**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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FORM 10-K

**(Mark One)**

**x** Annual report pursuant to Section 13or 15(d)of the Securities Exchange Act of 1934

**Forthe fiscal year ended March 31, 2005**

**or**

**o** Transition report pursuant to Section 13or 15(d)of the Securities Exchange Act of 1934

**Forthe transition period from                       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.) |
| **27001 Agoura Road**                     | ** **          |
| **Calabasas  Hills, CA**                  | **91301**           |
| (Address of  principal executive offices) | (Zip Code)          |

 

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

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Securitiesregistered pursuant to Section 12(b) of the Act: None.

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

**CommonStock,  $.01 par valuePreferred Stock Purchase Rights**

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

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§229.405 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

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).Yes  þ  No  o

The aggregate market valueof voting stock held by non-affiliates of the registrant as of May 27,2005 was approximately $1,132,533,000. As of May 27, 2005, 40,767,913shares of common stock were outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

The2005 Notice of Annual Meeting of Stockholders and Proxy Statement isincorporated by reference into Part III herein.

 

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**THQ INC.INDEX TO ANNUAL REPORT ON FORM 10-KFILED WITH THE SECURITIES AND EXCHANGE COMMISSIONFOR THE FISCAL YEAR ENDED MARCH 31, 2005**

**ITEMS IN FORM 10-K**
|                   | ** ** | **PAGE**                                                                                                                        | ** ** |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|
| **PART I**   |
| Item 1.           |       | Business                                                                                                                        | 1          |
| Item 2.           |       | Properties                                                                                                                      | 11         |
| Item 3.           |       | Legal  Proceedings                                                                                                              | 12         |
| Item 4.           |       | Submission  of Matters to a Vote of Security Holders                                                                            | 12         |
| **PART II**  |
| Item 5.           |       | Market  for the Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities         | 13         |
| Item 6.           |       | Selected  Consolidated Financial Data                                                                                           | 14         |
| Item 7.           |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations       | 17         |
| Item 7A.          |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                     | 50         |
| Item 8            |       | Financial  Statements and Supplementary Data                                                                                    | 51         |
| Item 9            |       | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                  | 82         |
| Item 9A           |       | Controls  and Procedures                                                                                                        | 82         |
| Item 9B           |       | Other  Information                                                                                                              | 83         |
| **PART III** |
| Item  10.         |       | Directors  and Executive Officers of the Registrant                                                                             | 87         |
| Item 11.          |       | Executive  Compensation                                                                                                         | 87         |
| Item  12.         |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                 | 87         |
| Item 13.          |       | Certain  Relationships and Related Transactions                                                                                 | 87         |
| Item 14.          |       | Principal  Accounting Fees and Services                                                                                         | 87         |
| **PART IV**  |
| Item  15.         |       | Exhibits,  Financial Statement Schedules and Reports on Form 8-K                                                           | 88         |
| Signatures        | 92         |
| Certifications    |       |

 

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**This Annual Reporton Form 10-K contains, or incorporates by reference, certainforward-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,”“expect,” “intend,” “estimate,” “may,” “could,” “project,” “potential,” “plan,”“forecast,” “future” and similar expressions to help identify forward-lookingstatements. These forward-looking statements are subject to business andeconomic risk, reflect management’s current expectations, estimates andprojections about our business, and are inherently uncertain and difficult topredict. Our actual results could differ materially. The forward-lookingstatements contained herein speak only as of the date on which they were made,and we disclaim any obligation to update any forward-looking statements toreflect events or circumstances after the date of this**Annual Report. Risks and uncertainties thatmay affect our future results include, but are not limited to, those discussedunder the heading “Risk Factors,” included in Item 7 herein. Allreferences to “we,” “us,” “our,” “THQ,” or the “Company” in the followingdiscussion and analysis mean THQ Inc. and its subsidiaries.

**PART I**

**Item1. Business**

**Introduction**

We are a leadingworldwide developer and publisher of interactive entertainment software for allpopular 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. We intend to develop games for the Nintendo Revolution;

·        Handheldplatforms such as Nintendo Game Boy Advance, Nintendo Dual Screen, PSPTMportable entertainment 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 in spring 2006;Nickelodeon properties such as SpongeBob SquarePantsTM, Fairly OddParentsTM andJimmy NeutronTM; World WrestlingEntertainmentTM; BratzTM; PowerRangers; Warhammer 40,000*®*: Dawn of WarTM; Marvel’s *The Punisher*TM; Scooby-Doo!TM; andSonic the HedgehogTM;**aswell as others. We also have licenses to create wireless products based on *Star Wars*, the National Football League (“NFL”), theNational Hockey League (“NHL”), Major League Baseball (“MLB”) and the

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(1)   Nintendo®,Dual Screen, Game Boy® Advance, GameCube® (“GameCube”) and Revolution aretrademarks and/or registered trademarks of Nintendo of America Inc. (“Nintendo”).“PlayStation” and the “PS” family logo are registered trademarks of SonyComputer Entertainment Inc., and “PSP” is a trademark of Sony ComputerEntertainment Inc. (“Sony”). Microsoft, Xbox® (“Xbox”) and Xbox 360TM aretrademarks and/or registered trademarks of Microsoft Corporation (“Microsoft”).Microsoft, Nintendo and Sony are referred to herein collectively as the “platformmanufacturers” or the “manufacturers.”

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National BasketballAssociation (“NBA”), including the players of each league. In addition tolicensed properties, we also publish games based upon owned intellectualproperties, including *Destroy All HumansTM,JuicedTM, MX, S.T.A.L.K.E.R.: Shadow of Chernobyl,*and***Tak*TM**(co-developedwith Nickelodeon).

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

In North America, we market and distribute gamesdirectly to leading mass merchandisers, consumer electronic stores, discountwarehouses and national retail chain stores. Our offices in the United Kingdom,Australia, France, Germany, Korea and Spain provide a global sales network,delivering products to retail shelves in more than 75 countries throughout theworld. We also market and distribute games and other content for wirelessdevices worldwide through major wireless carriers.

We were originallyincorporated in New York in 1989 as Trinity Acquisition Corporation, whichchanged its name in 1990 to T.HQ, Inc. through a merger with T.HQ, Inc.,a California corporation. We were reincorporated in Delaware in 1997. Ourprincipal executive offices are located at 27001 Agoura Road, Calabasas Hills,California 91301, and our telephone number is (818) 871-5000. Our website is at http://www.thq.com.(2)

**Narrative Descriptionof 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 7 herein.

**Strategy**

Inorder to maximize market share and increase profitability, we believe it isimportant to offer a broad portfolio of titles for all ages that are playableon all popular platforms. We intend to do this by executing on the followingstrategies:

·        ***Increase sales and profits from current mass-marketfranchises***

We have worked to grow and diversify our productstargeted at the mass-market by securing key content licenses, which will allowus to continue to leverage our family brands with both new products and throughthe catalog of existing products. In the fiscal year ended March 31, 2005(referred to as “fiscal 2005”), we extended our relationship with PixarAnimation Studios (“Pixar”) by entering into a new license with Pixar. The newPixar license grants us the exclusive interactive rights to four upcoming Pixaranimated feature films beginning with the first release following *Cars*, which we are currently developing and is scheduled forrelease in spring 2006. In fiscal 2005, we also extended our license agreementwith Nickelodeon, which grants us the exclusive right to continue publishinggames based on all existing and future Nickelodeon animated television andmovie properties targeting kids ages 6-14 across all viable game systemsthrough 2010.

In order to increase sales and profits from currentbrands, our goal is to continue building high quality products, market themaggressively and shift more development to our internal development studios. Infiscal 2005, our key Disney/Pixar and Nickelodeon titles were developed by ourinternal studios.

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

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In thefiscal year ending March 31, 2006 (“fiscal 2006”) and beyond, we plan toship mass-market titles for the current generation of console platforms, thePSP system and to continue to develop for the Nintendo Dual Screen (“DS”). Weexpect to release a total of 14 SKUs for the DS and PSP in fiscal 2006. A SKUis a version of a title designed for play on a particular platform.

·        ***Expand market share of the core gamer segment***

Webelieve that we can grow overall market share in our industry by expanding ourcore gamer market share. We have worked to create and acquire our own brandsand content and to secure content licenses for original intellectual properties.In fiscal 2005, we acquired the exclusive worldwide intellectual propertyrights to the *Juiced* franchise, a street racingproperty, and plan to release *Juiced* in thefirst quarter of fiscal 2006. Additionally, we released new products targetedat the core gamer based upon both original and licensed intellectual propertiesincluding *Full Spectrum WarriorTM*, *MX v. ATV UnleashedTM*, *The Punisher*,and *Warhammer 40,000: Dawn of WarTM*. Upcoming titles in thiscategory include *Company of HeroesTM,**Destroy AllHumans!, The OutfitTM,Saint’s RowTM* and *S.T.A.L.K.E.R.: Shadow of Chernobyl*, as well as a sequel to *Full Spectrum Warrior* and an expansion pack to *Warhammer 40,000: Dawn of War.*

·        ***Increase internal development capabilities andtechnology base***

We believe it is importantfor us to expand our internal development capabilities and to increaseownership of technology and intellectual property. During fiscal 2005, wecontinued to enhance our internal product development capabilities with theacquisitions of Relic Entertainment (“Relic”), located in Canada, Blue TongueEntertainment Limited (“Blue Tongue”), located in Australia, and with theformation of a new studio, Concrete Games, located near San Diego, California. Withthe addition of these studios and expansion in our existing studios, ourworldwide product development operations now include over 900 people located atour corporate offices and in 10 studios. Releases in fiscal 2005 that weredeveloped by our studios included *The Incredibles*,*MX v. ATV Unleashed, Polar Express, The Punisher,The SpongeBob Square PantsTM Movie*, and *Warhammer40,000: Dawn of War*.

We arededicating significant internal development resources to developing softwarefor next-generation platforms and we expect to release games through the growthof the installed base of the hardware. We plan to continue creating ownedintellectual properties and developing them internally. Additionally, we aredeveloping proprietary tools and technologies for use across our studioorganization. We plan to continue to expand our internal developmentcapabilities by selectively acquiring or establishing development studios andthrough internal growth of existing studios.

·        ***Expand international business***

As the global gamingmarket continues to grow, we believe that international markets represent asignificant growth opportunity for us. We distribute our products in more than75 countries and territories outside of North America. In fiscal 2005, weestablished an office in Spain and we also operate international offices in theUnited Kingdom, Australia, France, Germany and Korea. In fiscal 2006, we expectto continue expanding our sales force in Europe by establishing direct salesforces in Austria, Eastern European countries, the Benelux countries, Italy andthe Nordic territories. We expect to expand our Asia Pacific sales forces inNew Zealand and Japan and are targeting new territories, such as China, forexpansion. In addition, we plan to continue developing and acquiring contentthat sells well internationally (*e.g.*,Disney/Pixar, World WrestlingEntertainment*TM* and *Warhammer 40,000: Dawn of War*) and targeting wireless gamingapplications to appropriate foreign markets.

·        ***Becomea leading player in wireless interactive entertainment***

The mobile phone hasevolved from a voice-only device to a personal data and voice communicationdevice that includes technologies that enable multimedia applications,including games. We plan to 

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leverage our mass-marketfranchises, core gamer titles, wireless sports licenses and other exclusivewireless licenses, such as *Star Wars*, tobecome a leading provider of games and other content for wireless devices.

**Industry Overview**

As a publisher ofinteractive entertainment software, we consider ourselves to be part of theentertainment industry. At the most fundamental level, our products competewith other forms of entertainment, such as motion pictures, television andmusic, for the leisure time and discretionary spending of consumers. We believethat video games have increasingly become a mainstream entertainment choice forboth children and a maturing, technologically sophisticated audience. Accordingto the International Development Group, Inc. (“IDG”), an independentconsulting and advisory services company which analyzes the consumerelectronics and interactive entertainment industries, sales of PC, console andhandheld games (excluding wireless games) reached $7.7 billion in NorthAmerica, and $6.4 billion in Europe in 2004. As we approach the next generationof console systems, we look toward an expanding market for interactiveentertainment software. We believe that improved graphics, deeper onlinefunctionality and expanded artificial intelligence capabilities of the newplatforms will help grow our industry significantly. In addition, the number ofworldwide handsets that are enabled for wireless games is projected to growfrom 200 million in 2004 to almost 700 million in 2008 according tothe Arc Group, an independent advisory services company which analyzes thewireless telecommunications industry. Also, the U.S. wireless gaming market isprojected to grow from $345 million in 2004 to almost $1.5 billion in 2008according to IDC, an independent advisory services company which analyzes thetelecommunications industry.

Historically, there havebeen multiple gaming platforms and vigorous competition between consolemanufacturers. The first modern platform was introduced by Nintendo in 1985. Advancesin technology over the past 20 years have resulted in continuous increases inthe processing power of the chips that power both the consoles and PC. For thepast several years, Sony has been the clear leader in the console market (withits PlayStation and PlayStation 2 consoles), Microsoft and Nintendo arelarge and viable competitors, and PCs also continue to be a viable interactivegame platform. Also, over the past two years, wireless devices, such as mobilephones, have become a viable gaming platform. Nintendo has been the dominantmanufacturer of handheld platforms, most recently with its Game Boy Advance. Infiscal 2005, Nintendo released a new handheld platform, the Nintendo DS, andSony entered the handheld platform market with its PSP system.

We currently develop andpublish products for all major platforms, and this diversification continues tobe a cornerstone of our strategy. In fiscal 2005, our product releases were forthe Sony PlayStation 2, Microsoft Xbox, Nintendo GameCube, PC, Game BoyAdvance, Nintendo Dual Screen and wireless devices. In fiscal 2006, we plan torelease products on all of these platforms as well as the PSP system and theXbox 360, the next-generation Xbox videogame system, which Microsoft isexpected to launch in the 2005 holiday season. Sony is expected to launch itsnext-generation platform, the PlayStation 3, in 2006 and Nintendo has recentlyannounced that it will release its next-generation console, Revolution, in 2006.We expect to release games on each new console platform at or near the launchof the platforms.

**Products**

Wedevelop, market and sell video games and other interactive software and contentfor home console platforms, handheld platforms and personal computers. In fiscal2005, we published six titles that shipped more than one million units. Thefollowing list identifies games that generated a significant portion of oursales during the fiscal years ended March 31, 2005 and 2004 and the twelvemonths ended March 31, 2003:

·        Infiscal 2005, Disney/Pixar’s *The Incredibles, TheSpongeBob SquarePants Movie*,and *WWETMSmackDown! Vs. RawTM*;

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·        Infiscal 2004, Disney/Pixar’s *Finding Nemo, SpongeBobSquarePantsTM: Battle for Bikini BottomTM*, and *WWESmackDown!, Here comes the PainTM*; and

·        Inthe twelve months ended March 31, 2003, *WWESmackDown! Shut Your Mouth.*

ValuSoft, a division ofTHQ, develops and publishes value-priced interactive entertainment andproductivity software for PC. This allows us to sell our products to the casualgaming market. In fiscal 2005, ValuSoft released 67 titles, including *World Poker Championship*.

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, uponcompletion of development we extensively play-test each game, and if required,send the game to the manufacturer for its review and approval. Other than gamesthat we release for PCs or wireless devices, the manufacturers or theirauthorized vendors manufacture our products for us. We then market anddistribute our games for sale throughout the world.

**IntellectualProperty**

Our business processbegins with the creation of intellectual property or acquisition ofintellectual property rights. Traditionally, most of our titles were based uponlicensed properties which have attained a high level of consumer recognition oracceptance. We have relationships with many well-known licensors, includingDisney, Pixar, Nickelodeon, World Wrestling Entertainment, Warner Brothers andMarvel.

Our intellectual propertylicenses usually grant us the exclusive use of the property for specifiedtitles, on specified platforms, within a defined territory and during thelicense term. All of our licenses are of varying duration and may in someinstances be renewable upon payment of certain minimum royalties or the attainmentof specified sales levels. We pay royalties to our property licensors thatgenerally range from 3% to 20% of our net sales of the title which includes thelicensor’s intellectual property. We typically advance payments against minimumguaranteed royalties over the license term. Royalty rates are generally higherfor properties with proven popularity and less perceived risk of commercialfailure.

Our original intellectualproperty is created either by one of our ten development studios or by athird-party developer that we contract with, in which instance, we retain allownership rights in the intellectual property. If a third-party developercreated the intellectual property and develops the game, we obtain a licensethat is typically exclusive and we try to retain rights to any future productsbased on the intellectual property.

**Platform Licenses**

Inaddition to obtaining licenses to develop intellectual property, our businessis dependent upon entering into license agreements with the platform manufacturerswhich allow us the right to develop, publish and distribute titles for use onsuch manufacturer’s platform. Our key platform licenses currently include:

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

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

·        licenseswith Microsoft to develop games for the Xbox.

Each license is for afixed term, and as each license expires, we generally enter into a newagreement or an amendment with the licensor to extend the term of the agreement.Certain agreements, such as the licenses with Sony for the PlayStation 2,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 platformswhich are currently sold in the United States and Canada. We are licensed topublish 

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and distribute titles forGameCube, PlayStation 2, Xbox and Game Boy Advance in various additionalterritories, including Europe, Australia and New Zealand, parts of Asia andCentral and South America. We expect to enter into additional platform licensesor extend current licenses as new platforms are launched or our currentagreements expire.

The platform licenses arenot exclusive and require that each title be approved by the manufacturer priorto development of the software, and once developed, manufactured solely by suchmanufacturer or a designated vendor of the manufacturer. The licenses establishthe fees that we must pay to the manufacturer for each cartridge or disc made. Nintendocharges us a fixed amount for each Game Boy Advance cartridge manufactured. Thisamount varies based, in part, on the memory capacity of the cartridge. OurNintendo, 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 mustindemnify the manufacturers with respect to all loss, liability and expenseresulting from any claim against the manufacturer involving the development,marketing, sale, or use of our games, including any claims for copyright ortrademark infringement brought against the manufacturer. As a result, we bear arisk that the properties upon which the titles are based, or that the informationand technology licensed from others and incorporated in the products, mayinfringe the rights of third parties. Conversely, our agreements with ourindependent software developers and property licensors typically provide for usto be indemnified with respect to certain matters. If any claim is brought by amanufacturer against us for indemnification, however, our developers orlicensors may not have sufficient resources to, in turn, indemnify us. Furthermore,these parties’ indemnification of us may not cover the matter that gives riseto 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 productsusing both internal and external development resources. We make the decision asto which development resources to use based upon the creative and technicalchallenges of the product, whether the intellectual property which is beingdeveloped into a game is licensed, an original concept that we created, or anoriginal concept created by a third-party developer.

In fiscal 2005, 39% of our revenue was from titlesdeveloped by our internal studios. Our internal studio organization consists often studios, which are staffed by producers, game designers, softwareengineers, artists, animators and game testers. We also contract withthird-party software developers to develop games. We typically select thesethird-party developers for their expertise in developing products in a certaincategory. Each third-party developer is under contract with us to developspecific or multiple titles. For externally developed products, we generallypay either a royalty compensation, which ranges from 4% to 20% of net sales, orwe pay a development fee. We typically pay our independent developersinstallments of the development fee (and, in the case of royalty compensation,advances against future royalty payments) based either on specific developmentmilestones or on agreed-upon payment schedules.

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Our product development team manages the developmentof our games in a way which we believe encourages creativity and innovationwhile allowing us to implement our methodologies through the development cycleto assure product quality. Our procedure for the selection, development,production and quality assurance of our internally and externally producedinteractive entertainment software titles is known as the “Greenlight Process.”The Greenlight Process begins with the concept visualization stage, in which weevaluate and assess the opportunity for a product and determine whether anintellectual property will translate well into a game. Part of thegreen-light process is the identification of the development resource; whethera title will be developed using internal or external development resources. Withrespect to licensed properties, our strategy is to develop games based on ourlong-term key properties, such as those licensed from Disney/Pixar andNickelodeon, using our internal studios so that we maintain greater controlover the development process and obtain a higher operating margin. Originalproperties are generally developed by either an internal studio or third-partydeveloper which created the intellectual property.

Once we determine where a product will be developed,our internal product development team oversees the internal or externaldeveloper in its design, technical assessment and construction of each game. Uponcompletion of development, each game is extensively play-tested by us to ensurecompatibility with the appropriate hardware systems and configurations and tominimize the number of bugs and other defects found in the products. Ifrequired, we also send the game to the manufacturer for its review andapproval.

The development cycle for a new game depends on theplatform and whether it is based on an original or licensed property. Licensedproperties generally have a shorter development cycle than an original propertysince the concepts have already been created. 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 console platforms, PC games and the PSP system generally ranges from12 to 24 months, Game Boy Advance ranges from 6 to 9 months, Nintendo DS rangesfrom 9 to 12 months and wireless games range from 6 to 9 months. Theserelatively long development cycles require that we assess whether there will beadequate retailer and consumer demand for a game well in advance of itsrelease.

To support our productsafter 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 werelease for sale on PCs or wireless devices, our video games are manufacturedfor us by the platform manufacturers or their authorized vendors. We contractwith various PC replicators for the manufacturing of our PC products.

The platform gamemanufacturing process begins with our placing a purchase order with amanufacturer. We then send the software code and a prototype of the game to themanufacturer, together with related artwork, user instructions, warrantyinformation, brochures and packaging designs, for approval, defect testing, andmanufacture.

We are required by our platform licenses to provide astandard defective product warranty on all of the products sold. Generally, weare responsible for resolving, at our own expense, any warranty or repairclaims. We have not experienced any material warranty claims, but there is noguarantee that we will not experience such claims in the future.

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**Marketing and Sales**

Our marketing activitiesvary depending upon whether a video game title is based upon a licensed or anoriginal property. A licensed property has pre-existing brand popularity andthus often requires less initial effort by us to promote. Our marketing effortsfor titles based upon original properties begin well in advance of a title’srelease and focus on building positive awareness of our game concepts withconsumers and retailers alike. We conduct consumer and retail research whichprovide us with feedback to position a title prior to its release. Our publicrelations promotional activities for original titles in fiscal 2005 includedcoverage in broadcast, print and online media targeting enthusiast, lifestyleand major mainstream outlets. Additionally, we continue to increase ourcorporate public relations efforts by establishing relationships with leadingtechnology and business reporters.

Our marketing efforts forproducts released in fiscal 2005 covered a broad range of media including,national television, print, in-theater, radio, Internet advertising andpromotional campaigns. Our products shipped in fiscal 2005 that receivedtelevision support included *Fairly OddParents, FullSpectrum Warrior, The Incredibles, MX v. ATV Unleashed, Power Rangers,Scooby-Doo!, The SpongeBob SquarePants Movie, Tak 2: The Staff of Dreams, ThePunisher, WWE Day of ReckoningTM, and WWE SmackDown! Vs. Raw*. Ourgames were also supported by promotional activities such as trailers, demodiscs, over-sized boxes, standees, posters, pre-sell giveaways at retailstores, game kiosks at sporting and outdoor events, rebates and contests withnational packaged goods companies and fast food restaurants, and co-marketingefforts with the hardware manufacturers. Our games are promoted to retailers bydisplay at trade shows such as the annual Electronic Entertainment Expo (E3)and select retailer specific trade shows. We also conduct print and cooperativeretail advertising campaigns for most titles and prepare a range of promotionalsales and marketing materials to increase awareness among retailers.

We strive to create globalbrand awareness for our products. Consistent with our strategy to build andmaintain franchise properties with global appeal, our international marketingefforts include localization of products to conform to consumer preferences andlanguages in the countries in which each title is distributed. This structureis designed to maximize market performance in all territories.

*North American Sales.  *In North America,our products are primarily sold directly to mass merchandisers, consumerelectronics stores, discount warehouses and national retail chain stores. Ourproducts are also sold to smaller, regional retailers, as well as distributorswho, in turn, sell our products to retailers that we do not service directly,such as grocery and drug stores. Our domestic sales activities are led by ournational sales team which has representatives in most major markets in theUnited States. Since our customers do not have written agreements orunderstandings that commit them to make purchases, our sales team isresponsible for negotiating shelf space for new titles and our existing catalogas well as in-store marketing efforts, for every title.

We utilize electronic datainterchange with most of our major North American customers in order to (i) efficientlyreceive, process, and ship customer product orders and (ii) accuratelytrack and forecast sell-through of products to consumers in order to determinewhether to order additional products from the manufacturers. We believe thatthe direct relationship model we use in North America allows us to bettermanage inventory, merchandise and communications. We ship most of our productsto our domestic customers from warehouses located in Canada, Michigan,Minnesota and Ohio.

The domestic retail pricesfor our titles currently range between: (i) $15 and $35 for Game BoyAdvance; (ii) $20 and $35 for Nintendo Dual Screen; (iii) $20 and $55for the console platforms; and (iv) $10 and $55 for PC games. The domesticretail price for our wireless games currently range between $4 and $8 for a onetime purchase and between $2 and $3 for a monthly subscription.

*International Sales.*   Ourinternational sales activities operate via our offices in the United Kingdom,Australia, France, Germany, Korea and Spain. International offices market anddistribute direct-to-retail customers and through sub-distributors in boththeir home territories and to 70 additional territories.

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Our ten largest customersworldwide include Wal-Mart, Target, Toys “R” Us, Best Buy, GameStop,Electronics Boutique, Game Stores Group Ltd., and other national and regionalretailers, discount store chains and specialty retailers. Sales to thesecustomers collectively accounted for approximately 48% of our sales in fiscal2005. Our largest customer, Wal-Mart, accounted for 14% of our worldwide salesin fiscal 2005.

***Revenue Fluctuations andSeasonality.****  *We have experienced, and willlikely continue to experience, significant quarterly fluctuations in net salesand operating results due to a variety of factors. The software market ishighly seasonal, with sales typically significantly higher during the quarterending December 31 (due primarily to the increased demand for interactivegames during the year-end holiday buying season). Other factors that causefluctuations include the timing of our release of new titles, the popularity ofboth new titles and titles released in prior periods, changes in the mix oftitles with varying gross margins, the timing of customer orders, the timing ofshipments by the manufacturers, fluctuations in the size and rate of growth ofconsumer demand for software for various platforms, the timing of theintroduction of new platforms, and the accuracy of retailers’ forecasts ofconsumer demand. Our expenses are partially based on our expectations of futuresales and, as a result, operating results would be disproportionately andadversely affected by a decrease in sales or a failure by us to meet our salesexpectations. There can be no assurance that we can maintain consistentprofitability on a quarterly or annual basis.

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

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

·        For the period commencing November 16,1999 and ending June 30, 2006, JAKKS is entitled to receive a preferredpayment based upon specified percentages of the net sales from the WWE-licensedgames (as defined) in amounts that vary based on the platform. The payment ofthese amounts is guaranteed by us. We are entitled to the profits and cashdistributions remaining after the payment of these amounts;

·        For periods after June 30,2006, the amount of the preferred payment will be subject to renegotiationbetween the parties. An arbitration procedure is specified in the event theparties do not reach agreement; and

·        We are responsible for theday-to-day operations of the venture. We are responsible for development, salesand distribution of the WWE-licensed games, and JAKKS is responsible for theWWE approval process and other relationship matters with WWE.

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

In November 2001,through the venture with JAKKS, we entered into an amendment to expand the WWElicense to include exclusive rights to other wrestling content produced by theWWE. In exchange for these rights we have agreed to increase the minimumguarantee payable to WWE through December 31, 2013.

We are currently involvedin litigation with the JAKKS and WWE with respect to the license. See “Item 3.—LegalProceedings—WWE Lawsuit” for more information.

**Competition**

The video game industry isintensely competitive. It is characterized by the continuous introduction ofnew titles and the development of new technologies. Some of our competitors arevery large, diversified corporations. Our business is driven by hit titles,which requires us to invest significantly in production and 

9

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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, effectiveness of marketing and price.

We compete both forlicenses to properties and the sale of interactive entertainment software withSony, Microsoft and Nintendo, each of which is a large developer and marketerof software for its own platforms. Each of these competitors has the financialresources to withstand significant price competition and to implement extensiveadvertising campaigns, particularly for prime-time television spots. Inaddition to the manufacturers, our competitors include publishers anddevelopers of interactive entertainment software, such as Activision, Atari,Electronic Arts, LucasArts, Namco, Sega, Take-Two Interactive Software,Ubisoft, and Vivendi Universal Games.

In addition, large mediacompanies are increasing their focus in the interactive entertainment softwaremarket and, as a result, stand to become more direct competitors. Disneyrecently expanded its software game publishing efforts with the acquisition ofa developer, as well as the establishment of an internal development studio. Viacomhas also announced its intent to expand its efforts in interactiveentertainment software publishing.

**Employees**

As of March 31, 2005,we employed approximately 1,300 people, of whom over 400 were outside theUnited States. We believe that our ability to attract and retain qualifiedemployees is a critical factor in the successful development of our productsand that our future success will depend, in large measure, on our ability tocontinue to attract and retain qualified employees. None of our employees arerepresented by a labor union or covered by a collective bargaining agreementand we consider our relations with employees to be favorable.

**Financial Information About Geographic Areas**

See Item 7 “ManagementDiscussion and Analysis of Financial Condition and Results of Operations” andNote 17 of notes to consolidated financial statements included in Item 8.

**Available Information**

We file annual, quarterlyand current reports, proxy statements and other information with the Securitiesand Exchange Commission (“SEC”). Our SEC filings, including our annual reporton Form 10-K, quarterly reports on Form 10-Q, current reportson Form 8-K, and any amendments to those reports filed or furnishedpursuant to Section 13(a) of the Exchange Act are available to thepublic free of charge over the Internet at our website at http://www.thq.com orat the SEC’s web site at http://www.sec.gov. Our SEC filings will be availableon our website as soon as reasonably practicable after we have electronicallyfiled or furnished them to the SEC. Information contained on our website is notincorporated by reference into this annual report on Form 10-K. You canview our Code of Business Conduct and Ethics and our Code of Ethics forExecutive Officers and Other Senior Financial Officers free of charge on thecorporate governance section of our website. If we make any substantiveamendments to our Code of Ethics for Executive Officers and Other SeniorFinancial Officers or if any waivers of such code are granted, we will postthem on our web site.

