**UNITED STATESSECURITIES A**ND EXCHANGE COMMISSION

**WASHINGTON,D.C. 20549**

** **

**FORM 10-K**

 

**(MarkOne)**
| **ý**                                                                                                                                                                                                                               | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                     |                                                                                          |
| **For the fiscal year ended March 31, 2004**                                                                                                                                                                                             |
|                                                                                                                                                                                                                                     |                                                                                          |
| **OR**                                                                                                                                                                                                                                   |
| **o**                                                                                                                                                                                                                                    | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                     |                                                                                          |
| **For the transition period from                  to                  ** |
|                                                                                                                                                                                                                                     |                                                                                          |
| **Commission file number 0-18813**                                                                                                                                                                                                       |

** **

**THQ INC.**

(Exact Name of Registrant as Specified in Its Charter)

** **
| **Delaware**                                                                 |   | **13-3541686**                        |
|------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization)              |   | (I.R.S. Employer  Identification No.) |
|                                                                         |   |                                  |
| **27001 Agoura Road  Calabasas Hills, CA**                                   |   | **91301**                             |
| (Address of principal executive  offices)                                    |   | (Zip Code)                            |
|                                                                         |   |                                  |
| Registrant’s telephone number,  including area code: **(818) 871-5000** |
|                                                                         |   |                                  |
| Securities registered pursuant  to Section 12(b) of the Act:                 |
| **None.**                                                                    |
|                                                                         |   |                                  |
| Securities registered pursuant  to Section 12(g) of the Act:                 |
| **Common Stock,  $.01 par value  Preferred Stock Purchase Rights**      |

** **

Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý  No  o

** **

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

** **

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Exchange Act Rule12b-2).  Yes  ý  No  o

** **

The aggregate market value of voting stockheld by non-affiliates of the registrant as of June 4, 2004 was approximately$842,013,000. 38,784,847 shares of common stock were outstanding as of June 4,2004.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

The 2004 Notice of AnnualMeeting of Stockholders and Proxy Statement is incorporated by reference intoPart III herein.

 

 

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**THQINC.INDEX TO ANNUAL REPORT ON FORM 10-KFILED WITH THE SECURITIES AND EXCHANGE COMMISSIONFOR THE FISCAL YEAR ENDED MARCH 31, 2004**

 
|           | **ITEMS IN  FORM 10-K**                                                                                                 |       |
|----------------|-------------------------------------------------------------------------------------------------------------------------|------------|
|           |                                                                                                                    | ** ** |
| **Part I**     |                                                                                                                    |       |
| Item  1.       | Business                                                                                                                | 1          |
| Item 2.        | Properties                                                                                                              | 11         |
| Item 3.        | Legal  Proceedings                                                                                                      | 11         |
| Item  4.       | Submission of Matters to a Vote of Security  Holders                                                                    | 11         |
|           |                                                                                                                    |       |
| **Part II**    |                                                                                                                    |       |
| Item 5.        | Market  for the Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities | 12         |
| Item 6.        | Selected  Financial Data                                                                                                | 15         |
| Item 7.        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             | 17         |
| Item  7A.      | Quantitative  and Qualitative Disclosures About Market Risk                                                             | 43         |
| Item  8        | Financial  Statements and Supplementary Data                                                                            | 43         |
| Item  9        | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                                   | 75         |
| Item  9A       | Controls  and Procedures                                                                                                | 75         |
|           |                                                                                                                    |       |
| **Part III**   |                                                                                                                    |       |
| Item  10.      | Directors  and Executive Officers of the Registrant                                                                     | 76         |
| Item  11.      | Executive  Compensation                                                                                                 | 76         |
| Item  12.      | Security  Ownership of Certain Beneficial Owners and Management                                                         | 76         |
| Item  13.      | Certain  Relationships and Related Transactions                                                                         | 76         |
| Item  14.      | Principal  Accounting Fees and Services                                                                                 | 76         |
|           |                                                                                                                    |       |
| **Part IV**    |                                                                                                                    |       |
| Item  15.      | Exhibits,  Financial Statement Schedules and Reports on Form 8-K                                                        | 77         |
|           |                                                                                                                    |       |
| Signatures     |                                                                                                                    | 82         |
|           |                                                                                                                    |       |
| Certifications |                                                                                                                    | 83         |

 

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**This Annual Report contains, orincorporates by reference, certain forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995. Allstatements, other than statements of historical fact, including statementsregarding industry prospects and future results of operations or financialposition, made in this Report are forward looking. We use words such as“anticipate”, “believe”, “expect”, “intend”, “estimate”, “may”, “could”,“project”, “potential”, “plan”, “forecast”, “future” and similar expressions tohelp identify forward-looking statements. These forward-looking statements aresubject to business and economic risk and reflect management’s currentexpectations, estimates and projections about our business and are inherentlyuncertain and difficult to predict. Our actual results could differ materially.The forward-looking statements contained herein speak only as of the date onwhich they were made, and we do not undertake any obligation to update anyforward-looking statements to reflect events or circumstances after the date ofthis Annual Report. Risks and uncertainties that may affect our future resultsinclude, but are not limited to, those discussed under the heading “RiskFactors”, beginning on page 39.**

 

**PART I**

 

**Item 1.**            BUSINESS

** **

**Introduction**

 

THQ Inc. (“THQ” or the “Company”) is a leading globaldeveloper and publisher of interactive entertainment software that is playableon the following platforms:(1)

 

•                  Home video gameconsoles such as Sony PlayStation and Sony PlayStation 2, Microsoft Xbox, andNintendo GameCube;

 

•                  Handheldplatforms such as Nintendo Game Boy Advance;

 

•                  Personalcomputers; and

 

•                  Wirelessdevices.

 

Our titles span most major interactive entertainmentsoftware genres, including action, adventure, children’s, driving, fighting,puzzle, role-playing, simulation, sports and strategy.

 

Our software is based on intellectual propertylicensed or assigned from third parties or created internally.  We continually seek to identify and developtitles based on content from other entertainment media (such as movies andtelevision programs), sports and entertainment personalities, popular sportsand trends or concepts that have high public visibility or recognition or thatreflect the trends of popular culture. Our portfolio of licensed properties includes the Disney/Pixarproperties *Disney/Pixar’s**FindingNemo; The Incredibles,*which is**expected to be released this holiday**season;and*Cars,*which is expected to be released during the 2005 holiday season;Nickelodeon properties such as *The**FairlyOddParents and SpongeBob SquarePants;**Hot Wheels; Power Rangers; Scooby-Doo; Sonic the Hedgehog; WorldWrestling Entertainment;*as well as others.

 

We also develop software based on brands created byour eight internal development studios and by external developers undercontract with us.  Our original brandsinclude *Destroy All Humans!**Ô, Full Spectrum Warrior**Ô, MX Unleashed, Splashdown**â: Rides Gone Wild, S.T.A.L.K.E.R.: Shadow ofChernobyl,*and***Tak and the Power of Juju*(co-createdwith Nickelodeon).  Other than gamesthat we release on PCs, the manufacturers or their authorized vendorsmanufacture all of our products for us.

 

We market and distribute our software to customersincluding Wal-Mart, Toys “R” Us, Target, Best Buy, GameStop, ElectronicsBoutique, KB Toys, Game Stores Group Ltd., and other regional and nationalgeneral merchandisers, discount store chains, and specialty retailers.  Geographically, we market and distribute oursoftware to retailers in 70 countries and territories through offices in NorthAmerica, the United Kingdom, France, Germany, Australia and Korea.

 

In 2002, THQ formed THQWireless Inc. (“THQ Wireless”).  THQWireless provides a comprehensive wireless entertainment solution, includinggames, ring tones, wallpapers, messaging and information services for mobile phoneswith a current catalog of more than 50 titles.

 

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(1)                                  Microsoft, Nintendoand Sony are referred to herein collectively as the “hardware manufacturers” orthe “manufacturers.”  Nintendo®, GameBoy®, Game Boy® Color, Game Boy® Advance (“GBA”), GameCubeTM (“GameCube”) andNintendo® 64 (“N64”) are trademarks and/or registered trademarks of Nintendo ofAmerica Inc. (“Nintendo”).  SonyPlayStation® (“PS1”) and Sony PlayStation® 2 (“PS2”) are trademarks and/orregistered trademarks of Sony Computer Entertainment Inc. (“Sony”).  Microsoft and Xbox® (“Xbox”) are registeredtrademarks of Microsoft Corporation (“Microsoft”).

 

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We are a Delaware corporation that was re-incorporatedin 1997.  We were formerly incorporatedin New York in 1989 under the name Trinity Acquisition Corporation, whichchanged its name in 1990 to T.HQ, Inc. through a merger with T.HQ, Inc., aCalifornia corporation.  Our principalexecutive offices are located at 27001 Agoura Road, Calabasas Hills, California91301, and our telephone number is (818) 871-5000.  Our web site is at http://www.thq.com.  THQ and the THQ logo are registered trademarks of THQ Inc.(2)

 

**The Interactive EntertainmentIndustry and Technology**

 

The console, handheld, and PC games that we publishare made available to consumers on disc (usually a CD or DVD format) orcartridge media for use solely on dedicated hardware systems.  GBA is the only current platform that usescartridges.  Until 1996, most softwarefor dedicated platforms was sold in cartridge form.  Since then, disc-based products have become increasingly popularbecause they have substantially greater data storage capacity and lower coststhan cartridges.

 

The first modern platform was introduced by Nintendoin 1985 using 8-bit technology.  8-bitmeans that the central processing unit, or chip, on which the software operatesis capable of processing data in 8-bit units. Subsequent advances in technology have resulted in continuous increasesin the processing power of the chips that power both the consoles and PCs.  As the technology of the hardware hasadvanced, the software has similarly advanced, with faster and more compleximages, more lifelike animation and sound effects and more intricatescenarios.  The larger data storagecapacity of disc-based media for systems such as PS2, Xbox and GameCube enablesthem to provide richer content and longer play than previous platforms.  This new generation of systems is basedprimarily on 128-bit technology.  Thelatest handheld platform, GBA, uses 32-bit technology.

 

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(2)                                  Red Faction,Summoner, Splashdown, Heavy Iron Studios®, Helixe, Outrage® Games, PacificCoast Power & Light Co.®, ValuSoft®, Volition, Inc.®, THQ WirelessTM Inc.,Rainbow StudiosTMand Rainbow Multimedia, Cranky Pants GamesTM and  Relic® and Relic Entertainment  are trademarks and/or registered trademarksof THQ Inc.  All other trademarks areproperty of their respective owners.

 

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The following table sets forth select information on asample of the platforms for which we have published titles:

 
| **Manufacturer** |   | **Product Name**        |   | **Date of U.S. Introduction** |   | **Media Format** |   | **Technology**    |   |
|------------------|--------|-------------------------|--------|-------------------------------|--------|------------------|--------|-------------------|--------|
| Sony             |   | PlayStation             |   | 1995                          |   | CD-ROM Disc      |   | 32-bit            |   |
| Nintendo         |   | Nintendo 64             |   | 1996                          |   | Cartridge        |   | 64-bit            |   |
| Nintendo         |   | Game Boy  Color         |   | 1998                          |   | Cartridge        |   | 16-bit (portable) |   |
| Sony             |   | PlayStation  2          |   | 2000                          |   | DVD-ROM Disc     |   | 128-bit           |   |
| Nintendo         |   | Game Boy  Advance       |   | 2001                          |   | Cartridge        |   | 32-bit (portable) |   |
| Nintendo         |   | GameCube                |   | 2001                          |   | Proprietary Disc |   | 128-bit           |   |
| Microsoft        |   | Xbox                    |   | 2001                          |   | DVD-ROM Disc     |   | 128-bit           |   |
| Nintendo         |   | Game Boy  Advance SP(1) |   | 2003                          |   | Cartridge        |   | 32-bit (portable) |   |

 

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(1)                                  Sincethe Nintendo Game Boy® Advance and the Nintendo Game Boy® Advance SP use thesame cartridges and SKUs, we do not differentiate between the two productswithin this Annual Report.

 

PS2

Sony released the PS2console in Japan in March 2000, in North America in October 2000, and in Europein November 2000.  The PS2 console is a128-bit DVD-based system that is internet and cable ready, as well as backwardcompatible with games published for its predecessor, the PS1.  We have published and are currentlydeveloping numerous products for the Sony PS2.

 

Xbox

Microsoftlaunched the Xbox console in North America in November 2001, in Japan inFebruary 2002, and in Europe in March 2002. The Xbox video game system is a 128-bit DVD-based system.  We have published and are currentlydeveloping several products for Xbox.

 

GameCube

Nintendo launched theGameCube console in Japan in September 2001, in North America in November 2001,and in Europe in May 2002.  The GameCubeplays games that are manufactured on a proprietary optical disk.  We have published and are currentlydeveloping several products for the GameCube.

 

GBA

Nintendo launched thehandheld GBA platform in June 2001 and GBA SP, which is a front-lit screenversion of GBA, in March 2003.  We havepublished numerous games for GBA and are the leading independent publisher ofgames for GBA.

 

Software for each new platformrequires different standards of design and technology to fully exploit theplatform’s capabilities.  Theintroduction of new platforms also requires that game developers devotesubstantial additional resources to product design and development.

 

**Business Strategy**

 

Our corporate goal is to expand market share while increasingprofitability.  We believe that oursuccess in the following strategic initiatives will position us well to exploitgrowth opportunities in our market:

 

•                       *Build a well-diversified product portfolio acrossbrand, genre, and platform.* Due to constantly changing consumer demand and hardware platforms, webelieve it is important to offer a diversified portfolio of titles.  We have worked to grow and diversify ourproduct portfolio by securing additional content licenses, creating our ownbrands and content, seeking out unique co-development relationships (*e.g.* with Nickelodeon and Sega), andsupporting multiple platforms.  Throughlicensing agreements, we have diversified our portfolio of popular licensedproperties to include the Disney/Pixar properties *Disney/Pixar’s**Finding Nemo; The Incredibles,*which is**expectedto be released this holiday**season; and*Cars,*which is expected tobe released during the 2005 holiday season; Nickelodeon properties such as *The**Fairly OddParents and SpongeBob SquarePants;**Hot Wheels; Power Rangers; Scooby-Doo; Sonicthe Hedgehog; World Wrestling Entertainment*; as well as others.  Our titles span a wide spectrum of gamegenres.  We currently develop andpublish for the major interactive entertainment hardware platforms.  In July 2002, we expanded our productportfolio to include value PC titles with the acquisition of ValuSoft, Inc.(“ValuSoft”).  Our product offerings inthe fiscal year ending March 31, 2005 will reflect our development efforts inhigh-end PC core gamer titles as well. We will continue to work towards building a well-

 

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diversifiedproduct portfolio by obtaining additional licenses, increasing our internalbrands, and publishing titles across multiple platforms.

 

•                       *Establish strong technology and internal developmentcapabilities.*  We believe itis important for us to expand our internal development capabilities, toincrease ownership of technology and create intellectual properties.  We have increased our internal developmentcapabilities through the acquisition or formation of development studios,consisting of Cranky Pants GamesTM (“Cranky Pants”), Heavy IronStudiosâ (“Heavy Iron”), HelixeTM, PacificCoast Power & Light Co.â (“PCP&L”),Rainbow Multimedia Group, Inc. (also known as Rainbow StudiosTM(“Rainbow”)), THQ Australia StudiosTM Pty. Ltd., and Volition, Inc.â(“Volition”).  In April 2004, weacquired a new studio in Canada, Relicâ Entertainment Inc.(“Relic”).  Since 2001, we have launchedinternally-developed games, including *MXSuperfly featuring Ricky, Carmichael, MX Unleashed, Red Faction*â*II, Summoner*â*2, Scooby-Doo! Night of 100 Frights, Splashdown*â*;Rides Gone Wild*TM*, SpongeBob SquarePants; Battle for Bikini Bottom,*and*WWE Crush Hour.*We will continue toexpand our internal development capabilities by selectively acquiring orestablishing development studios.

