THQ Inc. (THQI) F1Q10 Earnings Call July 28, 2009 5:00 PM ET
I would like to welcome everyone to the THQ Inc. fiscal 2010 first quarter results conference call. (Operator Instructions) I would now like to turn the call over the Julie MacMedan, Vice President of Investor Relations and Corporate Communications.
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 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, 2009 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 these statements are made.
In describing THQ's financial performance we will discuss non-GAAP measures including net sales and EPS. These non-GAAP measures exclude the following; stock based compensation expense, the impact of deferred revenue and related costs, business realignment expense, the other than temporary write down of investments and mark to market adjustments on auction rate securities, other material, non recurring charges and benefits 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. In addition, earlier today, we announced plans to issue $90 million of convertible senior notes with a $10 million over allotment option. The net proceeds of the offering will be used for general corporate purposes. The announcement of the offering and any reference to the offering on this call are neither an offer to sell nor a solicitation of an offer to buy any of these securities and shall not constitute an offer, solicitation or sale in any jurisdiction in which such offer, solicitation or sale is unlawful.
In addition, the notes have not been and will not be registered under the Securities Act of 1933 as amended or any State Securities laws and may not be offered or sold in the United States absent registration or applicable exemption from registration requirement.
On today's call, Brian Farrell, THQ's President and Chief Executive Officer will review our first quarter achievements and will then turn the call over to Paul Pucino, our Executive Vice President and Chief Financial Officer to discuss THQ's financial results for our fiscal 2010 first quarter and provide our full year and second quarter outlook. 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.
Good afternoon everyone. We are pleased to report record results for the first quarter of fiscal 2010 with net sales of $234 million and net income of $6.9 million, a vast improvement from a year ago and evidence of a dramatic turn around here at THQ.
Our first quarter results reflect three key wins for THQ. One, we extended our leadership in fighting games with our new hit title UFC 2009 Undisputed. Two, we established our Red Faction franchise on current gen consoles, and three; we demonstrated successful execution on our focused product strategy and cost saving initiatives.
Clearly UFC is a successful new addition to our product portfolio with more than 2.9 million units shipped to date and still going strong. Consistent with our drive for quality across our portfolio, UFC 2009 Undisputed achieved an average metacritic rating of 84. It was the number one best selling title in the U.S. and number one best selling title from an independent publisher in the U.K. for the June quarter.
The success of UFC 2009 Undisputed, helped propel THQ to the number three independent publisher ranking in the U.S. and the U.K. for the June quarter.
We plan to launch games based on UFC on an annual basis and to build this franchise with new technology and game play, additional platforms and increase sales outside of North America as the UFC brand continues its global expansion.
We are pleased to have established Red Faction Guerilla as a franchise on current gen consoles. Red Action Gorilla achieved an average metacritic rating of 85 and we have shipped more than one million units of this title to date. The game was a top ten best seller in the U.S. and the U.K. in June.
We plan to drive future sales of Red Faction with continued advertising support and new downloadable content. We plan to continue to build this franchise by leverage Red Faction Guerilla's outstanding technology platform in the future.
Our first quarter results reflect successful execution on our more focused product strategy with a more streamlined organization and cost structure. We delivered quality products, achieved solid sales results and aggressively managed our costs.
In late June, we announced the formation of three new business units; core games, kid's family and casual games and online games. The new structure specifically aligns our primary business units with our five point product strategy, enabling each team to focus on planning and execution in highly defined product areas with more accountability to the organization.
Yesterday, we announced that we have prevailed in our arbitration with Jacks regarding the preferred return payment rate. The rate has been reduced by 40% to 6% of net sales of WWE video games, a clear victory for THQ.
In summary, we reported record first quarter results. We extended our leadership in fighting games with UFC 2009 Undisputed. We achieved strong critical acclaim for Red Faction Guerilla and established a foundation from which to expand this franchise going forward.
We successfully executed on our more focuses product strategy and cost savings to position THQ to return to profitability and to generate significant cash in fiscal '10. With that, I'd like to turn the call over to Paul Pucino, our Executive Vice President and CFO.
Good afternoon. Today, I'll recap our fiscal 2010 first quarter results and discuss our future business outlook. As I discuss our financial performance in more detail, I'll use non-GAAP results which are comparative to the prior period's non-GAAP results.