10

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**Item 2.** Properties

Thefollowing is a listing of the principal leased offices maintained by us as of May 27,2005:
| **Property**                    | ** ** | ** **                  | ** ** | **Location** | ** ** | **Square  Feet** |
|---------------------------------|------------|-----------------------------|------------|--------------|------------|------------------|
| THQ Corporate Office (1)        |       | Calabasas Hills, California |       | 123,600      |
| ValuSoft                        |       | Waconia, Minnesota          |       | 5,000        |
| **Studios**                     |       |                        |       |         |
| Blue Tongue Entertainment       |       | Melbourne, Australia        |       | 9,600        |
| Concrete Games                  |       | San Diego, California       |       | 9,400        |
| Cranky Pants Games              |       | Kirkland, Washington        |       | 8,300        |
| Heavy Iron Studios              |       | Culver City, California     |       | 16,800       |
| Helixe                          |       | Burlington, Massachusetts   |       | 10,300       |
| Locomotive Games, Inc. (2) |       | Santa Clara, California     |       | 12,400       |
| Rainbow Multimedia Group (3)    |       | Phoenix, Arizona            |       | 47,500       |
| Relic Entertainment (4)         |       | Vancouver, Canada           |       | 11,500       |
| THQ Australia Studios           |       | Spring Hill, Australia      |       | 12,200       |
| Volition, Inc.             |       | Champaign, Illinois         |       | 42,400       |
| **International Offices**       |       |                        |       |         |
| Australia                       |       | Melbourne, Australia        |       | 9,600        |
| France                          |       | Paris, France               |       | 4,300        |
| Germany                         |       | Krefeld, Germany            |       | 14,000       |
| Korea                           |       | Seoul, Korea                |       | 2,000        |
| Spain                           |       | Madrid, Spain               |       | 4,300        |
| United Kingdom                  |       | Woking,  England            |       | 10,400       |

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(1)   OnDecember 30, 2004, we entered into a lease for premises consisting ofapproximately 103,000 square feet of office space located in Agoura Hills,California, which we intend to use as our corporate headquarters. Our currentlease expires in October 2005.

(2)   In April2005, Pacific Coast Power & Light Company changed its name to LocomotiveGames, Inc.

(3)   On January31, 2005, we amended the existing lease for our Rainbow Multimedia Group studioin Phoenix, Arizona to include an additional approximately 19,500 square feet,commencing June 1, 2005.

(4)   On November19, 2004, we entered into a sublease for premises consisting of approximately35,000 square feet of office space located in Vancouver, Canada, commencingJuly 1, 2005, for our Relic Entertainment studio. Upon commencement of thislease, Relic will vacate its current premises.

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% ownershipinterest.

We also own 10,820 squarefeet of space in Phoenix, Arizona which will be used as a data center andmotion capture studio.

11

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**Item3.** Legal Proceedings

*WWE Lawsuit*.   On October 19, 2004,World Wrestling Entertainment, Inc. (“WWE”) filed a lawsuit in the UnitedStates District Court for the Southern District of New York against JAKKSPacific, Inc. (“JAKKS”), THQ, the THQ/JAKKS joint venture, and others,alleging, among other claims, improper conduct by JAKKS, certain executives ofJAKKS, an employee of the WWE and an agent of the WWE in granting the WWE videogame license to the THQ/JAKKS joint venture. The complaint seeks various formsof relief, including monetary damages and a judicial determination that, amongother things, the THQ/JAKKS video game license is void. On March 30, 2005,WWE filed an amended complaint, adding both new claims and THQ’s president andchief executive officer, Brian Farrell, as a defendant. THQ believes thatneither it, nor Brian Farrell, is directly 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.

*Patent Infringement litigation*.   OnAugust 30, 2004, THQ was served with a lawsuit entitled *American Video Graphics, L.P. v. Electronic Arts, Inc., et al.*,filed in the United States District Court for the Eastern District of Texas. ThePlaintiff claims that Defendants, including THQ, have infringed upon a patentowned by the Plaintiff entitled “Method and Apparatus for Spherical Panning.”Defendants in the lawsuit include THQ, Electronic Arts Inc., Take-TwoInteractive Software, Inc., Ubi Soft, Activision, Inc., Atari, Inc.,Vivendi Universal Games, Inc., Sega of America, Inc., Square Enix, Inc.,Temco, Inc., LucasArts Entertainment Co., and Namco Hometek, Inc. THQhas entered into a joint defense agreement with several of the other Defendantsand intends to vigorously defend the claims against us. Since the litigation isstill in an early stage, we cannot predict the likely outcome of this dispute.

*Tetris Litigation*.   On April 14,2005, THQ filed a complaint against The Tetris Company, LLC (“Tetris”) in theSuperior Court of California, County of Los Angeles. The complaint alleges thatTetris breached its license agreement and certain oral agreements with THQ,which prevented THQ from releasing a*Tetris*product for the Nintendo DS system as planned in March 2005. Additionally,Tetris has indicated that it believes the term of THQ’s license agreement withTetris may have expired on March 24, 2005, despite THQ’s compliance withthe requirements for renewal pursuant to the terms of the license. Ourcomplaint seeks monetary damages and injunctive relief against Tetris, as wellas a judicial declaration that the term of THQ’s license agreement with Tetrisextends to March 24, 2007.

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.

**Item4. Submission of Matters To A Vote of Security Holders**

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

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**PARTII**

**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.” Thefollowing table sets forth, for the periods indicated, the high and low closingsales prices of our common stock as reported by the NASDAQ National Market:
| ** **                              | ** ** | **Closing Sales Prices**           | ** ** |
|-----------------------------------------|------------|----------------------------------------------|------------|
| ** **                              | ** ** | **   High   ** | ** ** | **    Low    ** | ** ** |
| **Fiscal  Year Ended March 31, 2005**   |       |                                         |       |   |   |   |   |   |   |
| Fourth Quarter ended March 31, 2005     |       |                                         | 29.65      |   |   |   | 20.11 |   |   |
| Third Quarter ended December 31, 2004   |       |                                         | 23.67      |   |   |   | 16.94 |   |   |
| Second Quarter ended September 30, 2004 |       |                                         | 22.45      |   |   |   | 17.77 |   |   |
| First Quarter ended June 30, 2004       |       |                                         | 23.00      |   |   |   | 18.38 |   |   |
| **Fiscal  Year Ended March 31, 2004**   |       |                                         |       |   |   |   |   |   |   |
| Fourth Quarter ended March 31, 2004     |       |                                         | 20.30      |   |   |   | 15.94 |   |   |
| Third Quarter ended December 31, 2003   |       |                                         | 18.59      |   |   |   | 14.82 |   |   |
| Second Quarter ended September 30, 2003 |       |                                         | 19.52      |   |   |   | 15.46 |   |   |
| First Quarter  ended June 30, 2003      |       |                                         | 19.50      |   |   |   | 12.84 |   |   |

 

The last reported price ofour common stock on May 27, 2005, as reported by NASDAQ National Market, was$27.78 per share.

**Holders**

As of May 27, 2005 therewere approximately 278 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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**Securities Authorized for Issuance Under EquityCompensation Plans**

Informationfor our equity compensation plans in effect as of March 31, 2005 is as follows(amounts in thousands, except per share amounts):
| ** **                                                       | ** ** | **(a)**                              | ** ** | **(b)**                           | ** ** | **(c)**                               | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------|------------|---------------------------------------|------------|
| ** **                                                       | ** ** | ** **                           | ** ** | ** **                        | ** ** | **Number of securities**    | ** ** |
| ** **                                                       | ** ** | ** **                           | ** ** | ** **                        | ** ** | **remaining available for** | ** ** |
| ** **                                                       | ** ** | **Number of securities**   | ** ** | ** **                        | ** ** | **future issuance under**   | ** ** |
| ** **                                                       | ** ** | **to be issued upon** | ** ** | **Weighted-average**              | ** ** | **equity compensation**          | ** ** |
| ** **                                                       | ** ** | **exercise of**                 | ** ** | **exercise price of**   | ** ** | **plans (excluding**             | ** ** |
| ** **                                                       | ** ** | **outstanding options,**        | ** ** | **outstanding options,**     | ** ** | **securities reflected in** | ** ** |
| **Plan Category**                                           | ** ** | ** **                           | ** ** | **warrants and rights** | ** ** | **warrants and rights**     | ** ** | **column (a))** | ** ** |
| Equity  compensation plans approved by security holders          |       |                                 | 5,305,365  |                              |       |                                  | $          | 20.44 |   |   |   | 3,199,514 |   |   |
| Equity  compensation plans not approved by security holders |       |                                 | 1,616,470  | (1)                               |       |                                  | $          | 17.31 |   |   |   | 93,965 |   |   |
| Total                                                            |       |                                 | 6,921,835  |                              |       |                                  | $          | 19.71 |   |   |   | 3,293,479 |   |   |
|                                                                  |            |                                      |            |                                   |            |                                       |            |  |  |  |  |  |  |  |  |  |

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(1)          Representsthe aggregate number of shares of THQ common stock to be issued upon exerciseof individual compensation arrangements with employee and non-employee optionand warrant holders. The outstanding options were primarily granted under theCompany’s Third Amended and Restated Nonexecutive Employee Stock Option Plan(the “NEEP Plan”). For a description of the material features of the NEEP Plan,see “Note 11—Stock Option Plans” in the notes to the consolidated financialstatements.

**Stock OptionExchange Program**

On June 21, 2004, wegranted 758,836 replacement options to employees pursuant to the OptionExchange Program (the “Program”) adopted at the annual meeting of ourstockholders held on August 12, 2003. Under the Program, eligible employees,excluding all of our executive officers and directors, were offered a one-timeopportunity to exchange certain “out-of-the-money” stock options for options topurchase a lesser number of shares of common stock at a new exercise price pershare. The replacement options have an exercise price of $21.73, which was theclosing price of a share of our common stock on the Nasdaq Stock Market on June21, 2004. Pursuant to the Program, the options were fully vested on December21, 2004, as long as the optionholder was an employee of the Company on suchdate.

**Securities Issuedin Private Transactions**

During the fiscal yearended March 31, 2005, we finalized the terms of warrants we issued in exchangefor rights to publish video games based on a licensors’ intellectual properties.We issued 160,000 warrants to purchase our common stock.   The warrantsare convertible into our common stock at a purchase price of $20.23, which isequal to the closing sale price of a share of our common stock on the date ofthe grant. The warrants expire on December 31, 2009.

**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 31,2005.

**Item 6.** SelectedConsolidated Financial Data

Thefollowing table summarizes certain selected consolidated financial data, whichshould be read in conjunction with our consolidated financial statements andNotes thereto and with Management’s Discussion and Analysis of FinancialCondition and Results of Operations included elsewhere herein. 

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EffectiveJanuary 1, 2003, we changed our fiscal year end from December 31 to March 31. Thechange resulted 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 year endaffects 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, the selectedconsolidated financial data presented below as of and for each of the fiscalyears and Transition 2003 in the five-year period ended March 31, 2005 arederived from our audited consolidated financial statements. The consolidatedbalance sheets as of March 31, 2005 and 2004, and the consolidated statementsof operations for the fiscal years ended March 31, 2005 and 2004, the twelvemonths ended March 31, 2003 (unaudited), Transition 2003, and the year endedDecember 31, 2002, and the report thereon, are included elsewhere in this Form10-K.

**Statementof Operations Data(In thousands, except per share data)**
| ** **                                                              | ** ** | **Fiscal Year Ended March 31,** | ** ** | **  Transition  ** | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                              | ** ** | **2005 (a)**                                   | ** ** | **2004 (b)**                      | ** ** | **2003 (c)**                          | ** ** | **2003 (c)** | ** ** | **2002 (d)** | ** ** | **2001** | ** ** | **2000 (e)** | ** ** |
| ** **                                                              | ** ** | ** **                                          | ** ** | ** **                             | ** ** | **(Unaudited)**                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                               |       | $                                                   | 756,731    |                                   | $          | 640,846                                    |       |   | $ | 467,647 |   |   |   | $ | 66,800 |   |   | $ | 480,529 |   | $ | 378,992 |   | $ | 347,003 |   |
| Costs and  expenses:                                                    |       |                                                |       |                                   |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of sales                                                           |       | 250,055                                             |       | 229,218                                |       |                                       | 178,291    |   |   |   | 26,378 |   |   | 185,593 |   | 154,898 |   | 140,699 |   |
| License amortization and royalties                                 |       | 85,926                                              |       | 71,132                                 |       |                                       | 38,988     |   |   |   | 5,576 |   |   | 40,476 |   | 33,144 |   | 34,675 |   |
| Software development amortization                                       |       | 93,622                                              |       | 105,632                                |       |                                       | 84,916     |   |   |   | 12,018 |   |   | 83,698 |   | 35,144 |   | 42,875 |   |
| Product development                                                     |       | 72,959                                              |       | 36,850                                 |       |                                       | 36,531     |   |   |   | 8,899 |   |   | 34,696 |   | 17,774 |   | 18,605 |   |
| Selling and marketing                                                   |       | 115,646                                             |       | 92,475                                 |       |                                       | 70,978     |   |   |   | 14,294 |   |   | 66,443 |   | 46,745 |   | 42,446 |   |
| Payment to venture partner                                              |       | 9,774                                               |       | 9,675                                  |       |                                       | 9,218      |   |   |   | 644 |   |   | 10,146 |   | 8,673 |   | 17,707 |   |
| General and administrative                                              |       | 54,831                                              |       | 47,006                                 |       |                                       | 36,794     |   |   |   | 8,442 |   |   | 34,993 |   | 28,470 |   | 20,076 |   |
| Total costs and expenses                                                |       | 682,813                                             |       | 591,988                                |       |                                       | 455,716    |   |   |   | 76,251 |   |   | 456,045 |   | 324,848 |   | 317,083 |   |
| Income (loss) from operations                                           |       | 73,918                                              |       | 48,858                                 |       |                                       | 11,931     |   |   |   | (9,451 | ) |   | 24,484 |   | 54,144 |   | 29,920 |   |
| Interest income                                                         |       | 4,337                                               |       | 2,378                                  |       |                                       | 4,833      |   |   |   | 878 |   |   | 5,277 |   | 2,572 |   | 1,323 |   |
| Other income (expense)                                                  |       | —                                              |       | 4,000                                  |       |                                       | (12,409    | ) |   |   | (2,403 | ) |   | (10,006 | ) | — |   | — |   |
| Income (loss) before income taxes and  minority interest |       | 78,255                                              |       | 55,236                                 |       |                                       | 4,355      |   |   |   | (10,976 | ) |   | 19,755 |   | 56,716 |   | 31,243 |   |
| Income taxes                                                            |       | 15,204                                              |       | 19,397                                 |       |                                       | 1,812      |   |   |   | (3,290 | ) |   | 6,761 |   | 20,703 |   | 13,054 |   |
| Income (loss) before minority interest                                  |       | 63,051                                              |       | 35,839                                 |       |                                       | 2,543      |   |   |   | (7,686 | ) |   | 12,994 |   | 36,013 |   | 18,189 |   |
| Minority interest                                                       |       | (261                                                | )          | —                                 |       |                                       | —     |   |   |   | — |   |   | — |   | — |   | — |   |
| Net income (loss)                                                       |       | $                                                   | 62,790     |                                   | $          | 35,839                                     |       |   | $ | 2,543 |   |   |   | $ | (7,686 | ) |   | $ | 12,994 |   | $ | 36,013 |   | $ | 18,189 |   |
| Net income (loss) per share—basic                                  |       | $                                                   | 1.61       |                                   | $          | 0.94                                       |       |   | $ | 0.07 |   |   |   | $ | (0.20 | ) |   | $ | 0.33 |   | $ | 1.10 |   | $ | 0.60 |   |
| Net income (loss) per share—diluted                                |       | $                                                   | 1.56       |                                   | $          | 0.92                                       |       |   | $ | 0.06 |   |   |   | $ | (0.20 | ) |   | $ | 0.32 |   | $ | 1.01 |   | $ | 0.56 |   |
| Shares used in per share calculation—basic                         |       | 39,030                                              |       | 38,186                                 |       |                                       | 39,018     |   |   |   | 38,319 |   |   | 39,203 |   | 32,717 |   | 30,136 |   |
| Shares used in per  share calculation—diluted                      |       | 40,243                                              |       | 39,004                                 |       |                                       | 40,552     |   |   |   | 38,319 |   |   | 41,243 |   | 35,623 |   | 32,352 |   |

 

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**BALANCESHEET DATA(In thousands)**
| ** **                | ** ** | **Fiscal Year Ended March 31,** | ** ** | **Transition** | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|-----------------------------------------------------|------------|----------------|------------|--------------------------------------------|------------|
| ** **                | ** ** | **2005**                                            | ** ** | **2004**       | ** ** | **2003**                                   | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| Working capital           |       | $                                                   | 401,687    |           | $          | 309,633                                    |       | $ | 286,899 |   | $ | 286,899 |   | $ | 320,588 |   | $ | 319,605 |   | $ | 110,269 |   |
| Total assets              |       | $                                                   | 747,393    |           | $          | 527,151                                    |       | $ | 472,949 |   | $ | 472,949 |   | $ | 537,860 |   | $ | 487,966 |   | $ | 229,949 |   |
| Lines of credit           |       | $                                                   | —     |           | $          | —                                     |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 15,473 |   |
| Stockholders’ equity |       | $                                                   | 548,758    |           | $          | 438,592                                    |       | $ | 396,413 |   | $ | 396,413 |   | $ | 408,866 |   | $ | 398,862 |   | $ | 132,125 |   |

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Notes:

The tables above reflect the August 2000 pooling of interestswith Volition.

(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’ andofficers’ 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 as acharge of $4.6 million, net of tax related to the settlement of a class actionlawsuit and a charge of $1.1 million, net of tax related to the write-off ofinventory and software development for “WWF”-branded games that we had beenprevented from shipping pursuant to an action by the World Wide Fund for Natureagainst World Wrestling Entertainment, Inc. and a charge of $2.8 million, netof tax related to the discontinuation of our online joint venture in the UnitedKingdom (Network Interactive Sports, Ltd.).

(e)           Net income includes acharge of $5.9 million, net of tax related to a regular asset impairment reviewand also as a result of changing technology in the video game market. Thecharge consisted of costs associated with software development and relatedcosts for products that had been discontinued or whose values were deemedunrecoverable through future undiscounted cash flows.

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**Item7. Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

**Overview**

The following is a summarydiscussion of our operating results and the primary trends that affect ourbusiness. Management believes that an understanding of these trends isimportant to understand our results for the fiscal year ended March 31,2005 (“fiscal 2005”), as well as our future prospects. This summary is notintended to be exhaustive, nor is it intended to be a substitute for thedetailed discussion and analysis provided elsewhere in this Form 10-K,including in the remainder of “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” or the consolidated financialstatements and related notes. The discussion and analysis herein may beunderstood more fully by reference to the consolidated financial statements andnotes to the consolidated financial statements. All references to “we,” “us,” “our,”“THQ,” or the “Company” in the following discussion and analysis mean THQ Inc.and its subsidiaries.

**Overview of Fiscal2005 Results**

We are a leadingworldwide developer and publisher of interactive entertainment software. Ourfiscal 2005 highlights include the following:

·        Wepublished six titles that shipped more than one million units:

·         *The Incredibles*: more than 4.5 millionunits

·         *The SpongeBob SquarePants Movie*: more than2.5 million units

·         *WWE SmackDown! Vs. Raw:* more than 2million units

·         *Finding Nemo:*more than**2**million units (over 7 millionlife-to-date)

·         *SpongeBob SquarePants: Battle for Bikini Bottom*:more than one million units (over 3 million life-to-date)

·         *Full Spectrum Warrior*: more than onemillion units

·        Wegrew international revenues to 38% of net sales from 29% a year ago, bolsteredby the increased global appeal of our products and brands and our expandedsales organization.

·        Wemore than doubled our internal product development personnel to over 900 fromjust over 400 a year ago, enabling us to develop more franchises internally andto help establish a leadership position early in the next console cycle.

·        Ourwireless revenues more than tripled to $25 million from $7 million a year ago,fueled by sales of games based on the major sports leagues, Nickelodeon,MotoGP, and as a result of consolidating Minick in fiscal 2005.

·        Werenewed our exclusive master license agreement with Nickelodeon through 2010and extended our relationship with Pixar Animation Studios to publish gamesbased on that studio’s next four films after *Cars,*which we are developing pursuantto our current license from Disney/Pixar, providing a solid foundationfor revenue and profit growth through the back half of the current hardwarecycle and well into the next generation of hardware.

Our profitability isdependent upon revenues from the sales of our video game software. Netsales in fiscal 2005 increased 18% overthe fiscal year ended March 31, 2004 (“fiscal 2004”), from $640.8 millionto $756.7 million. The increase in net sales for fiscal 2005 was primarilyattributable to worldwide sales of the six titles listed above. In fiscal 2004,we published four titles which shipped more than one million units. 

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Profitability is also affected by the costs andexpenses associated with developing and publishing our games.

In fiscal 2005, our operating margin grew 220 basispoints over fiscal 2004, to 9.8% of net sales. Our operating margin improved infiscal 2005 due to (i) our strategy of internally developing key titlessuch as *The Incredibles* and *TheSpongeBob SquarePants Movie* (ii) our focus on fewer releasesenabling us to better leverage software development and marketing costs (iii) moresales of higher priced products targeted at the core gamer (iv) more salesof Game Boy Advance games, which have a lower product cost than console titlesand (v) increased international sales which further leverage productdevelopment spending by increasing sales per title. When we develop a titleinternally, our operating margin is positively impacted once we recoupdevelopment expenses because there are no incremental royalties paid as is thecase with externally developed products.

Net income for fiscal 2005 was $62.8 million, or $1.56per diluted share, compared to net income of $35.8 million, or $0.92 perdiluted share, for fiscal 2004. Net income for fiscal 2005 was positivelyaffected by $7.8 million, or $0.19 per diluted share, from the recognition ofresearch and development income tax credits claimed for prior years.

Cash provided byoperations was $60.5 million during fiscal 2005, as compared to $71.2 millionin fiscal 2004. The decline in cash provided by operations was caused by anincrease in our spending for licenses, software development and income taxesoffset by an increase in our net income and the timing of the collections ofour sales compared to fiscal 2004.

**OurFocus**

We view fiscal 2006 as a transition year in ourindustry, as Microsoft, Sony and Nintendo have all recently announced plans tointroduce new console platforms and both Nintendo and Sony have recentlylaunched new handheld platforms. Traditionally, sales of interactiveentertainment software have decreased in transition years, as consumersdecrease their purchases of software for current generation hardware while theywait for the release of the new platforms. Our strategy during this transitionis to leverage our current brands and catalog titles and to selectivelyintroduce high-potential new franchises for the growing installed base ofcurrent-generation hardware and the high-end PC market as we begin to establishunique new intellectual properties early in the cycle on next-generationplatforms; to leverage our handheld leadership; and to continue to growwireless revenues.

In fiscal 2005, our mass-market releases includedgames based on three major holiday movie releases: Walt Disney PicturesPresentation of a Pixar Animation Studios film *TheIncredibles*, Nickelodeon’s *TheSpongeBob SquarePants Movie*, and Warner Bros.’ *The**PolarExpress.* We also released popular franchise games such as *WWE SmackDown! Vs. Raw* and *Tak 2: The Staff of Dreams*. In fiscal2006, we will continue to focus on releasing titles based on our best-sellingbrands for the current generation platforms, including *TheIncredibles*, *SpongeBob SquarePants*,*Tak* and the WWE. New mass-market titleswe intend to publish in fiscal 2006 include games based on *Scooby-Doo!*from Warner Brothers, MGA’s popular *Bratz* propertyand the new *Barnyard* movie from Nickelodeon.

We intend to continue developing and publishing neworiginal properties and products targeted at the core gamer. In fiscal 2005,such releases included *Full Spectrum Warrior*,*ThePunisher* and *Warhammer40,000:**Dawn of War.*Upcoming titles for the current-generation console systems include *Destroy All Humans!,**Juiced*anda sequel to *Full Spectrum Warrior.*UpcomingPC products targeted at the core gamer include *Companyof Heroes, S.T.A.L.K.E.R.: Shadow of Chernobyl* as well as a sequelto *Full Spectrum Warrior* and anexpansion pack to *Warhammer 40,000: Dawn ofWar*. Our internal studios are developing games based on new,owned intellectual properties for the next-generation console systems,including *The Outfit* and *Saint’s Row*.

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We have traditionally been a market leader in videogames for handheld devices and we plan to leverage this leadership during thetransition period. In fiscal 2006, we plan to release more than ten titles onthe Nintendo DS and the Sony PlayStation Portable combined, capitalizing on thesignificant installed base of these devices by holiday 2005. We also expect tobenefit from the new Nintendo Micro handheld device, to be released in fall2005, which plays Game Boy Advance games. We are also expanding our handheldleadership position to wireless devices and plan to extend many of our upcomingconsole titles to the wireless platform, including *Destroy AllHumans!* and *Juiced*.

We continue to focus onestablishing strong technology and internal development capabilities in orderto improve our operating margins and create better quality products. Weexpanded our internal development resources in fiscal 2005 with theacquisitions of Relic Entertainment, located in Canada, and Blue TongueEntertainment Limited, located in Australia, and with the formation of a newstudio, Concrete Games, located near San Diego, California. With the additionof these three development studios and expansion in our existing studios, ourworldwide product development operations now include over 900 employees locatedat our corporate offices and in ten studios. Our focus on improvingprofitability includes bringing key brands, such as Disney/Pixar andNickelodeon, in-house to develop.

**Critical AccountingPolicies**

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 policies discussed below are considered by managementto be critical because they are both important to the portrayal of ourfinancial 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 policies aredescribed in the following paragraphs. For all of these policies, managementcautions that actual results may differ materially from these estimates underdifferent assumptions or conditions.

*Allowances for price protection, returns anddoubtful accounts.  *We derive revenue from sales ofpackaged software for video game systems and personal computers and sales ofcontent and services for 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- 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 in customerdemand 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 orreturns in subsequent periods. In the past, actual price protection and returnshave not 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 

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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 theadequacy of the allowance for doubtful accounts. Material differences mayresult in the amount and timing of our bad debt expense for any period ifmanagement made different judgments or utilized different estimates. If ourcustomers experience financial difficulties and are not able to meet theirongoing financial obligations to us, our results of operations may be adverselyimpacted.

*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 remains with the licensor. When significantperformance remains with the licensor, we record royalty payments as an asset(licenses) when payable rather than upon execution of the contract. Royaltypayments for intellectual property licenses are classified as current assetsand current liabilities to the extent such royalty payments relate toanticipated sales during the subsequent year and long-term assets and long-termliabilities if such royalty payments relate to anticipated sales after oneyear.

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. See—“*Long-Lived Assets*”below. If actual revenues or revised forecasted revenues fall below the initialforecasted revenues for a particular license, the charge to licenseamortization and royalties expense may be larger than anticipated in any givenquarter. As of March 31, 2005, the net carrying value of our licenses was$88 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. In the fiscal year ended March 31, 2005, wewrote off $4.0 million related to a license for which we no longer plan todevelop games.

*Software Development.  *Weutilize both internal development teams and independent software developers todevelop our software. We account for software development costs in accordancewith SFAS No. 86, “*Accounting for theCosts of Computer Software to be Sold, Leased, or Otherwise Marketed*.”We capitalize 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,capitalization of expenses may occur early in the development cycle. Weevaluate technological feasibility on a title-by-title basis. We capitalize themilestone payments made to independent software developers and the directpayroll and facilities costs for our internal development teams. Amountsrelated to software development for which technological feasibility is not yetmet are charged immediately to product development expense.

Capitalized software development is expensed tosoftware development amortization at the higher of (1) the contractualrate based on actual net product sales for such software or (2) aneffective rate based upon total projected revenue for such software. When, inmanagement’s estimate, future cash flows will not be sufficient to recoverpreviously capitalized costs, we expense these costs to software developmentamortization. See—“*Long-Lived Assets*”below. If actual revenues, or revised forecasted revenues, fall below theinitial forecasted revenue, the charge to software development amortization maybe larger than anticipated in any given quarter. As of March 31, 2005, thenet carrying value of our software development 

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was $65.3 million. If we were required to write offsoftware development due to changes in market condition or product quality ourresults of operations could be materially adversely affected.

*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, 2004 and June 30,2003, 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 the subsection entitled “*Risk Factors*” in “Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations” we maynot 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 or economictrends, significant changes in the manner or use of the acquired assets or thestrategy of our overall business and significant underperformance relative toexpected historical or projected future operating results. Although we believethe judgments and assumptions we have made in the past have been reasonable andappropriate, there is nonetheless a high degree of uncertainty and judgmentinvolved.

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.

*Long-Lived Assets.  *Weevaluate long-lived assets, including, but not limited to, licenses, softwaredevelopment, property and equipment and identifiable intangible assets withfinite lives, for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable. Factorswe consider in deciding when to perform an impairment review includesignificant under-performance of a product or platform in relation toexpectations, significant negative industry or economic trends, and significantchanges or planned changes in our use of the assets. Potential impairment ofthe assets is measured by a comparison of the carrying amount of an asset tofuture undiscounted net cash flows expected to be generated by the asset. Ifsuch assets are considered to be impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the asset exceeds itsfair value.

Judgments and assumptions about future values arecomplex and often subjective. They can be affected by a variety of factors,including, but not limited to, significant negative industry or economictrends, significant changes in the manner or use of the acquired assets or thestrategy of our overall business, and 

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significantunderperformance relative to expected historical or projected future operatingresults. Although we believe the judgments and assumptions management has madein the past have been reasonable and appropriate, there is nonetheless a highdegree of uncertainty and judgment involved. More conservative assumptions ofthe anticipated future cash flows from these assets would result in lower fairvalues which could result in impairment charges, which would in turn decreasenet income and result in lower asset values on our balance sheets. Conversely,less conservative assumptions would result in higher fair values which couldresult in lower impairment charges and higher net income.

We also make judgmentsabout the remaining useful lives of long-lived assets. When we determine thatthe useful lives of assets are shorter than we had originally estimated, andthere are sufficient cash flows to support the carrying value of the assets, weaccelerate the rate of depreciation charges in order to fully depreciate theassets over their new shorter useful lives.

