**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

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**FORM 10-K**

**(Mark One)**

**x**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended March 31, 2007

**OR**

**o** TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

**For the transition periodfrom _____ to _____**

**Commissionfile number 0-18813**

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**THQINC.**

(Exact Name of Registrantas Specified in Its Charter)

| **Delaware**                              |   | **13-3541686**       |
|-------------------------------------------|--------|----------------------|
| (State or Other  Jurisdiction of          |   | (I.R.S. Employer     |
| Incorporation or  Organization)           |   | Identification  No.) |
| **29903 Agoura Road**                     |   | ** **           |
| **Agoura  Hills, CA**                     |   | **91301**            |
| (Address of  principal executive offices) |   | (Zip Code)           |

 

Registrant’s telephone number, including area code: **(818) 871-5000**

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Securities registered pursuant to Section 12(b) ofthe Act:

**Common Stock,  $.01 par value**

**Preferred Stock PurchaseRights**

Securities registered pursuant to Section 12(g) ofthe Act: None.

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Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes  o  No  þ

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes  o  No  þ

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes  þ  No  o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405of this chapter) is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):

| Large accelerated filer   þ |   | Accelerated filer   o |   | Non-accelerated  filer   o |
|--------------------------------------------|--------|---------------------------------|--------|--------------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b 2 of theAct). Yes  o  No  þ

The aggregate market valueof the voting stock held by non-affiliates of the registrant as of the lastbusiness day of the registrant’s second fiscal quarter, September 30, 2006was approximately $1.9 billion (based on the closing sales price of theregistrant’s common stock on September 29, 2006). The number of sharesoutstanding of the registrant’s common stock as of May 25, 2007 wasapproximately 66,913,074.

**DOCUMENTSINCORPORATED BY REFERENCE**

The2007 Notice of Annual Meeting of Stockholders and Proxy Statement areincorporated by reference into Part III herein.

 

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**THQ INC.INDEX TO ANNUAL REPORT ON FORM 10-KFILED WITH THE SECURITIES AND EXCHANGE COMMISSIONFOR THE FISCAL YEAR ENDED MARCH 31, 2007**

**ITEMSIN FORM 10-K**
|                | ** ** | ** **                                                                                                                      | ** ** | **PAGE** | ** ** |
|----------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|           | ** ** | **Part I**                                                                                                                 |       |     |       |   |   |
| Item 1.   |       | Business                                                                                                                        |       |     | 1          |   |   |
| Item 1A.  |       | Risk Factors                                                                                                                    |       |     | 10         |   |   |
| Item 1B.  |       | Unresolved Staff Comments                                                                                                       |       |     | 16         |   |   |
| Item 2.   |       | Properties                                                                                                                      |       |     | 16         |   |   |
| Item 3.   |       | Legal  Proceedings                                                                                                              |       |     | 16         |   |   |
| Item 4.   |       | Submission of Matters to a Vote of Security Holders                                                                             |       |     | 19         |   |   |
| ** **     | ** ** | **Part II**                                                                                                                |       |     |       |   |   |
| Item 5.   |       | Market for the Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities          |       |     | 20         |   |   |
| Item 6.   |       | Selected Consolidated Financial Data                                                                                            |       |     | 23         |   |   |
| Item 7.   |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations       |       |     | 25         |   |   |
| Item 7A.  |       | Quantitative and Qualitative Disclosures About Market  Risk                                                                     |       |     | 49         |   |   |
| Item 8.   |       | Consolidated Financial Statements and Supplementary  Data                                                                       |       |     | 50         |   |   |
| Item 9.   |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                  |       |     | 86         |   |   |
| Item 9A.  |       | Controls and Procedures                                                                                                         |       |     | 86         |   |   |
| Item 9B.  |       | Other  Information                                                                                                              |       |     | 87         |   |   |
| ** **     | ** ** | **Part III**                                                                                                               |       |     |       |   |   |
| Item 10.  |       | Directors, Executive Officers and Corporate Governance                                                                          |       |     | 89         |   |   |
| Item 11.  |       | Executive Compensation                                                                                                          |       |     | 89         |   |   |
| Item 12.  |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                  |       |     | 89         |   |   |
| Item 13.  |       | Certain Relationships and Related Transactions, and  Director Independence                                                      |       |     | 89         |   |   |
| Item 14.  |       | Principal Accounting Fees and Services                                                                                          |       |     | 89         |   |   |
| ** **     | ** ** | **Part IV**                                                                                                                |       |     |       |   |   |
| Item 15.  |       | Exhibits and Consolidated Financial Statement  Schedules                                                                        |       |     | 90         |   |   |
| Signatures     |       |                                                                                                                            | 94         |     |       |
| Certifications |       |                                                                                                                            |       |     |       |

 

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**This Annual Report on Form 10-K contains,or incorporates by reference, certain forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995. Suchstatements include, but are not limited to, (1) projections of revenues,expenses, income or loss, earnings or loss per share, cash flow projections andother financial items; (2) statements of our plans and objectives,including those relating to product releases; (3) statements of futureeconomic performance; and (4) statements of assumptions underlying suchstatements. We generally use words such as “anticipate,” “believe,” “could,” “estimate,”“expect,” “forecast,” “future” “intend,” “may,” “plan,” “positioned,” “potential,”“project,” “scheduled,” “set to,” “subject to,” “upcoming” and other similarexpressions to help identify forward-looking statements. These forward-lookingstatements are subject to business and economic risk, reflect management’scurrent expectations, estimates and projections about our business, and areinherently uncertain and difficult to predict. Our actual results could differmaterially. The forward-looking statements contained herein speak only as ofthe date on which they were made, and we disclaim any obligation to update anyforward-looking statements to reflect events or circumstances after the date ofthis**Annual Report.Risks and uncertainties that may affect our future results include, but are notlimited to, those discussed under the heading “Risk Factors,” included in Item1A herein. All references to “we,” “us,” “our,” “THQ,” or the “Company”in the following discussion and analysis mean THQ Inc. and its subsidiaries.

**PART I**

**Item1. Business**

**Introduction**

We area leading worldwide developer and publisher of interactive entertainment softwarefor all popular game systems, including:(1)

·       Homevideo game consoles such as Microsoft Xbox 360, Microsoft Xbox, Nintendo Wii,Nintendo GameCube, Sony PlayStation 3 and Sony PlayStation 2;

·       Handheldplatforms such as Nintendo Dual Screen, Nintendo Game Boy Advance, PSP portableentertainment system (“PSP system”), wireless devices; and

·       Personalcomputers.

Our titles span a wide range of categories, includingaction, adventure, fighting, racing, role-playing, simulation, sports andstrategy. We have created, licensed and acquired a group of highly recognizablebrands, which we market to a variety of consumer demographics ranging fromproducts targeted at children and the mass market to products targeted at coregamers. Our portfolio of licensed properties includes the Disney•Pixar properties *Finding Nemo*, *The Incredibles*,*Cars*and*Ratatouille*;World Wrestling Entertainment®; Nickelodeon properties such as *SpongeBob SquarePants*TM, *Avatar*, *Barnyard* and *Nicktoons*; *Bratz*TM; *Warhammer*®40,000TM; and the Ultimate Fighting Championship®; as well as others. We alsohave licenses to create wireless products based on Disney•Pixar’s *Ratatouille*as well as *Star Wars* andmajor sports leagues. In addition to licensed properties, we also develop gamesbased upon owned intellectual properties, including Company of HeroesTM, DestroyAll Humans! ® JuicedTM, MXvs. ATVTM, Red Faction®, Saints RowTM and Stuntman®.

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(1)          Nintendo®, Dual Screen,Game Boy® Advance, GameCube® and Wii are trademarks and/or registeredtrademarks of Nintendo of America Inc. (“Nintendo”). “PSP” is a trademark and “PlayStation”and the “PS” Family logo are registered trademarks of Sony ComputerEntertainment Inc. (“Sony”). Microsoft, Xbox®, Xbox 360TM and the Xbox logos areeither registered trademarks or trademarks of Microsoft Corporation (“Microsoft”)in the U.S. and/or in other countries and are used under license fromMicrosoft. Microsoft, Nintendo and Sony are referred to herein collectively asthe “platform manufacturers” or the “manufacturers.”

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We develop our games using both internal and externalresources. We currently have 16 internal development studios located in theUnited States, Australia, the UK and Canada. We also contract with third-partydevelopers around the world to develop our products for us.

Our global sales network includes offices throughoutNorth America, Europe and Asia Pacific. In the U.S. and Canada, we market anddistribute games directly to mass merchandisers, consumer electronic stores,discount warehouses and other national retail chain stores. Internationally, wemarket and distribute games on a direct-to-retail basis in the territorieswhere we have a direct sales force and to a lesser extent, in the territorieswhere we do not have a direct sales force, third parties distribute our games. Wealso globally market and distribute games and other content for wirelessdevices through major wireless carriers.

We were originallyincorporated in New York in 1989 as Trinity Acquisition Corporation, whichchanged its name in 1991 to T.HQ, Inc. following a merger with THQ, Inc.,a California corporation. We were reincorporated in Delaware as THQ Inc. in1997. Our principal executive offices are located at 29903 Agoura Road, AgouraHills, California 91301, and our telephone number is (818) 871-5000. Ourinternet address is http://www.thq.com.(2)

**NarrativeDescription of Business**

Our corporate goal is togrow our revenues at or above the market and continue to increase ourprofitability. Our business strategy and a detailed summary of our businessoperations are detailed below and should be read in conjunction with our “RiskFactors,” included in Item 1A herein.

**Strategy**

Inorder to increase our revenues and expand our market share, we believe it isimportant to offer a broad portfolio of titles for all ages that are playableon all popular platforms. We are also focused on increasing the profitabilityof our business. We intend to do this by executing on the following strategies:

***·  Increase sales and profits from our leading portfolio ofmass-market franchises***

We have grown and diversified our products targeted atthe mass market by securing key content licenses. We have leveraged ourlicensed brands by introducing new products and through continued sales of ourcatalog of existing products. Our license with Pixar Animation Studios (“Pixar”)grants us the exclusive interactive rights to publish up to two game conceptsbased on each of the next four Pixar animated feature films beginning with *Ratatouille.*Our license agreement with World WrestlingEntertainment (“WWE”) through our joint venture with JAKKS Pacific, Inc.,grants us the exclusive rights to publish games based on WWE across all viablegame systems through 2014. Our license agreement with Nickelodeon grants us theexclusive right to publish games based on all existing and future Nickelodeonanimated television and movie properties targeting kids ages 6-14 acrossall viable game systems through 2010. Additionally, we have a content licensewith MGA for their Bratz brand and in fiscal 2007 secured the exclusive rightsto develop video games based upon the Ultimate Fighting Championship.

In order to increase salesand profits, our goal is to continue building high quality products based onour leading portfolio of mass-market franchises, market them aggressively andshift more development to our internal development studios. In fiscal 2007, ourkey Disney•Pixarand Nickelodeon titles were developed by our internal studios. We alsoentered into a long-term agreement with Yuke’s to continue to develop gamesbased on the WWE brand. We own less than a 20% interest in Yuke’s, which hasconsistently delivered extremely high quality WWE games since we startedworking with them in 1999.

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(2)          THQ, THQ Wireless and their respective logos are trademarks and/orregistered trademarks of THQ Inc.

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In fiscal 2007, we successfully executed upon ourstrategies by launching *Cars* in allmajor markets throughout the world across nine separate platforms, includingnew generation consoles Microsoft Xbox 360 and Nintendo Wii. We alsoincreased sales of games based on the WWE SmackDown vs. Raw franchise with theintroduction of that property to the Microsoft Xbox 360. We grew revenues fromour Nickelodeon franchise with the introduction of games based upon theirAvatar property and the continued strength of games based on SpongeBobSquarePants and Nicktoons.

In the fiscal year ending March 31, 2008 (“fiscal2008”), we plan to continue to execute on this strategy by shipping mass-markettitles for new generation console and handheld platforms, PlayStation 2 and PC,including the following games based upon our key licenses: Disney•Pixar’s *Ratatouille*, on even more platforms than Cars in fiscal2007, a multi-platform release of the sequel to *Cars*called *Cars: Mater-National;**WWE*®*SmackDown*®*vs. Raw*®**on sixplatforms up from three a year ago, including the Wii, PS3 and DS platforms forthe first time; and Nickelodeon titles led by*Avatar*,*Nicktoons* and *SpongeBob SquarePants*.Also for fiscal 2008, we plan to introduce a new Nickelodeon brand, *El Tigre* on the DS platform.

***·******      Sequel andextend our growing portfolio of owned intellectual property***

In order to grow revenue and increase profitability,we believe it is important for us to create and acquire new intellectual property,expand our internal development capabilities and increase ownership ofdevelopment tools and technology.

In fiscal 2007, we executed on this strategy with thelaunch of our internally developed Saints Row franchise, the internallydeveloped Company of Heroes franchise, the release of a sequel in our DestroyAll Humans! franchise and the introduction of PC game *Titan Quest*TM.In fiscal 2008, we plan to introduce internally developed *Frontlines*TM*: Fuel of War*TM*.*We also planto release a sequel from our recently acquired Stuntman franchise, *Stuntman*®*: Ignition*TM,our Juiced franchise, *Juiced*TM*2: Hot Import Nights*, the next installment in our MX vs ATVfranchise and the next chapter in our Company of Heroes franchise, alldeveloped internally by our Studio System.

Weplan to continue expanding our internal development capabilities by selectivelyacquiring and establishing development studios and through internal growth ofour existing studios. During fiscal 2007, we expanded our internal StudioSystem with the acquisitions of Paradigm Entertainment, located outside ofDallas, Texas, the developers of our Stuntman franchise, and Mass Media Inc.,located in Moorpark, California, a PlayStation 3 development studio. With theaddition of these studios, we now have 16 studios, which are staffed byproducers, game designers, software engineers, artists, animators and gametesters. Our worldwide product development operations have grown and nowinclude more than 1,500 people, an increase of more than 300 people over fiscal2006. Some of the titles released in fiscal 2007 that were developed by ourStudio System included owned properties: *Saints Row*and*Company of Heroes*TM**and licensedproperties:*Cars*, *Avatar: TheLast Airbender*, *Barnyard*, *Nicktoons: Battle for Volcano Island* and*Warhammer**® 40,000TM: Dawn of War: Dark CrusadeTM.* Infiscal 2008 we plan to release several internally developed games includingowned properties: *Frontlines: Fuel of War, Juiced 2: HotImport Nights*, *MX vs. ATV: UntamedTM*,*Stuntman: Ignition*, *Company ofHeroes*TM*: Opposing Fronts*TM**and licensed properties:*Ratatouille*and a sequel to *Cars*, *Cars:Mater-National;**Avatar: The Burning Earth*,*Nicktoons*, and others.

·       ***Pursue growing trends of digital content creationand distribution***

As the interactive entertainment industry continues toevolve, new revenue streams are emerging from the growing trends of digitalcontent creation and distribution. While still nascent, these revenueopportunities are expected to increase significantly in future years. We arecurrently focused on generating revenue from in-game advertising, downloadablecontent/micro-transactions, mobile content and massively multiplayer onlinegaming.

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Infiscal 2007, we positioned the company to take advantage of these growingtrends. We signed agreements with industry leaders for in-game advertising,which we plan to implement in several fiscal 2008 titles, including *Juiced 2: Hot Import Nights*, *MX vs. ATV:Untamed*, and *Stuntman: Ignition*.We offered our first PC titles via digital distribution channels. We provideddigital downloads of additional content for *Saints Row* andplan to expand our digital download offerings in fiscal 2008. We re-positionedour wireless business for future growth, adding new brands and developmentcapabilities to the business. We secured the rights to publish *Warhammer:40,000* as a massively multiplayer online game andcommenced internal development of this title.

·       ***Expandinternational business***

As the global gaming market continues to grow, webelieve that international markets represent a significant growth opportunityfor us. In fiscal 2007, we increased our market share in both Europe and theAsia-Pacific region. Our international revenues totaled $426.7 million or42% of total net sales, up from $316.6 million or 39% of revenues a yearago.

International revenues were driven by our increasinglyglobal product portfolio and our expanded direct sales presence. We currentlydistribute our products in more than 75 countries and territories outside ofNorth America. In fiscal 2007, we established sales offices in Italy and Mexico.We now operate international offices in North America, Europe and Asia-Pacificas follows: United States, Canada and Mexico; Austria, Denmark, France,Germany, Italy, Spain, Switzerland, the Netherlands and the United Kingdom;Australia, Korea, and Japan.

We expect to continue toexpand our international business. In fiscal 2008, we expect internationalrevenues to grow to 43% of revenues, driven by continued execution on ourglobal product portfolio and our ability to drive higher sales via directdistribution of our products. In addition, we are currently exploring newbusiness opportunities in China, which has not been a key market for us in thepast.

**Industry Overview**

As a publisher of interactive entertainment software,we consider ourselves to be part of the entertainment industry. At the mostfundamental level, our products compete with other forms of entertainment, suchas motion pictures, television and music, for the leisure time anddiscretionary spending of consumers. We believe that video games haveincreasingly become a mainstream entertainment choice for both children andadults. According to the International Development Group, Inc. (“IDG”), anindependent consulting and advisory services company that analyzes the consumerelectronics and interactive entertainment industries, sales of console,handheld and PC games (excluding wireless) reached $7.9 billion in NorthAmerica, and $7.1 billion in Europe in 2006. We look toward an expanding marketfor interactive entertainment software over the next several years due to theintroduction of the new generation of console systems. We believe that improvedgraphics and expanded artificial intelligence capabilities of the new platformswill enhance game play and help grow our industry significantly. In addition,incremental revenue opportunities from in-game advertising, downloadablecontent/micro-transactions and mobile content are expected to grow to $7billion in 2009 from $2 billion in 2006, according to DFC Intelligence andJuniper Research.

The first modern platform was introduced by Nintendoin 1985. Advances in technology over the past 20 years have resulted incontinuous increases in the processing power of the chips that power both theconsoles and PC. For the past several years, Sony has been the leader in theconsole market (with its PlayStation 2 console); however, Microsoft andNintendo are large and viable competitors. In 2005, Microsoft introduced itsnew generation console, Xbox 360, and both Sony and Nintendo released their newgeneration consoles, PlayStation 3 and Wii, respectively, in November 2006.Nintendo has been the dominant manufacturer of handheld platforms with itsNintendo DS and Game Boy Advance. In fiscal 

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2005 Sony introduced its first handheld platform, thePSP. PCs continue to be a viable interactive game platform and over the pastfew years, wireless devices, such as mobile phones, have become a viable gamingplatform.

We currently develop andpublish products for all major platforms, and this diversification continues tobe a cornerstone of our strategy. In fiscal 2007, our product releases were forthe Sony PlayStation 2 and PSP, Microsoft Xbox and Xbox 360, Nintendo Wii, DS,GameCube and Game Boy Advance, PC and wireless devices. In fiscal 2008 weexpect to add products for the Sony PlayStation 3 to this line-up and expect tocontinue to enter into additional platform licenses and extend current licensesas new platforms are launched or our current agreements expire.

**Products**

Wedevelop, market and sell video games and other interactive software and contentfor console platforms, handheld platforms and PCs. In fiscal 2007, we publishedeight titles that shipped more than one million units. The following listidentifies games that generated a significant portion of our sales during thefiscal years ended March 31, 2007, 2006 and 2005:

·       infiscal 2007, Disney•Pixar’s *Cars*, *WWE SmackDown vs. Raw 2007*, *Saints Row*,Nickelodeon titles, *Avatar: The Last Airbender*and *SpongeBob SquarePants: Creature from the KrustyKrab* and *Bratz: Forever Diamondz*,and;

·       infiscal 2006, *WWE SmackDown vs. Raw 2006*, *Juiced*, *Destroy All Humans!*,*SpongeBob SquarePants: Lights, Camera, PANTS!*and *The Incredibles: Rise of the Underminer*;and

·       infiscal 2005, Disney•Pixar’s *The Incredibles*,*The SpongeBob SquarePants*TM *Movie*, and *WWE SmackDown vs. Raw*.

Our games are based onintellectual property that is either wholly-owned by us or licensed from thirdparties. We develop our games using both internal development resources andexternal development resources working for us pursuant to contractualagreements. Whether a game is developed internally or externally, uponcompletion of development we extensively play-test each game, and if required,send the game to the manufacturer for its review and approval. Other than gamesthat we release for PCs or wireless devices, the console manufacturers or theirauthorized vendors manufacture our products for us. We then market anddistribute our games for sale throughout the world.

**Intellectual Property**

Our business process begins with the creation ofintellectual property or acquisition of intellectual property rights.Traditionally, most of our titles were based upon licensed properties that haveattained a high level of consumer recognition or acceptance. We haverelationships with many well-known licensors, including Disney•Pixar, Nickelodeon, WorldWrestling Entertainment, Warner Bros. and MGA Entertainment.

Our intellectual property licenses usually grant usthe exclusive use of the property for specified titles, on specified platforms,within a defined territory and during the license term. All of our licenses areof varying duration and we pay royalties to our property licensors generallybased on our net sales of the title which includes the licensor’s intellectualproperty. We typically advance payments against minimum guaranteed royaltiesover the license term. Royalty rates are generally higher for properties withproven popularity and less perceived risk of commercial failure.

Our original intellectualproperty is created either by one of our 16 development studios or by athird-party developer that we contract with, in which instance, we retain allownership rights in the intellectual property. In other instances, wherein athird-party developer creates the intellectual property and develops the game,we obtain a license that is typically exclusive and we try to retain rights toany future products based on the intellectual property.

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**Platform Licenses**

Our business is dependent upon entering into licenseagreements with the platform manufacturers, which allow us the right todevelop, publish and distribute titles for use on such manufacturer’s platform.Our platform licenses include licenses to publish on consoles and handheldplatforms manufactured by Nintendo, Sony and Microsoft. Each license is for afixed term, and as each license expires, we generally enter into a newagreement or an amendment with the licensor to extend the term of theagreement. Certain agreements, such as the licenses with Sony and Microsoft forPlayStation 2 and Xbox 360, respectively, automatically renew each year unlesseither party gives notice by the applicable date that it intends to terminatethe agreement. Additionally, each agreement designates a territory in which wecan publish and distribute titles. We currently are licensed or are in negotiationsto license rights to publish and distribute titles on all platforms that arecurrently sold in the United States and Canada. Our key platform licenses alsoallow us to publish and distribute titles in Europe, Australia, New Zealand andJapan. We are also licensed to publish and distribute titles for GameCube,PlayStation 2, Xbox, and Xbox 360 in various additional territories, includingparts of Asia and Central and South America. We expect to enter into additionalplatform licenses and extend current licenses as new platforms are launched orour current agreements expire.

The platform licenses are not exclusive and requirethat each title be approved by the manufacturer. The manufacturers have theright to review, evaluate and approve a prototype of each title and the title’spackaging and marketing materials. Once a title is developed and approved bythe manufacturer, the title is manufactured solely by such manufacturer or adesignated vendor of the manufacturer. The licenses establish the payment termsfor the manufacture of each cartridge or disc made, which generally provide fora charge for every cartridge or disc manufactured. The amounts charged by themanufacturers for both console discs and handheld cartridges include amanufacturing, printing and packaging fee as well as a royalty for the use ofthe manufacturer’s name, proprietary information and technology, and aresubject to adjustment by the manufacturers at their discretion.

In addition, we must indemnify the manufacturers withrespect to all loss, liability and expense resulting from any claim against themanufacturer involving the development, marketing, sale, or use of our games,including any claims for copyright or trademark infringement brought againstthe manufacturer. As a result, we bear a risk that the properties upon whichthe titles are based, or that the information and technology licensed fromothers and incorporated in the products, may infringe the rights of thirdparties. Conversely, our agreements with our third-party software developersand property licensors typically provide for us to be indemnified with respectto certain matters. If any claim is brought by a manufacturer against us forindemnification, however, our developers or licensors may not have sufficient resourcesto, in turn, indemnify us. Furthermore, these parties’ indemnification of usmay not cover the matter that gives rise to the manufacturer’s claim.

Each platform license maybe terminated by the manufacturer if a breach or default by us is not curedafter we receive written notice from the manufacturer, or if we becomeinsolvent. Upon termination of a platform license for any reason other than ourbreach or default, we have a limited period of time to sell any existingproduct inventory remaining as of the date of termination. The length of thissell-off period varies between 90 and 180 days, depending upon the platformagreement. We must destroy any such inventory remaining after the end of thesell-off period. Upon termination as a result of our breach or default, we mustdestroy any remaining inventory.

**Product Development**

We develop our products using both internal andexternal development resources. The internal resources consist of producers,game designers, software engineers, artists, animators and game testers locatedwithin our 16 internal studios and corporate headquarters. The externaldevelopment resources consist of 

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third-party software developers and otherindependent resources such as artists. We refer to this collective group ofdevelopment resources as our Studio System.

We make the decision as to which development resourcesto use based upon the creative and technical challenges of the product, whetherthe intellectual property which is being developed into a game is licensed, anoriginal concept that we created, or an original concept created by athird-party developer. Once we determine where a product will be developed, ourinternal product development team oversees the internal or external resourcesin its design, technical assessment and construction of each game.

The development cycle for a new game depends on theplatform and the complexity and scope of the game. Additionally, whendeveloping an intellectual property into a game which is simultaneously beingmade into a motion picture, our development schedule is designed to ensure thatour games are commercially available by the motion picture’s release. Thedevelopment cycle for console and PC games ranges from 12-36 months andthe development cycle for handheld games ranges from 9-24 months.

These development cycles require that we assesswhether there will be adequate retailer and consumer demand for a game well inadvance of its release. The investments in such development, prior to reachingtechnological feasibility, are recorded as product development expenses in ourconsolidated statement of operations. We had product development expenses of$97.1 million in fiscal 2007, $94.6 million in fiscal 2006 and $80.1 millionin fiscal 2005.

Upon completion ofdevelopment, each game is extensively play-tested by us to ensure compatibilitywith the appropriate hardware systems and configurations and to minimize thenumber of bugs and other defects found in the products. If required, we alsosend the game to the manufacturer for its review and approval. To support ourproducts after release, we provide online access to our customers on a 24 hourbasis as well as operator help lines during regular business hours. Thecustomer support group tracks customer inquiries, and we use this data to helpimprove the development and production processes.

**Manufacturing**

Other than games that we release for sale on PCs orwireless devices, our video games are manufactured for us by the platformmanufacturers or their authorized vendors. We contract with various PCreplicators for the manufacturing of our PC products.

The platform game manufacturing process begins withour placing a purchase order with a manufacturer. We then send the softwarecode and a prototype of the game to the manufacturer (together with relatedartwork, user instructions, warranty information, brochures and packagingdesigns) for approval, defect testing, and manufacture.

We are required by ourplatform licenses to provide a standard defective product warranty on all ofthe products sold. Generally, we are responsible for resolving, at our ownexpense, any warranty or repair claims. We have not experienced any materialwarranty claims, but there is no guarantee that we will not experience suchclaims in the future.

**Marketing and Sales**

Our marketing activities vary depending upon whether avideo game title is based upon a licensed or an original property. A licensedproperty has pre-existing brand popularity and thus often requires less initialeffort by us to promote. Our marketing efforts for titles based upon originalproperties begin well in advance of a title’s release and focus on buildingpositive awareness of our game concepts with consumers and retailers. Weconduct consumer and retail research, which provides us with feedback toposition a title prior to its release. Our public relations promotionalactivities for original titles in fiscal 2007 included coverage in broadcast,print and online media targeting enthusiast, lifestyle and major mainstreamoutlets. 

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Additionally, we continue to increase our corporatepublic relations efforts by establishing relationships with leading technologyand business reporters.

Our marketing efforts for products released in fiscal2007 covered a broad range of media including, television, print, in-theater,radio, internet advertising and promotional events. Most of our major newreleases in fiscal 2007 received television support. Our games were alsosupported by promotional activities such as trailers, demo discs, standees,posters, pre-sell giveaways at retail stores, game kiosks at sporting andoutdoor events, game demos and promotions with major consumer brands. Our gamesare also promoted to retailers by display at select retailer specific tradeshows. We also conduct print and cooperative retail advertising campaigns formost titles and prepare a range of promotional sales and marketing materials toincrease awareness among retailers.

We strive to create global brand awareness for ourproducts. Consistent with our strategy to build and maintain franchiseproperties with global appeal, our international marketing efforts includelocalization of products to conform to consumer preferences and languages inthe countries in which each title is distributed. This structure is designed tomaximize market performance in all territories.

*NorthAmerican Sales.*   In North America,our products are primarily sold directly to mass merchandisers, consumerelectronics stores, discount warehouses and national retail chain stores. Ourproducts are also sold to smaller, regional retailers, as well as distributorswho, in turn, sell our products to retailers that we do not service directly,such as grocery and drug stores. Our domestic sales activities are led by ournational sales team, which has representatives in most major markets in theUnited States.

We utilize electronic data interchange with most ofour major North American customers in order to (i) efficiently receive,process, and ship customer product orders and (ii) accurately track andforecast sell-through of products to consumers in order to determine whether toorder additional products from the manufacturers. We believe that the directrelationship model we use in North America allows us to better manageinventory, merchandise and communications. We ship all of our products to ourNorth American customers from warehouses located in Canada, Michigan andMinnesota.

The domestic retail prices for our titles currentlyrange between: (i) $15 and $35 for handheld platforms; (ii) $15 and$65 for console platforms; and (iii) $10 and $55 for PC games. Thedomestic retail price for our wireless games currently range between $2 and $8for a one time purchase and between $2 and $4 for a monthly subscription.

*InternationalSales.*   Our international sales activitiesoperate via our offices in the United Kingdom, Australia, France, Germany,Korea, Japan, Spain, Austria, Denmark, the Netherlands and Italy. Internationaloffices market and distribute direct-to-retail customers and throughdistributors in both their home territories and to approximately 60 additionalterritories.

Our largest customersworldwide include Best Buy, GameStop, Target, Toys “R” Us and Wal-Mart. We alsosell our products to other national and regional retailers, discount storechains and specialty retailers. Our largest customer, Wal-Mart, accounted for 18%of our worldwide sales in fiscal 2007. A substantial reduction, termination ofpurchases, or business failure by any of our largest customers could have amaterial adverse effect on us.

**Seasonality**

The interactiveentertainment software market is highly seasonal, with sales typicallysignificantly higher during the third quarter of our fiscal year, due primarilyto the increased demand for interactive games during the year-end holidaybuying season.

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**Competition**

The video game industry is intensely competitive. Itis characterized by the continuous introduction of new titles and thedevelopment of new technologies. Our business is driven by hit titles, whichrequires us to invest significantly in production and in marketing. Competitionin the video games segment is also based on product quality and features,timing of product releases, brand-name recognition, access to distributionchannels, and effectiveness of marketing and price.

We compete both for licenses to properties and thesale of interactive entertainment software with Sony, Microsoft and Nintendo,each of which is a large developer and marketer of software for its ownplatforms. Each of these competitors also has the financial resources towithstand significant price competition and to implement extensive advertisingcampaigns, particularly for prime-time television spots. In addition to themanufacturers, our competitors include publishers and developers of interactiveentertainment software, such as Activision, Atari, Electronic Arts, LucasArts,Namco, Sega, Take-Two Interactive Software, Ubisoft, and Vivendi Games.

In addition, some of ourcompetitors are very large, diversified corporations that have begun to developgames based upon their own highly recognizable brands, and, as a result, standto become more direct competitors. Disney Interactive Studios recently expandedits internal software game publishing efforts and Viacom has expanded itsefforts in interactive entertainment software publishing.

**Employees**

As of March 31, 2007,we employed approximately 2,000 people, of whom over 640 were outside theUnited States. We believe that our ability to attract and retain qualifiedemployees is a critical factor in the successful development of our productsand that our future success will depend, in large measure, on our ability tocontinue to attract and retain qualified employees. None of our employees arerepresented by a labor union or covered by a collective bargaining agreementand we consider our relations with employees to be favorable.

**FinancialInformation About Geographic Areas**

See Item 7 “ManagementDiscussion and Analysis of Financial Condition and Results of Operations” andNote 18 of notes to consolidated financial statements included in Item 8.

**AvailableInformation**

We file annual, quarterly and current reports, proxystatements and other information with the Securities and Exchange Commission (“SEC”).Our SEC filings, including our annual report on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K, andany amendments to those reports filed or furnished pursuant to Section 13(a) ofthe Exchange Act are available to the public free of charge over the internetat our website at http://www.thq.com or at the SEC’s web site athttp://www.sec.gov. Our SEC filings will be available on our website as soon asreasonably practicable after we have electronically filed or furnished them tothe SEC. Information contained on our website is not incorporated by referenceinto this annual report on Form 10-K. You may also read and copy anymaterials we file with the SEC at the SEC’s Public Reference Room at 100 FStreet, NE, Room 1580, Washington D.C. 20549. You may obtain informationon the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330or on the internet at http://www.sec.gov/info/edgar/prrrules.htm. You can viewour Code of Business Conduct and Ethics, our Code of Ethics for ExecutiveOfficers and Other Senior Financial Officers and the charters for each of ourcommittees of the Board of Directors free of charge on the corporate governancesection of our website.

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**Item 1A.** RiskFactors

Ourbusiness is subject to many risks and uncertainties which may affect our futurefinancial performance. Some of those important risks and uncertainties whichmay cause our operating results to vary or which may materially and adverselyaffect our operating results are as follows:

**Riskfactors related to console hardware**

Our business depends on hardware onwhich consumers play our games. In the past 18 months, Microsoft, Nintendo andSony each released a new console platform, the Xbox 360, Wii and PlayStation 3(“PS3”), respectively. These platforms are called “new generation” consoles andsucceed the Xbox, GameCube and PlayStation 2 (“PS2”), respectively, which werefer to herein as the “legacy platforms”. The new generation consoles canadversely affect sales of our video games and our profitability as follows:

***Hardware shortages.***   Each of the new generation consoles hasexperienced hardware shortages, which continue for some of the most recentlyreleased platforms. Hardware shortages generally negatively affect the sales ofvideo games since consumers do not have consoles on which to play the games.

***Hardware pricing.***   The new generation consoles are priced higherthan each of the predecessor platforms. The Xbox 360 can cost as much as $479.99,the Wii is priced at $249.99 and the PS3 can cost as much as $599.99. The costof the hardware could adversely affect their sales, which could negativelyaffect sales of our products for these platforms since consumers need aplatform in order to play our games.

***Software pricing.***   Software prices for the new generation consolegames are higher than prices for games for the predecessor platforms. There isno assurance that consumers will continue to pay the higher prices of thesegames.

Additionally, although we still publish games for thePS2, as consumers purchase games for new generation consoles rather than forthe PS2 and demand for games on the PS2 declines, the prices of our games forthe PS2 may also decline. Reduced pricing of our PS2 products may result in lower revenues, whichcould materially affect our profitability.

***Increasing development costs.***   Theintroduction of the new generation platforms has required the development ofnew software to play on such consoles and new technologies to create suchsoftware. Because the new generation consoles have greater complexity andcapabilities than the predecessor platforms, costs are higher to develop gamesfor new generation consoles. Greater costs can lead to lower operating margins,negatively affecting our profitability.

**We must continue todevelop and sell new titles in order to remain profitable.**

Our profitabilityhas directly resulted from our ability to develop and sell successful newtitles for use on multiple platforms. Consumer preferences for games aredifficult to predict, and even the most successful titles remain popular foronly limited periods of time, often less than six months.

**Competitivelaunches may negatively affect the sales of our games.**

Wecompete for consumer dollars with several other video game publishers andconsumers must make choices among available games. If we make our games availablefor sale at the same time as many other new games become available, consumersmay choose to spend their money on products published by our competitors ratherthan our products and retailers may choose to give more shelf space to ourcompetitors’ products, leaving less space to sell our products. Since, asdescribed above, the life cycle of a game is short, strong sales of ourcompetitors’ games could negatively affect the sales of our games.

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**We rely on arelatively small number of licensed brands for a significant portion of oursales.**

Games we develop based upon a small number of licensedbrands make up a substantial portion of our sales each year. In fiscal 2007,sales of titles for our three top-selling brands, Disney·Pixar,Nickelodeon and World Wrestling Entertainment (“WWE”) comprised 54% of our netsales; in fiscal 2006, 47% of our net sales were based on titles from suchbrands; and in fiscal 2005, 52% of our net sales were based on titles from suchbrands. A limited number of licensed brands may continue to produce adisproportionately large amount of our sales. Due to this dependence on alimited number of brands, the failure of one or more products based on thesebrands to achieve anticipated results or the loss of a license pursuant towhich we develop games for such brands may significantly harm our business andfinancial results.

We are currently involvedin litigation with the WWE with respect to our video game license. Since WWEtitles make up a significant portion of our sales, our inability to retain thelicense could harm us. See, Item 3 “Legal Proceedings” for a more detaileddiscussion of this litigation.

**Our inability to acquire or create intellectualproperty rights which have a high level of consumer recognition or acceptancecould harm us.**

A significant portion of our net sales are derivedfrom products based on popular licensed properties. A decrease in thepopularity of the underlying property of our licenses could negatively impactour ability to sell products based on such licenses.

We also generate revenuefrom wholly-owned intellectual property. The success of our internal brandsdepends on our ability to create original ideas which appeal to the avid gamer.Titles based on wholly-owned intellectual property can be expensive to developand market since they do not have a built-in consumer base or licensor support.Our inability to create new products targeted at the core gamer couldnegatively impact our operations.

**Our inability to enter into agreements with themanufacturers to develop, publish and distribute titles on their platformscould seriously impact our operations.**

We are dependent on the platformmanufacturers (Microsoft, Nintendo and Sony) and our non-exclusive licenseswith them, both for the right to publish titles for their platforms and for themanufacture of our products for their platforms. Our existing platform licensesrequire that we obtain approval for the publication of new games on atitle-by-title basis. As a result, the number of titles we are able to publishfor these platforms, and our sales from titles for these platforms, may belimited. Should any manufacturer choose not to renew or extend our licenseagreement at the end of its current term, or if any license was terminated, wewould be unable to publish additional titles for that manufacturer’s platform,which could negatively affect our operating results.

Additionally,since each of the manufacturers publish games for its own platform, and alsomanufactures products for all of its other licensees, a manufacturer may givepriority to its own products or those of other publishers in the event ofinsufficient manufacturing capacity. Unanticipated delays in the delivery ofproducts due to delayed manufacturing could also negatively affect our operatingresults.

**Video game product development schedules are difficultto predict and can be subject to delays. Postponements in shipments cansubstantially impact our earnings in any given quarter.**

Our ability to meetproduct development schedules is affected by a number of factors, including thecreative processes involved, the coordination of large and sometimesgeographically dispersed development teams required by the increasingcomplexity of our products, and the need to refine and tune our products priorto their release. We have in the past experienced development delays forseveral of our products. Failure to meet anticipated production schedules maycause a shortfall in our expected sales and 

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profitability and causeour operating results in any given quarter to be materially different fromexpectations. Delays that prevent release of our products during peak sellingseasons or in conjunction with specific events, such as the release of arelated movie, could adversely affect the sales of such products and thus ourfinancial performance.

