THQ F2Q08 (Qtr End 9/30/07) Earnings Call Transcript

| About: THQ, Inc. (THQIQ)

THQ, Inc. (THQI)

F2Q08 Earnings Call

November 1, 2007 6:30 pm ET


Julie MacMedan - VP of IR

Brian J. Farrell - President & CEO

Edward K. Zinser - CFO


Colin Sebastian - Lazard Capital Markets

Ben Schachter - UBS

John Taylor - Arcadia Investment Corporation

Ralph Schackart - William Blair

Tony Gikas - Piper Jaffray

Brent Thill - Citigroup

Shawn Milne - Oppenheimer

Eric Handler - Lehman Brothers

Mike Hickey - Janco Partners

Justin Post - Merrill Lynch

Doug Creutz - Cowen &Company


At this time I would like to welcome everyone to the THQ,Inc. fiscal 2008 second quarter results conference call. (OperatorInstructions) I would now like to turnthe call over to Julie MacMedan, Vice President of Investor Relations. You maybegin your conference.

Julie MacMedan

Thank you. Good afternoon, everyone. On today’s call,management will make forward-looking statements and projections regarding ourexpectations, estimates, and predictions of the future. These statements aboutour business are based in part on assumptions made by management and are notguarantees of future performance. Therefore, actual results may differmaterially from today’s forward-looking statements due to the risk factors thatare described in our March 31, 2007 Form 10-K. A copy of this filing may beobtained from our website.

In describing THQ’s financial performance, we will discussnon-GAAP measures, including operating margin and net income. Please refer tothe reconciliation of these measures to GAAP results in the tables provided intoday’s results release.

On today’s call, Brian J. Farrell, THQ’s President and ChiefExecutive Officer, will review our first half and will then turn the call overto Ed Zinser, our Chief Financial Officer, who will discuss THQ’s results forour fiscal 2008 second quarter and our guidance for the remainder of fiscal2008. Ed will also provide our calendar 2007 market growth and hardwareplatform assumptions. Brian will then close with a discussion of our plans forfiscal 2008 and long-term growth. We will then conduct a question-and-answersession following prepared remarks.

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

Brian J. Farrell

Thank you, Julie and good afternoon everyone. On today’scall, I would like to share with you our plans for the second half of fiscal2008 and how we position the company for long-term revenue and profitabilitygrowth. I will begin with a recap of our first half.

As we discussed on our October 22 conference call, duringthe September quarter we shipped more than 1 million units each of Juiced andStuntman, yet these titles both fell short of our expectations, impacting ourresults for the second quarter and our outlook for the year.

On a positive note, during the September quarter we shippednearly 2 million units of Ratatouille, driven primarily by a strong performancein international markets. The strong global appeal of titles such asRatatouille, Juiced and MotoGP coupled with our expanded direct sales presencein Europe and Asia drove 40%year-over-year increase in international sales. We expect revenue from newmarkets in Europe and Asia tocontinue to fuel THQ’s long-term growth.

As we said on our first quarter call, we believe Nintendo’snew platforms are expanding the market for video games and we plan to continueour leadership on Nintendo’s hardware. During the first half of fiscal 2008,our revenue on the handheld Nintendo DS doubled year-over-year, drivenprimarily by Ratatouille as well as strong performance from Drawn to Life, anew original game exclusive to the DS. We expect our Nintendo Wii revenues togrow significantly in the second half of fiscal 2008 as we ship our bigmass-market brands including WWE, Pixar, and Nickelodeon as well as MX vs. ATVand Destroy All Humans! on that platform.

In short, although the first half of fiscal2008 trackedbelow our expectations and affected our outlook for the year, as we said on ourOctober 22 call, we have taken steps to ensure that our products compete at thehighest levels. These steps include personnel and process changes in productdevelopment and quality assurance, a more rigorous product evaluation processand the move of certain titles out of our fiscal fourth quarter to give themmore development time.

