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THQ, Inc. (THQI)

F1Q 2007 Earnings Conference Call

July 27, 2006 5:00 pm ET

Executives

Julie MacMedan - Director, IR

Brian Farrell - President, CEO

Ed Zinser - EVP, CFO

Analysts

Colin Sebastian – Lazard Capital Markets

Anthony Gikas – Piper Jaffray

Edward Williams – BMO Capital Markets

[Lauren Fine] – Merrill Lynch

John Taylor – Arcadia

Elizabeth Osur – Citigroup

Arvind Bhatia - Sterne Agee & Leach

Paul-Jon McNealy- American Technology Research

Lowell Singer – Cowen and Company

Jason Kraft – Susquehanna Financial Group

Presentation

Operator

Good day, ladies and gentlemen. Thank you for your patience and welcome to the first quarter 2007 THQ earnings conference call. (Operator Instructions) I would now like to turn this presentation over to your host for today’s call, Ms. Julie MacMedan, Director of Investor Relations. Please proceed, ma’am.

Julie MacMedan

Thank you. Thank you and good afternoon, everyone. Welcome to THQ’s fiscal 2007 first quarter conference call.

Before we begin, I’d like to remind everyone that during this conference call management will make forward-looking statements and projections regarding our expectations, estimates and projections of the future. These statements about our business are based in part on assumptions made by management and are not guarantees of future performance. Therefore, actual results may differ materially from today’s forward-looking statements due to several risk factors which are described in our March 31, 2006 Form 10 K. A copy of this filing may be obtained from our web site.

The forward-looking statements made on today’s call are as of July 27, 2006 and we disclaim any duty to update them.

In addition, we will discuss non GAAP measures in describing THQ’s financial performance. 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, THQ’s President and Chief Executive Officer will review our recent accomplishments and will then turn the call over to Ed Zinser, our Chief Financial Officer, who will review the company’s operating results and financial outlook. Brian will then close with a discussion of our plans for fiscal 2007 and long-term growth. We will then conduct a question-and-answer session following prepared remarks.

I would now like to turn the call over to Brian Farrell, our President and Chief Executive Officer. Brian?

Brian Farrell

Thank you Julie, and good afternoon, everyone. THQ’s fiscal 2007 first quarter results exceeded our expectations due to the strength of our new releases.

During the quarter, we shipped more than 2 million units of games based on Disney/Pixar’s Cars. According to the NPD Group and GFK Australia, Cars achieved the No. 1 ranking in the U.S. and Australia for the month of June. On both a sell [end] and sell true basis, Cars videogames are outpacing the sales of our games based on Finding Nemo and The Incredibles during a comparable timeframe. We are pleased with Cars’ early success in the U.S. and Australia. Cars is also off to a strong start in the U.K., ranking No. 1 on the full-price chart in its first week of sales, even before the movie opens in theatres tomorrow. We look forward to generating strong sales from the title as we continue to roll Cars out across Europe and Asia this summer. In the December quarter, we plan to bring the title to Xbox 360 and Nintendo Wii.

Sales of Moto GP 2006 for Xbox 360 also surpassed our original expectations. We are pleased with the increased consumer response in both the U.S. and Europe to the latest version.

At the end of the quarter, we launched Titan Quest on PC. Titan Quest marks the first of four high-end PC titles slated for our fiscal year. The game has received strong critical acclaim, particularly in Europe, driving its performance in the U.S. and abroad. Because of the late June ship date, we expect the title to contribute to our September quarter as well.

In summary, our three key product releases for the June quarter have each exceeded our sales expectations and demonstrated a high level of game quality.

Creating the highest quality games has been an important strategic initiative for THQ. We demonstrated this at our E3 trade show in May, 2006. Many of our titles, including Supreme Commander, Company of Heroes, Moto GP 2006, Frontlines: Fuel of War, Titan Quest, SmackDown vs. RAW 2007, Destroy All Humans! 2 and Juiced Eliminator earned critical acclaim at the event.

Creating high quality, innovative products is driving our continued investment in building our studio system, which now includes approximately 1,300 people located in 15 studios, up 30% from 1,000 people a year ago.

We recently acquired the Stuntman franchise and its developer, Paradigm Entertainment, and we plan to bring the Stuntman franchise to next generation platforms in fiscal 2008.

We also recently announced the formation of Incinerator Studios, a sister studio to Concrete Games. We are pleased to have secured industry veterans from Rockstar San Diego and Sony 989 for both of these studios. Concrete is working on a new original property currently scheduled for release in fiscal 2008. Incinerator is working on Cars for next generation platforms. We intend to continue to selectively add to our studio system to support our growth.

In short, our first quarter titles delivered excellent sales results. We continue to invest in our studio system and intellectual properties with franchise potential, which we view as important drivers of THQ’s long-term growth.

We were pleased with our strong showing at E3 this year and look forward to unveiling more of our internally developed original properties over the coming months.

Now Ed Zinser, our Chief Financial Officer, will review our fiscal 2007 first quarter operating results and our forecast for fiscal 2007. Ed?

