific guidance, we expect net sales to be higher than the same quarter a year ago, based on a stronger new release schedule. This year we plan to launch UFC 2009 undisputed on Xbox 360 and PS3, Red Faction Gorilla and Disney Pixar’s UP on multiple platforms. This compares with the release of WALLE and Big Beach Sports in the first quarter of last year.

With three big releases in the quarter, we expect our software amortization to be higher on both a dollar and a percentage basis in this quarter, relative to the first quarter of last year, and selling and marketing expense to be a similar percentage of net sales as the prior year.

In closing, as Brian has said, fiscal 2009 was a tough year. Looking forward to fiscal ’10, our focus is on executing on our product slate and continuing to manage costs in order to generate positive cash flow and return to profitability.

And with that, I will turn it back to Brian.

Brian Farrell

Thank you, Paul. Earlier on the call, I shared with your our five point product strategy. Now I will review our fiscal ’10 lineup, which includes key drivers in each of these targeted categories.

First, core gamer titles -- we are looking forward to the launch of two important core gamer titles during fiscal ’10. Red Faction Gorilla is scheduled for launch on June 2nd. We expect this game to be highly rated and we are pleased with consumer and retail response to our recently released single player demo. A compelling multi-player demo, which showcases Red Faction Gorilla’s unique destruction technology, is scheduled to release later this month. We have a strong campaign to continue to build buzz leading up to the June 2nd launch.

Darksiders, an ambitious and promising new franchise for THQ, is scheduled for the back half of this fiscal year. We are currently determining the most advantageous launch window for this exciting action adventure game that will be featured at the upcoming E3 trade show in June.

Second, with respect to fighting, the launch of UFC 2009 Undisputed is right around the corner. As you have probably seen, the game looks great and plays terrific. We are very pleased with pre-orders on this title and are looking forward to expanding our leadership in the fighting genre with this game. We’d like to thank Dana White and the entire UFC organization for being such great partners in promoting and supporting this game.

Our fiscal 2010 holiday slate will be anchored by the perennial multi-million unit seller, WWE Smackdown Versus Raw 2010.

Third, our kids lineup -- our fiscal 2010 plan includes our first games based on Marvel Superhero Squad. This exciting new game features all of the favorite Marvel characters in a new setting and art style, and we are looking forward to unveiling the title at E3 in a few weeks. We look forward to launching the new games based on Disney Pixar’s UP later this month. This holiday, we are delighted to be bringing back one of the strongest brands in kids video games, Cars, with Cars Race-a-Rama.

Finally, we expect Nickelodeon’s celebration of Spongebob’s 10th anniversary to be a strong tent pole marketing event to generate interest in this year’s Spongebob videogames.

Fourth, mass appeal and family games -- later in the year, we plan to release the latest installment in our successful MX versus ATV Off-Road Racing franchise. We will also release several other mass appeal and family games for the Nintendo Wii and DS, including the recently announced All-Star Cheer 2.

In addition, we will be unveiling three exciting titles in this category at E3 next month. 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, online -- we currently have two fiscal year ’10 online initiatives. We look forward to launching Company of Heroes online in China with our partner, Shanda, 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 through our joint venture with ICE Entertainment. This free-to-play micro transaction based MMO is currently scheduled to launch this fall with beta testing currently scheduled for summer.

In summary, we have a strong fiscal ’10 lineup that reflects our focused product strategy. Combined with our aggressive cost reduction actions, we have positioned the company to return to profitability and generate cash in fiscal 2010.

In addition, we have a strong studio system and we are investing in the brands and games with the highest potential to drive THQ's long-term profitable growth. We look forward to executing on our strategy with strong franchises and the support and commitment of our dedicated and hard-working employees.

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

Question-and-Answer Session

Operator

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

Tony Gikas - Piper Jaffray

Thanks. Good afternoon, guys. A couple of questions -- and maybe we could just start with the restructuring -- in dollars, what is the expected non-GAAP decline to operating expenses in fiscal ’10 relative to fiscal ’09?

Second question, we’ve recently had some soft software and hardware trend data from NPD. Any concerns, Brian, in that regard, particularly on the hardware side? And have we seen those soft trends through April?

And then the last question, maybe you could just give us an update on your view of growth in the market for calendar ’09? Thanks.

