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THQ, Inc. (THQI)

F4Q07 Earnings Call

May 10, 2007 5:00 pm ET

Executives

Julie MacMedan - Director of IR

Brian Farrell - President & CEO

Ed Zinser - CFO

Analysts

Colin Sebastian - Lazard Capital Markets

Ben Schachter - UBS Securities

Edward Williams - BMO Capital Markets

Heath Terry - Credit Suisse

Justin Post - Merrill Lynch

Tony Gikas - Piper Jaffray

John McPeake - Prudential Securities

Michael Savner - Banc of America

Shawn Millman - Oppenheimer

Bill Crear - A.G. Edwards

Mike Hickey - Janco Partners

John Taylor - Arcadia

Edward Irvin - Bear Stearns

Presentation

Operator

Good day, ladies and gentlemen. Thank you for standing by, and welcome to the Fourth Quarter 2007 THQ Earnings Conference Call. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of today's presentation (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Ms. Julie MacMedan, Director of Investors Relations. Please proceed, ma'am.

Julie MacMedan

Thank you. Good afternoon everyone. On today's call, our management will make forward-looking statements and projections regarding our expectations, estimates and predictions 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 the risk factors that are described in our March 31, 2006 Form 10-KA. A copy of this filing may be obtained from our website.

In describing THQ's financial performance, we will discuss non-GAAP measures, including operating margin and net income. Please refer to the reconciliation of these measures to GAAP results in the tables provided in today's results release. In addition, please note that comparisons to prior year periods reflect restated fiscal 2006 results, due to the stock option grant review. Finally, any market share data mentioned in our remarks was obtained from the MPD Group, UK Chart-Track and GFK.

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 discuss THQ's results for our fiscal 2007 fourth quarter and our guidance for fiscal 2008. Ed will also provide our calendar 2007 market growth and hardware platform assumptions. Brian will then close with a discussion of our plans for fiscal 2008 and long-term growth. We will then conduct a question-and-answer session, following prepared remarks.

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

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Brian Farrell

Thank you Julie, and good afternoon, everyone. Fiscal 2007 was another record year for THQ. I'm pleased to report that we successfully executed against each of our stated strategies. We established two owned intellectual properties, Saints Row and Company of Heroes. We grew our license franchises and added to this foundation by securing the rights to the Ultimate Fighting Championship.

We expanded our studio system to more than 1,500 people at 16 studios. We increased the percent of internal development to 40% of our fiscal 2007 net sales, up from 30% a year ago. We further expanded our global footprint in Europe and Asia and increased our international revenues. We secured agreements for in-game advertising and generated our first revenues from digital distribution. THQ has never been better positioned as we enter the exciting growth years of the current hardware cycle.

In fiscal 2007, we posted record net sales of more than $1 billion, marking our 12th consecutive year of revenue growth. Our revenues increased 27% over the prior year, reflecting share gains in our major markets around the world. We also achieved significant operating leverage in fiscal 2007.

We posted a 10% operating margin, currently the highest of our major competitors and more than double our margin last fiscal year. It is important to note that our operating margin is already equal to our peak margin from the last cycle and we expect to see it expand each year of the current cycle.

We reported record net income of $84 million in fiscal 2007 and we further strengthened our balance sheet to support our planned growth over the video game cycle. At March 31, 2007, we had nearly $7 per share in cash and our stockholders equity was over three-quarters of $1 billion. Exciting titles on new platforms, such as, Saints Row, combined with our great mass-market brands on both new and legacy platforms drove our fiscal 2007 market share gains in North America, Europe and Asia-Pacific.

With the fiscal year ended March 31, 2007, we grew our revenues more than 20% versus the prior year period in each of our major markets; North America, Europe and Australia, New Zealand. This compares with industry growth of 13% in the U.S., 11% in the major European territories and 4% in Australia and New Zealand over the same period. Our share gains were fueled by our product portfolio, which has never been more robust or diversified.

In fiscal 2007 we established two internally developed owned properties, Saints Row and Company of Heroes. To date we have shipped more than 1.4 million units of Saints Row worldwide on the Xbox 360 platform alone, and we're pleased to announce that we just released Saints Row as a Platinum hit on the 360. Company of Heroes achieved the highest rating for a real-time strategy game in the past 10 years. We plan to sequel both of these brands in the future.

We significantly grew our revenues from our long-term license properties as well. We shipped nearly 8 million units of Cars and 4 million units of WWE SmackDown Versus Raw. We also shipped a combined 4 million units of our key Nickelodeon titles, Avatar, Nicktoons and SpongeBob. And our Bratz games exceeded 1.5 million units shipped.

Life-to-date shipments now stand in excess of 30 million units each of our Disney Pixar, Nickelodeon and WWE's franchises. More over, our Bratz shipments have now exceeded 3 million units life-to-date.

In fiscal 2007, we added to this foundation of strong license brands by securing the exclusive global rights to publish games based on the Ultimate Fighting Championship. The UFC is the fastest growing sport targeting the coveted 18 to 34 male demographic. Our studio system has never been stronger. We now have more than 1,500 people in 16 studios, up from only 200 people at the start of the last cycle.

In fiscal 2007, we acquired Paradigm Entertainment, the developers of our highly anticipated Stuntman game. We also acquired Mass Media to support our PlayStation 3 development efforts. And we recently announced that our Warhammer 40K MMO game is in development at our Vigil Game Studio, which we acquired last February.

In fiscal 2007, we increased the percent of sales from internally developed titles to 40%, up from 30% a year ago. We are targeting 50% in fiscal 2008, as we launch several internally developed and owned intellectual properties, such as, Frontlines, Juiced and Stuntman.

THQ's international revenues totaled $427 million or 42% of total net sales, up from $317 million or 39% of revenues a year ago. We now have direct sales operations in 18 countries and distribute our products in more than 75 territories around the world. During fiscal 2007, we opened direct sales operations in Italy, Mexico and Switzerland.

Finally, in fiscal 2007, we positioned the company to take advantage of the growing trends of digital content creation and distribution. We signed agreements with industry leaders for in-game advertising, which you will see in several fiscal 2008 titles. We offered our first PC titles via digital distribution channels.