As Julie mentioned, there were several adjustments to GAAP reporting. Please refer to our press release issued earlier today for a reconciliation of our GAAP and non-GAAP results.
To reiterate, as we discussed last quarter, beginning in fiscal 2010, we have adopted a 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 are applying a 15% tax rate to our fiscal 2010 non-GAAP operating results.
In addition, my remarks today do not include any impact from the planned senior convertible note offering announced earlier today.
Now I'd like to briefly recap the first quarter. As Brian mentioned we reported record fiscal first quarter net sales and net income for the three months ended June 30, 2009. UFC 2009 Undisputed and Red Faction Guerilla drove our record net sales of $234 million, up 93% from last year's $121 million.
Our product cost as a percentage of net sales decreased 13.3% to 33% due to the greater mix of premium price titles, UFC 2009 Undisputed and Red Faction Guerilla. Software amortization as a percentage of net sales increased by 1.7% to 18% due primarily to the fact that Red Faction Guerilla is an owned core gamer title with higher development costs.
License and royalties as a percentage of net sales increased to 13.4% due primarily to a higher licensing rate as a percentage of sales and up versus WALLE and a $.5 million impairment on one of our kid's license.
Our business realignment drove significant cost savings during the quarter as follows; product development expense decreased to $21 million from $29 million, selling and marketing expenses as a percentage of net sales decreased by 7.1% also reflecting strong sales of the UFC 2009 Undisputed at premium pricing.
G&A decreased to $15 million from $18 million a year ago. As a result, we generated operating income of $8 million compared to an operating loss of $44 million in the prior year.
We reported record June quarter net income of $6.9 million or $0.10 per diluted share compared with a net loss of $25.4 million or $0.38 per share last year.
In summary, we generated record first quarter net sales on the strength of UFC 2009 Undisputed and Red Faction Guerilla. We also delivered record net income due to the outstanding performance of UFC 2009 Undisputed and substantial cost savings from our fiscal 2009 business realignment.
Now let's turn to the balance sheet. As of June 30, 2009 we had $155 million or $2.29 per diluted share in cash and short term investments. This compares with $141 million at March 31, 2009. We had previously expected cash to decline due to normal seasonal patterns but in fact, cash improved due to the strong performance. In addition, we had $12 million in investments net of borrowings on our auction rate securities.
Net accounts receivable of $87 million increased from $60 million at March 31, 2009. This increase is primarily due to higher net sales in the June quarter versus the fiscal 2009 fourth quarter. Accounts receivable reserves of $72 million at quarter end decreased from $83 million a year ago, due to stronger performing products released this year.
The coverage ratio on a trailing nine months on a net sales basis was 9% compared with 10% in the prior year quarter end.
Inventory was $27 million compared with $26 million at March 31, 2009. Our investment in licenses decreased by $23 million from March 31, 2009, due to amortization and the previously mentioned impairment on one of our kid's titles.
Capitalized software development of $162 million was flat compared to last fiscal year. The June 2009 balance includes our investment in key fiscal 2010 second half releases such as WWE Smackdown versus Raw 2010, MX versus ATV Reflex and Darksiders.
Total current liability of $252 million includes approximately $58 million related to our joint venture with Jack's which has been approved at a payment rate that expired in June 2006. As we've just announced, THQ has prevailed in our arbitration with Jacks regarding the preferred return rate. As a result, for GAAP purposes, the company expects to report a one time benefit of approximately $23 million during the quarter ending September 30, 2009 and to reduce the accrual on our balance sheet by the same amount.
Our total THQ Inc. stockholders equity was $328 million. And that concludes the financial results for this first fiscal quarter of 2010.
Now I'd like to share with you our outlook and perspective on our business for the fiscal 2010 second quarter and full year. Please note that our second quarter and full year outlook exclude the anticipated one time benefit of approximately $23 million from the Jacks arbitration which we plan to exclude for non-GAAP purposes.
Looking forward to the 2010 fiscal second quarter, we expect to report net sales in the range of $85 million to $95 million, down from $152 million a year ago, based on no new titles scheduled for release in Q2 and an unfavorable year over year comparison for Up versus WALLE. We also expect fiscal 2010 second quarter catalog sales to be lower than last year.
