**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-K**

 

| **(Mark  One)** |
|-----------------|
| **ý**      |   | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For thefiscal year ended December 31, 2002**

** **

**OR**

** **

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

** **

**For thetransition period from          to          **

** **

**Commissionfile number 0-18813**

** **

| **THQ INC.**                                            |
|---------------------------------------------------------|
| (Exact Name of Registrant  as Specified in Its Charter) |

 

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|                                                                         |   |                                  |
|------------------------------------------------------------------------------|--------|---------------------------------------|
| **Delaware**                                                                 |   | **13-3541686**                        |
| (State or Other  Jurisdiction of  Incorporation or Organization)             |   | (I.R.S. Employer  Identification No.) |
|                                                                         |   |                                  |
| **27001  Agoura Road  Calabasas 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) of the Act:              |
|                                                                     |   |   |
| **None.**                                                                |
|                                                                     |   |   |
| Securities registered pursuant to Section 12(g) of the Act:              |
|                                                                     |   |   |
| **Common  Stock,  $.01 par value  Preferred Stock Purchase Rights** |

** **

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  ý  No  o

 

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

** **

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange Act Rule12b-2).  ý

** **

The aggregate marketvalue of voting stock held by non-affiliates of the registrant as of June 30,2002 was approximately $1,172,257,000. 38,009,541 shares of common stock were outstanding as of March 21, 2003.

 

 

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**THQ INC.**

**INDEX TOANNUAL REPORT ON FORM 10-K**

**FILEDWITH THE SECURITIES AND EXCHANGE COMMISSION**

**YEARENDED DECEMBER 31, 2002**

** **
|                   |
|------------------------|
| **Items in Form 10-K** |   |
| Facing page            |
|                   |   |
| **Part I**             |   |
| Item  1.               | Business. |
| Item  2.               | Properties. |
| Item  3.               | Legal Proceedings. |
| Item  4.               | Submission of Matters to a Vote of Security  Holders. |
|                   |   |
| **Part II**            |   |
| Item  5.               | Market for the Registrant’s Common Equity and  Related Stockholder Matters. |
| Item  6.               | Selected Financial Data. |
| Item  7.               | Management’s Discussion and Analysis of  Financial Condition and Results of Operations. |
| Item  7A.              | Quantitative and Qualitative Disclosures About  Market Risk. |
| Item 8                 | Financial Statements and Supplementary Data |
| Item 9                 | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure. |
|                   |   |
| **Part III**           |   |
| Item  10.              | Directors and Executive Officers of the  Registrant. |
| Item  11.              | Executive Compensation. |
| Item  12.              | Security Ownership of Certain Beneficial Owners  and Management. |
| Item  13.              | Certain Relationships and Related Transactions. |
| Item  14.              | Disclosure Controls and Procedures |
|                   |   |
| **Part IV**            |   |
| Item  15.              | Exhibits, Financial Statement Schedule and  Reports on Form 8-K. |
|                   |   |
| Signatures             |
|                   |   |
| Certifications         |
|                        |  |  |

 

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**This Annual Report contains, orincorporates by reference, certain statements that may be deemed“forward-looking statements” within the meaning of the Private SecuritiesLitigation Reform Act of 1995.  Suchstatements appear in a number of places in this Report, including, withoutlimitation “Management Discussion and Analysis of Financial Condition andResults of Operations.”  Thesestatements are based on current expectations, estimates and projections aboutour business based, in part, on assumptions made by management.  These statements are not guarantees offuture performance and involve risks, uncertainties and assumptions that aredifficult to predict.  Therefore, actualoutcomes and results may differ materially from what is expressed or forecastedin such forward-looking statements due to numerous factors, including thosedescribed above and the following: changes in demand for our products, product mix, the timing of customerorders and deliveries, the impact of competitive products and pricing anddifficulties encountered in the integration of acquired businesses.  In addition, such statements could beaffected by growth rates and market conditions relating to the interactivesoftware industry and general domestic and international economicconditions.  For specific informationconcerning these and other such factors please see the section entitled “RiskFactors” in “Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS.” The forward-looking statements contained herein speak only as of thedate on which they are made, and we do not undertake any obligation to updateany forward-looking statement to reflect events or circumstances after the dateof this Annual Report.**

 

**PART I**

 

**Item 1****.    BUSINESS**

 

**Introduction**

 

We are a leading globaldeveloper and publisher of interactive entertainment software for the majorhardware platforms in the home video game market.  We currently develop and publish titles for Sony PlayStation 2,Microsoft Xbox, Nintendo GameCube, Nintendo Game Boy Advance, PCs and wirelessdevices.  Our titles span most majorinteractive entertainment software genres, including action, adventure,children’s, driving, fighting, puzzle, role playing, simulation, sports andstrategy.

 

Our software is based onintellectual property licensed or assigned from third parties or createdinternally.  We continually seek toidentify and develop titles based on content from other entertainment media(such as movies and television programs), sports and entertainmentpersonalities, popular sports and trends or concepts that have high publicvisibility or recognition or that reflect the trends of popular culture.  Our portfolio of licensed brands includes *Hot Wheels, Power Rangers, Scooby-Doo, Sonic Advance,SpongeBob SquarePants, World Wrestling Entertainment*and**three future *Disney/Pixar* properties,**aswell as others.

 

We also develop softwarebased on brands created by our seven internal development studios and byexternal developers under contract with us. Our original brands include *RedFaction**â,Alter Echo**Ô, MX*and*Summoner**â*. Other than games that we release on PCs, the manufacturers(1) or theirauthorized vendors manufacture all of our products for us.

 

In North America, wemarket and distribute our software to customers including Wal-Mart, Toys “R”Us, Target, Electronics Boutique, Best Buy, GameStop, Kay Bee Toys and otherregional and national general merchandisers, discount store chains, andspecialty retailers.  Outside NorthAmerica, we market and distribute our software to retailers in 70 countries andterritories through offices in the United Kingdom, France, Germany andAustralia.

 

We are a Delawarecorporation that was re-incorporated in 1997. We were formerly incorporated in New York in 1989 under the name TrinityAcquisition Corporation, which changed its name in 1990 to T.HQ, Inc. through amerger with T.HQ, Inc., a California corporation.  Our principal executive offices are located at 27001 Agoura Road,Calabasas Hills, California 91301, and our telephone number is (818) 871-5000.  Our web site is at http://www.thq.com.  THQ and the THQ logo are registeredtrademarks of THQ Inc.(2)

 

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(1)                                  Microsoft,Nintendo and Sony are referred to herein collectively as the“manufacturers.”  Nintendo®, NintendoEntertainment System® (“NES”), Super Nintendo Entertainment System® (“SNES”), Game Boy®, Game Boy Color®, Game BoyAdvance, GameCube and Nintendo 64® are trademarks and/or registered trademarksof Nintendo of America Inc. (“Nintendo”). Sega®, Genesis®, Game Gear®, Saturn® and Dreamcast® are registered trademarksof Sega of America, Inc. (“Sega”).  SonyPlayStation® and Sony PlayStation® 2 are trademarks and/or registeredtrademarks of Sony Computer Entertainment Inc. (“Sony”).  Microsoft Xbox is a trademark of MicrosoftCorporation (“Microsoft”).

(2)                                  Red Faction, Summoner, Dark Summit, HeavyIron Studios®, Helixe, Outrage® Games, Pacific Coast Power & LightCompany®, ValuSoft®, Volition, THQ Wireless, Rainbow Studios and RainbowMultimedia, Cranky Pants Games and their respective logos are trademarks and/orregistered trademarks of THQ Inc.  Allother trademarks are property of their respective owners.

 

1

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**Acquisitions**

 

*ValuSoft.*  On July 1, 2002, we completed theacquisition of substantially all the assets of ValuSoft, Inc. (now a divisionreferred to as “ValuSoft”), a publisher and developer of value-pricedinteractive entertainment and productivity software.  The results of ValuSoft’s operations have been included in theconsolidated financial statements since that date.  The acquisition has been accounted for under the purchasemethod.  This acquisition has providedus with a channel for value-priced personal computer products.  We paid $9.6 million in cash and issuedapproximately 167,000 shares of our common stock as the initial purchase price.  In addition, former shareholders ofValuSoft, Inc. are entitled to additional consideration of up to $11.0 millionif ValuSoft reaches certain pre-tax income targets in the five years followingJuly 1, 2002.  The annual payments ofthe additional consideration, if any, range from $1.0 million to $2.8 millionper year and may be paid, at our discretion, in cash or shares of our commonstock.

 

**TheInteractive Entertainment Industry And Technology**

 

The home interactive gamemarket consists of software distributed on disc and cartridge media for usesolely on dedicated hardware systems, and software distributed on CD-ROM discsfor use on PCs.  Disc media includesDVD-ROM discs for use on the Sony PlayStation 2 and Microsoft Xbox, proprietarydiscs for use on the Nintendo GameCube and CD-ROM discs for use on the SonyPlayStation.  The Nintendo Game BoyAdvance is the only current platform that uses cartridges.  Until 1996, most software for dedicatedplatforms was sold in cartridge form. Since then, disc-based products have become increasingly popular becausethey have substantially greater data storage capacity and lower costs thancartridges.

 

The first modern platformwas introduced by Nintendo in 1985 using 8-bit technology.  8-bit means that the central processingunit, or chip, on which the software operates is capable of processing data in8-bit units.  Subsequent advances intechnology have resulted in continuous increases in the processing power of thechips that power both the consoles and PCs. As the technology of the hardware has advanced, the software hassimilarly advanced, with faster and more complex images, more lifelikeanimation and sound effects and more intricate scenarios.  The larger data storage capacity ofdisc-based media for systems such as the Sony PlayStation 2, Microsoft Xbox andthe Nintendo GameCube enables them to provide richer content and longerplay.  This new generation of systems isbased primarily on 128-bit technology. The latest hand-held platform, Game Boy Advance, uses 32-bit technology.

 

The following table setsforth the year in which each of the manufacturers’ platforms, for which we havepublished titles and technology, were released in the United States:

 
| **Manufacturer** |   | **Product  Name** |   | **Date of  U.S.  Introduction** |   | **Media Format** |   | **Technology**     |
|------------------|--------|-------------------|--------|---------------------------------|--------|------------------|--------|--------------------|
| Nintendo         |   | NES               |   | 1985                            |   | Cartridge        |   | 8-bit              |
| Nintendo         |   | Game Boy          |   | 1989                            |   | Cartridge        |   | 8-bit (portable)   |
| Sega             |   | Game Gear         |   | 1991                            |   | Cartridge        |   | 8-bit (portable)   |
| Sega             |   | Genesis           |   | 1989                            |   | Cartridge        |   | 16-bit             |
| Nintendo         |   | SNES              |   | 1991                            |   | Cartridge        |   | 16-bit             |
| Sega             |   | Saturn            |   | 1995                            |   | Cartridge        |   | 32-bit             |
| Sony             |   | PlayStation       |   | 1995                            |   | CD-ROM Disc      |   | 32-bit             |
| Nintendo         |   | Nintendo 64       |   | 1996                            |   | Cartridge        |   | 64-bit             |
| Nintendo         |   | Game Boy Color    |   | 1998                            |   | Cartridge        |   | 16-bit  (portable) |
| Sega             |   | Dreamcast         |   | 1999                            |   | CD-ROM Disc      |   | 128-bit            |
| Sony             |   | PlayStation 2     |   | 2000                            |   | DVD-ROM Disc     |   | 128-bit            |
| Nintendo         |   | Game Boy Advance  |   | 2001                            |   | Cartridge        |   | 32-bit  (portable) |
| Nintendo         |   | GameCube          |   | 2001                            |   | Proprietary Disc |   | 128-bit            |
| Microsoft        |   | Xbox              |   | 2001                            |   | DVD-ROM Disc     |   | 128-bit            |

 

Sony launched thePlayStation 2, the successor to the PlayStation, in the North American marketin October 2000.  Nintendo launched thehandheld Game Boy Advance platform in June 2001 and the GameCube platform inNovember 2001.  Nintendo plans to launchthe Game Boy Advance SP in March 2003, which is a front-lit screen version oftheir Game Boy Advance platform. Microsoft launched the Xbox in November 2001.  Software for new platforms requires different standards of designand technology to fully exploit their capabilities.  The introduction of new platforms also requires that gamedevelopers devote substantial additional resources to product design anddevelopment.

 

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**Business Strategy**

 

Our corporate goal is toexpand market share while increasing profitability.  We believe that our success in the following strategicimperatives will position us well to exploit the current console cycle andother growth opportunities:

 

•                  *Build a well-diversified product portfolio acrossbrand, genre and platform.* Due to constantly changing consumer demand and hardware platforms, webelieve it is important to offer a diversified portfolio of titles.  We have worked to grow and diversify ourproduct portfolio by securing additional content licenses, creating our ownbrands and content, seeking out unique co-development relationships (e.g. withNickelodeon and Sega) and supporting multiple platforms.  Through licensing agreements with Disney,Disney/Pixar, Mattel, Nickelodeon, Sega, Warner Bros., World WrestlingEntertainment and others, we have diversified our portfolio of popular licensedbrands to include *Hot Wheels, Power Rangers,Scooby-Doo, Sonic Advance, SpongeBob SquarePants, World Wrestling Entertainment*and three future *Disney/Pixar*properties,**as well asothers.  Our titles span a wide spectrumof genres.  We currently develop andpublish for all existing major interactive entertainment hardwareplatforms.  In July 2002, we expandedour product portfolio to include value PC titles with the acquisition ofValuSoft.  We will continue to worktowards building a well-diversified product portfolio by obtaining additionallicenses, increasing our internal brands and publishing titles across multipleplatforms.

 

•                  *Establish strong technology and internal developmentcapabilities*.  We believe itis important for us to expand our internal development capabilities.  We have increased our internal developmentcapabilities through the acquisition or formation of development studios,consisting of Cranky Pants Games (“Cranky Pants”), Genetic Anomalies (“GA”),Heavy Iron Studios® (“Heavy Iron”), Helixe, Outrage Games (“Outrage”), PacificCoast Power & Light Company (“PCP&L”), Rainbow Multimedia Group, Inc.,also known as Rainbow Studios, (“Rainbow”) and Volition, Inc. (“Volition”).  Since 2000, we have launched internallydeveloped games, including *Red Faction, RedFaction II, MX Superfly featuring Ricky Carmichael, Summoner, Summoner 2,Rocket Power: Dream Scheme*and *Scooby-Doo!Night of 100 Frights*.  Wewill continue to expand our internal development capabilities by selectivelyacquiring or establishing development studios.

 

•                  *Expand global product development capabilities.*  We believe it is important for our businessto establish global product development capabilities.  We are in the process of implementing a new product developmentinitiative that will result in the globalization of our product developmentstaff.  The staff will be located inthree separate locations — United States, United Kingdom and Australia, andwill manage the development of product both internally developed through oureight development studios as well as externally developed through independentdevelopers.  The three production groupswill each be comprised of technical, creative, project management and qualityassurance teams.  This structure willallow us to more effectively work with product development talent worldwide andimprove product quality.

 

•                  *Expand internationally.*  International markets represent asignificant growth opportunity for us. We operate offices in the United Kingdom, Germany, France, Australia andKorea and distribute our products in 66 other countries and territories.  We have a dedicated group that adapts ourtitles for international markets by localizing language and other culturalfeatures.  We will continue to expandinternationally by establishing offices in new territories, developing andacquiring content that has international appeal, possibly acquiring foreigndevelopment studios and targeting wireless gaming applications to appropriateforeign markets.

 

•                  *Prudently invest in emerging applications such aswireless gaming.*  We arepursuing opportunities within wireless gaming that we believe will allow us tobenefit from the rapid growth projected for this emerging market whileremaining consistent with our focus on profitability.  We are establishing relationships with wireless operators andwireless software developers worldwide.

 

•                  *Increase profit margins through improved executionand disciplined management.* Profitability continues to be a leading corporate focus.  We continue to (i) utilize strict orderingand inventory controls to reduce inventory risk; (ii) proactively work with keycustomers to manage inventories, reduce the need for allowances or priceprotection, accelerate cash collection and reduce accounts receivable; (iii)scrutinize costs and minimize corporate overhead and (iv) build an experiencedmanagement team and a financial and operating system infrastructure based onsophisticated technology.  We believethat our continued emphasis on all of these practices will help us increaseprofitability and stockholder value in the future.

 

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We intend to continuepursuing potential acquisition transactions consistent with these strategies.  In addition, in order to create a closerrelationship with independent developers, we may from time to time makeinvestments or acquire interests in independent developers.

 

**IntellectualProperty Licenses**

 

Our strategy includes thecreation of exciting games based on licensed properties that have attained ahigh level of consumer recognition or acceptance.  We have relationships with a number of licensors, includingDisney, Disney/Pixar, Mattel, Nickelodeon, Sega, Warner Bros. and WorldWrestling Entertainment.

 

We pay royalties to ourproperty licensors that generally range from 3% to 25% of our net sales of thecorresponding title.  We typicallyadvance payments against minimum guaranteed royalties over the license term. Licenseroyalties tend to be higher for properties with proven popularity and lessperceived risk of commercial failure. To the extent competition intensifies for licenses of highly desirableproperties, we may encounter difficulty in obtaining or renewing theselicenses.  See – “Competition.”  Licenses are of variable duration, may beexclusive for a specific title or line of titles, and may in some instances berenewable upon payment of certain minimum royalties or the attainment of specifiedsales levels.  Other licenses are notrenewable upon expiration, and it cannot be assured that we and the licensorwill reach agreement to extend the term of any particular license.

 

Our property licensesusually grant us exclusive use of the property for the specified titles, onspecified platforms, within a defined territory and during the licenseterm.  Licensors typically however,retain the right to exploit the property for all other purposes, including theright to license the property for use with other platforms, and have generalapproval rights.  Our games based on aparticular property for use with one or more particular platforms may competewith games published by other companies that are based on the same property butfor a different platform.

 

**IntellectualProperty Rights**

 

Each game we releaseembodies a number of separately protected intellectual property rights of themanufacturer, the property licensor and, to a lesser extent, the externaldeveloper and us.  The licensor of theproperty owns the trademarks, trade names, copyrights and other intellectualproperty rights relating to the property on which the game is based.  The manufacturer owns the patents andsubstantially all of the other intellectual property embodied in the product;and the developer, whether internal or external, often owns proprietary toolsand technology embedded in the game software. While we own the game software embodied in the product, we believe thatsuch software has little independent economic value.  Accordingly, we often must rely on the manufacturer and theproperty licensor with respect to protection from infringement of the propertyrights by third parties.

 

Each of the manufacturersincorporates security devices in its platforms and products to preventunlicensed use.  In addition, Nintendorequires its licensees to display the trademarked Nintendo Seal of Approval tonotify the public that the game has been approved by Nintendo for use with aNintendo platform.

 

**PlatformLicenses**

 

Our business is dependenton our license agreements with the manufacturers.  All of these licenses are for fixed terms and are notexclusive.  Each license grants us theright to develop, publish and distribute titles for use on such manufacturer’splatform(s), and requires that each such title be approved by the manufacturerprior to development of the software and embodied in products that aremanufactured solely by such manufacturer or (in the case of Microsoft) itsauthorized vendor.

 

The following table setsforth information with respect to our platform licenses.  In some instances, we have more than oneplatform license for a particular platform.

 

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| **Manufacturer** |   | **Platform**           |   | **Territory**                                    |   | **Expiration Date(s)** |
|------------------|--------|------------------------|--------|--------------------------------------------------|--------|------------------------|
| Nintendo         |   | Nintendo 64            |   | All  countries in the Western Hemisphere         |   | May 2003               |
| Nintendo         |   | Nintendo 64            |   | Europe, Australia and  New Zealand               |   | January 2004           |
| Nintendo         |   | Game Boy Color         |   | All  countries in the Western Hemisphere         |   | March 2004             |
| Nintendo         |   | Game Boy Color         |   | Europe, Australia and  New Zealand               |   | October 2002(1)        |
| Nintendo         |   | Game Boy Advance       |   | All  countries in the Western Hemisphere         |   | July 2004              |
| Nintendo         |   | Game Boy Advance (2)   |   | Europe, Australia and  New Zealand               |   | (2)                    |
| Nintendo         |   | GameCube               |   | All  countries in the Western Hemisphere         |   | April 2005             |
| Nintendo         |   | GameCube (2)           |   | Europe, Australia and  New Zealand               |   | (2)                    |
| Sony             |   | PlayStation            |   | United States, Canada,  Mexico and Latin America |   | August 2006            |
| Sony             |   | PlayStation            |   | Europe, Australia and  New Zealand               |   | December 2005          |
| Sony             |   | PlayStation 2          |   | United States and  Canada                        |   | March 2004(3)          |
| **Sony**         |   | **PlayStation  2 (4)** |   | **Europe,  Australia and New Zealand**           |   | **(4)**                |
| Microsoft        |   | Xbox                   |   | (5)                                              |   | November 2004          |

 

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(1)           The renewal for this agreement iscurrently in negotiation, and provides for an expiration of October 2005.

(2)                                  Thelong form agreement is currently in negotiation, and provides for an expirationof three (3) years from the date of execution.

(3)                                  ThePlayStation 2 Licensed Publisher Agreement provides for an automatic annualrenewal unless either party terminates the agreement by January 31 of theapplicable year.  To date, thisagreement has not been terminated.

(4)                                  Thelong form agreement is currently in negotiation, and provides for an expirationof March 31, 2003 with an automatic annual renewal unless either partyterminates the agreement by February 28 of the applicable year.

(5)                                  Theterritory is determined on a title-by-title basis.

 

Nintendo charges us anamount for each Nintendo Game Boy Advance and Game Boy Color cartridge.  This amount varies based, in part, on thememory capacity of the cartridges.  NintendoGameCube, Sony and Microsoft agreements include a charge for every discmanufactured.  The amounts charged bythe manufacturers include a manufacturing, printing and packaging fee as wellas a royalty for the use of the manufacturer’s name, proprietary informationand technology, and are subject to adjustment by the manufacturers at theirdiscretion.  The manufacturers have theright to review, evaluate and approve a prototype of each title and the title’spackaging.

 

In addition, we mustindemnify the manufacturers with respect to all loss, liability and expenseresulting from any claim against the manufacturer involving the development,marketing, sale or use of our games, including any claims for copyright ortrademark infringement brought against the manufacturer.  As a result, we bear a risk that theproperties upon which the titles are based, or that the information andtechnology licensed from the manufacturer and incorporated in the products, mayinfringe the rights of third parties. Our agreements with our independent software developers and propertylicensors typically provide for us to be indemnified with respect to certainmatters.  If any claim is brought by amanufacturer against us for indemnification, however, our developers orlicensors may not have sufficient resources to in turn, indemnify us.  Furthermore, these parties’ indemnificationof us may 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 aplatform license for any reason other than our breach or default, we have alimited period of time to sell any existing product inventory remaining as ofthe date of termination.  The length ofthis sell-off period varies between 90 and 180 days, depending upon theplatform agreement.  We must destroy anysuch inventory remaining after the end of the sell-off period.  Upon termination as a result of our breachor default, we must destroy any remaining inventory.

 

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**SoftwareDesign and Development**

 

After we acquire aproperty from a licensor or develop a concept internally, we design and developa game with features intended to utilize the characteristics of the propertyand to appeal to the game’s target consumers. The development of our software is now managed through three separatelocations – offices in the United States, United Kingdom and Australia.  The head of each product developmentlocation and the head of each of our internal studios report to our ExecutiveVice President – Worldwide Studios.  Oursoftware development process takes one of two forms, Internal Development or ExternalDevelopment.

 

*InternalDevelopment.*  Thein-house development of product is currently conducted by our studios: CrankyPants, Heavy Iron, Helixe, Outrage, PCP&L, Rainbow and Volition.  Our studios are staffed by producers, gamedesigners, software engineers, artists, animators and game testers.

 

*ExternalDevelopment.*  Wecontract with independent software developers to conceptualize and developgames under our supervision.  Ouragreements with software developers are usually entered into on a game-by-gamebasis and generally provide for the payment of a fixed amount and/orcompensation based on actual sales.  Thecompensation is generally based on a percentage of net sales ranging from 4% to20%.  We generally pay our developersinstallments of the fixed fee based on specific development milestones.  We generally obtain ownership of thesoftware code and related documentation. We may make strategic investments in third party developers for thepurpose of securing access to proprietary software and talented developers.

 

Upon completion ofdevelopment, each game is extensively play-tested by us and sent to themanufacturer for its review and approval. Related artwork, user instructions, warranty information, brochures andpackaging designs are also developed under our supervision.  The development cycle for a new game,including the development of the necessary software, approval by themanufacturer and production of the initial products, typically has ranged from12 to 24 months for home console games and seven to 12 months for handheldgames.  This relatively long developmentcycle requires that we assess whether there will be adequate retailer andconsumer demand for a game well in advance of its release.

 

**Manufacturing**

 

Other than games that werelease on PCs, all of our home interactive entertainment products aremanufactured for us by the manufacturers or their authorized vendors.  We contract with various PC replicators forthe manufacturing of our PC products.

 

The platform gamemanufacturing process begins with our placing a purchase order with amanufacturer and prepaying the manufacturer, opening either a letter of creditin favor of the manufacturer or utilizing credit granted by themanufacturer.  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.  Nintendo typically delivers products to uswithin 15 to 60 days of its receipt of an order and a payment or correspondingletter of credit and Sony typically delivers products to us within 10 to 24days.  Microsoft’s authorized vendorstypically deliver products to us within 10 to15 days.

 

We are required by theplatform licenses to provide a standard defective product warranty on all ofthe products sold.  Generally, we areresponsible for resolving, at our own expense, any warranty or repairclaims.  We have not experienced anymaterial warranty claims, but there is no guarantee that we will not experienceclaims in the future.

 

 

 

**Marketing,Sales and Distribution**

 

We are dependent on thepopularity of our games based on licensed properties and positive awareness ofour original game concepts to attract customers and to obtain shelf space instores.  Our domestic sales activitiesare directed by our Executive Vice President — North American Publishing, whomaintains contact with major retail accounts and manages the activities of ourinternal sales staff.  Our marketingactivities are directed by our Senior Vice President – Worldwide Marketing, whomanages the activities of our worldwide internal marketing staff.

 

*NorthAmerican Sales.*  Ourgames are promoted to retailers by display at trade shows such as the annualElectronic Entertainment Expo (E3).  Wealso conduct print and cooperative retail advertising campaigns for most titlesand prepare promotional materials, including product videos, to increaseawareness among retailers and consumers.

 

Our marketing efforts forproducts released in 2002 included national television, print, radio andInternet advertising and promotional campaigns.  Products shipped in 2002 that received television supportincluded *WWE Raw, WWE WrestleMania X8,**WWE SmackDown! Shut Your Mouth, MX SuperflyFeaturing Ricky Carmichael, Britney’s Dance Beat, Hot Wheels Velocity X,Disney/Pixar’s Monsters, Inc., Red Faction II, Jimmy Neutron Boy Genius,*and titles released under the following brands, *Rocket Power, Rugrats, Scooby-Doo*and*SpongeBob SquarePants*.  Our games

 

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were supported bypromotions such as trailers, demo discs, over-sized boxes, standees, posters,and pre-sell giveaways at retail stores, game kiosks at sporting and outdoorevents, rebates and contests with national packaged goods companies and fastfood restaurants and co-marketing efforts with the hardware manufacturers.  Product public relations for 2002 includedcover, feature, preview, review and round-up coverage in broadcast, print andonline media targeting enthusiast, lifestyle and major mainstream outlets.  Additionally, we continue to increase ourcorporate public relation efforts, establishing relationships with leadingtechnology and business reporters.

 

We utilize electronic datainterchange with most of our major domestic customers in order to (i)efficiently receive, process and ship customer product orders, and (ii)accurately track and forecast sell-through of products to consumers in order todetermine whether to order additional products from the manufacturers.  The electronic data interchange system isintegrated with our enterprise resource planning system, which allows forfurther efficiencies in the items mentioned above.  We ship most of our products to our domestic customers frompublic bonded warehouses located in Ohio, Tennessee and Minnesota.

 

In the past, wesupplemented the efforts of our sales employees with independent salesrepresentatives.  As of January 2002,our own sales employees handle all sales efforts.

 

The domestic retail pricefor our titles currently ranges between $20 and $35 for Game Boy Advance, $20for Game Boy Color, between $10 and $25 for PlayStation, between $20 and $55for PlayStation 2, between $40 and $55 for Xbox, between $40 and $55 for GameCubeand between $10 and $35 for PC games.

 

*InternationalSales.*  Ourinternational sales activities are directed by our Senior Vice President –International Publishing via our international offices in the United Kingdom,France, Germany and Australia.  Werecently opened an office in Korea, which will begin to sell product in March2003.  International offices market anddistribute direct-to-retail and through sub-distributors in both their hometerritories and to 66 additional territories.

 

*Concentrationof Sales.*  Some of ourindividual titles make up a substantial portion of our gross sales.  The following includes games that generatedmore than 10% of our gross sales during each of the last three years:

 

•                  In2002, sales for *WWE SmackDown! Shut YourMouth*for the Sony PlayStation 2 was the only title to generate morethan 10% of our gross sales at 10.8%.

 

•                  In2001, *WWF SmackDown! “Just Bring It”*for the Sony PlayStation 2 was the only title to generate more than 10% of ourgross sales at 14.6%.

 

•                  In2000, sales for *WWF SmackDown!*and*WWF SmackDown! 2: Know Your Role*forthe Sony PlayStation and *WWF No Mercy*for the Nintendo 64 were 16.9%, 16.0% and 15.5% of gross sales, respectively.

 

Our sales are madedirectly to retailers and independent distributors.  We distribute our games primarily to mass merchandisers andnational retail chain stores, including Wal-Mart (representing 16.4% of grosssales in 2002), Toys “R” Us (representing 12.6% of gross sales in 2002),Target, Electronics Boutique, Best Buy, GameStop and Kay Bee Toys.  Sales to our ten largest customerscollectively accounted for approximately 63.9% of our gross sales in 2002 and2001.  We do not have any writtenagreements or other understandings with any of our customers that relate to theirfuture purchases, so our customers may terminate their purchases from us at anytime.

 

*RevenueFluctuations and Seasonality.*  We have experienced, and will likely continue to experience,significant quarterly fluctuations in net sales and operating results due to avariety of factors.  The software marketis highly seasonal with sales typically significantly higher during the quarterending December 31st (due primarily to the increased demand forinteractive games during the year-end holiday buying season).  Other factors that cause fluctuationsinclude the timing of our release of new titles, the popularity of both newtitles and titles released in prior periods, changes in the mix of titles withvarying gross margins, the timing of customer orders, the timing of shipmentsby the manufacturers, fluctuations in the size and rate of growth of consumerdemand for software for various platforms, the timing of the introduction ofnew platforms and the accuracy of retailers’ forecasts of consumer demand.  Our expenses are partially based on ourexpectations of future sales and, as a result, operating results would bedisproportionately and adversely affected by a decrease in sales or a failureby us to meet our sales expectations. There can be no assurance that we can maintain consistent profitabilityon a quarterly or annual basis.

 

Profit margins may varyover time as a result of a variety of factors. Profit margins for cartridge products for the Game Boy platforms canvary based on the cost of the memory chip used for a particular title.  The other platforms support disc-basedproducts that have significantly lower per unit manufacturing costs thancartridge-based products, however, they have higher development costs thancartridge-based products.

 

7

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**AgreementWith JAKKS Pacific, Inc.**

 

In June 1999, we enteredinto an agreement with JAKKS Pacific, Inc. (“JAKKS”) that governs ourrelationship with respect to the World Wrestling Entertainment license wejointly obtained from World Wrestling Entertainment, Inc. (the “WWE”).  This agreement was amended in January2002.  Our relationship with JAKKS wasestablished to develop, manufacture, distribute, market and sell video games,as well as sublicense products pursuant to the license from the WWE.  The principal terms of this operatingagreement are as follows:

 

•                  Weare responsible for funding all operations of the venture, including allpayments owed to the WWE.

 

•                  Forthe period commencing November 16, 1999 and ending June 30, 2006, JAKKS isentitled to receive a preferred payment equal to the greater of a fixedguarantee, payable quarterly, or specified percentages of the net sales fromthe WWE-licensed games (as defined) in amounts that vary based on the platform.  The payment of these amounts is guaranteedby us.  We are entitled to the profitsand cash distributions remaining after the payment of these amounts.

 

•                  Forperiods after June 30, 2006, the amount of the preferred payment will besubject to renegotiation between the parties. An arbitration procedure is specified in the event the parties do notreach agreement.

 

•                  Weare responsible for the day-to-day operations of the venture.  We are responsible for development, salesand distribution of the WWE-licensed games, and JAKKS is responsible for theapproval process and other relationship matters with the WWE.  We and JAKKS co-market the games.

 

For financial reportingpurposes, we are deemed to control the venture; therefore, all ventureoperating results are consolidated with our results.

 

In November 2001, throughthe venture, we entered into a letter of intent to expand the WWE license toinclude exclusive rights to other wrestling content produced by the WWE.  In exchange for these rights we have agreedto increase the minimum guarantee payable to the WWE through December 31, 2009.

 

**GeographicInformation**

 

We operate in onereportable segment in which we are a developer and publisher of interactiveentertainment software for the leading hardware platforms in the home videogame market.  Wireless gaming may becomea new reportable segment as our activity in this market increases.  The following information sets forthgeographic information on our sales generated by our regional offices for theyears ended December 31, 2002, 2001 and 2000 (also See Note 17 to theconsolidated financial statements for additional geographic information on oursales and long-lived assets):

 

**Sales to Unaffiliated Customers**

**($ in Thousands)**

 

|                 |   | **Years Ended December 31,** |    |
|----------------------|--------|------------------------------|---------|
|                 |   | **2002**                     |    | **2001** |   | **2000** |   |
| North  America       |   | $                            | 358,124 |   | $ | 262,676 |   | $ | 270,116 |   |
|                 |   |                         |    |   |   |   |   |
| United  Kingdom      |   | 67,218                       |    | 60,240 |   | 44,638 |   |
| Germany              |   | 26,051                       |    | 25,517 |   | 20,442 |   |
| France               |   | 14,556                       |    | 18,185 |   | 7,979 |   |
| Australia            |   | 14,580                       |    | 12,374 |   | 3,828 |   |
| International  Total |   | 122,405                      |    | 116,316 |   | 76,887 |   |
| Consolidated         |   | $                            | 480,529 |   | $ | 378,992 |   | $ | 347,003 |   |

 

8

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**Competition**

 

The interactiveentertainment software industry is intensely competitive.  We compete with hardware manufacturers forboth property licenses and software sales. Each of the manufacturers is typically one of the largest developers andpublishers for their platforms.  Thesecompanies may increase their own software development efforts.  As a result of their commanding positions inthe industry as the manufacturers of platforms and publishers of software fortheir platforms, the manufacturers generally have better bargaining positionswith respect to retail pricing, shelf space and purchases than any of theirlicensees, including us.