We drove awareness in record presale activity for Saints Row with an online game demo and provided digital downloads of additional content after the game shipped. And we've repositioned our wireless business for future growth, adding new brands and development capabilities to the business.

In summary, we successfully delivered on our goals in fiscal 2007, which drove our impressive sales growth and margin expansion.

Now I'll turn the call over to Ed to discuss our financial results and forecast in more detail. Ed?

Ed Zinser

Thank you, Brian. Good afternoon. Today, I'll recap our full year fiscal 2007 results and review our Q4 financial results. In addition, I'll provide guidance for full year fiscal 2008 and provide initial guidance for the upcoming June quarter.

THQ's financial results include stock-based compensation expense, the adoption of FAS 123(R). As I discuss our financial performance in more detail, I'll use the non-GAAP numbers, which give the true apples to apples comparison versus prior year line items. THQ gained market share both domestically and internationally in the fiscal year ended March 31, 2007 and posted net revenue of $1.027 billion, 27% growth over the prior year.

Net revenue was fueled by eight 1 million unit-plus titles, which included both license and new original intellectual properties. Operating margins more than doubled to 10% and earnings per share more than doubled to $1.24 from $0.54 in the prior year.

Now turning to our financial results for the fourth quarter, net sales for the fourth quarter of fiscal 2007 were $172 million, ahead of the guidance provided on our last call. This represents 16% growth versus the prior year quarter. We reported net earnings of $0.15 per share, slightly ahead of our guidance and up significantly from the $0.12 loss in the prior year quarter.

Our topline was driven by the PC releases; S.T.A.L.K.E.R, Shadow of Chernobyl and Supreme Commander and the continued strength of Cars and WWE. From a geographic perspective, all regions reported growth versus the prior year quarter. In particular, Europe was up 31% and Asia-Pacific was up 63%. Currency exchange rates increased our net sales during the quarter by $6.9 million or 4%.

Moving on to cost of sales, product costs of 37% declined 2.5 points versus the prior year quarter. The decrease was due primarily to the higher sales mix of PC titles in the current year quarter. Software amortization and royalties of 14% was 10 points below the prior year quarter. This is due to a prior year write-off and to greater amortization of titles in the prior year quarter.

License amortization and royalty costs of 7% of net sales decreased by 3 points compared to the fourth quarter of last year, due primarily to the greater sales mix of owned intellectual properties this year. As a result, the gross margin after these costs was 41% versus 26% in the prior year. Product development expenses of $22 million were essentially flat versus the prior year period.

Selling and marketing expenses were 13% of net sales, down from 14% in the prior year quarter. G&A expenses were $16.7 million, up $1.7 million from the prior year quarter due to higher legal and professional fees. As a result, our net income for the fourth quarter was $10.1 million or $0.15 per share compared to a net loss of $7.6 million or $0.12 per share in the prior year quarter.

Now let's turn to the balance sheet. THQ ended the year with $458 million or $6.78 per diluted share in cash and short-term investments. This was an increase of $86 million versus the March 31, 2006 balance. Net accounts receivable of $68 million decreased from $79 million at March 31, 2006.

Our day sales outstanding on a rolling 12-month basis was 24 days versus 36 days in the prior year period. This reflected sales timing and payment terms reductions in North America. Accounts receivable reserves were $81 million at quarter end, up from the $58 million balance at March 31, 2006. The coverage on a trailing nine-month of net sales basis was 8%, the same as the prior year quarter end.

Inventory was $27 million, a decrease from the $29 million at March 31, 2006 on a corresponding 27% growth in the business. On a rolling 12-month basis, inventory turns were 10, the same as a year ago. Our investment licenses of $91 million increased from $81 million at March 31, 2006. This reflected the timing of payments and amortization of existing licenses and the additions of the Ultimate Fighting Championship and the Warhammer 40,000 massive multiplayer licenses.

Capitalized software development increased to $164 million at yearend, up from $109 million at March 31, 2006. This growth reflected a greater mix of next generation title development compared to a year ago, including titles such as Ratatouille, Stuntman, WWE, MX vs. ATV and Frontlines. The prepaid expense and other current asset increases are primarily for product payments and co-marketing reimbursements.

Property and equipment of $45 million was up $8 million from the March 31, 2006 balance, due primarily to development kits facilities and business systems software.

Total current liabilities were $197 million, up from the March 31, 2006 balance of $149 million. The most significant increases were deferred income taxes and $15 million due to Jack Specific that has been accrued at the payment rate that expired June 30, 2006. Until the new rate is determined, which we expect to be significantly lower, this accrued balance will continue to grow as it will remain unpaid.

The company's current ratio is 4 to 1, with working capital of $562 million, up from $460 million a year ago. On a rolling 12-month basis, operating cash flow was $65 million, more than a 50% improvement from the $43 million in the prior year. Significantly higher net income and improved use of working capital more than offset increased investment in product development and licenses.

Return on invested capital on a rolling 12-month basis was 27% versus 13% for the prior year. We had no borrowings at quarter end, and total stockholder's equity was $769 million. In the quarter, we had a stock buyback of 116,000 shares.

That concludes the financial results for the fourth quarter of fiscal 2007. Before I discuss THQ's financial projections for the full year of fiscal 2008 and for the first quarter, I would like to review some of our assumptions. Expectations for calendar 2007 software dollar growth for North America and Europe remained unchanged at 12 to 15%.

In terms of hardware projections, the most significant changes were the increased DS forecast in both North America and Europe. Our unit hardware forecast in North America for each platform are as follows: Xbox 360, $5.5 to $6 million; Nintendo Wii, $5 to $5.5 million; PS3, $3.5 to $4 million; PS2, $3 to $3.5 million; DS, $9.5 to $10 million; and PSP, $3 to $3.5 million.

In Europe and the other territories, our forecast for each platform are as follows: Xbox 360, $2.5 to $3 million; Nintendo Wii, $4 to $4.5 million; PS3, $3.5 to $4 million; PS2, $3.5 to $4 million; DS, $8 to $8.5 million; and PSP, $3 to $3.5 million. On a worldwide basis, we expect minimal shipments of Xbox, GameCube and GBA.

