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THQ, Inc. (THQI)

F1Q08 Earnings Call

August 1, 2007 10:00 am ET

Executives

Julie MacMedan - VP of IR

Brian Farrell - President & CEO

Ed Zinser - CFO

Analysts

Colin Sebastian - Lazard Capital Markets

Heath Terry - Credit Suisse

Arvind Bhatia - Sterne, Agee & Leach

Justin Post - Merrill Lynch

Ben Schachter - UBS Securities

Michael Savner - Banc of America

Tony Gikas - Piper Jaffray

Evan Wilson - Pacific Crest

Jeetil Patel - Deutsche Bank Securities

Doug Creutz - Cowen and Company

John Taylor - Arcadia Investments

Presentation

Operator

Good day, ladies and gentlemen, thank you very much for your patience. And welcome to the First Quarter 2008, THO Inc. Results Conference Call. My name is Bill and I’ll be your conference coordinator for today. At this time, all participants are in a listen-only mode. (Operator Instructions). As a reminder, today’s conference is being recorded for replay purposes.

I would now like to transfer the call over to our host for today’s presentation, Ms. Julie MacMedan, Vice President of Investors Relations. Please proceed, ma'am.

Julie MacMedan

Thank you. Good morning everyone. On today's call, 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, 2007 Form 10-K filing. 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.

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 2008 first 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 the 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?

Brian Farrell

Thank you, Julie, and good morning, everyone. On today's call, I would like to share with you our THQ is continuing to execute on our strategies to drive revenue and margin growth. Specifically, we plan to, one, grow annual revenues from our big family and casual 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 from digital content distribution. And five, continue to expand our international businesses.

With respect to our big family and kids franchises during the June quarter, we shipped more than 1 million units of Ratatouille here in North America. Ratatouille is performing well at retail, as we anticipated. We expect this game to have an extremely long tail and strong international appeal just like finding Nemo.

Ratatouille is scheduled to launch in Europe and Asia Pacific over the next few months, and we expect game sales to benefit from the anticipated DVD release in North America this holiday. At these years E3, it was clear that Nintendo’s new platforms are truly expanding the markets for video games and we are excited to build upon our heritage as the leading independent publisher on Nintendo’s hardware.

We plan to release 11 titles on the Wii and twice as many DS SKUs in fiscal 2008, as last year. We expect the Nintendo platforms to be strong drivers of growth, for our family and kids franchises. Our continued investment in your studio system is paying dividend through more internally developed owned intellectual properties, which we expect will drive out operating margin expansion. We plan to ship more than 1 million units each of five owned properties, Stuntman, Juiced, Frontlines, MX vs. ATV and Destroy All Humans!

In addition, we think our original title de Blob, which is exclusive to Nintendo’s platforms has long-term franchise potential. Underscoring the strength of our studio system this year, four of our titles were nominated for the prestigious game critics awards, best of E3 2007. 3 of the 4 were original properties Stuntman, de Blob and Company of Heroes.

Our new WWE game was also nominated demonstrating our commitment to deliver the highest level of product quality to maximize this key franchise, two of our stated strategies are to exploit new revenue streams and to increase our international sales. Under our recently announced agreement with Shanda, the leading online game operator in China, we plan to bring our award winning Company of Heroes property to the online gaming market in China, beginning in calendar 2008.

The agreement marks our entry into this large and liquid market, and underscores our commitment to pursue new revenue streams through digital content distribution.

In short, we are pleased with our progress against our stated objectives and we remained on tracked to post yet another year of record results.

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

Ed Zinser

Yeah. Thank you, Brian. Good morning. Today, I'll review our Q1 fiscal results, provide initial guidance for the September quarter and provide guidance for our full year fiscal 2008.

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 excludes this expense.

In the first quarter of fiscal 2008, we reported net sales of $104 million and a net loss of $0.09 per share. Significantly ahead of our guidance of $0.26 loss and ahead of the $0.16 loss in the prior year quarter.

Please note that our Q1 results included $0.10 research and development tax benefit from prior years. We received IRS notification in May that our tax examinations have been favorably resolved.

We anticipated this in our full year rate, however the exact timing was uncertain. Our net revenue included one new release Ratatouille, which shipped late in June in the North American market.

In addition, we have solid catalog revenue led by Cars and WWE. As expected, our revenue was below the prior year quarter which had five new releases including Cars, which shipped early in the June 2006, primarily in North America.

Currency exchange rates increased our net sales in the first quarter by $3 million or 3%. Moving on the cost to sales, product cost of 42% of net sales, increased 7 points versus the prior year quarter. The increase was due primarily to the higher sales mix of catalog titles in the current year quarter, which was 66% versus 37% in the prior year quarter.

Software amortization and royalties of 10% of net sales was 8 points below the prior year quarter. This was due to a prior year write-off and to the amortization of a greater number of new title releases in the prior year quarter.

License amortization and royalty costs of 13% of net sales, was flat versus the prior year quarter. As a result, the gross margin after these costs was 34%, same is in the prior year quarter. Product development expenses of $24 million were roughly in line with the prior year quarter.

Selling and marketing expenses were 21% of net sales, up from 19% in the prior year quarter, due to lower sales from the release late in the quarter of Ratatouille versus the early Q1 release of Cars last year and Q1 spending for Stuntman.