 

In addition to themanufacturers, our competitors include Activision, Inc., Electronic Arts Inc.,Take-Two Interactive Software, Inc. and Infogrames, Inc.  Each of the manufacturers has a broadersoftware line and greater financial, marketing and other resources than us, asdo some of our other competitors. Accordingly, some of our competitors may be able to market theirsoftware more aggressively or make higher offers or guarantees in connection withthe acquisition of licensed properties.

 

At various times, toycompanies, large software companies, movie studios and others have entered thevideo game market resulting in greater competition for us.  Additionally, many of our competitors aredeveloping on-line interactive games and interactive networks that will becompetitive with our interactive products.

 

Competition is intenseamong an increasing number of newly introduced entertainment software titlesand hardware systems for adequate levels of limited retail shelf space andpromotional support and resources.  Competitionfor retail shelf space is expected to increase, which may require us toincrease our marketing expenditures from time to time to maintain sales of ourtitles.  Competitors with more extensivelines and popular titles frequently have greater bargaining power withretailers.  Accordingly, we may not beable to achieve the levels of support and shelf space that such competitorsreceive.  Similarly, as competition forpopular properties increases, our cost of acquiring licenses for suchproperties is likely to increase, possibly resulting in reduced margins.

 

In addition, the marketfor our products is characterized by significant price competition, and we mayface increasing pricing pressures from our current and future competitors.  Accordingly, these competitive pressureshave, from time to time, required us to reduce our prices on certainproducts.  Any material reduction in theprice of our products would adversely affect operating income as a percentageof net revenue and would require us to increase unit sales in order to maintainnet revenue.  Prolonged pricecompetition, increased marketing costs, increased licensing costs or reducedoperating margins would cause our profits to decrease significantly.

 

**RecentDevelopments**

 

On February 13, 2003, weannounced a fiscal year end change from December 31 of each year to March 31 ofeach year, effective March 31, 2003. We believe that the change in fiscal yearwill better reflect our natural business year and allow us to provide financialguidance after the holiday selling season.

 

**Employees**

 

As of December 31, 2002,we had 747 full-time employees, of whom 44 are located in the United Kingdom;52 are located in Germany; 11 are located in France; 12 are located inAustralia; and one is located in Korea. None of our employees are represented by a labor union or covered by acollective bargaining agreement, and we believe that relations with ouremployees are good.

 

**AvailableInformation**

 

We file annual, quarterlyand current reports, proxy statements and other information with the Securitiesand Exchange Commission (“SEC”).  OurSEC filings, including our annual report on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K, and any amendments to those reports filedor furnished pursuant to Section 13(a) of the Exchange Act, are available tothe public free of charge over the Internet at our website athttp://www.thq.com or at the SEC’s web site at http://www.sec.gov.  Our SEC filings will be available on ourwebsite as soon as reasonably practicable after we have electronically filed orfurnished them to the SEC.  You may alsoread and copy any document we file at the SEC’s Public Reference Room at 450Fifth Street, N.W., Washington, D.C. 20549.  You may obtain informationon the operation of the Public Reference Room by calling the SEC at1-800-SEC-0330.

 

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**Item 2****.    PROPERTIES**

 

AtDecember 31, 2002, we leased the facilities listed below:

 
| **Location of  Offices**     |   | **Approximate Square  Footage** |   | **Use**                                                                         |
|------------------------------|--------|---------------------------------|--------|---------------------------------------------------------------------------------|
| Calabasas Hills,  California |   | 67,000                          |   | Executive,  sales and marketing, product development and administrative offices |
|                         |   |                            |   |                                                                            |
| Woking,  England             |   | 25,000                          |   | Sales  and marketing, product development and administrative offices            |
|                         |   |                            |   |                                                                            |
| Phoenix,  Arizona            |   | 13,000                          |   | Software  development studio                                                    |
|                         |   |                            |   |                                                                            |
| Champaign,  Illinois         |   | 13,000                          |   | Software  development studio                                                    |
|                         |   |                            |   |                                                                            |
| Santa  Clara, California     |   | 12,000                          |   | Software  development studio                                                    |
|                         |   |                            |   |                                                                            |
| Lexington,  Massachusetts    |   | 10,000                          |   | Software  development studio                                                    |
|                         |   |                            |   |                                                                            |
| Culver  City, California     |   | 8,000                           |   | Software  development studio                                                    |
|                         |   |                            |   |                                                                            |
| Waconia, Minnesota           |   | 5,000                           |   | Sales  and marketing, product development and administrative offices            |
|                         |   |                            |   |                                                                            |
| Seattle,  Washington         |   | 3,000                           |   | Software  development studio                                                    |
|                         |   |                            |   |                                                                            |
| Grass  Valley, California    |   | 2,000                           |   | Software  development studio                                                    |
|                         |   |                            |   |                                                                            |
| Ann  Arbor, Michigan         |   | 1,000                           |   | Software  development studio                                                    |
|                         |   |                            |   |                                                                            |
| Other  international offices |   | 7,000                           |   | Sales,  marketing and administrative offices                                    |

 

In addition to the leasedfacilities listed above, we also own 10,820 square feet of office space locatedin Phoenix, Arizona.

 

On February 27, 2003, weentered into a lease agreement with an entity partially owned by the head ofone of our development studios.  Thelease is for approximately 29,000 square feet of office space to be occupied bythe development studio in Champaign, Illinois. The property is currently under development and should be ready foroccupancy in April 2004.

 

We believe that thesefacilities are adequate for our current needs. We believe that suitable additional or substitute space will beavailable as needed to accommodate our future needs.

 

**Item 3****.    LEGAL PROCEEDINGS**

 

We and certain of ourofficers and directors are defendants in a class action lawsuit filed in theUnited States District Court for the Central District of California entitled *In re THQ Inc.* Securities Litigation,Master File No. CV-00-1783-AHM.  OnDecember 20, 2000, the court dismissed this action with prejudice as to all ofthe defendants.  On April 23, 2001, theUnited States District Court for the Central District of California modifiedits December 20, 2000 order and permitted plaintiffs to file a third amendedcomplaint on that date.  Defendantsfiled an answer denying all of the material allegations of the third amendedcomplaint and asserting legal and factual defenses.  The third amended complaint alleges that defendants violated Rule10b-5 and Section 20(a) of the Securities Exchange Act of 1934, includingallegations that defendants manipulated our stock price; distributed false andmisleading information concerning revenue recognition, forecasts and earningsestimates; selectively disclosed material information; and engaged in insidertrading.  The complaint seeks anunspecified amount in damages.  As ofDecember 31, 2002, we entered into a settlement agreement with theplaintiffs.  While we continue to denyplaintiffs’ allegations, we agreed to pay $10.2 million under the terms of thesettlement agreement to resolve all claims by plaintiffs against alldefendants.  The District Court grantedpreliminary approval of the settlement on March 17, 2003, and final approval iscurrently pending.  Our directors’ andofficers’ insurance coverage should reimburse us $10 million towards the settlementagreement and related legal fees.

 

However, a dispute hasarisen between us and our directors’ and officers’ insurance carrier.  The insurance carrier asserts that it isonly obligated to contribute $5.0 million in coverage towards the securitieslitigation settlement.  Pursuant to the termsof our insurance policy, the matter has been submitted to arbitration under therules of the American Arbitration Association. As a result of the settlement agreement, related legal fees and thedispute with our insurance carrier, we have taken a charge of approximately$7.0 million during the quarter ended December 31, 2002 which is included inother expenses in the accompanying consolidated statements of operations.  Although we expect to prevail, at this earlystage we cannot predict the likely outcome of this dispute.

 

10

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As a result of a courtorder in an action filed in the United Kingdom by the World Wide Fund forNature (the “Fund”) against World Wrestling Entertainment, Inc. (“WWE”) the useof the initials “WWF” is prohibited directly or indirectly by the WWE afterNovember 10, 2002.  On November 10,2002, upon instruction from the WWE, we ceased sales at least temporarily ofcertain of our interactive entertainment software games containing the “WWF”brand.  These games contain artworkfiles with the initials WWF and/or the WWF logo that cannot practicably beremoved from the games. Contemporaneously, in November 2002, we (through our joint ventureTHQ/JAKKS Pacific LLC (“THQ/JAKKS”)) filed an application for relief from thecourt order.  That application wasdenied by the trial court and an appeal was filed and heard on February 24 and25, 2003.  The appeals court renderedits opinion on March 27, 2003, ruling that our continued marketing of thesevideo games, with the “WWF” initials and brand removed except to the extentembedded in the games, is neither a breach of the court order against WWE nor acontempt of court.  We do not know whatimpact the court's decision will have on our ability to sell the affectedproducts.  In addition, since October2002 we have been incorporating the “WWE” brand in place of the “WWF” brand inall of the new wrestling games that we publish, including the recently published*WWE Road to WrestleMania X8* forGame Boy Advance and *WWE SmackDown! ShutYour Mouth* for PlayStation 2.  We had approximately $1.3 million of inventory and $300,000 ofcapitalized software development for games that contain the “WWF” brand that wewrote-down to zero in the fourth quarter of 2002.

 

We are involved in otherroutine litigation arising in the ordinary course of our business.  In the opinion of our management, none ofthe other pending litigation will have a material adverse effect on ourconsolidated financial condition or results of operations.

 

**Item 4****.    SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

There were no matterssubmitted to a vote of security holders during the fourth quarter of 2002.

 

11

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**PART II**

 

**Item 5****.    MARKET FOR THE REGISTRANT’S COMMON EQUITYAND RELATED STOCKHOLDER MATTERS**

 

The common stock isquoted on the NASDAQ National 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 National Market:

 

|            |   | **Closing Sales Prices** |   |
|-----------------|--------|--------------------------|--------|
|            |   | **High**                 |   | **Low** |   |
| **2002**        |   |                     |   |   |   |
| First  Quarter  |   | 34.79                    |   | 26.29 |   |
| Second  Quarter |   | 36.17                    |   | 28.05 |   |
| Third  Quarter  |   | 27.79                    |   | 19.82 |   |
| Fourth  Quarter |   | 23.17                    |   | 12.22 |   |
| **2001**        |   |                     |   |   |   |
| First  Quarter  |   | 25.92                    |   | 14.96 |   |
| Second  Quarter |   | 39.75                    |   | 23.17 |   |
| Third  Quarter  |   | 39.81                    |   | 26.03 |   |
| Fourth  Quarter |   | 42.19                    |   | 27.49 |   |

 

The last reported priceof our common stock on March 21, 2003, as reported by NASDAQ National Market,was $14.03 per share.

 

**Holders**

 

As of March 21, 2003,there were approximately 290 holders of record of our common stock.

 

**DividendPolicy**

 

We have never paid cashdividends on our common stock.  Wecurrently intend to retain future earnings, if any, to finance the growth anddevelopment of our business and, therefore, we do not anticipate paying anycash dividends in the future.  Ourprincipal banking agreement provides that we will not pay any cash dividends.

 

**SecuritiesIssued in Private Transactions**

 

On July 1, 2002, inconnection with our acquisition of ValuSoft, we issued an aggregate ofapproximately 167,000 shares of our common stock to certain stockholders ofValuSoft, Inc. pursuant to the exemption from registration provided in Section4(2) of the Securities Act of 1933, as amended.  ValuSoft is now a division of THQ Inc.

 

On December 21, 2001, inconnection with our acquisition of Rainbow, we issued an aggregate ofapproximately 1,287,000 shares of our common stock to the stockholders ofRainbow pursuant to the exemption from registration provided in Section 4(2) ofthe Securities Act of 1933, as amended. In 2002, we issued approximately an additional 9,000 shares of ourcommon stock to the stockholders of Rainbow pursuant to the terms of the mergeragreement and a royalty participation agreement with the stockholders enteredinto at the time of the acquisition. The additional shares were also issued pursuant to the exemption fromregistration provided in Section 4(2) of the Securities Act of 1933, asamended.

 

12

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**Changesin Securities and Use of Proceeds**

 

On September 10, 2002, weannounced that our Board of Directors authorized the repurchase of up to $25.0million of our common stock from time to time on the open market or in privatetransactions.  On November 21, 2002, weannounced that our Board of Directors authorized the repurchase of up to anadditional $25.0 million of our common stock from time to time on the openmarket or in private transactions bringing the total authorized to $50.0million.  As of December 31, 2002, werepurchased approximately 1,672,000 shares of our common stock for $25.0million.

 

On March 8, 2002, weannounced that our Board of Directors declared a three-for-two stock split ofour shares of common stock to be effected in the form of a 50% stock dividenddistributed on April 9, 2002, to stockholders of record as of the close ofbusiness on March 26, 2002 (the “Dividend”). All references in this Form 10-K to number of shares, sales price andper share amounts of our common stock have been retroactively restated toreflect the increased number of shares of common stock outstanding.  In addition, stockholders’ equity has beenrestated to give retroactive recognition to the Dividend by reclassifying frompaid-in capital to common stock the par value of the additional shares ofcommon stock issued pursuant to the Dividend. The terms of our Amended and Restated Rights Agreement were adjusted totake into account the Dividend.

 

13

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**Item 6****.****           SELECTED CONSOLIDATED FINANCIAL DATA**

**(Inthousands, except per share data)**

 

The following tablepresents certain selected consolidated financial data for the years 1998through 2002.  The information presentedas of December 31, 2002 and 2001 and for each of the years ended December 31,2002, 2001 and 2000 have been derived from, and are qualified by reference to,our audited consolidated financial statements included elsewhere herein.  Those financial statements have been auditedby Deloitte & Touche LLP, our independent auditors.  The information presented as of December 31,2000 and for each of the years ended December 31, 1999 and 1998 were derivedfrom audited financial statements that are not included elsewhere herein.

 

This selectedconsolidated financial data should be read in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andthe Consolidated Financial Statements and Notes thereto included elsewhereherein.

 

**STATEMENTOF OPERATIONS DATA**

**(Inthousands, except per share data)**

 
|                                                 |   | **Years Ended December 31,** |    |
|------------------------------------------------------|--------|------------------------------|---------|
|                                                 |   | **2002**                     |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| Net  sales                                           |   | $                            | 480,529 |   | $ | 378,992 |   | $ | 347,003 |   | $ | 303,483 |   | $ | 216,716 |   |
| Costs  and expenses:                                 |   |                         |    |   |   |   |   |   |   |   |   |
| Cost  of sales                                       |   | 185,593                      |    | 154,898 |   | 140,699 |   | 134,563 |   | 100,019 |   |
| License  amortization and royalties                  |   | 40,476                       |    | 33,144 |   | 34,675 |   | 28,858 |   | 19,390 |   |
| Software  development amortization                   |   | 83,698                       |    | 35,144 |   | 42,875 |   | 19,512 |   | 28,740 |   |
| Product  development                                 |   | 38,572                       |    | 21,154 |   | 19,151 |   | 15,511 |   | 8,925 |   |
| Selling  and marketing                               |   | 66,443                       |    | 46,745 |   | 42,446 |   | 35,440 |   | 20,326 |   |
| Payment  to venture partner                          |   | 10,146                       |    | 8,673 |   | 17,707 |   | 6,119 |   | — |   |
| General  and administrative                          |   | 31,117                       |    | 25,090 |   | 19,530 |   | 14,970 |   | 10,107 |   |
| In-process  research and development                 |   | —                       |    | — |   | — |   | — |   | 7,232 |   |
| Total  costs and expenses                            |   | 456,045                      |    | 324,848 |   | 317,083 |   | 254,973 |   | 194,739 |   |
| Income  from operations                              |   | 24,484                       |    | 54,144 |   | 29,920 |   | 48,510 |   | 21,977 |   |
| Interest  income, net                                |   | 5,277                        |    | 2,572 |   | 1,323 |   | 1,109 |   | 819 |   |
| Other  expenses                                      |   | (10,006                      | )       | — |   | — |   | — |   | — |   |
| Income  before income taxes                          |   | 19,755                       |    | 56,716 |   | 31,243 |   | 49,619 |   | 22,796 |   |
| Income  taxes                                        |   | 6,761                        |    | 20,703 |   | 13,054 |   | 18,293 |   | 9,343 |   |
| Net  income                                          |   | $                            | 12,994  | (a) | $ | 36,013 |   | $ | 18,189 | (b) | $ | 31,326 |   | $ | 13,453 | (c) |
| Net  income per share — basic                   |   | $                            | 0.33    |   | $ | 1.10 |   | $ | 0.60 |   | $ | 1.10 |   | $ | 0.50 |   |
| Net  income per share — diluted                 |   | $                            | 0.32    |   | $ | 1.01 |   | $ | 0.56 |   | $ | 0.99 |   | $ | 0.42 |   |
| Shares  used in per share calculation — basic   |   | 39,203                       |    | 32,717 |   | 30,136 |   | 28,560 |   | 26,894 |   |
| Shares  used in per share calculation — diluted |   | 41,243                       |    | 35,623 |   | 32,352 |   | 31,796 |   | 31,844 |   |

** **

**BALANCESHEET DATA**

**(Inthousands)**

 
|                       |   | **Years Ended December 31,** |    |
|----------------------------|--------|------------------------------|---------|
|                       |   | **2002**                     |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| Working  capital           |   | $                            | 320,588 |   | $ | 319,605 |   | $ | 110,269 |   | $ | 91,860 |   | $ | 48,342 |   |
| Total  assets              |   | $                            | 537,860 |   | $ | 487,966 |   | $ | 229,942 |   | $ | 184,057 |   | $ | 128,218 |   |
| Lines  of credit           |   | $                            | —  |   | $ | — |   | $ | 15,473 |   | $ | 16,702 |   | $ | 9,909 |   |
| Stockholders’  equity |   | $                            | 408,866 |   | $ | 398,862 |   | $ | 132,125 |   | $ | 108,306 |   | $ | 62,065 |   |

 

Notes:

 

The table above reflectsthe May 1999 pooling of interests with PCP&L, the December 1999 pooling ofinterests with GA and the August 2000 pooling of interests with Volition.  All prior period information has beenrestated accordingly.

 

(a)          Net income includes acharge of $7.9 million, net of tax for the cancellation of 20 SKUs as well as acharge of $4.6 million, net of tax related to the settlement of a class actionlawsuit (See – "Item 3. Legal Proceedings") and a charge of $1.1million, net of tax

 

14

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related to the write-offof inventory and software development for “WWF”-branded games that we have beenprevented from shipping pursuant to an action by the World Wide Fund for Natureagainst World Wrestling Entertainment, Inc. (See – "Item 3. LegalProceedings") and a charge of $2.8 million, net of tax related to thediscontinuation of our online joint venture in the United Kingdom (NetworkInteractive Sports, Ltd.).

 

(b)         Net income includes acharge of $5.9 million, net of tax related to a regular impaired asset reviewand also as a result of changing technology in the video game market.  The charge consisted of costs associatedwith software development and related costs for products that had beendiscontinued or whose values were deemed unrecoverable through futureundiscounted cash flows.

 

(c)          Net income includes acharge of $7.2 million, net of tax for in process research and development inconnection with the acquisition of Game FX.

 

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**Item 7****.****           MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**CriticalAccounting Policies**

 

The Management’sDiscussion and Analysis of Financial Condition and Results of Operationsdiscusses our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America.  The preparation of theseconsolidated financial statements requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting period.  The policies discussedbelow are considered by management to be critical because they are bothimportant to the portrayal of our financial condition and results of operationsand their application places the most significant demands on management’sjudgment, with financial reporting results relying on estimates about theeffect of matters that are inherently uncertain.  Specific risks for these critical accounting policies aredescribed in the following paragraphs. For all of these policies, management cautions that actual results maydiffer materially from these estimates under different assumptions orconditions.

 

*Allowancesfor price protection, returns and doubtful accounts.*  We derive revenues from sales of packagedsoftware for video game systems and personal computers, sales of software andservices for wireless devices and from licensing software.  Product revenue is recognized net ofallowances for price protection and returns and various customer discounts.  We typically only allow returns for ourpersonal computer products.  We maydecide to provide price protection or allow returns for our video game systemand personal computer products after we analyze: i) inventory remaining in theretail channel, ii) the rate of inventory sell through in the retail channel, andiii) our remaining inventory on hand. We maintain a policy of giving credits for price protection and returns,but do not give cash refunds.

 

We establish salesallowances based on estimates of future price protection and returns withrespect to current period product revenue. We analyze historical price protection granted, historical returns,current sell through of retailer and distributor inventory of our products,current trends in the video game market and the overall economy, changes incustomer demand and acceptance of our products and other related factors whenevaluating the adequacy of the price protection and returns allowance.  In addition, management monitors the volumeof our sales to retailers and distributors and their inventories becausesubstantial overstocking in the distribution channel can result in therequirement for substantial price protection or high returns in subsequentperiods.  In the past, actual priceprotection and returns have not generally exceeded our reserves.  However, actual price protection and returnsin any future period are inherently uncertain as unsold products in thedistribution channels are exposed to rapid changes in consumer preferences,market conditions or technological obsolescence due to new platforms, productupdates or competing products.  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.  In addition, if actual price protection andreturns were significantly greater than the reserves we have established, theactual results would decrease our reported revenue.  Conversely, if actual price protection and returns weresignificantly less than our reserves, this would increase our reported revenue.

 

Similarly, managementmust use significant judgment and make estimates in connection withestablishing allowances for doubtful accounts in any accounting period.  Management analyzes customer concentrations,customer credit-worthiness and current economic trends when evaluating theadequacy of the allowance for doubtful accounts.  Material differences may result in the amount and timing of ourbad debt expense for any period if management made different judgments orutilized different estimates.  If ourcustomers experience financial difficulties and are not able to meet theirongoing financial obligations to us, our results of operations may be adverselyimpacted.  For example, in January 2002,one of our retail customers, Kmart, filed for bankruptcy protection.  We believe we have adequately reserved forour exposure from Kmart.

 

For the years endedDecember 31, 2002, 2001 and 2000, we recorded allowances for future priceprotection, returns and doubtful accounts of approximately $69.6 million, $47.4million and $35.4 million, respectively, during such periods.  As of December 31, 2002 and 2001, ouraggregate reserves against accounts receivable for price protection, returnsand doubtful accounts were approximately $59.9 million and $40.6 million,respectively.

 

*Licenses.*  Minimum guaranteed royalty payments forintellectual property licenses are initially recorded as an asset (licenses)and as a liability (accrued royalties) at the contractual amount upon executionof the contract when no significant performance remains with the licensor.  When significant performance remains withthe licensor, we record royalty payments as an asset (licenses) when actuallypaid rather than upon execution of the contract.  Royalty payments for intellectual property licenses areclassified as current assets and current liabilities to the extent such

 

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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.

 

Licenses are expensed tolicense amortization and royalties at the higher of (i) the contractual royaltyrate based on actual net product sales or (ii) the ratio of current units soldto total projected units sold.  When, inmanagement’s estimate, future cash flows will not be sufficient to recoverpreviously capitalized costs, we expense these capitalized costs to licenseamortization and royalties.  See “*Long-Lived Assets*” below.  If actual revenues, or revised forecastedunits, fall below the initial forecasted units, the charge to licenseamortization and royalties may be larger than anticipated in any given quarter.  As of December 31, 2002, the net carryingvalue of our licenses was $35.4 million. If we were required to write off licenses, due to changes in marketcondition or product quality, our results of operations could be materiallyadversely affected.

 

*SoftwareDevelopment*.  Weutilize both independent software developers and internal development teams todevelop our software.  We account forsoftware development costs in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to beSold, 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 provengame engine technology exists, this may occur early in the developmentcycle.  We capitalize the milestonepayments made to independent software developers and the direct payroll costsfor our internal development teams.  Weevaluate technological feasibility on a product-by-product basis.  Amounts related to software development forwhich technological feasibility is not yet met are charged immediately toproduct development expense.

 

Capitalized softwaredevelopment is expensed to software development amortization at the higher of(i) the contractual rate based on actual net product sales or (ii) the ratio ofcurrent units sold to total projected units sold.  When, in management’s estimate, future cash flows will not besufficient to recover previously capitalized costs, we expense these costs tosoftware development amortization.  See“*Long-Lived Assets*” below.  If actual revenues, or revised forecastedunits, fall below the initial forecasted units, the charge to softwaredevelopment amortization may be larger than anticipated in any givenquarter.  As of December 31, 2002, thenet carrying value of our software development was $47.4 million.  If we were required to write off softwaredevelopment, due to changes in market condition or product quality, our resultsof operations could be materially adversely affected.

 

*Goodwill.*  In conjunction with the implementation ofthe new accounting rules for goodwill as of the beginning of 2002, we completeda goodwill impairment review.  Accordingto our accounting policy, we also performed an annual review during the quarterended June 30, 2002, and in both reviews we found no impairment.  We will perform a similar review in thesecond quarter of each calendar year, or more frequently if indicators ofpotential impairment exist.  Ourimpairment review process is based on a discounted future cash flow approachthat uses our estimates of revenue for the reporting units, driven by assumedsuccess of our products and product release schedules, and estimated costs as wellas appropriate discount rates.  Theseestimates are consistent with the plans and estimates that we use to manage theunderlying businesses.  We performedsimilar impairment tests for indefinite lived intangible assets and found noimpairment.  The success of our productsis affected by the ability to accurately predict which platforms and whichproducts we develop will be successful. Also, our revenues and earnings are dependent on our ability to meet ourproduct release schedules.  Due to theseand other factors described in the subsection entitled “Risk Factors” in “Item7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS” we may not realize the future net cash flows necessary to recoverour goodwill.

 

Based on these judgmentsand assumptions, management determines whether we need to take an impairmentcharge to reduce the value of the goodwill stated on our balance sheet toreflect its estimated fair value. Judgments and assumptions about future values are complex and oftensubjective.  They can be affected by avariety of factors, including but not limited to, significant negative industryor economic trends, significant changes in the manner or use of the acquiredassets or the strategy of our overall business and significant underperformancerelative to expected historical or projected future operating results.  Although we believe the judgments andassumptions management has made in the past have been reasonable and appropriate,there is nonetheless a high degree of uncertainty and judgment involved.  We continue to encounter the risks anddifficulties faced with launching or acquiring a new business.  When the business is a development studio,we look for ways to maximize the talent and intellectual property within thestudio.  We make judgments andassumptions as to the commercial success and quantity of games developed by aparticular studio.  Different judgmentsand assumptions could materially impact our reported financial results.  For example, if Rainbow Studios does notdevelop games with the same commercial success or the same number of games aswe have estimated, we may need to take an impairment charge against ourgoodwill associated with Rainbow Studios in the future.  More conservative assumptions of theanticipated future benefits from these businesses would result in greaterimpairment charges, which would decrease net income and

 

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result in lower asset values on our balance sheet.  Conversely, less conservative assumptionswould result in smaller impairment charges and higher net income.

 

*Long-Lived Assets.*  We evaluate long-livedassets, including but not limited to licenses, software development, propertyand equipment and identifiable intangible assets with finite lives, forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable.  Factors we consider in deciding when to perform an impairmentreview include significant under-performance of a product or platform inrelation to expectations, significant negative industry or economic trends, andsignificant changes or planned changes in our use of the assets.  Recoverability of the assets are measured bya comparison of the carrying amount of an asset to future undiscounted net cashflows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to berecognized is measured by the amount by which the carrying amount of the assetexceeds its fair value.

 

Judgments and assumptionsabout future values are complex and often subjective.  They can be affected by a variety of factors, including but notlimited to, significant negative industry or economic trends, significantchanges in the manner or use of the acquired assets or the strategy of ouroverall business and significant underperformance relative to expectedhistorical or projected future operating results.  Although we believe the judgments and assumptions management hasmade in the past have been reasonable and appropriate, there is nonetheless ahigh degree of uncertainty and judgment involved.  More conservative assumptions of the anticipated future cashflows from these assets would result in greater impairment charges, which woulddecrease net income and result in lower asset values on our balance sheet.  Conversely, less conservative assumptionswould result in smaller impairment charges and higher net income.

 

We also make judgmentsabout the remaining useful lives of long-lived assets.  When we determine that the useful lives ofassets are shorter than we had originally estimated, and there are sufficientcash flows to support the carrying value of the assets, we accelerate the rateof depreciation charges in order to fully depreciate the assets over their new,shorter, useful lives.

 

*Incometaxes.*  As part of theprocess of preparing our consolidated financial statements, we are required toestimate our income taxes in each of the jurisdictions in which weoperate.  This process involvesestimating our current tax exposures in each jurisdiction including the impact,if any, of additional taxes resulting from tax examinations as well as makingjudgments regarding the recoverability of deferred tax assets.  To the extent recovery of deferred taxassets is not likely based on our estimation of future taxable income in eachjurisdiction, a valuation allowance is established.  Tax exposures can involve complex issues and may require anextended period to resolve.  Theestimated effective tax rate is adjusted for the tax related to significantunusual items.  Changes in thegeographic mix or estimated level of annual pre-tax income can affect theoverall effective tax rate.

 

*RecentlyIssued Accounting Pronouncements.*  In June 2002, the FASB issued SFAS No. 146, *“Accounting for Costs Associated with Exit orDisposal Activities.”*  SFASNo. 146 requires that the liability for costs associated with an exit ordisposal activity be initially measured at fair value and recognized when theliability is incurred.  The provisionsof SFAS No. 146 are required to be applied prospectively to exit or disposalactivities initiated after December 31, 2002. We do not expect the adoption of SFAS No. 146 to have a material impacton our financial statements, as we have not initiated any exit or disposalactivities.

 

In November 2002, FASBissued Interpretation (“FIN”) No. 45 – *“Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others.”* FIN No. 45 elaborates on thedisclosures to be made by a guarantor in its interim and annual financialstatements about its obligations under certain guarantees that it hasissued.  It also clarifies that aguarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee.  The initial recognition andinitial measurement provisions of this Interpretation are applicable on aprospective basis to guarantees issued or modified after December 31,2002.  We are currently evaluating theprovisions of FIN No. 45 and have not determined the impact, if any, they willhave on our financial statements.

 

In December 2002, theFASB issued SFAS No. 148, *“Accounting forStock-Based Compensation –Transition and Disclosure.”*  This statement amends SFAS No. 123, toprovide alternative methods of voluntary transition to change to the fair valuebased method of accounting for stock-based employee compensation.  Additionally, this statement amends disclosurerequirements of accounting for stock-based employee compensation and the effectof the method used on reporting results. Currently, we do not expect to adopt SFAS No. 123 related to theexpensing of the fair value based method of accounting for stock-based employeecompensation.  We have adopted the newdisclosure requirements of SFAS No. 148 as included in the Summary ofSignificant Accounting Policies, Stock-Based Compensation.

 

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**Resultsof Operations**

 

***Comparison of the Year Ended December 31, 2002 to the YearEnded December 31, 2001***

 

Salesby Platform

 

The following table setsforth our net sales by platform as a percentage of sales for the years endedDecember 31, 2002 and 2001:

 

| **Platform  Revenue Mix**  |   | **Years Ended  December 31,** |   |
|----------------------------|--------|-------------------------------|--------|
|                       |   | **2002**                      |   | **2001** |   |
| Sony  PlayStation 2        |   | 34.8                          | %      | 29.2 | % |
| Sony  PlayStation          |   | 7.8                           |   | 15.9 |   |
| Nintendo  Game Boy Advance |   | 24.9                          |   | 22.1 |   |
| Nintendo  Game Boy Color   |   | 5.4                           |   | 16.5 |   |
| Nintendo  Game Cube        |   | 10.2                          |   | — |   |
| Nintendo  64               |   | 0.1                           |   | 4.5 |   |
| Microsoft  Xbox            |   | 7.1                           |   | 1.4 |   |
| PC                         |   | 9.4                           |   | 9.7 |   |
| Other                      |   | 0.3                           |   | 0.7 |   |
|                       |   | 100.0                         | %      | 100.0 | % |

 

The following table setsforth our net sales by platform for the years ended December 31, 2002 and 2001:

 
| **Net Sales  for the Years  Ended  (In thousands)** |   | **December 31,  2002** |    | **December 31,  2001** |   | **Increase/  (Decrease)** |   | **%****Change** |    |
|-----------------------------------------------------|--------|------------------------|---------|------------------------|--------|---------------------------|--------|-----------------|---------|
| Sony PlayStation 2                                  |   | $                      | 167,032 |                   | $      | 110,642                   |   | $               | 56,390  |   | 51.0 | % |
| Sony  PlayStation                                   |   | 37,270                 |    | 60,340                 |   | (23,070                   | )      | (38.2           | )%      |
| Nintendo  Game Boy Advance                          |   | 119,614                |    | 83,830                 |   | 35,784                    |   | 42.7            | %       |
| Nintendo  Game Boy Color                            |   | 26,185                 |    | 62,569                 |   | (36,384                   | )      | (58.2           | )%      |
| Nintendo  Game Cube                                 |   | 49,004                 |    | —                 |   | 49,004                    |   | N/A             |    |
| Nintendo  64                                        |   | 277                    |    | 17,097                 |   | (16,820                   | )      | (98.4           | )%      |
| Microsoft  Xbox                                     |   | 34,143                 |    | 5,111                  |   | 29,032                    |   | 568.0           | %       |
| PC  CD-ROM                                          |   | 45,046                 |    | 36,814                 |   | 8,232                     |   | 22.4            | %       |
| Other                                               |   | 1,958                  |    | 2,589                  |   | (631                      | )      | (24.4           | )%      |
| Net  Sales                                          |   | $                      | 480,529 |                   | $      | 378,992                   |   | $               | 101,537 |   | 26.8 | % |

 

*Sony PlayStation 2 Net Sales*

 

We had 12 new releases ofPlayStation 2 titles in 2002 whereas we had five new PlayStation 2 releases in2001.  Key titles for PlayStation 2released in 2002 include*Red Faction II, Scooby-Doo! Night of 100 Frights, SpongeBob SquarePants: Revenge of the FlyingDutchman, Summoner 2*and*WWE SmackDown! Shut Your Mouth*.  Keytitles for PlayStation 2 released in 2001 included *WWF SmackDown! “Just Bring It”, RedFaction*and *MX 2002 featuring Ricky Carmichael.*

 

*Sony PlayStation Net Sales*

 

We did not release anyPlayStation products in the year ended December 31, 2002, whereas we releasedten PlayStation titles in the year ended December 31, 2001.  We do not anticipate releasing any newPlayStation products in the future, due to the transition to the nextgeneration of hardware.  We do notanticipate that this will have a material effect on our overall net salesbecause of the increase in PlayStation 2 net sales and the continued demand forour current PlayStation catalogue titles in the children’s genre.

 

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*Nintendo Game Boy Advance Net Sales*

 

We released 31 new GameBoy Advance titles in the year ended December 31, 2002, including *Scooby-Doo! The Movie, Sonic Advance, SpongeBobSquarePants: Revenge of the Flying Dutchman*and*Star Wars Episode 2: Attack of the Clones,*whereas we released 15 Game Boy Advance titles during 2001, including *Disney/Pixar’sMonsters, Inc., Jimmy Neutron: Boy Genius, MX 2002 featuring Ricky Carmichael, Rocket Power: Dream Scheme, Rugrats:Castle Capers*and*TetrisWorlds*.