Ed Zinser

Yeah. Thank you, Brian, and good afternoon. Today I’ll review our Q1 financial results, provide initial guidance for the upcoming September quarter and provide guidance for our full year.

This is the first quarter that THQ’s financial results include equity-based compensation expense [due to] the adoption of FAS 123R.

As I discuss our financial performance in more detail, I will use the non GAAP numbers, which give the true apples to apples comparison versus prior year line items.

Net sales for the first quarter of fiscal 2007 were $139 million, ahead of our guidance of 125 and 12% below the prior year quarter.

We reported a non GAAP $0.16 per share loss, which was $0.05 better than our guidance and $0.10 below the prior year quarter.

Net sales in the first quarter were driven by three new releases: Cars on seven platforms, Moto GP on Xbox 360, Titan Quest on PC. Cars and Moto GP accounted for the upside to the guidance.

The decline versus the prior year was due primarily to the launch of Cars in only North America and some international territories in Q1 2007 compared to the worldwide releases of Juiced and Destroy All Humans! in Q1 last year.

Gross margin for the quarter was 65%, the same as in the prior year quarter.

License amortization and royalty costs of 12% of net sales increased by 3 points compared to last year due to product mix. The top-selling title, Cars, a licensed property, generated approximately 40% of Q1 revenues this year prepared to the owned properties, Juiced and Destroy All Humans!, which generated approximately 40% of revenues in the prior year quarter.

[Inaudible] development amortization of 18% was up 3 points versus the prior year quarter. This is primarily due to our decision to discontinue development of the Sopranos Xbox 360 skew. There was no change to our plan to release the Sopranos on PS2 this holiday.

Product development expenses of $25.4 million were up $4.4 million from the prior year period. The key drivers were the increase in internal development headcount to approximately 1,300 from 1,000 in the prior year quarter and next generation externally developed titles.

Selling and marketing expenses were 19% of net sales, down from 23% in the prior year quarter, which included significant spending to support the launches of our owned intellectual properties, Juiced and Destroy All Humans!

G&A expenses were $13.6 million, down slightly from $13.9 million in the prior year quarter.

The net loss for the first quarter was $10.5 million, or $0.16 per share, excluding equity-based compensation expense, compared to a non GAAP net loss of $3.8 million, or $0.06 per share in the prior year quarter.

The lower bottom line primarily reflected the sale of Cars in one major market territory this year versus the worldwide launches of two owned intellectual properties in the prior year quarter.

Now let’s turn to the balance sheet:

THQ ended the quarter with $303 million, or $4.72 per diluted share, in cash and short-term investments. This represents a decrease of $68 million versus the March 31, 2006 balance and a decline of $10 million versus the prior year quarter end.

The uses of cash since March 2006 were for payments to developers such as Yukes, our WWE developer, stock buybacks, platform fees for Q1 shipments such as Cars and the acquisition of the Stuntman intellectual property and the game scheduled for launch next year.

Net accounts receivable [inaudible] of $85 million declined slightly from $86 million at June 30, 2005.

Our days sales outstanding on a rolling 12 month basis is 39 days, versus 38 days in the prior year period.

Accounts receivable reserves were $58 million at quarter end, unchanged compared to the June 30, 2005 balance. The coverage on a trailing nine month of sales basis was 7% versus 6% for the prior year quarter end.

Inventory was $38 million, an increase from the $29 million at March 31, 2006. The increase was primarily due to inventory purchases of Cars, Monster House and catalog titles. On a rolling 12 month basis, inventory turns were 9 versus 12 a year ago.

There were no significant additions or reductions to our investment in licenses, which was $80 million versus $81 million in the prior quarter end.

Capitalized software development increased to $133 million at quarter end, up from $109 million at March 31, 2006. The largest additions in the quarter were for Q2 and Q3 next generation platform releases such as WWE SmackDown vs. RAW 2007 and Saint’s Row, and for Company of Heroes on PC and the Sopranos on PS2.

Prepaid expense and other current asset increases were primarily for product-related payments international territories.

Property and equipment of $38 million was unchanged from the March 31, 2006 balance.

The increase in other long-term assets of $3.5 million was due primarily to the purchase of the Stuntman intellectual property.

Current liabilities were $145 million, down $3 million compared to the March 31, 2006 balance.

The company’s current ratio was 4.1 to 1, with working capital of $451 million, up from $409 million in the prior year.

Operating cash flow for the first quarter was negative $55 million versus negative $18 million in the prior year quarter. The net use of cash was due primarily to increased spending for software development and the net loss.

Fiscal 2007 cash flow is expected to increase a positive $43 million [inaudible] fiscal 2006.

Return on invested capital on a rolling 12 month basis was 8%.

We had no borrowings at quarter end.

[Global] stockholder’s equity was $623 million.

That concludes the financial results for the first quarter of fiscal 2007. Before I provide initial guidance for the second quarter and discuss THQ’s financial projections for the full year of fiscal 2007, I’d like to review some of our assumptions.