G&A expenses were 16.6 million, up 3 million from the prior year quarter, due primarily to higher legal and professional fees in international expansion. As a result, our net loss for the first quarter was 6.2 million or $0.09 per share compared to a net loss of 10.5 million or $0.16 per share in the prior year quarter. As I discussed, these results include the $0.10 tax benefit.

Now, let's turn to the balance sheet. THQ ended the quarter with $425 million or $6.35 per diluted share in cash and short-term investments. This was an increase if $122 million versus the June 30, 2006 balance. Net accounts receivable of 37 million decreased from 85 million at June 30, 2006.

Our day sales outstanding on a rolling 12 month basis, 14 days versus 39 days in the prior year period. This reflects the lower sales base in the current year quarter.

Accounts receivable allowances were $65 million at quarter end, up from the $58 million balance at June 30, 2006.

The coverage on a trailing nine-month of net sales basis was 7%, same as the prior year quarter end.

Inventory was $29 million, up slightly from the $27 million at March 31, 2007 but down significantly from the prior year balance of 38 million. On a rolling 12 month basis, inventory turns were 9, same as last year.

Our investment in licenses of $84 million decreased from $91 million at March 31, 2007. This was primarily due to the license amortization expense recorded in the quarter for Ratatouille.

As expected capitalized software development increased to $214 million at quarter end, up from $164 million at March 31, 2007. There was minimal amortization reduction to the asset balance in the quarter, since Ratatouille was the only new release shipped in one market. The $214 million balance is comprised primarily of titles in development, which are planned to ship this fiscal year such as Stuntman, Juiced and WWE. Approximately a quarter of the balance is for titles planned to ship in Fiscal '09.

Property and equipment of $48 million was up $3 million from the March 31, 2007 balance, due primarily to development kits, computer hardware and software.

Goodwill is $96 million up from $89 million at March 31, 2007 due primarily to the acquisition of Universomo, our wireless developer in May of this year.

Total current liabilities were $191 million, down slightly from the March 31, 2006 balance of $197 million. This balance includes $16 million due to Jack Specific that has been accrued at the payment rate that expired over a year ago. Till the new rate is determined, which we expect to be significantly lower, this accrued balance will continue to grow. They will remain unpaid until the new rate is established consistent with the recent court ruling.

The company's current ratio was 4:1, with working capital of $552 million, up from $451 million a year ago. On a rolling 12-month basis, operating cash flow was $85 million, up significantly from the $6 million in the prior year period. Significantly higher net income and improved use of working capital more than offset increased investments in product development and licenses.

Return on invested capital on a rolling 12-month basis was 25% versus 9% for the prior year. We had no borrowings at quarter end, and total stockholder's equity was $782 million. That concludes the financial results for the first quarter of fiscal 2008. Before I discuss THQ's financial projections for the full year of fiscal 2008 and for the second quarter, I would like to review some of our assumptions.

Expectations for calendar 2007 software dollar growth for North America and Europe remained at 12 to 15%. In terms of hardware projections, of significant change was the increase we forecast both in North America and Europe based upon our analysis and its success we are seeing in the marketplace. Our unit hardware forecast in North America for each platform are as follows: Xbox 360, $4.5 to $5 million; Nintendo Wii, $6 to $6.5 million; PS3, $3 to $3.5 million; PS2 $3 to $3.5 million, PS $9.5 to $10 million; PSP $3.5 to $4 million.

Europe and the other territories, our forecast for each platform are as follows: Xbox 360, 2.5 million to 3 million; Nintendo Wii, 4.5 million to $5 million; PS3, 3.5 million to 4 million; PS2, 4.5 million to 5 million; PS, 8 million to 8.5 million; PSP, 3 million 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. Our revenue will be driven by a strong product line-up, which includes a well-balanced mix of five owned intellectual properties of new and sequel and new releases with our partners, Disney Pixar, the WWE and Nickelodeon.

We expect gross margins to improve versus the fiscal 2007 level, due primarily to pricing from a greater mix of next generation console sales. Licensed amortization and royalties as a percent of net sales should decrease in fiscal 2008, reflecting an increase of owned intellectual properties from 20% of net revenue last year to roughly a third this year. Our product creation costs, which include both software amortization and product development expense, are expected to increase as a percent of sales.

We anticipate marketing and selling expenses to increase in fiscal year 2008 as a percent of net sales, as we launch new intellectual properties and spend to fully support new titles, based upon our owned and licensed properties. Our G&A is expected to decrease as a percent of net sales. As a result, our operating margin is expected to improve 11% of net sales.

Our effective tax rate for 2008 is planned at 30% which reflects the $0.10 tax benefit in Q1 as we discussed the subject to change due to geographical profit mix and other factors. The fully diluted share account is planned at a little under 71 million. Net income is projected at $1.34 to $1.44 per share, excluding the impact of stock-based compensation expense, $0.23 per share.

Consistent with our normal pattern, we will now provide initial guidance for the 2008 fiscal second quarter. We expect net sales of approximately $240 million and net income of about $0.10 per share, excluding the impact of stock-based compensation expense of $0.07 per share. Net sales in the September quarter will be driven by Stuntman and PS2, PS3 and Xbox 360, Juiced on six platforms, continued sales of Ratatouille as it rolls out across Europe with the movie and Bratz on PS2 V, GBA and DS.