 

*Nintendo Game Boy Color Net Sales*

 

We did not release anyGame Boy Color products in the year ended December 31, 2002, whereas wereleased 16 Game Boy Color titles in the year ended December 31, 2001.  We do not anticipate releasing any new GameBoy Color products in the future, due to the transition to the next generationof hardware.  We do not anticipate thatthis will have a material effect on our overall net sales because of theincrease in Nintendo Game Boy Advance net sales.

 

*Nintendo GameCube Net Sales*

 

We released 11 GameCubetitles in the year ended December 31, 2002, including *Disney/Pixar’s Monsters, Inc. ScreamArena, MX Superfly featuring Ricky Carmichael, Rocket Power Beach Bandits, Scooby-Doo! Night of 100 Frights, SpongeBob SquarePants: Revenge of theFlying Dutchman*and*WWE WrestleMania X8*.  We had no releases of GameCube titles in theyear ended December 31, 2001, as the GameCube platform did not launch untilNovember 2001.

 

*Nintendo 64 Net Sales*

 

We did not release anyNintendo 64 (“N64”) products in the year ended December 31, 2002.  We released two N64 titles in the year endedDecember 31, 2001.  We do not anticipatereleasing any new N64 products in the future, due to the transition to the nextgeneration of hardware.  We do notanticipate that this will have a material effect on our overall net salesbecause of the transition to the next generation of hardware platforms.

 

*Microsoft Xbox*

 

We released seven Xboxtitles in the year ended December 31, 2002 including *MotoGP, Tetris Worlds*and *WWFRaw*.  We released our firsttwo Xbox titles in the fourth quarter of 2001.

 

*PC CD-ROM Net Sales*

 

We released 52 PC titlesin the year ended December 21, 2002 whereas we only released 13 PC titles in2001.  The increase in PC CD-ROM titlesreleased and net sales for 2002 as compared to the same period of 2001 isattributed to the acquisition ofValuSoft.  This increase in net salesfor 2002 attributed to ValuSoft is offset by lower net sales of our regularpriced PC CD-ROM products.

 

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Salesby Territory

 

The following table setsforth, for the years ended December 31, 2002 and 2001, our net sales for theNorth America and international territories:

 
| **Net Sales  for the Years Ended  (In thousands)** |   | **December 31,  2002** |    | **December 31,  2001** |   | **Increase/  (Decrease)** |   | **%****Change** |    |
|----------------------------------------------------|--------|------------------------|---------|------------------------|--------|---------------------------|--------|-----------------|---------|
| North  America                                     |   | $                      | 358,124 |                   | $      | 262,676                   |   | $               | 95,448  |   | 36.3 | % |
| International                                      |   | 122,405                |    | 116,316                |   | 6,089                     |   | 5.2             | %       |
| Net  Sales                                         |   | $                      | 480,529 |                   | $      | 378,992                   |   | $               | 101,537 |   | 26.8 | % |

* *

*NorthAmerica Net Sales*

 

The increase in net salesin North America for the year ended December 31, 2002 as compared to the sameperiod of 2001 was primarily due to the significant increase in the number oftitles released domestically.

 

Our net sales during thequarter ended December 31, 2002 were lower than expected due to sales of *Red FactionII* for PlayStation 2, our GameCube portfolio not meeting ourexpectations and a cautious retail environment.  Although we expect the cautious retail environment to continue,we believe we have taken measures necessary to meet net sales expectations inthe future.  These measures includereducing the number of SKUs for the GameCube platform, canceling thedevelopment of SKUs that did not meet quality or marketability standards andimplementing a new product development structure with a heightened focus onproduct quality.

 

Two of our key genres,wrestling and children’s, are best suited to the broader demographic whichoccurs as the hardware platforms reach a larger installed base.  Based on the higher installed base of allfour hardware platforms, particularly PlayStation 2 and Xbox, and ourincreasing product line, we anticipate our net sales in North America toincrease in our fiscal year ending March 31, 2004.

 

*International Net Sales*

 

Net sales in theinternational territories, with the exception of France, increased slightly forthe year ended December 31, 2002 as compared to the same period of 2001.  This slight increase was primarily due tothe launches of next generation hardware platforms occurring at later dates inforeign territories, resulting in a smaller installed base.  We expect our international net sales toincrease at a faster rate in our fiscal year ending March 31, 2004 as comparedto calendar year 2002 as the hardware platforms reach a larger installed base.

 

Net sales in Francedeclined by $3.6 million or 20% for the year ended December 31, 2002 ascompared to the same period of 2001. This decline in net sales was due to the demand for *Red Faction II* forPlayStation 2 being lower than anticipated and slower than anticipated growthof the GameCube installed base.  Weexpect sales in France to increase in our fiscal year ending March 31, 2004 dueto the expected increase in the installed base of PlayStation 2.

 

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Costsand Expenses, Interest Income, net, Other Expenses and Income Taxes

 

Information about ourcosts and expenses, interest income, net, other expenses and income taxes forthe years ended December 31, 2002 and 2001 is presented below:

 

|                                |   | **Percent of Net Sales**      |   |
|-------------------------------------|--------|-------------------------------|--------|
|                                |   | **Years Ended  December 31,** |   |
|                                |   | **2002**                      |   | **2001** |   |
| Costs  and expenses:                |   |                          |   |   |   |
| Cost  of sales                      |   | 38.6                          | %      | 40.9 | % |
| License  amortization and royalties |   | 8.4                           |   | 8.7 |   |
| Software  development amortization  |   | 17.4                          |   | 9.3 |   |
| Product  development                |   | 8.0                           |   | 5.6 |   |
| Selling  and marketing              |   | 13.8                          |   | 12.3 |   |
| Payment  to venture partner         |   | 2.1                           |   | 2.3 |   |
| General  and administrative         |   | 6.6                           |   | 6.6 |   |
| Total  costs and expenses           |   | 94.9                          |   | 85.7 |   |
| Income  from operations             |   | 5.1                           |   | 14.3 |   |
| Interest  income, net               |   | 1.1                           |   | 0.7 |   |
| Other  expenses                     |   | (2.1                          | )      | — |   |
| Income  before income taxes         |   | 4.1                           |   | 15.0 |   |
| Income  taxes                       |   | 1.4                           |   | 5.5 |   |
| Net  income                         |   | 2.7                           | %      | 9.5 | % |

 

*Cost of Sales*

 

Cost of sales as apercentage of net sales decreased for the year ended December 31, 2002 comparedto the same period of 2001 as a result of a larger proportion of sales in 2002of next generation console games which have lower manufacturing costs thanhandheld games and a reduction in the manufacturing costs for the Game BoyAdvance in 2002.  We expect our cost ofsales to decrease slightly in our fiscal year ending March 31, 2004 due to anexpected higher percentage of sales in such period of higher-margin disc-basedproducts.

 

*LicenseAmortization and Royalties*

 

License amortization androyalties increased in absolute dollars but decreased slightly as a percentageof net sales for the year ended December 31, 2002 as compared to the sameperiod of 2001 primarily due to the sale of key titles in 2002 that have lowerroyalty rates than our average titles and the titles that were sold in2001.  This decrease was also due to thesale of titles published by ValuSoft. ValuSoft products carry lower license rates compared to our standardconsole and PC CD-ROM products.

 

*SoftwareDevelopment Amortization*

 

Software developmentamortization includes a write-off of approximately $11.2 million for thediscontinued product development of 20 SKUs, which means that one or moreplatform versions of an individual product title may have beendiscontinued.  We discontinued thedevelopment of these SKUs after reviewing the quality of these SKUs anddetermining that the SKUs were not marketable. Excluding this write-off, software development amortization was $72.5million or 15.0% of net sales for the year ended December 31, 2002.  The increase as a percentage of net salesfrom the year ended December 31, 2001 is primarily due to lower than anticipatedsales during the fourth quarter of 2002 and the increased percentage of nextgeneration console games sold during 2002 as compared to 2001, which havelonger development cycles and higher development costs than handheld games andgames for legacy platforms.

 

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*Product Development*

 

Product developmentexpenses increased in absolute dollars and as a percentage of net sales for theyear ended December 31, 2002 as compared to the same period of 2001.  This increase is primarily due to the costsincurred by the three new development studios: Rainbow, Outrage and Cranky Pants. We also increased the number of personnel in our corporate productdevelopment department to support the increased number of SKUs underdevelopment, thereby contributing to the higher product development expenses in2002.  We also had increased expensesfor our wireless division.

 

*Selling and Marketing*

 

Selling and marketingexpenses increased by $19.7 million and have increased slightly as a percentageof net sales for the year ended December 31, 2002 as compared to the sameperiod of 2001.  The increase in sellingand marketing expenses as a percentage of net sales for the year ended December31, 2002 is primarily due to an increase in television media expenditures as apercentage of net sales for a greater number of SKUs in 2002 as compared to2001 and the lower than anticipated sales during the fourth quarter of 2002.

 

*Payment to Venture Partner*

 

The payment to JAKKS hasremained relatively constant as a percentage of total net sales for the yearended December 31, 2002 as compared to the same period of 2001.  In our fiscal year ending March 31, 2004, weexpect this expense to decrease as a percentage of net sales in direct relationto an expected decrease in World Wrestling Entertainment related sales as apercentage of our total net sales as we continue to diversify our productportfolio.

 

*General and Administrative*

 

General andadministrative expenses increased by $6.0 million due to the expenses requiredto support the increased net sales, an increase in our allowance for doubtfulaccounts related to the Chapter 11 bankruptcy filing of Kmart and the additionof ValuSoft’s general and administrative expenses, but it remained relativelyconstant as a percentage of net sales as compared to the same period of 2001.

 

*Interest Income, net*

 

Interest income, netincreased for the year ended December 31, 2002 as compared to the same periodof 2001 as a result of higher average cash, cash equivalents and short-terminvestment balances which increased as a result of our public offering of ourcommon stock in November 2001.

 

*Other Expenses*

 

Other expenses includes a$7.0 million charge related to the settlement of the class action lawsuit.  See – “Item 3. Legal Proceedings.”  The $7.0 million includes $2.0 million forthe portion of the settlement and legal fees that exceeds our directors andofficers insurance coverage and $5.0 million as a reserve against thereceivable from our insurer due to a dispute in the amount of coverage.  We are currently in arbitration with theinsurer.  See – “Item 3. LegalProceedings.”  Any amount received inarbitration will be recognized as other income in a future period.  Other expenses also includes a $3.0 millionnon-cash charge related to the discontinuation of our online joint venture inthe United Kingdom (Network Interactive Sports, Ltd.).

 

*Income Taxes*

 

The effective tax ratefor the year ended December 31, 2002 was 34.2%, and the effective tax rate for2001 was 36.5%.  The decrease in theeffective tax rate from 2001 to 2002 is due primarily to tax benefits relatedto our international business activities. We expect our effective tax rate for our fiscal year ending March 31,2004 to be approximately 37-38%.

 

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***Comparison of the Year Ended December 31, 2001 to the YearEnded December 31, 2000***

 

Sales by Platform

 

The following table setsforth our net sales by platform as a percentage of sales for the years endedDecember 31, 2001 and 2000:

 

| **Platform  Revenue Mix**  |   | **Years Ended  December 31,** |   |
|----------------------------|--------|-------------------------------|--------|
|                       |   | **2001**                      |   | **2000** |   |
| Sony  PlayStation 2        |   | 29.2                          | %      | 2.6 | % |
| Sony  PlayStation          |   | 15.9                          |   | 41.0 |   |
| Nintendo  Game Boy Advance |   | 22.1                          |   | — |   |
| Nintendo  Game Boy Color   |   | 16.5                          |   | 20.3 |   |
| Nintendo  64               |   | 4.5                           |   | 28.6 |   |
| Microsoft  Xbox            |   | 1.4                           |   | — |   |
| PC                         |   | 9.7                           |   | 3.2 |   |
| Other                      |   | 0.7                           |   | 4.3 |   |
|                       |   | 100.0                         | %      | 100.0 | % |

 

The following table setsforth our net sales by platform for the years ended December 31, 2001 and 2000:

 
| **Net Sales  for the Years  Ended  (In thousands)** |   | **December 31,  2001** |    | **December 31,  2000** |   | **Increase/  (Decrease)** |   | **%****Change** |    |
|-----------------------------------------------------|--------|------------------------|---------|------------------------|--------|---------------------------|--------|-----------------|---------|
| Sony PlayStation 2                                  |   | $                      | 110,642 |                   | $      | 9,064                     |   | $               | 101,578 |   | 1,120.7 | % |
| Sony  PlayStation                                   |   | 60,340                 |    | 142,429                |   | (82,089                   | )      | (57.6           | )%      |
| Nintendo  Game Boy Advance                          |   | 83,830                 |    | —                 |   | 83,830                    |   | N/A             |    |
| Nintendo  Game Boy Color                            |   | 62,569                 |    | 70,379                 |   | (7,810                    | )      | (11.1           | )%      |
| Nintendo  64                                        |   | 17,097                 |    | 99,176                 |   | (82,079                   | )      | (82.8           | )%      |
| Microsoft  Xbox                                     |   | 5,111                  |    | —                 |   | 5,111                     |   | N/A             |    |
| PC  CD-ROM                                          |   | 36,814                 |    | 11,035                 |   | 25,779                    |   | 233.6           | %       |
| Other                                               |   | 2,589                  |    | 14,920                 |   | (12,331                   | )      | (82.6           | )%      |
| Net  Sales                                          |   | $                      | 378,992 |                   | $      | 347,003                   |   | $               | 31,989  |   | 9.2 | % |

 

*Sony PlayStation 2 Net Sales*

 

We had five new releasesof PlayStation 2 titles in 2001 whereas we only had one new PlayStation 2release in 2000.  Key titles forPlayStation 2 released in 2001 include *Red Faction, WWF SmackDown! “Just Bring It”*and*MX 2002featuring Ricky Carmichael*.

 

*Sony PlayStation Net Sales*

 

PlayStation net salesdecreased for the year ended December 31, 2001 compared to the same period of2000 for two reasons: 1) decreased sales of *WWF SmackDown!* and *WWF SmackDown! 2: Know Your Role* whichwere both released in 2000 (we released no new World Wrestling Federationtitles on PlayStation in 2001) and 2) the declining market for PlayStationproducts due to the transition to PlayStation 2.

 

*Nintendo Game Boy Advance Net Sales*

 

We released 15 Game BoyAdvance titles during 2001 including *RocketPower: Dream Scheme,**MX 2002 featuring Ricky Carmichael, Tetris Worlds,Disney/Pixar’s Monsters, Inc., Jimmy Neutron: Boy Genius*and *Rugrats: Castle Capers*.

 

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*Nintendo Game Boy Color Net Sales*

 

Game Boy Color net salesdecreased during 2001 as compared to the same period of 2000 due to theintroduction of the Game Boy Advance platform.

 

*Nintendo 64 Net Sales*

 

We had two releases ofNintendo 64 (“N64”) product in 2001 versus four N64 releases in 2000.  Net sales decreased by 83% due to the weakermarket for N64 product as the industry transitioned to the next generation ofhardware.

 

*Microsoft Xbox*

 

We released our first twoXbox titles in the fourth quarter of 2001. The two titles were *Dark Summit* and *MX 2002 featuring Ricky Carmichael*.

 

*PC CD-ROM Net Sales*

 

The significant increasein PC CD-ROM net sales for 2001 as compared to the same period of 2000 isattributed to the worldwide release of *Red Faction*for the PC, numerous children’s titles including, *RocketPower:**ExtremeArcade Games, Bob The Builder: Can We Fix It?, SpongeBob SquarePants: Operation Krabby Patty, JimmyNeutron: Boy Genius* and *Rugrats: AllGrowed Up*, as well as salesfrom *HotWheels* and*Matchbox*titles released under our licenseagreement with Mattel.  We released 13PC titles in 2001 whereas we only released six PC titles in 2000.

 

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Salesby Territory

 

The following table setsforth, for the years ended December 31, 2001 and 2000, our net sales for theNorth America and international territories:

 
| **Net Sales  for the Years  Ended  (In thousands)** |   | **December 31,  2001** |    | **December 31,  2000** |   | **Increase/  (Decrease)** |   | **%****Change** |   |
|-----------------------------------------------------|--------|------------------------|---------|------------------------|--------|---------------------------|--------|-----------------|--------|
| North  America                                      |   | $                      | 262,676 |                   | $      | 270,116                   |   | $               | (7,440 | ) | (2.8 | )% |
| International                                       |   | 116,316                |    | 76,887                 |   | 39,429                    |   | 51.3            | %      |
| Net  Sales                                          |   | $                      | 378,992 |                   | $      | 347,003                   |   | $               | 31,989 |   | 9.2 | % |

 

*NorthAmerica Net Sales*

 

The decrease in net salesin North America for the year ended December 31, 2001 as compared to the sameperiod of 2000 was primarily due to the industry’s transition to four newhardware platforms, two of which were released in November of 2001.  In addition, two of our key genres,wrestling and children’s, are best suited to the broader demographic whichoccurs as the hardware platforms reach a larger installed base.

 

Although the total amountof actual units shipped in 2001 was 24% higher than in 2000, our net salesdecreased due to declining pricing on legacy products and no new releases ofN64 products which sell at a higher price than other products.

 

*International Net Sales*

 

The increase in net salesin the international territories for the year ended December 31, 2001 ascompared to the same period of 2000 was primarily due to:

 

•                  Ouroffices in France and Australia conducting business for the full year ascompared to only nine months and three months, respectively, in 2000.

 

•                  Therelease of five PlayStation 2 titles in 2001 as compared to no titles in 2000.

 

•                  A105% increase in net sales of titles for the handheld gaming systems NintendoGame Boy Color and Nintendo Game Boy Advance.

 

•                  A48% increase in PC CD-ROM net sales primarily due to *Red Faction* for PC CD-ROM.

 

•                  Thisincrease was offset by a 52% decrease in PlayStation net sales due to thetransition to PlayStation 2.

 

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Costsand Expenses, Interest Income, net, and Income Taxes

 

Information about ourcosts and expenses, interest income, net, and income taxes for the years endedDecember 31, 2001 and 2000 is presented below:

 

|                                |   | **Percent of Net Sales**      |   |
|-------------------------------------|--------|-------------------------------|--------|
|                                |   | **Years Ended  December 31,** |   |
|                                |   | **2001**                      |   | **2000** |   |
| Costs  and expenses:                |   |                          |   |   |   |
| Cost  of sales                      |   | 40.9                          | %      | 40.6 | % |
| License  amortization and royalties |   | 8.7                           |   | 10.0 |   |
| Software  development amortization  |   | 9.3                           |   | 12.4 |   |
| Product  development                |   | 5.6                           |   | 5.5 |   |
| Selling  and marketing              |   | 12.3                          |   | 12.2 |   |
| Payment  to venture partner         |   | 2.3                           |   | 5.1 |   |
| General  and administrative         |   | 6.6                           |   | 5.6 |   |
| Total  costs and expenses           |   | 85.7                          |   | 91.4 |   |
| Income  from operations             |   | 14.3                          |   | 8.6 |   |
| Interest  income, net               |   | 0.7                           |   | 0.4 |   |
| Income  before income taxes         |   | 15.0                          |   | 9.0 |   |
| Income  taxes                       |   | 5.5                           |   | 3.8 |   |
| Net  income                         |   | 9.5                           | %      | 5.2 | % |

 

*Cost of Sales*

 

Cost of sales as apercentage of net sales remained relatively constant for the year endedDecember 31, 2001 compared to the same period of 2000.

 

*LicenseAmortization and Royalties*

 

License amortization androyalties decreased as a percentage of net sales for the year ended December31, 2001 as compared to the same period of 2000 primarily due to sales of *Red Faction*and*Summoner*which carry nolicense amortization and royalties because we own the intellectual property.

 

*SoftwareDevelopment Amortization*

 

Software developmentamortization decreased as a percentage of net sales for the year ended December31, 2001 as compared to the same period of 2000 primarily due to:

 

•                  Anincrease in the percentage of handheld games sold during the period, whichgenerally carry lower software development costs than console games.

 

•                  TheMay 2000 non-cash charge which included a $7.1 million charge to softwaredevelopment amortization related to discontinued games or unrecoverablemilestone payments.  Before the May 2000non-cash charge, software development amortization for the year ended December31, 2000 was 10.3% of net sales.

 

*Product Development*

 

Product developmentexpenses remained relatively constant as a percentage of net sales for the yearended December 31, 2001 as compared to the same period of 2000.  Product development expenses increased by$2.0 million for the year ended December 31, 2001 as compared to the sameperiod of 2000.  This increase isrelated to the increased headcount of our corporate product developmentdepartment required to support the launch of four new hardware platforms over atwelve-month period and the increased number of titles under development.

 

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*Selling and Marketing*

 

Selling and marketingexpenses increased by $4.3 million for the year ended December 31, 2001 ascompared to the same period of 2000. This increase is directly related to the increase in net sales.  Selling and marketing expenses have remainedrelatively constant as a percentage of net sales for the years ended December31, 2001 and 2000.

 

*Payment to Venture Partner*

 

Payment to JAKKS hasdecreased as a percentage of total net sales and in absolute dollars for theyear ended December 31, 2001 as compared to the same period of 2000 in directrelation to the decrease in World Wrestling Entertainment related sales as apercentage of our total net sales for the year due to fewer titles released in2001.

 

*General and Administrative*

 

General andadministrative expenses increased by $5.6 million due to the expenses requiredto support the increased net sales and an increase in our allowance fordoubtful accounts.  General andadministrative expenses also increased as a percentage of net sales to 6.6%from 5.6% in the same period of 2000. The increase as a percentage of net sales is primarily due to anincrease in our bad debt allowance related to the Chapter 11 bankruptcy filingof Kmart.

 

*Interest Income, net*

 

Interest income, netincreased for the year ended December 31, 2001 as compared to the same periodof 2000 as a result of higher average cash, cash equivalents and short-terminvestment balances due to the proceeds from our secondary offering on November13, 2001.

 

*Income Taxes*

 

The effective tax ratefor the year ended December 31, 2001 was 36.5%, and the effective tax rate for2000 was 41.8%.  The decrease in theeffective tax rate from 2000 to 2001 is due primarily to the relocation of ourwarehouse to a state that has a lower overall tax rate.  In addition, the effective tax rate for 2000was negatively impacted by the acquisition of Volition, which increased therate by 2.5%.

 

**Liquidityand Capital Resources**

 

Our principal source ofcash is sales of our packaged software for video game consoles and personalcomputers.  In addition, we obtained$154.6 million in cash from a public offering of our common stock in November2001.  Our principal uses of cash areproduct purchases, payments to licensors, payments to developers and the costsof internal software development.  Inorder to purchase products from the manufacturers, we typically open letters ofcredit in their favor, obtain a line of credit from the manufacturer or makeprepayments for the product.

 

Our cash, cashequivalents and short-term investments decreased from $206.2 million atDecember 31, 2001 to $186.8 million during the year ended December 31,2002.  Cash, cash equivalents andshort-term investments were $221.2 million as of March 21, 2003, which reflectsthe amounts collected on accounts receivable from the holiday season.  Cash provided by operating activities forthe year ended December 31, 2002 was $16.3 million.

 

We entered intoapproximately 20 new license agreements during the year ended December 31,2002.

 

We used approximately$75.0 million to fund external and internal software development ofapproximately 203 games during the year ended December 31, 2002 and usedapproximately $53.1 million to fund external and internal development ofapproximately 120 games during the same period in 2001.

 

We used approximately$25.0 million to repurchase shares of our common stock during the year endedDecember 31, 2002.

 

The amount of ouraccounts receivable is subject to significant variations as a consequence ofthe seasonality of our sales and the timing of shipments within thequarter.  Accounts receivable istypically highest at the end of the calendar year.

 

*Settlementof class action lawsuit.* We paid approximately $10.2 million under the terms of a settlement ofthe class action lawsuit.  See – “Item3. Legal Proceedings.”  We have $10.0million in directors’ and officers’ insurance coverage, however, our insurer iscurrently disputing $5.0 million of our coverage and relatedreimbursement.  See – “Item 3. LegalProceedings.”  Accordingly, we have placeda $5.0 million reserve on the receivable from the insurer.  The insurance carrier has previouslyreimbursed us approximately $1.6 million for legal fees incurred.  The net receivable at December 31, 2002 was$3.4 million and is included in prepaid expenses and other current assets inthe accompanying balance sheet.

 

*WWFAction*.  As a resultof a court order in an action filed in the United Kingdom by the Fund againstWWE for the use of the initials “WWF” in previously released World WrestlingFederation titles and upon instruction from the

 

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WWE, we ceased sales at least temporarily of certain such titles.  See – “Item 3. Legal Proceedings.”  We had approximately $1.3 million ofinventory and $300,000 of capitalized software development for games thatcontain the “WWF” brand that we wrote-down to zero in the fourth quarter of2002.

 

*CybikoClaim*.  We received ademand from *Motorola*forindemnification under our license to it of certain wireless games distributedin France.  The demand arises out oflitigation commenced in France against *Motorola*and their distribution partners for trademark infringement and unfaircompetition, which seeks $10.0 million in damages plus an unspecified amountand an accounting.  We in turn have madea claim for indemnification against the developer of the games.  Although we expect to prevail, at this earlystage we cannot predict the likely outcome of the demand for indemnification.

 

*Guaranteesand Commitments.*  Weenter into contractual arrangements with third parties for the rights tointellectual property and for the development of products.  Under these agreements, we commit to providespecified payments to an intellectual property holder or developer, based uponcontractual arrangements.  Assuming allcontractual provisions are met, the total future minimum contract commitmentfor contracts in place as of December 31, 2002 is approximately $99.5 million.

 

In addition, we haveadvertising commitments under most of our major license agreements.  These minimum commitments generally rangefrom 2% to 12% of net sales related to the respective license.  We estimate that our minimum commitment foradvertising in 2003 will be $15.7 million. We also have various operating lease commitments of $12.2 millionexpiring at various times through 2012. As of December 31, 2002, we had approximately $2.1 million inobligations under our credit facilities with respect to outstanding letters ofcredit and no outstanding borrowings. We also have a commitment for $3.2 million under a sponsorship agreementcontingent upon certain events, the occurrence of which will require us to makepayments over the next three years.

 

Summary of minimumcontractual obligations and commercial commitments as of December 31, 2002 (inthousands):

 
|                          |   | **Contractual  Obligations and Commercial Commitments** |   |
|-------------------------------|--------|---------------------------------------------------------|--------|
| **Years Ended  December 31,** |   | **License  Guarantees**                                 |   | **Software  Development  Milestone  Payments** |   | **Advertising** |   | **Leases** |   | **Letters of  Credit** |   | **Other** |   | **Total** |   |
| 2003                          |   | $                                                       | 23,440 |   | $ | 31,636 |   | $ | 15,716 |   | $ | 3,884 |   | $ | 2,073 |   | $ | 792 |   | $ | 77,541 |   |
| 2004                          |   | 21,217                                                  |   | 645 |   | 14,670 |   | $ | 3,108 |   | — |   | 1,583 |   | $ | 41,223 |   |
| 2005                          |   | 21,967                                                  |   | — |   | 8,233 |   | $ | 2,497 |   | — |   | 792 |   | $ | 33,489 |   |
| 2006                          |   | 638                                                     |   | — |   | 2,020 |   | $ | 824 |   | — |   | — |   | $ | 3,482 |   |
| 2007                          |   | —                                                  |   | — |   | 2,020 |   | $ | 576 |   | — |   | — |   | $ | 2,596 |   |
| Thereafter                    |   | —                                                  |   | — |   | 3,540 |   | $ | 1,357 |   | — |   | — |   | $ | 4,897 |   |
|                          |   | $                                                       | 67,262 |   | $ | 32,281 |   | $ | 46,199 |   | $ | 12,246 |   | $ | 2,073 |   | $ | 3,167 |   | $ | 163,228 |   |

 

In addition to the abovelease commitments, on February 27, 2003, we entered into a lease agreement forapproximately 29,000 square feet of office space.  The term of the lease is ten years beginning April 15, 2004 withminimum future rental payments totaling $4.2 million.

 

*Warrants. *We are committed under various license andsoftware development agreements to issue warrants to purchase a total ofapproximately 430,000 shares of common stock.  At this time, the warrant terms related to these variousagreements are being negotiated.  Wewill record the fair market value of these warrants when the terms are finalized.**The fair market value will be included inlicense or software development in the accompanying balance sheet and will beamortized to license amortization and royalties or software developmentamortization over estimated sales for games not released and a portion may berecognized immediately for games that have been previously released.

 

*CreditFacilities.*  OnSeptember 27, 2002, we entered into an Amended and Restated Revolving CreditAgreement with Union Bank of California. Under the terms of the Amended and Restated Revolving Credit Agreement,we are permitted to borrow and maintain obligations under outstanding lettersof credit up to an aggregate of $35.0 million through August 31, 2004.

 

We are permitted tomaintain outstanding letters of credit for product purchases and outstandingborrowings in the aggregate as follows (in thousands):

 

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| September 27, 2002 – January 31, 2003 |   | $ | 35,000 |   |
|--------------------------------------------|--------|---|--------|--------|
| February 1, 2003 – August 31, 2003    |   | $ | 20,000 |   |
| September 1, 2003 – January 31, 2004  |   | $ | 35,000 |   |
| February 1, 2004 – August 31, 2004    |   | $ | 20,000 |   |

 

In addition, ouroutstanding borrowings cannot exceed the following amounts (in thousands):

 

| September 27, 2002 – October 31, 2002 |   | $ | 10,000 |   |
|--------------------------------------------|--------|---|--------|--------|
| November 1, 2002 – January 31, 2003   |   | $ | 20,000 |   |
| February 1, 2003 – October 31, 2003   |   | $ | 10,000 |   |
| November 1, 2003 – January 31, 2004   |   | $ | 20,000 |   |
| February 1, 2004 – August 31, 2004    |   | $ | 10,000 |   |

 

We are not permitted tohave any outstanding borrowings for a period of at least 60 days during eachyear of the agreement.

 

This credit facility issecured by a lien on substantially all of our assets and contains customaryfinancial and non-financial covenants which require us to maintain a specifiedminimum net worth and limits our ability to incur additional indebtedness, sellassets and enter into certain mergers or acquisitions.  At December 31, 2002 we were in violation ofthe specified minimum net worth covenant due to the $25 million sharerepurchase and fourth quarter operating results.  The Amended and Restated Revolving Credit Agreement was amendedon November 21, 2002.  On February 21,2003 a waiver of this covenant was executed. We are currently negotiating an amended credit agreement with the bank.  Any amounts outstanding under this creditfacility may be accelerated upon the happening of certain events ofdefault.  We are not permitted to paycash dividends.  Amounts outstandingunder these credit facilities bear interest, at our choice, at either (a) thebank’s prime rate (4.3% at December 31,2002) or (b) the London Interbank Offered Rate (1.4% at December 31, 2002) plus 1.60%. As of December 31, 2002, we had no borrowings on the creditfacility.  We had outstanding letters ofcredit of approximately $2.1 million at December 31, 2002.

 

Accordingly, we believethat our cash, cash equivalents and short-term investments, funds provided byoperations and our borrowing capacity will be adequate to meet our anticipatedrequirements, on both a short-term and long-term basis, for operating expenses,product purchases and payments for licenses and software development.

 

**RiskFactors**

 

Our business is subjectto many risks and uncertainties which may affect our future financialperformance. Some of those important risks and uncertainties which may causeour operating results to vary or which may materially and adversely affect ouroperating results are as follows:

 

**We MustContinue to Develop and Sell New Titles in Order to Remain Profitable.**

 

Our historicalprofitability has directly resulted from our ability to timely develop and sellsuccessful new titles for use on various platforms.  We may not be able to develop and secure the rights to new titlesat a rate that will maintain our current development and release schedule orrelease new titles by the dates we have scheduled.  If the revenues from our new titles fail to replace decliningrevenues from existing titles, our revenues and profits would be materially andadversely affected.

 

Consumer preferences forgames are difficult to predict, and even the most successful titles remainpopular for only limited periods of time, often less than six months.  The life cycle of a game generally consistsof a relatively high level of sales during the first few months afterintroduction, followed by a decline in sales. Accordingly, substantially all of our net sales for a particular yearare generated by titles released in that year and in the latter part of theprior year.  In some instances, a salesdecline may also be accompanied by decreasing sales prices, which may result incredits or allowances to our customers.

 

In addition, thedevelopment cycle for a new game, including the development of the necessarysoftware, approval by the manufacturer and production of the initial products,typically has ranged from 12 to 24 months for home console games and seven to12 months for handheld games.  In orderto distribute a product, we must develop the necessary game software, obtainapproval from the platform manufacturer and licensor, if required, and producethe initial order of cartridges, DVD-ROMs or CD-ROMs.  During the development cycle, the market appeal of a title maydecline.

 

**OurInability To Identify, License And Renew Properties Upon Which Our Products AreBased, Or A Sudden Decrease In Popularity Of The Properties We License, CouldHarm Us.**

 

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The development of mostof our new games is dependent upon our ability to identify and licensedesirable properties.  Examples ofproperties that we seek to license are entertainment projects, such as movies,television programs and arcade games, sports and entertainment personalities,and popular sports, fads or concepts that have high public visibility orrecognition or that reflect the trends of popular culture.  The inability to renew successful licenses,the sudden decrease in popularity of the underlying properties of our licenses,or changes in property content of our licenses could limit our economicsuccess.

 

We have developed and aredeveloping a limited number of internal brands, titles for which no license isrequired.  The success of internalbrands relies heavily on substantial marketing, innovative technology andoriginal ideas.  These titles can beexpensive to develop and market. Further, it is difficult to determine what level of consumer acceptancewill be achieved, as opposed to licensed titles, which generally have abuilt-in consumer base and licensor support.

 

**We RelyOn A Relatively Small Number Of Brands For A Significant Portion Of Our NetSales.**

 

A small number of ourproducts make up a substantial portion of our net sales.  For the year ended December 31, 2002, salesof titles for our three top selling brands, *WorldWrestling Entertainment, SpongeBob* and *Scooby-Doo* were 22.0%, 9.3% and 8.7% of net sales,respectively and for the year ended December 31, 2001, sales of our titles forour three top selling brands, *WorldWrestling Entertainment, Red Faction* and *Championship Motocross/MX featuring Ricky Carmichael* were23.5%, 9.5% and 6.1% of net sales, respectively.  A limited number of brands may continue to produce adisproportionately large amount of our net sales.  Due to this dependence on a limited number of brands, the failureof one or more products based on these brands to achieve anticipated resultsmay significantly harm our business and financial results.

