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THQ Inc. (THQI)

Q3 2006 Earnings Conference Call

February 3rd 2006, 11:00 AM.

Executives:

Julie MacMedan, Director of Investor Relations

Brian Farrell, President and Chief Executive Officer

Ed Zinser, Chief Financial Officer

Analysts:

Heath Terry, Credit Suisse

Tony Gikas, Piper Jaffray

Edward Williams, Harris Nesbitt

Mike Wallace, UBS

Justin Post, Merrill Lynch

Elizabeth Osur, Citigroup

John Taylor, Arcadia

Mark Argento, Craig-Hallum Capital

Gary Cooper, Banc of America Securities

Esgeme in for Jeetil Patel, Deutsche Bank

Operator

Good day, ladies and gentlemen, thank you for standing by and welcome to the THQ Inc. Third Quarter 2006 Earnings Conference Call. My name is Carlo, and I will be your coordinator for today’s Presentation. At this time, all of our participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s prepared remarks. At this time, if you would like to ask a question, you may do so by pressing ‘*’ ‘1’ on your telephone. If at anytime, during this call, you require audio assistance, please ‘*’ ‘0’ and a conference coordinator will be happy to assist you. I would now like to turn the presentation over to your host for today's conference, Julie MacMedan, Director of Investor Relations. Please proceed ma'am.

Julie MacMedan, Director of Investor Relations

Thank you. Good morning everyone. Welcome to THQ's conference call for the third quarter of our fiscal year ending March 31, 2006.

I would like to remind everyone that statements and projections made during this conference call regarding our expectations, estimates, and predictions of the future are forward-looking statements. These statements about our business are based in part on assumptions made by management, and are not guarantees of future performance. Therefore, actual results may differ materially from today's forward-looking statements, due to several risk factors which are set forth on March 31, 2005 Form 10-K. A copy of this filing may be obtained from our website.

On today's call, Brian Farrell, THQ's President and Chief Executive Officer, will review our recent accomplishments and our March quarter strategy and we will then turn the call over to Ed Zinser, our Chief Financial Officer, who will review the Company's third quarter results and financial outlook. Brian will then close with a discussion of our finance on fiscal 2007 and long-term growth. We will then conduct a question-and-answer session following prepared remarks. I would now like to introduce Brain Farrel, President and Chief Executive Officer of THQ. Brian?

Brian Farrell, THQ's President and Chief Executive Officer

Thank you Julie, and good morning everyone. We are pleased with THQ’s better-than-expected third quarter results and our recent accomplishments. In calendar 2005, THQ gained share in all of our key markets and consistently executed in a challenging period of our industry. Our strategy to target the mass market this Holiday proved successful. Over the year we grew share gains against core gamers and realized the benefits of our increasingly direct global sales network. We enhanced our studio system and took a first mover position in the exciting new area of dynamic in-game advertising. Going forward, we intend to build on our success as we continue to navigate thorough the console transition.

For the third quarter, we reported net sales of $358 million and net income of $0.72 per share ahead of our guidance of net sales of $320 million and net income of $0.65 per share. During the quarter, we shipped more than one million units each of our key title based on content from THQ’s long-term partnerships with Disney Pixar, Nickelodeon, and the WWE. We also shipped more than one million units of our new aimed at girls Bratz Rock Angelz. THQ stand outside of this holiday was WWE SmackDown Vs Raw 2006 on both PS2 and the PlayStation Portable. Revenues from this franchise increased more than 20% over last year and we shipped 2.5 million units during the Holiday quarter including 400,000 units on PSP, a great start for our first release on this platform.

Our success in the Holiday quarter helped drive the market share gain we achieved worldwide in 2005. For calendar 2005, THQ ranked as the number three independent video game publisher worldwide, excluding Japan according to NPD Group, Chart Track and GfK data. Our 2005 US video game market share increased to 7.1% from 6.7% a year ago, as we grew revenues in a declining market. We also posted strong market share gains in Europe and Asia Pacific in 2005. In the UK, we grew share to 6.4% from 4.8% in the prior year. In Australia, we increased our market share to 12% from 9% in the prior year.

Our 2005 market share gains reflect THQ’s execution on the strategy we outlined to you last year, owning the mass market and significantly increasing our share against the core gamer. These games also reflect THQ’s growing direct presence overseas. In the past year, we’ve expanded our European operations to facilitate direct sales of our product in the Austrian, Finolex, Nordic, Portuguese and Spanish market. Today I am pleased to announce that we are opening a new office in Japan later this month. With the addition of this office, our global reach now includes direct operations in all major sales territories.

In 2005, we also continued to enhance our growing studio system, a key driver of THQ’s future growth. This morning, we announced additional details about one of our newest studios Kaos. We are excited about the talent at Kaos, which includes industry veterans from the R&D team responsible for the multi-million unit franchise Battlefield 2. Kaos joins the growing number of THQ studios focused on the core gamer market. We look forward to the launch of their first project, an original property for next generation consoles and PCs slated for calendar 2007.

During the Holiday quarter, we took a first mover position in the exciting new area of dynamic in-game advertising for our announced agreement with Massive Incorporated one of the leaders in the field. Dynamic in-game advertising offers us a new revenue stream, and we plan to exploit this opportunity over the next several years in our online PC and next-gen titles.

Next month, we plan to release our first XBOX 360 title The Outfit from our Relic Entertainment Studio. The buzz produced original exclusively next-gen action game continued to build as we approach launch. Also slated for the March quarter is the sequel to Full Spectrum Warrior called Ten Hammers. The game plan for PS2, XBOX and PC is receiving high marks from the game press.

Consistent with our strategy releasing game for new handheld platforms at the installed base rams. During the March quarter, we plan to ship three new titles for the Sony PSP and two games for the Nintendo DS. With our expected March quarter net sales, fiscal 2006 will mark our 11th consecutive year of revenue growth. Now, Ed Zinser, our Chief Financial Officer will review our operating results and forecast for fiscal 2007. Ed?

Ed Zinser, our Chief Financial Officer

Thank you Brian, and good morning. Today I will review our Q3 financial results, provide initial guidance for the upcoming March quarter, and the full-year outlook for fiscal 2006. In addition, I will provide our 2006 market assumptions and net revenue and EPS guidance for fiscal 2007.