**Werely on external developers for the development of some of our titles.**

Some ofour titles are developed by third-party developers. We have no direct controlover the business, finances and operational practices of these externaldevelopers. A delay or failure to complete the work performed by externaldevelopers may result in delays in, or cancellations of, product releases. Additionally,the future success of externally developed titles will depend on our continued abilityto maintain relationships and obtain developer agreements on favorable termswith skilled external developers. Our competitors may acquire thebusinesses of key developers or sign them to exclusive developmentarrangements. In either case, we would not be able to continue to engage suchdevelopers’ services for our products, except for those that they arecontractually obligated to complete for us. Wecannot guarantee that we will be able to establish or maintain suchrelationships with external developers and failure to do so could result in amaterial adverse effect on our business and financial results.

**We rely on a smallnumber of customers that account for a significant amount of our sales.**

Our largest singlecustomer, Wal-Mart, accounted for 18% of our gross sales in fiscal 2007, 19% ofour gross sales in fiscal 2006 and 14% of our gross sales in fiscal 2005. Infiscal 2007, our five largest customers, including Wal-Mart, accounted for 46%of our gross sales. A substantial reduction,termination of purchases, or business failure by any of our largest customerscould have a material adverse effect on us.

**Increased sales ofused video game products could lower our sales.**

Increased sales of usedvideo games, which are generally priced lower than new video games, by one ofour key customers could negatively affect our sales of new titles and thus ourrevenues.

**Competition in the interactivesoftware entertainment industry may lead to reduced sales of our products andreduced market share.**

Our industry is intenselycompetitive. We compete for both the sale of games and licenses to propertieswith the platform manufacturers and other publishers. Such competition couldnegatively affect sales of our games as follows:

***Development ofsoftware by hardware manufacturers.***   Microsoft, Nintendo and Sony have eachincreased development efforts of software for their own hardware platforms. Asa result of their commanding positions in the industry, the manufacturers mayhave better bargaining positions with respect to retail pricing, shelf spaceand retailer accommodations than do any of their licensees, including us. Additionally,the manufacturers can bundle their software with their hardware, creating lessdemand for individual sales of our products.

***Development ofsoftware by intellectual property owners.***   As discussed above, a significant portion ofour revenue is due to sales of games based upon licensed properties. In recentyears, some of our key licensors, including Disney and Warner Bros., haveincreased their own development of video games, which could lead to suchlicensors not renewing our licenses to publish games based upon theirproperties or not grant future licenses to develop games based upon suchproperties. If we do not publish such games, our revenue could be significantlyaffected.

***Competition forlicenses.***   Someof our competitors have greater name recognition among consumers and licensorsof properties, a broader product line, or greater financial, marketing andother resources than we 

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do. Accordingly, these competitorsmay be able to market their products more effectively or make larger offers orguarantees in connection with the acquisition of licensed properties. Ascompetition for popular properties increases, our cost of acquiring licensesfor such properties may increase, resulting in reduced margins.

***Competition for shelf space.***   As competitors in our industry strive torelease more blockbuster titles and as retailers merge, competition for retailshelf space may become more intense. We may need to increase our marketingexpenditures to maintain sales of our titles. Increased expenses withoutcorresponding increased sales could reduce our profit margins and thus have anegative effect on our business and financial results.

**Competitionwith emerging forms of home-based entertainment may reduce sales of ourproducts.**

We alsocompete with other forms of entertainment and leisure activities. For example,we believe the overall growth in the use of the internet and online services byconsumers may pose a competitive threat if customers and potential customersspend less of their available time using interactive entertainment software andmore using the internet and online services.

**Competition for qualified personnelis intense in the interactive software entertainment industry and failure tohire and retain qualified personnel could seriously harm our business.**

We relyto a substantial extent on the management, marketing, sales, technical andsoftware development skills of a limited number of employees to formulate andimplement our business plan. Our success depends to a significant extent uponour ability to attract and retain key personnel. Competition for employees canbe intense and the process of locating key personnel with the right combinationof skills is often lengthy. The loss of services of key personnel could have amaterial adverse effect on our business.

**Consolidation in the interactivesoftware entertainment industry presents challenges with respect to resourcesand integration of acquired businesses.**

Consistent with our strategy toexpand our internal development capabilities and distribution channels, weintend to continue to pursue acquisitions of companies, intellectual propertyrights and other assets that can be acquired on acceptable terms and which webelieve can be operated or exploited profitably. As our industry continues toconsolidate, we face significant competition in making acquisitions, which mayconstrain our ability to complete suitable transactions.

Further,as we acquire companies, we are faced with additional challenges. Theintegration of newly acquired companies’ operations with our existingoperations takes management time and effort. Additionally, there is a risk ofloss of key employees, customers and vendors of the recently-acquiredcompanies.

**Emergingtechnologies, such as games for wireless devices, require investments andpresent many risks.**

Wireless network and mobile phone technologies areundergoing rapid innovation. New mobile phones with more advanced processorsand supporting advanced programming languages continue to be introduced in themarket. We have no control over the demand for, or success of, these products.However, if we fail to anticipate and adapt to these and other technologicalchanges, our market share and our operating results may suffer. Our futuresuccess in providing wireless games and other content will depend on ourability to adapt to rapidly changing technologies, develop applications toaccommodate evolving industry standards and improve the performance andreliability of our applications. In addition, the widespread adoption ofnetworking or telecommunications technologies or other technological changescould require substantial expenditures to modify or adapt our entertainmentapplications.

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The markets for ourapplications are also characterized by frequent new mobile phone modelintroductions and shortening mobile phone model life cycles. The development ofnew, technologically advanced applications to match the advancements in mobilephone technology is a complex process requiring significant research anddevelopment expense, as well as the accurate anticipation of technological andmarket trends. As the life cycle of mobile phone models and other wirelessdevices shortens, we will be required to develop and adapt our existingapplications and create new applications more quickly. These efforts may not besuccessful. Any failure or delay in anticipating technological advances ordeveloping and marketing new applications that respond to any significantchange in technology or customer demand could limit the available channels forour applications and limit or reduce our sales.

**A significant portion of our revenue is derived fromour international operations, which may subject us to economic, political,regulatory and other risks.**

In fiscal 2007 we derived 42% of our revenues from ourinternational operations, up from 39% in fiscal 2006. We intend to continueexpanding our international operations, which may subject us to many risks,including: differentconsumer preferences, unexpected changes in regulatory requirements, tariffsand other barriers, difficulties in staffing and managing foreign operations,and possible difficulties collecting foreign accounts receivable. These factorsor others could have an adverse effect on our future foreign sales or theprofits generated from these sales.

Salesgenerated by our international offices will generally be denominated in thecurrency of the country in which the sales are made. To the extent our foreignsales are not denominated in U.S. dollars, our sales and profits could be materiallyand adversely affected by foreign currency fluctuations.

**We may not be able to protect our intellectualproperty rights against piracy, infringement of our patents by third parties,or declining legal protection for intellectual property.**

We defend our intellectualproperty rights and combat unlicensed copying and use of software andintellectual property rights through a variety of techniques. Preventingunauthorized use or infringement of our rights is difficult. Unauthorized production occurs in the computersoftware industry generally, and were a significant amount of unauthorizedproduction of our products to occur, it could materially and adversely affectour results of operations. We hold copyrights on the products, manuals,advertising and other materials owned by us and we maintain certain trademarkrights. We regard our titles, including the underlying software, as proprietaryand rely on a combination of trademark, copyright and trade secret laws as wellas employee and third-party nondisclosure and confidentiality agreements, amongother methods to protect our rights. We include with our products a “shrink-wrap”or “click-wrap” license agreement or limitations on use of the software. It isuncertain to what extent these agreements and limitations are enforceable,especially in foreign countries. Policing unauthorized use of ourproducts is difficult, and software piracy is a persistent problem, especiallyin some international markets. Further, the laws of some countries where ourproducts are or may be distributed either do not protect our products andintellectual property rights to the same extent as the laws of the UnitedStates, or are poorly enforced. Legal protection of our rights may beineffective in such countries. We cannot be certain that existing intellectualproperty laws will provide adequate protection for our products.

**Thirdparties may claim we infringe their intellectual property rights.**

Although we believe thatwe make reasonable efforts to ensure that our products do not violate theintellectual property rights of others, from time to time we receive noticesfrom others claiming we infringe their intellectual property rights. The numberof these claims may grow. Responding to these claims may require us to enterinto royalty and licensing agreements on less favorable terms, require us tostop selling or to redesign affected products, or to pay damages or to satisfyindemnification commitments with our 

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customers includingcontractual provisions under various license arrangements. If we are requiredto enter into such agreements or take such actions, our operating margins maydecline as a result.

**Defects in our game software couldharm our reputation or decrease the market acceptance of our products.**

Our gamesoftware may contain defects. In addition, because we do not manufacture ourgames for console platforms, we may not discover defects until after ourproducts are in use by retail customers. Any defects in our software coulddamage our reputation, cause our customers to terminate relationships with usor to initiate product liability suits against us, divert our engineeringresources, delay market acceptance of our products, increase our costs or causeour revenue to decline.

**We cannot be certain of the future effectiveness ofour internal controls over financial reporting or the impact of the same on ouroperations or the market price for our common stock.**

Pursuant to Section 404of the Sarbanes-Oxley Act of 2002, we are required to include in our AnnualReport on Form 10-K our assessment of the effectiveness of ourinternal controls over financial reporting. Furthermore, our independentregistered public accounting firm is required to audit our assessment of theeffectiveness of our internal controls over financial reporting and separatelyreport on whether it believes we maintain, in all material respects, effectiveinternal controls over financial reporting. Although we believe that wecurrently have adequate internal controls procedures in place, we cannot becertain that future material changes to our internal controls over financialreporting will be effective. If we cannot adequately maintain the effectivenessof our internal controls over financial reporting, we might be subject tosanctions or investigation by regulatory authorities, such as the Securitiesand Exchange Commission. Any such action could adversely affect our financialresults and the market price of our common stock.

**Fluctuations in our quarterly operating results due toseasonality in the interactive software entertainment industry and otherfactors related to our business operations could result in substantial lossesto investors.**

Wehave experienced, and may continue to experience, significant quarterlyfluctuations in sales and operating results. The interactive softwareentertainment market is highly seasonal, with sales typically significantlyhigher during the year-end holiday buying season. Other factors that causefluctuations in our sales and operating results include:

·       the timing of our release of new titles as well as therelease of our competitor’s products;

·       the popularity of both new titles and titles releasedin prior periods;

·       the profit margins for titles we sell;

·       the competition in the industry for retail shelfspace;

·       fluctuations in the size and rate of growth ofconsumer demand for titles for different platforms; and

·       the timing of the introduction of new platforms andthe accuracy of retailers’ forecasts of consumer demand.

Webelieve that quarter-to-quarter comparisons of our operating results are not agood indication of our future performance. We may not be able to maintainconsistent profitability on a quarterly or annual basis. It is likely that insome future quarter, our operating results may be below the expectations of publicmarket analysts and investors and as a result of the factors described aboveand others described throughout this “Risk Factors” section, the price of ourcommon stock may fall or significantly fluctuate.

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**Ratingsystems and future legislation may make it difficult to successfully market andsell our products.**

Currently, the interactive softwareentertainment industry is self-regulated and rated by the EntertainmentSoftware Rating Board (“ESRB”). Our retail customers take the ESRB rating intoconsideration when deciding which of our products they will purchase. If theESRB or a manufacturer determines that a product should have a rating directedto an older or more mature consumer, we may be less successful in our marketingand sales of a particular product.

From timeto time, legislation has been introduced at the local, state and federal levelsfor the establishment of a government mandated rating and governing system inthe United States and in foreign countries for our industry. Various foreigncountries already allow government censorship of interactive entertainmentproducts. We believe that if our industry were to become subject to agovernment rating system, our ability to successfully market and sell ourproducts could be adversely affected.

**Any significant downturn in generaleconomic conditions which results in a reduction in discretionary spendingcould reduce demand for our products and harm our business.**

Our product sales are affected by theretail customer’s ability and desire to spend disposable income on the purchaseof our games. Any significant downturn in general economic conditions whichresults in a reduction in discretionary spending could result in a reduction indemand for our products and could harm our business. Such industry downturnshave been, and may continue to be, characterized by diminished product demandand subsequent erosion of average selling prices.

Becauseof these and other factors affecting our operating results and financialcondition, past financial performance should not be considered a reliableindicator of future performance, and investors should not use historical trendsto anticipate results or trends in future periods.

**Item 1B.** UnresolvedStaff Comments

None.

**Item 2.** Properties

Thefollowing is a summary of the principal leased offices we maintained as of May 25,2007:

| **Purpose**                 | ** ** | ** ** | ** ** | **North America** | ** ** | **Europe** | ** ** | **Asia Pacific** | ** ** | **Total** | ** ** |
|-----------------------------|------------|------------|------------|------------------------|------------|------------|------------|-----------------------|------------|-----------|------------|
| Sales and  administrative   |       |       | 116,800    |                   |       | 56,700     |       |                  | 11,600     |      |       | 185,100 |   |
| Product  development        |       |       | 373,900    |                   |       | 6,100      |       |                  | 20,700     |      |       | 400,700 |   |
| Total leased square footage |       |       | 490,700    |                   |       | 62,800     |       |                  | 32,300     |      |       | 585,800 |   |

 

We also own 10,820 squarefeet of space in Phoenix, Arizona which serves as our data center and motioncapture studio.

**Item 3.** LegalProceedings

*WWE relatedLawsuits*

On October 19, 2004, World WrestlingEntertainment, Inc. (“WWE”) filed a lawsuit in the United States DistrictCourt for the Southern District of New York (the “Court”) against JAKKS Pacific, Inc.(“JAKKS”), THQ, THQ/JAKKS Pacific LLC (the “LLC”), and others, alleging, amongother claims, improper conduct by JAKKS, certain executives of JAKKS, anemployee of the WWE and an agent of the WWE in granting the WWE videogamelicense to the LLC. The complaint seeks various forms of relief, includingmonetary damages and a judicial determination that, among other things, the WWEvideogame license is void. On March 30, 2005, WWE filed an amendedcomplaint, adding both new claims and THQ’s 

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president and chief executive officer, Brian Farrell,as a defendant. In August 2005, the Court directed the parties to filebriefs on the three federal law claims alleged by the Plaintiffs (i.e.,Robinson-Patman, and Sherman Act, and a threshold issue concerning thePlaintiff’s RICO claim). The motions to dismiss the amended complaint based onthese issues were fully briefed and argued and, on March 31, 2006, theCourt granted the defendants’ motion to dismiss the Robinson-Patman Act andSherman Act claims and denied the defendants’ motion seeking to dismiss theRICO claims on the basis of the threshold “enterprise” issue that was briefed(the “March 31 Order”).

On April 7, 2006, the Company and the otherdefendants sought certification to appeal from the portion of the March 31Order denying the motion to dismiss the RICO claim on the one ground that wasbriefed. Shortly thereafter, WWE filed a motion for re-argument with respect tothe portion of the March 31 Order that dismissed the Sherman Act claimand, alternatively, sought judgment with respect to the Sherman Act claim sothat it could pursue an immediate appeal. At a court hearing on April 26,2006, the Court deferred a ruling on the requests for partial judgment and forcertification and set briefing schedules with respect to the remaining groundsfor defendants’ motion to dismiss the RICO claim, currently the sole remainingbasis for federal jurisdiction in this action, that were not the subject of thefirst round of briefing. The Court also established a briefing schedule for WWE’smotion for re-argument of the dismissal of the Sherman Act claim. The briefingwas completed in August of 2006 and a hearing was held in September of2006. The Court has not yet ruled on the pending motions. Discovery in thisaction remains stayed.

THQ believes that neither it, nor Brian Farrell, isprimarily accused of any wrongdoing in the complaint or the amended complaint,and believes that either there is no basis for terminating the WWE videogamelicense, or that THQ will be made whole by those whose conduct is eventuallyfound to be unlawful. We intend to vigorously protect our rights and, ifnecessary, pursue appropriate claims against third parties.

On October 12, 2006, WWE filed a separate lawsuitagainst the Company and the LLC in the Superior Court of the State ofConnecticut, alleging that the Company’s agreements with Yuke’s Co., Ltd. (“Yukes”),a developer and distributor in Japan, violated a provision of the WWE videogamelicense prohibiting sublicenses without WWE’s written consent. The lawsuit seeks,among other things, a declaration that the WWE is entitled to terminate thevideo game license and seek monetary damages. On February 8, 2007, theCompany and the LLC jointly moved to strike one of the claims, for violation ofthe Connecticut Unfair Trading Practices Act; on March 28, 2007, the Courtdenied that motion, without prejudice to the defendants’ ability to raise thesame issue at a later date. On February 22, 2007, the Court established aschedule for this case, including discovery, and ordering that the case be “exposedfor trial” as of October 14, 2008. However, on March 30, 2007, WWEmoved for leave to amend its pleadings to add allegations and claimssubstantially similar to those already pending in WWE’s lawsuit in the SouthernDistrict of New York and to “cite in” the other defendants from that action. Thedefendants objected to this motion. At a hearing on May 8, 2007, the Courtgranted WWE’s request to amend the complaint and add defendants. The Court alsosuspended deadlines under its existing scheduling order and indicated it willre-examine the schedule after the new defendants have been served and haveappeared. The amended complaint was served on the Company and Brian Farrell onor about May 10, 2007. The Company believes it and the LLC have severalbases for defending any claim of breach of the WWE videogame license agreementresulting from the manner of distribution of WWE-licensed products in Japan andother Asian territories. We intend to vigorously defend ourselves against the claimsraised in this action, including those raised in the amended complaint.

Due to the early status of this litigation with WWE wecannot estimate a possible loss, if any. Games we develop based upon our WWEvideogame license have contributed to approximately 15% of our net sales duringeach of the three years in the period ended March 31, 2007. The loss ofthe WWE license would have a negative impact on our future financial results.

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*Operating agreementwith JAKKS Pacific, Inc.*

In June 1999 we entered into an operatingagreement with JAKKS that governs our relationship with respect to the WWEvideogame license. Pursuant to the terms of this agreement, JAKKS is entitledto a preferred payment from revenues derived from exploitation of the WWEvideogame license. The amount of the preferred payment to JAKKS for the periodbeginning July 1, 2006 and ending December 31, 2009 (the “FirstSubsequent Distribution Period”) is to be determined by agreement or, failingthat, by arbitration.

The parties have not reached agreement on thepreferred payment for the First Subsequent Distribution Period. Accordingly, asprovided in the operating agreement, the parties are in the process ofselecting an arbitrator to resolve this dispute. Although we believecontinuation of the previous preferred payment would represent significantlyexcessive compensation to JAKKS for the First Subsequent Distribution Period,we are not able to predict the outcome of the arbitration or otherwise estimatethe amount of the preferred payment for the First Subsequent DistributionPeriod. Accordingly, we are currently accruing for a preferred payment to JAKKSat the previous rate. However, we have advised JAKKS that we do not intend tomake any payment until the amount of the preferred payment payable to JAKKS forthe First Subsequent Distribution Period is agreed or otherwise determined asprovided in the operating agreement. On April 30, 2007, we filed apetition to compel arbitration and appoint an arbitrator in the Superior Courtof the State of California for the County of Los Angeles, West District. Ourpetition seeks a court order compelling JAKKS to comply with the arbitrationprovisions in the operating agreement and establishing a process and timelinefor selecting an arbitrator. On or about May 22, 2007, JAKKS filed aresponse to our petition, as well as an application for provisional reliefrequesting that, pending conclusion of the arbitration, THQ either be enjoinedfrom distributing to itself any proceeds from the joint venture since June 2006or be compelled to resume payments to JAKKS at the same rate that was in effectprior to June 2006. A hearing on the petition is scheduled for June 19,2007.

We do not expect theresolution of this dispute to have a material adverse impact on our results ofoperations, financial position or cash flows.

*SEC InformalInquiry*

On August 4, 2006, we received an informalinquiry from the Securities and Exchange Commission (“SEC”) requesting certaindocuments and information relating to our stock option grant practices from January 1,1996 to the present. We publicly announced this inquiry on August 7, 2006.Prior to August 4, 2006, we were already conducting an internal review ofour historical stock option grant practices with the assistance of outside counsel.We initiated the internal review following extensive news coverage and analystreports about the option practices of numerous companies across severaldifferent industries. The Company has cooperated fully with the SEC’s inquiry.

Upon receipt of the notice of informal inquiry fromthe SEC, our Board of Directors (the “Board”) formed a special committeeconsisting of one outside director, Jeffrey Griffiths (the “Special Committee”),to conduct an independent and comprehensive investigation of our stock optionpractices and to oversee our response to the SEC. The Special Committeeretained independent outside legal counsel and forensic accountants (the “InvestigativeTeam”) to aid in its investigation.

The Special Committeeconcluded its investigation and reported its findings to the full Board on December 2,2006. The Special Committee found no evidence of fraud or misconduct by anyperson with respect to the company’s historical stock option grant practices. TheSpecial Committee did identify instances where documentation of certain optiongrants was lacking. The Special Committee also determined that an incorrectmeasurement date for financial accounting purposes was used on a number ofoccasions. These errors resulted primarily from misapplication of accountingstandards related to certain measurement date selection methods discussed indetail in Note 2 to the Notes to the Consolidated 

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Financial Statements ofour Amendment No. 2 on Form 10-K/A for the year ended March 31,2006, which in a number of occasions resulted in employees receiving optionswith stated exercise prices lower than the market prices as measured based uponthe measurement dates as determined by the applicable accounting standards. TheSpecial Committee also recommended certain remedial measures with respect tothe Company’s stock option granting practices, which were adopted by the Board.The Special Committee and the Investigative Team reported the Special Committee’sfindings to the SEC on January 8, 2007.

*Lawsuits related toour historical stock option granting practices*

*Kukorand Ramsey v. Haller, et. Al.**  *OnAugust 25, 2006, following our announcement of the informal inquiry by theSEC, a purported shareholder derivative action captioned *Ramsey v.Haller et Al.* was filed against certain of our current and formerofficers and directors in the California Superior Court, Los Angeles County. Thecomplaint alleges, among other things, purported improprieties in our issuanceof stock options, breach of fiduciary duty and unjust enrichment. Anotherlawsuit was subsequently filed by the same law firm on behalf of anotherpurported shareholder, David Kukor, and the parties stipulated to consolidatethe two actions. On or about April 19, 2007, a Consolidated ShareholderDerivative Complaint (the “Consolidated Complaint”) was filed, alleging thesame types of claims and quoting from various public statements by THQ sincethe filing of the original complaint. THQ is also named as a nominal defendant.The Company intends to demur to the Consolidated Complaint. Pursuant to courtorder, the demurrer must be filed by May 28, 2007, and a hearing for thedemurrer is currently scheduled for August 9, 2007. Discovery in thismatter is currently stayed.

*HawaiiLaborers Pension Fund v. THQ, et. Al.**  *In October 2006, a purported shareholderderivative action captioned *Hawaii Laborers PensionFund v. THQ, et. Al.*, was filed against certain of our current andformer officers and directors in federal district court, alleging claims under Section 14(a) ofthe Securities Exchange Act of 1934 as well as various state law claims arisingout of alleged breaches of fiduciary duty related to stock option practices. Onor about April 20, 2007, the plaintiff filed an Amended and VerifiedShareholder Derivative Complaint (the “Amended Complaint”) alleging thatcertain current and former officers and directors engaged in a conspiracy tomanipulate grants dates associated with stock options and then concealed thealleged backdating option scheme and filed false and misleading statements withthe SEC. THQ is also named as a nominal defendant. The Company intends to filea Motion to Dismiss the Amended Complaint, which pursuant to a stipulationbetween the parties, must be filed by June 1, 2007. No discovery has yetcommenced in this action.

Although litigation issubject to inherent uncertainties, we do not believe the results of theseactions will, individually or in the aggregate, have a material adverse impacton our consolidated financial position or results of operations.

*Other*

We are also involved inadditional routine litigation arising in the ordinary course of our business. Inthe opinion of our management, none of such pending litigation is expected tohave a material adverse effect on our consolidated financial condition orresults of operations.

**Item 4.** Submissionof Matters to a Vote of Security Holders

There were no matters submitted to a vote of securityholders during the fourth quarter of the fiscal year covered by this AnnualReport.

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**PART II**

**Item 5.**         Market for the Registrant’sCommon Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

THQ’scommon stock is quoted on the NASDAQ Global Select Market under the symbol “THQI.”  The following table sets forth, for theperiods indicated, the high and low closing sales prices of our common stock asreported by the NASDAQ Global Select Market:

| ** **                                   | ** ** | **Closing  Sales Prices** | ** ** |
|----------------------------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **High**                       | ** ** | **Low** | ** ** |
| **Fiscal Year Ended  March 31, 2007**   | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Fourth Quarter ended March 31, 2007     |       | $                              | 34.33      |   | $ | 29.64 |   |
| Third Quarter ended December 31, 2006   |       | 34.00                          |       | 28.69 |   |
| Second Quarter ended September 30, 2006 |       | 30.87                          |       | 19.74 |   |
| First Quarter ended June 30, 2006       |       | 27.76                          |       | 19.65 |   |
| **Fiscal Year Ended  March 31, 2006**   |       |                           |       |   |   |
| Fourth Quarter ended March 31, 2006     |       | $                              | 27.62      |   | $ | 23.81 |   |
| Third Quarter ended December 31, 2005   |       | 24.58                          |       | 19.14 |   |
| Second Quarter ended September 30, 2005 |       | 23.97                          |       | 19.49 |   |
| First Quarter  ended June 30, 2005      |       | 20.67                          |       | 16.81 |   |

 

The last reported price ofour common stock on May 25, 2007, as reported by NASDAQ Global SelectMarket, was $32.46 per share.

**Stock PricePerformance Graph**

The following graph shows a five-year comparison ofcumulative total stockholder returns for the period from December 31, 2001through March 31, 2007, for the Company’s common stock, NASDAQ GlobalSelect Market Composite Index and the RDG Technology Index. The comparisonassumes an initial investment of $100 in each on December 31, 2001 andthat all dividends were reinvested. The Company has not paid any cash dividendsand, therefore, the cumulative total return calculation for the Company isbased solely upon stock price appreciation and not upon reinvestment of cashdividends.

The comparisons in thegraph below are based on historical data and are not intended to forecast thepossible future performance of THQ’s common stock.

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**COMPARISON OF 63 MONTH CUMULATIVE TOTAL RETURN***

Among THQ Inc., The NASDAQ Composite Index and The RDGTechnology Composite Index

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*                    $100invested on December 31, 2001 in stock or index-including reinvestment ofdividends. Fiscal year ending March 31.

| ** **               | ** ** | **12/31/2001** | ** ** | **12/31/2002** | ** ** | **3/31/2003** | ** ** | **3/31/2004** | ** ** | **3/31/2005** | ** ** | **3/31/2006** | ** ** | **3/31/2007** | ** ** |
|--------------------------|------------|----------------|------------|----------------|------------|---------------|------------|---------------|------------|---------------|------------|---------------|------------|---------------|------------|
| THQ Inc.                 |       |           | $          | 100.00         |       |          |       | $             | 41.00      |          |       |          | $          | 40.41         |       |   | $ | 62.61 |   | $ | 87.08 |   | $ | 120.18 |   | $ | 158.71 |   |
| NASDAQ Composite         |       |           | $          | 100.00         |       |          |       | $             | 70.85      |          |       |          | $          | 71.02         |       |   | $ | 104.35 |   | $ | 104.99 |   | $ | 124.25 |   | $ | 128.04 |   |
| RDG Technology Composite |       |           | $          | 100.00         |       |          |       | $             | 62.90      |          |       |          | $          | 62.52         |       |   | $ | 92.82 |   | $ | 89.48 |   | $ | 105.43 |   | $ | 109.51 |   |

 

Information presented isas of the end of the calendar year for December 31, 2002, as of March 31,2003 for our three-month transition period, and as of March 31 forfiscal 2004, fiscal 2005, fiscal 2006 and fiscal 2007.

**Holders**

As of May 25, 2007there were approximately 262 holders of record of our common stock.

**Dividend Policy**

We have never paid cashdividends on our common stock. We currently intend to retain future earnings,if any, to finance the growth and development of our business and, therefore,we do not anticipate paying any cash dividends in the future.

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**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

Informationfor our equity compensation plans in effect as of March 31, 2007 is asfollows (amounts in thousands, except per share amounts):

| ** **                                                   | ** ** | **(a)**    | ** ** | **(b)**                                                                                                                                          | ** ** | **(c)**                                                                                                     | ** ** |
|--------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| **Plan Category**                                       | ** ** | ** ** | ** ** | **Number of Securities  to be Issued Upon  Exercise of  Outstanding Options,  Warrants and Rights** | ** ** | **Weighted-average  Exercise Price of  Outstanding Options,  Warrants and Rights** | ** ** | **Number of Securities  Remaining Available for  Future Issuance Under  Equity Compensation  Plans (Excluding  Securities Reflected in  Column (a))** | ** ** |
| Equity  compensation plans approved by security holders |       |       | 7,471,425  |                                                                                                                                             |       |                                                                                                        | $          | 19.21 |   |   |   | 6,082,100 |   |   |
| Equity  compensation plans not approved by security holders  |       |       | 752,576    | (1)                                                                                                                                              |       |                                                                                                        | $          | 12.15 |   |   |   | — |   |   |
| Total                                                        |       |       | 8,224,001  |                                                                                                                                             |       |                                                                                                        | $          | 18.56 |   |   |   | 6,082,100 |   |   |
|                                                              |            |            |            |                                                                                                                                                  |            |                                                                                                             |            |  |  |  |  |  |  |  |  |  |

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(1)          Representsthe aggregate number of shares of THQ common stock to be issued upon exerciseof individual compensation arrangements with employee and non-employee optionand warrant holders. The outstanding options were primarily granted under theCompany’s Third Amended and Restated Non-executive Employee Stock Option Plan(the “NEEP Plan”). For a description of the material features of the NEEP Plan,see “Note 14—Stock-based Compensation” in the notes to the consolidatedfinancial statements.

**Purchases of EquitySecurities by the Issuer and Affiliated Purchases**

Thefollowing table presents the Company’s repurchases of our common stock duringthe three months ended March 31, 2007. 

| **Period**                          | ** ** | ** ** | ** ** | **Total Number   of Shares   Purchased (1)** | ** ** | **Average Price   Paid per Share** | ** ** | **Total Number of   Shares Purchased   as Part of Publicly  Announced Plans** | ** ** | **Maximum Number   (or Approximate Dollar  Value) of Shares that  May Yet Be Purchased  Under the Plans (2)** | ** ** |
|-------------------------------------|------------|------------|------------|-----------------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| January 1 -  January 31   |       |       | —     |                                                                  |       |                                                   | $          | —                                                                                                                     |       |                                                                                                                                                                           |       | — |   |   |   | $ | — |   |   |
| February 1 -  February 28 |       |       | 115,500    |                                                                  |       |                                                   | 30.53      |                                                                                                                       |       |                                                                                                                                                                           | 4,064,500  |   |   |   | 8,500,000 |   |   |
| March 1 -  March 31       |       |       | —     |                                                                  |       |                                                   | —     |                                                                                                                       |       |                                                                                                                                                                           | —     |   |   |   | — |   |   |
| Total                               |       |       | 115,500    |                                                                  |       |                                                   | $          | 30.53                                                                                                                      |       |                                                                                                                                                                           |       | 4,064,500 |   |   |   | $ | 8,500,000 |   |   |

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(1)          On September 10, 2002,November 21, 2002, and February 5, 2004 we announced that our Boardauthorized the repurchase of up to $25.0 million of our common stock from timeto time on the open market or in private transactions with a total authorizedrepurchase amount of $75.0 million. At March 31, 2006 there was $22.1million available for future repurchases. During the fiscal year ended March 31,2007, we repurchased $13.6 million of our common stock. As of March 31,2007, we have repurchased 4,064,500 shares of our common stock forapproximately $66.5 million, leaving $8.5 million available for futurerepurchases. On May 16, 2007, we announced that our Board authorized therepurchase of an additional $25.0 million of our common stock from time to timeon the open market or in private transactions bringing the total authorizedrepurchase amount to $100.0 million. Thereis no expiration date for the authorized repurchases.

(2)          Basedupon the closing price of THQ Common Stock on March 31, 2007.

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**Item 6.** SelectedConsolidated Financial Data

The following tablesummarizes certain selected consolidated financial data, which should be readin conjunction with our consolidated financial statements and Notes thereto andwith Management’s Discussion and Analysis of Financial Condition and Results ofOperations included elsewhere herein. Effective January 1, 2003, wechanged our fiscal year end from December 31 to March 31. Since thechange in fiscal year end affects the comparability of the informationreflected in the selected financial data, we have included unaudited resultsfor the period from April 1, 2002 through March 31, 2003. Other thanthis unaudited period, the selected consolidated financial data presented belowas of and for each of the fiscal years in the five-year period ended March 31,2007 are derived from our audited consolidated financial statements. Theconsolidated balance sheets as of March 31, 2007, and 2006, and theconsolidated statements of operations for the fiscal years ended March 31,2007, 2006 and 2005, and the report thereon are included elsewhere in this Form 10-K.

**STATEMENT OF OPERATIONS DATA(In thousands, except per share data)**

| ** **                                                                   | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **2005(a)** | ** ** | **2004(b)** | ** ** | **2003(c)(d)** | ** ** |
| ** **                                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| Net sales                                                                    |       | $                                                   | 1,026,856  |   | $ | 806,560 |   | $ | 756,731 |   | $ | 640,846 |   |   | $ | 467,647 |   |   |
| Costs and expenses:                                                          |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Cost of sales—product  costs                                            |       | 351,449                                             |       | 287,946 |   | 255,187 |   | 234,574 |   |   | 181,532 |   |   |
| Cost of sales—software  amortization and royalties                      |       | 165,462                                             |       | 116,371 |   | 93,622 |   | 105,632 |   |   | 84,916 |   |   |
| Cost of sales—license  amortization and royalties                       |       | 99,533                                              |       | 80,508 |   | 85,926 |   | 71,132 |   |   | 38,988 |   |   |
| Cost of sales—venture  partner expense                                  |       | 16,730                                              |       | 12,572 |   | 9,774 |   | 9,675 |   |   | 9,218 |   |   |
| Product development                                                          |       | 97,105                                              |       | 94,575 |   | 80,090 |   | 42,292 |   |   | 41,803 |   |   |
| Selling and marketing                                                        |       | 139,958                                             |       | 124,809 |   | 111,444 |   | 88,295 |   |   | 68,817 |   |   |
| General and  administrative                                                  |       | 78,413                                              |       | 57,944 |   | 50,278 |   | 43,831 |   |   | 33,951 |   |   |
| Total costs and expenses                                                     |       | 948,650                                             |       | 774,725 |   | 686,321 |   | 595,431 |   |   | 459,225 |   |   |
| Income from continuing  operations                                           |       | 78,206                                              |       | 31,835 |   | 70,410 |   | 45,415 |   |   | 8,422 |   |   |
| Interest and other  income, net                                              |       | 12,822                                              |       | 7,955 |   | 6,483 |   | 7,720 |   |   | (6,226 | ) |   |
| Income from continuing  operations before income taxes and minority interest |       | 91,028                                              |       | 39,790 |   | 76,893 |   | 53,135 |   |   | 2,196 |   |   |
| Income taxes                                                                 |       | 26,206                                              |       | 7,621 |   | 15,235 |   | 19,063 |   |   | 1,220 |   |   |
| Income from continuing  operations before minority interest                  |       | 64,822                                              |       | 32,169 |   | 61,658 |   | 34,072 |   |   | 976 |   |   |
| Minority interest                                                            |       | 136                                                 |       | (63 | ) | (261 | ) | — |   |   | — |   |   |
| Income from continuing  operations                                           |       | 64,958                                              |       | 32,106 |   | 61,397 |   | 34,072 |   |   | 976 |   |   |
| Gain on sale of  discontinued operations, net of tax                         |       | 3,080                                               |       | — |   | — |   | — |   |   | — |   |   |
| Net income                                                                   |       | $                                                   | 68,038     |   | $ | 32,106 |   | $ | 61,397 |   | $ | 34,072 |   |   | $ | 976 |   |   |
| Earnings per share—basic:                                               |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Continuing operations                                                        |       | $                                                   | 1.00       |   | $ | 0.51 |   | $ | 1.05 |   | $ | 0.59 |   |   | $ | 0.02 |   |   |
| Discontinued operations                                                      |       | 0.05                                                |       | — |   | — |   | — |   |   | — |   |   |
| Earnings per share—basic                                                |       | $                                                   | 1.05       |   | $ | 0.51 |   | $ | 1.05 |   | $ | 0.59 |   |   | $ | 0.02 |   |   |
| Earnings per share—diluted:                                             |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Continuing operations                                                        |       | $                                                   | 0.96       |   | $ | 0.49 |   | $ | 1.02 |   | $ | 0.58 |   |   | $ | 0.02 |   |   |
| Discontinued operations                                                      |       | 0.05                                                |       | — |   | — |   | — |   |   | — |   |   |
| Earnings per share—diluted                                              |       | $                                                   | 1.01       |   | $ | 0.49 |   | $ | 1.02 |   | $ | 0.58 |   |   | $ | 0.02 |   |   |
| Shares used in per share calculation—basic                              |       | 65,039                                              |       | 62,615 |   | 58,545 |   | 57,279 |   |   | 58,527 |   |   |
| Shares used in per share calculation—diluted                            |       | 67,593                                              |       | 65,520 |   | 60,367 |   | 58,605 |   |   | 60,881 |   |   |

 

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**BALANCE SHEET DATA(In thousands)**

| ** **                | ** ** | **As of March 31,** | ** ** |
|---------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **2007**                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Working capital           |       | $                                  | 562,316    |   | $ | 459,558 |   | $ | 400,063 |   | $ | 309,633 |   | $ | 286,899 |   |
| Total assets              |       | $                                  | 1,013,541  |   | $ | 848,468 |   | $ | 746,606 |   | $ | 527,901 |   | $ | 473,867 |   |
| Stockholders’ equity |       | $                                  | 768,957    |   | $ | 627,751 |   | $ | 547,758 |   | $ | 437,879 |   | $ | 397,309 |   |

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Notes:

(a)           Net income includes a$7.8 million benefit for research and development income tax credits claimedfor prior years.

(b)          Net income includes a$4.0 million benefit for a settlement of a dispute with directors’ and officers’insurance carrier, net of tax.

(c)           Net income includes acharge of $1.8 million due to the other than temporary impairment of ourinvestment in Yuke’s Co., Ltd. (See “Note 8—Other Long-Term Assets” in Note toConsolidated Financial Statements). We also changed our fiscal year end from December 31to March 31, effective January 1, 2003.