In a transition year, it’s even more difficult to predict market performance, software pricing and hardware installed base forecasts are subject to greater uncertainty. Nonetheless, our software dollar growth expectations for calendar 2006 remain unchanged and call for flat to down 5% for North America and Europe. We expect continued current generation software dollar declines with an offsetting increase in Microsoft Xbox 360, Sony PS3 and PSB and Nintendo Wii and DS software sales.

We discussed in our last call, we expect continued downward pricing pressure on current generation software. We expect that select titles on next generation platforms will continue to achieve a premium price.

Our calendar 2006 unit hardware forecasts for North America for each platform are as follows: PlayStation 2, 4.5 to 5 million; Xbox, up to 300,000; GameCube, 500,000 to 1 million; GBA, 2.5 to 3 million; PSP, 4 to 4.5 million; DS, 4 to 4.5 million; Xbox 360, 5 to 5.5 million; PS3, 750,000 to 1 million, and Nintendo Wii, 1.5 to 2 million.

Our calendar 2006 unit hardware forecasts in Europe and the other [power] territories for each platform are as follows: PlayStation 2, 3 to 3.5 million, Xbox, 500,000; GameCube, up to 300,000; GBA, 1 to 1.5 million; PSP, 3 to 3.5 million; DS, 4 to 4.5 million; Xbox 360, 2 to 2.5 million; PS3, 500,000 to 1 million, and Nintendo Wii, 500,000 to 1 million.

Turning to the second quarter of fiscal 2007, our initial guidance is approximately $195 million in net revenue and non GAAP profit of about $0.01 per share. This excludes $0.04 per share in equity-based compensation expense.

Our second quarter results are expected to be driven by nine new releases across 19 skews. We expect strong sales from Cars as it rolls out across the international territories, from our Saint’s Row release in August and from Company of Heroes in September.

As we look ahead to full-year fiscal 2007, our guidance remains unchanged from our previous call. We are projecting net revenue of approximately $900 to $950 million and net income of $0.90 to $1.00 per share, excluding the impact of equity-based compensation expense, which is projected at $0.16 per share.

While we are pleased with our Q1 results and the early sales performance of Cars, it is still very early in a transition year with many uncertainties, as we have mentioned.

As Brian will discuss, we have a solid line-up and some exciting new properties planned for this year. I would now like to turn the call back to Brian.

Brian Farrell

Thanks, Ed. We are pleased with THQ’s position as we near the end of this hardware transition. We continue to build our pipeline of innovative new products to support THQ’s long-term growth. We intend to outperform the market in fiscal 2007 with a balanced portfolio, anchored by our three biggest licensed franchises: Disney/Pixar, WWE and Nickelodeon. In addition to these proven brands, we are excited about the potential for our internally developed new, original properties, Saint’s Row on Xbox 360 and Company of Heroes on PC.

In our September quarter, we continue the international rollout of Cars. As I mentioned a moment ago, sales of Cars in the U.S. are outpacing those for Finding Nemo and The Incredibles, and the game is off to a strong start in the U.K. Cars continues to exhibit the strong characteristics of our other games based on Disney/Pixar films and we continue to believe that Cars will have a very long shelf life.

On August 29, we plan to release Saint’s Row from our Volition Studio on the Xbox 360 platform. Saint’s Row presents a new franchise opportunity for THQ. It is the first open world action game on next generation platforms and includes robust online multiplayer functionality. The game also offers a great opportunity to generate additional revenue from microtransactions and downloadable content via Xbox Live.

In September, we expect to launch the highly anticipated PC game, Company of Heroes, created by our Relic Entertainment Studio. Our Q2 line-up also includes the recently launched Monster House games and Juiced Eliminator on PSP, and our planned release of game space on the Barnyard movie, as well as the sequel to our Bratz brand, which shipped more than 1 million units in fiscal 2006.

Looking to our holiday quarter, we are approaching the market in a similar fashion to our successful quarter last year. This year we plan to bring our strong slate of popular franchises, Disney/Pixar, WWE and Nickelodeon, with the added benefit of the Xbox 360 and Nintendo Wii platforms. We plan to release four titles for the Nintendo Wii platform and two titles for our ramping Xbox 360 installed base this holiday.

We look forward to the launch of the Nintendo Wii this fall. Historically, our strong mass market portfolio has aligned well with Nintendo’s platforms. The Nintendo Wii offers us an opportunity to bring more of our family brands to next generation hardware earlier than we have done in past cycles.

We are excited about the anticipated arrival of the Sony PS3 in November. We have several games in development on this platform and we plan to release titles on PS3 as the installed base grows.

The highly anticipated WWE SmackDown vs. RAW 2007 is scheduled to ship for Xbox 360, PSP and PlayStation 2 in November compared with the launch on PSP and PlayStation 2 last holiday.

Consistent with our strategy to deliver a quality game that is aligned with a higher installed base, we’ve decided to debut the SmackDown series on PlayStation 3 at holiday 2007.

