**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**WASHINGTON, D.C.20549

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**FORM 10-K**

**(MarkOne)**

**x** ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended March 31, 2006

**OR**

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

**For the transition periodfrom _____ to _____**

**Commissionfile number 0-18813**

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**THQ INC.**

(Exact Name of Registrantas Specified in Its Charter)

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

 

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

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Securities registered pursuant toSection 12(b) of the Act: None.

Securities registered pursuant toSection 12(g) of the Act:

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

**Preferred Stock Purchase Rights**

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

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

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 thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes  þ  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-Kor any amendment to this Form 10-K.  o

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

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

 

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

The aggregate market valueof the voting stock held by non-affiliates of the registrant as of the lastbusiness day of the registrant’s most recently completed second fiscal quarter(September 30, 2005) was approximately $1.3 billion. The number of sharesoutstanding of the registrant’s common stock as of May 26, 2006 was approximately64,400,280.

**DOCUMENTS INCORPORATED BYREFERENCE**

The2006 Notice of Annual Meeting of Stockholders and Proxy Statement are incorporatedby reference into Part III herein.

 

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**THQ INC.INDEX TO ANNUAL REPORT ON FORM 10-KFILED WITH THE SECURITIES AND EXCHANGE COMMISSIONFOR THE FISCAL YEAR ENDED MARCH 31, 2006**

**ITEMSIN FORM 10 K**

|                | ** ** | ** **                                                                                                             | ** ** | **PAGE** | ** ** |
|----------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|           |       | **Part I**                                                                                                        |       |     |       |   |   |
| Item 1.        |       | Business                                                                                                               |       |     | 1          |   |   |
| Item  1A.      |       | Risk  Factors                                                                                                          |       |     | 10         |   |   |
| Item 1B.       |       | Unresolved Staff Comments                                                                                              |       |     | 16         |   |   |
| Item 2.        |       | Properties                                                                                                             |       |     | 16         |   |   |
| Item  3.       |       | Legal  Proceedings                                                                                                     |       |     | 17         |   |   |
| Item 4.        |       | Submission of Matters to a Vote of Security Holders                                                                    |       |     | 18         |   |   |
| ** **     |       | **Part II**                                                                                                       |       |     |       |   |   |
| Item 5.        |       | Market for the Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       |     | 19         |   |   |
| Item 6.        |       | Selected Consolidated Financial Data                                                                                   |       |     | 20         |   |   |
| Item 7.        |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                            |       |     | 23         |   |   |
| Item 7A.       |       | Quantitative and Qualitative Disclosures About Market  Risk                                                            |       |     | 47         |   |   |
| Item 8.        |       | Consolidated Financial Statements and Supplementary  Data                                                              |       |     | 48         |   |   |
| Item 9.        |       | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                                  |       |     | 77         |   |   |
| Item 9A.       |       | Controls and Procedures                                                                                                |       |     | 77         |   |   |
| Item  9B.      |       | Other  Information                                                                                                     |       |     | 77         |   |   |
| ** **     |       | **Part III**                                                                                                      |       |     |       |   |   |
| Item 10.       |       | Directors and Executive Officers of the Registrant                                                                     |       |     | 80         |   |   |
| Item 11.       |       | Executive Compensation                                                                                                 |       |     | 80         |   |   |
| Item 12.       |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                        |       |     | 80         |   |   |
| Item 13.       |       | Certain Relationships and Related Transactions                                                                         |       |     | 80         |   |   |
| Item 14.       |       | Principal Accounting Fees and Services                                                                                 |       |     | 80         |   |   |
| ** **     |       | **Part IV**                                                                                                       |       |     |       |   |   |
| Item 15.       |       | Exhibits and Consolidated Financial Statement  Schedules                                                               |       |     | 81         |   |   |
| Signatures     |       |                                                                                                                   | 86         |     |       |
| Certifications |       |                                                                                                                   |       |     |       |

 

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**ThisAnnual Report on Form 10-K contains, or incorporates by reference,certain forward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Such statements include, but are not limited to,(1) projections of revenues, expenses, income or loss, earnings or lossper share, cash flow projections and other financial items; (2) statementsof our plans and objectives, including those relating to product releases; (3) statementsof future economic performance; and (4) statements of assumptionsunderlying such statements. We generally use words such as “anticipate,” “believe,”“could,” “estimate,” “expect,” “forecast,” “future” “intend,” “may,” “plan,” “positioned,”“potential,” “project,” “scheduled,” “set to,” “subject to,” “upcoming” andother similar expressions to help identify forward-looking statements. Theseforward-looking statements are subject to business and economic risk, reflectmanagement’s current expectations, estimates and projections about ourbusiness, and are inherently uncertain and difficult to predict. Our actualresults could differ materially. The forward-looking statements containedherein speak only as of the date on which they were made, and we disclaim anyobligation to update any forward-looking statements to reflect events orcircumstances after the date of this Annual Report. Risks and uncertainties that may affect our future resultsinclude, but are not limited to, those discussed under the heading “RiskFactors,” included in Item 1A herein. All references to “we,” “us,” “our,”“THQ,” or the “Company” in the following discussion and analysis mean THQ Inc.and its subsidiaries.**

**PART I**

**Item1. Business**

**Introduction**

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

·       Homevideo game consoles such as Sony PlayStation 2, Microsoft Xbox, and NintendoGameCube, and the next-generation consoles Sony PlayStation 3, Microsoft Xbox360 and Nintendo Wii;

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

·       Personalcomputers.

Our titles span a widerange of categories, including action, adventure, fighting, racing,role-playing, simulation, sports and strategy. We have created, licensed andacquired a group of highly recognizable brands, which we market to a variety ofconsumer demographics ranging from products targeted at children and themass-market to products targeted at core gamers. Our portfolio of licensedproperties includes the Disney/Pixar properties*FindingNemo*, *The Incredibles*, and*Cars,*(whichis expected to be released globally beginning in North America in June 2006);World Wrestling Entertainment®; Nickelodeonproperties such as SpongeBob SquarePantsTM, Avatar, Fairly OddParentsTM andNicktoons; BratzTM; Power Rangers;Warhammer® 40,000; and Scooby-Doo!TM; as well as others. We also have licenses to create wirelessproducts based on *Star Wars* and major sportsleagues. In addition to licensed properties, we also publish games based uponowned intellectual properties, including *Companyof Heroes, Destroy All Humans!**TM, JuicedTM, MX*and*Saints RowTM*.

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(1)          Nintendo®, Dual Screen,Game Boy® Advance, GameCube® (“GameCube”) and Wii are trademarks and/orregistered trademarks of Nintendo of America Inc. (“Nintendo”). “PlayStation” and the “PS” family logo areregistered trademarks of Sony Computer Entertainment Inc., and “PSP” is atrademark of Sony Computer Entertainment Inc. (“Sony”). Microsoft, Xbox®(“Xbox”) and Xbox 360TM are trademarks and/or registered trademarks of MicrosoftCorporation (“Microsoft”). Microsoft, Nintendo and Sony are referred to hereincollectively as the “platform manufacturers” or the “manufacturers.”

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We develop our games usingboth internal and external resources. We currently have 14 internal developmentstudios located in the United States, Australia, the UK and Canada.  We also contract with leading third-partydevelopers around the world to develop our products for us.

Our global sales networkincludes offices throughout North America, Europe and Asia Pacific. In the U.S.and Canada we market and distribute games directly to mass merchandisers,consumer electronic stores, discount warehouses and other national retail chainstores. Internationally we market and distribute games on a direct-to-retailbasis and to a lesser extent through third-party distribution and licensingarrangements. We also globally market and distribute games and other contentfor wireless devices through major wireless carriers.

Wewere originally incorporated in New York in 1989 as Trinity AcquisitionCorporation, which changed its name in 1991 to T.HQ, Inc. following a mergerwith THQ, Inc., a California corporation. We were reincorporated in Delaware asTHQ Inc. in 1997. Our principal executive offices are located at 29903 AgouraRoad, Agoura Hills, California 91301, and our telephone number is (818) 8715000. Our internet address is http://www.thq.com.(2)

**Narrative Description of Business**

Our corporate goal is toexpand our market share while increasing profitability. Our business strategyand a detailed summary of our business operations are detailed below and shouldbe read in conjunction with our “Risk Factors,” included in Item 1A herein.

**Strategy**

Inorder to maximize market share we believe it is important to offer a broadportfolio of titles for all ages that are playable on all popular platforms. Weare also focused on increasing the profitability of our titles. We intend to dothis by executing on the following strategies:

·       ***Increase sales and profits by leveraging ourleading portfolio of mass-market franchises***

We have grown anddiversified our products targeted at the mass-market by securing key contentlicenses, and have leveraged our licensed brands by introducing new productsand through sales of our catalog of existing products. Our license with PixarAnimation Studios (“Pixar”) grants us the exclusive interactive rights to thenext four Pixar animated feature films beginning with the first release following*Cars.*Our license agreement with WorldWrestling Entertainment (“WWE”) through our joint venture with JAKKS Pacific, Inc.,grants us the exclusive rights to publish games based on WWE across all viablegame systems through 2014. Our license agreement with Nickelodeon grants us theexclusive right to publish games based on all existing and future Nickelodeonanimated television and movie properties targeting kids ages 6-14 acrossall viable game systems through 2010. Additionally, we have a content licensewith MGA for their Bratz brand.

In order to increase salesand profits, our goal is to continue building high quality products based onour leading portfolio of mass-market franchises, market them aggressively andshift more development to our internal development studios. In fiscal 2006, ourkey Disney/Pixar and Nickelodeon titles were developed by our internal studios.

In thefiscal year ending March 31, 2007 (“fiscal 2007”) and beyond, we plan toexecute on this strategy by shipping mass-market titles for the current andnext generation of console and handheld platforms, and PC, including thefollowing games based upon our key licenses: Disney/Pixar’s *Cars*, *WWE SmackDown vs. Raw2007, SpongeBob SquarePants: Creature from the Krusty Krab, Avatar: The LastAirbender*and*Bratz: Forever Diamonds*.

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(2)          THQ, THQ Wireless andtheir respective logos are trademarks and/or registered trademarks of THQInc.  

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·       ***Expand our core gamer market share***

We plan to grow ourmarket share by expanding our products targeted to core gamers. We have workedto create and acquire our own brands and content and to secure licenses fororiginal intellectual properties that appeal to the core gamer. In fiscal 2006we released our popular street racing property, *Juiced*,which has shipped more than 1.5 million units to date, and we released ouroriginal owned title, *Destroy All Humans!,*whichshipped nearly 1.5 million units. Also in fiscal 2006 we released our firstXbox 360 title, the owned and internally developed property, *The OutfitTM*.In fiscal 2007 we plan to release a sequel to *Destroy AllHumans!* on current-generation console platforms and *Saints Row* on Xbox 360. In fiscal 2007 we also intend torelease several core gamer titles on PC including:  *Company of Heroes*,*Titan QuestTM*, *Warhammer*®*40,000:**Dawn of War: Dark CrusadeTM, Supreme Commander*and *S.T.A.L.K.E.R.:Shadow of Chernobyl*.

·       ***Increase internal development capabilities andowned intellectual property***

In order toincrease profitability, we believe it is important for us to expand ourinternal development capabilities, increase ownership of development tools andtechnology, and create and acquire new intellectual property. We plan tocontinue expanding our internal development capabilities by selectivelyacquiring and establishing development studios and through internal growth ofour existing studios. During fiscal 2006, we expanded our internal StudioSystem with the acquisitions of Juice Games, located in the UK, Vigil Games,located in Austin, Texas, and with the formation of two new studios, KaosStudios in New York City and Incinerator Games, located near San Diego,California. With the addition of these studios, we now have 14 studios, whichare staffed by producers, game designers, software engineers, artists,animators and game testers. Our worldwide product development operations havegrown and now include approximately 1,200 people, an increase of 300 peopleover the prior fiscal year. Some of the releases in fiscal 2006 that weredeveloped by our Studio System included *The Incredibles: Rise ofthe Underminer*, *MX v. ATV: On the Edge,SpongeBob Square PantsTM: Lights, Camera, Pants*, *NicktoonsUnite*, *The Outfit*and *Warhammer® 40,000: Dawn of War: Winter AssaultTM*. We are dedicating significantinternal development resources to developing software for next-generationconsole platforms and we expect to release games throughout the growth of theinstalled base of the hardware.

·       ***Expand international business***

In calendar 2005,we increased our market share in both Europe and Australia. As the globalgaming market continues to grow, we believe that international marketsrepresent a significant growth opportunity for us. We distribute our productsin more than 75 countries and territories outside of North America. We operateinternational offices in the United Kingdom, Australia, France, Germany, Spain,Korea, Austria and in fiscal 2006 we established sales offices in theNetherlands, Denmark and Japan. In fiscal 2007 we will look to expand ourdirect sales force in Eastern Europe and Italy. In order to leverage ourportfolio of popular brands and increase profitability, we plan to continueacquiring and developing content that sells well internationally (*e.g.*, Disney/Pixar, WorldWrestling Entertainment, and *Juiced*).

·       ***Expand wireless interactive entertainment marketshare***

In fiscal 2006, THQ reported $36.1 million in netsales on the wireless platform, an increase of approximately 50% over fiscal2005. We view the wireless platform as a long-term growth area for THQ as wecontinue to leverage our mass-market franchises, core gamer titles, wirelesssports licenses and other exclusive wireless licenses, such as *Star Wars*on this platform. In fiscal 2007, we plan tore-align our product portfolio to emphasize more casual game content toposition ourselves for wireless platform share gains in the future.

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·       ***Pursue emerging revenue opportunities***

As the interactiveentertainment industry continues to evolve, new revenue streams are emergingthat are expected to develop over the next five years. These opportunitiesinclude in-game advertising, downloadable content/micro-transactions, andonline casual gaming. In fiscal 2006, we entered into agreements with twoleading in-game advertising enabling companies to facilitate in-gameadvertising in future games. We also started to explore an online casual gamesite. Beginning in fiscal 2007, we plan to offer downloadable content onnext-generation console systems from Microsoft and Sony.

**Industry Overview**

As a publisher of interactive entertainment software,we consider ourselves to be part of the entertainment industry. At the mostfundamental level, our products compete with other forms of entertainment, suchas motion pictures, television and music, for the leisure time anddiscretionary spending of consumers. We believe that video games haveincreasingly become a mainstream entertainment choice for both children andadults. According to the International Development Group, Inc. (“IDG”), anindependent consulting and advisory services company that analyzes the consumerelectronics and interactive entertainment industries, sales of PC, console andhandheld games (excluding wireless) reached $7.5 billion in North America, and$6.5 billion in Europe in 2005. We look toward an expanding market for interactiveentertainment software over the next several years due to the introduction ofthe next generation of console systems. We believe that improved graphics,greater online functionality and expanded artificial intelligence capabilitiesof the new platforms will enhance game play and help grow our industrysignificantly. In addition, new revenue opportunities from wireless gaming,in-game advertising and online console gaming are expected to grow to $5billion in 2009 from $1 billion in 2005, according to DFC Intelligence andMontgomery & Co.

The first modern platform was introduced by Nintendoin 1985. Advances in technology over the past 20 years have resulted incontinuous increases in the processing power of the chips that power both theconsoles and PC. For the past several years, Sony has been the leader in theconsole market (with its PlayStation and PlayStation 2 consoles); however,Microsoft and Nintendo are large and viable competitors. In 2005, Microsoftintroduced its next-generation console, Xbox 360, and both Sony and Nintendohave announced plans to release their next-generation consoles later in 2006.Nintendo has been the dominant manufacturer of handheld platforms with its GameBoy Advance. In fiscal 2005 two new handheld platforms were introduced,Nintendo DS and Sony PSP. PCs continue to be a viable interactive game platformand over the past few years, wireless devices, such as mobile phones, havebecome a viable gaming platform.

We currently develop andpublish products for all major platforms, and this diversification continues tobe a cornerstone of our strategy. In fiscal 2006, our product releases were forthe Sony PlayStation 2, Microsoft Xbox and Xbox 360, Nintendo GameCube, PC,Game Boy Advance, Nintendo DS, PSP and wireless devices. As Sony and Nintendolaunch their next-generation consoles, we expect to release games on eachplatform at or near their launch.

**Products**

We develop, marketand sell video games and other interactive software and content for consoleplatforms, handheld platforms and PCs. In fiscal 2006, we published ten titlesthat shipped more than one million units. The following list identifies gamesthat generated a significant portion of our sales during the fiscal years endedMarch 31, 2006, 2005 and 2004:

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

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·       Infiscal 2005, Disney/Pixar’s *The Incredibles, TheSpongeBob SquarePants*TM *Movie*, and *WWE SmackDown vs. Raw*; and

·       Infiscal 2004, Disney/Pixar’s *Finding Nemo, SpongeBobSquarePants*TM*: Battle for Bikini Bottom*TM,and *WWE SmackDown! Here Comes the Pain*TM.

All of our games are basedon intellectual property that is either wholly-owned by us or licensed fromthird parties. We develop our games using both internal development resourcesand external development resources working for us pursuant to contractualagreements. Whether a game is developed internally or externally, upon completionof development we extensively play-test each game, and if required, send thegame to the manufacturer for its review and approval. Other than games that werelease for PCs or wireless devices, the manufacturers or their authorizedvendors manufacture our products for us. We then market and distribute ourgames for sale throughout the world.

**IntellectualProperty**

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

Our intellectual property licenses usually grant usthe exclusive use of the property for specified titles, on specified platforms,within a defined territory and during the license term. All of our licenses areof varying duration and we pay royalties to our property licensors based on ournet sales of the title which includes the licensor’s intellectual property. Wetypically advance payments against minimum guaranteed royalties over thelicense term. Royalty rates are generally higher for properties with provenpopularity and less perceived risk of commercial failure.

Our original intellectualproperty is created either by one of our 14 development studios or by athird-party developer that we contract with, in which instance, we retain allownership rights in the intellectual property. In other instances, wherein athird-party developer creates the intellectual property and develops the game,we obtain a license that is typically exclusive and we try to retain rights toany future products based on the intellectual property.

**Platform Licenses**

In addition toobtaining licenses to develop intellectual property, our business is dependentupon entering into license agreements with the platform manufacturers, whichallow us the right to develop, publish and distribute titles for use on suchmanufacturer’s platform. Our key platform licenses currently include:

·       licenseswith Nintendo to develop games for GameCube, Game Boy Advance and DS;

·       licenseswith Sony to develop games for PlayStation 2 and PlayStation Portable; and

·       licenseswith Microsoft to develop games for Xbox and Xbox 360.

Each license is for a fixed term, and as each licenseexpires, we generally enter into a new agreement or an amendment with thelicensor to extend the term of the agreement. Certain agreements, such as thelicenses with Sony and Microsoft for PlayStation 2 and Xbox 360, respectively,automatically renew each year unless either party gives notice by theapplicable date that it intends to terminate the agreement. Additionally, eachagreement designates a territory in which we can publish and distribute titles.We currently are licensed to publish and distribute titles on all platformsthat are currently sold in the United States and Canada. We are licensed to publishand distribute titles for GameCube, PlayStation 2, PlayStation Portable, Xbox,Xbox 360 and Dual Screen in various additional territories, including Europe,Australia and New Zealand, parts of Asia and Central and South America. Weexpect to enter into 

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additional platform licenses and extend currentlicenses as new platforms are launched or our current agreements expire.

The platform licenses are not exclusive and requirethat each title be approved by the manufacturer prior to development of thesoftware, and once developed, manufactured solely by such manufacturer or adesignated vendor of the manufacturer. The licenses establish the fees that wemust pay to the manufacturer for each cartridge or disc made. Nintendo chargesus a fixed amount for each Game Boy Advance cartridge manufactured. This amountvaries based, in part, on the memory capacity of the cartridge. Our Nintendo,Sony and Microsoft console agreements include a charge for every discmanufactured. The amounts charged by the manufacturers for both console discsand handheld cartridges include a manufacturing, printing and packaging fee aswell as a royalty for the use of the manufacturer’s name, proprietaryinformation and technology, and are subject to adjustment by the manufacturersat their discretion. The manufacturers have the right to review, evaluate andapprove a prototype of each title and the title’s packaging.

In addition, we must indemnify the manufacturers withrespect to all loss, liability and expense resulting from any claim against themanufacturer involving the development, marketing, sale, or use of our games,including any claims for copyright or trademark infringement brought againstthe manufacturer. As a result, we bear a risk that the properties upon whichthe titles are based, or that the information and technology licensed fromothers and incorporated in the products, may infringe the rights of thirdparties. Conversely, our agreements with our third-party software developersand property licensors typically provide for us to be indemnified with respectto certain matters. If any claim is brought by a manufacturer against us forindemnification, however, our developers or licensors may not have sufficientresources 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 a platform license for any reason other than ourbreach or default, we have a limited period of time to sell any existingproduct inventory remaining as of the date of termination. The length of thissell-off period varies between 90 and 180 days, depending upon the platformagreement. We must destroy any such inventory remaining after the end of thesell-off period. Upon termination as a result of our breach or default, we mustdestroy any remaining inventory.

**Product Development**

We develop our products using both internal andexternal development resources. The internal resources consist of producers,game designers, software engineers, artists, animators and game testers locatedwithin our 14 internal studios and corporate headquarters. The externaldevelopment resources consist of third-party software developers and otherindependent resources such as artists. We refer to this collective group ofdevelopment resources as our Studio System.

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

The development cycle for a new game depends on theplatform and the complexity of the game. Additionally, when developing anintellectual property into a game which is simultaneously being made into amotion picture, our development schedule is designed to ensure that our gamesare commercially available by the motion picture’s release. The developmentcycle for games on current generation console platforms, PC games and the SonyPSP system generally ranges from 12 to 24 months, Game Boy Advance 

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ranges from 6 to 9 months, Nintendo DS ranges from 9to 12 months and wireless games range from 6 to 9 months. The development cyclefor the next generation of games on Microsoft Xbox 360 can range from 12 to 36months depending on the overall complexity and scope of the game, and weanticipate a similar development cycle for the next generation of games on SonyPlayStation 3 and Nintendo Wii. These relatively long development cyclesrequire that we assess whether there will be adequate retailer and consumerdemand for a game well in advance of its release. The investments in suchdevelopment, prior to reaching technological feasibility, are recorded asproduct development expenses in our consolidated statement of operations. Wehad product development expenses of $84.2 million in fiscal 2006, $73.0 millionin fiscal 2005 and $36.9 million in fiscal 2004.

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

**Manufacturing**

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

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

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

**Marketing and Sales**

Our marketing activities vary depending upon whether avideo game title is based upon a licensed or an original property. A licensedproperty has pre-existing brand popularity and thus often requires less initialeffort by us to promote. Our marketing efforts for titles based upon originalproperties begin well in advance of a title’s release and focus on buildingpositive awareness of our game concepts with consumers and retailers. Weconduct consumer and retail research, which provides us with feedback toposition a title prior to its release. Our public relations promotionalactivities for original titles in fiscal 2006 included coverage in broadcast, printand online media targeting enthusiast, lifestyle and major mainstream outlets.Additionally, we continue to increase our corporate public relations efforts byestablishing relationships with leading technology and business reporters.

Our marketing efforts for products released in fiscal2006 covered a broad range of media including, television, print, in-theater,radio, internet advertising and promotional events. Most of our major newreleases in fiscal 2006 received television support. Our games were alsosupported by promotional activities such as trailers, demo discs, over-sizedboxes, standees, posters, pre-sell giveaways at retail stores, game kiosks atsporting and outdoor events, rebates and contests with national packaged goodscompanies and fast food restaurants, and co-marketing efforts with the hardwaremanufacturers. Our games are promoted to retailers by display at trade showssuch as the annual Electronic Entertainment Expo (E3) and select retailerspecific trade shows. We also conduct print and cooperative retail advertisingcampaigns for most 

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titles and prepare a range of promotional sales andmarketing materials to increase awareness among retailers.

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

*North American Sales*.   InNorth America, our products are primarily sold directly to mass merchandisers,consumer electronics stores, discount warehouses and national retail chainstores. Our products are also sold to smaller, regional retailers, as well asdistributors who, in turn, sell our products to retailers that we do notservice directly, such as grocery and drug stores. Our domestic salesactivities are led by our national sales team, which has representatives inmost major markets in the United States.

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

The domestic retail prices for our titles currentlyrange between: (i) $15 and $35 for handheld platforms; (ii) $15 and $65 forconsole platforms; and (iii) $10 and $55 for PC games. The domestic retail pricefor our wireless games currently range between $5 and $8 for a one timepurchase and between $2 and $4 for a monthly subscription.

*International Sales.*   Ourinternational sales activities operate via our offices in the United Kingdom,Australia, France, Germany, Korea, Japan, Spain, Austria, Denmark and TheNetherlands. International offices market and distribute direct-to-retailcustomers and through sub-distributors in both their home territories and toapproximately 70 additional territories.

Our largest customersworldwide include Best Buy, GameStop, Target, Toys “R” Us and Wal-Mart. We alsosell our products to other national and regional retailers, discount storechains and specialty retailers. Our largest customer, Wal-Mart, accounted for19% of our worldwide sales in fiscal 2006. A substantial reduction, terminationof purchases, or business failure by any of our largest customers would have amaterial adverse effect on us.

**Seasonality**

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

**Competition**

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

We compete both for licenses to properties and thesale of interactive entertainment software with Sony, Microsoft and Nintendo,each of which is a large developer and marketer of software for its ownplatforms. Each of these competitors also has the financial resources towithstand significant price competition and to 

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implement extensive advertising campaigns,particularly for prime-time television spots. In addition to the manufacturers,our competitors include publishers and developers of interactive entertainmentsoftware, such as Activision, Atari, Electronic Arts, LucasArts, Namco, Sega,Take-Two Interactive Software, Ubisoft, and Vivendi Games.

In addition, some of ourcompetitors are very large, diversified corporations that have began to developgames based upon their own highly recognizable brands, and, as a result, standto become more direct competitors. Disney’s Buena Vista games division recentlyexpanded its internal software game publishing efforts and Viacom has expandedits efforts in interactive entertainment software publishing.

**Employees**

As of March 31, 2006, weemployed approximately 1,600 people, of whom over 600 were outside the UnitedStates. We believe that our ability to attract and retain qualified employeesis a critical factor in the successful development of our products and that ourfuture success will depend, in large measure, on our ability to continue toattract and retain qualified employees. None of our employees are representedby a labor union or covered by a collective bargaining agreement and weconsider our relations with employees to be favorable.

**FinancialInformation About Geographic Areas**

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

**AvailableInformation**

We file annual, quarterly and current reports, proxystatements and other information with the Securities and Exchange Commission(“SEC”). Our SEC filings, including our annual report on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K, and any amendments to thosereports filed or furnished pursuant to Section 13(a) of the Exchange Act areavailable to the public free of charge over the internet at our website at http://www.thq.comor at the SEC’s web site at http://www.sec.gov. Our SEC filings will beavailable on our website as soon as reasonably practicable after we haveelectronically filed or furnished them to the SEC. Information contained on ourwebsite is not incorporated by reference into this annual report on Form 10-K.You may read and copy any materials we file with the SEC at the SEC’s PublicReference Room at 450 Fifth Street, N.W., Washington D.C. 20549. You may obtaininformation on the operation of the Public Reference Room by calling the SEC at1-800-SEC-0330. You can view our Code of Business Conduct and Ethics and ourCode of Ethics for Executive Officers and Other Senior Financial Officers freeof charge on the corporate governance section of our website. If we make anysubstantive amendments to our Code of Ethics for Executive Officers and OtherSenior Financial Officers or if any waivers of such code are granted, we willpost them on our web site.

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**Item 1A.** RiskFactors

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

**Our industry is in a transition phase and theintroduction of new platforms could materially impact the sales of our products.**

In recent years, we have successfully developed videogames for the Microsoft Xbox, Nintendo GameCube and Sony PlayStation 2. In late2005, Microsoft launched its new console, the Xbox 360. Sony has announcedplans to launch the PlayStation 3 and Nintendo has announced plans to launchthe Wii in late 2006. When new platforms are announced or introduced into themarket, consumers typically reduce their purchases of entertainment softwareproducts for current platforms in anticipation of new platforms becomingavailable. During these periods, sales of our game console entertainment softwareproducts may be expected to slow or even decline until new platforms areintroduced and achieve wide consumer acceptance. If sales of our productsunexpectedly decline due to slowing consumer demand during this transition,this could materially impact our financial results.

Additionally, delays inthe launch of the platforms, hardware shortages, technical problems or lack ofconsumer acceptance of the next generation platforms could adversely affect oursales of products for these platforms, adversely affecting sales of products wedevelop and publish for the platforms.