 

**UnexpectedDeclines In The Popularity Of Platforms Could Have A Negative Effect OnConsumer Demand For Titles, Which Could Have A Material Adverse Effect On Us.**

 

The interactiveentertainment software industry has experienced periods of significant growthin consumer interest, followed by periods in which growth has substantiallydeclined.  Our sales are dependent,among other factors, on the popularity and unit sales of the game platforms ofthe various manufacturers.  Thepopularity of the game platforms marketed by the manufacturers has experiencedwide fluctuations.  We must continuallyanticipate and adapt our offerings to emerging platforms and evolving consumerpreferences.  Unexpected declines in thepopularity of a particular platform can be expected to have a material adverseeffect on consumer demand for titles released or scheduled for release for thatplatform.

 

**DevelopmentAnd Distribution Of Wireless Games Is Subject To Different Risks And MayAdversely Impact Our Existing Products.**

 

In 2001, we announced anew division, THQ Wireless, for the development and distribution of games onmobile platforms, including cellular telephones and mobile handhelddevices.  We released 27 wireless gamesin 2002.  Because we are lessexperienced in developing games for these devices and such platforms presentadditional and different risks than those related to traditional console games,we cannot predict with any degree of certainty the financial impact that ourapproach to wireless games will have.

 

**CustomerAccommodations Or Unsaleable Inventory Could Adversely Affect Our Earnings.**

 

We sometimes negotiateaccommodations to retailers or distributors when demand for specific gamesfalls below expectations, in order to maintain our relationships with ourcustomers.  These accommodations includeour not requiring that all booked orders be filled.  We also negotiate price discounts, credits against future ordersand the return of products with our customers.

 

Although we believe thatthe reserves that we have established for customer accommodations are adequate,there is the possibility that actual customer accommodations could exceed ourreserves.  The effect of this would be areduction in our earnings.  We cannotpredict with certainty the amount or nature of accommodations that will beprovided to our customers in future periods.

 

We write down slow-movingor obsolete inventory to net realizable value. An unsuccessful title requires that we write down the inventory for thattitle to its estimated net realizable value. We work to minimize this risk by communicating frequently with ourcustomers and by attempting to accurately forecast retailer and consumer demandfor each of our titles.

 

**For TheYear Ended December 31, 2002, 63.9% Of Our Gross Sales Were Made To Our 10Largest Customers.  We Could BeAdversely Affected If Any Of Them Reduced Or Terminated Their Purchases FromUs.**

 

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Sales to our 10 largestcustomers collectively accounted for approximately 63.9% of our gross sales forthe years ended December 31, 2002 and December 31, 2001, respectively.  Our largest single customer in both periodswas Wal-Mart.  Wal-Mart accounted for16.4% of our gross sales for the year ended December 31, 2002 and 14.1% of ourgross sales for the year ended December 31, 2001.

 

We have no writtenagreements or other understandings with any of our customers that relate tofuture purchases, so purchases by these customers or any others could bereduced or terminated at any time.  Asubstantial reduction or a termination of purchases by any of our largestcustomers would have a material adverse effect on us.

 

**ABusiness Failure By Any Of Our Largest Customers Could Have A Material AdverseEffect On Us.**

 

Our sales are typicallymade on credit, with terms that vary depending upon the customer and otherfactors.  Normally we do not hold anycollateral to secure payment by our customers, and currently we do not factor anyof our receivables.  While we attempt tocarefully monitor the creditworthiness of our customers and distributors, webear the risk of their inability to pay our receivables and of any delay inpayment.  A business failure by any ofour largest customers would have a material adverse effect on us.  Kmart filed for bankruptcy protection as ofJanuary 22, 2002.  Because Kmart is oneof our largest customers, if it is no longer able to do business with us, wecould be materially adversely affected.

 

**BecauseWe Cannot Publish Or Manufacture Titles Without Platform Manufacturers’Approval, Our Ability To Continue To Develop And Market Successful ConsoleTitles Is Dependent On The Manufacturers Continuing To Do Business With Us.**

 

We are dependent on theplatform manufacturers and our non-exclusive licenses with them, both for theright to publish titles for their platforms and for the manufacture of ourproducts for their platforms.  Ourexisting platform licenses for Sony PlayStation 2 and PlayStation, NintendoGameCube, Game Boy Advance and Game Boy Color, and Microsoft Xbox, require thatwe obtain approval for the publication of new games on a title-by-titlebasis.  As a result, the number oftitles we are able to publish for these platforms, and our revenues from titlesfor these platforms, may be limited. Should any manufacturer choose not to renew or extend our licenseagreement at the end of its current term, or if any manufacturer were toterminate our license for any reason, we would be unable to publish additionaltitles for that manufacturer’s platform, which could negatively affect ouroperating results.

 

Each of the manufacturersor their authorized vendors is the sole source for the fabrication of theproducts we publish for that manufacturer’s platforms.  Each platform license provides that themanufacturer may change prices for products at any time and includes otherprovisions that give the manufacturer substantial control over our release ofnew titles.  Since each of themanufacturers is also a publisher of games for its own platforms, 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 of products could also negativelyaffect our operating results.

 

**If WeNeeded To Write Down Licenses Or Software Development Costs Below The CurrentRecorded Value, Our Results Of Operations Could Be Adversely Affected.**

 

We typically enter intoagreements with licensors of properties that require advance payments ofroyalties and/or guaranteed minimum royalty payments.  We also enter into agreements with developers of titles thatrequire a development fee and additional compensation based on the respectivetitle sales performance.  Sales ofproducts for which such royalties are paid or guaranteed payments are made maynot be sufficient to cover the amount of these required payments.  In addition, we capitalize our advances todevelopers on our balance sheet as a part of “software development costs.”  When, in management’s opinion, futurerevenues will not be sufficient to recover previously capitalized costs, weexpense these items in the current period. If we needed to write down licenses or software development costs belowthe current recorded value, our results of operations could be adverselyaffected.

 

**IncreasedForeign Operations Subject Us To Different Business, Political And EconomicRisks.**

 

Foreign sales are subjectto inherent risks, including different consumer preferences, higherdistribution and operating expenses, unexpected changes in regulatoryrequirements, tariffs and other barriers, difficulties in staffing and managingforeign operations, and possible difficulties collecting foreign accounts receivable.  These factors or others could have anadverse effect on our future foreign sales or the profits generated from thesesales.

 

Sales generated by ourEuropean and Australian offices will generally be denominated in the currencydenomination of the country in which the sales are made or, if made in Europe,European Currency Units (“Euros”).  Tothe extent our foreign sales are not denominated in U.S. dollars, our sales andprofits could be materially and adversely affected by foreign currencyfluctuations.

 

**FluctuationsIn Our Quarterly Operating Results Could Result In Substantial Losses ToInvestors.**

 

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We have experienced, andmay continue to experience, significant quarterly fluctuations in net sales andoperating results.  The interactivesoftware entertainment market is highly seasonal, with sales typicallysignificantly higher during the calendar fourth quarter, due primarily to theincreased demand for games during the year-end holiday buying season.  Other factors that cause fluctuationsinclude:

 

•                  thetiming of our release of new titles;

 

•                  thepopularity of both new titles and titles released in prior periods;

 

•                  changesin the mix of titles with varying profit margins;

 

•                  thetiming of customer orders;

 

•                  thetiming of shipments by the manufacturers;

 

•                  thecompetition in the industry for retail shelf space;

 

•                  fluctuationsin the size and rate of growth of consumer demand for titles for differentplatforms; and

 

•                  thetiming of the introduction of new platforms and the accuracy of retailers’forecasts of consumer demand.

 

We believe thatquarter-to-quarter comparisons of our operating results are not a goodindication of our future performance. We may not be able to maintain consistent profitability on a quarterlyor annual basis.  It is likely that insome future quarter, our operating results may be below the results 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.

 

**CompetitionFor Qualified Personnel Is Intense In The Interactive Entertainment SoftwareIndustry And Failure To Hire And Retain Qualified Personnel Could SeriouslyHarm Our Business.**

 

We rely to a substantialextent on the management, marketing, sales, technical and software developmentskills of a limited number of employees to formulate and implement our businessplan, including the development of our titles and brands.  Our success depends to a significant extentupon our ability to attract and retain key personnel.  Competition for employees can be intense and the process oflocating key personnel with the right combination of skills is oftenlengthy.  The loss of services of keypersonnel could have a material adverse effect on us.

 

**FailureTo Adequately Protect Our Intellectual Property Could Cause Us To LoseCompetitive Advantage And Any Intellectual Property Litigation Could Be TimeConsuming And Expensive To Prosecute And Defend.**

 

Unauthorized productionoccurs in the computer software industry generally, and were a significantamount of unauthorized production of our DVD-ROM or CD-ROM products to occur,we could be materially and adversely affected. We hold copyrights on the products, manuals, advertising and othermaterials owned by us and we maintain trademark rights in the THQ name, THQstudios, names of certain products and their respective logos owned by us.  We regard our titles, including theunderlying software, as proprietary and rely on a combination of trademark,copyright and trade secret laws in the United States and under internationallaw, employee and third-party nondisclosure and confidentiality agreements,among other methods to protect our rights. We include with our products a “shrink-wrap” or “click-wrap” licenseagreement or limitations on use of the software.  It is uncertain to what extent these agreements and limitationsare enforceable, especially in foreign countries.  Third parties may infringe our rights and it is possible thatthird parties may assert infringement claims against us.  From time to time we receive communicationsregarding such claims and we investigate each claim individually.  Prosecuting or defending valid claims couldbe costly and could result in a diversion of management’s attention. Further,adverse determinations in any claims or litigation could also have a materialadverse effect on our business, operating results and financial condition.

 

**DefectsIn Our Game Software Could Harm Our Reputation Or Decrease The MarketAcceptance Of Our Products.**

 

Our game software maycontain defects.  In addition, we maynot discover software defects until after our products are in use by retailcustomers.  Any defects in our softwarecould damage our reputation, cause our customers to terminate relationshipswith us or to initiate product liability suits against us, divert ourengineering resources, delay market acceptance of our products, increase ourcosts or cause our revenue to decline.

 

**TheInteractive Entertainment Industry Is Consolidating. In Making Acquisitions, WeFace Significant Competition From Other Companies Some Of Which Have GreaterFinancial And Other Resources.  We AlsoFace Integration Challenges With The Companies That We Successfully Acquire.**

 

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Consistent with ourstrategy to enhance our distribution and product development capabilities, 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 the interactive entertainment industry continues toconsolidate, we face significant competition in making acquisitions, which mayconstrain our ability to complete suitable transactions.  This is particularly of concern for usbecause many of our competitors for potential acquisitions have greaterfinancial and other resources.

 

Further, as we acquireother companies we are faced with additional challenges.  The integration of newly acquired companies’operations with our existing operations takes management time and effort.  Additionally, there is a risk of loss of keyemployees, customers and vendors of the recently acquired companies.  Also, if we issue equity securities to payfor an acquisition, the ownership percentage of our existing stockholders wouldbe reduced and the value of the shares held by our existing stockholders couldbe diluted.  If we use cash to pay foran acquisition, the payment could significantly reduce the cash that would beavailable to fund our operations or to use for other purposes.  Acquisition financing may not be availableon favorable terms or at all.  We mayalso be required to amortize significant amounts of identifiable intangibleassets in connection with future acquisitions, which could adversely affect ourreported earnings.  Future acquisitionsmay also require us to assume contingent liabilities that could have a negativeeffect on our future results of operations.

 

**CompetitionIn The Interactive Entertainment Software Industry May Lead To Reduced Sales OfOur Products, Reduced Profits And Reduced Market Share.**

 

The interactiveentertainment software industry is intensely competitive.  We compete, for both licenses to propertiesand the sale of games, with the platform manufacturers and other externaldevelopers.  Each of the platformmanufacturers has the additional advantage of being the largest developer andmarketer of titles for its platforms. These companies may increase their own software developmentefforts.  As a result of theircommanding positions in the industry, the manufacturers generally have betterbargaining positions with respect to retail pricing, shelf space and retaileraccommodations than do any of their licensees, including us.

 

Some of our competitorshave greater name recognition among consumers and licensors of properties, abroader product line, or greater financial, marketing and other resources thanwe 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.  We also believe that other technology andentertainment companies are increasing their focus on the interactiveentertainment software market, which might result in greater competition forus.  In addition, many of ourcompetitors are developing on-line interactive games and interactive networksthat will be competitive with our interactive products.

 

As competition forpopular properties increases, our cost of acquiring licenses for suchproperties may increase, resulting in reduced margins.  In addition, as competition for retail shelfspace becomes more intense, we may need to increase our marketing expendituresto maintain sales of our titles. Prolonged price competition, increased licensing costs or reduced profitmargins would have a negative effect on our business and financial results.

 

**We RelyOn External Developers For The Development Of Many Of Our Titles.**

 

Many of our titles aredeveloped by external developers.  Wehave no control over the business, finances and operational practices of theseexternal developers.  A delay or failureto complete the work performed by external developers may result in delays in,or cancellations of, product releases. The future success of many of our titles will depend on our continuedability to maintain relationships and obtain developer agreements on favorableterms with skilled external developers. We cannot 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.

 

**TheDevelopment And Marketing Of PC Titles Differ From Console Titles And EntailAdditional Risks.**

 

The development andmarketing of PC games subject us to some different risks than those weencounter in connection with console games. These risks include the ability to accurately predict which titles haveappeal to the purchasers of games for PCs, greater reliance on distributors inorder to obtain retail distribution, and higher retailer returns experiencedfor PC games.  We may not be able tosuccessfully develop and market titles for the PC market.

 

**RatingSystems And Future Legislation May Make It Difficult To Successfully Market AndSell Our Products.**

 

Currently, the video gameindustry is self-regulated and rated by the Entertainment Software RatingBoard.  Our retail customers take theEntertainment Software Rating Board rating into consideration when decidingwhich of our products they will purchase. If the Entertainment Software Rating Board or a manufacturer determinesthat a

 

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product should have a rating directed to an older or more matureconsumer, we may be less successful in our marketing and sales of a particularproduct.

 

Recently, legislation hasbeen introduced at the local, state and federal levels for the establishment ofa government mandated rating and governing system in the United States and inforeign countries for the video game industry. Various foreign countries already allow government censorship of interactiveentertainment products.  We believe thatif the video game industry were to become subject to a government ratingsystem, our ability to successfully market and sell our products could beadversely affected.

 

**AnySignificant Downturn In General Economic Conditions Which Results In A ReductionIn Discretionary Spending Could Reduce Demand For Our Products And Harm OurBusiness.**

 

Our product sales areaffected by a retail customer’s ability and desire to spend disposable incomeon the purchase of our game titles.  Anysignificant downturn in general economic conditions which results in areduction in discretionary spending could result in a reduction in demand forour products and could harm our business. Such industry downturns have been, and may continue to be, characterizedby diminished product demand and subsequent erosion of average selling prices.

 

**OurBusiness And Future Operating Results Are Subject To A Wide Range OfUncertainties Arising Out Of The September 11, 2001 Terrorist Attacks AndCurrent Military Actions.**

 

Our business andoperating results are subject to uncertainties arising out of the terroristattacks on the United States, including the potential worsening or extension ofthe current global economic slowdown and the economic consequences of militaryaction or additional terrorist activities. Accordingly, while the terrorist attacks and current military actionshave not had a material impact on our financial position or results ofoperations to date, we cannot determine if the attacks, current militaryactions or any events arising as a result of such events will have a materialimpact on our business in the future.

 

Because of these andother factors affecting our operating results and financial condition, pastfinancial performance should not be considered a reliable indicator of futureperformance, and investors should not use historical trends to anticipateresults or trends in future periods.

 

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**Item 7A****. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

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

 

**InterestRate Risk**

 

We have interest raterisk primarily related to our investment portfolio.  A substantial portion of our short-term investments is in amutual fund made up of non-mortgage United States Government Securities,corporate notes and commercial paper and fixed and floating rate asset-backedsecurities.  The value of theseinvestments may fluctuate with changes in interest rates.  However, we believe this risk is immaterialdue to the short-term nature of the investments.  The credit facility is based on variable interest rates.  At December 31, 2002, we had no borrowingson the credit facility.

 

**ForeignCurrency Risk**

 

We transact business inmany different foreign currencies and may be exposed to financial market riskresulting from fluctuations in foreign currency exchange rates, particularlythe Great British Pound (“GBP”) and the Euro which may result in a gain or lossof earnings to us.  The volatility ofthe GBP and the Euro (and all other applicable currencies) is monitoredfrequently throughout the year.  Whilewe have not engaged in foreign currency hedging, we may in the future usehedging programs, currency forward contracts, currency options and/or otherderivative financial instruments commonly utilized to reduce financial marketrisks if it is determined that such hedging activities are appropriate to reducerisk.

 

**Item 8****.*   *FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

The Financial Statementstogether with the report of Deloitte & Touche LLP dated March 25, 2003,required by this Item are included in Item 15 of this Annual Report and areincorporated herein by reference.

 

**Item 9****.*   *CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

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**PART III**

 

**Item 10****.**DIRECTORS AND EXECUTIVE OFFICERS OF THEREGISTRANT**

 

**Directors(1)**

 

Our Board of Directors iscomprised of the following five members. There are no family relationships among any of our directors orexecutive officers.

 

**Brian J. Farrell** (age 49) has been ourPresident and Chief Executive Officer since January 1995 and a director sinceMarch 1993.  Between October 1992 andJanuary 1995, Mr. Farrell served as our Executive Vice President and ChiefOperating Officer.  From July 1991 toOctober 1992, Mr. Farrell served as our Vice President, Chief Financial Officerand Treasurer.  From 1984 until joiningus, Mr. Farrell was Vice President and Chief Financial Officer of StarwoodHotels & Resorts (formerly known as Hotel Investors Trust), a real estateinvestment trust.  Mr. Farrell wasemployed by Deloitte Haskins & Sells, a predecessor of Deloitte &Touche LLP, an international accounting firm and our current auditors, from1978 to 1984 and is a certified public accountant.

 

**Lawrence Burstein** (age 60) has been adirector since July 1991.  Since March1996, Mr. Burstein has served as President and a director and has been astockholder of Unity Venture Capital Associates Ltd., a private investmentcompany.  From 1986 through March 1996,Mr. Burstein was President, a director and a principal stockholder of TrinityCapital Corporation, a private investment company.  Mr. Burstein is a director of CAS Medical Systems, Inc., GenderSciences, Inc., I.D. Systems, Inc. and Traffix, Inc.

 

**James L. Whims** (age 48) has been a directorsince April 1997.  Since 1996, Mr. Whimshas been a Managing Director of TechFund Capital I, L.P., TechFund Capital II,L.P., and since 2001, TechFund Capital Europe, venture capital firmsconcentrating on high-technology enterprises. From 1994 to 1996, Mr. Whims was Executive Vice President of SonyComputer Entertainment of America.  From1990 to 1994, Mr. Whims was Executive Vice President of The Software ToolworksInc.

 

**L. Gregory Ballard** (age 49) has been adirector since April 1999.  Since April2002, Mr. Ballard has been the President, Chief Executive Officer and a memberof the Board of Directors of SonicBlue, Inc., a developer of digitalentertainment electronic products.  OnMarch 21, 2003, SonicBlue filed for voluntary reorganization under Chapter 11in connection with a sale of its assets. From January 2000 until June 2001, Mr. Ballard was the Chief ExecutiveOfficer of MyFamily.com, a leading community Internet company.  Prior to that, from December 1996 untilNovember 1999, Mr. Ballard was the President and Chief Executive Officer of3Dfx, an interactive entertainment company. From May 1995 to November 1996, Mr. Ballard was the President of CapcomEntertainment, Inc., a videogame and multimedia entertainment company.  From 1994 to March 1995, Mr. Ballard servedas Chief Operating Officer and Chief Financial Officer of Digital Pictures,Inc., a video game company.  From 1991to 1994, Mr. Ballard was President and Chief Executive Officer of Warner CustomMusic Corp., a multimedia marketing division of Time Warner, Inc.  Previously, Mr. Ballard was President andChief Operating Officer of Personics Corp., a predecessor to Warner Music.  In addition, Mr. Ballard has worked forBoston Consulting Group and as an attorney in Washington, D.C.  Mr. Ballard is also a director of PinnacleSystems.

 

**Brian Dougherty** (age 46) has been adirector since November 2002.  Mr.Dougherty most recently served as the Chairman and Chief Technology Officer ofWink Communications, a provider of end-to-end interactive television servicesto the cable and satellite industries that he founded in 1995 and sold toLiberty Media in 2002.  Mr. Doughertyalso founded Geoworks in 1983, a software consulting company that createdconsole and PC games. His first company, Imagic, developed games for variousconsoles including Atari, Intellivision, Colecovision, and Comodore 64 and waspurchased by Activision in 1984. Mr. Dougherty has a BS in ElectricalEngineering and Computer Science from UC Berkeley. He is a member of a numberof public and private boards including Neomagic (NMGC), Salon (SALN),PlanetWeb, and Bluemug.

 

Directors are electedannually by the stockholders and hold office until the next annual meeting anduntil their respective successors are elected and qualified.

 

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(1)                                  Jeffrey C. Lapin resigned as directorand our Chief Operating Officer and Vice Chairman in November 2002.

 

**ExecutiveOfficers**

 

Our executive officersinclude Messrs. Farrell, Gysi, Sorensen and Walsh and Ms. Locke.  All of our executive officers are appointedby and serve at the discretion of the Board of Directors.

 

**Fred A. Gysi** (age 48) was appointed ourSenior Vice President – Finance and Administration, Chief Financial Officer,Treasurer and Secretary in August 2000. Mr. Gysi previously served as our Vice President - Finance and

 

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Administration, Chief Financial Officer, Treasurer and Secretary sinceNovember 1997.  From October 1996 toOctober 1997, Mr. Gysi was the Chief Financial Officer of HPM-Stadco, amanufacturing company.  From August 1995to October 1996, Mr. Gysi was the President and co-founder of GP ManagementConsulting, a provider of financial, operations and systems consulting servicesto emerging and middle market companies. From 1992 to 1995, Mr. Gysi was a partner at Collett & Levy, anaccounting firm.  Mr. Gysi was employedby Deloitte & Touche LLP from 1980 to 1992 and was a partner of that firmfrom 1988 to 1992.  Mr. Gysi is acertified public accountant.

 

**Alison Locke** (age 48) was appointed ourExecutive Vice President – North American Publishing in August 2000.  Ms. Locke previously served as our SeniorVice President - Sales and Marketing since February 1999.  From January 1995 to January 1999, Ms. Lockeserved as our Senior Vice President - Sales. From 1991 to January 1995, Ms. Locke served as our Vice President -Sales.  Prior to her employment with us,Ms. Locke served as Vice President of Computer Product and Nintendo Game Salesfor Data East USA Incorporated, an interactive entertainment company, and invarious sales capacities with Activision, Inc. and Broderbund Software, Inc.

 

**Jack Sorensen** (age 41) was appointedExecutive Vice President – Worldwide Studios in September 2001.  From June 2000 to September 2001, Mr.Sorensen was President and CEO of Swan Systems, Inc., a private, venture-fundedsoftware company serving the advertising and marketing industries.  Between March and May 2000, Mr. Sorensen wasExecutive in Residence at Crosspoint Venture Partners, a venture firm.  From February 1991 to January 2000, Mr.Sorensen was employed at LucasArts Entertainment Company, an entertainmentsoftware developer and publisher, serving variously as head of operations,international, product development and as General Manager.  From April 1995 to January 2000, Mr.Sorensen served as President of LucasArts.

 

**Tim F. Walsh** (age 39) was appointed ourSenior Vice President – International Publishing in August 2000.  Mr. Walsh previously served as our VicePresident - International since January 1998. From May 1997 to January 1998 he was our Director of International.  Mr. Walsh was Director of International andOEM Sales of Accolade, a publisher of video and PC game software from January1996 to May 1997.  From September 1993to December 1995, Mr. Walsh held various positions at Time WarnerInteractive.  Mr. Walsh’s priorexperience includes positions in the productivity software industry from 1990to 1993 and the music industry from 1986 to 1989.

 

**Section16 (a) Beneficial Ownership Reporting Compliance**

 

Pursuant to Section 16(a)of the Exchange Act and the rules issued thereunder, our executive officers anddirectors are required to file with the SEC and the NASDAQ Stock Market reportsof ownership and changes in ownership of the Common Stock.  Copies of such reports are required to be furnishedto us.  Based solely on our review ofthe copies of such reports furnished to us or on written representations to usthat no such reports were required, we believe that during the year endedDecember 31, 2002, all of our executive officers and directors and allbeneficial owners of more than 10% of our Common Stock filed on a timely basisall reports, if any, required by Section 16(a) of the Exchange Act.

 

**Item 11****.**EXECUTIVECOMPENSATION**

 

The following tablesummarizes the compensation for the fiscal years ended December 31, 2000, 2001and 2002 of: (i) our Chief Executive Officer, (ii) our four most highlycompensated executive officers other than our Chief Executive Officer, each ofwhom was serving at the end of our fiscal year ended December 31, 2002, andwhose salary and bonus exceeded $100,000 in 2002, and (iii) Jeffrey C. Lapin,who was our Chief Operating Officer and Vice Chairman until November 8, 2002(the “Named Executives”):

 

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|                             |   | **Annual Compensation** |   | **Long-Term  Compensation  Awards** |    |      |   |
|----------------------------------|--------|-------------------------|--------|-------------------------------------|---------|-----------|--------|
| **Name and  Principal Position** |   | **Year**                |   | **Salary (1)**                      |    | **Bonus** |   | **Other Annual  Compensation  (2)** |   | **Shares  Underlying  Options (3)** |   | **All Other  Compensation  (4)** |   |
|                             |   |                    |   |                                |    |      |   |   |   |   |   |   |   |
| Brian  J. Farrell                |   | 2002                    |   | $                                   | 535,456 |      | $      | 525,000 |   | — |   | 375,000 |   | $ | 15,500 | (5) |
| Chairman  of the Board of        |   | 2001                    |   | $                                   | 469,000 |      | $      | 460,000 |   | — |   | 300,000 |   | $ | 14,300 | (5) |
| Directors,  President and        |   | 2000                    |   | $                                   | 409,000 |      | $      | 400,000 |   | — |   | 150,000 |   | $ | 6,400 |   |
| Chief  Executive Officer         |   |                    |   |                                |    |      |   |   |   |   |   |   |   |
|                             |   |                    |   |                                |    |      |   |   |   |   |   |   |   |
| Fred  A. Gysi                    |   | 2002                    |   | $                                   | 215,029 |      | $      | 80,500 |   | — |   | 56,250 |   | $ | 8,000 |   |
| Chief  Financial Officer         |   | 2001                    |   | $                                   | 185,000 |      | $      | 85,000 |   | — |   | 37,499 |   | $ | 6,800 |   |
| Senior  Vice President –    |   | 2000                    |   | $                                   | 193,333 |      | $      | 75,000 |   | — |   | 45,000 |   | $ | 6,400 |   |
| Finance  and Administration,     |   |                    |   |                                |    |      |   |   |   |   |   |   |   |
| Treasurer  and Secretary         |   |                    |   |                                |    |      |   |   |   |   |   |   |   |
|                             |   |                    |   |                                |    |      |   |   |   |   |   |   |   |
| Alison  Locke                    |   | 2002                    |   | $                                   | 305,386 |      | $      | 200,000 |   | — |   | 187,500 |   | $ | 8,000 |   |
| Executive  Vice President – |   | 2001                    |   | $                                   | 275,000 |      | $      | 250,000 |   | — |   | 59,999 |   | $ | 6,800 |   |
| North  American Publishing       |   | 2000                    |   | $                                   | 250,000 |      | $      | 210,000 |   | — |   | 75,000 |   | $ | 6,400 |   |
|                             |   |                    |   |                                |    |      |   |   |   |   |   |   |   |
| Jack  Sorensen                   |   | 2002                    |   | $                                   | 272,160 |      | $      | 200,000 |   | — |   | 62,500 |   | $ | 8,000 |   |
| Executive  Vice President – |   | 2001                    |   | $                                   | 63,462  |      | $      | 80,000 |   | — |   | 112,499 |   | $ | 6,800 |   |
| Worldwide  Studios               |   |                    |   |                                |    |      |   |   |   |   |   |   |   |
|                             |   |                    |   |                                |    |      |   |   |   |   |   |   |   |
| Tim  F. Walsh                    |   | 2002                    |   | $                                   | 235,167 |      | $      | 170,023 |   | — |   | 112,500 |   | $ | 8,000 |   |
| Senior  Vice President –    |   | 2001                    |   | $                                   | 210,000 |      | $      | 170,000 |   | — |   | 52,499 |   | $ | 6,800 |   |
| International  Publishing        |   | 2000                    |   | $                                   | 196,876 |      | $      | 140,000 |   | — |   | 67,500 |   | $ | 6,400 |   |
|                             |   |                    |   |                                |    |      |   |   |   |   |   |   |   |
| Jeffrey  C. Lapin                |   | 2002                    |   | $                                   | 361,014 |      | $      | 375,000 |   | — |   | 300,000 |   | $ | 8,000 |   |
| Former  Vice Chairman and        |   | 2001                    |   | $                                   | 325,000 |      | $      | 325,000 |   | — |   | 240,000 |   | $ | 14,300 | (5) |
| Chief  Operating Officer         |   | 2000                    |   | $                                   | 275,000 |      | $      | 275,000 |   | — |   | 105,000 |   | $ | 6,400 |   |

 

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(1)                                  Includedin each executive’s salary are amounts that were deferred by such executivepursuant to our Defined Contribution Plan.

(2)                                  Amountsshown do not include amounts expended by us pursuant to plans (including grouplife and health) that do not discriminate in scope, terms or operation in favorof our executive officers or directors and that are generally available to allsalaried employees.  The value of suchbenefits did not exceed the lesser of either $50,000 or 10% of the total annualsalary and bonus reported for any individual named.

(3)                                  Thenumber of shares underlying options has been adjusted to reflect the 50% stockdividend distributed on April 9, 2002 to holders of record of our shares ofcommon stock at the close of business on March 26, 2002.

(4)                                  Includesmatching contributions in the amounts of $6,400, $6,800, and $8,000 made by usin accordance with our Defined Contribution Plan in 2000, 2001 and 2002,respectively.  These amounts do notreflect special awards and payments Mr. Farrell is entitled to receive if hisemployment is terminated as a result of a change in control of our company**,**which would have had a value of approximately $1,196,000 as of December 31,2000, $1,375,400 as of December 31, 2001 and $1,569,750 as of December 31,2002.  See “Employment Agreement withBrian J. Farrell.”

(5)           Includes a life insurance premiumpaid by us in the amount of approximately $7,500.

 

**OptionGrants in Last Fiscal Year**

 

The following table setsforth the number of stock options granted to each of the Named Executivesduring the fiscal year ended December 31, 2002.  The table also sets forth the potential realizable value of suchstock options in the year of their expiration at arbitrarily assumed annualizedrates of stock price appreciation of five and ten percent over the fullfive-year term of the stock options.  Nogain to the Named Executives is possible without an increase in the price ofour Common Stock, which will benefit all stockholders proportionately.  Actual gains, if any, on stock optionexercises and Common Stock holdings are dependent on the future performance ofour Common Stock and overall stock market conditions.  There can be no assurance that the potential realizable valuesshown in this table will be achieved.

 

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|                 |   | **Individual  Grants**                 |    |                                                              |   |                                  |   |                   |     |                                                                                               |   |
|----------------------|--------|----------------------------------------|---------|-------------------------------------------------------------------|--------|---------------------------------------|--------|------------------------|----------|----------------------------------------------------------------------------------------------------|--------|
| **Name**             |   | **Shares  Underlying Options Granted** |    | **Percent of  Total Options Granted to Employees in Fiscal Year** |   | **Exercise  or Base Price Per Share** |   | **Expiration    Date** |     | **Potential  Realizable Value at Assumed Annual Rates of Stock Appreciation for Option  Term (1)** |   |
|                 | **5%** |                                   | **10%** |                                                              |
| Brian J. Farrell     |   | 375,000                                |    | 17                                                                | %      | $                                     | 30.04  |                   | 02/28/07 |                                                                                               | $      | 3,112,312 |   | $ | 6,877,395 |   |
| Fred A. Gysi         |   | 56,250                                 |    | 3                                                                 | %      | $                                     | 30.04  |                   | 02/28/07 |                                                                                               | $      | 466,847 |   | $ | 1,031,609 |   |
| Alison Locke         |   | 187,500                                |    | 9                                                                 | %      | $                                     | 30.04  |                   | 02/28/07 |                                                                                               | $      | 1,556,156 |   | $ | 3,438,698 |   |
| Jack Sorensen        |   | 37,500                                 |    | 2                                                                 | %      | $                                     | 30.04  |                   | 02/28/07 |                                                                                               | $      | 311,231 |   | $ | 687,740 |   |
|                 |   | 25,000                                 | %       | 1                                                                 |   | $                                     | 16.32  |                   | 11/20/07 |                                                                                               | $      | 112,723 |   | $ | 249,088 |   |
| Tim F. Walsh         |   | 112,500                                |    | 5                                                                 | %      | $                                     | 30.04  |                   | 02/28/07 |                                                                                               | $      | 933,694 |   | $ | 2,063,219 |   |
| Jeffrey C.  Lapin(2) |   | 300,000                                |    | 14                                                                | %      | $                                     | 30.04  |                   | 02/28/07 |                                                                                               | $      | 2,489,849 |   | $ | 5,501,916 |   |

 

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(1)                                  Forthe stock options indicated, these amounts represent the exercise pricemultiplied by the annual appreciation rate shown compounded annually for theterm of each option, less the exercise price, multiplied by the number ofoptions granted. The dollar amounts set forth under this heading are the resultof calculations at the 5% and 10% rates set by the SEC and therefore are notintended to forecast possible future appreciation, if any, of our stock price.

(2)                                  Asof November 8, 2002, Mr. Lapin no longer serves as our Chief Operating Officerand Vice Chairman.

 

**AggregatedOption Exercises in Last Fiscal Year And Fiscal Year-End Option Values**

 

The following table setsforth, for each of the Named Executives, certain information regarding thenumber of stock options exercised during the fiscal year ended December 31,2002 and the value of stock options held at fiscal year end.

 
|                 |   |                              |   |                |      | **Number of Shares  Underlying Unexercised  Options  at Fiscal Year-End** |    | **Value of Unexercised in-the-  Money Options  at Fiscal Year-End (1)** |    |
|----------------------|--------|-----------------------------------|--------|---------------------|-----------|---------------------------------------------------------------------------|---------|-------------------------------------------------------------------------|---------|
| **Name**             |   | **Shares  Acquired on  Exercise** |   | **Value  Realized** |      | **Exercisable**                                                           |    | **Unexercisable**                                                       |    | **Exercisable** |   | **Unexercisable** |   |
| Brian  J. Farrell    |   | 168,750                           |   | $                   | 3,064,067 |                                                                      | 966,502 |                                                                    | 624,998 |   | $ | 4,960,483 |   | $ | 149,997 |   |
| Fred  A. Gysi        |   | 42,000                            |   | $                   | 1,095,815 |                                                                      | 96,126  |                                                                    | 96,248  |   | $ | 147,747 |   | $ | 45,000 |   |
| Alison  Locke        |   | 44,689                            |   | $                   | 1,111,758 |                                                                      | 105,001 |                                                                    | 252,497 |   | $ | 75,003 |   | $ | 74,997 |   |
| Jack  Sorensen       |   | —                            |   | $                   | —    |                                                                      | 37,501  |                                                                    | 137,498 |   | $ | — |   | $ | — |   |
| Tim  F. Walsh        |   | —                            |   | $                   | —    |                                                                      | 124,377 |                                                                    | 169,998 |   | $ | 247,976 |   | $ | 67,500 |   |
| Jeffrey  C. Lapin(2) |   | 270,000                           |   | $                   | 2,497,248 |                                                                      | 262,502 |                                                                    | —  |   | $ | 210,003 |   | $ | — |   |

 

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(1)                                  Calculatedbased on the excess of fair market value of our common stock on December 31,2002 over the respective exercise prices of the options.