 

•                       *Expand global product development.*  We believe it is important for our businessto establish global product development presence.  We have implemented a product development initiative thatresulted in the globalization of our product development staff.  The staff is located in three separatelocations – United States, United Kingdom, and Australia – and manages thedevelopment of product both internally-developed through our eight developmentstudios as well as externally-developed through independent developers.  The three product development groups areeach comprised of technical, creative, project management and quality assuranceteams.  This structure allows us to moreeffectively work with product development talent worldwide and improve productquality.

 

•                       *Expand internationally.*  International markets represent asignificant growth opportunity for us. We operate offices in the United Kingdom, Germany, France, Australia,Korea, and Switzerland, and distribute our products in 65 other countries andterritories.  We have a dedicated groupthat adapts our titles for international markets by localizing language andother cultural features.  We willcontinue to expand internationally by establishing offices in new territories,developing and acquiring content that has international appeal, possiblyacquiring foreign development studios and targeting wireless gamingapplications to appropriate foreign markets.

 

•                       *Prudently invest in emerging applications such aswireless gaming.*  We arepursuing opportunities within wireless gaming that we believe will allow us tobenefit from the rapid growth projected for this emerging market while remainingconsistent with our focus on profitability. We are establishing relationships with wireless operators and wirelesscontent providers worldwide.  We haverecently entered into license agreements with the National Football League(“NFL”) and the National Hockey League (“NHL”) and their respective players’associations to develop a new selection of officially licensed mobile contentbased on the teams and players of the NFL and the NHL.  We have also recently renewed our licenseagreement with the Major League Baseball (“MLB”) and the Major League BaseballPlayers Association (MLBPA).

 

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

 

We intend to continue pursuing potential acquisitiontransactions consistent with these strategies. In addition, in order to create a closer relationship with independentdevelopers, we may from time to time make investments or acquire interests inindependent developers.

 

**Intellectual Property Licenses**

 

Our strategy includes the creation of exciting gamesbased upon licensed properties that have attained a high level of consumerrecognition or acceptance.  We haverelationships with a number of well-known licensors, including Disney,Disney/Pixar, Mattel, Nickelodeon, Sega, Warner Bros, and World WrestlingEntertainment.  Additionally, THQWireless has established licensing relationships with the NFL and NHL and theirrespective players’ associations and has recently renewed its licensingagreement with MLB.

 

We pay royalties to our property licensors thatgenerally range from 3% to 20% of our net sales of the correspondingtitle.  We typically advance paymentsagainst minimum guaranteed royalties over the license term.  License royalties

 

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are usually higher for properties with provenpopularity and less perceived risk of commercial failure.  To the extent competition intensifies forlicenses of highly-desirable properties, we may encounter difficulty inobtaining or renewing these licenses. Licenses are of variable duration, may be exclusive for a specific titleor line of titles, and may in some instances be renewable upon payment ofcertain minimum royalties or the attainment of specified sales levels.  Other licenses are not renewable uponexpiration, and it cannot be assured that we and the licensor will reachagreement to extend the term of any particular license.

 

Our property licenses usually grant us exclusive useof the property for the specified titles, on specified platforms, within adefined territory and during the license term. Licensors typically, however, retain the right to exploit the propertyfor all other purposes, including the right to license the property for usewith other platforms, and have general approval rights over the use of theircontent in our games.  Our games basedon a particular property for use with one or more particular platforms may competewith games published by other companies that are based on the same property butfor a different platform.

 

**Intellectual Property Rights**

 

Our business is based on the creation, acquisition,exploitation, and protection of intellectual property rights.  Each game we release embodies a number ofseparately protected intellectual property rights of the manufacturer, theproperty licensor and, to a lesser extent, the external developer and THQ.  In the case of games based upon licensedcontent, the licensor of the property owns the trademarks, trade names,copyrights and other intellectual property rights relating to the property onwhich the game is based.  In the case ofgames based upon internally-created property, we own or co-own suchrights.  The manufacturer owns thepatents and substantially all of the other intellectual property embodied inthe product; and the developer, whether internal or external, often ownsproprietary tools and technology embedded in the game software.  While we own the game software embodied inthe product, we believe that such software has little independent economicvalue.  Accordingly, we often must relyon the manufacturer and, in the case of licensed content, the property licensorwith respect to protection from infringement of the property rights by thirdparties.

 

Each manufacturer incorporates security devices in itsplatforms and products to prevent unlicensed use.  In addition, Nintendo requires its licensees to display thetrademarked Nintendo Seal of Approval to notify the public that the game hasbeen approved by Nintendo for use with a Nintendo platform.

 

**Platform Licenses**

 

Our business is dependent on our license agreementswith the manufacturers.  All of theselicenses are for fixed terms and are not exclusive.  Each license grants us the right to develop, publish anddistribute titles for use on such manufacturer’s platform(s), and requires thateach such title be approved by the manufacturer prior to development of the software.  For a further description, see Note 1 –“Description of Business – Platform License Agreements” in our Notes toConsolidated Financial Statements.

 

The following table sets forth information withrespect to our platform licenses.  Insome instances, we have more than one platform license for a particularplatform.  In certain instances notedbelow, we have reached agreement with the platform manufacturer regardingbusiness terms of a license or license renewal but have not yet completed thecontract documentation process.  In theinterim, and as is customary in our business, both we and the platformmanufacturer are operating in accordance with the agreed business terms.

 

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

 

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(1)           The PS2 Licensed Publisher Agreement provides for anautomatic annual renewal unless either party terminates the agreement byJanuary 31 of the applicable year.

(2)           The PS2 Licensed Publisher Agreement provides for  an automatic annual renewal unless eitherparty terminates the agreement by February 28 of the applicable year.

(3)           The territory is determined on a title-by-title basis.

 

Nintendo charges us anamount for each Nintendo Game Boy Advance and Game Boy Color cartridgemanufactured.  This amount varies based,in part, on the memory capacity of the cartridges.  Nintendo, Sony and Microsoft consoleagreements include a charge for every disc manufactured.  The amounts charged by the manufacturers forboth console discs and handheld cartridges include a manufacturing, printingand packaging fee as well as a royalty for the use of the manufacturer’s name,proprietary information and technology, and are subject to adjustment by themanufacturers at their discretion.  Themanufacturers have the right to review, evaluate and approve a prototype ofeach 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 beara risk that the properties upon which the titles are based, or that theinformation and technology licensed from the manufacturer and incorporated inthe products, may infringe the rights of third parties.  Our agreements with our independent softwaredevelopers and property licensors typically provide for us to be indemnifiedwith respect to certain matters.  If anyclaim is brought by a manufacturer against us for indemnification, however, ourdevelopers or licensors may not have sufficient resources to, in turn,indemnify us.  Furthermore, theseparties’ indemnification of us may not cover the matter that gives rise to themanufacturer’s claim.

 

Each platform license may be terminated by themanufacturer if a breach or default by us is not cured after we receive writtennotice from the manufacturer, or if we become insolvent.  Upon termination of a platform license forany reason other than our breach or default, we have a limited period of timeto sell any existing product inventory remaining as of the date oftermination.  The length of thissell-off period varies between 90 and 180 days, depending upon the platformagreement.  We must destroy any suchinventory remaining after the end of the sell-off period.  Upon termination as a result of our breachor default, we must destroy any remaining inventory.

 

**Products**

 

Some of our individual titles make up a substantialportion of our gross sales.  Thefollowing list identifies games that generated more than 10% of our gross salesduring the fiscal year ended March 31, 2004, the twelve months ended March 31,2003, and the calendar years ended December 31, 2002 and 2001:

 

•                       Infiscal year ended March 31, 2004, no title generated more than 10% of our grosssales.

 

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•                       Inthe twelve-month period ended March 31, 2003, *WWE SmackDown! Shut Your Mouth*forthe Sony PS2 generated 12.2% of our gross sales.

 

•                       Inthe year ended December 31, 2002, *WWESmackDown! Shut Your Mouth*for the Sony PS2 generated 10.8% of ourgross sales.

 

•                       Inthe year ended December 31, 2001, *WWFSmackDown! “Just Bring It”* for the Sony PS2 generated 14.6% of ourgross sales.

 

Our sales are made directly to retailers andindependent distributors.  We distributeour games primarily to mass merchandisers and national retail chain stores,including Wal-Mart (representing 19% of gross sales in the fiscal year endedMarch 31, 2004) and Toys “R” Us (representing 7% of gross sales in the fiscalyear ended March 31, 2004).  Some of ourother retailers include Target, Best Buy, GameStop, Electronics Boutique, KBToys, and Game Stores Group Ltd.  Salesto our ten largest customers collectively accounted for approximately 54% and60% of our gross sales in the fiscal year ended March 31, 2004 and thetwelve-month period ended March 31, 2003 (unaudited), respectively; and 67% ofour gross sales in the three months ended March 31, 2003; and 64% of our grosssales in each of the years ended December 31, 2002 and 2001.  Most of our customers do not have writtenagreements or understandings which commit them to make purchases from us.

 

*Revenue Fluctuations andSeasonality.*  We haveexperienced, and will likely continue to experience, significant quarterlyfluctuations in net sales and operating results due to a variety offactors.  The software market is highlyseasonal, with sales typically significantly higher during the quarter endingDecember 31st (due primarily to the increased demand for interactivegames during the year-end holiday buying season).  Other factors that cause fluctuations include the timing of ourrelease of new titles, the popularity of both new titles and titles released inprior periods, changes in the mix of titles with varying gross margins, thetiming of customer orders, the timing of shipments by the manufacturers,fluctuations in the size and rate of growth of consumer demand for software forvarious platforms, the timing of the introduction of new platforms, and theaccuracy of retailers’ forecasts of consumer 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 assurancethat we can maintain consistent profitability on a quarterly or annual basis.

 

Profit margins may vary over time as a result of avariety of factors.  Profit margins forcartridge products for the Game Boy platforms can vary based on the cost of thememory chip used for a particular title. The other platforms support disc-based products that have significantlylower per unit manufacturing costs than cartridge-based products; however, theyalso have higher development costs than cartridge-based products.

 

**Software Design and Development**

 

We produce products internally based on original andlicensed content.  Internal, originalproducts include *MX Unleashed* and*Red Faction*.  Internally created products based uponlicensed materials include Heavy Iron Studios’ development of *SpongeBob SquarePants* and *Scooby-Doo!.* The products producedinternally are designed and created by employees at our eight studios: CrankyPants, Heavy Iron, Helixe, PCP&L, Rainbow, Relic, THQ Australia Studios,and Volition.  Our studios are staffedby producers, game designers, software engineers, artists, animators and gametesters.

 

For certain internallydeveloped concepts, we contract with independent software developers toconceptualize and develop games under our supervision and may own theintellectual property.  We pay theindependent developer a development fee in advance.  Once we have recouped the expenses of the development fee, theindependent developers generally receive a contingent compensation based on apercentage of net sales.

 

We also contract withindependent software developers to conceptualize and develop properties, underour supervision, based upon either original concepts created by the developeror licenses we acquire.  For these products,we generally pay either a development fee or royalty compensation based uponactual sales.  The royalty compensationis based upon a percentage of net sales, ranging from 4% to 20%.  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.  The intellectual property is owned by either the developer or thelicensor.

 

Whether a game is developedinternally or externally, upon completion of development, each game isextensively play-tested by us and sent to the manufacturer for its review andapproval.  Related artwork, userinstructions, warranty information, brochures and packaging designs are alsodeveloped under our supervision.  Thedevelopment cycle for a new game, including the development of the necessarysoftware, approval by the manufacturer and

 

7

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production of the initialproducts, typically has ranged from 12 to 24 months for console games and PCproducts and seven to 12 months for handheld games.  This relatively long development cycle requires that we assesswhether there will be adequate retailer and consumer demand for a game well inadvance of its release.

 

**Manufacturing**

 

Other than games that we release for sale on PCs, allof our home interactive entertainment products are manufactured for us by themanufacturers or their authorized vendors. We contract with various PC replicators for the manufacturing of our PCproducts.

 

The platform game manufacturing process begins withour placing a purchase order with a manufacturer and prepaying themanufacturer, opening either a letter of credit in favor of the manufacturer orutilizing credit granted by the manufacturer. 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.  Nintendo typicallydelivers products to us within 10 to 60 days of its receipt of an order and apayment or corresponding letter of credit. Sony typically delivers products to us within 10 to 24 days.  Microsoft’s authorized vendors typicallydeliver products to us within 10 to15 days.

 

We are required by the platform licenses to provide astandard defective product warranty on all of the products sold.  Generally, we are responsible for resolving,at our own expense, any warranty or repair claims.  We have not experienced any material warranty claims, but thereis no guarantee that we will not experience such claims in the future.

 

**Marketing, Sales and Distribution**

 

We are dependent on the popularity of our games basedon licensed properties and positive awareness of our original game concepts toattract customers and to obtain shelf space in stores.  Our domestic sales activities are directedby our Senior Vice President – North American Sales and Distribution, whomaintains contact with major retail accounts and manages the activities of ourinternal sales staff.  Our marketingactivities are directed by our Senior Vice President – Worldwide Marketing, whomanages the activities of our worldwide internal marketing staff.  The Senior Vice President – North AmericanSales and Distribution and the Senior Vice President – Worldwide Marketingreport to our Chief Operating Officer.

 

*North American Sales.*  Our games are promoted to retailers bydisplay at trade shows such as the annual Electronic Entertainment Expo(E3).  We also conduct print andcooperative retail advertising campaigns for most titles and preparepromotional materials, including product videos, to increase awareness among retailersand consumers.

 

Our marketing efforts for products released in thefiscal year ended March 31, 2004 included national television, print, radio andInternet advertising. and promotional campaigns. * *Products shipped in fiscal year 2004 that receivedtelevision support included *WWE SmackDown! Here Comes the Pain*, *Disney/Pixar’s**Finding Nemo, WWE Wrestlemania X9, BigMutha Truckers, Jimmy Neutron Jet Fusion, Hot WheelsTM World RaceTM, Pride FC, SpongeBob SquarePants: Battle for Bikini Bottom*, *Sphinx andthe Cursed Mummy*Ô*, Splashdown*â*:Rides GoneWild*Ô*,**Tak andthe Power of Juju*, *MX Unleashed. *Our games were supported by promotions such as trailers, demodiscs, over-sized boxes, standees, posters, and 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.  Product public relations for the fiscal yearincluded cover, feature, preview, review and round-up coverage in broadcast, printand online media targeting enthusiast, lifestyle and major mainstreamoutlets.  Additionally, we continue toincrease our corporate public relations efforts, establishing relationshipswith leading technology and business reporters.