**During the platform transition, pricing for ourproducts may decline, materially impacting our revenuesand profitability.**

As demand for games on thecurrent generation of platforms declines, the prices of our games may alsodecline. Reduced pricing of our products may result in credits or allowances toour customers, which could materially affect our profitability.

**Platform transitions are generally marked byescalating development costs, which could materially affect our profitability.**

New platforms havehistorically required the development of new software and also have the effectof undermining demand for products based on older technologies. Because productdevelopment cycles are difficult to predict, we must make substantial productdevelopment and other investments in technologies for a particular platformwell in advance of introduction of the platform. If the platforms for which wedevelop new software products or modify existing products are not released on atimely basis or do not attain significant market penetration, or if we developproducts for a delayed or unsuccessful platform, our business and financialresults could be significantly harmed.

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

Ourprofitability has directly resulted from our ability to develop and sellsuccessful new titles for use on multiple platforms. 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 lifecycle of a game generally consists of a relatively high level of sales duringthe first few months after introduction, followed by a decline in sales. In someinstances, a sales decline may also be accompanied by decreasing sales prices,which may result in credits or allowances to our customers.

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

Games we develop based upon a small number of licensedbrands make up a substantial portion of our sales each year. In fiscal 2006,sales of titles for our three top-selling brands, Disney / Pixar, Nickelodeon 

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and World Wrestling Entertainment (“WWE”) comprised47% of our net sales; in fiscal 2005, 52% of our net sales were based on titlesfrom such brands; and in fiscal 2004, 50% of our net sales were based on titlesfrom such brands. A limited number of licensed brands may continue to produce adisproportionately large amount of our sales. Due to this dependence on alimited number of brands, the failure of one or more products based on thesebrands to achieve anticipated results or the loss of a license pursuant towhich we develop games for such brands may significantly harm our business andfinancial results.

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

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

A significant portion of our net sales in fiscal 2006,fiscal 2005 and fiscal 2004 were derived from products based on popularlicensed properties. A decrease in the popularity of the underlying property ofour licenses could negatively impact our ability to sell products based on suchlicenses.

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

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

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

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

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

Our ability to meetproduct development schedules is affected by a number of factors, including thecreative processes involved, the coordination of large and sometimesgeographically dispersed development teams required by the increasingcomplexity of our products, and the need to refine and tune our products priorto their release. We have in the past experienced development delays forseveral of our products. Failure to meet anticipated production schedules maycause a shortfall in our expected sales and profitability and cause ouroperating results to be materially different from expectations. Delays that preventrelease of our products during peak selling seasons or in conjunction withspecific events, such as the release of a related movie, could adversely affectour financial performance. Further, since we haven’t developed or released agame for the Sony PlayStation 3 or the Nintendo Wii, and since the Microsoft 

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Xbox 360 is new to themarket, product development schedules for the next generation platforms may bedifficult to predict and may cause us to delay the launch of certain products.

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

Some ofour titles are developed by third-party developers. We have no direct controlover the business, finances and operational practices of these externaldevelopers. A delay or failure to complete the work performed by externaldevelopers may result in delays in, or cancellations of, product releases. Thefuture success of externally developed titles will depend on our continuedability to maintain relationships and obtain developer agreements on favorableterms with skilled external developers. Our competitors may acquire thebusinesses of key developers or sign them to exclusive development arrangements.In either case, we would not be able to continue to engage such developers’services for our products, except for those that they are contractuallyobligated to complete for us. We cannotguarantee that we will be able to establish or maintain such relationships withexternal developers and failure to do so could result in a material adverseeffect on our business and financial results.

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

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

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

Our largest singlecustomer, Wal-Mart, accounted for 19% of our gross sales in fiscal 2006, 14% ofour gross sales in fiscal 2005 and 19% of our gross sales in fiscal 2004. A substantial reduction, termination of purchases, orbusiness failure by any of our largest customers would have a material adverseeffect on us.

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

Some of our customers,such as Blockbuster and Hollywood Video, specialize in renting video games. Thesecustomers also may sell video games that have been rented by their customersafter a certain period of time following each title’s release. Increased salesof used video games, which are generally priced lower than new video games,could negatively affect our sales of new titles and thus our revenues.

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

In fiscal 2006 we derived 39% of our revenues from ourinternational operations, up from 38% in fiscal 2005. We intend to continueexpanding our international operations, which may subject us to many risks,including: differentconsumer preferences, unexpected changes in regulatory requirements, tariffsand other barriers, difficulties in staffing and managing foreign operations,and possible difficulties collecting foreign accounts receivable. These factorsor others could have an adverse effect on our future foreign sales or theprofits generated from these sales.

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

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

Our industry is intensely competitive.We compete for both licenses to properties and the sale of games with theplatform manufacturers and other publishers. As a result of their commandingpositions in the industry, the manufacturers may have better bargainingpositions with respect to retail pricing, shelf space and retaileraccommodations than do any of their licensees, including us. Some of ourcompetitors have greater name recognition among consumers and licensors ofproperties, a broader product line, or greater financial, marketing and otherresources than we do. Accordingly, these competitors may be able to markettheir products more effectively or make larger offers or guarantees inconnection with the acquisition of licensed properties.

Ascompetition for popular properties increases, our cost of acquiring licensesfor such properties may increase, resulting in reduced margins. In addition, ascompetition for retail shelf space becomes more intense, we may need toincrease our marketing expenditures to maintain sales of our titles. Prolongedprice competition, increased licensing costs or reduced profit margins wouldhave a negative effect on our business and financial results.

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

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

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

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

**Consolidation in the interactivesoftware entertainment industry presents challenges with respect to resources and integrationof acquired businesses.**

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

Further,as we acquire companies, we are faced with additional challenges. Theintegration of newly acquired companies’ operations with our existingoperations takes management time and effort. Additionally, there is a risk ofloss of key employees, customers and vendors of the recently-acquired companies.Also, if we issue equity securities to pay for an acquisition, the ownershippercentage of our existing stockholders would be reduced and the value of theshares held by our existing stockholders could be diluted. If we use cash topay for an acquisition, the payment could significantly reduce the cash thatwould be available to fund our operations or to use for other purposes. Acquisitionfinancing may not be available on favorable terms or at all. We may also berequired to amortize significant amounts of identifiable intangible assets inconnection with future acquisitions, which could adversely affect our 

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reportedearnings. Future acquisitions may also require us to assume contingentliabilities that could have a negative effect on our future results ofoperations.

**Emerging technologies, such as games for wirelessdevices, require capital investments and present many unknown risks.**

Wireless network and mobile phone technologies areundergoing rapid innovation. New mobile phones with more advanced processorsand supporting advanced programming languages continue to be introduced in themarket. We have no control over the demand for, or success of, these products. However,if we fail to anticipate and adapt to these and other technological changes,our market share and our operating results may suffer. Our future success inproviding wireless games and other content will depend on our ability to adaptto rapidly changing technologies, develop applications to accommodate evolvingindustry standards and improve the performance and reliability of ourapplications. In addition, the widespread adoption of networking ortelecommunications technologies or other technological changes could requiresubstantial expenditures to modify or adapt our entertainment applications.

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

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

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

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

Although we believe thatwe make reasonable efforts to ensure that our products do not violate theintellectual property rights of others, from time to time we receive noticesfrom others claiming we infringe their intellectual property rights. The numberof these claims may grow. Responding to these claims may 

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require us to enter intoroyalty and licensing agreements on less favorable terms, require us to stopselling or to redesign affected products, or to pay damages or to satisfyindemnification commitments with our customers including contractual provisionsunder various license arrangements. If we are required to enter into suchagreements or take such actions, our operating margins may decline as a result.

**Our reportedfinancial results could be affected by changes in current accountingprinciples.**

Recent actions and publiccomments from the Securities and Exchange Commission have focused on theintegrity of financial reporting generally. Similarly, Congress has considereda variety of bills that could affect certain accounting principles. TheFinancial Accounting Standards Board and other regulatory accounting agencieshave recently introduced several new or proposed accounting standards, such asaccounting for stock options, some of which represent a significant change fromcurrent practices. Changes in our accounting for stock options will materiallyincrease our reported expenses when we adopt Statement of Financial AccountingStandard No. 123R in the first quarter of fiscal 2007.

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

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

**Fluctuations in our quarterly operating results due toseasonality in the interactive software entertainment industrycould result in substantial losses to investors.**

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

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

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

·       the profit margins for titles we sell;

·       the competition in the industry for retail shelfspace;

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

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

Webelieve that quarter-to-quarter comparisons of our operating results are not agood indication of our future performance. We may not be able to maintainconsistent profitability on a quarterly or annual basis. It is likely that insome future quarter, our operating results may be below the expectations ofpublic 

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marketanalysts and investors and as a result of the factors described above andothers described throughout this “Risk Factors” section, the price of ourcommon stock may fall or significantly fluctuate.

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

Currently, the interactive softwareentertainment industry is self-regulated and rated by the EntertainmentSoftware Rating Board. Our retail customers take the Entertainment SoftwareRating Board rating into consideration when deciding which of our products theywill purchase. If the Entertainment Software Rating Board or a manufacturerdetermines that a product should have a rating directed to an older or moremature consumer, we may be less successful in our marketing and sales of aparticular product.

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

**Any significant downturn in generaleconomic conditions which results in a reduction in discretionary spending could reducedemand for our products and harm our business.**

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

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

**Item 1B.** Unresolved Staff Comments

None.

**Item 2.** Properties

Thefollowing is a summary of the principal leased offices maintained by us as of May 26,2006:
| Purpose                      | ** ** | ** ** | ** ** | **North America** | ** ** | **Europe** | ** ** | **Asia Pacific** | ** ** | **Total** | ** ** |
|------------------------------|------------|------------|------------|------------------------|------------|------------|------------|-----------------------|------------|-----------|------------|
| Sales and  administrative    |       |       | 138,800    |                   |       | 50,100     |       |                  | 10,600     |      |       | 199,500 |   |
| Product  development         |       |       | 249,400    |                   |       | 6,100      |       |                  | 18,400     |      |       | 273,900 |   |
| Total leased  square footage |       |       | 388,200    |                   |       | 56,200     |       |                  | 29,000     |      |       | 473,400 |   |

 

In addition to the leased facilities listed above, wealso lease office space in various countries outside of the U.S. in order tosupport the international sales, marketing and administrative efforts of ourwireless platform. The majority of these leased facilities are occupied byMinick Holdings AG and its subsidiaries, of which we have a 50% ownership interest.

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

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**Item 3.** Legal Proceedings

*World WrestlingEntertainment.*

On October 19, 2004, World WrestlingEntertainment, Inc. (“WWE”) filed a lawsuit in the United States DistrictCourt for the Southern District of New York (the “Court”) against JAKKS Pacific, Inc.(“JAKKS”), THQ, the THQ/JAKKS joint venture, and others, alleging, among otherclaims, improper conduct by JAKKS, certain executives of JAKKS, an employee ofthe WWE and an agent of the WWE in granting the WWE video game license to theTHQ/JAKKS joint venture. The complaint seeks various forms of relief, includingmonetary damages and a judicial determination that, among other things, theTHQ/JAKKS video game license is void. On March 30, 2005, WWE filed anamended complaint, adding both new claims and THQ’s president and chiefexecutive officer, Brian Farrell, as a defendant. In August 2005, theCourt directed the parties to file briefs on the three federal law claimsalleged by the Plaintiffs (*i.e.*,Robinson-Patman, and Sherman Act, and a threshold issue concerning thePlaintiff’s RICO claim). The motions to dismiss the amended complaint based onthese issues were fully briefed and argued and, on March 31, 2006, theCourt granted the defendants’ motion to dismiss the Robinson-Patman Act andSherman Act claims and denied the defendants’ motion seeking to dismiss theRICO claims on the basis of the threshold “enterprise” issue that was briefed(the “March 31 Order”). On April 7, 2006, the Company and the otherdefendants sought certification to appeal from the portion of the March 31Order denying the motion to dismiss the RICO claim on the one ground that wasbriefed. Shortly thereafter, WWE filed a motion for re-argument with respect tothe portion of the March 31 Order that dismissed the Sherman Act claimand, alternatively, sought judgment with respect to the Sherman Act claim sothat it could pursue an immediate appeal. At a court hearing on April 26,2006, the Court deferred a ruling on the requests for partial judgment and forcertification and set briefing schedules with respect to the remaining groundsfor defendants’ motion to dismiss the RICO claim, currently the sole remainingbasis for federal jurisdiction in this action, that were not the subject of thefirst round of briefing. The Court also established a briefing schedule for WWE’smotion for re-argument of the dismissal of the Sherman Act claim. The briefingand argument of these motions is scheduled to be completed by September 2006.Discovery in this action remains stayed. On June 2, 2006, we filed a motion todismiss the RICO claims against THQ and Brian Farrell. THQ believes thatneither it, nor Brian Farrell, is primarily accused of any wrongdoing in thecomplaint or the amended complaint, and believes that either there is no basisfor terminating the license with THQ, or that THQ will be made whole by thosewhose conduct is eventually found to be unlawful. We intend to vigorouslyprotect our rights and, if necessary, pursue appropriate claims against thirdparties.

On March 30, 2006, WWE’s counsel wrote a letterto our counsel and counsel for JAKKS, alleging breaches by the THQ/JAKKS jointventure of the video game license related to the manner of distribution andpayment of royalties to the WWE with respect to sales of the WWE video games inJapan. WWE demanded that the alleged breaches be cured within the time periodsprovided in the video game license, while reserving all of its rights,including its alleged right of termination of the video game license. On April 28,2006, our counsel responded on behalf of the THQ/JAKKS joint venture,asserting, among other things, that the WWE had been aware and had consented tothe manner of distribution in Japan and the payment of royalties with respectto such sales and, in addition, had separately released the joint venture fromany claims with respect to such matter as a result of a settlement of a royaltyaudit of the THQ/JAKKS joint venture. We have also provided documentation tothe WWE’s counsel in support of our position. WWE’s counsel has subsequentlyresponded by letter, reiterating its claims and reservation of all rights, and hasrequested additional information regarding sales of WWE video games in Japanand certain other Asian countries. We are currently developing our response toWWE’s counsel’s most recent communications. We believe we have several basesfor defending any claim of breach of the video game license agreement resultingfrom the manner of distribution of WWE-licensed products in****Japan and other Asian territories.

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Due to the early status ofthis litigation with WWE we cannot estimate a possible loss, if any. Games wedevelop based upon our WWE license have contributed to approximately 15% of ournet sales during each of the three years in the period ended March 31,2006. The loss of the WWE license would have a negative impact on our futurefinancial results.

*RegulatoryProceedings*

Update on 2003 SEC inquiry. On July 11, 2003 wewere informed by the staff of the Securities and Exchange Commission (the “SEC”)that the SEC was conducting a non-public formal investigation entitled “In theMatter of Certain Video Game Manufacturers and Distributors.”  In connection with the investigation, the SECrequested information from us and informed us that other companies in the videogame industry had received similar requests for information. The investigationwas focused on certain accounting practices, with specific emphasis on revenuerecognition. The SEC advised us that its investigation is non-public and shouldnot be construed as an indication from the SEC or its staff that any violationsof the law have occurred, nor should it reflect negatively upon any person,entity or security. We cooperated fully with the SEC in its investigation intothis matter. Recently, we were advised by the SEC staff that they haveconcluded their inquiry with respect to THQ and have no present intention tomake an enforcement recommendation.

Due to the early status ofthis litigation with WWE we cannot estimate a possible loss, if any. Games wedevelop based upon our WWE license have contributed to approximately 15% of ournet sales during each of the three years in the period ended March 31,2006. The loss of the WWE license would have a negative impact on our futurefinancial results.

*Other*

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

**Item 4.** Submission of Matters to aVote of Security Holders

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

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**PART II**

**Item 5.** Marketfor the Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities

THQ’scommon stock is quoted on the NASDAQ National Market under the symbol “THQI.”  The following table sets forth, for the periodsindicated, the high and low closing sales prices of our common stock asreported by the NASDAQ National Market:
|                                              | ** ** | **Closing  Sales Prices** | ** ** |
|----------------------------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **High**                       | ** ** | **Low** | ** ** |
| **Fiscal Year Ended  March 31, 2006**   | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Fourth Quarter ended March 31, 2006     |       | 27.62                          |       | 23.81 |   |
| Third Quarter ended December 31, 2005   |       | 24.58                          |       | 19.14 |   |
| Second Quarter ended September 30, 2005 |       | 23.97                          |       | 19.49 |   |
| First Quarter ended June 30, 2005       |       | 20.67                          |       | 16.81 |   |
| **Fiscal Year Ended  March 31, 2005**   |       |                           |       |   |   |
| Fourth Quarter ended March 31, 2005     |       | 19.77                          |       | 13.41 |   |
| Third Quarter ended December 31, 2004   |       | 15.78                          |       | 11.29 |   |
| Second Quarter ended September 30, 2004 |       | 14.97                          |       | 11.85 |   |
| First Quarter  ended June 30, 2004      |       | 15.33                          |       | 12.25 |   |

 

The last reported price ofour common stock on May 26, 2006, as reported by NASDAQ National Market,was $23.10 per share.

**Holders**

As of May 26, 2006there were approximately 287 holders of record of our common stock.

**Dividend Policy**

We have never paid cashdividends on our common stock. We currently intend to retain future earnings,if any, to finance the growth and development of our business and, therefore,we do not anticipate paying any cash dividends in the future. Our principalcredit facility agreement provides that we will not pay any cash dividendswithout consent of the bank.

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**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

Informationfor our equity compensation plans in effect as of March 31, 2006 is asfollows (amounts in thousands, except per share amounts):
|                                                                                      | ** ** | **(a)**    | ** ** | **(b)**                                                                                                                                          | ** ** | **(c)**                                                                                                     | ** ** |
|--------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| **Plan Category**                                                               | ** ** | ** ** | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** | ** ** |
| Equity compensation  plans approved by security holders     |       |       | 8,247,411  |                                                                                                                                             |       |                                                                                                        | $          | 16.49 |   |   |   | 2,007,949 |   |   |
| Equity compensation  plans not approved by security holders                     |       |       | 1,237,442  | (1)                                                                                                                                              |       |                                                                                                        | $          | 11.59 |   |   |   | 237,031 |   |   |
| Total                                                                                |       |       | 9,484,853  |                                                                                                                                             |       |                                                                                                        | $          | 15.85 |   |   |   | 2,244,980 |   |   |
|                                                                                      |            |            |            |                                                                                                                                                  |            |                                                                                                             |            |  |  |  |  |  |  |  |  |  |

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(1)          Represents the aggregatenumber of shares of THQ common stock to be issued upon exercise of individualcompensation arrangements with employee and non-employee option and warrant holders.The outstanding options were primarily granted under the Company’s ThirdAmended and Restated Nonexecutive Employee Stock Option Plan (the “NEEP Plan”).For a description of the material features of the NEEP Plan, see “Note 14—Stock-basedCompensation” in the notes to the consolidated financial statements.

**Securities Issuedin Private Transactions**

In fiscal 2005 we granted240,000 warrants to third parties to purchase up to 240,000 shares of ourcommon stock at an exercise price of $13.49 per share in connection with alicense agreement that allows us to utilize intellectual property owned by suchthird parties. The warrants vested upon grant and have a six-year term. Thefair value of the warrants was determined using the Black-Scholes pricing model,assuming a risk-free rate of 2.9%, a volatility factor of 67% and the six-yearterm as noted above. The fair value of these warrants was $2.0 million.

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

There were no repurchasesof our common stock by the Company during the three months ended March 31,2006.

**Item 6.** Selected ConsolidatedFinancial Data

The following tablesummarizes certain selected consolidated financial data, which should be readin conjunction with our consolidated financial statements and Notes thereto andwith Management’s Discussion and Analysis of Financial Condition and Results ofOperations included elsewhere herein. Effective January 1, 2003, wechanged our fiscal year end from December 31 to March 31. The changeresulted in a three-month transitional period ended March 31, 2003. Referencesto Transition 2003, unless otherwise indicated, refer to the three-monthtransitional period ended March 31, 2003. Since the change in fiscal yearend affects the comparability of the information reflected in the selectedfinancial data, we have included unaudited results for the period from April 1,2002 through March 31, 2003. Other than this unaudited period, theselected consolidated financial data presented below as of and for each of thefiscal years and Transition 2003 in the five-year period ended March 31,2006 are derived from our audited consolidated financial statements. Theconsolidated balance sheets as of March 31, 2006, and 2005, and the 

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consolidated statements ofoperations for the fiscal years ended March 31, 2006, 2005 and 2004, andthe report thereon are included elsewhere in this Form 10-K.

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

| ** **                                               | ** ** | **Fiscal Year Ended March 31,** | ** ** | **Transition** | ** ** | **Year Ended  December 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------|------------|----------------------------------------|------------|
|                                                          | ** ** | **2006**                                            | ** ** | **2005(a)**    | ** ** | **2004(b)**                            | ** ** | **2003(c)** | ** ** | **2003(c)** | ** ** | **2002(d)** | ** ** |
| ** **                                               | ** ** | ** **                                          | ** ** | ** **     | ** ** | ** **                             | ** ** | **(Unaudited)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                |       | $                                                   | 806,560    |           | $          | 756,731                                |       | $ | 640,846 |   |   | $ | 467,647 |   |   |   | $ | 66,800 |   |   |   | $ | 480,529 |   |   |
| Costs and expenses:                                      |       |                                                |       |           |       |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of sales                                            |       | 287,946                                             |       | 255,187        |       | 234,574                                |       |   | 181,532 |   |   |   | 27,158 |   |   |   | 188,559 |   |   |
| License amortization and royalties                  |       | 80,508                                              |       | 85,926         |       | 71,132                                 |       |   | 38,988 |   |   |   | 5,576 |   |   |   | 40,476 |   |   |
| Software development amortization                        |       | 116,371                                             |       | 93,622         |       | 105,632                                |       |   | 84,916 |   |   |   | 12,018 |   |   |   | 83,698 |   |   |
| Product development                                      |       | 84,242                                              |       | 72,959         |       | 36,850                                 |       |   | 36,531 |   |   |   | 8,899 |   |   |   | 34,696 |   |   |
| Selling and marketing                                    |       | 123,552                                             |       | 110,514        |       | 87,119                                 |       |   | 67,737 |   |   |   | 13,514 |   |   |   | 63,477 |   |   |
| Payment to venture partner                               |       | 12,572                                              |       | 9,774          |       | 9,675                                  |       |   | 9,218 |   |   |   | 644 |   |   |   | 10,146 |   |   |
| General and administrative                               |       | 67,615                                              |       | 54,831         |       | 47,006                                 |       |   | 36,794 |   |   |   | 8,442 |   |   |   | 34,993 |   |   |
| Total costs and expenses                                 |       | 772,806                                             |       | 682,813        |       | 591,988                                |       |   | 455,716 |   |   |   | 76,251 |   |   |   | 456,045 |   |   |
| Income (loss)  from operations                           |       | 33,754                                              |       | 73,918         |       | 48,858                                 |       |   | 11,931 |   |   |   | (9,451 | ) |   |   | 24,484 |   |   |
| Interest income                                          |       | 8,478                                               |       | 4,337          |       | 2,378                                  |       |   | 4,833 |   |   |   | 878 |   |   |   | 5,277 |   |   |
| Other income  (expense)                                  |       | —                                              |       | —         |       | 4,000                                  |       |   | (12,409 | ) |   |   | (2,403 | ) |   |   | (10,006 | ) |   |
| Income (loss)  before income taxes and minority interest |       | 42,232                                              |       | 78,255         |       | 55,236                                 |       |   | 4,355 |   |   |   | (10,976 | ) |   |   | 19,755 |   |   |
| Income taxes                                             |       | 7,900                                               |       | 15,204         |       | 19,397                                 |       |   | 1,812 |   |   |   | (3,290 | ) |   |   | 6,761 |   |   |
| Income (loss)  before minority interest                  |       | 34,332                                              |       | 63,051         |       | 35,839                                 |       |   | 2,543 |   |   |   | (7,686 | ) |   |   | 12,994 |   |   |
| Minority interest                                        |       | (63                                                 | )          | (261           | )          | —                                 |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Net income (loss)                                        |       | $                                                   | 34,269     |           | $          | 62,790                                 |       | $ | 35,839 |   |   | $ | 2,543 |   |   |   | $ | (7,686 | ) |   |   | $ | 12,994 |   |   |
| Net income (loss)  per share—basic                  |       | $                                                   | 0.55       |           | $          | 1.07                                   |       | $ | 0.63 |   |   | $ | 0.04 |   |   |   | $ | (0.13 | ) |   |   | $ | 0.22 |   |   |
| Net income (loss)  per share—diluted           |       | $                                                   | 0.52       |           | $          | 1.04                                   |       | $ | 0.61 |   |   | $ | 0.04 |   |   |   | $ | (0.13 | ) |   |   | $ | 0.21 |   |   |
| Shares used in  per share calculation—basic         |       | 62,615                                              |       | 58,545         |       | 57,279                                 |       |   | 58,527 |   |   |   | 57,479 |   |   |   | 58,805 |   |   |
| Shares used in per share  calculation—diluted       |       | 65,575                                              |       | 60,365         |       | 58,506                                 |       |   | 60,828 |   |   |   | 57,479 |   |   |   | 61,865 |   |   |

 

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**BALANCESHEET DATA(In thousands)**
|                           | ** ** | **Fiscal Year Ended March 31,** | ** ** | **Transition** | ** ** | **Year Ended  December 31,** | ** ** |
|---------------------------|------------|-----------------------------------------------------|------------|----------------|------------|----------------------------------------|------------|
| ** **                | ** ** | **2006**                                            | ** ** | **2005**       | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Working capital           |       | $                                                   | 463,207    |           | $          | 401,687                                |       | $ | 309,633 |   | $ | 286,899 |   | $ | 286,899 |   |   | $ | 320,588 |   |   |
| Total assets              |       | $                                                   | 850,614    |           | $          | 747,393                                |       | $ | 527,151 |   | $ | 472,949 |   | $ | 472,949 |   |   | $ | 537,860 |   |   |
| Stockholders’ equity |       | $                                                   | 630,809    |           | $          | 548,758                                |       | $ | 438,592 |   | $ | 396,413 |   | $ | 396,413 |   |   | $ | 408,866 |   |   |

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Notes:

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

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

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

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

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**Item 7.** Management’sDiscussion and Analysis of Financial Condition and Results of Operations

**Overview**

The following is adiscussion of our operating results and the primary trends that affect ourbusiness. Certain of these trends and other statements made herein may be “forward-looking”within the meaning of the Private Securities Litigation Reform Act of 1995. Suchstatements are included herein because management believes that anunderstanding of these trends is important to understand our results for thefiscal year ended March 31, 2006 (“fiscal 2006”), as well as our futureprospects. This summary is not intended to be exhaustive, nor is it intended tobe a substitute for the detailed discussion and analysis provided elsewhere inthis Form 10-K, including in the remainder of “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” orthe consolidated financial statements and related notes. The discussion andanalysis herein may be understood more fully by reference to the consolidatedfinancial statements and notes to the consolidated financial statements. Additionally,readers should refer to our cautionary statement on page 1 herein as wellas “Risk Factors” set forth in Item 1A. All references to “we,” “us,” “our,” “THQ,”or the “Company” in the following discussion and analysis mean THQ Inc. and itssubsidiaries.

**Overview of Fiscal2006 Results**

Net sales in fiscal 2006 increased7% over the fiscal year ended March 31, 2005 (“fiscal 2005”), from$756.7 million to $806.6 million. The increase in net sales for fiscal2006 was primarily attributable to worldwide sales of 10 titles that sold morethan one million units. In fiscal 2005, we published six titles which shippedmore than one million units.

In fiscal 2006, our operating margin declined by 560basis points over fiscal 2005, to 4% of net sales. Our operating margindeclined in fiscal 2006 due primarily to (i) higher catalog sales as apercentage of total net sales (ii) a change in development strategy forour WWE games wherein we ceased internal product development for wrestlinggames and as a result we wrote-off the underlying capitalized softwaredevelopment costs to software development amortization, and (iii) highprice protection and software development amortization for thecurrent-generation title *Full Spectrum Warrior**TM: Ten Hammers*.

Net income for fiscal 2006 was $34.3 million, or $0.52per diluted share, compared to net income of $62.8 million, or $1.04 perdiluted share, for fiscal 2005. Fiscal 2006 results reflect increasedinvestment in development of video games for next generation consoles. Netincome for fiscal 2005 was positively affected by $7.8 million, or $0.13 perdiluted share, from the recognition of research and development income taxcredits claimed for prior years.

Cash provided byoperations was $42.8 million during fiscal 2006, as compared to $60.5 millionin fiscal 2005. The decline in cash provided by operations was primarily due tolower net income, higher spending for software development, and higher paymentsof accrued expenses, partially offset by lower cash spending for licenses.