(d)          Net income includes acharge of $7.9 million, net of tax, for the cancellation of 20 SKUs as well asa charge of $4.6 million, net of tax, related to the settlement of a classaction lawsuit and a charge of $1.1 million, net of tax, related to thewrite-off of inventory and software development for “WWF” branded games that wehad been prevented from shipping pursuant to an action by the World Wide Fundfor Nature against World Wrestling Entertainment, Inc. and a charge of$2.8 million, net of tax, related to the discontinuation of our online jointventure in the United Kingdom (Network Interactive Sports, Ltd.).

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**Item7.** Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

**Overview**

The following is adiscussion of our operating results and the primary trends that affect ourbusiness. Certain of these trends and other statements made herein may be “forward-looking”within the meaning of the Private Securities Litigation Reform Act of 1995.Such statements are included herein because management believes that anunderstanding of these trends is important to understand our results for thefiscal year ended March 31, 2007 (“fiscal 2007”), as well as our futureprospects. This summary is not intended to be exhaustive, nor is it intended tobe a substitute for the detailed discussion and analysis provided elsewhere inthis Form 10-K, including in the remainder of “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” orthe consolidated financial statements and related notes. The discussion andanalysis herein may be understood more fully by reference to the consolidatedfinancial statements and notes to the consolidated financial statements.Additionally, readers should refer to our cautionary statement on page 1herein as well as “Risk Factors” set forth in Item 1A. All references to “we,” “us,”“our,” “THQ,” or the “Company” in the following discussion and analysis meanTHQ Inc. and its subsidiaries.

**Overview of Fiscal 2007 Results**

In the fiscal year ended March 31,2007, we recorded the highest total annual revenue in our history. Net sales infiscal 2007 increased 27% over the fiscalyear ended March 31, 2006 (“fiscal 2006”), to $1,026.9 million, up from$806.6 million. The year-over-year growth in our net sales was dueprimarily to significant growth in sales of games from our key long-termlicensed properties; Disney•Pixar, WWE and Nickelodeon aswell as sales of our new, owned intellectual property, *Saints Row*. Titles released in fiscal 2007 under our keylicensed properties included *Cars*, *WWE SmackDown vs. Raw 2007* and a new title from ourNickelodeon license, *Avatar: The Last Airbender*.Additionally, in fiscal 2007, our operating margin improved by 367 basis pointsover fiscal 2006, to 8% of net sales. Our operating margin improved in fiscal2007 due primarily to improved gross margins on our key titles, led bymulti-million unit sales of *Cars* and *WWE SmackDown vs. Raw* and leverage of our selling andmarketing and general and administrative expenses.

Net income from continuingoperations for fiscal 2007 was $65.0 million, or $0.96 per diluted share,compared to net income from continuing operations of $32.1 million, or$0.49 per diluted share, for fiscal 2006. Net income for fiscal 2007 was $68.0million, or $1.01 per diluted share, and included a $3.1 million gain on saleof discontinued operations. Our fiscal 2007 results include our continuedinvestment in development of games based on new generation consoles.

Cash provided byoperations was $64.0 million during fiscal 2007, up 50% as compared to fiscal2006, which had $42.8 million. The increase in cash provided by operations wasprimarily a result of an increase in earnings, improved working capital andamortization of licenses and software, partially offset by increases in cashpayments for software development and licenses.

**Prospective Business Trends**

We operate in one businesssegment: video game development and publishing. We derive revenue principallyfrom sales of packaged interactive software games designed for play on videogame consoles, handheld devices and personal computers.

*Transition to new generationconsole systems.**  *In fiscal 2007, our industry continued to transitionfrom the legacy consoles, Sony PlayStation 2 (“PS2”) and Nintendo GameCube, tothe new generation consoles, Sony PlayStation 3 (“PS3”) and Nintendo Wii. Additionally,in fiscal 2006, Microsoft launched its new generation platform, the MicrosoftXbox 360 and two new handheld platforms were launched, the Nintendo DS and SonyPSP. With the new generation of console systems and new handheld platforms, webelieve that market segmentation will be extremely important. We have designedour publishing strategy to 

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take advantage of theunique feature sets of the new consoles, handhelds and PC. Our strategy toreach core gamers focuses on the Xbox 360, PS3 and PC platforms. Ourmass-market brands are targeted primarily for the Nintendo Wii, PS2 and DSplatforms. We plan to publish some of our licensed brands, such as WWE andDisney•Pixaracross all viable platforms.

*Software development.**  *The newgeneration consoles have increased functionality (e.g., realistic environmentsand artificial intelligence) over their legacy counterparts. The increasedfunctionality delivers a more exciting gaming experience but adds complexity tothe development of video games for these new consoles. This complexityincreases the overall cost to develop these games and accordingly, duringfiscal 2008, we expect our average software development costs to increase as wedevelop more games for these new consoles.

*Products.*   Inorder to increase revenues while facing higher development costs, we believethat it is more important than ever in our industry to have a robust anddiversified product portfolio. In recent years, we have focused our efforts ongrowing both our owned intellectual properties and our licensed brands. As aresult of these efforts, we believe that we can continue to grow our revenuesat or above the market growth rate in our industry.

*International growth.**  *Over the past few years,sales of video games outside of the United States have grown significantly. Infiscal 2007, international sales growth drove approximately $110.1 million ofour overall net sales increase of $220.3 million. The internationalinstalled base of video game platforms continues to increase and we are focusedon expanding our international presence by identifying territories where we seeopportunity and establishing a direct sales presence to seize suchopportunities. In addition to our sales force presence, we are focused onreleasing and aggressively marketing titles with international appeal. Wecontinue to evaluate new business opportunities in the Asia Pacific region.

*Incremental revenueopportunities.*   Digital content creation anddistribution is an emerging revenue source in our industry. We expect severalof our games in fiscal 2008 to include in-game advertising. In fiscal 2007, webegan offering our first PC titles via digital distribution channels andprovided digital downloads of new content after shipping *Saints Row*.We are focused on growing these sources of incremental revenue in the future. Additionally,we re-positioned our wireless business for future growth, adding new brands anddevelopment capabilities to the business.

**Critical Accounting Estimates**

The Management’s Discussionand Analysis of Financial Condition and Results of Operations discusses ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America. Thepreparation of these consolidated financial statements requires management tomake estimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the consolidated financial statements and the reported amounts of revenuesand expenses during the reporting period. The estimates discussed below areconsidered by management to be critical because they are both important to theportrayal of our financial condition and results of operations and becausetheir application places the most significant demands on management’s judgment,with financial reporting results relying on estimates about the effect ofmatters that are inherently uncertain. Specific risks for these criticalaccounting estimates are described in the following paragraphs. For all ofthese estimates, management cautions that actual results may differ materiallyfrom these estimates under different assumptions or conditions.

*Accounts receivableallowances.**  *We deriverevenue from sales of packaged software for video game systems and personalcomputers and sales of content and services for wireless devices. Productrevenue is recognized net of allowances for price protection and returns andvarious customer discounts. We typically only allow returns for our personalcomputer products; however, we may decide to provide price protection or allowreturns for our video game systems or personal computer products after weanalyze: (1) inventory remaining in the retail channel, (2) the rateof inventory sell-through in the retail channel, 

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and (3) our remaininginventory on hand. We maintain a policy of giving credits for price protectionand returns, but do not give cash refunds. Included in our accounts receivableallowances is our allowance for co-operative advertising that we engage in withour retail channel partners. Our co-operative advertising allowance is basedupon specific contractual commitments and does not involve estimates made bymanagement.

We establish salesallowances based on estimates of future price protection and returns withrespect to current period product revenue. We analyze historical priceprotection granted, historical returns, current sell-through of retailer anddistributor inventory of our products, current trends in the video game marketand the overall economy, changes in customer demand and acceptance of ourproducts, and other related factors when evaluating the adequacy of the priceprotection and returns allowance. In addition, management monitors the volumeof our sales to retailers and distributors and their inventories, becauseslow-moving inventory in the distribution channel can result in the requirementfor price protection or returns in subsequent periods. In the past, actualprice protection and returns have not generally exceeded our reserves. However,actual price protection and returns in any future period are uncertain. Whilemanagement believes it can make reliable estimates for these matters, if wechanged our assumptions and estimates, our price protection and returnsreserves would change, which would impact the net revenue we report. Inaddition, if actual price protection and returns were significantly greaterthan the reserves we have established, the actual results of our reported net saleswould decrease. Conversely, if actual price protection and returns weresignificantly less than our reserves, our reported net sales would increase.

Similarly, management mustuse significant judgment and make estimates in connection with establishing allowancesfor doubtful accounts in any accounting period. Management analyzes customerconcentrations, customer credit-worthiness and current economic trends whenevaluating the adequacy of the allowance for doubtful accounts. Materialdifferences may result in the amount and timing of our bad debt expense for anyperiod if management made different judgments or utilized different estimates.If our customers experience financial difficulties and are not able to meettheir ongoing financial obligations to us, our results of operations may beadversely impacted.

*Licenses.**  *Minimum guaranteed royalty payments for intellectualproperty licenses are initially recorded on our balance sheet as an asset(licenses) and as a liability (accrued royalties) at the contractual amountupon execution of the contract if no significant performance obligation remainswith the licensor. When a significant performance obligation remains with thelicensor, we record royalty payments as an asset (licenses) when payable ratherthan upon execution of the contract. Royalty payments for intellectual propertylicenses are classified as current assets and current liabilities to the extentsuch royalty payments relate to anticipated sales during the subsequent yearand long-term assets and long-term liabilities if such royalty payments relateto anticipated sales after one year.

We evaluate the futurerecoverability of our capitalized licenses on a quarterly basis. Therecoverability of capitalized license costs is evaluated based on the expectedperformance of the specific products in which the licensed trademark orcopyright is to be used. As many of our licenses extend for multiple productsover multiple years, we also assess the recoverability of capitalized licensecosts based on certain qualitative factors such as the success of otherproducts and/or entertainment vehicles utilizing the intellectual property,whether there are any future planned theatrical releases or television seriesbased on the intellectual property and the rights holder’s continued promotionand exploitation of the intellectual property. Prior to the related product’srelease, we expense, as part of cost of sales—license amortization androyalties, capitalized license costs when we believe such amounts are not recoverable.

Licenses are expensed tocost of sales—license amortization and royalties at the higher of (1) thecontractual royalty rate based on actual net product sales related to suchlicense or (2) an effective rate based upon total projected revenue relatedto such license. When, in management’s estimate, future cash flows will not besufficient to recover previously capitalized costs, we expense thesecapitalized costs to cost of sales—license amortization and royalties. Ifactual revenues or revised forecasted revenues fall below 

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the initial forecastedrevenues for a particular license, the charge to cost of sales—licenseamortization and royalties expense may be larger than anticipated in any givenquarter. As of March 31, 2007, the net carrying value of our licenses was$91.1 million. If we were required to write off licenses, due to changes inmarket conditions or product acceptance, our results of operations could bematerially adversely affected.

*Software Development.**  *We utilize both internal development teams andthird-party software developers to develop our software. We account forsoftware development costs in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 86, “Accounting for the Costs of Computer Softwareto be Sold, Leased, or Otherwise Marketed.” We capitalize software development costs once technological feasibilityis established and we determine that such costs are recoverable against futurerevenues. For products where proven game engine technology exists, this mayoccur early in the development cycle. We capitalize the milestone payments madeto third-party software developers and the direct payroll and overhead costsfor our internal development teams. We evaluate technological feasibility on aproduct-by-product basis. Amounts related to software development for whichtechnological feasibility is not yet met are charged as incurred to productdevelopment expense in our consolidated statements of operations.

On a quarterlybasis, we compare our unamortizedsoftware development costs to net realizable value, on aproduct-by-product basis. The amount by which any unamortized softwaredevelopment costs exceed their net realizable value is charged to cost of sales—softwareamortization and royalties. The net realizable value is the estimated futuregross revenues from the product, reduced by the estimated future costs ofcompleting the product.

Commencing upon productrelease, capitalized software development costs are amortized to cost of sales—softwareamortization and royalties based on the ratio of current revenues to totalprojected revenues. If actual revenues, or revised projected revenues, fallbelow the initial projections, the charge to cost of sales—software amortizationand royalties may be larger than anticipated in any given quarter. As of March 31,2007, the net carrying value of our software development was $164.3 million.

The milestone paymentsmade to our third-party developers during their development of our games aretypically considered non-refundable advances against the total compensationthey can earn based upon the sales performance of the products. Any additionalcompensation earned beyond the milestone payments are expensed to cost of sales—softwareamortization and royalties as earned.

*Goodwill.**  *When we adopted SFAS No. 142, “Goodwill andOther Intangible Assets” (“FAS 142”) effective January 1, 2002, weelected to perform the annual review of goodwill impairment required by FAS 142on June 30th ofeach calendar year which at that time corresponded to the second quarter of ourfiscal year. In February 2003 we changed our fiscal year end from December 31st to March 31st. Since changing our fiscal year end to March 31st we continued to perform our annual review ofgoodwill impairment on June 30th,which also changed to be the end of our first fiscal quarter. In fiscal 2007,we changed the date of our annual review of goodwill for impairment to thefirst day of our fourth fiscal quarter. Our first fiscal quarter is generallywhen we are required to adopt recently issued accounting pronouncements inaddition to managing our annual financial reporting requirements, which canstrain our personnel resources in that quarter. We changed the quarter in whichwe perform our annual review of goodwill impairment to better utilize theseresources. Additionally, the first day of our fourth fiscal quarter’s proximityto our fiscal year end provides us with more comprehensive data to be includedin our review. It was not intended to delay, accelerate or avoid any impairmentcharge. Accordingly, we believe that this change is preferable. Goodwillimpairment tests performed as of January 1, 2007 and June 30, 2006,2005 and 2004 concluded that no impairment charges were required as of thosedates. The change in accounting principle related to the annual testing doesnot result in adjustments to our financial statements when appliedretrospectively. We will perform this annual review on the first day of ourfourth fiscal quarter in future years or more frequently if indicators ofpotential impairment exist.

Our impairment reviewprocess is based on a discounted future cash flow approach that uses ourestimates of revenue for the reporting units, driven by anticipated success ofour products and product release 

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schedules, and estimatedcosts as well as appropriate discount rates. These estimates are consistentwith the plans and estimates that we use to manage the underlying businesses.The success of our products is affected by the ability to accurately predictwhich platforms and which products we develop will be successful. Also, ourrevenues and earnings are dependent on our ability to meet our product releaseschedules. Due to these and other factors described in “Item 1A Risk Factors”we may not realize the future net cash flows necessary to recover our goodwill.

Based on these judgmentsand assumptions, we determine whether we need to take an impairment charge toreduce the value of the goodwill and indefinite-lived intangible assets statedon our balance sheets to reflect their estimated fair values. Judgments andassumptions about future values are complex and often subjective. They can beaffected by a variety of factors, including, but not limited to, significant negativeindustry or economic trends, significant changes in the manner or use of theacquired assets or the strategy of our overall business and significantunderperformance relative to expected historical or projected future operatingresults. Although we believe the judgments and assumptions we have made in thepast have been reasonable and appropriate, there is nonetheless a high degreeof uncertainty and judgment involved.

We continue to encounterthe risks and difficulties faced with launching or acquiring a new business.When the business is a development studio, we look for ways to maximize thetalent and intellectual property within the studio. We make judgments andassumptions as to the commercial success and quantity of games developed by aparticular studio. Different judgments and assumptions could materially impactour reported financial results. For example, if we do not develop games withthe same commercial success or the same number of games as we have estimated,we may need to take an impairment charge against goodwill in the future. Moreconservative assumptions of the anticipated future benefits from thesebusinesses would result in lower fair values which could result in impairmentcharges, which would decrease net income and result in lower asset values onour balance sheets. Conversely, less conservative assumptions would result inhigher fair values which could result in lower impairment charges and highernet income.

*Stock-based compensation.*   Weadopted SFAS No. 123(R) “Share-Based Payment” (“FAS 123R”) in ourfirst quarter of fiscal 2007 and accordingly, we now record stock-basedcompensation expense for all of our stock-based awards. The adoption of thisaccounting pronouncement had a material impact on our consolidated statement ofoperations and our cash flows from operating and financing activities forfiscal 2007. See “Note 14 - Stock-based Compensation” in the notes to theconsolidated financial statements.

Under FAS 123R, weestimate the fair value of stock options granted using the Black-Scholes optionpricing model. The fair value for awards that are expected to vest is thenamortized on a straight-line basis over the requisite service period of theaward, which is generally the option vesting term. The amount of expenserecognized represents the expense associated with the stock options we expectto ultimately vest based upon an estimated rate of forfeitures; this rate offorfeitures is updated as necessary and any adjustments needed to recognize thefair value of options that actually vest or are forfeited are recorded. TheBlack-Scholes option pricing model, used to estimate the fair value of anaward, requires the input of subjective assumptions, including the expectedvolatility of our common stock and an option’s expected life. As a result, thefinancial statements include amounts that are based upon our best estimates andjudgments relating to the expenses recognized for stock-based compensation. Weadopted FAS 123R under the modified prospective transition method wherein noprior period financial statement information was affected. All prior periodfinancial statements include stock-based compensation accounted for underAccounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”(“APB 25”) and the disclosure only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,”as amended (“FAS 123”). The financial statements for fiscal 2007, includestock-based compensation accounted for under FAS 123R. There were no materialdifferences in valuation methodologies or assumptions compared to those thatwere used in estimating the fair value of stock options under the disclosureonly provisions of FAS 123.

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Thefollowing table sets forth the amount of stock-based compensation expense recognizedin fiscal 2007, 2006 and 2005 (in thousands):

| ** **                                              | ** ** | **Year Ended March 31,** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                              | ** ** | **2007**                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| Cost of  sales—software amortization and royalties |       | $                                       | 2,087      |   | $ | — |   | $ | — |   |
| Product  development                                    |       | 3,364                                   |       | 926 |   | 475 |   |
| Selling and  marketing                                  |       | 2,817                                   |       | 981 |   | 132 |   |
| General and  administrative                             |       | 10,704                                  |       | 1,515 |   | 199 |   |
| Total stock-based  compensation expense                 |       | $                                       | 18,972     |   | $ | 3,422 |   | $ | 806 |   |

 

*Income taxes.**  *As part of the process of preparing our consolidatedfinancial statements, we are required to estimate our income taxes in each ofthe jurisdictions in which we operate. This process involves: (1) estimatingour current tax exposure in each jurisdiction including the impact, if any, ofchanges or interpretations to applicable tax laws and regulations, (2) estimatingadditional taxes resulting from tax examinations and (3) making judgmentsregarding the recoverability of deferred tax assets. To the extent recovery ofdeferred tax assets is not likely based on our estimates of future taxableincome in each jurisdiction, a valuation allowance is established.

The calculation of our taxliabilities involves dealing with uncertainties in the application of complextax regulations. We recognize liabilities for anticipated tax audit issues inthe U.S. and other tax jurisdictions based on our estimate of whether, and theextent to which, additional taxes will be due. Our estimate for the potentialoutcome for any uncertain tax issue, including our recent claim for researchand development income tax credits, requires judgment. We believe we haveadequately provided for any reasonably foreseeable outcome related to thesematters. However, our future results may include favorable or unfavorableadjustments to our estimated tax liabilities in the period the assessments aremade or resolved or when statutes of limitation on potential assessmentsexpire.

As of March 31, 2007,the non-current portion of income tax receivable is recorded net of a$17.0 million contingent tax liability. The contingent tax liability relatesto tax positions taken in previously filed tax returns and similar positionsexpected to be taken in our current year tax returns. Moreover, the InternalRevenue Service (“IRS”) has commenced a routine examination of our U.S. incometax returns for the calendar year 1999 through fiscal year 2004. A portion ofthe contingent tax liability relates to the fiscal years under examination. OnMay 24, 2007 we received notification from the IRS that the JointCommittee on Taxation had completed its review of our file and took no exceptionto the conclusions reached by the IRS. The conclusions reached by the IRS werenot significantly different from the positions taken on our tax returns. We areevaluating the impact the conclusions of the IRS examination has on the measurementof our contingent tax liabilities and will make any necessary adjustments in thequarter ending June 30, 2007. The amount of tax benefit recognized may beimpacted by our adoption of FIN 48, which is effective for us as ofApril 1, 2007.

As a result of the itemsdiscussed above, our actual effective income tax rates can differ from theprojected effective income tax rates used when preparing our consolidatedfinancial statements.

**Recently Issued Accounting Pronouncements**

In February 2006, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accountingfor Certain Hybrid Financial Instruments” (“FAS 155”), an amendment of SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities”, and SFAS No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentsof Liabilities” (“FAS 140”), allowing companies to elect fair value measurementfor instruments in their entirety in cases otherwise requiring a derivative tobe bifurcated. FAS 155 is effective for all financial instruments acquired orissued in fiscal years beginning after September 15, 2006, which will beour fiscal year 2008. We do not expect the 

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adoption of this statementto have a material impact on our results of operations, financial position orcash flows.

In July 2006, theFASB issued Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes—an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48contains a two step approach to recognizing and measuring uncertain taxpositions accounted for in accordance with SFAS No. 109 “Accounting forIncome Taxes” (“FAS 109”). The first step is to evaluate the tax position forrecognition by determining if the weight of available evidence indicates it ismore likely than not that the position will be sustained on audit, includingresolution of related appeals or litigation processes, if any. If a taxposition is to be recognized after the first step, the second step is tomeasure the tax benefit as the largest amount which is more than 50% likely of beingrealized upon ultimate settlement. This provision is effective for fiscal yearsbeginning after December 15, 2006, which will be our fiscal year 2008. Weare evaluating the impact, if any, the adoption of this statement will have onour results of operations, financial position or cash flows.

In September 2006,the Securities and Exchange Commission (“SEC”) issued Staff Accounting BulletinNo. 108 (“SAB 108”). SAB 108 states that both a balance sheet (ironcurtain) approach and an income statement (rollover) approach should be usedwhen quantifying and evaluating the materiality of a misstatement. SAB 108contains guidance on correcting errors under the dual approach and providestransition guidance for correcting errors existing in prior years. SAB 108 iseffective for fiscal years beginning after November 15, 2006, which willbe our fiscal year 2008. We do not expect the adoption of this statement to havematerial impact on our results of operations, financial position or cash flows.

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurement” (“FAS 157”). FAS157 provides a single definition of fair value, together with a framework formeasuring it, and requires additional disclosure about the use of fair value tomeasure assets and liabilities. FAS 157 emphasizes that fair value is amarket-based measurement, not an entity-specific measurement, and sets out afair value hierarchy with the highest priority being quoted prices in activemarkets. FAS 157 is effective for fiscal years beginning after November 15,2007, which will be our fiscal year 2009. We are evaluating the impact, if any,the adoption of this statement will have on our results of operations,financial position or cash flows.

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities—Including an Amendment of FASB Statement No. 115” (“FAS159”). FAS 159 permits an entity to choose to measure many financialinstruments and certain other items at fair value at specified election dates.Subsequent unrealized gains and losses on items for which the fair value optionhas been elected will be reported in earnings. FAS 159 is effective for fiscalyears beginning after November 15, 2007, which will be our fiscal year2009. We are evaluating the impact, if any, the adoption of this statement willhave on our results of operations, financial position or cash flows.

**Results of Operations**

**Comparison of Fiscal 2007 to Fiscal 2006**

Net income from continuingoperations for fiscal 2007 was $65.0 million, or $0.96 per diluted share,compared to net income from continuing operations of $32.1 million, or$0.49 per diluted share, for fiscal 2006. Net income for fiscal 2007 was $68.0million, or $1.01 per diluted share, and included a $3.1 million gain on saleof discontinued operations.

**Net Sales**

We derive revenueprincipally from sales of packaged interactive software games designed for playon video game consoles, handheld devices and personal computers. We also deriverevenue through downloads by mobile phone users of our wireless content.

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Thefollowing table details our net sales by territory for fiscal 2007 and 2006 (inthousands):

| ** **              | ** ** | **Fiscal Year Ended March 31,** | ** ** | **Increase/** | ** ** | ** **     | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|---------------|------------|----------------|------------|
| ** **              | ** ** | **2007**                                            | ** ** | **2006**      | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| North America           |       | $                                                   | 600,159    |          | 58.4       | %              | $          | 489,945 |   | 60.7 | % | $ | 110,214 |   |   | 22.5 | % |   |
| Europe                  |       | 365,406                                             |       | 35.6          |       | 269,928        |       | 33.5 |   | 95,478 |   |   | 35.4 | % |   |
| Asia Pacific            |       | 61,291                                              |       | 6.0           |       | 46,687         |       | 5.8 |   | 14,604 |   |   | 31.3 | % |   |
| International           |       | 426,697                                             |       | 41.6          |       | 316,615        |       | 39.3 |   | 110,082 |   |   | 34.8 | % |   |
| Consolidated net  sales |       | $                                                   | 1,026,856  |          | 100.0      | %              | $          | 806,560 |   | 100.0 | % | $ | 220,296 |   |   | 27.3 | % |   |

 

North America and international net sales in fiscal2007 were primarily driven by the release of *Cars*,from the Disney•Pixar franchise, *WWE SmackDown vs. Raw 2007*, and the successful launch of *Saints Row*, a new internally developed and owned intellectualproperty.

Net sales in fiscal2007 increased 27% over fiscal 2006, from $806.6 million to $1,026.9 million.The increase in net sales was primarily due to the following:

·       growthin sales from games from our Disney•Pixar license, led by the release of *Cars*, which shipped nearly eight million units in the fiscal2007. Sales of *Cars* outperformed sales of *The Incredibles: Rise of the Underminer*, which was releasedin fiscal 2006 and was a sequel to *The Incredibles*,which was released in fiscal 2005;

·       salesof *WWE SmackDown vs. Raw 2007*, whichshipped four million units in fiscal 2007, outperforming sales of *WWE SmackDown vs. Raw 2006* in fiscal 2006;

·       growthin sales of games from our Nickelodeon license, which increased byapproximately 22% over sales from this license in fiscal 2006; and

·       salesof *Saints Row*, a new internally developedand owned intellectual property.

In fiscal 2007, our North American sales increased by22.5% over fiscal 2006. Our international sales increased by $110.1 million, or35% in fiscal 2007 due to marketing and sales expansion in the internationalmarkets as well as the release of games with increased international appeal. Whilewe expect net sales in North America to continue to constitute the largestportion of our consolidated net sales in fiscal 2008, we expect net sales forNorth America as a percentage of total sales to decrease slightly as wecontinue to expand our international direct sales and product mix. We willcontinue to focus on growing sales internationally in fiscal 2008 as we expandour product portfolio and direct sales forces in the international markets. Infiscal 2007, we established sales offices in Italy and Mexico. In fiscal 2008we will look to expand our direct sales force into Eastern Europe, and we continueto explore opportunities in Asia, especially China.

Changes in foreigncurrency rates increased reported international net sales by $25.2 million or6% in fiscal 2007, as compared to fiscal 2006. Excluding the impacts of foreignexchange rates, international net sales increased by 22% in fiscal 2007.

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**Net Sales byPlatform**

Ourworldwide net sales by platform for fiscal 2007 and fiscal 2006 are as follows(in thousands):

| ** **                 | ** ** | **Fiscal Year Ended March 31,** | ** ** | **Increase/** | ** ** | ** ** | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|---------------|------------|------------|------------|
| **Platform**               | ** ** | ** **                                          | ** ** | **2007**      | ** ** | **2006**   | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| **Consoles**               | ** ** | ** **                                          | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Microsoft Xbox 360         |       | $                                                   | 134,908    |          | 13.1       | %          | $          | 14,479 |   | 1.8 | % | $ | 120,429 |   |   | 831.7 | % |   |
| Microsoft Xbox             |       | 27,476                                              |       | 2.7           |       | 88,181     |       | 10.9 |   | (60,705 | ) |   | (68.8 | )% |   |
| Nintendo Wii               |       | 30,025                                              |       | 2.9           |       | —     |       | — |   | 30,025 |   |   | — | % |   |
| Nintendo GameCube          |       | 52,338                                              |       | 5.1           |       | 59,255     |       | 7.3 |   | (6,917 | ) |   | (11.7 | )% |   |
| Sony PlayStation 2         |       | 304,916                                             |       | 29.7          |       | 296,294    |       | 36.7 |   | 8,622 |   |   | 2.9 | % |   |
|                       |       | 549,663                                             |       | 53.5          |       | 458,209    |       | 56.7 |   | 91,454 |   |   | 20.0 | % |   |
| **Handheld**               | ** ** | ** **                                          | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Nintendo Dual Screen       |       | 114,143                                             |       | 11.1          |       | 32,855     |       | 4.1 |   | 81,288 |   |   | 247.4 | % |   |
| Nintendo Game Boy  Advance |       | 119,869                                             |       | 11.7          |       | 171,477    |       | 21.3 |   | (51,608 | ) |   | (30.1 | )% |   |
| Sony PlayStation  Portable |       | 65,402                                              |       | 6.4           |       | 29,406     |       | 3.6 |   | 35,996 |   |   | 122.4 | % |   |
| Wireless                   |       | 26,467                                              |       | 2.6           |       | 36,112     |       | 4.5 |   | (9,645 | ) |   | (26.7 | )% |   |
|                       |       | 325,881                                             |       | 31.8          |       | 269,850    |       | 33.5 |   | 56,031 |   |   | 20.8 | % |   |
| **PC**                     |       | 149,546                                             |       | 14.6          |       | 77,615     |       | 9.6 |   | 71,931 |   |   | 92.7 | % |   |
| **Other**                  |       | 1,766                                               |       | 0.1           |       | 886        |       | 0.2 |   | 880 |   |   | 99.3 | % |   |
| **Net Sales**              |       | $                                                   | 1,026,856  |          | 100.0      | %          | $          | 806,560 |   | 100.0 | % | $ | 220,296 |   |   | 27.3 | % |   |
|                            |            |                                                     |            |               |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Console Platforms**

Net sales for consoleplatforms increased by 20% in fiscal 2007 to $549.7 million from $458.2 millionin fiscal 2006. In fiscal 2007, sales of games for the Sony PlayStation 2constituted 55% of our sales for console platforms, down from 65% of totalconsole sales in fiscal 2006, while sales of games on the Microsoft Xbox 360climbed from approximately 3% of total console sales in fiscal 2006 to almost25% in fiscal 2007. We released 31 new SKUs for console platforms in fiscal2007 and 2006. A SKU is a version of a title designed for play on a particularplatform.

***Microsoft Xbox 360Net Sales (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $134,908                                  |       |                              | 13.1       | %                                             |       |                              | $          | 14,479            |       |   |   | 1.8 | % |   |   | 831.7 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2007, net salesof video games for Xbox 360 were primarily driven by the release of our owned and internally developed property*Saints Row* and by *WWE SmackDown vs. Raw 2007*.In fiscal 2006, *The Outfit* was the only gamereleased for the Xbox 360, while we released five new SKUs in fiscal 2007. The$120.4 million increase in net sales in fiscal 2007 is due to our releaseof four more SKUs as compared to fiscal 2006. As the installed base of Xbox 360hardware has grown since its launch in November 2005, we have brought moretitles to the platform, including Disney•Pixar’s *Cars*.We expect to continue to bring new titles to this platform as theinstalled base of Xbox 360 continues to grow.

***Microsoft Xbox NetSales (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $27,476                                   |       |                              | 2.7        | %                                             |       |                              | $          | 88,181            |       |   |   | 10.9 | % |   |   | (68.8 | )% |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

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In fiscal 2007, net salesof video games for Xbox were primarily driven by the release of Disney•Pixar’s*Cars*,*Destroy All Humans! 2*and sales of ourcatalog titles. We released three and 11 new SKUs in fiscal 2007 and 2006,respectively. Net sales decreased by $60.7 million in fiscal 2007 ascompared to fiscal 2006 primarily due to fewer units sold of video games forXbox as consumer demand shifted to games for Microsoft’s new generationconsole, Xbox 360.

***Nintendo Wii NetSales (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $30,025                                   |       |                              | 2.9        | %                                             |       |                              | $          | —            |       |   |   | — | % |   |   | — | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Nintendo launched its new generationconsole, Nintendo Wii (“Wii”) in November 2006. In fiscal 2007, wereleased four new SKUs, which accounted for all sales on Wii in fiscal 2007. Thegames released were Disney•Pixar’s*Cars*and three Nickelodeon titles: *SpongeBob SquarePants:Creature from the Krusty Krab*, *Avatar: The Last Airbender*and *Barnyard*. We expect to continue to bringnew titles to this platform as the installed base of Wii continues to growincluding bringing *WWE SmackDown vs. Raw 2008*to Wii in fiscal 2008 as well as original content developed solely for Wii.

***Nintendo GameCubeNet Sales (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $52,338                                   |       |                              | 5.1        | %                                             |       |                              | $          | 59,255            |       |   |   | 7.3 | % |   |   | (11.7 | )% |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2007, net salesof video games for Nintendo GameCube (“GameCube”) were primarily driven bysales of Disney•Pixar’s*Cars*and our Nickelodeon titles, as well as sales of our catalog titles. We releasedeight and seven new SKUs in fiscal 2007 and 2006, respectively. Net salesdecreased by $6.9 million in fiscal 2007 as compared to fiscal 2006 primarilydue to decreased sales of catalog titles in fiscal 2007 as consumers shifted tothe new generation consoles. We expect net sales for GameCube to continue todecline in the future as consumer demand shifts to video games made for Wii.

***Sony PlayStation 2Net Sales (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $304,916                                  |       |                              | 29.7       | %                                             |       |                              | $          | 296,294           |       |   |   | 36.7 | % |   |   | 2.9 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2007, net salesof video games for PlayStation 2 (“PS2”) were primarily driven by *WWE SmackDown vs. Raw 2007*, Disney•Pixar’s*Cars*and**sales of our Nickelodeon and catalog titles. We released 11 and 12 new SKUs infiscal 2007 and 2006, respectively. Net sales increased $8.6 million in fiscal2007 as compared to fiscal 2006 primarily due to sales of Disney•Pixar’s*Cars*as compared to sales of*The Incredibles: Rise ofthe Underminer* in fiscal 2006, partially offset by lower sales ofcatalog titles, which were higher in fiscal 2006. Sony released its newgeneration console, PS3, in November 2006. We expect net sales of gamesfor PS2 to decline in the future as the installed base of PS3 grows.

**Handheld Platforms**

Net sales for handheldplatforms increased by 21% in fiscal 2007 to $325.9 million from $269.9 millionin fiscal 2006. We released 27 and 22 new handheld SKUs in fiscal 2007 and2006, respectively. Consistent with our expectations, net sales of games for Nintendo’sDual Screen (“DS”) and Sony’s PlayStation Portable (“PSP”) continued toincrease in fiscal 2007 with the growth of the installed base, while net sales 

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of games for Game BoyAdvance (“GBA”) declined from 64% of game sales for handheld platforms infiscal 2006 to 37% in fiscal 2007.

***Nintendo DualScreen Net Sales (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $114,143                                  |       |                              | 11.1       | %                                             |       |                              | $          | 32,855            |       |   |   | 4.1 | % |   |   | 247.4 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2007, sales of *Cars*, *Bratz: Forever Diamondz*and sales of our Nickelodeon and catalog titles drove our sales and contributedto an $81.3 million increase in net sales over fiscal 2006. We released nineand eight new SKUs in fiscal 2007 and 2006, respectively. As the installed baseof DS hardware continues to grow, we expect to continue to bring more titles tothe platform.

***Nintendo Game BoyAdvance Net Sales (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $119,869                                  |       |                              | 11.7       | %                                             |       |                              | $          | 171,477           |       |   |   | 21.3 | % |   |   | (30.1 | )% |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2007, net salesof video games for GBA were primarily driven by *Cars*and sales of our catalog titles. We released 13 and 10 new SKUs in fiscal 2007and 2006, respectively. Net sales decreased by $51.6 million in fiscal 2007 ascompared to fiscal 2006 as consumer demand shifted to DS. We expect net salesfrom GBA products to continue to decline as a result of continued growth of DSand PSP into the handheld video game market.

***PlayStationPortable Net Sales (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $65,402                                   |       |                              | 6.4        | %                                             |       |                              | $          | 29,406            |       |   |   | 3.6 | % |   |   | 122.4 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2007, net salesof video games for PSP were driven by *Cars* and *WWE SmackDown vs. Raw 2007*. We released five and four newSKUs in fiscal 2007 and 2006, respectively. Net sales increased by $36.0million in fiscal 2007 as compared to fiscal 2006 primarily due to sales of *Cars* and increased sales of catalog titles. As the installedbase of PSP hardware continues to grow, we expect to continue to bring moretitles to the platform.

***Wireless Net Sales(in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $26,467                                   |       |                              | 2.6        | %                                             |       |                              | $          | 36,112            |       |   |   | 4.5 | % |   |   | (26.7 | )% |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Wireless net sales consist of wireless games and othercontent such as wireless wallpapers and ringtones. Prior to December 2006we also derived wireless revenue by providing infrastructure services for thedelivery of wireless content and entertainment through our controlling interestin Minick Holding AG (“Minick”).

In fiscal 2007, wireless net sales consisted of gamesand other content based on *Star Wars* and *Worms;* licensed properties such as SpongeBob SquarePants andWWE; and owned intellectual properties such as *Saints Row*and *Juiced*. Wireless net sales decreased by$9.6 million during fiscal 2007 as compared to fiscal 2006. The decrease is dueto the sale of our interest in Minick in December 2006 and fewer newtitles 

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released as we re-align our wireless product portfolioto emphasize more casual game content to position ourselves for wirelessplatform share gains in the future.

We expect a slightdecrease in wireless net sales in fiscal 2008, as compared to fiscal 2007, dueto the sale of our interest in Minick, which comprised approximately 34% oftotal wireless net sales in fiscal 2007. Excluding net sales from Minick, weexpect our wireless net sales to increase by approximately 50% in fiscal 2008as we execute against our product strategy, leveraging our strong portfolio ofowned and licensed properties.

***PC Net Sales (inthousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $149,546                                  |       |                              | 14.6       | %                                             |       |                              | $          | 77,615            |       |   |   | 9.6 | % |   |   | 92.7 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2007, net salesof video games for PC products were primarily driven by the release of our newowned and internally developed property, *Company of Heroes*,as well as *S.T.A.L.K.E.R.: Shadow of Chernobyl*, *Supreme Commander* and *Titan Quest*. Wereleased nine and 11 new SKUs in fiscal 2007 and 2006, respectively. Net salesincreased by $71.9 million in fiscal 2007, as compared to fiscal 2006 primarilydue to these core-gamer titles with premium PC pricing. We expect PC net salesto decrease in fiscal 2008 due to our product line-up.