Net sales for the third quarter at fiscal 2006 were $368 million, ahead of our guidance of 320 million and another resemble of the prior year quarter. Earnings per share was $0.72 cents, favorable to our guidance is $0.65 and above the $1.5 in the prior year quarter which included $0.13 per share on development, tax credits planned for prior years.

Net sales in the third quarter were driven by WWE SmackDown Vs Raw 2006, The Incredibles, Rise of the Underminer, SpongeBob SquarePants, Lights Camera PANTS! and Bratz Rock Angelz. These key titles accounted for approximately half of our quarterly revenue and performed well worldwide. Better than expected WWE sales drove our revenue gain versus guidance. The decline versus the prior year quarter reflected The Incredibles and The SpongeBob SquarePants movie titles, which was supported by theatrical releases last year.

Gross margin for the quarter was 65%, down three points from the prior year quarter. This is due primarily to the mix of GBA dual packs, catalog titles and lower net pricing for titles that were released in the fiscal first quarter. License amortization and royalty costs of 12% of net sales decreased by 190 basis points compared to last year. Approximately 100 basis points of the decline was due to the write-off of the metal license in the prior year period and the remainder was due to our sales mix this year, which included more owned intellectual properties.

Software development amortization of 9% was down 260 basis points compared to the prior year quarter. The prior year quarter included additional amortization expense for products that did not meet sales expectations. Product development expenses of $24 million were essentially flat compared to the prior year period.

Selling and marketing expenses of 12% of net sales were the same as in the prior year quarter. G&A expenses were $18 million, up 5.7 million versus the prior year quarter. The increase is primarily due to a 3.5 million gain on foreign exchange activity in the prior year quarter. Depreciation expense driven by hardware and software purchases including development kits for next generation platform and leasehold improvements accounted for the remaining increase.

Interest income was $1.8 million, up from 0.8 million in the prior year quarter, due to the higher cash balance and higher yields. The net income for the December 2005 quarter was $47.6 million or $0.72 per share compared to net income of 62.9 million or $1.05 per share in the prior year quarter, which included $0.13 per share in research and development tax credit claims for prior years. Our profit results versus the prior year quarter primarily reflect the impact of lower sales this Holiday quarter.

Now, let’s turn to the balance sheet. THQ end of the quarter was $296 million or $4.50 per diluted share in cash and investments. This represents an increase of $94 million versus the December 2004 balance of 202 million with a decline of 35 million versus March 2005. This decline reflects increased used of working capital due to seasonality and growth. Net accounts receivable increased to $188 million from 74 million at March 2005 and was down 14% down versus the prior year due to sales decline in this holiday quarter versus the prior year quarter.

Our day sales outstanding were 48 days, an improvement versus the 49 days in the prior year period. Accounts receivable reserves were $80 million at quarter end, up 22 million from the March 2005 balance of 58 million. The coverage on a trailing nine-month of sales basis was 9% versus 10% in the prior year quarter. The increase in our catalog business, which requires less price protection and lower weeks on hand in the channel in North America account for the difference.

Inventory was $31 million, down 6 million from the prior quarter with an increase from the 24 million at March 2005. On a rolling 12-month basis, inventory turns were 10, up from 8 a year ago. There were no significant additions or reductions for $86 million investment in licenses which is down slightly versus the 88 million in balance at March 2005. Capitalized software development increased to $96 million at December 2005 from 65 million at March 2005. The largest additions in the past three quarters were for Q4 title Full Spectrum Warrior Ten Hammers in the outfit and first half fiscal 2007 titles Cars and Saints Row.

The prepaid expense, another current assets of $24 million was up 10 million versus March 2005, primarily due to the timing of product related payments. Net property and equipment of $35 million was essentially flat versus the prior quarter, however increased by 9 million from March 2005 due primarily to systems initiatives, next generation development kits, leasehold improvements and the redundant site for our data center.

Total current liabilities were $184 million, up 63 million compared to the March 2005 balance. The increase is driven by growth in the business, accrued royalties and license obligations which have moved from long-term to short-term. The Company’s current ration was 3.5 to 2 with working capital of 462 million. Our operating cash flow for the third quarter was $18.9 million. This net source of cash was due primarily to 47.6 million of net income plus non-cash amortization expense was exceeded our working capital usage primarily accounts receivables. On a trailing 12-month basis, operating cash flow was positive $64 million. Return on invested capital on a rolling 12-month basis was 15%, down from 19% in the corresponding prior year period. We had no borrowings at quarter end and total stockholders' equity was $633 million. That concludes the financial discussion for the third quarter of fiscal 2006.

Now, we will turn to THQ’s projections for the fourth quarter and full-year fiscal 2006. For the fourth quarter of fiscal 2006, we are projecting approximately $135 million of net revenue with a profit of approximately $0.02 per share. Our fourth quarter results are expected to be driven by four new title releases in 11 skews. As Brian mentioned, our line-up consists of our internally developed original property for the XBOX 360 The Outfit, the sequel Full Spectrum Warrior for the PS2 XBOX and PC, three titles for the Sony PSP and two titles for the Nintendo DS. We expect wireless revenues of 9 million in the fourth quarter brining fiscal 2006 revenues to 37 million, which is 50% growth versus the prior year. Our resistance below our original expectations of 50 million and we now anticipate a loss in the wireless in the quarter end for the year.

For the full-year fiscal 2006, our revenue guidance has been increased to approximately $790 million, which reflects our better than projected results in the third quarter. Largely because of projected loss in wireless in the fourth quarter, we’re holding our clear EPS at $0.67. To recap, this fiscal year we plan to generate approximately $790 million in net revenue and earnings per share of $0.67. We expect revenues to be driven by our diversified portfolio of mass market brands and our original properties on both current and next generation consoles and PC. The $0.67 earnings per share estimate include significant spending in our product development organization, which is an investment in our future.