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

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

**Recently Issued Accounting Pronouncements**

In December 2004, the FASB issued Statement No. 123(revised 2004), “*Share-Based Payment*” (“SFAS No.123R”), which replaces SFAS No. 123, “*Accounting for Stock-BasedCompensation*,” (“SFAS No. 123”) and supersedes APB Opinion No.25, “*Accounting for Stock Issued to Employees*.”SFAS No. 123R originally required all share-based payments to employees,including grants of employee stock options, to be recognized in the financialstatements based on their fair values beginning with the first quarter orannual period after June 15, 2005. On April 21, 2005 the SEC issued a rule thatamends the date of compliance with SFAS No. 123R (“the SEC amendment”). Underthe SEC amendment, SFAS No. 123R must be adopted beginning with the firstinterim or annual reporting period of the registrant’s first fiscal yearbeginning on or after June 15, 2005, which means that we must adopt SFAS No.123R by April 1, 2006. The pro forma disclosures previously permitted underSFAS No. 123 no longer will be an alternative to financial statementrecognition. Under SFAS No. 123R, we must determine the appropriate fair valuemodel to be used for valuing share-based payments, the amortization method forcompensation cost and the transition method to be used at date of adoption. Thetransition methods include prospective and retroactive adoption. Under theretroactive method, prior periods may be restated either as of the beginning ofthe year of adoption or for all periods presented. The prospective methodrequires that compensation expense be recorded for all unvested stock optionsand restricted stock at the beginning of the first quarter of adoption of SFASNo. 123R, while the retroactive methods would record compensation expense forall unvested stock options and restricted stock beginning with the first periodrestated. We are 

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evaluating the requirementsof SFAS No. 123R and believe the adoption of SFAS No. 123R may have a materialimpact on our consolidated results of operations and earnings per share. Wehave not yet determined the method of adoption or the effect of adopting SFASNo. 123R, and we have not determined whether the adoption will result inamounts that are similar to the current pro forma disclosures under SFAS No.123.

FASB Staff Position (“FSP”)No. 109-2, “*Accounting and Disclosure Guidance for theForeign Earnings Repatriation Provision within the American Jobs Creation Actof 2004*” (“FSP 109-2”), provides guidance under FASB Statement No.109, “*Accounting for Income Taxes,*” withrespect to recording the potential impact of the repatriation provisions of theAmerican Jobs Creation Act of 2004 (the “Jobs Act”) on enterprises’ income taxexpense and deferred tax liability. The Jobs Act was enacted on October 22,2004. FSP 109-2 states that an enterprise is allowed time beyond the financialreporting period of enactment to evaluate the effect of the Jobs Act on itsplan for reinvestment or repatriation of foreign earnings for purposes ofapplying FASB Statement No. 109. We have not yet completed evaluating theimpact of the repatriation provisions. Accordingly, as provided for in FSP 109-2,we have not adjusted our tax expense or deferred tax liability to reflect therepatriation provisions of the Jobs Act.

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**Selected Consolidated Statements of Operations Data**

Thefollowing****table sets forthcertain consolidated statements of operations data for the periods indicated asa percentage of total net sales (in thousands):
| ** **                                       | ** ** | **Fiscal Year Ended March 31,** | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **2005 (a)**                                   | ** ** | **2004 (b)**                          | ** ** | **2003 (c) (d)** | ** ** | **2002 (d)** | ** ** |
| ** **                                       | ** ** | ** **                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** | **                      ** | ** ** | **               ** | ** ** |
| Net sales                                        |       | $                                                   | 756,731    |                                       | 100.0      | % | $ | 640,846 |   | 100.0 | % | $ | 467,647 |   | 100.0 | % |   | $ | 480,529 |   |   |   | 100.0 | % |   |
| Costs and expenses:                              |       |                                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of sales                                    |       | 250,055                                             |       | 33.0                                       |       | 229,218 |   | 35.8 |   | 178,291 |   | 38.1 |   |   | 185,593 |   |   |   | 38.6 |   |   |
| License amortization and royalties          |       | 85,926                                              |       | 11.4                                       |       | 71,132 |   | 11.1 |   | 38,988 |   | 8.3 |   |   | 40,476 |   |   |   | 8.4 |   |   |
| Software development amortization                |       | 93,622                                              |       | 12.4                                       |       | 105,632 |   | 16.5 |   | 84,916 |   | 18.2 |   |   | 83,698 |   |   |   | 17.4 |   |   |
| Product development                              |       | 72,959                                              |       | 9.6                                        |       | 36,850 |   | 5.8 |   | 36,531 |   | 7.8 |   |   | 34,696 |   |   |   | 7.2 |   |   |
| Selling and marketing                            |       | 115,646                                             |       | 15.3                                       |       | 92,475 |   | 14.4 |   | 70,978 |   | 15.2 |   |   | 66,443 |   |   |   | 13.8 |   |   |
| Payment to venture partner                       |       | 9,774                                               |       | 1.3                                        |       | 9,675 |   | 1.5 |   | 9,218 |   | 2.0 |   |   | 10,146 |   |   |   | 2.1 |   |   |
| General and administrative                       |       | 54,831                                              |       | 7.2                                        |       | 47,006 |   | 7.3 |   | 36,794 |   | 7.9 |   |   | 34,993 |   |   |   | 7.4 |   |   |
| Total costs and expenses                         |       | 682,813                                             |       | 90.2                                       |       | 591,988 |   | 92.4 |   | 455,716 |   | 97.5 |   |   | 456,045 |   |   |   | 94.9 |   |   |
| Income from  operations                          |       | 73,918                                              |       | 9.8                                        |       | 48,858 |   | 7.6 |   | 11,931 |   | 2.6 |   |   | 24,484 |   |   |   | 5.1 |   |   |
| Interest income                                  |       | 4,337                                               |       | 0.5                                        |       | 2,378 |   | 0.4 |   | 4,833 |   | 1.0 |   |   | 5,277 |   |   |   | 1.1 |   |   |
| Other income (expense)                           |       | —                                              |       | 0.0                                        |       | 4,000 |   | 0.6 |   | (12,409 | ) | (2.6 | ) |   | (10,006 | ) |   |   | (2.1 | ) |   |
| Income before income taxes and minority interest |       | 78,255                                              |       | 10.3                                       |       | 55,236 |   | 8.6 |   | 4,355 |   | 0.9 |   |   | 19,755 |   |   |   | 4.1 |   |   |
| Income taxes                                     |       | 15,204                                              |       | 2.0                                        |       | 19,397 |   | 3.0 |   | 1,812 |   | 0.4 |   |   | 6,761 |   |   |   | 1.4 |   |   |
| Income before minority interest                  |       | 63,051                                              |       | 8.3                                        |       | 35,839 |   | 5.6 |   | 2,543 |   | 0.5 |   |   | 12,994 |   |   |   | 2.7 |   |   |
| Minority interest                                |       | (261                                                | )          | 0.0                                        |       | — |   | 0.0 |   | — |   | 0.0 |   |   | — |   |   |   | 0.0 |   |   |
| Net income                                       |       | $                                                   | 62,790     |                                       | 8.3        | % | $ | 35,839 |   | 5.6 | % | $ | 2,543 |   | 0.5 | % |   | 12,994 |   |   |   | 2.7 | % |   |

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(a)           Netincome includes a $7.8 million benefit for research and development income taxcredits claimed for 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 as acharge of $4.6 million, net of tax related to the settlement of a class actionlawsuit and a charge of $1.1 million, net of tax related to the write-offof inventory and software development for “WWF”-branded games that we had beenprevented from shipping pursuant to an action by the World Wide Fund for Natureagainst World Wrestling Entertainment, and a charge of $2.8 million, net of taxrelated to the discontinuation of our online joint venture in the UnitedKingdom (Network Interactive Sports, Ltd.).

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**Results ofOperations**

**Comparison ofFiscal 2005 to Fiscal 2004**

Net income for fiscal 2005was $62.8 million, or $1.56 per diluted share, as compared to $35.8 million, or$0.92 per diluted share in fiscal 2004.

**NetSales**

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

Our consolidatednet sales in fiscal 2005 increased 18%over fiscal 2004, from $640.8 million to $756.7 million. The increase in netsales 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 *TheIncredibles* and *The SpongeBob SquarePantsMovie*, were based upon successful holiday movies.

·        Thesuccessful launch of new properties targeted to the core gamer and high-end PCmarket: *Full Spectrum Warrior* on Xbox,PlayStation2, and PC, *The Punisher* onXbox, PlayStation2 and PC, and *Warhammer 40,000: Dawn ofWar* 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 more international appeal, (iii) growth of the installed base forcurrent generation console and handheld platforms, and (iv) thestrengthening of foreign exchange rates.

·        Thecontinued success of the fiscal 2004 releases of Disney/Pixar’s *Finding Nemo* and *SpongeBob SquarePants:Battle for Bikini Bottom*which shipped two million and one millionunits, respectively, in fiscal 2005*.*

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 | % |   |

 

***NorthAmerica***

For fiscal 2005,North American net sales increased to $470.6 million from $453.4 million infiscal 2004 driven by:

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

·        strongsales of original titles: *Full Spectrum Warrior, MXv. ATV Unleashed, The Punisher*and*Tak 2: TheStaff of Dreams;*

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·        strongcatalog sales of Disney/Pixar’s *Finding Nemo*, *MX Unleashed* and *SpongeBob SquarePants: Battlefor Bikini Bottom*. Catalog sales are sales of titles released inprior fiscal years.

North Americansales in fiscal 2004 were driven by:

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

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

Year-over-year net sales growth in North America wasprimarily due to sales of *The SpongeBob SquarePantsMovie* game, which was released in conjunction with the holidaymovie; sales of *Full Spectrum Warrior* and *The Punisher;* and strong sales of our catalog titles infiscal 2005. These items were partially offset by the release of asignificantly fewer number of SKUs in fiscal 2005 than in fiscal 2004.

While we expect net salesin North America to continue to constitute the largest portion of our net salesin fiscal 2006, we expect net sales for North America as a percentage of totalsales to decrease as we continue to expand our international direct sales andproduct mix. Since we expect our overall consolidated net sales in fiscal 2006to be approximately the same as consolidated net sales in fiscal 2005, weexpect a slight decline of sales of our games in North America in fiscal 2006.

***International***

For fiscal 2005,international net sales increased by 53%, to $286.1 million from $187.4 millionin fiscal 2004 driven by:

·        salesof Disney/Pixar’s *The Incredibles, The SpongeBob SquarePants Movie*and *WWE SmackDown! Vs. Raw;* and

·        strongsales of original titles *Full Spectrum Warrior*,*the Punisher*and*Warhammer40,000: Dawn of War*.

International salesin fiscal 2004 were driven by:

·        theperformance of Disney/Pixar’s *Finding Nemo***and*WWE SmackDown! Here Comes the Pain*; and

·        twooriginal products targeted at the core gamer, *Broken Sword*and *Warhammer 40,000: Fire Warrior.*

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 of our products, thestrengthening of foreign exchange rates, primarily the Great British Pound (“GBP”)and the European Currency Unit (“Euro”), increased reported international netsales by $19.5 million in fiscal 2005. Excluding the impacts of foreignexchange rates, international net sales increased by 42%.

We will continue to focuson expanding sales internationally in fiscal 2006, as we expand our productportfolio and direct sales forces in the international markets. In early 2005, we established a presence in Austriaand Spain in order to facilitate direct sales of our products into the Austria,Spain and Portugal markets. In fiscal 2006, we expect to expand ourpresence in Eastern Europe, the Benelux countries, Italy, the Nordicterritories, New Zealand and Japan.

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**Net Sales by Platform**

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.

***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: Battlefor Bikini Bottom, Tak and the Power of Juju* and *MX Unleashed*.

PlayStation 2 net sales in fiscal 2004 were primarilydriven by:

·        salesof Disney/Pixar’s *Finding Nemo, SpongeBob SquarePants: Battlefor Bikini Bottom* and *WWE SmackDown! Here Comesthe Pain*; and

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

The increase in sales of games for PlayStation 2 infiscal 2005 was primarily attributable to stronger sales of our three keyproducts targeted at the mass-market in fiscal 2005 as well as sales of *The Punisher* and our catalog titles. These increases werepartially offset by the release of fewer games in fiscal 2005; we released 

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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.

We expect net sales fromPlayStation 2 products in fiscal 2006 to be about equal to net sales in fiscal2005. Sony has announced that they plan to launch their next-generationconsole, the PlayStation 3, in 2006. Once the PlayStation 3 is launched, weexpect sales of games for the PlayStation 2 to decrease as sales of games forthe PlayStation 3 increase with the growth of the installed base.

***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, MXv. 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 sales for Xbox in fiscal 2005 fromfiscal 2004 was primarily attributable to sales of *FullSpectrum Warrior,* partially offset by the release of more games infiscal 2004. We released 8 SKUs during fiscal 2005 compared to 16 SKUs duringfiscal 2004.

We expect net sales from Xbox to grow in fiscal 2006. Wereleased *WWE® Wrestlemania® XX1*for Xbox in April 2005. In addition, weexpect to release *Destroy All Humans!* and *Juiced* in the first quarter of fiscal 2006.

***Microsoft Xbox 360****.  *We expect to release new titles at or around thelaunch of the new Xbox console platform, which Microsoft announced will belaunched in North America, Europe and Japan by holiday 2005. As the installedbase of the Xbox 360 platform grows, we also expect to bring our market-leadingfamily brands to the platform, including games based on our licensed propertieswith Disney/Pixar,**Nickelodeon properties such as *SpongeBob SquarePants,* as well astitles based on our WWE licenseand our own MX brand.

***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*;

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·        salesof original properties including *Tak 2: The Staff of Dreams;*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 during fiscal 2005 compared to 11SKUs during fiscal 2004.

We expect net sales fromGameCube products to decrease in fiscal 2006. Nintendo recently announced thatit will release its next-generation console, the Revolution, in 2006. We expectsales for the GameCube to continue declining as sales of games for theRevolution increase with the growth of the installed base.

**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, SpongeBobSquarePants: Battle for Bikini Bottom* and *Scooby-Doo!Monsters Unleashed*; and

·        strongsales of other key titles, such as *Finding Nemo*: *The Continuing Adventures*and*Tak2: TheStaff 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, SimpsonsRoad Rage, Sonic Battle*and*Tak and the Power of Juju*as well as strong catalog sales of *SonicAdvance 2*.

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.

Due to the introduction of two new handheld devicesand a reduced SKU count (expected to be 13 in fiscal 2006 compared to 19 infiscal 2005), we expect net sales from Game Boy Advance products to decrease in

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fiscal 2006. Nintendo recently announced that in fall2005, they will release the Game Boy Micro, a pocket-size platform which playsGame Boy Advance games. We believe that sales of this handheld platform willhelp sales of our Game Boy Advance games.

***Nintendo Dual Screen****.  *Nintendo recently released a new handheld platform,the Nintendo DS portable game system (“Nintendo DS”). We released *Ping Pals* for the Nintendo DS in December 2004.As the installed base of Nintendo DS hardware grows, we expect to bring ourmarket-leading kids and family brands to the platform, including games based onDisney/Pixar’s*The Incredibles, Scooby-Doo!*,*SpongeBob SquarePants*, *Tak.* WWE andothers*.*We currently expect to release ninetitles for the Nintendo DS in fiscal 2006.

***PlayStation Portable****.  *We expect to release five titles in fiscal 2006 forthe PSP system, a handheld platform which Sony has released in North Americaand Japan, and has announced it plans to release in Europe on September 1,2005. As the installed base of the PSP system hardware grows, we expect tobring our market-leading kids and family brands to the platform, includinggames based on Disney/Pixar’s*TheIncredibles* and *SpongeBobSquarePants* as well as titles based on our WWE license and our own MXbrand.

***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

·        increasedinstalled base of wireless handsets with game capabilities in the wireless gamingmarket.

We expect wireless netsales to increase in fiscal 2006 as the installed base continues to grow and wecontinue to expand our product offerings.

***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.

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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 Sword 3.*

Additionally, we released67 PC titles published by our ValuSoft division, including *World PokerChampionship,*during fiscal 2005, and we released 52 PC titlespublished from our ValuSoft division in 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.

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

Thefollowing table sets forth information about our costs and expenses, interestincome, other income, income taxes, and minority interest for the periodsindicated as a percentage of total net sales:
| ** **                                        | ** ** | **Percent of Net Sales**         | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                        | ** ** | **Fiscal Year Ended  March 31,** | ** ** |
| ** **                                        | ** ** | **  2005  **                | ** ** | **  2004   ** | ** ** |
| Costs and expenses:                               |       |                                            |       |   |   |   |   |   |   |
| Cost of sales                                     |       |                                            | 33.0       | % |   |   | 35.8 | % |   |
| License amortization and royalties                |       |                                            | 11.4       |   |   |   | 11.1 |   |   |
| Software development amortization                 |       |                                            | 12.4       |   |   |   | 16.5 |   |   |
| Product development                               |       |                                            | 9.6        |   |   |   | 5.8 |   |   |
| Selling and marketing                             |       |                                            | 15.3       |   |   |   | 14.4 |   |   |
| Payment to venture partner                        |       |                                            | 1.3        |   |   |   | 1.5 |   |   |
| General and administrative                        |       |                                            | 7.2        |   |   |   | 7.3 |   |   |
| Total costs and  expenses                         |       |                                            | 90.2       |   |   |   | 92.4 |   |   |
| Income from  operations                           |       |                                            | 9.8        |   |   |   | 7.6 |   |   |
| Interest income                                   |       |                                            | 0.5        |   |   |   | 0.4 |   |   |
| Other income                                      |       |                                            | 0.0        |   |   |   | 0.6 |   |   |
| Income before  income taxes and minority interest |       |                                            | 10.3       |   |   |   | 8.6 |   |   |
| Income taxes                                      |       |                                            | 2.0        |   |   |   | 3.0 |   |   |
| Income before  minority interest                  |       |                                            | 8.3        |   |   |   | 5.6 |   |   |
| Minority interest                                 |       |                                            | 0.0        |   |   |   | 0.0 |   |   |
| Net income                                        |       |                                            | 8.3        | % |   |   | 5.6 | % |   |

 

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. We believe that the expenditures wemade in fiscal 2005 for product development have helped position us to be aleader early on in the next-generation of video game platforms.

***Cost of Sales (inthousands)***
| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
|                                          | $250,055   |                              |       |                                          | 33.0       | %                                 |       |              | $          | 229,218 |   |   |   | 35.8 | % |   |   | (2.8 | )% |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

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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. We expect cost of sales as a percentage of net sales for fiscal2006 to remain relatively unchanged as compared to fiscal 2005.

***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 | % |   |   | 0.3 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

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 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 sellingbrands—Disney/Pixar, SpongeBob SquarePants and WWE licensing amortization ratesby brand remaining relatively constant for fiscal 2005 and 2004. We expectlicense amortization and royalties as a percentage of net sales to decrease infiscal 2006, reflecting greater sales mix of games based upon originalproperties.

***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 | % |   |   | (4.1 | )% |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Software developmentamortization expense consists of amortization of capitalized payments made toindependent software developers and amortization of capitalized internal studiodevelopment costs. 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 *SpongeBob SquarePants:Battle for Bikini Bottom* released in fiscal 2004 as we were able toleverage the technology developed on the fiscal 2004 title. Further, in fiscal2004 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. We expect software development amortization as apercentage of net sales to increase in fiscal 2006 as compared to fiscal 2005which benefited from the internally developed title, *TheIncredibles*. To a lesser extent, software development fornext-generation platforms in fiscal 2006 will be higher than in fiscal 2005.

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***Product Development(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 | % |   |   | 3.8 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

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. We expect product development expenseto increase in fiscal 2006 as we continue to increase development of softwarefor next-generation platforms and wireless products.

***Selling andMarketing (in thousands)***
| **Year Ended  March 31, 2005** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
|                                          | $115,646   |                              |       |                                          | 15.3       | %                                 |       |              | $          | 92,475 |   |   |   | 14.4 | % |   |   | 0.9 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

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 $23.2 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. We expect selling and marketing expense toincrease in fiscal 2006 as compared to fiscal 2005 as we support the launchesof an increased number of key titles based upon new original properties.

***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 | % |   |   | (0.2 | )% |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

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 slightly in absolute dollars for fiscal 2005 compared tofiscal 2004. The increase is in direct relation to the increases in sales ofgames based upon the WWE license in fiscal 2005 as compared 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 | % |   |   | (0.1 | )% |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

General and administrativeexpenses consist of personnel and related expenses of executive andadministrative staff, fees for professional services such as legal andaccounting, depreciation and 

33

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amortization, allowancesfor bad debts, foreign exchange transaction gains and losses, and facilities. Generaland administrative expenses increased by $7.8 million for fiscal 2005 as comparedto fiscal 2004. Fiscal 2004 included a charge of $7 million for doubtfulaccounts related to KB Toys’ bankruptcy filing. Excluding this $7 millionexpense, general and administrative expenses increased by $14.8 million forfiscal 2005 as compared to fiscal 2004. The increase is primarily attributableto growth in our international and wireless operations, as well asSarbanes-Oxley compliance and professional fees. In addition, the increase alsoincludes $1.5 million of amortization expense for intangible assets obtainedthrough the fiscal 2005 acquisitions of Relic and Blue Tongue, and theacquisition of a controlling interest in Minick during fiscal 2005. We expectgeneral and administrative expenses to remain relatively unchanged in fiscal2006 as compared to fiscal 2005.

***Other* Income**

Other income for fiscal2004 consisted of a $4 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 been 29%.We expect our effective income tax rate to be approximately 31% for fiscal2006.

***Minority Interest***

Minority interest reflectsthe income allocable to equity interests in Minick which are not owned by THQ. InApril 2004, we purchased an additional 25% of the outstanding common stockof Minick, bringing us to a 50% ownership interest and control of the Board ofDirectors. As a result of this transaction, we began consolidating the balancesheet, statement of operations and cash flows of Minick. Minority interestincluded in our consolidated statement of operations was $261,000 for fiscal2005 compared to zero for fiscal 2004.

**Comparison ofFiscal 2004 to the Twelve Months Ended March 31, 2003 (unaudited)**

Net income for fiscal 2004was $35.8 million or $0.92 per diluted share, on net sales of $640.8 million,as compared to $2.5 million or $0.06 per diluted share for the twelve monthsended March 31, 2003, based on net sales of $467.6 million. The increasein net income for fiscal 2004 is primarily attributable to increased net sales,improved gross margin and leverage of our operating costs and expenses. Netincome for fiscal 2004 was positively affected by a $4.0 million settlement ofa dispute with our directors’ and officers’ insurance carrier.

**Net Sales**

Consolidated netsales in fiscal 2004 increased 37% over the twelve months ended March 31,2003, from $467.6 million to $640.8 million. The increase in net sales forfiscal 2004 was primarily attributable to the following:

·        thesuccess of Disney/Pixar’s *Finding Nemo*,on all platforms worldwide;

·        therelease of our original brands such as *Takand the Power of Juju* on PS2, Game Boy Advance and GameCube;

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·        therelease of a significantly higher number of SKUs in fiscal 2004 as compared tothe twelve months ended March 31, 2003; and

·        thehigher installed base of all hardware platforms compared to the same periodlast year.

Thefollowing table details our net sales by territory for fiscal 2004 and thetwelve months ended March 31, 2003 (unaudited) (in thousands):
| ** **             | ** ** | **Year Ended March 31,** | ** ** | **Increase/**   | ** ** | ** **     | ** ** |
|------------------------|------------|-----------------------------------------|------------|-----------------|------------|----------------|------------|
| ** **             | ** ** | **2004**                                | ** ** | **2003**        | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **             | ** ** | ** **                              | ** ** | **(Unaudited)** | ** ** | ** **     | ** ** | ** ** | ** ** |
| North America          |       | $                                       | 453,426    |            | 70.8       | %              | $          | 358,233 |   | 76.6 | % | $ | 95,193 |   |   | 26.6 | % |   |
| Europe                 |       | 161,857                                 |       | 25.2            |       | 95,380         |       | 20.4 |   | 66,477 |   |   | 69.7 | % |   |
| Asia Pacific           |       | 25,563                                  |       | 4.0             |       | 14,034         |       | 3.0 |   | 11,529 |   |   | 82.2 | % |   |
| International          |       | 187,420                                 |       | 29.2            |       | 109,414        |       | 23.4 |   | 78,006 |   |   | 71.3 | % |   |
| Consolidated net sales |       | $                                       | 640,846    |            | 100.0      | %              | $          | 467,647 |   | 100.0 | % | $ | 173,199 |   |   | 37.0 | % |   |

 

*North America*

North America netsales increased by 27% from $358.2 million in the twelve months ended March 31,2003, to $453.4 million in fiscal 2004. The increase in North America net salesfor fiscal 2004 as compared to the twelve months ended March 31, 2003, wasdue to:

·        thestrong performance of the following the mass-market titles, which drove NorthAmerican sales in fiscal 2004: Disney/Pixar’s *Finding Nemo*,*SpongeBob SquarePants: Battle for BikiniBottom*,*WWE SmackDown!: Here Comes The Pain*for PlayStation 2, *WWETM RawTM 2* for Xbox, *WWE Wrestlemania X9*for GameCube, and *Sonic Advance 2* for Game Boy Advance; and

·        ahigher installed base of all hardware platforms, which created a larger marketfor our products.

The key titles released in the twelve months ended March 31,2003 included *WWE Raw* on Xbox, *WWE SmackDown Shut Your Mouth* on PlayStation 2 and anoriginal property, *Red Faction II.*

North America net salesconsisted of 71% of our total net sales in fiscal 2004 compared to 77% in thetwelve months ended March 31, 2003.

*International*

International netsales increased by 71% from $109.4 million in the twelve months ended March 31,2003, to $187.4 million in fiscal 2004. International net sales in fiscal 2004were primarily driven by:

·        therelease on all platforms of Disney/Pixar’s *Finding Nemo;*

·        thesuccess of *WWE SmackDown!: Here Comes the Pain* forPS2; and

·        therelease of three titles focused on our international territories—*Broken Sword 3*for PS2, Xbox, and PC, and *MotoGP 2* and *Yager*for bothXbox and PC.

Year over year growth of international net sales infiscal 2004 from the twelve months ended March 31, 2003 was alsoattributable to the strengthening of foreign currencies, primarily the GBP andthe Euro, which increased reported international sales by $23.5 million or 22%.

For fiscal 2004,international net sales grew to 29% of our total net sales, up from 23% in thetwelve months ended March 31, 2003.

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**Net Sales byPlatform**

Ourworldwide net sales by platform as a percentage of sales for fiscal 2004 andthe twelve months ended March 31, 2003 (unaudited) are as follows:
| ** **                | ** ** | **Year Ended March 31,** | ** ** | **Increase/** | ** ** | **%**           | ** ** |
|---------------------------|------------|-----------------------------------------|------------|---------------|------------|-----------------|------------|
| **Platform**              | ** ** | ** **                              | ** ** | **2004**      | ** ** | **2003**        | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| ** **                | ** ** | ** **                              | ** ** | ** **    | ** ** | **(Unaudited)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Consoles**              | ** ** | ** **                              | ** ** | ** **    | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sony PlayStation 2        |       | $                                       | 247,603    |          | 38.6       | %               | $          | 183,432 |   | 39.2 | % | $ | 64,171 |   | 35.0 | % |
| Microsoft Xbox            |       | 71,132                                  |       | 11.1          |       | 18,709          |       | 4.0 |   | 52,423 |   | 280.2 | % |
| Nintendo GameCube         |       | 61,356                                  |       | 9.6           |       | 51,468          |       | 11.0 |   | 9,888 |   | 19.2 | % |
|                      |       | 380,091                                 |       | 59.3          |       | 253,609         |       | 54.2 |   | 126,482 |   | 49.9 | % |
| **Handheld**              | ** ** | ** **                              | ** ** | ** **    | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nintendo Game Boy Advance |       | 162,109                                 |       | 25.3          |       | 108,353         |       | 23.2 |   | 53,756 |   | 49.6 | % |
| Wireless                  |       | 6,860                                   |       | 1.1           |       | 1,944           |       | 0.4 |   | 4,916 |   | 252.9 | % |
|                      |       | 168,969                                 |       | 26.4          |       | 110,297         |       | 23.6 |   | 58,672 |   | 53.2 | % |
| **PC**                    |       | 74,934                                  |       | 11.7          |       | 49,333          |       | 10.5 |   | 25,601 |   | 51.9 | % |
| **Other**                 |       | 16,852                                  |       | 2.6           |       | 54,408          |       | 11.7 |   | (37,556 | ) | (69.0 | )% |
| **Net Sales**             |       | $                                       | 640,846    |          | 100.0      | %               | $          | 467,647 |   | 100.0 | % | $ | 173,199 |   | 37.0 | % |
|                           |            |                                         |            |               |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |

 

Net sales for fiscal 2004increased 37% to $640.8 million from $467.6 million in the twelve months ended March 31,2003.

**Consoles**

***Sony PlayStation 2Net Sales (in thousands)***
| **Year Ended  March31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                              | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                    | $247,603   |                              |       |                                          | 38.6       | %                                 |       |              | $          | 183,432 |   |   |   | 39.2 | % |   |   | 35 | % |   |
|                                         |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Net sales of video gamesfor PlayStation 2 increased for fiscal 2004 due to the releases of:Disney/Pixar’s *Finding Nemo*, *Scooby-Doo! Mystery**Mayhem, SpongeBob SquarePants: Battle for BikiniBottom*, *WWE SmackDown!**Here Comes the Pain* and thelaunch of two new original brands—*MX Unleashed*and *Tak and the Power of Juju*. In the twelve months ended March 31,2003, net sales for the PlayStation 2 were driven by one internally developedoriginal title,  *Red Faction*IIand *WWE SmackDown!: Shut Your Mouth*. Wereleased 17 new SKUs for PlayStation 2 in fiscal 2004 compared to 11 SKUs inthe twelve months ended March 31,2003. The sales increase was also due to the higher installed base ofPlayStation 2 hardware in fiscal 2004.

***Microsoft Xbox NetSales (in thousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $71,132    |                              |       |                                          | 11.1       | %                                 |       |              | $          | 18,709 |   |   |   | 4.0 | % |   |   | 280.2 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Net sales of video gamesfor Xbox increased for fiscal 2004 primarily due to the sales of: Disney/Pixar’s*Finding Nemo*and*WWE Raw 2*and original titles *MotoGP2*and*MX Unleashed. WWE Raw*was the only significant Xbox titlelaunched in the twelve months ended March 31, 2003. The increase in netsales was 

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also due to the higherinstalled base of Xbox hardware compared to the twelve months ended March 31,2003. In total we released 16 SKUs for Xbox during fiscal 2004 compared to 5SKUs in the twelve months ended March 31, 2003.