The quarter includes significant marketing spending, up approximately 5 points as a percent of net revenue or about $10 million versus last year helped by brand awareness and drive Q2 and Q3 sales of our own intellectual properties, Stuntman and Juiced.

Our results in the first half of the year are expected to be little better than breakeven, consistent with last year, and we are projecting a very strong second half. In particular, Q4 net sales should be up approximately 60% versus last year, led by the multi-platform launches of Frontlines on three platforms, Destroy All Humans! on five platforms and a strong Wii and DS titled de Blob. This compares the two PC titles in the first quarter of fiscal 2007.

In summary, in fiscal year 2008, we plan to generate $1.2 billion to $1.5 billion in net revenue earnings per share of a $1.34 to $1.44, driven by an improved operating margin to 11%. Now I would like to turn -- and now I would now like to turn the call back to Brian.

Brian Farrell

Thanks, Ed. We expect our fiscal 2008 revenue, operating margin and earnings growth to be driven by continued growth in our big brands and our strong position on Nintendo's platforms, as well as, a robust offering on internally developed owned IP. Our Nintendo lineup includes a broad spectrum of titles targeted to gamers of all ages including games based on our popular Pixar, Nickelodeon and WWE franchises, and our number one girls game Bratz.

We expect our WWE game to be a top five Wii title this holiday based on that platform’s ability to broaden the appeal of this already popular franchise. Also targeting an older demographic, we plan to bring our MX versus ATV title to the Wii and DS platforms.

In addition, we continue to bring creative new content to the Nintendo platforms as exemplified by the strong critical reception to our recently announced game de Blob. De Blob is a perfect example of a creative, yet easy-to-play game targeted at the expanding audience of casual gamers.

We are looking forward to releasing this game exclusively on the Wii and DS in the March quarter.

Our fiscal 2008 holiday line up is consistent with the successful strategy we've executed over the past several years which is to drive sales with our big established mass market franchises. We plan to launch WWE on twice as many platforms as last year, including the highly popular Wii platform, as I just mentioned. We also have another strong Nickelodeon line up anchored by Avatar, SpongeBob and Nicktoons.

Our Pixar offerings include Cars 2, Mater-National and an expected holiday list of Ratatouille sales supported by the DVD launch in North America. Finally, we will have games from our popular Bratz franchise supported by the theatrical release of the Bratz movie. Increasing our revenue from owned intellectual properties is the second major pillar of growth for THQ. Our revenue from owned properties will be driven primarily by the launch of five internally developed titles with expected shipments in excess of 1 million units each. These include Stuntman, Juiced and MX vs. ATV, Frontlines and Destroy All Humans!.

We believe we have positioned these titles for success with strong product quality and extensive global marketing campaign. These campaigns are reaching more markets than ever before and encompass a broad scope from traditional television to cutting edge online campaigns including user-generated content and vital marketing. We also plan to support our titles with extensive in-store promotions. For example, we are looking forward to launching the highly anticipated Stuntman on three platforms on August 28. This action racer has already generated more than 500,000 Xbox live demo downloads, mirroring the download activity for our successful Saints Row game last year.

And in September, we plan to launch the sequel to our multi-million units selling Juiced franchise, Juiced 2: Hot Import Nights across multiple platforms. As with the first game, we expect international sales of Juiced 2 to exceed US sales. In December, we plan to release the next installment of the number one off road racing franchise MX vs. ATV on multiple platforms. This franchise has strong casual gamer appeal and we are excited to offer support for the new Nintendo Wii driving peripheral with this game. To date, we have shipped more than 4 million units of this great franchise.

Back to holiday, we plan to launch Frontlines, our new open road shooter in what we view as a favorable launch window that capitalizes on the holiday hardware ramp and gift card redemptions.

Frontlines is differentiated by its unique open-rolled experience and online multiplayer capability.

At E3, we unveiled our latest Destroy All Humans! game. This year, we are creating two experiences based on this brand, high definition destruction on Xbox 360 and PS3 and more casual experience for the Nintendo Wii, PS2 and handhelds.

Rounding out our holiday line up is action title Conan, which is scheduled to ship on PS3 and Xbox 360 in October.

We continue to execute on our plan to grow revenue from new areas, such as, digital content distribution.

In fiscal 2008, each of our three racing titles will include in-game advertising. We also plan to offer downloadable content for Juiced and Frontlines and we expect significant growth in our wireless publishing revenues, driven by games based on Ratatouille, Star Wars, Stuntman and warrants.

In summary, our fiscal 2008 growth will be driven by growth from our big franchises that are expected to perform well on the fast growing install base of Nintendo platforms and the release of five own titles that capitalize on the growing installed base of new high-definition consoles.

Looking at fiscal 2009, we have an exciting product pipeline to take advantage of expected double-digit market growth.

At E3, we demonstrated why we are so excited about our new games based on the Ultimate Fighting Championship.

Last quarter, we announced Saints Row 2. Today, we are confirming the next Red Faction game. Our recently announced action, adventure game Dark Siders is also slated for next fiscal year.

In addition to this strong line-up targeted toward core gamers, we are excited about our games currently in development based on the next Disney/Pixar film Wally, which looks to have strong video game appeal.

Fiscal 2009 will also mark our entry into the online gaming market in China, with Company of Heroes online.