**Costs and Expenses,Interest Income, Other Income, Income Taxes and Minority Interest**

Our costs and expensesincreased by $174.0 million, or 22%, in fiscal 2007 compared to fiscal 2006, to$948.7 million, from $774.7 million. This increase was primarily due to:

·       higherproduct costs related to our increase in net sales,

·       anincrease in software amortization and royalties due to greater sales and thehigher cost of developing games for new generation consoles, and

·       $19.0million of stock-based compensation expense primarily due to our adoption ofFAS 123R in our first quarter of fiscal 2007, $15.6 million higher than infiscal 2006; $5.0 million of legal and accounting fees incurred in connectionwith the investigation of our historical stock option grant practices in fiscal2007 and $2.9 million from the payroll tax effects of our historical stockoption grant practices investigation in fiscal 2007.

Costs and expenses as apercentage of net sales decreased by 4 points to 92% in fiscal 2007 from 96% infiscal 2006. This decrease was primarily due to product mix of higher pricedtitles and leverage of our selling and marketing and general and administrativeexpenses.

***Cost of Sales—ProductCosts (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $351,449                                  |       |                              | 34.2       | %                                             |       |                              | $          | 287,946           |       |   |   | 35.7 | % |   |   | 22.1 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Product costs primarilyconsist of direct manufacturing costs (including platform manufacturer licensefees), net of manufacturer volume rebates and discounts. Product costs as apercentage of net sales decreased by 1.5 points in fiscal 2007 as compared tofiscal 2006. This decrease was primarily due to an increase in sales from ourpremium priced PC games including*Company of Heroes*,*S.T.A.L.K.E.R.: Shadow of Chernobyl*,*Supreme Commander* and *Titan Quest*.These PC games have lower product costs as compared to most of our otherplatforms due to the lack of a platform manufacturer license fee.

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***Cost of Sales—SoftwareAmortization and Royalties (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $165,462                                  |       |                              | 16.1       | %                                             |       |                              | $          | 116,371           |       |   |   | 14.4 | % |   |   | 42.2 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Software amortization androyalties primarily consists of amortization of capitalized payments made tothird-party software developers and amortization of capitalized internal studiodevelopment costs. Commencing upon product release, capitalized softwaredevelopment costs are amortized to software amortization and royalties based onthe ratio of current revenues to total projected revenues. In fiscal 2007software amortization and royalties as a percentage of net sales increased by1.7 points over fiscal 2006. This increase was primarily due to a greater mixof new generation titles with higher development costs.

***Cost of Sales—LicenseAmortization and Royalties (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $99,533                                   |       |                              | 9.7        | %                                             |       |                              | $          | 80,508            |       |   |   | 10.0 | % |   |   | 23.6 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

License amortization androyalties expense consists of royalty payments due to licensors, which areexpensed at the higher of (1) the contractual royalty rate based on actualnet product sales for such license or (2) an effective rate based upontotal projected revenue for such license. In fiscal 2007 license amortizationand royalties as a percentage of net sales decreased slightly versus fiscal2006. The top selling titles in fiscal 2007 were *Cars* and *WWE® SmackDown vs. Raw 2007*, bothlicensed properties. However, the increased mix of net sales from games basedon our owned intellectual properties including *Saints Row*,*Destroy All Humans! 2*, *Company of Heroes* and *Titan Quest*lowered the overall rate as compared to fiscal 2006.

***Cost of Sales—VenturePartner Expense (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $16,730                                   |       |                              | 1.6        | %                                             |       |                              | $          | 12,572            |       |   |   | 1.6 | % |   |   | 33.1 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Venture partner expense isrelated to the joint license agreement that THQ and JAKKS Pacific, Inc.(“JAKKS”) have with the WWE under which our role is to develop, manufacture,distribute, market and sell WWE video games. Venture partner expense increasedby $4.2 million in fiscal 2007 as compared to fiscal 2006. This increase is dueto an overall increase in net sales of games based upon the WWE license, whichis primarily due to the release of *WWE*®*SmackDown vs. Raw 2007* in fiscal 2007 andthe introduction of this game to the new generation console Xbox360. See “Item3—Legal Proceedings” for information regarding our venture partner agreement.

***Product Development(in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $97,105                                   |       |                              | 9.5        | %                                             |       |                              | $          | 94,575            |       |   |   | 11.7 | % |   |   | 2.7 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Product developmentexpense primarily consists of expenses incurred by internal development studiosand payments made to external development studios prior to products reachingtechnological feasibility. Product development expense increased by $2.5million in fiscal 2007 as compared to fiscal 2006. This increase is primarilydue to $3.4 million of stock-based compensation expense due to our adoption of 

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FAS 123R in our firstquarter of fiscal 2007, $2.4 million higher than in fiscal 2006, and $1.5million from the payroll tax effects of our historical stock option grantpractices investigation in fiscal 2007. This increase was partially offset bymore products under development that reached technological feasibility earlierin the development process in fiscal 2007 as compared to fiscal 2006.

***Selling andMarketing (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $139,958                                  |       |                              | 13.6       | %                                             |       |                              | $          | 124,809           |       |   |   | 15.5 | % |   |   | 12.1 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Selling and marketing expenses consist of advertising,promotional expenses, and personnel-related costs. In fiscal 2007, selling andmarketing expenses increased on a dollar basis by $15.1 million over fiscal2006. This increase was primarily due to the promotional efforts supporting *Cars*and  *WWE SmackDown vs. Raw2007* which exceeded the promotional costs for *Incredibles:  Rise of the Underminer*and  *WWESmackDown vs. Raw 2006*in fiscal 2006 as well as the launch of *Saints Row* in fiscal 2007. The increase is also due to $2.8million of stock-based compensation expense due to our adoption of FAS 123R inour first quarter of fiscal 2007, $1.8 million higher than in fiscal 2006, and$0.7 million from the payroll tax effects of our historical stock option grantpractices investigation in fiscal 2007.

In fiscal 2007, sellingand marketing expenses decreased by 1.9 points as a percentage of net sales ascompared to fiscal 2006. This decrease is due to our effective marketing spendthat drove a 27% increase in net sales as compared to fiscal 2006.

***General andAdministrative (in thousands)***
| Year Ended  March 31, 2007 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $78,413                                   |       |                              | 7.6        | %                                             |       |                              | $          | 57,944            |       |   |   | 7.2 | % |   |   | 35.3 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

General and administrativeexpenses consist of personnel and related expenses of executive andadministrative staff, as well as fees for professional services such as legaland accounting. General and administrative expenses increased by $20.5 millionin fiscal 2007 as compared to fiscal 2006. The increase was primarily due to$10.7 million of stock-based compensation expense due to our adoption of FAS123R in our first quarter of fiscal 2007, which was $9.2 million higher than infiscal 2006. The increase is also attributable to $5.0 million in legal andaccounting fees incurred in connection with the investigation of our historicalstock option grant practices and $0.8 million for the related payroll taxeffects.

***Interestand Other Income, net***

Interest and other incomeconsists of interest earned on our short-term investments as well as gains andlosses resulting from exchange rate changes for transactions denominated incurrencies other than the functional currency. Interest and other incomeincreased by $4.9 million in fiscal 2007 as compared to fiscal 2006. Theincrease was primarily due to higher average yields on our short-terminvestment balances.

***Income Taxes***

The effective income taxrate was 29% for fiscal 2007 and 19% for fiscal 2006. The fiscal 2006 effectiveincome tax rate benefited from the following factors: (1) a higher ratioof research and development tax credits to pre-tax income and (2) a higherratio of tax exempt interest income to overall pre-tax income. If fiscal 2006pretax income was the same as in fiscal 2005 the effective tax rate would havebeen 

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approximately 28%. The taxrate for fiscal 2007 is higher because of non-deductible stock-basedcompensation expense recognized under FAS 123R.

***Minority Interest and Discontinued Operations***

Minorityinterest reflects the income allocable to equity interests in Minick that arenot owned by THQ. Prior to December 1, 2006, we owned 50% of Minick’soutstanding common stock and controlled its board of directors. OnDecember 1, 2006, we sold our interest in Minick. As of March 31,2007 we received approximately $17.1 million in cash and recognized a gain ofapproximately $3.1 million in discontinued operations due to the sale. Pursuantto the Minick sale agreement, we may receive additional consideration ofapproximately $2.7 million over the next 9 to 15 months. If such amounts arereceived, the additional gain recognized will be reported in discontinuedoperations in the period the proceeds are collected. The results of Minick’soperations were not material to any of the periods presented and have thereforenot been reclassified as discontinued operations.

**Comparison ofFiscal 2006 to Fiscal 2005**

Our net income for fiscal2006 was $32.1 million, or $0.49 per diluted share, as compared to $61.4million, or $1.02 per diluted share in fiscal 2005.

**Net Sales**

Thefollowing table details our net sales by territory for fiscal 2006 and 2005 (inthousands):

| ** **              | ** ** | **Fiscal Year Ended March 31,** | ** ** | **Increase/** | ** ** | ** **     | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|---------------|------------|----------------|------------|
| ** **              | ** ** | **2006**                                            | ** ** | **2005**      | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| North America           |       | $                                                   | 489,945    |          | 60.7       | %              | $          | 470,619 |   | 62.2 | % |   | $ | 19,326 |   |   |   | 4.1 | % |   |
| Europe                  |       | 269,928                                             |       | 33.5          |       | 245,083        |       | 32.4 |   |   | 24,845 |   |   |   | 10.1 | % |   |
| Asia Pacific            |       | 46,687                                              |       | 5.8           |       | 41,029         |       | 5.4 |   |   | 5,658 |   |   |   | 13.8 | % |   |
| International           |       | 316,615                                             |       | 39.3          |       | 286,112        |       | 37.8 |   |   | 30,503 |   |   |   | 10.7 | % |   |
| Consolidated net  sales |       | $                                                   | 806,560    |          | 100.0      | %              | $          | 756,731 |   | 100.0 | % |   | $ | 49,829 |   |   |   | 6.6 | % |   |

 

Net sales in fiscal2006 increased 7% over fiscal 2005, from $756.7 million to $806.6 million. Theincrease in net sales was primarily due to the following:

·       Anincrease in the number of titles that shipped more than one million units inthe fiscal year from six in fiscal 2005 to 10 in fiscal 2006.

·       Higherfiscal 2006 sales of new original, owned properties targeted to the core gamer,*Juiced,**Destroy All Humans!* and *The Outfit*,**our first new generation console title,as compared to**core gamer titles released in fiscal2005: *Full Spectrum WarriorTM,**The Punisher*and *Warhammer 40,000: Dawn of War*.

·       Internationalnet sales increased $30.5 million and 11% in fiscal 2006 as compared to fiscal2005 due to continued sales and marketing expansion in the internationalmarkets as well as the release of games with increased international appeal.

·       Thecontinued sales of games released in prior fiscal years (we refer to this as “catalogsales”).

·       Highersales of games on handheld platforms due to the introduction of Nintendo DualScreen and PlayStation Portable.

·       These items were partiallyoffset by lower fiscal 2006 sales of titles based on two of our key brands: *The Incredibles: Rise of the Underminer*and *SpongeBob SquarePants: Lights, Camera, PANTS!* as 

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compared to fiscal2005 releases: *The Incredibles* and *The SpongeBob SquarePants Movie,* which were released inconjunction with their respective movie releases.

*North America*

Year-over-year net salesgrowth in North America was primarily due to sales of original, ownedproperties targeted to the core gamer, *Destroy All Humans!*and*Juiced*, sales of games based on our WWESmackDown vs. Raw franchise on current generation console platforms as well asthe first-time release of the WWE SmackDown vs. Raw franchise on PSP. Theseitems were partially offset by lower fiscal 2006 sales of *TheIncredibles: Rise of the Underminer*and *SpongeBobSquarePants: Lights, Camera, PANTS!* as compared to fiscal 2005releases of *The Incredibles* and *TheSpongeBob SquarePants Movie,* which were released in conjunction withtheir respective movie releases.

*International*

Year-over-year international net sales growth wasprimarily due to increased sales of our original, owned properties targeted tothe core gamer, *Juiced* and *Destroy AllHumans!*, as compared to *Full Spectrum Warrior*and *The Punisher* in fiscal 2005, as well asincreased sales of games based on our WWE SmackDown vs. Raw franchise on legacygeneration console platforms and the first-time release of the WWE SmackDownvs. Raw franchise on PSP. These items were partially offset by lower fiscal2006 sales of *The Incredibles: Rise of the Underminer*and*SpongeBob SquarePants: Lights, Camera, PANTS!*as compared to fiscal 2005 releases of *The Incredibles*and*The SpongeBob SquarePants Movie*, whichwere released in conjunction with their respective movie releases.

Changes in foreigncurrency rates reduced reported international net sales by $11.4 million or 3%in fiscal 2006, as compared to fiscal 2005. Excluding the impacts of foreignexchange rates, international net sales increased by 15% in fiscal 2006.

**Net Sales byPlatform**

Ourworldwide net sales by platform for fiscal 2006 and 2005 are as follows (inthousands):

| ** **                       | ** ** | **Fiscal Year Ended March 31,** | ** ** | **Increase/** | ** ** | ** ** | ** ** |
|----------------------------------|------------|-----------------------------------------------------|------------|---------------|------------|------------|------------|
| **Platform**                     | ** ** | ** **                                          | ** ** | **2006**      | ** ** | **2005**   | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| **Consoles**                     | ** ** | ** **                                          | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Sony PlayStation 2               |       | $                                                   | 296,294    |          | 36.7       | %          | $          | 275,850 |   | 36.5 | % |   | $ | 20,444 |   |   |   | 7.4 | % |   |
| Microsoft Xbox and Xbox 360 |       | 102,660                                             |       | 12.7          |       | 80,623     |       | 10.7 |   |   | 22,037 |   |   |   | 27.3 | % |   |
| Nintendo GameCube                |       | 59,255                                              |       | 7.3           |       | 73,157     |       | 9.7 |   |   | (13,902 | ) |   |   | (19.0 | )% |   |
|                             |       | 458,209                                             |       | 56.7          |       | 429,630    |       | 56.9 |   |   | 28,579 |   |   |   | 6.7 | % |   |
| **Handheld**                     | ** ** | ** **                                          | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Nintendo Game Boy Advance        |       | 171,477                                             |       | 21.3          |       | 204,348    |       | 27.0 |   |   | (32,871 | ) |   |   | (16.1 | )% |   |
| Nintendo Dual Screen             |       | 32,855                                              |       | 4.1           |       | 3,110      |       | 0.4 |   |   | 29,745 |   |   |   | 956.4 | % |   |
| Sony PlayStation  Portable       |       | 29,406                                              |       | 3.6           |       | —     |       | — |   |   | 29,406 |   |   |   | — | % |   |
| Wireless                         |       | 36,112                                              |       | 4.5           |       | 24,613     |       | 3.3 |   |   | 11,499 |   |   |   | 46.7 | % |   |
|                             |       | 269,850                                             |       | 33.5          |       | 232,071    |       | 30.7 |   |   | 37,779 |   |   |   | 16.3 | % |   |
| **PC**                           |       | 77,615                                              |       | 9.6           |       | 86,667     |       | 11.5 |   |   | (9,052 | ) |   |   | (10.4 | )% |   |
| **Other**                        |       | 886                                                 |       | 0.2           |       | 8,363      |       | 0.9 |   |   | (7,477 | ) |   |   | (89.4 | )% |   |
| **Net Sales**                    |       | $                                                   | 806,560    |          | 100.0      | %          | $          | 756,731 |   | 100.0 | % |   | $ | 49,829 |   |   |   | 6.6 | % |   |
|                                  |            |                                                     |            |               |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Console Platforms**

Net sales for consoleplatforms increased 7% for fiscal 2006 as compared to fiscal 2005. We released31 and 30 new console SKUs in fiscal 2006 and 2005, respectively.

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***Sony PlayStation 2Net Sales (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $296,294                                  |       |                              | 36.7       | %                                             |       |                              | $          | 275,850           |       |   |   | 36.5 | % |   |   | 7.4 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2006, netsales of video games for PlayStation 2 (“PS2”) were primarily driven by therelease of *WWE SmackDown vs. Raw 2006*, *Juiced*and *Destroy All Humans!*,as well as catalog sales. In fiscal 2005, net sales of video games for PS2**were primarily driven by the release of *WWE SmackDown vs. Raw*, *The Incredibles*,and *The SpongeBob SquarePants Movie*, as well as catalog sales. We released 12 and 14 new SKUs infiscal 2006 and 2005, respectively. A SKU is a version of a title designed forplay on a particular platform. Net sales increased $20.4 million in fiscal 2006as compared to fiscal 2005 primarily due to:

·       highersales of our two new owned, original properties targeted to the core gamer: *Juiced*and *Destroy All Humans!*,as compared to core gamer titles released in fiscal 2005: *FullSpectrum Warrior*, *MX v. ATV Unleashed*and *The Punisher;*

·       highersales of *WWE SmackDown vs. Raw 2006*as comparedto the fiscal 2005 release of *WWE SmackDown vs. Raw;*

·       highercatalog sales mainly attributable to increases in sales of games based on ourWWE and MX franchises, as well as Disney•Pixar’s *TheIncredibles* and *The SpongeBob SquarePantsMovie*;

·       partially offset by lowerfiscal 2006 sales of *The Incredibles: Rise ofthe Underminer*as compared to the fiscal 2005 release of *The Incredibles,* which was released in conjunction with itsmovie release.

***Microsoft Xbox andXbox 360 Net Sales (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $102,660                                  |       |                              | 12.7       | %                                             |       |                              | $          | 80,623            |       |   |   | 10.7 | % |   |   | 27.3 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2006, netsales of video games for Xbox and Xbox 360 were primarily driven by the releaseof *WWE*®*Wrestlemania*®*21*, *Destroy All Humans!, TheOutfit*TM**and *Juiced*.In fiscal 2005 net sales of video games for Xbox were primarily driven by therelease of *Full Spectrum Warrior, The Incredibles*and *The Punisher*. We released 12 and eightnew SKUs in fiscal 2006 and 2005, respectively. Net sales increased by$22.0 million in fiscal 2006 as compared to fiscal 2005 primarily due to:

·       therelease of *The Outfit*for Xbox 360 whereas there were no Xbox 360 SKUs releasedin fiscal 2005;

·       salesof our new release *WWE Wrestlemania 21,*there were no WWE titles released on Xbox in fiscal 2005;

·       highersales of our two new owned, original properties targeted to the core gamer: *Juiced*and *Destroy All Humans!*,as compared to core gamer titles released in fiscal 2005: *MX v. ATVUnleashed* and *The Punisher;*

·       fouradditional SKUs released in fiscal 2006 as compared to fiscal 2005;

·       partiallyoffset by lower sales of *Full Spectrum Warrior*TM*: Ten Hammers*TM, as compared to *FullSpectrum Warrior* released in fiscal 2005;

·       andpartially offset by lower fiscal 2006 sales of *TheIncredibles: Rise of the Underminer*as compared to fiscal 2005wherein we released *The Incredibles*which was released in conjunction with its movie release.

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In November 2005,Microsoft launched its new generation console, Xbox 360, in North America,Europe and Japan.

***Nintendo GameCubeNet Sales (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $59,255                                   |       |                              | 7.3        | %                                             |       |                              | $          | 73,157            |       |   |   | 9.7 | % |   |   | (19.0 | )% |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2006, netsales of video games for GameCube were primarily driven by the release of *WWE*®*Day of Reckoning*TM*2, SpongeBob SquarePants: Lights, Camera, PANTS!*, *Nicktoons: Unite*and *The Incredibles: Rise ofthe Underminer*, as well as catalog sales. In fiscal 2005, net salesof video games for GameCube were primarily driven by the release of *The Incredibles, WWE Day of Reckoning* and*The SpongeBob SquarePants Movie.*We released seven andeight new SKUs in fiscal 2006 and 2005, respectively. Net sales decreased by$13.9 million in fiscal 2006 as compared to fiscal 2005 primarily due to:

·       lowersales of our fiscal 2006 releases of *The Incredibles: Rise ofthe Underminer* and *SpongeBob SquarePants:Lights, Camera, PANTS!* as compared to fiscal 2005 releases of *The Incredibles* and *The SpongeBob SquarePantsMovie*, both which were released in conjunction with their respectivemovie releases;

·       lowersales of our fiscal 2006 release of *WWE Day of Reckoning 2*,as compared to *WWE Day of Reckoning* in fiscal2005;

·       partially offset by salesof our fiscal 2006 release of *Bratz: Rock Angelz*with no comparable title in fiscal 2005.

**Handheld Platforms**

Net sales for handheldplatforms increased 16% for fiscal 2006 as compared to fiscal 2005. We released22 and 20 new handheld SKUs in fiscal 2006 and 2005, respectively. BothNintendo and Sony have launched new handheld platforms, Dual Screen (“DS”) andPlayStation Portable (“PSP”), respectively. Consistent with our expectations,net sales of games for those new platforms increased in fiscal 2006, while netsales of games for Game Boy Advance declined.

***Nintendo Game BoyAdvance Net Sales (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $171,477                                  |       |                              | 21.3       | %                                             |       |                              | $          | 204,348           |       |   |   | 27.0 | % |   |   | (16.1 | )% |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2006, netsales of video games for Game Boy Advance were primarily driven by the releaseof*Bratz: Rock Angelz*, *SpongeBob SquarePants: Lights, Camera, PANTS!*and *The Incredibles: Rise of the Underminer*, as well as sales ofour Game Boy Advance Double Packs. Game Boy Advance Double Packs feature twopreviously released titles on one cartridge, providing us with a way toreintroduce our top selling mass-market titles. In fiscal 2005, net sales ofvideo games for Game Boy Advance were primarily driven by the release of *The Incredibles*, *The SpongeBob SquarePantsMovie* and *Sonic Advance 3*,as well as catalog titles. We released 10 and 19 new SKUs in fiscal 2006 and2005, respectively. Net sales decreased by $32.9 million in fiscal 2006 ascompared to fiscal 2005 primarily due to:

·       lowersales on our fiscal 2006 releases of *The Incredibles: Rise ofthe Underminer* and *SpongeBob SquarePants:Lights, Camera, PANTS!* as compared to fiscal 2005 releases of *The Incredibles* and *The*

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*SpongeBob SquarePants Movie*,both which were released in conjunction with their respective movie releases;

·       strongfiscal 2005 performance of *Sonic Advance 3*withouta comparable game released in fiscal 2006;

·       ninefewer SKUs released in fiscal 2006 as compared to fiscal 2005 and an overalldecline in the Game Boy Advance market due to the introduction of DS and PSPinto the handheld video game market;

·       partially offset by a 21%increase in sales of catalog titles, mainly Game Boy Advance Double Packs.

***Nintendo DualScreen Net Sales (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $32,855                                   |       |                              | 4.1        | %                                             |       |                              | $          | 3,110             |       |   |   | 0.4 | % |   |   | 956.4 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2006, net salesof video games for DS were primarily driven by the release of *Zoo Tycoon, SpongeBob SquarePants: Yellow Avenger*and *TheIncredibles: Rise of the Underminer*. We released eight andone new SKUs in fiscal 2006 and 2005, respectively. Net sales increased by$29.7 million in fiscal 2006 as compared to fiscal 2005. The increase is due tothe increased number of titles released in fiscal 2006 as compared to fiscal2005.

***PlayStationPortable Net Sales (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $29,406                                   |       |                              | 3.6        | %                                             |       |                              | $          | —            |       |   |   | — | % |   |   | — | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2006, net salesof video games for PSP were driven by the release of *WWESmackDown vs. Raw 2006*. We released four and zero new SKUs in fiscal2006 and fiscal 2005, respectively.

***Wireless Net Sales(in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $36,112                                   |       |                              | 4.5        | %                                             |       |                              | $          | 24,613            |       |   |   | 3.3 | % |   |   | 46.7 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Wireless revenues consist of sales of wireless gamesand other content such as wireless wallpapers and ringtones. Prior to December 2006we also derived wireless revenue by providing infrastructure services for thedelivery of wireless content and entertainment through our controlling interestin Minick Holding AG (“Minick”).

Wireless net salesincreased by $11.5 million in fiscal 2006 as compared to fiscal 2005. Ourproduct content for wireless devices grew significantly in fiscal 2006 overfiscal 2005. The increase in wireless net sales reflected sales of *Star Wars*, *SpongeBob SquarePants*and NFL based content, as well as the continued growth in the installedbase of data enabled wireless handsets with game capabilities.

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***PC Net Sales (inthousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $77,615                                   |       |                              | 9.6        | %                                             |       |                              | $          | 86,667            |       |   |   | 11.5 | % |   |   | (10.4 | )% |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2006, netsales of video games for PC were primarily driven by the release of *Warhammer*®*40,000*TM*: Dawn of War: Winter Assault*TM**and*Juiced*, as well as catalog titles. Infiscal 2005, net sales of video games for PC were primarily driven by therelease of *Warhammer 40,000: Dawn of War, The Incredibles,Full Spectrum Warrior*and *The SpongeBob SquarePantsMovie*. We released 11 and 12 new titles in fiscal 2006 and 2005,respectively. Net sales decreased by $9.1 million in fiscal 2006 as compared tofiscal 2005 primarily due to:

·       lowersales of our *Warhammer 40,000: Dawn of War: WinterAssault*, an expansion pack to the successful core gamer title *Warhammer 40,000: Dawn of War* released in fiscal 2005;

·       lowersales of our *Full Spectrum Warrior: Ten Hammers*,as compared to *Full Spectrum Warrior* released infiscal 2005;

·       lowersales of our fiscal 2006 releases of *The Incredibles: Rise ofthe Underminer* and *SpongeBob SquarePants:Lights, Camera, PANTS!* as compared to fiscal 2005 releases of *The Incredibles* and *The SpongeBob SquarePantsMovie*, both which were released in conjunction with their respectivemovie releases;

·       partially offset by a 44%increase in sales of catalog titles.

***Other Net Sales***

Other net sales in fiscal2006 and 2005 were primarily comprised of sales from Sony PlayStation products.

**Costs and Expenses,Interest Income, Other Income, Income Taxes and Minority Interest**

Our costs andexpenses increased by $88.4 million or 13% in fiscal 2006 compared to fiscal2005, to $774.7 million, from $686.3 million. Costs and expenses as apercentage of net sales increased by five points to 96% in fiscal 2006 from 91%in fiscal 2005. The increase in costs and expenses in fiscal 2006 wereprimarily due to:

·       highercatalog sales as a percentage of total net sales,

·       achange in development strategy for our WWE games wherein we ceased internalproduct development for wrestling games and as a result we wrote-off theunderlying capitalized software development costs to software amortization androyalties, and

·       higher price protection andsoftware amortization and royalties for *Full Spectrum Warrior: TenHammers*.

***Cost of Sales—ProductCosts (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $287,946                                  |       |                              | 35.7       | %                                             |       |                              | $          | 255,187           |       |   |   | 33.7 | % |   |   | 12.8 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Product costs primarilyconsists of direct manufacturing costs net of manufacturer volume rebates anddiscounts. Product costs as a percentage of net sales increased for fiscal 2006as compared to fiscal 2005, 

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due to higher catalogsales as a percentage of total net sales in fiscal 2006, including reduced yearover year pricing primarily from our Game Boy Advance Dual Packs.

***Cost of Sales—SoftwareAmortization and Royalties (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $116,371                                  |       |                              | 14.4       | %                                             |       |                              | $          | 93,622            |       |   |   | 12.4 | % |   |   | 24.3 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Software amortization androyalties consists of amortization of capitalized payments made to third-partysoftware developers and amortization of capitalized internal studio developmentcosts. Commencing upon product release, capitalized software development costsare amortized to software amortization and royalties based on the ratio ofcurrent revenues to total projected revenues. In fiscal 2006 softwareamortization and royalties as a percentage of net sales increased by 2.0 pointsover fiscal 2005 primarily due to a change in our development strategy for ourWWE games wherein we ceased internal product development for wrestling gamesand as a result we wrote-off the underlying capitalized software developmentcosts to software amortization and royalties. The increase in softwareamortization and royalties as a percent of net sales is also due to highsoftware amortization and royalties related to the performance of *Full Spectrum Warrior: Ten Hammers* on Xbox.

***Cost of Sales—LicenseAmortization and Royalties (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $80,508                                   |       |                              | 10.0       | %                                             |       |                              | $          | 85,926            |       |   |   | 11.4 | % |   |   | (6.3 | )% |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

License amortization androyalties expense consists of royalty payments due to licensors, which areexpensed at the higher of (1) the contractual royalty rate based on actualnet product sales for such license or (2) an effective rate based upontotal projected revenue for such license. For fiscal 2006, license amortizationand royalties as a percentage of net sales decreased by 1.4 points compared tofiscal 2005. This is partially due to a $4.0 million write-off of a license infiscal 2005. The decrease is also due to a higher mix of net sales in fiscal2006 from games with lower contractual royalty rates and games based on ownedintellectual properties with no license rate as compared to fiscal 2005.

***Cost of sales—VenturePartner Expense (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $12,572                                   |       |                              | 1.6        | %                                             |       |                              | $          | 9,774             |       |   |   | 1.3 | % |   |   | 28.6 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Venture partner expense isrelated to the joint license agreement that THQ and JAKKS Pacific, Inc.have with the WWE under which our role is to develop, manufacture, distribute,market and sell WWE video games. Venture partner expense increased by $2.8million in fiscal 2006 as compared to fiscal 2005 due to increases in net salesof games based upon the WWE license. In fiscal 2006 we released *WWE SmackDown vs. Raw 2006*on PlayStation 2 and PlayStationPortable and in fiscal 2005 we released *WWE SmackDown vs. Raw*onPlayStation 2.

***Product Development(in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $94,575                                   |       |                              | 11.7       | %                                             |       |                              | $          | 80,090            |       |   |   | 10.6 | % |   |   | 18.1 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

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Product developmentexpense primarily consists of expenses incurred by internal development studiosand payments made to external development studios prior to products reachingtechnological feasibility. Product development expense increased by $14.5million in fiscal 2006 as compared to fiscal 2005. This increase was primarilydue to the expansion of our internal studios with the acquisitions of JuiceGames Limited and Vigil Games, LLC and with the formation of two new studios, KaosStudios and Incinerator Games. Product development expense also increased dueto spending on development of games for new generation platforms.

***Selling andMarketing (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $124,809                                  |       |                              | 15.5       | %                                             |       |                              | $          | 111,444           |       |   |   | 14.7 | % |   |   | 12.0 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Selling and marketingexpense consists of advertising, promotional expenses, and personnel-relatedcosts. In fiscal 2006, selling and marketing expenses increased as a percentageof net sales as compared to fiscal 2005. Selling and marketing expensesincreased in absolute dollars by $13.4 million for fiscal 2006 as compared tofiscal 2005. This increase was primarily due to promotional efforts to support thelaunch of two new owned and original titles: *Juiced*and *Destroy All Humans!*.

***General andAdministrative (in thousands)***
| Year Ended  March 31, 2006 | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $57,944                                   |       |                              | 7.2        | %                                             |       |                              | $          | 50,278            |       |   |   | 6.6 | % |   |   | 15.2 | % |   |
|                                           |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

General and administrativeexpenses consist of personnel and related expenses of executive andadministrative staff, as well as fees for professional services such as legaland accounting. General and administrative expenses increased by $7.7 millionin fiscal 2006 as compared to fiscal 2005. The increase in fiscal 2006 isprimarily due to foreign exchange transactions in fiscal 2005, as well asgrowth in European operations, higher depreciation expense and higher amortizationexpense related to prior acquisitions.

***Income Taxes***

The effective income taxrate was 19% for fiscal 2006 and 20% for fiscal 2005. The fiscal 2006 effectiveincome tax rate benefited from the following factors: (1) a higher ratioof research and development tax credits to pre-tax income and (2) a higherratio of tax exempt interest income to overall pre-tax income. If our pretaxincome was the same as in fiscal 2005 our effective tax rate would have beenapproximately 28%. The fiscal 2005 effective income tax rate benefited from thefollowing factors: (1) the recognition of $7.8 million of researchand development income tax credits claimed for prior years and (2) ourestimate of fiscal 2005 year research and development income tax credits.Excluding the one-time benefit of $7.8 million, our effective income taxrate for fiscal 2005 would have been 30%.

***Minority Interest***

Minority interest reflectsthe income allocable to equity interests in Minick that were not owned by THQ.Prior to December 1, 2006, we owned 50% of Minick’s outstanding commonstock and controlled its board of directors. Minority interest included in ourconsolidated statement of operations is $63,000 for fiscal 2006 and $261,000for fiscal 2005.

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**Liquidity and Capital Resources**

| ** **                                        | ** ** | **March 31, 2007** | ** ** | **March 31, 2006** | ** ** | **Change** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|------------|------------|
| **(In thousands)**                           | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash  equivalents                        |       |                         | $          | 174,748                      |       |       |       | $ | 91,517 |   |   | $ | 83,231 |   |
| Short-term  investments                           |       |                         | 283,210    |                         |       |       | 280,120    |   |   | 3,090 |   |
| Cash, cash equivalents and short-term investments |       |                         | $          | 457,958                      |       |       |       | $ | 371,637 |   |   | $ | 86,321 |   |
| Percentage of total  assets                       |       |                         | 45         | %                            |       |       | 44         | % |   |   |   |
|                                                   |            |                              |            |                              |            |            |            |  |  |  |  |  |  |  |  |  |

 

| ** **                                            | ** ** | **Year Ended March 31,** | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------|------------|------------|------------|
| ** **                                            | ** ** | **2007**                                | ** ** | **2006**   | ** ** | **Change** | ** ** |
| **(In thousands)**                               | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash provided by  operating activities                |       | $                                       | 63,997     |       | $          | 42,789 |   | $ | 21,208 |   |
| Cash used in  investing activities                    |       | (28,135                                 | )          | (85,882    | )          | 57,747 |   |
| Cash provided by  financing activities                |       | 40,939                                  |       | 37,787     |       | 3,152 |   |
| Effect of  exchange rate changes on cash              |       | 6,430                                   |       | (1,352     | )          | 7,782 |   |
| Net increase  (decrease) in cash and cash equivalents |       | $                                       | 83,231     |       | $          | (6,658 | ) | $ | 89,889 |   |
|                                                       |            |                                         |            |            |            |  |  |  |  |  |  |  |

 

*CashFlow from Operating Activities.**  *Our principal source of cash isfrom sales of interactive software games designed for play on video gameconsoles, handheld devices and personal computers. Our principal uses of cashare for product purchases**ofdiscs and cartridges along with associated manufacturer’s royalties, paymentsto external developers and licensors, the costs of internal softwaredevelopment and selling and marketing expenses.

Cash provided by operating activities increased byapproximately $21.2 million in fiscal 2007 as compared to fiscal 2006. Theincrease in cash provided was primarily a result of an increase in earnings,improved working capital and amortization of licenses and software development,partially offset by increases in cash payments for software development and licenses.We expect to generate positive operating cash flow for the full fiscal year2008*.*

*CashFlow from Investing Activities.**  *Cash used in investing activitiesin fiscal 2007 decreased by approximately $57.7 million primarily due tomovement between our short-term investments and our cash balances.

*CashFlow from Financing Activities.**  *Cash provided by financingactivities increased by approximately $3.2 million in fiscal 2007 as comparedto fiscal 2006, primarily due to an increase in proceeds from exercise of stockoptions, partially offset by common stock repurchases. We had $13.6 million ofstock repurchases in fiscal 2007 and no repurchases in fiscal 2006.

In fiscal 2008, we expectto generate more cash than we did in fiscal 2007. The increase in the generationof cash is expected to be primarily attributable to higher net income.

*Key Balance SheetAccounts*

*AccountsReceivable.*   Accounts receivable decreased $11.3million in fiscal 2007, from $78.9 million at March 31, 2006 to $67.6million at March 31, 2007. The decrease in net accounts receivable isprimarily due to improved collection cycles and the timing of our fourth quarterproduct releases. Accounts receivable allowances were $80.5 million as of March 31,2007, a $22.7 million increase from March 31, 2006. Allowances for priceprotection and returns as a percentage of trailing nine month net sales were 8%as of March 31, 2007 and 2006. We believe our current reserves areadequate based on historical experience, inventory remaining in the retailchannel and the rate of inventory sell-through in the retail channel.

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*Inventory.**  *Inventory decreased $1.2 million in fiscal 2007, from$28.6 million at March 31, 2006 to $27.4 million at March 31,2007. The decrease in inventory is primarily due to increased focus oninventory processes and an increase in catalog sales. Inventory turns on arolling twelve month basis were 10 at March 31, 2007 and 2006,respectively.

*Licenses.**  *Licenses increased $9.6 million in fiscal 2007, from$81.5 million at March 31, 2006 to $91.1 million at March 31,2007. The increase in licenses is due to the acquisition of new licenses duringfiscal 2007, partially offset by amortization of our existing licenses.

*SoftwareDevelopment.**  *Softwaredevelopment increased $55.2 million in fiscal 2007, from $109.1 million at March 31,2006 to $164.3 million at March 31, 2007. The increase in softwaredevelopment is primarily the result of our investment in new generationcross-platform titles with higher development costs which are scheduled to bereleased in fiscal 2008 and beyond.

*Accrued and Other CurrentLiabilities.**  *Accruedand other current liabilities increased $32.5 million in fiscal 2007, from$110.9 million at March 31, 2006 to $143.4 million at March 31, 2007.The increase in accrued and other current liabilities is primarily due to thewithholding of payments due our venture partner as well as an increase inaccrued compensation.

*Inflation*

Our management currentlybelieves that inflation has not had a material impact on continuing operations.

*Financial Condition*

We believe the existing cash, cash equivalents, short-terminvestments, and cash generated from operations will be sufficient to meet ouroperating requirements for at least the next twelve months, including workingcapital requirements, capital expenditures and potential future acquisitions orstrategic investments. We may choose at any time to raise additional capital tostrengthen our cash position, facilitate expansion, pursue strategicinvestments or to take advantage of business opportunities as they arise.

Our ability to maintainsufficient liquidity could be affected by various risks and uncertaintiesdescribed in Item 1A “Risk Factors” in this Annual Report on Form 10-K.