Now I will turn the call over to Ed to discuss our financialresults and forecast in more detail.

Edward K. Zinser

Today I will review our Q2 financial results and reaffirmguidance for the remaining quarters and for our full fiscal year ending March 31, 2008. THQ’s financialresults include stock-based compensation expense and the adoption of FAS 123R.As I discuss our financial performance in more detail, I’ll use the non-GAAPnumbers, which exclude this expense.

For the second quarter of fiscal 2008, we’ve reported netsales of $229 million and a net loss of $0.03 per share, below our August 1stguidance of $240 million in net revenue and a $0.10 profit. Our miss to theAugust 1st guidance was due to revenue shortfalls of Stuntman: Ignition andJuiced 2, including increased price protection, primarily for Stuntman. Our prior-yearquarter was $240 million in net revenue and earnings per share of $0.25.

Our fiscal 2008 second quarter net revenue was drivenprimarily by Ratatouille and the releases of Stuntman: Ignition and Juiced 2. In addition, we had solid catalogrevenue led by Cars and WWE. The revenue was down slightly versus the prior-yearquarter, which was led by Cars, Saints Row, and Monster House. From ageographic perspective, 41% growth in our international business versus prioryear could not offset the decline in North America.

Moving on to cost of sales, product costs of 38% of netsales increased 6 points versus the prior-year quarter. The increase was dueprimarily to price protection on Stuntman: Ignition and Juiced 2 compared tothe prior year’s mix of Saints Row on the Xbox 360 at a premium price and ahigher gross margin PC product, Company of Heroes.

Software, amortization and royalties of 16% of net salesdecreased 2 points versus the prior-year quarter. This was due primarily towrite-off in the prior-year quarter. License, amortization and royalty costs of10% of net sales was up modesty from 9% in the prior-year quarter due to salesmix. As a result, the gross margin after these costs was 36%, down from 41% inthe prior-year quarter.

Product development expenses of $27 million were up from $24million in the prior-year quarter, due to increased product development effortsto support future growth, including the wireless development and ouracquisition of Universomo, a mobile developer.

Selling and marketing expenses were 20% of net sales, upfrom 16% in the prior-year quarter due to the launches Stuntman: Ignition andJuiced 2, compared to the prior year launch of Saints Row, which had first partyco-marketing support.

G&A expenses were $13.8 million, down $2.3 million fromthe prior-year quarter due primarily to lower performance-based competition andprofessional fees. As a result, our net loss for the second quarter was $2.2million or $0.03 per share, compared to net profit of $16.4 million or $0.25per share in the prior-year quarter.

Now, let’s turn to the balance sheet. THQ ended the quarterwith $297 million or $4.47 per diluted share in cash and short-terminvestments. This balance reflects the repurchase of $42 million of stock inthe quarter. This quarter end balance was an increase from the $284 millionbalance on September 30, 2006.

Net accounts receivable of $166 million increased from $110million at September 30, 2006.Our days sales outstanding on a rolling 12-month basis was 62 days versus 45days in the prior year period. This reflected the heavy sales late in thequarter this year and a much higher international sales mix in the prior-yearquarter.

Accounts receivable allowances were $89 million at quarter end,up from the $78 million balance at September 30, 2006. The coverage on a trailing nine months of net sales basiswas 14%, up from 12% in the prior-year quarter end. Inventory was $42 million,up from $27 million at March 31, 2007,but flat to the prior-year balance. On a rolling 12 month basis, inventoryturns were ten, up from nine in the prior-year period.

Our investment in licenses of $98 million increased from $91million at March 31, 2007.This was primarily due to the Disney/Pixar advance, partially offset by thelicense amortization expense recorded in the quarter for Ratatouille.

As expected, capitalized software development increased to $241million at quarter end, up from $164 million at March 31, 2007; nearly 60% of the $241 million balance iscomprised of titles which are planned to ship this fiscal year.