Our objective today was to underscore our commitment to continued execution on our stated strategies for growth. The upcoming launch of Stuntman will mark the beginning of a steady stream of product flow from THQ.

I shared with you our products and programs that will drive THQs revenue, operating margin and earnings growth. We've never been better positioned for growth from a product development and global marketing and sales perspective.

Now, our task is to execute upon our plan and to keep delivering record results for our stockholders.

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

Question-and-Answer Session

Operator

Thank you very much sir. (Operator Instructions). And our first question comes from the line of Colin Sebastian of Lazard Capital Markets. Please proceed.

Colin Sebastian - Lazard Capital Markets

Good morning. Thanks for taking my question. Brian, first question, you have been pretty clear that Ratatouille wouldn't perform on the same level as Cars. So, I guess, given that expectation, how would you characterize sales of Bratz relative to your original expectations? That's the first one. And then secondly, Ed, just trying to reconcile the EPS upside in Q1, and then also Q2 EPS guidance, now has been in the additional market and expense is it something shift from one quarter to the other? Thank you.

Brian Farrell

Yeah Colin, this is Brian. With respect to Ratatouille, I think we've been fairly vocal that we expected Ratatouille to perform very similar to our Finding Nemo and the performance at retail for the first several weeks and remember it's just here in the US, it's not rolled out yet across Europe and some parts of Asia. But the sales for the first several weeks on Ratatouille have been very consistent with what we saw for Finding Nemo, so that continues to be our expectation.

Ed Zinser

Yeah. In terms of your, the other part of your question Colin, as far as our Q1 upside, if you pull out the tax benefit that we got in Q1 which obviously won't be a full year impact but it obviously is an upside for Q1 relative to our guidance. On an operating basis, it was pretty much on some expense timing and some favorable product mix in North America. We had a pretty heavy mix of catalogue but within those catalogue titles, we had ended up a little bit better than we thought bottom-line wise.

As far as the second quarter goes, as I said in my prepared remarks, it pretty much is a marketing situation. We are spending on the order of $10 million about 5 points in marketing in Q2 versus Q2 last year. We are really driving, to drive Juiced and Stuntman, as well as, Ratatouille in Q2, as well as in Q3 and beyond. We feel that's the appropriate level of support to put in the marketplace and contrast that to last year where we had a pretty strong title in Monster House which didn’t require a lot of marketing, Saints Row which did get some first-party support and Cars. So, when you compare those, it really comes down to those driving those top titles in those brands and marketing really is the difference and why our EPS in Q2 wouldn't be higher than normally it would be for that level of sales.

Colin Sebastian - Lazard Capital Markets

Okay. And just last question, quickly. We've been hearing that July sales were pretty strong, at least, overall for the industry and I am curious if you'd agree with that sentiment. Thank you very much.

Brian Farrell

Yeah, anecdotally July what we are hearing is that the price cut on the PS3 hardware has moved the needle on hardware sales. I haven’t seen any hard numbers, so it's all anecdotal information. The pickup in software what we are hearing is not quite as high as the pickup in hardware but that's not unusual in the first week or two after a price cut. So, I think the way, as I started my prepared remarks, the year is sort of shaping up as we anticipated and it looks very much like we forecast earlier this year.

Colin Sebastian - Lazard Capital Markets

Thank you.

Operator

Thank you very much sir. Ladies and gentlemen your next question comes from the line of Heath Terry of Credit Suisse. Please proceed.

Heath Terry - Credit Suisse

Great thank you. You talked a little bit about the fact that the three racing games this fall will have in-game advertising in them. You talked about what the hurdles are to broadening that out into your other franchises, particularly those where you've got licensing relationships like the WWE and Nickelodeon. And then, if you can also give us an idea -- thought pretty extensively about the returns that they saw in advertising and their Need for Speed franchise.

Can you talk to us about what your initial expectations are for what advertising could add to those games on a per unit basis?

Brian Farrell

See, let's start with the broads [out there] that we really liked what we see in -- what's going on within game advertising. And also remember what advertisers are looking for is iBalls they are going to measure and pay us at the end of the day based on the amount of iBalls that we attract and the users that we attract.

As we said a number of times Heath it a nascent market so, while we're all ramping up it’s a matter of getting into the games, getting into the games in a way that creatively doesn't interrupt the games I think all of us are working with that. So, in terms of your question as to how we are broadening that; yes, these first three games are initial push into this market but it is a very initial push. I think we are a lot more bullish on the longer-term prospect for in-game advertising overall. And we think, we have a number of titles that will support in-game advertising broadly and we can probably get into those with a little more detail on our next call.

With respect to the licensed content, we are in discussions with all our major license owners, with respect to the revenue share, between them and us, after the split to the major providers like massive and IGA and Double Fusion. We expect, we are going to get there with all of our partners. But again, this is a new area and everyone’s trying to figure out what the right strategy there is.

So, bottom line is, we love the market, we like the traction there, the amount of dollars any publisher is going to see, goes back to the whole thing about if you make hits you are going to make money on your core property and you are going to make more money on your in-game advertising. So, that’s how, we are thinking about it.

Heath Terry - Credit Suisse

Great. Thanks, Brain.

Operator

Thank you very much, sir. Ladies and gentlemen your next question comes from the line of Arvind Bhatia, Sterne, Agee. Please proceed.