Brian Farrell

Let me start with the second two-thirds of your question, Tony. The way we are thinking about the year, yeah we had two good months according to NPD in January and February, growth months. March was down month over month. Our view on that was there weren’t any -- as many compelling new releases, and as we get later in the year, the next several months, we have some pretty tough comps that get a little better later in the year. You know, net, net, net -- we are still in the flat to up mid-single-digits in our key markets which are North America and Europe. Obviously currency can swing those things just a little bit so we are still in that flat to mid-single-digits with respect to software.

On hardware, sort of a similar theme -- you know, nothing really happened with respect to hardware in the March month. We are pleased with Microsoft’s momentum at their price point. We are seeing a little softness in the Wii which we kind of think of the glass as half full here, in that the Wii has been going for an unprecedented amount of time without a price reduction, so we just may be seeing some both economic and the fact that they’ve already got a pretty substantial installed base at their original price point.

The challenging platform obviously is the PS3. The right people to ask about price cuts there are Sony. We are not expecting a price cut at E3 but we do expect one later in the year but again, that’s just our guess -- that’s not based on any knowledge from Sony.

Paul J. Pucino

Total realignment for fiscal 2009, our total expense was about $89 million, and for fiscal ’10, we estimate we have about $10 million left.

Tony Gikas - Piper Jaffray

Okay. And then Brian, I guess the hardware, there’s nothing concerning to you in the hardware trends to date?

Brian Farrell

No, actually the year is very much playing out as we suspected so far, Tony. So the answer to the question is no. What I said about the three different platforms is the feedback that we’ve been getting from our retail partners.

Tony Gikas - Piper Jaffray

Okay. Thank you, guys.

Operator

Our next question comes from the line of Colin Sebastian of Lazard Capital.

Colin Sebastian - Lazard Capital Markets

Thanks. Good afternoon. I was hoping you could break out the portion of revenues you are expecting over the coming year from licensed titles versus owned IP. And then overall, what your planned SKU count is for the year -- how does it compare to fiscal ’09?

Brian Farrell

With respect to our SKU count, as you might expect, our SKUs are down from about 58 SKUs last year to 56 this year. The important thing with our focus is those 56 SKUs are based on 20 titles this year, rather than 30 titles last year, so it’s a much more focused product line.

Paul J. Pucino

And with respect to revenues, 55% revenues are licensed, 45% are owned.

Colin Sebastian - Lazard Capital Markets

Those were this past year or the plan for the coming year?

Paul J. Pucino

That’s the plan for fiscal ’10.

Colin Sebastian - Lazard Capital Markets

Okay. Thanks very much.

Operator

Our next question comes from the line of Arvind Bhatia of Sterne Agee & Leach.

Arvind Bhatia - Sterne Agee & Leach

Thanks. Good afternoon. Brian, I wanted to understand what you are doing, specifically for UFC in terms of marketing, your budget relative to some of your other bigger games. And then on World Wrestling, are you doing anything different this year to bring it back to the levels? You know, you’ve had obviously unprecedented success in ’07 but are you thinking that we can get back to those levels? Or do you think that UFC may not eat into it but just to the extent that there is some overlap and the audience just won’t understand how you are thinking about the two main franchises.

Brian Farrell

With respect to UFC and WWE, we’ve been very clear on the last several calls -- we view these as two very different brands, a slightly different demographic and we treat them very differently. As you know, UFC is a real sport. We think, and based on our reconnaissance with our retail partners, we think this has a chance to be one of the top three sports titles for the year.

With respect to marketing, again our objective here in the first year is to do perfect execution on the brand -- what that means is a quality product, we think we’ve got that; a very full marketing program, that includes both traditional media like print and TV, doing a lot of online media. And as I mentioned in my prepared remarks, UFC has been a tremendous partner. If you watch any of their pay-per-views or their television show or even some of the things they have done online, they have done a lot of promotional work with us on the game. I think it is fair to say, like everyone else, they love the game. So it’s a full marketing program intended to establish this as one of the solid sports franchises.

On WWE, it’s a little more complicated. As you know, we’ve been doing WWE for almost 10 years and that brand ebbs and flows based on the popularity of stars at any point in time. And it also relates to where we are on the platform cycles. In the past platform cycles, it’s taken a year or two longer for the WWE consumer to migrate to the next generation of platforms, and we are in the midst of a pretty nasty recession which we think is hurting the WWE consumer a little more than normal.