**Fiscal 2007 Outlook**

We expect net sales in fiscal 2007 to increase 12% to18% as compared to fiscal 2006, resulting in expected net sales of $900 to $950million. Key titles that we expect to release in fiscal 2007 are *Cars*on nine platforms, *Saints Row* onXbox360 and *WWE Smackdown vs. Raw 2007*. We alsoexpect to release titles based on Nickelodeon brands and core gamer PC titlessuch as *Company of Heroes*and *Supreme Commander*. We expect our SKU count in fiscal 2007 toincrease to approximately 70 from 64 in fiscal 2006 and title count to remainflat in fiscal 2007 compared to fiscal 2006. Our catalog sales are expected tobe 25% of our product mix, down from 34% in fiscal 2006.

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The following discussionof fiscal 2007 expected results excludes equity based compensation, such as theimpact of expensing stock options under SFAS 123R, “Share-Based Payment” (“SFAS No. 123R”),a revision of SFAS No. 123, that we will adopt in our first quarterof fiscal 2007. We expect cost of sales to decline slightly as a percentage ofnet sales in fiscal 2007 compared to fiscal 2006. License amortization androyalties expense, as a percentage of net sales, are expected to decline infiscal 2007 as we have more original properties in our product mix. Softwaredevelopment amortization, as a percentage of net sales, is expected to increasein fiscal 2007 as compared to fiscal 2006, primarily due to the higherdevelopment costs for games on next-generation platforms and productdevelopment expense is expected to decrease in fiscal 2007 as many nextgeneration titles have reached technological feasibility. General andadministrative costs are expected to remain constant in absolute dollars and declineas a percentage of net sales. We expect operating margins to improve from 4% infiscal 2006 to 8 to 9% in fiscal 2007. The effective tax rate in fiscal 2007 isexpected to be 30% and is subject to change based on changes in geographicalprofits and other factors. Based on an expected fully diluted share count of 68million, we expect earnings per share of $0.90 to $1.00 in fiscal 2007. Forfiscal 2007, we expect the impact of equity based compensation to beapproximately $0.16 per fully diluted share.

**ProspectiveBusiness Trends**

*Transition to next-generation console systems.**  *Our industry is currently in a transitionphase as sales of games for the existing platforms decline and sales of gamesfor new platforms begin to accelerate as new hardware installed bases grow. Microsoftrecently launched Xbox 360; Sony and Nintendo have announced plans to introducenew console platforms in calendar 2006 and in fiscal 2005 Nintendo and Sonyeach launched new handheld platforms. In terms of volume and pricing, sales ofinteractive entertainment software have traditionally decreased in transitionyears, as consumers decrease their purchases of software for current generationhardware while they wait for the release of the new platforms. Our strategyduring this transition is to: leverage our current brands and catalog titlesand selectively introduce high-potential new franchises for the growinginstalled base of current-generation hardware and the high-end PC market;establish unique new intellectual properties early in the cycle onnext-generation platforms; leverage our handheld leadership; continue to growwireless revenues and profitability; and pursue emerging revenue opportunities.

*Increase in development costs.**  *The next-generation consoles have increasedfunctionality (e.g., realistic environments, artificial intelligence andon-line game play) over their current generation counterparts. The increasedfunctionality delivers a more exciting gaming experience but adds complexity tothe development of video games for these new consoles. This complexityincreases the overall cost to develop these games and accordingly, duringfiscal 2007, we expect our average software development costs to increase as wedevelop games for these new consoles.

*Software pricing.**  *We expect the average selling price of videogames on current generation systems will continue to decline as the industrytransitions to next-generation console systems. Traditionally video game saleshave decreased in transition years, as consumers decrease their purchases ofsoftware for current generation hardware while they wait for the release of thenew platforms. As the installed base of next-generation hardware grows, and asnet sales of video games made for play on those next-generation consoles increases,we expect the average selling price of video games to increase, having apositive impact on our margin.

*Increase in installed base.**  *With the introduction of new consoleplatforms, the overall installed base of video game platforms has historicallyincreased. Platform manufactures have reduced pricing on their existingconsoles and we expect to continue to ship both new titles and games from ourexpansive catalog of previously released titles made for play on these consoles.As the installed base of next-generation console platforms increases, we planto release titles based on our most popular owned and licensed 

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franchise games and we’ve already built a substantialline-up of games to take advantage of the accelerating market growth which isexpected to begin in calendar 2007.

*Internationalgrowth.**  *In fiscal 2006,approximately $31 million of our overall net sales increase of $50 millionwas attributable to international growth. The international installed base ofvideo game platforms continues to increase and we are focused on expanding ourinternational presence by identifying territories wherein we see opportunityand establishing a direct sales presence to seize such opportunities. Inaddition to our sales force presence, we are focused on releasing andaggressively marketing titles with international appeal.

**Critical AccountingEstimates**

The Management’s Discussion and Analysis of FinancialCondition and Results of Operations discusses our consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States of 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 estimates discussed below are considered bymanagement to be critical because they are both important to the portrayal ofour financial condition and results of operations and because their applicationplaces the most significant demands on management’s judgment, with financialreporting results relying on estimates about the effect of matters that areinherently uncertain. Specific risks for these critical accounting estimatesare described in the following paragraphs. For all of these estimates,management cautions that actual results may differ materially from theseestimates under different assumptions or conditions.

*Allowances for price protection, returns anddoubtful accounts.**  *We derive revenuefrom sales of packaged software for video game systems and personal computersand sales of content and services for wireless devices. Product revenue isrecognized net of allowances for price protection and returns and variouscustomer discounts. We typically only allow returns for our personal computerproducts; however, we may decide to provide price protection or allow returnsfor our video game systems or personal computer products after we analyze: (1) inventoryremaining in the retail channel, (2) the rate of inventory sell- throughin the retail channel, and (3) our remaining inventory on hand. Wemaintain a policy of giving credits for price protection and returns, but donot give cash refunds.

We establish sales allowances based on estimates offuture price protection and returns with respect to current period productrevenue. 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. Inaddition, management monitors the volume of our sales to retailers anddistributors and their inventories, because slow-moving inventory in thedistribution channel can result in the requirement for price protection or returnsin subsequent periods. In the past, actual price protection and returns havenot generally exceeded our reserves. However, actual price protection andreturns in any future period are uncertain. While management believes it canmake reliable estimates for these matters, if we changed our assumptions andestimates, our price protection and returns reserves would change, which wouldimpact the net revenue we report. In addition, if actual price protection andreturns were significantly greater than the reserves we have established, theactual results of our reported net sales would decrease. Conversely, if actualprice protection and returns were significantly less than our reserves, ourreported net sales would increase.

Similarly, management must use significant judgmentand make estimates in connection with establishing allowances for doubtfulaccounts in any accounting period. Management analyzes customer concentrations,customer credit-worthiness and current economic trends when evaluating the adequacyof 

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the allowance for doubtful accounts. Materialdifferences may result in the amount and timing of our bad debt expense for anyperiod if management made different judgments or utilized different estimates. Ifour customers experience financial difficulties and are not able to meet theirongoing financial obligations to us, our results of operations may be adverselyimpacted.

*Licenses.**  *Minimumguaranteed royalty payments for intellectual property licenses are initiallyrecorded on our balance sheet as an asset (licenses) and as a liability(accrued royalties) at the contractual amount upon execution of the contract ifno significant performance obligation remains with the licensor. When asignificant performance obligation remains with the licensor, we record royaltypayments as an asset (licenses) when payable rather than upon execution of thecontract. Royalty payments for intellectual property licenses are classified ascurrent assets and current liabilities to the extent such royalty paymentsrelate to anticipated sales during the subsequent year and long-term assets andlong-term liabilities if such royalty payments relate to anticipated salesafter one year.

We evaluate the future recoverability of ourcapitalized licenses on a quarterly basis. The recoverability of capitalizedlicense costs is evaluated based on the expected performance of the specificproducts in which the licensed trademark or copyright is to be used. As many ofour licenses extend for multiple products over multiple years, we also assessthe recoverability of capitalized license costs based on certain qualitativefactors such as the success of other products and/or entertainment vehiclesutilizing the intellectual property, whether there are any future plannedtheatrical releases or television series based on the intellectual property andthe rights holder’s continued promotion and exploitation of the intellectualproperty. Prior to the related product’s release, we expense, as part oflicense amortization and royalties, capitalized license costs when we believesuch amounts are not recoverable.

Licenses are expensed to license amortization androyalties at the higher of (1) the contractual royalty rate based onactual net product sales related to such license or (2) an effective ratebased upon total projected revenue related to such license. When, in management’sestimate, future cash flows will not be sufficient to recover previouslycapitalized costs, we expense these capitalized costs to license amortizationand royalties. If actual revenues or revised forecasted revenues fall below theinitial forecasted revenues for a particular license, the charge to licenseamortization and royalties expense may be larger than anticipated in any givenquarter. As of March 31, 2006, the net carrying value of our licenses was$81.5 million. If we were required to write off licenses, due to changes inmarket conditions or product acceptance, our results of operations could bematerially adversely affected.

*Software Development.**  *We utilize both internal development teams andthird-party software developers to develop our software. We account forsoftware development costs in accordance with SFAS No. 86, “Accounting forthe Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.”  We capitalize software development costs oncetechnological feasibility is established and we determine that such costs arerecoverable against future revenues. For products where proven game enginetechnology exists, this may occur early in the development cycle. We capitalizethe milestone payments made to third-party software developers and the directpayroll and overhead costs for our internal development teams. We evaluatetechnological feasibility on a product-by-product basis. Amounts related tosoftware development for which technological feasibility is not yet met arecharged as incurred to product development expense in our consolidatedstatements of operations.

On a quarterly basis, we compare ourunamortized software development costs to net realizablevalue, on a product-by-product basis. The amount by which any unamortizedsoftware development costs exceed their net realizable value is charged tosoftware development amortization. The net realizable value is the estimatedfuture gross revenues from the product, reduced by the estimated futurecosts of completing the product.

Commencing upon product release, capitalized softwaredevelopment costs are amortized to software development amortization based onthe ratio of current revenues to total projected revenues. If actual 

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revenues, or revised projected revenues, fall belowthe initial projections, the charge to software development amortization may belarger than anticipated in any given quarter. As of March 31, 2006, thenet carrying value of our software development was $109.1 million.

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

*Goodwill.**  *Weperform our annual review for goodwill impairment during the quarters ending June 30,or more frequently if indicators of potential impairment exist. We performedour goodwill impairment review for the quarters ended June 30, 2005 and June 30,2004, and in both reviews we found no impairment. Our impairment review processis based on a discounted future cash flow approach that uses our estimates ofrevenue for the reporting units, driven by anticipated success of our productsand product release schedules, and estimated costs as well as appropriatediscount rates. These estimates are consistent with the plans and estimatesthat we use to manage the underlying businesses. We performed similarimpairment tests for indefinite-lived intangible assets and found no impairment.The success of our products is affected by the ability to accurately predictwhich platforms and which products we develop will be successful. Also, ourrevenues and earnings are dependent on our ability to meet our product releaseschedules. Due to these and other factors described in “Item 1A Risk Factors”we may not realize the future net cash flows necessary to recover our goodwill.

Based on these judgments and assumptions, we determinewhether we need to take an impairment charge to reduce the value of thegoodwill and indefinite-lived intangible assets stated on our balance sheets toreflect their estimated fair values. Judgments and assumptions about futurevalues are complex and often subjective. They can be affected by a variety offactors, including, but not limited to, significant negative industry oreconomic 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. Althoughwe believe the judgments and assumptions we have made in the past have beenreasonable and appropriate, there is nonetheless a high degree of uncertaintyand judgment involved.

We continue to encounter the risks and difficultiesfaced with launching or acquiring a new business. When the business is adevelopment studio, we look for ways to maximize the talent and intellectualproperty within the studio. We make judgments and assumptions as to thecommercial success and quantity of games developed by a particular studio. Differentjudgments and assumptions could materially impact our reported financialresults. For example, if we do not develop games with the same commercialsuccess or the same number of games as we have estimated, we may need to takean impairment charge against goodwill in the future. More conservativeassumptions of the anticipated future benefits from these businesses wouldresult in lower fair values which could result in impairment charges, whichwould decrease net income and result in lower asset values on our balancesheets. Conversely, less conservative assumptions would result in higher fairvalues which could result in lower impairment charges and higher net income.

*Income taxes.**  *As partof the process of preparing our consolidated financial statements, we arerequired to estimate our income taxes in each of the jurisdictions in which weoperate. This process involves: (1) estimating our current tax exposure ineach jurisdiction including the impact, if any, of changes or interpretationsto applicable tax laws and regulations, (2) estimating additional taxesresulting from tax examinations and (3) making judgments regarding therecoverability of deferred tax assets. To the extent recovery of deferred taxassets is not likely based on our estimates of future taxable income in eachjurisdiction, a valuation allowance is established.

The calculation of our tax liabilities involvesdealing with uncertainties in the application of complex tax regulations. Werecognize liabilities for anticipated tax audit issues in the U.S. and othertax jurisdictions 

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based on our estimate of whether, and the extent towhich, additional taxes will be due. Our estimate for the potential outcome forany uncertain tax issue, including our recent claim for research anddevelopment income tax credits, requires judgment. We believe we haveadequately provided for any reasonably foreseeable outcome related to thesematters. However, our future results may include favorable or unfavorableadjustments to our estimated tax liabilities in the period the assessments aremade or resolved or when statutes of limitation on potential assessmentsexpire.

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

**Recently IssuedAccounting Pronouncements**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment”(“SFAS No. 123R”), a revision of SFAS No. 123. SFAS No. 123Rrequires companies to, among other things, measure all employee stock-basedcompensation awards using a fair value method and record the expense in thecompany’s consolidated financial statements. The provisions of SFAS No. 123R,SEC Staff Accounting Bulletin (“SAB”) No. 107, “Share-Based Payment”and other related clarifying pronouncements, are effective no later than thebeginning of the next fiscal year that begins after June 15, 2005. We willadopt the new requirements in our fiscal year beginning April 1, 2006using the modified prospective transition method, wherein prior period amountswill not be restated. In addition to the recognition of expense in thefinancial statements, under SFAS No. 123R, any excess tax benefitsreceived upon exercise of options will be presented as a financing activityinflow rather than as an adjustment of operating activity as currentlypresented. Based on our current analysis and information, management hasdetermined the adoption of SFAS No. 123R will have a material impacton our consolidated results of operations and earnings per share. We expect theadoption of SFAS No. 123R will result in amounts that are similar to our currentpro forma disclosures under SFAS No. 123.

In November 2005, the FASB issued Staff Position No. FAS 115-1,“The Meaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments” (“FSP No. 115-1”). FSP No. 115-1provides accounting guidance for identifying and recognizingother-than-temporary impairments of debt and equity securities, as well as costmethod investments in addition to disclosure requirements. FSP No. 115-1is effective for reporting periods beginning after December 15, 2005, andearlier application is permitted. We adopted FSP No. 115-1 inour fiscal fourth quarter beginning January 1, 2006, and this adoption didnot have a material impact on our consolidated results of operations andearnings per share.

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**Results ofOperations**

**Comparison ofFiscal 2006 to Fiscal 2005**

Our net income for fiscal2006 was $34.3 million, or $0.52 per diluted share, as compared to $62.8million, or $1.04 per diluted share in the prior fiscal year.

**Net Sales**

We derive revenue principally from sales of packagedinteractive software games designed for play on video game consoles, handhelddevices and personal computers. We also derive revenue through downloads bymobile phone users of our wireless content.

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

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

 

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

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

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

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

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

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

·       These items were partiallyoffset by lower fiscal 2006 sales of titles based on two of our key brands: *The Incredibles: Rise of the Underminer*and *SpongeBob SquarePants: Lights, Camera, PANTS!* as compared tofiscal 2005 releases: *The Incredibles*and *The SpongeBob SquarePants Movie,* whichwere released in conjunction with their respective movie releases.

*North America*

Year-over-year net sales growth in North America wasprimarily due to sales of original, owned properties targeted to the coregamer, *Destroy All Humans!*and *Juiced*, sales of games based on our WWE SmackDown vs. Rawfranchise on current generation console platforms as well as the first-timerelease of the WWE SmackDown vs. Raw franchise on PSP. These items werepartially offset by lower fiscal 2006 sales of *TheIncredibles: Rise of the Underminer*and *SpongeBobSquarePants: Lights, Camera, PANTS!* as 

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compared to fiscal 2005 releases of *The Incredibles* and *The SpongeBob SquarePantsMovie,* which were released in conjunction with their respectivemovie releases.

While we expect net salesin North America to continue to constitute the largest portion of our net salesin fiscal 2007, we expect net sales for North America as a percentage of totalsales to decrease slightly as we continue to expand our international directsales and product mix.

*International*

Year-over-year international net sales growth wasprimarily due to increased sales of our original, owned properties targeted tothe core gamer, *Juiced* and *Destroy AllHumans!*, as compared to *Full Spectrum Warrior*and *The Punisher* in the prior fiscal year,as well as increased sales of games based on our WWE SmackDown vs. Rawfranchise on current generation console platforms and the first-time release ofthe WWE SmackDown vs. Raw franchise on PSP. These items were partially offsetby lower fiscal 2006 sales of *The Incredibles: Rise ofthe Underminer*and *SpongeBob SquarePants:Lights, Camera, PANTS!* as compared to fiscal 2005 releases of *The Incredibles* and*The SpongeBob SquarePantsMovie*, which were released in conjunction with their respectivemovie releases.

Changes in foreign currency rates reduced reportedinternational net sales by $11.4 million or 3% in fiscal 2006, as compared tothe prior fiscal year. Excluding the impacts of foreign exchange rates,international net sales increased by 15% in fiscal 2006.

We will continue to focuson growing sales internationally in fiscal 2007, as we expand our productportfolio and direct sales forces in the international markets. In early 2006,we established offices in Denmark and Japan to facilitate direct sales of ourproducts into the Nordic territories and the Japanese market. We plan to expandour direct sales force into Italy and Eastern Europe and we continue to exploreopportunities in Asia, especially China.

**Net Sales byPlatform**

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

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

 

**Console Platforms**

Net sales for console platforms increased 7% forfiscal 2006 as compared to the prior fiscal year. We released 31 and 30 new consoleSKUs in fiscal 2006 and 2005, respectively.

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***Sony PlayStation 2Net Sales (in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $296,294                                      |       |                              | 36.7       | %                                             |       |                              | $          | 275,850           |       |   |   | 36.5 | % |   |   | 7.4 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

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

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

·       highersales of *WWE SmackDown! vs. Raw 2006*as comparedto the prior year release of *WWE SmackDown! vs. Raw;*

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

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

Sonyannounced it would release its next-generation console, PlayStation 3, in November 2006.We expect sales of games for PlayStation 2 to decline in the future as consumerdemand shifts to PlayStation 3.

***Microsoft Xbox andXbox 360 Net Sales (in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $102,660                                      |       |                              | 12.7       | %                                             |       |                              | $          | 80,623            |       |   |   | 10.7 | % |   |   | 27.3 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

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

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

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

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

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

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

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

In November 2005,Microsoft launched its next-generation console, Xbox 360, in North America,Europe and Japan. We expect to release new SKUs in fiscal 2007 for Xbox 360. Asthe installed base of Xbox 360 hardware grows, we expect to bring more titlesto the platform, including games targeted to the core gamer such as our new,owned intellectual property *Saints Row*,titles based on our WWE license and agame based on Disney/Pixar’s *Cars*.We expect sales of games for Xbox to decline as consumer demand shiftsto games for the Xbox 360.

***Nintendo GameCubeNet Sales (in thousands)***

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

 

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

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

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

·       partiallyoffset by sales of our fiscal 2006 release of *Bratz: RockAngelz* with no comparable title in the prior fiscal year.

We expect net sales fromGameCube products to decline in fiscal 2007, as compared to fiscal 2006, due toa reduced SKU count and the upcoming launch of Nintendo’s next-generation console,Wii. We expect sales of games for GameCube to decline in the future as consumerdemand shifts to video games made for Wii.

**Handheld Platforms**

Net sales for handheldplatforms increased 16% for fiscal 2006 as compared to the prior fiscal year. Wereleased 22 and 20 new handheld SKUs in fiscal 2006 and 2005, respectively. BothNintendo and Sony have launched new handheld platforms, Dual Screen (“DS”) andPlayStation Portable (“PSP”), respectively. Consistent with our expectations,net sales of games for those new platforms increased in fiscal 2006, while netsales of games for Game Boy Advance declined.

***Nintendo Game BoyAdvance Net Sales (in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $171,477                                      |       |                              | 21.3       | %                                             |       |                              | $          | 204,348           |       |   |   | 27.0 | % |   |   | (16.1 | )% |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

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

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

·       strongprior year performance of *Sonic Advance 3*withouta comparable game released in fiscal 2006;

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

·       partiallyoffset by a 21% increase in sales of catalog titles, mainly Game Boy AdvanceDouble Packs.

We expect net sales fromthe Game Boy Advance products to decline in fiscal 2007, as compared to fiscal2006, due to a reduced SKU count as we expand our offerings to DS and PSP.

***Nintendo DualScreen Net Sales (in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $32,855                                       |       |                              | 4.1        | %                                             |       |                              | $          | 3,110             |       |   |   | 0.4 | % |   |   | 956.4 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2006, net sales of video games for DS wereprimarily driven by the release of *ZooTycoon, SpongeBob SquarePants: Yellow Avenger*and *TheIncredibles: Rise of the Underminer*. We released eight andone new SKUs in fiscal 2006 and 2005, respectively. Net sales increased by$29.7 million in fiscal 2006 as compared to the prior fiscal year. The increaseis due to the increased number of titles released in fiscal 2006 as compared tothe prior fiscal year.

As the installed base ofDS hardware grows, we expect to continue to bring more titles to the platform,including our market-leading family brands, games based on Disney/Pixar’s *Cars*,**and titlesbased on Nickelodeon properties such as *SpongeBobSquarePants* and *Nicktoons*.

***PlayStationPortable Net Sales (in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $29,406                                       |       |                              | 3.6        | %                                             |       |                              | $          | —            |       |   |   | — | % |   |   | 100.0 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

In fiscal 2006, net salesof video games for PSP were driven by the release of *WWESmackDown vs. Raw 2006*. We released four and zero new SKUs in fiscal2006 and fiscal 2005, respectively. As the installed base of PSP hardwaregrows, we expect to bring more titles to the platform, including ourmarket-leading family brands, games based on Disney/Pixar’s *Cars*,**and titlesbased on our own Juiced brand.

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***Wireless Net Sales(in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $36,112                                       |       |                              | 4.5        | %                                             |       |                              | $          | 24,613            |       |   |   | 3.3 | % |   |   | 46.7 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Wireless revenues consist of sales of wireless gamesand other content such as wireless wallpapers and ringtones. Through ourcontrolling interest in Minick Holding AG (“Minick”), we also derive wirelessrevenue by providing infrastructure services for the delivery of wirelesscontent and entertainment.

Wireless net sales increased by $11.5 million duringfiscal 2006 compared to the prior fiscal year. Our product content for wirelessdevices has grown significantly. The increase in wireless net sales reflectedsales of *Star Wars*, *SpongeBobSquarePants* and NFL based content, as well as the continuedgrowth in the installed base of data enabled wireless handsets with gamecapabilities.

We expect wireless netsales to increase in fiscal 2007, as compared to fiscal 2006, as the installedbase of data enabled wireless handsets with game capabilities continues to grow.In fiscal 2007, we plan to re-align our product portfolio to emphasize morecasual game content in order to position ourselves for wireless platform sharegains in the future.

***PC Net Sales (inthousands)***

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

 

In fiscal 2006, netsales of video games for PC were primarily driven by the release of *Warhammer 40,000: Dawn of War: Winter Assault*and *Juiced*, as well as catalog titles. In fiscal 2005, net salesof video games for PC were primarily driven by the release of *Warhammer 40,000: Dawn of War, The Incredibles, Full Spectrum Warrior*and*The SpongeBob SquarePants Movie*. Wereleased 11 and 12 new titles in fiscal 2006 and 2005, respectively. Net salesdecreased by $9.1 million in fiscal 2006 as compared to the prior fiscal yearprimarily due to:

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

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

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

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

We expect PC net sales toincrease in fiscal 2007, as compared to fiscal 2006, mainly due to our focus onreleasing high-end PC games targeted at the core gamer including:  *Company ofHeroes*, *Titan Quest*, *Supreme Commander*, and a mass-market title based onDisney/Pixar’s *Cars*.

***Other Net Sales***

Other net sales primarilyconsist of sales from older platforms. Fiscal 2006 and 2005 are primarily madeup of sales from Sony PlayStation products.

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

Our costs and expensesincreased by $90.0 million or 13% in fiscal 2006 compared to the prior fiscalyear, to $772.8 million, from $682.8 million. Costs and expenses as apercentage of net sales increased by six points to 96% in fiscal 2006 from 90%in the prior fiscal year. The increase in costs and expenses in fiscal 2006were primarily due to (i) higher catalog sales as a percentage of totalnet sales (ii) a change in development strategy for our WWE games whereinwe ceased internal product development for wrestling games and as a result wewrote-off the underlying capitalized software development costs to softwaredevelopment amortization and (iii) higher price protection and softwaredevelopment amortization for the current-generation title *Full SpectrumWarrior**TM:Ten Hammers*.

***Cost of  Sales (in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $287,946                                      |       |                              | 35.7       | %                                             |       |                              | $          | 255,187           |       |   |   | 33.7 | % |   |   | 12.8 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Cost of sales primarilyconsists of direct manufacturing costs net of manufacturer volume rebates anddiscounts. Cost of sales as a percentage of net sales increased for fiscal 2006as compared to the prior fiscal year, due to higher catalog sales as apercentage of total net sales in fiscal 2006, including reduced year over yearpricing primarily from our Game Boy Advanced Dual Packs.

***LicenseAmortization and Royalties (in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $80,508                                       |       |                              | 10.0       | %                                             |       |                              | $          | 85,926            |       |   |   | 11.4 | % |   |   | (6.3 | )% |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

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

***SoftwareDevelopment Amortization (in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $116,371                                      |       |                              | 14.4       | %                                             |       |                              | $          | 93,622            |       |   |   | 12.4 | % |   |   | 24.3 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Software developmentamortization consists of amortization of capitalized payments made tothird-party software developers and amortization of capitalized internal studiodevelopment costs. Software development is expensed at the higher of (1) thecontractual rate based on actual net product sales for such software or (2) aneffective rate based upon total projected revenue for such software. For fiscal2006 software development amortization as a percentage of net sales increasedby 2 points over the prior fiscal year primarily due to a change in ourdevelopment strategy for our WWE games wherein we ceased internal productdevelopment for wrestling games and as a result we wrote-off the underlyingcapitalized software development costs to software development amortization. Theincrease in software development amortization as a percent of net sales is alsodue to high software development amortization related to the performance of thecurrent-generation title *Full Spectrum Warrior: TenHammers* on Xbox.

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***Product Development(in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $84,242                                       |       |                              | 10.4       | %                                             |       |                              | $          | 72,959            |       |   |   | 9.6 | % |   |   | 15.5 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Product developmentexpense primarily consists of expenses incurred by internal development studiosand payments made to external development studios prior to products reachingtechnological feasibility. Product development expense increased by $11.3million in fiscal 2006 as compared to the prior fiscal year. This increase wasprimarily due to the expansion of our internal studios with the acquisitions ofJuice Games Limited and Vigil Games, LLC and with the formation of two newstudios, Kaos Studios and Incinerator Games. Product development expense alsoincreased due to spending on development of games for next-generationplatforms.

***Selling and Marketing(in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $123,552                                      |       |                              | 15.3       | %                                             |       |                              | $          | 110,514           |       |   |   | 14.6 | % |   |   | 11.8 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Selling and marketingexpense consists of personnel-related costs, advertising and promotionalexpenses. For fiscal 2006, selling and marketing expenses increased as apercentage of net sales as compared to the prior fiscal year. Selling andmarketing expenses increased in absolute dollars by $13.0 million for fiscal2006 compared to the prior fiscal year. This increase was primarily due topromotional efforts to support the launch of two new owned and originaltitles:  *Juiced*and *Destroy All Humans!*.

***Payment to VenturePartner (in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $12,572                                       |       |                              | 1.6        | %                                             |       |                              | $          | 9,774             |       |   |   | 1.3 | % |   |   | 28.6 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

The payment made toventure partner is related to the joint license agreement that THQ and JAKKSPacific, Inc. have with the WWE under which our role is to develop,manufacture, distribute, market and sell WWE video games. Payment to venturepartner increased by $2.8 million dollars in fiscal 2006 as compared to theprior fiscal year due to increases in net sales of games based upon the WWElicense. In fiscal 2006 we released *WWE SmackDown vs. Raw 2006*on PlayStation 2 and PlayStation Portable and in the prior fiscalyear we released *WWE SmackDown vs. Raw*onPlayStation 2.