Turning to THQ's fiscal year 2008, our sales and profit projections remain unchanged from our last call. We are projecting net revenue of approximately $1.12 to $1.15 billion. As Brian will discuss, our revenue will be driven by a strong product line-up, which includes a well-balanced mix of new and sequeled owned intellectual properties and new releases with our partners, Disney Pixar, the WWE and Nickelodeon.

Net income is projected at $1.34 to $1.44 per share, excluding the impact of stock-based compensation expense of $0.23 per share. Our key assumptions regarding title and skew count, catalog and platform and international sales mix remain largely unchanged from our last call.

Consistent with our normal pattern, we will now provide additional guidance for the 2008 fiscal first quarter. We expect net sales of approximately $110 million and net loss of about $0.26 per share, excluding the impact of stock-based compensation expense of $0.05 per share. As we discussed on our last call, the June quarter reflects a light new release schedule in the comp and one month later ship date of Ratatouille versus Cars in the prior year.

In addition, Saints Row on PS3, which was expected in Q1, has been cancelled. We are rolling the resources on to Saints Row 2, which was announced earlier today. As you know, our quarterly results are driven by our title release schedule.

Looking ahead through remainder of the year, we are projecting a very strong second half. In particular, Q4 should be up approximately 50% versus this year, due primarily to the multi-platform launches of Frontlines and MX vs. ATV, compared with two PC titles in the fourth quarter of fiscal 2007.

In summary, in fiscal year 2008, we plan to generate $1.12 to $1.15 billion in net revenue and earnings per share of $1.34 to $1.44, driven by improved operating margin to approximately 11%.

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

Brian J. Farrell

Thanks, Ed. Like last year, our fiscal 2008 publishing strategy is well aligned with the best performing platforms in the marketplace. This cycle, we believe, market segmentation is extremely important. We have designed our publishing strategy to take advantage of the unique feature sets of the new consoles, handhelds, and PC.

Our strategy to reach core gamers focuses on the Xbox 360, PS3 and PC platforms. Our mass-market brands are targeted primarily for the Nintendo Wii, PS2 and DS platforms. Some brands, of course, such as Pixar and WWE, warrant publishing across all viable platforms. We are particularly excited about our ability to grow share on the Nintendo Wii platform this year.

We have 11 titles planned for the Wii, including games targeted at a slightly older demographic, such as WWE and MX vs. ATV. We also plan to launch original content exclusive to the Nintendo Wii platform in fiscal 2008.

Revenue from owned intellectual properties is expected to be an important driver for us this cycle. We currently expect a third of net sales from owned properties in fiscal 2008, up from approximately 20% in fiscal 2007. Our revenue from owned IP will be driven primarily by the launch of two new THQ properties, Frontlines and Stuntman, and sequels to proven brands such as Juiced, MX vs. ATV and Company of Heroes.

With our successful launch of four new owned intellectual properties over the past two years, we've learned that the right launch window is critical for establishing new IP. In late August, we plan to ship Stuntman on the Xbox 360, PS3 and PS2 platforms.

We're very excited about this action racing title, which has generated positive buzz with the game press and has been testing very well with consumers. With its unique game elements, we think Stuntman truly has crossover appeal between mass market and core gamers alike.

We have selected a January 2008 launch window for our new open world shooter Frontlines. Developed by our chaos studio, Frontlines is a great opportunity for THQ to grow share in an important video game genre. We plan to support Frontlines and Stuntman with multimillion-dollar marketing campaigns. We also plan to launch sequels to our proven franchises. Juiced is slated to ship on multiple platforms in September.

To date, we have shipped more than 2 million units of the first juiced game. We expect to launch the next installment of MX vs. ATV on multiple platforms during the March quarter, the traditional launch quarter for this brand. To-date, we have shipped more than 4 million units of this great franchise, which continues to sell extremely well on legacy platforms. In the September quarter, we plan to release the next chapter in our Company of Heroes franchise on the PC.

We are excited to launch new original properties exclusive to the Nintendo platforms this fiscal year. Yesterday, we announced the expected release of Drawn to Life for the Nintendo DS. We look forward to launching more original titles to take advantage of the fast-growing Nintendo platforms. Stay tuned for more announcements of additional owned intellectual properties scheduled for fiscal 2008.

Even with our growing portfolio of owned IP, our licensed properties are expected to drive the majority of our fiscal 2008 sales with a significant contribution from our three long-term franchises, Pixar, WWE, and Nickelodeon.

In fiscal 2008, we plan to ship two new games based on our Pixar license, Ratatouille and Cars International. We also expect a strong Pixar catalog led by continued sales of Cars, which looks be an expanding franchise for our partners at Disney and Pixar.

We plan to ship games based on Pixar's Ratatouille concurrent with the movie launches around the world. Ratatouille hits theaters in North America on June 29 and rolls out across Europe and Asia-Pacific throughout the summer and fall months. We plan to launch Ratatouille in more than 20 languages across all viable platforms. And we expect strong holiday sales of this game, supported by an expected DVD release.

We plan to launch the sequel to Cars called Mater-National, across multiple platforms this holiday. Based on the success and our previous experience with our Incredibles sequel, we expect Mater-National to perform very well. We expect WWE SmackDown versus Raw 2008 to be the top driver of revenues in the December quarter.

We plan to bring the brand to twice as many platforms this year, including our first WWE games for the Nintendo Wii and Sony PlayStation 3 platforms. We think the WWE is a great title for the Nintendo Wii and have designed a game to take advantage of the Wii's unique controller.

As we announced earlier this week, we are planning another great Nickelodeon line-up this year, with the return of Avatar, Nicktoons and SpongeBob. We think these games match extremely well to the Wii, PS2 and DS platforms.

We also plan to introduce a new Nickelodeon brand, El Tigre, on the DS platform this year and we plan to continue release games based on our Bratz license on the Wii, PS2 and DS platforms. Rounding out our licensed portfolio, we plan to launch action title Conan on the PlayStation 3 and Xbox 360 platforms in the fall.

Consistent with our strategy to exploit new revenue streams, we plan to offer digital downloads and in-game advertising in at least four titles in fiscal 2008, including Juiced, MX vs. ATV, and Stuntman. We expect revenue from in-game adds and digital downloads of approximately $5 million in fiscal 2008.