Despite much lower net sales, we expect our operating loss to improve versus the $53.5 million operating loss reported in our fiscal 2009 second quarter due to lower product costs as a percentage of net sales and the cost savings from our business realignment. However, given that we are using a 15% tax rate versus a 41% rate last year, we expect to realize a much smaller tax benefit this year. As a result, we expect a greater net loss compared with last year's results.
Now turning to the fiscal 2010 full year; given our strong first quarter performance, we now expect our fiscal 2010 net sales to be higher than those reported in fiscal 2009 instead of flat to fiscal 2009. We also expect to achieve profitability instead of targeting profitability.
We are reaffirming our expectation to report a cash balance that will be at least $50 million higher at the end of fiscal 2010 than fiscal 2009 excluding any amounts currently payable to Jacks.
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 September quarter and then to rebound in the December and March quarters as we collect cash from holiday sales.
In addition, at this time we have no borrowings under our $35 million credit facility with Bank of America. And once again, earlier today, we announced plans to issue $90 million of convertible senior notes with a $10 million overall allotment. The net proceeds of the offering will be used for general corporate purposes.
In closing, we delivered record 2010 first quarter results that underscored the success of our more focused product strategy and the cost savings from our business realignment. We remain focused on executing our product slate and continuing to manage costs in order to achieve profitability and generate positive cash flow in fiscal 2010.
With that, I'll turn the call back over to Brian.
We plan to build on our first quarter product momentum as we approach the second half of fiscal 2010. We have a well positioned holiday line up with proven franchises such as WWE and X versus ATV and a strong kid's and family line up. We look forward to launching our new core gaming franchises, Darksiders in January.
I will address these games and other key upcoming releases as I drill down on our product strategy and our new business units. First, core games; [Danny Bilson] is in charge of our core games group which encompasses action, shooter, strategy, racing and fighting games. Danny brings more than 20 years of creative development experience to his role, including work in film, television and comics as well as video games.
The benefits of the people and processes put into place by Danny and his team over the past year and a half are reflected in the significantly improved quality of THQ's core games.
For fiscal 2010 to date, our core games have achieved an average metacritic rating of 84, up from 80 in fiscal in 2009 and 72 in 2008. A key pillar of our core game strategy is to grow our existing core game franchises through quality and innovation. Red Faction is a great example. The game has already shipped over one million units and has achieved an 85 metacritic rating.
Another great example is our 2011 title Homefront, which we unveiled last month. With Homefront, we are building on a single and multi-player technology foundation established with a million unit seller, Frontlines Fuel of War, and adding a compelling new story in game play experience. At E3, the game generated a lot of buzz and we intend to continue to build on this momentum until launch with a comprehensive marketing campaign.
Our stated strategy is to launch one to two titles targeted at the core gamer each year, each with the potential to become a long term franchise. In early January, we plan to release our new action game, Darksiders. Darksiders generated tremendous interest at E3 this year and was nominated for best action game by leading game publications IGN and Game Spy.
We believe we are positioning Darksiders for success by delivering a quality game experience, strong marketing campaign and the right sales window.
Looking into fiscal 2011, in addition to Homefront, we unveiled our Warhammer 40,000 Spacegreen action game at E3. We have had great success with our Warhammer 40,000 PC series which has been developed by our award winning Relic Entertainment Studio and is approaching five million units shipped to date.
Our strategy for fighting games is to continue to dominate the fighting category by innovating and building on our flagship UFC and WWE brands. We plan to release games based on these franchises annually and upgrade features and technology for each franchise each year.
For example, this holiday we plan to release Smackdown versus Raw 2010 with more customization than ever before. Next year, our UFC games will include new features and game modes as we build on the ground breaking fighting technology established this year. Over time, we plan to build our UFC franchise by expanding international sales and by developing games on new platforms such as hand held's and the Nintendo Wii.
Racing is one of the biggest categories in gaming. We are the leader in off road racing with our MX brand which is approaching eight million units shipped to date. For this year's game, MX versus ATV Reflex, we are reinventing the MX experience with significant technology and game play innovation that we believe will appeal to a broader audience than ever before.
Now I'd like to talk about our kid's family and casual games unit, headed by [Doug Klemmer]. Doug joined THQ in 2002 when we acquired his successful value games business called Value Soft. Doug has been running Value Soft in our THQ wireless group and has been migrating our casual strategy from boxed PC product to online markets and the Nintendo Wii and DS platforms.