 

We utilize electronic data interchange with most ofour major domestic customers in order to (i) efficiently receive, process, andship customer product orders; and (ii) accurately track and forecastsell-through of products to consumers in order to determine whether to orderadditional products from the manufacturers. The electronic data interchange system is integrated with our enterpriseresource planning system, which allows for further efficiencies in the itemsmentioned above.  We ship most of ourproducts to our domestic customers from public bonded warehouses located inOhio, Michigan, Minnesota and Canada.

 

The domestic retail price for our titles currentlyranges between $20 and $35 for Game Boy Advance, between $10 and $15 for PS1,between $20 and $55 for PS2, between $20 and $55 for Xbox, between $20 and $55for GameCube, and between $10 and $55 for PC games.  The domestic retail price for Game Boy Color titles is currently$20.

 

*International Sales.*  Our international sales activities aredirected by our Vice President European Publishing and our Vice PresidentAsia-Pacific Publishing via our international offices in the United Kingdom,France, Germany,

 

8

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Australia, and Korea. The Vice President European Publishing and Vice President Asia-PacificPublishing report to our Chief Operating Officer.  International offices market and distribute direct-to-retailcustomers and through sub-distributors in both their home territories and to 65additional territories.

 

**Agreement with JAKKS Pacific, Inc. /Relationship with WWE**

 

In June 1999, we entered into an agreement with JAKKSPacific, Inc. (“JAKKS”) that governs our relationship with respect to the WorldWrestling Entertainment license we jointly obtained from World WrestlingEntertainment, Inc. (“WWE”).  Thisagreement 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 licensefrom WWE.  The principal terms of thisoperating agreement are as follows:

 

•                       We areresponsible for funding all operations of the venture, including all paymentsowed to WWE.

 

•                       For theperiod commencing November 16, 1999 and ending June 30, 2006, JAKKS is entitledto receive a preferred payment equal to the greater of a fixed guarantee,payable quarterly, or specified percentages of the net sales from theWWE-licensed games (as defined) in amounts that vary based on theplatform.  The payment of these amountsis guaranteed by us.  We are entitled tothe profits and cash distributions remaining after the payment of theseamounts.

 

•                       For periodsafter June 30, 2006, the amount of the preferred payment will be subject torenegotiation between the parties.  Anarbitration procedure is specified in the event the parties do not reachagreement.

 

•                       We areresponsible for the day-to-day operations of the venture.  We are responsible for development, salesand distribution of the WWE-licensed games, and JAKKS is responsible for theapproval process and other relationship matters with 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, weentered into an amendment to expand the WWE license to include exclusive rightsto other wrestling content produced by the WWE.  In exchange for these rights we have agreed to increase theminimum guarantee payable to WWE through December 31, 2013.

 

**Geographic Information**

 

We operate in one reportable segment in which we are adeveloper and publisher of interactive entertainment software for the leadinghardware platforms in the home video game market.  Wireless gaming may become a new reportable segment as our activityin this market increases.  The followinginformation sets forth geographic information on our sales generated by ourregional offices for the fiscal years ended March 31, 2004 and 2003(unaudited), and the years ended December 31, 2002 and 2001 (also See Note 18to the consolidated financial statements for additional geographic informationon our sales and long-lived assets):

 

**Net Sales by Territories**

**(In Thousands)**

 
|                |   | **Fiscal  Year Ended  March 31,  2004** |    | **Twelve  Months Ended****March 31,  2003** |   | **Years Ended December 31,** |   |
|---------------------|--------|-----------------------------------------|---------|---------------------------------------------|--------|------------------------------|--------|
|                |   |                                    |    | **2002**                                    |   | **2001**                     |   |
|                |   |                                    |    | **(Unaudited)**                             |   |                         |   |   |   |
| North America       |   | $                                       | 453,426 |                                        | $      | 358,233                      |   | $ | 358,124 |   | $ | 262,676 |   |
|                |   |                                    |    |                                        |   |                         |   |   |   |
| United Kingdom      |   | 88,325                                  |    | 61,189                                      |   | 67,218                       |   | 60,240 |   |
| Germany             |   | 44,571                                  |    | 22,205                                      |   | 26,051                       |   | 25,517 |   |
| France              |   | 28,961                                  |    | 11,986                                      |   | 14,556                       |   | 18,185 |   |
| Asia Pacific        |   | 25,563                                  |    | 14,034                                      |   | 14,580                       |   | 12,374 |   |
| International Total |   | 187,420                                 |    | 109,414                                     |   | 122,405                      |   | 116,316 |   |
| Consolidated        |   | $                                       | 640,846 |                                        | $      | 467,647                      |   | $ | 480,529 |   | $ | 378,992 |   |

 

International operations createadditional risks for our business, including internal controls over financialreporting.  For additional risks, seeItem 7 – “Management's Discussion and Analysis of Financial Condition andResults of Operations – Risk Factors.”

 

9

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**Competition**

 

The interactive entertainment software industry isintensely competitive.  We compete withhardware manufacturers for both property licenses and software sales.  These companies typically publish for theirplatform and may increase their own software development efforts.  As a result of their commanding positions inthe industry as the manufacturers of platform hardware and publishers ofsoftware for their platforms, the manufacturers generally have betterbargaining positions with respect to retail pricing, shelf space and purchasesthan any of their licensees, including THQ.

 

In addition to the manufacturers, our competitorsinclude publishers and developers of interactive entertainment software, suchas Activision, Atari, Capcom, Electronic Arts, Take-Two Interactive Software,and Vivendi Universal.

 

At various times, toy companies, large softwarecompanies, movie studios, and others have entered the video game market,resulting in greater competition for us. Additionally, many of our competitors are developing wirelessinteractive games and interactive networks that will be competitive with ourinteractive products.

 

Each of the manufacturers has a broader software lineand greater financial, marketing, and other resources than we do, as do some ofour other competitors.  Accordingly,some of our competitors may be able to market their software more aggressivelyor make higher offers or guarantees in connection with the acquisition oflicensed properties or agreements with external developers.

 

Competition is intense among an increasing number ofnewly-introduced entertainment software titles and hardware systems foradequate levels of limited retail shelf space and promotional support andresources.  Competition for retail shelfspace is expected to increase, which may require us to increase our marketingexpenditures from time to time to maintain sales of our titles.  Competitors with more extensive lines andpopular titles frequently have greater bargaining power with retailers.  Accordingly, we may not be able to achievethe levels of support and shelf space that such competitors receive.  Similarly, as competition for popularproperties increases, our cost of acquiring licenses for such properties islikely to increase, possibly resulting in reduced margins.

 

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

 

**Recent Developments**

 

In April 2004 we acquired Relic, a development studiolocated in Canada.  Also, In April 2004,we announced that THQ Wireless purchased a controlling interest in MinickHolding AG (“Minick”), a European-based mobile applications and billing expert.

 

**Employees**

 

As of March 31, 2004, we had 796 full-time employees,of whom 609 are located in the United States; 59 are located in the UnitedKingdom; 56 are located in Germany; 21 are located in France; 45 are located inAustralia; 4 are located in Korea; and 2 are located in Singapore.  None of our employees is represented by alabor union or covered by a collective bargaining agreement, and we considerour relations with employees to be favorable.

 

**Available Information**

 

We file annual, quarterly and current reports, proxystatements and other information with the Securities and Exchange Commission(“SEC”).  Our SEC filings, including ourannual report on Form 10-K, quarterly reports on Form 10-Q, current reports onForm 8-K, and any amendments to those reports filed or furnished pursuant toSection 13(a) of the Exchange Act  areavailable to the public free of charge over the Internet at our website athttp://www.thq.com or at the SEC’s web site at http://www.sec.gov.  You can also view our Code of BusinessConduct and Ethics and our Code of Ethics for Executive Officers and OtherSenior Financial Officers free of charge on the corporate governance section ofour 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.  Our SEC filingswill be available on our website as soon as reasonably practicable after wehave electronically filed or furnished them to the SEC.  You may also read and copy any document wefile at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington,D.C.  20549.  You may obtain information on the operation of the PublicReference Room by calling the SEC at 1-800-SEC-0330.

 

10

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**Item 2.**            PROPERTIES

 

At March 31, 2004, we leased andoccupied the facilities listed below:

 
| **Location of Offices**     |   | **Approximate Square  Footage** |   | **Use**                                                                         |
|-----------------------------|--------|---------------------------------|--------|---------------------------------------------------------------------------------|
| Calabasas Hills, California |   | 104,000                         |   | Executive, sales and  marketing, product development and administrative offices |
|                        |   |                            |   |                                                                            |
| Champaign, Illinois         |   | 11,500                          |   | Software development studio                                                     |
|                        |   |                            |   |                                                                            |
| Woking, England             |   | 25,000                          |   | Sales and marketing, product  development and administrative offices            |
|                        |   |                            |   |                                                                            |
| Culver City, California     |   | 16,800                          |   | Software development studio                                                     |
|                        |   |                            |   |                                                                            |
| Krefeld, Germany            |   | 14,000                          |   | Sales and marketing, and  administrative offices                                |
|                        |   |                            |   |                                                                            |
| Phoenix, Arizona            |   | 13,500                          |   | Software development studio                                                     |
|                        |   |                            |   |                                                                            |
| Santa Clara, California     |   | 12,000                          |   | Software development studio                                                     |
|                        |   |                            |   |                                                                            |
| Kirkland, Washington        |   | 8,300                           |   | Software development studio                                                     |
|                        |   |                            |   |                                                                            |
| Lexington, Massachusetts    |   | 7,000                           |   | Software development studio                                                     |
|                        |   |                            |   |                                                                            |
| Melbourne, Australia        |   | 5,100                           |   | Sales and marketing and  administrative offices                                 |
|                        |   |                            |   |                                                                            |
| Waconia, Minnesota          |   | 5,000                           |   | Sales and marketing, product  development and administrative offices            |
|                        |   |                            |   |                                                                            |
| Paris, France               |   | 4,500                           |   | Sales and marketing and  administrative offices                                 |
|                        |   |                            |   |                                                                            |
| Spring Hill, Australia      |   | 3,400                           |   | Software development studio                                                     |
|                        |   |                            |   |                                                                            |
| Seoul, Korea                |   | 1,000                           |   | Sales, marketing and  administrative offices                                    |
|                        |   |                            |   |                                                                            |
| Zollikon, Switzerland       |   | 900                             |   | Sales and marketing                                                             |

 

In addition to the leased facilities listed above, wealso own 10,820 square feet of office space located in Phoenix, Arizona.

 

On February 27, 2003, weentered into a lease agreement with an entity partially owned by the head ofone of our development studios.  Thelease is for approximately 29,000 square feet of office space which is occupiedby the development studio in Champaign, Illinois as of June 1, 2004.

 

We believe that these facilities are adequate forour current needs.  We believe thatsuitable additional or substitute space will be available as needed toaccommodate our future needs.

 

**Item 3.**            LEGAL PROCEEDINGS

 

On July 11, 2003 we wereinformed by the staff of the Securities and Exchange Commission (the “SEC”)that the SEC is conducting a non-public formal investigation entitled “In theMatter of Certain Video Game Manufacturers and Distributors.”  In connection with the investigation, theSEC requested information from us.  TheSEC staff has informed us that other companies in the video game industry havereceived similar requests for information. The investigation appears to be focused on certain accounting practices,with specific emphasis on revenue recognition. The SEC has advised us that its investigation is non-public and shouldnot be construed as an indication from the SEC or its staff that any violationsof the law have occurred, nor should it reflect negatively upon any person,entity or security.  We responded to theSEC’s request for information in September 2003 and intend to cooperate fullywith any further requests from the SEC in its investigation.

 

We are involved in routine litigation arising in theordinary course of our business.  In theopinion of our management, none of the pending litigation will have a materialadverse effect on our consolidated financial condition or results ofoperations.

 

**Item 4.**            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.

 

11

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**PART II**

 

**Item 5.**            MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATEDSTOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SHARES

 

The common stock is quoted on the NASDAQ NationalMarket 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 2004 (4/1/03 – 3/31/04)**             |   |                      | ** ** |   | ** ** |
| First Quarter ended June 30, 2003                   |   | 19.50                     |       | 12.84 |   |
| Second Quarter ended September 30, 2003             |   | 19.52                     |       | 15.46 |   |
| Third Quarter ended December 31, 2003               |   | 18.59                     |       | 14.82 |   |
| Fourth Quarter ended March 31, 2004                 |   | 20.30                     |       | 15.94 |   |
| **Transition 2003**                                 |   |                      |       |   |   |
| Three-Month Transition Period ended March  31, 2003 |   | 14.18                     |       | 11.15 |   |
| **2002**                                            |   |                      |       |   |   |
| First Quarter ended March 31, 2002                  |   | 34.79                     |       | 26.29 |   |
| Second Quarter ended June 30, 2002                  |   | 36.17                     |       | 28.05 |   |
| Third Quarter ended September 30, 2002              |   | 27.79                     |       | 19.82 |   |
| Fourth Quarter ended December 31, 2002              |   | 23.17                     |       | 12.22 |   |

 

The last reported price of our common stock on June 4,2004, as reported by NASDAQ National Market, was $21.90 per share.

 

**Holders**

 

As of June 4, 2004 there were approximately 284holders of record of our common stock.

 

**Dividend Policy**

 

We have never paid cash dividends on our commonstock.  We currently intend to retainfuture earnings, if any, to finance the growth and development of our businessand, therefore, we do not anticipate paying any cash dividends in the future.  Our principal banking agreement providesthat we will not pay any cash dividends.

 

**Securities Authorized for IssuanceUnder Equity Compensation Plans**

 

Information for our equity compensation plans ineffect as of March 31, 2004 is as follows (amounts in thousands, except pershare amounts):

 
|                                                        |   | **(a)**                                                                                              |   | **(b)**                                                                            |   | **(c)**                                                                                                                                                |      |
|-------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
| **Plan Category**                                           |   | **Number of  securities  to be issued upon  exercise of  outstanding options,  warrants and rights** |   | **Weighted-average  exercise price of  outstanding options,  warrants and rights** |   | **Number of  securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** |      |
| Equity compensation plans approved by  security holders     |   | 4,779,246                                                                                            |   | $                                                                                  | 18.65  |                                                                                                                                                   | 5,793,627 |   |
| Equity compensation plans not approved by  security holders |   | 2,180,600                                                                                            | (1)    | $                                                                                  | 15.63  |                                                                                                                                                   | 110,005   |   |
| Total                                                       |   | 6,959,846                                                                                            |   | $                                                                                  | 17.70  |                                                                                                                                                   | 5,903,632 |   |

 

12

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(1)                                  Represents theaggregate number of shares of THQ Common Stock to be issued upon exercise ofindividual compensation arrangements with employee and non-employee option andwarrant holders.  The outstandingoptions were primarily granted under the Company’s Third Amended and RestatedNonexecutive Employee Stock Option Plan (the “NEEP” Plan”).  For a description of the material featuresof the NEEP Plan, see Note 11 - “Stock Option Plans” in the notes to theconsolidated financial statements.

 

**Option Exchange Program**

** **

At the annual meeting held on August 12, 2003, ourstockholders approved the Option Exchange Program (the “Program”).  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 to purchase alesser number of shares of common stock at a new exercise price per share.  Options that were eligible for exchange inthe Program were options granted under either our 1997 Stock Option Plan or ourNonexecutive Employee Stock Option Plan that had exercise prices equal to or greaterthan $27.00 per share.  The opportunityto elect to exchange eligible options expired on December 15, 2003 (the“Exchange Date”).

