Foolish Forecast: THQ Fesses Up

Welcome to the time when most public companies are reporting their Q1 2006 earnings news. But when I say most, I'm leaving one company out: game maker THQ (Nasdaq: THQI), which has already wrapped up its fiscal 2006. The company reports Q4 and full-year 2006 results tomorrow morning.

What analysts say:

• Buy, sell, or waffle? Twenty-two analysts play THQ, which scores eight buy ratings and 14 holds.
• Revenues. Analysts expect THQ's quarterly sales to tumble 16% versus last year's Q4, to $143.7 million.
• Earnings. And the year-ago profit should yield to a $0.09-per share loss.

What management says:
THQ made quite the strange guidance adjustment late last month (hey, never do ahead of time what you can put off until two weeks before earnings day). The company upped sales guidance to $150 million from $135 million (thus it's pretty much guaranteed to beat analyst sales estimates). At the same time, however, it pulled its guidance of $0.02 per share in profit and replaced it with -- get this -- a $0.13 projected loss. Ouch. The company blamed "higher-than-expected price protection and software development expenses" for $0.06 of the decrease, and an $0.08 charge to write off software development costs for its latest World Wrestling Entertainment offering, in connection with transferring responsibility for getting the game ready to YUKE's Co.

The good news? No news yet that would contradict CEO Brian Farrell's assertion, made in the February earnings report, that THQ has "gained market share in each of [its] major markets, especially among the core gamer audience, driving [THQ's] ranking as the #3 independent video game publisher worldwide, excluding Japan."

What management does:
Hey, no one likes earnings warnings. But you must admit that up to this point, THQ has done remarkably well in a tough -- sorry, "transitional" -- industry environment. Over the last 18 months, it grew its rolling gross margins nearly 100 basis points, did even better on the operating margin front, and at last report was 46% more profitable than it was a year and a half ago.

Oh, and it raised sales guidance, too.

Margins	9/04	12/04	3/05	6/05	9/05	12/05
Gross	63.4%	64.9%	65.7%	65.9%	66%	64.3%
Op.	6%	10.3%	9.8%	8.8%	9.2%	7.2%
Net	4.3%	8.2%	8.3%	7.6%	7.8%	6.3%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-months performance for the quarters ended in the named months.

One Fool says:
For all that's going right with THQ, this is still not a company I'd invest my own money into, for two reasons. First, the valuation. Over the last 12 months, THQ generated $40 million in free cash flow. Weigh that against the firm's $1.5 billion market cap and what you've got is a company trading for 38 times trailing free cash flow, for which analysts project an earnings growth rate of only 18% per year over the next five years.

Add to this the fact that THQ's diluted share count rose 10% over the last year, and no matter how much the industry improves as the next wave of gaming consoles arrive, I see little chance that THQ's outside shareholders will profit from it.

Competitors:

• Activision (Nasdaq: ATVI)
• Atari (Nasdaq: ATAR)
• Electronic Arts (Nasdaq: ERTS)
• Microsoft (Nasdaq: MSFT)
• Midway Games (NYSE: MWY)
• Take-Two Interactive (Nasdaq: TTWO)

Activision and Electronic Arts are Motley Fool Stock Advisor recommendations; Microsoft is an Inside Value pick. The Fool has a newsletter for almost every style of investing.

Fool contributor Rich Smith does not own shares of any company named above.