Property and equipment of $50 million was up $5 million fromthe March 31, 2007 balancedue primarily to development kits in computer hardware and software. Goodwillwas $99 million, up from $89 million at March 31, 2007 due primarily to the acquisition of Universomo, ourwireless developer, in May of this year.

Total current liabilities were $277 million, up $80 millionfrom the March 31, 2007balance of $197 million. This balance includes $17 million to Jakks Pacificthat has been accrued at the payment rate that expired over a year ago. Untilthe new rate is determined through arbitration, which we have filed a courtaction to expedite, this accrued balancewill continue to grow but will remain unpaid until the new rate is established,which is expected to be a significant reduction.

In addition, other key increases in current liabilities, duein part to the significantly larger Q2 versus the March 31, 2007 quarter, included product purchases, VATand inventory. The company’s current ratio is 3:1 with working capital of $504million, up from $475 million a year ago.

On a rolling 12 month basis, operating cash flow was $29million, up from the $18 million in the prior-year period.

Return on invested capital on a rolling 12-month basis was16% versus 13% for the prior year. We had no borrowings at quarter end and totalstockholders’ equity was $753 million.

That concludes the financial results for the second quarterof fiscal 2008. Before I discussed THQ’s financial projections for the fullyear of fiscal 2008 and for the third and fourth quarters, I would like toreview some of our assumptions.

Expectations for calendar 2007 software dollar growth for North America and Europe are expected to be northof 15%. There are updates to our hardware projections; most are half a millionunits up or down, depending upon the platform. Our unit hardware forecast in North America for each platform are as follows:

Xbox 360, 4.5 million to 5 million; Nintendo Wii, 6.5 millionto 7 million; PS3, 2.5 million to 3 million; PS2, 3 million to 3.5 million; DS,9.5 million to 10 million; and PSP, 3.5 million to 4 million.

In Europe and the other territoriesour forecast for each platform are as follows:

Xbox 360, 2 million to 2.5 million; Nintendo Wii, 4.5 millionto 5 million; PS3, 3 million to 3.5 million; PS2, 4 million to 4.5 million; DS9 million to 9.5 million; PSP 3 million to 3.5 million.

Turning to THQ’s fiscal year 2008, our sales and profitprojections remain unchanged from our call of October 22. We are projecting netrevenue of approximately $1.06 billion and net income of approximately $0.80per share excluding the impact of stock-based compensation expense of $0.24 pershare.

As we discussed on our October 22 call, the change in profitin revenue versus our August 1 guidance forecast, was due to lower sales and priceprotection on Stuntman: Ignition and Juiced 2, and tiles moving from Q4 tofiscal 2009.These included De Blob on Wii and DS, Destroy All Humans! on Xbox360 and PS3 and Frontlines on PS3.

For the 2008 fiscal third-quarter, our guidance remainsunchanged from our October 22 call. We expect net sales of approximately $490million and net income of approximately $0.67 per share, excluding the impactof stock-based compensation expense of $0.06 per share.

Net sales in the December quarter will be driven by WWE onsix platforms, Cars: Mater-National and Ratatouille, a solid Nickelodeon lineup of Avatar, Nicktoons and SpongeBob and Bratz. The quarter includes increasedinvestment in product development and marketing versus the prior-year quarter.

For the fiscal 2008 fourth quarter, we expect net sales of $240million and net income of approximately $0.25 per share, excluding the impactof stock-based compensation expense of $0.06 per share. Net sales will bedriven by Frontlines on Xbox 360 and PC, Destroy All Humans!, Big WillyUnleashed on Wii and PS2 and continued sales of MX vs. ATV Untamed on sixplatforms, WWE and Ratatouille.

In summary, in fiscal year 2008 we plan to generateapproximately $1.06 billion in net revenue and earnings per share ofapproximately $0.80.

I would like to turn the call back to Brian.