 

The following table shows the specific number ofshares, by exercise price, that participants in the Program had to surrender toreceive a replacement option to purchase one share of common stock:

 

| **EXERCISE PRICE  PER SHARE** |   | **EXCHANGE RATIO  (SURRENDERED TO NEW)** |   |
|-------------------------------|--------|------------------------------------------|--------|
| $27.00 to $33.00              |   | 1.5-for-1                                |   |
| $33.01 and above              |   | 1.75-for-1                               |   |

 

As of the Exchange Date, options to purchase 1,494,614shares of THQ common stock, with a weighted average exercise price of $30.77per share and a range of $27.49 to $39.11 per share, were held by employeeseligible to participate in the Program. On the Exchange Date, pursuant to a Tender Offer Statement on ScheduleTO (the “Offer”) filed with the Securities and Exchange Commission (“SEC”) onNovember 14, 2003, as amended by Amendment No. 1 to the Offer filed with theSEC on December 4, 2003, we accepted for cancellation options to purchase1,216,903 shares of our common stock, which represented approximately 81% ofall eligible options.  Subject to theterms and conditions of the Offer, as amended, we will grant replacementoptions to purchase approximately 769,000 shares of our common stock in exchangefor the options cancelled through the Program. We plan to grant the new options on June 21, 2004.  The replacement options will have anexercise price per share equal to the closing price of a share of our commonstock on the Nasdaq Stock Market on the grant date of such replacement options.

 

**Securities Issued in PrivateTransactions**

 

None.

 

**Purchases of Equity Securities by theIssuer and Affiliated Purchases**

 

13

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The following table sets forth information, as ofMarch 31, 2004, with respect to purchases of THQ Common Stock by the Company:

 
| **Period**                   |   | **Total  Number of  Shares  Repurchased(1)** |   | **Average  Price Paid  per Share** |   | **Total Number of  Shares  Purchased as  Part of Publicly  Announced Plans** |   | **Maximum  Number of  Shares that May  Yet Be  Purchased  Under the Plans(2)** |   |
|------------------------------|--------|----------------------------------------------|--------|------------------------------------|--------|------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------|--------|
| Year ended December 31, 2002 |   | 1,671,530                                    |   | 14.96                              |   | 1,671,530                                                                    |   | 1,886,792                                                                      |   |
| Transition 2003              |   | 568,307                                      |   | 13.65                              |   | 568,307                                                                      |   | 1,321,292                                                                      |   |
| August 2003                  |   | 512,198                                      |   | 15.61                              |   | 512,198                                                                      |   | 457,229                                                                        |   |
| December 2003                |   | 196,893                                      |   | 15.24                              |   | 196,893                                                                      |   | 308,908                                                                        |   |
| **Total**                    |   | 2,948,928                                    |   | 14.87                              |   | 2,948,928                                                                    |   | 1,544,696                                                                      |   |

 

----

(1)                                  On September 10,2002, we announced that our Board of Directors authorized the repurchase of upto $25.0 million of our common stock from time to time on the open market or inprivate transactions.  On November 21,2002, we announced that our Board of Directors authorized the repurchase of upto an additional $25.0 million of our common stock from time to time on theopen market or in private transactions. On February 5, 2004, we announced that our Board of Directors authorizedthe repurchase of an additional $25.0 million of shares of our common stock,bringing the total authorized to $75.0 million.  As of March 31, 2004, we have repurchased 2,949,000 shares of ourcommon stock for $43.8 million, leaving $31.2 million available for futurerepurchases.   There is no expirationdate for the authorized repurchases.

 

(2)                                  Based upon theclosing price of THQ Common Stock on March 31, 2004.

 

14

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**Item 6.**            SELECTED CONSOLIDATED FINANCIAL DATA

 

The following table summarizes certain selectedconsolidated financial data, which should be read in conjunction with ourConsolidated Financial Statements and Notes thereto and with Management’sDiscussion and Analysis of Financial Condition and Results of Operationsincluded elsewhere herein.  Effective January 1, 2003, we changed ourfiscal year end from December 31 to March 31. The change resulted in a three-month transitional period ended March 31,2003.  References to Transition 2003,unless otherwise indicated, refer to the three-month transitional period endedMarch 31, 2003. Since the change in fiscal year end affects the comparabilityof the information reflected in the selected financial data, we have includedunaudited results for the period from April 1, 2002 through March 31,2003.  Other than this unaudited period,the selected consolidated financial data presented below as of and for each ofthe fiscal years and Transition 2003 in the five-year period ended March 31,2004 are derived from our audited consolidated financial statements.  TheConsolidated Balance Sheets as of March 31, 2004, March 31, 2003 and December31, 2002 and the Consolidated Statements of Operations and ConsolidatedStatements of Cash Flows for the fiscal year ended March 31, 2004, the twelvemonths ended March 31, 2003 (unaudited), Transition 2003, and the four yearsended December 31, 2002, 2001, 2000, and 1999, and the reports thereon, areincluded elsewhere in this Form 10-K.

 

**STATEMENT OFOPERATIONS DATA**

**(In thousands, exceptper share data)**

 
|                                                 |   | **Years  Ended March 31,** |    | **Transition  2003(b)** |   | **Years  Ended December 31,** |        |
|------------------------------------------------------|--------|----------------------------|---------|-------------------------|--------|-------------------------------|-------------|
|                                                 |   | **2004(a)**                |    | **2003**                |   |                          | **2002(c)** |   | **2001** |   | **2000(d)** |   | **1999** |   |
|                                                 |   |                       |    | **(Unaudited)**         |   |                          |        |   |   |   |   |   |   |   |   |
| Net sales                                            |   | $                          | 640,846 |                    | $      | 467,647                       |        | $ | 66,800 |   | $ | 480,529 |   | $ | 378,992 |   | $ | 347,003 |   | $ | 303,483 |   |
| Costs and expenses:                                  |   |                       |    |                    |   |                          |        |   |   |   |   |   |   |   |   |
| Cost of sales                                        |   | 229,218                    |    | 178,291                 |   | 26,378                        |        | 185,593 |   | 154,898 |   | 140,699 |   | 134,563 |   |
| License amortization and  royalties             |   | 71,132                     |    | 38,988                  |   | 5,576                         |        | 40,476 |   | 33,144 |   | 34,675 |   | 28,858 |   |
| Software development  amortization              |   | 105,632                    |    | 84,916                  |   | 12,018                        |        | 83,698 |   | 35,144 |   | 42,875 |   | 19,512 |   |
| Product development                                  |   | 36,850                     |    | 36,531                  |   | 8,899                         |        | 34,696 |   | 17,774 |   | 18,605 |   | 15,511 |   |
| Selling and marketing                                |   | 92,475                     |    | 70,978                  |   | 14,294                        |        | 66,443 |   | 46,745 |   | 42,446 |   | 35,440 |   |
| Payment to venture partner                           |   | 9,675                      |    | 9,218                   |   | 644                           |        | 10,146 |   | 8,673 |   | 17,707 |   | 6,119 |   |
| General and administrative                           |   | 47,006                     |    | 36,794                  |   | 8,442                         |        | 34,993 |   | 28,470 |   | 20,076 |   | 14,970 |   |
| Total costs and expenses                             |   | 591,988                    |    | 455,716                 |   | 76,251                        |        | 456,045 |   | 324,848 |   | 317,083 |   | 254,973 |   |
| Income (loss) from operations                        |   | 48,858                     |    | 11,931                  |   | (9,451                        | )           | 24,484 |   | 54,144 |   | 29,920 |   | 48,510 |   |
| Interest income, net                                 |   | 2,378                      |    | 4,833                   |   | 878                           |        | 5,277 |   | 2,572 |   | 1,323 |   | 1,109 |   |
| Other income (expenses)                              |   | 4,000                      |    | (12,409                 | )      | (2,403                        | )           | (10,006 | ) | — |   | — |   | — |   |
| Income (loss) before income  taxes              |   | 55,236                     |    | 4,355                   |   | (10,976                       | )           | 19,755 |   | 56,716 |   | 31,243 |   | 49,619 |   |
| Income taxes                                         |   | 19,397                     |    | 1,812                   |   | (3,290                        | )           | 6,761 |   | 20,703 |   | 13,054 |   | 18,293 |   |
| Net income (loss)                                    |   | $                          | 35,839  |                    | 2,543  |                          | $           | (7,686 | ) | $ | 12,994 |   | $ | 36,013 |   | $ | 18,189 |   | $ | 31,326 |   |
| Net income (loss) per share —  basic       |   | $                          | 0.94    |                    | $      | 0.07                          |        | $ | (0.20 | ) | $ | 0.33 |   | $ | 1.10 |   | $ | 0.60 |   | $ | 1.10 |   |
| Net income (loss) per share —  diluted     |   | $                          | 0.92    |                    | $      | 0.06                          |        | $ | (0.20 | ) | $ | 0.32 |   | $ | 1.01 |   | $ | 0.56 |   | $ | 0.99 |   |
| Shares used in per share calculation —  basic   |   | 38,186                     |    | 39,018                  |   | 38,319                        |        | 39,203 |   | 32,717 |   | 30,136 |   | 28,560 |   |
| Shares used in per share calculation —  diluted |   | 39,004                     |    | 40,552                  |   | 38,319                        |        | 41,243 |   | 35,623 |   | 32,352 |   | 31,796 |   |
|                                                      |        |                            |         |                         |        |                               |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**BALANCE SHEET DATA**

**(In thousands)**

 
|                      |   | **March 31,** |    | **Transition** |   | **December  31,** |   |
|---------------------------|--------|---------------|---------|----------------|--------|-------------------|--------|
|                      |   | **2004**      |    | **2003**       |   | **2003**          |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
| Working capital           |   | $             | 309,633 |           | $      | 286,899           |   | $ | 286,899 |   | $ | 320,588 |   | $ | 319,605 |   | $ | 110,269 |   | $ | 91,860 |   |
| Total assets              |   | $             | 527,151 |           | $      | 472,949           |   | $ | 472,949 |   | $ | 537,860 |   | $ | 487,966 |   | $ | 229,949 |   | $ | 184,057 |   |
| Lines of credit           |   | $             | —  |           | $      | —            |   | $ | — |   | $ | — |   | $ | — |   | $ | 15,473 |   | $ | 16,702 |   |
| Stockholders’ equity |   | $             | 438,592 |           | $      | 396,413           |   | $ | 396,413 |   | $ | 408,866 |   | $ | 398,862 |   | $ | 132,125 |   | $ | 108,306 |   |
|                           |        |               |         |                |        |                   |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Notes:

 

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

 

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(a)          Netincome includes a $4.0 million benefit for a settlement of dispute withdirectors’ and officers’ insurance carrier.

 

(b)         Netincome includes a charge of $1.8 million due to the other than temporaryimpairment of our investment in Yuke’s Co., Ltd. (See – “Note 8 – OtherLong-Term Assets”).  We also changed ourfiscal year end from December 31 to March 31, effective January 1, 2003.

 

(c)          Netincome includes a charge of $7.9 million, net of tax for the cancellation of 20SKUs as well as a charge of $4.6 million, net of tax related to the settlementof a class action lawsuit and a charge of $1.1 million, net of tax related tothe write-off of inventory and software development for “WWF”-branded gamesthat we had been prevented from shipping pursuant to an action by the WorldWide Fund for Nature against World Wrestling Entertainment, Inc. and a chargeof $2.8 million, net of tax related to the discontinuation of our online jointventure in the United Kingdom (Network Interactive Sports, Ltd.).

 

(d)         Netincome includes a charge of $5.9 million, net of tax related to a regular assetimpairment review and also as a result of changing technology in the video gamemarket.  The charge consisted of costsassociated with software development and related costs for products that hadbeen discontinued or whose values were deemed unrecoverable through futureundiscounted cash flows.

 

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**Item 7.**            MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

** **

**Overview**

 

THQ is a leading global developer and publisher ofinteractive entertainment software that is playable on the following platforms:

 

•                       Homevideo game consoles such as Sony PlayStation and Sony PlayStation 2, MicrosoftXbox, and Nintendo GameCube;

 

•                       Handheldplatforms such as Nintendo Game Boy Advance;

 

•                       Personalcomputers; and

 

•                       Wirelessdevices.

 

Sony and Nintendo recentlyannounced that they would be introducing new handheld gaming devices.  Sony’s PlayStation Portable (“PSP”) iscurrently expected to be released in March 2005, and the Nintendo DSpotentially in late 2004.  We haveproducts in development on both handheld platforms as well as the nextgeneration platforms, and will launch them when the platforms are released.

 

Ourbusiness involves the development, marketing and sale of video game products,either internally, through co-development relationships, or by license.  We develop our products using our internaldevelopment resources and external development resources acting under contractwith us, some of which are independent and in some of which we take anownership position.  We typically selectour external developers based on their track records and expertise in producingproducts in the same category.  Onedeveloper will often produce the same game for multiple platforms and willproduce sequels to the original game. We believe that selecting and using development resources in this mannerallows us to strengthen and leverage the particular expertise of our internaland external development resources that we anticipate will add to the qualityof our products.  In the United States,we primarily sell our products on a direct basis to mass merchandisers andnational retail chain stores.  Our products are sold internationally inmore than 70 countries, on a direct-to-retail basis and through sub-distributors.  We conduct our international activities through offices inthe United Kingdom, France, Germany, Australia, and Korea.

 

Ourprofitability is directly affected by revenues from the sales of our video gamesoftware.  After the gross margin on thesales of our titles recoup development and marketing expenses for internallydeveloped titles, the gross margin on the incremental net sales positivelyimpacts our operating margin.  Forexternally developed titles, development fees are paid to third partydevelopers.  Once the development feesare recouped, the gross margin less royalties on the incremental net salesdirectly impact our operating margin.

 

Consistent with our business strategy, our focus withrespect to future game development will primarily be to continue to build awell-diversified product portfolio.  We areexecuting against our strategic plan to increase our share on PS2, Xbox and PCwhile maintaining our leadership position in the family and handheldmarket.  We plan to achieve this throughthe launch of high-quality new original properties for the mature and seriousgamer as well as continuing to capture the mass-market consumer with titlesbased on well-known licenses.  In fiscal 2005 we intend to publish gamesfrom our leading franchises, including Disney/Pixar, WWE, Nickelodeon, Sega andWarner Brothers.  Upcoming titles beingdeveloped include games based on three major holiday movie releases: WaltDisney Pictures Presentation of a Pixar Animation Studios film *The Incredibles*, Nickelodeon’s *The SpongeBob SquarePants Movie*, andWarner Bros.’ *Polar Express.*  Additionally, our mass-market lineup infiscal 2005 will include popular Nickelodeon titles such as *TheFairly OddParents, Jimmy Neutron*and*Nicktoons.*   We intend to continue to develop new original properties andcore gamer titles as well, such as  *Full Spectrum Warrior*, which was releasedin June 2004, as well as the upcoming titles*S.T.A.L.K.E.R.: Shadow of Chernobyl, Warhammer®40,000:**Dawn of War*, *The Punisher* and *DestroyAll Humans!*.

 

In addition to acquiring or creating high profilegames, we will also continue our focus on establishing strong technology andinternal development capabilities.  In April 2004, we bolstered ourinternal development capabilities with the acquisition of Relic.  With the addition of Relic,our development operations now include 17 teams and nearly 400 people locatedin eight studios.  We are aggressively buildingon this base of talent and expect to spend an additional $10 million in productdevelopment in fiscal 2005, up from the $37 million spent in fiscal 2004.  These funds will be used to support currentgeneration projects such as bringing development for key franchises in-house,as well as developing tools and establishing shared technologies fornext-generation consoles and new handheld

 

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devices.   We will also continue to work withindependent studios, maintaining our balance of internally and externallydeveloped content.