***General andAdministrative (in thousands)***

| **Year Ended  March 31, 2006** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $67,615                                       |       |                              | 8.4        | %                                             |       |                              | $          | 54,831            |       |   |   | 7.2 | % |   |   | 23.3 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

General and administrativeexpenses consist of personnel and related expenses of executive andadministrative staff, fees for professional services such as legal andaccounting, depreciation and amortization, allowances for bad debts, foreignexchange transaction gains and losses, and facilities. General and administrativeexpenses increased by $12.8 million for fiscal 2006 as compared to the priorfiscal year. The increase in fiscal 2006 is primarily due to foreign exchangetransactions in the prior fiscal year, as well as growth in Europeanoperations, higher depreciation expense and higher amortization expense relatedto prior-year acquisitions.

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***Income Taxes***

The effective income taxrate was 19% for fiscal 2006 and fiscal 2005. The fiscal 2006 effective incometax rate benefited from the following factors: (1) a higher ratio ofresearch and development tax credits to pre-tax income and (2) a higherratio of tax exempt interest income to overall pre-tax income. If our pretaxincome was the same as the last fiscal year our effective tax rate would havebeen approximately 28%. The fiscal 2005 effective income tax rate benefitedfrom the following factors: (1) the recognition of $7.8 million ofresearch and development income tax credits claimed for prior years and(2) our estimate of fiscal 2005 year research and development income taxcredits. Excluding the one-time benefit of $7.8 million, our effectiveincome tax rate for fiscal 2005 would have been 29%.

***Minority Interest***

Minority interest reflectsthe income allocable to equity interests in Minick that are not owned by THQ.We own 50% of Minick’s outstanding common stock and control its board of directors.Minority interest included in our consolidated statement of operations was$63,000 for fiscal 2006 compared to $261,000 for fiscal 2005.

**Comparison ofFiscal 2005 to Fiscal 2004**

Net income for fiscal 2005was $62.8 million, or $1.04 per diluted share, as compared to $35.8 million, or$0.61 per diluted share in fiscal 2004.

**Net Sales**

We derive revenue principally from sales of packagedinteractive software games designed for play on video game consoles, handhelddevices and personal computers. We also derive revenue through downloads bymobile phone users of our wireless games.

Thefollowing table details our net sales by territory for fiscal 2005 and 2004 (inthousands):

| ** **              | ** ** | **Fiscal Year Ended March 31,** | ** ** | **Increase/** | ** ** | ** **     | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|---------------|------------|----------------|------------|
| ** **              | ** ** | **2005**                                            | ** ** | **2004**      | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| North America           |       | $                                                   | 470,619    |          | 62.2       | %              | $          | 453,426 |   | 70.8 | % | $ | 17,193 |   |   | 3.8 | % |   |
| Europe                  |       | 245,083                                             |       | 32.4          |       | 161,857        |       | 25.2 |   | 83,226 |   |   | 51.4 |   |   |
| Asia Pacific            |       | 41,029                                              |       | 5.4           |       | 25,563         |       | 4.0 |   | 15,466 |   |   | 60.5 |   |   |
| International           |       | 286,112                                             |       | 37.8          |       | 187,420        |       | 29.2 |   | 98,692 |   |   | 52.7 |   |   |
| Consolidated net  sales |       | $                                                   | 756,731    |          | 100.0      | %              | $          | 640,846 |   | 100.0 | % | $ | 115,885 |   |   | 18.1 | % |   |

 

Our consolidatednet sales in fiscal 2005 increased 18%over fiscal 2004, from $640.8 million to $756.7 million. The increase innet sales for fiscal 2005 was primarily attributable to the following factors:

·       Growthfrom our established licensed brands and franchises: Disney/Pixar, SpongeBobSquarePants and WWE SmackDown!, all performing better than the prior fiscalyear. Two of the titles this fiscal year, Disney/Pixar’s *The Incredibles*and *The SpongeBob SquarePants Movie*, werebased upon holiday movies.

·       The successful launch ofnew properties targeted to the core gamer and high-end PC market: *Full Spectrum Warrior* on Xbox, PlayStation2, and PC, *The Punisher* on Xbox, PlayStation2 and PC, and *Warhammer 40,000: Dawn of War* on PC.

·       International net salesincreased 53% in fiscal 2005 as compared to fiscal 2004 primarily due to (i) ourcontinued sales and marketing expansion in the international markets, (ii) contentthat has 

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more international appeal,(iii) growth of the installed base for current generation console andhandheld platforms, and (iv) the strengthening of foreign exchange rates.

·       The continued success ofthe fiscal 2004 releases of Disney/Pixar’s *Finding Nemo*and *SpongeBob SquarePants: Battle for Bikini Bottom*whichshipped two million and one million units, respectively, in fiscal 2005*.*

*North America*

Year-over-year net salesgrowth in North America was primarily due to sales of *TheSpongeBob SquarePants Movie* game, which was released in conjunctionwith the holiday movie; sales of *Full Spectrum Warrior*and *The Punisher;* and strong sales of ourcatalog titles in fiscal 2005. These items were partially offset by the releaseof a significantly fewer number of SKUs in fiscal 2005 than in fiscal 2004.

*International*

Year-over-year international net sales growth wasprimarily due to increased sales of each of our three products targeted at themass-market in fiscal 2005 as compared to sales of titles from the same brandsin fiscal 2004; and stronger sales of our three key original products targetedat the core gamer in fiscal 2005 than our two key titles in fiscal 2004.

In addition to sales ofour products, the strengthening of foreign exchange rates, primarily the GreatBritish Pound (“GBP”) and the European Currency Unit (“Euro”), increasedreported international net sales by $19.5 million in fiscal 2005. Excluding theimpacts of foreign exchange rates, international net sales increased by 42%.

**Net Sales byPlatform**

Ourworldwide net sales by platform for fiscal 2005 and fiscal 2004 are as follows(in thousands):

| ** **                | ** ** | **Fiscal Year Ended March 31,** | ** ** | **Increase/** | ** ** | ** ** | ** ** |
|---------------------------|------------|-----------------------------------------------------|------------|---------------|------------|------------|------------|
| **Platform**              | ** ** | ** **                                          | ** ** | **2005**      | ** ** | **2004**   | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| **Consoles**              | ** ** | ** **                                          | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Sony PlayStation 2        |       | $                                                   | 275,850    |          | 36.5       | %          | $          | 247,603 |   | 38.6 | % | $ | 28,247 |   |   | 11.4 | % |   |
| Microsoft Xbox            |       | 80,623                                              |       | 10.7          |       | 71,132     |       | 11.1 |   | 9,491 |   |   | 13.3 |   |   |
| Nintendo GameCube         |       | 73,157                                              |       | 9.7           |       | 61,356     |       | 9.6 |   | 11,801 |   |   | 19.2 |   |   |
|                      |       | 429,630                                             |       | 56.9          |       | 380,091    |       | 59.3 |   | 49,539 |   |   | 13.0 |   |   |
| **Handheld**              | ** ** | ** **                                          | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Nintendo Game Boy Advance |       | 204,348                                             |       | 27.0          |       | 162,109    |       | 25.3 |   | 42,239 |   |   | 26.1 |   |   |
| Nintendo Dual Screen      |       | 3,110                                               |       | 0.4           |       | -          |       | - |   | 3,110 |   |   | 100.0 |   |   |
| Wireless                  |       | 24,613                                              |       | 3.3           |       | 6,860      |       | 1.1 |   | 17,753 |   |   | 258.8 |   |   |
|                      |       | 232,071                                             |       | 30.7          |       | 168,969    |       | 26.4 |   | 63,102 |   |   | 37.3 |   |   |
| **PC**                    |       | 86,667                                              |       | 11.5          |       | 74,934     |       | 11.7 |   | 11,733 |   |   | 15.7 |   |   |
| **Other**                 |       | 8,363                                               |       | 0.9           |       | 16,852     |       | 2.6 |   | (8,489 | ) |   | (50.4 | ) |   |
| **Net Sales**             |       | $                                                   | 756,731    |          | 100.0      | %          | $          | 640,846 |   | 100.0 | % | $ | 115,885 |   |   | 18.1 | % |   |
|                           |            |                                                     |            |               |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Consoles**

Net sales for consoleplatforms increased by $49.5 million, or 13%, for fiscal 2005 compared tofiscal 2004. During fiscal 2005 we released 30 console titles, compared to 44console titles released during fiscal 2004.

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***Sony PlayStation 2Net Sales (in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $275,850                                      |       |                              | 36.5       | %                                             |       |                              | $          | 247,603           |       |   |   | 38.6 | % |   |   | 11.4 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Net sales of videogames for PlayStation 2 increased by $28.2 million for fiscal 2005 as comparedto fiscal 2004. PlayStation 2 net sales in fiscal 2005 were primarily drivenby:

·       newreleases of Disney/Pixar’s *The Incredibles*, *TheSpongeBob SquarePants Movie* and *WWE SmackDown! vs. Raw*;

·       salesof titles based on original properties *Full Spectrum Warrior*,*MX v. ATV Unleashed*, *The Punisher* and *Tak 2: The Staff of Dreams*;

·       catalogsales of *WWE SmackDown! Here Comes The Pain*,Disney/Pixar’s *Finding Nemo*, *SpongeBob SquarePants: Battle for Bikini Bottom*, *Tak and the Power of Juju* and *MX Unleashed*.

PlayStation 2 netsales in fiscal 2004 were primarily driven by:

·       salesof Disney/Pixar’s *Finding Nemo*, *SpongeBob SquarePants: Battle for Bikini Bottom* and *WWE SmackDown! Here Comes the Pain*; and

·       salesof original titles *MX Unleashed*and *Tak and the Power of Juju*.

The increase in sales ofgames for PlayStation 2 in fiscal 2005 was primarily attributable to strongersales of our three key products targeted at the mass-market in fiscal 2005 aswell as sales of *The Punisher* and our catalogtitles. These increases were partially offset by the release of fewer games infiscal 2005; we released 14 new SKUs in fiscal 2005 and 17 new SKUs in theprior fiscal year. A SKU is a version of a title designed for play on aparticular platform.

***Microsoft Xbox NetSales (in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $80,623                                       |       |                              | 10.7       | %                                             |       |                              | $          | 71,132            |       |   |   | 11.1 | % |   |   | 13.3 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Net sales of videogames for Xbox increased by $9.5 million for fiscal 2005, as compared to fiscal2004. Net sales in fiscal 2005 were driven by:

·       salesof original properties including *Full Spectrum Warrior*,*MX v. ATV Unleashed* and *The Punisher*;

·       salesof Disney/Pixar’s *The Incredibles* and *TheSpongeBob SquarePants Movie*;and

·       strongcatalog sales.

Net sales in fiscal2004 were driven by:

·       the release of titles based on our three keymass-market brands: Disney/Pixar’s *Finding Nemo, SpongeBobSquarePants: Battle for Bikini Bottom* and *WWE Raw 2*; and

·       salesof *MotoGP 2* and *MX Unleashed*.

The increase in net salesfor Xbox in fiscal 2005 from fiscal 2004 was primarily attributable to sales of*Full Spectrum Warrior,* partially offsetby the release of more games in fiscal 2004. We released 8 SKUs during fiscal2005 compared to 16 SKUs during fiscal 2004.

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***Nintendo GameCubeNet Sales (in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $73,157                                       |       |                              | 9.7        | %                                             |       |                              | $          | 61,356            |       |   |   | 9.6 | % |   |   | 19.2 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Net sales of videogames for GameCube increased by $11.8 million for fiscal 2005, as compared tofiscal 2004. Net sales in fiscal 2005 were driven by:

·       salesof mass market titles including Disney/Pixar’s *The Incredibles*, *The SpongeBob SquarePants Movie*, and *WWEDay of Reckoning*;

·       salesof original properties including *Tak 2: The Staff ofDreams;* and

·       strongcatalog sales, specifically Disney/Pixar’s *Finding Nemo*and *SpongeBob SquarePants: Battle for Bikini Bottom*.

Net sales in fiscal2004 were driven by:

·       sales of key mass market brands:Disney/Pixar’s  *Finding Nemo*, *SpongeBob SquarePants: Battle for Bikini Bottom* and *WWETM Wrestlemania X9*®; and

·       salesof *Tak and the Power of Juju*.

The increase in net sales for GameCube in fiscal 2005was due to increased sales of our three mass market titles as well as strongcatalog sales.

We released 8 SKUs duringfiscal 2005 compared to 11 SKUs during fiscal 2004.

**Handheld Platforms**

Another factor thatpositively impacted net sales for fiscal 2005 was an increase in sales of videogames for handheld platforms, which increased 37%, to $232.1 million in fiscal2005 from $169.0 million during fiscal 2004.

***Nintendo Game BoyAdvance Net Sales (in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $204,348                                      |       |                              | 27.0       | %                                             |       |                              | $          | 162,109           |       |   |   | 25.3 | % |   |   | 26.1 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Net sales of videogames for Game Boy Advance in fiscal 2005 were primarily driven by:

·       strongsales of Disney/Pixar’s *The Incredibles*, *TheSpongeBob SquarePants Movie*and *Sonic Advance3*;

·       strongcatalog sales, in particular Disney/Pixar’s *Finding Nemo*, *SpongeBob SquarePants: Battle for Bikini Bottom* and *Scooby-Doo! Monsters Unleashed*; and

·       strongsales of other key titles, such as *Finding Nemo: TheContinuing Adventures* and *Tak2: The Staff of Dreams*.

Net sales of videogames for Game Boy Advance in fiscal 2004 were primarily driven by:

·       Disney/Pixar’s *Finding Nemo*and, *SpongeBob SquarePants: Battle for Bikini Bottom*;and

·       strongsales of *Banjo Kazooie*, *Scooby-Doo!:Mystery Mayhem*, *Simpsons Road Rage*,*Sonic Battle* and *Tak and thePower of Juju* as well as strong catalog sales of *Sonic Advance 2*.

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The increase in sales of video games for Game BoyAdvance in fiscal 2005 was primarily attributable to increased sales of ourDisney/Pixar and SpongeBob SquarePants brands as compared to sales of thosebrands in fiscal 2004, as well as strong catalog sales in fiscal 2005 ascompared to fiscal 2004. These increases were partially offset by the releaseof fewer titles in fiscal 2005 as compared to fiscal 2004. We released 19 SKUs during fiscal 2005compared to 33 SKUs during fiscal 2004.

***Nintendo Dual Screen.****  *We released *PingPals* for the Nintendo DS portable game system (“Nintendo DS”) in December 2004.

***Wireless Net Sales(in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $24,613                                       |       |                              | 3.3        | %                                             |       |                              | $          | 6,860             |       |   |   | 1.1 | % |   |   | 258.8 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Wireless revenues consist primarily of sales ofwireless games, ringtones and wallpapers. Through our controlling interest inMinick, we also derive wireless revenue by providing SMS voting, informationand wireless marketing campaigns.

Wireless net salesincreased by $17.8 million during fiscal 2005 compared to fiscal 2004. Theincrease in wireless net sales was due to:

·       strongsales of games based on major sports leagues, Nickelodeon, and Moto GP;

·       ouracquisition of the controlling interest in Minick; and

·       increased installed base ofwireless handsets with game capabilities in the wireless gaming market.

***PC Net Sales (inthousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $86,667                                       |       |                              | 11.5       | %                                             |       |                              | $          | 74,934            |       |   |   | 11.7 | % |   |   | 15.7 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Net sales of PCproducts increased to $86.7 million for fiscal 2005 from $74.9 million infiscal 2004, an increase of 16%. PC sales in fiscal 2005 were primarily drivenby:

·       salesof products targeted at the core gamer *Full Spectrum Warrior*and *Warhammer 40,000: Dawn of War*;

·       salesof Disney/Pixar’s *The Incredibles* and *The SpongeBob SquarePants Movie*; and

·       strongcatalog sales.

The increase in fiscal 2005 compared to fiscal 2004was primarily due to *Full Spectrum Warrior*and*Warhammer 40,000: Dawn of War*. Infiscal 2004, sales were primarily driven by the strong performance of Disney/Pixar’s *Finding Nemo* and  international sales of *Broken Sword3.*

Additionally, we released 67 PC titles published byour ValuSoft division, including *World Poker Championship,*duringfiscal 2005, and we released 52 PC titles published from our ValuSoft divisionin fiscal 2004. 

***Other Net Sales.******  ***Other net sales primarilyconsist of sales from older platforms. Fiscal 2005 and 2004 are primarily madeup of sales from Sony PlayStation products.

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

Our costs and expensesincreased in fiscal 2005 to $682.8 million, from $592.0 million in fiscal 2004;however, total costs and expenses as a percentage of net sales decreased from92% of net sales to 90% of net sales. As a percentage of net sales, thegreatest increase in costs were due to product development expenses as we morethan doubled the size of our internal product development organization,aggressively ramped up development of next-generation console games andincreased development of wireless games.

***Cost of Sales (inthousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $255,187                                      |       |                              | 33.7       | %                                             |       |                              | $          | 234,574           |       |   |   | 36.6 | % |   |   | 8.8 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Cost of sales primarilyconsists of direct manufacturing costs net of manufacturer volume rebates anddiscounts. Cost of sales as a percentage of net sales decreased for fiscal 2005as compared to fiscal 2004, primarily due to lower average manufacturing costsacross all platforms and higher average selling price of Game Boy Advance andPC products.

***LicenseAmortization and Royalties (in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $85,926                                       |       |                              | 11.4       | %                                             |       |                              | $          | 71,132            |       |   |   | 11.1 | % |   |   | 20.8 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

License amortization androyalties expense consists of royalty payments due to licensors, which areexpensed at the higher of (1) the contractual royalty rate based on actualnet product sales for such license or (2) an effective rate based upontotal projected revenue for such license. For fiscal 2005, license amortizationand royalties as a percentage of net sales remained relatively flat as comparedto fiscal 2004. This is primarily due to our top three selling brands—Disney/Pixar,SpongeBob SquarePants and WWE licensing amortization rates by brand remainingrelatively constant for fiscal 2005 and 2004. 

***SoftwareDevelopment  Amortization (in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $93,622                                       |       |                              | 12.4       | %                                             |       |                              | $          | 105,632           |       |   |   | 16.5 | % |   |   | (11.4 | )% |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Software developmentamortization consists of amortization of capitalized payments made to third-partysoftware developers and amortization of capitalized internal studio developmentcosts. Software development costs are expensed at the higher of (1) thecontractual rate based on actual net product sales for such software or (2) aneffective rate based upon total projected revenue for such software. For fiscal2005 software development amortization as a percentage of net sales decreasedas compared to fiscal 2004 primarily due to our strategy of bringing thedevelopment of games based upon our core franchises, such as Disney/Pixar’s*The Incredibles*, in-house, as compared toDisney/Pixar’s*Finding Nemo*,which was externally developed. Also, the effective amortization rate for *The SpongeBobSquarePants Movie* released in fiscal 2005 was lower as compared tothe amortization rate for *SpongeBobSquarePants: Battle for Bikini Bottom* released in fiscal 2004 as wewere able to leverage the technology developed on the fiscal 2004 title. Further,in fiscal 2004 we had high development costs associated with creating *Sphinx**and the**Cursed Mummy*, an original brand for which we did not developa title in fiscal 2005. 

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***ProductDevelopment  (in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $72,959                                       |       |                              | 9.6        | %                                             |       |                              | $          | 36,850            |       |   |   | 5.8 | % |   |   | 98.0 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Product developmentexpense primarily consists of expenses incurred by internal development studiosand payments made to external development studios prior to products reachingtechnological feasibility. For fiscal 2005, product development expensesincreased by $36.1 million from fiscal 2004. This increase was primarily due tothe following factors: (1) a significant increase in internal developmentheadcount to approximately 900 from 400 compared to fiscal 2004 due in part tothe acquisitions of Relic and Blue Tongue and the formation of Concrete Games, (2) spendingon development for games for next-generation platforms, and (3) increasedspending on product development for our wireless content as we continue toincrease our wireless product offerings.

***Selling andMarketing (in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $110,514                                      |       |                              | 14.6       | %                                             |       |                              | $          | 87,119            |       |   |   | 13.6 | % |   |   | 26.9 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

Selling and marketingexpense consists of personnel-related costs, advertising and promotionalexpenses. For fiscal 2005, selling and marketing expenses increased as apercentage of net sales as compared to fiscal 2004. Selling and marketingexpenses increased in absolute dollars by $23.4 million for fiscal 2005compared to fiscal 2004. This increase was primarily due to promotional effortsto support the new releases of original titles *The Punisher*and *Full Spectrum Warrior*, as well asDisney/Pixar’s*The Incredibles, TheSpongeBob SquarePants Movie,*and*WWE SmackDown! vs. Raw*, and other releases. 

***Payment to VenturePartner (in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $9,774                                        |       |                              | 1.3        | %                                             |       |                              | $          | 9,675             |       |   |   | 1.5 | % |   |   | 1.0 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

The payment made to venture partner is related to thejoint license agreement that THQ and JAKKS Pacific, Inc. have with the WWEunder which our role is to develop, manufacture, distribute, market and sellWWE video games. Payment to venture partner increased slightly in absolute dollarsfor fiscal 2005 compared to fiscal 2004. The increase is in direct relation tothe increases in sales of games based upon the WWE license in fiscal 2005 ascompared to fiscal 2004. 

***General andAdministrative (in thousands)***

| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| $54,831                                       |       |                              | 7.2        | %                                             |       |                              | $          | 47,006            |       |   |   | 7.3 | % |   |   | 16.6 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |

 

General and administrativeexpenses consist of personnel and related expenses of executive andadministrative staff, fees for professional services such as legal andaccounting, depreciation and amortization, allowances for bad debts, foreignexchange transaction gains and losses, and facilities. General andadministrative expenses increased by $7.8 million for fiscal 2005 as comparedto fiscal 2004. Fiscal 2004 included a charge of $7.0 million for doubtfulaccounts related to KB Toys’ bankruptcy filing. Excluding this $7.0 millionexpense, general and administrative expenses increased by $14.8 million for 

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fiscal 2005 as compared tofiscal 2004. The increase is primarily attributable to growth in ourinternational and wireless operations, as well as Sarbanes-Oxley compliance andprofessional fees. In addition, the increase also includes $1.5 million ofamortization expense for intangible assets obtained through the fiscal 2005acquisitions of Relic and Blue Tongue, and the acquisition of a controllinginterest in Minick during fiscal 2005.

***Other* Income**

Other income for fiscal2004 consisted of a $4.0 million settlement of a dispute we had with ourdirectors’ and officers’ insurance carrier related to a previous securitieslitigation settlement.

***Income Taxes***

The effective income taxrate was 19% for fiscal 2005 compared to 35% for fiscal 2004. The fiscal 2005effective income tax rate benefited from the following two factors: (1) therecognition of $7.8 million of research and development income tax creditsclaimed for prior years and (2) our estimate of current fiscal yearresearch and development income tax credits. Excluding the one-time benefit of$7.8 million, our effective income tax rate for fiscal 2005 would have been29%.

***Minority Interest***

Minority interest reflects the income allocable toequity interests in Minick which are not owned by THQ. In April 2004, wepurchased an additional 25% of the outstanding common stock of Minick, bringingus to a 50% ownership interest and control of Minick’s board of directors. As aresult of this transaction, we began consolidating the balance sheet, statementof operations and cash flows of Minick. Minority interest included in ourconsolidated statement of operations was $261,000 for fiscal 2005 compared tozero for fiscal 2004.

**Liquidity and Capital Resources**

| ** **                                        | ** ** | **March 31, 2006** | ** ** | **March 31, 2005** | ** ** | **Change** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|------------|------------|
| **(In thousands)**                           | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash  equivalents                        |       |                         | $          | 91,517                       |       |       |       | $ | 98,175 |   |   | $ | (6,658 | ) |
| Short-term  investments                           |       |                         | 280,120    |                         |       |       | 232,998    |   |   | 47,122 |   |
| Cash, cash equivalents and short-term investments |       |                         | $          | 371,637                      |       |       |       | $ | 331,173 |   |   | $ | 40,464 |   |
| Percentage of  total assets                       |       |                         | 44         | %                            |       |       | 44         | % |   |   |   |
|                                                   |            |                              |            |                              |            |            |            |  |  |  |  |  |  |  |  |  |

 

| ** **                                            | ** ** | **Year Ended March 31,** | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------|------------|------------|------------|
| ** **                                            | ** ** | **2006**                                | ** ** | **2005**   | ** ** | **Change** | ** ** |
| **(In thousands)**                               | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash provided by  operating activities                | ** ** | $                                       | 42,789     |       | $          | 60,455 |   | $ | (17,666 | ) |
| Cash used in  investing activities                    |       | (85,882                                 | )          | (77,891    | )          | (7,991 | ) |
| Cash provided by  financing activities                |       | 37,787                                  |       | 33,764     |       | 4,023 |   |
| Effect of  exchange rate changes on cash              |       | (1,352                                  | )          | 605        |       | (1,957 | ) |
| Net increase  (decrease) in cash and cash equivalents |       | $                                       | (6,658     | )          | $          | 16,933 |   | $ | (23,591 | ) |
|                                                       |            |                                         |            |            |            |  |  |  |  |  |  |  |

 

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*Cash Flow from OperatingActivities.**  *Ourprincipal source of cash is from sales of interactive software games designedfor play on video game consoles, handheld devices and personal computers. Ourprincipal uses of cash are for product purchases**of discs and cartridges along with associated manufacturer’sroyalties, payments to external developers and licensors, the costs of internalsoftware development and selling and marketing expenses.

Cash provided by operatingactivities decreased by approximately $17.7 million in fiscal 2006 as comparedto fiscal 2005. The decrease was mainly due to lower net income in fiscal 2006as well as higher spending for software development, higher payments of accruedexpenses, partially offset by lower cash spending for licenses. We expect togenerate positive operating cash flow for the full fiscal year 2007.

*Cash Flow from InvestingActivities.**  *Cashused in investing activities increased by approximately $8.0 million infiscal 2006 as compared to fiscal 2005, primarily due to an increase in theamount of net disbursements from purchases and sales of short-term investments,an increase in purchases of property and equipment, offset by a decrease inacquisition related activity.

*Cash Flow from FinancingActivities.**  *Cashprovided by financing activities increased by approximately $4.0 million infiscal 2006 as compared to fiscal 2005, primarily due to a reduction in theamount paid for repurchases of our common stock offset by a decrease in cashprovided by the exercise of stock options. We did not repurchase any of ourcommon stock in fiscal 2006 and had $9.1 million of stock repurchases in fiscal2005.

In fiscal 2007, we expectto generate more cash than we did in fiscal 2006. The increase in thegeneration of cash will be primarily attributable to higher net income.

***Key Balance Sheet Accounts***

*Accounts Receivable.*   Accountsreceivable increased $5.2 million in fiscal 2006, from $73.7 million at March 31,2005 to $78.9 million at March 31, 2006. The increase in net accountsreceivable is primarily due the timing of our fourth quarter product releases. Allowancesfor price protection, returns and doubtful accounts were $57.8 million as of March 31,2006, a $0.3 million increase from March 31, 2005. Allowances for priceprotection and returns as a percentage of trailing nine month net sales were 8%and 7% as of March 31, 2006 and 2005, respectively. While the allowance asa percent of trailing nine month net sales increased in North America due tohigher than expected price protection related to the release of *Full Spectrum Warrior: Ten Hammers*, this title was notreleased internationally and the allowance as a percent of trailing nine monthnet sales actually decreased internationally. We believe our current reservesare adequate based on historical experience, inventory remaining in the retailchannel and the rate of inventory sell-through in the retail channel.

*Inventory.**  *Inventory increased $4.8 million in fiscal 2006, from$23.8 million at March 31, 2005 to $28.6 million at March 31,2006. The increase in inventory is primarily due to the growth of our businessand to a lesser extent the timing of our product releases and the timing ofproduct reorders.

*Licenses.**  *Licenses decreased $6.5 million in fiscal 2006, from$88.0 million at March 31, 2005 to $81.5 million at March 31,2006. The decrease in licenses is due to license amortization in excess ofnewly acquired licenses during fiscal 2006.

*Software Development.**  *Software development increased $43.8 million infiscal 2006, from $65.3 million March 31, 2005 to $109.1 million March 31,2006. The increase in software development is primarily the result of ourinvestment in next generation titles with higher development costs which arescheduled to be released in fiscal 2007 and beyond.