Brian J. Farrell

Thanks, Ed. We expect a solid second half anchored by provenfranchises to drive THQ’s 13th consecutive year of revenue growth in fiscal2008. We are executing on our proven strategy to deliver our big mass marketfranchises on the most popular gaming systems for the holiday. Over the pastfew weeks we released our Nickelodeon-based games, Avatar, Nicktoons, andSpongeBob. Earlier this week, we released Cars 2: Mater-National, a sequel tothe top-selling family game of 2006.

On November 13,the release of WWE Smackdown versus Raw 2008will mark the biggest Smackdown launch in the franchise’s history. We plan topublish the game on six platforms plus wireless, including the Smackdownfranchise debut on the Sony PS3, Nintendo Wii and DS platforms.

In mid-December we plan to release to next installment ofthe number one off-road racing franchise MX vs. ATV across six platforms. Thisfranchise has strong mass market appeal and has consistently shipped more than 1million units.

We expect our fourth quarter growth to be driven by newreleases, Frontlines for the Xbox 360and PC and Destroy All Humans! for the Wii and PS2. We also expect strongcontinued shipments of holiday releases particularly MX vs. ATV, WWE and Pixartitles.

Frontlines is a new intellectual property in the competitivebut also large and lucrative shooter genre. We believe we have a uniquely-positionedgame distinguished by large-scale multiplayer action and open world game play.

Also in the March quarter we plan to bring the Destroy AllHumans! franchise to Wii and PlayStation II. Destroy All Humans!, Big WillyUnleashed was designed specifically for the huge audience of casual gamers onthose systems. Given the mid-December ship for MX vs. ATV, we expectsignificant shipments of this title in the March quarter.

In summary, our fiscal 2008 second half performance will bedriven by a balanced portfolio of proven mass market and owned franchisesreleased on the most popular platforms with content targeted for the differentgaming audiences active on the relevant platforms.

Looking at fiscal 2009, our product pipeline is designed totake full advantage of expected double-digit market growth. Drive titles forthe year will include games based on WALL•E, the next Disney Pixar film, ourfirst games based on the Ultimate Fighting Championships and as well as sequelsto the popular Red Faction and Saints Row franchises.

Other planned fiscal 2009 releases includes Darksiders, De Blob,Destroy All Humans!: Path of the Furon, as well as games based on our WWE andNickelodeon brands. With this great lineup, you can see why we’re confident inour ability to increase revenue and profitability in fiscal 2009.

Longer term, we are optimistic about the growth of thecurrent hardware cycle. We have a strong product pipeline of both mass marketfranchises and owned intellectual properties that are well aligned with themost popular platforms and support our long-term plans for revenue andprofitability growth.

We also look forward to continuing to increase ourinternational market penetration and in growing of revenue from digital contentcreation and distribution.

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



Your first question comes from Colin Sebastian - LazardCapital Markets.

Colin Sebastian -Lazard Capital Markets

First of all, have you determined pricing on the PS2 SKU ofWWE at this point? Looking into next year, perhaps how the SKU plan is shapingup on legacy platforms and whether the royalty structure on place on the PS2 might make the economics at lower price points alittle more attractive?

Brian J. Farrell

With respect to pricing on PS2, WWE we believe will commanda premium price of $49.99, which is where we are pricing that title. Some ofour other titles like Cars: Mater-National and a few others will be at $39.99and then many of our kids titles will be at $29.99.So as usual, it will be ourpolicy to stratify the market in the way we think maximizes our profitopportunity.

With respect to your legacy platform question, we will giveyou more visibility as to, I presume you mean mostly PS2. We will continue tobe active on Playstation 2 next year. We do not currently have any visibilityinto a revised business model for Playstation 2 but we think given the massiveinstalled base, not just in the USbut particularly in some of the developing markets around Europe,there is still a significant opportunity there.

So we’ll continue to ship products for the PlayStation 2 andwe will give you more visibility probably later on our next call or two.