(2)                                  Asof November 8, 2002, Mr. Lapin no longer serves as our Chief Operating Officerand Vice Chairman.

 

**DirectorCompensation**

 

Directors who are alsoemployees and officers of our company are not paid any compensation for serviceas directors.  Non-employee directorsare compensated by cash payments comprised of $12,000 for the year plus $1,500for attendance at each Board meeting held in person and $500 for attendance ateach Board meeting held by telephone, and the grant of options pursuant to our1997 Stock Option Plan.  Pursuant tosuch plan, each non-employee director is granted options to purchase 5,625shares of Common Stock on the first day of each fiscal quarter at a per shareexercise price equal to the market price of a share of Common Stock on the dateof grant.

 

During 2002, each of thenon-employee directors received grants under our 1997 Stock Option Plan ofoptions exercisable for 22,500 shares of Common Stock, with the exception ofBrian Dougherty who received grants under our 1997 Stock Option Plan of optionsexercisable for 5,625 shares of Common Stock.

 

**EmploymentAgreement with Brian J. Farrell**

 

Mr. Farrell’s EmploymentAgreement provides for employment by us through December 31, 2006 (hereinafterreferred to as the “Farrell Employment Period”).

 

40

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Mr. Farrell’s currentEmployment Agreement provides for an annual base salary of $525,000, subject toannual review for possible increase, and an annual bonus equal to the lesser ofhis base salary for that year or 4.5% of our annual net income beforetaxes.  Mr. Farrell may also be awardeda performance bonus at the discretion of our Board of Directors.  We also agreed to grant Mr. Farrell stockoptions under our Amended and Restated 1997 Stock Option Plan to purchase187,500 shares of our common stock, with an exercise price per share equal tothe fair-market value per share of our common stock on the date the options aregranted.  These options vest in threeequal installments on the first of January of each of 2002, 2003 and 2004.  Further, we are required to provide Mr.Farrell with a life insurance policy in the amount of $3.0 million, disabilityinsurance for 80% of his base salary and a grantor trust established underSections 671, et. seq. of the Internal Revenue Code (a Rabbi Trust) for thepurpose of protecting the payment, in the event of a change in control, of anyof our unfunded obligations to Mr. Farrell.

 

Mr. Farrell’s currentEmployment Agreement provides that if Mr. Farrell voluntarily terminates hisemployment without “Good Reason” or we terminate his employment for “Cause,” hewill be precluded, during the twelve months following any such termination,from engaging in any business activities in competition with our business andfrom soliciting our employees.

 

Mr. Farrell’s currentEmployment Agreement also provides Mr. Farrell with the following payments andbenefits in the event that his current Employment Agreement is terminated byhim for “Good Reason” or by us without “Cause”:  (i) a lump sum payment equal to (A) the greater of three years’base salary or the salary payable during the then-existing balance of theFarrell Employment Period, plus (B) bonus compensation at the highest possibleannual bonus for the greater of three years or the then-existing balance of theFarrell Employment Period; (ii) medical and dental insurance coverage until theend of the Farrell Employment Period; (iii) life and disability insurancecoverage until the end of the Farrell Employment Period; (iv) various otherperquisites as more fully described in Mr. Farrell’s current EmploymentAgreement; (v) the immediate vesting of all stock options, stock appreciationrights and restricted stock, if any, not fully vested at such time; (vi) theimmediate vesting of Mr. Farrell’s rights in all other employee benefit andcompensation plans; (vii) payment of the fees and disbursements incurred bycounsel to Mr. Farrell as a result of the termination of Mr. Farrell’semployment; and (viii) appropriate office and secretarial assistance for sixmonths after termination of Mr. Farrell’s employment.  If Mr. Farrell was terminated in accordance with the foregoing hecurrently would receive a lump sum payment under item (i) of $4,134,375 plusthe other benefits in items (ii) through (viii).

 

If, within one year aftera change of control, Mr. Farrell’s employment is terminated by us other thanfor “Cause,” or voluntarily by Mr. Farrell, then Mr. Farrell shall receivecertain benefits, as more fully described in his current Employment Agreement,in addition to those described above.  Achange of control includes such events as a person gaining 15% or morebeneficial ownership of us, our current members of the Board of Directorsceasing to comprise at least a majority of our Board of Directors (with someexceptions), and/or a sale of all or substantially all of our assets or of ourbusiness operations generating two-thirds of our consolidated revenues.  Mr. Farrell would receive approximately thesame amount of compensation upon a change in control that he would receive upontermination as specified in the preceding paragraph.

 

**SeveranceAgreements**

 

We have entered into severanceagreements (the “Severance Agreements”) with each of our executives except forMr. Farrell.  Mr. Farrell’s employmentagreement provides for the payment of benefits as discussed above in“Employment Agreement with Brian J. Farrell.”

 

The Severance Agreementsprovide for the payment of benefits to the executives upon a “Change inControl.”  The executives agree not tovoluntarily leave us without “Good Reason” until the earlier of (a) suchattempted Change in Control terminates, or (b) if a Change in Control occurs,90 days following such Change in Control.

 

A “Change in Control” isdefined, subject to certain exceptions, as an acquisition by any person orgroup of persons of 30% or more of either (a) our outstanding shares of commonstock, or (b) the combined voting power of our outstanding securities entitledto vote for the election of directors.

 

“Good Reason” is definedto include any of the following events after a Change in Control: (a) anyremoval or involuntary termination of the executive; (b) a reduction of theexecutive’s rate of annual base salary as in effect immediately prior to theChange in Control or our failure to pay such salary; (c) a requirement that theexecutive relocate; (d) our failure to provide the executive with compensation,vacation and other fringe benefits, expense reimbursement, and welfare benefitsin accordance with the most favorable plans and benefits in effect for suchexecutive’s peer officers after the Change in Control; and (e) our failure tomaintain the effectiveness of the Severance Agreements after the Change ofControl.

 

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The Severance Agreementsprovide that if an executive’s employment is terminated within the yearfollowing a Change in Control for any other reason, such executive will beentitled to receive, among other benefits, a cash amount equal to (i) one timessuch executive’s annual base salary paid to such executive at the time of theChange in Control, plus (ii) one times such executive’s annual bonus paid orpayable to such executive in respect of our fiscal year immediately precedingthe fiscal year in which the Change in Control occurs.  In addition, if on the date of terminationsuch executive’s stock options are not fully vested, all such stock optionsshall become immediately vested and exercisable for such period as provided inthe plan and/or agreement governing such options.  If Messrs. Gysi, Sorensen, Walsh and Ms. Locke were terminated inaccordance with the foregoing they currently would receive $322,000, $515,000,$416,777 and $520,250, respectively.

 

**EmploymentArrangements with Jeffrey C. Lapin**

 

Mr. Lapin received asalary of $375,000 and a bonus of $375,000 in 2002.  Mr. Lapin resigned on November 8, 2002.

 

**CompensationCommittee Interlocks and Insider Participation**

 

The CompensationCommittee in 2002 consisted of Messrs. Burstein and Whims.  Each of Messrs. Burstein and Whims arenon-employee Directors and neither have any direct or indirect materialinterest in, or relationship with, us outside of his position as aDirector.  To our knowledge, there wereno other interrelationships involving members of the Compensation Committee orother Directors requiring disclosure.

 

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**Item 12****.**SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

**PrincipalStockholders**

 

The following table setsforth information as to all persons who are, to our knowledge, the beneficialowners of 5% or more of our outstanding shares of common stock as of March 21,2003.

 
| **Title of  Class** |   | **Name and Address of  Beneficial Owner**             |   | **Amount and Nature of  Beneficial Ownership** |      | **Percent of  Class** |   |
|---------------------|--------|-------------------------------------------------------|--------|------------------------------------------------|-----------|-----------------------|--------|
| Common              |   | Capital Group  International, Inc.                    |   | 2,235,220                                      | (1)  | 5.9                   | %(1)   |
|                |   | Capital Guardian Trust  Company                       |   |                                           |      |                  |   |
|                |   | 11100  Santa Monica Blvd.                             |   |                                           |      |                  |   |
|                |   | Los  Angeles, CA 90025                                |   |                                           |      |                  |   |
|                |   |                                                  |   |                                           |      |                  |   |
| Common              |   | Deutsche Bank AG                                      |   | 2,099,810                                      | (2)  | 5.5                   | %(2)   |
|                |   | Deutsche  Investment Management Americas Inc.         |   |                                           |      |                  |   |
|                |   | Deutsche  Bank Trust Company Americas                 |   |                                           |      |                  |   |
|                |   | Taunusanlage  12, D-60325                             |   |                                           |      |                  |   |
|                |   | Frankfurt  am Main                                    |   |                                           |      |                  |   |
|                |   | Federal  Republic of Germany                          |   |                                           |      |                  |   |
|                |   |                                                  |   |                                           |      |                  |   |
| Common              |   | Liberty Wanger Asset  Management, L.P.                |   | 2,333,500                                      | (3)  | 6.1                   | %(3)   |
|                |   | WAM  Acquisition GP, Inc.                             |   |                                           |      |                  |   |
|                |   | 227  West Monroe Street, Suite 3000                   |   |                                           |      |                  |   |
|                |   | Chicago,  IL 60606                                    |   |                                           |      |                  |   |
|                |   | Liberty  Acorn Trust                                  |   |                                           |      |                  |   |
|                |   | 227  West Monroe Street, Suite 3000                   |   |                                           |      |                  |   |
|                |   | Chicago,  IL 60606                                    |   |                                           |      |                  |   |
|                |   |                                                  |   |                                           |      |                  |   |
| Common              |   | Maverick Capital, Ltd.                                |   | 2,241,250                                      | (4)  | 5.9                   | %(4)   |
|                |   | Maverick  Capital Management, LLC                     |   |                                           |      |                  |   |
|                |   | 300  Crescent Court, 18th Floor                       |   |                                           |      |                  |   |
|                |   | Dallas,  TX 75201                                     |   |                                           |      |                  |   |
|                |   | Lee  S. Ainslie III                                   |   |                                           |      |                  |   |
|                |   | 767  Fifth Avenue, 11th Floor                         |   |                                           |      |                  |   |
|                |   | New  York, NY 10153                                   |   |                                           |      |                  |   |
|                |   |                                                  |   |                                           |      |                  |   |
| Common              |   | J. & W. Seligman  & Co. Incorporated          |   | 3,373,890                                      | (5)  | 8.9                   | %(5)   |
|                |   | William  C. Morris                                    |   |                                           |      |                  |   |
|                |   | Seligman  Communications & Information Fund, Inc. |   |                                           |      |                  |   |
|                |   | 100  Park Avenue                                      |   |                                           |      |                  |   |
|                |   | New  York, New York 10017                             |   |                                           |      |                  |   |
|                |   |                                                  |   |                                           |      |                  |   |
| Common              |   | Tudor Investment  Corporation                         |   | 2,361,300                                      | (6)  | 6.2                   | %(6)   |
|                |   | Paul  Tudor Jones, II                                 |   |                                           |      |                  |   |
|                |   | 1275  King Street                                     |   |                                           |      |                  |   |
|                |   | Greenwich,  CT 06831                                  |   |                                           |      |                  |   |
|                |   | The  Raptor Global Portfolio Ltd.                     |   |                                           |      |                  |   |
|                |   | c/o  CITCO                                            |   |                                           |      |                  |   |
|                |   | Kaya  Flamboyan 9                                     |   |                                           |      |                  |   |
|                |   | Curacao,  Netherlands Antilles                        |   |                                           |      |                  |   |

 

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(1)                                  Basedsolely on information set forth in Schedule 13G (the “Capital Schedule 13G”)dated December 31, 2002 and filed on February 11, 2003 with the Securities andExchange Commission by Capital Group International, Inc. (“CGII”) and CapitalGuardian Trust Company (“CGTC”).  CGIIis the parent holding company of a group of investment management companiesthat hold investment

 

43

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power and, in some,cases, voting power over the shares reported in the Capital Schedule 13G.  The investment management companies, whichinclude a bank and several investment advisers, provide investment advisory andmanagement services for their respective clients which include registeredinvestment companies and institutional accounts.  CGII does not have investment power or voting power over any ofthe shares reported in the Capital Schedule 13G.  However, by virtue of Rule 13d-3 under the Act, CGII may bedeemed to beneficially own the shares reported in the Capital Schedule 13G.  CGTC, a wholly owned subsidiary of CGII anda bank as defined in Section 3(a)(6) of the Act is deemed to be the beneficialowner of the shares reported in the Capital Schedule 13G as a result of itsserving as the investment manager of various institutional accounts.  According to the Capital Schedule 13G, CGIIand CGTC each has sole voting power of 1,612,000 shares, no shared votingpower, sole dispositive power of 2,235,220 shares and no shared dispositivepower.

(2)                                  Basedsolely on information set forth in Schedule 13G (the “Deutsche Bank Schedule13G”) dated December 31, 2002 and filed on February 14, 2003 with theSecurities and Exchange Commission by Deutsche Bank AG (“Deutsche Bank”).  Deutsche Investment Management Americas Inc.(“DIMA”), an investment advisor, and Deutsche Bank Trust Company Americas(“DBTCA”), a bank, are subsidiaries of Deutsche Bank.  The shares reported in the Deutsche Bank Schedule 13G are ownedby the Private Clients and Asset Management business group of Deutsche Bank andits subsidiaries and affiliates.  ThePrivate Clients and Asset Management business group of Deutsche Bank expresslydisclaims beneficial ownership of the shares reported in the Deutsche BankSchedule 13G.  According to the DeutscheBank Schedule 13G, Deutsche Bank has sole voting power of 1,909,577 shares, sharedvoting power of 76,016 shares, sole dispositive power of 1,835,310 shares andshared dispositive power of 383,000 shares; DIMA has sole voting power of745,540 shares, shared voting power of 70,000 shares, sole dispositive power of432,540 shares and shared dispositive power of 383,000 shares; and DBTCA hassole voting power of 1,164,037 shares, shared voting power of 6,016 shares,sole dispositive power of 1,402,770 shares and no shared dispositive power.

(3)                                  Basedsolely on information set forth in Schedule 13G (the “Liberty Schedule 13G”)dated December 31, 2002 and filed on February 14, 2003 with the Securities andExchange Commission by Liberty Wanger Asset Management, L.P. (“WAM”), WAMAcquisition GP, Inc. (“WAM GP”) and Liberty Acorn Trust (“Acorn”).  WAM GP is the general partner of WAM, aninvestment advisor and Acorn is an investment company.  The shares reported in the Liberty Schedule13G were acquired on behalf of discretionary clients of WAM, includingAcorn.  Persons other than WAM and WAMGP are entitled to receive all dividends from, and proceeds from the sale of,the shares reported.  Acorn is the onlysuch person known to be entitled to all dividends from, and all proceeds fromthe sale of, shares reported in the Liberty Schedule 13G to the extent of morethan 5% of the class.  According to theLiberty Schedule 13G, WAM and WAM GP each has no sole voting power, sharedvoting power of 2,333,500 shares, no sole dispositive power and shared dispositivepower of 2,333,500 shares; and Acorn has no sole voting power, shared votingpower of 2,042,500 shares, no sole dispositive power and shared dispositivepower of 2,042,500 shares.

(4)                                  Basedsolely on information set forth in Schedule 13G (the “Maverick Schedule 13G”)dated December 31, 2002 and filed on February 14, 2003 with the Securities andExchange Commission by Maverick Capital, Ltd. (“Maverick”), Maverick CapitalManagement, LLC (“MCM”) and Lee S. Ainslie III (“Ainslie”).  Maverick is an investment adviser and hasbeneficial ownership of the shares reported in the Maverick Schedule 13Gthrough the investment discretion it exercises over its clients’ accounts.  MCM is the general partner of Maverick.  Ainslie is a manager of MCM and is grantedsole investment discretion pursuant to MCM regulations.  According to the Maverick Schedule 13G,Maverick, MCM and Ainslie each has sole voting power of 2,241,250 shares, noshared voting power, sole dispositive power of 2,241,250 shares and no shareddispositive power.

(5)                                  Basedsolely on information set forth in the fifth amendment to Schedule 13G (the“JWS Schedule 13G”) dated February 28, 2003 and filed on March 10, 2003 withthe Securities and Exchange Commission by J. & W. Seligman & Co.Incorporated (“JWS”), William C. Morris (“Morris”) and Seligman Communications& Information Fund, Inc. (“Seligman”). JWS is an investment adviser to Seligman, an investment company.  Morris is a control person of JWS.  JWS, as an investment adviser for Seligman,may be deemed to beneficially own the shares reported by Seligman in the JWSSchedule 13 G.  Accordingly, the sharesreported by JWS in the JWS Schedule 13G include the shares reported in suchSchedule by Seligman.  Morris, as theowner of a majority of the outstanding voting securities of JWS, may be deemedto beneficially own the shares reported by JWS in the JWS Schedule 13G.  Accordingly, the shares reported in the JWSSchedule 13G by Morris include the shares reported in such Schedule by JWS.  According to the JWS Schedule 13G, each ofJWS and Morris has no sole voting power, shared voting power of 3,373,890shares, no sole dispositive power and shared dispositive power of 3,373,890shares.  Seligman has no sole votingpower, shared voting power of 2,900,000shares, no sole dispositive power andshared dispositive power of 2,900,000 shares.

(6)                                  Basedsolely on information set forth in the Schedule 13G (the “Tudor Schedule 13G”)dated January 27, 2003 and filed on February 5, 2003 with the Securities andExchange Commission by Tudor Investment Corporation (“TIC”), Paul Tudor Jones,II (“Jones”), Tudor Proprietary Trading, L.L.C. (“TPT”), The Altar Rock FundL.P. (“Altar Rock”), The Tudor BVI Global Portfolio Ltd. (“BVI”) and The RaptorGlobal Portfolio Ltd. (“Raptor”).  Theshares reported as beneficially owned in the Tudor Schedule 13G are owneddirectly by TPT (172,221 shares), Altar Rock (12,034 shares), Raptor (1,858,635shares) and BVI (318,410 shares). Because TIC is the sole general partner of Altar Rock and providesinvestment advisory services to Raptor and BVI, TIC may be deemed tobeneficially own the shares owned by each of Altar Rock, Raptor and BVI.  TIC expressly disclaims such beneficialownership.  In addition, because Jonesis the controlling shareholder of TIC and the indirect controlling equityholder of TPT, Jones may be deemed to beneficially own the shares deemedbeneficially owned by TIC and TPT. Jones expressly disclaims such beneficial ownership.  According to the Tudor Schedule 13G:  TIC has no sole voting power, shared votingpower of 2,189,079 shares, no sole dispositive power and shared dispositivepower of 2,189,079 shares; Jones has no sole voting power, shared voting powerof 2,361,300 shares, no sole dispositive power and shared dispositive power of2,361,300 shares; TPT has no sole voting power, shared voting power of 172,221shares, no sole dispositive power and shared dispositive power of 172,221shares; BVI has no sole voting power, shared voting power of 318,410 shares, nosole dispositive power and shared dispositive power of 318,410 shares;  Altar Rock has no sole voting power, sharedvoting power of 12,034 shares, no sole dispositive power and shared dispositivepower of 12,034 shares; and  Raptor hasno sole voting power, shared voting power of 1,858,635 shares, no soledispositive power and shared dispositive power of 1,858,635 shares.

 

The following table setsforth certain information with respect to beneficial ownership of our shares ofcommon stock as of March 21, 2003 by each of our directors and Named Executivesand by all directors and executive officers as a group, and (iii) Jeffrey C.Lapin, who was a director and our Chief Operating Officer and Vice Chairmanuntil November 8, 2002 (the “Named Executives”).  Unless otherwise indicated below, each individual named in thetable

 

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has sole voting power and sole investment power with respect to all ofthe shares beneficially owned, subject to community property laws, whereapplicable.

 
| **Title of  Class** |   | **Name and Address of  Beneficial Owner (1)**                      |   | **Amount and Nature of  Beneficial Ownership** |   | **Percent of  Class** |   |
|---------------------|--------|--------------------------------------------------------------------|--------|------------------------------------------------|--------|-----------------------|--------|
| Common              |   | Brian J. Farrell                                                   |   | 1,278,153                                      | (2)    | 3.3                   | %      |
| Common              |   | Lawrence Burstein                                                  |   | 174,003                                        | (3)    | *                     |   |
| Common              |   | James L. Whims                                                     |   | 216,069                                        | (4)    | *                     |   |
| Common              |   | L. Gregory Ballard                                                 |   | 95,812                                         | (5)    | *                     |   |
| Common              |   | Brian Dougherty                                                    |   | 16,875                                         | (6)    | *                     |   |
| Common              |   | Fred A. Gysi                                                       |   | 120,126                                        | (7)    | *                     |   |
| Common              |   | Alison Locke                                                       |   | 167,501                                        | (8)    | *                     |   |
| Common              |   | Jack Sorensen                                                      |   | 50,001                                         | (9)    | *                     |   |
| Common              |   | Tim F. Walsh                                                       |   | 173,877                                        | (10)   | *                     |   |
| Common              |   | Jeffrey C. Lapin                                                   |   | 10,250                                         | (11)   | *                     |   |
| Common              |   | All Directors and  Executive Officers  as a group (10 individuals) |   | 2,302,667                                      | (12)   | 5.9                   | %      |
|                |   |                                                               |   |                                           |   |                  |   |

 

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*  Less than 1%.
| (1)  |   | The address for each individual is c/o THQ Inc.,  27001 Agoura Road, Calabasas Hills, California 91301.                                                                                                                                                                                                                                                                                                                                                                  |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  |   | Includes 1,154,002 shares of common stock issuable  upon exercise of options exercisable within 60 days.                                                                                                                                                                                                                                                                                                                                                                 |
| (3)  |   | Includes 157,503 shares of common stock issuable  upon exercise of options exercisable within 60 days.                                                                                                                                                                                                                                                                                                                                                                   |
| (4)  |   | Includes 140,623 shares of common stock issuable upon  exercise of options exercisable within 60 days and 17,196 shares of common  stock held of record by TechFund Capital L.P. (“TechFund”).  Mr. Whims is a managing member of the  general partner of TechFund and accordingly may be deemed to share beneficial  ownership of the shares of common stock held of record by TechFund.  Mr. Whims disclaims beneficial ownership  of such shares. |
| (5)  |   | Includes 91,312 shares of common stock issuable upon  exercise of options exercisable within 60 days.                                                                                                                                                                                                                                                                                                                                                                    |
| (6)  |   | Includes 16,875 shares of common stock issuable upon  exercise of options exercisable within 60 days.                                                                                                                                                                                                                                                                                                                                                                    |
| (7)  |   | Includes 114,876 shares of common stock issuable  upon exercise of options exercisable within 60 days.                                                                                                                                                                                                                                                                                                                                                                   |
| (8)  |   | Includes 167,501 shares of common stock issuable  upon exercise of options exercisable within 60 days.                                                                                                                                                                                                                                                                                                                                                                   |
| (9)  |   | Includes 50,001 shares of common stock issuable upon  exercise of options exercisable within 60 days.                                                                                                                                                                                                                                                                                                                                                                    |
| (10) |   | Includes 161,877 shares of common stock issuable  upon exercise of options exercisable within 60 days.                                                                                                                                                                                                                                                                                                                                                                   |
| (11) |   | As of November 8, 2002, Mr. Lapin no longer serves  as a director and our Chief Operating Officer and Vice Chairman.                                                                                                                                                                                                                                                                                                                                                     |
| (12) |   | Includes an aggregate  of 2,054,570 shares of common stock issuable upon exercise of options within  60 days.                                                                                                                                                                                                                                                                                                                                                            |

 

 

**EquityCompensation Plan**

 

The following tableprovides certain information with respect to all of our equity compensationplans in effect as of December 31, 2002.

 
|                                                        |   | **(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     |   | 6,734,096                                                                                            |      | $                                                                                  | 20.39  |                                                                                                                                                   | 1,990,198 |   |
| Equity  compensation plans not approved by security holders |   | 711,387                                                                                              | (1)  | $                                                                                  | 4.93   |                                                                                                                                                   | 315,284   |   |
| Total                                                       |   | 7,445,483                                                                                            |      | $                                                                                  | 20.12  |                                                                                                                                                   | 2,305,482 |   |

 

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(1)                                  Representsthe aggregate number of shares of common stock issuable upon exercise ofindividual arrangements with option and warrant holders and upon exercise ofoptions granted under our Second Amended and Restated Non-executive EmployeeStock

 

45

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Option Plan (the NEEPPlan).  The vesting of the outside planoptions and the NEEP Plan options is determined by our Board of Directors upongrant by such options typically vest over three years.  In addition, the NEEP Plan options areexercisable and expire within five years from date of grant and havetermination provisions similar to options granted under stockholder approvedplans.  The warrants are exercisableupon grant and expire within five years from date of grant

 

**Item 13****.**CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

There were no reportablerelationships or transactions with management during the year ended December31, 2002.

 

**Item 14****.**DISCLOSURECONTROLS AND PROCEDURES**

 

OurChief Executive Officer and Chief Financial Officer, as of a date within 90days before the filing of this Form 10-K, have evaluated our disclosurecontrols and procedures (as defined in Rules 13a-14 and 15d-14 under theSecurities Exchange Act of 1934) and have concluded that such controls andprocedures are effective.  There havebeen no significant changes in internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of their evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

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**PART IV**

 

**Item 15****. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K**

 

**(a)****          *Financial Statements and Financial StatementSchedules.***

 

See Index to FinancialStatements.

 

**(b)****          *Reports on Form 8-K.***

 

Current Report on Form8-K dated November 21, 2001, reporting under Item 5.

 

**(c)****          *Exhibits.***

 
| **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 period ended June 30, 2001  (the “June 2001 10-Q”)).                                                                                                                      |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 3.4                |   | Amended and Restated  Bylaws (incorporated by reference to Exhibit 3 to the Registrant’s Current  Report on Form 8-K, dated 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 Form 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 quarterly period ended September 30,  2001 (the “September 2001 10-Q”)).                                      |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 4.1                |   | Amended and Restated  Rights Agreement, dated as of August 22, 2001 between the Registrant and  Computershare Investor Services, LLC, as Rights Agent (incorporated by  reference to Exhibit 1 to Amendment No. 2 to the Registrant’s August 2001  Form 8-A).                                                                       |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 4.2                |   | First Amendment to  Amended and Restated Rights Agreement, dated April 9, 2002 between the  Registrant 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†         |   | Amended and Restated  Employment Agreement dated as of January 1, 2001, between the Company and  Brian J. Farrell (incorporated by reference to Exhibit 10.1 to the  Registrant’s Annual Report on Form 10-K for the fiscal year ended December  31, 2000 (the “December 2000 10-K”)).                                    |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.2†         |   | Amended and Restated  Employment Agreement dated as of January 1, 2001, between the Company and  Jeffrey C. Lapin (incorporated by reference to Exhibit 10.2 to the  Registrant’s December 2000 10-K).                                                                                                                              |

 

47

----

 
| **Exhibit Number** |   | **Title**                                                                                                                                                                                                                                                                                                                                |
|--------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.3†*        |   | Letter Agreement, dated  November 16, 2002,between the Company and Jeffrey C. Lapin.                                                                                                                                                                                                                                                     |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.4†         |   | Employment Agreement  between Fred A. Gysi and the Company dated October 1, 1997 (incorporated by  reference to Exhibit 10.6 to the Registrant’s Annual Report on Form 10-K for  the fiscal year ended December 31, 1998 (the “ December 1998 10-K”)).                                                                    |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.5†         |   | Form of Severance  Agreement with Executive Officers (incorporated by reference to Exhibit 10.7  to the December 1998 10-K).                                                                                                                                                                                                             |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.6†         |   | Amended and Restated  1990 Stock Option Plan (incorporated by reference to Exhibit 10.1 to the  Registrant’s Registration Statement on Form S-2 filed on December 23, 1996  (File No. 333-18641)).                                                                                                                                  |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.7†         |   | Stock Option Agreement  dated as of August 28, 1996, between the Company and Brian J. Farrell  (incorporated by reference to Exhibit  10.31 to the Registrant’s Annual Report on Form 10-K for the fiscal year  ended December 31, 1996).                                                                                      |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.8†         |   | Amended and Restated  1997 Stock Option Plan (incorporated by reference to Appendix A to  Registrant’s Proxy Statement On Schedule 14A filed on June 25, 2001).                                                                                                                                                                     |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.9†         |   | Form of Stock Option  Agreement for the Amended and Restated 1997 Stock Option Plan (incorporated  by reference to Exhibit 10.8 to the Registrant’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2001 (the “December 2001 10-K”)).                                                                  |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.10†        |   | Stock Option Agreement  dated as of October 21, 1998, between the Company and Jeffrey C. Lapin  (incorporated by reference to Exhibit 10.8 to the Registrant’s Quarterly  Report on Form 10-Q for the quarterly period ended June 30, 1999 (the “June  1999 10-Q”)).                                                      |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.11†        |   | Form of Stock Option  Agreement dated as of December 23, 1998, between the Company and each of  Messrs. Lawrence Burstein and James Whims (incorporated by reference to  Exhibit 10.9 to the Registrant’s June 1999 10-Q).                                                                                                          |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.12†        |   | Second Amended and  Restated Nonexecutive Employee Stock Option Plan dated as of March 6, 2002 (incorporated  by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form  10-Q for the quarterly period ended March 31, 2002).                                                                                       |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.13†        |   | Form of Nonexecutive  Employee Stock Option Agreement for the Second Amended and Restated  Nonexecutive Employee Stock Option Plan   (incorporated by reference to Exhibit 4.10 to the Registrant’s  Registration Statement on Form S-8 filed on June 21, 2002 (File No.  333-90986)).                                         |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.14              |   | Second Amendment to  Revolving Credit Agreement, dated as of February 20, 2001, between the  Company, Union Bank as Agent and as Lender, BNP Paribas, and Pacific Century  Bank, N.A. (incorporated by reference to Exhibit 10.3 to the Registrant’s  Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2001). |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.15              |   | Third Amendment to  Revolving Credit Agreement, dated as of June 12, 2001, between the Company,  Union Bank as Agent and as Lender, BNP Paribas, and Pacific Century Bank,  N.A. (incorporated by reference to Exhibit 10.2 to the Registrant’s June 2001  10-Q).                                                                   |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.16              |   | Fourth Amendment to  Revolving Credit Agreement, dated as of July 31, 2001, between the Company,  Union Bank as Agent and as Lender and BNP Paribas (incorporated by reference  to Exhibit 10.3 to the Registrant’s June 2001 10-Q).                                                                                                |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.17              |   | Fifth Amendment to  Revolving Credit Agreement, dated as of August 28, 2001, between the Company,  Union Bank as Agent and as Lender and BNP Paribas (incorporated by reference  to Exhibit 10.1 to the Registrant’s September 2001 10-Q).                                                                                          |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.18              |   | Sixth Amendment to  Revolving Credit Agreement, dated as of October 26, 2001, between the  Company, Union Bank as Agent and as Lender and BNP Paribas (incorporated by  reference to Exhibit 10.2 to the Registrant’s September 2001 10-Q).                                                                                         |
|               |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.19              |   | Seventh Amendment to  Revolving Credit Agreement and First Amendment to Security Agreement, dated  as of January 8, 2002, between the Company, Union Bank as Agent and as Lender  and BNP Paribas (incorporated by reference to Exhibit 10.18 to the  Registrant’s December 2001 10-K).                                             |

 

48

----

 
| **Exhibit Number** |   | **Title**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|--------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.20              |   | Eighth Amendment to  Revolving Credit Agreement, dated as of May 1, 2002, between the Company,  Union Bank as Agent and as Lender and BNP Paribas (incorporated by reference  to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the  quarterly period ended June 30, 2002 (the “June 2002 10-Q”)).                                                                                                                                                                                                                                                                 |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.21              |   | Ninth Amendment to  Revolving Credit Agreement, dated as of July 26, 2002, between the Company,  Union Bank as Agent and as Lender and BNP Paribas (incorporated by reference  to Exhibit 10.2 to the Registrant’s June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                              |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.22              |   | Waiver under Revolving  Credit Agreement, dated as of September 10, 2002 by and between the Company  and Union Bank (incorporated by reference to Exhibit 10.1 to the Registrant’s  Quarterly Report on Form 10-Q for the quarterly period ended September 30,  2002 (the “September 2002 10-Q”)).                                                                                                                                                                                                                                                                                     |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.23              |   | Amended and Restated  Revolving Credit Agreement, dated as of September 27, 2002 by and between the  Company and Union Bank (incorporated by reference to Exhibit 10.2 to the  Registrant’s September 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.24*             |   | First Amendment to the  Amended and Restated Revolving Credit Agreement, dated November 21, 2002, by  and between the Company and Union Bank.                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.25*             |   | Waiver under Amended  and Restated Revolving Credit Agreement, dated February 21, 2003, by and  between the Company and Union Bank.                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.26              |   | Second  Amendment to Security Agreement, dated as of September 27, 2002 between the  Company and Union Bank (incorporated by reference to Exhibit 10.3 to the  Registrant’s September 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.27              |   | Confidential License  Agreement for Game Boy, Game Boy Color and Game Boy Pocket Handheld Video  Game Systems (Western Hemisphere), dated as of March 9, 1999, between  Nintendo of America Inc. (“NOA”) and the Company (incorporated by reference  to Exhibit 10.4 to the Registrant’s September 2002 10-Q).  (Portions have been omitted and filed  separately with the Securities and Exchange Commission pursuant to a request  for confidential treatment in accordance with Rule 24b-2 under the Securities  Exchange Act of 1934, as amended (“Exchange Act”)). |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.28              |   | First  Amendment to the Confidential License Agreement for Game Boy, Game Boy Color  and Game Boy Pocket Handheld Video Game Systems (Western Hemisphere) dated as  of March 8, 2002, between NOA and the Company (incorporated by  reference to Exhibit 10.5 to the Registrant’s September 2002 10-Q).                                                                                                                                                                                                                                                                                          |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.29              |   | Confidential License  Agreement for Game Boy Advance (Western Hemisphere), dated as of July 18,  2001, between NOA and the Company (incorporated by reference to Exhibit 10.6  to the Registrant’s September 2002 10-Q).   (Portions have been omitted and filed separately with the Securities  and Exchange Commission pursuant to a request for confidential treatment in  accordance with Rule 24b-2 under the Exchange Act.).                                                                                                                                                          |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.30              |   | Confidential  License Agreement for Nintendo GameCube (Western Hemisphere), dated as of  April 5, 2002, between NOA and the Company (Western Hemisphere) (incorporated  by reference to Exhibit 10.7 to the Registrant’s September 2002 10-Q). (Portions have been omitted and filed  separately with the Securities and Exchange Commission pursuant to a request  for confidential treatment in accordance with Rule 24b-2 under the Exchange  Act.).                                                                                                                                          |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.31              |   | Microsoft Corporation  Xbox TM 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).  (Portions have been omitted and filed separately  with the Securities and Exchange Commission pursuant to a request for  confidential treatment in accordance with Rule 24b-2 under the Exchange Act.)                                                                                                                                                    |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.32              |   | Licensed  Publisher Agreement, dated as of August 28, 2002, by and between Sony Computer  Entertainment America Inc. (“Sony”) and the Company (incorporated by  reference to Exhibit 10.9 to the Registrant’s September 2002 10-Q). (Portions have been omitted and filed  separately with the Securities and Exchange Commission pursuant to a request  for confidential treatment in accordance with Rule 24b-2 under the Exchange  Act.)                                                                                                                                            |

 

49

----

 
| **Exhibit Number** |   | **Title**                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|--------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.33              |   | PlayStation ® 2 CD-Rom/  DVD-Rom Licensed Publisher Agreement, dated as of April 1, 2000, between Sony  and the Company (incorporated by  reference to Exhibit 10.10 to the Registrant’s September 2002 10-Q).  (Portions have been omitted and filed  separately with the Securities and Exchange Commission pursuant to a request  for confidential treatment in accordance with Rule 24b-2 under the Exchange  Act.)                                        |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.34              |   | PlayStation® Licensed  Publisher Agreement, dated as of June 25, 1998, between Sony Computer  Entertainment Europe and THQ International Limited (incorporated by reference to Exhibit 10.11 to the Registrant’s  September 2002 10-Q).  (Portions have  been omitted and filed separately with the Securities and Exchange Commission  pursuant to a request for confidential treatment in accordance with Rule 24b-2  under the Exchange Act.)               |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.35              |   | PlayStation® Licensed  Publisher — Supplemental Agreement, dated as of June 25, 1998, between Sony  Computer Entertainment Europe and THQ International Limited (incorporated by reference to Exhibit  10.12 to the Registrant’s September 2002 10-Q). (Portions have been omitted  and filed separately with the Securities and Exchange Commission pursuant to  a request for confidential treatment in accordance with Rule 24b-2 under the  Exchange Act.) |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 21*                |   | Subsidiaries of the  Registrant                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 23.1*              |   | Consent of Deloitte  & Touche LLP.                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 99.1*              |   | Certification of Brian J. Farrell, Chief Executive  Officer, Pursuant to Section 1350 of Chapter 63 of Title 18 of the United  States Code.                                                                                                                                                                                                                                                                                                                                   |
|               |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 99.2*              |   | Certification  of Fred A. Gysi, Chief Financial Officer, Pursuant to Section 1350 of Chapter  63 of Title 18 of the United States Code.                                                                                                                                                                                                                                                                                                                                       |

 

----

†              Management contract or compensatory plan or arrangementrequired to be filed as an exhibit hereto pursuant to Item 14(c) of Form 10-K.