We plan to release a broad Nickelodeon line-up, comprised of multiplatform releases based on SpongeBob SquarePants, Avatar, Danny Phantom and Nicktoons. SpongeBob, Avatar and the Barnyard movie are scheduled for the new Nintendo Wii console.

We also expect strong sales of our Cars game at holiday, supported by the anticipated DVD release of the film and the additional Xbox 360 and Nintendo Wii products.

Rounding out our December release schedule is Destroy All Humans! 2 on PS2 and Xbox, Sopranos on PS2 and an expansion pack to our Dawn of War PC franchise.

For our fiscal fourth quarter, we’ve announced several new titles for the core gamer, including two new high-end PC titles, the award-winning Supreme Commander and critically acclaimed STALKER: Shadow of Chernobyl. Our TTR racing title for Xbox 360 is also slated for Q4.

To summarize, THQ’s fiscal 2007 line-up is comprised of a balanced mix of high-profile, licensed franchises and innovative core gamer titles. Over the cycle, our plan is grow at or above the market. We intend to achieve this goal by growing our share of the core gamer market and by expanding our mass market offerings with increasing penetration into next generation platforms.

Handheld continues to be a focus for THQ. Year-to-date, we’re the No. 1 independent publisher on DS and the No. 3 independent publisher on the PSP according to NPD. We are pleased with our increasing share on both the DS and PSP platforms, and we expect THQ Wireless growth to accelerate in fiscal 2008.

We also expect to continue to grow our international sales as we increase our direct international sales efforts and continue to publish games with broad global appeal.

As we continue to grow our top line, we are focused on increasing operating margins this cycle. In addition to the benefits of scale, we believe we can increase our operating margins by focusing on three key areas.

First, we continue to bring more development in house. We are targeting north of 50% of fiscal 2008 net sales to come from products developed by our internal studios.

Second, we plan to increase the percent of owned intellectual properties in our portfolio. We expect owned intellectual properties to approach 40% of net sales in fiscal 2008.

Third, margin should also benefit from our expected higher average sales price in fiscal 2008 versus fiscal 2007, reflecting a greater mix of games on next generation consoles.

In summary, THQ is well-positioned as we exit this hardware transition. We are focused on growing our business at or above the market over the cycle with improved profitability.

We also continue to invest in our studio system, owned intellectual properties and our global sales network to support our long-term growth.

We now look forward to responding to your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is coming from the line of Colin Sebastian of Lazard Capital Markets.

Colin Sebastian – Lazard Capital Markets

Thanks and congratulations on the quarter. Just wanted to start on Cars for a moment. One clarification on the units. Was the 2 million plus units a quarterly number or is that a number that’s to date?

Related to that, do you expect the linearity of Cars to continue to be, I think, 30, 30, 30 and 10 for the four quarters of the year, or is that changing?

I have a follow up. Thank you.

Brian Farrell

I’ll take the first part of the question. The 2 million is what we shipped in the quarter. Obviously we’ve continued to ship the product, both reorders in the U.S. and as the product rolls out, throughout Europe.

You know, with respect to the expectations on the 30, 30, 10, Ed?

Ed Zinser

Yeah, the 30, 30, 30, 10 was kind of in round terms. You’re going to be a little higher in the first two quarters. The third quarter will be a little bit less than 30 and then the fourth quarter will be around that 10 number but, you know, directionally and [magnitudally], that’s still a pretty good way to think about it.

Colin Sebastian – Lazard Capital Markets

Okay, and then it sounds like you guys still expect Saint’s Row to perform well on the 360. I’m just curious if you’re getting any feedback at this point from the retail channel. You’re, you know, about a month or so ahead of the launch. Thank you.

Brian Farrell

Well as you might know, Colin, there was a Microsoft Summit up in Seattle this week that I attended. Yeah, I think there was a strong reception to all of our product line. As we said before, the balance mix between the strong licensed stuff and then the new, original properties like Saint’s Row and Company of Heroes, yeah, Saint’s Row is getting a very warm reception at retail. We’re looking forward to rolling it out here in a little over 30 days and, you know, stand by. We’ll keep you posted as it rolls out.

Colin Sebastian – Lazard Capital Markets

Great. Thank you.

Operator

Your next question comes from the line of Anthony Gikas from Piper Jaffray.

Anthony Gikas – Piper Jaffray

Hi. Good morning, guys. A couple questions. You talked about one of the areas of focus looking forward is going to be developing new IP and helping you to grow margins. Could you characterize how many new intellectual properties you plan on launching per year and then, second question, do you expect that the Wii is going to take, you know, some meaningful market share over the course of the next couple years? Looking at your hardware estimates, it looks like you think that’s going to be off to a strong start. If so, how much market share do you think that they could take in the early innings, anyway and then, is Cars tracking more in line with Nemo at this juncture or The Incredibles?