***Nintendo GameCubeNet Sales (in thousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $61,356    |                              |       |                                          | 9.6        | %                                 |       |              | $          | 51,468 |   |   |   | 11.0 | % |   |   | 19.2 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Net sales of video gamesfor GameCube in fiscal 2004 included releases of *WWE WrestlemaniaX9*, *SpongeBob SquarePants: Battle for BikiniBottom*and the launch of our original title, *Tak and thePower of Juju.*We released 11 GameCube SKUs during fiscal 2004compared to 10 SKUs in the twelve months ended March 31, 2003. Net salesfor fiscal 2004 primarily increased due to strong sales of Disney/Pixar’s***Finding Nemo.*

**Handheld Platforms**

Net sales growth forfiscal 2004 was also driven by the increase in handheld sales, which increased53% to $169.0 million from $110.3 million in the twelve months ended March 31,2003.

***Nintendo Game BoyAdvance Net Sales (in thousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $162,109   |                              |       |                                          | 25.3       | %                                 |       |              | $          | 108,353 |   |   |   | 23.2 | % |   |   | 49.6 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Net sales of video gamesfor Game Boy Advance primarily increased in fiscal 2004 due to strong sales ofDisney/Pixar’s *Finding Nemo*. Other significantreleases for fiscal 2004 included: *SpongeBob SquarePants:Battle for Bikini Bottom, Tak & The Power of Juju, Sonic Battle*and*Banjo Kazooie*. The increase in net sales was also due tothe higher installed base of Game Boy Advance hardware as compared to thetwelve months ended March 31, 2003. The increase in hardware sales is duein part to Nintendo’s launch in March 2003 of the Game Boy Advance SP,which is a front-lit screen version of their Game Boy Advance platform. Intotal we released 33 SKUs for Game Boy Advance during fiscal 2004 compared to24 SKUs in the twelve months ended March 31, 2003.

***Wireless Net Sales(in thousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $6,860     |                              |       |                                          | 1.1        | %                                 |       |              | $          | 1,944 |   |   |   | 0.4 | % |   |   | 252.9 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Wireless net sales, whichconsisted primarily of sales of wireless games, increased in fiscal 2004primarily due to our increased product offerings and greater distributionacross the cellular carriers.

**PCs**

Net sales of PC productsin fiscal 2004 also contributed to sales growth. Net sales for fiscal 2004increased 52% to $74.9 million from $49.3 million in the twelve months ended March 31,2003.

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***PC Net Sales (inthousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $74,934    |                              |       |                                          | 11.7       | %                                 |       |              | $          | 49,333 |   |   |   | 10.5 | % |   |   | 51.9 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Net sales of our PC gamesincreased in fiscal 2004 primarily due to strong sales of Disney/Pixar’s *Finding Nemo.*Growth in net sales during fiscal 2004 wasalso due to strong sales of PC titles published by ValuSoft, our value division.In total we released 52 PC SKUs published from our ValuSoft division and 16other PC SKUs during fiscal 2004 compared to 51 PC SKUs published by ourValuSoft division and 11 other PC SKUs in the twelve months ended March 31,2003.

**Costs and Expenses,Interest Income, Other Income (Expenses) and Income Taxes**

Thefollowing table sets forth information about our costs and expenses, interestincome, other income (expenses) and income taxes for the periods indicated as apercentage of total net sales:
| ** **                         | ** ** | **Percent of Net Sales** | ** ** |
|------------------------------------|------------|-----------------------------------------|------------|
| ** **                         | ** ** | **Year Ended March 31,** | ** ** |
| ** **                         | ** ** | **  2004  **        | ** ** | **2003** | ** ** |
| ** **                         | ** ** | ** **                              | ** ** | **(Unaudited)** | ** ** |
| Costs and expenses:                |       |                                    |       |   |   |   |   |   |   |
| Cost of sales                      |       |                                    | 35.8       | % |   |   | 38.1 | % |   |
| License amortization and royalties |       |                                    | 11.1       |   |   |   | 8.3 |   |   |
| Software development amortization  |       |                                    | 16.5       |   |   |   | 18.2 |   |   |
| Product development                |       |                                    | 5.8        |   |   |   | 7.8 |   |   |
| Selling and marketing              |       |                                    | 14.4       |   |   |   | 15.2 |   |   |
| Payment to venture partner         |       |                                    | 1.5        |   |   |   | 2.0 |   |   |
| General and administrative         |       |                                    | 7.3        |   |   |   | 7.9 |   |   |
| Total costs and  expenses          |       |                                    | 92.4       |   |   |   | 97.5 |   |   |
| Income from  operations            |       |                                    | 7.6        |   |   |   | 2.5 |   |   |
| Interest income                    |       |                                    | 0.4        |   |   |   | 1.0 |   |   |
| Other income  (expense)            |       |                                    | 0.6        |   |   |   | (2.6 | ) |   |
| Income before  income taxes        |       |                                    | 8.6        |   |   |   | 0.9 |   |   |
| Income taxes                       |       |                                    | 3.0        |   |   |   | 0.4 |   |   |
| Net income                         |       |                                    | 5.6        | % |   |   | 0.5 | % |   |

 

Costs and expenses forfiscal 2004 increased as compared to the twelve months ended March 31, 2003,from $455.7 million to $592.0 million; however, costs and expenses as a percentof net sales decreased from 98% to 92%. The only increase as a percentage ofnet sales in fiscal 2004 was higher license amortization and royalty expense. Asignificant portion of this increase was attributable to global sales ofDisney/Pixar’s *Finding Nemo*, a licensedproperty.

***Cost of Sales (inthousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $229,218   |                              |       |                                          | 35.8       | %                                 |       |              | $          | 178,291 |   |   |   | 38.1 | % |   |   | 28.6 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of sales represented36% and 38% of net sales for the twelve months ended March 31, 2004 and2003, respectively. The primary factors that decreased the cost of sales as apercentage of net sales for fiscal 2004 

38

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were: (1) highermargins on software developed for Game Boy Advance; (2) higher average netselling price for our PC products due to the success of Disney/Pixar’s***Finding Nemo*; and (3) the increasedpercentage of wireless net sales, which carry minimal cost of sales.

***LicenseAmortization and Royalties (in thousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $71,132    |                              |       |                                          | 11.1       | %                                 |       |              | $          | 38,988 |   |   |   | 8.3 | % |   |   | 82.4 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

License amortization androyalties expense increased as a percentage of net sales for fiscal 2004 ascompared to the twelve months ended March 31, 2003. In absolute dollars,license amortization and royalties for fiscal 2004 also increased as comparedto the twelve months ended March 31, 2003, from $39.0 million to $71.1million. This increase was primarily driven by the release of more licensedtitles in fiscal 2004, including Disney/Pixar’s *Finding Nemo*on all platforms.

***SoftwareDevelopment Amortization (in thousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $105,632   |                              |       |                                          | 16.5       | %                                 |       |              | $          | 84,916 |   |   |   | 18.2 | % |   |   | 24.4 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Software developmentamortization costs increased from $84.9 million in the twelve months ended March 31,2003 to $105.6 million in fiscal 2004. Software development amortization forthe twelve months ended March 31, 2003, included a charge of approximately$12.0 million related to an assessment of the recoverability of capitalizeddevelopment costs pertaining to 20 SKUs. Excluding this charge, softwaredevelopment amortization increased as a percentage of net sales byapproximately 1%.

***Product Development(in thousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $36,850    |                              |       |                                          | 5.8        | %                                 |       |              | $          | 36,531 |   |   |   | 7.8 | % |   |   | 0.9 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Product developmentexpenses decreased as a percentage of net sales from 8% for the twelve monthsended March 31, 2003, to 6% for fiscal 2004. The decrease in productdevelopment expenses as a percentage of net sales was due to the significantincrease in sales as well as changes we implemented to improve product quality,including the shutdown of our Outrage® Games development studio, the downsizingof Pacific Coast Power & Light development studio (now known asLocomotive Games, Inc.), and the restructuring of our corporate productdevelopment department.

***Selling andMarketing (in thousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $92,475    |                              |       |                                          | 14.4       | %                                 |       |              | $          | 70,978 |   |   |   | 15.2 | % |   |   | 30.3 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Selling and marketingexpenses decreased slightly as a percentage of net sales for fiscal 2004 ascompared to the twelve months ended March 31, 2003, from 15% to 14%. Inabsolute dollars, selling and marketing expenses increased for fiscal 2004 ascompared to the twelve months ended March 31, 2003, from $71.0 

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million to $92.5 million. Theincrease in absolute dollars was due to the advertising and other promotionalsupport needed for such titles as *WWE SmackDown! Here ComesThe Pain, SpongeBob SquarePants Battle for Bikini Bottom, Splashdown: RidesGone Wild,*Disney/Pixar’s***Finding Nemo*and the launch of original titles *Sphinx and the Cursed Mummy* and *Tak and thePower of Juju*.

***Payment to venturepartner (in thousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $9,675     |                              |       |                                          | 1.5        | %                                 |       |              | $          | 9,218 |   |   |   | 2.0 | % |   |   | 5.0 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

Payment to JAKKS decreasedslightly as a percentage of total net sales for fiscal 2004 as compared to thetwelve months ended March 31, 2003, from 2.0% to 1.5%. The payment made toJAKKS is related to the joint license agreement that THQ and JAKKS obtainedfrom WWE, where THQ’s role is to develop, manufacture, distribute, market andsell video games. The decrease as a percentage of net sales is in directrelation to the decrease in WWE-related sales as a percentage of our total netsales. The payment to JAKKS in fiscal 2004 was driven by the release of *WWE SmackDown! Here Comes the Pain*for PS2.

***General andAdministrative (in thousands)***
| **Year Ended  March 31, 2004** | ** ** | **% of net sales** | ** ** | **Year Ended  March 31, 2003** | ** ** | **% of net sales** | ** ** | **% change** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | ** **                        | ** ** | **(Unaudited)**                               | ** ** | ** **                        | ** ** | ** **        | ** ** |
|                                          | $47,006    |                              |       |                                          | 7.3        | %                                 |       |              | $          | 36,794 |   |   |   | 7.9 | % |   |   | 27.8 | % |   |
|                                               |            |                                   |            |                                               |            |                                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

General and administrativeexpenses for fiscal 2004 increased $10.2 million from the twelve months ended March 31,2003, from $36.8 million to $47.0 million; however, they decreased as apercentage of net sales from 8% to 7%. Excluding the $7.0 million increase inour allowance for doubtful accounts related to KB Toys’ filing of bankruptcyprotection on January 14, 2004, general and administrative expensesdeclined to 6% in fiscal 2004. This decrease was the result of our continuedfocus on building operating efficiencies and controlling costs.

***Other Income (Expense)***

Other income for fiscal2004 consisted of a $4 million settlement of a dispute we had with ourdirectors’ and officers’ insurance carrier related to a previous securitieslitigation settlement. Other expenses for the twelve months ended March 31,2003, included a $7 million charge related to the settlement of a class actionlawsuit and a $3.0 million non-cash charge related to the discontinuation ofour online joint venture in the United Kingdom (Network Interactive Sports,Ltd.). Additionally, the twelve months ended March 31, 2003, included a$1.8 million write-down of our long-term investment in Yuke’s Co., Ltd due toan other-than-temporary decline in the market value of the investment. See “Note8—Other Long-Term Assets.”

***Income Taxes***

The income tax provision of $19.4 million for fiscal2004 reflected our effective income tax rate of 35%. The decrease in theeffective 42%******taxrate from the twelve months ended March 31, 2003, was due primarily to anon-deductible capital loss related to the discontinuation of our online jointventure in the United Kingdom in September 2002. The decrease in the ratefrom the prior estimate of 37% for fiscal 2004 was due to an increase in theproportion of our profits earned in our international territories that havelower statutory income tax rates.

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**Liquidity andCapital Resources**

Our total assets as of March 31, 2005 were $747.4million, as compared to $527.2 million as of March 31, 2004. Of the totalassets at March 31, 2005, $522.6 million, or 70%, were current assets,with $331.2 million, or 44% of this amount, in cash, cash equivalents andshort-term investments. Other significant current assets at March 31, 2005included $73.7 million of net accounts receivable, and $57.1 million ofsoftware development assets. The amount of our accounts receivable is subjectto significant variations as a consequence of the seasonality of our sales andthe timing of shipments within the quarter. Of the total assets at March 31,2004, $397.1 million were current assets, with $253.0 million of this amount,in cash, cash equivalents and short-term investments.

At March 31, 2005,our total current liabilities were $120.9 million, which consisted primarily of$43.7 million of accrued expenses, $36.5 million of accounts payable and $33.1million of accrued royalties. Total current liabilities were $87.4 million at March 31,2004. The increase in current liabilities in fiscal 2005 reflects the growth ofour business and the significant revenue increase in the third and fourthquarters of fiscal 2005 compared to the same periods in fiscal 2004.

*Changes in Cash Flow*
| ** **                                       | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** | **Change** | ** ** |
|--------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|------------|------------|
| **(In thousands)**                          | ** ** | ** **                   | ** ** | ** **                   | ** ** |
| Cash provided by  operating activities           |       |                         | $          | 60,455                       |       |       |       | $ | 71,154 |   |   | $ | (10,699 | ) |
| Cash used in  investing activities               |       |                         | (77,891    | )                            |       |       | (53,153    | ) |   | (24,738 | ) |
| Cash provided by  (used in) financing activities |       |                         | 33,764     |                         |       |       | (3,873     | ) |   | 37,637 |   |
| Effect of  exchange rate changes on cash         |       |                         | 605        |                         |       |       | 4,079      |   |   | (3,474 | ) |
| Net increase in cash and  cash equivalents       |       |                         | $          | 16,933                       |       |       |       | $ | 18,207 |   |   | $ | (1,274 | ) |
|                                                  |            |                              |            |                              |            |            |            |  |  |  |  |  |  |  |  |  |

 

Our principal source of cash is from sales of ourpackaged software for video game consoles, handheld game platforms, andpersonal computers. We also derive cash by revenue received from cellularcarriers for providing content for wireless devices. We expect cash collectionsin fiscal 2006 to remain approximately equal to cash collections in fiscal2005, as we expect our total net sales to be roughly the same in both fiscalyears.

Our principal uses of cashare for product purchases**ofdiscs and cartridges along with associated manufacturer’s royalties, paymentsto external developers and licensors, the costs of internal softwaredevelopment, and selling and marketing expenses. In fiscal 2006, we expect touse more cash than we did in fiscal 2005. We expect this increase in use of cashwill be primarily attributable to (i) increased development ofnext-generation platform products, which have higher development costs thancurrent generation platform products; (ii) increased marketing expensesassociated with the release of titles based on new original intellectualproperties; and (iii) our continued ramp-up of the wireless platform andincreased product development of wireless games.

During fiscal 2005, wegenerated $60.5 million of cash from operating activities, as compared to $71.2million generated from operating activities for fiscal 2004. Cash provided byoperations during fiscal 2005 was approximately equivalent to our net income. Thedecline in cash provided by operations was caused by an increase in ourspending for licenses, software development and income taxes offset by anincrease in our net income and the timing of the collections of our salescompared to fiscal 2004. We expect to continue to make significant expendituresin fiscal 2006 relating to our investment in software development andintellectual property licenses.

Cash used in investingactivities increased by $24.7 million for fiscal 2005, as compared to fiscal2004 primarily due to our fiscal 2005 acquisitions of Relic and Blue Tongue andour additional investment in Minick.

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Short-term investmentsincreased by $61.2 million in fiscal 2005. Short-term investments are primarilyauction rate securities. The interest rates on these securities are typicallyreset to market prevailing rates every 50 days or less, and in all cases every90 days or less, but have longer stated maturities. Prior to the end of fiscal2005, we classified auction rate securities in cash and cash equivalents. Priorperiod information was reclassified, including the impact on cash flow frominvesting activities, to conform to the current year presentation. There was noimpact on net income or cash flow from operating activities as a result of thereclassification. We had $209.4 million of investments in auction ratesecurities as of March 31, 2005. In the previously reported consolidatedstatement of cash flows for the year ended March 31, 2004, cash used ininvesting activities related to these short-term investments of $166.0 millionwas included in cash and cash equivalents.

Cash provided by financingactivities increased by $37.6 million for fiscal 2005, as compared to fiscal2004, primarily due to the exercise of stock options.

*Guarantees andCommitments*

Asummary of annual minimum contractual obligations and commercial commitments asof March 31, 2005 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** | ** ** |
| 2006                                        |       |                                                                       | $          | 82,157 |   |   |   | $ | 16,362 |   |   |   | $ | 7,659 |   |   |   | $ | 3,800 |   |   |   | $ | 2,000 |   |   | $ | 111,978 |   |
| 2007                                        |       |                                                                       | 54,221     |   |   |   | 5,796 |   |   |   | 8,482 |   |   |   | — |   |   |   | 2,000 |   |   | 70,499 |   |
| 2008                                        |       |                                                                       | 43,424     |   |   |   | 2,498 |   |   |   | 8,751 |   |   |   | — |   |   |   | — |   |   | 54,673 |   |
| 2009                                        |       |                                                                       | 37,000     |   |   |   | 2,335 |   |   |   | 8,357 |   |   |   | — |   |   |   | — |   |   | 47,692 |   |
| 2010                                        |       |                                                                       | 12,000     |   |   |   | 1,752 |   |   |   | 7,515 |   |   |   | — |   |   |   | — |   |   | 21,267 |   |
| Thereafter                                  |       |                                                                       | 22,000     |   |   |   | — |   |   |   | 28,586 |   |   |   | — |   |   |   | — |   |   | 50,586 |   |
|                                        |       |                                                                       | $          | 250,802 |   |   |   | $ | 28,743 |   |   |   | $ | 69,350 |   |   |   | $ | 3,800 |   |   |   | $ | 4,000 |   |   | $ | 356,695 |   |
|                                             |            |                                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          *Licenses andSoftware Development*.   We enter into contractual agreementswith third parties for the rights to intellectual property and for thedevelopment of products. Under these agreements, we commit to provide specifiedpayments to an intellectual property holder or developer. Assuming allcontractual provisions are met, the total future minimum contract commitmentsfor contracts in place as of March 31, 2005 are approximately $250.8million. License/software development commitments included $78.3 million ofcommitments to licensors that have been included in our consolidated balancesheet as of March 31, 2005 because the licensors do not have anysignificant performance obligations to us. These commitments were included inboth current and long-term licenses and accrued royalties.

(2)          *Advertising*.   Wehave certain minimum advertising commitments under most of our major licenseagreements. These minimum commitments generally range from 2% to 12% of netsales related to the respective license. We estimate that our minimumcommitment for advertising in fiscal 2006 will be $16.4 million.

(3)          *Leases*.   Weare committed under operating leases with lease termination dates through 2015.On December 30, 2004, we entered into a lease for premises consisting ofapproximately 103,000 rentable square feet of office space located in AgouraHills, California, which we intend to use as our corporate headquarters. Ourcurrent corporate headquarters lease expires in October 2005. Most of ourleases contain rent escalations.

(4)          *Letters ofCredit*.   We had approximately $3.8 million in obligations underour credit facility with respect to letters of credit and no outstandingborrowings.

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(5)          *Other*.   OnApril 26, 2005 we paid $2.0 million in cash, and will pay an additional$2.0 million in the following fiscal year related to the purchase of Relic.

Other potential future expenditures relate to thefollowing:

*Manufacturer Indemnification.  *Wemust indemnify the manufacturers of our games with respect to all loss,liability and expenses resulting from any claim against the manufacturerinvolving the development, marketing, sale or use of our games, including anyclaims for copyright or trademark infringement brought against the manufacturer.As a result, we bear a risk that the properties upon which the titles of ourgames are based, or that the information and technology licensed from othersand incorporated into the products, may infringe the rights of third parties. Ouragreements with our independent software developers and property licensorstypically provide indemnification rights for us with respect to certain matters.However, if a manufacturer brings a claim against us for indemnification, thedevelopers or licensors may not have sufficient resources to, in turn,indemnify us.

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

*CreditFacility.**  *OnNovember 29, 2004, we amended our revolving credit agreement to (i) extendthe term of the credit agreement through November 29, 2006; and (ii) increasethe maximum monthly facility amount to $40.0 million for each August, September andOctober, and reduce the maximum monthly facility amount to $12.0 million forevery other month. Additionally, pursuant to the amendment, the credit facilityis now unsecured and accordingly the bank terminated its lien over our assetson January 4, 2005. The credit agreement contains customary financial andnon-financial covenants that require us to maintain specified operating profitsand liquidity and limits our ability to incur additional indebtedness, sellassets, pay cash dividends and enter into certain mergers or acquisitions. Asof March 31, 2005, we were in compliance with all the covenants under thecredit facility and had outstanding letters of credit of approximately $3.8million.

*Inflation*

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

*Financial Condition*

We believe the existing cash, cash equivalents,short-term investments, and cash generated from operations will be sufficientto meet our operating requirements for at least the next twelve months,including working capital requirements, capital expenditures and potentialfuture acquisitions or strategic investments. We may choose at any time toraise additional capital to strengthen our cash position, facilitate expansion,pursue strategic investments or to take advantage of business opportunities asthey arise.

Our ability to maintainsufficient liquidity could be affected by various risks and uncertaintiesdescribed in the subsection entitled “*Risk Factors*”,below.

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**RISK FACTORS**

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:

**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. Insome instances, a sales decline may also be accompanied by decreasing salesprices, which may result in credits or allowances to our customers.

**We rely on arelatively small number of brands for a significant portion of our sales.**

A small number of our products make up a substantialportion of our sales each year, and these products are responsible for adisproportionate amount of our net income. In fiscal 2005, sales of titles forour three top-selling brands, Disney/Pixar, Nickelodeon, and WWE were 21%, 17%and 14% of net sales, respectively, and in fiscal 2004, net sales of productsbased on such brands were 18%, 16% and 16%, respectively. For the twelve monthsended March 31, 2003, sales of titles for our three top selling brands,Nickelodeon, WWE, and *Scooby-Doo!*were 22%, 20% and 9% of net sales, respectively. A limited number of brands maycontinue to produce a disproportionately large amount of our sales. Due to thisdependence on a limited number of brands, the failure of one or more productsbased on these brands to achieve anticipated results may significantly harm ourbusiness and financial results.

Additionally, we arecurrently involved in litigation with the WWE with respect to our video gamelicense. Since WWE titles make up a significant portion of our sales, ourinability to retain the license could harm us.

**Ourinability to acquire or create intellectual property rights which have a highlevel of consumer recognition or acceptance could harm us.**

Approximately two-thirds of our net sales in fiscal2005, fiscal 2004 and the twelve months ended March 31, 2003 was derivedfrom products based on popular licensed properties. Our economic success couldbe limited by our inability to obtain other mass-market licenses in the future.Additionally, a decrease in the popularity of the underlying property of ourlicenses 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 core 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.

**Ourinability to enter into agreements with the manufacturers to develop, publishand distribute titles on their platforms could seriously impact our operations.**

We are dependent on the platformmanufacturers and our non-exclusive licenses with them, both for the right topublish titles for their platforms and for the manufacture of our products fortheir platforms. Our existing platform licenses require that we obtain approvalfor the publication of new games on a title-by-title basis. As a result, thenumber of titles we are able to publish for these platforms, and our sales fromtitles for these platforms, may be limited. Should any manufacturer choose notto renew or extend our 

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license agreement at the end of itscurrent term, or if any license were terminated, we would be unable to publishadditional titles for that manufacturer’s platform, which could negativelyaffect 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.

**Theintroduction of new platforms could materially impact the sales of our productsand our development expenses.**

Our future success depends on our ability to adapt torapidly changing technologies, including the development and sale of entertainmentsoftware to accommodate the introduction of new platforms to the interactiveentertainment software industry. When new platforms are announced or introducedinto the market, consumers typically reduce their purchases of entertainmentsoftware products for current platforms in anticipation of new platformsbecoming available. During these periods, sales of our game consoleentertainment software products may be expected to slow or even decline untilnew platforms are introduced and achieve wide consumer acceptance. Microsoft,Sony, and Nintendo have announced plans to introduce new console platforms inthe next year. Further, Sony recently introduced its hand-held gaming device,PSP, and Nintendo launched a new dual-screened, portable game system, NintendoDS. Delays in the launch, shortages, technical problems or lack of consumeracceptance of the next generation platforms could adversely affect our sales ofproducts for these platforms.

Additionally, platformtransitions are generally marked by escalating development costs. New platformshave historically required the development of new software and also have theeffect of undermining demand for products based on older technologies. Becauseproduct development cycles are difficult to predict, we must make substantialproduct development and other investments in products 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, we may not be able to recoverin revenues our development costs, which could be significant, and our businessand financial results could be significantly harmed.

**Videogame product development schedules are difficult to predict and can be subjectto delays. Postponements in shipments can substantially impact our earnings inany 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 sales and profitability and cause our operating resultsto be materially different from expectations. Delays that prevent release ofour products during peak selling seasons or in conjunction with specificevents, such as the release of a related movie, could adversely affect ourfinancial performance.

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

Some of our titles aredeveloped by external developers. We have no direct control over the business,finances and operational practices of these external developers. A delay orfailure to complete the work performed by external developers may result indelays in, or cancellations of, product releases. The future success ofexternally developed titles will depend on our continued ability to maintainrelationships and 

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obtain developer agreementson favorable terms with skilled external developers. Our competitors mayacquire the businesses of key developers or sign them to exclusive developmentarrangements. In either case, we would not be able to continue to engage suchdevelopers’ services for our products, except for those that they arecontractually obligated to complete for us. We cannot guarantee that we will beable to establish or maintain such relationships with external developers andfailure to do so could result in a material adverse effect on our business andfinancial results.

**Defects in our game software could harm our reputation ordecrease 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.

**Werely on a small number of customers that account for a significant amount ofour sales.**

Sales to our 10 largestcustomers collectively accounted for approximately 48%, 54% and 60% of ourgross sales for fiscal 2005, fiscal 2004 and the twelve months ended March 31,2003, respectively. Our largest single customer in those periods was Wal-Mart. Wal-Martaccounted for 14% of our gross sales in fiscal 2005, 19% of our gross sales forfiscal 2004 and 18% of our gross sales for the twelve months ended March 31,2003. A substantial reduction, termination ofpurchases, or business failure by any of our largest customers would have amaterial adverse effect on us.

**Increasedforeign operations subject us to different business and economic risks.**

Foreign sales are subject todifferent risks, including different consumer preferences, unexpected changesin regulatory requirements, tariffs and other barriers, difficulties instaffing and managing foreign operations, and possible difficulties collectingforeign accounts receivable. These factors or others could have an adverseeffect on our future foreign sales or the profits generated from these sales.

Salesgenerated by our European and Australian offices will generally be denominatedin the currency of the country in which the sales are made or, if made inEurope, Euros, if made in the United Kingdom, GBP and if made in Australia, theAustralian Dollar. To the extent our foreign sales are not denominated in U.S.dollars, our sales and profits could be materially and adversely affected byforeign currency fluctuations.

**Competition in the interactive software entertainmentindustry 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 in connectionwith the acquisition of licensed properties. Additionally, large mediacompanies, such as Disney and Viacom, are increasing their focus on theinteractive entertainment software market, which might result in greatercompetition for us.

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 

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intense,we may need to increase our marketing expenditures to maintain sales of ourtitles. Prolonged price competition, increased licensing costs or reducedprofit margins would have a negative effect on our business and financialresults.

**Competition for qualified personnel is intense in theinteractive 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, including the development of our titles and brands.Our success depends to a significant extent upon our ability to attract andretain key personnel. Competition for employees can be intense and the processof locating key personnel with the right combination of skills is often lengthy.The loss of services of key personnel could have a material adverse effect onus.

**Consolidation in the interactive software entertainmentindustry presents challenges with respect to resources and integration ofacquired 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. This is particularlyof concern for us because many of our competitors for potential acquisitionshave greater financial and other resources.

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

**Emergingtechnologies, such as games for wireless devices, require capital investmentsand 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 our applications.In addition, the widespread adoption of networking or telecommunicationstechnologies or other technological changes could require substantialexpenditures 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 

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requiring significantresearch and development expense, as well as the accurate anticipation oftechnological and market trends. As the life cycle of mobile phone models andother wireless devices shortens, we will be required to develop and adapt ourexisting applications and create new applications more quickly. These effortsmay not be successful. Any failure or delay in anticipating technologicaladvances or developing and marketing new applications that respond to anysignificant change in technology or customer demand could limit the availablechannels for our applications and limit or reduce our sales.

**Unauthorizedproduction and use of our intellectual property and rights could cause usmaterial harm.**

Unauthorized productionoccurs in the computer software industry generally, and were a significantamount of unauthorized production of our products to occur, it could materiallyand adversely affect our results of operations. We hold copyrights on theproducts, manuals, advertising and other materials owned by us and we maintaincertain trademark rights. We regard our titles, including the underlyingsoftware, as proprietary and rely on a combination of trademark, copyright andtrade secret laws as well as employee and third-party nondisclosure andconfidentiality agreements, among other methods to protect our rights. Weinclude with our products a “shrink-wrap” or “click-wrap” license agreement orlimitations on use of the software. It is uncertain to what extent theseagreements and limitations are enforceable, especially in foreign countries. Policingunauthorized use of our products is difficult, and software piracy is apersistent problem, especially in some international markets. Further, the lawsof some countries where our products are or may be distributed either do notprotect our products and intellectual property rights to the same extent as thelaws of the United States, or are poorly enforced. Legal protection of ourrights may be ineffective in such countries. We cannot be certain that existingintellectual property laws will provide adequate protection for our products.

**Wemay be subject to intellectual property claims.**

Many patents have beenissued that may apply to widely used game technologies. Although we believethat we make reasonable efforts to ensure that our products do not violate theintellectual property rights of others, it is possible that third parties stillmay claim infringement. We are currently involved in litigation regarding sucha claim. Existing or future infringement claims against us, whether valid ornot, may be time consuming and expensive to defend and could force us to ceaseselling, incorporating or using products or services that incorporate thechallenged intellectual property; obtain a license from the holder of the infringedintellectual property, which if available at all, may not be available oncommercially favorable terms; redesign the effected interactive entertainmentsoftware products, which could cause us to incur additional costs, delayintroduction and possibly reduce commercial appeal of our products; or paydamages to the holder of the infringed intellectual property for use of itsproperty without a license. Any of these actions may cause material harm to ourbusiness and financial results.