And we expect significant growth in our wireless revenues, driven by games based on Ratatouille, Star Wars, Stuntman and Worms. Yesterday we announced the acquisition of mobile game developer Universomo.

Based in Finland, they have great technology and a proven track record of efficient development and porting for handsets in all major markets. We expect this acquisition to support our strategy to bring cross platform mobile development capabilities in-house.

In summary, our fiscal 2008 growth will be driven by a diversified product portfolio that is well segmented and capitalizes on the growing install base of new consoles, as well as the strong Nintendo DS and PlayStation 2 platforms. We continue to build an exciting product pipeline.

Just before the call today, we announced that Saints Row 2 is coming to the Xbox 360 and PlayStation 3 platforms. Our Volition Studio is working diligently to continue to set new precedents for open world gaming with this fiscal 2009 anchor title.

We've also discussed our expectations to launch our first games based on the Ultimate Fighting Championship in fiscal 2009. Stay tuned for more exciting announcements over the coming months. Over the long-term, our strategy for growing revenue at or above the market and continuing to expand operating margins is as follows.

One, grow annual revenues from our licensed franchises. Two, sequel and extend our growing portfolio of owned intellectual properties. Three, introduce one to three new intellectual properties each year that have long-term franchise potential. Four, exploit new revenue opportunities such as digital downloads, in-game advertising, and wireless. And five, continue to expand our international businesses.

With our tremendous studio system, extensive global footprint and diversified franchise portfolio, we have never been better positioned for growth. We believe we have the right strategy and resources in place. Now it's all about execution. We look forward to continuing to post record results and generating value for our shareholders.

We now look forward to responding to your questions. Operator, please open the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will come from the line of Colin Sebastian with Lazard Capital Markets. Please proceed.

Colin Sebastian - Lazard Capital Markets

Thanks for taking my questions. I have a couple of them. First, I'm curious what your plan is from a marketing point of view for fiscal '08. Shaping up to be a fairly competitive year, I think, and there are a lot of movie titles this summer and some pretty strong new releases the back half of the year. So, curious what your plans are there and if they have changed at all.

Brian Farrell

Yes, with respect to marketing, as we said in our prepared remarks, Collin, with respect to new IP, like Stuntman and Frontlines, both of those will be supported by multimillion dollar marketing campaigns, as will Juiced. But it's not just the marketing campaigns that we're looking at to drive these titles. It's also selecting the right launch window, as we've done for I think Frontlines, Juiced and Stuntman.

With respect to the movie slate this summer, we really like the way Ratatouille is positioned against the other competitors and we've seen the film and it's fantastic. So we'll let the movie and the great game drive the sales of that. We will market it heavily, but those games are really based on the licensed brand and a little less on the marketing campaign.

Colin Sebastian - Lazard Capital Markets4

Okay, and in terms of the guidance, I was just curious, if you could talk a little bit about gross margins, where you expect those to trend through the year? Thank you.

Ed Zinser

Sure. In general, Collin, as we had said last time on our call, when we gave a little bit more specific guidance on the full year, we expect our gross margins to increase a bit year-over-year in fiscal '08.

Obviously, we're going to have less PC mix than we did. We had a very strong PC line-up in fiscal '07, but we will see some expansion in our gross margins in fiscal '08, due obviously to the product mix for next-gen and the pricing that comes along with it.

Colin Sebastian - Lazard Capital Markets

Okay, great. Thank you.

Operator

And your next question will come from the line of Ben Schachter of UBS Securities.

Ben Schachter - UBS Securities

Hi, guys. I wan wondering if you could talk about PS3, what it's doing now and what you think how to look when we get around to the holiday. Then also, specifically on international, just wondering what you think will really drive internationals and I think some of the titles have the more European flair to them.

Brian Farrell

Just so I understand the question, Ben, the internationals that relate to PS3 or international business in general?

Ben Schachter - UBS Securities

International in general.

Brian Farrell

Great, okay. With respect to the PlayStation 3, it's actually been tracking very much to our expectations this year. We actually have an internal program here that maps the monthly sales from MPD and other services around the world and then takes a seasonal multiplier.

And the PlayStation 3 is actually tracking right to the numbers that Ed talked about. We have six titles coming on, or 7 titles coming on PS3, Frontline, Stuntman, Juiced, MX, Conan, WWE, Ratatouille. So we're expecting to be a very strong competitor in that marketplace.

Obviously, I think all of us would like to see a more accelerated take-up of the PlayStation 3. That should happen seasonally in the back half, as I think you were suggesting. If you're asking if we hear that Sony's going do anything about pricing, we have no knowledge of that at this time.

I do like our line-up, as you suggest for international this year. Things like Juiced and Stuntman are clearly very international in their flavor, as will Frontline. So I'm not sure we're projecting any growth in the percent of sales coming from international, but we think we will continue to accelerate along the same lines as we're doing here in the U.S.

Ben Schachter - UBS Securities

Great, thank you.

Operator

And your next question is from the line of Edward Williams of BMO Capital Markets.

Edward Williams - BMO Capital Markets

Good afternoon, guys. Just a couple questions for you. First of all, what sort of percentage of revenues do you think come from licenses in '08, and how should that trend as we look out to the next platform cycle? And then, again, kind of looking out several years into the platform cycle, where do you see your operating margin expansion coming more from? You know, what's the bigger lever, the gross margin side of it, or is the operating expense part of the equation?

Ed Zinser

Yes, I'll take the second one first. So with respect to gross margins, I think it really comes from a little bit in a lot of places, Ed. I mean, it's not coming from any one thing. We are clearly going to get leverage on SG&A if we grow at the market rates like we said we planned to or above.

That's double-digit growth rates and our infrastructure's not going grow at that rate. So clearly, we're going to get leverage there. We should see leverage from our margin as we shift into more next-gen properties. We should start to see a leveling off and a decline even in our product development costs as the percentage of sales as the install base ramps.

So really all three of those things, I think are going help us drive margins, as well as continued growth in the international markets and leveraging that development spend across more units per title. And the first part of the question…?

Julie MacMedan

Licenses.

Ed Zinser

Yes, as far as licensing goes, about two-thirds of our revenue should come from licensed properties and about a third from owned intellectual property in fiscal '08.