So we’ve conservatively planned the WWE franchise down slightly this year but certainly if the platform transition happens more quickly, if the brand exhibits more strength, you know, obviously there’s some upside to that.

Arvind Bhatia - Sterne Agee & Leach

Okay, and then a question for Paul -- just the cash situation -- on the balance sheet there is $30 million of amount in long-term that is pledged. I think you said there was $11 million in ARS. I just want to understand exactly what the cash is right this second.

And then, net of the cash payable to Jacks, kind of where the guidance is implying numbers to be.

Paul J. Pucino

With respect to cash on the balance sheet, at this point in time, as we’ve said, cash and short-term investments of about $141 million, and to be clear, that compares to $144 million at the end of the December quarter, so we are very pleased that our cash balance has stabilized.

In fact, as I said in my prepared remarks, if you exclude the cash we paid during the quarter for the restructuring, which was about $4 million, our cash balance would have been flat quarter over quarter. So again, $141 million as of March 31st.

With respect to the long-term investments, the auction rate securities, if you look at our balance sheet and you see $30 million of long-term investments pledged and $5 million of long-term investments, that totals about $36 million. They are the auction rate securities, $30 million of which we have pledged and received the cash for. So if you go down a little further on the balance sheet, you see that we have a secured credit line of $24 million. So we’ve already received that cash with respect to the auction rate securities. These auction rate securities are scheduled to redeem no later than July of 2010, at which point in time the debt would be paid off at that point in time.

So if you want to think about our cash, it’s $141 million in cash and short-term investments, and the net between the assets on the books, which are long-term auction rate securities, and the debt is about another $10 million to $11 million.

Arvind Bhatia - Sterne Agee & Leach

Great. Thank you, guys.

Operator

Our next question comes from the line of Heath Terry of Friedman Billings Ramsay.

Heath Terry - FBR Capital Markets

Great. Thank you. Brian, I was wondering if you could just give us a sense as you look at where your incremental development dollars are going for next fiscal year, where we should expect to see kind of platform shifts, if we should continue to expect your development shift to go towards the Wii, or should we expect something more static with what we are seeing this fiscal year.

Brian Farrell

Yeah, I think the growth you will see in fiscal ’10, if you are talking about fiscal ’10, Heath, yeah, we’ll see growth. If you just look at our release schedule, particularly with the big brands like UFC, Red Faction Gorilla and Darksiders, you will see a little more emphasis on the 360 and PS3. The Wii, again we grew it -- you know, we almost doubled our percentage of revenues from Wii last fiscal year to about 17%. Directionally that’s where we think we will be in the current fiscal year, so we like the Wii but it is -- you know, our development dollars are really spread to the platform opportunities, sort of relative to where they are in the marketplace.

As we look further out, again I really encourage you to come to our event and our booth at E3 because when you talk about incremental development dollars, you will see a couple of exciting new titles for fiscal ’11 and we’ll give you a little glimpse of what we are thinking about for fiscal ’11 and beyond that, E3.

Heath Terry - FBR Capital Markets

Okay, yeah, I was really looking more towards fiscal ’11 and the new stuff that is going -- being put into development now.

Brian Farrell

Yeah, again there’s a couple of things that we will be highlighting at E3 that we obviously are very excited about. The MMO, as you might expect, is a consumer of development dollars, and as you also know, the Wii, we can have a broad range of both budget and full-priced titles without the same level of investment in terms of investment dollars, which was specific to your question. As you know, the Wii is not as expensive to develop for as the 360 and PS3, so when you talk about investment dollars, they are more skewed to 360, PS3, and then PC online.

Heath Terry - FBR Capital Markets

Great. Thanks, Brian.

Operator

Our next question comes from the line of John Taylor of Arcadia.

John Taylor - Arcadia Investment

I have a couple of questions too -- Brian, if you look at the five product categories, the way you are thinking about it, I wonder if there’s a way you could give us a sense of how much the break even has come down in terms of units in each of those categories, because obviously the cost to go to market, to develop and go to market is different on each of those. So that’s -- I wonder if you could help us understand that. That’s the first question.

The second question is what is your current NOL?