Arvind Bhatia - Sterne, Agee & Leach

Hi guys. Couple of questions. Can you guys refresh us on what your thinking is percentage breakdown, internal development, the percentage of overall revenue for the year and then owned IP, and then platform mix, just any thoughts there?

Brian Farrell

Sure, Arvid. Yeah. From our internal development, we are looking about half of our revenue this year, to come from internally developed titles and that’s something about 40% last year. In terms of volumes, we have messaged on the order of a third, or even a little bit better than that of our revenue this year coming from owned intellectual properties.

Arvind Bhatia - Sterne, Agee & Leach

And then how about platform mix, next-gen versus current gen?

Brian Farrell

Obviously, it’s a much heavier mix of next-gen as we ship this year. In terms of the platform metrics that we've messaged in the past, we are looking at about 40% to 50% of our revenues coming from next-gen consoles, and obviously do we still expect to see a healthy PS2 20% to 25%, and then about 25% to 30% on total handhelds, obviously a big chunk of that coming from the DS.

Arvind Bhatia - Sterne, Agee & Leach

Again, and I just want to revisit the tax situation, just to be clear that the $0.10 benefit that you got in the first quarter, are you saying that you are expecting that later in the year, but that just happened to be in Q1, and therefore you may have expected that, lets say, in the second quarter, just looking at where the street was versus where you are guiding, I’m just trying to reconcile that.

Brian Farrell

Yeah, we were anticipating it for the year, Irwin, we did have a totally put in -- obviously in the year end in our projections over the balance of the year, in one of the quarters. It was not in the first quarter and based upon the notification that we received in the month of May, that was the month that we needed to book this tax benefits. So it was anticipated on our full year rate of 30%, and so obviously that full year rate won’t change but it does have an impact on the tax expense that you need to report in any individual quarter.

Arvind Bhatia - Sterne, Agee & Leach

Got it. That’s all I had. Thank you.

Operator

Thank you very much sir. Ladies and gentlemen, your next question comes from the line of Justin Post of Merrill Lynch. Please proceed.

Justin Post - Merrill Lynch

Yes. Thank you for taking my question. Brian, first on the Pixar franchise, I think the results were a little bit below your guidance. What drove kind of the softness, and is this just a shipment timing issue from where you were at the beginning of the quarter or could you just talk a little bit about that?

Brian Farrell

On Ratatouille, let's be really clear, Ratatouille shipments in the quarter were actually ahead of our expectations by a couple of million dollars. The slight reduction from our guidance, I think our guidance was 110 million, was all related to PC catalogue in Europe. We are a little more bullish about those markets in going ends, so Ratatouille was actually a bit above forecast the quarter, and the slight softness we saw was on the catalog. The catalog sales were primarily PC in Europe.

Justin Post - Merrill Lynch

Okay. It’s going to be cleared that up. Is there any forward implication from that PC weakness in Europe in the future quarters?

Brian Farrell

No. We won't expect that all. It was related to products we launched in our Q4, as you remember, our Soccer and Supreme Commander. Those both, as you know, Justin, opened very strong. I think we are fairly optimistic that they would continue in that band and like a lot of these more core gamer title they sell off a little more rapidly than we anticipated. So, again, we are talking about an order of magnitude of 4 million to 5 million bucks. So it’s not anything I would call direction of the business.

Julie MacMedan

Operator?

Operator

Yes sir. Question and answer, sir.

Brian Farrell

I think we lost our last call.

Operator

Okay. You just stop talking, I apologize, I thought there was a pause. We'll go to our next question. And that comes from the line of Mr. Ben Schachter of UBS Securities. Please proceed.

Ben Schachter - UBS Securities

Hey guys, I am alone, can you hear me. When you talk about international revenue, you talk about your distribution capabilities, international, particularly in the UK and Europe, and is there anything you need to acquire there or is there anything that you can acquire to hope that. And then also you talked about software?

Brian Farrell

Ben, we've lost you as well.

Ed Zinser

We were able to hear you from your mobile back.

Operator

I really think we lost Mr. Schachter as well. I do apologize for that. We'll go to the next question from Michael Savner of Banc of America. Please proceed.

Michael Savner - Banc of America

Hi. Hopefully, you can hear me just fine?

Brian Farrell

Hi, Michael

Ed Zinser

That's like a landline, Michael.

Michael Savner - Banc of America

Yeah, I am not that complicated. Couple of questions; kind of bigger picture. First, can you talk about your margin progress, I guess in just one quarter end. Can you talk about operating margins versus your internal projections given that PlayStation revenues still making such a big chunk of revenue close to 25% this quarter, and I would assume that's probably slightly higher than what you've thought it would have been 12 to 18 months ago. So, is that weighing on margins at all, and how should we think about that going forward or is it the really the key margin constraint right now, just higher R&D spending to ramp up the next-gen, and then I have a follow-up please?

Ed Zinser

In terms of the product mix and the platform mix, it really is pretty consistent with our projections, you know, the strength that we saw in PS2 was from last year obviously reflected our planning and our guidance that we provided even on our last call, from the fiscal year so with respect our margins in the quarters, they are actually very consistent with we expected. We certainly didn’t expect you guys to understand the level of spending we were going to do to support some of our key launches, but in terms of the product mix and the margins we are very consistent with what we had anticipated.