Edward Williams - BMO Capital Markets

Okay. And how do you see that particular line trending throughout the platform cycle?

Ed Zinser

You should see an increase in our owned intellectual property and a decrease in our licensed as a percentage of our mix. We'll continue to build and grow our licensed properties through the cycle, but you will see us growing at a greater rate as expected on our internally developed, as you are growing off a smaller base.

Edward Williams - BMO Capital Markets

Okay. And then last question, how many of the, kind of, key games in fiscal '08 have not yet been announced?

Brian Farrell

More than one and less than 20. How's that? There's one or two, but we really haven't, there's a number of things that we're working on that we'll save for the right time.

Edward Williams - BMO Capital Markets

Okay. Thank you.

Operator

And your next question is from the line of Heath Terry of Credit Suisse.

Heath Terry - Credit Suisse

Thank you. When you at your Wii portfolio to this year, how many of those games would you qualify, or would you kind of categorize as being specifically developed for the Wii versus, I mean, obviously you don't want to call any of them ports, but titles that are more kind of cross-platform in nature?

Brian Farrell

Yes, the two I would highlight, Heath, and what we're trying do with each of our Wii titles is do unique things with the controller to make the game seem to the Wii consumer as if it were designed specifically for the Wii. That being said, I think the WWE, which we showed at our gamers day, and I think you might have seen it, just that type of game play, with the wrestling mechanics does work really well on the Wii and our developers at Youth have done a great job of making that game a very Wii-specific title.

We also have an original title that I mentioned in my prepared remarks that we've not announced yet, that is a Wii exclusive and obviously has been designed explicitly for the Wii. So that's, that's where we are on the Wii.

Heath Terry - Credit Suisse

And when you're talking to your retail partners, obviously Nintendo talked about share or the number of units making it to retail, ramping, kind of beginning in May. Are you hearing that from your retail partners? Are you noticing it in your software sales, that there's more hardware available to the market?

Brian Farrell

We haven't heard much about the ramp yet. It's still, you know, fairly early in May, so it's not perceptible yet, but we're confident. We have been speaking with Nintendo recently and we're confident in their ability to put the hardware numbers that they have guided to and that we suggested in our prepared marks, that Ed suggested in his remarks.

Based on Nintendo's history, they have been pretty good at their manufacturing numbers and we're confident they will hit their numbers.

Heath Terry - Credit Suisse

Great. Thank you very much.

Operator

And your next question will come from the line of Justin Post of Merrill Lynch.

Justin Post - Merrill Lynch

Hi, thank you. First, could you talk a little bit about your guidance process? If we go back last year, every quarter beat by at least 10% on the top line. What led to the numbers being ahead last year? What's going really well for you? And how do you think about guidance when you look forward?

Brian Farrell

Well, I think last year I think it's true, as I said in my prepared remarks, Justin, that we really had a very, very strong year on a number of fronts. I mean I'm pleased with the way the team is executing here, that we're executing on the development side, our game rankings are up, our marketing has been very strong and our sales teams around the world have done a great job really driving our products through the channel, both getting it on the shelf and with retail promotions to get it off the shelf.

So and you can't count on all of those things all the time. So we do take our sort of our best estimate of our results for any given quarter and year and put them out there. That's why you see generally a range around certain numbers, but I am particularly pleased with the execution last year and, believe me, we're going to continue to try and execute as we move forward.

Ed Zinser

And as far as the process goes, Justin, as I'm sure you can imagine, it's a bottoms-up plan where we're looking at every title, the platforms, pricing, tier ratio assumptions, obviously a complete cost build-up, so it's obviously a very rigorous process that we go through and we update on a very detailed way every quarter and put our best estimate.

As Brian said, our best estimate out there on what we think the titles can do. I think we've executed pretty well this past year and, fortunately, we're able to outperform the original numbers that we had put out there.

Justin Post - Merrill Lynch

Great. A couple more. Looks like Saints Row was cancelled and you kept the guidance the same. Is that just more optimism for your other titles or have you added a couple this you think might help you out next year?

Brian Farrell

Well, as you know, Justin, products move in and out of certain windows and we do have some flexibility there. So, no, it reflects more just movement around in some of the product flow that we've had from our studios, the addition of some titles in and then moving Saints Row out. It's normal product movement.

Justin Post - Merrill Lynch

Okay, great. And last one. If you look at the short-term capitalized development on the balance sheet, it's up around 40%. And with the revenue increase, maybe 12% to 15%. It looks like you're not going to get leverage there. Do you expect some of the other gross profit lines to give you some leverage next year as we model that out?

Ed Zinser

Well in terms of leverage next year, when you look at how we're going to improve sort of the operating margin year-over-year, you're going to see, again you'll see some improvement in the gross margin. You're going to see some, obviously, some leverage on SG&A.

You're going to see lower licensing as a percentage of sales and total based upon the increase in the owned intellectual property. You're going to see higher marketing and selling as a percentage of sales, as we have messaged, and we'll be fully supporting from marketing perspective our titles this is year in what we expect to be fairly competitive environment.

And then you're going to see increased development costs as a percentage of sales in fiscal '08 based upon the, where we are in the install base ramp and the increased cost of product development. You should see that start to level off and even decline. As I said earlier, later in the cycle, as the install base ramps and we all get more efficient at, at developing for the next gen platforms.

Justin Post - Merrill Lynch

Great. Thanks, and congratulations on the market share gain this year.

Brian Farrell

Thanks, Justin.

Operator

And your next question is from the line of Tony Gikas of Piper Jaffray.

Tony Gikas - Piper Jaffray

Good afternoon, guys. Congratulations on a terrific year. Couple of questions. I get this competition question from time to time as well, and do you agree that Payload and Grand Theft Auto are not risk factors; they are perhaps two of the most significant catalysts that are going to come this year for the industry, because they are going to drive a lot of hardware sales and regardless how that hardware gets out there, it's positive overall.

And then second question, recently you acquired another mobile game developer. Maybe you could just talk a little bit about what they bring to the table. Seems like growth rates in that particular segment have been slowing a little bit. Was this a situation of the right company, at the right price, maybe you could just elaborate. Thanks.