**Our reported financialresults could be affected by changes in current accounting principles.**

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 could materiallyincrease our reported expenses.

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**Wecannot be certain of the future effectiveness of our internal controls overfinancial reporting or the impact of the same on our operations or the marketprice 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 our internalcontrols over financial reporting. Furthermore, our independent registeredpublic accounting firm is required to audit our assessment of the effectivenessof our internal controls over financial reporting and separately report onwhether it believes we maintain, in all material respects, effective internalcontrols over financial reporting. Although we believe that we currently haveadequate internal controls procedures in place, we can not be certain thatfuture material changes to our internal controls over financial reporting willbe effective. If we cannot adequately maintain the effectiveness of ourinternal controls over financial reporting, we might be subject to sanctions orinvestigation by regulatory authorities, such as the Securities and ExchangeCommission. Any such action could adversely affect our financial results andthe market price of our common stock.

**Fluctuations in our quarterly operating results due toseasonality in the interactive software entertainment industry could result insubstantial 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 ofour release of new titles as well as the release of our competitor’s products;

·        the popularityof both new titles and titles released in prior periods;

·        the profitmargins for titles we sell;

·        the competitionin the industry for retail shelf space;

·        fluctuations inthe size and rate of growth of consumer demand for titles for differentplatforms; and

·        the timing ofthe introduction of new platforms and the accuracy of retailers’ forecasts ofconsumer 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 market analysts and investors and as a result of the factors describedabove and others described throughout this “Risk Factors” section, the price ofour common 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 our productscould be adversely affected.

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**Any significant downturn in general economic conditions whichresults in a reduction in discretionary spending could reduce demand for ourproducts 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 financial condition,past financial performance should not be considered a reliable indicator offuture performance, and investors should not use historical trends toanticipate results or trends in future periods.

**Item7A. Quantitative and Qualitative Disclosures About Market Risk**

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

**Interest Rate Risk**

We have interest rate riskprimarily related to our investment portfolio. A substantial portion of ourportfolio is in short-term investments made up of floating rate securities andmunicipal securities. The value of these investments may fluctuate with changesin interest rates. However, we believe this risk is immaterial due to theshort-term nature of the investments. The credit facility is based on variableinterest rates. At March 31, 2005, we had outstanding letters of credit of$3.8 million.

**Foreign CurrencyRisk**

We transact business in many different foreigncurrencies and are exposed to financial market risk resulting from fluctuationsin foreign currency exchange rates, particularly the GBP and the Euro, whichmay result in a gain or loss of earnings to us. The volatility of the GBP andthe Euro (and all other applicable currencies) is monitored frequentlythroughout the year. We face two risks related to foreign currency exchange:translation risk and transaction risk. Amounts invested in our foreignoperations are translated into U.S. dollars at the exchange rates in effect atthe balance sheet date. The resulting translation adjustments are recorded as acomponent of accumulated other comprehensive income (loss) in the stockholders’equity section of the consolidated balance sheets. Our foreign subsidiariesgenerally collect revenues and pay expenses in currencies other than the U.S.dollar. Since the functional currencies of our foreign operations are generallydenominated in the local currency of our subsidiaries, the foreign currencytranslation adjustments are reflected as a component of stockholders’ equityand do not impact operating results. Revenues and expenses in foreigncurrencies translate into higher or lower revenues and expenses in U.S. dollarsas the U.S. dollar weakens or strengthens against other currencies. Therefore,changes in exchange rates may negatively affect our consolidated revenues andexpenses (as expressed in U.S. dollars) from foreign operations. Currencytransaction gains or losses arising from transactions in currencies other thanthe functional currency are included within general and administrative expensewithin the consolidated statements of operations.

We utilize foreignexchange forward contracts to mitigate foreign currency risk associated withforeign currency denominated assets and liabilities, primarily certaininter-company receivables and payables. Our foreign exchange forward contractsare accounted for as derivatives whereby the fair value of the contracts arereflected as other current assets or other current liabilities and theassociated gains and losses are reflected in general and administrative expensein the consolidated statements of operations. These gains and losses are designedto offset gains and losses on the underlying foreign-currency-denominatedassets and liabilities. As of March 31, 2005, we had foreign exchangeforward contracts in the notional amount of 

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$35.1 million, all withmaturities of less than one month, consisting primarily of Euros, Great BritishPounds, and Canadian Dollars. The counterparties to these forward contracts arecreditworthy multinational commercial and investment banks. The risks ofcounterparty nonperformance associated with these contracts are not consideredto be material. Notwithstanding our efforts to manage foreign exchange risks,there can be no assurances that our mitigating or hedging activities willadequately protect us against the risks associated with foreign currencyfluctuations.

**Item8.****Financial 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 Directors and Stockholders of THQInc.,

Calabasas Hills, California

We have audited the accompanying consolidated balancesheets of THQ Inc. and subsidiaries (the “Company”) as of March 31, 2005and 2004, and the related consolidated statements of operations, stockholders’equity and cash flows for the years ended March 31, 2005 and 2004, the threemonths ended March 31, 2003 and the year ended December 31, 2002. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour 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, 2005 and 2004, and the results of its operations and itscash flows for the years ended March 31, 2005 and 2004, the three monthsended March 31, 2003 and the year ended December 31, 2002, inconformity with accounting principles generally accepted in the United Statesof 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, 2005, based on the criteriaestablished in *Internal Control—Integrated Framework issuedby the Committee of Sponsoring Organizations of the Treadway Commission*and our report dated June 8, 2005 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**

Los Angeles, CaliforniaJune 8, 2005

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**Part I—FinancialInformation**

**Item 1. FinancialStatements.**

**THQ INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS (In thousands, except share data)**
| ** **                                                                                                                                                              | ** ** | ** March 31, ** | ** ** | ** March 31, ** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                                              | ** ** | **2005**                       | ** ** | **2004**                       | ** ** |
| **ASSETS**                                                                                                                                                              |       |                           |       |                           |       |   |   |   |   |
| Current assets:                                                                                                                                                         |       |                           |       |                           |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                              |       |                           | $          | 98,175                         |       |   |   | $ | 81,242 |   |   |
| Short-term  investments                                                                                                                                                 |       |                           | 232,998    |                           |       |   | 171,797 |   |   |
| Cash, cash  equivalents and short-term investments                                                                                                                      |       |                           | 331,173    |                           |       |   | 253,039 |   |   |
| Accounts  receivable, net of allowances                                                                                                                                 |       |                           | 73,700     |                           |       |   | 59,088 |   |   |
| Inventory                                                                                                                                                               |       |                           | 23,802     |                           |       |   | 22,303 |   |   |
| Licenses                                                                                                                                                                |       |                           | 12,464     |                           |       |   | 13,172 |   |   |
| Software  development                                                                                                                                                   |       |                           | 57,107     |                           |       |   | 39,997 |   |   |
| Income taxes  receivable                                                                                                                                                |       |                           | 9,783      |                           |       |   | — |   |   |
| Prepaid expenses  and other current assets                                                                                                                              |       |                           | 14,530     |                           |       |   | 9,451 |   |   |
| Total current  assets                                                                                                                                                   |       |                           | 522,559    |                           |       |   | 397,050 |   |   |
| Property and  equipment, net                                                                                                                                            |       |                           | 26,822     |                           |       |   | 17,468 |   |   |
| Licenses, net of  current portion                                                                                                                                       |       |                           | 75,523     |                           |       |   | 9,068 |   |   |
| Software  development, net of current portion                                                                                                                           |       |                           | 8,144      |                           |       |   | 9,798 |   |   |
| Deferred income  taxes                                                                                                                                                  |       |                           | —     |                           |       |   | 560 |   |   |
| Income taxes  receivable, net of current portion                                                                                                                        |       |                           | 9,513      |                           |       |   | — |   |   |
| Goodwill, net                                                                                                                                                           |       |                           | 83,440     |                           |       |   | 59,399 |   |   |
| Long-term  marketable securities                                                                                                                                        |       |                           | —     |                           |       |   | 24,320 |   |   |
| Other long-term  assets, net                                                                                                                                            |       |                           | 21,392     |                           |       |   | 9,488 |   |   |
| TOTAL ASSETS                                                                                                                                                            |       |                           | $          | 747,393                        |       |   |   | $ | 527,151 |   |   |
| **LIABILITIES,  MINORITY INTEREST AND STOCKHOLDERS’ EQUITY**                                                                                                       |       |                           |       |                           |       |   |   |   |   |
| Current  liabilities:                                                                                                                                                   |       |                           |       |                           |       |   |   |   |   |
| Accounts payable                                                                                                                                                        |       |                           | $          | 36,499                         |       |   |   | $ | 22,147 |   |   |
| Accrued  liabilities                                                                                                                                                    |       |                           | 43,745     |                           |       |   | 22,361 |   |   |
| Accrued payment to  venture partner                                                                                                                                     |       |                           | 639        |                           |       |   | 746 |   |   |
| Accrued royalties                                                                                                                                                       |       |                           | 33,148     |                           |       |   | 41,305 |   |   |
| Income taxes  payable                                                                                                                                                   |       |                           | —     |                           |       |   | 216 |   |   |
| Deferred income  taxes                                                                                                                                                  |       |                           | 6,841      |                           |       |   | 642 |   |   |
| Total current  liabilities                                                                                                                                              |       |                           | 120,872    |                           |       |   | 87,417 |   |   |
| Accrued  liabilities, net of current portion                                                                                                                            |       |                           | 2,059      |                           |       |   | — |   |   |
| Accrued royalties,  net of current portion                                                                                                                              |       |                           | 70,000     |                           |       |   | 1,142 |   |   |
| Deferred income  taxes, net of current portion                                                                                                                          |       |                           | 4,466      |                           |       |   | — |   |   |
| Commitments and  contingencies                                                                                                                                          |       |                           | —     |                           |       |   | — |   |   |
| Minority interest                                                                                                                                                       |       |                           | 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; 40,459,748 and 38,166,978 shares  issued and outstanding as of March 31, 2005 and 2004, respectively |       |                           | 405        |                           |       |   | 382 |   |   |
| Additional paid-in  capital                                                                                                                                             |       |                           | 347,664    |                           |       |   | 304,860 |   |   |
| Accumulated other  comprehensive income                                                                                                                                 |       |                           | 12,851     |                           |       |   | 8,302 |   |   |
| Retained earnings                                                                                                                                                       |       |                           | 187,838    |                           |       |   | 125,048 |   |   |
| Total stockholders’  equity                                                                                                                                        |       |                           | 548,758    |                           |       |   | 438,592 |   |   |
| TOTAL LIABILITIES,  MINORITY INTEREST AND STOCKHOLDERS’ EQUITY                                                                                                     |       |                           | $          | 747,393                        |       |   |   | $ | 527,151 |   |   |

 

See notes to consolidated financial statements.

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**THQ INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data)**
| ** **                                               | ** ** | **Year Ended  March 31,** | ** ** | **Transition** | ** ** | **Year Ended  December 31,** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------|------------|----------------|------------|----------------------------------------|------------|
| ** **                                               | ** ** | **2005**                            | ** ** | **2004**       | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| Net sales                                                |       | $                                   | 756,731    |           | $          | 640,846                                |       | $ | 66,800 |   |   | $ | 480,529 |   |   |
| Costs and expenses:                                      |       |                                |       |           |       |                                   |       |   |   |   |   |
| Cost of sales                                            |       | 250,055                             |       | 229,218        |       | 26,378                                 |       |   | 185,593 |   |   |
| License amortization and royalties                       |       | 85,926                              |       | 71,132         |       | 5,576                                  |       |   | 40,476 |   |   |
| Software development amortization                        |       | 93,622                              |       | 105,632        |       | 12,018                                 |       |   | 83,698 |   |   |
| Product development                                      |       | 72,959                              |       | 36,850         |       | 8,899                                  |       |   | 34,696 |   |   |
| Selling and marketing                                    |       | 115,646                             |       | 92,475         |       | 14,294                                 |       |   | 66,443 |   |   |
| Payment to venture partner                               |       | 9,774                               |       | 9,675          |       | 644                                    |       |   | 10,146 |   |   |
| General and administrative                               |       | 54,831                              |       | 47,006         |       | 8,442                                  |       |   | 34,993 |   |   |
| Total costs and  expenses                                |       | 682,813                             |       | 591,988        |       | 76,251                                 |       |   | 456,045 |   |   |
| Income (loss) from operations                            |       | 73,918                              |       | 48,858         |       | (9,451                                 | )          |   | 24,484 |   |   |
| Interest income                                          |       | 4,337                               |       | 2,378          |       | 878                                    |       |   | 5,277 |   |   |
| Other income  (expense)                                  |       | —                              |       | 4,000          |       | (2,403                                 | )          |   | (10,006 | ) |   |
| Income (loss) before income taxes and minority  interest |       | 78,255                              |       | 55,236         |       | (10,976                                | )          |   | 19,755 |   |   |
| Income taxes                                             |       | 15,204                              |       | 19,397         |       | (3,290                                 | )          |   | 6,761 |   |   |
| Income (loss) before minority interest                   |       | 63,051                              |       | 35,839         |       | (7,686                                 | )          |   | 12,994 |   |   |
| Minority interest                                        |       | (261                                | )          | —         |       | —                                 |       |   | — |   |   |
| Net income (loss)                                        |       | $                                   | 62,790     |           | $          | 35,839                                 |       | $ | (7,686 | ) |   | $ | 12,994 |   |   |
| Net income (loss) per share—basic                   |       | $                                   | 1.61       |           | $          | 0.94                                   |       | $ | (0.20 | ) |   | $ | 0.33 |   |   |
| Net income (loss) per share—diluted                 |       | $                                   | 1.56       |           | $          | 0.92                                   |       | $ | (0.20 | ) |   | $ | 0.32 |   |   |
| Shares used in per share calculation—basic          |       | 39,030                              |       | 38,186         |       | 38,319                                 |       |   | 39,203 |   |   |
| Shares used in per share  calculation—diluted       |       | 40,243                              |       | 39,004         |       | 38,319                                 |       |   | 41,243 |   |   |

 

See notes to consolidated financial statements.

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

**Year Ended December 31,2002 and Three Months Ended March 31, 2003 and Fiscal Years Ended March 31,2004 and 2005**
| ** **                                                              | ** ** | ** **            | ** ** | ** **             | ** ** | ** **               | ** ** | **Accumulated   Other** | ** ** | ** **               | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|--------------------------|------------|-------------------------|------------|--------------------------|------------|------------|------------|
| ** **                                                              | ** ** | **Common Stock** | ** ** | **Additional**         | ** ** | **Comprehensive**        | ** ** | **Retained**            | ** ** | ** **               | ** ** |
| ** **                                                              | ** ** | **Shares**            | ** ** | ** Amount ** | ** ** | **Paid-In Capital** | ** ** | **Income (Loss)**  | ** ** | ** Earnings ** | ** ** | **Total**  | ** ** |
| **Balance at January 1, 2002**                                     |       | 38,979,747            |       |                   | $          | 390                      |       |                    |       | $                        | 316,758    |       |       |   | $ | (2,187 | ) |   |   | $ | 83,901 |   |   | $ | 398,862 |   |
| Exercise of options                                                     |       | 932,234               |       |                   | 9          |                     |       |                    | 7,741      |                     |       |       | —     |   |   |   | — |   |   | 7,750 |   |
| Issuance of common stock  for ValuSoft acquisition                      |       | 166,600               |       |                   | 2          |                     |       |                    | 4,626      |                     |       |       | —     |   |   |   | — |   |   | 4,628 |   |
| Issuance of warrants                                                    |       | —                |       |                   | —     |                     |       |                    | 1,214      |                     |       |       | —     |   |   |   | — |   |   | 1,214 |   |
| Repurchase of common  stock                                             |       | (1,671,531            | )          |                   | (17        | )                        |       |                    | (24,988    | )                        |       |       | —     |   |   |   | — |   |   | (25,005 | ) |
| Adjustments related to  2001 secondary offering                         |       | —                |       |                   | —     |                     |       |                    | 52         |                     |       |       | —     |   |   |   | — |   |   | 52 |   |
| Stock compensation                                                      |       | 8,952                 |       |                   | —     |                     |       |                    | 436        |                     |       |       | —     |   |   |   | — |   |   | 436 |   |
| Tax benefit related to  the exercise of employee stock options          |       | —                |       |                   | —     |                     |       |                    | 5,124      |                     |       |       | —     |   |   |   | — |   |   | 5,124 |   |
| Comprehensive income:                                                   |       |                  |       |                   |       |                     |       |                    |       |                     |       |       |       |   |   |   |   |   |   |   |   |
| Net income                                                              |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | —     |   |   |   | 12,994 |   |   | 12,994 |   |
| Other comprehensive  income                                             |       |                  |       |                   |       |                     |       |                    |       |                     |       |       |       |   |   |   |   |   |   |   |   |
| Foreign currency  translation adjustment                                |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | 4,318      |   |   |   | — |   |   | 4,318 |   |
| Unrealized loss on  investments                                         |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | (1,507     | ) |   |   | — |   |   | (1,507 | ) |
| Comprehensive income                                                    |       |                  |       |                   |       |                     |       |                    |       |                     |       |       |       |   |   |   |   |   |   | 15,805 |   |
| **Balance at December 31, 2002**                                        |       | 38,416,002            |       |                   | 384        |                     |       |                    | 310,963    |                     |       |       | 624        |   |   |   | 96,895 |   |   | 408,866 |   |
| Exercise of options                                                     |       | 144,411               |       |                   | 2          |                     |       |                    | 1,406      |                     |       |       | —     |   |   |   | — |   |   | 1,408 |   |
| Tax benefit related to  the exercise of employee stock options          |       | —                |       |                   | —     |                     |       |                    | 181        |                     |       |       | —     |   |   |   | — |   |   | 181 |   |
| Repurchase of common  stock                                             |       | (568,307              | )          |                   | (6         | )                        |       |                    | (7,752     | )                        |       |       | —     |   |   |   | — |   |   | (7,758 | ) |
| Stock compensation                                                      |       | 15,773                |       |                   | —     |                     |       |                    | 530        |                     |       |       | —     |   |   |   | — |   |   | 530 |   |
| Comprehensive loss:                                                     |       |                  |       |                   |       |                     |       |                    |       |                     |       |       |       |   |   |   |   |   |   |   |   |
| Net loss                                                                |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | —     |   |   |   | (7,686 | ) |   | (7,686 | ) |
| Other comprehensive loss                                                |       |                  |       |                   |       |                     |       |                    |       |                     |       |       |       |   |   |   |   |   |   |   |   |
| Foreign currency  translation adjustment                                |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | (404       | ) |   |   | — |   |   | (404 | ) |
| Unrealized loss on  investments                                         |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | (1,127     | ) |   |   | — |   |   | (1,127 | ) |
| Reclassification  adjustment for net losses included in net income |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | 2,403      |   |   |   |   |   |   | 2,403 |   |
| Comprehensive loss                                                      |       |                  |       |                   |       |                     |       |                    |       |                     |       |       |       |   |   |   |   |   |   | (6,814 | ) |
| **Balance at March 31, 2003**                                           |       | 38,007,879            |       |                   | 380        |                     |       |                    | 305,328    |                     |       |       | 1,496      |   |   |   | 89,209 |   |   | 396,413 |   |
| Exercise of options                                                     |       | 868,190               |       |                   | 9          |                     |       |                    | 7,112      |                     |       |       | —     |   |   |   | — |   |   | 7,121 |   |
| Issuance of warrants                                                    |       | —                |       |                   | —     |                     |       |                    | 956        |                     |       |       | —     |   |   |   | — |   |   | 956 |   |
| Repurchase of common stock                                              |       | (709,091              | )          |                   | (7         | )                        |       |                    | (10,987    | )                        |       |       | —     |   |   |   | — |   |   | (10,994 | ) |
| Stock 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 adjustment                                 |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | 5,431      |   |   |   | — |   |   | 5,431 |   |
| Unrealized gain on investments                                          |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | 1,375      |   |   |   | — |   |   | 1,375 |   |
| Comprehensive income                                                    |       |                  |       |                   |       |                     |       |                    |       |                     |       |       |       |   |   |   |   |   |   | 42,645 |   |
| **Balance at March 31, 2004**                                           |       | 38,166,978            |       |                   | 382        |                     |       |                    | 304,860    |                     |       |       | 8,302      |   |   |   | 125,048 |   |   | 438,592 |   |
| Exercise of options                                                     |       | 2,792,770             |       |                   | 28         |                     |       |                    | 42,817     |                     |       |       | —     |   |   |   | — |   |   | 42,845 |   |
| Issuance of warrants                                                    |       | —                |       |                   | —     |                     |       |                    | 2,422      |                     |       |       | —     |   |   |   | — |   |   | 2,422 |   |
| Repurchase of common stock                                              |       | (500,000              | )          |                   | (5         | )                        |       |                    | (9,075     | )                        |       |       | —     |   |   |   | — |   |   | (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 adjustment                                 |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | 2,802      |   |   |   | — |   |   | 2,802 |   |
| Unrealized gain on investments, net of $1.9 million  tax benefit   |       | —                |       |                   | —     |                     |       |                    | —     |                     |       |       | 1,747      |   |   |   | — |   |   | 1,747 |   |
| Comprehensive income                                                    |       |                  |       |                   |       |                     |       |                    |       |                     |       |       |       |   |   |   |   |   |   | 67,339 |   |
| **Balance at March 31, 2005**                                      |       | 40,459,748            |       |                   | $          | 405                      |       |                    |       | $                        | 347,664    |       |       |   | $ | 12,851 |   |   |   | $ | 187,838 |   |   | $ | 548,758 |   |

 

See notes to consolidated financial statements.

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**THQ INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**
| ** **                                                                                | ** ** | **Year Ended March 31,** | ** ** | **Transition** | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------|------------|----------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                | ** ** | **2004**       | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| **OPERATING ACTIVITIES:**                                                                 |       |                                    |       |           |       |                                   |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                                       | 62,790     |           | $          | 35,839                                 |       | $ | (7,686 | ) |   | $ | 12,994 |   |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                    |       |           |       |                                   |       |   |   |   |   |
| Minority interest                                                                         |       | 261                                     |       | —         |       | —                                 |       |   | — |   |   |
| Depreciation and  amortization                                                            |       | 10,485                                  |       | 7,227          |       | 1,956                                  |       |   | 6,385 |   |   |
| Amortization of  licenses and software development                                        |       | 121,801                                 |       | 126,686        |       | 13,323                                 |       |   | 91,677 |   |   |
| Loss on disposal  of property and equipment                                               |       | 48                                      |       | 258            |       | —                                 |       |   | 137 |   |   |
| Stock compensation                                                                        |       | —                                  |       | 84             |       | 530                                    |       |   | 436 |   |   |
| Tax benefit  related to the exercise of employee stock options                            |       | 6,640                                   |       | 2,367          |       | 181                                    |       |   | 5,124 |   |   |
| Deferred income  taxes                                                                    |       | 7,442                                   |       | 2,464          |       | (1,180                                 | )          |   | (730 | ) |   |
| Other than  temporary impairment on investments                                           |       | —                                  |       | —         |       | 2,403                                  |       |   | — |   |   |
| Write-off of  Network Interactive Sports Ltd.                                             |       | —                                  |       | —         |       | —                                 |       |   | 3,006 |   |   |
| Changes in operating  assets and liabilities:                                             |       |                                    |       |           |       |                                   |       |   |   |   |   |
| Accounts  receivable, net                                                                 |       | (8,507                                  | )          | (21,766        | )          | 111,022                                |       |   | (15,371 | ) |   |
| Inventory                                                                                 |       | (1,015                                  | )          | 3,427          |       | 233                                    |       |   | (12,112 | ) |   |
| Licenses                                                                                  |       | (107,679                                | )          | (24,072        | )          | (4,027                                 | )          |   | (33,918 | ) |   |
| Software  development                                                                     |       | (92,863                                 | )          | (80,803        | )          | (19,305                                | )          |   | (75,049 | ) |   |
| Prepaid expenses  and other current assets                                                |       | (4,362                                  | )          | 2,318          |       | 771                                    |       |   | (2,101 | ) |   |
| Accounts payable                                                                          |       | 11,205                                  |       | (343           | )          | (20,374                                | )          |   | 11,067 |   |   |
| Accrued  liabilities                                                                      |       | 12,744                                  |       | 970            |       | (12,543                                | )          |   | 14,203 |   |   |
| Accrued payment to  venture partner                                                       |       | (129                                    | )          | 70             |       | (5,169                                 | )          |   | (626 | ) |   |
| Accrued royalties                                                                         |       | 60,694                                  |       | 15,012         |       | (18,181                                | )          |   | 8,834 |   |   |
| Income taxes                                                                              |       | (19,100                                 | )          | 1,416          |       | (3,479                                 | )          |   | 2,374 |   |   |
| Net cash provided  by operating activities                                                |       | 60,455                                  |       | 71,154         |       | 38,475                                 |       |   | 16,330 |   |   |
| **INVESTING ACTIVITIES:**                                                                 |       |                                    |       |           |       |                                   |       |   |   |   |   |
| Proceeds from  sales and maturities of investments                                        |       | 243,607                                 |       | 42,500         |       | 65,019                                 |       |   | 90,732 |   |   |
| Purchase of  short-term investments                                                       |       | (280,488                                | )          | (61,325        | )          | (99,104                                | )          |   | (106,227 | ) |   |
| Purchases of  long-term marketable securities                                             |       | —                                  |       | (24,320        | )          | —                                 |       |   | — |   |   |
| (Increase)  decrease in other long-term assets                                            |       | (5,125                                  | )          | (70            | )          | 1,510                                  |       |   | (1,422 | ) |   |
| Acquisitions, net  of cash acquired                                                       |       | (19,234                                 | )          | (2,300         | )          | —                                 |       |   | (9,373 | ) |   |
| Acquisition of  property and equipment                                                    |       | (16,651                                 | )          | (7,638         | )          | (2,099                                 | )          |   | (7,794 | ) |   |
| Investment in  Network Interactive Sports Ltd.                                            |       | —                                  |       | —         |       | —                                 |       |   | (221 | ) |   |
| Net cash used in  investing activities                                                    |       | (77,891                                 | )          | (53,153        | )          | (34,674                                | )          |   | (34,305 | ) |   |
| **FINANCING ACTIVITIES:**                                                                 |       |                                    |       |           |       |                                   |       |   |   |   |   |
| Stock repurchase                                                                          |       | (9,080                                  | )          | (10,994        | )          | (7,758                                 | )          |   | (25,005 | ) |   |
| Proceeds from  issuance of common stock                                                   |       | —                                  |       | —         |       | —                                 |       |   | 52 |   |   |
| Proceeds from  exercise of warrants and stock options                                     |       | 42,844                                  |       | 7,121          |       | 1,408                                  |       |   | 7,750 |   |   |
| Net cash provided  by (used in) financing activities                                      |       | 33,764                                  |       | (3,873         | )          | (6,350                                 | )          |   | (17,203 | ) |   |
| Effect of exchange  rate changes on cash                                                  |       | 605                                     |       | 4,079          |       | (784                                   | )          |   | 862 |   |   |
| Net increase  (decrease) in cash and cash equivalents                                     |       | 16,933                                  |       | 18,207         |       | (3,333                                 | )          |   | (34,316 | ) |   |
| Cash and cash  equivalents—beginning of period                                       |       | 81,242                                  |       | 63,035         |       | 66,368                                 |       |   | 100,684 |   |   |
| Cash and cash  equivalents—end of period                                             |       | $                                       | 98,175     |           | $          | 81,242                                 |       | $ | 63,035 |   |   | $ | 66,368 |   |   |
| Cash paid during  the period for:                                                         |       |                                    |       |           |       |                                   |       |   |   |   |   |
| Income taxes                                                                              |       | $                                       | 21,825     |           | $          | 15,625                                 |       | $ | 2,616 |   |   | $ | 3,257 |   |   |
| Interest                                                                                  |       | $                                       | 199        |           | $          | 144                                    |       | $ | 11 |   |   | $ | 76 |   |   |

 

See notes to consolidated financial statements.

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

**1.   Description of Business**

*Business*.   THQInc., a Delaware corporation, is a leading worldwide developer and publisher ofinteractive entertainment software for the major hardware platforms in thevideo game market. We currently develop and/or publish titles primarily forSony PlayStation 2, Microsoft Xbox, Nintendo GameCube, Nintendo Game BoyAdvance, Nintendo Dual Screen, Sony PlayStation Portable, personal computersand wireless devices. Sony, Microsoftand Nintendo recently announced that they would be releasing new consoles: theSony PlayStation 3, Microsoft Xbox 360 and Nintendo Revolution. We aredeveloping games for the PlayStation 3 and Xbox 360, and we intend to developgames for the Revolution, and plan to release games at or near the launch ofeach platform. Our titles span a wide range of categories, includingaction, adventure, fighting, racing, role playing, simulation, sports andstrategy. Our customers include Wal-Mart, Toys “R” Us, Target, Best Buy, GameStop, Electronics Boutique, Game Stores Group Ltd. and other national andregional retailers, discount store chains and specialty retailers.

All references to “we,” “us,” “our,” “THQ,” or the “Company”in the following notes mean THQ Inc. and its subsidiaries.

*FiscalYear.  *Effective January 1, 2003, we changed ourfiscal year end from December 31 to March 31. Accordingly, thetransitional period ended March 31, 2003 (Transition 2003) representsthree months of operations.

*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 the GameCube, Game Boy Advance and DualScreen;

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

·        licenseswith Microsoft to develop games for the Xbox.

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 for the PlayStation 2, automatically renew each year unlesseither party gives notice by the applicable date that it intends to terminatethe agreement. Additionally, each agreement designates a territory in which wecan publish and distribute titles. We currently are licensed to publish anddistribute titles on all platforms which are currently sold in the UnitedStates and Canada. We are licensed to publish and distribute titles forGameCube, PlayStation 2, Xbox and Game Boy Advance in various additionalterritories, including Europe, Australia and New Zealand, parts of Asia andCentral and South America. We expect to enter into additional platform licensesor extend current licenses as new platforms are launched or our currentagreements 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 

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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 independent 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’indemnification of us may not cover the matter that gives rise to themanufacturer’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.