On the full year, we are obviously extremely confident and growing our margins this year, and we’ve certainly envisaged 11% and are very confident in that. Its obviously more of it is coming in the second half of the year based upon our product lineup, and I think once Stuntman ships in the next month or so, I think you will see a pretty steady flow of products. As Brian said, and I think you will see a significantly different picture on the bottom-line as some of these titles launch. In the first quarter we were working of 66% catalog; in the second quarter we’ve got a big marketing spend to drive Q2 and Q3 revenue and some big brands that we think have a lot of legs. So, from that perspective, from a margin point of view we feel really good about it.

Michael Savner - Banc of America

Thanks, and so my second question is a follow-up to that one, which is, what we noticed on the balance sheet is, again another very healthy year-over-year ramp up in capitalized software development cost of more than 30% year-on-year, and I think an all-time high, net revenue is down significantly during the quarter, neither those moves directionally or surprise of what it would seem and please correct me if I am interpreting this wrong, but it seems to imply there is a lot of pressure on these next few quarters that if the revenue of the unit shipped particularly some of these new IP titles where a lot of the spending is going, you know, missing by a little bit there’ll seem to be a real acceleration in development costs, and after the expense at a minimum, I would assume that we are going to have to see a lot of that software development cost hit the P&L in the second half of the year. So, I am just -- I want to get a sense, may be not, because you say you are very comfortable with margins, but I guess your expectation of volatility around those margin given the balance sheet, given the capitalized software development cost that is really increased.

Ed Zinser

Yeah. That’s not a -- here is how we characterize it, I mean we’ve got a number of titles that are shipping in the second half that are our cross platform next-gen titles and obviously those carry a higher development cost. And the build, as I said in my prepared remarks, three quarters of the 240 million of software development is coming from titles that we will ship this fiscal year. So, those are our titles, like Juiced and Stuntman and Destroy All Humans! and Frontlines. So there are a number of titles, obviously those titles, are have a forecast that we feel confident in and there is no title and there that needs to do huge-huge numbers plus to make our yearly message to them all as more than million unit properties, which were extremely comfortable with and the amortization that we have against those titles reflects, those projection. Certainly, if titles don’t perform as you expect them to then there are ramifications for that, but we think we’ve planned out the right amount of revenue for these titles and we have very reasonable assumptions in and the marketing to support it.

Michael Savner - Banc of America

Got it. Thanks, Ed.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Tony Gikas of Piper Jaffray. Please proceed.

Tony Gikas - Piper Jaffray

Hey good morning, guys, couple of questions. Could you help us out a little bit with the revenue split for Q3 and Q4, and then just going back to the capitalized software, how many projects does that represent? And then I have one follow-up.

Ed Zinser

Sure. In terms of the revenue split I would work off the prepared remarks of about a 60% growth in the fourth quarter, and I would solve for Q3. And I think that's probably the best way to think about it. Tony. In terms of the number of titles that it represents, let me put it to you this way, if we have approximately $214 million, three quarters of that is applies to titles that we said are going to ship this year. But that's a 150 million or so, and we've given direction this year of about 25 to 30 titles. We have only shipped one of those so far. So even over 24 titles, that's on the order of $6 million to $6.5 million on title for the titles that shipped this year on average. So the $200 million should not be a scary number to anyone for a 1.2 billion or a 1.1 billion business, that's got that level of development going on.

Tony Gikas - Piper Jaffray

Okay. Thanks. That's very helpful. And then the last question with Payload and Grand Theft Auto coming here in the next few months and I think that's a catalyst for the industry over the longer term with a lot of hardware sales related to that, how disruptive do you think that could be though, however the software sales for all of the third party publishers, not THQs specific, but you know during that September to November timeframe do you think its going to be moderately disruptive for sale for the industry or it could be meaningful?

Ed Zinser

Well, first of all Tony, we agree with you, we love to see big titles whether from first or third parties that drive hardware and so our thinking for just holidays, since we've been through these court murders there were a couple of times before, it's how you plan around them. So, it's not the disruptions so much that occurs as much as a crowding, so what you've got to do and what we've done is plan your titles around that. For example, as we pointed out Stuntman is shipping in August, well in advance of these titles, Juiced is a racing title; I think we are well away from the other racing titles. We've moved Frontlines into the sort of gift card, post holiday hardware ramp period. And then for the holiday quarters, you've seen as we have done in the last couple of times, this has occurred, while some people are coming at the market with Halo and Grand Theft Auto, we are coming with WWE, Pixar and Nickelodeon. So, I am not talking of products that are directly competitive. So, I think the answer to your question is, it depends on how you attack the market. If you attack it smartly as we've done in the past, there is plenty of room for quality titles.

Tony Gikas - Piper Jaffray

Okay. Thank you, guys. Good luck.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Evan Wilson of Pacific Crest. Please proceed.

Evan Wilson - Pacific Crest

Hello. Thanks for taking the questions. Curious relative to the reserve you are taking on Jack's license, you mentioned a recent development on WWE. We haven’t had an update there in a while, could you give us some highlight there and then secondly a question I get a lot is what percentage of sales and Nintendo would represent across all platforms including all the older generation titles as well as NexGen to clear that up.