 

*                 Filedherewith.

 

50

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| Dated:  March 31, 2003 | THQ INC. |
|-----------------------------|----------|
|                        | By:      | /s/Brian J. Farrell |   |
|                        |     | Brian J. Farrell,  Chairman of the Board, |
|                        |     | President and Chief  Executive Officer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.

 
| **Signature**           |   | **Title** |                                                                                                                                                       | **Date** |
|-------------------------|--------|-----------|------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
|                    |   |      |                                                                                                                                                       |     |
| /s/ Brian J.  Farrell   |   |      | Director,  Chairman of the Board, President and Chief Executive Officer (Principal  Executive Officer)                                                     |     | March 31, 2003 |
| Brian J. Farrell        |   |      |                                                                                                                                                       |
|                    |   |      |                                                                                                                                                       |     |
| /s/ Fred A. Gysi        |   |      | Senior Vice President - Finance and Administration, Chief Financial  Officer and Secretary (Principal Financial Officer and Principal  Accounting Officer) |     | March 31, 2003 |
| Fred A. Gysi            |   |      |                                                                                                                                                       |
|                    |   |      |                                                                                                                                                       |     |
| /s/Lawrence  Burstein   |   |      | Director                                                                                                                                                   |     | March 31, 2003 |
| Lawrence  Burstein      |   |      |                                                                                                                                                       |     |
|                    |   |      |                                                                                                                                                       |     |
| /s/ James L.  Whims     |   |      | Director                                                                                                                                                   |     | March 31, 2003 |
| James L. Whims          |   |      |                                                                                                                                                       |     |
|                    |   |      |                                                                                                                                                       |     |
| /s/ L. Gregory  Ballard |   |      | Director                                                                                                                                                   |     | March 31, 2003 |   |
| L. Gregory  Ballard     |   |      |                                                                                                                                                       |     |
|                    |   |      |                                                                                                                                                       |     |
|                    |   |      | Director                                                                                                                                                   |     | March 31, 2003 |
| Brian Dougherty         |   |      |                                                                                                                                                       |     |
|                         |        |           |                                                                                                                                                            |          |  |  |  |  |  |  |

 

51

----

 

**CERTIFICATIONS**

 

I, Brian J. Farrell,Chief Executive Officer of THQ Inc., certify that:

 

1.             I have reviewed this annual report on Form 10-K of THQInc., the registrant;

 

2.             Based on my knowledge, this annual report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this annual report;

 

3.             Based on my knowledge, the financial statements, andother financial information included in this annual report, fairly present inall material respects the financial condition, results of operations and cashflows of the registrant as of, and for, the periods presented in this annualreport;

 

4.             The registrant’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant andhave:

 

a.             designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

b.             evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c.             presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifying officers and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a.             allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.             anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.             The registrant’s other certifying officers and I haveindicated in this annual report whether there were significant changes ininternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of our most recent evaluation, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 
| Date:  March 31, 2003 |   |   |   |   |                    |   |   |
|----------------------------|--------|--------|--------|--------|-------------------------|--------|--------|
|                       |   |   |   |   |                    |   |   |
|                       |   |   |   |   |                    |   |   |
|                       |   |   |   |   |                    |   |
|                       |   |   |   | By:    | /s/ Brian J. Farrell    |   |
|                       |   |   |   |   |                    |
|                       |   |   |   |   | Brian J. Farrell        |
|                       |   |   |   |   | Chief Executive Officer |
|                            |        |        |        |        |                         |        |        |  |  |

 

52

----

 

**CERTIFICATIONS**

 

I, Fred A. Gysi, ChiefFinancial Officer of THQ Inc., certify that:

 

1.             I have reviewed this annual report on Form 10-K of THQInc., the registrant;

 

2.             Based on my knowledge, this annual report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this annual report;

 

3.             Based on my knowledge, the financial statements, andother financial information included in this annual report, fairly present inall material respects the financial condition, results of operations and cashflows of the registrant as of, and for, the periods presented in this annualreport;

 

4.             The registrant’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant andhave:

 

a.             designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

b.             evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c.             presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifying officers and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a.             allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.             anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.             The registrant’s other certifying officers and I haveindicated in this annual report whether there were significant changes ininternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of our most recent evaluation, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 
| Date:  March 31, 2003 |   |   |   |   |                    |   |   |
|----------------------------|--------|--------|--------|--------|-------------------------|--------|--------|
|                       |   |   |   |   |                    |
|                       |   |   |   |   |                    |
|                       |   |   |   | By:    | /s/ Fred A. Gysi        |   |
|                       |   |   |   |   |                    |
|                       |   |   |   |   | Fred A. Gysi            |
|                       |   |   |   |   | Chief Financial Officer |
|                            |        |        |        |        |                         |        |        |  |  |

 

53

----

 

 

**THQ INC.**

**INDEXTO FINANCIAL STATEMENTS**

 
| INDEPENDENT AUDITORS’  REPORT                                                                                        |
|---------------------------------------------------------------------------------------------------------------------------|
| CONSOLIDATED FINANCIAL  STATEMENTS                                                                                        |
| Consolidated Balance Sheets  — December 31, 2002 and 2001                                                            |
| Consolidated  Statements of Operations for Each of the Three Years in the Period Ended  December 31, 2002                 |
| Consolidated  Statements of Stockholders’ Equity for Each of the Three Years in the Period  Ended  December 31, 2002 |
| Consolidated  Statements of Cash Flows for Each of the Three Years in the Period Ended  December 31, 2002                 |
| NOTES TO  CONSOLIDATED FINANCIAL STATEMENTS                                                                               |

 

All financial statementschedules have been omitted since either (i) the schedule or conditionrequiring a schedule is not applicable or not material or (ii) the informationrequired by such schedule is contained in the Consolidated Financial Statementsand Notes thereto.

 

F-1

----

 

**INDEPENDENTAUDITORS’ REPORT**

 

To the Stockholders ofTHQ Inc.,

 

Calabasas Hills,California

 

We have audited theaccompanying consolidated balance sheets of THQ Inc. and subsidiaries (the“Company”) as of December 31, 2002 and 2001, and the related consolidatedstatements of operations, stockholders’ equity, and cash flows for each of thethree years in the period ended December 31, 2002.  These financial statements are the responsibility of theCompany’s management.  Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our auditsin accordance with auditing standards generally accepted in the United Statesof America.  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of the Company as of December 31, 2002 and 2001, and theresults of its operations and its cash flows for each of the three years in theperiod ended December 31, 2002, in conformity with accounting principlesgenerally accepted in the United States of America.

 

As discussed in Note 2 tothe financial statements, the Company adopted Statement of Financial AccountingStandards No. 142 “Goodwill and Other Intangible Assets” effective January 1,2002.

 

**DELOITTE& TOUCHE LLP**

 

Los Angeles, California

 

March 25, 2003

 

F-2

----

 

**THQINC. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**(Inthousands, except per share data)**

 
|                                                                                                                                                                  |   | **December 31,** |    |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------|---------|
|                                                                                                                                                                  |   | **2002**         |    | **2001** |   |
| **ASSETS**                                                                                                                                                            |   |             |    |   |   |
| Current  assets:                                                                                                                                                      |   |             |    |   |   |
| Cash  and cash equivalents                                                                                                                                            |   | $                | 132,898 |   | $ | 171,059 |   |
| Short-term  investments                                                                                                                                               |   | 53,951           |    | 35,106 |   |
| Cash,  cash equivalents and short-term investments                                                                                                                    |   | 186,849          |    | 206,165 |   |
| Accounts  receivable, net of allowances                                                                                                                               |   | 146,508          |    | 126,011 |   |
| Inventory                                                                                                                                                             |   | 24,362           |    | 9,917 |   |
| Licenses                                                                                                                                                              |   | 15,897           |    | 16,758 |   |
| Software  development                                                                                                                                                 |   | 45,633           |    | 34,664 |   |
| Deferred  income taxes                                                                                                                                                |   | 1,334            |    | — |   |
| Income  taxes receivable                                                                                                                                              |   | —           |    | 290 |   |
| Prepaid  expenses and other current assets                                                                                                                            |   | 12,092           |    | 7,498 |   |
| Total  current assets                                                                                                                                                 |   | 432,675          |    | 401,303 |   |
| Property  and equipment, net                                                                                                                                          |   | 16,103           |    | 13,891 |   |
| Licenses,  net of current portion                                                                                                                                     |   | 19,525           |    | 8,345 |   |
| Software  development, net of current portion                                                                                                                         |   | 1,785            |    | 4,466 |   |
| Goodwill,  net                                                                                                                                                        |   | 58,609           |    | 48,202 |   |
| Other  long-term assets, net                                                                                                                                          |   | 9,163            |    | 11,759 |   |
| TOTAL  ASSETS                                                                                                                                                         |   | $                | 537,860 |   | $ | 487,966 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                         |   |             |    |   |   |
| Current  liabilities:                                                                                                                                                 |   |             |    |   |   |
| Accounts  payable                                                                                                                                                     |   | $                | 41,148  |   | $ | 27,186 |   |
| Accrued  expenses                                                                                                                                                     |   | 32,548           |    | 16,293 |   |
| Accrued  payment to venture partner                                                                                                                                   |   | 5,845            |    | 6,651 |   |
| Accrued  royalties                                                                                                                                                    |   | 30,215           |    | 30,001 |   |
| Income  taxes payable                                                                                                                                                 |   | 2,331            |    | — |   |
| Deferred  income taxes                                                                                                                                                |   | —           |    | 1,567 |   |
| Total  current liabilities                                                                                                                                            |   | 112,087          |    | 81,698 |   |
| Accrued  royalties, net of current portion                                                                                                                            |   | 15,373           |    | 6,686 |   |
| Deferred  income taxes                                                                                                                                                |   | 1,534            |    | 720 |   |
| Commitments  and contingencies                                                                                                                                        |   | —           |    | — |   |
| Stockholders’  equity:                                                                                                                                           |   |             |    |   |   |
| Common  stock, par value $.01, 75,000,000 shares authorized; 38,416,002 and  38,979,747 shares issued and outstanding as of December 31, 2002 and 2001,  respectively |   | 384              |    | 390 |   |
| Additional  paid-in capital                                                                                                                                           |   | 310,963          |    | 316,758 |   |
| Accumulated  other comprehensive income (loss)                                                                                                                        |   | 624              |    | (2,187 | ) |
| Retained  earnings                                                                                                                                                    |   | 96,895           |    | 83,901 |   |
| Total  stockholders’ equity                                                                                                                                      |   | 408,866          |    | 398,862 |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                      |   | $                | 537,860 |   | $ | 487,966 |   |

 

See notes to consolidated financial statements.

 

F-3

----

 

**THQINC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Inthousands, except per share data)**

 
|                                                 |   | **Years Ended December 31,** |    |
|------------------------------------------------------|--------|------------------------------|---------|
|                                                 |   | **2002**                     |    | **2001** |   | **2000** |   |
| Net  sales                                           |   | $                            | 480,529 |   | $ | 378,992 |   | $ | 347,003 |   |
| Costs  and expenses:                                 |   |                         |    |   |   |   |   |
| Cost  of sales                                       |   | 185,593                      |    | 154,898 |   | 140,699 |   |
| License  amortization and royalties                  |   | 40,476                       |    | 33,144 |   | 34,675 |   |
| Software  development amortization                   |   | 83,698                       |    | 35,144 |   | 42,875 |   |
| Product  development                                 |   | 38,572                       |    | 21,154 |   | 19,151 |   |
| Selling  and marketing                               |   | 66,443                       |    | 46,745 |   | 42,446 |   |
| Payment  to venture partner                          |   | 10,146                       |    | 8,673 |   | 17,707 |   |
| General  and administrative                          |   | 31,117                       |    | 25,090 |   | 19,530 |   |
| Total  costs and expenses                            |   | 456,045                      |    | 324,848 |   | 317,083 |   |
| Income  from operations                              |   | 24,484                       |    | 54,144 |   | 29,920 |   |
| Interest  income, net                                |   | 5,277                        |    | 2,572 |   | 1,323 |   |
| Other  expenses                                      |   | (10,006                      | )       | — |   | — |   |
| Income  before income taxes                          |   | 19,755                       |    | 56,716 |   | 31,243 |   |
| Income  taxes                                        |   | 6,761                        |    | 20,703 |   | 13,054 |   |
| Net  income                                          |   | $                            | 12,994  |   | $ | 36,013 |   | $ | 18,189 |   |
| Net  income per share — basic                   |   | $                            | 0.33    |   | $ | 1.10 |   | $ | 0.60 |   |
| Net  income per share — diluted                 |   | $                            | 0.32    |   | $ | 1.01 |   | $ | 0.56 |   |
|                                                 |   |                         |    |   |   |   |   |
| Shares  used in per share calculation — basic   |   | 39,203                       |    | 32,717 |   | 30,136 |   |
| Shares  used in per share calculation — diluted |   | 41,243                       |    | 35,623 |   | 32,352 |   |

 

See notes to consolidated financial statements.

 

F-4

----

 

**THQINC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**(Inthousands, except per share data)**

 
|                                                           |   | **Years Ended December 31, 2000, 2001 and 2002** |   |
|----------------------------------------------------------------|--------|--------------------------------------------------|--------|
|                                                           |   | **Common  Shares**                               |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Retained  Earnings** |   | **Total** |   |
| Balance  at January 1, 2000                                    |   | 29,845,851                                       |   | $ | 298 |   | $ | 79,151 |   | $ | (842 | ) | $ | 29,699 |   | $ | 108,306 |   |
| Exercise  of warrants and options                              |   | 844,956                                          |   | 9 |   | 4,296 |   | — |   | — |   | 4,305 |   |
| Stock  compensation                                            |   | —                                           |   | — |   | 406 |   | — |   | — |   | 406 |   |
| Tax  benefit related to the exercise of employee stock options |   | —                                           |   | — |   | 1,792 |   | — |   | — |   | 1,792 |   |
| Comprehensive  income:                                         |   |                                             |   |   |   |   |   |   |   |   |   |   |   |
| Net  income                                                    |   | —                                           |   | — |   | — |   | — |   | 18,189 |   | 18,189 |   |
| Other  comprehensive income                                    |   |                                             |   |   |   |   |   |   |   |   |   |   |   |
| Foreign  currency translation adjustment                       |   | —                                           |   | — |   | — |   | (873 | ) | — |   | (873 | ) |
| Comprehensive  income                                          |   | —                                           |   | — |   | — |   | — |   | — |   | 17,316 |   |
| Balance  at January 1, 2001                                    |   | 30,690,807                                       |   | 307 |   | 85,645 |   | (1,715 | ) | 47,888 |   | 132,125 |   |
| Exercise  of warrants and options                              |   | 2,405,413                                        |   | 24 |   | 16,697 |   | — |   | — |   | 16,721 |   |
| Issuance  of common stock from secondary offering              |   | 4,596,222                                        |   | 46 |   | 154,559 |   | — |   | — |   | 154,605 |   |
| Issuance  of common stock for Rainbow acquisition              |   | 1,287,305                                        |   | 13 |   | 48,635 |   | — |   | — |   | 48,648 |   |
| Stock  compensation                                            |   | —                                           |   | — |   | 299 |   | — |   | — |   | 299 |   |
| Tax  benefit related to the exercise of employee stock options |   | —                                           |   | — |   | 10,923 |   | — |   | — |   | 10,923 |   |
| Comprehensive  income:                                         |   | —                                           |   | — |   | — |   | — |   | — |   |   |   |
| Net  income                                                    |   | —                                           |   | — |   | — |   | — |   | 36,013 |   | 36,013 |   |
| Other  comprehensive income                                    |   | —                                           |   | — |   | — |   | — |   | — |   |   |   |
| Foreign  currency translation adjustment                       |   | —                                           |   | — |   | — |   | (703 | ) | — |   | (703 | ) |
| Unrealized  gain / (loss) on investments                       |   | —                                           |   | — |   | — |   | 231 |   | — |   | 231 |   |
| Comprehensive  income                                          |   | —                                           |   | — |   | — |   | — |   | — |   | 35,541 |   |
| Balance  at December 31, 2001                                  |   | 38,979,747                                       |   | $ | 390 |   | $ | 316,758 |   | $ | (2,187 | ) | $ | 83,901 |   | $ | 398,862 |   |

 

See notes to consolidated financial statements.

 

F-5

----

 

**THQINC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY (Cont’d)**

**(Inthousands, except per share data)**

 
|                                                           |   | **Years Ended December 31, 2000, 2001 and 2002** |   |
|----------------------------------------------------------------|--------|--------------------------------------------------|--------|
|                                                           |   | **Common  Shares**                               |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Retained  Earnings** |   | **Total** |   |
| Balance  at January 1, 2002                                    |   | 38,979,747                                       |   | 390 |   | 316,758 |   | (2,187 | ) | 83,901 |   | $ | 398,862 |   |
| Exercise  of options                                           |   | 932,234                                          |   | 9 |   | 7,741 |   | — |   | — |   | 7,750 |   |
| Issuance  of common stock for ValuSoft acquisition             |   | 166,600                                          |   | 2 |   | 4,626 |   | — |   | — |   | 4,628 |   |
| Issuance  of warrants                                          |   | —                                           |   | — |   | 1,214 |   | — |   | — |   | 1,214 |   |
| Repurchase  of common stock                                    |   | (1,671,531                                       | )      | (17 | ) | (24,988 | ) | — |   | — |   | (25,005 | ) |
| Adjustments  related to 2001 secondary offering                |   | —                                           |   | — |   | 52 |   | — |   | — |   | 52 |   |
| Stock  compensation                                            |   | 8,952                                            |   | — |   | 436 |   | — |   | — |   | 436 |   |
| Tax  benefit related to the exercise of employee stock options |   | —                                           |   | — |   | 5,124 |   | — |   | — |   | 5,124 |   |
| Comprehensive  income:                                         |   | —                                           |   | — |   | — |   | — |   | — |   | — |   |
| Net  income                                                    |   | —                                           |   | — |   | — |   | — |   | 12,994 |   | 12,994 |   |
| Other  comprehensive income                                    |   | —                                           |   | — |   | — |   | — |   | — |   | — |   |
| Foreign  currency translation adjustment                       |   | —                                           |   | — |   | — |   | 4,318 |   | — |   | 4,318 |   |
| Unrealized  loss on investments                                |   | —                                           |   | — |   | — |   | (1,507 | ) | — |   | (1,507 | ) |
| Comprehensive  income                                          |   | —                                           |   | — |   | — |   | — |   | — |   | 15,805 |   |
| Balance  at December 31, 2002                                  |   | 38,416,002                                       |   | $ | 384 |   | $ | 310,963 |   | $ | 624 |   | $ | 96,895 |   | $ | 408,866 |   |
|                                                                |        |                                                  |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See notes toconsolidated financial statements.

 

F-6

----

 

**THQINC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Inthousands)**

 
|                                                                               |   | **Years Ended December 31,** |    |
|------------------------------------------------------------------------------------|--------|------------------------------|---------|
|                                                                               |   | **2002**                     |    | **2001** |   | **2000** |   |
| Cash  flows from operating activities:                                             |   |                         |    |   |   |   |   |
| Net  income                                                                        |   | $                            | 12,994  |   | $ | 36,013 |   | $ | 18,189 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |   |                         |    |   |   |   |   |
| Depreciation  and amortization                                                     |   | 6,385                        |    | 5,416 |   | 3,225 |   |
| Amortization  of licenses and software development                                 |   | 91,677                       |    | 35,335 |   | 50,193 |   |
| Provision  for price protection, returns and doubtful accounts                     |   | 69,641                       |    | 47,374 |   | 35,387 |   |
| Loss  on disposal of property and equipment                                        |   | 137                          |    | 117 |   | 114 |   |
| Stock  compensation                                                                |   | 436                          |    | 299 |   | 406 |   |
| Tax  benefit related to the exercise of employee stock options                     |   | 5,124                        |    | 10,923 |   | 1,792 |   |
| Deferred  income taxes                                                             |   | (730                         | )       | 11,338 |   | (112 | ) |
| Write-off  of Network Interactive Sports Ltd.                                      |   | 3,006                        |    | — |   | — |   |
| Changes  in operating assets and liabilities:                                      |   |                         |    |   |   |   |   |
| Accounts  receivable                                                               |   | (85,012                      | )       | (37,665 | ) | (74,770 | ) |
| Inventory                                                                          |   | (12,112                      | )       | 743 |   | (5,442 | ) |
| Licenses                                                                           |   | (33,918                      | )       | (22,596 | ) | (6,680 | ) |
| Software  development                                                              |   | (75,049                      | )       | (53,095 | ) | (28,763 | ) |
| Prepaid  expenses and other current assets                                         |   | (2,101                       | )       | (2,901 | ) | (2,374 | ) |
| Accounts  payable                                                                  |   | 11,067                       |    | 5,517 |   | 8,797 |   |
| Accrued  expenses and accrued payment to venture partner                           |   | 13,577                       |    | (4,197 | ) | 10,494 |   |
| Accrued  royalties                                                                 |   | 8,834                        |    | 6,952 |   | (1,427 | ) |
| Income  taxes                                                                      |   | 2,374                        |    | (6,336 | ) | 7,107 |   |
| Net  cash provided by operating activities                                         |   | 16,330                       |    | 33,237 |   | 16,136 |   |
| Cash  flows used in investing activities:                                          |   |                         |    |   |   |   |   |
| Proceeds  from sale of property and equipment                                      |   | —                       |    | 65 |   | 64 |   |
| Proceeds  from sales and maturities of short-term investments                      |   | 90,732                       |    | — |   | — |   |
| Purchases  of short-term investments                                               |   | (110,072                     | )       | (35,124 | ) | — |   |
| Acquisition  of property and equipment                                             |   | (7,794                       | )       | (5,750 | ) | (7,877 | ) |
| Acquisition  of ValuSoft, net of cash acquired                                     |   | (9,373                       | )       | — |   | — |   |
| Investment  in Network Interactive Sports Ltd.                                     |   | (221                         | )       | (3,325 | ) | — |   |
| Investment  in Yuke’s Co., Ltd.                                               |   | —                       |    | — |   | (5,020 | ) |
| Increase  (decrease) in other long-term assets                                     |   | (1,422                       | )       | 50 |   | (114 | ) |
| Net  cash used in investing activities                                             |   | (38,150                      | )       | (44,084 | ) | (12,947 | ) |
| Cash  flows provided by financing activities:                                      |   |                         |    |   |   |   |   |
| Net  (decrease) in short-term borrowings                                           |   | —                       |    | (15,473 | ) | (1,229 | ) |
| Repurchase  of common stock                                                        |   | (25,005                      | )       | — |   | — |   |
| Principal  payments on long-term debt                                              |   | —                       |    | (1,806 | ) | — |   |
| Proceeds  from issuance of common stock                                            |   | 52                           |    | 154,605 |   | — |   |
| Proceeds  from exercise of warrants and options                                    |   | 7,750                        |    | 16,721 |   | 4,305 |   |
| Net  cash provided by financing activities                                         |   | (17,203                      | )       | 154,047 |   | 3,076 |   |
| Effect  of exchange rate changes on cash                                           |   | 862                          |    | (139 | ) | 279 |   |
| Net  increase in cash and cash equivalents                                         |   | (38,161                      | )       | 143,061 |   | 6,544 |   |
| Cash  and cash equivalents — beginning of period                              |   | 171,059                      |    | 27,998 |   | 21,454 |   |
| Cash  and cash equivalents — end of period                                    |   | $                            | 132,898 |   | $ | 171,059 |   | $ | 27,998 |   |

 

See notes toconsolidated financial statements.

 

F-7

----

 

**Supplementaldisclosures of cash flow information:**

 
| Cash  paid during the year for: |   |   |   |   |   |   |   |
|---------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Income  taxes                   |   | $      | 3,257  |   | $      | 8,204  |   | $ | 4,350 |   |
| Interest                        |   | $      | 76     |   | $      | 74     |   | $ | 354 |   |

 

On July 1, 2002, we paid$9.6 million in cash and issued approximately 167,000 shares of common stock aspart of the purchase price of ValuSoft. The issuance increased common stock and additional paid-in-capital by$2,000 and $4.6 million respectively, and was allocated among the assetsacquired.  (See Note 3)

 

| Estimated  Fair Value (in thousands): |   |   |   |
|---------------------------------------|--------|--------|--------|
| Tangible  assets acquired             |   | $      | 2,837  |   |
| Software  development acquired        |   | 1,491  |   |
| Licenses  acquired                    |   | 1,109  |   |
| Liabilities  assumed                  |   | (2,940 | )      |
| Goodwill                              |   | 12,042 |   |
| Purchase  price                       |   | $      | 14,539 |   |

 

On December 21, 2001, weissued approximately 1,287,000 shares of common stock and assumed approximately159,000 stock options as part of the purchase price of Rainbow MultimediaGroup, Inc.  The issuance increasedcommon stock and additional paid-in-capital by $13,000 and $48.6 millionrespectively, and was allocated among the assets acquired.  (See Note 3)

 

| Estimated  Fair Value (in thousands): |   |   |   |
|---------------------------------------|--------|--------|--------|
| Tangible  assets acquired             |   | $      | 5,838  |   |
| Intangible  assets acquired           |   | 3,531  |   |
| Liabilities  assumed                  |   | (5,411 | )      |
| Goodwill                              |   | 44,972 |   |
| Purchase  price                       |   | $      | 48,930 |   |

 

On June 8, 2001, WorldWrestling Federation Entertainment exchanged all of its warrants for 302,490shares of common stock in a non-cash transaction.  On July 23, 2001, Stanley Shenker Associates, Inc. (a related partyto the World Wrestling Federation Entertainment) exchanged all of its warrantsfor 37,923 shares of common stock in a non-cash transaction.

 

See notes toconsolidated financial statements.

 

F-8

----

 

**THQINC. AND SUBSIDIARIES**

 

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.   Description of Business**

 

*Business*.  THQ Inc., a Delaware corporation, is aleading global developer and publisher of interactive entertainment softwarefor the major hardware platforms in the home video game market.  We currently develop and publish titles forSony PlayStation 2, Microsoft Xbox, Nintendo GameCube, Nintendo Game BoyAdvance, personal computers (“PCs”) and wireless devices.  Our titles span most major interactive entertainmentsoftware genres, including action, adventure, children’s, driving, fighting,puzzle, role playing, simulation, sports and strategy.  Our customers include Wal-Mart, Toys “R” Us,Target, Electronics Boutique, Best Buy, Game Stop, Kay Bee Toys, and othernational and regional retailers, discount store chains and specialty retailers.

 

Unless the contextotherwise requires, references in this document to “THQ” or the “Company”include THQ Inc. and all of its wholly owned subsidiaries.

 

*PlatformLicense Agreements.* We have a license agreement with Sony pursuant to which we have thenon-exclusive right to utilize the Sony name, related trademarks, and itsproprietary information and technology in order to develop and market softwarefor use with the 128-bit Sony PlayStation 2 in the United States and Canadawhich expires in March 2004.  We arecurrently in negotiation for the Sony PlayStation 2 license agreement forEurope, Australia and New Zealand.  Wealso have two license agreements with Sony pursuant to which we have thenon-exclusive right to utilize the Sony name, related trademarks, and itsproprietary information and technology in order to develop and market softwarefor use with the 32-bit Sony PlayStation in the United States, Canada, Mexicoand Latin America and Europe, Australia and New Zealand which expire in August2006 and December 2005, respectively.

 

We have a licenseagreement with Nintendo pursuant to which we have the non-exclusive right toutilize the Nintendo name, related trademarks, and its proprietary informationand technology in order to develop and market software for use with the GameBoy Advance handheld game console in all countries in the Western Hemispherewhich expires in July 2004.  We arecurrently in negotiation for the Nintendo Game Boy Advance license agreementfor Europe, Australia and New Zealand. We have a license agreement with Nintendo pursuant to which we have thenon-exclusive right to utilize the Nintendo name, related trademarks, and itsproprietary information and technology in order to develop and market softwarefor use with the 128-bit Nintendo GameCube in all countries in the WesternHemisphere which expires in April 2005. We are currently in negotiation for the Nintendo GameCube licenseagreement for Europe, Australia and New Zealand.  We also have a license agreement with Nintendo pursuant to whichwe have the non-exclusive right to utilize the Nintendo name, relatedtrademarks, and its proprietary information and technology in order to developand market software for use with the Game Boy Color handheld game console inall countries in the Western Hemisphere which expires in March 2004.  We also have a license agreement withNintendo pursuant to which we have the non-exclusive right to utilize the Nintendoname, related trademarks, and its proprietary information and technology inorder to develop and market software for use with the Game Boy Color handheldgame console in Europe, Australia and New Zealand which expired in October2002.  The renewal is currently innegotiation, and provides for an expiration of October 2005.  We have two license agreements with Nintendopursuant to which we have the non-exclusive right to utilize the Nintendo name,related trademarks, and its proprietary information and technology in order todevelop and market software for use with the 64-bit Nintendo 64 in allcountries in the Western Hemisphere and Europe, Australia and New Zealand whichexpire in May 2003 and January 2004, respectively.

 

We have a licenseagreement with Microsoft pursuant to which we have the non-exclusive right toutilize the Microsoft name, related trademarks, and its proprietary informationand technology in order to develop and market software for use with the 128-bitMicrosoft Xbox which expires in November 2004. The territory is determined on a title-by-title basis.

 

Our business is dependenton these license agreements with Sony, Nintendo and Microsoft.  Substantially all of our products aremanufactured by Sony, Nintendo and Microsoft authorized vendors who charge usan amount for each disc-based product or cartridge manufactured.  This charge includes a manufacturing,printing and packaging fee as well as a royalty for the use of their respectivenames, proprietary information and technology.

 

In addition, we mustindemnify Sony, Nintendo and Microsoft, as appropriate, with respect to allloss, liability and expense resulting from any claim against Sony, Nintendo andMicrosoft involving the development, marketing, sale or use of our titles,including any claims for copyright or trademark infringement brought againstSony, Nintendo and Microsoft.  As such,we bear the risk that the properties and information and technology licensedfrom Sony,

 

F-9

----

 

Nintendo and Microsoftand incorporated in the software may infringe the rights of third parties.  Generally, we are entitled toindemnification from our software developers and property licensors to coverour indemnification obligations to Sony, Nintendo and Microsoft but noassurance can be given that, if any claim is brought against us, the developersand/or licensors will have sufficient resources to indemnify us.

 

**2.   Summary of Significant Accounting Policies**

 

*Principlesof Consolidation.*  Theconsolidated financial statements include the accounts of THQ Inc. and ourwholly owned subsidiaries.  Investmentsin business entities in which we do not have control, but have the ability toexercise significant influence over operating and financial policies (generally20-50% ownership), are accounted for by the equity method.  Allmaterial intercompany balances and transactions have been eliminated inconsolidation.

 

*ForeignCurrency Translation.* Assets and liabilities of foreign operations are translated at currentrates of exchange while results of operations are translated at average ratesin effect for the period.  Translationgains or losses are shown as a separate component of accumulated othercomprehensive income (loss).  Thetranslation gain (loss) on long-term intercompany balances included in theforeign currency translation was $1.8 million and ($0.6) million for the yearsended December 31, 2002 and 2001, respectively.  The gain (loss) for the year ended December 31, 2000 wasimmaterial.  Foreign currency gains andlosses result from exchange rate changes for transactions denominated incurrencies other than the functional currency. Foreign currency transaction gains and losses are not material and areincluded in general and administrative expenses.