Colin Sebastian -Lazard Capital Markets

Given the point in the year in which Grand Theft Auto is launching,does that mean or does that suggest that Saints Row might be a holiday title? Whereare you thinking in terms of the year for UFC? Thank you very much.

Brian J. Farrell

I will take the second part of the question first. One ofthe reasons we like controlling the UFC franchise is because we can plan itaround our other major release like the WWE. So you should think about that notwhen we are going to WWE and probably later than that, although we are notprepared to announce the launch date at this time.

For Saints Row, we think we have got a terrific product thathas some very unique and differentiating features. We are not prepared todiscuss the launch date at this time. As you know, we try and find the properlaunch windows for our titles and you can be assured that we will do that forour Saints Row.


Your next question comes from Ben Schachter - UBS.

Ben Schachter - UBS

Brian, given a lot of the success you have had with kids’titles over the years, I was wondering if there was any focus on doing things,PC, casual games around some of the success you have seen on Club Penguin andgames like that? If you do something like that, can you do it on your own or arethere partnerships you are thinking about there? Just in general with that and theemerging revenue opportunities around some of the online opportunities, what areyou doing there? Thanks.

Brian J. Farrell

The online question is obviously a very broad one. Tocompete directly with things like Club Penguin, I am not sure what our competitiveadvantage would be there so that’s not an area that we think will be a hugegrowth opportunity for us. We really like the trends in our digital downloadbusiness right now on the PC market.

We think the bigger opportunity with respect to online hasto do with things like micro transactions and things of that nature, moretargeted at the core than casual gamers. The real problem, as you know, withmonetizing casual gamers is you either need to have a subscription oradvertising model that works and we are not huge fans of either thosebusinesses in their current state.

We like the kid’s business, we think there is a hugeopportunity in the traditional console and PC business. But don’t think of usdoing anything like as you mentioned, Club Penguin, in the near future.


Your next question comes from the line of John Taylor - ArcadiaInvestment Corporation.

John Taylor - Arcadia Investment Corporation

You guys don’t report this numberthis way, but I am wondering if you could give us a sense of what it looks like?If you put all your product development spending into one basket, whether it’sgoing on the balance sheet or running through the P&L either in the form ofR&D or amortization, I wonder if you could give us a sense of how big thatbasket looks in total this year, and how you are thinking about it next year?Thanks.

Brian J. Farrell

The easiest way to think about the basket, JT, and you get alittle bit of a timing difference if you add the product development expensenumber to the amortization number on the P&L. Those two would really giveyou a sense for the size of the basket and you are north of $300 million. So wevery much look at that basket of spending on a title by title basis and as welook at embarking on a new title and go through a greenlight process, we arelooking at that as an investment opportunity and it has to stand alone on itsown merits, both financial and strategic. So that spending of $300 million ayear is really not title and SKU basis as it is an individual investment.

John Taylor - ArcadiaInvestment Corporation

Can you give us a sense of how you expect that might changegoing into next year? I guess what I am looking for is have we passed the peakof the pain in terms of getting ramped up on 360 and PS3?

Brian J. Farrell

I would say that if you are talking about what it is goingto run as a percentage of revenue, yes, I think you are going to start to see itleveling off and declining in the future. Obviously as the installed bases rampand we get more units sold per title, we start to see more efficiencies in ourdevelopment areas as we are more familiar when to build tools and tech fornext-gen, you should start to see those costs start to come down.


Your next question comes from Ralph Schackart - WilliamBlair.

Ralph Schackart -William Blair

Can you give us a sense, obviously without giving guidancefor ’09, of the angle of trajectory both on the growth and how we should thinkabout the recovery in the margin structure?

Brian J. Farrell

We said on our last call and I think we tried to give somevisibility into ‘09, and I probably won’t give a whole lot more, but just tomake sure that were clear. What we said in the last call is we expect to beable to grow at above market rate next year. When you look at our line up andyou look at the modest growth that we plan to experience this year, we think abovemarket growth is certainly something that you should expect when we give ourofficial guidance for the full year.