 

Our business strategy also includes investments inemerging applications, such as wireless gaming.  In fiscal 2004, THQ Wireless executed on its strategy of buildingrelationships with many major carriers worldwide, securing content with leadingbrands and establishing a direct-to-consumer portal for games delivery.  THQ Wireless recently entered into agreementswith the National Football League (NFL) and the National Hockey League (NHL)and their respective players’ associations to develop officially licensedmobile content based on the teams and players of the NFL and NHL. THQ Wirelessalso recently renewed its license agreement with Major League Baseball (MLB)and the Major League Baseball Players Association (MLBPA).  Additionally, in April 2004, THQ Wirelessacquired a controlling interest in Minick, a European-based mobile applicationsand billing expert.  This acquisitiongives THQ Wireless one of the largest direct-to-consumer billing anddistribution network solutions in the world, building on its strength as aturnkey solution for consumers, carriers and handset manufacturers.

 

**Critical Accounting Policies**

 

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.  Thepreparation of these consolidated financial statements requires managementto make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosureof contingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period.  The policiesdiscussed below are considered by management to be critical because they areboth important to the portrayal of our financial condition and results ofoperations and their application places the mostsignificant demands onmanagement’s judgment, with financial reporting results relying on estimatesabout the effect of matters that are inherently uncertain.  Specific risks for these critical accountingpolicies are describedin the following paragraphs.  For all of thesepolicies, management cautions that actual results may differ materially from theseestimates under different assumptions or conditions.

 

*Allowances forprice protection, returns and doubtful accounts.* We derive revenues from sales of packaged software for video gamesystems and personal computers and sales of software and services for wirelessdevices.  Product revenue is recognizednet of allowances for price protection and returns and various customer discounts.  We typically only allow returns for ourpersonal computer products; however, we may decide to provide price protection or allow returns forour video game system or personal computer products after we analyze: i) inventoryremaining in the retail channel, ii) the rate of inventory sellthrough in the retail channel, and iii) our remaining inventory onhand.  We maintain a policy of givingcredits for price protection and returns, but do not give cash refunds.

 

We establish salesallowances based on estimates of future price protection and returns with respect to current period product revenue.  We analyze historical price protection granted, historical returns,current sell through of retailerand distributor inventory ofour products, current trends in the videogame market and the overall economy, changes in customer demand and acceptance of ourproducts, and other related factors when evaluating the adequacy of the price protection and returnsallowance.  In addition, managementmonitors the volume of our sales to retailers and distributors and theirinventories, because slow-moving inventory in the distribution channel canresult in the requirement for price protection or returns in subsequentperiods.  In the past, actual priceprotection and returns have not generally exceeded our reserves.  However, actual price protection and returnsin any future period are uncertain. While management believes it can make reliable estimates for thesematters, if we changed our assumptions and estimates, our price protection andreturns reserves would change, which would impact the net revenue wereport.  In addition, if actual priceprotection and returns were significantly greater than the reserves we haveestablished, the actual results of our reported net sales would decrease.  Conversely, if actual price protection andreturns were significantly less than our reserves, our reported net sales wouldincrease.

 

Similarly, management must usesignificant judgment and make estimates in connection with establishingallowances for doubtful accounts in any accounting period. Management analyzes customer concentrations, customercredit-worthiness and current economic trends when evaluating the adequacy ofthe allowance for doubtful accounts. Material differences may result in the amount and timing of our bad debtexpense for any period if management made different judgments or utilizeddifferent estimates.  If our customersexperience financial difficulties and are not able to meet their ongoingfinancial obligations to us, our results of operations may be adverselyimpacted.

 

For the fiscal year ended March 31, 2004, the threemonths ended March 31, 2003 and the calendar year ended December 31, 2002, we recorded allowancesfor future priceprotection, returns and doubtful accounts of approximately$121

 

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million, $10 million, and $69.6 million,respectively.  The increase in fiscal2004 in allowances for future price protection, returns and doubtful accountsis related to the increase in sales during the fiscal year and our estimate offuture price protection and returns based on the factors discussed above.Additionally, during the fiscal year ended March 31, 2004 we recordedapproximately $7 million of bad debt expense due to KB Toys’ filing forbankruptcy protection on January 14, 2004. As of March 31, 2004, March 31, 2003, and December 31, 2002, ouraggregate reserves against accounts receivable for price protection, returnsand doubtful accounts were approximately $52.4 million, $43.4 million and $59.9million, respectively.

 

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

 

Licenses are expensed to license amortization androyalties at the higher of (i) the contractual royalty rate based on actual netproduct sales or (ii) the ratio of current units sold to total projected unitssold.  When, in management’s estimate,future cash flows will not be sufficient to recover previously capitalizedcosts, we expense these capitalized costs to license amortization androyalties.  See – “*Long-Lived Assets*” below.  If actual revenues or revised forecasted units fall below the initialforecasted units, the charge to license amortization and royalties may belarger than anticipated in any given quarter.  As of March 31, 2004, the net carrying valueof our licenses was $22.2 million.  Ifwe were required to write off licenses, due to changes in market condition orproduct quality, our results of operations could be materially adverselyaffected.

 

*Software Development*.  We utilize both independent software developersand internal development teams to develop our software.  We account for software development costs inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 86,“Accounting for the Costs of Computer Software to be Sold, Leased, or OtherwiseMarketed.”  We capitalize softwaredevelopment costs once technological feasibility is established and wedetermine that such costs are recoverable against future revenues.  For products where proven game enginetechnology exists, this may occur early in the development cycle.  We evaluate technological feasibility on atitle-by-title basis.  Amounts relatedto software development for which technological feasibility is not yet met arecharged immediately to product development expense.  We capitalize the milestone payments made to independent softwaredevelopers and the direct payroll costs for our internal development teams.

 

Capitalized software development is expensed tosoftware development amortization at the higher of (i) the contractual ratebased on actual net product sales or (ii) the ratio of current units sold tototal projected units sold.  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 units, fall below the initialforecasted units, the charge to software development amortization may be largerthan anticipated in any given quarter.  As of March 31, 2004, the net carrying valueof our software development was $49.8 million. If we were required to write off software development, due to changes inmarket condition or product quality, our results of operations could bematerially adversely affected.

 

*Goodwill.*  In conjunction with the implementation ofthe new accounting rules for goodwill as of the beginning of 2002, we completeda goodwill impairment review.  Accordingto our accounting policy, we also performed an annual review during thequarters ended June 30, 2003 and June 30, 2002, and in both reviews we found noimpairment.  We will perform a similarreview in future quarters ending June 30, or more frequently if indicators ofpotential impairment exist.  Ourimpairment review process is based on a discounted future cash flow approachthat uses our estimates of revenue for the reporting units, driven byanticipated success of our products and product release schedules, andestimated costs as well as appropriate discount rates.  These estimates are consistent with theplans and estimates that we use to manage the underlying businesses.  We performed similar impairment tests forindefinite-lived intangible assets and found no impairment.  The success of our products is affected bythe ability to accurately predict which platforms and which products we developwill be successful.  Also, our revenuesand earnings are dependent on our ability to meet our product releaseschedules.  Due to these and otherfactors described in the subsection entitled “Risk Factors” in “Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations” we may not realize the future net cash flows necessary to recoverour goodwill.

 

Based on these 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 future values are complex and oftensubjective.  They can be affected by avariety of factors, including but not limited to, significant negative industryor economic trends, significant

 

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changes in the manner or use of the acquired assets orthe strategy of our overall business and significant underperformance relativeto expected historical or projected future operating results.  Although we believe the judgments andassumptions we have made in the past have been reasonable and appropriate,there is nonetheless a high degree of uncertainty and judgment involved.

 

We continue to encounter the risks and difficultiesfaced with launching or acquiring a new business.  When the business is a development studio, we look for ways tomaximize the talent and intellectual property within the studio.  We make judgments and assumptions as to thecommercial success and quantity of games developed by a particular studio.  Different judgments and assumptions couldmaterially impact our reported financial results.  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 conservative assumptions of the anticipated future benefitsfrom these businesses would result in lower fair values which could result inimpairment charges, which would decrease net income and result in lower assetvalues on our balance sheets.  Conversely,less conservative assumptions would result in higher fair values which couldresult in lower impairment charges and higher net income.

 

*Long-Lived Assets.*  We evaluate long-lived assets, including butnot limited to licenses, software development, property and equipment andidentifiable intangible assets with finite lives, for impairment wheneverevents or changes in circumstances indicate that the carrying amount of anasset 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 of the assets is measured by a comparison ofthe carrying amount of an asset to future undiscounted net cash flows expectedto be generated by the asset.  If suchassets are considered to be impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the asset exceeds itsfair value.

 

Judgments and assumptions about future values arecomplex and often subjective.  They canbe affected by a variety of factors, including but not limited to, significantnegative industry or economic trends, significant changes in the manner or useof the acquired assets or the strategy of our overall business, and significantunderperformance relative to expected historical or projected future operatingresults.  Although we believe thejudgments and assumptions management has made in the past have been reasonableand appropriate, there is nonetheless a high degree of uncertainty and judgmentinvolved.  More conservative assumptionsof the anticipated future cash flows from these assets would result in lowerfair values which could result in impairment charges, which would decrease netincome and result in lower asset values on our balance sheets.  Conversely, less conservative assumptionswould result in higher fair values which could result in lower impairmentcharges and higher net income.

 

We also make judgments about the remaining usefullives of long-lived assets.  When wedetermine that the useful lives of assets are shorter than we had originallyestimated, and there are sufficient cash flows to support the carrying value ofthe assets, we accelerate the rate of depreciation charges in order to fullydepreciate the assets over their new shorter useful lives.

 

*Income taxes.* As part of the process of preparing our consolidated financialstatements, we are required to estimate our income taxes in each of thejurisdictions in which we operate.  Thisprocess involves estimating our current tax exposures in each jurisdictionincluding the impact, if any, of additional taxes resulting from tax examinationsas well as making judgments regarding the recoverability of deferred taxassets.  To the extent recovery ofdeferred tax assets is not likely based on our estimation of future taxableincome in each jurisdiction, a valuation allowance is established.  Tax exposures can involve complex issues andmay require an extended period to resolve. The estimated effective tax rate is adjusted for the tax related tosignificant unusual items.  Changes inthe geographic mix or estimated level of annual pre-tax income can affect theoverall effective tax rate.

 

*Recently Issued AccountingPronouncements.* In December 2003, the FASB issuedInterpretation No. 46, “Consolidation of Variable Interest Entities”(revised in December 2003) (“FIN 46-R”). This interpretation of AccountingResearch Bulletin No. 51, “Consolidated Financial Statements,” addressesconsolidation by business enterprises of variable interest entities (“VIEs”)that either: (i) do not have sufficient equity investment at risk topermit the entity to finance its activities without additional subordinatedfinancial support, or (ii) are owned by equity investors who lack anessential characteristic of a controlling financial interest. Generally,application of FIN 46-R is required in financial statements of public entitiesthat have interests in structures commonly referred to as special-purposeentities for periods ending after December 15, 2003, and, for other types ofVIEs, for periods ending after March 15, 2004. We have reviewed this pronouncement and determined it is not applicablesince we do not own or have an investment in any VIEs.

 

In March 2004, the EmergingIssues Task Force ratified the consensus reached on paragraphs 6 through 23 ofIssue No. 03-01 (“EITF 03-1”),*“The Meaningof Other-Than-Temporary Impairment and Its Application to Certain*

 

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*Investments”*. EITF 03-1 requires that certainquantitative and qualitative disclosures should be required for debt andmarketable equity securities classified as available-for-sale or held-to-maturityunder SFAS No. 115,*“Accounting for CertainInvestments in Debt and Equity Securities”* and SFAS No. 124, *“Accounting for Certain Investments Held byNot-for-Profit Organizations”*that are impaired at the balance sheetdate but for which an other-than-temporary impairment has not been recognized.We adopted EITF 03-1 in the year ended March 31, 2004; however, it did not havea material impact on the disclosures in our Consolidated Financial Statements.

 

**Change in Fiscal Year**

 

On February 13, 2003, we announced that the Board ofDirectors approved a change of our fiscal year end from December 31 to March31, effective January 1, 2003.  Thischange resulted in a three month transitional reporting period ended March 31,2003. References to Transition 2003, unless otherwise indicated, refer to thethree-month transitional period ended March 31, 2003.  This discussion compares: (i) the fiscal year ended March 31,2004 (“fiscal 2004”) with the twelve months ended March 31, 2003 (unaudited);and (ii) our fiscal years ended December 31, 2002 and 2001 (“fiscal 2002” and“fiscal 2001”), respectively.

 

**Selected Consolidated Statements ofOperations Data**

 

The following table sets forthcertain consolidated statements of operations data for the periods indicated asa percentage of total net sales (In Thousands):

 
|                               |   | **Year Ended  March 31,** |    | **Year Ended  December 31,** |   |
|------------------------------------|--------|---------------------------|---------|------------------------------|--------|
|                               |   | **2004 (a)**              |    |                         |   | **2003  (b)(c)** |   |   |   | **2002 (c)** |   |   |   | **2001** |   |   |   |
|                               |   |                      |    |                         |   | **(Unaudited)** |   |   |   |   |   |   |   |   |   |   |   |
| Net sales                          |   | $                         | 640,846 |                         | 100.0  | % | $ | 467,647 |   | 100.0 | % | $ | 480,529 |   | 100.0 | % | $ | 378,992 |   | 100.0 | % |
| Costs and expenses:                |   |                      |    |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of sales                      |   | 229,218                   |    | 35.8                         |   | 178,291 |   | 38.1 |   | 185,593 |   | 38.6 |   | 154,898 |   | 40.9 |   |
| License amortization and royalties |   | 71,132                    |    | 11.1                         |   | 38,988 |   | 8.3 |   | 40,476 |   | 8.4 |   | 33,144 |   | 8.7 |   |
| Software development amortization  |   | 105,632                   |    | 16.5                         |   | 84,916 |   | 18.2 |   | 83,698 |   | 17.4 |   | 35,144 |   | 9.3 |   |
| Product development                |   | 36,850                    |    | 5.8                          |   | 36,531 |   | 7.8 |   | 34,696 |   | 7.2 |   | 17,774 |   | 4.7 |   |
| Selling and marketing              |   | 92,475                    |    | 14.4                         |   | 70,978 |   | 15.2 |   | 66,443 |   | 13.8 |   | 46,745 |   | 12.3 |   |
| Payment to venture partner         |   | 9,675                     |    | 1.5                          |   | 9,218 |   | 2.0 |   | 10,146 |   | 2.1 |   | 8,673 |   | 2.3 |   |
| General and administrative         |   | 47,006                    |    | 7.3                          |   | 36,794 |   | 7.9 |   | 34,993 |   | 7.4 |   | 28,470 |   | 7.5 |   |
| Total costs and expenses           |   | 591,988                   |    | 92.4                         |   | 455,716 |   | 97.5 |   | 456,045 |   | 94.9 |   | 324,848 |   | 85.7 |   |
| Income from operations             |   | 48,858                    |    | 7.6                          |   | 11,931 |   | 2.6 |   | 24,484 |   | 5.1 |   | 54,144 |   | 14.3 |   |
| Interest income, net               |   | 2,378                     |    | 0.4                          |   | 4,833 |   | 1.0 |   | 5,277 |   | 1.1 |   | 2,572 |   | 0.7 |   |
| Other income (expense)             |   | 4,000                     |    | 0.6                          |   | (12,409 | ) | (2.6 | ) | (10,006 | ) | (2.1 | ) | — |   | — |   |
| Income before income taxes         |   | 55,236                    |    | 8.6                          |   | 4,355 |   | 0.9 |   | 19,755 |   | 4.1 |   | 56,716 |   | 15.0 |   |
| Income taxes                       |   | 19,397                    |    | 3.0                          |   | 1,812 |   | 0.4 |   | 6,761 |   | 1.4 |   | 20,703 |   | 5.5 |   |
| Net income                         |   | $                         | 35,839  |                         | 5.6    | % | 2,543 |   | 0.5 | % | $ | 12,994 |   | 2.7 | % | $ | 36,013 |   | 9.5 | % |
|                                    |        |                           |         |                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(a)          Netincome includes a $4.0 million settlement of dispute with directors’ andofficers’ insurance carrier.