Brian Farrell

Well, we’re [expecting] new IP per year as we’ve said before. You know, generally we’re thinking about two to four new IPs per year and the reason there’s a range is obviously we’ve got to find the right title, particularly with respect to next gen, you’ve got to be very selective about making sure there’s a right target audience, that the product is well positioned, so you can think about somewhere between two and four new IPS from THQ per year.

With respect to the Wii, yeah, we’ve said that they seem to be poised to take share but, as we know, over the course of a cycle a lot of different things play out. You know, I like the uniqueness of it. I like the price point of the Wii. I think retailers are excited about both of those as well, so it gives the Wii a good chance to compete as the second system of choice in the home.

You know, I think that benefits us because, as I said before, I think we’ve got – that our portfolio matches very, very well with the Nintendo Wii demographics so I think that positions us well.

Cars, it’s really outperforming both Nemo and The Incredibles on a percentage basis so it’s really both products that it’s trending better than.

Anthony Gikas – Piper Jaffray

Okay, just a quick follow up on the new intellectual property comment, the two to four per year. Would those be full, front-line products?

Brian Farrell

Yes.

Anthony Gikas – Piper Jaffray

Okay. Thanks, guys.

Operator

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

Edward Williams – BMO Capital Markets

Good afternoon, guys. Just a couple of questions. Looking at your next gen games that you’re developing right now, can you just comment on a percentage basis at least just how many of them are being developed internally versus externally?

Brian Farrell

Over what timeframe, Edward?

Edward Williams – BMO Capital Markets

The ones that you have in development right now. You made a comment that you have, you know, part of the reason that the cap’s off for a number [inaudible] was the next gen games. I was just curious how many of those are internal versus external.

Brian Farrell

Well, the preponderance of them are internal. As we said a number of times, you know, owning our own technology, our own tools for next gen is very critical so we’re focusing on internal development there. You know, that’s not to say we’re not doing some significant external development as well. I don’t have the figures in front of me. We can get back to you offline as to what the percentage is, but you could think of more of our real focused titled coming from internal development.

Our strategy, as we’ve stated before, is the things we want out of our internal development are owned intellectual properties and our core franchises. So, when you think about those types of titles, they’re most likely coming out of our internal studios.

Edward Williams – BMO Capital Markets

Okay and just to put this in a frame of reference, how does that compare directionally to where you were, say, 5 years ago with the launch of PlayStation 2?

Ed Zinser

I can tell you, Edward, just from last year alone, you know, we’re internally developed in this fiscal year we’re talking about, around 40% or so. That’ s up significantly from last year and for fiscal 08 we’re, you know, Brian mentioned it in his prepared remarks, you know, more than 50% coming so you go back to the, you know, to the [freebie] and such transition, I mean it’s a pretty [long arm there].

Brian Farrell

From less than 10% to 40% to 50%, directionally, is a good way to think about it.

Edward Williams – BMO Capital Markets

As you look at Saint’s Row and the opportunity with microtransactions, how significant do you think that will be in your fiscal 07 or, if you want to look into a longer time period, how significant do you think the microtransaction opportunity is, you know, kind of in the [meets] of the next [block] from cycle?

Brian Farrell

As you know, microtransactions is a [inaudible] market where I think most industry people including ourselves think that there’s some significant growth ahead of us.

That being said, we don’t think the initial numbers on microtransactions will be that strong so we’re not planning on big numbers from Saint’s Row.

Our plan here is to be an innovator and a leader in this space because we think there is good long-term potential, but in the short-term, don’t count on significant numbers from those microtransactions.

Edward Williams – BMO Capital Markets

Then, if we look at the cap software number, how should that number trend on the balance sheet over the next three quarters of the fiscal year? Will we see you amortizing more than you’re capitalized, or capitalizing more than you’re amortizing?

Ed Zinser

You know, in any given quarter it’s going to depend on exactly what they release in that quarter but I think in general, Edward, through the year, you will see that number continue to increase as we approach a more normalized level of next gen console development relative to our product mix. The core gamer shift, as you know, we’re moving more into core gamer. As that starts to level off a bit, you will start to see it increasing at a decreasing rate. But you’ll see it continue to grow, certainly, through this year as we are building to grow for a pretty aggressive product line up for fiscal 08 and fiscal 09.

Edward Williams – BMO Capital Markets

And then the last question is, can you just remind us where you are with your buyback at this point?

Ed Zinser

Yeah, we had about $21 million long-term prior to our most recent activity this quarter. We’ve got about $11 million left in our buyback program.

Edward Williams – BMO Capital Markets

Okay. Good. Thank you, guys.

Operator

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

Lauren Fine – Merrill Lynch

This is Lauren Fine filling in for Justin. I was just wondering the year looks like it’s checking ahead of your plans as of when you last reported in May but you haven’t raised your guidance for the year. Have your sales expectations for upcoming titles declined or are you just adding more conservatism to your model? Have you pushed out any titles over the year at all?