*Accrued and Other CurrentLiabilities.**  *Accruedand other current liabilities increased $31.9 million in fiscal 2006, from$77.5 million at March 31, 2005 to $109.4 million at March 31, 2006. Theincrease in accrued and other current liabilities is primarily due to movementof accrued royalties from long-term into 

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short-term as theyare expected to be paid out within a year as well as an increase in amounts dueto third-party developers for the production of our games.

***Inflation***

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

***Financial Condition***

We believe the existingcash, cash equivalents, short-term investments, and cash generated fromoperations will be sufficient to meet our operating requirements for at leastthe next twelve months, including working capital requirements, capitalexpenditures and potential future acquisitions or strategic investments. We maychoose at any time to raise additional capital to strengthen our cash position,facilitate expansion, pursue strategic investments or to take advantage ofbusiness opportunities as they arise.

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

***Guarantees and Commitments***

Asummary of annual minimum contractual obligations and commercial commitments asof March 31, 2006 is as follows (in thousands): 

| ** **                                | ** ** | **Contractual Obligations and Commercial Commitments** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **FiscalYears Ending**March 31, | ** ** | ** **                                                                 | ** ** | **License /**SoftwareDevelopment  Commitments(1) | ** ** | **Advertising(2)** | ** ** | **Leases(3)** | ** ** | **Letters of  Credit(4)** | ** ** | **Other(5)** | ** ** | **Total** | ** ** |
| 2007                                      |       |                                                                       | $          | 97,558 |   |   |   | $ | 21,762 |   |   |   | $ | 11,332 |   |   |   | $ | 7,563 |   |   |   | $ | 1,463 |   |   | $ | 139,678 |   |
| 2008                                      |       |                                                                       | 39,102     |   |   |   | 14,616 |   |   |   | 11,595 |   |   |   | — |   |   |   | — |   |   | 65,313 |   |
| 2009                                      |       |                                                                       | 39,613     |   |   |   | 13,184 |   |   |   | 11,189 |   |   |   | — |   |   |   | — |   |   | 63,986 |   |
| 2010                                      |       |                                                                       | 37,000     |   |   |   | 9,777 |   |   |   | 10,812 |   |   |   | — |   |   |   | — |   |   | 57,589 |   |
| 2011                                      |       |                                                                       | 22,000     |   |   |   | 9,777 |   |   |   | 10,137 |   |   |   | — |   |   |   | — |   |   | 41,914 |   |
| Thereafter                                |       |                                                                       | —     |   |   |   | — |   |   |   | 28,779 |   |   |   | — |   |   |   | — |   |   | 28,779 |   |
|                                      |       |                                                                       | $          | 235,273 |   |   |   | $ | 69,116 |   |   |   | $ | 83,844 |   |   |   | $ | 7,563 |   |   |   | $ | 1,463 |   |   | $ | 397,259 |   |
|                                           |            |                                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          *Licenses and Software Development*.   We enter intocontractual agreements with third parties for the rights to intellectualproperty and for the development of products. Under these agreements, we committo provide specified payments to an intellectual property holder or developer. Assumingall contractual provisions are met, the total future minimum contractcommitments for contracts in place as of March 31, 2006 are approximately$235.3 million. License/software development commitments in the table aboveinclude $74.2 million of commitments to licensors that are included in ourconsolidated balance sheet as of March 31, 2006 because the licensors donot have any significant performance obligations to us. These commitments areincluded in both current and long-term licenses and accrued royalties.

(2)          *Advertising*.   We have certain minimum advertisingcommitments under most of our major license agreements. These minimumcommitments generally range from 2% to 12% of net sales related to therespective license. We estimate that our minimum commitment for advertising infiscal 2007 will be $21.8 million.

(3)          *Leases*.   We are committed under operating leases withlease termination dates through 2015. Most of our leases contain rentescalations.

(4)          *Letters of Credit*.   As of March 31, 2006, we werein compliance with all the covenants under our credit facility, had outstandingletters of credit of approximately $7.6 million and no borrowings.

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(5)          *Other*.   This amount reflects an additional $1.5 millionrelated to the purchase of Relic in April 2004. This amount was paid in April 2006.

Other potential futureexpenditures relate to the following:

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

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

*Credit Facility.**  *We have a credit agreement that lasts through November 29,2006 that provides us a maximum monthly facility amount of $40.0 million foreach August, September and October, and a maximum monthly facility amountof $12.0 million for every other month. The credit facility is unsecured andcontains customary financial and non-financial covenants that require us tomaintain specified operating profits and liquidity and limits our ability toincur additional indebtedness, sell assets, pay cash dividends and enter intocertain mergers or acquisitions. As of March 31, 2006, we were incompliance with all the covenants under the credit facility and had outstandingletters of credit of approximately $7.6 million.

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

**Item7A. Quantitative andQualitative Disclosures About Market Risk**

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

**Interest Rate Risk**

We have interest rate riskprimarily related to our investment portfolio and to a lesser extent our creditfacility. A substantial portion of our portfolio is in short-term investmentsmade up of floating rate securities and municipal securities. The value ofthese investments may fluctuate with changes in interest rates. However, webelieve this risk is immaterial due to the short-term nature of the investments.The credit facility is based on variable interest rates. At March 31,2006, we had outstanding letters of credit of $7.6 million.

**Foreign Currency Risk**

We transact business inmany different foreign currencies and are 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 orloss of earnings to us. Our international business is 

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subject to risks typicalof an international business, including, but not limited to, foreign currencyexchange rate volatility. Accordingly, our future results could be materiallyand adversely affected by changes in foreign currency exchange rates.

Throughout the year, wefrequently monitor the volatility of the GBP and the Euro (and all otherapplicable currencies). We utilize foreign exchange forward contracts tomitigate foreign currency risk associated with foreign currency denominatedassets and liabilities, primarily certain inter-company receivables andpayables. Our foreign exchange forward contracts are accounted for asderivatives whereby the fair value of the contracts are reflected as othercurrent assets or other current liabilities and the associated gains and lossesare reflected in general and administrative expense in the consolidatedstatements of operations. The forward contracts generally have a contractualterm of less than one month and are transacted near month-end. Therefore, thefair value of the forward contracts generally is not significant at eachmonth-end.

Foreign exchange forwardcontracts are designed to offset gains and losses on the underlyingforeign-currency-denominated assets and liabilities. Any movement in foreigncurrency exchange rates resulting in a gain or loss on our foreign exchangeforward contracts would be offset by an opposing gain or loss in the underlyingforeign-currency-denominated assets and liabilities that were hedged and wouldnot have a material impact on our financial position.

As of March 31, 2006,we had foreign exchange forward contracts in the notional amount of $60.3million, all with maturities of less than one month, consisting primarily ofEuros, Great British Pounds, and Canadian Dollars. The counterparties to theseforward contracts are creditworthy multinational commercial and investmentbanks. The risks of counterparty nonperformance associated with these contractsare not considered to be material. Notwithstanding our efforts to manage foreignexchange risks, there can be no assurances that our mitigating or hedgingactivities will adequately protect us against the risks associated with foreigncurrency fluctuations.

We do not hedge foreigncurrency translation risk. A hypothetical 10% adverse change in exchange rateswould result in a reduction of reported net sales ofapproximately $31.9 million and a reduction of reported income beforetaxes of approximately $1.0 million. This estimate assumes an adverseshift in all foreign currency exchange rates, which do not always move in thesame direction; actual results may differ materially.

**Item8. ConsolidatedFinancial Statements and Supplementary Data**

The report of IndependentRegistered Public Accounting Firm, consolidated financial statements and notesto consolidated financial statements follow below.

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directorsand Stockholders of THQ Inc.,

Agoura Hills, California

We have audited the accompanying consolidated balancesheets of THQ Inc. and subsidiaries (the “Company”) as of March 31, 2006and 2005, and the related consolidated statements of operations, stockholders’equity and cash flows for each of the three years in the period ended March 31,2006. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

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

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of the Companyas of March 31, 2006 and 2005, and the results of its operations and itscash flows for each of the three years in the period ended March 31, 2006,in conformity with accounting principles generally accepted in the UnitedStates of America.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of March 31, 2006, based on the criteriaestablished in *Internal Control—Integrated Framework issuedby the Committee of Sponsoring Organizations of the Treadway Commission*and our report dated June 6, 2006 expressed an unqualified opinion onmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting and an unqualified opinion on the effectiveness of theCompany’s internal control over financial reporting.

**DELOITTE &TOUCHE LLP**

LosAngeles, California

June 6, 2006

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

| ** **                                                                                                                                                              | ** ** | **March 31,  2006** | ** ** | **March 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| **ASSETS**                                                                                                                                                              |       |                     |       |                     |       |
| Current assets:                                                                                                                                                         |       |                     |       |                     |       |
| Cash and cash equivalents                                                                                                                                               |       | $                        | 91,517     |                     | $          | 98,175 |   |
| Short-term investments                                                                                                                                                  |       | 280,120                  |       | 232,998                  |       |
| Cash, cash equivalents and short-term investments                                                                                                                       |       | 371,637                  |       | 331,173                  |       |
| Accounts receivable, net of allowances                                                                                                                                  |       | 78,876                   |       | 73,700                   |       |
| Inventory                                                                                                                                                               |       | 28,620                   |       | 23,802                   |       |
| Licenses                                                                                                                                                                |       | 20,849                   |       | 12,464                   |       |
| Software development                                                                                                                                                    |       | 91,843                   |       | 57,107                   |       |
| Income taxes receivable                                                                                                                                                 |       | 6,832                    |       | 9,783                    |       |
| Prepaid expenses and other current assets                                                                                                                               |       | 12,420                   |       | 14,530                   |       |
| Total current assets                                                                                                                                                    |       | 611,077                  |       | 522,559                  |       |
| Property and  equipment, net                                                                                                                                            |       | 37,485                   |       | 26,822                   |       |
| Licenses, net of  current portion                                                                                                                                       |       | 60,623                   |       | 75,523                   |       |
| Software  development, net of current portion                                                                                                                           |       | 17,236                   |       | 8,144                    |       |
| Income taxes  receivable, net of current portion                                                                                                                        |       | 10,273                   |       | 9,513                    |       |
| Goodwill                                                                                                                                                                |       | 90,872                   |       | 83,440                   |       |
| Other long-term  assets, net                                                                                                                                            |       | 23,048                   |       | 21,392                   |       |
| **TOTAL ASSETS**                                                                                                                                                        |       | $                        | 850,614    |                     | $          | 747,393 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                          |       |                     |       |                     |       |
| Current liabilities:                                                                                                                                                    |       |                     |       |                     |       |
| Accounts payable                                                                                                                                                        |       | $                        | 34,871     |                     | $          | 36,499 |   |
| Accrued and other current liabilities                                                                                                                                   |       | 109,421                  |       | 77,532                   |       |
| Deferred income taxes                                                                                                                                                   |       | 3,578                    |       | 6,841                    |       |
| Total current liabilities                                                                                                                                               |       | 147,870                  |       | 120,872                  |       |
| Other long-term  liabilities                                                                                                                                            |       | 60,323                   |       | 72,059                   |       |
| Deferred income taxes,  net of current portion                                                                                                                          |       | 10,272                   |       | 4,466                    |       |
| Commitments and  contingencies                                                                                                                                          |       | —                   |       | —                   |       |
| Minority interest                                                                                                                                                       |       | 1,340                    |       | 1,238                    |       |
| Stockholders’  equity:                                                                                                                                             |       |                     |       |                     |       |
| Preferred stock, par value $0.01, 1,000,000 shares  authorized                                                                                                          |       | —                   |       | —                   |       |
| Common stock, par value $0.01, 75,000,000 shares  authorized; 64,140,977 and 60,689,622 shares issued and outstanding as of  March 31, 2006 and 2005, respectively |       | 642                      |       | 607                      |       |
| Additional paid-in capital                                                                                                                                              |       | 397,693                  |       | 347,462                  |       |
| Accumulated other comprehensive income                                                                                                                                  |       | 10,367                   |       | 12,851                   |       |
| Retained earnings                                                                                                                                                       |       | 222,107                  |       | 187,838                  |       |
| Total stockholders’ equity                                                                                                                                         |       | 630,809                  |       | 548,758                  |       |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                    |       | $                        | 850,614    |                     | $          | 747,393 |   |

 

See notes to consolidated financial statements.

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**THQ INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data)**
|                                                    | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net sales                                          |       | $                                                   | 806,560    |   | $ | 756,731 |   | $ | 640,846 |   |
| Costs and  expenses:                               |       |                                                |       |   |   |   |   |
| Cost of sales                                      |       | 287,946                                             |       | 255,187 |   | 234,574 |   |
| License amortization and royalties                 |       | 80,508                                              |       | 85,926 |   | 71,132 |   |
| Software development amortization                  |       | 116,371                                             |       | 93,622 |   | 105,632 |   |
| Product development                                |       | 84,242                                              |       | 72,959 |   | 36,850 |   |
| Selling and marketing                              |       | 123,552                                             |       | 110,514 |   | 87,119 |   |
| Payment to venture partner                         |       | 12,572                                              |       | 9,774 |   | 9,675 |   |
| General and administrative                         |       | 67,615                                              |       | 54,831 |   | 47,006 |   |
| Total costs and expenses                           |       | 772,806                                             |       | 682,813 |   | 591,988 |   |
| Income from  operations                            |       | 33,754                                              |       | 73,918 |   | 48,858 |   |
| Interest income                                    |       | 8,478                                               |       | 4,337 |   | 2,378 |   |
| Other income                                       |       | —                                              |       | — |   | 4,000 |   |
| Income before  income taxes and minority interest  |       | 42,232                                              |       | 78,255 |   | 55,236 |   |
| Income taxes                                       |       | 7,900                                               |       | 15,204 |   | 19,397 |   |
| Income before  minority interest                   |       | 34,332                                              |       | 63,051 |   | 35,839 |   |
| Minority interest                                  |       | (63                                                 | )          | (261 | ) | — |   |
| Net income                                         |       | $                                                   | 34,269     |   | $ | 62,790 |   | $ | 35,839 |   |
| Net income per  share—basic                   |       | $                                                   | 0.55       |   | $ | 1.07 |   | $ | 0.63 |   |
| Net income per share—diluted                  |       | $                                                   | 0.52       |   | $ | 1.04 |   | $ | 0.61 |   |
| Shares used in  per share calculation—basic   |       | 62,615                                              |       | 58,545 |   | 57,279 |   |
| Shares used in per share  calculation—diluted |       | 65,575                                              |       | 60,365 |   | 58,506 |   |

 

See notes to consolidated financial statements.

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

**Fiscal Years Ended March 31, 2004, 2005 and 2006**
|                                                                  | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Retained**           | ** ** | ** **   | ** ** |
|------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|---------------------------------------|------------|------------------------|------------|--------------|------------|
| ** **                                                       | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Paid-In Capital**              | ** ** | **Income (Loss)** | ** ** | **Earnings** | ** ** | **Total** | ** ** |
| **Balance at March 31, 2003**                               |       | 57,011,819            |       |           | $          | 570                                   |       |                   |       | $            | 305,138    |   |   |   | $ | 1,496 |   |   |   | $ | 89,209 |   |   | $ | 396,413 |   |
| Exercise of options                                              |       | 1,302,285             |       |           | 13         |                                  |       |                   | 7,108      |         |       |   | — |   |   |   | — |   |   | 7,121 |   |
| Issuance of warrants                                             |       | —                |       |           | —     |                                  |       |                   | 956        |         |       |   | — |   |   |   | — |   |   | 956 |   |
| Repurchase of common stock                                       |       | (1,063,637            | )          |           | (10        | )                                     |       |                   | (10,984    | )            |       |   | — |   |   |   | — |   |   | (10,994 | ) |
| Stock-based compensation                                         |       | —                |       |           | —     |                                  |       |                   | 84         |         |       |   | — |   |   |   | — |   |   | 84 |   |
| Tax benefit related to the exercise of employee stock  options   |       | —                |       |           | —     |                                  |       |                   | 2,367      |         |       |   | — |   |   |   | — |   |   | 2,367 |   |
| Comprehensive income:                                            |       |                  |       |           |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                       |       | —                |       |           | —     |                                  |       |                   | —     |         |       |   | — |   |   |   | 35,839 |   |   | 35,839 |   |
| Other  comprehensive income                                      |       |                  |       |           |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation gain                                |       | —                |       |           | —     |                                  |       |                   | —     |         |       |   | 5,431 |   |   |   | — |   |   | 5,431 |   |
| Unrealized gain on investments                                   |       | —                |       |           | —     |                                  |       |                   | —     |         |       |   | 1,375 |   |   |   | — |   |   | 1,375 |   |
| Comprehensive income                                             |       |                  |       |           |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   | 42,645 |   |
| **Balance at March 31, 2004**                               |       | 57,250,467            |       |           | $          | 573                                   |       |                   |       | $            | 304,669    |   |   |   | $ | 8,302 |   |   |   | $ | 125,048 |   |   | $ | 438,592 |   |
| Exercise of options                                              |       | 4,189,155             |       |           | 42         |                                  |       |                   | 42,803     |         |       |   | — |   |   |   | — |   |   | 42,845 |   |
| Issuance of warrants                                             |       | —                |       |           | —     |                                  |       |                   | 2,422      |         |       |   | — |   |   |   | — |   |   | 2,422 |   |
| Repurchase of common stock                                       |       | (750,000              | )          |           | (8         | )                                     |       |                   | (9,072     | )            |       |   | — |   |   |   | — |   |   | (9,080 | ) |
| Tax benefit related to the exercise of employee stock  options   |       | —                |       |           | —     |                                  |       |                   | 6,640      |         |       |   | — |   |   |   | — |   |   | 6,640 |   |
| Comprehensive income:                                            |       |                  |       |           |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                       |       | —                |       |           | —     |                                  |       |                   | —     |         |       |   | — |   |   |   | 62,790 |   |   | 62,790 |   |
| Other  comprehensive income                                      |       |                  |       |           |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation gain                                |       | —                |       |           | —     |                                  |       |                   | —     |         |       |   | 2,802 |   |   |   | — |   |   | 2,802 |   |
| Unrealized gain on investments, net of $1.9 million  tax expense |       | —                |       |           | —     |                                  |       |                   | —     |         |       |   | 1,747 |   |   |   | — |   |   | 1,747 |   |
| Comprehensive income                                             |       |                  |       |           |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   | 67,339 |   |
| **Balance at March 31, 2005**                               |       | 60,689,622            |       |           | $          | 607                                   |       |                   |       | $            | 347,462    |   |   |   | $ | 12,851 |   |   |   | $ | 187,838 |   |   | $ | 548,758 |   |
| Exercise of options                                              |       | 3,187,569             |       |           | 32         |                                  |       |                   | 37,755     |         |       |   | — |   |   |   | — |   |   | 37,787 |   |
| Issuance of restricted stock                                     |       | 263,786               |       |           | 3          |                                  |       |                   | 855        |         |       |   |   |   |   |   |   |   |   | 858 |   |
| Stock-based compensation                                         |       | —                |       |           | —     |                                  |       |                   | 1,009      |         |       |   | — |   |   |   | — |   |   | 1,009 |   |
| Tax benefit related to the exercise of employee stock  options   |       | —                |       |           | —     |                                  |       |                   | 10,612     |         |       |   | — |   |   |   | — |   |   | 10,612 |   |
| Comprehensive income:                                            |       |                  |       |           |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                       |       | —                |       |           | —     |                                  |       |                   | —     |         |       |   | — |   |   |   | 34,269 |   |   | 34,269 |   |
| Other  comprehensive income (loss)                               |       |                  |       |           |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation loss                                |       | —                |       |           | —     |                                  |       |                   | —     |         |       |   | (3,085 | ) |   |   | — |   |   | (3,085 | ) |
| Unrealized gain on investments, net of $0.4 million  tax expense |       | —                |       |           | —     |                                  |       |                   | —     |         |       |   | 601 |   |   |   | — |   |   | 601 |   |
| Comprehensive income                                             |       |                  |       |           |       |                                  |       |                   |       |         |       |   |   |   |   |   |   |   |   | 31,785 |   |
| **Balance at March 31, 2006**                               |       | 64,140,977            |       |           | $          | 642                                   |       |                   |       | $            | 397,693    |   |   |   | $ | 10,367 |   |   |   | $ | 222,107 |   |   | $ | 630,809 |   |

 

See notes to consolidated financial statements.

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

| ** **                                                                         | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| **OPERATING  ACTIVITIES:**                                                         | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                                   | 34,269     |   | $ | 62,790 |   | $ | 35,839 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                                |       |   |   |   |   |
| Minority interest                                                                  |       | 63                                                  |       | 261 |   | — |   |
| Depreciation and amortization                                                      |       | 14,162                                              |       | 10,485 |   | 7,227 |   |
| Amortization of licenses and software development                                  |       | 112,916                                             |       | 121,801 |   | 126,686 |   |
| Loss on disposal of property and equipment                                         |       | 538                                                 |       | 48 |   | 258 |   |
| Stock-based compensation                                                           |       | 1,867                                               |       | — |   | 84 |   |
| Tax benefit related to the exercise of employee  stock options                     |       | 10,612                                              |       | 6,640 |   | 2,367 |   |
| Deferred income taxes                                                              |       | 2,050                                               |       | 7,442 |   | 2,464 |   |
| Changes in operating  assets and liabilities:                                      |       |                                                |       |   |   |   |   |
| Accounts receivable, net of allowances                                             |       | (5,902                                              | )          | (8,507 | ) | (21,766 | ) |
| Inventory                                                                          |       | (5,501                                              | )          | (1,015 | ) | 3,427 |   |
| Licenses                                                                           |       | (13,392                                             | )          | (107,679 | ) | (24,072 | ) |
| Software development                                                               |       | (134,943                                            | )          | (92,863 | ) | (80,803 | ) |
| Prepaid expenses and other current assets                                          |       | 1,970                                               |       | (4,362 | ) | 2,318 |   |
| Accounts payable                                                                   |       | (397                                                | )          | 11,205 |   | (343 | ) |
| Accrued and other liabilities                                                      |       | 22,259                                              |       | 73,309 |   | 16,052 |   |
| Income taxes                                                                       |       | 2,218                                               |       | (19,100 | ) | 1,416 |   |
| Net cash provided  by operating activities                                         |       | 42,789                                              |       | 60,455 |   | 71,154 |   |
| **INVESTING  ACTIVITIES:**                                                         | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from sales and maturities of short-term  investments                      |       | 510,555                                             |       | 394,965 |   | 400,957 |   |
| Purchase of short-term investments                                                 |       | (557,677                                            | )          | (431,846 | ) | (419,782 | ) |
| Purchases of long-term marketable securities                                       |       | —                                              |       | — |   | (24,320 | ) |
| Other long-term assets                                                             |       | (3,366                                              | )          | (5,125 | ) | (70 | ) |
| Acquisitions, net of cash acquired                                                 |       | (12,282                                             | )          | (19,234 | ) | (2,300 | ) |
| Purchases of property and equipment                                                |       | (23,112                                             | )          | (16,651 | ) | (7,638 | ) |
| Net cash used in  investing activities                                             |       | (85,882                                             | )          | (77,891 | ) | (53,153 | ) |
| **FINANCING  ACTIVITIES:**                                                         | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Stock repurchase                                                                   |       | —                                              |       | (9,080 | ) | (10,994 | ) |
| Proceeds from exercise of warrants and stock options                               |       | 37,787                                              |       | 42,844 |   | 7,121 |   |
| Net cash provided  by (used in) financing activities                               |       | 37,787                                              |       | 33,764 |   | (3,873 | ) |
| Effect of  exchange rate changes on cash                                           |       | (1,352                                              | )          | 605 |   | 4,079 |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | (6,658                                              | )          | 16,933 |   | 18,207 |   |
| Cash and cash  equivalents—beginning of period                                |       | 98,175                                              |       | 81,242 |   | 63,035 |   |
| Cash and cash  equivalents—end of period                                      |       | $                                                   | 91,517     |   | $ | 98,175 |   | $ | 81,242 |   |
| **Supplemental  cash flow information:**                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid during the period for income taxes                                       |       | $                                                   | 6,037      |   | $ | 21,825 |   | $ | 15,625 |   |
| Cash paid during  the period for interest                                          |       | $                                                   | 155        |   | $ | 199 |   | $ | 144 |   |

 

See notes to consolidated financial statements.

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

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

We develop andpublish interactive entertainment software for all popular game systems,including:

·       Homevideo game consoles such as Sony PlayStation 2, Microsoft Xbox, and NintendoGameCube, and the next-generation consoles Sony PlayStation 3, Microsoft Xbox360 and Nintendo Wii;

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

·       Personalcomputers.

Our titles span a wide range of categories, includingaction, adventure, fighting, racing, role-playing, simulation, sports andstrategy. We have created, licensed and acquired a group of highly recognizablebrands, which we market to a variety of consumer demographics ranging fromproducts targeted at children and the mass-market to products targeted at coregamers. Our portfolio of licensed properties includes the Disney/Pixarproperties*Finding Nemo*, *The Incredibles*, and*Cars*(which is expected to be released globally beginningin North America in June 2006); WorldWrestling Entertainment®; Nickelodeon properties such as SpongeBobSquarePantsTM, Avatar, Fairly OddParentsTM and Nicktoons; BratzTM; Power Rangers; Warhammer® 40,000; andScooby-Doo!TM; as well asothers. We also have licenses to create wireless products based on *Star Wars* and major sports leagues. In addition to licensedproperties, we also publish games based upon owned intellectual properties,including *Company of Heroes, Destroy AllHumans!**TM, JuicedTM, MX*and*Saints RowTM*.

*Principles of Consolidation.**  *The consolidated financial statements includethe accounts of THQ Inc. and our wholly owned and majority owned subsidiariesas well as the venture we have with JAKKS Pacific, Inc. See “Note 16—Agreementwith JAKKS Pacific, Inc.”  Theresults of operations for acquisitions of companies have been included in theconsolidated statements of operations beginning on the closing date ofacquisition. All material intercompany balances and transactions have beeneliminated in consolidation.

*Pervasiveness of Estimates.**  *The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates. The most significant estimates relate tolicenses, software development, the allowance for price protection, returns anddoubtful accounts and income taxes.

*Reclassifications.**  *Certain reclassifications have been made tothe prior periods consolidated financial statements to conform to currentperiod consolidated financial statements. In the fourth quarter of fiscal 2006,we reclassified warehousing expenses from selling and marketing to cost ofsales. Classification of these expenses as a component of cost of sales is apractice that is consistent with others within our industry. The reclassifiedwarehousing expenses for the fiscal years ended March 31, 2006, 2005 and2004 were $5.7 million, $5.1 million and $5.4 million, respectively.

*Foreign Currency Translation.**  *Assets and liabilities of foreign operationsare translated at current rates of exchange while results of operations aretranslated at average rates in effect for the period. Translation gains orlosses are shown as a separate component of accumulated other comprehensiveincome (loss). Foreign currency transaction gains and losses result fromexchange rate changes for transactions denominated in currencies other than thefunctional currency. For the fiscal year ended March 31, 2006, 

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foreign currency transaction losses were $0.3 million,and for the fiscal years ended March 31, 2005 and 2004, foreign currencytransaction gains were $2.3 million and $1.4 million, respectively, and areincluded in general and administrative expenses in our consolidated statementsof operations.

*Cash, Cash Equivalents, Short-Term Investments andFinancial Instruments.**  *Weconsider all highly liquid investments with maturities less than three monthswhen purchased to be cash equivalents. Investments with maturities greater thanthree months, but less than one year, when purchased are considered short-terminvestments. Our short-term investments are primarily auction rate securities. Theseauction rate securities are variable rate bonds tied to short-term interestrates with maturities on the face of the underlying security in excess of 90days. Auction rate securities have interest rate resets through a modifiedDutch auction at predetermined short-term intervals, typically every 7, 28, or35 days. Interest paid during a given period is based upon the interest ratedetermined during the prior auction. Although the securities are issued andrated as long-term bonds, they are priced and traded as short-term instrumentsbecause of the liquidity provided through the interest rate reset. We had$280.1 million and $209.4 million of investments in auction rate securities asof March 31, 2006 and March 31, 2005, respectively. These short-terminvestments are classified as available-for-sale and changes in the fair valueare included in accumulated other comprehensive income (loss), net ofapplicable income taxes, in the consolidated financial statements. At March 31,2006, we did not have any short-term investments classified as held tomaturity, and at March 31, 2005, our short-term investments classified asheld to maturity were municipal bonds with maturity dates of less than oneyear.

*Financial Instruments.**  *The carrying value of certain financialinstruments, including cash and cash equivalents, short-term investments heldto maturity, accounts receivable, accounts payable, accrued expenses andaccrued royalties, approximate fair value based on their short-term nature. Short-terminvestments classified as available for sale are stated at fair value.