Brian Farrell

Yes, Tony, with respect to your first question on competition, there's always competitive titles every year. In the past, as you know and suggest, both Halo and GTA have had a bit of a blast radius around them. But I think you're focusing on the right thing, which is, I'm sure that Microsoft is looking at Halo 3 as a big platform driver and GTA has historically been a platform driver as well.

So, our strategy, as you've seen before and as we've talked about for this year, is, is to do two things. Number one, when Halo and GTA are in the marketplace, what you'll see from THQ is the properties that in the past have succeeded very well against those titles, which are WWE and our kid's titles.

And then moving Frontlines, as we did to January, now we have a window of opportunity where we'll have the mind share of the retailers, of the game press and consumers, all to ourselves. So, yes, it is a mixed bag with Halo and GTA, but if you plan properly, you can use those as an opportunity.

With respect to Universomo. Yes, that's really a development importing solution and that's a key to getting our expenses and time-to-market better aligned in our wireless business. They are one of the best developers we worked with in this marketplace.

We have worked with them for a period of time and we like the way they do things. So it's really a more time-to-market and expense issue than any other statement about mobile.

Tony Gikas - Piper Jaffray

Okay. Thank you.

Operator

And next your question will come from John McPeake of Prudential Equity Group.

John McPeake - Prudential Securities

Thanks for taking my call. I just have a couple of, I think, quick ones. With respect to Sony's online capabilities with Sony Home, do you have any features in your games that are going to give your games some unique game play there first off?

Brian Farrell

Yes, with respect to Sony online, probably the first game we'll have out with Sony online capabilities will be our Stuntman game. You know, whether that's going to be a market driver, we don't know exactly what Sony's plans are there yet, so we're going to wait and see.

But with Stuntman particularly, we're relying more on that very unique game play, because it is a really unique franchise. The action-driving capabilities in that game as a Stuntman, and we really like the way our developer Paradigm has blown that out.

So it will be online-enabled in a fairly robust way, but we think the real driver of Stuntman is going to be its game play, not the online focus.

John McPeake - Prudential Securities

Okay, and then you have a tough compare with the Pixar title Cars, right? I mean that, that was a pretty blockbuster game. Now, could you talk a little bit about Ratatouille and your expectation to potentially drive growth out of that relationship this year in terms of game play and that sort of stuff?

Brian Farrell

Yes, John. We've said a number of times that we never expected Ratatouille to comp against the great success of Cars. I think Ed pointed out that, at the time of the call last quarter, we had done about 7 million units of Cars and we should more be thinking about something like Nemo, which was 5 million units. So we were expecting the comp to be down on Rats versus Cars.

Now, the way we grow the franchise this year is bringing Cars 2, the Mater-National game to the market this holiday, along with the catalog sales of Cars. So between Ratatouille, Cars 2 and the catalog of Cars, we still expect to see growth in the Pixar business this year.

John McPeake - Prudential Securities

Great, thank you.

Operator

And your next question will come from the line of Michael Savner of Banc of America.

Michael Savner, Banc of America

Hi, good afternoon. Thanks. Two questions, if I could. First, just to delve into your guidance for the fiscal year a little bit more because, again, I would have thought that now you seem to be kind of giving yourself a little more wiggle room on the owned IP accounting for a third, instead of the 40% you've talked about for a while, but maintaining the guidance.

You know, just doing the math back of the envelope, that can't all come from Saints Row. Otherwise, I'm sure you wouldn't have cancelled it, which certainly makes sense strategically.

But can you then talk about, specifically, which titles in the license portfolio you expect to either have moved in or to do better relative to the shortfall now or for the lower expectations for owned IP? And then I have a follow-up.

Brian Farrell

Yes, there is a lot of movement as you update forecasts over the years, I'm sure you can sense, Michael, as we look at the product shares, we do our line reviews and then work with our sales and marketing people to sort of tweak our internal forecast.

As you suggest, the cancellation of Saints Row is one factor. We have become incrementally more positive on our WWE for the Wii and we're seeing a lot of strength in the PS2 market, which, as you know, is probably all licensed titles, as well as the DS is mostly licensed.

So the strongest markets, which are the -- which are the PS2, DS and Wii, have more of a licensed component than the other platforms. So that's a part of it as well.

Michael Savner, Banc of America

That's very helpful. Thanks. And then the second question, which is much more big picture, at least as we look out over the next 12 months and, you know, clearly if we had gone back a year ago, the Wii market share right now is higher than I think anybody would have expected.

It's probably too early in the cycle still, though, to be talking about the market having expanded already, if you just look at total units. So with the share shift going on right now, basically between the Wii and the PS3, over the next 12 months, what are the financial implications to you, in terms of -- basically rotated from a higher ASP product to a lower ASP product.

Both in terms of the implications absolute dollar and on margins, at least in the next -- in this current fiscal year?

Brian Farrell

Well, you got to remember the whole picture, as I'm sure you do, Michael. The biggest win you get with the Wii compared to its two next generation competitors is your development cost environment.

So the business model, even though you have a lower price point on the Wii, since we're expecting a higher install base, we're expecting incrementally more units, so you get a bit -- little bit of a shift there between retail dollars at one price point versus slightly higher volume.

And then on the dev cost side, as you know, the Wii development costs are way less than they are for 360 or PS3.

Michael Savner, Banc of America

Okay so you're comfortable that on an absolute dollar basis, the margin upside is enough to offset the volume or the ASP difference?

Brian Farrell

That is our current thinking.

Michael Savner, Banc of America

Okay. Thanks very much.

Operator

And your next question will come from the line of Shawn Millman of Oppenheimer.

Shawn Millman - Oppenheimer

Good afternoon, thanks. It's Shawn Millman, Oppenheimer. Couple questions. Ed, if you could just give us, just housekeeping, give us the catalog number in the quarter and what you think catalog will be in the first quarter.

Ed Zinser

Sure. Yes. Our catalog in the fourth quarter of fiscal '07 was about 24%. Obviously, as we look to the first quarter of fiscal '08 with really only one new launch title, being Ratatouille, you'll see more than half of our revenue coming from catalog.