Brian Farrell

Evan, this is Brian. With respect and let's make sure we are very clear. There's really no update with respect to the WWE itself, the litigation there, really nothing substitute the capital in that case for quite some time. On the part you mentioned with respect to Jack Specific, as I had mentioned the agreement between us and Jacks provided for a reset of the rate that we pay Jack's, that was to have happened on June 30th of a year ago. The agreement further provides for arbitration as we disclosed earlier. We filed suit to compel arbitration and a judge recently -- his ruling outlined the procedures for arbitration, and then also confirmed the fact that we do not need to pay Jack's pending the outcome of the arbitration. So that's -- those were the recent developments, but they always relate to the Jack's arbitration.

Ed Zinser

Well, Jack has actually made us, just to further that point, actually made us a request that they be paid and the court denied that request. Until the arbitration is complete, there will be no payment.

Evan Wilson - Pacific Crest

Great. And the Nintendo question?

Brian Farrell

Yeah. Our Nintendo as a percentage of our revenue for this year is projected to be over 30%.

Evan Wilson - Pacific Crest

Could you also give us, based on your EPS, your expectations for development cost for this year, a range for what you would expect cash to be at the end of this fiscal year?

Brian Farrell

Our cash balance?

Evan Wilson - Pacific Crest

Yes, exactly.

Brian Farrell

Or operating cash flow?

Evan Wilson - Pacific Crest

The cash balance for the end of this year.

Brian Farrell

We don't normally provide a sort of balance sheet projections ever as you know, but certainly we expect our cash balance to increase pretty significantly this year. You should be thinking about that on the order of a 100 million plus kind of a number year-over-year.

Evan Wilson - Pacific Crest

Thanks very much.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Jeetil Patel, Deutsche Bank Securities. Please proceed.

Jeetil Patel - Deutsche Bank Securities

Great, thanks. Any guys on the holiday season, do you believe that there is risk out there at pricing your sell-through did not live up to expectations either certain publishers or products it may seem like very crowded holiday season in terms of the month of November in particular, as you pointed out. And I guess, how do you gauge the risk on overall price points coming down if you are looking at a very crowded holiday season? A quick follow-up?

Brian Farrell

Yeah. Jeetil, as you know, because you've been doing this a long time, as well, but pricing usually is not a broad stroke, it usually relates to individual titles. If there are some publishers that ship weaker titles in quantities that don’t sell-through, often times they adjust the prices so they will sell-through. But I think on the strong Frontline titles, there is clearly demand. If you look at, good point is looking at how Microsoft is pricing their various Halo 3 special editions. So, I don’t think there is an overall risk to pricing. There maybe pricing issues that certain companies have if they over ship weaker titles.

Jeetil Patel - Deutsche Bank Securities

Got it. And as we look at your guidance for the year and just trying to back into back half. Early to take the loss of $0.09 for the first quarter and use that for in your guidance or you adjust the number of losses of $0.19 for the tax?

Brian Farrell

Yeah. What you should do, Jeetil is the tax benefit is not going to be an incremental impact on the full year.

Jeetil Patel - Deutsche Bank Securities

Great.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Doug Creutz of Cowen and Company. Please proceed.

Doug Creutz - Cowen and Company

Thanks. Thinking about Cars in international, it looks to us like The Incredibles sequel did on a platform-to-platform basis about 20% to 25% of the units are the original Incredibles game. So, we've been thinking about international the same way, how are you thinking about it? Thanks.

Brian Farrell

Yeah, I think that would be conservative estimate, obviously, Cars was a stronger brand than Incredibles, was -- it is as good as Incredible was Cars was slightly stronger, but that would not be inconsistent with our planning.

Doug Creutz - Cowen and Company

Great. Thank you.

Operator

Thank you very much sir. Ladies and gentlemen, your next question comes from the line of Mr. John Taylor of Arcadia Investments. Please proceed.

John Taylor - Arcadia Investments

Hi, I've got a couple of questions as well. First one, it looks like the other income line got a pretty good bump in the first quarter, wondering if you could give us some sense of what was underneath that?

Ed Zinser

Sure, a little bit of that was [inaudible] JT and also some higher yields on higher cash balance.

John Taylor - Arcadia Investments

Okay. So, overall, I think you said the FX impact on revenue was about 3% is there a specific number that you can relate to EPS, related to the currency?

Ed Zinser

There is about $1.5 million worth of currency impact in the other income expense line.

John Taylor - Arcadia Investments

Okay. Alright, good. And then, lets see, as it relates to Ratatouille, looking at your sell-through numbers, I wonder if you’re seeing any surprises in terms of sell-through by platform and I guess Brian, maybe talk a little bit about whether there is any kind of unusual complexity and planning in the SKU mix as you released your titles, Stuntman we know where that’s going to sell, it's going to be strongest on the next-gen platforms, but as you look at the Nick and the Pixar titled stuff for the fall, is there any increased risk in making a wrong bid on the wrong platform and having it sit out here, what do you see there?

Brian Farrell

As you probably would guess JT, our biggest expectations on all our family, kids and family, the more casual titles are on PS2, DS and Wii that's where the real action is on the Pixar Nickelodeon titles and then certainly that would be true for Bratz, as well. There is a market, albeit, smaller on the 360 and PS3 for the kid stuff more cognizant of that we don't have big numbers baked in for next-gen as you know as we get later and later and later into the PS3 and 360 cycles more-and-more kids will come to those as the price points come down but right now what we are expecting and what we are seeing is the action is on DS, Wii and PS2 and then the lower markets right now and the kid stuff is in 360 and PS3.