Before I discuss our initial guidance for fiscal year 2007, I would like to review some of our market assumptions. There are many variables impacting our industry this year that make a challenging to predict market performance necessarily in the year. Nonetheless, our current expectations for calendar 2006 called for essentially flat software dollar growth for North America and Europe, consisting with generally lowered industry expectations. We expect continued current generations software dollar declines with an offsetting increase in Microsoft XBOX 360, Sony PS3 and PSP, and Nintendo Revolution DS software sales. We expect PS2 and PSP hardware price reductions in calendar 2006, although timing of that reductions is uncertain. With regards to pricing we expect continued downward pricing pressure on current generation software, we expect at select titles on next generation platform can achieve a premium price.

Our unit hardware forecast in North America for each platform are as follows. PlayStation2, 4.5 to 5 million; XBOX, up 2.5 million; GAMECUBE, 0.5 to 1 million; GBA, 2.5 to 3 million; PSP 5 to 5.5 million; DS 3 to 3.5; XBOX 360, 5 to 5.5 million; PS3, 1 to 2 million, and in Revolution, 1 to 1.5 million. Our unit hardware forecast in Europe and the other PAL territories for each platform are as follows. PlayStation2, 3.5 to 4; XBOX, 0.5 to 1 million; GAMECUBE, up 2.5 million; GBA, 1 to 1.5; PSP, 4 to 4.5; DS, 2.5 to 3 million; XBOX 360, 2 to 2.5 million; PS3, 1 to 2 million; and Revolution, 0.5 to 1 million.

Turning to THQ’s fiscal year 2007, our sales and profits projects reflect a transition year uncertainties of software and hardware pricing, as well as the hardware ramp-up for next generation consoles. We are projecting net revenue of approximately $900 to 950 million, which is 14% to 20% growth versus the fiscal 2006 projection. As Brain will discuss, our revenue will be driven by a strong product line up, which includes Disney Pixar Cars across nine platforms, XBOX 360 titles Saints Row, PT title, Company of Heroes, and Titan Quest and new title releases from our partners to WWE and Nickelodeon.

Net income as projected at approximately $0.90 to a $1 per share. EPS projections does not include the impact of stock-based compensation, we’re finalizing the estimate and will include it on our next earnings call. Our skew count is expected to increase to approximately 75 from 66, due primarily to next generation console platforms. Our title count is relatively flat versus the fiscal 2006 projection. Catalog is planned at 20% to 25% of the sales mix, down somewhat from the fiscal 2006 projections.

Our international revenues are expected to increase slightly to 42% of the mix. Wireless revenues are expected to show modest growth of approximately 10% as we execute against the more focused product line, which leverages THQ’s strong portfolio of owned and license properties. We’ve plan to provide in more detailed financial statement guidance on our next call as we gain greater visibility into next year over the upcoming months.

In summary, in fiscal year 2007 we plan to generate approximately $900 to $950 million of net revenue with a bottom line of $0.90 to a $1 per share. This projection represents net revenue growth of 14% to 20% and earnings per share growth of 34% to 50%. I would now like to turn the call back to Brian.

Brian Farrell, THQ's President and Chief Executive Officer

Thanks, Ed. As Ed noted THQ is on plan to execute effectively through this hardware transition. We are very confident in our lineup for fiscal 2007 into robust pipeline of innovative new products we’re building in THQ. We are pleased with our diversified fiscal 2007 product portfolio. While we view 2006 as a transition year for the industry, we plan to grow revenues 14% to 20% with higher operating margins and earnings per share, while continuing to increase our investment in product development.

We intend to achieve this goal by launching new games and sequels based on our strong license brands, extensions to our recently established original brands and new original properties for next-gen consoles and PC. We plan to start fiscal 2007 with a strong June quarter led by seven platform launch of games based on Disney Pixar’s Cars in conjunction with the theatrical release, which is expected to begin in North America on June 9th, and then rollout to other territories over the following months. Our racing experts at Rainbow studios are on track to deliver an exciting interactive experience based on another amazing Pixar movie.

Rounding out our first quarter lineup, we plan to release our high-end PC game Titan Quest, MotoGP 2006 for XBOX 360, and a PSP extension to our popular Juice franchise. In the September question, we plan to launch our innovative and critically acclaimed XBOX 360 title Saints Row developed by our Volition studio. We use Saints Row as an important opportunity to establish a leadership position in next-gen open world gaming. In addition of Saints Row, we expect to release the highly anticipated PC game Company of Heroes, created by our Relic Entertainment studio, which took "Best Strategy Game" honors at last year’s E3. We also plan the launch games based on the Monster House and Barnyard movies in conjunction with their theatrical release. For the second half of fiscal 2007, we plan to release our popular mass market titles for holiday. We plan to publish WWE games on multiple platforms including next-gen and to bring back our popular Nickelodeon brands including games based on SpongeBob SquarePants, HandyScanum (phonetics) NickToons and a promising new property Avatar.

We also expect strong sales of our Cars games in holiday based on our experience with Finding Nemo and other popular family games. During our fourth quarter, we planed to deliver new titles for the core gamer including two new high-end PC titles, Supreme Commander, and S.T.A.L.K.E.R Shadow of Chernobyl.

Consistent with our past practices you can look forward to more announcements on other fiscal 2007 games including PS3 and Nintendo Revolution titles as we progress through the year. As we’ve discussed previously, we have a solid pipeline of next-gen titles for both our internal studios and from top notch external studios. While we are pleased to achieve THQ’s outperform the market in fiscal 2007, we are also positioning our company to capitalize on industry growth over the next cycle.

We have already built a substantial lineup of games for fiscal 2008 to take advantage of accelerating market growth in calendar 2007 and we continue to enhance our long-term product plan. We’re currently having 18 titles in development for next generation hardware, up from the 13 we discussed on our last call. We also have a growing number of titles for the Sony PSP and Nintendo DS to support our continued leadership on handheld platforms.

We remain bullish on the growth opportunity in the wireless market and our ability to leverage THQ’s content onto the wireless platform. We have new management in-place and are executing on a more focused product strategy. We have video game industry Veteran Doug Clemmer to lead our Wireless group. Doug as President of our highly successful value soft game division and he is expertise in the casual gaming market over the past nine years made some of the ideal candidates to manage and grow our Wireless revenues.