Our strategy for our licensed kid's games is to maximize the profitability of our existing licenses and re-invigorate our portfolio with new licenses that work well in the video game space. This year, we have already launched games based on Disney Pixar's Up in North America. During the second and third quarters of fiscal 2010, we plan to roll out games based on Up as the movie hits theaters internationally.
We are pleased to be launching our new Cars Race-a-Rama games this holiday. The Cars brand continues to resonate with families and kids and to be promoted across multiple consumer categories by Disney. We plan to release new SpongeBob games this holiday, supported by Nickelodeon's celebration of SpongeBob's 10th anniversary.
We are pleased to be re-invigorating our kid's license portfolio with our first games based on Marvel's Superhero Squad releasing this holiday. Superhero Squad is a stylized kid's version of all of Marvel's most famous superheroes. Marvel will be supporting this brand with television programming, on the Cartoon Network this fall as well as with Hasbro Action Figures at retail.
In addition to publishing kid's license games; we plan to increase our mix of mass appeal brands where there are proven and growing segments of consumer demand. This year we intend to introduce highly targeted new casual games scheduled for the important holiday season. Our line up includes our first Drawn to Life games with the Nintendo Wii platform and a sequel to this top selling franchise on the DS.
To date, we have shipped two million units of Drawn to Life games on the DS platform. This year's game, Drawn to Life the Next Chapter, achieved strong critical acclaim at E3 including being named best DS platforming game of E3 by leading game site, IGN.com.
We plan to launch World of Zoo on Nintendo Wii, DS and PC platforms this holiday. This family friendly game is being developed by the studio that created the successful Zoo Tycoon franchise which has sold more than seven million units world wide.
We have a strong new entry in the fitness category with the Biggest Loser video game for Wii and DS based on the highly rated NBC television show. Since its debut in 2004, the Biggest Loser has grown to become a major health and lifestyle brand. We believe that the popularity of this show gives our game a strong competitive advantage in the fitness category.
Other holiday games include James Patterson's Women's Murder Club, Are You Smarter than a Fifth Grader and All Star Cheer Squad Two.
Now turning to online games; we view the fast growing online gaming market as a solid long term opportunity for THQ. The world wide online gaming market is expected to grow at a five year compound annual growth rate of 16% to $24 billion in 2013. Online games offer compelling, high margin business characteristics such as customer loyalty and retention, extended life cycles, multiple revenue models and broad geographic appeal.
[Steve Daughterman] has been appointed to run our online games division and will oversee all online initiatives. He will also work with Danny and Doug to achieve their online objectives. Steve has been running our product development efforts in Asia Pacific and has been heavily involved in our online gaming initiatives to date.
Our online games strategy is to become a world wide leader in the development, operation and distribution of interactive online games. Currently, we are working with external partners with strong online experience to bring our established brands such as Company of Heroes and WWE into the dedicated online space. Our strategy is to pursue new game concepts and new business models in growing consumer segments.
We are pleased to announce that earlier this month, we received Chinese government approval to launch Company of Heroes online and we expect to do so with our partner Shanda during the September quarter. We also plan to bring Company of Heroes online to Korea and other Asian territories over this fiscal year end next.
Our next brand extension initiative is our WWE online game being developed in Korea which is scheduled for release next fiscal year. In addition, we have a joint venture with leading Chinese game operator, Ice Entertainment to operate our new casual MMO Draconica in North America. Ice has already successfully launched Draconica in China and we plan to bring the game to North America together this fall.
Finally, we have an experienced team of MMO veterans at our digital games studio developing our War Hammer 40,000 MMO. We continue to build War Hammer 40,000 brand awareness within the gaming community with our Dawn of War PC games and next year with our first War Hammer 40,000 console games.
In summary, we have a strong upcoming product pipeline in each of our business units; core games, kid's family and casual games and online games. I'm pleased with the progress we've made since these units were formed and I look forward to working closely with Danny, Doug and Steve and the rest of the THQ team worldwide as we continue to deliver on our goal to return THQ to long term profitable growth.
With that I'd like to ask the operator to open the call up to questions.
(Operator Instructions) Your first question comes from Jeetil Patel – Deutsche Bank.