John Taylor - Arcadia Investments

Okay. So, as far as you can tell, you are happy with the sell-through on the PS2, in that particular skew?

Brian Farrell

Yes.

John Taylor - Arcadia Investments

Yeah, okay. Alright and then last question what -- I don't know if you can pull this out or not but as you are shifting form external to internal, I wonder if you could give us a guesstimate as to what that, what impact that might have on the first quarter in particular looks like your total spending on product development, however, that had all lines and stuff dropped a couple of million bucks from may be what I was thinking of. So, is there a specific number you can say this or that?

Ed Zinser

I am not sure, I followed your question JT but in terms of internal development in the first quarter, I mean our main title we shift as you know is Ratatouille that was an internally developed title. Our results through the quarter are really just a function of that title and one market. And then, obviously 66% of our business coming from catalog.

John Taylor - Arcadia Investments

So, could you have any guesses that if you would done that externally what that would have represented in terms of increased royalty cost?

Brian Farrell

Yeah. We don't normally give exact profit contributions on every title, but I think it's certainly safe to say that it would be, we certainly would have had a less favorable bottom-line in Q1 and that had Ratatouille been developed externally we've said on some previous calls that when we moved the license from externally developed on Nemo to internally undeveloped on Incredibles, we picked up some significant margin points and I think you are looking at a significant impact, having not done it internally.

John Taylor - Arcadia Investments

Okay. Alright good and let me ask one last one if I can, the recent WWE tragedy is that had any impact on visibility of your title?

Ed Zinser

Not at all, our game is going to reflect the current status of the WWE and we will not include that wrestler.

John Taylor - Arcadia Investments

Okay, alright. Thank you.

Julie MacMedan

May be we have time for one more please.

Operator

Okay. Thank you very much your last question comes from the line of Justin Post of Merrill Lynch

Justin Post - Merrill Lynch

Thank you putting me back on. On the PlayStation 3, 300 units today NPD year-to-date, I am sorry in the last calendar quarter, and you give a number of 3 to 3.5, how do you feel about that number and what's going to really accelerate sales for that consoles?

Brian Farrell

I am sorry, the first part of your question.

Justin Post - Merrill Lynch

PlayStation 3 units, I think you reiterated US numbers 3 to 3.5 million for the year? And last quarter, it was like, I think it was like 250,000 per NPD in the quarter sell-through. How do you see that platform getting to those type of numbers, do you think there really can be an acceleration in the second half, looks like it's even more back and loaded than ever for the fourth quarter for that platform?

Brian Farrell

Yeah, we’ve got a pretty good model, Justin I don't think it’s a 100% reliable but what it does is two things, particularly with respect to PS3, we’re take into account seasonality, so our model is weighted by months, I mean, we also took into account the recent price cut by selling in competitive prior historical trends, I grant you that this $100 is a different $100 in prior cycles, but yeah that’s our best guess to what's achievable and I think, we are actually still below Sony's numbers. So, it is an estimate but it's based on empirical evidence and some pretty good analysis.

Ed Zinser

And as, you know, Justin it stand a little bit versus what we'd said last time on the North America market.

Justin Post - Merrill Lynch

Okay. And do you think there really can be an acceleration for the next-gen hardware as we enter the holidays just, it is just the pent-up demand or do you think the price cuts are really what's going to drive it?

Brian Farrell

I think as you know Justin, software will drive it, so there is some great titles coming on all the platforms. So, between great software and seasonal demand and price cuts, I think we'll see an acceleration of hardware.

Justin Post - Merrill Lynch

Okay. The Wii seems to be a pretty big investment theme, right now, given the strong growth for the hardware. And if you go through your five kind of proprietary or owned-IP titles, which platforms should we really be on look out for the Wii versions?

Brian Farrell

Remember, how our strategy is overall segmenting the market. And so things like Conan and Frontlines are really more 360 PS3 really high-end are going after that core gamer. We have some titles that cross over segments, which are MX, Destroy All Humans!, WWE that you'll see on multiple platforms including PS3, 360 and Wii and then we have some titles that are more re-exclusive things like the Blob that is, again really just lays our focus on that casual gamer with the really unique game play for the Wii. So, it's not about throwing every title on every platform it's about segmenting the market and having the right game on whatever platform it maybe.

Justin Post - Merrill Lynch

Okay. Last question on the buyback, it looks like you authorized an additional $25 million. Are there been any reasons why you have been able to buyback so far and does your internal model shows some accretion on EPS at certain levels?

Ed Zinser

Yeah, as you know Justin, we used our cash for investments in the business for acquiring content or the ability to create content or acquiring technology and so forth. But from time-to-time, we do go back and buy our stock when we feel it's an attractive time to do so and we've authorized -- the Board has authorized an additional 25 million to enable us to do that as we see for.

Justin Post - Merrill Lynch

Great. Thank you.

Julie MacMedan

Great. Well, that concludes our first quarter call. I would like to thank everyone for joining us today.

Operator

Thank you very much ma'am. Thank you ladies and gentlemen for your participation in today's conference call, this concludes your presentation and you may now disconnect. Have a good day.

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