*Guarantees andCommitments*

Asummary of annual minimum contractual obligations and commercial commitments asof March 31, 2007 is as follows (in thousands): 

| ** **            | ** ** | **Contractual Obligations and Commercial Commitments** | ** ** |
|-----------------------|------------|----------------------------------------------------------------------------|------------|
| ** **            | ** ** | **License /**                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Fiscal**            | ** ** | **Software**                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Years Ending** | ** ** | **Development**                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | **Letters of** | ** ** | ** ** | ** ** |
| **March 31,**    | ** ** | ** **                                                                 | ** ** | **Commitments(1)** | ** ** | **Advertising(2)** | ** ** | **Leases(3)** | ** ** | **Credit(4)** | ** ** | **Total** | ** ** |
| 2008                  |       |                                                                       | $          | 95,642 |   |   |   | $ | 14,078 |   |   |   | $ | 14,206 |   |   |   | $ | 22,699 |   |   | $ | 146,625 |   |
| 2009                  |       |                                                                       | 49,294     |   |   |   | 14,034 |   |   |   | 13,669 |   |   |   | — |   |   | 76,997 |   |
| 2010                  |       |                                                                       | 43,115     |   |   |   | 14,815 |   |   |   | 13,151 |   |   |   | — |   |   | 71,081 |   |
| 2011                  |       |                                                                       | 13,850     |   |   |   | 9,678 |   |   |   | 12,558 |   |   |   | — |   |   | 36,086 |   |
| 2012                  |       |                                                                       | 850        |   |   |   | 1,461 |   |   |   | 10,637 |   |   |   | — |   |   | 12,948 |   |
| Thereafter            |       |                                                                       | 1,100      |   |   |   | 2,557 |   |   |   | 23,044 |   |   |   | — |   |   | 26,701 |   |
|                  |       |                                                                       | $          | 203,851 |   |   |   | $ | 56,623 |   |   |   | $ | 87,265 |   |   |   | $ | 22,699 |   |   | $ | 370,438 |   |
|                       |            |                                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          *Licenses andSoftware Development*.   We enter intocontractual agreements with third parties for the rights to intellectual propertyand for the development of products. Under these agreements, we commit toprovide specified payments to an intellectual property holder or developer.Assuming all 

48

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contractual provisions aremet, the total future minimum contract commitments for contracts in place as ofMarch 31, 2007 are approximately $203.9 million. License/softwaredevelopment commitments in the table above include $67.0 million of commitmentsto licensors that are included in our consolidated balance sheet as of March 31,2007 because the licensors do not have any significant performance obligationsto us. These commitments are included in both current and long-term licensesand accrued royalties.

(2)          *Advertising*.   Wehave certain minimum advertising commitments under most of our major licenseagreements. These minimum commitments generally range from 2% to 12% of netsales related to the respective license. We estimate that our minimumcommitment for advertising in fiscal 2008 will be $14.1 million.

(3)          *Leases*.   Weare committed under operating leases with lease termination dates through 2015.Most of our leases contain rent escalations. Rent expense was$14.0 million, $10.6 million and $6.0 million for the fiscalyears ended March 31, 2007, 2006 and 2005, respectively.

(4)          *Letters ofCredit*.   As of March 31, 2007, we had outstanding letters of credit ofapproximately $22.7 million. Our previous credit facility expired on November 29,2006 and we did not renew it. On October 3, 2006, we entered into anagreement with a bank primarily to provide stand-by letters of credit to aplatform manufacturer from whom we purchase products. We are required to pledgecash equivalents and investments to the bank as collateral in an amount equalto 110% of the amount of the outstanding stand-by letters of credit.

Other potentialfuture expenditures relate to the following:

*ManufacturerIndemnification.**  *We mustindemnify the platform manufacturers (Microsoft, Nintendo, Sony) of our gameswith respect to all loss, liability and expenses resulting from any claimagainst such manufacturer involving the development, marketing, sale or use ofour games, including any claims for copyright or trademark infringement broughtagainst such manufacturer. As a result, we bear a risk that the properties uponwhich the titles of our games are based, or that the information and technologylicensed from others and incorporated into the products, may infringe therights of third parties. Our agreements with our third-party softwaredevelopers and property licensors typically provide indemnification rights forus with respect to certain matters. However, if a manufacturer brings a claimagainst us for indemnification, the developers or licensors may not havesufficient resources to, in turn, indemnify us.

*DirectorIndemnity Agreements.**  *Wehave entered into indemnification agreements with the members of our Board ofDirectors to provide a contractual right of indemnification to our Directors tothe extent permitted by law against any and all liabilities, costs, expenses,amounts paid in settlement and damages incurred by the Directors as a result ofany lawsuit, or any judicial, administrative or investigative proceeding inwhich the Directors are sued as a result of their service as members of ourBoard of Directors. The indemnification agreements provide specific proceduresand time frames with respect to requests for indemnification and clarify thebenefits and remedies available to Directors in the event of an indemnificationrequest.

*Litigation.**  *For information related to legal proceedings that mayresult in future expenditures to the Company, see “Item 3—Legal Proceedings.”

**Item 7A.Quantitative and Qualitative Disclosures About Market Risk**

We are exposed to certainmarket risks arising from transactions in the normal course of business,principally risks associated with interest rate and foreign currencyfluctuations.

49

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**Interest Rate Risk**

We have interest rate riskprimarily related to our investment portfolio. A substantial portion of ourportfolio is in short-term investments made up of floating rate securities andmunicipal securities. The value of these investments may fluctuate with changesin interest rates. However, we believe this risk is immaterial due to theshort-term nature of the investments. At March 31, 2007, we hadoutstanding letters of credit of approximately $22.7 million.

**Foreign CurrencyRisk**

We transact business in many different foreigncurrencies and are exposed to financial market risk resulting from fluctuationsin foreign currency exchange rates, particularly the British Pound (“GBP”) andthe Euro, which may result in a gain or loss of earnings to us. Ourinternational business is subject to risks typical of an internationalbusiness, including, but not limited to, foreign currency exchange ratevolatility. Accordingly, our future results could be materially and adverselyaffected by changes in foreign currency exchange rates.

Throughout the year, we frequently monitor thevolatility of the GBP and the Euro (and all other applicable currencies). Weutilize foreign exchange forward contracts to mitigate foreign currency riskassociated with foreign currency denominated assets and liabilities, primarilycertain inter-company receivables and payables. Our foreign exchange forwardcontracts are accounted for as derivatives whereby the fair value of thecontracts are reflected as other current assets or other current liabilitiesand the associated gains and losses are reflected in interest and other incomein the consolidated statements of operations. The forward contracts generallyhave a contractual term of one month or less and are transacted near month-end.Therefore, the fair value of the forward contracts generally is not significantat each month-end.

Foreign exchange forward contracts are designed tooffset gains and losses on the underlying foreign-currency-denominated assetsand liabilities. Any movement in foreign currency exchange rates resulting in again or loss on our foreign exchange forward contracts would be offset by anopposing gain or loss in the underlying foreign-currency-denominated assets andliabilities that were hedged and would not have a material impact on ourfinancial position.

As of March 31, 2007, we had foreign exchangeforward contracts in the notional amount of $47.0 million, all with maturitiesof one month, consisting primarily of Euros, British Pounds, and AustralianDollars. The counterparties to these forward contracts are creditworthymultinational commercial and investment banks. The risks of counterpartynon-performance associated with these contracts are not considered to bematerial. Notwithstanding our efforts to manage foreign exchange risks, therecan be no assurances that our mitigating or hedging activities will adequatelyprotect us against the risks associated with foreign currency fluctuations.

We do not hedge foreigncurrency translation risk. A hypothetical 10% adverse change in exchange rateswould result in a reduction of reported net sales ofapproximately $42.5 million and a reduction of reported income beforetaxes of approximately $3.2 million. This estimate assumes an adverseshift in all foreign currency exchange rates, which do not always move in thesame direction; actual results may differ materially.

**Item 8.Consolidated Financial Statements and Supplementary Data**

The report of Independent Registered Public AccountingFirm, consolidated financial statements and notes to consolidated financialstatements follow below.

50

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**To the Board of Directors andStockholders of THQ Inc.,**

**Agoura Hills, California**

We have audited the accompanying consolidated balancesheets of THQ Inc. and subsidiaries (the “Company”) as of March 31, 2007and 2006, and the related consolidated statements of operations, stockholders’equity and cash flows for each of the three years in the period ended March 31,2007. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of the Companyas of March 31, 2007 and 2006, and the results of its operations and itscash flows for each of the three years in the period ended March 31, 2007,in conformity with accounting principles generally accepted in the UnitedStates of America.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of the Company’s internal control over financial reporting as of March 31,2007, based on the criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission and our report dated May 30, 2007 expressed anunqualified opinion on management’s assessment of the effectiveness of theCompany’s internal control over financial reporting and an unqualified opinionon the effectiveness of the Company’s internal control over financialreporting.

As discussed in Note 1, “Descriptionof Business and Summary of Significant Accounting Policies” to the consolidatedfinancial statements, the Company adopted Statement of Financial AccountingStandards No. 123(R), “Share-Based Payment,” effective April 1, 2006.

**DELOITTE &TOUCHE LLP**

Los Angeles, CaliforniaMay 30, 2007

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**THQ INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS (In thousands, except share data)**

| ** **                                                                                                                                                              | ** ** | **March 31,  2007** | ** ** | **March 31,  2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| **ASSETS**                                                                                                                                                              |       |                     |       |                     |       |
| Current assets:                                                                                                                                                         |       |                     |       |                     |       |
| Cash and cash  equivalents                                                                                                                                              |       | $                        | 174,748    |                     | $          | 91,517 |   |
| Short-term investments                                                                                                                                                  |       | 283,210                  |       | 280,120                  |       |
| Cash, cash equivalents  and short-term investments                                                                                                                      |       | 457,958                  |       | 371,637                  |       |
| Accounts receivable, net  of allowances                                                                                                                                 |       | 67,586                   |       | 78,876                   |       |
| Inventory                                                                                                                                                               |       | 27,381                   |       | 28,620                   |       |
| Licenses                                                                                                                                                                |       | 41,406                   |       | 20,849                   |       |
| Software development                                                                                                                                                    |       | 130,512                  |       | 91,843                   |       |
| Income taxes receivable                                                                                                                                                 |       | 18,525                   |       | 4,686                    |       |
| Prepaid expenses and  other current assets                                                                                                                              |       | 16,238                   |       | 12,420                   |       |
| Total current assets                                                                                                                                                    |       | 759,606                  |       | 608,931                  |       |
| Property and equipment,  net                                                                                                                                            |       | 45,095                   |       | 37,485                   |       |
| Licenses, net of current  portion                                                                                                                                       |       | 49,661                   |       | 60,623                   |       |
| Software development,  net of current portion                                                                                                                           |       | 33,766                   |       | 17,236                   |       |
| Income taxes receivable,  net of current portion                                                                                                                        |       | 2,163                    |       | 10,273                   |       |
| Deferred income taxes                                                                                                                                                   |       | 15,812                   |       | —                   |       |
| Goodwill                                                                                                                                                                |       | 88,688                   |       | 90,872                   |       |
| Other long-term assets,  net                                                                                                                                            |       | 18,750                   |       | 23,048                   |       |
| **TOTAL  ASSETS**                                                                                                                                                       |       | $                        | 1,013,541  |                     | $          | 848,468 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                           |       |                     |       |                     |       |
| Current liabilities:                                                                                                                                                    |       |                     |       |                     |       |
| Accounts payable                                                                                                                                                        |       | $                        | 28,225     |                     | $          | 34,871 |   |
| Accrued and other  current liabilities                                                                                                                                  |       | 143,418                  |       | 110,924                  |       |
| Deferred income taxes                                                                                                                                                   |       | 25,647                   |       | 3,578                    |       |
| Total current  liabilities                                                                                                                                              |       | 197,290                  |       | 149,373                  |       |
| Other long-term liabilities                                                                                                                                             |       | 47,294                   |       | 60,323                   |       |
| Deferred income taxes,  net of current portion                                                                                                                          |       | —                   |       | 9,681                    |       |
| Commitments and  contingencies                                                                                                                                          |       | —                   |       | —                   |       |
| Minority interest                                                                                                                                                       |       | —                   |       | 1,340                    |       |
| Stockholders’ equity:                                                                                                                                              |       |                     |       |                     |       |
| Preferred stock, par  value $0.01, 1,000,000 shares authorized                                                                                                          |       | —                   |       | —                   |       |
| Common stock, par value  $0.01, 75,000,000 shares authorized; 66,677,721 and 64,140,977 shares issued  and outstanding as of March 31, 2007 and 2006, respectively |       | 667                      |       | 642                      |       |
| Additional paid-in  capital                                                                                                                                             |       | 471,332                  |       | 405,425                  |       |
| Accumulated other  comprehensive income                                                                                                                                 |       | 17,603                   |       | 10,367                   |       |
| Retained earnings                                                                                                                                                       |       | 279,355                  |       | 211,317                  |       |
| Total stockholders’  equity                                                                                                                                        |       | 768,957                  |       | 627,751                  |       |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                     |       | $                        | 1,013,541  |                     | $          | 848,468 |   |

 

See notes to consolidated financial statements.

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**THQ INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data)**

| ** **                                                                   | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                                                                    |       | $                                                   | 1,026,856  |   | $ | 806,560 |   | $ | 756,731 |   |
| Costs and expenses:                                                          |       |                                                |       |   |   |   |   |
| Cost of sales—product costs                                             |       | 351,449                                             |       | 287,946 |   | 255,187 |   |
| Cost of sales—software amortization and royalties                       |       | 165,462                                             |       | 116,371 |   | 93,622 |   |
| Cost of sales—license amortization and royalties                        |       | 99,533                                              |       | 80,508 |   | 85,926 |   |
| Cost of sales—venture partner expense                                   |       | 16,730                                              |       | 12,572 |   | 9,774 |   |
| Product development                                                          |       | 97,105                                              |       | 94,575 |   | 80,090 |   |
| Selling and marketing                                                        |       | 139,958                                             |       | 124,809 |   | 111,444 |   |
| General and administrative                                                   |       | 78,413                                              |       | 57,944 |   | 50,278 |   |
| Total costs and expenses                                                     |       | 948,650                                             |       | 774,725 |   | 686,321 |   |
| Income from  continuing operations                                           |       | 78,206                                              |       | 31,835 |   | 70,410 |   |
| Interest and other income, net                                               |       | 12,822                                              |       | 7,955 |   | 6,483 |   |
| Income from  continuing operations before income taxes and minority interest |       | 91,028                                              |       | 39,790 |   | 76,893 |   |
| Income taxes                                                                 |       | 26,206                                              |       | 7,621 |   | 15,235 |   |
| Income from  continuing operations before minority interest                  |       | 64,822                                              |       | 32,169 |   | 61,658 |   |
| Minority interest                                                            |       | 136                                                 |       | (63 | ) | (261 | ) |
| Income from  continuing operations                                           |       | 64,958                                              |       | 32,106 |   | 61,397 |   |
| Gain on sale of  discontinued operations, net of tax                         |       | 3,080                                               |       | — |   | — |   |
| Net income                                                                   |       | $                                                   | 68,038     |   | $ | 32,106 |   | $ | 61,397 |   |
| Earnings per  share—basic:                                              |       |                                                |       |   |   |   |   |
| Continuing operations                                                        |       | $                                                   | 1.00       |   | $ | 0.51 |   | $ | 1.05 |   |
| Discontinued operations                                                      |       | 0.05                                                |       | — |   | — |   |
| Earnings per share—basic                                                |       | $                                                   | 1.05       |   | $ | 0.51 |   | $ | 1.05 |   |
| Earnings per  share—diluted:                                            |       |                                                |       |   |   |   |   |
| Continuing operations                                                        |       | $                                                   | 0.96       |   | $ | 0.49 |   | $ | 1.02 |   |
| Discontinued operations                                                      |       | 0.05                                                |       | — |   | — |   |
| Earnings per share—diluted                                              |       | $                                                   | 1.01       |   | $ | 0.49 |   | $ | 1.02 |   |
| Shares used in per share calculation—basic                              |       | 65,039                                              |       | 62,615 |   | 58,545 |   |
| Shares used in per share  calculation—diluted                           |       | 67,593                                              |       | 65,520 |   | 60,367 |   |

 

See notes to consolidated financial statements.

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**THQ INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(In thousands, except share data)**

**Fiscal Years Ended March 31, 2005, 2006 and 2007**

| ** **                                                       | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Retained**           | ** ** | ** **   | ** ** |
|------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|---------------------------------------|------------|------------------------|------------|--------------|------------|
| ** **                                                       | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**                           | ** ** | **Income (Loss)** | ** ** | **Earnings** | ** ** | **Total** | ** ** |
| **Balance at  March 31, 2004**                              |       | 57,250,467            |       |                    | $          | 573                                   |       |                   |       | $            | 311,190    |   |   |   | $ | 8,302 |   |   |   | $ | 117,814 |   |   | $ | 437,879 |   |
| Exercise of options                                              |       | 4,189,155             |       |                    | 42         |                                  |       |                   | 42,803     |         |       |   | — |   |   |   | — |   |   | 42,845 |   |
| Issuance of warrants                                             |       | —                |       |                    | —     |                                  |       |                   | 2,422      |         |       |   | — |   |   |   | — |   |   | 2,422 |   |
| Repurchase of common stock                                       |       | (750,000              | )          |                    | (8         | )                                     |       |                   | (9,072     | )            |       |   | — |   |   |   | — |   |   | (9,080 | ) |
| Stock-based compensation                                         |       | —                |       |                    | —     |                                  |       |                   | 806        |         |       |   | — |   |   |   | — |   |   | 806 |   |
| Tax benefit related to the  exercise of employee stock options   |       | —                |       |                    | —     |                                  |       |                   | 6,940      |         |       |   | — |   |   |   | — |   |   | 6,940 |   |
| Comprehensive  income:                                           |       |                  |       |                    |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                       |       | —                |       |                    | —     |                                  |       |                   | —     |         |       |   | — |   |   |   | 61,397 |   |   | 61,397 |   |
| Other comprehensive income                                       |       |                  |       |                    |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Foreign currency  translation gain                               |       | —                |       |                    | —     |                                  |       |                   | —     |         |       |   | 2,802 |   |   |   | — |   |   | 2,802 |   |
| Unrealized gain on  investments, net of $1.9 million tax expense |       | —                |       |                    | —     |                                  |       |                   | —     |         |       |   | 1,747 |   |   |   | — |   |   | 1,747 |   |
| Comprehensive income                                             |       |                  |       |                    |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   | 65,946 |   |
| **Balance at  March 31, 2005**                              |       | 60,689,622            |       |                    | $          | 607                                   |       |                   |       | $            | 355,089    |   |   |   | $ | 12,851 |   |   |   | $ | 179,211 |   |   | $ | 547,758 |   |
| Exercise of options                                              |       | 3,187,569             |       |                    | 32         |                                  |       |                   | 37,755     |         |       |   | — |   |   |   | — |   |   | 37,787 |   |
| Issuance of restricted  stock                                    |       | 263,786               |       |                    | 3          |                                  |       |                   | 855        |         |       |   | — |   |   |   | — |   |   | 858 |   |
| Stock-based compensation                                         |       | —                |       |                    | —     |                                  |       |                   | 2,564      |         |       |   | — |   |   |   | — |   |   | 2,564 |   |
| Tax benefit related to the  exercise of employee stock options   |       | —                |       |                    | —     |                                  |       |                   | 9,162      |         |       |   | — |   |   |   | — |   |   | 9,162 |   |
| Comprehensive  income:                                           |       |                  |       |                    |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                       |       | —                |       |                    | —     |                                  |       |                   | —     |         |       |   | — |   |   |   | 32,106 |   |   | 32,106 |   |
| Other comprehensive income (loss)                                |       |                  |       |                    |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Foreign currency  translation loss                               |       | —                |       |                    | —     |                                  |       |                   | —     |         |       |   | (3,085 | ) |   |   | — |   |   | (3,085 | ) |
| Unrealized gain on  investments, net of $0.4 million tax expense |       | —                |       |                    | —     |                                  |       |                   | —     |         |       |   | 601 |   |   |   | — |   |   | 601 |   |
| Comprehensive income                                             |       |                  |       |                    |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   | 29,622 |   |
| **Balance at  March 31, 2006**                              |       | 64,140,977            |       |                    | $          | 642                                   |       |                   |       | $            | 405,425    |   |   |   | $ | 10,367 |   |   |   | $ | 211,317 |   |   | $ | 627,751 |   |
| Exercise of options                                              |       | 3,193,844             |       |                    | 31         |                                  |       |                   | 50,532     |         |       |   | — |   |   |   | — |   |   | 50,563 |   |
| Conversion of stock unit  awards                                 |       | 8,100                 |       |                    | —     |                                  |       |                   | —     |         |       |   | — |   |   |   | — |   |   | — |   |
| Cancellation of restricted  stock                                |       | (49,700               | )          |                    | —     |                                  |       |                   | —     |         |       |   | — |   |   |   | — |   |   | — |   |
| Repurchase of common stock                                       |       | (615,500              | )          |                    | (6         | )                                     |       |                   | (13,581    | )            |       |   | — |   |   |   | — |   |   | (13,587 | ) |
| Stock-based compensation                                         |       | —                |       |                    | —     |                                  |       |                   | 20,090     |         |       |   | — |   |   |   | — |   |   | 20,090 |   |
| Tax benefit related to the  exercise of employee stock options   |       | —                |       |                    | —     |                                  |       |                   | 8,866      |         |       |   | — |   |   |   | — |   |   | 8,866 |   |
| Comprehensive  income:                                           |       |                  |       |                    |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                       |       | —                |       |                    | —     |                                  |       |                   | —     |         |       |   | — |   |   |   | 68,038 |   |   | 68,038 |   |
| Other comprehensive income (loss)                                |       |                  |       |                    |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Foreign currency  translation gain                               |       | —                |       |                    | —     |                                  |       |                   | —     |         |       |   | 9,463 |   |   |   | — |   |   | 9,463 |   |
| Unrealized loss on  investments, net of $1.3 million tax benefit |       | —                |       |                    | —     |                                  |       |                   | —     |         |       |   | (2,227 | ) |   |   | — |   |   | (2,227 | ) |
| Comprehensive income                                             |       |                  |       |                    |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   | 75,274 |   |
| **Balance  at March 31, 2007**                              |       | 66,677,721            |       |                    | $          | 667                                   |       |                   |       | $            | 471,332    |   |   |   | $ | 17,603 |   |   |   | $ | 279,355 |   |   | $ | 768,957 |   |

 

See notes to consolidated financial statements.

54

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**THQ INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**

| ** **                                                                         | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| **OPERATING ACTIVITIES:**                                                          | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                                   | 68,038     |   | $ | 32,106 |   | $ | 61,397 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                                |       |   |   |   |   |
| Minority  interest and other                                                       |       | 54                                                  |       | 63 |   | 261 |   |
| Depreciation  and amortization                                                     |       | 15,651                                              |       | 14,162 |   | 10,485 |   |
| Amortization  of licenses and software development                                 |       | 179,684                                             |       | 112,916 |   | 121,801 |   |
| Gain  on sale of discontinued operations                                           |       | (3,080                                              | )          | — |   | — |   |
| Loss  on disposal of property and equipment                                        |       | 1,395                                               |       | 538 |   | 48 |   |
| Stock-based  compensation                                                          |       | 16,253                                              |       | 3,422 |   | 806 |   |
| Tax  benefit related to stock-based awards                                         |       | 8,866                                               |       | 9,162 |   | 6,940 |   |
| Excess  tax benefit related to stock-based awards                                  |       | (3,963                                              | )          | — |   | — |   |
| Deferred  income taxes                                                             |       | (948                                                | )          | 2,082 |   | 7,569 |   |
| Changes in operating assets  and liabilities:                                      |       |                                                |       |   |   |   |   |
| Accounts  receivable, net of allowances                                            |       | 7,053                                               |       | (5,902 | ) | (8,507 | ) |
| Inventory                                                                          |       | 2,277                                               |       | (5,501 | ) | (1,015 | ) |
| Licenses                                                                           |       | (37,809                                             | )          | (13,392 | ) | (107,679 | ) |
| Software  development                                                              |       | (203,089                                            | )          | (134,943 | ) | (92,863 | ) |
| Prepaid  expenses and other current assets                                         |       | (3,275                                              | )          | 1,970 |   | (4,362 | ) |
| Accounts  payable                                                                  |       | (5,584                                              | )          | (397 | ) | 11,205 |   |
| Accrued  and other liabilities                                                     |       | 28,380                                              |       | 22,925 |   | 73,741 |   |
| Income  taxes                                                                      |       | (5,906                                              | )          | 3,578 |   | (19,372 | ) |
| Net cash provided by operating activities                                          |       | 63,997                                              |       | 42,789 |   | 60,455 |   |
| **INVESTING ACTIVITIES:**                                                          | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds  from sales and maturities of short-term investments                      |       | 672,645                                             |       | 510,555 |   | 394,965 |   |
| Purchase  of short-term investments                                                |       | (675,735                                            | )          | (557,677 | ) | (431,846 | ) |
| Other  long-term assets                                                            |       | (2,933                                              | )          | (3,366 | ) | (5,125 | ) |
| Acquisitions,  net of cash acquired                                                |       | (7,797                                              | )          | (12,282 | ) | (19,234 | ) |
| Net  proceeds from sale of discontinued operations                                 |       | 7,181                                               |       | — |   | — |   |
| Purchases  of property and equipment                                               |       | (21,496                                             | )          | (23,112 | ) | (16,651 | ) |
| Net cash used in investing activities                                              |       | (28,135                                             | )          | (85,882 | ) | (77,891 | ) |
| **FINANCING ACTIVITIES:**                                                          | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Stock  repurchase                                                                  |       | (13,587                                             | )          | — |   | (9,080 | ) |
| Proceeds  from exercise of stock options                                           |       | 50,563                                              |       | 37,787 |   | 42,844 |   |
| Excess  tax benefit related to stock-based awards                                  |       | 3,963                                               |       | — |   | — |   |
| Net cash provided by financing activities                                          |       | 40,939                                              |       | 37,787 |   | 33,764 |   |
| Effect of exchange rate changes on cash                                            |       | 6,430                                               |       | (1,352 | ) | 605 |   |
| Net increase (decrease) in cash and cash equivalents                               |       | 83,231                                              |       | (6,658 | ) | 16,933 |   |
| Cash and cash equivalents—beginning of period                                 |       | 91,517                                              |       | 98,175 |   | 81,242 |   |
| Cash and cash equivalents—end of period                                       |       | $                                                   | 174,748    |   | $ | 91,517 |   | $ | 98,175 |   |
| **Supplemental cash flow  information:**                                           |       |                                                |       |   |   |   |   |
| Cash  paid during the period for income taxes                                      |       | $                                                   | 28,476     |   | $ | 6,037 |   | $ | 21,825 |   |
| Cash paid during the period  for interest                                          |       | $                                                   | 79         |   | $ | 155 |   | $ | 199 |   |

 

See notes to consolidated financial statements.

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**THQ INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.**   Descriptionof Business and Summary of Significant Accounting Policies

We are a leadingworldwide developer and publisher of interactive entertainment software for allpopular game systems, including:

·       Homevideo game consoles such as Microsoft Xbox 360, Microsoft Xbox, Nintendo Wii,Nintendo GameCube, Sony PlayStation 3 and Sony PlayStation 2;

·       Handheldplatforms such as Nintendo Dual Screen, Nintendo Game Boy Advance, PSP portableentertainment system (“PSP system”), wireless devices; and

·       Personalcomputers.

Our titles span a wide range of categories, includingaction, adventure, fighting, racing, role-playing, simulation, sports andstrategy. We have created, licensed and acquired a group of highly recognizablebrands, which we market to a variety of consumer demographics ranging fromproducts targeted at children and the mass market to products targeted at coregamers. Our portfolio of licensed properties includes the Disney•Pixar properties *Finding Nemo*, *The Incredibles*,*Cars*and*Ratatouille*;World Wrestling Entertainment; Nickelodeon properties such as *SpongeBob SquarePants*, *Avatar*, *Barnyard* and *Nicktoons*; *Bratz*TM; *MotoGP*; *Warhammer* 40,000; and the Ultimate Fighting Championship; aswell as others. We also have licenses to create wireless products based onDisney•Pixar’s *Ratatouille*as well as *Star Wars* andmajor sports leagues. In addition to licensed properties, we also develop gamesbased upon owned intellectual properties, including Company of Heroes, DestroyAll Humans!, Juiced, MX vs. ATV, Red Faction, Saints Row and Stuntman.

*Principlesof Consolidation.**  *Theconsolidated financial statements include the accounts of THQ Inc. and ourwholly owned and majority owned subsidiaries as well as the venture we havewith JAKKS Pacific, Inc. See “Note 16—Agreement with JAKKS Pacific, Inc.”  The results of operations for acquisitions ofcompanies have been included in the consolidated statements of operationsbeginning on the closing date of acquisition. All material intercompanybalances and transactions have been eliminated in consolidation.

*Pervasivenessof Estimates.**  *Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.The most significant estimates relate to licenses, software development,accounts receivable allowances, income taxes and stock-based compensationexpense.

*Reclassifications.**  *Certain reclassifications have been madeto the prior periods consolidated financial statements to conform to currentperiod consolidated financial statements. In the first quarter of fiscal 2007,we reclassified certain depreciation and amortization expenses from general andadministrative expenses to selling and marketing expenses and to productdevelopment expenses. Depreciation and amortization expenses are nowclassified in our consolidated statement of operations according to thedepartment utilizing the related assets. The reclassified depreciation andamortization expenses for the fiscal years ended March 31, 2006 and 2005were $0.9 million and $0.7 million, respectively, to selling and marketingexpenses and $9.3 million and $6.5 million, respectively, to productdevelopment expenses. We also reclassified transactional foreign currency gainsand losses from general and administrative expenses 

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to net interest and other income. The reclassifiedtransactional foreign currency gains and losses for the fiscal years ended March 31,2006 and 2005 were $0.3 million and $2.3 million, respectively.

*ForeignCurrency Translation.**  *Assetsand liabilities of foreign operations are translated at current rates ofexchange while results of operations are translated at average rates in effectfor the period. Translation gains or losses are shown as a separate componentof accumulated other comprehensive income (loss). Foreign currency transactiongains and losses result from exchange rate changes for transactions denominatedin currencies other than the functional currency and are included in interestand other income in our consolidated statements of operations. For the fiscalyear ended March 31, 2007, foreign currency transaction gains were $0.1million. For the fiscal year ended March 31, 2006, foreign currencytransaction losses were $0.3 million and for the fiscal year ended March 31,2005, foreign currency transaction gains were $2.3 million.

*Cash,Cash Equivalents and Short-Term Investments.**  *We consider all highly liquid investmentswith maturities of three months or less when purchased to be cash equivalents.Investments with maturities greater than three months, but less than one year,when purchased are considered short-term investments. Our short-terminvestments are primarily auction rate securities. These auction ratesecurities are variable rate bonds tied to short-term interest rates withmaturities on the face of the underlying security in excess of 90 days. Auctionrate securities have interest rate resets through a modified Dutch auction atpredetermined short-term intervals, typically every 7, 28, or 35 days. Interestpaid during a given period is based upon the interest rate determined duringthe prior auction. Although the securities are issued and rated as long-termbonds, they are priced and traded as short-term instruments because of theliquidity provided through the interest rate reset. We had $230.2 million and$280.1 million of investments in auction rate securities as of March 31,2007 and March 31, 2006, respectively. These short-term investments areclassified as available-for-sale and changes in the fair value are included inaccumulated other comprehensive income (loss), net of applicable income taxes,in the consolidated financial statements. At March 31, 2007 and 2006, wedid not have any short-term investments classified as held to maturity.

*FinancialInstruments.**  *Thecarrying value of certain financial instruments, including cash and cashequivalents, short-term investments held to maturity, accounts receivable,accounts payable, accrued expenses and accrued royalties, approximate fairvalue based on their short-term nature. Short-term investments classified asavailable for sale are stated at fair value.

We account for our derivative and hedging activitiesunder Statements of Financial Accounting Standards (“SFAS”) No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” as amended. The assets orliabilities associated with our derivative instruments and hedging activitiesare recorded at fair value in other current assets or liabilities,respectively, on our consolidated balance sheets. As discussed below, gains andlosses resulting from changes in fair value are accounted for depending on theuse of the derivative and whether it is designated and qualifies for hedgeaccounting.

We utilize forward contracts in order to reducefinancial market risks. These instruments are used to hedge foreign currencyexposures of underlying assets, liabilities, or certain forecasted foreigncurrency denominated transactions. Our accounting policies for theseinstruments are based on whether they meet the criteria for designation ashedging transactions. Changes in fair value of derivatives that are designatedas cash flow hedges, are highly effective, and qualify as hedging instruments,are recorded in other comprehensive income until the underlying hedged item is recognizedin earnings within the financial statement line item consistent with the hedgeditem. Any ineffective portion of a derivative change in fair value isimmediately recognized in earnings. During the periods presented we did nothave any derivatives that qualify for hedge accounting. Changes in the fairvalue of derivatives that do not qualify for hedge accounting treatment arerecorded in earnings. The fair value of foreign currency contracts is estimatedbased on the forward rate of the various hedged currencies as of the end of theperiod. As of March 31, 

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2007, 2006 and 2005, we had foreign exchange forwardcontracts in the notional amount of $47.0 million, $60.3 million and $35.1million, respectively. The net loss recognized from foreign currency contractsin fiscal 2007 was $872,000, and the net gains recognized from foreign currencycontracts in fiscal 2006 and fiscal 2005 were $493,000 and $682,000,respectively, and are included in interest and other income in our consolidatedstatements of operations.

*AccountsReceivable Allowances.**  *Wederive revenues from sales of packaged software for video game systems andpersonal computers and sales of content and services for wireless devices.Product revenue is recognized net of allowances for price protection andreturns and various customer discounts. We typically only allow returns for ourpersonal computer products; however, we may decide to provide price protectionor allow returns for our video game systems or personal computer products afterwe analyze: (1) inventory remaining in the retail channel, (2) therate of inventory sell-through in the retail channel, and (3) ourremaining inventory on hand. We maintain a policy of giving credits for priceprotection and returns, but do not give cash refunds. Management usessignificant judgment and makes estimates in connection with establishingallowances for price protection, returns, and doubtful accounts in anyaccounting period. Included in our accounts receivable allowances is ourallowance for co-operative advertising that we engage in with our retailchannel partners. Our co-operative advertising allowance is based upon specificcontractual commitments and does not involve estimates made by management.

*Concentrationsof Credit Risk.**  *Financialinstruments which potentially subject us to concentration of credit riskconsist principally of cash and cash equivalents, short-term investments,accounts receivable and long-term marketable securities. We place cash and cashequivalents and short-term investments with high credit-quality institutionsand limit the amount of credit exposure to any one institution. We believe thisrisk is immaterial due to the short-term nature of such investments. As of March 31,2007 we did not have any long-term marketable securities. Most of our sales aremade directly to mass merchandisers and national retailers. Due to theincreased volume of sales to these channels, we have experienced an increasedconcentration of credit risk, and as a result, may maintain individuallysignificant receivable balances with such mass merchandisers and nationalretailers. We perform ongoing credit evaluations of our customers, maintain anallowance for potential credit losses, and most of our foreign receivables arecovered by credit insurance. As of March 31, 2007 and 2006, approximately22% and 25%, respectively, of our gross accounts receivable outstanding waswith one major customer. Our largest single customer accounted for 18% of ourgross sales in fiscal 2007, 19% of our gross sales in fiscal 2006 and 14% ofour gross sales in fiscal 2005.

*Inventory.**  *Inventory, which consists principally offinished products, is stated at the lower of cost (moving weighted average) ormarket. We estimate the net realizable value of slow-moving inventory on atitle by title basis, and charge the excess of cost over net realizable valueto cost of sales—product costs.

*Propertyand Equipment.**  *Propertyand equipment are recorded at cost. Depreciation is computed using thestraight-line method over the estimated useful lives of the assets. Leaseholdimprovements are depreciated over the shorter of their useful lives or theremaining lease term.

*Licenses.**  *Minimum guaranteed royalty payments for intellectualproperty licenses are initially recorded on our balance sheet as an asset(licenses) and as a liability (accrued royalties) at the contractual amountupon execution of the contract if no significant performance obligation remainswith the licensor. When a significant performance obligation remains with thelicensor, we record royalty payments as an asset (licenses) when payable ratherthan upon execution of the contract. Royalty payments for intellectual propertylicenses are classified as current assets and current liabilities to the extentsuch royalty payments relate to anticipated sales during the subsequent yearand long-term assets and long-term liabilities if such royalty payments relateto anticipated sales after one year.

We evaluate the future recoverability of ourcapitalized licenses on a quarterly basis. The recoverability of capitalizedlicense costs is evaluated based on the expected performance of the specificproducts in which 

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the licensed trademark or copyright is to be used. Asmany of our licenses extend for multiple products over multiple years, we alsoassess the recoverability of capitalized license costs based on certainqualitative factors such as the success of other products and/or entertainmentvehicles utilizing the intellectual property, whether there are any future plannedtheatrical releases or television series based on the intellectual property andthe rights holder’s continued promotion and exploitation of the intellectualproperty. Prior to the related product’s release, we expense, as part of costof sales—license amortization and royalties, capitalized license costs when webelieve such amounts are not recoverable.

Licenses are expensed to cost of sales—licenseamortization and royalties at the higher of (1) the contractual royaltyrate based on actual net product sales related to such license or (2) aneffective rate based upon total projected revenue related to such license.When, in management’s estimate, future cash flows will not be sufficient torecover previously capitalized costs, we expense these capitalized costs tocost of sales—license amortization and royalties. If actual revenues or revisedforecasted revenues fall below the initial forecasted revenues for a particularlicense, the charge to cost of sales—license amortization and royalties expensemay be larger than anticipated in any given quarter. As of March 31, 2007,the net carrying value of our licenses was $91.1 million. If we were requiredto write off licenses, due to changes in market conditions or productacceptance, our results of operations could be materially adversely affected.

*SoftwareDevelopment.*   We utilize both internaldevelopment teams and third-party software developers to develop our software.We account for software development costs in accordance with SFAS No. 86, “Accountingfor the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.”  We capitalize software development costs oncetechnological feasibility is established and we determine that such costs arerecoverable against future revenues. For products where proven game enginetechnology exists, this may occur early in the development cycle. We capitalizethe milestone payments made to third-party software developers and the directpayroll and overhead costs for our internal development teams. We evaluate technologicalfeasibility on a product-by-product basis. Amounts related to softwaredevelopment for which technological feasibility is not yet met are charged asincurred to product development expense in our consolidated statements ofoperations.

On a quarterly basis, we compare ourunamortized software development costs to net realizablevalue, on a product-by-product basis. The amount by which any unamortizedsoftware development costs exceed their net realizable value is charged to costof sales—software amortization and royalties. The net realizable value is theestimated future gross revenues from the product, reduced by the estimatedfuture costs of completing the product.

Commencing upon product release, capitalized softwaredevelopment costs are amortized to cost of sales—software amortization androyalties based on the ratio of current revenues to total projected revenues.If actual revenues, or revised projected revenues, fall below the initialprojections, the charge to cost of sales—software amortization and royaltiesmay be larger than anticipated in any given quarter. As of March 31, 2007,the net carrying value of our software development was $164.3 million.

The milestone payments made to our third-partydevelopers during their development of our games are typically considerednon-refundable advances against the total compensation they can earn based uponthe sales performance of the products. Any additional compensation earnedbeyond the milestone payments are expensed to cost of sales—software amortizationand royalties as earned.