With respect to our operating margin, we expect to get backto at least where we were in fiscal ‘07.

Ralph Schackart -William Blair

Can you give us any prospective, some of the discussionsthat you’re having with retailers at this point, both in terms of how itapplies to THQ as well as the overall industry in how they are thinking about thisholiday season? Thank you.

Brian J. Farrell

I think in general, retail is reasonably positive,particularly with respect to our sector. We are seeing some nice growth and Iam sure some of our competitors may have mentioned this on their calls already.PS3 had a nice little pop after the recent introduction by Sony; we’ve got somegood information, although no MPD data on how there has been an uplift in 360hardware based on Halo 3. So there’s a lot of DS and Wii, I can’t count themout, of course. So I think there is a lot of positive sentiment on thecategory.

We are very pleased that as usual, in the holiday season, wehave big brands that will command more than our fair share of shelf space. So Ithink the general sentiment so far at retail, especially with respect to oursector, is, I would say, reasonably positive.


Your next question comes from Tony Gikas - Piper Jaffray.

Tony Gikas - PiperJaffray

Just looking out at next year with the consensus, actuallyif you look at the range of estimates, it’s a pretty wide range -- $2.14 to$1.18 in earnings per share -- anything you can do to help us narrow that downa little bit?

Part of that being, should we assume that there are titlesthat are slipping out of fiscal ‘09, like slipped out of fiscal ‘08 that mightneed some additional research and development work? Anything you can do to helpus tighten that up?

Second question, WALL•E, any early read on that brand atthis point and how it might comp to Ratatouille?

Edward K. Zinser

Sure, I will take the first part, and I am sure Brian willgive you an update on WALL•E. As far as next year goes, Tony you should know itis a little early to be giving guidance for fiscal ‘09 as we are closing out thesecond quarter this year. We have tried to give some color to next year. Certainlyto be thinking about us, as I said earlier, above market growth rate in termsof the top line and at least back to where we were in fiscal ‘07 on anoperating margin standpoint, I think it gives you some at least initialdirection.

Certainly we will give much more specific guidance, as we do,in our future call, but I think that should at least give you a sense for whereour thinking is today.

Brian J. Farrell

And with respect to WALL•E, we’ve seen a fair amount ofthat. I don’t know how much you’ve seen, Tony, but once again we think ourfriends over at Pixar have just nailed it. It looks to be another terrificmovie, great story, compelling characters, all the things that you love about aPixar film.

But what we really like about it is while Ratatouille wasanother terrific movie, it just wasn’t as videogame friendly as we think WALL•Eis, so that’s one point I would make.

The other is the summer movie slate, particularly for familymovies, doesn’t appear to be nearly as crowded as it was in this past year, sothat should give us a window to have some pretty favorable comps of WALL•E overRatatouille.


Your next question comes from the line of Brent Thill withCitigroup.

Brent Thill -Citigroup

Thanks. You alluded to some changes in the studio to betteroptimize some development cycles, and I’m just curious in terms of if you couldelaborate on what changes you’ve been making.

Brian J. Farrell

Well, the things we pointed to in our prepared remarks,we’ve made some personnel changes at a number of levels throughout our PD andQA organization we think will strengthen our structure there.

In terms of process improvements, probably the mostsignificant thing is more frequent reviews by a cross-section of seniormanagement of our titles that are in development, so more high level scrutinyearlier in the process and all along the process, so we think -- and morefrequent, both consumer testing, both focus testing and usability testing.Those are the key things and we could go on for a bit, but we’ve put a fairnumber of things in place in the last 60 days to make sure that our titles docompete at the highest levels.

Brent Thill -Citigroup



Your next question comes from the line of Shawn Milne withOppenheimer.