Brian Farrell

Yeah, I mean, we obviously – it’s pretty early in the transition, in the fiscal year. You know, we did give a range of 9 to 950. Yes, the initial sales of Cars have been strong and we’re very pleased with the results but it’s still very early. There’s still a lot of Cars sales to come in the rest of the fiscal year and a lot of other variables so, you know, we were, you know, up a bit, you know, 139 versus 125, but with a 9 to 950 range we felt that, you know, our best estimate and most likely scenario is for guidance that’s in the same range.

Lauren Fine – Merrill Lynch

And you haven’t pushed out any titles this year?

Brian Farrell

Our titles move in and out of the year, but nothing significant.

Lauren Fine – Merrill Lynch

Okay and just secondly, from your guidance for the September quarter it looks like you might be stepping up some expenses in the quarter. Did you raise expenses based on the upside in the June quarter, and can you discuss maybe what you’re investing in?

Brian Farrell

You know, there is no real step-up in any expenses for the second quarter. You will see a fairly significant marketing spend in our second quarter to really support, you know, what we think should be a great property for us in Saint’s Row so we’ll, yeah, obviously we’ll spend accordingly and you’ll see our marketing expenses higher in the second quarter of this fiscal year versus the second quarter of next fiscal year. But in terms of the remaining expenses, you’ll see, you know, the same kinds of things you saw in the first quarter. Obviously, we’ll, you know, we’re spending in the product area to support our growth but there’s nothing unusual or strange in there.

Lauren Fine – Merrill Lynch

All right. Thank you.

Operator

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

John Taylor - Arcadia

Hi. I’ve got a couple of small things here. Number one, so you’re discontinuing the development of the Sopranos on 360. Did you write off anything in the quarter and maybe quantify that for us as a one time kind of thing. Second, the WWE for PS3 being pushed into next year. I gather, you know, that had a somewhat of a revenue impact, maybe a greater profitability impact, though, because you would have had to amortize that off. Maybe talk a little bit about how that impacted things. Apparently not too much because you’re not changing your guidance. Third thing, what was the catalog in the quarter? Finally, you’ve got a couple of 360 titles under your belt now and if you were to contrast that with last year’s Juiced and Destroy All Humans! on old gen platforms, could you give us a sense of kind of what the development costs multiplier is that you’re seeing on the 360 titles as opposed to those two guys last year? Thanks.

Brian Farrell

I think I’ve got it all jotted down, JT. With respect to Sopranos, I’ll let Ed talk to the number but yeah, we are doing the PS2 for clarity and not doing the 360 and that resulted in a write-off of –

Ed Zinser

Yeah, there was a write-off in the period. It pretty much explains the increase in our amortization rate for software amortization in the quarter which, you know, versus prior year which was about 3 point so you do the math on our revenue and you’re looking at about a $4 to $5 million number.

Brian Farrell

And on the WWE, JT, we had never put PS3 numbers in our forecast, obviously because we had very little visibility on when could actually get the title out and what we said we’d like to do strategically, I think it’s the best thing for the brand and for us, and that’s to have a multi-platform launch and when we realized we couldn’t get it at or very close to launch, we decided the best thing for the brand and for THQ is to make sure they all sync up next holiday so, you know, it’s just, you know, nothing has happened in development. We’re just going to give it a little more time and hit the calendar 07 window.

Ed Zinser

Yeah, in terms of catalog, our catalog for the quarter was about 38% of revenue. In terms of costs, I mean, we don’t give specific and never have given specific development numbers for any title that we’ve developed but when you do compare, JT, the cost to develop the Saint’s Row versus, you know, a Destroy All Humans! or Juiced in the prior year, obviously, they’re significantly higher. We have said in previous calls, think about it as a 50% kind of an increase and it’s that order of magnitude when you compare current gen to next gen.

John Taylor - Arcadia

Okay. Thank you.

Operator

Sir, your next question comes from the line of Elizabeth Osur from Citigroup.

Elizabeth Osur - Citigroup

Thanks. Just wanted to touch on the expansion in the studio infrastructure. Are you still looking to expand, is there an M&A priority in terms of, you know, a niche of product type that you’d like to acquire, that you feel like you don’t have enough of? Should we look forward to seeing you guys move more into, you know, owned intellectual property that’s more, you know, aimed at core gamers or is there something else you’re looking to build out?

Brian Farrell

Our strategy with respect to studio M&A is first and foremost the ability to generate new intellectual properties. Having proprietary tools or technology is also important to us. If you look at the acquisitions we’ve made such as Juice Games, that’s in the racing category, Relic in the strategy category, Volition was in the first person and third person action, Paradigm is working on Stuntman, which is action driving hybrid, so what we don’t do is say we want to get into this category, let’s find a developer. If we find a very talented developer because, you know, our approach to the game business is a little different than some of our competitors. It’s all about the content. It’s all about the game and so, if we find a good property and/or a good developer working on it, that’s what drives it, not a particular market niche.

Elizabeth Osur - Citigroup

Okay, thanks, and then just [wondering] could you give us a little bit more specifics about what your expectations are for next gen pricing declines and also there was a comment about your ASPs increasing as you move to more next gen. Can you just talk about what kind of pricing you’d expect on Wii titles and if you think that you’ll be able to get, you know, $50 pricing on sort-of mass market titles or are we going to be looking at $40 again? Thanks.