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

We utilize forward contracts in order to reducefinancial market risks. These instruments are used to hedge foreign currencyexposures of underlying assets, liabilities, or certain forecasted foreigncurrency denominated transactions. Our accounting policies for theseinstruments are based on whether they meet the criteria for designation ashedging transactions. Changes in fair value of derivatives that are designatedas cash flow hedges, are highly effective, and qualify as hedging instruments,are recorded in other comprehensive income until the underlying hedged item isrecognized in earnings within the financial statement line item consistent withthe hedged item. Any ineffective portion of a derivative change in fair valueis immediately recognized in earnings. During each of the periods presented wedid not have any derivatives that qualify for hedge accounting. Changes in thefair value of derivatives that do not qualify for hedge accounting treatmentare recorded in earnings. The fair value of foreign currency contracts isestimated based on the forward rate of the various hedged currencies as of theend of the period. As of March 31, 2006 and 2005, we had foreign exchangeforward contracts in the notional amount of $60.3 million and $35.1 million,respectively. The net gains recognized from foreign currency contracts infiscal 2006 and fiscal 2005 were $493,000 and $682,000, respectively, and areincluded in general and administrative expense in our consolidatedstatements of operations. We did not have any gains or losses from foreigncurrency contracts in fiscal years prior to 2005.

*Allowance for Price Protection, Returns and DoubtfulAccounts.**  *Wederive revenues from sales of packaged software for video game systems andpersonal computers and sales of content and services for 

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wireless devices. Product revenue is recognized net ofallowances for price protection and returns and various customer discounts. Wetypically only allow returns for our personal computer products; however, wemay decide to provide price protection or allow returns for our video gamesystems or personal computer products after we analyze: (1) inventoryremaining in the retail channel, (2) the rate of inventory sell-through inthe retail channel, and (3) our remaining inventory on hand. We maintain apolicy of giving credits for price protection and returns, but do not give cashrefunds.  Management uses significantjudgment and makes estimates in connection with establishing allowances forprice protection, returns, and doubtful accounts in any accounting period.

*Concentrations of Credit Risk.**  *Financial instruments which potentiallysubject us to concentration of credit risk consist principally of cash and cashequivalents, short-term investments, accounts receivable and long-termmarketable securities. We place cash and cash equivalents and short-terminvestments with high credit-quality institutions and limit the amount of creditexposure to any one institution. We believe this risk is immaterial due to theshort-term nature of such investments. As of March 31, 2006 we did nothave any long-term marketable securities. Most of our sales are made directlyto mass merchandisers and national retailers. Due to the increased volume ofsales to these channels, we have experienced an increased concentration ofcredit risk, and as a result, may maintain individually significant receivablebalances with such mass merchandisers and national retailers. We performongoing credit evaluations of our customers, maintain an allowance forpotential credit losses, and most of our foreign receivables are covered bycredit insurance. As of March 31, 2006 and 2005, approximately 25% and16%, respectively, of our gross accounts receivable outstanding was with onemajor customer. Our largest single customer accounted for 19% of our grosssales in fiscal 2006, 14% of our gross sales in fiscal 2005 and 19% of ourgross sales in fiscal 2004.

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

*Property and Equipment.**  *Property and equipment are recorded at cost. Depreciationis computed using the straight-line method over the estimated useful lives ofthe assets. Leasehold improvements are depreciated over the shorter of theiruseful lives or the remaining lease term.

*Licenses.**  *Minimumguaranteed royalty payments for intellectual property licenses are initiallyrecorded on our balance sheet as an asset (licenses) and as a liability(accrued royalties) at the contractual amount upon execution of the contract ifno significant performance obligation remains with the licensor. When asignificant performance obligation remains with the licensor, we record royaltypayments as an asset (licenses) when payable rather than upon execution of thecontract. Royalty payments for intellectual property licenses are classified ascurrent assets and current liabilities to the extent such royalty paymentsrelate to anticipated sales during the subsequent year and long-term assets andlong-term liabilities if such royalty payments relate to anticipated salesafter one year.

We evaluate the future recoverability of ourcapitalized licenses on a quarterly basis. The recoverability of capitalizedlicense costs is evaluated based on the expected performance of the specificproducts in which the licensed trademark or copyright is to be used. As many ofour licenses extend for multiple products over multiple years, we also assessthe recoverability of capitalized license costs based on certain qualitativefactors such as the success of other products and/or entertainment vehiclesutilizing the intellectual property, whether there are any future plannedtheatrical releases or television series based on the intellectual property andthe rights holder’s continued promotion and exploitation of the intellectualproperty. Prior to the related product’s release, we expense, as part oflicense amortization and royalties, capitalized license costs when we believesuch amounts are not recoverable.

Licenses are expensed to license amortization androyalties at the higher of (1) the contractual royalty rate based onactual net product sales related to such license or (2) an effective ratebased upon total projected 

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revenue related to such license. When, in management’sestimate, future cash flows will not be sufficient to recover previouslycapitalized costs, we expense these capitalized costs to license amortizationand royalties. If actual revenues or revised forecasted revenues fall below theinitial forecasted revenues for a particular license, the charge to licenseamortization and royalties expense may be larger than anticipated in any givenquarter. As of March 31, 2006, the net carrying value of our licenses was$81.5 million. If we were required to write off licenses, due to changes inmarket conditions or product acceptance, our results of operations could bematerially adversely affected.

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

On a quarterly basis, we compare ourunamortized software development costs to net realizablevalue, on a product-by-product basis. The amount by which any unamortizedsoftware development costs exceed their net realizable value is charged tosoftware development amortization. The net realizable value is the estimatedfuture gross revenues from the product, reduced by the estimated futurecosts of completing the product.

Commencing upon product release, capitalized softwaredevelopment costs are amortized to software development amortization based onthe ratio of current revenues to total projected revenues. If actual revenues,or revised projected revenues, fall below the initial projections, the chargeto software development amortization may be larger than anticipated in anygiven quarter. As of March 31, 2006, the net carrying value of oursoftware development was $109.1 million.

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

*Goodwill and Other Intangible Assets.**  *In accordance with our accounting policy, weperformed an annual review of goodwill for impairment during the quarter ended June 30,2005, and found no impairment. We will perform a similar review in futurequarters ended June 30, or more frequently if indicators of potentialimpairment exist. Our impairment review process is based on a discounted futurecash flow approach that uses our estimates of revenue for the reporting units,driven by assumed success of our products and product release schedules, andestimated costs as well as appropriate discount rates. These estimates areconsistent with the plans and estimates that we use to manage the underlyingbusinesses. We performed similar impairment tests during the quarter ended June 30,2005 for indefinite-lived intangible assets and found no impairment. Allidentifiable intangible assets with finite lives will continue to be amortizedover their estimated useful lives and assessed for impairment under SFAS No. 144,“Accounting for the Impairment orDisposal of Long-Lived Assets.”

*Revenue Recognition.**  *Our revenue recognition policies are incompliance with American Institute of Certified Public Accountants Statement ofPosition (“SOP”) 97-2, “Software Revenue Recognition,” as amended by SOP98-9, “Modification of SOP 97-2, Software Revenue Recognition, WithRespect to Certain Transactions,” which provide guidance on generally acceptedaccounting principles for recognizing revenue on software transactions, andStaff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition 

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in Financial Statements,”which outlines the basic criteria that must be met to recognize revenue andprovides guidance for presentation of revenue and for disclosure related torevenue recognition policies in financial statements filed with the Securitiesand Exchange Commission (“SEC”).

Product Sales:   We recognize revenue for packagedsoftware when title and risk of loss transfers to the customer, provided thatno significant vendor support obligations remain outstanding and thatcollection of the resulting receivable is deemed probable by management. Althoughwe generally sell our products on a no-return basis, in certain circumstanceswe may allow price protection, returns or other allowances on a negotiatedbasis. We estimate such price protection, returns or other allowances based uponmanagement’s evaluation of our historical experience, retailer inventories, thenature of the titles and other factors. Such estimates are deducted from grosssales. See “Note 3—Allowance for Price Protection, Returns and DoubtfulAccounts.” Software is sold under a limited 90-day warranty againstdefects in material and workmanship. To date, we have not experienced materialwarranty claims.

Software Licenses:   For those agreements thatprovide the customers the right to multiple copies in exchange for guaranteedminimum royalty amounts, revenue is recognized at delivery of the productmaster or the first copy. Per copy royalties on sales that exceed the guaranteeare recognized as earned. Revenue from the licensing of software for the fiscalyears ended March 31, 2006, 2005 and 2004 was $6.3 million, $8.1million and $8.3 million, respectively.

Wireless Revenue:   We recognize wireless revenuesprincipally from the sale or subscription of our applications to wirelesssubscribers under distribution agreements with wireless carriers in the periodin which the applications are purchased by the subscribers, assuming that: feesare fixed and determinable; we have no significant obligations remaining andcollection of the related receivable is reasonably assured. In accordance withthe distribution agreements, the wireless carriers are responsible for billing,collecting and remitting our fees to us. The wireless carriers generally reportthe final sales data to us within 10 to 45 days following the end of eachmonth. When final sales data is not available in a timely manner for reportingpurposes, we estimate our revenues based on available sales data and historicaltrends. We will record differences between estimated revenues and actualrevenues in the next reporting period once the actual amounts are determined.

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

*Advertising.**  *Advertising and sales promotion costs aregenerally expensed as incurred, except for television airtime and print mediacosts associated with media campaigns, which are deferred and charged toexpense in the period the airtime or advertising space is used for the firsttime. Advertising costs for the fiscal years ended March 31, 2006, 2005and 2004 were $61 million, $57 million and $45.3 million, respectively.

*EmployeeStock-Based Compensation.**  *Under SFAS No. 123 “Accounting forStock-Based Compensation,” compensation expense is recorded for the issuance ofemployee stock-based compensation, including stock options and restrictedstock, based on the fair value of the employee stock-based compensation on thedate of grant or measurement date. Alternatively, SFAS No. 123 allowscompanies to continue to account for the issuance of employee stock-basedcompensation in accordance with Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees.” Under APB Opinion No. 25,compensation expense is recorded for employee stock-based compensation based onthe intrinsic value of the employee stock-based compensation on the date ofgrant or measurement date. Under the intrinsic value method, compensationexpense is recorded on the date of grant or measurement date only if thecurrent market price of the underlying stock exceeds the employee stock-basedcompensation exercise price. We account for our employee stock-basedcompensation under 

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therecognition and measurement principles of APB Opinion No. 25 and relatedinterpretations. The following table illustrates the effect on net income andearnings per share if we had applied the fair value recognition provisions ofSFAS No. 123 to employee stock-based compensation (in thousands, except pershare data):

| ** **                                                                                                                                    | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | ** **                                          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income—as  reported                                                                                                                  |       | $                                                   | 34,269     |   | $ | 62,790 |   | $ | 35,839 |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax benefit                                   |       | 1,153                                               |       | - |   | 54 |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax benefit |       | (13,389                                             | )          | (12,996 | ) | (14,890 | ) |
| Net income—pro  forma                                                                                                                    |       | $                                                   | 22,033     |   | $ | 49,794 |   | $ | 21,003 |   |
| Earnings per share:                                                                                                                           |       |                                                |       |   |   |   |   |
| Basic—as reported                                                                                                                        |       | $                                                   | 0.55       |   | $ | 1.07 |   | $ | 0.63 |   |
| Basic—pro forma                                                                                                                          |       | $                                                   | 0.35       |   | $ | 0.85 |   | $ | 0.37 |   |
| Diluted—as reported                                                                                                                      |       | $                                                   | 0.52       |   | $ | 1.04 |   | $ | 0.61 |   |
| Diluted—pro forma                                                                                                                        |       | $                                                   | 0.34       |   | $ | 0.82 |   | $ | 0.36 |   |
|                                                                                                                                               |            |                                                     |            |  |  |  |  |  |  |  |  |  |

 

Thefair value of options granted under the stock option plans during the fiscalyears ended March 31, 2006, 2005 and 2004, respectively, has beenestimated at the date of grant using a Black-Scholes option pricing model withthe following weighted average assumptions:

| ** **                                | ** ** | **Fiscal Year Ended March 31** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                | ** ** | **2006**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Dividend yield                            |       | 0                                                  | %          | 0 | % | 0 | % |
| Anticipated  volatility                   |       | 51                                                 | %          | 57 | % | 69 | % |
| Weighted average  risk-free interest rate |       | 4.11                                               | %          | 3.48 | % | 2.60 | % |
| Expected lives                            |       | 3 years                                            |       | 4 years |   | 4 years |   |

 

The Black-Scholes option pricing model requires theinput of highly subjective assumptions, including the expected stock pricevolatility. For purposes of the above pro forma disclosure, the fair value ofemployee stock-based compensation granted is amortized over the period(s) inwhich the related employee services are rendered. Accordingly, the pro formastock-based compensation cost for any period will typically relate to awardsgranted in both the current period and prior periods.

We have granted common stock warrants to non-employeesin connection with the acquisition of licensing rights for intellectualproperty. In accordance with EITF No. 96-18, “Accounting for EquityInstruments that are Issued to Other Than Employees for Acquiring or inConnection with Selling Goods or Services,” the fair value of common stockwarrants granted is determined as of the measurement date and is capitalized,expensed and amortized consistent with our policies relating to license costs.

*Income Taxes.**  *Deferred income taxes are provided fortemporary differences between the financial statement and income tax bases ofour assets and liabilities, based on enacted tax rates. A valuation allowanceis provided when it is more likely than not that some portion or all of thedeferred income tax assets will not be realized.

*Basic and Diluted Earnings Per Share.**  *Basic earnings per share is computed bydividing net income by the weighted average number of common shares outstandingfor the period. Diluted earnings per share is computed by dividing net incomeby the weighted average number of common shares outstanding for the period,increased by common stock equivalents. Common stock equivalents are calculatedusing the 

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treasury stock method and represent incremental sharesissuable upon exercise of our outstanding options and warrants and, ifapplicable in the period, conversion of our convertible debt. However,potential common shares are not included in the denominator of the dilutedearnings per share calculation when inclusion of such shares would beanti-dilutive, such as in a period in which a net loss is recorded.

*Recently Issued Accounting Pronouncements.**  *In December 2004, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-BasedPayment” (“SFAS No. 123R”), a revision of SFAS No. 123. SFAS No. 123Rrequires companies to, among other things, measure all employee stock-basedcompensation awards using a fair value method and record the expense in theirconsolidated financial statements. The provisions of SFAS No. 123R,SEC SAB No. 107, “Share-Based Payment” and other related clarifyingpronouncements, are effective no later than the beginning of the next fiscalyear that begins after June 15, 2005. We will adopt the new requirementsin our fiscal year beginning April 1, 2006 using the modified prospectivetransition method, wherein prior period amounts will not be restated. Inaddition to the recognition of expense in the financial statements, underSFAS No. 123R, any excess tax benefits received upon exercise ofoptions will be presented as a financing activity inflow rather than as anadjustment of operating activity as currently presented. Based on our currentanalysis and information, management has determined the adoption of SFAS No. 123Rwill have a material impact on our consolidated results of operations andearnings per share. We expect the adoption of SFAS No. 123R will result inamounts that are similar to our current pro forma disclosures under SFAS No. 123.

In November 2005, theFASB issued Staff Position No. FAS 115-1, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP No. 115-1”).FSP No. 115-1 provides accounting guidance for identifying andrecognizing other-than-temporary impairments of debt and equity securities, aswell as cost method investments in addition to disclosure requirements. FSP No. 115-1is effective for reporting periods beginning after December 15, 2005,although earlier application is permitted. We adopted FSP No. 115-1in our fiscal fourth quarter beginning January 1, 2006, and this adoptiondid not have a material impact on our consolidated results of operations andearnings per share.

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

Cash,cash equivalents and short-term investments at March 31, 2006 and 2005consist of the following (in thousands):

| ** **                                                                | ** ** | **March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                | ** ** | **2006**           | ** ** | **2005** | ** ** |
| Cash and cash  equivalents                                                |       | $                  | 91,517     |   | $ | 98,175 |   |
| Short-term investments:                                                   |       |               |       |   |   |
| Available-for-sale  securities:                                           |       |               |       |   |   |
| Corporate notes and bonds                                                 |       | 19,000             |       | 23,200 |   |
| Municipal securities                                                      |       | 261,120            |       | 186,178 |   |
|                                                                      |       | 280,120            |       | 209,378 |   |
| Held-to-maturity  securities:                                             |       |               |       |   |   |
| Municipal securities                                                      |       | —             |       | 23,620 |   |
|                                                                      |       | —             |       | 23,620 |   |
| Total short-term investments                                              |       | 280,120            |       | 232,998 |   |
| Cash, cash equivalents,  short-term investments and financial instruments |       | $                  | 371,637    |   | $ | 331,173 |   |

 

 

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As of March 31, 2006 and 2005, we did not haveany unrealized gains or losses on our available-for-sale or held-to-maturitysecurities.

There were no realized gains or (losses) from sales ofavailable-for-sale securities in fiscal 2006, and realized gains from sales ofavailable-for-sale securities were $130,000 and $126,000 for fiscal 2005 and2004, respectively. There were no unrealized gains or (losses) fromavailable-for-sale securities for fiscal 2006, 2005 and 2004 except for Yuke’sCo., Ltd. (“Yuke’s”) which is classified as available-for-sale and is includedin other long-term assets (see “Note 8—Other Long-Term Assets”).

In the fourth quarter offiscal 2006 we changed the presentation of our proceeds from sales andmaturities of short-term investments and purchases of short-terminvestments in our consolidated statements of cash flows. The statements ofcash flows presented in these financial statements presents the grossamount of these transactions during each of the three years ended March 31,2006, whereas previously reported statements of cash flows presented theseactivities at a net transactional level. As a result, the amounts reported inthese financial statements for our proceeds from sales and maturitiesof short-term investments and purchases of short-term investments arehigher than previously reported. The change in presentation does not impact thenet proceeds from sales and maturities of short-term investments andpurchases of short-term investments, our cash flow from investing activities orour overall change in cash and cash equivalents.

**3.**   Allowancefor Price Protection, Returns and Doubtful Accounts

Theallowance for price protection, returns and doubtful accounts at March 31,2006 and 2005 consists of the following (in thousands): 

| ** **                                                             | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Beginning balance                                                      |       | $                                                   | (58,120    | ) | $ | (52,426 | ) | $ | (43,406 | ) |
| Provision for  price protection, returns and doubtful accounts         |       | (169,480                                            | )          | (106,504 | ) | (120,982 | ) |
| Actual deductions  for price protection, returns and doubtful accounts |       | 169,780                                             |       | 100,810 |   | 111,962 |   |
| Ending balance                                                         |       | $                                                   | (57,820    | ) | $ | (58,120 | ) | $ | (52,426 | ) |

 

**4.**   BalanceSheet Details

*Inventory.**  *Inventory at March 31, 2006 and 2005consists of the following (in thousands):

| ** **     | ** ** | **March 31,  2006** | ** ** | **March 31,  2005** | ** ** |
|----------------|------------|--------------------------|------------|--------------------------|------------|
| Raw material   |       |                     | $          | 1,530                    |       |   |   | $ | 1,825 |   |   |
| Finished goods |       |                     | 27,090     |                     |       |   | 21,977 |   |   |
| Inventory      |       |                     | $          | 28,620                   |       |   |   | $ | 23,802 |   |   |

 

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*Property andEquipment.*   Property andequipment at March 31, 2006 and 2005 consists of the following (inthousands):

| ** **                         | ** ** | **Useful  Lives** | ** ** | **March 31,  2006** | ** ** | **March 31,  2005** | ** ** |
|------------------------------------|------------|-------------------|------------|--------------------------|------------|--------------------------|------------|
| Building                           |       | 30  yrs           |       | $                        | 719        |                     | $          | 719 |   |
| Land                               |       | —            |       | 401                      |       | 401                      |       |
| Computer  equipment and software   |       | 3-10  yrs         |       | 44,776                   |       | 45,254                   |       |
| Furniture,  fixtures and equipment |       | 5  yrs            |       | 7,324                    |       | 5,842                    |       |
| Leasehold  improvements            |       | 3-6  yrs          |       | 7,847                    |       | 4,221                    |       |
| Automobiles                        |       | 2-5  yrs          |       | 128                      |       | 162                      |       |
|                               |       |              |       | 61,195                   |       | 56,599                   |       |
| Less: accumulated  depreciation    |       |              |       | (23,710                  | )          | (29,777                  | )          |
|                               |       |              |       | $                        | 37,485     |                     | $          | 26,822 |   |

 

Depreciation expense associated with property andequipment amounted to $11.7 million, $8.6 million and $6.7 million for thefiscal years ended March 31, 2006, 2005 and 2004, respectively.

*Accrued and OtherCurrent Liabilities.**  *Accruedand other current liabilities at March 31, 2006 and 2005 consist of thefollowing (in thousands):

| ** **                             | ** ** | **March 31,  2006** | ** ** | **March 31,  2005** | ** ** |
|----------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Accrued  liabilities                   |       | $                        | 34,194     |                     |       | $ | 27,173 |   |   |
| Accrued  compensation                  |       | 21,864                   |       |                     | 16,572     |   |   |
| Accrued payment  to venture partner    |       | 1,419                    |       |                     | 639        |   |   |
| Accrued royalties                      |       | 51,944                   |       |                     | 33,148     |   |   |
| Accrued and other  current liabilities |       | $                        | 109,421    |                     |       | $ | 77,532 |   |   |

 

*Other Long-TermLiabilities.**  *Other long-termliabilities at March 31, 2006 and 2005 consist of the following (inthousands):

| ** **                   | ** ** | **March 31,  2006** | ** ** | **March 31,  2005** | ** ** |
|------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Accrued royalties            |       |                     | $          | 58,025                   |       |   |   | $ | 70,000 |   |   |
| Accrued  liabilities         |       |                     | 2,298      |                     |       |   | 2,059 |   |   |
| Other long-term  liabilities |       |                     | $          | 60,323                   |       |   |   | $ | 72,059 |   |   |

 

**5.**   BusinessCombinations

In fiscal 2006, weacquired all of the voting and non-voting equity interests in the following twoentities for a total cost of $7.5 million, which was paid in cash:

·       JuiceGames Ltd., located in Centre Park, Warrington, United Kingdom, a developer ofinteractive entertainment software for video game hardware devices and personalcomputers;

·       VigilGames, LLC, located in Austin, Texas, a developer of interactive entertainmentsoftware for video game hardware devices.

Goodwill recognized in the above transactions amountedto $4.8 million, none of which is expected to be deductible for income taxpurposes. The preliminary purchase price allocation, including the allocationof goodwill, will be updated as additional information becomes available. Wedid not present pro forma information as these acquisitions were immaterial toour financial position and results of operations.

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In 2002, we acquiredValuSoft, Inc. for a total cost of $14.2 million, which was paid primarilyin cash. In addition, we have since paid the former shareholders of ValuSoftadditional consideration in the amount of $7.4 million because ValuSoft reachedcertain pre-tax income targets in the three years subsequent to the acquisition.They are still eligible for additional consideration in the amount of $3.6million, which may be paid by us in cash or stock, if they reach certainpre-tax income targets over the next two years. Any additional considerationdetermined to be payable will increase goodwill in the period such pre-taxincome targets are reached. Goodwill recognized in the original transaction andin the payments of the additional consideration has amounted to $19.4 millionand is expected to be deductible for income tax purposes.

**6.**   Goodwill

Thechanges in the carrying amount of goodwill for the fiscal years ended March 31,2006 and 2005 were as follows (in thousands): 

| Balance at  March 31, 2004                     |   | $      | 59,399 |   |
|-----------------------------------------------------|--------|--------|--------|--------|
| Goodwill acquired                                   |   | 18,168 |   |
| Additional consideration paid for ValuSoft          |   | 2,300  |   |
| Reclassification of initial investment in Minick    |   | 1,959  |   |
| Effect of foreign currency exchange rates           |   | 1,614  |   |
| Balance at  March 31, 2005                     |   | $      | 83,440 |   |
| Goodwill acquired                                   |   | 4,801  |   |
| Additional consideration paid for ValuSoft          |   | 2,800  |   |
| Effect of foreign currency exchange rates and other |   | (169   | )      |
| Balance at  March 31, 2006                     |   | $      | 90,872 |   |

 

**7.**   OtherIntangible Assets

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

| ** **                          | ** ** | ** **        | ** ** | **March 31, 2006** | ** ** | **March 31, 2005**  | ** ** |
|-------------------------------------|------------|-------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **                          | ** ** | **Useful  Lives** | ** ** | **Gross  Carrying  Amount**  | ** ** | **Accumulated  Amortization** | ** ** | **Net  Amount** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Amount** | ** ** |
| Software technology                 |       | 2-3 years         |       |                         | $          | 3,055                         |       |   |   | $ | (2,085 | ) |   |   | $ | 970 |   |   |   | $ | 2,988 |   |   |   | $ | (894 | ) |   |   | $ | 2,094 |   |   |
| Trade secrets                       |       | 5 years           |       |                         | 1,800      |                          |       |   | (1,530 | ) |   |   | 270 |   |   |   | 1,800 |   |   |   | (1,170 | ) |   |   | 630 |   |   |
| Customer list                       |       | 4-5 years         |       |                         | 1,414      |                          |       |   | (550 | ) |   |   | 864 |   |   |   | 1,523 |   |   |   | (254 | ) |   |   | 1,269 |   |   |
| Trade names                         |       | 3-10 years        |       |                         | 3,196      |                          |       |   | (739 | ) |   |   | 2,457 |   |   |   | 3,055 |   |   |   | (298 | ) |   |   | 2,757 |   |   |
| Non-compete /  Employment contracts |       | 3-6.5 years       |       |                         | 1,055      |                          |       |   | (656 | ) |   |   | 399 |   |   |   | 967 |   |   |   | (435 | ) |   |   | 532 |   |   |
| Total                               |       |              |       |                         | $          | 10,520                        |       |   |   | $ | (5,560 | ) |   |   | $ | 4,960 |   |   |   | $ | 10,333 |   |   |   | $ | (3,051 | ) |   |   | $ | 7,282 |   |   |

 

Amortization of otherintangible assets for the fiscal years ended March 31, 2006, 2005 and 2004 was$2.6 million, $2.0 million and $1.2 million, respectively. Finite-lived otherintangible assets are amortized using the straight-line method over the lesserof their estimated useful lives or the agreement terms, typically from two toten years and are assessed for impairment under SFAS No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets.”

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The following tablesummarizes the estimated amortization expense for each of the next five fiscalyears and thereafter (in thousands):

| **Fiscal Years Ending March 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                                  |       | $          | 2,080      |       |
| 2008                                                  |       | 980        |       |
| 2009                                                  |       | 592        |       |
| 2010                                                  |       | 237        |       |
| 2011                                                  |       | 237        |       |
| Thereafter                                            |       | 834        |       |
|                                                  |       | $          | 4,960      |       |

 

**8.**   OtherLong-Term Assets

In addition to other intangible assets See “Note 7—OtherIntangible Assets,” other long-term assets include our investment in Yuke’s. Weown less than a 20% interest in a Japanese developer, Yuke’s, which is publiclytraded on the Nippon New Market in Japan. Accordingly, we account for thisinvestment under SFAS No. 115 “Accountingfor Certain Investments in Debt and Equity Securities” asavailable-for-sale. Unrealized holding gains and losses are excluded fromearnings and are included as a component of other comprehensive income untilrealized. In fiscal 2006 and 2005, the unrealized holding gains wereapproximately $1.0 million and $3.6 million, respectively. Due to the long-termnature of this relationship, this investment is included in other long-termassets in the consolidated balance sheet. Under separate developmentagreements, Yuke’s creates certain World Wrestling Entertainment wrestlinggames for us.

Otherlong-term assets as of March 31, 2006 and 2005 are as follows (in thousands):

| ** **                            | ** ** | **March 31,  2006** | ** ** | **March 31,  2005** | ** ** |
|---------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Investment in  Yuke’s            |       |                     | $          | 9,217                    |       |   |   | $ | 8,244 |   |   |
| Other intangible  assets (see Note 7) |       |                     | 4,960      |                     |       |   | 7,282 |   |   |
| Other                                 |       |                     | 8,871      |                     |       |   | 5,866 |   |   |
| Total other  long-term assets         |       |                     | $          | 23,048                   |       |   |   | $ | 21,392 |   |   |

 

**9.**   CapitalStock Transactions

On August 9, 2005, we announced that our Board ofDirectors (“Board”) declared a three-for-two stock split of our shares ofcommon stock to be effected in the form of a 50% stock dividend (the “Dividend”).The Dividend was distributed on September 1, 2005 to stockholders ofrecord as of the close of business on August 19, 2005. Cash was paid inlieu of issuance of fractional shares. The par value of our common stock wasmaintained at the pre-split amount of $0.01. All references in the accompanyingconsolidated financial statements and in this annual report on Form 10-Kto number of shares, sales price and per share amounts of our common stock havebeen retroactively restated to reflect the increased number of shares of commonstock outstanding as of the earliest period presented. In addition,stockholders’ equity has been restated to give retroactive recognition to theDividend by reclassifying from paid-in capital to common stock the par value ofthe additional shares of common stock issued pursuant to the Dividend. TheDividend did not dilute rights to stockholders under the Amended and RestatedRights Agreement between THQ and Computershare Investor Services, LLC, asRights Agent, dated as of August 22, 2001, as amended by the FirstAmendment to the Amended and Restated Rights Agreement, dated as of April 9,2002.