*Goodwilland Other Intangible Assets.  *When we adoptedSFAS No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”) effectiveJanuary 1, 2002, we elected to perform the annual review of goodwillimpairment required by FAS 142 on June 30th of each calendar year which at that timecorresponded to the second quarter of our fiscal year. In February 2003 wechanged our fiscal year end from December 31st toMarch 31st. Sincechanging our fiscal year end to March 31st wecontinued to perform our annual review of goodwill impairment on June 30th, which also changed to be theend of our first fiscal quarter. In fiscal 2007, we changed the date of ourannual review of goodwill for impairment to the first day of our fourth 

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fiscal quarter. Our first fiscal quarter is generallywhen we are required to adopt recently issued accounting pronouncements inaddition to managing our annual financial reporting requirements, which canstrain our personnel resources in that quarter. We changed the quarter in whichwe perform our annual review of goodwill impairment to better utilize theseresources. Additionally, the first day of our fourth fiscal quarter’s proximityto our fiscal year end provides us with more comprehensive data to be includedin our review. It was not intended to delay, accelerate or avoid any impairmentcharge. Accordingly, we believe that this change is preferable. Goodwillimpairment tests performed as of January 1, 2007 and June 30, 2006,2005 and 2004 concluded that no impairment charges were required as of thosedates. The change in accounting principle related to the annual testing doesnot result in adjustments to our financial statements when appliedretrospectively. We will perform this annual review on the first day of ourfourth fiscal quarter in future years or more frequently if indicators ofpotential impairment exist.

Our impairment review process is based on a discountedfuture cash flow approach that uses our estimates of revenue for the reportingunits, driven by anticipated success of our products and product releaseschedules, and estimated costs as well as appropriate discount rates. Theseestimates are consistent with the plans and estimates that we use to manage theunderlying businesses. All identifiable intangible assets with finite liveswill continue to be amortized over their estimated useful lives and assessedfor impairment under SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets.”

*RevenueRecognition.**  *Ourrevenue recognition policies are in compliance with American Institute ofCertified Public Accountants Statement of Position (“SOP”) 97-2, “SoftwareRevenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions,” whichprovide guidance on generally accepted accounting principles for recognizingrevenue on software transactions, and Staff Accounting Bulletin (“SAB”) No. 104,“Revenue Recognition in FinancialStatements,” which outlines the basic criteria that must be met torecognize revenue and provides guidance for presentation of revenue and fordisclosure related to revenue recognition policies in financial statementsfiled with the Securities and Exchange Commission (“SEC”).

Product Sales:   Werecognize revenue for packaged software when title and risk of loss transfersto the customer, provided that no significant vendor support obligations remainoutstanding and that collection of the resulting receivable is deemed probableby management. Although we generally sell our products on a no-return basis, incertain circumstances we may allow price protection, returns or otherallowances on a negotiated basis. We estimate such price protection, returns orother allowances based upon management’s evaluation of our historicalexperience, retailer inventories, the nature of the titles and other factors.Such estimates are deducted from gross sales. See “Note 3—Accounts ReceivableAllowances.” Software is sold under a limited 90-day warranty against defectsin material and workmanship. To date, we have not experienced material warrantyclaims.

Software Licenses:   Forthose agreements that provide the customers the right to multiple copies inexchange for guaranteed minimum royalty amounts, revenue is recognized atdelivery of the product master or the first copy. Per copy royalties on salesthat exceed the guarantee are recognized as earned. Revenue from the licensingof software for the fiscal years ended March 31, 2007, 2006 and 2005 was$8.6 million, $6.3 million and $8.1 million, respectively.

Wireless Revenue:   Werecognize wireless revenues principally from the sale or subscription of ourapplications to wireless subscribers under distribution agreements withwireless carriers in the period in which the applications are purchased by thesubscribers, assuming that: fees are fixed and determinable; we have nosignificant obligations remaining and collection of the related receivable isreasonably assured. In accordance with the distribution agreements, thewireless carriers are responsible for billing, collecting and remitting ourfees to us. The wireless carriers generally report the final sales data to uswithin 10 to 45 days following the end of each month. When final salesdata is not available in a timely manner for reporting purposes, we estimateour revenues based on available sales data and historical trends. We willrecord 

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differences between estimated revenues and actualrevenues in the next reporting period once the actual amounts are determined.

Also, in accordance with Emerging Issues Task Force (“EITF”)No. 99-19, “Reporting Revenue Gross as a Principal Versus Net as anAgent,” we recognize as revenues the net amount the wireless carrier pays to usupon the sale of our applications, net of any service or other fees earned anddeducted by the wireless carrier.

*Advertising.**  *Advertising and sales promotion costs aregenerally expensed as incurred, except for television airtime and print mediacosts associated with media campaigns, which are deferred and charged toexpense in the period the airtime or advertising space is used for the firsttime. We engage in co-operative advertising with some of our retail channelpartners. We accrue the associated costs when revenue is recognized and suchamounts are included in selling and marketing expense if there is a separateidentifiable benefit for which we can reasonably estimate the fair value of thebenefit identified; otherwise, they are recognized as a reduction of net sales.Advertising costs for the fiscal years ended March 31, 2007, 2006 and 2005were $61.2 million, $61.0 million and $57.0 million, respectively.

*Stock-basedcompensation.*   We adopted SFAS No. 123(R) Share-BasedPayment (“FAS 123R”) in our first quarter of fiscal 2007 and accordingly, wenow record stock-based compensation expense for all of our stock-based awards. Theadoption of this accounting pronouncement had a material impact on ourconsolidated statement of operations and our cash flows from operating andfinancing activities for fiscal 2007. See “Note 14—Stock-based Compensation” inthe notes to the consolidated financial statements.

Under FAS 123R, we estimate the fair value of stockoptions granted using the Black-Scholes option pricing model. The fair valuefor awards that are expected to vest is then amortized on a straight-line basisover the requisite service period of the award, which is generally the optionvesting term. The amount of expense recognized represents the expenseassociated with the stock options we expect to ultimately vest based upon anestimated rate of forfeitures; this rate of forfeitures is updated as necessaryand any adjustments needed to recognize the fair value of options that actuallyvest or are forfeited are recorded. The Black-Scholes option pricing model,used to estimate the fair value of an award, requires the input of subjectiveassumptions, including the expected volatility of our common stock and anoption’s expected life. As a result, the financial statements include amountsthat are based upon our best estimates and judgments relating to the expenses recognizedfor stock-based compensation. We adopted FAS 123R under the modifiedprospective transition method wherein no prior period financial statementinformation was affected. All prior period financial statements includestock-based compensation accounted for under Accounting Principles BoardOpinion (“APB”) No. 25, “Accountingfor Stock Issued to Employees” (“APB 25”) and the disclosure onlyprovisions of SFAS No. 123, “Accountingfor Stock-Based Compensation,” as amended (“FAS 123”). The financial statementsfor fiscal 2007, include stock-based compensation accounted for under FAS 123R.There were no material differences in valuation methodologies or assumptionscompared to those that were used in estimating the fair value of stock optionsunder the disclosure only provisions of FAS 123.

*IncomeTaxes.**  *Deferredincome taxes are provided for temporary differences between the financialstatement and income tax bases of our assets and liabilities, based on enactedtax rates. A valuation allowance is provided when it is more likely than notthat some portion or all of the deferred income tax assets will not berealized.

*Basicand Diluted Earnings Per Share.**  *Basic earnings per share is computed bydividing net income by the weighted average number of common shares outstandingfor the period. Diluted earnings per share is computed by dividing net incomeby the weighted average number of common shares outstanding for the period,increased by common stock equivalents. Common stock equivalents are calculatedusing the treasury stock method and represent incremental shares issuable uponexercise of our outstanding options, warrants, the employee stock purchaseplan, other stock unit awards and, if applicable in the period, 

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conversion of our convertible debt. However, potentialcommon shares are not included in the denominator of the diluted earnings pershare calculation when inclusion of such shares would be anti-dilutive, such asin a period in which a net loss is recorded.

*RecentlyIssued Accounting Pronouncements.**  *In February 2006, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting forCertain Hybrid Financial Instruments” (“FAS 155”), an amendment of SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities”, and SFAS No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentsof Liabilities”, allowing companies to elect fair value measurement forinstruments in their entirety in cases otherwise requiring a derivative to bebifurcated. FAS 155 is effective for all financial instruments acquired orissued in fiscal years beginning after September 15, 2006, which will beour fiscal year 2008. We do not expect the adoption of this statement to have amaterial impact on our results of operations, financial position or cash flows.

In July 2006, the FASB issued Interpretation No. 48,“Accounting for Uncertainty in Income Taxes—an interpretation of FASB StatementNo. 109” (“FIN 48”). FIN 48 contains a two step approach to recognizingand measuring uncertain tax positions accounted for in accordance with SFAS No. 109.The first step is to evaluate the tax position for recognition by determiningif the weight of available evidence indicates it is more likely than not thatthe position will be sustained on audit, including resolution of relatedappeals or litigation processes, if any. If a tax position is to be recognizedafter the first step, the second step is to measure the tax benefit as thelargest amount which is more than 50% likely of being realized upon ultimatesettlement. FIN 48 is effective for fiscal years beginning after December 15,2006, which will be the first quarter of our fiscal year 2008. We areevaluating the impact, if any, the adoption of this statement will have on ourresults of operations, financial position or cash flows.

In September 2006, the SEC issued StaffAccounting Bulletin No. 108 (“SAB 108”). SAB 108 states that both abalance sheet (iron curtain) approach and an income statement (rollover)approach should be used when quantifying and evaluating the materiality of amisstatement. SAB 108 contains guidance on correcting errors under the dualapproach and provides transition guidance for correcting errors existing inprior years. SAB 108 is effective for fiscal years beginning after November 15,2006, which will be our fiscal year 2008. We do not expect the adoption of thisstatement to have material impact on our results of operations, financialposition or cash flows.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurement” (“FAS 157”). FAS 157 provides a single definition offair value, together with a framework for measuring it, and requires additionaldisclosure about the use of fair value to measure assets and liabilities. FAS157 emphasizes that fair value is a market-based measurement, not anentity-specific measurement, and sets out a fair value hierarchy with the highestpriority being quoted prices in active markets. FAS 157 is effective for fiscalyears beginning after November 15, 2007, which will be our fiscal year2009. We are evaluating the impact, if any, the adoption of this statement willhave on our results of operations, financial position or cash flows.

In February 2007, the FASB issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities—Includingan Amendment of FASB Statement No. 115” (“FAS 159”). FAS 159 permits anentity to choose to measure many financial instruments and certain other itemsat fair value at specified election dates. Subsequent unrealized gains andlosses on items for which the fair value option has been elected will bereported in earnings. FAS 159 is effective for fiscal years beginning after November 15,2007, which will be our fiscal year 2009. We are evaluating the impact, if any,the adoption of this statement will have on our results of operations,financial position or cash flows.

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*Fiscal Year.*   EffectiveApril 1, 2006, we began reporting our fiscal year on a 52/53-weekperiod. Beginning with the fiscal year ending March 31, 2007, our fiscalyear ended on the Saturday nearest March 31. The results of operations forthe fiscal year ended March 31, 2007, 2006 and 2005 contain the followingnumber of weeks:

| **Fiscal Period**          | ** ** | ** ** | ** ** | **Number of Weeks** | ** ** | **Fiscal Period End Date** | ** **          |
|---------------------------------|------------|------------|------------|-------------------------------|------------|-------------------------------------------|---------------------|
| Year ended March 31,  2007 |       |       | 52 weeks   |                          |       |                                      | March 31, 2007 |   |   |
| Year ended March 31,  2006 |       |       | 52 weeks   |                          |       |                                      | March 31, 2006 |   |   |
| Year ended March 31,  2005 |       |       | 52 weeks   |                          |       |                                      | March 31, 2005 |   |   |

 

For simplicity, all fiscalperiods in our consolidated financial statements and accompanying notes arepresented as ending on a calendar month end.

**2.**   Cash,Cash Equivalents and Short-Term Investments

Our investments with maturities beyond one year may beclassified as short-term based on their liquid nature and because suchsecurities represent the investment of cash that is available for currentoperations. All of our short-term investments are classified as available-for-saleand are carried at fair market value with unrealized gains (losses) reported asa separate component of accumulated other comprehensive income (loss) inshareholders’ equity.

Thefollowing table summarizes our cash, cash equivalents and short-term investmentsas of March 31, 2007 (in thousands):

| ** **                                         | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                         | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| ** **                                         | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
| Cash and cash  equivalents                         |       | $             | 174,748    |           |       | —         |       |       |       | — |   |   | $ | 174,748 |   |
| Short-term investments:                            |       |          |       |           |       |           |       |       |       |   |   |   |   |
| U.S. agency securities                             |       | 12,495        |       |           | 3          |           |       |       | (2         | ) |   | 12,496 |   |
| Municipal securities                               |       | 245,761       |       |           | —     |           |       |       | (45        | ) |   | 245,716 |   |
| Corporate notes                                    |       | 25,000        |       |           | —     |           |       |       | (2         | ) |   | 24,998 |   |
| Total short-term investments                       |       | 283,256       |       |           | 3          |           |       |       | (49        | ) |   | 283,210 |   |
| Cash, cash equivalents  and short-term investments |       | $             | 458,004    |           |       | 3              |       |       |       | (49 | ) |   | $ | 457,958 |   |

 

Thefollowing table summarizes the gross unrealized losses and fair value of ourshort-term investments, aggregated by investment category and length of timethat individual securities have been in a continuous unrealized loss positionas of March 31, 2007 (in thousands):

| ** **              | ** ** | **Unrealized Losses   Less Than 12 Months** | ** ** | **Unrealized Losses   12 Months or Greater** | ** ** | **Total**  | ** ** |
|-------------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|------------|------------|
| ** **              | ** ** | ** **                                                           | ** ** | **Gross**                                                             | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **              | ** ** | **Fair**                                                             | ** ** | **Unrealized**                                                        | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **              | ** ** | **Value**                                                            | ** ** | **Losses**                                                            | ** ** | **Value**  | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| U.S. agency  securities |       | $                                                                    | 12,496     |                                                                  |       | $          | (2         | ) |   |   | $ | — |   |   |   | $ | — |   |   | $ | 12,496 |   |   | $ | (2 | ) |   |
| Municipal  securities   |       | 245,716                                                              |       |                                                                  | (45        | )          |       |   | — |   |   |   | — |   |   | 245,716 |   |   | (45 | ) |   |
| Corporate notes         |       | 24,998                                                               |       |                                                                  | (2         | )          |       |   | — |   |   |   | — |   |   | 24,998 |   |   | (2 | ) |   |
| Total                   |       | $                                                                    | 283,210    |                                                                  |       | $          | (49        | ) |   |   | $ | — |   |   |   | $ | — |   |   | $ | 283,210 |   |   | $ | (49 | ) |   |

 

The gross unrealized losses in each of the securitiesin the above tables were primarily caused by a decrease in the fair value ofthe investments as a result of an increase in interest rates. The contractualterms of these securities do not permit the issuer to call, prepay or otherwisesettle the securities at prices 

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less than the stated par value of the security. Accordingly,we do not consider these investments to be other-than-temporarily impaired as ofMarch 31, 2007.

During the year ended March 31, 2007 and 2006there were no realized gains or (losses) from sales of available-for-salesecurities. In addition to the net unrealized loss of approximately $46,000from our short-term investments, we had an unrealized loss on our investment inYuke’s Co., Ltd. (“Yuke’s”) which is classified as available-for-sale and isincluded in other long-term assets (see “Note 8—Other Long-Term Assets”).

Thefollowing table summarizes the amortized cost and fair value of our short-terminvestments, classified by stated maturity as of March 31, 2007 (inthousands):

| ** **                            | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|---------------------------------------|------------|---------------------|------------|-----------------|------------|
| Due in one year  or less              |       | $                   | 255,630    |            | $          | 255,614 |   |
| Due after one  year through two years |       | 27,626              |       | 27,596          |       |
| Total                                 |       | $                   | 283,256    |            | $          | 283,210 |   |

 

**3.**   AccountsReceivable Allowances

Accountsreceivable allowances at March 31, 2007, 2006 and 2005 consist of thefollowing (in thousands):

| ** **                                  | ** ** | **Balance at  Beginning of  Period** | ** ** | **Provisions** | ** ** | **Deductions** | ** ** | **Balance at  End of  Period** | ** ** |
|---------------------------------------------|------------|------------------------------------------------|------------|----------------|------------|----------------|------------|------------------------------------------|------------|
| **Year ended  March 31, 2007**         | ** ** |                                           | ** ** | ** **     |       | ** **     | ** ** | ** **                               | ** ** |   | ** ** | ** ** |   |
| Allowance for price  protection and returns |       |                                           | $          | 48,223         | ** ** |           | $          | 128,454                                  |       | $ | (110,606 | ) |   | $ | 66,071 | ** ** |   |
| Allowance for co-op  advertising            |       |                                           | 8,440      | ** **     |       | 40,726         |       | (35,554                                  | )          |   | 13,612 | ** ** |   |
| Allowance for doubtful  accounts and other  |       |                                           | 1,157      | ** **     |       | 975            |       | (1,266                                   | )          |   | 866 | ** ** |   |
| Combined balance                            |       |                                           | $          | 57,820         | ** ** |           | $          | 170,155                                  |       | $ | (147,426 | ) |   | $ | 80,549 | ** ** |   |
| **Year ended March 31, 2006**          | ** ** |                                           | ** ** | ** **     |       | ** **     | ** ** | ** **                               | ** ** |   | ** ** | ** ** |   |
| Allowance for price  protection and returns |       |                                           | $          | 46,909         | ** ** |           | $          | 133,756                                  |       | $ | (132,442 | ) |   | $ | 48,223 | ** ** |   |
| Allowance for co-op  advertising            |       |                                           | 10,324     | ** **     |       | 33,272         |       | (35,156                                  | )          |   | 8,440 | ** ** |   |
| Allowance for doubtful  accounts and other  |       |                                           | 887        | ** **     |       | 2,452          |       | (2,182                                   | )          |   | 1,157 | ** ** |   |
| Combined balance                            |       |                                           | $          | 58,120         | ** ** |           | $          | 169,480                                  |       | $ | (169,780 | ) |   | $ | 57,820 | ** ** |   |
| **Year ended March 31, 2005**          | ** ** |                                           | ** ** | ** **     |       | ** **     | ** ** | ** **                               | ** ** |   | ** ** | ** ** |   |
| Allowance for price  protection and returns |       |                                           | $          | 43,608         | ** ** |           | $          | 74,102                                   |       | $ | (70,801 | ) |   | $ | 46,909 | ** ** |   |
| Allowance for co-op  advertising            |       |                                           | 6,925      | ** **     |       | 30,739         |       | (27,340                                  | )          |   | 10,324 | ** ** |   |
| Allowance for doubtful  accounts and other  |       |                                           | 1,893      | ** **     |       | 1,663          |       | (2,669                                   | )          |   | 887 | ** ** |   |
| Combined balance                            |       |                                           | $          | 52,426         | ** ** |           | $          | 106,504                                  |       | $ | (100,810 | ) |   | $ | 58,120 | ** ** |   |

 

**4.**   BalanceSheet Details

*Inventory.**  *Inventory at March 31, 2007 and 2006 consists ofthe following (in thousands):

| ** **     | ** ** | **March 31,  2007** | ** ** | **March 31,  2006** | ** ** |
|----------------|------------|--------------------------|------------|--------------------------|------------|
| Raw material   |       |                     | $          | 1,693                    |       |   |   | $ | 1,530 |   |   |
| Finished goods |       |                     | 25,688     |                     |       |   | 27,090 |   |   |
| Inventory      |       |                     | $          | 27,381                   |       |   |   | $ | 28,620 |   |   |

 

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*Property and Equipment.*   Propertyand equipment at March 31, 2007 and 2006 consists of the following (inthousands):

| ** **                         | ** ** | **Useful  Lives** | ** ** | **March 31,  2007** | ** ** | **March 31,  2006** | ** ** |
|------------------------------------|------------|-------------------|------------|--------------------------|------------|--------------------------|------------|
| Building                           |       | 30  yrs           |       | $                        | 719        |                     | $          | 719 |   |
| Land                               |       | —            |       | 401                      |       | 401                      |       |
| Computer  equipment and software   |       | 3-10  yrs         |       | 50,777                   |       | 44,776                   |       |
| Furniture,  fixtures and equipment |       | 5  yrs            |       | 8,262                    |       | 7,324                    |       |
| Leasehold  improvements            |       | 3-6  yrs          |       | 12,694                   |       | 7,847                    |       |
| Automobiles                        |       | 2-5  yrs          |       | 92                       |       | 128                      |       |
|                               |       |              |       | 72,945                   |       | 61,195                   |       |
| Less: accumulated  depreciation    |       |              |       | (27,850                  | )          | (23,710                  | )          |
|                               |       |              |       | $                        | 45,095     |                     | $          | 37,485 |   |

 

Depreciation expense associated with property andequipment amounted to $13.7 million, $11.7 million and $8.6 million for thefiscal years ended March 31, 2007, 2006 and 2005, respectively.

*Accrued and Other CurrentLiabilities.**  *Accrued andother current liabilities at March 31, 2007 and 2006 consist of thefollowing (in thousands):

| ** **                             | ** ** | **March 31,  2007** | ** ** | **March 31,  2006** | ** ** |
|----------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Accrued  liabilities                   |       | $                        | 40,512     |                     | $          | 34,194 |   |
| Accrued  compensation                  |       | 36,591                   |       | 23,367                   |       |
| Accrued payment  to venture partner    |       | 15,273                   |       | 1,419                    |       |
| Accrued royalties                      |       | 51,042                   |       | 51,944                   |       |
| Accrued and other  current liabilities |       | $                        | 143,418    |                     | $          | 110,924 |   |

 

*Other Long-TermLiabilities.**  *Other long-termliabilities at March 31, 2007 and 2006 consist of the following (inthousands):

| ** **                   | ** ** | **March 31,  2007** | ** ** | **March 31,  2006** | ** ** |
|------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Accrued royalties            |       |                     | $          | 43,966                   |       |   |   | $ | 58,025 |   |   |
| Accrued  liabilities         |       |                     | 3,328      |                     |       |   | 2,298 |   |   |
| Other long-term  liabilities |       |                     | $          | 47,294                   |       |   |   | $ | 60,323 |   |   |

 

**5.**   BusinessCombinations

In fiscal 2007, weacquired all of the assets and/or outstanding equity interests in the followingtwo entities for a total cost of $5.2 million, of which $4.9 million was paidin cash and the remaining $0.3 million is to be paid in fiscal 2009:

·       ParadigmEntertainment, Inc., located outside of Dallas, Texas, a developer ofinteractive entertainment software for video game hardware devices;

·       MassMedia, Inc., located in Moorpark, California, a developer of interactiveentertainment software for video game hardware devices.

Goodwill recognized in the above transactions amountedto $3.8 million, none of which is expected to be deductible for income taxpurposes. The preliminary purchase price allocation, including the allocationof 

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goodwill, will be updated as additional informationbecomes available. We did not present pro forma information as theseacquisitions were immaterial to our financial position and results ofoperations.

In fiscal 2007 we paid theformer shareholders of ValuSoft additional consideration of $1.8 million forreaching certain pre-tax income targets pursuant to the purchase agreement. In2002, we acquired ValuSoft, Inc. for a total cost of $14.2 million, whichwas paid primarily in cash. In addition, we have since paid the formershareholders of ValuSoft additional consideration in the amount of $9.2 millionbecause ValuSoft reached certain pre-tax income targets in the four yearssubsequent to the acquisition. They are still eligible for additionalconsideration of up to $1.8 million, which may be paid by us in cash or stock,if they reach certain pre-tax income targets in the last annual period endingon June 30, 2007. Any additional consideration determined to be payablewill increase goodwill in the period such pre-tax income targets are reached.Goodwill recognized in the original transaction and in the payments of theadditional consideration has amounted to $21.2 million and is expected to bedeductible for income tax purposes.

**6.**   Goodwill

Thechanges in the carrying amount of goodwill for the fiscal years ended March 31,2007 and 2006 were as follows (in thousands): 

| Balance at  March 31, 2005                                  |   | $      | 83,440 |   |
|------------------------------------------------------------------|--------|--------|--------|--------|
| Goodwill acquired                                                |   | 4,801  |   |
| Additional consideration paid for ValuSoft                       |   | 2,800  |   |
| Effect of foreign currency exchange rates and other              |   | (169   | )      |
| Balance at  March 31, 2006                                  |   | 90,872 |   |
| Sale of 50% interest in Minick Holdings AG  (“Minick”) |   | (9,598 | )      |
| Goodwill acquired                                                |   | 3,753  |   |
| Additional consideration paid for ValuSoft                       |   | 1,800  |   |
| Effect of foreign currency exchange rates and other              |   | 1,861  |   |
| Balance at  March 31, 2007                                  |   | $      | 88,688 |   |

 

We performed an annualreview of goodwill impairment in each of the fiscal years ended March 31,2007, 2006 and 2005 and found no impairment.

**7.**   OtherIntangible Assets

Intangibleassets include licenses, software development and other intangible assets.Intangible assets are included in other long-term assets, net, except licensesand software development, which are reported separately in the consolidatedbalance sheets. Other intangible assets are as follows (in thousands):

| ** **                          | ** ** | ** **        | ** ** | **March 31, 2007** | ** ** | **March 31, 2006**  | ** ** |
|-------------------------------------|------------|-------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **                          | ** ** | **Useful  Lives** | ** ** | **Gross  Carrying  Amount**  | ** ** | **Accumulated  Amortization** | ** ** | **Net  Amount** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Amount** | ** ** |
| Software  technology                |       | 2-3 years         |       |                         | $          | 953                           |       |   |   | $ | (715 | ) |   |   | $ | 238 |   |   | $ | 3,055 |   |   | $ | (2,085 | ) |   |   | $ | 970 |   |   |
| Trade secrets                       |       | 5 years           |       |                         | 1,800      |                          |       |   | (1,800 | ) |   |   | — |   |   | 1,800 |   |   | (1,530 | ) |   |   | 270 |   |   |
| Customer list                       |       | 4-5 years         |       |                         | —     |                          |       |   | — |   |   |   | — |   |   | 1,414 |   |   | (550 | ) |   |   | 864 |   |   |
| Trade names                         |       | 3-10 years        |       |                         | 2,100      |                          |       |   | (922 | ) |   |   | 1,178 |   |   | 3,196 |   |   | (739 | ) |   |   | 2,457 |   |   |
| Non-compete /  Employment contracts |       | 1-6.5 years       |       |                         | 1,048      |                          |       |   | (828 | ) |   |   | 220 |   |   | 1,055 |   |   | (656 | ) |   |   | 399 |   |   |
| Total                               |       |              |       |                         | $          | 5,901                         |       |   |   | $ | (4,265 | ) |   |   | $ | 1,636 |   |   | $ | 10,520 |   |   | $ | (5,560 | ) |   |   | $ | 4,960 |   |   |

 

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Amortization of other intangible assets for the fiscalyears ended March 31, 2007, 2006 and 2005 was $1.9 million, $2.6 millionand $2.0 million, respectively. Finite-lived other intangible assets areamortized using the straight-line method over the lesser of their estimateduseful lives or the agreement terms, typically from two to ten years and areassessed for impairment under SFAS No. 144, “Accounting for the Impairmentor Disposal of Long-Lived Assets.”

In December 2006, we sold our 50% interest inMinick. See Note 20, “Discontinued Operations” for further discussion of thesale. As a result of the sale of Minick, gross and net intangible assetsdecreased in fiscal 2007 as compared to fiscal 2006 by $4.1 million and $2.5million, respectively.

Thefollowing table summarizes the estimated amortization expense for each of thenext five fiscal years and thereafter (in thousands):

| **Fiscal Years Ending March 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|
| 2008                                                  |       | $          | 659        |       |
| 2009                                                  |       | 327        |       |
| 2010                                                  |       | 147        |       |
| 2011                                                  |       | 102        |       |
| 2012                                                  |       | 102        |       |
| Thereafter                                            |       | 299        |       |
|                                                  |       | $          | 1,636      |       |

 

**8.**   OtherLong-Term Assets

In addition to other intangible assets See “Note 7—OtherIntangible Assets,” other long-term assets include our investment in Yuke’s, aJapanese developer. We own less than a 20% interest in Yuke’s which is publiclytraded on the Nippon New Market in Japan. Accordingly, we account for thisinvestment under SFAS No. 115 “Accountingfor Certain Investments in Debt and Equity Securities” asavailable-for-sale. Unrealized holding gains and losses are excluded fromearnings and are included as a component of other comprehensive income untilrealized. In fiscal 2007 the pre-tax unrealized holding loss was approximately$3.5 million, and in fiscal 2006 the pre-tax unrealized holding gain wasapproximately $1.0 million. Due to the long-term nature of this relationship,this investment is included in other long-term assets in the consolidatedbalance sheet. Under separate development agreements, Yuke’s creates certainWorld Wrestling Entertainment wrestling games for us.

Otherlong-term assets as of March 31, 2007 and 2006 are as follows (inthousands):

| ** **                            | ** ** | **March 31,  2007** | ** ** | **March 31,  2006** | ** ** |
|---------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Investment in  Yuke’s            |       |                     | $          | 5,726                    |       |   |   | $ | 9,217 |   |   |
| Other intangible  assets (see Note 7) |       |                     | 1,636      |                     |       |   | 4,960 |   |   |
| Other                                 |       |                     | 11,388     |                     |       |   | 8,871 |   |   |
| Total other  long-term assets         |       |                     | $          | 18,750                   |       |   |   | $ | 23,048 |   |   |

 

**9.**   CapitalStock Transactions

On September 10,2002, November 21, 2002, February 5, 2004, and May 16, 2007 weannounced that our Board authorized the repurchase of up to $25.0 million ofour common stock from time to time on the open market or in private transactionswith a total authorized repurchase amount of $100.0 million. At March 31,2006 there was $22.1 million available for future repurchases. During thefiscal year ended March 31, 2007, we repurchased $13.6 million of ourcommon stock. As of March 31, 2007, we have repurchased 4,064,500 sharesof our common stock for approximately $66.5 million, leaving $33.5 millionavailable for future repurchases. Thereis no expiration date for the authorized repurchases.

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**10.**   AccumulatedOther Comprehensive Income

Thecomponents of accumulated other comprehensive income were as follows (inthousands):

| ** **                         | ** ** | **Foreign  Currency  Translation  Gains (Losses)** | ** ** | **Net Unrealized  Gains (Losses)  on Securities** | ** ** | **Net Accumulated  Other Comprehensive  Income (Loss)** | ** ** |
|------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| Balance at  March 31, 2004    |       |                                                    | $          | 6,927                                                            |       |                                                                   |       | $ | 1,375 |   |   |   | $ | 8,302 |   |   |
| Other  comprehensive income        |       |                                                    | 2,802      |                                                             |       |                                                                   | 1,747      |   |   |   | 4,549 |   |   |
| Balance at  March 31, 2005    |       |                                                    | 9,729      |                                                             |       |                                                                   | 3,122      |   |   |   | 12,851 |   |   |
| Other  comprehensive income (loss) |       |                                                    | (3,085     | )                                                                |       |                                                                   | 601        |   |   |   | (2,484 | ) |   |
| Balance at  March 31, 2006    |       |                                                    | 6,644      |                                                             |       |                                                                   | 3,723      |   |   |   | 10,367 |   |   |
| Other  comprehensive income (loss) |       |                                                    | 9,463      |                                                             |       |                                                                   | (2,227     | ) |   |   | 7,236 |   |   |
| Balance at  March 31, 2007    |       |                                                    | $          | 16,107                                                           |       |                                                                   |       | $ | 1,496 |   |   |   | $ | 17,603 |   |   |

 

**11.**   EarningsPer Share

Basicearnings per share is computed as net income divided by the weighted averagenumber of shares outstanding for the period. Diluted earnings per sharereflects the potential dilution that could occur from common shares issuablethrough stock-based compensation plans including stock options, stock-basedawards and purchase opportunities under our ESPP. Effective April 1, 2006,we adopted FAS 123R using the modified prospective transition method (see“Note 14—Stock-based Compensation” for further disclosure of ourstock-based compensation plans and our adoption of FAS 123R). In applyingthe treasury stock method in determining our dilutive potential common shares,assumed proceeds from dilutive weighted average outstanding options as ofMarch 31, 2007 include the windfall tax benefits, net of shortfalls,calculated under the “as-if” method as prescribed by FAS 123R. Thefollowing table is a reconciliation of the weighted-average shares used in thecomputation of basic and diluted earnings per share for the periods presented(in thousands):

| ** **                                                        | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                        | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income used  to compute basic and diluted earnings per share  |       | $                                                   | 68,038     |   | $ | 32,106 |   | $ | 61,397 |   |
| Weighted average number of shares outstanding—basic          |       | 65,039                                              |       | 62,615 |   | 58,545 |   |
| Dilutive  potential common shares                                 |       | 2,554                                               |       | 2,905 |   | 1,822 |   |
| Number of shares used to  compute earnings per share—diluted |       | 67,593                                              |       | 65,520 |   | 60,367 |   |
|                                                                   |            |                                                     |            |  |  |  |  |  |  |  |

 

Thefollowing amounts of potential common shares were excluded from the computationof diluted earnings per share above because including them would beantidilutive for the periods presented (in thousands):

| ** **               | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Potential common  shares |       | 2,086                                               |       |   | 738 |   |   | 3,123 |   |
|                          |            |                                                     |            |  |  |  |  |  |  |

 

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**12.**   IncomeTaxes

UnitedStates and foreign income before taxes and details of the provision for incometax are as follows (in thousands):

| ** **                                                                    | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                    | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Income from continuing  operations before income taxes and minority interest: |       |                                                |       |   |   |   |   |
| United States                                                                 |       | $                                                   | 60,955     |   | $ | 29,753 |   | $ | 67,826 |   |
| Foreign                                                                       |       | 30,073                                              |       | 10,037 |   | 9,067 |   |
|                                                                          |       | $                                                   | 91,028     |   | $ | 39,790 |   | $ | 76,893 |   |
| Provision for income tax  expense (benefit):                                  |       |                                                |       |   |   |   |   |
| Current                                                                       |       |                                                |       |   |   |   |   |
| Federal                                                                       |       | $                                                   | (518       | ) | $ | (9,877 | ) | $ | 323 |   |
| State                                                                         |       | (12                                                 | )          | 1,151 |   | (3,695 | ) |
| Foreign                                                                       |       | 11,211                                              |       | 5,325 |   | 2,593 |   |
| Total current                                                                 |       | 10,681                                              |       | (3,401 | ) | (779 | ) |
| Deferred                                                                      |       |                                                |       |   |   |   |   |
| Federal                                                                       |       | 6,905                                               |       | 8,967 |   | 7,867 |   |
| State                                                                         |       | (1,036                                              | )          | (5,057 | ) | 1,393 |   |
| Foreign                                                                       |       | (519                                                | )          | (1,679 | ) | 1,754 |   |
| Total deferred                                                                |       | 5,350                                               |       | 2,231 |   | 11,014 |   |
| Add back benefit  (expense) recorded to stockholders’ equity:            |       |                                                |       |   |   |   |   |
| Tax benefit related to stock option exercises                                 |       | 8,866                                               |       | 9,162 |   | 6,940 |   |
| Tax expense related to unrealized gain on  investments                        |       | 1,309                                               |       | (371 | ) | (1,940 | ) |
| Provision for income tax                                                      |       | $                                                   | 26,206     |   | $ | 7,621 |   | $ | 15,235 |   |

 

Thedifferences between the U.S. federal statutory tax rate and our effective taxrate, expressed as a percentage of income before income taxes and minorityinterest, were as follows: 

| ** **                                                                | ** ** | **Fiscal Year Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                | ** ** | **2007**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| U.S. federal  statutory tax rate                                          |       | 35.0                                            | %          | 35.0 | % | 35.0 | % |
| State taxes, net  of federal benefit and research and development credits |       | 0.2                                             |       | (2.5 | ) | (2.3 | ) |
| Research and  development credits                                         |       | (4.3                                            | )          | (5.4 | ) | (7.9 | ) |
| Tax exempt  interest income                                               |       | (2.9                                            | )          | (5.1 | ) | (1.1 | ) |
| Stock-based  compensation                                                 |       | 2.0                                             |       | — |   | — |   |
| Rate differences  in foreign taxes and other                              |       | (1.2                                            | )          | (2.9 | ) | (3.9 | ) |
| Effective tax  rate                                                       |       | 28.8                                            | %          | 19.1 | % | 19.8 | % |

 

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Deferredincome taxes reflect the net tax effects of temporary differences between theamounts of assets and liabilities for accounting purposes and the amounts usedfor income tax purposes. The components of the net deferred income tax assetand liability are as follows (in thousands):

| ** **                                      | ** ** | **March 31,** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|
| ** **                                      | ** ** | **2007**           | ** ** | **2006** | ** ** |
| Deferred income tax  assets:                    |       |               |       |   |   |
| Accruals, reserves and other expenses           |       | $                  | 29,080     |   | $ | 27,816 |   |
| Tax credit carryforwards                        |       | 22,371             |       | 10,123 |   |
| Net operating loss carryforwards                |       | 5,513              |       | 4,855 |   |
| Other                                           |       | 2,859              |       | — |   |
| Total                                           |       | 59,823             |       | 42,794 |   |
| Valuation allowance                             |       | (7,126             | )          | (5,576 | ) |
| Deferred tax asset, net of valuation allowance  |       | 52,697             |       | 37,218 |   |
| Deferred income tax  liabilities:               |       |               |       |   |   |
| Software development costs                      |       | 60,207             |       | 42,422 |   |
| Depreciation and amortization                   |       | 2,065              |       | 4,441 |   |
| Unrealized gain on marketable equity securities |       | 260                |       | 1,632 |   |
| Other                                           |       | —             |       | 1,982 |   |
| Total                                           |       | 62,532             |       | 50,477 |   |
| Net deferred tax  liability                     |       | $                  | 9,835      |   | $ | 13,259 |   |

 

As of March 31, 2007, current net deferred taxliabilities were $25.6 million and long term net deferred tax assets were $15.8million. As of March 31, 2006, net deferred tax liabilities of $3.6million and $9.7 million were classified as current and long-term liabilities,respectively. The non-current portion of income tax receivable is recorded netof a $17.0 million contingent tax liability. The contingent tax liabilityrelates to tax positions taken in previously filed tax returns and similarpositions expected to be taken in our current year tax returns. Moreover, theInternal Revenue Service (“IRS”) has commenced a routine examination of ourU.S. income tax returns for the calendar year 1999 through fiscal year 2004. Aportion of the contingent tax liability relates to the fiscal years underexamination. On May 24, 2007 we received notification from the IRS thatthe Joint Committee on Taxation had completed its review of our file and tookno exception to the conclusions reached by the IRS. The conclusions reached bythe IRS were not significantly different from the positions taken on our taxreturns. We are evaluating the impact the conclusions of the IRS examinationhas on the measurement of our contingent tax liabilities and will make anynecessary adjustments in the quarter ending June 30, 2007. The amount oftax benefit recognized may be impacted by our adoption of FIN 48, which iseffective for us as of April 1, 2007.