Brian Farrell

To the last part of your question, we haven’t announced any pricing on our Wii titles yet at all. We’re still undertaking all of our market research with respect to that and we’ll certainly come up with something in the near future.

It’s way too early to speculate on next gen pricing. It appears that consumers are not resisting the $59.99 price point at all. Good titles are selling at a very crisp rate at that price point at least for the near term, we expect that pricing to hold.

Elizabeth Osur - Citigroup

Then would you also look for the same kind of, say, you know, 10% historical rates that we talk about on current gen pricing or is it more likely that, given where we are in the cycle, we should be talking about something like 30%, 40% declines?

Brian Farrell

In terms of units or pricing?

Elizabeth Osur - Citigroup

Pricing. On current gen.

Brian Farrell

Well, the only thing that changes as you get later in the cycle, Liz, is not necessarily pricing as much as mix so, you know, things like our strong mass market titles can still command a $39.99 price point but what you see is more activity at the greatest hits, you know, the $19.99-type price point. So ASPs actually decline but it’s more a function of mix than actual pricing decisions.

Elizabeth Osur - Citigroup

Okay. Thanks.

Operator

Sir, your next question comes from the line of Arvind Bhatia from Sterne Agee & Leach.

Arvind Bhatia - Sterne Agee & Leach

Good afternoon, guys. Brian, first question for you is on porting across platforms. Wondering what your thoughts are now on the, you know, next gen, how you perceive that versus what happened to the old gen, how you were able to leverage across different platforms.

My second question is, are you doing anything on the digital downloading front?

Brian Farrell

To your porting question, we have developed cross-platform tools with respect to 360 and PS3. What we expect to see, and our strategy on Nintendo Wii, is to do unique development for the Wii since it is a fairly unique platform. Obviously, we’ll continue to, you know, improve on those tools and technologies and expect the learning curve to bring costs down as we get deeper into the cycle but yes, we have developed PS3 porting technologies.

With respect to digital download, it’s another way, obviously, to reach our consumers with new content. We’ve done some things with digital delivery such as establishing PC games such as our future Dawn of War updates. We’re doing microtransactions as we said in our Saint’s Row game, our wireless content is also going to THQ Wireless on a download basis and we continue to evaluate the online casual space so we are actively involved in digital download and, you know, we think we’ll be a leader there.

Arvind Bhatia - Sterne Agee & Leach

Brian, on the porting question, I guess what I was trying to ask is, you know, there was concern earlier that it would be harder to port from say a 360 to PS3. One, do you buy that, you know, what’s your experience been in terms of – or as you anticipate doing that, do you think there’ll be big differences in cost? More of a leverage question than anything else.

Brian Farrell

Well, to that question and again, as you know, I’m not the technical guy but the art assets, which is the tremendous cost increase, the cost of generating all the art and animation, is very portable across the two platforms. It’s the programming environment and now that we’ve been working with it now for, you know, well over a year, we are solving the programming problems. So yeah, the leverage should come as, you know, not only us but I think most companies will be able to leverage art assets across both platforms fairly efficiently.

Arvind Bhatia - Sterne Agee & Leach

Last question, on the retail side of things what’s the feedback that you’re getting, you know, in terms of trends and inventory trends, things of that nature?

Brian Farrell

I think the industry is in pretty good shape at retail is the feedback that I got at the Microsoft show this week. You know, I think everybody, I think the year is playing out very much as most people anticipated. You know, decline in current gen, ramp of next gen. So I think the real thing that people are thinking about is, you know, the exact dates and launch quantities and ramp on the Wii and the PlayStation 3.

Arvind Bhatia - Sterne Agee & Leach

Great. Thanks. Good quarter.

Operator

Sir, your next question comes from the line of P. J. McNealy from American Technology Research.

Paul-Jon McNealy- American Technology Research

Hi. Good afternoon. A couple of quick, small questions. One on, you mentioned the 2 million unit number for Cars. Does any of that include Europe, or was that all North America?

Brian Farrell

It was primarily North America, P.J. I think Spain launched, and France; Australia, obviously, we talked about on the call. But it was primarily North America.

Paul-Jon McNealy- American Technology Research

Got it. Thanks. In the past you talked about [inaudible] wireless for the year, it looked like it was flat sequentially. Any plans there to help reinvigorate this and spike it back north?

Brian Farrell

For the most part it was pretty consistent with our expectations. You know, you’re comparing to a strong [fire] year quarter with Star Wars. You know, we’re tracking to the approximate 10% growth that we talked about and again, we should be looking as we sort of, you know, shift over the product line for more casual gaming, you should see more significant growth in fiscal 08.

Paul-Jon McNealy- American Technology Research

Yeah but now, Brian, you said earlier, you said you liked the Wii price points. Is your assumption $199 or $249 on the hardware?