As we look to the future, we’re well positioned for substantial future. We built an industry leading portfolio of both owned and license brands. We’ve built a world-class studio system with 1100 professionals in 12 studios and secured partnerships with many of the best third party developers. Our global reach now includes direct operations in all major sales territories. With nearly $300 million in cash and more than $600 million in stockholders equity we have a strong balance sheet to support our future growth. We now look forward to responding to your questions, operator can you please open the call for questions.

Questions-and-Answer Session

Operator

Yes sir, thank you. Ladies and gentleman at this time if you wish to ask a question you may do so by pressing “*” “1” on your touchtone telephone. If your question has been answered, and if you wish to remove yourself from the queue, you may then press the ‘*’ ‘2’. Again ‘*’ ‘1’ at this time for any questions. One moment please. Our first question is from the line of Heath Terry with Credit Suisse.

Q - Heath Terry

Great, thank you. I was wondering if you could talk to us a little about the difference that you’re seeing in the US versus the European market. You know, in terms of where consumer demand is, there, you know, particularly on the new XBOX 360 console, but also what you think that strength in the current generation in that market is going to look like over the course of this year?

A - Brian Farrel

You know, if you look that how we’re thinking about US versus Europe right now, on 360 Europe is experiencing the same shortages of hardware, the ramp has been slower than our European executives have anticipated just because of the hardware supply. Like the US we expect that hardware to start flowing much better over the next several months. On the current gen, the real strong platform there is PlayStation2, the PlayStation2 market is still fairly robust throughout Europe. So, you know, the way I like to think about Europe without sending our European friends, that they generally tends to be 6 months to 12 months behind US in terms of trends, generally the hardware platform seemed to launch there somewhere three to six months later. So, the PSP on the other hand has done quite well in Europe, has had great sales momentum there. So, overall I don’t see tremendously different trend, you know, between the US and Europe.

Q - Heath Terry

Great, thanks. Then, could you just also talk a little bit about, you know, to the extent that the candidate at this point, your PlayStation3 develop that what timing look like for you in terms of when you should be able to get you first product done? And, you know, to what extent that you kind of getting the developing kits and support that you need?

A - Brian Farrel

Yeah, we said in our last call, you know, we have, you know, PlayStation 3 development kits. We’re expecting final hardware. Here in the near term I’m not able to say exactly when. So, we should be prepared to launch products at or near the launch window. As you know Heath, we don’t know when launch is. So, it’s hard to say it would be at launch, but certainly because we’ve already invested very heavily in next-gen technology, getting that technology over the PS, excuse me, over to the PS3, is something we think we can do extremely well. So, we’ll time our lease is sort of in the managing our brands and not necessarily around the launch, but I think the big thing to think about is, we intend to be very, very aggressive over the next-gen, as I said in my prepared remarks we have 18 next-gen titles in development. So, we intend to be a leader in next-gen on all platforms.

Q - Heath Terry

Great, thank you.

Operator

And sir, our next question is from the line of Tony Gikas with Piper Jaffray.

Q - Tony Gikas

Hi, good morning guys. Could you provide a little bit of visibility at how large some of this new revenue opportunities could be over the course of the next few years, like the in-game advertising and console downloads? And also, what’s your industry growth estimate for wireless over the next couple of years?

A - Brian Farrel

Well, we’ll take the first part of the question about the additional revenue models. We have not seen any reliable data yet, Tony, if you guys have somebody love to see it on market projections for both in-game advertising and downloads, you know, we have seen the number strong around, but I haven’t seen any really good numbers. But, takeaway here is, these are both nascent market, but we think there’re going to develop and develop in the near-term. And the driver to those markets is more and more online capability, we know that we have our consumer online, the dynamic in-game advertising is a way to relate to that consumer and with a similar concept with the micro-transactions. We now have our consumer online and we can interact and potentially sell to that customer online. And you just wait, really the start giving any meaningful market projections. Again the takeaway is THQ’s, you know, prepared – we are first mover in the dynamic in-game advertising, we’re doing something obviously with the micro-transaction, but we’re not planning anything that will give revenue in the near term of either of those markets. But, as we get deeper into the next-gen cycle, we think there is a tremendous opportunity there.

With respect to wireless, you know, there has been growth rate allover the map, and in the point in wireless it’s still a nascent market a bit of the wildwest in terms of what happens in the various markets with handsets. So, what we can say about the wireless market right now is the uptake on handsets, but our wireless Internet enables that it has been very consistent with our projections, and we expect that to continue to grow next year. I don’t have a specific number on the wireless market growth. I’ll leave that up to the industry analyst.

Q - Tony Gikas

Is the technology, you know, handsets changing so rapidly that you can’t, you know, keep up with it. And then, the last question what’s your pricing strategy looking to the next strategy, the next cycle that you intend on still remaining little bit of a competitive advantage to the average frontline product?

A - Brian Farrel

Well, with respect to wireless the issue is always been, you know, the number of handsets reporting to the right handsets and calling the markets right in terms of, you know, how you can get your content into which handsets and which territories. We think the big win in wireless is the casual game opportunity, when we look at what’s been successful in the marketplace, one thing that research is pretty clear on is this, the users are very, very casual which speaks to our strategy. What may have changed there overtime, but I think it’s going to be a slower burn, it’s the shift from 2D to 2.5 and 3D overtime, you know, we’re prepared to handle that probably, you know, as well as anyone based on, that we’ve been doing 3D handheld games for quite sometime.

With respect to pricing, your question on pricing, we think pricing it’s going to be stratified into the next-gen just as it is in this gen, you know, you’ll see titles from THQ at 5999 on next-gen, and you will see titles frontline titles from us, are still on current gen at 4999, you will see our mass market titles at 3999, and then you’ll see our greatest chips titles in the sort of budget catalogs that was 1999. That’s our expectations with respect to that had not changed.

Q - Tony Gikas

Thanks, Brian.

Operator

And sir, our next question is from the line of Edward Williams with Harris Nesbitt.

Q - Edward Williams

Good morning. Couple of questions for you. Brian, what’s your thought looking into fiscal 2007 as to the percent of your revenue that should come and maybe at the skews that should come from owned IP, as well as from your owned studios?