The tax credit carryforwards as of March 31, 2007includes research and development tax credit carryforwards of $11.4 million and$11.6 million for federal and state purposes, respectively. The federal taxcredit carryforward expires in 2026, while the majority of the state creditsare from California and can be carried forward indefinitely. In addition, wehave foreign tax credit carryforwards of $2.0 million. These credits expire in2017.

As of March 31, 2007, we have various state netoperating loss carryforwards totaling $5.9 million that expire between 2008 and2026 and foreign net operating loss carryforwards totaling $17.5 million thatcan be carried forward indefinitely. At March 31, 2007, our deferredincome tax asset for net operating loss carryforwards was reduced by avaluation allowance of $5.2 million as compared to $3.9 million in the priorfiscal year. Realization of the deferred tax assets is dependent upon thecontinued generation of sufficient taxable income prior to the expiration ofthe net operating loss carryforwards. Although realization is not assured,management believes it is more likely than not that the net carrying value ofthe deferred tax asset will be realized.

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The tax benefits associated with certain net operatingloss carryforwards relate to employee stock options. Pursuant to SFAS No. 109,“Accounting for Income Taxes” (“SFAS No. 109”), net operating losses havebeen reduced by $3.7 million relating to these items which will be credited to additionalpaid-in capital when we can reduce our income taxes payable.

At March 31, 2007 wehad accumulated foreign earnings of $41.5 million. We do not plan to repatriatethese earnings, therefore, no U.S. income tax has been provided on the foreignearnings. Additionally, we have not tax effected the cumulative translationadjustment as we have no intention of repatriating foreign earnings.

**13.**   EmployeeDefined Contribution Plan

For our United Statesemployees we sponsor a defined contribution plan under Section 401(k) ofthe Internal Revenue Code. The plan allows employees the ability to defer up to60% of their annual compensation (up to the annual maximum amount allowable bylaw). The plan also provides that we will make a matching contribution equal toeach employee’s deferral, up to 4% of eligible compensation. We may alsocontribute funds to the plan in the form of a discretionary profit-sharingcontribution. Employer contributions under the plan were $4.9 million, $3.5million and $2.7 million in the fiscal years ended March 31, 2007,2006 and 2005, respectively.

**14.**   Stock-basedCompensation

Prior to July 20, 2006, we utilized two stockoption plans:  the THQ Inc. Amended andRestated 1997 Stock Option Plan (the “1997 Plan”) and the THQ Inc. Third Amendedand Restated Nonexecutive Employee Stock Option Plan (the “NEEP Plan”). The1997 Plan provided for the issuance of up to 14,357,500 shares available foremployees, consultants and non-employee directors, and the NEEP plan providedfor the issuance of up to 2,142,000 shares available for nonexecutive employeesof THQ of which no more than 20% was available for awards to our nonexecutiveofficers and no more than 15% was available for awards to the nonexecutiveofficers or general managers of our subsidiaries or divisions. The 1997 Planand the NEEP Plan were cancelled on July 20, 2006, the same day THQ’sstockholders approved the THQ Inc. 2006 Long-Term Incentive Plan (“LTIP”).

Under the 1997 Plan, we granted incentive stockoptions, non-qualified stock options, performance accelerated restricted stock(“PARS”) and performance accelerated restricted stock units (“PARSUs”). TheNEEP Plan provided for the grant of only non-qualified stock options tonon-executive officers of the Company. The LTIP provides for the grant of stockoptions (including incentive stock options), stock appreciation rights (SARs),restricted stock awards, other stock unit awards, and performance awards (inthe form of performance shares or performance units) to eligible directors andemployees of, and consultants or advisors to, the Company. Subject to certainadjustments, the total number of shares of THQ common stock that may be issuedunder the LTIP shall not exceed 6,000,000 shares. Shares subject to awards ofstock options or SARs will count as one share for every one share grantedagainst the share limit, and all other awards will count as 1.6 shares forevery one granted against the share limit. As of March 31, 2007, we had5,692,908 shares under the LTIP available for grant.

The purchase price per share of common stockpurchasable upon exercise of each option granted under the 1997 Plan, the NEEPPlan and the LTIP may not be less than the fair market value of such share ofcommon stock on the date that such option is granted. Generally, optionsgranted under our plans become exercisable over three years and expire on thefifth anniversary of the grant date. PARS and PARSUs that have been granted toour officers under the 1997 Plan and the LTIP vest with respect to 100% of theshares subject to the award on the fifth anniversary of the grant date;provided, however, 20% of the shares subject to each award will vest on each ofthe first through fourth anniversaries of the grant date if certain performancetargets for the Company are attained each fiscal year. To date, no vesting ofPARS or 

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PARSUs has been accelerated. PARSUs granted to ournon-employee directors vest one year after their grant date. Deferred StockUnits (“DSUs”) granted to our non-employee directors vest immediately, however,may not be paid to a director until thirteen (13) months after the date ofgrant. The fair value of our nonvested restricted stock is determined based onthe closing trading price of our common stock on the grant date. The fair valueof PARS, PARSUs and DSUs granted is amortized over the vesting period.

In March 2007, we offered our employees theability to participate in an employee stock purchase plan (“ESPP”). Pursuant toour ESPP, eligible employees may authorize payroll deductions of up to 15percent of their base salary, subject to certain limitations, to purchaseshares at 85 percent of the lower of the fair market value of our common stockon the first day of the offering period or the last. Our first offering periodbegan on March 1, 2007 and will end on August 31, 2007. The fairvalue of the stock purchased under the ESPP is amortized over the offeringperiod. As of March 31, 2007, we had 500,000 shares available for issuanceunder the ESPP.

Any references we make to unspecified “stock-basedcompensation” and “stock-based awards” are intended to represent the collectivegroup of all our awards and purchase opportunities:  stock options, PARS, PARSUs, DSUs and ESPP. Anyreferences we make to “nonvested shares” and “vested shares” are intended torepresent our PARS, PARSU and DSU awards.

Prior to April 1, 2006, we accounted for ourstock-based compensation using the intrinsic value method in accordance withAPB 25 and the disclosure-only provisions of FAS 123. Effective April 1,2006, we adopted the fair value recognition provisions of FAS 123R using themodified prospective transition method. Under that transition method, resultsfor prior periods have not been restated as a result of adopting FAS 123R.

The compensation expense related to stock-basedcompensation was $19.0 million, $3.4 million and $0.8 million, respectively,for the fiscal years ended ended March 31, 2007, 2006 and 2005. The totalincome tax benefit recognized in the statement of operations for stock-basedcompensation expense was $5.1 million, $0.9 million and $0.2 million,respectively, for the fiscal years ended March 31, 2007, 2006 and 2005. Stock-basedcompensation cost capitalized during the fiscal year ended March 31, 2007was $5.9 million, and is included in software development, net of associatedamortization of $2.1 million, in the consolidated balance sheet. No amountswere capitalized in years prior to fiscal 2007.

Forthe fiscal years ended March 31, 2007, 2006 and 2005, stock-basedcompensation expense recognized in the statement of operations was as follows(in thousands):

| ** **                                              | ** ** | **Year Ended March 31,** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                              | ** ** | **2007**                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| Cost of  sales—software amortization and royalties |       | $                                       | 2,087      |   | $ | — |   | $ | — |   |
| Product  development                                    |       | 3,364                                   |       | 926 |   | 475 |   |
| Selling and  marketing                                  |       | 2,817                                   |       | 981 |   | 132 |   |
| General and  administrative                             |       | 10,704                                  |       | 1,515 |   | 199 |   |
| Total stock-based  compensation                         |       | $                                       | 18,972     |   | $ | 3,422 |   | $ | 806 |   |

 

FAS 123R requires that stock-based compensationexpense be based on awards that are ultimately expected to vest andaccordingly, stock-based compensation expense recognized in the fiscal yearended March 31, 2007 has been reduced by estimated forfeitures. Ourestimate of forfeitures is based on historical forfeiture behavior as well asany expected trends in future forfeiture behavior.

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Theadoption of FAS 123R, using the fair value method, had the following effect onour income from continuing operations before income taxes and minorityinterest, income from continuing operations, gain on sale of discontinuedoperations, net income, and basic and diluted net income per share as comparedto what would have been reported under APB 25 using the intrinsic value method,which was the method used prior to our adoption (in thousands, except per sharedata):

| ** **                                                                   | ** ** | **Year Ended March 31, 2007** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                   | ** ** | **Fair Value  Method**                       | ** ** | **Intrinsic Value  Method** | ** ** | **Impact of   Change** | ** ** |
| Income from  continuing operations before income taxes and minority interest |       |                                              | $          | 91,028 |   |   |   | $ | 105,613 |   |   |   | $ | 14,585 |   |   |
| Income from continuing operations                                            |       |                                              | 64,958     |   |   |   | 75,963 |   |   |   | 11,005 |   |   |
| Gain on sale of  discontinued operations, net of tax                         |       |                                              | 3,080      |   |   |   | 3,080 |   |   |   | — |   |   |
| Net income                                                                   |       |                                              | $          | 68,038 |   |   |   | $ | 79,043 |   |   |   | $ | 11,0051 |   |   |
| Earnings per  share—basic:                                              |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Continuing operations                                                        |       |                                              | $          | 1.00 |   |   |   | $ | 1.17 |   |   |   | $ | 0.17 |   |   |
| Discontinued operations                                                      |       |                                              | 0.05       |   |   |   | 0.05 |   |   |   | — |   |   |
| Earnings per share—basic                                                |       |                                              | $          | 1.05 |   |   |   | $ | 1.22 |   |   |   | $ | 0.17 |   |   |
| Earnings per  share—diluted:                                            |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Continued operations                                                         |       |                                              | $          | 0.96 |   |   |   | $ | 1.12 |   |   |   | $ | 0.16 |   |   |
| Discontinued operations                                                      |       |                                              | 0.05       |   |   |   | 0.05 |   |   |   | — |   |   |
| Earnings per  share—diluted                                             |       |                                              | $          | 1.01 |   |   |   | $ | 1.17 |   |   |   | $ | 0.16 |   |   |

 

Prior to the adoption of FAS 123R, we presented alltax benefits of deductions resulting from our stock-based awards as operatingcash flows in the statement of cash flows. FAS 123R requires the cash flowsresulting from the tax benefits arising out of tax deductions in excess of thecompensation recognized for the stock-based awards (“excess tax benefits”) tobe classified as financing cash flows. Prior to our adoption of FAS 123R on April 1,2006, the $4.0 million excess tax benefit classified as a financing cash inflowin the year ended March 31, 2007 would have been classified as anoperating cash inflow.

Thefair value of stock options and ESPP shares granted during the year ended March 31,2007 were estimated on the date of grant using the Black-Scholes option pricingmodel with the weighted-average assumptions noted in the table below. Anticipatedvolatility is based on implied volatilities from traded options on our stockand on our stock’s historical volatility. The expected term of our stockoptions granted is based on historical exercise data and represents the periodof time that stock options granted are expected to be outstanding. Separategroups of employees that have similar historical exercise behavior areconsidered separately for valuation purposes. The expected term of our ESPP isthe offering period. The risk-free rate for periods within the expected livesof options and ESPP are based on the US Treasury yield in effect at the time ofgrant.

| ** **                                | ** ** | **Stock Option   Grants**           | ** ** | **Employee Stock   Purchase Plan** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **Year Ended  March 31, 2007** | ** ** | **Year Ended  March 31, 2007**     | ** ** |
| Dividend yield                            |       |                                          | —     | %                                                 |       |   | — | % |   |
| Anticipated  volatility                   |       |                                          | 37         | %                                                 |       |   | 37 | % |   |
| Weighted-average  risk-free interest rate |       |                                          | 4.9        | %                                                 |       |   | 5.1 | % |   |
| Expected lives                            |       |                                          | 3.2 years  |                                              |       |   | 0.5 year |   |   |

 

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Asummary of our stock option activity for each of the three years ended March 31,2007, 2006 and 2005 is as follows (in thousands, except per share amounts):

| ** **                          | ** ** | ** ** | ** ** | ** **         | ** ** | **Weighted-**       | ** ** | ** **    | ** ** |
|-------------------------------------|------------|------------|------------|--------------------|------------|---------------------|------------|---------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Weighted-**      | ** ** | **Average**         | ** ** | ** **    | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Average**        | ** ** | **Remaining**       | ** ** | ** **    | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Exercise**       | ** ** | **Contractual**     | ** ** | **Aggregate** | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Price**          | ** ** | **Term**            | ** ** | **Intrinsic** | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Per Share** | ** ** | **(in years)** | ** ** | **Value**     | ** ** |
| Outstanding at  March 31, 2004 |       | 10,177     |       |               | $          | 11.73               |       |          |       |   |   |   |   |   |
| Granted                             |       | 4,579      |       |               | $          | 13.51               |       |          |       |   |   |   |   |   |
| Exercised                           |       | (4,189     | )          |               | $          | 10.22               |       |          |       |   |   |   |   |   |
| Forfeited/expired/cancelled         |       | (687       | )          |               | $          | 13.17               |       |          |       |   |   |   |   |   |
| Outstanding at  March 31, 2005 |       | 9,880      |       |               | $          | 13.10               |       |          |       |   |   |   |   |   |
| Granted                             |       | 3,276      |       |               | $          | 20.48               |       |          |       |   |   |   |   |   |
| Exercised                           |       | (3,187     | )          |               | $          | 12.03               |       |          |       |   |   |   |   |   |
| Forfeited/expired/cancelled         |       | (894       | )          |               | $          | 14.44               |       |          |       |   |   |   |   |   |
| Outstanding at  March 31, 2006 |       | 9,075      |       |               | $          | 16.00               |       |          |       |   |   |   |   |   |
| Granted                             |       | 2,638      |       |               | $          | 24.60               |       |          |       |   |   |   |   |   |
| Exercised                           |       | (3,217     | )          |               | $          | 15.66               |       |          |       |   |   |   |   |   |
| Forfeited/expired/cancelled         |       | (932       | )          |               | $          | 18.61               |       |          |       |   |   |   |   |   |
| Outstanding at  March 31, 2007 |       | 7,564      |       |               | $          | 19.15               |       |          |       | 3.1 |   |   | $ | 113,791 |   |
| Vested and expected to vest         |       | 6,706      |       |               | $          | 18.81               |       |          |       | 3.1 |   |   | $ | 103,106 |   |
| Exercisable at  March 31, 2007 |       | 2,723      |       |               | $          | 14.48               |       |          |       | 2.2 |   |   | $ | 53,673 |   |

 

The aggregate intrinsic value is calculated as thedifference between the exercise price of a stock option and the quoted price ofour common stock at March 31, 2007. It excludes stock options that haveexercise prices in excess of the quoted price of our common stock at March 31,2007. The aggregate intrinsic value of stock options exercised during the fiscalyears ended March 31, 2007, 2006 and 2005 was $42.9 million, $32.9 millionand $24.9 million, respectively.

The weighted-average grant-date fair value per shareof options granted during fiscal years ended March 31, 2007, 2006 and 2005was $7.81, $9.15 and $6.74.

As a result of the stock option grant practicesinquiry, as discussed more fully in our March 31, 2006 Amendment No. 2on Form 10-K/A, certain of our stock options were found to have beengranted with an exercise price below the fair market value of our common stockon the date determined to be the correct measurement date. Those that vestedsubsequent to December 2004 result in nonqualified deferred compensationfor purposes of Section 409A of the Internal Revenue Code, and holders aresubject to an excise tax on the value of the options in the year in which theoptions vest. We have determined that options to purchase approximately 1.1million shares of our common stock held by current and former employees may besubject to adverse tax consequences under Section 409A. All of theaffected shares pertained to grants made to non-executive employees.

In order to mitigate the unfavorable personal taxconsequences under Section 409A, in December 2006 the CompensationCommittee of our Board of Directors, pursuant to the terms and conditions ofour compensatory stock plans under which our stock options had been granted,unilaterally corrected the exercise price of affected options that remainedoutstanding to increase the exercise price to the fair market value of ourcommon stock on the revised measurement date. In January 2007, theCompensation Committee determined to give each affected option holder, subjectto certain conditions, a cash payment equal to the aggregate difference betweenthe initial exercise price and the increased exercise price of each holder’saffected options (“Cash Payment”). We estimate the total Cash Payment will beapproximately $2.4 million and as of March 31, 2007, $2.3 million had beenpaid out to affected employees. We accounted 

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for the impact of the corrected options as a stockoption modification under FAS 123R. As a result of this partial cash settlementof these options and the application of the modification accounting, werecognized $0.7 million in additional compensation cost due to the increase inthe fair value of these options and $0.6 million in accelerated compensationcost.

We also plan to compensate individuals who hadexercised affected options prior to December 2006 for excise tax liabilityand certain other adverse consequences under Section 409A. We incurredadditional compensation expense of $0.9 million in the three months ended December 31,2006 based upon our best estimate of this liability at that point in time. Inthe three months ended March 31, 2007 we increased our estimate of thisliability by $1.2 million based upon our review of the IRS ComplianceResolution Program (the “Program”), announced in February 2007 (IRSAnnouncement 2007-18). It is our intent to participate in this Program,and we estimate our total liability under this Program will be approximately$2.1 million. This amount is included in accrued and other current liabilitiesin our consolidated balance sheet at March 31, 2007.

Asummary of the status of our nonvested shares as of March 31, 2007 andchanges during the year then ended, is as follows (in thousands, except pershare amounts):

| ** **                               | ** ** | ** ** | ** ** | **Weighted-**       | ** ** |
|------------------------------------------|------------|------------|------------|---------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                               | ** ** | ** ** | ** ** | **Grant-date**      | ** ** |
| ** **                               | ** ** | ** ** | ** ** | **Fair Value** | ** ** |
| ** **                               | ** ** | **Shares** | ** ** | **Per Share**  | ** ** |
| Nonvested shares  at April 1, 2006  |       |       | 284        |                |       |   | $ | 19.54 |   |   |
| Granted                                  |       |       | 155        |                |       |   | 26.21 |   |   |
| Vested                                   |       |       | (42        | )                   |       |   | 25.66 |   |   |
| Forfeited/cancelled                      |       |       | (58        | )                   |       |   | 19.63 |   |   |
| Nonvested shares at  March 31, 2007 |       |       | 339        |                |       |   | $ | 21.81 |   |   |

 

The weighted-average grant-date fair value ofnonvested shares granted in the fiscal year ended March 31, 2006 was $19.34.There were no grants of nonvested shares in the fiscal year ended March 31,2005.

Theunrecognized compensation cost, that we expect to vest, related to ournonvested stock-based awards at March 31, 2007, and the weighted-averageperiod over which we expect to recognize that compensation, is as follows (inthousands):

| ** **       | ** ** | **Unrecognized  Compensation Cost at  March 31, 2007** | ** ** | **Weighted-   Average Period  (in years)** | ** ** |
|------------------|------------|----------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Stock options    |       |                                                                       | $          | 23,755                                                    |       |   |   | 1.3 |   |   |
| Nonvested shares |       |                                                                       | 5,330      |                                                      |       |   | 3.6 |   |   |
| ESPP             |       |                                                                       | 777        |                                                      |       |   | 0.4 |   |   |
|             |       |                                                                       | $          | 29,862                                                    |       |   |   |   |   |   |

 

Cash received from exercises of stock options for thefiscal years ended March 31, 2007, 2006 and 2005 was $50.6 million, $37.8million and $42.8 million, respectively. The actual tax benefit realized forthe tax deductions from exercises of all stock-based awards totaled $8.9million, $9.2 million and $6.9 million for the fiscal years ended March 31,2007, 2006 and 2005, respectively.

The fair value of all our stock-based awards thatvested during the years ended March 31, 2007, 2006 and 2005 was $19.9million, $14.8 million and $17.6 million, respectively.

*Non-EmployeeWarrants.*   Inprior years, we have granted stock warrants to third parties in connection withthe acquisition of licensing rights for intellectual property. The warrantsgenerally vest upon grant and 

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are exercisable over the term of the warrant. Theexercise price of third-party warrants is equal to their fair market value ofour common stock at the date of grant. No third-party warrants were granted orexercised during the fiscal years ended March 31, 2007 and 2006.

In fiscal 2005 we granted 240,000 warrants to thirdparties to purchase up to 240,000 shares of our common stock at an exerciseprice of $13.49 per share in connection with a license agreement that allows usto utilize intellectual property owned by such third parties. The warrantsvested upon grant and have a six-year term. The fair value of the warrants wasdetermined using the Black-Scholes pricing model, assuming a risk-free rate of2.9%, a volatility factor of 67% and the six-year term as noted above. The fairvalue of these warrants was $2.0 million.

At March 31, 2007 and 2006, we had 390,000warrants outstanding with weighted average exercise prices per share of $12.32.In fiscal 2006, 112,500 warrants expired unexercised.

In accordance with EITF No. 96-18,“Accounting for Equity Instruments that are Issued to Other Than Employees forAcquiring or in Connection with Selling Goods or Services,” we measure the fairvalue of these warrants on the measurement date. The fair value of each warrantis capitalized and amortized to expense when the related product is releasedand the related revenue is recognized. Additionally, as more fully described inNote 1, the recoverability of intellectual property licenses is evaluated on aquarterly basis with amounts determined as not recoverable being charged to expense.In connection with the evaluation of capitalized intellectual propertylicenses, any capitalized amounts for related third-party warrants areadditionally reviewed for recoverability with amounts determined as notrecoverable being amortized to expense. For the years ended March 31,2007, 2006 and 2005, $738,000, $1.3 million and $2.2 million, respectively, wasamortized and included in cost of sales—license amortization and royaltiesexpense.

**Proformainformation for periods prior to the adoption of FAS 123R**

Prior to the adoption of FAS 123R, we accounted forour stock-based compensation to employees using the intrinsic value method inaccordance with APB 25 and the disclosure-only provisions of FAS 123. Employeestock-based compensation expense recognized under FAS 123R was not reflected inour results of operations for the fiscal years ended March 31, 2006 and2005. Forfeitures of our stock-based awards were reflected in our disclosuresas they occurred. Previously reported amounts have not been restated relativeto our adoption of FAS 123R.

Thefair value of each option grant was estimated on the date of grant using theBlack-Scholes option-pricing model. The following weighted-average assumptionswere used for option grants made under our stock option plans during the fiscalyears ended March 31, 2006 and 2005:

| ** **                                | ** ** | **Fiscal Year Ended  March 31,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| Dividend yield                            |       | 0                                               | %          | 0 | % |
| Anticipated  volatility                   |       | 51                                              | %          | 57 | % |
| Weighted average  risk-free interest rate |       | 4.11                                            | %          | 3.48 | % |
| Expected lives                            |       | 3 years                                         |       | 4 years |   |

 

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Thefollowing table shows what our net income and income per share would havebeen for the fiscal years ended March 31, 2006 and 2005, had compensationcost for our stock-based compensation been measured based on the estimated fairvalue at the grant dates in accordance with the provisions of FAS 123 (inthousands, except per share amounts):

| ** **                                                                                                                                    | ** ** | **Fiscal Year Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| Net income—as  reported                                                                                                                  |       | $                                               | 32,106     |   | $ | 61,397 |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax benefit                                   |       | 2,396                                           |       | 595 |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax benefit |       | (13,131                                         | )          | (17,058 | ) |
| Net income—pro  forma                                                                                                                    |       | $                                               | 21,371     |   | $ | 44,934 |   |
| Earnings per  share:                                                                                                                          |       |                                            |       |   |   |
| Basic—as reported                                                                                                                        |       | $                                               | 0.51       |   | $ | 1.05 |   |
| Basic—pro forma                                                                                                                          |       | $                                               | 0.34       |   | $ | 0.77 |   |
| Diluted—as reported                                                                                                                      |       | $                                               | 0.49       |   | $ | 1.02 |   |
| Diluted—pro forma                                                                                                                        |       | $                                               | 0.33       |   | $ | 0.75 |   |

 

**15.**   StockholdersRights Plan

THQ’s stockholders hold their stock subject to anAmended and Restated Rights Agreement dated August 22, 2001, as amended bythe First Amendment to the Amended and Restated Rights Agreement, dated as of April 9,2002 (collectively, the “Rights Agreement”). Pursuant to the Rights Agreement,and as adjusted pursuant to Section 11(p) of the Rights Agreement asa result of the stock splits which occurred on April 9, 2002 and on September 1,2005, each share of THQ common stock is accompanied by four-ninths (4/9) of apreferred stock purchase right (“Right”) which entitles the registered holderto purchase four nine-thousandths (4/9000) of a share of Series A JuniorParticipating Preferred Stock at an exercise price of $44.44. The Rights becomeexercisable 10 days after any person or group acquires, or 10 business daysafter any person or group has announced its intention to commence a tenderoffer for, 15% or more of the outstanding common stock of THQ. In the eventthat any person or group acquires 15% or more of our outstanding common stock,each holder of a Right (other than such person or group) will be entitled topurchase, at the exercise price, the number of shares of common stock having acurrent market value equal to two times the exercise price of the Right. If weare acquired in a merger or other business combination, each registered holderof a Right will be entitled to purchase, at the exercise price, a number ofshares of common stock of the acquirer having a current market value equal totwo times the exercise price of the Right.

The Board may redeem the Rights at a redemption priceof $0.001 per Right, subject to adjustment, at any time until 10 days after theacquisition of 15% or more of the common stock of THQ. At any time after aperson or group has acquired 15% or more but less than 50% of the common stock,the Board may exchange all or part of the Rights for shares of common stock atan exchange ratio of 4/9 shares of common stock for each Right or fournine-thousandths (4/9000) of a share of Series A Junior ParticipatingPreferred Stock (“Preferred Stock”) per Right. The Rights expire on June 21,2010.

Pursuantto the Certificate of Designation, as amended (the “Certificate of Designation”),establishing the Preferred Stock, effective as September 1, 2005:  (i) each share of Preferred Stock isentitled to quarterly dividends equal to 2,250 times the aggregate per shareamount of all dividends declared on the common stock, (ii) each share ofPreferred Stock will be entitled to 2,250 votes on all matters submitted to avote of 

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THQ’sstockholders, (iii) the “adjustment number” (as defined in the Certificateof Designation) used in Section 6 of the Certificate of Designation forcalculating the liquidation amount for Preferred Stock is 2,250 and (iv) inthe event of a consolidation, merger, combination or similar transaction, eachshare of Preferred Stock will be exchanged or changed into an amount per shareequal to 2,250 times the amount of capital stock, securities, cash or otherproperty for which each share of common stock is exchanged or changed. Thedescription of the Rights contained herein does not purport to be complete andis qualified in its entirety by reference to the Rights Agreement and theCertificate of Designation.

**16.**   Agreementwith JAKKS Pacific, Inc.

In June 1999we entered into an operating agreement with JAKKS Pacific, Inc. (“JAKKS”)that governs our relationship with respect to the World Wrestling Entertainment, Inc.(“WWE”) license. This agreement was amended in January 2002. Ourrelationship with JAKKS was established to enable THQ to develop, manufacture,distribute, market and sell video games pursuant to the license from WWE. Theprincipal terms of this operating agreement are as follows:

·       Weare responsible for funding all operations of the venture, including allpayments owed to WWE;

·       Forthe period commencing November 16, 1999 and ending June 30, 2006,JAKKS was entitled to receive a preferred payment equal to the greater of afixed guarantee, payable quarterly, or specified percentages of the net salesfrom WWE-licensed games (as defined) in amounts that vary based on the platform.We were entitled to the profits and cash distributions remaining after thepayment of these amounts;

·       Forperiods after June 30, 2006, the amount of the preferred payment issubject to renegotiation between the parties. The parties have not yet reachedagreement as to the amount of the preferred payment. We have not paid JAKKSsince June 30, 2006, but are accruing at the payment rate that expired June 30,2006. This preferred payment is included in our consolidated statements ofoperations in the caption “Cost of sales—venture partner expense.”  An arbitration procedure is specified in theevent the parties do not reach agreement; and

·       Weare responsible for the day-to-day operations of the venture. We areresponsible for development, sales and distribution of WWE-licensed games, andJAKKS is responsible for the approval process and other relationship matterswith WWE.

For financial reporting purposes, we are deemed tocontrol the venture; therefore, all venture operating results are consolidatedwith our results.

In November 2001, through the venture with JAKKS,we entered into an amendment to expand the WWE license to include exclusiverights to other wrestling content produced by the WWE throughDecember 2014. In exchange for these rights we paid a minimum guarantee toWWE that has already been recouped.

We are currently involvedin litigation with WWE and JAKKS with respect to the license and the preferredpayment. See “Note 17—Commitments and Contingencies - Litigation.”

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**17.**   Commitmentsand Contingencies

Asummary of annual minimum contractual obligations and commercial commitments asof March 31, 2007 is as follows (in thousands):

| ** **            | ** ** | **Contractual Obligations and Commercial Commitments** | ** ** |
|-----------------------|------------|----------------------------------------------------------------------------|------------|
| ** **            | ** ** | **License /**                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Fiscal**            | ** ** | **Software**                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Years Ending** | ** ** | **Development**                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | **Letters of** | ** ** | ** ** | ** ** |
| **March 31,**    | ** ** | ** **                                                                 | ** ** | **Commitments(1)** | ** ** | **Advertising(2)** | ** ** | **Leases(3)** | ** ** | **Credit(4)** | ** ** | **Total** | ** ** |
| 2008                  |       |                                                                       | $          | 95,642 |   |   |   | $ | 14,078 |   |   |   | $ | 14,206 |   |   |   | $ | 22,699 |   |   | $ | 146,625 |   |
| 2009                  |       |                                                                       | 49,294     |   |   |   | 14,034 |   |   |   | 13,669 |   |   |   | — |   |   | 76,997 |   |
| 2010                  |       |                                                                       | 43,115     |   |   |   | 14,815 |   |   |   | 13,151 |   |   |   | — |   |   | 71,081 |   |
| 2011                  |       |                                                                       | 13,850     |   |   |   | 9,678 |   |   |   | 12,558 |   |   |   | — |   |   | 36,086 |   |
| 2012                  |       |                                                                       | 850        |   |   |   | 1,461 |   |   |   | 10,637 |   |   |   | — |   |   | 12,948 |   |
| Thereafter            |       |                                                                       | 1,100      |   |   |   | 2,557 |   |   |   | 23,044 |   |   |   | — |   |   | 26,701 |   |
|                  |       |                                                                       | $          | 203,851 |   |   |   | $ | 56,623 |   |   |   | $ | 87,265 |   |   |   | $ | 22,699 |   |   | $ | 370,438 |   |
|                       |            |                                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          *Licenses andSoftware Development*.   We enter intocontractual agreements with third parties for the rights to intellectualproperty and for the development of products. Under these agreements, we committo provide specified payments to an intellectual property holder or developer.Assuming all contractual provisions are met, the total future minimum contractcommitments for contracts in place as of March 31, 2007 are approximately$203.9 million. License/software development commitments in the table aboveinclude $67.0 million of commitments to licensors that are included in ourconsolidated balance sheet as of March 31, 2007 because the licensors donot have any significant performance obligations to us. These commitments areincluded in both current and long-term licenses and accrued royalties.

(2)          *Advertising*.   Wehave certain minimum advertising commitments under most of our major licenseagreements. These minimum commitments generally range from 2% to 12% of netsales related to the respective license. We estimate that our minimumcommitment for advertising in fiscal 2008 will be $14.1 million.

(3)          *Leases*.   Weare committed under operating leases with lease termination dates through 2015.Most of our leases contain rent escalations. Rent expense was$14.0 million, $10.6 million and $6.0 million for the fiscalyears ended March 31, 2007, 2006 and 2005, respectively.

(4)          *Letters ofCredit*.   As of March 31, 2007, we had outstanding letters of credit ofapproximately $22.7 million. Our previous credit facility expired onNovember 29, 2006 and we did not renew it. On October 3, 2006, weentered into an agreement with a bank primarily to provide stand-by letters ofcredit to a platform manufacturer from whom we purchase products. We are requiredto pledge cash equivalents and investments to the bank as collateral in anamount equal to 110% of the amount of the outstanding stand-by letters ofcredit.

Other potential future expenditures relate to thefollowing:

*ManufacturerIndemnification.**  *We mustindemnify the platform manufacturers (Microsoft, Nintendo, Sony) of our gameswith respect to all loss, liability and expenses resulting from any claimagainst such manufacturer involving the development, marketing, sale or use ofour games, including any claims for copyright or trademark infringement broughtagainst such manufacturer. As a result, we bear a risk that the properties uponwhich the titles of our games are based, or that the information and technologylicensed from others and incorporated into the products, may infringe therights of third parties. Our agreements with our third-party softwaredevelopers and property licensors typically provide indemnification rights forus with respect to certain matters. However, if a manufacturer brings a claim 

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against us for indemnification, the developers orlicensors may not have sufficient resources to, in turn, indemnify us.

*Director IndemnityAgreements.**  *We haveentered into indemnification agreements with the members of our Board ofDirectors to provide a contractual right of indemnification to our Directors tothe extent permitted by law against any and all liabilities, costs, expenses,amounts paid in settlement and damages incurred by the Directors as a result ofany lawsuit, or any judicial, administrative or investigative proceeding inwhich the Directors are sued as a result of their service as members of ourBoard of Directors. The indemnification agreements provide specific proceduresand time frames with respect to requests for indemnification and clarify thebenefits and remedies available to Directors in the event of an indemnificationrequest.

*Litigation.*

*WWE relatedLawsuits*

On October 19, 2004, World WrestlingEntertainment, Inc. (“WWE”) filed a lawsuit in the United States DistrictCourt for the Southern District of New York (the “Court”) against JAKKS Pacific, Inc.(“JAKKS”), THQ, THQ/JAKKS Pacific LLC (the “LLC”), and others, alleging, amongother claims, improper conduct by JAKKS, certain executives of JAKKS, anemployee of the WWE and an agent of the WWE in granting the WWE videogamelicense to the LLC. The complaint seeks various forms of relief, includingmonetary damages and a judicial determination that, among other things, the WWEvideogame license is void. On March 30, 2005, WWE filed an amendedcomplaint, adding both new claims and THQ’s president and chief executiveofficer, Brian Farrell, as a defendant. In August 2005, the Court directedthe parties to file briefs on the three federal law claims alleged by thePlaintiffs (i.e., Robinson-Patman, and Sherman Act, and a threshold issueconcerning the Plaintiff’s RICO claim). The motions to dismiss the amendedcomplaint based on these issues were fully briefed and argued and, on March 31,2006, the Court granted the defendants’ motion to dismiss the Robinson-PatmanAct and Sherman Act claims and denied the defendants’ motion seeking to dismissthe RICO claims on the basis of the threshold “enterprise” issue that wasbriefed (the “March 31 Order”).

On April 7, 2006, the Company and the otherdefendants sought certification to appeal from the portion of the March 31Order denying the motion to dismiss the RICO claim on the one ground that wasbriefed. Shortly thereafter, WWE filed a motion for re-argument with respect tothe portion of the March 31 Order that dismissed the Sherman Act claimand, alternatively, sought judgment with respect to the Sherman Act claim sothat it could pursue an immediate appeal. At a court hearing on April 26,2006, the Court deferred a ruling on the requests for partial judgment and forcertification and set briefing schedules with respect to the remaining groundsfor defendants’ motion to dismiss the RICO claim, currently the sole remainingbasis for federal jurisdiction in this action, that were not the subject of thefirst round of briefing. The Court also established a briefing schedule for WWE’smotion for re-argument of the dismissal of the Sherman Act claim. The briefingwas completed in August of 2006 and a hearing was held in September of2006. The Court has not yet ruled on the pending motions. Discovery in thisaction remains stayed.

THQ believes that neither it, nor Brian Farrell, isprimarily accused of any wrongdoing in the complaint or the amended complaint,and believes that either there is no basis for terminating the WWE videogamelicense, or that THQ will be made whole by those whose conduct is eventuallyfound to be unlawful. We intend to vigorously protect our rights and, ifnecessary, pursue appropriate claims against third parties.

On October 12, 2006, WWE filed a separate lawsuitagainst the Company and the LLC in the Superior Court of the State ofConnecticut, alleging that the Company’s agreements with Yuke’s Co., Ltd. (“Yukes”),a developer and distributor in Japan, violated a provision of the WWE videogamelicense prohibiting sublicenses without WWE’s written consent. The lawsuitseeks, among other things, a 

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declaration that the WWE is entitled to terminate thevideo game license and seek monetary damages. On February 8, 2007, theCompany and the LLC jointly moved to strike one of the claims, for violation ofthe Connecticut Unfair Trading Practices Act; on March 28, 2007, the Courtdenied that motion, without prejudice to the defendants’ ability to raise thesame issue at a later date. On February 22, 2007, the Court established aschedule for this case, including discovery, and ordering that the case be “exposedfor trial” as of October 14, 2008. However, on March 30, 2007, WWEmoved for leave to amend its pleadings to add allegations and claimssubstantially similar to those already pending in WWE’s lawsuit in the SouthernDistrict of New York and to “cite in” the other defendants from that action. Thedefendants objected to this motion. At a hearing on May 8, 2007, the Courtgranted WWE’s request to amend the complaint and add defendants. The Court alsosuspended deadlines under its existing scheduling order and indicated it willre-examine the schedule after the new defendants have been served and haveappeared. The amended complaint was served on the Company and Brian Farrell onor about May 10, 2007. The Company believes it and the LLC have severalbases for defending any claim of breach of the WWE videogame license agreementresulting from the manner of distribution of WWE-licensed products in Japan andother Asian territories. We intend to vigorously defend ourselves against theclaims raised in this action, including those raised in the amended complaint.

Due to the early status ofthis litigation with WWE we cannot estimate a possible loss, if any. Games wedevelop based upon our WWE videogame license have contributed to approximately15% of our net sales during each of the three years in the period ended March 31,2007. The loss of the WWE license would have a negative impact on our futurefinancial results.

*Operating agreementwith JAKKS Pacific, Inc.*

In June 1999 we entered into an operatingagreement with JAKKS that governs our relationship with respect to the WWEvideogame license. Pursuant to the terms of this agreement, JAKKS is entitledto a preferred payment from revenues derived from exploitation of the WWEvideogame license. The amount of the preferred payment to JAKKS for the periodbeginning July 1, 2006 and ending December 31, 2009 (the “FirstSubsequent Distribution Period”) is to be determined by agreement or, failingthat, by arbitration.

The parties have not reached agreement on thepreferred payment for the First Subsequent Distribution Period. Accordingly, asprovided in the operating agreement, the parties are in the process ofselecting an arbitrator to resolve this dispute. Although we believecontinuation of the previous preferred payment would represent significantlyexcessive compensation to JAKKS for the First Subsequent Distribution Period,we are not able to predict the outcome of the arbitration or otherwise estimatethe amount of the preferred payment for the First Subsequent DistributionPeriod. Accordingly, we are currently accruing for a preferred payment to JAKKSat the previous rate. However, we have advised JAKKS that we do not intend tomake any payment until the amount of the preferred payment payable to JAKKS forthe First Subsequent Distribution Period is agreed or otherwise determined asprovided in the operating agreement. On April 30, 2007, we filed apetition to compel arbitration and appoint an arbitrator in the Superior Courtof the State of California for the County of Los Angeles, West District. Ourpetition seeks a court order compelling JAKKS to comply with the arbitrationprovisions in the operating agreement and establishing a process and timelinefor selecting an arbitrator. On or about May 22, 2007, JAKKS filed aresponse to our petition, as well as an application for provisional reliefrequesting that, pending conclusion of the arbitration, THQ either be enjoinedfrom distributing to itself any proceeds from the joint venture since June 2006or be compelled to resume payments to JAKKS at the same rate that was in effectprior to June 2006. A hearing on the petition is scheduled for June 19,2007.