The third question on UFC and the Red Faction, I wonder if you could give us how many downloads, demo downloads there have been on live and so on. And I guess that probably does it. Thanks.

Brian Farrell

Okay. I wrote as fast as I could, JT. If we miss something, come back to us.

On the five categories, I mean, that’s why we are comfortable with our strategy in several of the areas and let’s talk about three of them first -- with respect to fighting, kids, and the mass appeal, fighting we’ve been in for a long time. We understand how to do that, so we are very comfortable with the break evens there and I think those have been relatively stable, if not coming down a little bit over time.

Clearly on kids and mass appeal, the reason we like those markets is the break evens are relatively low. On a game like Big Beach Sports, I mean, our break even was very low and it’s been extremely profitable because we put out big units on a very low investment. So on those three categories, we are either flat or declining break even.

Online, it depends on the segment of that market. You know, we like the way we’ve structured a couple of our initial online investments. We have really no net investment in the Shanda deal, yet we’ve extracted a lot of learning from that. Getting into the casual MMO space, we did a joint venture, as you know, so I think it was a very smart deal. That being said, the MMO was a pretty significant investment but we love the prospects for that brand.

The only area where the break evens are challenging for us and the industry is in the core area. If you are going to compete in that segment, you’ve got to have game play, storyline, technology, marketing spend, that drive you home with that core consumer. And that’s the one segment where the break even points are still relatively challenging, which is why we said let’s just focus on one to two per year.

John Taylor - Arcadia Investment

I wonder if -- I guess what I am trying to get at is if you look at kids, mass appeal, and maybe the core, is there a range you might give us, you know, high, low, sort of that you are shooting for in terms of break even on units in each of those categories. Granted, I am sure the budgets within the core area are different too but it would be nice to know you could break even on 700,000 or 800,000 on one of those games. Is that ridiculous?

Brian Farrell

On the core titles, yeah, 700,000, 800,000 units, those days unfortunately we think are over. But within the kids segment, the break evens are very low -- I mean, depending on the title, how many SKUs you do, per SKU your break-evens are, depending on the platform, could be somewhere between even 100 and 400,000 units.

On the mass appeal, the beauty of that business is those are all driven by consumer trends, the type of game play and not necessarily cost. And we have seen some very, very low break-evens. You know, as you move up the food chain and we get more complex on things like The Blob, the breakeven would go up. So I would give you a similar range, sort of 1 to 440,000 units, in those areas.

So fairly low in the kids and mass appeal as you might suspect but much higher on the core titles.

And then to go to your other question before I let Paul talk about the NOL is with UFC and RFG, with UFC, what Microsoft has advised us is that game is in the top 1% of all downloads for game demos to date on the Xbox Live service, and Red Faction is in the top 7% of downloads for games. And both of those are weak figures for figures in a week, so we are very pleased with the demo downloads with respect to those.

Paul J. Pucino

And with respect to NOLs, as of March 31st, we had about $330 of NOLs.

John Taylor - Arcadia Investment

Okay. Very good. Thanks.

Operator

Our next question comes from the line of Edward Williams of BMO Capital Markets.

Edward Williams - BMO Capital Markets

Good afternoon. Brian, could you talk a little bit about the relationship with Shanda and Company of Heroes, how we should think about it financially, and the impact in the Chinese market versus other markets in Asia as you bring that game out to other territories.

Brian Farrell

Yeah, the deal was that Shanda would pay for our development costs to convert the game from a straightforward, real-time strategy game, RTS, to this free-to-play model. And in the exchange for that, we are getting a royalty on every micro transaction in China, and that’s the deal with them. We also have the rights to take the game -- we do have to build our own lobby system, which is not a significant investment, but we do have to do that, for all the other markets and we are in the process of doing that. And once that is completed, we can either operate the game or partner with an operator in any other territory in the world and for that, we pay back to Shanda a royalty and a return, so that’s the structure of that deal.

Edward Williams - BMO Capital Markets

When do you expect the game to be live in China?

Brian Farrell

Yeah, that’s the tough one -- really, we’re waiting for final government approval of the content and as soon as we have that, we will go open beta and after that, it will be a very short period from open beta to launch. It’s just -- you know, we have no experience with the Chinese Government approval process. That’s why we partner with Shanda. We believe it’s forthcoming but again, that’s -- we just don’t know.