Shawn Milne -Oppenheimer

Thank you. Just a couple of questions. Going back to thecomments you just made on making some process improvements, it seems that wouldtake a little bit of time to work out and your next big test in terms of new intellectualproperties, obviously Front Lines, can you just talk about how you are viewingthat in the model? Do you believe you have expectations that are reflected thatit’s new intellectual property? Secondly, Brian, if you can just give us somecolor on WWE for the holiday. I know it’s on more platforms. Do you expect itto grow year over year. Any kind of color there on pre-orders, et cetera? Thankyou.

Edward K. Zinser

I think with respect to how we modeled, we certainly take ahard look at the property and the genre and so forth and obviously work closelywith marketing and sales and we’ve planned out a number for Front Lines that wethink is appropriate, given that it’s new and given the genre that it competesin. So obviously when we revised guidance and provided that, it’s a number thatwe feel confident in being able to achieve.

Brian J. Farrell

I don’t know if you subscribe to any of the buzz trackingservices, but WWE always tests very well in that regard, so we are reallyconfident in that product. What we really like this year, as we said, is it’son all platforms so whether that WWE gamer is on PS2, Wii, 360 or PS3 thisholiday, we really don’t care. We’re covering all the bases.

So I think just the fact we have all the platforms covered,I think we’ll drive some pretty good growth in that brand this year.


Your next question comes from the line of Eric Handler withLehman Brothers.

Eric Handler - LehmanBrothers

Thanks for taking my question. Given the glut of Wii productthat has come into the market and Nintendo's tight control of the softwaremanufacturing process, are you finding that you guys are getting all of theinventory that you require?

Brian J. Farrell

One of the things that’s been well-chronicled, Eric, is thatNintendo has some supply constraints both on the hardware and software side.When you have big brands for the holiday like we do, things like CarsMater-National, which is already launched, WWE which is about to launch, we aregetting more than our fair share of mine share from Nintendo. MX, one of ourcore brands, so we don’t disagree that there will be a fair number of titlesthat may flounder in the marketplace on Wii this fall just because they don’thave a reason for being, but we will be coming at the Wii market in particularwith our strong mass market brands.

One I would particularly watch out for is WWE. That’sgetting a fair amount of heat in the marketplace, but we are getting fullcooperation from Nintendo with respect to our product line.

Eric Handler - LehmanBrothers

Thank you.


Your next question comes from the line of Mike Hickey with Janco Partners.

Mike Hickey- Janco Partners

Thanks for taking my question. You mentioned in yourcomments that you expected significant shipments of MX Versus ATV in Q4. Justcurious what gives you the confidence there for additional reshipment over theholiday release.

And if you could speak, I know you did last call briefly,but the margin differential between WWE and the UFC, and if you could clarifywhether the UFC is being developed internally, externally. And the lastquestion, the pricing, I know this is the first question on the call but thepricing is about $50 for a WWE on the PS2. It seems a little aggressive inlight of some of your competitors’ comments on some key sports franchises thatmaybe should have been priced at $40, so if you could just reassure us thatthat price point is going to work in the market.

Brian J. Farrell

The first part of your question again, Mike -- I’m sorry,I’m writing quickly but not that quickly.

Mike Hickey- Janco Partners

All right. The first question was the MX Versus ATV.

Brian J. Farrell

Okay, got it. Just to clarify what we said, it launches inmid-December, MX Versus ATV, and what we said is because of the launch date ofmid-December, we expect significant reorders of that in our fourth fiscalquarter.

The experience we’ve had, and if you check the NPD data overthe years, MX is one of those titles that is more steady. It is not a huge dayone or week one or week two. It’s just a nice, slow steady burn, which is oneof the things we love about that franchise, so just for clarity, we’ll put whatwe think the right amount into the channel is in the middle of December, butwhat tends to happen is that product just sells, has a very long tale to it.