A - Ed Zinser

Yes sure, I will take that one Edward. As far as IP initiatives, that’s been a big focus in strategy of the company. So, you know, next year is a little bit of albeit not only in the sense that we’re going to have what we believe to be very successful Cars property which will have a significant impact on our revenue mix that you will see, something more on the line of 70:30, you know, license versus own split next year that order of magnitude, because of very successful Cars release. And you will start to see the own percentage will start to increase fairly significantly beyond that.

Q - Edward Williams

You get wind up from your own studios.

A - Ed Zinser

As far as our internal development Cars, next fiscal year, we’ll have approaching half of our revenue becoming from internal studios.

Q - Edward Williams

Good. And how does that compare to the current fiscal year?

A - Ed Zinser

That’s up – up from the current fiscal year fairly significantly.

Q - Edward Williams

And looking up the wireless business, where do revenues coming from at this point? And are you developing any of the games internally your studios and external studios? And then, what are your basic plans, was there any change any executives running there?

A - Brian Farrel

Well, like any business, Edward, the focus should be on the ultimate product and the end consumer. And, you know, when we look at the marketplace and look at the top selling games, we’re actually starting to get some decent sell-through information, one of the season that at least provide some information on sell-through now. And what is the big – the very clear trend there is the emphasis on the casual game. So, the big win for us is we’ll continue to do the very successful license brands, and some of the brands based on our own content, some of those gains worked very well, but you’ll see more emphasis on the casual games. From a development standpoint that’s another area where we’re sort of reorienting what we’re going. One of the things, I think we’re learning as we move up to learning curve is how to more effectively and efficiently make the games, actually produce them and port them to the multiple handsets, and I don’t think we are there yet, and I think you’ll see a lot of focus on that. So, the two things we’re focusing on in wireless is products, which includes that, you know, our biggest titles plus more casual content, and then on the PD side more efficient way of developing the games and porting them to multiple handsets.

Q - Edward Williams

And then, the last question for you. What's your thought with regards to the original XBOX console systems for next fiscal year? Are you planning on – have you cut back in your expected skews over the last couple of months or you're still kind of going with the original thoughts?

A - Brian Farrel

This is very consistent Ed. Because, what was happening with the XBOX now is very consistent with our expectations. As Ed said in his remarks, I think we expect up to 0.5 million units of new XBOX hardware that's not very much. You know, that being said, you know, we have a number of cross platforms development tools, now to port any of our titles to the XBOX platform, if we think we can money we will do that. But, our expectations with respect to the XBOX market really haven’t changed as we said. You know, repeatedly we think that market will decline quickly because of Microsoft, you know, inability because of the cost structure of the XBOX to migrate that hardware down the price curve.

Q - Edward Williams

Okay. Great, thank you very much.

Operator

And sir, our next question is from the line of Mike Wallace with UBS.

Q - Mike Wallace

Hi, couple of questions. First, Brian could you just give us an update on Disney Pixar, was there anything that changes, you know, some people thought that maybe that they’ll accelerate the number of movies they do? What is your current thinking -- to do one per year? And maybe if you could refresh our memory on what sort of sequel rights you own under new agreement?

A - Brian Farrel

Sure. We have an agreement with Pixar for the next four films after Cars. As you might have seen on the wire today, currently Disney and Pixar have structured a new distribution for the next – for Pixar's next movie 'Ratatouille'. And this is currently they record in their press release just in case, you know, their merger does not close for any reason. But, so, that would be the next film on our schedule, and we do have an introduction. You know, the acquisition of Pixar by Disney does not change any of our rights. So, just to recap, you know, what we have and what we still have is the next four Pixar films after Cars, we are committed to make sequels to those games based on the movie rights we have. We do not have the rights to produce games based on any movie sequel that Pixar and Disney do to previously existing Disney Pixar films. Now, that being said, you know, we’ve done 8 million units of Finding Nemo and 6 million units of The Incredibles, and we think we’re going to have a very strong results with Cars. So, we certainly like to work very closely with Disney and Pixar to see if there are other opportunities for us in the future beyond the rights we have.

Q - Mike Wallace

Okay. And as far as the Wireless, I don’t know if you said that for fiscal ’07 do you think that business profitable?

A - Brian Farrel

Which business?

Q - Mike Wallace

The Wireless business. I think you said revenues up 10%.

A - Ed Zinser

No, we haven’t said. We will give more specific, you know, guidance on our next call, and we’ll give bottom line number for our Wireless business on our next earnings call. We have said as we do plan to grow this offline in a more conservatively than we did year, and as far as bottom line goes we’ll discuss that in a more detail on our next call.

Q - Mike Wallace

Okay. And then last question, maybe if you could talk your expectations for the Nintendo business going forward, things like their consoles under the rate, you know, what do you think they are for success, you think they have the similar market what they had this summer around? And maybe you can touch on the handheld business, as far as you see in the GBA, how they have done relative to the PSP going forward, you think now strength of their position, do you expect the new GBA going forward that sort of things?

A - Brian Farrel

Well, I mean let’s talk about the handheld business Mike, let’s take away on Nintendo if I miss something Mike please come back to us. But, we said repeatedly what the way we think about the handheld is that there are various segments, mostly based on age. So, GBA now seems to be in the fairly young age demographic, DS sort in the middle age – middle ages, but middle of that, you know, probably, you know, 9 to 16 years old, and then, PSP seems assuming older. And we’ve said consistently we’ll attract those markets based on the properties we have to those demographic. So, for example we had great success with the property called Zoo Tycoon and lot of other mass market products like SpongeBob, The Incredibles, things like that on DS, it’s been a very strong market for us. We are very pleased with both DS and hardware and software number last holiday. And now, PSP, you know, an older demographic, we just attract it very successfully with the WWE on PSP coming at this quarter with things, you know, like MX and some of the other titles we have in the pipeline. So, if you think about the handheld market Nintendo tend to dominate the lower and middle age demographic, PSP the upper and very consistent with our expectations, and we’ll continue to attract the market according. With respect to Revolution, you know, THQ has historically made a lot of money by looking at Nintendo and being very smart with the games on their platforms.