Edward Williams - BMO Capital Markets

Okay, and then just looking at your guidance for the year, how material is Company of Heroes to the year?

Brian Farrell

Again, since it’s such a new and unknown market, we haven’t forecasted virtually anything for that.

Edward Williams - BMO Capital Markets

Okay. And then looking at the $220 million that you are talking about in kind of reduced spending, reduced brand spending in FY2010, can you phrase that number a little bit differently and maybe give us a comparison to what the non-GAAP ’09 spending, what the delta would be relative to non-GAAP ’09 spending was, or maybe directionally what you are budgeting for spending to be in FY2010?

Brian Farrell

We said that the PD spend was about $170 million lower than we had originally budgeted for fiscal ’10, and that number is about $120 million lower than the run-rate, the non-GAAP run-rate that you saw for fiscal ’09. So is that clear?

Edward Williams - BMO Capital Markets

Yeah.

Paul J. Pucino

And then there’s $50 million of G&A as well.

Edward Williams - BMO Capital Markets

Okay.

Brian Farrell

And that’s non-GAAP to non-GAAP.

Paul J. Pucino

Exactly.

Edward Williams - BMO Capital Markets

Okay, and then also, can you just talk a little bit about -- there’s been game developers -- OnLive spoke about a new platform just to do kind of streaming of games to PCs or even to TV sets, and then there is speculation about a new PlayStation portable that would be download only.

What is your thought with the -- with regard to the consumers’ willingness to adopt to an online only or a download only business model at this point?

Brian Farrell

I mean, obviously consumers have shown a propensity to adopt digital means for consumer their entertainment. I mean, look at iPods, DVRs -- I mean, digital ownership is certainly something that has happened. I mean, entertainment being on demand is part of what consumers have said they wanted. And obviously, just to restate, we’ve always said we are going to be platform and delivery method agnostic with respect to our entertainment.

So it’s happening, Edward, and we all know that. The question is how quickly and what’s the model. You know, we like the technology behind OnLive we know the team reasonably well there, It’s a very fascinating new service but that being said, it is new and again, there’s a lot of different models. Xbox Live is a tremendous service. I mean, it’s a very user-friendly online game service. So these things are happening.

Another thing I would point out is on our very successful launch of Warhammer Dawn of War II, we were surprised, I think just short of 20% of our sales on the games were digitally downloaded by consumers, the highest we’ve ever had. So this trend is happening and will continue. How quickly it will be, that’s really up to the consumer. Our strategy is to meet our consumer where they want to consume their entertainment.

Edward Williams - BMO Capital Markets

Okay, great. Thank you.

Operator

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

Douglas Creutz - Cowen & Company

Thanks. [inaudible] has been probably your most consistent owned IP studio and you’ve gotten [inaudible] out of them last year and Red Faction this year -- do we expect to see a game for them a year, going forward? Do you think we can get more than a game a year from them? What are your plans with regard to the studio?

Brian Farrell

Well, first of all, [inaudible] has been a terrific studio for, gosh, I think we’ve owned them eight or 10 years. A terrific studio, one of our larger studios. There are two plus teams there, so that’s the capacity there.

With respect to the cadence, that just depends on the scope and timing of each project -- you know, how they fall into each fiscal year we are not prepared to comment on now but yeah, they have the capacity to do at least two projects at a time, and really more like 2.5, I think. One or more of the prototype phase and two in full production.

Douglas Creutz - Cowen & Company

All right, thanks.

Operator

Our next question comes from the line of Justin Post of Banc of America.

Justin Post - Banc of America

Thank you. I would like to get into the cash flow guidance. If you -- what was our operating cash flow for 2009?

Paul J. Pucino

Well, look at it this way -- in fiscal 2009, our cash balances went down by about $220 million.

Justin Post - Banc of America

Okay, and so you are positive 50 this year, and I think you said that you are going to be cutting costs by about 170 in total on a run-rate basis, so is there any implication there on your profitability or are some of the balance sheet accounts going to start going in your favor when you look out to next year? How do you see that working?

Paul J. Pucino

Good question -- so if I can frame it a little differently, we burn through about $220 million this year. We say we are going to generate in excess of $50 million in fiscal ’10, so there’s a swing there of $270 million -- $170 million we cut out through our business realignment -- that took place already in fiscal 2010, so that leaves about another $100 million or so. That’s going to come from a number of areas.