**2.   Summaryof Significant Accounting Policies**

*Principles of Consolidation.  *Theconsolidated financial statements include the accounts of THQ Inc. and itswholly owned and majority owned subsidiaries as well as the venture we havewith JAKKS Pacific, Inc. See “Note 13—Agreement with JAKKS Pacific, Inc.”The results of operations for acquisitions of companies accounted for using thepurchase method have been included in the consolidated statements of operationsbeginning on the closing date of acquisition. All material intercompanybalances and transactions have been eliminated in consolidation.

*ForeignCurrency Translation.  *Assets and liabilities of foreignoperations are translated at current rates of exchange while results ofoperations are translated at average rates in effect for the period. Translationgains or losses are shown as a separate component of accumulated othercomprehensive income (loss). The translation gain (loss) on long-termintercompany balances included in the foreign currency translation was $1.2million and $2.3 million for the fiscal years ended March 31, 2005 and2004, respectively. The translation gain (loss) on long-term intercompanybalances included in the foreign currency translation was ($0.4) million and$1.8 million for Transition 2003 and the year ended December 31, 2002,respectively. Foreign currency transaction gains and losses result fromexchange rate changes for transactions denominated in currencies other than thefunctional currency. For the fiscal years ended March 31, 2005 and 2004,foreign currency transaction gains were $2.3 million and $1.4 million,respectively, and are included in general and administrative expenses. ForTransition 2003 and the year ended December 31, 2002 foreign currencytransaction gains (losses) were not material.

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*Cash, Cash Equivalents, Short-Term Investments, andLong-Term Marketable Securities*
| ** **                                                                          | ** ** | **March 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                          | ** ** | **2005**           | ** ** | **2004** | ** ** |
| **(in thousands)**                                                             | ** ** | ** **         | ** ** | ** ** | ** ** |
| Cash and cash  equivalents                                                          |       | $                  | 98,175     |   | $ | 81,242 |   |
| Short-term  investments                                                             |       |               |       |   |   |
| Available for sale                                                                  |       | 209,378            |       | 165,995 |   |
| Held to maturity                                                                    |       | 23,620             |       | 5,802 |   |
| Short-term  investments                                                             |       | 232,998            |       | 171,797 |   |
| Long-term  marketable securities                                                    |       | —             |       | 24,320 |   |
| Cash, cash equivalents,  short-term investments and long-term marketable securities |       | $                  | 331,173    |   | $ | 277,359 |   |
|                                                                                     |            |                    |            |  |  |  |  |  |  |

 

Investments with original maturities greater thanthree months, but less than one year, are considered short-term investments. Weinvest in highly liquid debt instruments with strong credit ratings. Thecarrying amounts of the investments approximate fair value due to their shortmaturities. Unrealized gains and (losses) are recorded as a separate componentof accumulated other comprehensive income (loss) for investments classified asavailable-for-sale.

We invest in marketable securities and classify thesecurities as available-for-sale under Statement of Financial AccountingStandard (SFAS No. 115), “Accounting for Certain Investments in Debt andEquity Securities.” In accordance with SFAS No. 115, available-for-salemarketable securities are accounted for at market prices, with the unrealizedgain or loss, less applicable deferred income taxes, shown as a separatecomponent of stockholders’ equity.

Short-term investments are primarily auction ratesecurities. The interest rates on these securities are typically reset tomarket prevailing rates every 50 days or less, and in all cases every 90 daysor less, but have longer stated maturities. Despite the long-term nature of theirstated contractual maturities, we have the ability to quickly liquidate thesesecurities. Short-term investments are classified as available-for-sale andchanges in the fair value are included in accumulated other comprehensiveincome (loss), net of applicable income taxes in the consolidated financialstatements. Prior to the end of fiscal 2005, we classified auction ratesecurities as cash and cash equivalents. Prior period information wasreclassified, including the impact on cash flow from investing activities, toconform to the current year presentation. There was no impact on net income orcash flow from operating activities as a result of the reclassification. We had$209.4 million of investments in auction rate securities as of March 31,2005. In the previously reported consolidated statement of cash flows for theyear ended March 31, 2004, cash used in investing activities related tothese short-term investments of $166 million was included in cash and cashequivalents.

The realized gains from sales of available-for-salesecurities were $130,000 and $126,000 for fiscal 2005 and 2004, respectively.There were no unrealized gains or (losses) from sales of available-for-salesecurities for fiscal 2005 and 2004, respectively except Yuke’s Co., Ltd.(“Yuke’s”) which is classified as available-for-sale and is included in otherlong-term assets. At March 31, 2003 we reclassified $556,000 of unrealizedlosses to net income (loss). The unrealized gains and (losses) on theinvestments in securities for Transition 2003 and the year ended December 31,2002 were $44,000 and ($492,000), respectively. See “Note 8—Other Long-TermAssets” for disclosure of activity related to Yuke’s.

During fiscal 2004 we acquired municipal bonds withmaturities of greater than one year for $24.3 million. These bonds areclassified as held-to-maturity. Investments with a maturity greater than oneyear at the time of purchase are considered to be long-term assets. During thefiscal year ended March 31, 2005, $24.3 million of these marketablesecurities were reclassified as short-term investments due to their maturity datebeing less than one year. As of March 31, 2005, the value of our long-termmarketable securities was 

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zero. As of March 31, 2005, our available-for-saledebt securities have stated maturities ranging from 8 to 34 years. Ourheld-to-maturity debt securities have maturities less than one year.

Short-terminvestments and long-term marketable securities at March 31, 2005 and 2004were as follows (in thousands):
| ** **                                    | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                    | ** ** | **Amortized  Costs**         | ** ** | **Gross  Unrealized  Costs** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Amortized  Costs** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| ***Available-for-sale  (current):***          |       |                         |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Corporate notes  and bonds                    |       | $                            | 23,200     |                         |       | $ | — |   |   |   | $ | — |   |   | $ | 23,200 |   | $ | 53,600 |   |   | $ | — |   |   |   | $ | — |   |   | $ | 53,600 |   |
| Municipal  securities                         |       | 186,178                      |       |                         | —     |   |   |   | — |   |   | 186,178 |   | 112,395 |   |   | — |   |   |   | — |   |   | 112,395 |   |
| Total available-for-sale investments          |       | $                            | 209,378    |                         |       | $ | — |   |   |   | $ | — |   |   | $ | 209,378 |   | $ | 165,995 |   |   | $ | — |   |   |   | $ | — |   |   | $ | 165,995 |   |
| ***Held-to-maturity  (current):***            |       |                         |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Corporate debt  securities                    |       | $                            | —     |                         |       | $ | — |   |   |   | $ | — |   |   | $ | — |   | $ | 4,800 |   |   | $ | — |   |   |   | $ | — |   |   | $ | 4,800 |   |
| Municipal  securities                         |       | 23,620                       |       |                         | —     |   |   |   | — |   |   | 23,620 |   | 1,002 |   |   | — |   |   |   | — |   |   | 1,002 |   |
| Total current held-to-maturity investments    |       | $                            | 23,620     |                         |       | $ | — |   |   |   | $ | — |   |   | $ | 23,620 |   | $ | 5,802 |   |   | $ | — |   |   |   | $ | — |   |   | $ | 5,802 |   |
| ***Held-to-maturity  (long-term):***          |       |                         |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Municipal  securities                         |       | $                            | —     |                         |       | $ | — |   |   |   | $ | — |   |   | $ | — |   | $ | 24,320 |   |   | $ | — |   |   |   | $ | — |   |   | $ | 24,320 |   |
| Total long-term  held-to-maturity investments |       | $                            | —     |                         |       | $ | — |   |   |   | $ | — |   |   | $ | — |   | $ | 24,320 |   |   | $ | — |   |   |   | $ | — |   |   | $ | 24,320 |   |

 

*Financial Instruments.  *Thecarrying value of certain financial instruments, including cash and cashequivalents, short-term investments held to maturity, accounts receivable,accounts payable, accrued expenses and accrued royalties, approximate fairmarket value based on their short-term nature. Short-term investmentsclassified as available for sale are stated at fair value.

We account for our derivative and hedging activitiesunder SFAS No. 133, “*Accounting for DerivativeInstruments 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 

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statement line item consistent with the hedged item. Anyineffective portion of a derivative change in fair value is immediatelyrecognized in earnings. During each of the periods presented we did not haveany derivatives that qualified for hedge accounting. Changes in fair value ofderivatives that do not qualify as hedging instruments are recorded in earnings.The fair value of foreign currency contracts is estimated based on the forwardrate of the various hedged currencies as of the end of the period. As of March 31,2005 and 2004, we had foreign exchange forward contracts in the notional amountof $35.1 million and zero, respectively. The net gain recognized from foreigncurrency contracts in fiscal 2005 was $682,000 and is included in general &administrative expense in our consolidated statements of operations. We did nothave any gains or losses from foreign currency contracts in fiscal years priorto 2005.

*Concentrations of Credit Risk.  *Financialinstruments which potentially subject us to concentration of credit riskconsist principally of cash and cash equivalents, short-term investments,accounts receivable and long-term marketable securities. We place cash and cashequivalents and short-term investments with high credit-quality institutionsand limit the amount of credit exposure to any one institution. We believe thisrisk is immaterial due to the short-term nature of such investments. As of March 31,2005 we did not have any long-term marketable securities. Most of our sales aremade directly to mass merchandisers and national retailers. Due to theincreased volume of sales to these channels, we have experienced an increasedconcentration of credit risk, and as a result, may maintain individuallysignificant receivable balances with such mass merchandisers and nationalretailers. We perform ongoing credit evaluations of our customers and maintainan allowance for potential credit losses.

Sales (before returns and allowances) to a majorcustomer represented 14%, 19%, 25% and 16% of gross sales in the fiscal yearsended March 31, 2005 and 2004, Transition 2003 and the year ended December 31,2002, respectively. This customer accounted for approximately 16% and 20% ofaccounts receivable (before reserve for returns and allowances) at March 31,2005 and 2004, respectively. Sales (before returns and allowances) to anothermajor customer represented 7%, 7%, 11% and 13% of gross sales in the yearsended March 31, 2005 and 2004, Transition 2003 and the year ended December 31,2002, respectively. This customer accounted for approximately 5% and 12% ofaccounts receivable (before reserve for returns and allowances) at March 31,2005 and 2004, respectively.

*Inventory.  *Inventory,which consists principally of finished products, is stated at the lower of cost(moving weighted average) or market. We estimate the net realizable value ofslow-moving inventory on a title by title basis, and charge the excess of costover net realizable value to cost of sales.

*Propertyand Equipment.  *Property and equipment are recorded atcost. Depreciation is computed using the straight-line method over theestimated useful lives of the assets. Leasehold improvements are amortized overthe shorter of their useful lives or the remaining lease term. Property andequipment consist of the following:
| ** **                                      | ** ** | **Useful** | ** ** | **March 31,** | ** ** |
|-------------------------------------------------|------------|------------|------------|--------------------|------------|
| ** **                                      | ** ** | **Lives**  | ** ** | **2005**           | ** ** | **2004** | ** ** |
| **(In  thousands)**                             | ** ** | ** ** | ** ** | ** **         | ** ** | ** ** | ** ** |
| Building                                        |       | 30  yrs    |       | $                  | 719        |   | $ | 719 |   |
| Land                                            |       | —     |       | 401                |       | 401 |   |
| Computer  equipment and software                |       | 3-10  yrs  |       | 45,254             |       | 31,111 |   |
| Furniture,  fixtures and equipment              |       | 5  yrs     |       | 5,842              |       | 3,960 |   |
| Leasehold  improvements                         |       | 3-6  yrs   |       | 4,221              |       | 2,422 |   |
| Automobiles                                     |       | 2-5  yrs   |       | 162                |       | 153 |   |
| Less: accumulated depreciation and amortization |       |       |       | (29,777            | )          | (21,298 | ) |
|                                            |       |       |       | $                  | 26,822     |   | $ | 17,468 |   |
|                                                 |            |            |            |                    |            |  |  |  |  |  |  |

 

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Depreciation and amortization expense associated withproperty and equipment amounted to $8.6 million, $6.7 million, $1.7 million,and $5.9 million for the fiscal years ended March 31, 2005 and 2004,Transition 2003, and the year ended December 31, 2002, respectively.

*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 contractwhen no significant performance remains with the licensor. When significantperformance remains with the licensor, we record royalty payments as an asset(licenses) when actually paid rather than upon execution of the contract. Royaltypayments for intellectual property licenses are classified as current assetsand current liabilities to the extent such royalty payments relate toanticipated sales during the subsequent year and long-term assets and long-termliabilities if such royalty payments relate to anticipated sales after oneyear.

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. See—“Long-Lived Assets” below. If actual revenues or revisedforecasted revenues fall below the initial forecasted revenue for a particularlicense, the charge to license amortization and royalties expense may be largerthan anticipated in any given quarter. As of March 31, 2005, the netcarrying value of our licenses was $88 million.

*Software Development*.   Weutilize both internal development teams and independent software developers todevelop our software. We account for software development costs in accordancewith SFAS No. 86, “*Accounting for the Costsof Computer Software to be Sold, 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 independent software developers and the direct payroll and facilities 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 immediately to productdevelopment expense.

Capitalized software development is expensed tosoftware development amortization at the higher of (1) the contractualrate based on actual net product sales for such software or (2) aneffective rate based upon total projected revenue for such software. When, inmanagement’s estimate, future cash flows will not be sufficient to recoverpreviously capitalized costs, we expense these items to software developmentamortization. See—“Long-Lived Assets” below. If actual revenues, or revisedforecasted revenues, fall below the initial forecasted revenue, the charge tosoftware development amortization may be larger than anticipated in any givenquarter. As of March 31, 2005, the net carrying value of our softwaredevelopment was $65.3 million.

*Goodwill and Other Intangible Assets.  *Inaccordance with the adoption of SFAS No. 142, “*Goodwill andOther Intangible Assets,*” on January 1, 2002, we ceasedamortizing goodwill. According to our accounting policy, we performed an annualreview during the quarter ended June 30, 2004, and found no impairment. Wewill perform a similar review in future quarters ended June 30, or morefrequently if indicators of potential impairment exist. Our impairment reviewprocess is based on a discounted future cash flow approach that uses ourestimates of revenue for the reporting units, driven by assumed success of ourproducts and product release schedules, and estimated costs as well asappropriate discount rates. These estimates are consistent with the plans andestimates that we use to manage the underlying businesses. We performed similarimpairment tests during the quarter ended June 30, 2004 forindefinite-lived intangible assets and found no impairment. All identifiableintangible assets with finite lives will continue to be 

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amortized over their estimated useful lives andassessed for impairment under SFAS No. 144, “*Accounting for the Impairment or Disposal ofLong-Lived Assets*.”

*Long-Lived Assets.  *Weevaluate long-lived assets, including, but not limited to, licenses, softwaredevelopment, property and equipment and identifiable intangible assets withfinite lives, for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable. Potentialimpairment of assets is measured by a comparison of the carrying amount of anasset to future undiscounted net cash flows expected to be generated by theasset. If such assets are considered impaired, the impairment to be recognizedis measured by the amount by which the carrying amount of the asset exceeds itsfair value.

*Revenue Recognition.  *Ourrevenue recognition policies are in compliance with American Institute ofCertified Public Accountants Statement of Position (“SOP”) 97-2, “SoftwareRevenue Recognition”, as amended by SOP 98-9, “Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions”, whichprovide guidance on generally accepted accounting principles for recognizingrevenue on software transactions, and Staff Accounting Bulletin (“SAB”) No. 104,*“Revenue Recognition in 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 5—Allowance for Price Protection, Returns and DoubtfulAccounts.” Software is sold under a limited 90-day warranty against defects inmaterial and workmanship. To date, we have not experienced material warrantyclaims.

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, 2005 and 2004, Transition 2003 and the year ended December 31,2002 was $13.2 million, $8.4 million, $4.1 million and $2.0 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 EITF No. 99-19, “*Reporting Revenue Gross as a Principal Versus Net as an Agent*,”we recognize as revenues the net amount the wireless carrier pays to us uponthe sale of our applications, net of any service or other fees earned anddeducted by the wireless carrier.

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*Advertising.  *Advertisingand sales promotion costs are generally expensed as incurred, except fortelevision airtime and print media costs associated with media campaigns, whichare deferred and charged to expense in the period the airtime or advertisingspace is used for the first time. Advertising costs for the fiscal years ended March 31,2005 and 2004, Transition 2003 and the year ended December 31, 2002 were$57 million, $45.3 million, $5.2 million and $34.4, respectively.

*Employee Stock-Based Compensation*.   Weaccount for our employee stock-based compensation plans under the intrinsicvalue method in accordance with Accounting Principles Board (“APB”) Opinion No. 25,*“Accounting for Stock Issued to Employees,”*and related interpretations. No stock option compensation expense, other thanacquisition-related compensation, is recognized in our consolidated statementsof operations because all stock options granted had an exercise price equal tothe fair value of the underlying common stock on the grant date, except foroptions issued by Locomotive Games, Inc. (which changed its name fromPacific Coast Power & Light Company in April 2005) and GeneticAnomalies prior to their acquisitions, which were issued at below market. Theestimated fair value of the options granted in the fiscal years ended March 31,2005 and 2004, Transition 2003 and the year ended December 31, 2002 was$22.7 million, $20.6 million, $3.4 million and $31.3 million, respectively.

On November 13, 2003, we commenced a Stock OptionExchange Program (“the Program”) under which eligible employees holding optionsto purchase an aggregate of 1,494,614 shares of our common stock, with aweighted average exercise price of $30.77 per share and a range of $27.49 to$39.11 per share, could elect to exchange their options for a designated fewernumber of replacement options with a new exercise price to be granted at leastsix months and one day from the cancellation date. Our executive officers anddirectors were not eligible to participate in the Program. In accordance withthe terms of the Program, we canceled 1,216,903 outstanding stock options on December 15,2003 and on June 21, 2004 granted, in exchange for the canceled options,758,836 new options. The replacement options have an exercise price of $21.73,which was the closing price of a share of THQ common stock on the Nasdaq StockMarket on June 21, 2004 and were fully vested as of December 21, 2004.In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123,“*Accounting for Stock-Based Compensation,*”the table below includes a modification of the 1,216,903 stock options canceledunder the Exchange Program that were immediately reissued as 758,836 newoptions on the cancellation date.

Thefair value of options granted under the stock option plans during the fiscalyears ended March 31, 2005 and 2004, Transition 2003 and the year ended December 31,2002, respectively, was determined using the Black-Scholes option pricing modelutilizing the following assumptions:
| ** **                               | ** ** | **Fiscal Year Ended  March 31** | ** ** | **Transition** | ** ** | **Year Ended  December 31,** | ** ** |
|------------------------------------------|------------|------------------------------------------------|------------|----------------|------------|----------------------------------------|------------|
| ** **                               | ** ** | **2005**                                       | ** ** | **2004**       | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| Dividend yield                           |       | 0%                                             |       | 0%             |       |                                   | 0%         |   |   |   | 0% |   |   |
| Anticipated volatility                   |       | 57%                                            |       | 69%            |       |                                   | 73%        |   |   |   | 73% |   |   |
| Weighted average risk-free interest rate |       | 3.48%                                          |       | 2.60%          |       |                                   | 3.46%      |   |   |   | 3.46% |   |   |
| Expected lives                           |       | 4 years                                        |       | 4 years        |       |                                   | 4 years    |   |   |   | 4 years |   |   |

 

 

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Thefollowing table shows what our net income and earnings per share wouldhave been for the fiscal years ended March 31, 2005 and 2004, Transition2003 and the year ended December 31, 2002 had we accounted for ourstock-based compensation plans under the fair value method of SFAS No. 123,as amended by SFAS No. 148, “*Accountingfor Stock-Based Compensation—Transition and Disclosure*,” using theassumptions in the table above. For purposes of this pro forma disclosure, theestimated value of the options is amortized ratably to expense over the options’vesting periods. Because the estimated value is determined as of the date ofgrant, the actual value ultimately realized by the employee may besignificantly different.
| ** **                                                                                                                                              | ** ** | **Fiscal Year Ended  March 31,**                                        | ** ** | **Transition**                                                                         | ** ** | **Year Ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                              | ** ** | **      2005       ** | ** ** | **      2004       ** | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| **(In thousands, except per share data)**                                                                                      | ** ** | ** **                                                                             | ** ** | ** **                                                                             | ** ** |
| Net income  (loss)—as reported                                                                                                                     |       |                                                                                   | $          | 62,790                                                                                 |       |                                   |       | $ | 35,839 |   |   | $ | (7,686 | ) |   | $ | 12,994 |   |   |
| Add: Stock-based employee compensation expense included  in reported net income (loss), net of related tax effects                                 |       |                                                                                   | —     |                                                                                   |       |                                   | 54         |   |   | 119 |   |   | 104 |   |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of related  tax effects |       |                                                                                   | (12,996    | )                                                                                      |       |                                   | (14,890    | ) |   | (4,033 | ) |   | (19,436 | ) |   |
| Net income (loss)—pro forma                                                                                                                        |       |                                                                                   | $          | 49,794                                                                                 |       |                                   |       | $ | 21,003 |   |   | $ | (11,600 | ) |   | $ | (6,338 | ) |   |
| Earnings (loss)  per share:                                                                                                                             |       |                                                                                   |       |                                                                                   |       |                                   |       |   |   |   |   |   |   |   |   |
| Basic—as reported                                                                                                                                  |       |                                                                                   | $          | 1.61                                                                                   |       |                                   |       | $ | 0.94 |   |   | $ | (0.20 | ) |   | $ | 0.33 |   |   |
| Basic—pro forma                                                                                                                                    |       |                                                                                   | $          | 1.28                                                                                   |       |                                   |       | $ | 0.55 |   |   | $ | (0.30 | ) |   | $ | (0.16 | ) |   |
| Diluted—as reported                                                                                                                                |       |                                                                                   | $          | 1.56                                                                                   |       |                                   |       | $ | 0.92 |   |   | $ | (0.20 | ) |   | $ | 0.32 |   |   |
| Diluted—pro forma                                                                                                                                  |       |                                                                                   | $          | 1.24                                                                                   |       |                                   |       | $ | 0.54 |   |   | $ | (0.30 | ) |   | $ | (0.16 | ) |   |
|                                                                                                                                                         |            |                                                                                        |            |                                                                                        |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

*Basicand Diluted Earnings (Loss) Per Share.  *The followingtable is a reconciliation of the weighted-average shares used in thecomputation of basic and diluted earnings (loss) per share for the periodspresented:
| ** **                                                                    | ** ** | **Fiscal Year Ended  March 31,**                                              | ** ** | ** Transition **                                                                   | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                    | ** ** | **       2005       ** | ** ** | **       2004       ** | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| **(In thousands, except per share data)**            | ** ** | ** **                                                                                   | ** ** | ** **                                                                                   | ** ** |
| Net income (loss)  used to compute basic and diluted earnings per share  |       |                                                                                         | $          | 62,790                                                                                       |       |                                   |       | $ | 35,839 |   |   |   | $ | (7,686 | ) |   |   | $ | 12,994 |   |   |
| Weighted average  number of shares outstanding—basic                     |       |                                                                                         | 39,030     |                                                                                         |       |                                   | 38,186     |   |   |   | 38,319 |   |   |   | 39,203 |   |   |
| Dilutive effect  of stock options and warrants                                |       |                                                                                         | 1,213      |                                                                                         |       |                                   | 818        |   |   |   | — |   |   |   | 2,040 |   |   |
| Number of shares used to  compute earnings (loss) per share—diluted |       |                                                                                         | 40,243     |                                                                                         |       |                                   | 39,004     |   |   |   | 38,319 |   |   |   | 41,243 |   |   |
|                                                                               |            |                                                                                              |            |                                                                                              |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Stock options to purchase approximately 1,957,000,4,146,000, and 2,462,000 shares of common stock in the fiscal years ended March 31,2005 and 2004, and the year ended December 31, 2002, respectively, wereoutstanding but are not included in the computation of diluted earnings percommon share because the option exercise prices for these options were greaterthan the average market price per of our common 

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stock during the period. Stock options to purchaseapproximately 600,000 shares of common stock in Transition 2003 were outstandingbut not included in the computation of diluted earnings per share due to thenet loss reported in this period.

*Recently Issued AccountingPronouncements.  *In December 2004, the FASB issuedStatement No. 123 (revised 2004), “*Share-Based Payment*”(“SFAS No. 123R”), which replaces SFAS No. 123, “*Accountingfor Stock-Based Compensation*,” (“SFAS No. 123”) andsupersedes APB Opinion No. 25, “*Accounting for StockIssued to Employees*.” SFAS No. 123R originally requiredall share-based payments to employees, including grants of employee stockoptions, to be recognized in the financial statements based on their fairvalues beginning with the first quarter or annual period after June 15,2005. On April 21, 2005 the SEC issued a rule that amends the date ofcompliance with SFAS No. 123R (“the SEC amendment”). Under the SECamendment, SFAS No. 123R must be adopted beginning with the first interimor annual reporting period of the registrant’s first fiscal year beginning onor after June 15, 2005, which means that we must adopt SFAS No. 123Rby April 1, 2006. The pro forma disclosures previously permitted underSFAS No. 123 no longer will be an alternative to financial statementrecognition. Under SFAS No. 123R, we must determine the appropriatefair value model to be used for valuing share-based payments, the amortizationmethod for compensation cost and the transition method to be used at date ofadoption. The transition methods include prospective and retroactive adoption.Under the retroactive method, prior periods may be restated either as of thebeginning of the year of adoption or for all periods presented. The prospectivemethod requires that compensation expense be recorded for all unvested stockoptions and restricted stock at the beginning of the first quarter of adoptionof SFAS No. 123R, while the retroactive methods would recordcompensation expense for all unvested stock options and restricted stockbeginning with the first period restated. We are evaluating the requirements ofSFAS No. 123R and believe the adoption of SFAS No. 123R mayhave a material impact on our consolidated results of operations and earningsper share. We have not yet determined the method of adoption or the effect ofadopting SFAS No. 123R, and we have not determined whether the adoptionwill result in amounts that are similar to the current pro forma disclosuresunder SFAS No. 123.

FASB Staff Position (“FSP”) No. 109-2, “*Accounting and Disclosure Guidance for the Foreign EarningsRepatriation Provision within the American Jobs Creation Act of 2004*”(“FSP 109-2”), provides guidance under FASB Statement No. 109, “*Accounting for Income Taxes*,” with respect to recording thepotential impact of the repatriation provisions of the American Jobs CreationAct of 2004 (the “Jobs Act”) on enterprises’ income tax expense and deferredtax liability. The Jobs Act was enacted on October 22, 2004. FSP 109-2states that an enterprise is allowed time beyond the financial reporting periodof enactment to evaluate the effect of the Jobs Act on its plan forreinvestment or repatriation of foreign earnings for purposes of applying FASBStatement No. 109. We have not yet completed evaluating the impact of therepatriation provisions. Accordingly, as provided for in FSP 109-2, we have notadjusted our tax expense or deferred tax liability to reflect the repatriationprovisions of the Jobs Act.

*Pervasiveness of Estimates.  *The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period. Actualresults could differ from those estimates. The most significant estimatesrelate to licenses, software development, and the allowance for priceprotection, returns and doubtful accounts.

*Reclassifications.  *Certainreclassifications have been made to the prior periods consolidated financialstatements to conform to current period consolidated financial statements.

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**3.   BusinessCombinations**

In fiscal 2005, weacquired the following two entities for a total cost of $14.3 million, whichwas paid primarily in cash:

·   Relic Entertainment, located in Vancouver,British Columbia, Canada, a developer of interactive entertainment software forvideo game hardware devices and personal computers

·   Blue Tongue Entertainment Limited, located inMelbourne, Australia, a developer of interactive entertainment software forvideo game hardware devices.

Also in fiscal 2005, we purchased an additional 25% ofthe outstanding common stock of Minick Holdings AG for a total cost of $10.7million. Minick develops and operates interactive software applications forwireless devices such as Short Messaging Service (“SMS”), Enhanced MessagingService (“EMS”), Multimedia Messaging Service (“MMS”), messaging information,and multimedia and voting applications. They are based in Zurich, Switzerland.

Goodwill recognized in the above transactions amountedto $18.2 million, none of which is expected to be deductible for income taxpurposes.

In 2002, we acquiredValuSoft, Inc. for a total cost of $14.2 million, which was paid primarily incash. In addition, we have since paid the former shareholders of ValuSoftadditional consideration in the amount of $4.6 million because ValuSoft reachedcertain pre-tax income targets in the two years subsequent to the acquisition.They are still eligible for additional consideration in the amount of $6.4 million,which may be paid by us in cash or stock, if they reach certain pre-tax incometargets over the next three years. Any additional consideration determined tobe payable will increase goodwill in the period such pre-tax income targets arereached. Goodwill recognized in the original transaction and in the payments ofthe additional consideration has amounted to $16.6 million and is expected tobe deductible for income tax purposes.

**4.   Credit Facility**

On November 29, 2004,we amended our revolving credit agreement to (i) extend the term of thecredit agreement through November 29, 2006; and (ii) increase themaximum monthly facility amount to $40 million for each August, September andOctober, and reduce the maximum monthly facility amount to $12 million forevery other month. Additionally, pursuant to the amendment, the credit facilityis now unsecured and accordingly the bank terminated its lien over our assetson January 4, 2005.  The creditagreement contains customary financial and non-financial covenants that requireus to maintain specified operating profits and liquidity and limits our abilityto incur additional indebtedness, sell assets, pay cash dividends and enterinto certain mergers or acquisitions. As of March 31, 2005, we were incompliance with all the covenants under the credit facility and had outstandingletters of credit of approximately $3.8 million.

**5.**   Allowance for Price Protection, Returnsand Doubtful Accounts

We derive revenues from sales of packaged software forvideo game systems and personal computers and sales of content and services forwireless devices. Product revenue is recognized net of allowances for priceprotection and returns and various customer discounts. We typically only allowreturns for our personal computer products; however, we may decide to provideprice protection or allow returns for our video game systems or personalcomputer products after we analyze: (1) inventory remaining in the retailchannel, (2) the rate of inventory sell-through in the retail channel, and(3) our remaining inventory on hand. We maintain a policy of givingcredits for price protection and returns, but do not give cash refunds. Managementuses significant judgment and makes estimates in connection with establishingallowances for price protection, returns, and doubtful accounts in anyaccounting period.