On September 10,2002, November 21, 2002, and February 5, 2004, we announced that ourBoard authorized the repurchase of up to $25.0 million of our common stock fromtime to time on the open 

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market or in privatetransactions with a total authorized repurchase amount of $75.0 million. As of March 31,2005, we had repurchased 3,449,000 shares of our common stock for approximately$52.9 million, and there were no repurchases in fiscal 2006. At March 31,2006 there is $22.1 million available for future repurchases. There is no expiration date for theauthorized repurchases.

**10.**   AccumulatedOther Comprehensive Income

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

| ** **                         | ** ** | **Foreign  Currency  Translation  Gains (Losses)** | ** ** | **Net Unrealized  Gains (Losses)  on Securities** | ** ** | **Net Accumulated  Other Comprehensive  Income (Loss)** | ** ** |
|------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| Balance at  March 31, 2003    |       |                                                    | $          | 1,496                                                            |       |                                                                   |       | $ | — |   |   |   | $ | 1,496 |   |   |
| Other comprehensive  income        |       |                                                    | 5,431      |                                                             |       |                                                                   | 1,375      |   |   |   | 6,806 |   |   |
| Balance at  March 31, 2004    |       |                                                    | 6,927      |                                                             |       |                                                                   | 1,375      |   |   |   | 8,302 |   |   |
| Other comprehensive  income        |       |                                                    | 2,802      |                                                             |       |                                                                   | 1,747      |   |   |   | 4,549 |   |   |
| Balance at  March 31, 2005    |       |                                                    | 9,729      |                                                             |       |                                                                   | 3,122      |   |   |   | 12,851 |   |   |
| Other comprehensive  income (loss) |       |                                                    | (3,085     | )                                                                |       |                                                                   | 601        |   |   |   | (2,484 | ) |   |
| Balance at  March 31, 2006    |       |                                                    | $          | 6,644                                                            |       |                                                                   |       | $ | 3,723 |   |   |   | $ | 10,367 |   |   |

 

**11.**   NetIncome Per Share

Thefollowing table is a reconciliation of the weighted-average shares used in thecomputation of basic and diluted earnings (loss) per share for the periodspresented (in thousands):

| ** **                                                        | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                        | ** ** | ** **                                          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income used  to compute basic and diluted earnings per share  |       | $                                                   | 34,269     |   | $ | 62,790 |   | $ | 35,839 |   |
| Weighted average  number of shares outstanding—basic         |       | 62,615                                              |       | 58,545 |   | 57,279 |   |
| Dilutive effect  of stock options and warrants                    |       | 2,960                                               |       | 1,820 |   | 1,227 |   |
| Number of shares  used to compute earnings per share—diluted |       | 65,575                                              |       | 60,365 |   | 58,506 |   |
|                                                                   |            |                                                     |            |  |  |  |  |  |  |  |  |  |

 

Thefollowing amounts of options and warrants were excluded from the computation ofdiluted earnings per share as their exercise prices were in excess of theaverage market price of the common shares for the periods presented (inthousands, except per share data):

| ** **                        | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Outstanding  options and warrants |       | 275                                                 |       | 3,048 |   | 6,332 |   |
| Average exercise price            |       | $                                                   | 23.66      |   | $ | 17.63 |   | $ | 16.58 |   |
|                                   |            |                                                     |            |  |  |  |  |  |  |  |

 

 

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**12.**   IncomeTaxes

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

| ** **                                                         | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                         | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Income before income  taxes:                                       |       |                                                |       |   |   |   |   |
| United States                                                      |       | $                                                   | 31,454     |   | $ | 68,933 |   | $ | 46,115 |   |
| Foreign                                                            |       | 10,778                                              |       | 9,322 |   | 9,121 |   |
|                                                               |       | $                                                   | 42,232     |   | $ | 78,255 |   | $ | 55,236 |   |
| Provision for income tax  expense (benefit):                       |       |                                                |       |   |   |   |   |
| Current                                                            |       |                                                |       |   |   |   |   |
| Federal                                                            |       | $                                                   | (11,165    | ) | $ | 373 |   | $ | 9,054 |   |
| State                                                              |       | 957                                                 |       | (3,687 | ) | 2,407 |   |
| Foreign                                                            |       | 5,325                                               |       | 2,593 |   | 4,495 |   |
| Total current                                                      |       | (4,883                                              | )          | (721 | ) | 15,956 |   |
| Deferred                                                           |       |                                                |       |   |   |   |   |
| Federal                                                            |       | 9,238                                               |       | 8,050 |   | 2,775 |   |
| State                                                              |       | (5,016                                              | )          | 1,421 |   | 319 |   |
| Foreign                                                            |       | (1,679                                              | )          | 1,754 |   | (2,020 | ) |
| Total deferred                                                     |       | 2,543                                               |       | 11,225 |   | 1,074 |   |
| Add back benefit  (expense) recorded to stockholders’ equity: |       |                                                |       |   |   |   |   |
| Tax benefit related to stock option exercises                      |       | 10,612                                              |       | 6,640 |   | 2,367 |   |
| Tax expense related to unrealized gain on  investments             |       | (372                                                | )          | (1,940 | ) | — |   |
| Provision for income tax                                           |       | $                                                   | 7,900      |   | $ | 15,204 |   | $ | 19,397 |   |

 

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

| ** **                                                                | ** ** | **Fiscal Year Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                | ** ** | **2006**                                        | ** ** | **2005** | ** ** | **2004** | ** ** |
| U.S. federal  statutory tax rate                                          |       | 35.0                                            | %          | 35.0 | % | 35.0 | % |
| State taxes, net  of federal benefit and research and development credits |       | (2.3                                            | )          | (2.2 | ) | 3.6 |   |
| Research and  development credits                                         |       | (5.4                                            | )          | (7.9 | ) | — |   |
| Tax exempt  interest income                                               |       | (5.1                                            | )          | (1.1 | ) | (1.0 | ) |
| Rate differences  in foreign taxes and other                              |       | (3.5                                            | )          | (4.4 | ) | (2.5 | ) |
| Effective tax  rate                                                       |       | 18.7                                            | %          | 19.4 | % | 35.1 | % |

 

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

| ** **                                      | ** ** | **March 31,** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|
| ** **                                      | ** ** | **2006**           | ** ** | **2005** | ** ** |
| Deferred income tax  assets:                    |       |               |       |   |   |
| Accruals, reserves and other expenses           |       | $                  | 27,225     |   | $ | 22,364 |   |
| Tax credit carryforwards                        |       | 10,123             |       | — |   |
| Net operating loss carryforwards                |       | 4,855              |       | 1,328 |   |
| State income tax                                |       | —             |       | 1,382 |   |
| Total                                           |       | 42,203             |       | 25,074 |   |
| Valuation allowance                             |       | (5,576             | )          | (2,158 | ) |
| Deferred tax asset, net of valuation allowance  |       | 36,627             |       | 22,916 |   |
| Deferred income tax  liabilities:               |       |               |       |   |   |
| Software development costs                      |       | 42,422             |       | 26,019 |   |
| Depreciation and amortization                   |       | 4,441              |       | 5,122 |   |
| Unrealized gain on marketable equity securities |       | 1,632              |       | 1,290 |   |
| Other                                           |       | 1,982              |       | 1,792 |   |
| Total                                           |       | 50,477             |       | 34,223 |   |
| Net deferred tax  liability                     |       | $                  | 13,850     |   | $ | 11,307 |   |

 

As of March 31, 2006, net deferred taxliabilities of $3.6 million and $10.3 million were classified as current andlong-term liabilities, respectively. As of March 31, 2005, net deferredtax liabilities of $6.8 million and $4.5 million were classified as current andlong-term liabilities, respectively. The non-current portion of income taxreceivable is recorded net of an $11.8 million contingent tax liability. Thecontingent tax liability relates to tax positions taken in previously filed taxreturns and similar positions expected to be taken in our current year taxreturns. Moreover, the IRS has commenced a routine examination of our U.S.income tax returns for the fiscal years 2003 and 2004. A portion of thecontingent tax liability relates to the fiscal years under examination. Whilethe ultimate resolution of tax audits involves a degree of uncertainty, webelieve that adequate tax accruals have been provided for any adjustments thatare expected to result for these years.

The tax credit carryforwards as of March 31, 2006includes research and development tax credit carryforwards of $4.2 million and$5.9 million for federal and California purposes, respectively. The federal taxcredit carryforward expires in 2025, while the California tax credit can becarried forward indefinitely.

As of March 31, 2006, we have various state netoperating loss carryforwards totaling $17.0 million that expire between 2008and 2013 and foreign net operating loss carryforwards totaling $15.0 millionthat can be carried forward indefinitely. At March 31, 2006, our deferredincome tax asset for net operating loss carryforwards was reduced by avaluation allowance of $3.9 million as compared to $330,000 in the prior fiscalyear. Realization of the deferred tax assets is dependent upon the continuedgeneration of sufficient taxable income prior to the expiration of the netoperating loss carryforwards. Although realization is not assured, managementbelieves it is more likely than not that the net carrying value of the deferredtax asset will be realized.

The tax benefits associated with certain net operatingloss carryovers relate to employee stock options. Pursuant to SFAS No. 109,“Accounting for Income Taxes” (“SFAS No. 109”), net operating losses have beenreduced by $15.7 million relating to these items which will be credited toadditional paid-in capital when realized.

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At March 31, 2006 wehad accumulated foreign earnings of $32.1 million. We do not plan to repatriatethese earnings, therefore, no U.S. income tax has been provided on the foreignearnings. Additionally, we have not tax effected the cumulative translationadjustment as we have no intention of repatriating foreign earnings.

**13.**   EmployeeDefined Contribution Plan

For our United Statesemployees we sponsor a defined contribution plan under Section 401(k) ofthe Internal Revenue Code. Commencing January 1, 2005 the plan was amendedto allow employees the ability to defer up to 60% of their annual compensation(up to the annual maximum amount allowable by law). The plan also provides thatwe will make a matching contribution equal to each employee’s deferral, up to4% of eligible compensation. We may also contribute funds to the plan in theform of a discretionary profit-sharing contribution. Employer contributionsunder the plan were $3.5 million, $2.7 million and $1.7 million in thefiscal years ended March 31, 2006, 2005 and 2004, respectively.

**14.**   Stock-basedCompensation

As of March 31, 2006, we utilize two stock optionplans:  the THQ Inc. Amended and Restated1997 Stock Option Plan (the “1997 Plan”) and the THQ Inc. Third Amended andRestated Nonexecutive Employee Stock Option Plan (the “NEEP Plan”). The 1997Plan provides for the issuance of up to 14,357,500 shares available foremployees, consultants and non-employee directors, and the NEEP plan providesfor the issuance of up to 2,142,000 shares available for nonexecutive employeesof THQ of which no more than 20% is available for awards to our nonexecutiveofficers and no more than 15% is available for awards to the nonexecutiveofficers or general managers of our subsidiaries or divisions. As of March 31,2006, we had 2,007,949 shares under the 1997 Plan available for grant and237,031 shares under the NEEP Plan available for grant. On April 3, 2006we granted 681,000 options to certain officers of THQ, reducing the amount ofoptions available for grant to 1,564,148. Information related to the April 3,2006 option grant is included in our 2006 Proxy Statement.

Stock options granted under the 1997 Plan may beincentive stock options or non-qualified stock options. Stock options may begranted under the 1997 Plan to, in the case of incentive stock options, allemployees (including officers) of THQ; or, in the case of non-qualified stockoptions, all employees (including officers), consultants and non-employeedirectors of THQ. Additionally, under the 1997 Plan, the Company may grantPerformance Accelerated Restricted Stock (“PARS”) or Performance AcceleratedRestricted Stock Units (“PARSUs”) to officers and certain other high-levelemployees of the Company. Other than the right to grant PARS and PARSUs, theNEEP Plan has primarily the same attributes as the 1997 Plan, but participationis reserved for employees who are not executive officers and only non-qualifiedoptions may be granted.

The purchase price per share of common stockpurchasable upon exercise of each option may not be less than the fair marketvalue of such share of common stock on the date that such option is granted. Generally,options granted under these plans become exercisable over three years andexpire on the fifth anniversary of the grant date. PARS and PARSUs that havebeen granted to our officers under the 1997 Plan vest with respect to 100% ofthe shares subject to the award on the fifth anniversary of the grant date;provided, however, 20% of the shares subject to each award will vest on each ofthe first through fourth anniversaries of the grant date if certain performancetargets for the Company are attained each fiscal year. To date, no vesting ofPARS or PARSUs has been accelerated. PARSUs granted to our non-employeedirectors vest one year after their grant date. The fair value of PARS andPARSUs granted is amortized over the period(s) in which the relatedservices are rendered.

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Theexercise price per share of all options granted in the fiscal years ended March 31,2006, 2005 and 2004, has been the closing market price of the stock on the dateof the grant.

| ** **                        | ** ** | **2006**   | ** ** | **2005**                                   | ** ** | **2004**   | ** ** |
|-----------------------------------|------------|------------|------------|--------------------------------------------|------------|------------|------------|
| ** **                        | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| Outstanding at  beginning of year |       | 9,880,253  |       |                                       | $          | 13.10      |       |   | 10,177,268 |   |   | $ | 11.73 |   |   | 10,906,494 |   |   | $ | 13.19 |   |   |
| Granted                           |       | 3,276,078  |       |                                       | 20.48      |       |       | 4,578,969 |   |   | 13.51 |   |   | 3,621,638 |   |   | 10.73 |   |   |
| Exercised                         |       | (3,187,569 | )          |                                       | 12.03      |       |       | (4,189,155 | ) |   | 10.22 |   |   | (1,302,285 | ) |   | 5.47 |   |   |
| Cancelled                         |       | (894,159   | )          |                                       | 14.44      |       |       | (686,829 | ) |   | 13.17 |   |   | (3,048,579 | ) |   | 18.03 |   |   |
| Outstanding at  end of year       |       | 9,074,603  |       |                                       | $          | 16.00      |       |   | 9,880,253 |   |   | $ | 13.10 |   |   | 10,177,268 |   |   | $ | 11.73 |   |   |
| Exercisable at end of  year       |       | 3,480,265  |       |                                       | $          | 15.20      |       |   | 4,494,209 |   |   | $ | 14.15 |   |   | 5,353,334 |   |   | $ | 11.56 |   |   |

 

The estimated fair value of the employee stock-basedcompensation granted in the fiscal years ended March 31, 2006, 2005 and2004 was $26.8 million, $22.7 million and $20.6 million, respectively. Additionally,during fiscal 2006 we began issuing PARS and PARSUs. We issued 263,786 sharesof PARS and 20,250 units of PARSUs with an estimated fair value of $5.1 millionand $0.4 million, respectively, in the fiscal year ended March 31, 2006.

Thefollowing table summarizes information about stock options outstanding andexercisable at March 31, 2006:

| ** **                                 | ** ** | **Options Outstanding**                              | ** ** | **Options Exercisable**                                | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| **Range of Exercise Price** | ** ** | **Number  Outstanding at  March 31, 2006** | ** ** | **Weighted Average  Remaining  Contractual Life** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Shares Exercisable  at March 31, 2006** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| $  0.99  - $0.99                 |       |                                                      | 75,741     |                                                        |       |   | 0.41 |   |   |   | $ | 0.99 |   |   |   | 75,741 |   |   |   | $ | 0.99 |   |   |
| $  6.18  - $8.80                 |       |                                                      | 596,884    |                                                        |       |   | 2.01 |   |   |   | $ | 8.35 |   |   |   | 412,924 |   |   |   | $ | 8.18 |   |   |
| $  8.90  - $12.82                |       |                                                      | 2,589,325  |                                                        |       |   | 2.93 |   |   |   | $ | 11.82 |   |   |   | 997,415 |   |   |   | $ | 11.67 |   |   |
| $12.84 - $19.00                            |       |                                                      | 2,788,319  |                                                        |       |   | 3.02 |   |   |   | $ | 16.39 |   |   |   | 1,064,421 |   |   |   | $ | 15.60 |   |   |
| $19.01 - $23.53                            |       |                                                      | 2,536,444  |                                                        |       |   | 3.30 |   |   |   | $ | 20.43 |   |   |   | 910,638 |   |   |   | $ | 20.21 |   |   |
| $23.55 - $26.96                            |       |                                                      | 487,890    |                                                        |       |   | 4.59 |   |   |   | $ | 24.53 |   |   |   | 19,126 |   |   |   | $ | 25.43 |   |   |
| ** **                                 |       |                                                      | 9,074,603  |                                                        |       |   | 3.07 |   |   |   | $ | 16.00 |   |   |   | 3,480,265 |   |   |   | $ | 15.20 |   |   |

 

*Non-Employee Warrants.*   In prior years, we have granted stock warrants tothird parties in connection with the acquisition of licensing rights forintellectual property. The warrants generally vest upon grant and areexercisable over the term of the warrant. The exercise price of third-partywarrants is equal to their fair market value of our common stock at the date ofgrant. No third-party warrants were granted during the fiscal year ended March 31,2006.

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

In fiscal 2004 we granted 150,000 warrants to a third partyto purchase up to 150,000 shares of our common stock at an exercise price of$10.45 per share in connection with a license agreement that allows us toutilize intellectual property owned by the third party. The warrants vestedupon grant and have a 10-year term. The fair value of the warrants wasdetermined using the Black-Scholes pricing model, assuming a 

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risk-free rate of 4.87%, a volatility factor of 87%and the 10-year term as noted above. The fair value of these warrants was$1.4 million.

At March 31, 2006, we had 390,000 warrantsoutstanding with weighted average exercise price of $12.32. In fiscal 2006,112,500 warrants expired unexercised. At March 31, 2005 we had 502,500warrants outstanding with weighted average exercise price of $13.91.

In accordance with EITF 96-18,we measure the fair value of the securities on the measurement date. The fairvalue of each warrant is capitalized and amortized to expense when the relatedproduct is released and the related revenue is recognized. Additionally, asmore fully described in Note 1, the recoverability of intellectual propertylicenses is evaluated on a quarterly basis with amounts determined as notrecoverable being charged to expense. In connection with the evaluation ofcapitalized intellectual property licenses, any capitalized amounts for relatedthird-party warrants are additionally reviewed for recoverability with amountsdetermined as not recoverable being amortized to expense. For the years ended March 31,2006, 2005 and 2004, $1.3 million, $2.2 million and $932,000, respectively, wasamortized and included in license amortization expense.

**15.**   StockholdersRights Plan

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

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

Pursuant to theCertificate of Designation, as amended (the “Certificate of Designation”),establishing the Preferred Stock, effective as September 1, 2005:  (i) each share of Preferred Stock isentitled to quarterly dividends equal to 2,250 times the aggregate per shareamount of all dividends declared on the common stock, (ii) each share ofPreferred Stock will be entitled to 2,250 votes on all matters submitted to avote of THQ’s stockholders, (iii) the “adjustment number” (as defined inthe Certificate of Designation) used in Section 6 of the Certificate ofDesignation for calculating the liquidation amount for Preferred Stock is 2,250and (iv) in the event of a consolidation, merger, combination or similartransaction, each share of Preferred Stock will be exchanged or changed into anamount per share equal to 2,250 times the amount of capital stock, securities,cash or other property for which each share of common stock is exchanged or 

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changed. The descriptionof the Rights contained herein does not purport to be complete and is qualifiedin its entirety by reference to the Rights Agreement and the Certificate ofDesignation.

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

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

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

·       Forthe period commencing November 16, 1999 and ending June 30, 2006,JAKKS is entitled to receive a preferred payment equal to the greater of afixed guarantee, payable quarterly, or specified percentages of the net salesfrom WWE-licensed games (as defined) in amounts that vary based on the platform.The payment of these amounts is guaranteed by us. We are entitled to theprofits and 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 isspecified in the event the parties do not reach agreement; and

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

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

In November 2001, through the venture with JAKKS,we entered into an amendment to expand the WWE license to include exclusiverights to other wrestling content produced by the WWE. In exchange for theserights we paid a minimum guarantee to WWE that recoups through December 31,2014.

We are currently involved in litigation with WWE andJAKKS with respect to the license. See “Note 17—Commitments and Contingencies.”  Further, pursuant to the terms of theoperating agreement with JAKKS, we are currently renegotiating the amount ofthe preferred payment for the period subsequent to June 30, 2006, but havenot yet reached an agreement.

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**17.  Commitments and Contingencies**

A summary of annualminimum contractual obligations and commercial commitments as of March 31,2006 is as follows (in thousands):

| ** **                                  | ** ** | **Contractual Obligations and Commercial Commitments** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **FiscalYears Ending  March 31,** | ** ** | ** **                                                                 | ** ** | **License /  Software  Development  Commitments(1)** | ** ** | **Advertising(2)** | ** ** | **Leases(3)** | ** ** | **Letters of  Credit(4)** | ** ** | **Other(5)** | ** ** | **Total** | ** ** |
| 2007                                        |       |                                                                       | $          | 97,558 |   |   |   | $ | 21,762 |   |   |   | $ | 11,332 |   |   |   | $ | 7,563 |   |   |   | $ | 1,463 |   |   | $ | 139,678 |   |
| 2008                                        |       |                                                                       | 39,102     |   |   |   | 14,616 |   |   |   | 11,595 |   |   |   | — |   |   |   | — |   |   | 65,313 |   |
| 2009                                        |       |                                                                       | 39,613     |   |   |   | 13,184 |   |   |   | 11,189 |   |   |   | — |   |   |   | — |   |   | 63,986 |   |
| 2010                                        |       |                                                                       | 37,000     |   |   |   | 9,777 |   |   |   | 10,812 |   |   |   | — |   |   |   | — |   |   | 57,589 |   |
| 2011                                        |       |                                                                       | 22,000     |   |   |   | 9,777 |   |   |   | 10,137 |   |   |   | — |   |   |   | — |   |   | 41,914 |   |
| Thereafter                                  |       |                                                                       | —     |   |   |   | — |   |   |   | 28,779 |   |   |   | — |   |   |   | — |   |   | 28,779 |   |
|                                        |       |                                                                       | $          | 235,273 |   |   |   | $ | 69,116 |   |   |   | $ | 83,844 |   |   |   | $ | 7,563 |   |   |   | $ | 1,463 |   |   | $ | 397,259 |   |
|                                             |            |                                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          *Licenses andSoftware Development.*We enter into contractual arrangements withthird parties for the rights to intellectual property and for the developmentof products. Under these agreements, we commit to provide specified payments toan intellectual property holder or developer. Assuming all contractualprovisions are met, the total future minimum contract commitments for contractsin place as of March 31, 2006 are approximately $235.3 million. License/softwaredevelopment commitments in the table above include $74.2 million of commitmentsto licensors that are included in our consolidated balance sheet as of March 31,2006 because the licensors do not have any significant performance obligationsto us. These commitments were included in both current and long-term licensesand accrued royalties.

(2)          *Advertising.*We have certain minimumadvertising commitments under most of our major license agreements. Theseminimum commitments generally range from 2% to 12% of net sales related to therespective license. We estimate that our minimum commitment for advertising infiscal 2007 will be $21.8 million.

(3)          *Leases.*We are committed under operatingleases with lease termination dates through 2015. Most of our leases containrent escalations.

Rent expense was $10.6 million, $6.0 million and $4.5million for the fiscal years ended March 31, 2006, 2005 and 2004,respectively.

(4)          *Letters ofCredit.* As of March 31, 2006, we were in compliance with allthe covenants under our credit facility, had outstanding letters of credit ofapproximately $7.6 million and no borrowings.

(5)          *Other.*This amount reflects an additional$1.5 million related to the purchase of Relic in April 2004. This amountwas paid in April 2006.

Other potential future expenditures relate to thefollowing:

*Manufacturer Indemnification.**  *We must indemnify the platform manufacturers(Microsoft, Nintendo, Sony) of our games with respect to all loss, liabilityand expenses resulting from any claim against such manufacturer involving thedevelopment, marketing, sale or use of our games, including any claims forcopyright or trademark infringement brought against such manufacturer. As aresult, we bear a risk that the properties upon which the titles of our gamesare based, or that the information and technology licensed from others andincorporated into the products, may infringe the rights of third parties. Ouragreements with our third-party software developers and property licensorstypically provide indemnification rights for us with respect to certain matters.However, if a manufacturer brings a claim 

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

*Director Indemnity Agreements.**  *We have entered into indemnificationagreements with the members of our Board to provide a contractual right ofindemnification to our Directors to the extent permitted by law against any andall liabilities, costs, expenses, amounts paid in settlement and damagesincurred by the Directors as a result of any lawsuit, or any judicial,administrative or investigative proceeding in which the Directors are sued as aresult of their service as members of our Board.  The indemnificationagreements provide specific procedures and time frames with respect to requestsfor indemnification and clarify the benefits and remedies available toDirectors in the event of an indemnification request.

*Credit Facility.**  *We have a credit agreement that lasts through November 29,2006 that provides us a maximum monthly facility amount of $40.0 million foreach August, September and October, and a maximum monthly facility amountof $12.0 million for every other month. The credit facility is unsecured andcontains customary financial and non-financial covenants that require us tomaintain specified operating profits and liquidity and limits our ability toincur additional indebtedness, sell assets, pay cash dividends and enter intocertain mergers or acquisitions. As of March 31, 2006, we were incompliance with all the covenants under the credit facility and had outstandingletters of credit of approximately $7.6 million.

*Litigation.*

*World WrestlingEntertainment.*

On October 19, 2004, World WrestlingEntertainment, Inc. (“WWE”) filed a lawsuit in the United States DistrictCourt for the Southern District of New York (the “Court”) against JAKKS Pacific, Inc.(“JAKKS”), THQ, the THQ/JAKKS joint venture, and others, alleging, among otherclaims, improper conduct by JAKKS, certain executives of JAKKS, an employee of theWWE and an agent of the WWE in granting the WWE video game license to theTHQ/JAKKS joint venture. The complaint seeks various forms of relief, includingmonetary damages and a judicial determination that, among other things, theTHQ/JAKKS video game license is void. On March 30, 2005, WWE filed anamended complaint, adding both new claims and THQ’s president and chiefexecutive officer, Brian Farrell, as a defendant. In August 2005, theCourt directed the parties to file briefs on the three federal law claimsalleged by the Plaintiffs (*i.e.*,Robinson-Patman, and Sherman Act, and a threshold issue concerning thePlaintiff’s RICO claim). The motions to dismiss the amended complaint based onthese issues were fully briefed and argued and, on March 31, 2006, theCourt granted the defendants’ motion to dismiss the Robinson-Patman Act andSherman Act claims and denied the defendants’ motion seeking to dismiss theRICO claims on the basis of the threshold “enterprise” issue that was briefed(the “March 31 Order”). On April 7, 2006, the Company and the otherdefendants sought certification to appeal from the portion of the March 31Order denying the motion to dismiss the RICO claim on the one ground that wasbriefed. Shortly thereafter, WWE filed a motion for re-argument with respect tothe portion of the March 31 Order that dismissed the Sherman Act claimand, alternatively, sought judgment with respect to the Sherman Act claim sothat it could pursue an immediate appeal. At a court hearing on April 26,2006, the Court deferred a ruling on the requests for partial judgment and forcertification and set briefing schedules with respect to the remaining groundsfor defendants’ motion to dismiss the RICO claim, currently the sole remainingbasis for federal jurisdiction in this action, that were not the subject of thefirst round of briefing. The Court also established a briefing schedule for WWE’smotion for re-argument of the dismissal of the Sherman Act claim. The briefingand argument of these motions is scheduled to be completed by September 2006.Discovery in this action remains stayed. On June 2, 2006, we filed a motion todismiss the RICO claims against THQ and Brian Farrell. THQ believes thatneither it, nor Brian Farrell, is primarily accused of any wrongdoing in thecomplaint or the amended complaint, and believes that either there is no basisfor terminating the license with THQ, or that THQ will be made whole by thosewhose conduct is eventually 

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found to be unlawful. We intend to vigorously protectour rights and, if necessary, pursue appropriate claims against third parties.