Jeetil Patel – Deutsche Bank
On the WWE royalties that are coming down about 40%, I guess it's your view that you let that flow through to the bottom line or look to reinvest that into newer initiatives. Second, can you give us a rough breakdown of the revenues by the three different core groups, segments that you're now giving, breaking down and maybe an idea which ones are probably the relatively speaking the faster growth rates versus slower of the three. And then lastly, on OpEx, I guess there's been obviously a lot of restructuring and cost cutting in the business. Is the fiscal 1Q OpEx run rate a good proxy to use as we try to look at the business for the balance of the year and into 2011?
With respect to the WWE, we're going to let that flow through to the bottom line as far as we know now. Obviously, that's just a net win for us so that's something we would expect to flow through.
With respect to revenue breakdown for the business units, the business units are still completing their formal business plans so we don't have the entire breakdown by business units yet. But what I would say is the biggest one, just because it's the largest segment is the core games units since it comprises action, fighting, racing strategy etc., followed by the kid's family and casual.
And then online as you know, we don't have significant online revenues at this time, but that's the area that I would characterize as the largest growth opportunity, especially as you take a three to five year time horizon.
With respect of OpEx, Q1 is indeed a good proxy for Q2 and Q4. However, the holiday season of Q3, we would anticipate in particular selling and marketing expenses to be higher given that our revenues are so much higher.
Your next question comes from Edward Williams – BMO Capital Markets.
Edward Williams – BMO Capital Markets
Looking at the Jacks royalty rate, can you just point out that this is through 2009? What happens post 2009? And then looking over a UFC for a moment, how has the product been performing international markets at this stage and how does it compare to WWE as a proxy?
With respect to Jacks, again the royalty rate, and just to be clear, just for Jacks, not for the WWE, but just for Jacks, has come down about 40% to about 6%. With respect to modeling that beyond 2009, at this point I would not use a rate higher than 6%.
On the UFC, we talked about this before. The big opportunity with the UFC is to build that brand with the UFC and overseas markets very similarly to what we've done with the WWE in overseas markets. We expect UFC in our fiscal '10 to be around 30% from international markets. And again, WWE has gotten to be about 50% of overall revenues, so we look at that as the opportunity.
As the UFC brand continues to strengthen in overseas market, we'd like to see that be closer to 50% so we see that as a long term opportunity.
Your next question comes from Colin Sebastian – Lazard Capital Markets.
Colin Sebastian – Lazard Capital Markets
I wonder whether your September quarter guidance has factored in the recent slowdown in industry sales for the past four to six weeks and also related to the market conditions, could you comment more broadly on retail buying patterns ahead of the back to school period and perhaps more importantly, whether you expect the $59.00 price point to hold this holiday.
Our guidance for Q2 was not based on any recent trend. It's really based on the fact that we have no new titles being released in Q2. So it's all catalogue sales from prior year and what we released in Q1. And if you remember, last year in Q2, we had Drawn to Life, Baja, WALLE being a higher comp to us, so that's the differential. So there's really nothing new in the environment that changed our thinking on Q2.
I say a similar thing about retail buying patterns. Retail buying patterns have been and we expect them to continue to remain very tight. Retail will buy in what they think is a limited weak supply of stock and they will chase items that are selling through to consumers. It's been happening for a number of years. It was pronounced last holiday season and we expect tight retail buying conditions to continue for this foreseeable future so really nothing new on that front.
With respect to full price pricing, or front line pricing, yes. Look at what's happened with something like UFC and Red Faction Guerilla. Almost three million units and over one million units at full $59.99 and I think the take away there is high quality titles that have created consumer demand are in demand at full price. So I don't see any weakness there with respect to front line pricing.
And then generally as you know, hardware has been slowing down on a couple of the major platforms and our expectation is for a price reduction potentially on a couple of platforms on holiday season.
Colin Sebastian – Lazard Capital Markets
Just a follow up on the Jacks contract, is there any way for you to go it alone with WWE after December 31, or is it just a matter of negotiating with Jacks on an extension or new rate going forward.
Obviously there's a lot of moving parts to all of the issues surrounding Jacks and WWE. And again, the real take away there is we've got a great relationship with the WWE. It's a very important license to us, so that's as far as we want to go at this point.
Your next question comes from [John Taylor – Arcadia Investment Corporation]
[John Taylor – Arcadia Investment Corporation]
When you're talking about your confidence in being profitable for the year, how much of that relates to the new royalty rate from Jack and how much of that relates to UFC or other things that are going on?