Number one, as we said, we are going to have relatively flat revenues year over year but we are going to be selling fewer units at a higher average selling price, therefore our cost of goods sold, the product portion of cost of goods sold, is going to go down and could go down pretty significantly.

We also are going to be paying less in licenses in fiscal ’10 relative to fiscal ’09. We had three or four big license payments that took place in fiscal ’09 that are not going to be repeated in fiscal ’10. And then we actually paid about $20 million or so in cash for realignment activity that took place in fiscal ’09 that will not repeat in fiscal ’10 as well.

So if you look at it that way, so you take the 170 out, you are trying to reconcile about 270. You take 170 out that we’ve already talked about, you’d have lower COGS and you have lower license payments and you don’t have some of the realignment expenses on a cash basis that took place this year as well.

Justin Post - Banc of America

Okay, well, we can talk about the math on profitability offline on that. And then Brian, on Darksiders, when you think about that, I think it’s a September title -- anything you can talk about what you are hearing from retail on that? And what’s kind of the real niche there or the kind of advantage that the company is putting out than other titles that are out there?

Brian Farrell

I said in my prepared remarks, Justin, Darksiders is going to launch in the back half of our fiscal year, which implies Q3 or Q4. And the niche that product occupies, first of all, it’s probably one of the most beautiful games on either the PS3 or 360 -- visually stunning. Again, we are going to give it a big unveiling at E3 and you will see what we mean. It’s got an incredibly rich story. Joe Madureira, the comic book sort of Rock Star artist, is the lead art guy on that and so the whole presentation of the game is fantastic. There’s a variety of different kinds of weapons -- again, I don’t want to get too deep because I want to save something for the unveiling but it’s a very special action adventure game. We showed it at destination PlayStation a couple of months ago and we received a very enthusiastic response.

So pursuant to our strategy, we want to make sure we nail the product quality. We think we are on track for that. We believe strongly we are on track for that. We have very high expectations for this game on a quality standpoint. The second key thing is we’ve got to build the marketing buzz. That’s going to -- you are going to see the pedal go to the metal starting at E3. And the third thing is picking an appropriate launch window and by E3, I think we’ll pick that window.

Justin Post - Banc of America

Okay, and last question -- any way to frame the size of the UFC audience based on the number of people that do a pay-per-view or number of attendees at events during the year? Any thoughts on that?

Brian Farrell

Big. Seriously, Justin, we were kind of knocking our heads over on how big this brand can be -- it feels very strong. We like all the metrics we are seeing, both on some of the traditional buzz metrics. You know, we talked about downloads before. Pre-orders are strong. Again, the brand itself is red hot. The pay-per-views -- it’s the number one pay-per-view that we track, so it feels very strong but we just don’t know how high that potential is yet. We are very excited but we will begin to get some of those answers in two weeks.

Justin Post - Banc of America

Thank you.

Operator

Our next question comes from the line of Todd Mitchell of Kaufmann Brothers.

Todd Mitchell - Kaufmann Brothers

Most of my questions have been asked -- I just want to ask one real question with regard to retailers -- you sort of talked about hardware/software demand, how are your retailers acting differently in this environment? Have you lost any major retailers in North America or Europe? And basically how are their order patterns changing?

Brian Farrell

With respect to the order patterns and just the behavior, it’s been a bit of an up and down thing. As we talked about on our last call, and I think our competitors were very consistent in this as well, the buying patterns last fall, retail did seize up and buying patterns were very inconsistent and I think it cost us all a lot of business in the last holiday period.

It normalized in the first quarter. We were pleased with our catalog sales in the first calendar quarter, the January to March timeframe, as retailers did restock their shelves and seemed to loosen up a little bit. Now, let me not overstate that -- it went from seized up to a little bit looser. We expect retailers to continue to be very disciplined, that they will buy what they think is the right amount of an opening order and chase winning titles. They have been doing that for some time now and we don’t think that is going to change. I think the days of loading insignificant quantities and hoping are over. You’ve got to have a great title, you’ve got to show this marketing and buzz, and I don’t think that’s going to change.