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Theallowance for price protection, returns and doubtful accounts at March 31,2005, 2004 and Transition 2003 consisted of the following:
| ** **                                                                  | ** ** | **Fiscal Year Ended March 31,**                                                      | ** ** | **Transition**                                                                                           | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **        2005        ** | ** ** | **        2004        ** | ** ** | **2003** | ** ** |
| **(In thousands)**                                                     | ** ** | ** **                                                                                               | ** ** | ** **                                                                                               | ** ** |
| Beginning balance                                                           |       |                                                                                                     | $          | (52,426                                                                                                  | )          |   |   | $ | (43,406 | ) |   | $ | (59,919 | ) |
| Provision for  price protection, returns and doubtful accounts         |       |                                                                                                     | (106,504   | )                                                                                                        |       |   | (120,982 | ) |   | (10,046 | ) |
| Actual deductions  for price protection, returns and doubtful accounts |       |                                                                                                     | 100,810    |                                                                                                     |       |   | 111,962 |   |   | 26,559 |   |
| Ending balance                                                              |       |                                                                                                     | $          | (58,120                                                                                                  | )          |   |   | $ | (52,426 | ) |   | $ | (43,406 | ) |
|                                                                             |            |                                                                                                          |            |                                                                                                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

**6.   Goodwill**

Thechanges in the carrying amount of goodwill for the fiscal years ended March 31,2005 and 2004 were as follows (in thousands):
| Balance at  March 31, 2003            |   | $      | 58,609 |   |
|--------------------------------------------|--------|--------|--------|--------|
| Adjustments to goodwill during the period  |   | (1,510 | )      |
| Additional consideration paid for ValuSoft |   | 2,300  |   |
| Balance at March 31, 2004             |   | 59,399 |   |
| Purchase of Relic                          |   | 9,064  |   |
| Additional investment in Minick            |   | 8,611  |   |
| Additional consideration paid for ValuSoft |   | 2,300  |   |
| Purchase of Blue Tongue                    |   | 2,452  |   |
| Effect of foreign currency exchange rates  |   | 1,614  |   |
| Balance at  March 31, 2005            |   | $      | 83,440 |   |

 

The adjustment to goodwillin fiscal 2004 related to acquired net operating loss carry forwards in Germanythat were not recorded at the time of acquisition due to uncertainties abouttheir realization. Due to the recent clarification in the tax law, we nowexpect to realize the net operating losses.

 

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**7.**   IntangibleAssets

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. Intangible assets are as follows:
| ** **                          | ** ** | ** **  | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
|-------------------------------------|------------|-------------|------------|------------------------------|------------|------------------------------|------------|
| **Intangible Assets**          | ** ** | ** **  | ** ** | **Useful  Lives**            | ** ** | **Gross  Carrying  Amount**  | ** ** | **Accumulated   Amortization ** | ** ** | **Net  Amount** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated   Amortization ** | ** ** | **Net  Amount** | ** ** |
| **(In thousands)**             | ** ** | ** **  | ** ** | ** **                   | ** ** | ** **                   | ** ** |
| Amortizable intangible  assets:     |       |        |       |                         |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Licenses                            |       | Varies      |       | $                            | 220,982    |                         |       | $ | (132,995 | ) |   | $ | 87,987 |   | $ | 113,118 |   |   | $ | (90,878 | ) |   | $ | 22,240 |   |
| Software development                |       | Varies      |       | 226,083                      |       |                         | (160,832   | ) |   | 65,251 |   | 198,659 |   |   | (148,864 | ) |   | 49,795 |   |
| Acquired intellectual property      |       | Varies      |       | 4,368                        |       |                         | —     |   |   | 4,368 |   | — |   |   | — |   |   | — |   |
| Software technology                 |       | 2-3 years   |       | 2,123                        |       |                         | (614       | ) |   | 1,509 |   | — |   |   | — |   |   | — |   |
| Software games                      |       | 2 years     |       | 865                          |       |                         | (280       | ) |   | 585 |   | — |   |   | — |   |   | — |   |
| Trade secrets                       |       | 5 years     |       | 1,800                        |       |                         | (1,170     | ) |   | 630 |   | 1,800 |   |   | (810 | ) |   | 990 |   |
| Customer list                       |       | 4-5 years   |       | 1,523                        |       |                         | (254       | ) |   | 1,269 |   | — |   |   | — |   |   | — |   |
| Trade names                         |       | 3-10 years  |       | 3,055                        |       |                         | (298       | ) |   | 2,757 |   | 1,025 |   |   | — |   |   | 1,025 |   |
| Non-compete/  Employment  contracts |       | 3-6.5 years |       | 967                          |       |                         | (435       | ) |   | 532 |   | 706 |   |   | (244 | ) |   | 462 |   |
| Total                               |       |        |       | $                            | 461,766    |                         |       | $ | (296,878 | ) |   | $ | 164,888 |   | $ | 315,308 |   |   | $ | (240,796 | ) |   | $ | 74,512 |   |

 

Theuseful lives of licenses, software development and acquired intellectualproperty are based on net product sales and therefore not disclosed in years. Theestimated amortization expense for licenses, software development and acquiredintellectual property is based on anticipated release dates and total projectedrevenue. Amortization expense related to licenses and software development forthe fiscal years ended March 31, 2005 and 2004, Transition 2003 and theyear ended December 31, 2002 was $121.8 million, $126.7 million, $13.3million and $91.7 million, respectively. Amortization expense related to otherintangible assets for the fiscal years ended March 31, 2005 and 2004,Transition 2003 and the year ended December 31, 2002 was $2.0 million,$1.2 million, $280,000 and $1.0 million, respectively.

**EstimatedAmortization Expense**(In thousands):
| **Fiscal Years  Ending March 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------|------------|------------|------------|
| 2006                                    |       | $          | 73,657     |       |
| 2007                                    |       | 26,889     |       |
| 2008                                    |       | 18,481     |       |
| 2009                                    |       | 16,453     |       |
| 2010                                    |       | 17,044     |       |
| Thereafter                              |       | 12,364     |       |
|                                    |       | $          | 164,888    |       |

 

69

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**8.**   OtherLong-Term Assets

In addition to intangible assets See “Note7—Intangible Assets,” other long-term assets include our investment in Yuke’s. OnMarch 21, 2000, we acquired less than a 20% interest in a Japanesedeveloper, Yuke’s, which was privately held. In December 2001, Yuke’s hadan initial public offering of its common stock, which is now traded on theNippon New Market in Japan. Accordingly, we account for this investment underSFAS No. 115 “*Accounting for CertainInvestments in Debt and Equity Securities*” as available-for-sale. Unrealizedholding gains and losses are excluded from earnings and are included as acomponent of other comprehensive income until realized. The original cost ofthis investment was $5.0 million. At March 31, 2003 the investment inYuke’s was written down to $3.2 million due to an other than temporary declinein the fair value of the investment. At March 31, 2004, the carrying valueof the investment in Yuke’s was $4.6 million. For the fiscal year ended March 31,2005, the unrealized holding gain was $3.6 million, which brings the carryingvalue of the investment to $8.2 million at March 31, 2005. Due to thelong-term nature of this relationship, this investment is included in otherlong-term assets in the consolidated balance sheet. Under separate developmentagreements, Yuke’s creates exclusively for us certain World WrestlingEntertainment wrestling games for the PlayStation 2 and GameCube.

In November 2004, weacquired all intellectual property rights to the *Juiced*franchise, a street racing property, including the *Juiced*videogame that we plan to release in the first quarter of fiscal 2006, for $8.6 millionin cash. Of the $8.6 million paid, we attributed $4.4 million to theintellectual property rights, which is included in other long-term assets inthe consolidated balance sheet, and attributed $4.2 million to the currentproduct under development which is included in software development in theconsolidated balance sheet. The amount attributed to the intellectual propertyrights will be amortized over the estimated useful life of the franchise andthe amount attributed to the current product under development will beamortized consistent with our accounting policy described in Note 2.

**9.   Income Taxes**

Income(loss) before provision (benefit) for income taxes consisted of:
| ** **              | ** ** | **Fiscal Year Ended March 31,**                                          | ** ** | **Transition**                                                                               | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **              | ** ** | **       2005       ** | ** ** | **       2004       ** | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| **(In thousands)** | ** ** | ** **                                                                                   | ** ** | ** **                                                                                   | ** ** |
| United States           |       |                                                                                         | $          | 68,933                                                                                       |       |                                   |       | $ | 46,115 |   |   | $ | (5,871 | ) |   | $ | 16,471 |   |   |
| Foreign                 |       |                                                                                         | 9,322      |                                                                                         |       |                                   | 9,121      |   |   | (5,105 | ) |   | 3,284 |   |   |
|                    |       |                                                                                         | $          | 78,255                                                                                       |       |                                   |       | $ | 55,236 |   |   | $ | (10,976 | ) |   | $ | 19,755 |   |   |
|                         |            |                                                                                              |            |                                                                                              |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theprovision (benefit) for income taxes consists of the following:
| ** **                           | ** ** | **Fiscal Year Ended March 31,**                                          | ** ** | **Transition**                                                                               | ** ** | **Year Ended  December 31,** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **       2005       ** | ** ** | **       2004       ** | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| **(In thousands)**              | ** ** | ** **                                                                                   | ** ** | ** **                                                                                   | ** ** |
| **Current**                          |       |                                                                                         |       |                                                                                         |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Federal                              |       |                                                                                         | $          | 6,160                                                                                        |       |                                   |       | $ | 11,112 |   |   |   | $ | (139 | ) |   |   | $ | 6,742 |   |   |
| State                                |       |                                                                                         | (2,428     | )                                                                                            |       |                                   | 2,716      |   |   |   | — |   |   |   | 814 |   |   |
| Foreign                              |       |                                                                                         | 4,776      |                                                                                         |       |                                   | 4,495      |   |   |   | (1,960 | ) |   |   | 1,765 |   |   |
|                                 |       |                                                                                         | 8,508      |                                                                                         |       |                                   | 18,323     |   |   |   | (2,099 | ) |   |   | 9,321 |   |   |
| **Deferred**                         |       |                                                                                         |       |                                                                                         |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Federal                              |       |                                                                                         | 6,012      |                                                                                         |       |                                   | 2,775      |   |   |   | (1,295 | ) |   |   | (1,940 | ) |   |
| State                                |       |                                                                                         | 1,113      |                                                                                         |       |                                   | 319        |   |   |   | (125 | ) |   |   | (194 | ) |   |
| Foreign                              |       |                                                                                         | (429       | )                                                                                            |       |                                   | (2,020     | ) |   |   | 229 |   |   |   | (426 | ) |   |
|                                 |       |                                                                                         | 6,696      |                                                                                         |       |                                   | 1,074      |   |   |   | (1,191 | ) |   |   | (2,560 | ) |   |
| Provision (benefit) for income taxes |       |                                                                                         | $          | 15,204                                                                                       |       |                                   |       | $ | 19,397 |   |   |   | $ | (3,290 | ) |   |   | $ | 6,761 |   |   |
|                                      |            |                                                                                              |            |                                                                                              |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

70

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Areconciliation of the provision (benefit) for income taxes at the federalstatutory rate to the provision (benefit) recorded in the consolidatedfinancial statements is as follows:
| ** **                                                                                       | ** ** | **Fiscal Year Ended  March 31,**                                                          | ** ** | **Transition**                                                                                           | ** ** | **Year Ended  December 31,**                                           | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **        2005        ** | ** ** | **        2004        ** | ** ** | **      2003      ** | ** ** | **      2002      ** | ** ** |
| **(In thousands)**                                                                          | ** ** | ** **                                                                                               | ** ** | ** **                                                                                               | ** ** |
| Federal provision  (benefit) at statutory rate                                                   |       |                                                                                                     | 35.0       | %                                                                                                        |       |                                                                             | 35.0       | % |   |   | (35.0 | )% |   |   | 35.0 | % |   |
| State taxes (net  of Federal benefit and state research and development income tax credit)  |       |                                                                                                     | (2.2       | )                                                                                                        |       |                                                                             | 3.6        |   |   |   | (1.1 | ) |   |   | 2.0 |   |   |
| Research and  development income tax credit claimed for prior years                              |       |                                                                                                     | (7.9       | )                                                                                                        |       |                                                                             | —     |   |   |   | — |   |   |   | — |   |   |
| Other than  temporary impairment in Yuke’s Co., Ltd.                                        |       |                                                                                                     | —     |                                                                                                     |       |                                                                             | —     |   |   |   | 5.9 |   |   |   | — |   |   |
| Rate differences  in foreign taxes and other, net                                                |       |                                                                                                     | (5.5       | )                                                                                                        |       |                                                                             | (3.5       | ) |   |   | — |   |   |   | (2.8 | ) |   |
|                                                                                             |       |                                                                                                     | 19.4       | %                                                                                                        |       |                                                                             | 35.1       | % |   |   | (30.0 | )% |   |   | 34.2 | % |   |
|                                                                                                  |            |                                                                                                          |            |                                                                                                          |            |                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

71

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Deferredincome taxes were:
| ** **                                                     | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
|----------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                     | ** ** | **2005**           | ** ** | **2004**           | ** ** |
| ** **                                                     | ** ** | **Federal**        | ** ** | **State**          | ** ** | **Foreign** | ** ** | **Federal** | ** ** | **State** | ** ** | **Foreign** | ** ** |
| **(In thousands)**                                        | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Current**                                                    |       |               |       |               |       |   |   |   |   |   |   |   |   |
| Deferred income tax  assets:                                   |       |               |       |               |       |   |   |   |   |   |   |   |   |
| Net operating loss                                             |       | $                  | —     |               | $          | — |   | $ | 1,323 |   | $ | — |   | $ | — |   | $ | — |   |
| Allowance for price protection, returns and doubtful  accounts |       | 8,648              |       | 1,235              |       | 774 |   | 8,697 |   | 1,242 |   | 821 |   |
| Accrued expenses                                               |       | 6,010              |       | 859                |       | — |   | 1,653 |   | 237 |   | — |   |
| State income taxes                                             |       | 1,382              |       | —             |       | — |   | 687 |   | — |   | — |   |
| Other—net                                                 |       | 401                |       | 62                 |       | 626 |   | 703 |   | 109 |   | (551 | ) |
| Valuation allowance                                            |       | —             |       | —             |       | (330 | ) | — |   | — |   | — |   |
| Total deferred  income tax assets                              |       | $                  | 16,441     |               | $          | 2,156 |   | $ | 2,393 |   | $ | 11,740 |   | $ | 1,588 |   | $ | 270 |   |
| Deferred income  tax liabilities:                              |       |               |       |               |       |   |   |   |   |   |   |   |   |
| Software development costs                                     |       | (21,722            | )          | (3,103             | )          | — |   | (12,291 | ) | (1,756 | ) | — |   |
| Other—net                                                 |       | (2,502             | )          | (358               | )          | (146 | ) | (169 | ) | (24 | ) | — |   |
| Deferred income  taxes                                         |       | $                  | (7,783     | )                  | $          | (1,305 | ) | $ | 2,247 |   | $ | (720 | ) | $ | (192 | ) | $ | 270 |   |
| **Non-Current**                                                |       |               |       |               |       |   |   |   |   |   |   |   |   |
| Deferred income tax  assets:                                   |       |               |       |               |       |   |   |   |   |   |   |   |   |
| Net operating loss                                             |       | $                  | —     |               | $          | — |   | $ | — |   | $ | — |   | $ | 124 |   | $ | 1,951 |   |
| Other—net                                                 |       | 1,534              |       | 219                |       | 2,000 |   | 2,163 |   | 322 |   | — |   |
| Valuation allowance                                            |       | —             |       | —             |       | (1,828 | ) | (854 | ) | (79 | ) | — |   |
| Net deferred tax  assets                                       |       | $                  | 1,534      |               | $          | 219 |   | $ | 172 |   | $ | 1,309 |   | $ | 367 |   | $ | 1,951 |   |
| Deferred income  tax liabilities:                              |       |               |       |               |       |   |   |   |   |   |   |   |   |
| Software development costs                                     |       | (1,045             | )          | (149               | )          | — |   | (768 | ) | (110 | ) | — |   |
| Depreciation and amortization                                  |       | (1,483             | )          | (142               | )          | — |   | (397 | ) | — |   | — |   |
| Identifiable intangible assets                                 |       | (825               | )          | (118               | )          | (1,947 | ) | (825 | ) | (118 | ) | — |   |
| Other—net                                                 |       | (592               | )          | (85                | )          | (5 | ) | (743 | ) | (106 | ) | — |   |
| Deferred income taxes                                          |       | $                  | (2,411     | )                  | $          | (275 | ) | $ | (1,780 | ) | $ | (1,424 | ) | $ | 33 |   | $ | 1,951 |   |
|                                                                |            |                    |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The valuation allowance increased by $1.3 million duringfiscal 2005.

As of March 31, 2005 we had no federal, no stateand $3.3 million of foreign net operating loss carryforwards. The foreign netoperating loss carryforward is indefinite.

Total deferred tax assets and total deferred taxliabilities at March 31, 2005 were $22.9 million and $34.2 million,respectively. Total deferred tax assets and total deferred tax liabilities at March 31,2004 were $17.2 million and $17.3 million, respectively.

The non-current portion of income tax receivablerepresents the research and development income tax credits that we anticipatereceiving beyond our normal operating cycle of 12 months.

At March 31, 2005 wehad accumulated foreign earnings of $20.2 million. We do not plan to repatriatethese earnings, therefore, no United States income tax has been provided on theforeign earnings. Additionally, we have not tax effected the cumulativetranslation adjustment as we have no intention of repatriating foreignearnings.

72

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**10.**   Employee Defined Contribution Plan

We sponsor for our UnitedStates employees 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 thatthe company will make a matching contribution equal to each employee’sdeferral, up to 4% of eligible compensation. We may also contribute funds tothe plan in the form of a discretionary profit-sharing contribution. Expensesunder the plan were $2.7 million, $1.7 million, $389,000, and $1.5 million inthe fiscal years ended March 31, 2005 and 2004, Transition 2003 and theyear ended December 31, 2002, respectively.

**11.**   StockOption Plans

As of March 31, 2005, we utilize two stock optionplans, the THQ Inc. Amended and Restated 1997 Stock Option Plan (the “1997 Plan”)and the THQ Inc. Third Amended and Restated Nonexecutive Employee Stock OptionPlan (the “NEEP Plan”). The 1997 Plan provides for the issuance of up to14,357,500 shares available for employees, consultants and non-employeedirectors and the NEEP plan provides for the issuance of up to 2,142,000 sharesavailable for nonexecutive employees of THQ of which no more than 20% isavailable for awards to our nonexecutive officers and no more than 15% isavailable for awards to the nonexecutive officers or general managers of oursubsidiaries or divisions.

As of March 31, 2005, 3,199,514 options under the1997 Plan were available for grant and 93,965 options under the NEEP Plan wereavailable for grant. Stock options granted under the 1997 Plan may be incentivestock options or non-qualified stock options. Options may be granted under the1997 Plan to, in the case of incentive stock options, all employees (includingofficers) of THQ; or, in the case of non-qualified stock options, all employees(including officers), consultants and non-employee directors of THQ. The NEEPPlan has primarily the same attributes as the 1997 Plan, but participation isreserved 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 within five years from the date of grant.

 

73

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Theexercise price per share of all options granted under the plans in the yearended December 31, 2002, Transition 2003 and the fiscal years ended March 31,2004 and 2005 has been the closing market price of the stock on the date of thegrant.
| ** **                                    | ** ** | **Weighted Average** | ** ** | **Number of**      | ** ** |
|-----------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| **Stock Options**                        | ** ** | ** **                | ** ** | **Exercise Price** | ** ** | **Shares** | ** ** |
| Balance at  January 1, 2002              |       |                      | $          | 18.42                   |       |   | 6,367,212 |   |
| Granted                                       |       |                      | $          | 26.54                   |       |   | 2,192,639 |   |
| Exercised                                     |       |                      | $          | 9.58                    |       |   | (545,937 | ) |
| Canceled                                      |       |                      | $          | 24.54                   |       |   | (1,042,064 | ) |
| Balance at  December 31, 2002            |       |                      | $          | 20.93                   |       |   | 6,971,850 |   |
| Granted                                       |       |                      | $          | 12.40                   |       |   | 487,500 |   |
| Exercised                                     |       |                      | $          | 9.83                    |       |   | (143,148 | ) |
| Canceled                                      |       |                      | $          | 20.46                   |       |   | (442,410 | ) |
| Balance at  March 31, 2003               |       |                      | $          | 20.58                   |       |   | 6,873,792 |   |
| Granted                                       |       |                      | $          | 16.10                   |       |   | 2,414,425 |   |
| Exercised                                     |       |                      | $          | 8.59                    |       |   | (781,330 | ) |
| Canceled                                      |       |                      | $          | 27.05                   |       |   | (2,030,468 | ) |
| Balance at  March 31, 2004               |       |                      | $          | 18.14                   |       |   | 6,476,419 |   |
| Granted                                       |       |                      | $          | 20.26                   |       |   | 3,052,646 |   |
| Exercised                                     |       |                      | $          | 15.71                   |       |   | (2,688,653 | ) |
| Canceled                                      |       |                      | $          | 19.74                   |       |   | (457,346 | ) |
| Balance at  March 31, 2005               |       |                      | $          | 20.07                   |       |   | 6,383,066 |   |
| Options exercisable at December 31, 2002 |       |                      | $          | 16.75                   |       |   | 3,164,326 |   |
| Options  exercisable at March 31, 2003   |       |                      | $          | 18.03                   |       |   | 3,382,098 |   |
| Options  exercisable at March 31, 2004   |       |                      | $          | 18.39                   |       |   | 3,260,463 |   |
| Options exercisable at  March 31, 2005   |       |                      | $          | 22.31                   |       |   | 2,792,370 |   |
|                                               |            |                           |            |                         |            |  |  |  |  |  |

 

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Optionsgranted and shares exercised relating to options granted outside of our stockoption plans during the year ended December 31, 2002, Transition 2003 andthe fiscal years ended March 31, 2004 and 2005, are listed below. Shareexercise prices for these options equal the market price of our common stock atthe date of the grant except for options issued by Locomotive Games, Inc.and Genetic Anomalies prior to the acquisitions, which were issued at belowmarket value. These options were accounted for under APB Opinion No. 25and we have recognized stock compensation of zero, $84,000, $189,000 and$169,000 for the fiscal years ended March 31, 2005 and 2004, Transition2003 and for the year ended December 31, 2002, respectively. Generally,options granted outside of our stock option plans become exercisable over threeyears and expire within five years from the date of grant.
| ** **                                    | ** ** | **Weighted Average** | ** ** | **Number of**      | ** ** |
|-----------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| **Stock Options**                        | ** ** | ** **                | ** ** | **Exercise Price** | ** ** | **Shares** | ** ** |
| Balance at  January 1, 2002              |       |                      | $          | 6.53                    |       |   | 793,484 |   |
| Granted                                       |       |                      | $          | —                  |       |   | — |   |
| Exercised                                     |       |                      | $          | 6.95                    |       |   | (386,297 | ) |
| Canceled                                      |       |                      | $          | 11.00                   |       |   | (8,554 | ) |
| Balance at  December 31, 2002            |       |                      | $          | 6.05                    |       |   | 398,633 |   |
| Granted                                       |       |                      | $          | —                  |       |   | — |   |
| Exercised                                     |       |                      | $          | 0.57                    |       |   | (1,263 | ) |
| Canceled                                      |       |                      | $          | 0.62                    |       |   | (166 | ) |
| Balance at  March 31, 2003               |       |                      | $          | 6.07                    |       |   | 397,204 |   |
| Granted                                       |       |                      | $          | —                  |       |   | — |   |
| Exercised                                     |       |                      | $          | 4.72                    |       |   | (86,860 | ) |
| Canceled                                      |       |                      | $          | 20.52                   |       |   | (1,918 | ) |
| Balance at  March 31, 2004               |       |                      | $          | 6.29                    |       |   | 308,426 |   |
| Granted                                       |       |                      | $          | —                  |       |   | — |   |
| Exercised                                     |       |                      | $          | 5.83                    |       |   | (104,117 | ) |
| Canceled                                      |       |                      | $          | 31.50                   |       |   | (540 | ) |
| Balance at  March 31, 2005               |       |                      | $          | 6.46                    |       |   | 203,769 |   |
| Options exercisable at December 31, 2002 |       |                      | $          | 6.06                    |       |   | 397,492 |   |
| Options  exercisable at March 31, 2003   |       |                      | $          | 6.07                    |       |   | 397,204 |   |
| Options  exercisable at March 31, 2004   |       |                      | $          | 6.29                    |       |   | 308,426 |   |
| Options exercisable at  March 31, 2005   |       |                      | $          | 6.46                    |       |   | 203,769 |   |
|                                               |            |                           |            |                         |            |  |  |  |  |  |

 

Thefollowing table summarizes information about stock options outstanding at March 31,2005:
| ** **                             | ** ** | **Number** | ** ** | **Weighted Average**                         | ** ** | **Weighted**                         | ** ** |
|----------------------------------------|------------|------------|------------|---------------------------------------------------|------------|--------------------------------------|------------|
| **Range of  Exercise Price** | ** ** | ** ** | ** ** | **Outstanding at  March 31, 2005** | ** ** | **Remaining  Contractual Life** | ** ** | **Average Exercise  Price** | ** ** |
| $  0.49  - $10.25            |       |       | 176,410    |                                              |       |                                 | 1          |   |   |   | $ | 2.35 |   |   |
| $11.33 - $16.70                        |       |       | 1,309,715  |                                              |       |                                 | 3          |   |   |   | $ | 13.81 |   |   |
| $16.82 - $22.08                        |       |       | 3,577,940  |                                              |       |                                 | 4          |   |   |   | $ | 19.09 |   |   |
| $22.09 - $30.04                        |       |       | 1,454,704  |                                              |       |                                 | 2          |   |   |   | $ | 27.70 |   |   |
| $30.93 - $38.53                        |       |       | 68,066     |                                              |       |                                 | 2          |   |   |   | $ | 34.35 |   |   |
|                                   |       |       | 6,586,835  |                                              |       |                                 | 3          |   |   |   | $ | 19.65 |   |   |
|                                        |            |            |            |                                                   |            |                                      |            |  |  |  |  |  |  |  |  |  |

 

75

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Thefollowing table summarizes information about stock options exercisable at March 31,2005:
| ** **                             | ** ** | **Shares** | ** ** | **Weighted**                                      | ** ** |
|----------------------------------------|------------|------------|------------|---------------------------------------------------|------------|
| **Range of  Exercise Price** | ** ** | ** ** | ** ** | **Exercisable at  March 31, 2005** | ** ** | **Average Exercise  Price** | ** ** |
| $  0.49  - $10.25            |       |       | 176,410    |                                              |       |   | $ | 2.35 |   |   |
| $11.33 - $16.70                        |       |       | 649,232    |                                              |       |   | $ | 13.90 |   |   |
| $16.82 - $22.08                        |       |       | 947,516    |                                              |       |   | $ | 20.03 |   |   |
| $22.09 - $30.04                        |       |       | 1,154,914  |                                              |       |   | $ | 28.45 |   |   |
| $30.93 - $38.53                        |       |       | 68,067     |                                              |       |   | $ | 34.35 |   |   |
|                                   |       |       | 2,996,139  |                                              |       |   | $ | 21.81 |   |   |
|                                        |            |            |            |                                                   |            |  |  |  |  |  |  |  |

 

**12.**   CapitalStock Transactions

On September 10, 2002, we announced that ourBoard of Directors authorized the repurchase of up to $25.0 million of ourcommon stock from time to time on the open market or in private transactions. OnNovember 21, 2002, we announced that our Board of Directors authorized therepurchase of up to an additional $25.0 million of our common stock from timeto time on the open market or in private transactions. On February 5,2004, we announced that our Board of Directors authorized the repurchase of anadditional $25.0 million of our common stock, bringing the total authorizedrepurchase amount to $75.0 million. As of March 31, 2005, we haverepurchased 3,449,000 shares of our common stock for approximately $52.9million, leaving $22.1 million available for future repurchases. There is no expiration date for theauthorized repurchases.

During the fiscal year ended March 31, 2005, wefinalized the terms of warrants we committed to issue in connection with alicensing agreement under which we had previously shipped product. We issuedthese warrants to purchase 160,000 shares of common stock at $20.23 per sharehaving an estimated fair value of $2.0 million. Prior to finalizing thewarrants terms, we estimated the fair value of the warrants commitment basedupon the terms subject to our then ongoing negotiations with the licensor, andamortized this estimated value to license amortization and royalties inaccordance with our accounting policy described in Note 5 over the periodsduring which we had been shipping product under the license. The fair value ofthe finalized warrants was determined using the Black-Scholes option pricingmodel with the following assumptions: an anticipated volatility of 67.2%, aweighted average risk-free interest rate of 2.9%, and a term of 6 years. Thefair value of the warrants are included in licenses in the consolidated balancesheet. The fair value of the finalized warrants were less than previouslyestimated and as a result we recorded a reduction in license amortization androyalties expense in the consolidated statement of operations for the fiscalyear ended March 31, 2005, of approximately $1.7 million. The warrantsexpire December 31, 2009. As of March 31, 2005, these warrants hadnot been exercised and are all outstanding.

In connection with a licensing agreement, in September 2003,we issued a warrant to purchase 100,000 shares of common stock at $15.68 pershare having an estimated fair value of $1.4 million. The estimated fair valuewas determined using the Black-Scholes option pricing model with the followingassumptions: an anticipated volatility of 87%, a weighted average risk-freeinterest rate of 4.87%, and a term of 10 years. The fair value of the warrantis included in licenses in the consolidated balance sheet. The warrant expires December 31,2013. As of March 31, 2005, this warrant has not been exercised and isoutstanding.

On July 1, 2002, we issued approximately 167,000shares of common stock as part of the purchase price of ValuSoft.

In connection withobtaining a license agreement, in February 2002, we issued a warrant topurchase 75,000 shares of common stock at $29.13 per share having a fair valueof $1.2 million at the time of issuance. The estimated fair value wasdetermined using the Black-Scholes option pricing model with the followingassumptions: an anticipated volatility of 71%, a weighted average risk-freeinterest rate of 4.38%, 

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and a term of 4 years. Thefair value of the warrant is included in licenses in the consolidated balancesheet. The warrant expires December 31, 2005. As of March 31, 2005,this warrant has not been exercised and is outstanding.

**13.**   Agreement with 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 have agreed to increase the minimum guarantee payable to WWE through December 31,2013.

We are currently involved inlitigation with WWE and JAKKS with respect to the license. See “Note 15—Commitmentsand Contingencies.”