 

*Cash,Cash Equivalents and Short-Term Investments*

 

| **(In  thousands)**                                |   | **December 31,** |    |
|----------------------------------------------------|--------|------------------|---------|
|                                               |   | **2002**         |    | **2001** |   |
| Cash  and cash equivalents                         |   | $                | 132,898 |   | $ | 171,059 |   |
|                                               |   |             |    |   |   |
| Short-term  investments                            |   |             |    |   |   |
| Available  for sale                                |   | 44,940           |    | 30,106 |   |
| Held  to maturity                                  |   | 9,011            |    | 5,000 |   |
| Short-term  investments                            |   | 53,951           |    | 35,106 |   |
|                                               |   |             |    |   |   |
| Cash,  cash equivalents and short-term investments |   | $                | 186,849 |   | $ | 206,165 |   |

 

We consider all highlyliquid investments purchased with maturities less than three months to be cashequivalents.

 

Investments with amaturity greater than three months, but less than one year, at the time ofpurchase are considered to be short-term investments.  We invest in highly liquid debt instruments with strong creditratings.  The carrying amounts of theinvestments approximate fair value due to their short maturities.  Unrealized gains and (losses) are recordedas a separate component of accumulated other comprehensive income (loss) forinvestments classified as available-for-sale. The unrealized gains and (losses) on the investments in securities forthe years ended December 31, 2002 and 2001, respectively were ($492,000) and($20,000).

 

F-10

----

 

Short-term investments atDecember 31 were as follows:

 

|                                  |   |                |       |                                  |       |                                   |       |            |       |
|---------------------------------------|--------|---------------------|------------|---------------------------------------|------------|----------------------------------------|------------|-----------------|------------|
| **(In  thousands)**                   |   | **Amortized  Cost** |       | **Gross  Unrealized  Holding  Gains** |       | **Gross  Unrealized  Holding  Losses** |       | **Fair  Value** |       |
| **Available-for-sale:**               |   |                | ** ** |                                  | ** ** |                                   | ** ** |            | ** ** |
| **2002**                              |   |                | ** ** |                                  | ** ** |                                   | ** ** |            | ** ** |
| Corporate  notes and bonds            |   | $                   | 22,953     |                                  | $          | —                                 |       | $               | (259       | ) | $ | 22,694 |   |
| U.S.  government and agencies         |   | 22,499              |       | —                                |       | (253                                   | )          | $               | 22,246     |   |
|                                  |   |                |       |                                  |       |                                   |       |            |       |
| Total  available-for-sale investments |   | $                   | 45,452     |                                  | $          | —                                 |       | $               | (512       | ) | $ | 44,940 |   |
|                                  |   |                |       |                                  |       |                                   |       |            |       |
| **2001**                              |   |                | ** ** |                                  | ** ** |                                   | ** ** |            | ** ** |
| Corporate  notes and bonds            |   | $                   | 13,798     |                                  | $          | 2                                      |       | $               | (12        | ) | $ | 13,788 |   |
| U.S.  government and agencies         |   | 16,329              |       | 3                                     |       | (13                                    | )          | $               | 16,319     |   |
|                                  |   |                |       |                                  |       |                                   |       |            |       |
| Total  available-for-sale investments |   | $                   | 30,127     |                                  | $          | 5                                      |       | $               | (25        | ) | $ | 30,107 |   |
|                                  |   |                |       |                                  |       |                                   |       |            |       |
| **Held-to-maturity:**                 |   |                | ** ** |                                  | ** ** |                                   | ** ** |            | ** ** |
| **2002**                              |   |                | ** ** |                                  | ** ** |                                   | ** ** |            | ** ** |
| Corporate  debt securities            |   | $                   | 5,000      |                                  | $          | —                                 |       | $               | —     |   | $ | 5,000 |   |
| Municipal  securities                 |   | 4,011               |       | —                                |       | —                                 |       | $               | 4,011      |   |
|                                  |   |                |       |                                  |       |                                   |       |            |       |
| Total  held-to-maturity investments   |   | $                   | 9,011      |                                  | $          | —                                 |       | $               | —     |   | $ | 9,011 |   |
|                                  |   |                |       |                                  |       |                                   |       |            |       |
| **2001**                              |   |                | ** ** |                                  | ** ** |                                   | ** ** |            | ** ** |
| Municipal  securities                 |   | $                   | 5,000      |                                  | $          | —                                 |       | $               | —     |   | $ | 5,000 |   |
|                                  |   |                |       |                                  |       |                                   |       |            |       |
| Total  held-to-maturity investments   |   | $                   | 5,000      |                                  | $          | —                                 |       | $               | —     |   | $ | 5,000 |   |

 

Realized gains and(losses) from short-term investments were not material in 2002.  There were no realized gains and (losses)from short-term investments in 2001 or 2000.

 

The investment in Yuke’sCo., Ltd. is also classified as available-for-sale and is included in otherlong-term assets in the accompanying balance sheets.  The unrealized holding gain (loss) on the investment in Yuke’sCo., Ltd. for the years ended December 31, 2002 and December 31, 2001 was($1,015,000) and $249,000, respectively.

 

*Fair Valuesof Financial Instruments.* The carrying value of certain financial instruments, including cash andcash equivalents, short-term investments held to maturity, accounts receivable,accounts payable, accrued expenses and accrued royalties approximate fairmarket value based on their short—term nature. Short-term investments classified as available for sale are stated atfair value.  The value of short-terminvestments are determined using quoted market prices.

 

*Concentrationsof Credit Risk.* Financial instruments which potentially subject us to concentration ofcredit risk consist principally of cash and cash equivalents, short-terminvestments and accounts receivable.  Weplace cash and cash equivalents with high credit-quality institutions and limitthe amount of credit exposure to any one institution.  Most of our sales are made directly to mass merchandisers andnational 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.  While we frequently monitorand manage this risk, financial difficulties on the part of one or more of ourmajor customers may have a material adverse effect on us.  We perform ongoing credit evaluations of ourcustomers and maintain an allowance for potential credit losses.

 

Sales (before returns andallowances) to a major customer represented 16%, 14% and 17% of gross sales inthe years ended December 31, 2002, 2001 and 2000, respectively.  This customer accounted for approximately17% and 18%

 

F-11

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of accounts receivable atDecember 31, 2002 and 2001, respectively. Sales (before returns and allowances) to another major customerrepresented 13%, 12% and 16% of gross sales in the years ended December 31,2002, 2001 and 2000, respectively.  Thiscustomer accounted for approximately 16% of accounts receivable at bothDecember 31, 2002 and 2001.

 

*Inventory.*  Inventory, which consists principally offinished products, are stated at the lower of cost (moving weighted average) ormarket.  We estimate the net realizablevalue of slow-moving inventory on a title by title basis, and charge the excessof cost over net realizable value to cost of sales.

 

*Propertyand Equipment.* Property and equipment are stated at cost.  Depreciation is computed using the straight-line method over theestimated useful lives of the assets. Leasehold improvements are amortized over the shorter of their usefullives or the remaining lease term. Property and equipment consist of the following:

 

|                                             |   | **Useful** |   | **December 31,** |   |
|--------------------------------------------------|--------|------------|--------|------------------|--------|
| **(In  thousands)**                              |   | **Lives**  |   | **2002**         |   | **2001** |   |
| Building                                         |   | 30 yrs     |   | $                | 719    |   | $ | 689 |   |
| Land                                             |   | —     |   | 401              |   | 401 |   |
| Computer  equipment and software                 |   | 3-10 yrs   |   | 23,138           |   | 16,860 |   |
| Furniture,  fixtures and equipment               |   | 5 yrs      |   | 3,375            |   | 2,579 |   |
| Leasehold  improvements                          |   | 3-6 yrs    |   | 1,443            |   | 1,137 |   |
| Automobiles                                      |   | 2-5 yrs    |   | 74               |   | 111 |   |
|                                             |   |       |   |             |   |   |   |
| Less:  accumulated depreciation and amortization |   |       |   | (13,047          | )      | (7,886 | ) |
|                                             |   |       |   | $                | 16,103 |   | $ | 13,891 |   |

 

*Licenses.*  Minimum guaranteed royalty payments forintellectual property licenses are initially recorded as an asset (licenses)and as a liability (accrued royalties) at the contractual amount upon executionof the contract when no significant performance remains with the licensor.  When significant performance remains withthe licensor, we record royalty payments as an asset (licenses) when actuallypaid rather than upon execution of the contract.  Royalty payments for intellectual property licenses areclassified as current assets and current liabilities to the extent such royaltypayments relate to anticipated sales during the subsequent year and long-termassets and long-term liabilities if such royalty payments relate to anticipatedsales after one year.

 

Licenses are expensed tolicense amortization and royalties at the higher of (i) the contractual royaltyrate based on actual net product sales or (ii) the ratio of current units soldto total projected units sold.  When, inmanagement’s estimate, future cash flows will not be sufficient to recoverpreviously capitalized costs, we expense these capitalized costs to licenseamortization and royalties.  See “*Long-Lived Assets*” below.  If actual revenues, or revised forecastedunits, fall below the initial forecasted units, the charge to licenseamortization and royalties may be larger than anticipated in any givenquarter.  As of December 31, 2002, thenet carrying value of our licenses was $35.4 million.

 

*SoftwareDevelopment*.  Weutilize both independent software developers and internal development teams todevelop our software.  We account forsoftware development costs in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to beSold, 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 provengame engine technology exists, this may occur early in the developmentcycle.  We capitalize the milestonepayments made to independent software developers and the direct payroll costsfor our internal development teams.  Weevaluate technological feasibility on a product-by-product basis.  Amounts related to software development forwhich technological feasibility is not yet met are charged immediately toproduct development expense.

 

Capitalized softwaredevelopment is expensed to software development amortization at the higher of(i) the contractual rate based on actual net product sales or (ii) the ratio ofcurrent units sold to total projected units sold.  When, in management’s estimate, future cash flows will not besufficient to recover previously capitalized costs, we expense these items tosoftware development amortization.  See“*Long-Lived Assets*” below.  If actual revenues, or revised forecastedunits, fall below the initial forecasted units, the charge to software developmentamortization may be larger than anticipated in any given quarter.  As of December 31, 2002, the net carryingvalue of our software development was $47.4 million.

 

F-12

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*Goodwilland Other Intangible Assets.* Effective January 1, 2002, we completed the adoption of Statement ofFinancial Accounting Standards (SFAS) No. 142, “Goodwill and Other IntangibleAssets.”  As required by SFAS No. 142,we discontinued amortizing the remaining balances of goodwill as of January 1,2002.  All remaining and future acquiredgoodwill and indefinite lived intangible assets will be subject to animpairment test in the second quarter of each calendar year, or earlier ifindicators of potential impairment exist, using a fair-value-basedapproach.  All identifiable intangibleassets with finite lives will continue to be amortized over their estimateduseful lives and assessed for impairment under Statement of Financial Accounting Standards No. 144 (“SFAS 144”),“Accounting for the Impairment or Disposal of Long-Lived Assets.”  In conjunction with the implementation ofSFAS No. 142, we completed a goodwill impairment review as of the beginning of2002 and found no impairment.

 

A reconciliation ofpreviously reported net income and earnings per share to the amounts adjustedfor the exclusion of goodwill amortization, including $196,000 of goodwillamortization associated with an equity method investment in 2001, is asfollows:

 

| **(In  thousands, except per share data)** |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Reported net income                        |   | $        | 12,994 |     | $      | 36,013   |   | $ | 18,189 |   |
| Add  back: Goodwill amortization           |   | —   |   | 404      |   | 215      |   |
| Adjusted  net income                       |   | $        | 12,994 |     | $      | 36,417   |   | $ | 18,404 |   |
|                                       |   |     |   |     |   |     |   |
| **Basic earnings per share:**              |   |     |   |     |   |     |   |
| Reported  net income                       |   | $        | 0.33   |     | $      | 1.10     |   | $ | 0.60 |   |
| Goodwill  amortization                     |   | —   |   | 0.01     |   | 0.01     |   |
| Adjusted  net income                       |   | $        | 0.33   |     | $      | 1.11     |   | $ | 0.61 |   |
|                                       |   |     |   |     |   |     |   |
| **Diluted earnings per share:**            |   |     |   |     |   |     |   |
| Reported  net income                       |   | $        | 0.32   |     | $      | 1.01     |   | $ | 0.56 |   |
| Goodwill  amortization                     |   | —   |   | 0.01     |   | 0.01     |   |
| Adjusted  net income                       |   | $        | 0.32   |     | $      | 1.02     |   | $ | 0.57 |   |

 

*Long-Lived Assets.*  We evaluate long-livedassets, including but not limited to licenses, software development, propertyand equipment and identifiable intangible assets with finite lives, forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable.  Recoverability of assets is measured by a comparison of thecarrying amount of an asset to future undiscounted net cash flows expected tobe generated by the asset.  If suchassets are considered to be impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the asset exceeds itsfair value.

 

InJanuary 2002, we adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”,which addresses financial accounting and reporting for the impairment ordisposal of long-lived assets.  Theadoption of SFAS 144 did not have a material impact on our financial statements.

 

*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.

 

In December 1999, theSecurities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No.101 (“SAB 101”), “Revenue Recognition in Financial Statements”, which outlinesthe basic criteria that must be met to recognize revenue and provides guidancefor presentation of revenue and for disclosure related to revenue recognitionpolicies in financial statements filed with the SEC.  The adoption of SAB 101 did not have a material impact on ourconsolidated financial position and results of operations.

 

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 generallysell our products on a no-return basis, in certain circumstances we may allowprice protection, returns or other allowances on a negotiated basis.  We estimate such price protection, returnsor other allowances based upon management’s evaluation of our historicalexperience, retailer inventories, the nature of the titles and otherfactors.  Such estimates are deductedfrom gross sales (See Note

 

F-13

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5).  Software is sold under a limited 90-daywarranty against defects in material and workmanship.  To date, we have not experienced material warranty claims.

 

Software Licenses:  For those agreements that provide thecustomers the right to multiple copies in exchange for guaranteed minimumroyalty amounts, revenue is recognized at delivery of the product master or thefirst copy.  Per copy royalties on salesthat exceed the guarantee are recognized as earned.

 

Revenue from thelicensing of software was $2.0 million, $1.4 million and $346,000 for the yearsended December 31, 2002, 2001 and 2000, respectively.

 

*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.  Advertising costs were $23.4million, $14.8 million and $27.1 million in the years ended December 31, 2002,2001 and 2000, respectively.

 

*Stock-BasedCompensation.*  Weaccount for our employee stock option plans under the intrinsic value method prescribedby Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees” and related interpretations.  We account for equity instruments issued to other than employeesfor acquiring goods and services, typically rights to intellectual property,using the fair value at the date of grant.

 

At December 31, 2002, wehad three stock-based compensation plans, which are described more fully inNote 11.  No stock-based employeecompensation cost is reflected in net income, as all options granted underthose plans had an exercise price equal to the market value of the underlyingcommon stock on the date of grant.  Thefollowing table illustrates the effect on the net income and earnings per shareif we had applied the fair value recognition provisions of FASB Statement No.123, *Accounting for Stock-Based Compensation*,to stock-based employee compensation.

 

| **(In  thousands, except per share data)**                                                                                                          |   | **Years Ended December 31,** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|
|                                                                                                                                                |   | **2002**                     |       | **2001** |   | **2000** |   |
|                                                                                                                                                |   |                         | ** ** |   | ** ** |   | ** ** |
| Net  income-as reported                                                                                                                             |   | $                            | 12,994     |   | $ | 36,013 |   | $ | 18,189 |   |
| Deduct:  Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |   | 19,267                       |       | 11,970 |   | 7,328 |   |
| Net  income (loss)—pro forma                                                                                                                   |   | $                            | (6,273     | ) | $ | 24,043 |   | $ | 10,861 |   |
| Earnings  per share:                                                                                                                                |   |                         | ** ** |   | ** ** |   | ** ** |
| Basic-as  reported                                                                                                                                  |   | $                            | 0.33       |   | $ | 1.10 |   | $ | 0.60 |   |
| Basic-pro  forma                                                                                                                                    |   | $                            | (0.16      | ) | $ | 0.73 |   | $ | 0.36 |   |
|                                                                                                                                                |   |                         |       |   |   |   |   |
| Diluted-as  reported                                                                                                                                |   | $                            | 0.32       |   | $ | 1.01 |   | $ | 0.56 |   |
| Diluted-pro  forma                                                                                                                                  |   | $                            | (0.16      | ) | $ | 0.67 |   | $ | 0.34 |   |

 

The fair market value ofoptions granted under the stock option plans during 2002, 2001 and 2000 wasdetermined using the Black-Scholes option pricing model utilizing the followingassumptions:

 

|                                      |   | **Years Ended December 31,** |   |
|-------------------------------------------|--------|------------------------------|--------|
|                                      |   | **2002**                     |   | **2001** |   | **2000** |   |
| Dividend  yield                           |   | 0                            | %      | 0 | % | 0 | % |
| Anticipated  volatility                   |   | 73                           | %      | 74 | % | 73 | % |
| Weighted  average risk-free interest rate |   | 3.46                         | %      | 4.33 | % | 6.12 | % |
| Expected  lives                           |   | 4 years                      |   | 4 years |   | 4 years |   |

 

F-14

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*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 isprovided when it is more likely than not that some portion or all of thedeferred income tax assets will not be realized.

 

*Basicand Diluted Earnings Per Share.*  The following table is a reconciliation of the weighted-averageshares used in the computation of basic and diluted EPS for the yearspresented:

 

|                                                                |   | **Years Ended December 31,** |   |
|---------------------------------------------------------------------|--------|------------------------------|--------|
| **(In thousands,  except per share data)**                          |   | **2002**                     |   | **2001** |   | **2000** |   |
| Net  income used to compute basic and diluted earnings per share    |   | $                            | 12,994 |   | $ | 36,013 |   | $ | 18,189 |   |
| Weighted  average number of shares outstanding — basic         |   | 39,203                       |   | 32,717 |   | 30,136 |   |
| Dilutive  effect of stock options and warrants                      |   | 2,040                        |   | 2,906 |   | 2,216 |   |
| Number  of shares used to compute earnings per share — diluted |   | 41,243                       |   | 35,623 |   | 32,352 |   |
|                                                                     |        |                              |        |  |  |  |  |  |  |  |

 

Stock options to purchase2,462,000, 724,500 and 2,118,000 shares of common stock in 2002, 2001 and 2000,respectively, were outstanding but not included in the computation of dilutedearnings per common share because the option exercise price for these optionswas greater than the average market price of our shares of common stock.

 

*RecentlyIssued Accounting Pronouncements.*  In June 2002, the FASB issued SFAS No. 146, *“Accounting for Costs Associated with Exit orDisposal Activities.”*  SFASNo. 146 requires that the liability for costs associated with an exit ordisposal activity be initially measured at fair value and recognized when theliability is incurred.  The provisionsof SFAS No. 146 are required to be applied prospectively to exit or disposalactivities initiated after December 31, 2002. We do not expect the adoption of SFAS No. 146 to have a material impacton our financial statements, as we have not initiated any exit or disposalactivities.

 

In November 2002, FASBissued Interpretation (“FIN”) No. 45 – *“Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others.”* FIN No. 45 elaborates on thedisclosures to be made by a guarantor in its interim and annual financialstatements about its obligations under certain guarantees that it hasissued.  It also clarifies that aguarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee.  The initial recognition andinitial measurement provisions of this Interpretation are applicable on aprospective basis to guarantees issued or modified after December 31,2002.  We are currently evaluating theprovisions of FIN No. 45 and have not determined the impact, if any, they willhave on our financial statements.

 

In December 2002, theFASB issued SFAS No. 148, *“Accounting forStock-Based Compensation –Transition and Disclosure.”*  This statement amends SFAS No. 123, toprovide alternative methods of voluntary transition to change to the fair valuebased method of accounting for stock-based employee compensation.  Additionally, this statement amendsdisclosure requirements of accounting for stock-based employee compensation andthe effect of the method used on reporting results.  Currently, we do not expect to adopt SFAS No. 123 related to theexpensing of the fair value based method of accounting for stock-based employeecompensation.  We have adopted the newdisclosure requirements of SFAS No. 148 as included in the Summary ofSignificant Accounting Policies, Stock-Based Compensation.

 

*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.  Actualresults could differ from those estimates. The most significant estimates relate to licenses, software development,accrued returns and allowances and the allowance for doubtful accounts.

 

*Reclassifications.*  Certain reclassifications have been made tothe prior years consolidated financial statements to conform to current yearconsolidated financial statements.

 

**3.   Business Combinations**

 

*ValuSoft.*  On July 1, 2002, we completed theacquisition of substantially all the assets of ValuSoft, Inc. (now referred toas “ValuSoft”), a publisher and developer of value-priced interactiveentertainment and productivity

 

F-15

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software.  The results of ValuSoft’s operations havebeen included in the consolidated financial statements since that date.  This acquisition has provided us with achannel for value-priced personal computer products.  We paid $9.6 million in cash and issued approximately 167,000shares of our common stock valued at $4.6 million as the initial purchaseprice.  In addition, former shareholdersof ValuSoft, Inc. are entitled to additional consideration of up to $11.0million if ValuSoft reaches certain pre-tax income targets in the five yearsfollowing July 1, 2002.  The annualpayments of the additional consideration, if any, range from $1.0 million to$2.8 million per year and may be paid, at our discretion, in cash or shares ofour common stock and will be added to goodwill.

 

The acquisition has beenaccounted for using the purchase method under SFAS No. 141. The purchase priceincludes the cash paid, the fair value of our common stock issued, transactioncosts and an adjustment for ValuSoft’s accounts receivable and net book valueat July 1, 2002.  The total amount ofgoodwill is expected to be deductible for income tax purposes.  The allocation of the purchase price is asfollows:

 

| Estimated  Fair Value (in thousands): |   |   |   |
|---------------------------------------|--------|--------|--------|
| Tangible  assets acquired             |   | $      | 2,837  |   |
| Software  development acquired        |   | 1,491  |   |
| Licenses  acquired                    |   | 1,109  |   |
| Liabilities  assumed                  |   | (2,940 | )      |
| Goodwill                              |   | 12,042 |   |
| Purchase  price                       |   | $      | 14,539 |   |

* *

*RainbowMultimedia Group, Inc.* On December 21, 2001, we completed the acquisition of Rainbow MultimediaGroup, Inc., an Arizona corporation. The results of Rainbow’s operations have been included in theconsolidated financial statements since that date.  Rainbow designs entertainment content for video game consoles andpersonal computers.  Rainbow’s team ofartist and engineers helps strengthen our internal development and our abilityto create original content.

 

In the acquisition, eachshare of Rainbow was converted into 0.05397 of a share of our common stock, orapproximately 1,287,000 shares valued at $44.6 million.  In addition, outstanding Rainbow employeestock options were assumed by us and converted, at the same conversion rate,into options to purchase approximately 159,000 shares of our common stock.

 

The acquisition has beenaccounted for using the purchase method under SFAS No. 141.  The purchase price includes the fair valueof our common stock issued, fair value of vested stock options assumed, thetransaction costs, and an adjustment for Rainbow’s net book value at December21, 2001.  In 2002, an adjustment wasmade to the initial allocation of the purchase primarily due to deferred taxassets that were not previously recognized. The allocation of the purchase price is as follows:

 

| Estimated  Fair Value (in thousands): |   |   |   |
|---------------------------------------|--------|--------|--------|
| Tangible  assets acquired             |   | $      | 5,841  |   |
| Intangible  assets acquired           |   | 3,531  |   |
| Liabilities  assumed                  |   | (5,411 | )      |
| Goodwill                              |   | 44,972 |   |
| Purchase  price                       |   | $      | 48,933 |   |

 

The purchase agreementand a related royalty participation agreement calls for contingent compensationbased on the future revenue generated by certain titles being developed byRainbow prior to the acquisition.  Thecontingent compensation is expensed to software development amortization.  The contingent compensation may be paid, atour discretion, in cash or shares of our common stock.  For the year ended December 31, 2002, weissued 8,952 shares of our common stock and recognized $267,000 of stockcompensation related to the contingent compensation.

 

The following unauditedpro-forma financial information for the years ended December 31, 2002 and 2001assumes the purchase of substantially all the assets of ValuSoft, Inc. and thepurchase of Rainbow Multimedia Group, Inc., (which occurred on December 21,2001), had occurred as of the beginning of the respective periods.  The pro-forma results have been prepared forcomparative purposes only and are not necessarily indicative of the results ofoperations that may occur in the future or that would have occurred had theacquisition of the assets been consummated on the dates indicated.

 

F-16

----

 

|                                       |   | **Years  EndedDecember 31,** |    |
|--------------------------------------------|--------|------------------------------|---------|
| **(In  thousands, except per share data)** |   | **2002**                     |    | **2001** |   |
| Revenue                                    |   | $                            | 491,582 |   | $ | 413,268 |   |
| Net  income                                |   | 14,584                       |    | 40,538 |   |
| Basic  earnings per share                  |   | 0.37                         |    | 1.19 |   |
| Diluted  earnings per share                |   | 0.35                         |    | 1.09 |   |
|                                            |        |                              |         |  |  |  |  |

 

*Volition,Inc.*  On August 31,2000, we completed the acquisition of Volition, Inc., a Delaware corporation(“Volition”).  In the acquisition, eachshare of Volition was converted into 0.16484 of a share of our common stock, orapproximately 1,335,000 shares.  Inaddition, outstanding Volition employee stock options were assumed by us andconverted, at the same conversion rate, into options to purchase approximately165,000 shares of our common stock.

 

The acquisition has beenaccounted for as a pooling of interests under Accounting Principles BoardOpinion No. 16.  Accordingly, all priorperiod consolidated financial statements presented have been restated to includethe combined results of operations, financial position and cash flows as ifVolition had always been part of our company.

 

All transactions betweenus and Volition have been eliminated in the consolidated financial statements.

 

**4.   Credit Facility**

 

On September 27, 2002, weentered into an Amended and Restated Revolving Credit Agreement with Union Bankof California.  The Amended and RestatedRevolving Credit Agreement was amended on November 21, 2002.  Under the terms of the Amended and RestatedRevolving Credit Agreement, we are permitted to borrow and maintain obligationsunder outstanding letters of credit up to an aggregate of $35.0 million throughAugust 31, 2004.

 

We are permitted tomaintain outstanding letters of credit for product purchases and outstandingborrowings in the aggregate as follows (in thousands):

 

| September 27, 2002 – January 31, 2003 |   | $ | 35,000 |   |
|--------------------------------------------|--------|---|--------|--------|
| February 1, 2003 – August 31, 2003    |   | $ | 20,000 |   |
| September 1, 2003 – January 31, 2004  |   | $ | 35,000 |   |
| February 1, 2004 – August 31, 2004    |   | $ | 20,000 |   |

 

In addition, ouroutstanding borrowings cannot exceed the following amounts (in thousands):

 

| September 27, 2002 – October 31, 2002 |   | $ | 10,000 |   |
|--------------------------------------------|--------|---|--------|--------|
| November 1, 2002 – January 31, 2003   |   | $ | 20,000 |   |
| February 1, 2003 – October 31, 2003   |   | $ | 10,000 |   |
| November 1, 2003 – January 31, 2004   |   | $ | 20,000 |   |
| February 1, 2004 – August 31, 2004    |   | $ | 10,000 |   |

 

We are not permitted tohave any outstanding borrowings for a period of at least 60 days during eachyear of the agreement.

 

This credit facility issecured by a lien on substantially all of our assets and contains customaryfinancial and non-financial covenants which require us to maintain a specifiedminimum net worth and limits our ability to incur additional indebtedness, sellassets and enter into certain mergers or acquisitions.  At December 31, 2002 we were in violation ofthe specified minimum net worth covenant due to the $25 million sharerepurchase and the fourth quarter operating results.  The Amended and Restated Revolving Credit Agreement was amendedon November 21, 2002.  On February 21,2003 a waiver of this covenant was executed. We are currently negotiating an amended credit agreement with the bank.  Any amounts outstanding under this creditfacility may be accelerated upon the happening of certain events ofdefault.  We are not permitted to paycash dividends.  Amounts outstandingunder these credit facilities bear interest, at our choice, at either (a) thebank’s prime rate (4.3% at December 31,2002) or (b) the London Interbank Offered Rate (1.4% at December 31, 2002) plus 1.60%. As of December 31, 2002, we had no borrowings on the creditfacility.  We had outstanding letters ofcredit of approximately $2.1 million at December 31, 2002.

 

F-17

----

 

**5.   Allowance for Price Protection, Returns andDoubtful Accounts**

 

The allowance for priceprotection, returns and doubtful accounts at December 31, 2002 and 2001consists of the following:

 
|                                                                   |   | **December 31,** |    |
|------------------------------------------------------------------------|--------|------------------|---------|
| **(In  thousands)**                                                    |   | **2002**         |    | **2001** |   | **2000** |   |
| Balance  at January 1                                                  |   | $                | (40,616 | ) | $ | (31,534 | ) | $ | (24,171 | ) |
| Provision  for price protection, returns and doubtful accounts         |   | (69,641          | )       | (47,386 | ) | (35,387 | ) |
| Actual  deductions for price protection, returns and doubtful accounts |   | 50,338           |    | 38,304 |   | 28,024 |   |
| Ending  balance                                                        |   | $                | (59,919 | ) | $ | (40,616 | ) | $ | (31,534 | ) |

** **

**6.   Goodwill**

 

The changes in thecarrying amount of goodwill for the years ended December 31, 2002 and 2001 areas follows:

 

|                                       |   | **Years Ended  December 31,** |   |
|--------------------------------------------|--------|-------------------------------|--------|
| **(In  thousands)**                        |   | **2002**                      |   | **2001** |   |
| Balance at beginning of  period            |   | $                             | 48,202 |   | $ | 1,717 |   |
| Goodwill  acquired during the period       |   | 12,042                        |   | 46,688 |   |
| Adjustments  to goodwill during the period |   | (1,716                        | )      | — |   |
| Amortization  during the period            |   | —                        |   | (208 | ) |
| Effect  of foreign currency exchange rates |   | 81                            |   | 5 |   |
| Balance  at end of period                  |   | $                             | 58,609 |   | $ | 48,202 |   |

 

**7.   Intangible Assets**

 

Intangible assets includelicenses, software development and other intangible assets.  Other intangible assets are included inother long-term assets, net, except licenses and software development, whichare reported separately in the accompanying balance sheets.  Intangible assets are as follows:

 
|                                |   |              |   |                        |    |                          |   |                        |   |                          |    |
|-------------------------------------|--------|-------------------|--------|-----------------------------|---------|-------------------------------|--------|-----------------------------|--------|-------------------------------|---------|
| **Intangible  Assets**              |   |              |   | **December 31, 2002**       |    | **December 31, 2001**         |   |
| **(In  thousands)**                 |   | **Useful  Lives** |   | **Gross  Carrying  Amount** |    | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |    |
| Amortized intangible  assets        |   |              |   |                        |    |                          |   |                        |   |                          |    |
| Licenses                            |   | Varies            |   | $                           | 95,299  |                          | $      | (59,877                     | )      | $                             | 52,435  |   | $ | (27,332 | ) |
|                                |   |              |   |                        |    |                          |   |                        |   |                          |    |
| Software  development               |   | Varies            |   | 152,263                     |    | (104,845                      | )      | 88,707                      |   | (49,577                       | )       |
|                                |   |              |   |                        |    |                          |   |                        |   |                          |    |
| Trade  secrets                      |   | 5 years           |   | 1,800                       |    | (360                          | )      | 1,800                       |   | —                        |    |
| Non-compete  / Employment contracts |   | 6.5 years         |   | 706                         |    | (109                          | )      | 706                         |   | —                        |    |
| Subtotal,  other                    |   |              |   | 2,506                       |    | (469                          | )      | 2,506                       |   | —                        |    |
| Total  amortized intangible assets  |   |              |   | 250,068                     |    | (165,191                      | )      | 143,648                     |   | (76,909                       | )       |
|                                |   |              |   |                        |    |                          |   |                        |   |                          |    |
| Unamortized  intangible assets      |   |              |   |                        |    |                          |   |                        |   |                          |    |
| Trade  name                         |   | indefinite        |   | 1,025                       |    | N/A                           |   | 1,025                       |   | N/A                           |    |
| Total                               |   |              |   | $                           | 251,093 |                          | $      | (165,191                    | )      | $                             | 144,673 |   | $ | (76,909 | ) |

 

The useful lives oflicenses and software development are based on units of product sold andtherefore not disclosed in years.  Theestimated amortization expense for licenses and software development is basedon anticipated release

 

F-18

----

 

dates and forecasts ofunits to be sold.  For the years endedDecember 31, 2002, 2001 and 2000, our aggregate amortization expense related tointangible assets was $91,677, $35,335 and $50,193, respectively.

 

**EstimatedAmortization Expense**

**(Inthousands):**

 

| **Years Ended  December 31,** |   |   |   |
|-------------------------------|--------|--------|--------|
| 2003                          |   | $      | 61,999 |   |
| 2004                          |   | $      | 9,866  |   |
| 2005                          |   | $      | 8,527  |   |
| 2006                          |   | $      | 2,010  |   |
| 2007                          |   | $      | 1,500  |   |
| Thereafter                    |   | $      | 975    |   |

 

**8.   Other Long-Term Assets**

 

In addition to otherintangible assets (see Note 7), other long-term assets also includes thefollowing:

 

On June 13, 2001, T.HQInternational Ltd. and HotGen Studios Ltd. entered into a Joint VentureAgreement pursuant to which T.HQ International Ltd. acquired a 44% interest inNetwork Interactive Sports Limited (“NI Sports”), formerly wholly owned byHotGen Studios Ltd.  In exchange forthis interest, T.HQ International Ltd. agreed to invest $3.3 million incash.  Goodwill, which resulted from theinvestment, net of accumulated amortization was $1.9 million at December 31,2001.  In July 2002, we announced plansto discontinue operations and took a charge of $3.0 million, including thewrite-off of associated goodwill of $1.9 million, in June 2002 for thewrite-off of this investment, which is included in other expenses in theaccompanying statements of operations. Prior to the write-off, this investment was included in other long-termassets in the accompanying balance sheet and was accounted for using the equitymethod.  For the year ended December 31,2001, our equity in the net loss of the joint venture was immaterial and wasincluded in general and administrative expenses in the accompanying statementsof operations.  The financial statementsof the joint venture are immaterial and have therefore not been included.

 

On March 21, 2000, weacquired less than a 20% interest in Japanese developer, Yuke’s Co., Ltd.,which at the time was privately held. In December 2001, Yuke’s Co., Ltd. had an initial public offering of itscommon stock which is now traded on the Japanese NASDAQ stock market.  Accordingly, we account for this investmentunder SFAS No. 115 “Accounting for Certain Investments in Debt and EquitySecurities”.  (See Note 2)  Unrealized holding gains and losses areexcluded from earnings and are included as a component of other comprehensiveincome until realized.  The originalcost of this investment was $5.0 million. The agreement provides that for a certain time period, under separatedevelopment agreements, Yuke’s Co., Ltd. will create exclusively for uswrestling games for the PlayStation and PlayStation 2 in North America and Europe.  Due to the long-term nature of thisagreement, this investment is included in other long-term assets in theaccompanying balance sheet.  Theinvestment in Yuke’s Co., Ltd. was $4.3 million and $5.3 million as of December31, 2002 and 2001, respectively.