Brian Farrell

Well honestly, P.J., I don’t think it makes any difference because it’s going to be significantly below its two competitive platforms. You know, personally I wouldn’t be surprised to see $249 just because of the differential but, you know, we don’t know how aggressive Nintendo’s going to be so either one gives them a significant advantage, you know, on a pricing basis, you know, over 360 or PS3.

Paul-Jon McNealy- American Technology Research

[Inaudible] for the last one, if you look at the Saint’s Row expectations and growing and I would imagine the buzz on it will pick up with the Xbox Live download but how do you, what’s a good comp for Saint’s Row, especially given that it’s a single platform game?

Brian Farrell

Well, I mean, it’s hard to call comps this early in the cycle but, you know, this product, you know, we’re very confident in the prospects for this product based on all the things we’re hearing online, the reaction we’re getting to the demo that was just launched to retail. As you mentioned, the demo is going up on Xbox Live around August 1. So, and then the marketing plan starts rolling out a couple weeks before a launch; it continues well after launch. So we think we’ve teed up Saint’s Row as well as you can tee up any product from a product quality, marketing launch and just sheer window of opportunity given the fact it’s the first open world game, you know, with its really robust multiplayer aspect so I think we’ve teed this one up well and, as I said before, stand by.

Paul-Jon McNealy- American Technology Research

All right. Thank you.

Operator

Sir, your next question comes from the line of Lowell Singer from Cowen and Company.

Lowell Singer – Cowen and Company

Hi, thanks. Two questions. First, can you talk a little bit about Cars? You gave the quarterly splits. I’m wondering what you think the geographic split of that title will be through the entirety of the year?

And Brian, can you talk a little bit about how you think about allocation of capital on the development side? I mean, there’s obviously three new hardware consoles, there’s a couple of, I guess really three dominant handheld platforms, and you have PC. How do you think about allocating the company’s capital as you look at the size of those opportunities over the next couple of years?

Thanks.

Brian Farrell

Sure, on the Cars question, it should end up the year at about a 50/50 split between North America and international.

And then with respect to how we allocate our capital, you know, let’s take an example of PC. You know, we researched the PC market and found that there’s three categories that do really well at PC. Real time strategy, first person shooter and role playing games and that‘s why we have four products, all four of those products are in one of those genres.

Then when we look at the high-end console market, it’s our expectation that the high-end core gamer is going to be on the PS3 and the 360 so it’s likely that we will have multiplatform launches on our core gamer titles on 360 and PS3. And Nintendo Wii, as I mentioned before, maps very well to the younger and mass market demographic so you can expect to see all of our mass market franchises on Wii. And on handheld, again, if the market is segmented, PSP tends to skew a bit older. The DS is younger and starting to reach down and we think that will eventually replace the GBA platform.

So when we look at greenlighting a new product, we figure out which market segment it fits into and then allocate it that way.

Lowell Singer – Cowen and Company

Okay. Thanks.

Operator

Sir, your next question comes from the line of Jason Kraft from Susquehanna Financial Group.

Jason Kraft – Susquehanna Financial Group

Susquehanna Financial Group. Thanks. Two questions. One, given the early success of Cars, should we expect a tail of Cars units and shelf-live wise to continue the momentum and surpass that of what Incredibles and Nemo did?

Then I have a follow up. Thanks.

Brian Farrell

Just based on the fact that it’s outpacing Incredibles and Nemo early on in what’s generally a weak time of year certainly makes us more optimistic on the long-term potential of Cars.

The other thing I’d say, Jason, is the fact that the game rankings on Cars has been very, very high for a product in that category and we’ve gotten a lot of very positive feedback on the game play and the product quality which also give the product very long legs. So, you know, we’re only a couple of weeks and a couple of markets into the launch but I would say all signs are good.

Jason Kraft – Susquehanna Financial Group

And then I just wanted to circle back on a previous question regarding Saint’s Row. If we look at the upcoming titles on the 360 coming out this fall holiday, most of the big name key titles really aren’t going to hit the shelf until the October/November timeframe so, in essentially when the 360 consumers get tired of playing football, Saint’s Row is about the only thing out there. What’s going to be considered a success in your eyes unit-wise for this title?

Brian Farrell

Well, yeah, we’ve been fishing, Jason. I’d love to take the bait but what we’re going to do is, you know, again, this one is teed up. Let’s see how it goes. We have, as you suggest, a market opportunity. The product is really, really, really fun to play. We have a strong marketing campaign. We’ve created a buzz. We’re getting a warm reception at retail. You know, it has a lot of features and it has this window of opportunity so again, it launches in 30 days so, you know, let’s see what happens.

Jason Kraft – Susquehanna Financial Group

Thanks.

Julie MacMedan

That’s all the time we have today for questions so we’d really like to thank everyone for joining us in the call and I guess that’s it. Thank you.

Operator

Ladies and gentlemen, thank you for participating in this conference. This concludes the presentation. You may now disconnect. Have a good day.

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Source: THQ Q1 2007 Earnings Conference Call Transcript (THQI)
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