 

(b)         Netincome includes a charge of $1.8 million due to the other than temporaryimpairment of our investment in Yuke’s Co., Ltd. (See – “Note 8 – OtherLong-Term Assets”).  We also changed ourfiscal year end from December 31 to March 31, effective January 1, 2003.

 

(c)          Netincome includes a charge of $7.9 million, net of tax for the cancellation of 20SKUs as well as a charge of $4.6 million, net of tax related to the settlementof a class action lawsuit and a charge of $1.1 million, net of tax related tothe write-off of inventory and software development for “WWF”-branded gamesthat we

 

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had been prevented from shipping pursuant to an action by the WorldWide Fund for Nature against World Wrestling Entertainment, Inc. and a chargeof $2.8 million, net of tax related to the discontinuation of our online jointventure in the United Kingdom (Network Interactive Sports, Ltd.).

 

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Thefollowing table breaks****down net sales by territory for theperiods indicated as a percentage of total net sales (In Thousands):

 

**Net Sales By Territory**

 
|            |   | **Year Ended March 31,** |    | **Year Ended December 31,** |   |
|-----------------|--------|--------------------------|---------|-----------------------------|--------|
|            |   | **2004**                 |    |                        |   | **2003** |   |   |   | **2002** |   |   |   | **2001** |   |   |   |
|            |   |                     |    |                        |   | **(Unaudited)** |   |   |   |   |   |   |   |   |   |   |   |
| North America   |   | $                        | 453,426 |                        | 70.8   | % | $ | 358,233 |   | 76.6 | % | $ | 358,124 |   | 74.5 | % | $ | 262,676 |   | 69.3 | % |
| United Kingdom  |   | 88,325                   |    | 13.8                        |   | 61,189 |   | 13.1 |   | 67,218 |   | 14.0 |   | 60,240 |   | 15.9 |   |
| Germany         |   | 44,571                   |    | 6.9                         |   | 22,205 |   | 4.7 |   | 26,051 |   | 5.5 |   | 25,517 |   | 6.7 |   |
| France          |   | 28,961                   |    | 4.5                         |   | 11,986 |   | 2.6 |   | 14,556 |   | 3.0 |   | 18,185 |   | 4.8 |   |
| Asia Pacific    |   | 25,563                   |    | 4.0                         |   | 14,034 |   | 3.0 |   | 14,580 |   | 3.0 |   | 12,374 |   | 3.3 |   |
| Total net sales |   | $                        | 640,846 |                        | 100.0  | % | $ | 467,647 |   | 100.0 | % | $ | 480,529 |   | 100.0 | % | $ | 378,992 |   | 100.0 | % |

 

**Results of Operations**

 

***Comparison of theFiscal Year Ended March 31, 2004 to the Twelve Months Ended March 31, 2003(Unaudited)***

 

Netincome for the fiscal year ended March 31, 2004 was $35.8 million or $0.92 perdiluted share, on net sales of $640.8 million, as compared to $2.5 million or$0.06 per diluted share for the twelve months ended March 31, 2003 (unaudited),based on net sales of $467.6 million. The increase in net income for fiscal 2004 is attributable to increasednet sales, improved gross margin and leverage of our operating costs andexpenses. Net income for fiscal 2004 was positively affected by a $4.0 millionsettlement of a dispute with our directors’ and officers’ insurance carrier.

 

Net Sales

 

The following table sets forth our net sales byplatform for the fiscal year ended March 31, 2004 and the twelve months endedMarch 31, 2003 (unaudited):

 

**Net Sales for the Years Ended (Inthousands):**

 
| **Platform**              |   | **March 31,  2004** |    |   |   | **March 31,  2003** |   |    |   | **Increase/  (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            | %       |
| Sony PlayStation          |   | 14,749              |    | 2.3    |   | 34,254              |   | 7.3     |   | (19,505                   | )      | (56.9           | )%      |
|                      |   | 394,840             |    | 61.6   |   | 287,863             |   | 61.6    |   | 106,977                   |   | 37.2            | %       |
| Handheld                  |   |                |    |   |   |                |   |    |   |                      |   |            |    |
| Nintendo Game Boy Color   |   | 1,621               |    | 0.2    |   | 20,480              |   | 4.4     |   | (18,859                   | )      | (92.1           | )%      |
| Nintendo Game Boy Advance |   | 162,109             |    | 25.3   |   | 108,353             |   | 23.2    |   | 53,756                    |   | 49.6            | %       |
|                      |   | 163,730             |    | 25.5   |   | 128,833             |   | 27.5    |   | 34,897                    |   | 27.1            | %       |
| PC CD-ROM                 |   | 74,934              |    | 11.7   |   | 49,333              |   | 10.5    |   | 26,601                    |   | 51.9            | %       |
| Wireless                  |   | 6,860               |    | 1.1    |   | 1,944               |   | 0.4     |   | 4,916                     |   | 252.9           | %       |
| Other                     |   | 482                 |    | 0.1    |   | (326                | )      | 0.0     |   | 808                       |   | 247.9           | %       |
| Net Sales                 |   | $                   | 640,846 |   | 100.0  | %                   | $      | 467,647 |   | 100.0                     | %      | $               | 173,199 |   | 37.0 | % |

 

Net Sales for the fiscal year ended March 31, 2004increased 37% from the prior twelve-month period, from $467.6 million to $640.8million.  There were several factors that affected the fiscal 2004 netsales performance. First, positively impacting our performance was animprovement in video game sales for consoles. Net sales for the year ended March 31, 2004 for the three major consoleplatforms: PS2, Xbox, and GameCube, increased 50% from the prior twelve-monthperiod, from $253.6 million to $380.1 million and overall console salesincreased 37.2%.

 

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Consoles

 

*Sony PlayStation 2 Net Sales* (In thousands):

 
| **Fiscal Year Ended  March 31, 2004** |    | **% of net  sales** |   | **Twelve  months  ended  March 31, 2003** |   | **% of net  sales** |   | **% change  in net  sales** |   |
|---------------------------------------|---------|---------------------|--------|-------------------------------------------|--------|---------------------|--------|-----------------------------|--------|
|                                  |    |                |   | **(Unaudited)**                           |   |                |   |                        |   |
| $                                     | 247,603 |                | 38.6   | %                                         | $      | 183,432             |   | 39.2                        | %      | 35.0 | % |
|                                       |         |                     |        |                                           |        |                     |        |                             |        |  |  |

 

Net sales of video games for PS2 increased for thefiscal year ended March 31, 2004 due to new releases of *WWE SmackDown! Here Comes the Pain,**Disney/Pixar’s**FindingNemo, SpongeBob SquarePants: Battle for Bikini Bottom*, *MXUnleashed, Scooby-Doo! Mystery Mayhem* and the launch of two new originalbrands – *Takand the Power of Juju*and *Sphinx and the Cursed Mummy*.  Inthe twelve-month period ended March 31, 2003, we released  *WWE SmackDown!: Shut Your Mouth* and *Red FactionII*for PS2.  We released 17 new SKUs in fiscal year 2004compared to 11 SKUs in the prior twelve-month period.  The increases were also due to the higher installed base of PS2hardware in fiscal 2004.

 

We expect net sales from PS2 products to continue togrow in fiscal 2005, but as net sales from these products increase, we expectour growth rates to decrease due to the maturity of the current hardwarecycle.  However, all three major consoleplatforms— PS2, Xbox and GameCube—have recently reduced their console prices to$149, which could increase demand for the consoles and thus for the videogames.

 

Net sales of video games for Sony PS1 decreased infiscal 2004, from $34.3 million in the twelve months ended March 31, 2003 to$14.7 million.  This decrease wasattributable to the transition to newer generation console systems, such asPS2.  Although our PS1 products areplayable on the PS2 console, we expect sales of PS1 titles to continue todecline in the future.

 

*Microsoft Xbox Net Sales* (In thousands):

 
| **Fiscal Year Ended  March 31, 2004** |   | **% of net  sales** |   | **Twelve  months  ended  March 31, 2003** |   | **% of net  sales** |   | **% change  in net  sales** |   |
|---------------------------------------|--------|---------------------|--------|-------------------------------------------|--------|---------------------|--------|-----------------------------|--------|
|                                  |   |                |   | **(Unaudited)**                           |   |                |   |                        |   |
| $                                     | 71,132 |                | 11.1   | %                                         | $      | 18,709              |   | 4.0                         | %      | 280.2 | % |
|                                       |        |                     |        |                                           |        |                     |        |                             |        |  |  |

 

Net sales of video games for Xbox increased for thefiscal year ended March 31, 2004 primarily due to sales of *WWE Raw 2*and *Disney/Pixar’s**Finding Nemo*.  Other significant releases included *MotoGP2*and*MXUnleashed.*  *WWE Raw*wasthe only significant title launched in the previous twelve-month period.  The increase in net sales was also due tothe higher installed base of Xbox hardware compared to the same period lastyear.  In total we released 16 SKUsduring the current fiscal year compared to 5 SKUs in the same period last year.

 

We expect net sales from Xbox products to continue tobe a significant portion of our total net sales in fiscal 2005; however, thegrowth rates should decrease due to the maturity of the current hardwarecycle.  However, all three major consoleplatforms— PS2, Xbox and GameCube—have recently reduced their console prices to$149, which could increase demand for the consoles and thus for the videogames.

 

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*Nintendo GameCube Net Sales* (In thousands):

 
| **Fiscal Year Ended  March 31, 2004** |   | **% of net  sales** |   | **Twelve  months  ended  March 31, 2003** |   | **% of net  sales** |   | **% change  in net  sales** |   |
|---------------------------------------|--------|---------------------|--------|-------------------------------------------|--------|---------------------|--------|-----------------------------|--------|
|                                  |   |                |   | **(Unaudited)**                           |   |                |   |                        |   |
| $                                     | 61,356 |                | 9.6    | %                                         | $      | 51,468              |   | 11.0                        | %      | 19.2 | % |
|                                       |        |                     |        |                                           |        |                     |        |                             |        |  |  |

 

Net sales of video games for GameCube for the fiscalyear ended March 31, 2004 included releases of *WWE Wrestlemania X9*, *SpongeBobSquarePants: Battle for Bikini Bottom*and *Tak and the Power of Juju. *We released 11 GameCube SKUsduring the 2004 fiscal year compared to 10 SKUs in the same period in2003.  Net sales for fiscal year endedMarch 31, 2004 also increased due to strong sales of *Disney/Pixar’s**Finding Nemo.*

 

We expect net sales fromGameCube products to increase moderately in fiscal 2005.

 

Handheld Platforms

 

The second factor positively affecting net sales forfiscal 2004 was increase in sales for GBA, a handheld platform.  Sales for GBA, increased 50%, from $108.4 million in thetwelve-month period ended March 31, 2003 to $162.1 million in fiscal 2004.

 

*Nintendo Game Boy Advance Net Sales* (Inthousands):

 
| **Fiscal Year Ended  March 31, 2004** |    | **% of net  sales** |   | **Twelve  month  period ended  March 31, 2003** |   | **% of net  sales** |   | **% change  in net  sales** |   |
|---------------------------------------|---------|---------------------|--------|-------------------------------------------------|--------|---------------------|--------|-----------------------------|--------|
|                                  |    |                |   | **(Unaudited)**                                 |   |                |   |                        |   |
| $                                     | 162,109 |                | 25.3   | %                                               | $      | 108,353             |   | 23.2                        | %      | 49.6 | % |
|                                       |         |                     |        |                                                 |        |                     |        |                             |        |  |  |

 

Net sales of video games for GBA primarily increasedfor the fiscal year ended March 31, 2004 due to strong sales of *Disney/Pixar’s**Finding Nemo*.  Other significant releases for the yearincluded:  *SpongeBob SquarePants:  Battle for Bikini Bottom, Tak & ThePower of Juju, Sonic Battle*and*Banjo Kazooie*.  The increase in net sales was also due to the higher installedbase of GBA hardware compared to the same period last year.  The increase in hardware sales is due inpart to Nintendo’s launch in March 2003 of the Game Boy Advance SP, which is afront-lit screen version of their GBA platform.  In total we released 33 SKUs during the current fiscal yearcompared to 24 SKUs in the same period last year.

 

We expect net sales from GBA products to continue tobe a significant portion of our total net sales in fiscal 2005.  The launch of new handheld platforms(Nintendo DS and Sony PSP) may negatively impact demand for GBA and could resultin decreased sales in this platform.

 

Sales of video games for the Nintendo Game Boy Colordecreased from $20.5 million in the twelve-month period ended March 31, 2003 to$1.6 million in fiscal 2004.  Thedecrease in net sales was attributable to the transition to newer generationhandheld systems.  Although our Game BoyColor products are playable on GBA hardware, we expect sales of Game Boy Colortitles to continue to decline in the future.

 

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PC CD-ROMs

 

The third factor positivelyaffecting net sales in fiscal 2004 was sales of PC CD-ROMs.  Net sales for fiscal 2004 increased 52% fromthe prior twelve-month period, from $49.3 million to $74.9 million.

 

*PC CD-ROM Net Sales* (In thousands):

 
| **Fiscal Year Ended  March 31, 2004** |   | **% of net  sales** |   | **Twelve  month  period ended  March 31, 2003** |   | **% of net  sales** |   | **% change  in net  sales** |   |
|---------------------------------------|--------|---------------------|--------|-------------------------------------------------|--------|---------------------|--------|-----------------------------|--------|
|                                  |   |                |   | **(Unaudited)**                                 |   |                |   |                        |   |
| $                                     | 74,934 |                | 11.7   | %                                               | $      | 49,333              |   | 10.5                        | %      | 51.9 | % |
|                                       |        |                     |        |                                                 |        |                     |        |                             |        |  |  |

 

Net sales of our PC CD-ROM games increased for thefiscal year ended March 31, 2004 primarily due to strong current year sales of *Disney/Pixar’s**Finding Nemo.*   Increases in net sales during the currentfiscal year were also due to strong sales of Valusoft’s PC CD-ROMs.  In total we released 52 PC CD-ROM SKUspublished from our ValuSoft division and 16 other PC CD-ROM SKUs during thecurrent fiscal year compared to 51 PC CD-ROM SKUs published by our ValuSoftdivision and 11 other PC CD-ROM SKUs in the same period last year.