 

During 2002, we loanedMinick Holding AG (“Minick”) $1.5 million. In February 2003, the loan was converted to an equity investment inMinick.  We now own approximately 25% ofthe outstanding common stock of Minick and will account for this investment usingthe equity method of accounting.  Minickdevelops and operates interactive mobile applications.  We will work with Minick to provide licensedwireless gaming through their mobile applications.

 

F-19

----

 

**9.   Income Taxes**

 

Income before provisionfor income taxes consisted of:

 

| **(In  thousands)** |   | **Years Ended December 31,** |   |
|---------------------|--------|------------------------------|--------|
|                |   | **2002**                     |   | **2001** |   | **2000** |   |
| United  States      |   | $                            | 16,471 |   | $ | 52,569 |   | $ | 29,540 |   |
| Foreign             |   | 3,284                        |   | 4,147 |   | 1,703 |   |
|                |   | $                            | 19,755 |   | $ | 56,716 |   | $ | 31,243 |   |

 

The provision for incometaxes consists of the following:

 

| **(In  thousands)**         |   | **2002** |   | **2001** |   | **2000** |   |
|-----------------------------|--------|----------|--------|----------|--------|----------|--------|
| **Current**                 |   |     |   |     |   |     |   |
| Federal                     |   | $        | 6,742  |     | $      | 8,000    |   | $ | 9,048 |   |
| State                       |   | 814      |   | 434      |   | 3,395    |   |
| Foreign                     |   | 1,765    |   | 1,231    |   | 712      |   |
|                        |   | 9,321    |   | 9,665    |   | 13,155   |   |
| **Deferred**                |   |     |   |     |   |     |   |
| Federal                     |   | (1,940   | )      | 9,223    |   | 209      |   |
| State                       |   | (194     | )      | 1,524    |   | (200     | )      |
| Foreign                     |   | (426     | )      | 291      |   | (110     | )      |
|                        |   | (2,560   | )      | 11,038   |   | (101     | )      |
| Provision  for income taxes |   | $        | 6,761  |     | $      | 20,703   |   | $ | 13,054 |   |

 

A reconciliation of theprovision for income taxes at the federal statutory rate to the provisionrecorded in the accompanying financial statements is as follows:

 

| **(In  thousands)**                               |   | **2002** |   | **2001** |   | **2000** |   |
|---------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Federal  provision at statutory rate              |   | 35.0     | %      | 35.0     | %      | 35.0     | %      |
| State  taxes (net of Federal benefit)             |   | 2.0      |   | 2.2      |   | 4.1      |   |
| Preacquisition  loss from Volition, Inc.          |   | —   |   | —   |   | 2.5      |   |
| Rate  differences in foreign taxes and other, net |   | (2.8     | )      | (0.7     | )      | 0.2      |   |
|                                              |   | 34.2%    |   | 36.5     | %      | 41.8     | %      |

 

F-20

----

 

Deferred income taxeswere:

 
|                                                    |   | **December 31,** |   |
|---------------------------------------------------------|--------|------------------|--------|
|                                                    |   | **2002**         |   | **2001** |   |
| **(In  thousands)**                                     |   | **Federal**      |   | **State** |   | **Foreign** |   | **Federal** |   | **State** |   | **Foreign** |   |
| **Current**                                             |   |             |   |   |   |   |   |   |   |   |   |   |   |
| Deferred income tax assets:                             |   |             |   |   |   |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts, discounts and  returns |   | $                | 12,065 |   | $ | 1,120 |   | $ | 430 |   | $ | 8,400 |   | $ | 779 |   | $ | 4 |   |
| Litigation reserve                                      |   | 3,553            |   | 330 |   | — |   | — |   | — |   | — |   |
| Package design costs                                    |   | —           |   | — |   | — |   | 664 |   | 62 |   | — |   |
| Deferred compensation                                   |   | —           |   | — |   | — |   | 280 |   | 26 |   | — |   |
| State income taxes                                      |   | 106              |   | — |   | — |   | 391 |   | — |   | — |   |
| Net operating loss                                      |   | 1,023            |   | 3 |   | — |   | 246 |   | — |   | — |   |
| Credits                                                 |   | —           |   | 109 |   | — |   | — |   | — |   | — |   |
| Other — net                                        |   | 3,126            |   | 290 |   | — |   | 558 |   | 54 |   | — |   |
| Total deferred income tax assets                        |   | 19,873           |   | 1,852 |   | 430 |   | 10,539 |   | 921 |   | 4 |   |
|                                                    |   |             |   |   |   |   |   |   |   |   |   |   |   |
| Deferred income tax liabilities:                        |   |             |   |   |   |   |   |   |   |   |   |   |   |
| Software development costs                              |   | (16,029          | )      | (1,477 | ) | — |   | (11,924 | ) | (1,107 | ) | — |   |
| Other — net                                        |   | (3,039           | )      | (276 | ) | — |   | — |   | — |   | — |   |
| Deferred income taxes                                   |   | $                | 805    |   | $ | 99 |   | $ | 430 |   | $ | (1,385 | ) | $ | (186 | ) | $ | 4 |   |
|                                                    |   |             |   |   |   |   |   |   |   |   |   |   |   |
| **Non-Current**                                         |   |             |   |   |   |   |   |   |   |   |   |   |   |
| Deferred income tax assets:                             |   |             |   |   |   |   |   |   |   |   |   |   |   |
| Other — net                                        |   | $                | 1,287  |   | $ | 123 |   | $ | — |   | $ | 284 |   | $ | 26 |   | $ | — |   |
| Valuation reserve                                       |   | (284             | )      | (26 | ) | — |   | — |   | — |   | — |   |
| Net deferred tax assets                                 |   | 1,003            |   | 97 |   | — |   | 284 |   | 26 |   | — |   |
|                                                    |   |             |   |   |   |   |   |   |   |   |   |   |   |
| Deferred income tax liabilities                         |   |             |   |   |   |   |   |   |   |   |   |   |   |
| Software development costs                              |   | (622             | )      | (69 | ) | — |   | — |   | — |   | — |   |
| Depreciation and amortization                           |   | (575             | )      | (12 | ) | — |   | — |   | — |   | — |   |
| Identifiable intangible assets                          |   | (1,276           | )      | (80 | ) | — |   | (1,030 | ) | — |   | — |   |
| Deferred income taxes                                   |   | $                | (1,470 | ) | $ | (64 | ) | $ | — |   | $ | (746 | ) | $ | 26 |   | $ | — |   |

 

The valuation reserveincreased by $310,000 during 2002.  Thevaluation reserve was zero for the year ended December 31, 2001.

 

As of December 31, 2002we had federal net operating loss carryforwards of approximately $2.9 million(expiring from 2009 to 2020).

 

At December 31, 2002 wehad accumulated foreign earnings of $10.8 million.  We do not plan to repatriate these earnings, therefore, no UnitedStates income tax has been provided on the foreign earnings.  Additionally, we have not tax effected thecumulative translation adjustment as we have no intention of repatriatingforeign earnings.

 

**10.   Employee Pension Plan**

 

We sponsor for our UnitedStates employees, a defined contribution plan under Section 401(k) of theInternal Revenue Code.  The planprovides that employees may defer up to 12% of annual compensation, and that wewill make a matching contribution equal to each employee’s deferral, up to 4%of eligible compensation.  We may alsocontribute funds to the plan in the form of a discretionary profit-sharingcontribution.  Expenses under the planwere $1.5 million, $1.3 million and $1.1 million in 2002, 2001 and 2000,respectively.

 

F-21

----

 

**11.   Stock Option Plan**

 

We have three stockoption plans (the 1990 Plan, the 1997 Plan and the NEEP Plan).

 

The 1990 Plan and the1997 Plan provide for the issuance of up to 2,193,750 and 10,537,500 shares,respectively, available for employees, consultants and non-employee directors.

 

As of December 31, 2002,no options under the 1990 Plan and 1,990,198 options under the 1997 Plan wereavailable for grant.  Stock optionsgranted under the option plans may be incentive stock options or non-statutorystock options.  Options may be grantedunder the option plans to, in the case of incentive stock options, allemployees (including officers) of THQ; or, in the case of non-statutory stockoptions, all employees (including officers), consultants and non-employeedirectors of THQ.

 

On July 20, 2001, ourstockholders approved an amendment to the Amended and Restated 1997 StockOption Plan (the “1997 Amended Plan”) to increase the number of shares ofcommon stock for which options may be issued. The 1997 Amended Plan now provides for the issuance of up to 10,537,500shares of common stock for option grants to directors, officers and keyemployees.  The purchase price per shareof common stock purchasable upon exercise of each option may not be less thanthe fair market value of such share of common stock on the date that such optionis granted.  Generally, options grantedunder this plan become exercisable over three years and expire within fiveyears from the date of grant.

 

On June 8, 2000, theBoard of Directors approved the THQ Inc. Non-executive Employee Stock OptionPlan (the NEEP Plan).  The NEEP Plan hasprimarily the same attributes as the 1990 Plan and the 1997 Plan, butparticipation is reserved for employees who are not executive officers andunder the NEEP Plan only nonqualified options will be granted.  The NEEP Plan provides for the issuance ofup to 2,142,000 shares, of which no more than 20% is available for awards toour non-executive officers and no more than 15% is available for awards to thenon-executive officers or general managers of our subsidiaries or divisions.  As of December 31, 2002, 315,284 optionswere available for grant.

 

The exercise price pershare of all options granted under the plans in 2000, 2001 and 2002 has beenthe closing market price of the stock on the date of the grant.

 

| **Stock  Options**                        |   | **Weighted Average  Exercise Price** |   | **Number of  Shares** |       |
|-------------------------------------------|--------|--------------------------------------|--------|-----------------------|------------|
| Balance  at January 1, 2000               |   | $                                    | 10.07  |                  | 3,863,887  |   |
| Granted                                   |   | $                                    | 10.52  |                  | 2,278,439  |   |
| Exercised                                 |   | $                                    | 6.10   |                  | (377,498   | ) |
| Canceled                                  |   | $                                    | 9.69   |                  | (644,873   | ) |
| Balance  at December 31, 2000             |   | $                                    | 10.61  |                  | 5,119,955  |   |
| Granted                                   |   | $                                    | 26.01  |                  | 3,206,811  |   |
| Exercised                                 |   | $                                    | 9.43   |                  | (1,628,538 | ) |
| Canceled                                  |   | $                                    | 13.47  |                  | (331,016   | ) |
| Balance  at December 31, 2001             |   | $                                    | 18.42  |                  | 6,367,212  |   |
| Granted                                   |   | $                                    | 26.54  |                  | 2,192,639  |   |
| Exercised                                 |   | $                                    | 9.58   |                  | (545,937   | ) |
| Canceled                                  |   | $                                    | 24.54  |                  | (1,042,064 | ) |
| Balance  at December 31, 2002             |   | $                                    | 20.93  |                  | 6,971,850  |   |
|                                      |   |                                 |   |                  |       |
| Options  exercisable at December 31, 2000 |   | $                                    | 8.98   |                  | 1,826,669  |   |
| Options  exercisable at December 31, 2001 |   | $                                    | 11.51  |                  | 1,759,140  |   |
| Options  exercisable at December 31, 2002 |   | $                                    | 16.75  |                  | 3,164,326  |   |

 

Options granted andshares exercised relating to options granted outside of our stock option plansduring 2000, 2001 and 2002 are listed below. Share exercise prices for these options equal the market price of ourcommon stock at the date of the grant except for options issued by PCP&Land GA prior to the acquisitions, which were issued at below market value.  These options were accounted for under APBOpinion No. 25 and we have recognized stock compensation of $169,000, $299,000and $406,000 for 2002, 2001 and 2000, respectively.  Generally, options

 

F-22

----

 

options granted outsideof our stock option plans become exercisable over three years and expire withinfive years from the date of grant.

 
| **Stock  Options**                        |   | **Weighted Average  Exercise Price** |   | **Number of  Shares** |      |
|-------------------------------------------|--------|--------------------------------------|--------|-----------------------|-----------|
| Balance  at January 1, 2000               |   | $                                    | 3.35   |                  | 1,434,862 |   |
| Exercised                                 |   | $                                    | 1.30   |                  | (317,459  | ) |
| Canceled                                  |   | $                                    | 0.46   |                  | (45,648   | ) |
| Balance  at December 31, 2000             |   | $                                    | 4.07   |                  | 1,071,755 |   |
| Granted                                   |   | $                                    | 13.78  |                  | 159,398   |   |
| Exercised                                 |   | $                                    | 3.17   |                  | (436,737  | ) |
| Canceled                                  |   | $                                    | 0.57   |                  | (932      | ) |
| Balance  at December 31, 2001             |   | $                                    | 6.53   |                  | 793,484   |   |
| Granted                                   |   | $                                    | — |                  | —    |   |
| Exercised                                 |   | $                                    | 6.95   |                  | (386,297  | ) |
| Canceled                                  |   | $                                    | 11.00  |                  | (8,554    | ) |
| Balance  at December 31, 2002             |   | $                                    | 6.05   |                  | 398,633   |   |
|                                      |   |                                 |   |                  |      |
| Options  exercisable at December 31, 2000 |   | $                                    | 4.48   |                  | 965,028   |   |
| Options  exercisable at December 31, 2001 |   | $                                    | 6.83   |                  | 755,777   |   |
| Options  exercisable at December 31, 2002 |   | $                                    | 6.06   |                  | 397,492   |   |

 

The following tablesummarizes information about stock options outstanding at December 31, 2002:

 
| **Range of  Exercise Price** |   | **Number  Outstanding at  December 31, 2002** |   | **Weighted Average  Remaining  Contractual Life** |   | **Weighted  Average Exercise  Price** |   |
|------------------------------|--------|-----------------------------------------------|--------|---------------------------------------------------|--------|---------------------------------------|--------|
| $0.25  - $10.25              |   | 1,585,813                                     |   | 2                                                 |   | $                                     | 7.05   |   |
| $10.42  - $17.19             |   | 1,626,671                                     |   | 2                                                 |   | $                                     | 14.99  |   |
| $17.44  - $27.49             |   | 2,611,771                                     |   | 4                                                 |   | $                                     | 24.10  |   |
| $27.79  - $36.02             |   | 1,482,855                                     |   | 4                                                 |   | $                                     | 31.90  |   |
| $38.53  - $39.11             |   | 63,373                                        |   | 4                                                 |   | $                                     | 38.85  |   |
|                         |   | 7,370,483                                     |   | 3                                                 |   | $                                     | 20.12  |   |

 

| **Range of  Exercise Price** |   | **Shares  Exercisable at  December 31, 2002** |   | **Weighted  Average Exercise  Price** |   |
|------------------------------|--------|-----------------------------------------------|--------|---------------------------------------|--------|
| $0.25  - $10.25              |   | 1,315,268                                     |   | $                                     | 6.74   |   |
| $10.42  - $17.19             |   | 1,152,889                                     |   | $                                     | 15.31  |   |
| $17.44  - $27.49             |   | 844,068                                       |   | $                                     | 23.99  |   |
| $27.79  - $36.02             |   | 217,216                                       |   | $                                     | 34.01  |   |
| $38.53  - $39.11             |   | 32,377                                        |   | $                                     | 38.74  |   |
|                         |   | 3,561,818                                     |   | $                                     | 15.55  |   |

 

The estimated fair valueof the options granted in 2002, 2001 and 2000 was $31.3 million, $47.0 millionand $12.7 million, respectively.  Weapply APB Opinion No. 25 and related Interpretations in accounting for stockoption plans.  Accordingly, nocompensation cost for our stock option plans has been recognized in 2002, 2001or 2000, except for options issued by PCP&L and GA prior to theacquisitions, which were issued at below market value.

 

F-23

----

 

**12.   Capital Stock Transactions**

 

On September 10, 2002, weannounced that our Board of Directors authorized the repurchase of up to $25.0million of our common stock from time to time on the open market or in privatetransactions.  On November 21, 2002, weannounced that our Board of Directors authorized the repurchase of up to anadditional $25.0 million of our common stock from time to time on the openmarket or in private transactions bringing the total authorized to $50.0million.  As of December 31, 2002, werepurchased approximately 1,672,000 shares of our common stock for $25.0million.

 

On July 1, 2002 we issuedapproximately 167,000 shares of common stock as part of the purchase price ofValuSoft (See note 3).

 

On March 8, 2002, weannounced that our Board of Directors declared a three-for-two stock split of ourshares of common stock to be effected in the form of a 50% stock dividenddistributed on April 9, 2002, to stockholders of record as of the close ofbusiness on March 26, 2002 (the “Dividend”). All references in this Form 10-K to number of shares, sales price andper share amounts of our common stock have been retroactively restated toreflect the increased number of shares of common stock outstanding.  In addition, stockholders’ equity has beenrestated to give retroactive recognition to the Dividend by reclassifying frompaid-in capital to common stock the par value of the additional shares ofcommon stock issued pursuant to the Dividend. The terms of our Amended and Restated Rights Agreement were adjusted totake into account the Dividend.

 

In connection withobtaining the Nickelodeon master license, in February 2002, we issued to MTVNetworks, a division of Viacom International Inc., warrants to purchase 75,000shares of common stock at $29.13 per share having a fair value of $1.2 millionat the time of issuance.  The fair valueof the warrants is included in licenses in the accompanying balance sheet.  The warrants expire December 31, 2005.

 

On December 21, 2001, weissued approximately 1,287,000 shares of common stock as part of the purchaseprice of Rainbow (See Note 3).

 

On November 13, 2001, weissued 4,125,000 shares of our common stock in a secondary publicoffering.  As part of the offering, onDecember 12, 2001, the underwriters exercised their right to purchase anadditional 471,222 shares.  The netproceeds from these issuances were $154.6 million.  We intend to use the net proceeds for general corporate purposes,including working capital, capital expenditures, product development, jointventures and strategic acquisitions.

 

OnJuly 20, 2001, our shareholders approved an amendment to our Certificate ofIncorporation to increase the number of authorized shares of our common stockfrom 35,000,000 to 75,000,000.  On July24, 2001, we amended our Certificate of Incorporation to reflect this increasein authorized shares.

 

In connection withobtaining the World Wrestling Entertainment license (See Note 13), in August1999, we issued to World Wrestling Entertainment and a related party to WorldWrestling Entertainment, warrants to purchase 421,875 shares of common stock at$6.95 per share having a fair value of $3.1 million at the time ofissuance.  The warrants expire December31, 2009.  On June 8, 2001, WorldWrestling Federation Entertainment exchanged all of its warrants for 302,490shares of common stock in a non-cash transaction.  On July 23, 2001, Stanley Shenker Associates, Inc. (a relatedparty to World Wrestling Federation Entertainment) exchanged all of itswarrants for 37,923 shares of common stock in a non-cash transaction.  The issuance of shares of our common stockupon the exchange of warrants to both World Wrestling Federation Entertainmentand Stanley Shenker was made pursuant to the exemption from registrationprovided in Section 4(2) of the Securities Act of 1933, as amended.

 

On August 31, 2000, weissued 1,335,165 shares of common stock as part of the purchase price forVolition.  (See Note 3)

 

Other than WorldWrestling Federation Entertainment and Stanley Shenker warrants that wereexchanged for common stock mentioned above, there were no additional warrantsexercised in 2001 and no warrants exercised in 2002.  During the year ended December 31, 2000, the number of warrantsto purchase our common stock exercised were 150,000.  We received proceeds from the exercise of such warrants totaling$1.6 million in the year ended December 31, 2000.

 

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**13.   Agreement with JAKKS Pacific, Inc.**

 

In June 1999 we enteredinto an agreement with JAKKS Pacific, Inc. (“JAKKS”), that governs ourrelationship with respect to the World Wrestling Entertainment license wejointly obtained from World Wrestling Entertainment, Inc. (the “WWE”).  This agreement was amended in January 2002.  Our relationship with JAKKS was establishedto develop, manufacture, distribute, market and sell video games, as well assublicense products pursuant to the license from the WWE.  The principal terms of this operatingagreement are as follows:

 

We are responsible forfunding all operations of the venture, including all payments owed to the WWE.

 

For the period commencingNovember 16, 1999 and ending June 30, 2006, JAKKS is entitled to receive apreferred payment equal to the greater of a fixed guarantee, payable quarterly,or specified percentages of the net sales from the WWE-licensed games (asdefined) in amounts that vary based on the platform.  The payment of these amounts is guaranteed by us.  We are entitled to the profits and cash distributionsremaining after the payment of these amounts.

 

For periods after June30, 2006, the amount of the preferred payment will be subject to renegotiationbetween the parties.  An arbitrationprocedure is specified in the event the parties do not reach agreement.

 

We are responsible forthe day-to-day operations of the venture. We are responsible for development, sales and distribution of theWWE-licensed games, and JAKKS is responsible for the approval process and otherrelationship matters with the WWE.  Weand JAKKS co-market the games.

 

For financial reportingpurposes, we are deemed to control the venture; therefore, all ventureoperating results are consolidated with our results.

 

In November 2001, throughthe venture, we entered into a letter of intent to expand the WWE license toinclude exclusive rights to other wrestling content produced by the WWE.  In exchange for these rights we have agreedto increase the minimum guarantee payable to the WWE through December 31, 2009.

 

**14.   Stockholders Rights Plan**

 

On August 15, 2001, theBoard of Directors (the Board) approved an amended and restated StockholdersRights Plan (the Plan).  Each share ofcommon stock has one preferred stock purchase right (“Right”) associated withit.  Pursuant to the Plan, each Rightentitles the holder to buy one one-thousandth (1/1000) of a share of a newseries of preferred stock at an exercise price of $10, subject toadjustment.  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 tender offerfor, 15% or more of the outstanding common stock.

 

In the event that anyperson or group acquires 15% or more of our outstanding common stock, eachholder 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 we are acquired in amerger or other business combination, each holder of a Right will be entitledto purchase, at the exercise price, a number of shares of common stock of theacquirer having a current market value equal to two times the exercise price ofthe Right.

 

We may redeem the Rightsat a redemption price of $.001 per right at any time until 10 days after theacquisition of 15% of our common stock. At any time after a person or group has acquired 15% or more but lessthan 50% of our common stock, we may exchange all or part of the Rights forshares of common stock at an exchange ratio of one share of common stock foreach Right or 1/1000 of such new series of preferred stock per Right, subjectto adjustment.  The rights expire onJune 21, 2010.

 

**15.   Commitments and Contingencies**

 

*Advertising.*  We have certain minimum advertising commitments under most of ourmajor license agreements.  The minimumcommitments generally range from 2% to 12% of net sales related to therespective license.  We estimate thatour minimum commitment for advertising in 2003 to be approximately $15.7million.  We also have a commitment for$3.2 million under a sponsorship agreement. The payments under the agreement will be made over the next three years.

 

*Leases.* We are committed under operating leases with lease termination dates to2012.  Certain leases contain rentescalations.  Minimum future rentalspursuant to these leases as of December 31, 2002 are as follows:

 

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| **(In  thousands)** |   | **Facilities** |   | **Equipment** |   |
|---------------------|--------|----------------|--------|---------------|--------|
| 2003                |   | $              | 3,449  |          | $      | 435 |   |
| 2004                |   | $              | 2,783  |          | 325    |   |
| 2005                |   | $              | 2,240  |          | 257    |   |
| 2006                |   | $              | 660    |          | 164    |   |
| 2007                |   | $              | 515    |          | 61     |   |
| Thereafter          |   | $              | 1,357  |          | — |   |
|                |   | $              | 11,004 |          | $      | 1,242 |   |

 

Rent expense was $3.4million, $2.7 million, and $2.2 million in 2002, 2001 and 2000, respectively.

 

On February 27, 2003, weentered into a lease agreement with an entity partially owned by the head ofone of our development studios.  Thelease is for approximately 29,000 square feet of office space to be occupied bythe development studio.  The term of thelease is ten years beginning April 15, 2004 with minimum future rental paymentstotaling $4.2 million.

 

*Warrants. *We are committed under various license andsoftware development agreements to issue warrants to purchase a total ofapproximately 430,000 shares of common stock.  At this time, the warrant terms related to these variousagreements are being negotiated.  Wewill record the fair market value of these warrants when the terms arefinalized.**The fair market valuewill be included in license or software development in the accompanying balancesheet and will be amortized to license amortization and royalties or softwaredevelopment amortization over estimated sales for games not released and aportion may be recognized immediately for games that have been previouslyreleased.

 

*Legal Proceedings.*  We and certain of our officers and directorsare defendants in a class action lawsuit filed in the United States DistrictCourt for the Central District of California entitled *In re THQ Inc.* Securities Litigation,Master File No. CV-00-1783-AHM.  OnDecember 20, 2000, the court dismissed this action with prejudice as to all ofthe defendants.  On April 23, 2001, theUnited States District Court for the Central District of California modifiedits December 20, 2000 order and permitted plaintiffs to file a third amendedcomplaint on that date.  Defendantsfiled an answer denying all of the material allegations of the third amendedcomplaint and asserting legal and factual defenses.  The third amended complaint alleges that defendants violated Rule10b-5 and Section 20(a) of the Securities Exchange Act of 1934, includingallegations that defendants manipulated our stock price; distributed false andmisleading information concerning revenue recognition, forecasts and earningsestimates; selectively disclosed material information; and engaged in insidertrading.  The complaint seeks anunspecified amount in damages.  As ofDecember 31, 2002, we entered into a settlement agreement with the plaintiffs.  While we continue to deny plaintiffs’allegations, we agreed to pay $10.2 million under the terms of the settlementagreement to resolve all claims by plaintiffs against all defendants.  The District Court granted preliminaryapproval of the settlement on March 17, 2003, and final approval is currentlypending.  Our directors’ and officers’insurance coverage should reimburse us $10 million towards the settlementagreement and related legal fees.

 

However, a dispute hasarisen between us and our directors’ and officers’ insurance carrier.  The insurance carrier asserts that it isonly obligated to contribute $5.0 million in coverage towards the securitieslitigation settlement.  Pursuant to theterms of our insurance policy, the matter has been submitted to arbitrationunder the rules of the American Arbitration Association.  As a result of the settlement agreement,related legal fees and the dispute with our insurance carrier, we have taken acharge of approximately $7.0 million during the quarter ended December 31, 2002which is included in other expenses in the accompanying consolidated statementsof operations.  Although we expect toprevail, at this early stage we cannot predict the likely outcome of thisdispute.

 

As a result of a courtorder in an action filed in the United Kingdom by the World Wide Fund forNature (the “Fund”) against World Wrestling Entertainment, Inc. (“WWE”) the useof the initials “WWF” is prohibited directly or indirectly by the WWE afterNovember 10, 2002.  On November 10,2002, upon instruction from the WWE, we ceased sales at least temporarily ofcertain of our interactive entertainment software games containing the “WWF”brand.  These games contain artworkfiles with the initials WWF and/or the WWF logo that cannot practicably beremoved from the games. Contemporaneously, in November 2002, we (through our joint ventureTHQ/JAKKS Pacific LLC (“THQ/JAKKS”)) filed an application for relief from thecourt order.  That application wasdenied by the trial court and an appeal was filed and heard on February 24 and25, 2003.  The appeals court renderedits opinion on March 27, 2003, ruling that our continued marketing of thesevideo games, with the “WWF” initials and

 

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brand removed except to the extent embedded in the games, is neither abreach of the court order against WWE nor a contempt of court.  We do not know what impact the court'sdecision will have on our ability to sell the affected products.  In addition, since October 2002 we have beenincorporating the “WWE” brand in place of the “WWF” brand in all of the newwrestling games that we publish, including the recently published *WWE Road to WrestleMania X8* for Game BoyAdvance and *WWE SmackDown! Shut Your Mouth*for PlayStation 2.   We hadapproximately $1.3 million of inventory and $300,000 of capitalized softwaredevelopment for games that contain the “WWF” brand that we wrote-down to zeroin the fourth quarter of 2002.

 

We received a demand fromMotorola for indemnification under our license to it of certain wireless gamesdistributed in France.  The demand arisesout of litigation commenced in France against Motorola and their distributionpartners for trademark infringement and unfair competition, which seeks $10.0million in damages plus an unspecified amount and an accounting.  We in turn have made a claim forindemnification against the developer of the games.  Although we expect to prevail, at this early stage we cannotpredict the likely outcome of the demand for indemnification.

 

We are involved in otherroutine litigation arising in the ordinary course of our business.  In the opinion of our management, none ofthe other pending litigation will have a material adverse effect on ourconsolidated financial condition or results of operations.

 

**16.   Subsequent Events**

 

On February 13, 2003, weannounced a fiscal year end change from December 31 of each year to March 31 ofeach year. We believe that the change in fiscal year will better reflect ournatural business year and allow us to provide financial guidance after theholiday selling season.

 

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**17.   Segment and Geographic Information**

 

We operate in onereportable segment in which we are a developer, publisher and distributor ofinteractive entertainment software for the leading hardware platforms in thehome video game market.  The followinginformation sets forth geographic information on our sales and long-livedassets for the years ended December 31, 2000, 2001 and 2002:

 
| **(In  thousands of dollars)**           |   | **United  States** |       | **United  Kingdom** |       | **Germany** |       | **France** |       | **Australia** |       | **Consolidated** |       |
|------------------------------------------|--------|--------------------|------------|---------------------|------------|-------------|------------|------------|------------|---------------|------------|------------------|------------|
|                                     |   |               | ** ** |                | ** ** |        | ** ** |       | ** ** |          | ** ** |             | ** ** |
| Year ended December 31, 2000:            |   |               |       |                |       |        |       |       |       |          |       |             |       |
| Sales to unaffiliated Customers          |   | $                  | 270,116    |                | $          | 44,638      |       | $          | 20,442     |          | $          | 7,979            |       | $ | 3,828 |   | $ | 347,003 |   |
|                                     |   |               |       |                |       |        |       |       |       |          |       |             |       |
| Long-lived  assets at  December 31, 2000 |   | $                  | 16,792     |                | $          | 1,957       |       | $          | 1,971      |          | $          | 320              |       | $ | 235 |   | $ | 21,275 |   |
|                                     |   |               |       |                |       |        |       |       |       |          |       |             |       |
| Year ended December 31, 2001:            |   |               |       |                |       |        |       |       |       |          |       |             |       |
| Sales to unaffiliated Customers          |   | $                  | 262,676    |                | $          | 60,240      |       | $          | 25,517     |          | $          | 18,185           |       | $ | 12,374 |   | $ | 378,992 |   |
|                                     |   |               |       |                |       |        |       |       |       |          |       |             |       |
| Long-lived  assets atDecember  31, 2001  |   | $                  | 80,289     |                | $          | 3,541       |       | $          | 2,370      |          | $          | 267              |       | $ | 196 |   | $ | 86,663 |   |
|                                     |   |               |       |                |       |        |       |       |       |          |       |             |       |
| Year ended December 31, 2002:            |   |               |       |                |       |        |       |       |       |          |       |             |       |
| Sales to unaffiliated Customers          |   | $                  | 358,124    |                | $          | 67,218      |       | $          | 26,051     |          | $          | 14,556           |       | $ | 14,580 |   | $ | 480,529 |   |
|                                     |   |               |       |                |       |        |       |       |       |          |       |             |       |
| Long-lived  assets at  December 31, 2002 |   | $                  | 101,104    |                | $          | 759         |       | $          | 2,721      |          | $          | 356              |       | $ | 244 |   | $ | 105,184 |   |

 

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

 

Our summarized quarterlyfinancial data is as follows:

 
| **(Amounts in thousands,  except per share data)** |   | **March  31,** |   | **June  30,** |   | **September  30,** |   | **December  31,** |   |
|----------------------------------------------------|--------|----------------|--------|---------------|--------|--------------------|--------|-------------------|--------|
|                                               |   |           |   |          |   |               |   |              |   |
| Year  ended December 31, 2001:                     |   |           |   |          |   |               |   |              |   |
| Revenues                                           |   | $              | 59,328 |          | $      | 55,236             |   | $                 | 68,045 |   | $ | 196,383 |   |
| Expenses                                           |   | 57,986         |   | 49,696        |   | 62,930             |   | 151,664           |   |
| Income  before income taxes                        |   | 1,342          |   | 5,540         |   | 5,115              |   | 44,719            |   |
| Income  taxes                                      |   | 482            |   | 2,086         |   | 1,901              |   | 16,234            |   |
| Net  income                                        |   | $              | 860    |          | $      | 3,454              |   | $                 | 3,214  |   | $ | 28,485 |   |
|                                               |   |           |   |          |   |               |   |              |   |
| Net  income per share:                             |   |           |   |          |   |               |   |              |   |
| Basic                                              |   | $              | 0.03   |          | $      | 0.11               |   | $                 | 0.10   |   | $ | 0.81 |   |
| Diluted                                            |   | $              | 0.03   |          | $      | 0.10               |   | $                 | 0.09   |   | $ | 0.75 |   |
|                                               |   |           |   |          |   |               |   |              |   |
| Year  ended December 31, 2002:                     |   |           |   |          |   |               |   |              |   |
| Revenues                                           |   | $              | 79,681 |          | $      | 85,762             |   | $                 | 97,335 |   | $ | 217,751 |   |
| Expenses                                           |   | 75,255         |   | 80,893        |   | 89,895             |   | 214,731           |   |
| Income  before income taxes                        |   | 4,426          |   | 4,869         |   | 7,440              |   | 3,020             |   |
| Income  taxes                                      |   | 1,659          |   | 2,578         |   | 2,636              |   | (112              | )      |
| Net  income                                        |   | $              | 2,767  |          | $      | 2,291              |   | $                 | 4,804  |   | $ | 3,132 |   |
|                                               |   |           |   |          |   |               |   |              |   |
| Net  income per share:                             |   |           |   |          |   |               |   |              |   |
| Basic                                              |   | $              | 0.07   |          | $      | 0.06               |   | $                 | 0.12   |   | $ | 0.08 |   |
| Diluted                                            |   | $              | 0.07   |          | $      | 0.05               |   | $                 | 0.12   |   | $ | 0.08 |   |

 

Due to rounding some of the figures above may differslightly from the 10-Q’s previously filed.

 

For the quarter ended December 31, 2002, net incomeincludes a charge of $7.9 million, net of tax for the cancellation of 20 SKUsas well as a charge of $4.6 million, net of tax related to the settlement of aclass action lawsuit and a charge of $1.1 million, net of tax related to thewrite-off of inventory and software development for "WWF"-brandedgames that we have been prevented from shipping pursuant to an action by theWorld Wide Fund for Nature against World Wrestling Entertainment, Inc. 

 

 

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