**14.**   StockholdersRights Plan

On March 6, 2002, the Board of Directors (the “Board”)approved an amendment to the Amended and Restated Rights Agreement dated August 22,2001 (the “Plan”). Pursuant to the Plan, each share of common stock has onepreferred stock purchase right (“Right”) which entitles the registered holderto purchase one one-thousandth (1¤1000) of ashare of Series A Junior Participating Preferred Stock at an exerciseprice of $100, subject to adjustment. The Rights become exercisable 10 days afterany person or group acquires, or 10 business days after any person or group hasannounced its intention to commence a tender offer for, 15% or more of theoutstanding common stock of THQ. In the event that any person or group acquires15% or more of our outstanding common stock, each holder of a Right (other thansuch person or group) will be entitled to purchase, at the exercise price, thenumber of shares of common stock having a current market value equal to twotimes the exercise price of the Right.

In the event that any person or group acquires 15% ormore of the outstanding common stock of THQ, each registered holder of a Right(other than such person or group) will be entitled to purchase, at the exerciseprice, the number of shares of common stock having a current market value equalto two times the exercise price of the Right. If we are acquired in a merger orother business combination, each registered 

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holder of a Right will be entitled to purchase, at theexercise price, a number of shares of common stock of the acquirer having acurrent market value equal to two times the exercise price of the Right.

The Board may redeem theRights at a redemption price of $.001 per Right, subject to adjustment, at anytime until 10 days after the acquisition of 15% or more of the common stock ofTHQ. At any time after a person or group has acquired 15% or more but less than50% of the common stock, the Board may exchange all or part of the Rights forshares of common stock at an exchange ratio of one share of common stock foreach Right or one one-thousandth (1¤1000) of ashare of Series A Junior Participating Preferred Stock per Right, subjectto adjustment. The Rights expire on June 21, 2010.

**15.**   Commitmentsand Contingencies

Asummary of annual minimum contractual obligations and commercial commitments asof March 31, 2005 is as follows (in thousands):
| ** **            | ** ** | **Contractual Obligations and Commercial  Commitments** | ** ** |
|-----------------------|------------|---------------------------------------------------------|------------|
| ** **            | ** ** | **License /**                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Fiscal**            | ** ** | **Software**                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Years Ending** | ** ** | **Development**                                         | ** ** | ** ** | ** ** | ** ** | ** ** | **Letters of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **March 31,**    | ** ** | ** **                                              | ** ** | **Commitments(1)** | ** ** | **Advertising(2)** | ** ** | **Leases(3)** | ** ** | **Credit(4)** | ** ** | ** Other(5) ** | ** ** | **Total** | ** ** |
| 2006                  |       |                                                    | $          | 82,157 |   |   |   | $ | 16,362 |   |   | $ | 7,659 |   |   | $ | 3,800 |   |   |   | $ | 2,000 |   |   | $ | 111,978 |   |
| 2007                  |       |                                                    | 54,221     |   |   |   | 5,796 |   |   | 8,482 |   |   | — |   |   |   | 2,000 |   |   | 70,499 |   |
| 2008                  |       |                                                    | 43,424     |   |   |   | 2,498 |   |   | 8,751 |   |   | — |   |   |   | — |   |   | 54,673 |   |
| 2009                  |       |                                                    | 37,000     |   |   |   | 2,335 |   |   | 8,357 |   |   | — |   |   |   | — |   |   | 47,692 |   |
| 2010                  |       |                                                    | 12,000     |   |   |   | 1,752 |   |   | 7,515 |   |   | — |   |   |   | — |   |   | 21,267 |   |
| Thereafter            |       |                                                    | 22,000     |   |   |   | — |   |   | 28,586 |   |   | — |   |   |   | — |   |   | 50,586 |   |
|                  |       |                                                    | $          | 250,802 |   |   |   | $ | 28,743 |   |   | $ | 69,350 |   |   | $ | 3,800 |   |   |   | $ | 4,000 |   |   | $ | 356,695 |   |
|                       |            |                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          *Licenses andSoftware Development.  *We enter into contractual arrangementswith third parties for the rights to intellectual property and for thedevelopment of products. Under these agreements, we commit to provide specifiedpayments to an intellectual property holder or developer. Assuming allcontractual provisions are met, the total future minimum contract commitmentfor contracts in place as of March 31, 2005 are approximately $250.8million. License/software development commitments included $78.3 million ofcommitments to licensors that have been included in our consolidated balancesheet as of March 31, 2005 because the licensors do not have anysignificant performance obligations to us. These commitments were included inboth current and long-term licenses and 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 2006 will be $16.4 million.

(3)          *Leases.  *We are committed underoperating leases with lease termination dates through 2015. On December 30,2004, we entered into a lease for premises located in Agoura Hills, California,which we intend to use as our corporate headquarters. Our current corporate headquarterslease expires in October 2005. Most of our leases contain rentescalations.

Rent expense was $6.0 million, $4.5 million, $1.1million and $3.4 million for the fiscal years ended March 31, 2005 and2004, Transition 2003 and the year ended December 31, 2002, respectively.

(4)          *Letters ofCredit.  *We had approximately $3.8 million in obligations underour credit facility with respect to letters of credit and no outstandingborrowings.

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(5)*          Other.  *On April 26, 2005 wepaid $2.0 million in cash, and will pay an additional $2.0 million in thefollowing fiscal year related to the purchase of Relic. See “Note 3—BusinessCombinations”.

Other potential future expenditures relate to thefollowing:

*Manufacturer Indemnification.  *Wemust indemnify the manufacturers of our games with respect to all loss,liability and expenses resulting from any claim against the manufacturerinvolving the development, marketing, sale or use of our games, including anyclaims for copyright or trademark infringement brought against the manufacturer.As a result, we bear a risk that the properties upon which the titles of ourgames are based, or that the information and technology licensed from othersand incorporated into the products, may infringe the rights of third parties. Conversely,our agreements with our independent software developers and property licensorstypically provide indemnification rights for us with respect to certain matters.However, if a manufacturer brings a claim against us for indemnification, thedevelopers or licensors may not have sufficient resources to, in turn,indemnify us. Furthermore, parties’ indemnification of us may not cover thematter that gives rise to the manufacturer’s claim.

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

*WWE Lawsuit*.   On October 19, 2004, WWEfiled a lawsuit in the United States District Court for the Southern Districtof New York against JAKKS, THQ, the THQ/JAKKS joint venture, and others,alleging, among other claims, improper conduct by JAKKS, certain executives ofJAKKS, an employee of the WWE and an agent of the WWE in granting the WWE videogame license to the THQ/JAKKS joint venture. The complaint seeks various formsof relief, including monetary damages and a judicial determination that, amongother things, the THQ/JAKKS video game license is void. On March 30, 2005,WWE filed an amended complaint, adding both new claims and our president andchief executive officer, Brian Farrell, as a defendant. We believe that neitherwe, nor Brian Farrell, are directly accused of any wrongdoing in the complaintor the amended complaint, and believe that either there is no basis forterminating the license with us, or that we will be made whole by those whoseconduct is eventually found to be unlawful. We intend to vigorously protect ourrights and, if necessary, pursue appropriate claims against third parties.

*Patent Infringement litigation*.   OnAugust 30, 2004, we were served with a lawsuit entitled *American Video Graphics, L.P. v. Electronic Arts, Inc., et al.*,filed in the United States District Court for the Eastern District of Texas. ThePlaintiff claims that Defendants, including us, have infringed upon a patentowned by the Plaintiff entitled “Method and Apparatus for Spherical Panning.”Defendants in the lawsuit include us, Electronic Arts Inc., Take-Two InteractiveSoftware, Inc., Ubi Soft, Activision, Inc., Atari, Inc., VivendiUniversal Games, Inc., Sega of America, Inc., Square Enix, Inc.,Temco, Inc., LucasArts Entertainment Co., and Namco Hometek, Inc. Wehave entered into a joint defense agreement with several of the otherDefendants and intend to vigorously defend the claims against us. Since thelitigation is still in an early stage, we cannot predict the likely outcome ofthis dispute.

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*Tetris Litigation*.   On April 14,2005, we filed a complaint against The Tetris Company, LLC (“Tetris”) in theSuperior Court of California, County of Los Angeles. The complaint alleges thatTetris breached its license agreement and certain oral agreements with us,which prevented us from releasing a*Tetris*product for the Nintendo DS system as planned in March 2005. Additionally,Tetris has indicated that it believes the term of our license agreement withTetris may have expired on March 24, 2005, despite our compliance with therequirements for renewal pursuant to the terms of the license. Our complaintseeks monetary damages and injunctive relief against Tetris, as well as ajudicial declaration that the term of our license agreement with Tetris extendsto March 24, 2007.

We are involved in otherroutine litigation arising in the ordinary course of our business. In theopinion of our management, none of this pending routine litigation will have amaterial adverse effect on our consolidated financial condition or results ofoperations.

**16.   FiscalYear Change**

EffectiveJanuary 1, 2003, we changed our fiscal year from December 31 to March 31.The table below summarizes the selected data for the three months ended March 31,2003 and 2002 (unaudited), respectively, (in thousands, except per share data):
| ** **                                         | ** ** | **Three Months Ended March 31,**                                                     | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **        2003        ** | ** ** | **         2002         ** | ** ** |
| ** **                                         | ** ** | ** **                                                                                               | ** ** | **(unaudited)** | ** ** |
| Net sales                                          |       |                                                                                                     | $          | 66,800 |   |   |   | $ | 79,682 |   |   |
| Costs and expenses:                                |       |                                                                                                     |       |   |   |   |   |   |   |
| Cost of sales                                      |       |                                                                                                     | 26,378     |   |   |   | 33,680 |   |   |
| License amortization and royalties                 |       |                                                                                                     | 5,576      |   |   |   | 7,064 |   |   |
| Software development amortization                  |       |                                                                                                     | 12,018     |   |   |   | 10,800 |   |   |
| Product development                                |       |                                                                                                     | 8,899      |   |   |   | 7,064 |   |   |
| Selling and marketing                              |       |                                                                                                     | 14,294     |   |   |   | 9,759 |   |   |
| Payment to venture partner                         |       |                                                                                                     | 644        |   |   |   | 1,572 |   |   |
| General and administrative                         |       |                                                                                                     | 8,442      |   |   |   | 6,641 |   |   |
| Total costs and  expenses                          |       |                                                                                                     | 76,251     |   |   |   | 76,580 |   |   |
| Income (loss)  from operations                     |       |                                                                                                     | (9,451     | ) |   |   | 3,102 |   |   |
| Interest income                                    |       |                                                                                                     | 878        |   |   |   | 1,322 |   |   |
| Other income  (expenses)                           |       |                                                                                                     | (2,403     | ) |   |   | — |   |   |
| Income (loss)  before income taxes                 |       |                                                                                                     | (10,976    | ) |   |   | 4,424 |   |   |
| Income taxes                                       |       |                                                                                                     | (3,290     | ) |   |   | 1,659 |   |   |
| Net income (loss)                                  |       |                                                                                                     | $          | (7,686 | ) |   |   | $ | 2,765 |   |   |
| Net income (loss)  per share—diluted          |       |                                                                                                     | $          | (0.20 | ) |   |   | $ | 0.07 |   |   |
| Shares used in per share  calculation—diluted |       |                                                                                                     | 38,319     |   |   |   | 41,725 |   |   |

 

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**17.   Segmentand 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 long-lived assets for the fiscal yearsended March 2005 and 2004, Transition 2003 and the year ended December 31,2002:
| ** **                             | ** ** | **North**   | ** ** | ** ** | ** ** | **Asia**    | ** ** | ** **       | ** ** |
|----------------------------------------|------------|-------------|------------|------------|------------|-------------|------------|------------------|------------|
| ** **                             | ** ** | **America** | ** ** | **Europe** | ** ** | **Pacific** | ** ** | **Consolidated** | ** ** |
| **(In thousands)**                | ** ** | ** **  | ** ** | ** ** | ** ** |
| **Year ended March 31, 2005**     | ** ** | ** **  | ** ** | ** ** | ** ** | ** **  | ** ** |             | ** ** | ** ** |   |
| Net sales to unaffiliated customers    |       | $           | 470,619    |       | $          | 245,083     |       | $                | 41,029     |   |   | $ | 756,731 | ** ** |   |
| Depreciation and  amortization         |       | 8,682       |       | 1,686      |       | 117         |       |             | 10,485     | ** ** |   |
| Interest income                        |       | 3,334       |       | 808        |       | 195         |       |             | 4,337      | ** ** |   |
| Income taxes                           |       | 11,681      |       | 2,905      |       | 618         |       |             | 15,204     | ** ** |   |
| Long-lived assets                      |       | 208,003     |       | 16,270     |       | 561         |       |             | 224,834    | ** ** |   |
| **Year  ended March 31, 2004**    | ** ** | ** **  | ** ** | ** ** | ** ** | ** **  | ** ** |             | ** ** | ** ** |   |
| Net sales to unaffiliated customers    |       | $           | 453,426    |       | $          | 161,857     |       | $                | 25,563     |   |   | $ | 640,846 | ** ** |   |
| Depreciation and  amortization         |       | 6,290       |       | 817        |       | 120         |       |             | 7,227      | ** ** |   |
| Interest income                        |       | 1,923       |       | 337        |       | 118         |       |             | 2,378      | ** ** |   |
| Income taxes                           |       | 16,839      |       | 2,122      |       | 436         |       |             | 19,397     | ** ** |   |
| Long-lived assets                      |       | 125,128     |       | 4,516      |       | 457         |       |             | 130,101    | ** ** |   |
| **Transition  period March 2003** |       |        |       |       |       |        |       |             |       | ** ** |   |
| Net sales to unaffiliated customers    |       | $           | 56,649     |       | $          | 8,422       |       | $                | 1,729      |   |   | $ | 66,800 | ** ** |   |
| Depreciation and  amortization         |       | 1,774       |       | 163        |       | 19          |       |             | 1,956      | ** ** |   |
| Interest income                        |       | 741         |       | 112        |       | 25          |       |             | 878        | ** ** |   |
| Income taxes                           |       | (1,646      | )          | (1,492     | )          | (152        | )          |             | (3,290     | **)** |   |
| Long-lived assets                      |       | 109,779     |       | 3,951      |       | 307         |       |             | 114,037    | ** ** |   |
| **Year  ended December 31, 2002** | ** ** | ** **  | ** ** | ** ** | ** ** | ** **  | ** ** |             | ** ** | ** ** |   |
| Net sales to unaffiliated customers    |       | $           | 358,124    |       | $          | 107,825     |       | $                | 14,580     |   |   | $ | 480,529 | ** ** |   |
| Depreciation and  amortization         |       | 5,785       |       | 538        |       | 62          |       |             | 6,385      | ** ** |   |
| Interest income                        |       | 5,001       |       | 246        |       | 30          |       |             | 5,277      | ** ** |   |
| Income taxes                           |       | 5,510       |       | 1,005      |       | 246         |       |             | 6,761      | ** ** |   |
| Long-lived assets                      |       | 101,105     |       | 3,836      |       | 244         |       |             | 105,185    | ** ** |   |
|                                        |            |             |            |            |            |             |            |                  |            |  |  |  |  |  |  |  |  |

 

Informationabout THQ’s net revenue by platform for fiscal 2005, and 2004, Transition 2003and the year ended December 31, 2002 is presented below (in thousands):
| ** **                 | ** ** | **Fiscal Year ended** | ** ** | ** **                 | ** ** | **Year ended**   | ** ** |
|----------------------------|------------|---------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **March 31,**              | ** ** | ** Transition ** | ** ** | **December 31,** | ** ** |
| **Platform**               | ** ** | ** **                      | ** ** | **2005**                   | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Sony PlayStation  2        |       | $                               | 275,850    |                       | $          | 247,603               |       |   | $ | 24,818 |   |   |   | $ | 167,032 |   |   |
| Microsoft Xbox             |       | 80,623                          |       | 71,132                     |       |                  | 1,195      |   |   |   | 34,143 |   |   |
| Nintendo GameCube          |       | 73,157                          |       | 61,356                     |       |                  | 3,538      |   |   |   | 49,004 |   |   |
| Nintendo Game Boy  Advance |       | 204,348                         |       | 162,109                    |       |                  | 17,799     |   |   |   | 119,614 |   |   |
| Nintendo Dual  Screen      |       | 3,110                           |       | —                     |       |                  | —     |   |   |   | — |   |   |
| Wireless                   |       | 24,613                          |       | 6,860                      |       |                  | —     |   |   |   | 1,453 |   |   |
| PC                         |       | 86,667                          |       | 74,934                     |       |                  | 10,258     |   |   |   | 45,046 |   |   |
| Other                      |       | 8,363                           |       | 16,852                     |       |                  | 9,192      |   |   |   | 64,237 |   |   |
| Total Net Sales            |       | $                               | 756,731    |                       | $          | 640,846               |       |   | $ | 66,800 |   |   |   | $ | 480,529 |   |   |
|                            |            |                                 |            |                            |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

***Twelve Months Ended March 31, 2005***
| ** **                                                                  | ** ** | **Quarter Ended**  | ** ** | ** **               | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                  | ** ** | **June 30,  2004** | ** ** | **Sept. 30,  2004** | ** ** | **Dec. 31,  2004** | ** ** | **March 31,  2005** | ** ** | **Fiscal Year  Ended** | ** ** |
| **(Amounts in thousands,  except per share data)** | ** ** | ** **              | ** ** | ** **               | ** ** |
| 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                                                                       |       | $                       | (0.10      | )                        | $          | (0.16 | ) | $ | 1.61 |   | $ | 0.25 |   | $ | 1.61 |   |
| Diluted                                                                     |       | $                       | (0.10      | )                        | $          | (0.16 | ) | $ | 1.58 |   | $ | 0.24 |   | $ | 1.56 |   |
|                                                                             |            |                         |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Twelve Months EndedMarch 31, 2004***
| ** **                                                                  | ** ** | **Quarter Ended**  | ** ** | ** **               | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                  | ** ** | **June 30,  2003** | ** ** | **Sept. 30,  2003** | ** ** | **Dec. 31,  2003** | ** ** | **March 31,  2004** | ** ** | **Fiscal Year  Ended** | ** ** |
| **(Amounts in thousands,  except per share data)** | ** ** | ** **              | ** ** | ** **               | ** ** |
| Net sales                                                                   |       | $                       | 98,095     |                     | $          | 126,517 |   | $ | 293,099 |   | $ | 123,135 |   | $ | 640,846 |   |
| Expenses and  other                                                         |       | 103,742                 |       | 120,816                  |       | 245,642 |   | 115,410 |   | 585,610 |   |
| Income (loss)  before income taxes                                          |       | (5,647                  | )          | 5,701                    |       | 47,457 |   | 7,725 |   | 55,236 |   |
| Income taxes                                                                |       | (2,090                  | )          | 2,109                    |       | 17,084 |   | 2,294 |   | 19,397 |   |
| Net income (loss)                                                           |       | $                       | (3,557     | )                        | $          | 3,592 |   | $ | 30,373 |   | $ | 5,431 |   | $ | 35,839 |   |
| Net income (loss)  per share                                                |       |                    |       |                     |       |   |   |   |   |   |   |
| Basic                                                                       |       | $                       | (0.09      | )                        | $          | 0.09 |   | $ | 0.80 |   | $ | 0.14 |   | $ | 0.94 |   |
| Diluted                                                                     |       | $                       | (0.09      | )                        | $          | 0.09 |   | $ | 0.78 |   | $ | 0.14 |   | $ | 0.92 |   |
|                                                                             |            |                         |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

For the quarter ended September 30, 2003, netincome included a $4.0 million settlement of dispute with directors’ andofficers’ insurance carrier, including the related income tax effect.

For the quarter ended December 31,2004, net income included a $7.8 million benefit for research and developmentincome tax credits claimed for prior years.

**Item 9.**             Changes in and Disagreementswith Accountants on Accounting and Financial Disclosure

None.

**Item 9A.**     Controls and Procedures

(a)           Disclosure controls andprocedures

Our principalexecutive officer and principal financial officer, based on their evaluation ofour disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K,have concluded that our disclosure controls and 

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procedures areeffective for ensuring that information required to be disclosed by us in thereports that we file or submit under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms.

(b)          Internal Control overFinancial Reporting

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Exchange Act Rules 13a-15(f). Our management conducted anevaluation of the effectiveness of our internal control over financialreporting based on the framework in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based on this evaluation under theframework in *Internal Control—Integrated Framework*,our management concluded that our internal control over financial reporting waseffective as of March 31, 2005.

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 in internalcontrol over financial reporting.

There were no changes inour internal control over financial reporting that occurred during our lastfiscal quarter that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

**Item 9B.**    Other Information

None.

 

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**ManagementReport on 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, 2005 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, 2005.

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

 

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders of THQInc.,Calabasas 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, 2005,based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

We conducted our audit 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 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, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (2) provide reasonable assurance that transactionsare recorded 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 (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

Because of the inherent limitations of internalcontrol over financial reporting, including the possibility of collusion orimproper management override of controls, material misstatements due to erroror fraud may not be prevented or detected on a timely basis. Also, projectionsof any evaluation 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 31,2005, 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, 2005,based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

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We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the Company’s consolidated balance sheet as of March 31,2005 and the related consolidated statements of operations, stockholder’sequity and cash flows for the year then ended. Our report dated June 8,2005 expressed an unqualified opinion on those financial statements.

**DELOITTE & TOUCHE LLP**

Los Angeles, California

June 8, 2005

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**PART III**

**Item10.****Directors and Executive Officers of the Registrant

The followinginformation required by Item 10 is incorporated herein by reference fromour definitive Proxy Statement for the 2005 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.”

**Item11.****ExecutiveCompensation

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

**Item 12.****Security Ownership of Certain BeneficialOwners 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.”

**Item13.****CertainRelationships and Related Transactions

There were no reportablebusiness relationships, transactions with management, or indebtedness ofmanagement during the fiscal year ended March 31, 2005.

**Item14.****PrincipalAccounting Fees and Services

The information regarding principal accounting feesand services and the Company’s pre-approval policies and procedures for auditand non-audit services provided by the Company’s independent accountant isincorporated by reference to the Proxy Statement under the caption “ProposalNumber 2—Approval of Proposed Ratification of Independent Auditors.”

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**PART IV**

**Item15.**   Exhibits, Financial StatementSchedules and Reports on Form 8-K

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

Thefollowing financial statements of the Company are included in Part II Item8:
| REPORT OF INDEPENDENT  REGISTERED PUBLIC ACCOUNTING FIRM                                                                                                                                             | 52     |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| CONSOLIDATED  FINANCIAL STATEMENTS                                                                                                                                                                   |   |
| Consolidated  balance sheets—March 31, 2005 and 2004                                                                                                                                       | 53     |
| Consolidated  statements of operations for the fiscal years ended March 31, 2005 and  2004, the three months ended March 31, 2003 and the year ended  December 31, 2002               | 54     |
| Consolidated statements of stockholders’ equity  for the fiscal years ended March 31, 2005 and 2004, the three months  ended March 31, 2003 and the year ended December 31, 2002 | 55     |
| Consolidated  statements of cash flows for the fiscal years ended March 31, 2005 and  2004, the three months ended March 31, 2003 and the year ended  December 31, 2002               | 56     |
| NOTES TO CONSOLIDATED FINANCIAL  STATEMENTS                                                                                                                                                          | 57     |

 

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

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| 4.2       |   | First Amendment to  Amended and Restated Rights Agreement, dated April 9, 2002 between the  Registrant and Computershare Investor Services, LLC, as Rights Agent  (incorporated by reference to Exhibit 2 to Amendment No. 3 to the  Registrant’s Registration Statement on Form 8-A filed on April 12,  2002 (file No. 000-18813) (the “April 2002 8-A”)).                                       |
|-----------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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 quarterly period 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 (the “December 2000 10-K”)).                                                                                                                      |
| 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 quarterly period  ended June 30, 2004 (the “June 2004 10-Q”)).                                                                                                                                                                                           |
| 10.5 #    |   | Separation Agreement and  General Release, dated as of July 29, 2004 between Eric Doctorow and the  Company (incorporated by reference to Exhibit 10.4 to the Registrant’s  June 2004 10-Q).                                                                                                                                                                                                                                    |
| 10.6 #    |   | Indemnification Agreements,  dated as of November 30, 2004 between THQ Inc. 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 #    |   | Amended and Restated  1997 Stock Option Plan (incorporated by reference to Appendix B to  Registrant’s Proxy Statement on Schedule 14A filed July 3, 2003).                                                                                                                                                                                                                                                                               |
| 10.8 #    |   | 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).                                                                                                                                                                                                                                                       |
| 10.9 #    |   | 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 (the “December 1998 10-K”)).                                                                                                                                                                                   |
| 10.10 * # |   | Form of Severance  Agreement for Senior Officers, effective January 27, 2005.                                                                                                                                                                                                                                                                                                                                                             |
| 10.11 #   |   | THQ Inc. Management  Deferred Compensation Plan, effective as of January 1, 2005  (incorporated by reference to Exhibit 10.1 to the Registrant’s Current  Report on Form 8-K filed on December 23, 2004).                                                                                                                                                                                                             |
| 10.12     |   | Amended and Restated  Revolving Credit Agreement, dated as of September 27, 2002 by and  between the Company and Union Bank (incorporated by reference to  Exhibit 10.2 to the Registrant’s September 2002 10-Q).                                                                                                                                                                                                               |
| 10.13     |   | 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).                                                                                                                                     |

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| 10.14   |   | 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). |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15   |   | 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  quarterly period ended September 30, 2003 (the “September 2003  10-Q”)).                                                                                      |
| 10.16   |   | Fourth Amendment—Extension  letter dated August 25, 2004, relating to the Credit Agreement between  THQ Inc. 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).                                                                                                                                                                                                                         |
| 10.17 + |   | 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).                                                                                                                                                   |
| 10.18 + |   | PlayStation® 2 CD-Rom /  DVD-Rom Licensed Publisher Agreement, dated as of April 1, 2000 between  Sony Computer Entertainment America Inc. and the Company (incorporated by  reference to Exhibit 10.10 to the Registrant’s September 2002  10-Q).                                                                                                                                                                                                                                            |
| 10.19 + |   | Licensed Publisher  Agreement, dated as of August 28, 2002 by and between Sony Computer  Entertainment America Inc. and the Company (incorporated by reference to  Exhibit 10.9 to the Registrant’s September 2002 10-Q).                                                                                                                                                                                                                                                                          |
| 10.20   |   | PlayStation® 2 Licensed  Publisher Agreement, dated as of May 21, 2003 between Sony Computer  Entertainment Korea Inc. and THQ Korea Ltd. (incorporated by reference to  Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for  the quarterly period ended June 30, 2003 (the “June 2003 10-Q”)).                                                                                                                                                            |
| 10.21   |   | PlayStation® 2 Licensed  Publisher Agreement, dated as of July 28, 2003 between Sony Computer  Entertainment Europe Limited and THQ International Limited (incorporated by  reference to Exhibit 10.1 to the Registrant’s September 2003 10-Q).                                                                                                                                                                                                                                               |
| 10.22 + |   | PlayStation® Portable  Licensed Publisher Agreement, dated as of November 17, 2004 between Sony  Computer Entertainment America Inc. and THQ Inc. (incorporated by reference  to Exhibit 10.2 to the Registrant’s December 2004 10-Q).                                                                                                                                                                                                                                                        |
| 10.23 + |   | 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).                                                                                                                                                                                                                                                                     |
| 10.24   |   | 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 2003 10-Q).                                                                                                                                                                                                  |
| 10.25   |   | Term Extension to XboxTM  Publisher License Agreement, dated October 13, 2004 between THQ Inc. 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).                                                                                                                                                                                                                                       |

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| 10.26     |   | 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 March 2004 10-K).                                                                                                    |
|-----------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.27 * + |   | 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.                                                                                                                                                         |
| 10.28 +   |   | 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).                                                                |
| 10.29     |   | 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). |
| 10.30 +   |   | Confidential License  Agreement for Nintendo GameCube (Western Hemisphere), dated as of  April 5, 2002 between Nintendo of America, Inc. and the Company  (Western Hemisphere) (incorporated by reference to Exhibit 10.7 to the  Registrant’s September 2002 10-Q).                                          |
| 10.31 +   |   | 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).                                                                             |
| 10.32 * + |   | Confidential License  Agreement for the Nintendo DS handheld platform, dated as of January 25,  2005 between Nintendo of America, Inc. and THQ Inc.                                                                                                                                                                          |
| 10.33     |   | Lease agreement dated  December 22, 2004 between THQ Inc., 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).                                                                |
| 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                                                                                                                                                                              |

----

*                    Filedherewith.

#                 Managementcontract of compensatory plan or arrangement

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

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.
| Dated: June 8, 2005 | THQ INC.                                 |
|--------------------------|------------------------------------------|
|                     | By:                                      | /s/  BRIAN J. FARRELL |
|                     | Brian J. Farrell,                        |
|                     | *Chairman  of the Board,*                |
|                     | *President  and Chief Executive Officer* |
|                          |                                          |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated.
|                        | **Signature** | ** **                                                        | ** ** | ** **         | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------|---------------|-------------------------------------------------------------------|------------|--------------------|-----------|------------|------------|------------|----------|------------|
| /s/  BRIAN J. FARRELL  |          | Director, Chairman of  the Board,                                 |       | June 8,  2005 |
| Brian J. Farrell       |          | President and Chief Executive Officer                             |       |               |
|                   |          | *(Principal Executive Officer)*                                   |       |               |
| /s/  EDWARD ZINSER     |          | Executive Vice  President, Chief Financial Officer                |       | June 8,  2005 |
| Edward Zinser          |          | and Chief Accounting Officer                                      |       |               |
|                   |          | *(Principal Financial Officer and Principal  Accounting Officer)* |       |               |
| /s/  LAWRENCE BURSTEIN |          | Director                                                          |       | June 8,  2005 |
| Lawrence Burstein      |          |                                                              |       |               |
| /s/  HENRY DENERO      |          | Director                                                          |       | June 8,  2005 |
| Henry DeNero           |          |                                                              |       |               |
| /s/  BRIAN DOUGHERTY   |          | Director                                                          |       | June 8,  2005 |
| Brian Dougherty        |          |                                                              |       |               |
| /s/  JAMES L. WHIMS    |          | Director                                                          |       | June 8,  2005 |
| James L. Whims         |          |                                                              |       |               |

 

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