I’ll speak to you before Ed handles the question aboutmargins for WWE, we spent a lot of time analyzing and researching the $50 pricepoint and we think the WWE consumer is a very avid consumer. We have a lot ofdata points that point to that. We’ve said a number of times if you think backto the Nintendo 64 era, we actually sold about $2 million units of WWE at $59when the hardware was $99, so there seems to be a fair amount of priceinelasticity.

And what we did say is that we expect this price point tohold through the holidays, so obviously we’ll reassess but we have a lot ofresearch that points to this being the right price point.

I think what also underscores that is our other products areat price points that we think maximizes the sales and profit potential forthem.

The UFC developer, we’ve not announced yet, so stay tunedfor that. Obviously we want to have a big release surrounding UFC at the righttime. Obviously the margins on that title will be -- we think will be verycompetitive, just because there is only two parties involved.

Mike Hickey- Janco Partners

Thank you very much.


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

JustinPost - Merrill Lynch

One quick question -- two quick questions for Ed and then abigger picture for Brian. When you look at the capitalized softwaredevelopment, I think it is up 65% year over year. That’s the short-term number,and the guidance for the back half, revenues are up 17%. So my question is, isthat extra expense coming through in the back half? Are you looking for a bigtitle line-up in Q1 of ’09? And then what’s your estimate for the tax rate forthe back half of the year, just so we can get to the EPS numbers?

Edward K. Zinser

The cap software development, the number is obviously upsignificantly, as you would expect it to be in a growing business like ours. Ithink the right way to think about it, Justin, would be that’s really there to,for the titles that are going to ship in obviously the rest of this year as wellas titles in development for fiscal ’09 and even for titles that are indevelopment for fiscal ’10, I think the important point to note is that about60% of that balance is going to go away in this fiscal year, by the end of thefiscal year and be replaced to a lesser degree by additional investment fortitles that are going to ship in fiscal ’09 and fiscal ’10, so what you reallywant to make sure is that that’s churning and as far as the absolute levelgoes, we would expect the dollar level to be lower at the end of the year thanit is today.

As far as the tax rate, we are projecting about a 30% taxrate on the full year and about 35% for the balance of the year should get youto 30% on the full year.

Justin Post - MerrillLynch

Okay, great. And then Brian, when you think about thedirection of the company, you’ve obviously added a lot of developers over thelast couple of years to get ready for this cycle, how do you feel about thecompany’s ability to really develop competitive IP? And do you think you are alot better off now that you’ve gone through this cycle, as we look out to themidpoint and then the back half of this cycle, do you really think you can havetitles that show up in the 80s and 90s quality ratings? And what do you thinkyour outlook is for next year’s titles in that respect?

Brian J. Farrell

I think the thing I would point to first is as you know,we’ve done it. Company of Heroes I think was the highest rated real-timestrategy game in PC history. I think a 93 rating. Saints Row was very highlyrated. We certainly are not happy with the review scores of something likeJuiced. Stuntman was slightly higher but still not in the range we would liketo see, so we’ve done it. We now how to do it and we intend to get back tothat.

We think we offer one of the most creative environments forthe development community. We are growing our development workforce by being agreat place to work for creative people and I think you will see more and moreof that as not only this cycle unfolds but the next one.


Your final question comes from the line of Doug Creutz with Cowen & Company.

Doug Creutz - Cowen & Company

Thanks. Could you talk about what your expectations are for CarsMater-National relative to your other Pixar branded titles? Thanks.

Brian J. Farrell

As you might know, Doug, we try and do a game sequel to eachPixar film. The experience is the unit sales are clearly down a fair amountfrom the prior version. For example, when we did The Incredibles 2: Rise of theUnderminer, as you’ll notice in NPD, it was well over a million units. So theyare off significantly from the film launch versions but they are still over amillion units.


Gentlemen, are there any closing remarks?

Julie MacMedan

I think that’s it, Operator. We would just like to thankeveryone for your participation on the call and we look forward to speakingwith you next quarter.


Ladies and gentlemen, this concludes today’s conferencecall. You may now disconnect.

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