Shawn Millman - Oppenheimer

Right, and just looking to go back to the guidance and the questions on the guidance, it looks like you reiterated the top line was about 9 to 12% growth. What is your FX forecast, or what are you thinking in terms of exchange rate in the next -- for the fiscal '08?

Ed Zinser

Pretty flat overall from where we are today. No major changes in our projections from where the dollar is today relative to the two main currencies, which is obviously the Pound and the Euro.

Shawn Millman - Oppenheimer

Right, and Brian, the Company's done a good job of growing fast in the market in the last few years, but now your guidance is implying a decent amount of market share loss next year. Is this -- obviously, it's tough comparing Cars, which we've talked about, but is it because some of the new IPs coming later in the year as well?

Brian Farrell

Yes, as Ed pointed out in his prepared remarks, we do some really strong IP coming with Frontlines in our Q4, in our fiscal year, which is obviously next calendar year. MX vs. ATV and then a couple of other unannounced titles that we've alluded in Q4 as well.

But again, just to be clear and I don't want to put too fine a point on it, but our revenue guidance is fairly much in line, we think, with overall market growth. So, no, we're not really predicting to lose share.

I think our guidance is roughly in line with where we think market growth is. So we're just trying to, again, as the year unfolds, see where those markets go and hopefully our market share will hold, if not grow, as we accelerate into next year.

Shawn Millman - Oppenheimer

Okay. Thank you very much.

Operator

And your next question is from the line of Bill Crear [ph] of A.G. Edwards.

Bill Crear - A.G. Edwards

Hi, thanks for taking my question. Revenue obviously was very strong in the quarter versus your expectations, and earnings came in essentially flat. Could you just help us with some of the factors that led to the lack of flow-through from the upside in revenues to the bottom line?

And then the second question is do you see any material movement of revenues from '08 to '09 due to the deferred revenue recognition related to package goods and digital content?

Ed Zinser

Yes, so as far as our, as far as our mix goes -- our revenue recognition goes for 8 to 9 other, there's really no plans to move any revenue on a recognition basis from 8 to 9 when you look at how our business functions and obviously our facts and circumstances are always going to be different than other companies.

Our revenue is primarily driven by box sales and there's no, no plans to change the recognition of revenue at this point, you know, based upon that. And the first part of your question? As far as the Q4 flow-through, it's primarily product mix related.

There's ups and downs of expense items here and there, but I think we flowed through about a penny more than what we had in the original forecast. It was primarily product mix for the most part; our assumptions were pretty consistent with what we had in guidance relative to our actuals.

Bill Crear - A.G. Edwards

Okay. Thank you, guys.

Operator

And your next question is from the line of Mike Hickey of Janco Partners.

Mike Hickey - Janco Partners

Hi, guys. Thanks for taking my question. Just a little perplexed on your sales expectations from owned IP, bringing it down to 33%, depending on how you do the math, that would suggest you're pulling in unit ship expectations of 1.67 million?

And I would expect that that has somewhat of a dramatic impact on your operating margin, but you seem to have maintained that. Could you give a little bit more granularity on where you expect the offset to come from? And then I have a follow-up.

Brian Farrell

Yes, couple things and I think we've partially answered that a moment ago, but part of it is with Frontline's now in January, it's a little further -- it's later in the fiscal year, so that's moving out a little bit. As we said a little earlier, the real strength we're seeing in the marketplace right now is on the Wii PS2 and DS platforms, which is a much more heavily licensed business.

And you got to remember, I know it's not always what people want to believe, but when you have very high unit volume licensed properties, the margins on those are very, very strong and when you're adding marginal units to already known titles, there's a lot of flow-through on those.

So it's really a change in the mix from moving a couple titles later in the year, canceling Saints Row for the PS3, and then seeing more, more acceleration into more heavily licensed businesses, which means more unit volumes on Wii, PS2 and DS.

Mike Hickey - Janco Partners

Okay, and then for Saints Row on the PS3, why was that title cancelled, and do you guys expect to expense any of the capitalized dev costs that you've already accrued?

Brian Farrell

Yes, with respect to the decision, as you know, we've done great things by our brands in the last couple years by putting them in the right timeframe. We think the most important thing for the Saints Row franchise is to have a simultaneous shift into a larger install base next year.

So that's what we're looking for with Saints Row 2, and so getting the resources fully on and expanding the resources on that Saints Row 2 product was a lot more important than getting the Saints Row PS3 game out in the next few months.

So it was a very, I think at the right brand decision. I think, if you look at the past, we've been making those decisions. And with respect to the impact?

Ed Zinser

Yes, it wasn't very significant. It was about a $0.02 impact on the quarter.

Mike Hickey - Janco Partners

Okay, and then quickly, the development time for Saints Row 2, had you separated your teams, so that they had kind of already started on Saints Row 2 and you had another portion of your team that was maybe trying to port the title to the PS3, or are they just kind of starting today on Saints Row 2?

Brian Farrell

No, no. It has been in development, and then the real thing we want to do, as you know, Mike, Saints Row is a great franchise for us, and we think the bigger opportunity is the multi-platform launch, and to expend more -- as we said in a couple of calls before, you know, other than capital, the most dear resource we have is development resources and we thought the highest and best use of those resources is for -- to hit the sim ship into a higher install base next year.

Mike Hickey

Great. Thanks, guys.

Operator

And your next question is from the line of John Taylor of Arcadia.

John Taylor - Arcadia

Hi, nice job. I got a couple of questions. Ed, what do you think the capitalized software development costs are going look like at the end of fiscal '08? And I'm looking for both short-term and long-term, part of that. And I got a couple stacked up here, I guess.

Ed Zinser

Yes, I'll just answer it, JT, kind off a top-line basis. We don't really give detailed balance sheet projections, as you know. But you should expect that to grow from where it is today. You'll see obviously increased development slate.

We're still ramping up with respect to Next Gen development. So we've got, if you looked at where we are this year versus last year, this year you've got titles like Rats, Stuntman, WWE, MX, Frontlines, all which are multi-platform.

And Next Gen development efforts and significantly, obviously more expensive to develop than even a year ago, where you had titles like Saints Row, Cars or WWE and a number of titles like Saints Row were single platform, as we ramp, for fiscal ’09, we start to then get to more of a steady state, if you will.