 

Wireless

 

*Wireless Net Sales* (In thousands):

 
| **Fiscal Year Ended  March 31, 2004** |   | **% of net  sales** |   | **Twelve  month  period ended  March 31, 2003** |   | **% of net  sales** |   | **% change  in net  sales** |   |
|---------------------------------------|--------|---------------------|--------|-------------------------------------------------|--------|---------------------|--------|-----------------------------|--------|
|                                  |   |                |   | **(Unaudited)**                                 |   |                |   |                        |   |
| $                                     | 6,860  |                | 1.1    | %                                               | $      | 1,944               |   | 0.4                         | %      | 252.9 | % |
|                                       |        |                     |        |                                                 |        |                     |        |                             |        |  |  |

 

Net sales of content forwireless devices increased from $1.9 million in the twelve-month period endedMarch 31, 2003, to $6.9 million in fiscal 2004, which primarily includedwireless games content.  We expect netsales of wireless content to increase in fiscal 2005 as we expand our productofferings and relationships with the carriers. In addition, we have recently entered into licensing agreements with theNFL and NHL and their respective players’ associations to develop mobilecontent based on the teams and players of each league, renewed our licence withthe MLB and entered into a new licence with the MLBPA.

 

Forward-Looking Net Sales Information

 

Theplatform mix of our future net sales will be impacted by a number of factors,including the ability of hardware manufacturers to continue to increase theirinstalled hardware bases, the introduction of new hardware platforms, and thetiming of key product releases from our own product release schedule.  Infiscal 2004 and in the twelve months ended March 31, 2003, sales of video gamesfor console platforms consisted of 62% of our net sales.  We expect that net sales from console titleswill continue to represent the largest component of our net sales, with PS2having the largest percentage of that business due to its larger installedhardware base.  In fiscal 2004, sales of video games for handheldplatforms consisted of 26% of our net sales. We are the leading independent publisher of games for GBA and we expectnet sales from handheld titles to remain approximately one-quarter of our netsales.  With the expected introduction of Sony’s PSP in fiscal 2005, aswell as the expected introduction of Nintendo’s GBA DS in fiscal 2005, we maysee an increase in the percentage of our handheld business versus fiscal2004.  Our net sales from PC titles will be primarily driven by ourexpanded product release schedule.  We expect netsales of wireless content to increase significantly in fiscal 2005 as we expandour product offerings and relationships with carriers.

 

Anotherfactor that could affect fiscal year 2005 net sales performance is software andhardware pricing.  All three major console platforms, PS2, Xbox and GameCube have reduced their console prices to $149, which could increase demand forthe consoles and thus for the video games. Pricing for premier titles is expected to hold; however, the increasedinstalled base due to lower hardware prices should bring in the value-consciousconsumer who targets the mid- to lower-tier priced titles.

 

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Sales by Territory

 

The following table sets forth, for the fiscal yearended March 31, 2004 and the twelve months ended March 31, 2003, our net salesfor the North America and international territories:

 
| **Net Sales for the Twelve Months Ended  (In thousands)** |   | **March 31,  2004** |    | **March 31,  2003** |   | **Increase/  (Decrease)** |   | **%****Change** |    |
|-----------------------------------------------------------|--------|---------------------|---------|---------------------|--------|---------------------------|--------|-----------------|---------|
|                                                      |   |                |    | **(Unaudited)**     |   |                      |   |            |    |
| North America                                             |   | $                   | 453,426 |                | $      | 358,233                   |   | $               | 95,193  |   | 26.6 | % |
| International                                             |   | 187,420             |    | 109,414             |   | 78,006                    |   | 71.3            | %       |
| Net Sales                                                 |   | $                   | 640,846 |                | $      | 467,647                   |   | $               | 173,199 |   | 37.0 | % |

 

*North America Net Sales*

 

North America net salescomprised 71% of our net sales in fiscal 2004 and 77% of net sales for thetwelve-month period ended March 31, 2003. Total net sales in North America increased by 27% in fiscal 2004, from$358.2 million in the twelve-month period ended March 31, 2003, to $453.4million.  The increase in North Americanet sales for the fiscal year ended March 31, 2004 as compared to the sameperiod last year was due to:

 

•                       the success of *Disney/Pixar’s**Finding Nemo* on all platforms;

 

•                       the release of *WWE SmackDown: Here Comes The Pain* forPS2, *WWERaw 2* for Xbox,   *SpongeBob SquarePants: Battle for Bikini Bottom*on all platforms,  *Sonic Advance 2* for GBA and *WWE Wrestlemainia X9*for GameCube;

 

•                       the domestic release of 81 SKUs(3) (excluding ValuSoft) in the currentfiscal year compared to 63 SKUs (excluding ValuSoft) released in the sameperiod of the prior year; and

 

•                       the higher installed base of all hardware platforms compared to the sameperiod last year.

 

We expect North America netsales to continue to constitute the largest portion of our net sales in fiscal2005.

 

*International Net Sales*

 

International net salesincreased by 71% for the fiscal year ended March 31, 2004 as compared to theprior twelve-month period, from $109.4 million to $187.4 million.  The strengthening of foreign currencies,primarily the Great British Pound (“GBP”) and the European Currency Unit(“Euro”), increased reported international sales by $23.5 million or 22%.  Based on reported amounts, the increase innet sales was primarily due to:

 

•                       the release on all platforms of *Disney/Pixar’s**Finding Nemo* in all of our internationalterritories;

 

•                       success of *WWE SmackDown: Here Comes the Pain* for PS2; and

 

•                       the release of three SKUs focused on ourinternational territories – *Broken Sword 3*for PS2, Xbox, and PCCD-ROM, and *MotoGP2* and *Yager*for both Xbox and PC CD-ROM.

 

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(3)   A SKU or “Stock Keeping Unit,” is a versionof a title designed for play on a particular platform and intended fordistribution in a particular territory.

 

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Costs and Expenses, NetInterest Income, Other Income (Expenses) and Income Taxes

 

The following table sets forth information about ourcosts and expenses, net interest income, other income (expenses) and incometaxes for the periods indicated as a percentage of total net sales:

 
|                               |   | **Percent of Net Sales**           |   |
|------------------------------------|--------|------------------------------------|--------|
|                               |   | **Twelve Months 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, net               |   | 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 for the fiscal year ended March 31,2004 increased over the prior twelve-month period, from $455.7 million to$592.0 million; however, costs and expenses as a percent of net sales decreasedfrom 98% to 92%.  The largest componentof costs and expenses is the cost of sales, which consisted of $178.3 millionin the twelve months ended March 31, 2003 and $229.2 million in fiscal2004.  Software development amortizationand selling and marketing expenses are the next most significant factors whichimpacted costs and expenses.

 

Cost of Sales

 

Cost of sales represented 36% and 38% of net sales forthe twelve-month periods ended March 31, 2004 and 2003, respectively.  Theprimary factors that decreased the cost of sales as a percentage of net salesfor the fiscal year ended March 31, 2004 were: (1) higher margins on software developed for GBA; (2) higher average netselling price for our PC CD-ROM products due to the success of *Disney/Pixar’s**Finding Nemo*; and (3) the increased percentage ofwireless net sales, which carry little to no cost of sales.  We expect improved operating margins infiscal 2005 due to key releases of higher priced PC CD-ROM products, including *Full Spectrum Warrior*, *S.T.A.L.K.E.R.: Shadow of Chernobyl*, and *Warhammer 40,000:Dawn of War*.

 

License Amortization and Royalties

 

License amortization and royalties increased as apercentage of net sales for the fiscal year ended March 31, 2004 as compared tothe same twelve-month period last year. In absolute dollars, license amortization and royalties for the fiscalyear ended March 31, 2004 also increased over the prior twelve-month period,from $39.0 million to $71.1 million. This increase was primarily volume-driven, led by the release of *Disney/Pixar’s**Finding Nemo* on all platforms, which generatedsignificant net revenue and at a higher overall royalty rate than the titlesreleased in the same twelve-month period last year, which included *Red FactionII,*an internally-owned brand, which carried no license fees.

 

Software Development Amortization

 

Software development amortization costs increasedfrom $84.9 million in the twelve-month period ended March 31, 2003 to $105.6million in fiscal 2004.  Softwaredevelopment amortization for the twelve-month period ended March 31, 2003 includeda charge of approximately $12 million related to an assessment of therecoverability of capitalized

 

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development costs pertaining to 20 SKUs.  Excluding this charge, software developmentamortization increased as a percentage of net sales by approximately 1%.  This increase is due to the higher mix ofnet sales from console products which carry higher development costs.

 

Product Development

 

Product development expenses decreased as a percentageof net sales from 8% for the twelve-month period ended March 31, 2003 to 6% forthe fiscal year ended March 31, 2004. The decrease in product development expenses as a percentage of netsales is due to increased sales volume as well as changes we implemented toimprove product quality, including the shutdown of our Outrage® Gamesdevelopment studio, the downsizing of Pacific Coast Power & Light Co.development studio, and the restructuring of our corporate product developmentdepartment.   We expect productdevelopment expenses to increase in our fiscal year ending March 31, 2005,reflecting our investment in the next generation of hardware consoles and ourfocus on internal studio development.

 

Selling and Marketing

 

Selling and marketing expenses decreased slightly as apercentage of net sales for the fiscal year ended March 31, 2004 as compared tothe same period last year, from 15% to 14%. In absolute dollars, selling and marketing expenses increased for thefiscal year ended March 31, 2004, from $71.0 million to $92.5 million.  The increase in absolute dollars is due tothe advertising and other promotional support needed for such titles as *WWESmackDown! Here Comes The Pain, SpongeBob SquarePants: Battle for BikiniBottom, Sphinx and The Cursed Mummy, Splashdown: Rides Gone Wild, Tak and ThePower of Juju*and *Disney/Pixar’s**Finding Nemo*.  We expect selling and marketing expenses toslightly decline as a percent of sales in fiscal year ending March 31, 2005 dueto improved leverage of greater projected sales with a lower SKU count.

 

Payment to Venture Partner

 

Payment to JAKKS decreased slightly as a percentage oftotal net sales for the fiscal year ended March 31, 2004 compared to the sametwelve-month period last year, from 2.0% to 1.5%.  The payment made to JAKKS is related to the joint license agreementthat THQ and JAKKS obtained from WWE to develop, manufacture, distribute,market and sell video games, as well as sublicense products pursuant to thelicense from the WWE.  The decrease as apercentage of net sales is in direct relation to the decrease in WWE-relatedsales as a percentage of our total net sales. The payment to JAKKS in the fiscal year ended March 31, 2004 was drivenby the release of *WWE SmackDown! Here Comes the Pain*for PS2.

 

General and Administrative

 

General and administrative expenses for the fiscalyear ended March 31, 2004 increased $10.2 million from the prior twelve-monthperiod, from $36.8 million to $47.0 million; however, they decreased as apercentage of net sales from 8% to 7%.  Excluding the $7 million increasein our allowance for doubtful accounts related to KB Toys’ filing of bankruptcyprotection on January 14, 2004 general and administrative expenses declined to6% in fiscal 2004.  This decrease is theresult of our continued focus on building operating efficiencies andcontrolling costs.

 

Interest Income, net

 

Net interest income decreased for the fiscal yearended March 31, 2004 as compared to the same period last year due to lowerinterest rates.

 

Other Income (Expense)

 

Other income for fiscal year ended March 31, 2004consisted of a $4 million settlement of a dispute we had with our directors’and officers’ insurance carrier related to a previous securities litigationsettlement.  Other expenses for thetwelve months ended March 31, 2003 included a $7 million charge related to thesettlement of a class action lawsuit and a $3.0 million non-cash charge relatedto the discontinuation of our 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 ofour long-term investment in Yuke’s Co., Ltd due to an other than temporarydecline in the market value of the investment. (See Note 8 – Other Long-Term Assets.)

 

Income Taxes

 

The income tax provision of $19.4 million for thefiscal year ended March 31, 2004 reflects our effective income tax rate of 35%.  The decrease in theeffective 42% taxrate from the twelve months ended March 31, 2003, is 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 rate from the prior estimate of 37% for thefiscal year ending March 31, 2004 is due to an increase in the proportion ofour profits earned in our international territories that have lower statutoryincome tax rates.  We expect oureffective tax rate for fiscal year ending March 31, 2005 to be approximately36%.

 

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

 

Net income for the yearended December 31, 2002 was $13.0 million, or $0.32 per diluted share, on netsales of $480.5 million, as compared to net income of $36.0 million, or $1.01per diluted share, on net sales of $379.0 million for the year ended December31, 2001.  Net income for the year endedDecember 31, 2002 was negatively affected by the inclusion of the followingspecial charges: (1) $7.9 million, net of tax for the cancellation of 20 SKUs;(2) $4.6 million, net of tax related to the settlement of a class actionlawsuit; (3) $1.1 million, net of tax related to the write-off of inventory andsoftware development for “WWF” –branded games that we had been prevented fromshipping pursuant to an action by the World Wide Fund for Nature against WorldWrestling Entertainment, Inc.; and (4) $2.8 million, net of tax related to thediscontinuation of our online joint venture in the United Kingdom (NetworkInteractive Sports, Ltd.).  In additionto the special charges, net income in 2002 was negatively impacted due to anincrease in software development amortization.   

 

Net Sales

 

The following table sets forth our net sales byplatform and net sales by platform as a percentage of net sales for the twelvemonths ended December 31, 2002 and 2001:

 

**NetSales for the Years Ended (In thousands):**

 
| **Platform**              |   | **December 31,  2002** |    |   |   | **December 31,  2001** |   |    |   | **Increase/  (Decrease)** |   | **%****Change** |    |
|---------------------------|--------|------------------------|---------|--------|--------|------------------------|--------|---------|--------|---------------------------|--------|-----------------|---------|
| Consoles:                 |   |                   |    |   |   |                   |   |    |   |                      |   |            |    |
|                      |   |                   |    |   |   |                   |   |    |   |                      |   |            |    |
| Sony PlayStation 2        |   | $                      | 167,032 |   | 34.8   | %                      | $      | 110,642 |   | 29.2                      | %      | $               | 56,390  |   | 51.0 | % |
|                      |   |                   |    |   |   |                   |   |    |   |                      |   |            |    |
| Microsoft Xbox            |   | 34,143                 |    | 7.1    |   | 5,111                  |   | 1.4     |   | 29,032                    |   | 568.0           | %       |
| Nintendo Game Cube        |   | 49,004                 |    | 10.2   |   | —                 |   | —  |   | 49,004                    |   | N/A             |    |
|                      |   |                   |    |   |   |                   |   |    |   |                      |   |            |    |
| Sony PlayStation          |   | 37,270                 |    | 7.8    |   | 60,340                 |   | 15.9    |   | (23,070                   | )      | (38.2           | )%      |
|                      |   |                   |    |   |   |                   |   |    |   |                      |   |            |    |
| Nintendo 64               |   | 277                    |    | 0.1    |   | 17,097                 |   | 4.5     |   | (16,820                   | )      | (98.4           | )%      |
|                      |   | 287,726                |    | 60.0   |   | 193,190                |   | 51.0    |   | 94,536                    |   | 48.9            | %       |
| Handheld:                 |   |                   |    |   |   |                   |   |    |   |                      |   |            |    |
|                      |   |                   |    |   |   |                   |   |    |   |                      |   |            |    |
| Nintendo Game Boy Color   |   | 26,185                 |    | 5.4    |   | 62,569                 |   | 16.5    |   | (36,384                   | )      | (58.2           | )%      |
|                      |   |                   |    |   |   |                   |   |    |   |                      |   |            |    |
| Nintendo Game Boy Advance |   | 119,614                |    | 24.9   |   | 83,830                 |   | 22.1    |   | 35,784                    |   | 42.7            | %       |
|                      |   | 145,799                |    | 30.3   |   | 146,399                |   | 38.6    |   | (600                      | )      | 0.4             | %       |
|                      |   |                   |    |   |   |                   |   |    |   |                      |   |            |    |
| PC CD-ROM                 |   | 45,046                 |    | 9.4    |   | 36,814                 |   | 9.7     |   | 8,232                     |   | 22.4            | %       |
|                      |   |                   |    |   |   |                   |   |    |   |                      |   |            |    |
| Other                     |   | 1,958                  |    | 0.3    |   | 2,589                  |   | 0.7     |   | (631                      | )      | (24.4           | )%      |
| Net Sales                 |   | $                      | 480,529 |   | 100.0  | %                      | $      | 378,992 |   | 100.0                     | %      | $               | 101,537 |   | 26.8 | % |

 

Net salesfor the year ended December 31, 2002 increased 27% from the year ended December31, 2001, from $379.0 million to $480.5 million.  There were severalfactors that affected the fiscal 2002 net sales performance. First, positivelyimpacting net sales was an improvement in console sales, in total dollars andas a percentage of net sales.  Net salesfor the year ended December 31, 2002 for the console platforms: PS2, PS1, Xbox, Game Cube, and N64,increased 49% from the prior fiscal year, from $193.2 million to $287.7million.