On March 30, 2006, WWE’s counsel wrote a letterto our counsel and counsel for JAKKS, alleging breaches by the THQ/JAKKS jointventure of the video game license related to the manner of distribution andpayment of royalties to the WWE with respect to sales of the WWE video games inJapan. WWE demanded that the alleged breaches be cured within the time periodsprovided in the video game license, while reserving all of its rights,including its alleged right of termination of the video game license. On April 28,2006, our counsel responded on behalf of the THQ/JAKKS joint venture,asserting, among other things, that the WWE had been aware and had consented tothe manner of distribution in Japan and the payment of royalties with respectto such sales and, in addition, had separately released the joint venture fromany claims with respect to such matter as a result of a settlement of an auditof the THQ/JAKKS joint venture. We have also provided documentation to the WWE’scounsel in support of our position. WWE’s counsel has subsequently responded byletter, reiterating its claims and reservation of all rights, and has requestedadditional information regarding sales of WWE video games in Japan and certainother Asian countries. We are currently developing our response to WWE’scounsel’s most recent communications. We believe we have several bases fordefending any claim of breach of the video game license agreement resultingfrom the manner of distribution of WWE-licensed products in****Japan and other Asian territories.

Due to the early status ofthis litigation with WWE we cannot estimate a possible loss, if any. Games wedevelop based upon our WWE license have contributed to approximately 15% of ournet sales during each of the three years in the period ended March 31, 2006.The loss of the WWE license would have a negative impact on our futurefinancial results.

***Other***

Additionally, we are involved in routine litigationarising in the ordinary course of our business. In the opinion of ourmanagement, none of this pending routine litigation will have a materialadverse effect on our consolidated financial condition or results ofoperations.

**18.  Segment and Geographic Information**

Weoperate in one reportable segment in which we are a developer, publisher anddistributor of interactive entertainment software for home video game consoles,handheld platforms and personal computers. The following information sets forthgeographic information on our sales and total assets for the fiscal years endedMarch 31, 2006, 2005 and 2004 (in thousands):

| ** **                           | ** ** | **North  America** | ** ** | **Europe** | ** ** | **Asia  Pacific** | ** ** | **Consolidated** | ** ** |
|--------------------------------------|------------|--------------------|------------|------------|------------|-------------------|------------|------------------|------------|
| **Year ended March 31, 2006**   | ** ** | ** **         | ** ** | ** ** | ** ** | ** **        | ** ** |             | ** ** | ** ** |   |
| Net sales to  unaffiliated customers |       | $                  | 489,945    |       | $          | 269,928           |       | $                | 46,687     |   |   | $ | 806,560 | ** ** |   |
| Total assets                         |       | 776,272            |       | 62,664     |       | 11,678            |       |             | 850,614    | ** ** |   |
| **Year  ended March 31, 2005**  | ** ** | ** **         | ** ** | ** ** | ** ** | ** **        | ** ** |             | ** ** | ** ** |   |
| Net sales to  unaffiliated customers |       | $                  | 470,619    |       | $          | 245,083           |       | $                | 41,029     |   |   | $ | 756,731 | ** ** |   |
| Total assets                         |       | 672,284            |       | 64,948     |       | 10,161            |       |             | 747,393    | ** ** |   |
| **Year  ended March 31, 2004**  | ** ** | ** **         | ** ** | ** ** | ** ** | ** **        | ** ** |             | ** ** | ** ** |   |
| Net sales to  unaffiliated customers |       | $                  | 453,426    |       | $          | 161,857           |       | $                | 25,563     |   |   | $ | 640,846 | ** ** |   |
| Total assets                         |       | 479,198            |       | 41,515     |       | 6,438             |       |             | 527,151    | ** ** |   |

 

Our largest single customer accounted for 19% of ourgross sales in fiscal 2006, 14% of our gross sales in fiscal 2005 and 19% ofour gross sales in fiscal 2004.

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Informationabout THQ’s net sales by platform for fiscal 2006, 2005 and 2004 is presentedbelow (in thousands):

| ** **                   | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|
| **Platform**                 | ** ** | ** **                                          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Consoles**                 | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sony PlayStation  2          |       | $                                                   | 296,294    |   | $ | 275,850 |   | $ | 247,603 |   |
| Microsoft Xbox  and Xbox 360 |       | 102,660                                             |       | 80,623 |   | 71,132 |   |
| Nintendo GameCube            |       | 59,255                                              |       | 73,157 |   | 61,356 |   |
|                         |       | 458,209                                             |       | 429,630 |   | 380,091 |   |
| **Handheld**                 | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nintendo Game Boy  Advance   |       | 171,477                                             |       | 204,348 |   | 162,109 |   |
| Nintendo Dual  Screen        |       | 32,855                                              |       | 3,110 |   | — |   |
| Sony PlayStation  Portable   |       | 29,406                                              |       | — |   | — |   |
| Wireless                     |       | 36,112                                              |       | 24,613 |   | 6,860 |   |
|                         |       | 269,850                                             |       | 232,071 |   | 168,969 |   |
| **PC**                       |       | 77,615                                              |       | 86,667 |   | 74,934 |   |
| **Other**                    |       | 886                                                 |       | 8,363 |   | 16,852 |   |
| **Total Net Sales**          |       | $                                                   | 806,560    |   | $ | 756,731 |   | $ | 640,846 |   |
|                              |            |                                                     |            |  |  |  |  |  |  |  |  |  |

 

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

***Twelve Months Ended March 31, 2006***

| ** **                                                                  | ** ** | ** ** | ** ** | **Quarter Ended**  | ** ** | ** **               | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-------------------------|------------|--------------------------|------------|
| **(Amounts in thousands,  except per share data)** | ** ** | ** ** | ** ** | **June 30,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **Dec. 31,  2005** | ** ** | **March 31,  2006** | ** ** | **Fiscal Year  Ended** | ** ** |
| Net sales                                                                   |       |       | $          | 157,967                 |       |                     | $          | 142,692 |   | $ | 357,848 |   | $ | 148,053 |   |   | $ | 806,560 |   |   |
| Expenses and  other                                                         |       |       | 163,623    |                    |       | 144,747                  |       | 292,159 |   | 163,799 |   |   | 764,328 |   |   |
| Income (loss)  before income taxes and minority interest                    |       |       | (5,656     | )                       |       | (2,055                   | )          | 65,689 |   | (15,746 | ) |   | 42,232 |   |   |
| Income taxes                                                                |       |       | (1,753     | )                       |       | (637                     | )          | 18,044 |   | (7,754 | ) |   | 7,900 |   |   |
| Income (loss)  before minority interest                                     |       |       | (3,903     | )                       |       | (1,418                   | )          | 47,645 |   | (7,992 | ) |   | 34,332 |   |   |
| Minority interest                                                           |       |       | (57        | )                       |       | 3                        |       | (62 | ) | 53 |   |   | (63 | ) |   |
| Net income (loss)                                                           |       |       | $          | (3,960                  | )          |                     | $          | (1,415 | ) | $ | 47,583 |   | $ | (7,939 | ) |   | $ | 34,269 |   |   |
| Net income (loss) per  share                                                |       |       |       |                    |       |                     |       |   |   |   |   |   |   |   |   |
| Basic                                                                       |       |       | $          | (0.06                   | )          |                     | $          | (0.02 | ) | $ | 0.76 |   | $ | (0.12 | ) |   | $ | 0.55 |   |   |
| Diluted                                                                     |       |       | $          | (0.06                   | )          |                     | $          | (0.02 | ) | $ | 0.72 |   | $ | (0.12 | ) |   | $ | 0.52 |   |   |

 

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***Twelve Months Ended March 31, 2005***

| ** **                                                                  | ** ** | ** ** | ** ** | **Quarter Ended**  | ** ** | ** **               | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-------------------------|------------|--------------------------|------------|
| **(Amounts in thousands,  except per share data)** | ** ** | ** ** | ** ** | **June 30,  2004** | ** ** | **Sept. 30,  2004** | ** ** | **Dec. 31,  2004** | ** ** | **March 31,  2005** | ** ** | **Fiscal Year  Ended** | ** ** |
| Net sales                                                                   |       | $          | 88,194     |                    | $          | 96,295                   |       | $ | 400,315 |   | $ | 171,927 |   |   | $ | 756,731 |   |   |
| Expenses and  other                                                         |       | 94,242     |       | 106,328                 |       | 319,249                  |       | 158,657 |   |   | 678,476 |   |   |
| Income (loss)  before income taxes and minority interest                    |       | (6,048     | )          | (10,033                 | )          | 81,066                   |       | 13,270 |   |   | 78,255 |   |   |
| Income taxes                                                                |       | (2,147     | )          | (3,774                  | )          | 18,057                   |       | 3,068 |   |   | 15,204 |   |   |
| Income (loss)  before minority interest                                     |       | (3,901     | )          | (6,259                  | )          | 63,009                   |       | 10,202 |   |   | 63,051 |   |   |
| Minority interest                                                           |       | —     |       | (95                     | )          | (74                      | )          | (92 | ) |   | (261 | ) |   |
| Net income (loss)                                                           |       | $          | (3,901     | )                       | $          | (6,354                   | )          | $ | 62,935 |   | $ | 10,110 |   |   | $ | 62,790 |   |   |
| Net income (loss)  per share                                                |       |       |       |                    |       |                     |       |   |   |   |   |   |   |
| Basic                                                                       |       | $          | (0.07      | )                       | $          | (0.11                    | )          | $ | 1.08 |   | $ | 0.17 |   |   | $ | 1.07 |   |   |
| Diluted                                                                     |       | $          | (0.07      | )                       | $          | (0.11                    | )          | $ | 1.05 |   | $ | 0.16 |   |   | $ | 1.04 |   |   |

 

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

For the quarter ended December 31, 2004, netincome included a $7.8 million benefit for research and development income taxcredits claimed for prior years.

 

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

None.

**Item9A.**                Controls and Procedures

(a)   *Definitionand limitations of disclosure controls*. Our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) arecontrols and other procedures that are designed to ensure that informationrequired to be disclosed in our reports filed under the Exchange Act, such asthis report, is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms. Disclosure controls andprocedures are also designed to ensure that such information is accumulated andcommunicated to our management, including the Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure. Our management evaluates these controls and procedures on anongoing basis.

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

(b)  *Evaluationof disclosure controls and procedures*. Our Chief Executive Officerand Chief Financial Officer, after evaluating the effectiveness of ourdisclosure controls and procedures, believe that as of the end of the periodcovered by this report, our disclosure controls and procedures were effectivein providing the requisite reasonable assurance that material informationrequired to be disclosed in the reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms, and is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

Deloitte &Touche LLP, the registered public accounting firm that audited the financialstatements included in this Annual Report on Form 10-K, has issuedan audit report on management’s assessment of our internal control overfinancial reporting.

(c)   *Changes ininternal control over financial reporting*. In the fourth quarter offiscal 2006, we implemented certain components of a new system for projectmanagement and project costing (the “Project Management System”) that enhanceour ability to track and allocate the overall costs related to the developmentof our video games. This change materially affected our internal control overfinancial reporting. The Project Management System is a process improvementinitiative intended to strengthen the overall design and operatingeffectiveness of our financial reporting controls and is not in response to anidentified internal control deficiency. Other than the Project ManagementSystem implementation, there were were no changes in our internal control overfinancial reporting that occurred during our last fiscal quarter that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting. We have continued to implementadditional components of the Project Management System that are reasonablylikely to have a material affect on our internal control over financialreporting in the first quarter of fiscal 2007.

**Item 9B.**               OtherInformation

None.

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**Management Reporton Internal Control Over Financial Reporting**

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

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

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

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

Management has evaluated the effectiveness of itsinternal control over financial reporting as of March 31, 2006 based onthe control criteria established in a report entitled *Internal Control—Integrated Framework*,issued by the Committee of Sponsoring Organizations of the Treadway Commission.Based on such evaluation, we have concluded that the Company’s internal controlover financial reporting is effective as of March 31, 2006.

Theregistered independent public accounting firm of Deloitte & ToucheLLP, as auditors of the Company’s consolidated financial statements, has issuedan attestation report on management’s assessment of the Company’s internalcontrol over financial reporting.
| /s/ BRIAN J. FARRELL                                                                          |   |                                                                                                            |   | /s/ EDWARD  K. ZINSER |   |   |
|-----------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------|--------|-----------------------|--------|--------|
| Brian J. Farrell  Chairman of the Board, President and  Chief Executive Officer  June 7, 2006 |   | Edward K. Zinser  Executive Vice President,  Chief Financial Officer and Chief Accounting Officer  June 7, 2006 |

 

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders of THQ Inc.,Agoura Hills, California

We have audited management’s assessment, included inthe accompanying Management Report on Internal Control over FinancialReporting, that THQ Inc. and its subsidiaries (the “Company”) maintainedeffective internal control over financial reporting as of March 31, 2006,based on criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the Company’s internal control over financial reporting basedon our audit.

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

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

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

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of March 31,2006, is fairly stated, in all material respects, based on the criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.Also in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of March 31, 2006,based on the criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), the Company’sconsolidated balance sheet as of March 31, 2006 and the relatedconsolidated statements of operations, stockholders’ equity and cash flows for theyear then ended. Our report dated June 6, 2006 expressed an unqualifiedopinion on those financial statements.

**DELOITTE & TOUCHE LLP**Los Angeles, California

June 6, 2006

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**PART III**

**Item 10.***                *Directors and ExecutiveOfficers of the Registrant

The followinginformation required by Item 10 is incorporated herein by reference fromour definitive Proxy Statement for the 2006 Annual Meeting of Stockholders,which will be filed within 120 days after the close of our fiscal year (the “ProxyStatement”):

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

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

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

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

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

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

**Item 11.***                *Executive Compensation

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

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

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

**Item 13.***                *Certain Relationships andRelated Transactions

There were no reportablebusiness relationships, transactions with management, or indebtedness ofmanagement during the fiscal year ended March 31, 2006.

**Item 14.***                *Principal Accounting Feesand Services

The information regardingprincipal accounting fees and services and the Company’s pre-approval policiesand procedures for audit and non-audit services provided by the Company’sindependent accountant is incorporated by reference to the Proxy Statementunder the caption “Proposal Number 4—Ratification of Independent RegisteredPublic Accounting Firm.”

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**PART IV**

**Item 15.**                 Exhibits and ConsolidatedFinancial Statement Schedules

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

Thefollowing financial statements of the Company are included in Part II Item8:

|                                                                                                                     | ** ** | **Page** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING  FIRM                                                            |       |     | 49         |   |   |
| CONSOLIDATED FINANCIAL STATEMENTS                                                                                   |       |     |       |   |   |
| Consolidated  balance sheets—March 31, 2006 and 2005                                                      |       |     | 50         |   |   |
| Consolidated statements of operations for the fiscal  years ended March 31, 2006, 2005  and 2004               |       |     | 51         |   |   |
| Consolidated statements of stockholders’ equity for  the fiscal years ended March 31, 2006, 2005 and 2004 |       |     | 52         |   |   |
| Consolidated statements of cash flows for the fiscal  years ended March 31, 2006, 2005  and 2004               |       |     | 53         |   |   |
| NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                          |       |     | 54         |   |   |

 

***(b) Exhibits.***

Thefollowing exhibits are filed herewith or are incorporated by reference toexhibits previously filed with the SEC. We will furnish copies of the exhibitsfor a reasonable fee (covering the expense of furnishing copies) upon request:

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

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| 4.2     |   | First Amendment to  Amended and Restated Rights Agreement, dated April 9, 2002 between the  Company and Computershare Investor Services, LLC, as Rights Agent  (incorporated by reference to Exhibit 2 to Amendment No. 3 to the  Registrant’s Registration Statement on Form 8-A filed on  April 12, 2002 (file No. 000-18813)).                                                                                    |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1 #  |   | Stock Option Agreement,  dated as of 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).                                                                                                                                                                                     |
| 10.2 #  |   | 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 Quarterly Report on Form 10-Q  for the quarter ended June 30, 1999).                                                                                                                                                    |
| 10.3 #  |   | 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).                                                                                                                                                                    |
| 10.4 #  |   | Ed Zinser Offer Letter  dated March 24, 2004 (incorporated by reference to Exhibit 10.3 to  the Registrant’s Quarterly Report on Form 10-Q for the quarter  ended June 30, 2004 (the “June 2004 10-Q”)).                                                                                                                                                                                                        |
| 10.5 #  |   | Kelly Flock Offer Letter  dated August 11, 2005 (incorporated by reference to Exhibit 10.1 to  the Registrant’s Quarterly Report on Form 10-Q for the quarter  ended September 30, 2005 (the “September 2005 10-Q”)).                                                                                                                                                                                           |
| 10.6 #  |   | Indemnification  Agreements, dated as of November 30, 2004 between the Company and each  director of the Company, being the following: Lawrence Burstein, Henry  DeNero, Brian P. Dougherty, Brian J. Farrell, and James L. Whims  (incorporated by reference to Exhibit 10.4 to the Registrant’s Quarterly  Report on Form 10-Q for the quarterly period ended  December 31, 2004 (the “December 2004 10-Q”)). |
| 10.7 #  |   | Indemnification  Agreement, dated as of March 28, 2006 between the Company and Jeffrey W.  Griffiths (the form of which is incorporated by reference to  Exhibit 10.4 to the Registrant’s December 2004 10-Q).                                                                                                                                                                                                                      |
| 10.8 #  |   | THQ Inc. Amended and  Restated 1997 Stock Option Plan, as amended on August 18, 2005  (incorporated by reference to Exhibit 10.2 to the Registrant’s  September 2005 10-Q).                                                                                                                                                                                                                                                         |
| 10.9 #  |   | Third Amended and  Restated Nonexecutive Employee Stock Option Plan (incorporated by reference  to Appendix C to Registrant’s Proxy Statement on Schedule 14A filed  July 3, 2003).                                                                                                                                                                                                                                                           |
| 10.10 # |   | THQ Inc. Performance  Accelerated Restricted Stock Unit Deferred Compensation Plan, effective as of  August 18, 2005 (incorporated by reference to Exhibit 10.3 to the  Registrant’s September 2005 10-Q).                                                                                                                                                                                                                          |
| 10.11 # |   | Form of Severance  Agreement with Executive Officers (incorporated by reference to  Exhibit 10.7 to the Registrant’s Annual Report on Form 10-K  for the fiscal year ended December 31, 1998).                                                                                                                                                                                                                                 |
| 10.12 # |   | Form of Severance  Agreement for Senior Officers, effective January 27, 2005 (incorporated  by reference to Exhibit 10.10 to the Registrant’s Annual Report on  Form 10-K for the fiscal year ended March 31, 2005 (the  “March 2005 10-K”)).                                                                                                                                                              |
| 10.13 # |   | THQ Inc. Management  Deferred Compensation Plan, effective as of January 1, 2005  (incorporated by reference to Exhibit 10.1 to the Registrant’s Current  Report on Form 8-K filed on December 23, 2004).                                                                                                                                                                                                                      |

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| 10.14   |   | 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 Quarterly Report on Form 10-Q  for the quarter ended September 30, 2002 (the “September 2002 10-Q”)).                                                                                                                                                                              |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15   |   | First Amendment to the  Amended and Restated Revolving Credit Agreement, dated November 21, 2002  by and between the Company and Union Bank (incorporated by reference to  Exhibit 10.24 to the Registrant’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2002).                                                                                                                                                                                                        |
| 10.16   |   | Second Amendment to the  Amended and Restated Revolving Credit Agreement and Third Amendment to the  Security Agreement, dated May 30, 2003 by and between the Company and  Union Bank of California, N.A., as sole lender, and Union Bank of California,  N.A., as administrative agent for the Lender (incorporated by reference to  Exhibit 10.35 to the Registrant’s Transitional Annual Report on  Form 10-KT for the transitional period from January 1, 2003  to March 31, 2003). |
| 10.17   |   | Third Amendment to the  Amended and Restated Revolving Credit Agreement, dated September 26,  2003 by and between the Company and Union Bank of California, N.A., as  administrative agent for the Lender (incorporated by reference to  Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q  for the quarter ended September 30, 2003 (the “September 2003 10-Q”)).                                                                                                |
| 10.18   |   | Fourth Amendment -  Extension letter dated August 25, 2004, relating to the Credit Agreement  between the Company and Union Bank of California (incorporated by reference  to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K  filed on August 31, 2004).                                                                                                                                                                                                                         |
| 10.19 + |   | Fifth Amendment to  Amended and Restated Revolving Credit Agreement, dated as of  November 29, 2004 by and between the Company, Union Bank of California,  N.A., a sole lender, and Union Bank of California, N.A., as administrative  agent for the Lender (incorporated by reference to Exhibit 10.3 to the  Registrant’s December 2004 10-Q).                                                                                                                                                   |
| 10.20 + |   | PlayStation® 2 CD-Rom /  DVD-Rom Licensed Publisher Agreement, dated as of April 1, 2000 between  Sony Computer Entertainment America Inc. and the Company (incorporated by  reference to Exhibit 10.10 to the Registrant’s September 2002 10-Q).                                                                                                                                                                                                                                             |
| 10.21 + |   | Licensed Publisher  Agreement, dated as of August 28, 2002 by and between Sony Computer  Entertainment America Inc. and the Company (incorporated by reference to  Exhibit 10.9 to the Registrant’s September 2002 10-Q).                                                                                                                                                                                                                                                                          |
| 10.22   |   | PlayStation® 2 Licensed  Publisher Agreement, dated as of May 21, 2003 between Sony Computer Entertainment  Korea Inc. and THQ Korea Ltd. (incorporated by reference to Exhibit 10.1  to the Registrant’s Quarterly Report on Form 10-Q for the quarter  ended June 30, 2003 (the “June 2003 10-Q”)).                                                                                                                                                                     |
| 10.23   |   | PlayStation® 2 Licensed  Publisher Agreement, dated as of July 28, 2003 between Sony Computer  Entertainment Europe Limited and THQ International Limited (incorporated by  reference to Exhibit 10.1 to the Registrant’s September 2003 10-Q).                                                                                                                                                                                                                                               |
| 10.24 + |   | PlayStation® Portable  Licensed Publisher Agreement, dated as of November 17, 2004 between Sony  Computer Entertainment America Inc. and the Company (incorporated by  reference to Exhibit 10.2 to the Registrant’s December 2004 10-Q).                                                                                                                                                                                                                                                     |

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| 10.25 + |   | Xbox 360 Publisher License Agreement, dated as of  October 31, 2005 by and between Microsoft Licensing, GP and the Company  (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly  Report on Form 10-Q for the quarter ended December 31, 2005).                                       |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.26 + |   | Microsoft Corporation  XboxTM Publisher License Agreement, dated as of March 20, 2001 between  Microsoft Corporation and the Company (incorporated by reference to  Exhibit 10.8 to the Registrant’s September 2002 10-Q).                                                                                 |
| 10.27   |   | Amendment to the XboxTM  Publisher Licensing Agreement (Tiered Royalty Rate Structure and Xbox  Platinum Hits Program), dated as of January 31, 2003 between Microsoft  Licensing, Inc. and the Company (incorporated by reference to  Exhibit 10.2 to the Registrant’s June 200310-Q).               |
| 10.28   |   | Term Extension to XboxTM  Publisher License Agreement, dated October 13, 2004 between the Company  and Microsoft Licensing, GP (incorporated by reference to Exhibit 10.1  of the Registrant’s Current Report on Form 8-K filed on  October 18, 2004).                                                |
| 10.29   |   | Amendment to the XboxTM  Publisher Licensing Agreement (Platinum Hits Family Programs), dated as of  March 15, 2004 (incorporated by reference to Exhibit 10.30 to the  Registrant’s Annual Report on Form 10-K for the fiscal year ended  March 31, 2004).                                           |
| 10.30 + |   | Amendment to XboxTM  Publisher License Agreement, effective as of March 1, 2005 and dated  March 9, 2005 by and between Microsoft Licensing, GP and the Company  (incorporated by reference to Exhibit 10.27 to the Registrant’s  March 2005 10-K).                                                   |
| 10.31 + |   | Confidential License  Agreement for Game Boy Advance (Western Hemisphere), dated as of  July 18, 2001 between Nintendo of America, Inc. and the Company  (incorporated by reference to Exhibit 10.6 to the Registrant’s  September 2002 10-Q).                                                            |
| 10.32   |   | First Amendment to the  Confidential License Agreement for Game Boy Advance, dated as of  July 18, 2004 between Nintendo of America, Inc. and the Company  (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly  Report on Form 10-Q for the quarter ended September 30,  2004). |
| 10.33 + |   | Confidential License  Agreement for Nintendo GameCube (Western Hemisphere), dated as of  April 5, 2002 between Nintendo of America, Inc. and the Company  (incorporated by reference to Exhibit 10.7 to the Registrant’s  September 2002 10-Q).                                                           |
| 10.34 + |   | First Amendment to  Confidential License Agreement for Nintendo GameCube, dated as of  April 5, 2005 between Nintendo of America, Inc. and the Company  (incorporated by reference to the Registrant’s Quarterly Report on  Form 10-Q for the quarter ended June 30, 2005).                               |
| 10.35 + |   | Confidential License  Agreement for Nintendo GameCube (Asia), dated as of November 17, 2003  between Nintendo Co., Ltd. and THQ Asia Pacific Pty Ltd. (incorporated by  reference to Exhibit 10.1 to the Registrant’s June 2004 10-Q).                                                                         |
| 10.36 + |   | Confidential License  Agreement for the Nintendo DS handheld platform, dated as of January 25,  2005 between Nintendo of America, Inc. and the Company (incorporated by  reference to Exhibit 10.32 to the Registrant’s March 2005 10-K).                                                                 |
| 10.37   |   | Lease agreement dated  December 22, 2004 between the Company, as Tenant, and FORCE-AGOURA ROAD,  LLC and Dennis D. Jacobsen Family Holdings II, LLC, as Landlord (incorporated  by reference to Exhibit 10.6 to the Registrant’s December 2004 10-Q).                                                          |
| 14*     |   | Code of Ethics for  Executive Officers and Other Senior Financial Officers, as adopted  May 27, 2004                                                                                                                                                                                                                          |

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| 21*   |   | Subsidiaries of the  Registrant                                                                                                                           |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
| 23.1* |   | Consent of  Deloitte & Touche LLP                                                                                                                |
| 31.1* |   | Certification of Brian  J. Farrell, Chief Executive Officer, pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                              |
| 31.2* |   | Certification of Edward  K. Zinser, Chief Financial Officer and Chief Accounting Officer, pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32.1* |   | Certification of Brian  J. Farrell, Chief Executive Officer, pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                              |
| 32.2* |   | Certification of Edward  K. Zinser, Chief Financial Officer and Chief Accounting Officer, pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

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*       Filedherewith

#      Managementcontract of compensatory plan or arrangement

+     Portionshave been omitted and filed separately with the Securities and ExchangeCommission pursuant to a request for confidential treatment in accordance with Rule 24b-2under the Securities Exchange Act of 1934, as amended

85

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.

| Dated: June 7, 2006 | THQ INC. |
|--------------------------|----------|
|                     | By:      | /s/ BRIAN J.  FARRELL |
|                     |     | Brian J. Farrell, Chairman of the Board, President  and Chief Executive Officer |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the following personson behalf of the Registrant and in the capacities and on the dates indicated.

| Signature                | ** ** | **Title**                                                                                | ** ** | **Date**          |
|--------------------------|------------|------------------------------------------------------------------------------------------|------------|-------------------|
| /s/ BRIAN J. FARRELL     |       | Director, Chairman of  the Board, President and Chief                                    |       | June 7, 2006 |
| Brian J. Farrell         |       | Executive Officer (Principal Executive Officer)                                          |       |              |
| /s/ EDWARD ZINSER        |       | Executive Vice  President, Chief Financial Officer and                                   |       | June 7, 2006 |
| Edward Zinser            |       | Chief Accounting Officer (Principal Financial  Officer and Principal Accounting Officer) |       |              |
| /s/ LAWRENCE BURSTEIN    |       | Director                                                                                 |       | June 7, 2006 |
| Lawrence Burstein        |       |                                                                                     |       |              |
| /s/ HENRY DENERO         |       | Director                                                                                 |       | June 7, 2006 |
| Henry DeNero             |       |                                                                                     |       |              |
| /s/ BRIAN DOUGHERTY      |       | Director                                                                                 |       | June 7, 2006 |
| Brian Dougherty          |       |                                                                                     |       |              |
| /s/ JEFFREY W. GRIFFITHS |       | Director                                                                                 |       | June 7, 2006 |
| Jeffrey W. Griffiths     |       |                                                                                     |       |              |
| /s/ JAMES L. WHIMS       |       | Director                                                                                 |       | June 7, 2006 |
| James L. Whims           |       |                                                                                     |       |              |

 

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