Under what license agreement does the WWE online game fall? Is that subject to the same deadlines as the published game in Asia? And I wonder what your catalog sales were in the first quarter, and is the release of the WWE renewal, as you are bickering with Jacks about who gets to go first and who gets to trigger the renewal, is there a deadline or is there something in the contract which could end up spoiling it for everybody?
Number one, the greater degree of confidence with respect to being profitable for the fiscal year is independent of the arbitration ruling with respect to Jacks, primarily driven by the strong performance in Q1. As we said on this call last quarter, we had expected Q2 to be down relative to the same quarter in fiscal 2009, and we had expected Q3 and Q4 to be relatively flat.
That forecast has not changed for us. So any upside that we're confident with at this point in time, not a function of the ruling by the arbitrator with respect to Jacks.
I'll jump now to catalog. Catalog for the quarter was 24%.
The WWE, the online game is governed by the same contractual agreement with WWE as all of the other games. And then with respect to the renewal, the renewal is due to be advised by the joint venture by October, so there's certainly a lot of time for us to try and sort this out as we move forward. So there's really no rush on that.
Your next question comes from Mike Hickey – Janco Partners.
Mike Hickey – Janco Partners
Could you just walk through your reasoning on the convertible assets? It seems that a huge effort reducing the cost structure. It certainly was a hit with UFC. You actually increased your cash position in Q1. You reaffirmed $50 plus million in cash for the year. Fiscal '11 looks strong so why the convertible at this time?
First of all, let me start by saying I'm limited to what I can say about the offering given that it is a private placement. However, as we stated, we will be using the proceeds for general corporate purposes. This offering primarily is driven from our perspective to increase our financial flexibility going forward and funding our future growth, and funding the future growth of the business. So we feel it's the best thing to do with respect to the long term growth of the business.
Mike Hickey – Janco Partners
And for fiscal '10, how confident are you on your release dates?
There's a lot of work that goes into calling our release dates and we're very comfortable with our major releases that we've talked about through Darksiders, so through the holiday season and through Darksiders, we're very confident that our release dates are in order.
Mike Hickey – Janco Partners
Then for fiscal ''11 or Q4 '10 we haven't heard much from Saints Row, is that a reasonable assuming for fiscal '11 or is that a later date?
As you know, we haven't announced anything regarding the Saints Row franchise yet so it's premature to talk about when the next installment of Saints Row will come.
Mike Hickey – Janco Partners
On the Up video game and Cars, do you think that will be able to comp WALLE from last year?
I don't think it's too far off. As we've said before on prior calls, we expect Up to be down fairly significant from WALLE. We've been pleased it's been running slightly ahead of our internal projections which were reasonably conservative. Adding Cars to that may get you close to WALLE but certainly not above it.
Your next question comes from Mark Wienkes – Goldman Sachs.
Mark Wienkes – Goldman Sachs
How do you think the catalog sales for handheld games are comparing to console right now in the market and can you comment, are you seeing an impact from more I-phones out there or smart phones on hand held sales?
There's a lot of things as you probably know going on with respect to hand held sales. I know there's been a lot of talk in Europe about piracy. We've been pleased with our DS particularly. Catalog sales, it's not a bad market. We have as you probably know a little more disciplined SKU strategy than some of our competitors and so our DS business, we're fine with it for now.
We think there's some growth coming with the DSI. It will be interesting to see how the PSP business continues with Sony's new entry, but we're not seeing any major trends in the hand held business between the DS, PSP or even the I-phone affecting our overall outlook at this time.
Your next question comes from Ralph Shackhart – William Blair.
Ralph Shackhart – William Blair
Can you talk about your industry growth rate assumptions that you have factored into your outlook that you provided tonight, and has there been any major changes or any changes at all with that growth rate? On a broader macro front, since there are some concerns in the cycle, have you seen anything material or meaningful since E3 in early June? And you talked about your thoughts that there might be a price cut on the hardware front that people are anticipating. Have you factored a price cut on the hardware consoled into your guidance?
We've been saying for quite some time that we expected industry sales to be flat to up single digits and I think a lot of folks are coming down and more around our range now. So our outlook has not changed over the last several months.