We do not expect theresolution of this dispute to have a material adverse impact on our results ofoperations, financial position or cash flows.

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*SEC InformalInquiry*

On August 4, 2006, we received an informalinquiry from the Securities and Exchange Commission (“SEC”) requesting certaindocuments and information relating to our stock option grant practices from January 1,1996 to the present. We publicly announced this inquiry on August 7, 2006.Prior to August 4, 2006, we were already conducting an internal review ofour historical stock option grant practices with the assistance of outsidecounsel. We initiated the internal review following extensive news coverage andanalyst reports about the option practices of numerous companies across severaldifferent industries. The Company has cooperated fully with the SEC’s inquiry.

Upon receipt of the notice of informal inquiry fromthe SEC, our Board of Directors (the “Board”) formed a special committeeconsisting of one outside director, Jeffrey Griffiths (the “Special Committee”),to conduct an independent and comprehensive investigation of our stock optionpractices and to oversee our response to the SEC. The Special Committeeretained independent outside legal counsel and forensic accountants (the “InvestigativeTeam”) to aid in its investigation.

The Special Committeeconcluded its investigation and reported its findings to the full Board on December 2,2006. The Special Committee found no evidence of fraud or misconduct by anyperson with respect to the company’s historical stock option grant practices. TheSpecial Committee did identify instances where documentation of certain optiongrants was lacking. The Special Committee also determined that an incorrectmeasurement date for financial accounting purposes was used on a number ofoccasions. These errors resulted primarily from misapplication of accountingstandards related to certain measurement date selection methods discussed indetail in Note 2 to the Notes to the Consolidated Financial Statements of ourAmendment No. 2 on Form 10-K/A for the year ended March 31,2006, which in a number of occasions resulted in employees receiving optionswith stated exercise prices lower than the market prices as measured based uponthe measurement dates as determined by the applicable accounting standards. TheSpecial Committee also recommended certain remedial measures with respect tothe Company’s stock option granting practices, which were adopted by the Board.The Special Committee and the Investigative Team reported the Special Committee’sfindings to the SEC on January 8, 2007.

*Lawsuits related toour historical stock option granting practices*

*Kukorand Ramsey v. Haller, et. Al.**  *OnAugust 25, 2006, following our announcement of the informal inquiry by theSEC, a purported shareholder derivative action captioned *Ramsey v.Haller et Al.* was filed against certain of our current and formerofficers and directors in the California Superior Court, Los Angeles County. Thecomplaint alleges, among other things, purported improprieties in our issuanceof stock options, breach of fiduciary duty and unjust enrichment. Anotherlawsuit was subsequently filed by the same law firm on behalf of anotherpurported shareholder, David Kukor, and the parties stipulated to consolidatethe two actions. On or about April 19, 2007, a Consolidated ShareholderDerivative Complaint (the “Consolidated Complaint”) was filed, alleging thesame types of claims and quoting from various public statements by THQ sincethe filing of the original complaint. THQ is also named as a nominal defendant.The Company intends to demur to the Consolidated Complaint. Pursuant to courtorder, the demurrer must be filed by May 28, 2007, and a hearing for thedemurrer is currently scheduled for August 9, 2007. Discovery in thismatter is currently stayed.

*HawaiiLaborers Pension Fund v. THQ, et. Al.**  *In October 2006, a purported shareholderderivative action captioned *Hawaii Laborers PensionFund v. THQ, et. Al.*, was filed against certain of our current andformer officers and directors in federal district court, alleging claims under Section 14(a) ofthe Securities Exchange Act of 1934 as well as various state law claims arisingout of alleged breaches of fiduciary duty related to stock option practices. Onor about April 20, 2007, the plaintiff filed an Amended and VerifiedShareholder Derivative Complaint (the “Amended Complaint”) alleging thatcertain current and former officers and directors engaged in a conspiracy tomanipulate grants dates associated with stock options and 

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then concealed the alleged backdating option schemeand filed false and misleading statements with the SEC. THQ is also named as anominal defendant. The Company intends to file a Motion to Dismiss the AmendedComplaint, which pursuant to a stipulation between the parties, must be filedby June 1, 2007. No discovery has yet commenced in this action.

Although litigation issubject to inherent uncertainties, we do not believe the results of theseactions will, individually or in the aggregate, have a material adverse impacton our consolidated financial position or results of operations.

*Other*

Additionally, we areinvolved in routine litigation arising in the ordinary course of our business.In the opinion of our management, none of this pending routine litigation willhave a material adverse effect on our consolidated financial condition orresults of operations.

**18.** Segment and Geographic Information

Weoperate in one reportable segment in which we are a developer, publisher anddistributor of interactive entertainment software for home video game consoles,handheld platforms and personal computers. The following information sets forthgeographic information on our sales and total assets for the fiscal years endedMarch 31, 2007, 2006 and 2005 (in thousands):

| ** **                           | ** ** | **North  America** | ** ** | **Europe** | ** ** | **Asia  Pacific** | ** ** | **Consolidated** | ** ** |
|--------------------------------------|------------|--------------------|------------|------------|------------|-------------------|------------|------------------|------------|
| **Year ended March 31, 2007**   | ** ** | ** **         | ** ** | ** ** | ** ** | ** **        | ** ** |             | ** ** | ** ** |   |
| Net sales to  unaffiliated customers |       | $                  | 600,159    |       | $          | 365,406           |       | $                | 61,291     |   |   | $ | 1,026,856 | ** ** |   |
| Total assets                         |       | 900,579            |       | 89,950     |       | 23,012            |       |             | 1,013,541  | ** ** |   |
| **Year  ended March 31, 2006**  | ** ** | ** **         | ** ** | ** ** | ** ** | ** **        | ** ** |             | ** ** | ** ** |   |
| Net sales to  unaffiliated customers |       | $                  | 489,945    |       | $          | 269,928           |       | $                | 46,687     |   |   | $ | 806,560 | ** ** |   |
| Total assets                         |       | 774,126            |       | 62,664     |       | 11,678            |       |             | 848,468    | ** ** |   |
| **Year  ended March 31, 2005**  | ** ** | ** **         | ** ** | ** ** | ** ** | ** **        | ** ** |             | ** ** | ** ** |   |
| Net sales to  unaffiliated customers |       | $                  | 470,619    |       | $          | 245,083           |       | $                | 41,029     |   |   | $ | 756,731 | ** ** |   |
| Total assets                         |       | 671,497            |       | 64,948     |       | 10,161            |       |             | 746,606    | ** ** |   |

 

Our largest single customer accounted for 18% of ourgross sales in fiscal 2007, 19% of our gross sales in fiscal 2006 and 14% ofour gross sales in fiscal 2005.

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Informationabout THQ’s net sales by platform for fiscal 2007, 2006 and 2005 is presentedbelow (in thousands):

| ** **                | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|---------------------------|------------|-----------------------------------------------------|------------|
| **Platform**              | ** ** | ** **                                          | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Consoles**              | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Microsoft Xbox 360        |       | $                                                   | 134,908    |   | $ | 14,479 |   | $ | — |   |
| Microsoft Xbox            |       | 27,476                                              |       | 88,181 |   | 80,623 |   |
| Nintendo Wii              |       | 30,025                                              |       | — |   | — |   |
| Nintendo GameCube         |       | 52,338                                              |       | 59,255 |   | 73,157 |   |
| Sony PlayStation 2        |       | 304,916                                             |       | 296,294 |   | 275,850 |   |
|                      |       | 549,663                                             |       | 458,209 |   | 429,630 |   |
| **Handheld**              | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nintendo Dual Screen      |       | 114,143                                             |       | 32,855 |   | 3,110 |   |
| Nintendo Game Boy Advance |       | 119,869                                             |       | 171,477 |   | 204,348 |   |
| Sony PlayStation Portable |       | 65,402                                              |       | 29,406 |   | — |   |
| Wireless                  |       | 26,467                                              |       | 36,112 |   | 24,613 |   |
|                      |       | 325,881                                             |       | 269,850 |   | 232,071 |   |
| **PC**                    |       | 149,546                                             |       | 77,615 |   | 86,667 |   |
| **Other**                 |       | 1,766                                               |       | 886 |   | 8,363 |   |
| **Total Net Sales**       |       | $                                                   | 1,026,856  |   | $ | 806,560 |   | $ | 756,731 |   |
|                           |            |                                                     |            |  |  |  |  |  |  |  |  |  |

 

**19.** Quarterly Financial Data (Unaudited)

***Twelve Months EndedMarch 31, 2007***

| ** **                                                                          | ** ** | ** ** | ** ** | **Quarter Ended**  | ** ** | ** **               | ** ** |
|-------------------------------------------------------------------------------------|------------|------------|------------|-------------------------|------------|--------------------------|------------|
| **(Amounts in thousands, except per share data)**     | ** ** | ** ** | ** ** | **June 30,  2006** | ** ** | **Sept. 30,  2006** | ** ** | **Dec. 31,  2006** | ** ** | **March 31,  2007** | ** ** | **Fiscal Year  Ended** | ** ** |
| Net sales                                                                           |       | $          | 138,829    |                    | $          | 240,197                  |       | $ | 475,741 |   | $ | 172,089 |   | $ | 1,026,856 |   |
| Expenses and  other                                                                 |       | 157,037    |       | 222,796                 |       | 391,419                  |       | 164,576 |   | 935,828 |   |
| Income (loss)  from continuing operations before income taxes and minority interest |       | (18,208    | )          | 17,401                  |       | 84,322                   |       | 7,513 |   | 91,028 |   |
| Income taxes                                                                        |       | (6,009     | )          | 5,857                   |       | 24,367                   |       | 1,991 |   | 26,206 |   |
| Income (loss)  from continuing operations before minority interest                  |       | (12,199    | )          | 11,544                  |       | 59,955                   |       | 5,522 |   | 64,822 |   |
| Minority interest                                                                   |       | 98         |       | 45                      |       | (7                       | )          | — |   | 136 |   |
| Income (loss)  from continuing operations                                           |       | (12,101    | )          | 11,589                  |       | 59,948                   |       | 5,522 |   | 64,958 |   |
| Gain on sale of  discontinued operations, net of tax                           |       | —     |       | —                  |       | 2,107                    |       | 973 |   | 3,080 |   |
| Net income (loss)                                                                   |       | $          | (12,101    | )                       | $          | 11,589                   |       | $ | 62,055 |   | $ | 6,495 |   | $ | 68,038 |   |
| Earnings (loss) per share—basic:                                               |       |       |       |                    |       |                     |       |   |   |   |   |
| Continuing operations                                                               |       | $          | (0.19      | )                       | $          | 0.18                     |       | $ | 0.92 |   | $ | 0.08 |   | $ | 1.00 |   |
| Discontinued operations                                                             |       | —     |       | —                  |       | 0.03                     |       | 0.02 |   | 0.05 |   |
| Earnings (loss) per share—basic                                                |       | $          | (0.19      | )                       | $          | 0.18                     |       | $ | 0.95 |   | $ | 0.10 |   | $ | 1.05 |   |
| Earnings (loss)  per share—diluted:                                            |       |       |       |                    |       |                     |       |   |   |   |   |
| Continuing operations                                                               |       | $          | (0.19      | )                       | $          | 0.17                     |       | $ | 0.88 |   | $ | 0.08 |   | $ | 0.96 |   |
| Discontinued operations                                                             |       | —     |       | —                  |       | 0.03                     |       | 0.01 |   | 0.05 |   |
| Earnings (loss) per  share—diluted                                             |       | $          | (0.19      | )                       | $          | 0.17                     |       | $ | 0.91 |   | $ | 0.09 |   | $ | 1.01 |   |

 

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***Twelve Months EndedMarch 31, 2006***

| ** **                                                                      | ** ** | ** ** | ** ** | **Quarter Ended**  | ** ** | ** **               | ** ** |
|---------------------------------------------------------------------------------|------------|------------|------------|-------------------------|------------|--------------------------|------------|
| **(Amounts in thousands, except per share data)** | ** ** | ** ** | ** ** | **June 30,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **Dec. 31,  2005** | ** ** | **March 31,  2006** | ** ** | **Fiscal Year  Ended** | ** ** |
| Net sales                                                                       |       | $          | 157,967    |                    | $          | 142,692                  |       | $ | 357,848 |   | $ | 148,053 |   |   | $ | 806,560 |   |   |
| Expenses and  other                                                             |       | 163,913    |       | 145,296                 |       | 292,945                  |       | 164,616 |   |   | 766,770 |   |   |
| Income (loss)  before income taxes and minority interest                        |       | (5,946     | )          | (2,604                  | )          | 64,903                   |       | (16,563 | ) |   | 39,790 |   |   |
| Income taxes                                                                    |       | (1,772     | )          | (663                    | )          | 17,917                   |       | (7,861 | ) |   | 7,621 |   |   |
| Income (loss)  before minority interest                                         |       | (4,174     | )          | (1,941                  | )          | 46,986                   |       | (8,702 | ) |   | 32,169 |   |   |
| Minority interest                                                               |       | (57        | )          | 3                       |       | (62                      | )          | 53 |   |   | (63 | ) |   |
| Net income (loss)                                                               |       | $          | (4,231     | )                       | $          | (1,938                   | )          | $ | 46,924 |   | $ | (8,649 | ) |   | $ | 32,106 |   |   |
| Earnings (loss)  per share                                                      |       |       |       |                    |       |                     |       |   |   |   |   |   |   |
| Basic                                                                           |       | $          | (0.07      | )                       | $          | (0.03                    | )          | $ | 0.75 |   | $ | (0.14 | ) |   | $ | 0.51 |   |   |
| Diluted                                                                         |       | $          | (0.07      | )                       | $          | (0.03                    | )          | $ | 0.71 |   | $ | (0.14 | ) |   | $ | 0.49 |   |   |

 

Due to rounding andreclassifications, some of the figures above may differ slightly from the 10-Q’spreviously filed. See Note 1, “Description of Business and Summary ofSignificant Accounting Policies” for description of certain reclassificationsmade to the prior period consolidated financial statements to conform to thecurrent period consolidated financial statements.

**20.** Discontinued Operations

In December 2006, we sold our 50% interest inMinick. As of March 31, 2007 we have received approximately $17.1 millionin cash and recognized a gain of approximately $3.1 million in discontinuedoperations due to the sale of Minick. Pursuant to the Minick sale agreement, wemay receive additional consideration of approximately $2.7 million over thenext 9 to 15 months. If such amounts are received, the additional gainrecognized will be reported in discontinued operations in the period theproceeds are collected. The results of Minick’s operations were not material toany of the periods presented and have therefore not been reclassified asdiscontinued operations.

85

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**Item 9.**                        Changesin and Disagreements with Accountants on Accounting and Financial Disclosure

None.

**Item 9A.**                Controlsand Procedures

(a) *Definition and limitations of disclosure controls*.Our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the“Exchange Act”)) are controls and other procedures that are designed to ensurethat information required to be disclosed in our reports filed under theExchange Act, such as this report, is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms. Disclosure controls and procedures are alsodesigned to ensure that such information is accumulated and communicated to ourmanagement, including the Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosure. Ourmanagement evaluates these controls and procedures on an ongoing basis todetermine if improvements or modifications are necessary.

There are inherentlimitations to the effectiveness of any system of disclosure controls andprocedures. These limitations include the possibility of human error, thecircumvention or overriding of the controls and procedures and reasonableresource constraints. In addition, because we have designed our system ofcontrols based on certain assumptions, which we believe are reasonable, aboutthe likelihood of future events, our system of controls may not achieve itsdesired purpose under all possible future conditions. Accordingly, ourdisclosure controls and procedures provide reasonable assurance, but notabsolute assurance, of achieving their objectives.

(b) *Evaluation ofdisclosure controls and procedures*. Our Chief Executive Officer andChief Financial Officer, after evaluating the effectiveness of our disclosurecontrols and procedures, believe that as of the end of the period covered bythis report, our disclosure controls and procedures were effective in providingthe requisite reasonable assurance that material information required to bedisclosed in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosure.

(c) *Changes ininternal control over financial reporting*. There were no materialchanges in our internal control over financial reporting in the fourth quarterof fiscal 2007.

86

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**Management Reporton Internal Control Over Financial Reporting**

We, as management of THQ Inc. and its subsidiaries(the “Company”), are responsible for establishing and maintaining adequateinternal controls over financial reporting. Pursuant to the rules andregulations of the Securities and Exchange Commission, internal control overfinancial reporting is a process designed by, or under the supervision of, theCompany’s principal executive and principal financial officers, or personsperforming similar functions, and effected by the Company’s board of directors,management and other personnel, to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples and includes those policies and procedures that:

Pertain to the maintenance of records that inreasonable detail accurately and fairly reflect the transactions anddispositions of the assets of the Company;

Provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the Company are being made only in accordance withauthorizations of management and directors of the Company; and

Provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use or disposition of the Company’sassets that could have a material effect on the financial statements.

Management has conducted an assessment of theeffectiveness of the Company’s internal control over financial reporting as of March 31,2007 based on the control criteria established in a report entitled InternalControl—Integrated Framework, issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based on such assessment, we haveconcluded that the Company’s internal control over financial reporting iseffective as of March 31, 2007.

Theregistered independent public accounting firm of Deloitte & ToucheLLP, as auditors of the Company’s consolidated financial statements, has issuedan attestation report on management’s assessment of the Company’s internalcontrol over financial reporting.

| /s/ BRIAN  J. FARRELL                |                                                 | /s/ EDWARD K.  ZINSER |   |
|--------------------------------------|------------------------------------------------------|-----------------------|--------|
| Brian J. Farrell                     | Edward K. Zinser                                     |
| Chairman of the Board, President and | Executive Vice President,                            |
| Chief Executive Officer              | Chief Financial Officer and Chief Accounting Officer |
| May 30, 2007                    | May 30, 2007                                    |

 

**Item 9B.**               OtherInformation

None.

87

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

Tothe Board of Directors and Stockholders of THQ Inc.,

Agoura Hills, California

We have audited management’s assessment, included inthe accompanying Management Report on Internal Control over FinancialReporting, that THQ Inc. and its subsidiaries (the “Company”) maintainedeffective internal control over financial reporting as of March 31, 2007,based on criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the Company’s internal control over financial reporting basedon our audit.

We conducted our audit in accordance with the standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed by, or under the supervision of, the company’s principalexecutive and principal financial officers, or persons performing similarfunctions, and effected by the company’s board of directors, management, andother personnel to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal controlover financial reporting, including the possibility of collusion or impropermanagement override of controls, material misstatements due to error or fraudmay not be prevented or detected on a timely basis. Also, projections of anyevaluation of the effectiveness of the internal control over financialreporting to future periods are subject to the risk that the controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of March 31,2007, is fairly stated, in all material respects, based on the criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.Also in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of March 31, 2007,based on the criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the Company’s consolidated balance sheet as of March 31,2007 and the related consolidated statements of operations, stockholders’equity and cash flows for the year then ended. Our report dated May 30,2007 expressed an unqualified opinion on those financial statements.

**DELOITTE & TOUCHELLP**

Los Angeles, California

May 30, 2007

88

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**PART III**

**Item 10.***                *Directors,Executive Officers and Corporate Governance

The followinginformation required by Item 10 is incorporated herein by reference fromour definitive Proxy Statement for the 2007 Annual Meeting of Stockholders,which will be filed within 120 days after the close of our fiscal year (the “ProxyStatement”):

·       Informationregarding directors who are nominated for election is included under thecaption “Proposal Number 1—Election of Directors;”

·       Informationregarding executive officers is included under the caption “Executive Officers;”

·       Informationrelated to involvement in certain legal proceedings is included under thecaption “Involvement in Certain Proceedings;”

·       Informationregarding the audit committee and its financial expert is included under thecaption “Committees of the Board of Directors;” and

·       Informationregarding Section 16 compliance is included under the caption “Section 16(a) BeneficialOwnership Reporting Compliance.”

Information regarding ourcode of ethics applicable to our directors, principal executive officer,principal financial officer, principal accounting officer, and other seniorfinancial officers appears under the caption “Charters, Code of Ethics, andCode of Business Conduct and Ethics.”

**Item 11.***                *Executive Compensation

The information requiredunder this Item relating to executive compensation will be included in theProxy Statement under the heading “Executive Compensation,” and is incorporatedherein by reference.

**Item12.***                *SecurityOwnership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information requiredby Item 12 related to securities authorized for issuance under equitycompensation plans is included in Item 5 herein. The information required byItem 12 related to security ownership of certain beneficial owners andmanagement is incorporated herein by reference to the information in the ProxyStatement under the caption “Security Ownership of Certain Beneficial Ownersand Management.”

**Item 13.***                *Certain Relationships and RelatedTransactions, and Director Independence

There were no reportablebusiness relationships, transactions with management, or indebtedness ofmanagement during the fiscal year ended March 31, 2007.

**Item 14.***                *Principal Accounting Fees andServices

The information regardingprincipal accounting fees and services and the Company’s pre-approval policiesand procedures for audit and non-audit services provided by the Company’sindependent accountant is incorporated by reference to the Proxy Statement underthe caption “Proposal Number 3—Ratification of Independent Registered PublicAccounting Firm.”

89

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**PART IV**

**Item 15.**                 Exhibitsand Consolidated Financial Statement Schedules

***(a) Financial Statements andFinancial Statement Schedules***

Thefollowing financial statements of the Company are included in Part II Item8:
|                                                                                                                                                    | ** ** | **Page** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING  FIRM                                                                                           |       |     | 51         |   |   |
| CONSOLIDATED  FINANCIAL STATEMENTS                                                                                                                 |       |     |       |   |   |
| Consolidated  balance sheets—March 31, 2007 and 2006                                                                                     |       |     | 52         |   |   |
| Consolidated  statements of operations for the fiscal years ended March 31, 2007, 2006  and 2005                                              |       |     | 53         |   |   |
| Consolidated  statements of stockholders’ equity for the fiscal years ended March 31,  2007, 2006 and 2005      |       |     | 54         |   |   |
| Consolidated  statements of cash flows for the fiscal years ended March 31, 2007, 2006  and 2005                                              |       |     | 55         |   |   |
| NOTES  TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                        |       |     | 56         |   |   |

 

***(b) Exhibits.***

Thefollowing exhibits are filed herewith or are incorporated by reference toexhibits previously filed with the SEC. We will furnish copies of the exhibitsfor a reasonable fee (covering the expense of furnishing copies) upon request:
| Exhibit  Number | ** ** | **Title**                                                                                                                                                                                                                                                                                                                                                  |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |       | Certificate of  Incorporation (incorporated by reference to Exhibit 3.1 to  Post-Effective Amendment No. 1 to the Registration Statement on  Form S-3 filed on January 9, 1998 (File No. 333-32221)  (the “S-3 Registration Statement”)).                                                                          |
| 3.2             |       | Amendment to  Certificate of Incorporation (incorporated by reference to Exhibit 3.2  to Post-Effective Amendment No. 1 to the S-3 Registration  Statement).                                                                                                                                                                                     |
| 3.3             |       | Amendment to  Certificate of Incorporation (incorporated by reference to Exhibit 3.3  to the Registrant’s Quarterly Report on Form 10-Q for the quarter  ended June 30, 2001).                                                                                                                                                         |
| 3.4             |       | Amended and  Restated Bylaws (incorporated by reference to Exhibit 3 to the  Registrant’s Current Report on Form 8-K filed on June 22,  2000).                                                                                                                                                                                         |
| 3.5             |       | Certificate of  Designation of Series A Junior Participating Preferred Stock of THQ Inc.  (incorporated by reference to Exhibit A of Exhibit 1 of Amendment  No. 2 to the Registrant’s Registration Statement on Form 8-A  filed on August 28, 2001 (File No. 001-15959) (the  “August 2001 8-A”)). |
| 3.6             |       | Amendment to  Certificate of Designation of Series A Junior Participating Preferred  Stock of THQ Inc. (incorporated by reference to Exhibit 3.6 to the  Registrant’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2001).                                                                                   |
| 4.1             |       | Amended and  Restated Rights Agreement, dated as of August 22, 2001 between the  Company and Computershare Investor Services, LLC, as Rights Agent  (incorporated by reference to Exhibit 1 to Amendment No. 2 to the Registrant’s  August 2001 8-A).                                                                             |

 

90

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| Exhibit  Number | ** ** | **Title**                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.2             |       | First Amendment to  Amended and Restated Rights Agreement, dated April 9, 2002 between the  Company and Computershare Investor Services, LLC, as Rights Agent  (incorporated by reference to Exhibit 2 to Amendment No. 3 to the  Registrant’s Registration Statement on Form 8-A filed on  April 12, 2002 (file No. 000-18813)).                                                                                    |
| 10.1 #          |       | Stock Option  Agreement dated as of December 23, 1998, between the Company and James  Whims (incorporated by reference to Exhibit 10.9 to the Registrant’s  Quarterly Report on Form 10-Q for the quarter ended June 30,  1999).                                                                                                                                                                                               |
| 10.2 #          |       | Amended and  Restated Employment Agreement, dated as of July 20, 2006 between the  Company and Brian J. Farrell (incorporated by reference to Exhibit 10.1  to the Registrant’s Quarterly Report on Form 10-Q for the quarter  ended September 30, 2006 (the “September 2006 10-Q”)).                                                                                                                           |
| 10.3 #          |       | Ed Zinser Offer  Letter dated March 24, 2004 (incorporated by reference to Exhibit 10.3  to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2004 (the “June 2004 10-Q”)).                                                                                                                                                                                                        |
| 10.4 #          |       | Kelly Flock Offer  Letter dated August 11, 2005 (incorporated by reference to  Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for  the quarter ended September 30, 2005 (the “September 2005 10-Q”)).                                                                                                                                                                                           |
| 10.5 #          |       | Indemnification  Agreements, dated as of November 30, 2004 between the Company and each  director of the Company, being the following: Lawrence Burstein, Henry DeNero,  Brian P. Dougherty, Brian J. Farrell, and James L. Whims (incorporated by  reference to Exhibit 10.4 to the Registrant’s Quarterly Report on  Form 10-Q for the quarterly period ended December 31, 2004  (the “December 2004 10-Q”)). |
| 10.6 #          |       | Indemnification  Agreement, dated as of March 28, 2006 between the Company and Jeffrey W.  Griffiths (the form of which is incorporated by reference to  Exhibit 10.4 to the Registrant’s December 2004 10-Q).                                                                                                                                                                                                                      |
| 10.7 #          |       | THQ Inc. 2006  Long Term Incentive Plan (incorporated by reference to Exhibit A to  Company’s Proxy Statement on Schedule 14A filed June 21, 2006).                                                                                                                                                                                                                                                                                      |
| 10.8 #          |       | THQ Inc. Employee  Stock Purchase Plan (incorporated by reference to Exhibit A to Company’s  Proxy Statement on Schedule 14A filed June 21, 2006).                                                                                                                                                                                                                                                                                       |
| 10.9 #          |       | THQ Inc. Amended  and Restated 1997 Stock Option Plan, as amended on August 18, 2005  (incorporated by reference to Exhibit 10.2 to the Registrant’s  September 2005 10-Q).                                                                                                                                                                                                                                                         |
| 10.10 #         |       | Third Amended and  Restated Non-executive Employee Stock Option Plan (incorporated by reference  to Appendix C to Registrant’s Proxy Statement on Schedule 14A filed  July 3, 2003).                                                                                                                                                                                                                                                          |
| 10.11 #*        |       | THQ Inc. Stock  Unit Deferred Compensation Plan, effective as of August 18, 2005.                                                                                                                                                                                                                                                                                                                                                                  |
| 10.12 #         |       | Form of  Severance Agreement with Executive Officers entered into June 15, 2006  (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly  Report on Form 10-Q for the quarter ended June 30, 2006 (the  “June 2006 10-Q”)).                                                                                                                                                               |
| 10.13 #         |       | Form of  Severance Agreement with Senior Officers entered into June 15, 2006  (incorporated by reference to Exhibit 10.2 to the Registrant’s  June 2006 10-Q).                                                                                                                                                                                                                                                                 |
| 10.14 #         |       | Form of  Severance Agreement with Officers entered into June 15, 2006  (incorporated by reference to Exhibit 10.3 to the Registrant’s  June 2006 10-Q).                                                                                                                                                                                                                                                                        |
| 10.15 #         |       | Form of  Change-in-Control Agreement with Executive and Senior Officers entered into  on June 15, 2006 (incorporated by reference to Exhibit 10.4 to the  Registrant’s June 2006 10-Q).                                                                                                                                                                                                                                        |

 

91

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| Exhibit  Number | ** ** | **Title**                                                                                                                                                                                                                                                                                                                                           |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.16 #         |       | Form of  Change-in-Control Agreement with Officers entered into on June 15, 2006  (incorporated by reference to Exhibit 10.5 to the Registrant’s June 2006  10-Q).                                                                                                                                                         |
| 10.17 #         |       | THQ Inc.  Management Deferred Compensation Plan, effective as of January 1, 2005  (incorporated by reference to Exhibit 10.1 to the Registrant’s Current  Report on Form 8-K filed on December 23, 2004).                                                                                                                  |
| 10.18 +         |       | PlayStation® 2  CD-Rom / DVD-Rom Licensed Publisher Agreement, dated as of April 1, 2000  between Sony Computer Entertainment America Inc. and the Company  (incorporated by reference to Exhibit 10.10 to the Registrant’s  September 2002 10-Q).                                                                         |
| 10.19 +         |       | Licensed  Publisher Agreement, dated as of August 28, 2002 by and between Sony  Computer Entertainment America Inc. and the Company (incorporated by  reference to Exhibit 10.9 to the Registrant’s September 2002 10-Q).                                                                                                       |
| 10.20           |       | PlayStation® 2  Licensed Publisher Agreement, dated as of May 21, 2003 between Sony  Computer Entertainment Korea Inc. and THQ Korea Ltd. (incorporated by  reference to Exhibit 10.1 to the Registrant’s Quarterly Report on  Form 10-Q for the quarter ended June 30, 2003 (the  “June 2003 10-Q”)). |
| 10.21           |       | PlayStation® 2  Licensed Publisher Agreement, dated as of July 28, 2003 between Sony  Computer Entertainment Europe Limited and THQ International Limited  (incorporated by reference to Exhibit 10.1 to the Registrant’s  September 2003 10-Q).                                                                           |
| 10.22 +         |       | PlayStation® Portable  Licensed Publisher Agreement, dated as of November 17, 2004 between Sony  Computer Entertainment America Inc. and the Company (incorporated by  reference to Exhibit 10.2 to the Registrant’s December 2004 10-Q).                                                                                  |
| 10.23 +         |       | Xbox 360  Publisher License Agreement, dated as of October 31, 2005 by and between  Microsoft Licensing, GP and the Company (incorporated by reference to  Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q  for the quarter ended December 31, 2005).                                                       |
| 10.24           |       | Amendment to the  Xbox 360 Publisher License Agreement, effective as of October 1, 2006,  by and between Microsoft Licensing, GP and the Company (incorporated by  reference to Exhibit 10.1 to the Registrant’s Quarterly Report on  Form 10-Q for the quarter ended December 31, 2006).                                  |
| 10.25 *         |       | Amendment to the  Xbox 360 Publisher License Agreement, dated as of January 17, 2007, by  and between Microsoft Licensing, GP and the Company.                                                                                                                                                                                                 |
| 10.26 +         |       | Microsoft  Corporation XboxTM Publisher License Agreement, dated as of March 20,  2001 between Microsoft Corporation and the Company (incorporated by reference  to Exhibit 10.8 to the Registrant’s September 2002 10-Q).                                                                                                  |
| 10.27           |       | Amendment to the  XboxTM Publisher Licensing Agreement (Tiered Royalty Rate Structure and Xbox  Platinum Hits Program), dated as of January 31, 2003 between Microsoft  Licensing, Inc. and the Company (incorporated by reference to  Exhibit 10.2 to the Registrant’s June 200310-Q).                                |
| 10.28           |       | Term Extension to  XboxTM Publisher License Agreement, dated October 13, 2004 between the  Company and Microsoft Licensing, GP (incorporated by reference to  Exhibit 10.1 of the Registrant’s Current Report on Form 8-K  filed on October 18, 2004).                                                                 |
| 10.29           |       | Amendment to the  XboxTM Publisher Licensing Agreement (Platinum Hits Family Programs), dated as  of March 15, 2004 (incorporated by reference to Exhibit 10.30 to  the Registrant’s Annual Report on Form 10-K for the fiscal year  ended March 31, 2004).                                                            |
| 10.30 +         |       | Amendment to  XboxTM Publisher License Agreement, effective as of March 1, 2005 and  dated March 9, 2005 by and between Microsoft Licensing, GP and the  Company (incorporated by reference to Exhibit 10.27 to the Registrant’s  March 2005 10-K).                                                                    |

 

92

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| Exhibit  Number | ** ** | **Title**                                                                                                                                                                                                                                                                                                                          |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.31 +         |       | Confidential License  Agreement for Game Boy Advance (Western Hemisphere), dated as of  July 18, 2001 between Nintendo of America, Inc. and the Company  (incorporated by reference to Exhibit 10.6 to the Registrant’s  September 2002 10-Q).                                                            |
| 10.32           |       | First Amendment  to the Confidential License Agreement for Game Boy Advance, dated as of  July 18, 2004 between Nintendo of America, Inc. and the Company  (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly  Report on Form 10-Q for the quarter ended September 30,  2004). |
| 10.33 +         |       | Confidential  License Agreement for Nintendo GameCube (Western Hemisphere), dated as of  April 5, 2002 between Nintendo of America, Inc. and the Company (incorporated  by reference to Exhibit 10.7 to the Registrant’s September 2002 10-Q).                                                            |
| 10.34 +         |       | First Amendment  to Confidential License Agreement for Nintendo GameCube, dated as of  April 5, 2005 between Nintendo of America, Inc. and the Company  (incorporated by reference to the Registrant’s Quarterly Report on  Form 10-Q for the quarter ended June 30, 2005).                               |
| 10.35 +         |       | Confidential  License Agreement for Nintendo GameCube (Asia), dated as of November 17,  2003 between Nintendo Co., Ltd. and THQ Asia Pacific Pty Ltd. (incorporated  by reference to Exhibit 10.1 to the Registrant’s June 2004 10-Q).                                                                         |
| 10.36 +         |       | Confidential  License Agreement for the Nintendo DS handheld platform, dated as of  January 25, 2005 between Nintendo of America, Inc. and the Company  (incorporated by reference to Exhibit 10.32 to the Registrant’s  March 2005 10-K).                                                                |
| 10.37           |       | Lease agreement  dated December 22, 2004 between the Company, as Tenant, and FORCE-AGOURA  ROAD, LLC and Dennis D. Jacobsen Family Holdings II, LLC, as Landlord  (incorporated by reference to Exhibit 10.6 to the Registrant’s  December 2004 10-Q).                                                         |
| 14              |       | Code of Ethics  for Executive Officers and Other Senior Financial Officers, as adopted  May 27, 2004 (incorporated by reference from the Registrant’s  Form 10-K for the fiscal year ended March 31, 2006).                                                                                                    |
| 18 *            |       | Letter from  Independent Registered Public Accounting Firm Regarding Change in Accounting  Principle dated May 30, 2007.                                                                                                                                                                                                      |
| 21 *            |       | Subsidiaries of  the Registrant.                                                                                                                                                                                                                                                                                                   |
| 23.1*           |       | Consent of  Deloitte & Touche LLP                                                                                                                                                                                                                                                                                         |
| 31.1*           |       | Certification of  Brian J. Farrell, Chief Executive Officer, pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                       |
| 31.2*           |       | Certification of  Edward K. Zinser, Chief Financial Officer and Chief Accounting Officer,  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                          |
| 32.1*           |       | Certification of  Brian J. Farrell, Chief Executive Officer, pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                       |
| 32.2*           |       | Certification of  Edward K. Zinser, Chief Financial Officer and Chief Accounting Officer,  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                          |

----

*                    Filed herewith

#                 Managementcontract of compensatory plan or arrangement

+                Portions have beenomitted and filed separately with the Securities and Exchange Commissionpursuant to a request for confidential treatment in accordance with Rule 24b-2under the Securities Exchange Act of 1934, as amended

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.
| Dated:  May 30, 2007 | THQ INC. |
|---------------------------|----------|
|                      | By:      | /s/ Brian J. Farrell |
|                      |     | Brian J. Farrell, Chairman of the Board, President  and Chief Executive Officer |

 
| Dated: May 30, 2007 | THQ INC. |
|--------------------------|----------|
|                     | By:      | /s/ Edward Zinser |
|                     |     | Edward Zinser, Executive Vice President, Chief  Financial Officer and Chief Accounting Officer (Principal Financial Officer  and Principal Accounting Officer) |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated.
| Signature                | ** ** | **Title**                                                                                    | ** ** | **Date**          |
|--------------------------|------------|----------------------------------------------------------------------------------------------|------------|-------------------|
| /s/ BRIAN J. FARRELL     |       | Director, Chairman of  the Board, President and                                              |       | May 30, 2007 |
| Brian J. Farrell         |       | Chief Executive Officer (Principal Executive  Officer)                                       |       |              |
| /s/ EDWARD ZINSER        |       | Executive Vice President,  Chief Financial Officer                                           |       | May 30, 2007 |
| Edward Zinser            |       | and Chief Accounting Officer (Principal Financial  Officer and Principal Accounting Officer) |       |              |
| /s/ LAWRENCE BURSTEIN    |       | Director                                                                                     |       | May 30, 2007 |
| Lawrence Burstein        |       |                                                                                         |       |              |
| /s/ HENRY DENERO         |       | Director                                                                                     |       | May 30, 2007 |
| Henry DeNero             |       |                                                                                         |       |              |
| /s/ BRIAN DOUGHERTY      |       | Director                                                                                     |       | May 30, 2007 |
| Brian Dougherty          |       |                                                                                         |       |              |
| /s/ JEFFREY W. GRIFFITHS |       | Director                                                                                     |       | May 30, 2007 |
| Jeffrey W. Griffiths     |       |                                                                                         |       |              |
| /s/ GARY REISCHEL        |       | Director                                                                                     |       | May 30, 2007 |
| Gary Reischel            |       |                                                                                         |       |              |
| /s/ JAMES L. WHIMS       |       | Director                                                                                     |       | May 30, 2007 |
| James L. Whims           |       |                                                                                         |       |              |

 

94

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