We believe there will be a significant opportunity on Revolutions, it’s really hard to call specific market share, but we believe the Nintendo will certainly gain enough market share to justify a very solid return investment as we invest in the Nintendo Revolution development. Nintendo Revolution is not as ambitious technically as the PS3 and 360, I think they have said that themselves. And what that means is the development cost and that nearly as high as they are for the other two platforms. So, we think there is going be a market for the Revolution, we’re pretty excited about it as it plays to some of our strength. And so, we’ll aggressively attract the Revolution when it comes out as well.

Q - Mike Wallace

Thank you.

Operator

And sir, our next question is from the line of Justin Post with Merrill Lynch.

Q - Justin Post

Hi, congratulations on making your numbers for the quarter, I know it wasn’t easy this year. Could you talk a little bit about first to PlayStation 3 development, our semiconductor team, you know, kind of lead that’s going to be a pretty complicated operating environment. And can you talk about the challenges developing for that platform?

A - Brian Farrel

Well, I mean we’d certain agree with your engineers and as far, you know, the tech guys around the call they would certainly echo that the sediments that are being complicated, but complications come opportunity, I think there is a tremendous opportunity in next-gen, you know, the multi spreading aspect of the PS3 allows us to do something in game play that never been done before. And so, I would sort of characterize that this is what happens in next-gen, PS2 was far more complicated than the previous generations. So, I think what you will see is first generation games we’ll all be learning that happens every time, and as we get deeper in the cycle and, you know, our technicians, you know, learn more and more and more about the machines, and the games will get even better. And I think this generation is no different.

Q - Justin Post

Okay, then thinking about your 4Q guidance little lower than what have add October obviously for the year is actually higher. But, was that just to lower expectations for your new title releases or just you think a little loss the catalog?

A - Brian Farrel

Well, actually, you know, we didn’t go after with too much, our original, you know, thinking is pretty consistent with the guidance we have provided, you know, it’s been more wireless story for us in the fourth quarter, they came up their revenue of that, and that obviously impacted our bottom line as well. So, that was the reason for holding our EPS number at $0.67 on the full-year, it also contributed to some of the volume variance from the top line as well.

Q - Justin Post

Okay. Then I think, well, it’s going to per se one quarter, correct me if I’m wrong, is that just to wait for the installed base to grow a little bit more?

A - Brian Farrel

Well, our goal with Saints Row that we said all along is to establish a leadership position in open world game, and we think there is tremendous opportunity for those of who have seen the game and I think the three front covers that Saint Row has garnered and some of the press that’s it’s getting. So, we think there is an opportunity to establish a leadership position here. So, between just taking a couple more months to tweak tune and really, you know, have the game be as special as we think that potential is. And as you suggest the fact will be selling into a higher installed base at the installed base ramp to assist another win. So, we think it just a prudent roof.

Q - Justin Post

And last one, just thinking about the Cars, can you talk a little bit about the game, about the game play and I know it’s going to be a big title for your next year. So, any details on your looking things that is exciting for the consumer?

A - Brian Farrel

Well, the great thing about Pixar always is just tremendous story and characters. So, we have the benefit of a tremendous story and characters and in an environmental this is very contested to gaming, which is a great thing. And so, we you know, we’ll have the studio the doing the game for Cars is Rainbow studio, they are a studio with the most expertise in the racing era, and it’s a very action oriented racing game with a lot of style and personality reflecting from the movie. So, it’s just a fun game based on an awesome movie. So, we’re very excited about Cars, and on a personal level I just love what they’re doing with Pixar.

Q - Justin Post

Thanks, Brian.

Operator

Yes sir, our next question is from the line of Elizabeth Osur with Citigroup.

Q - Elizabeth Osur

Thanks. And just a thought on the mobile issue, can you guys speak a little bit, kind of, why we re looking at mobile platform in fiscal third quarter and what kind of driven you above the expectations, is there something and you said the handset sell-through has been on verification, is there something else in for a declining consumer, and just anything else you can speak just I thought?

A - Brian Farrel

Well, I mean let’s start with the first thing, there is still been significant growth in the wireless sector overall in calendar 2005.And again to focus on the positive, I mean our Wireless group is up 50% year-over-year, but, you know, I think like a lot of people in this new and nascent market, you know, which products consumers are adopting and where they are whether in Europe, or the US or in the Asian markets there are some differences. So, it’s just adopting what we’ve learned over the last couple of years and trying to attack the markets more aggressively with products we think we’re going to be more successful. So, I don’t think there is anything negative overall in the market, it just a matter of attacking the market with the right product mix in the right product flow in the various territories.

Q - Elizabeth Osur

Okay. Two it’s kind of quick question, one can you comment on Cars pricing or its launch?

A - Brian Farrel

The current gen PS2 XBOX, GAMECUBE will obvious 3999, just the normal pricing we would have for those titles. Our GBA 2999, our DS and PSP 29 and 39 I believe, but I can get back to you those offline miss.

Q - Elizabeth Osur

Okay, thanks. And then just final question, and I guess, can I get detailed guidance of fiscal ’07, but can you just directionally, can you give us a sense about how you think about gross margin?

A - Ed Zinser

Actually, I would like to give the insight on our next call, we’ll actually go with this line by line through the P&L and give you a fairly specific guidance, next to this still a lot of moving parts as we discussed, we obviously have a plan that we built up that, we feel confident and never used to provide the guidance and we provided of $0.90 to $1 on the bottom line, but we’ll you thorough, you know, all that in terms of margin changes, mix changes and things like that on the next call.

Q - Elizabeth Osur

Okay, thanks.

Operator

And sir, our next question is from the line of John Taylor with Arcadia.

A - Ed Zinser

Good morning.

Q - John Taylor

Good morning. And I have a couple of questions, first housekeeping things. So, December quarter, Ed, can you give us what the catalog was at there, and kind of what you thinking about for March?

A - Ed Zinser

Sure, our catalog for the quarter was about – it part of between 25% and 30% for this quarter, and for the fourth quarter you will it more in the 20% kind of range.

Q - John Taylor

Okay, great. And then, inventory went up with sales down, if you look at kind of what the COGs is likely to be in March, it suggest a pretty significant increase year-over-year, is there any concentration in there of things that we’re to be thinking about?