With respect to the cycle itself, if you look at what's happening in the industry, the fact that we have for example, Natol from Microsoft, a platform addition coming late next year. And also to your question with respect to price cuts, the fact that Nintendo Wii is still at its launch price and PlayStation 3 is still a relatively high price point by historical standards.
I think when we start thinking about the cycle; we should think about what lower price points may do to both hardware and software sales as we get into 2010 and 2011. So our view on the cycle we reiterate what we talked about on our last couple of calls is we think it will be a longer cycle.
As hardware prices come down, we don't think Microsoft is going to be alone in introducing either peripherals or new devices to keep the current hardware fresh for at least the next three to five years.
Price cuts again, they are factored into our guidance, our internal model. We did anticipate price cuts coming this fall. Obviously we'll let the hardware guys announce both the magnitude and the timing, but again, just look at the hardware numbers and it would seem that a price cut would be in order by at least two of the three manufacturers.
Your next question comes from Ben Schachter – Broadpoint AmTech.
Ben Schachter – Broadpoint AmTech
On the industry growth rate, do you see a $100 cut for Sony or can you get there if it's only $50? And then on Red Faction, can you talk about sell through versus shipments and do you expect reorders there? And then on UFC, you mentioned it's still going strong, you already shipped 2.9 million. How much more do you expect for the year and will we see it on the Wii next year. And also with UFC it's still going strong so why should we expect catalog to be so much lower next quarter. And then the last one, on WWE online, is that going to be the U.S. and can you talk about the type of model? Is it going to be a subscription, free to play?
I'll leave it to the hardware guys to announce the magnitude and timing of their price cuts, but something on the higher end of the range certainly wouldn't surprise us.
With respect to Red Faction, we've been very pleased with the sell through. It's been fairly robust world wide on a percentage sell through. The amount its been dropping off week after week has been something that would indicate good word of mouth on the game based on the high metacritic rating, so we hope that Red Faction has a long tail on it as we move into the holiday season.
Just to be clear, we define catalog as prior year releases, so UFC is not considered a catalog title in Q2. It's still a new release. That's just how we define catalog.
WWE online, that game is being made in Asia specifically for the online free to play Asian market. As I said in my prepared remarks and the thing about online, it is a brave new world as you know, so this is a bit of an experiment.
Could it be brought to the U.S.? Yes. is it the right thing to do? I think we're a long way from knowing the answer to that. But for now it's being made in Asia specifically to address the WWE brand in the free to play online Asian market.
Your next question comes from Anthony Gikas – Piper Jaffray.
Anthony Gikas – Piper Jaffray
Can you talk a little bit about the downloadable content? You talked about some coming for Red Faction and maybe where the opportunity is in some of the other franchises. How significant could it be for the company specifically on Red Faction if you have any idea on pricing, the revenue opportunity and timing?
Is it fair to say that the product development expense for the year will track under 10%? I think that would in keeping with the comment that you made earlier. Did you give your industry outlook for 2009? Do you continue to expect growth in the category this year or are we looking at more of flatter down year?
As I said a moment ago, our outlook for the industry remains flat to up mid single digits for the year in our addressable markets which are the U.S., Europe and Asia pack.
Downloadable content is a pretty broad issue. We are just releasing or about to release more DLC for Saints Row so that is still very much alive. There has been and will be more DLC for Red Faction Guerilla. We look at it as a revenue opportunity, but more importantly what we've learned with DLC is customer retention and customer engagement, primarily to prevent trade in and used games and to keep that brand active with the consumer.
So when we look at DLC, the revenue, it's not that great. It's good, but we also like the fact that it keeps the customers engaged with our games for a long period of time.
With respect to product development, if you recall on our last call when we gave guidance, high level guidance for fiscal '10, our product development for Q4 was about $21 million and we said that's what you can anticipate throughout fiscal 2010. Indeed that's what it was in Q1 and our views remain consistent with that so instead of giving you a percentage, about flat with where it was in terms of dollars this quarter.
Your next question comes from Heath Terry – FBR Capital Markets.
Heath Terry – FBR Capital Markets
I wonder if you could give us a sense, you kind of touched on this a little bit, to what extent are you seeing the metacritic rating for Red Faction have an impact on, and online play have an impact on the direction of sales post Red Factions launch relative to what you would normally expect for a new release?