And a heavier mix of what you'll see on a more normal basis for our Next Gen platforms, you'll start to see that capitalized software number start to level off a bit, as you're now going to be amortizing a comparable amount to what you're adding in each year.

We're still in that growth phase right now with respect to Next Gen, so, the number will be growing from where it is today.

John Taylor - Arcadia

So, I think your incremental on that combined long-term, short-term went up about, what, 55 million or something.

Ed Zinser

That's correct.

John Taylor - Arcadia

Yes, so do you think was that the peak year or do you think you're up from that?

Ed Zinser

Yes, we will be -- we expect to be up from the number that we ended this fiscal year. So if we're sitting here a year from now, I would expect to be talking about the increase in our capitalized software development number in the end of fiscal 8 versus where we are at the beginning today.

But as we get into the following fiscal year, and like I said, now that we're more at a normalized run rate, you would expect to see really a leveling off of that because your amortization will start to catch up on a more of a run rate basis.

John Taylor - Arcadia

Yes. No, I'm with you there. I'm just trying to figure out sort of what the total amount or what the total cash budget is committed to product development maybe in fiscal '08 versus '07, whether it's accounted for as R&D flow-through or whether it goes on the balance sheet. Can you give us a sense of whether it's percentage increase, decrease there?

Ed Zinser

I'm sorry, I'm sorry?

John Taylor - Arcadia

If you look at the total amount of cash spending allocated to product development, whether it's either flowed through the P&L or goes on the balance sheet, what the delta might look like in fiscal '08 versus '07?

Ed Zinser

Sure. I mean if you look at our balance, our total number's going to increase and by the end of the fiscal year versus where we are at the beginning, you should -- you're going to see -- you're not going to see a very significant increase in the product development expense number that's on the P&L year-over-year. Most of that growth's going come in the capitalized asset.

John Taylor - Arcadia

Okay. So does that grow faster or does that cash payment, sorry to belabor this, does that cash payment grow faster than revenue, do you think? The cash amount paid either flow through the P&L or put on the balance sheet, does that grow faster in the 12 to 15% revenue number?

Ed Zinser

I'd say you're probably somewhere in a comparable amount. If you look at this year, we grew from, in rough terms, 100 and change to 150. So that's a pretty significant increase. We wouldn't expect to grow at that same rate in fiscal '08, by the end of the year as to where we are today. Our revenue we've guide to 12 to 15%, so I would, expect, you could potentially be higher than what our revenue growth is.

John Taylor - Arcadia

Okay, all right. That's helpful. And then, let's see, Brian, or one of you guys, maybe it was you, Ed, talking about the DS estimate. I think you're $9.5 million to $10 million, if I heard you correctly, is, in the U.S., is one of the highest estimates out there. So, I don't want to pick on that, but I wonder of the 12% to 15% software growth rate you're thinking about, how much of that is driven specifically by Nintendo format growth as opposed to other growth?

Ed Zinser

I don't know exactly how much is coming offhand, JT, from that. But obviously we went back in and, you're re-looking at that based upon what, how we're seeing that the DS perform relative to other handheld platforms as well. We have gone in and made our best estimate and we've taken those numbers up in terms of what our expectations are and that sort of factors in and we crunch through a growth rate. So obviously, it's having a little bit more of an impact on the 12% to 15% industry growth rate than it did before.

John Taylor - Arcadia

Right, okay. Right. And then last question, so if you look at the way Cars was distributed by quarter through fiscal '07, I wonder how you're thinking Ratatouille is going to be distributed through fiscal '08?

Brian Farrell

We're thinking about Ratatouille more acting like Nemo. We haven't specifically compared it to Cars, but if you look at how Nemo performed, that's how we're thinking about Ratatouille.

John Taylor - Arcadia

Do you remember offhand kind of what that was…?

Ed Zinser

JT, is it about the calendarization?

John Taylor - Arcadia

Yes. Well, I'm thinking of whatever number you have baked into your plan for fiscal '08, how much of that falls in each quarter roughly?

Ed Zinser

In general terms, I mean obviously I think last year we kind of talked about, sort of, a pretty strong, second and third quarter and a little bit lighter fourth and a lighter first. I mean what you'll see this year, and I don't have the exact numbers in front of me.

But obviously you're going to have a smaller Q1 for Ratatouille than, as a percentage and not only on an absolute basis, but as a percentage of total sales, as well, based upon shipping almost a month later, with the beginning of June versus the end of the month, for, compared to Cars last year.

Then it's going to roll out through Europe, which I believe is comparable timing. That's the biggest driver. Obviously, as we roll the game out coincident with the movie. So you'll see a smaller Q1 percentage of the total than Cars, and you'll see a correspondingly larger Q2 and Q3 and, I would imagine, probably a comparable percentage of the sales in terms of Q4.

John Taylor - Arcadia

Okay, great. Thank you very much.

Julie MacMedan

I think we have time for one more.

Operator

Your last question will come from the line of Edward Irvin of Bear Stearns.

Edward Irvin - Bear Stearns

Thanks, good afternoon. On your last call, you had guided to wireless growth of approximately 45%. And I'm wondering how you expect the acquisition of Universomo to impact that guidance.

Secondly, how many people were added through that acquisition? And then separately, I was wondering if you could just talk generally about the acquisition environment, both in the wireless and online space?

Brian Farrell

Yes, with respect to your first question, Universomo is not a publisher, they're a developer, so it's not a revenue play at all. It really is, as I said earlier, getting quality products to market faster at a more reasonable cost and importing all the different handsets very efficiently. That's really what Universomo and their technology brings to us.

I believe there were between 30 and 40 people there. I think closer to 40, and then the acquisition market in general, I don't see any major sea changes there. We will continue to look for things that is always has been our strategy, to think that either grow our intellectual properties, the ability to create intellectual properties or to add to our technical base. So that's where we continue to be focused.

Edward Irvin - Bear Stearns

Great, thanks.

Julie MacMedan

Great. Well, that concludes our fourth quarter call. Thank you for joining us, and we'll look forward to seeing you next quarter.

Operator

Ladies and gentlemen, thank you for your participation in today's call. This concludes the presentation. You may now disconnect. Have a wonderful day.

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