A - Ed Zinser

Actually not all, when you look at our inventory our balance is down from the last quarter, but obviously it’s up from the year ago, and when you look at our inventory turns on a rolling basis year-over-year we actually improved it from 8 to 10 turns. So, obviously we look at inventory very closely in the provision, there is significant explosion there at all. And, as you know, you basically need to cover your product cost and your inventory, and our reserves are certainly adequate for that. And again our turns are up and that’s where the thing we focused on.

Q - John Taylor

Okay, great. You know, you are the bigger, kind of a bigger still summer gamer there, a question I guess, you know, there has been a lot of talk about sequel and whether sequel as, you know, whether consumer are kind of squealed out, you guys are positioned a little differently from some of the other publishers and that your sequel and kits titles and they seemed to be, you know, maybe little a excuse in and resistance to that. So, you’re going forward, developing IP for the new platforms and here is an opportunity for you to, you know, take some share early on that generation. I am wondering kind of what you think the cost occur IP introduction is going to be for the next-gen machines when you, you know, add up all the development cost that are required to put in there, and the marketing cost to launch something that people not aware. Can you give kind of a range or ballpark on that?

A - Brian Farrel

Well, it’s been a pretty broad range, as you might suspect. Saying you, whether you’re using existing tag, or you know, to build the game, but, you know, if you look next-gen development cost and people say you know, they could be up to 10 to 15 and then yet, you know, an equivalent market budget, could it up in the $20, $30 million range to launch new IP and next-gen, you know, without sharpening the pencil that’s a pretty broad range, and I’m sure, I’m not introduce anything new there. But, our philosophy with respect to sequels, specifically you got to have something that adds to the brands. In addition the kids title, I will just going on and give a great reception to WWE, which, you know, as they probably a cross over core gamer and mass market brand, but we introduce something new to the consumer, we gave the consumer a reason to buy the product. So, when we think about sequels to our owned IP in the future, our long-term product brand is not assume we’re going to sequel every brand, every year. We do not think that’s the right strategy for our brand management over the term of the cycle. So, when we look at something when we’re going to introduce a new IP here in the next cycle, we may have two to three adorations in the plan, you know, over the six or seven year cycle.

You know, for example, Tac which has been a very successful kids franchise, of course we done 1, 2 and 3. You know, we are done with this generation, there is nothing new we can do with brand, it’s getting in the cycle, we come back with Tac in the next generation, we’ll come back with something new and different with the consumer, you’re giving the consumer a reason to purchase that product again. So, what you’ll not see from THQ is the sequel, sequel, sequel, of every product every year.

Q - John Taylor

Okay, great. And then, last question. On the wireless business, it sounds like, maybe influenced too much here, but it sounds like the shortfalls related to lack of appropriate product for where the market is running now. I am wondering if that’s true. And second, that’s the case then, are you going to have to write-off anything that is in the pipeline, that is, you know, also not also not on target, and does that represent kind of a non-recurring thing that might hit either might have affected some of December, or some of March's numbers?

A - Brian Farrel

Yeah, in the Car race it just the matter of focus duty. You know, if you look at the revenues versus the expenses, if there were some titles that didn’t perform what we wanted them to do, they just didn’t live up to those expectations, we had a number of those, you know, of those titles sort of the bottom end of the SpongeBob, they just didn’t perform the expectations, that's not one thing, and there is no write-off that we expect from the wireless position at all. All of that development extends currently. And, you know, it's just – it's just the matter now, refocusing the product line, again as I said before we’re learned a lot in our couple of years as being the leader in the segment, and, you know, there are some very, very bring spots, some things have done very well there. The Star Wars games that performed very well, WWE and SpongeBob had performed well. There are a lot of our brands that have performed well. And we just want to build on our successes, and cut the lower performance out of the portfolio.

Q - John Taylor

Okay, great. Thank you.

Operator

And sir, our next question is from the line of Mark Argento with Craig-Hallum Capital.

Q - Mark Argento

Yeah, good morning. Quick question, can you just refresh us on where you stand today in terms of the number of internal studios you have, number of - kind of the headcount number in comparing contrast that to say just a year ago? And then, reaching back, you know, five or six years ago when you’re in the middle transition before and just kind of lay out for us where you guys stand today in terms of your internal development capabilities?

A - Brian Farrel

Yeah, Mark, we now have 12 studios, over a 1100 people, and we can get you the exact number, but I think a year ago my recollection was the number was around 800 people. So, that’s, you know, 40% growth year-over-year in terms of studios headcount that’s been something we've been talking about for the last, at least four or five year, as you know building a world class studio organizations and building it right, either buying studios with talent and management in place as we have done with places like you know, Volition and Relic and Rainbow and some of the other real high profile studios we have. And then, we've also had very good success with starting some of our own studios, Heavy Iron, which has done some of the SpongeBob, and Pixar games was the studio we started up, and the Kaos studio in New York we talked today, our studio in San Diego, our studio in Seattle were all studios that were formed, our Studio Australia formed. So, I think we had a very smart and strategic approach, it’s been very measured, but we have grown fairly quickly there and our expectation would be that, that studio organization would grow further next year, you know, in the range of 10% to 20% in terms of headcount.

Q - Mark Argento

Sure. And just a followup on some of the questions in term of next-gen cost with related to developing these games. Can just kind of help me understand little bit better, and what are some of the key drivers of, you know, cost per game is 10 to 15 million cost or whatever kind of practice you want to put around it. That’s surely the number of people you have working on these games, is it the length of development, could you just, you know, I know it’s still early in the cycle, but you guys do you have edge into these games, it’s sounds like an development, right now. What are you seeing in terms of the size of the teams are there, you know, the kind of the internal cost structure?

A - Brian Farrel

Well, team size has clearly gone up, and it is the function of headcount and time. And most of the headcount, one of the program, in one of the previous question, yes, the programming, the technical programming is difficult, but were the team size that really expanded for all of us is in the area of content creation, you know, making these high tech assets, you know, animations are, you know, all that really takes a lot of people, a lot of time. Like a lot of our competitors, how are we managing that? We’re outsourcing content to lower cost areas. You know, we’re looking at ways that we using content. All of those things are potentials for cost savings in the future. What we’re seeing now is very consistent with what we’ve seen in previous generations. The initial investment in tech, the initial investors were making in things like Saints Row and The Outfit, and some of the other next-gen titles.