Red Faction Guerilla for us, again we're pleased with the metacritic. We're delighted to have already shipped over one million units. Frankly, I think on the next generation of Red Faction Guerilla we need to do a better job of creating day one demand. That being said, we do like the sales curve that its been exhibiting which shows that quality and word of mouth and downloadable content matters.
So again, I'd give us a B on the launch of Red Faction Guerilla. I think we did a good job, but I think we can do a better job with the next generation creating day one demand. As you know we moved the title a couple of times. That's doesn't help. I'm very pleased with a lot of the strides we've made recently, but that doesn't mean we can't do some things better.
Your next question comes from Justin Post – Bank of America.
Justin Post – Bank of America
Just to clarify with UFC and some of your other titles, you haven't seen any kind of change in market conditions over the last month or so. And then your outlook, we had a down first half, so something like 15% growth needed in the back half to get to flat. Maybe you could just talk about some of the key drivers for the industry. Do you think it's more titles from publishers like yourself, easier comps or anything like that? I think UFC took almost two years to develop and you pushed Red Faction back a little bit and it came out with really good quality ratings to your credit. Did you learn anything from that and are you taking that into account on your future releases?
On the industry as a whole, I think there's a very robust release rate for the industry as a whole in the back half overall. I'm not sure it's worthwhile for me to go through a litany of all of those, but I think we're going to get more than our fair share with, obviously we have WWE coming. We've got all of our kid's and family titles coming. Darksider is right after the first of the year.
As you know, the industry is always very competitive. About half of the sales as you know come in the calendar fourth quarter and while we still see a cautious retail and consumer spending environment, we also don't anticipate a real seizing up of both retailers and consumers that we saw last December.
I think that adversely, I don't think that adverse impact will happen this fall although we think consumers will be cautious and retailers will be cautious. We're not anticipating the total seizing up that we saw last November and December.
I think we've been pretty clear on what we think the formula for success for the launch in the core gamer category is. It's quality ratings, build up the marketing buzz, and then pick a window where you have a competitive edge over your competitors. Those are our three inputs for success.
You need all three of those. Again, it's easy to say let's delay games for quality. You see that happen a lot, but you can lose marketing momentum as does happen in this industry from time to time. Our job moving forward is to execute better and better on getting those things right.
Your next question comes from Arvind Bagga – Sterne Agee.
Arvind Bagga – Sterne Agee
On world wrestling, I wonder what you're targeting for units sales versus last. On the Jacks call, they talked about the toy business being down quite a bit. Just wondering what your thinking is on the brand right now and unit expectations. Are retailers viewing world wrestling as dramatically different from the UFC brand and are you expecting no cannibalization whatsoever?
To start off with respect to units, if you recall we shipped 4.5 million units of WWE last year and to be conservative as we've said in the past, we have planned it to be down this year. So again, 4.5 million units last year, planning it to be down, still a very, very strong franchise for us.
Arvind Bagga – Sterne Agee
UFC versus WWE?
We're not hearing retailers really compare the two at all. One of the great things about us controlling both those brands is we've spaced them by quite a bit. We've had a great run with the UFC and will continue to promote it through the holiday season. But at WWE, we will do what we've always done which is create a big marketing buzz, hit our day with a high quality game and promote it aggressively.
And I don't think retailers are looking at it as an either/or cannibalization. The two brands are positioned very, very differently. The games are vey different. Presentation is different. So on the margin, could there be some slight cannibalization, hard to argue, but they are two great brands we look forward to exploiting both of them for a very long time.
Your next question comes from Jess Lubert – Brean Murray.
Jess Lubert – Brean Murray
Did you say you still expect Q3 and Q4 sales to be roughly flat on a year over year basis?
We did, yes.
Jess Lubert – Brean Murray
Over the last month or so a number of big competitive titles originally expected to launch over the holiday season have been pushed into the March 2010 quarter. How does this impact your thought process regarding the windowing and potential opportunity of Darksiders and will you enter into any hedges to limit the dilution on the convertible?
On Darksiders again, titles move around a lot and we have picked our date with retail. We're setting up retail programs around the world, so we've picked our date now. Can't say what other players may put some of their titles, but we like where we're placed right now.
As I said earlier, given that this is a private placement, I'm not able to comment on the terms of the offering at this point.
Thank you for your questions. That concludes our call for the first quarter of fiscal '10. We look forward to speaking with you next quarter.
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