So I would characterize retail now as better than it was in the fall but it’s still very disciplined. As you know, we are have Circuit City has gone bankrupt, so we do have that retailer has gone from the U.S. landscape, and then we had a couple of retailers -- or excuse me, one wholesaler and one retailer in the U.K. go under, fairly widely chronicled. I think Paul spoke to in his prepared, we had some credit write-offs with respect to those. Those retailers are on our last fiscal year.

So the landscape seems to have stabilized but that’s the way it looks today.

Todd Mitchell - Kaufmann Brothers

Thank you. And I apologize if you already spoke to this -- this year’s catalog as a percent versus last year’s, or even if you can give us a percent as guidance?

Paul J. Pucino

Yeah, for Q4 it was 20% and for the full fiscal year, it was 23%.

Todd Mitchell - Kaufmann Brothers

And how do you expect that to trend in fiscal ’10?

Paul J. Pucino

At this point in time, we are not getting into specific guidance but relatively flat.

Todd Mitchell - Kaufmann Brothers

Okay. Okay, thank you very much.

Operator

Our next question comes from the line of Eric Handler of MKM Partners.

Eric Handler - MKM Partners

Thanks for taking my question. With regard to your revenue outlook and when you look at your five buckets, it seems like you should get nice revenue boost from your fighting, from the fighting bucket with UFC. Can you talk about how we might think of the other categories if your revenue is going to be flattish?

Brian Farrell

Yeah, the one area where I think we are a little more challenged this year is in our kids business. You know, as we’ve said a number of times -- I’m not sure if we said it on this call, we are planning the Disney Pixar film UP down this year from WALLE last year and we are planning the Nickelodeon business down this year versus last year as well. We are uncertain with the new brands like Cars and the Marvel product will offset those, so that’s the way to be thinking about it directionally.

Eric Handler - MKM Partners

And the core gamer category?

Brian Farrell

Core should be slightly up based on the fact we have both Darksiders and Red Faction Gorilla comping against Saints Row 2 last year.

Eric Handler - MKM Partners

Perfect. Thank you.

Julie MacMedan

Great. We have time for one more question, please.

Operator

Our next question comes from the line of Jeetil Patel with Deutsche Bank.

Jeetil Patel - Deutsche Bank

Great, thank you. A couple of questions -- on the five categories that you kind of segmented the business in, can you talk about where, as you look at this year, where do you think the biggest improvement in contribution profits will come from, which division? I guess that encapsulates both obviously volumes, prices, and obviously costs coming down on software re-use, but if you could address that real quick by category, where you think the biggest improvement is. And then I just had a quick follow-up question as well.

Brian Farrell

Probably fighting just because we should get good leverage on the UFC title, we believe, on the volumes we are expecting. Core should improve again, just because we have two fairly significant releases versus one. That being said, even though it’s a smaller segment of our business, we love the mass appeal business. The P&L on that business looks really good. It’s a smaller business relatively as it relates to size of our business, but based on the development costs there, the P&Ls are pretty attractive.

Jeetil Patel - Deutsche Bank

If I look at the P&L a little bit differently than the way Justin described or the question he had, which was if you look at your total costs and OpEx, it ran at about $970 million on a non-GAAP basis for 2009, and if I back out the $170 million in realignment costs and $20 million in cash realignment that you’ve already taken, it’s probably like $200 million. If I adjust that out and kind of compare that against the revenue base that you were kind of looking at for this year, is that a good idea of how we should look at the profitability for this year?

Paul J. Pucino

Again, if you could maybe go through, I want to make sure you didn’t double count there -- so you said you took out $170 million.

Jeetil Patel - Deutsche Bank

Yes, and then if I -- I don’t know, I think the $20 million in cash realignment that you already pointed out, if that comes out or not incrementally but at the very least, you take the $170 out and that gets you to about a cost base of about $800 million, maybe less, against the revenue base that you have this year. Is that a good way to look at it or…

Paul J. Pucino

That is a good way of looking at it and to be clear, I think the numbers you are looking at are non-GAAP and the $20 million would not be included in there.

Jeetil Patel - Deutsche Bank

Okay.

Paul J. Pucino

For realignment expense -- but that’s a good way of looking at it.

Jeetil Patel - Deutsche Bank

Okay. Thank you.

Julie MacMedan

Great. Operator, we would like to conclude the call.

Operator

And this concludes today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: THQ F4Q09 (Qtr End 3/31/09) Earnings Call Transcript
This Transcript
All Transcripts