We expect to reuse a lot of that technology. As we go into the cycle, because we’re building all of our next-gen from the ground up. And so, when you talk about costs, a lot of the initial costs are being incurred right now. And we’d like to think we’re doing a pretty good job leveraging some of our technology that we have invented across studios, and we will give you a little more color on that, if not the next call or maybe at E3 or just after that. And the other thing is the type of the game, it’s a very significant, a very significant influence on the cost. We do not anticipate for example, when we bring some of our kids titles next-gen, we will be looking at budget anywhere near that level. And again like for example, Saints Row we’re inventing something we think is cutting edge and that’s absolutely a killer approximately, that’s going to be more expensive. When we do some of our younger titles based on existing tech we have build, two or three years from now, those cost will come down dramatically. So, the number of people, you know, how long it takes, but also a big function of the cost is the type of game our ambition is.

Q - Mark Argento

Thanks Brian. That was helpful.

Operator

Sir, our next question is from the line of Gary Cooper with Banc of America Securities.

Q - Gary Cooper

Hi, couple of questions. The PS3 launch, I know, you are not prepared to talk to about this. But I was wondering, if your WWE franchise was the something that would come out around the time of the launch of that platform, that's question one. Question two, maybe just kind of philosophy discuss how you will take some your children's titles to the next-gen platform, should we wait a full-year, or some of them popular enough maybe put out earlier than that. nd then can you name your owned IP games, I know about The Outfit, Saints Row, but I am guess, specifically I am wondering what should be PC games is in your plan for next on owned IP. Thanks.

A - Ed Zinser

Okay, on the PS3 launch, yes WWE I am actually answering the previous question Gary. But, WWE the kind of brand, if we can make launch for the high quality product, that really does well by the brand, we would give that. But you know, as we talk about on previous calls, you know the ramping install base is not a bad thing, so to say we are targeting at a launch window now. So, you know, launch or launch plus three or four depending on when Sony launches, because certainly with a game like WWE, I wouldn't want to compromise quality for a day. So, I think it gives you hopefully a little census and how are thinking about it.

On the Kids titles, you know, it's not really philosophical thing. It's more an installed base thing that we look at when we target when to put our Kids games on next-gen. One of the things, Microsoft has been very vocal about, is they want to target family consumers earlier in the cycle. We can start thinking about Kids titles on next-gen when the install base approaches the 8 to 10 million unit range. So, that's what we would think about. So, you know with the product like Cars for example, you might think about a couple of next-gen skews, you know, towards holiday on that particular franchise, you know probably not PS3 because of, you know, that would be launch window and that would be the core gamer, and I think between the Nintendo and the 360 platforms, we might have some valid install base to there. So the case by case basis, that once you get pass the 8, the 10 million unit install base, other than the Nintendo platform which is starting to get a little lower here, just start to get the most younger consumers. And then with respect to the owned IP, you mentioned Outfit and Saints Row, which we own. Company of Heroes is done by Relic and we do own that. Titan Quest, we own, and then the other two are S.T.A.L.K.E.R and Supreme Commander; we have not discussed the ownership of those franchises.

Q - Gary Cooper

Okay. And could you just quickly name your PSP and PS title for Q4, thanks.

A - Brian Farrel

Sure. For the fourth question, let's see, we have got for DS we have got tune for beyond DS, and we have a warms title that's also on DS. For PSP, we have got, you know a SpongeBob title. We have also got a -- we have got our WWE title or so in that fourth quarter as well. MX versus ATV is that the PSP title will also as this warms.

Q - Gary Cooper

Thanks.

A - Brian Farrel

We have time for just one more question.

Operator

And sir, our question is from the line of Jeetil Patel with Deutsche Bank.

Q - Esgeme

Hey guys, this is actually Esgeme (phonetics) in for Jeetil. So you guys have done a good grow of gain in market shares to, I guess a 7% so for. What is your sort of expectations for further market share growth in the next calendar year and moving into the next cycles? Should we look to, you know 9%, 10%, would that all, what sort of incremental gains can you get? And then related to that question, how quickly, do these sorts of incremental revenue would flow through the bottom line, given the sort of fixed cost base that you have. Was that another way, you know, what do you anticipate sort of peak margin being as you gain share in the next cycle?

A - Brian Farrel

Well, the way we think about our market share, and we could certainly do the math. But, you know as we said in our guidance we expect to grow 14% to 20% on the topline next year in a market that we believe will be flat. So that would imply some pretty significant gains. And the way we think about that is, we want to continue to own the mass market with things Cars and our Nickelodeon franchises, and all of our mass market portfolio. But the real opportunity for THQ is the continued gain share we are pleased with the share gains we have made against the core gamer. But I think we've just scratched the service there, and I think that’s where you will see the most of the share gains coming, with things like The Outfit, Saints Row, with some of our unannounced next-gen titles, in addition to some of the things like Company of Heroes; and S.T.A.L.K.E.R; and Titan Quest; and Supreme Commander on PC. Those are real opportunities to gain share against the core gamer. So that's how we think about it.

You know, we can do the math here, the very robust long-term plan. But, just to put market share targets out there, just not how we think, we think about how we are going to grow the top product line, and we think since we own the mass market and we like what we are doing against the core gamer, we think it's a very, very realistic expectation to assume we can gain share over the next cycle. It's really premature to start talking about operating margins for the next cycle. I think it's very too early to speculate on that. But, as you know and we know the big drivers of operating margins are just scale and so we're mindful that we are going to need to grow very aggressively and we plan to, and the other one is creating hints. And I think we have a proven record to do that. So we think that those are two keys to operating margin expansion along with what we've talked about before which is the global expansion, and that owning our own IP. So the potential leverage in our business as we grow is pretty interesting.

Q - Esgeme

Okay. Thank you.

Julie MacMedan, Director of Investor Relations

Well, that concludes our third quarter call. Thank you for joining us today.

Operator

Ladies and gentlemen, we thank you for your participation on today's conference. This concludes your presentation and you may now disconnect.

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Source: THQ Inc. F3Q06 (Qtr Ending Dec 31, 2005) Earnings Conference Call Transcript (THQI)
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