 

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Consoles

 

*Sony PlayStation2 Net Sales (in thousands)*

 
| **Year ended  December 31,** |    | **% of net** |   | **Year ended  December 31,** |   | **% of net** |   | **% change**      |   |
|------------------------------|---------|--------------|--------|------------------------------|--------|--------------|--------|-------------------|--------|
| **2002**                     |    | **sales**    |   | **2001**                     |   | **sales**    |   | **in net  sales** |   |
| $                            | 167,032 |         | 34.8   | %                            | $      | 110,642      |   | 29.2              | %      | 51.0 | % |
|                              |         |              |        |                              |        |              |        |                   |        |  |  |

 

Net sales of video games for PS2 increased for theyear ended December 31, 2002 due to the release of 12 new SKUs in 2002 ascompared to five new SKUs in 2001.  Netsales increased for the year ended December 31, 2002 primarily due to strongsales of *RedFaction II, Scooby-Doo! Night of 100 Frights, SpongeBob SquarePants: Revenge of the Flying Dutchman, Summoner 2*and*WWE SmackDown! Shut Your Mouth*.  Key titles for PS2released in 2001 included *WWF SmackDown! “Just Bring It”, Red Faction*and*MX 2002featuring Ricky Carmichael.*

 

*Sony PlayStation Net Sales*(in thousands)

 
| **Year ended  December 31,** |   | **% of net** |   | **Year ended  December 31,** |   | **% of net** |   | **% change**      |   |
|------------------------------|--------|--------------|--------|------------------------------|--------|--------------|--------|-------------------|--------|
| **2002**                     |   | **sales**    |   | **2001**                     |   | **sales**    |   | **in net  sales** |   |
| $                            | 37,270 |         | 7.8    | %                            | $      | 60,340       |   | 15.9              | %      | (38.2 | )% |
|                              |        |              |        |                              |        |              |        |                   |        |  |  |

 

Net sales for PS1 decreased by $23.1 million in 2002as compared to 2001.  We did not releaseany new PS1 products in the year ended December 31, 2002, whereas we releasedten SKUs in the year ended December 31, 2001.

 

*Microsoft Xbox Net Sales*(in thousands)

 
| **Year ended  December 31,** |   | **% of net** |   | **Year ended  December 31,** |   | **% of net** |   | **% change**      |   |
|------------------------------|--------|--------------|--------|------------------------------|--------|--------------|--------|-------------------|--------|
| **2002**                     |   | **sales**    |   | **2001**                     |   | **sales**    |   | **in net  sales** |   |
| $                            | 34,143 |         | 7.1    | %                            | $      | 5,111        |   | 1.4               | %      | 568.0 | % |
|                              |        |              |        |                              |        |              |        |                   |        |  |  |

 

We released our first two Xbox SKUs in the fourthquarter of 2001.  Net sales for XboxSKUs increased for the year ended December 31, 2002 by $29.0 million due to therelease of seven SKUs in 2002, including *MotoGP*,*Tetris Worlds* and *WWF Raw*. The increase was also due to the higher installed base of Xbox hardwarein fiscal 2002 as compared to fiscal 2001. 

 

*Nintendo GameCube Net Sales*(in thousands)

 
| **Year ended  December 31,** |   | **% of net** |   | **Year ended  December 31,** |   | **% of net** |   | **% change**      |   |
|------------------------------|--------|--------------|--------|------------------------------|--------|--------------|--------|-------------------|--------|
| **2002**                     |   | **sales**    |   | **2001**                     |   | **sales**    |   | **in net  sales** |   |
| $                            | 49,004 |         | 10.2   | %                            | — |         | — |              | N/A    |   |
|                              |        |              |        |                              |        |              |        |                   |        |  |

 

The Nintendo GameCube platform launched in November2001 and we did not have any releases for GameCube in the year 2001.  Net sales for the year ended December 31,2002 included releases of eleven SKUs including *Disney/Pixar’s**Monsters,Inc.: Scream Arena*, *MX Superflyfeaturing Ricky Carmichael, Rocket Power Beach*

 

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*Bandits, Scooby-Doo! Night of 100Frights, SpongeBob SquarePants: Revenge of the Flying Dutchman*and *WWE WrestleMania X8*.

 

*Nintendo 64 Net Sales*(in thousands)

 
| **Year ended  December 31,** |   | **% of net** |   | **Year ended  December 31,** |   | **% of net** |   | **% change**      |   |
|------------------------------|--------|--------------|--------|------------------------------|--------|--------------|--------|-------------------|--------|
| **2002**                     |   | **sales**    |   | **2001**                     |   | **sales**    |   | **in net  sales** |   |
| $                            | 277    |         | 0.1    | %                            | $      | 17,097       |   | 4.5               | %      | (98.4 | )% |
|                              |        |              |        |                              |        |              |        |                   |        |  |  |

 

We did not release any new Nintendo 64 (“N64”)products in the year ended December 31, 2002. We released two N64 SKUs in the year ended December 31, 2001.

 

Handheld Platforms

 

The second factor positively affecting net sales forthe year ended December 31, 2002 was an increase in sales for the Nintendo Game Boy Advance (“GBA”), ahandheld platform.  Sales for GBA,increased 43%, from $83.8 million in the year ended December 31, 2001 to $119.6million in 2002.

 

*Nintendo Game Boy Advance Net Sales*(in thousands)

 
| **Year ended  December 31,** |    | **% of net** |   | **Year ended  December 31,** |   | **% of net** |   | **% change**      |   |
|------------------------------|---------|--------------|--------|------------------------------|--------|--------------|--------|-------------------|--------|
| **2002**                     |    | **sales**    |   | **2001**                     |   | **sales**    |   | **in net  sales** |   |
| $                            | 119,614 |         | 24.9   | %                            | $      | 83,830       |   | 22.1              | %      | 42.7 | % |
|                              |         |              |        |                              |        |              |        |                   |        |  |  |

 

Net sales increased for the year ended December 31,2002 due to strong sales of *Scooby-Doo! TheMovie, Sonic Advance, SpongeBob SquarePants: Revenge of the Flying Dutchman*and*Star Wars Episode 2: Attack of the Clones*.  The increase was also due to the higherinstalled base of GBA hardware in 2002 compared to 2001.  In total we released 31 GBA SKUs during 2002compared to 15 GBA SKUs in 2001.  Keytitles released in 2001 included *Disney/Pixar’sMonsters, Inc., Jimmy Neutron: Boy Genius, MX 2002 featuring Ricky Carmichael,Rocket Power: Dream Scheme, Rugrats: Castle Capers* and *Tetris Worlds*.

 

*Nintendo Game Boy Color Net Sales*(in thousands)

 
| **Year ended  December 31,** |   | **% of net** |   | **Year ended  December 31,** |   | **% of net** |   | **% change**      |   |
|------------------------------|--------|--------------|--------|------------------------------|--------|--------------|--------|-------------------|--------|
| **2002**                     |   | **sales**    |   | **2001**                     |   | **sales**    |   | **in net  sales** |   |
| $                            | 26,185 |         | 5.4    | %                            | $      | 62,569       |   | 16.5              | %      | (58.2 | )% |
|                              |        |              |        |                              |        |              |        |                   |        |  |  |

 

We did not release any Game Boy Color products inthe year ended December 31, 2002.  Wereleased 16 SKUs in the year 2001.

 

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PC CD-ROMs

 

The thirdfactor positively affecting net sales in the year ended December 31, 2002  was sales of PC CD-ROMs.  Net sales for 2002 increased 22% from theyear ended December 31, 2001, from $36.8 million to $45.0 million.

 

*PC CD-ROM Net Sales* (in thousands)

 
| **Year ended  December 31,** |   | **% of net** |   | **Year ended  December 31,** |   | **% of net** |   | **% change**      |   |
|------------------------------|--------|--------------|--------|------------------------------|--------|--------------|--------|-------------------|--------|
| **2002**                     |   | **sales**    |   | **2001**                     |   | **sales**    |   | **in net  sales** |   |
| $                            | 45,046 |         | 9.4    | %                            | $      | 36,814       |   | 9.7               | %      | 22.4 | % |
|                              |        |              |        |                              |        |              |        |                   |        |  |  |

 

Net sales increased for the year ended December 31,2002 primarily due to releases of 52 PC SKUs, as compared to 13 PC SKUsreleased in 2001*.*  The increase in PCCD-ROM SKUs released and net sales in 2002 as compared to 2001 is attributed toour acquisition of ValuSoft in July 2002. Prices for ValuSoft CD-ROMs are generally priced lower than the otherSKUs we release.  The increase in netsales for 2002 is a combination of increased volume of   ValuSoft sales and other PC CD-ROMproducts.

 

Sales by Territory

 

The following table sets forth, for the years endedDecember 31, 2002 and 2001, our net sales for the North America andinternational territories:

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

 

*North America Net Sales*

 

North America net salescomprised 75% of our net sales in the fiscal year 2002 and 69% of net sales infiscal 2001.  Total net sales in NorthAmerica increased by 36% in fiscal 2002, from $262.7 million in fiscal 2001, to$358.1 million in fiscal 2002.  Theincrease was primarily due to the significant increase in the number ofSKUs released domestically.

 

*InternationalNet Sales*

 

International net sales increasedby 5% for the year ended December 31, 2002 as compared to 2001, from $116.3million to $122.4  million.   Net sales in all of theinternational territories, with the exception of France, increased slightly forthe year ended December 31, 2002 as compared to the same period of 2001.

 

•                       The moremodest increase as compared to North America was primarily due to the launchesof next generation hardware platforms occurring at later dates in foreignterritories, resulting in a smaller installed base.

 

•                       Net salesin France declined by $3.6 million or 20% for the year ended December 31, 2002as compared to the same period of 2001. This decline was due to lower demand for *Red Faction II* for PS2 andslower than anticipated growth of the GameCube installed base.

 

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Costs andExpenses, Net Interest Income, Other Expenses and Income Taxes

 

The following table sets forth information about ourcosts and expenses, net interest income, other expenses and income taxes forthe periods indicated as a percentage of total net sales:

 
|                               |   | **Percent of Net Sales**      |   |
|------------------------------------|--------|-------------------------------|--------|
|                               |   | **Years Ended  December 31,** |   |
|                               |   | **2002**                      |   | **2001** |   |
| Costs and expenses:                |   |                          |   |   |   |
| Cost of sales                      |   | 38.6                          | %      | 40.9 | % |
| License amortization and royalties |   | 8.4                           |   | 8.7 |   |
| Software development amortization  |   | 17.4                          |   | 9.3 |   |
| Product development                |   | 7.2                           |   | 4.7 |   |
| Selling and marketing              |   | 13.8                          |   | 12.3 |   |
| Payment to venture partner         |   | 2.1                           |   | 2.3 |   |
| General and administrative         |   | 7.4                           |   | 7.5 |   |
| Total costs and expenses           |   | 94.9                          |   | 85.7 |   |
| Income from operations             |   | 5.1                           |   | 14.3 |   |
| Interest income, net               |   | 1.1                           |   | 0.7 |   |
| Other expenses                     |   | (2.1                          | )      | — |   |
| Income before income taxes         |   | 4.1                           |   | 15.0 |   |
| Income taxes                       |   | 1.4                           |   | 5.5 |   |
| Net income                         |   | 2.7                           | %      | 9.5 | % |

 

Costs and expenses for theyear ended December 31, 2002 increased over the prior twelve-month period, from$324.8 million to $456.0 million.  Thelargest component is the cost of sales, which consisted of $154.9 million infiscal 2001 and $185.6 million in fiscal 2002. Software development amortization and selling and marketing expenseswere the next largest components of costs and expenses.

 

Cost of Sales

 

Cost of sales represented 39% and 41% of net sales forthe years ended December 31, 2002 and 2001, respectively.  The primaryfactor that decreased the cost of sales as a percentage of net sales for theyear ended December 31, 2002 was a larger proportion of sales in fiscal 2002 ofnext generation console games, which have lower manufacturing costs as apercentage of net sales than handheld games, as well as a reduction in themanufacturing costs for the games for GBA in fiscal 2002.

 

License Amortization and Royalties

 

License amortization and royalties decreased slightlyas a percentage of net sales for the year ended December 31, 2002 as comparedto 2001.  In absolute dollars, licenseamortization and royalties for the year ended December 31, 2002 increased overthe prior year, from $33.1 million to $40.5 million.  The decrease in this expense as a percentage of net sales wasprimarily due to (i) the sale of key titles in 2002 that had lower royaltyrates than the titles that were sold in 2001; and (ii) the sale of titlespublished by ValuSoft in 2002, which carry a lower mix of licensed PC CD-ROMproducts.

 

Software Development Amortization

 

Software development amortization costs increased from$35.1 million in the year ended December 31, 2001 to $83.7 million in 2002, andalso increased as a percentage of net sales, from 9% in 2001 to 17% in2002.  The $48.6 million increaseincludes a write-off of approximately $11.5 million for the discontinuedproduct development of 20 SKUs which were determined to be not marketable.   The increase is also due to lower salesduring the fourth quarter of 2002 and the increased percentage of nextgeneration console games sold during 2002, as compared to 2001, which havelonger development cycles and higher development costs than handheld games.

 

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Product Development

 

Product development expenses increased as a percentageof net sales from 5% for the year ended December 31, 2001 to 7% for the fiscalyear 2002, an increase of $17.0 million. The increase in product development expenses is primarily due to thecosts incurred by the three development studios acquired or formed duringfiscal 2001 and fiscal 2002:  Rainbow,Outrage and Cranky Pants.  We alsoincreased the number of personnel in 2002 in our corporate product developmentdepartment to support the increased number of SKUs under development.

 

Selling and Marketing

 

Selling and marketing expenses of $66.4 million and$46.7 million represented 14% and 12% of net sales for the years ended December31, 2002 and 2001, respectively.  Theincrease of $19.7 million was primarily due to an increase in television mediaexpenditures for a greater number of SKUs in 2002 as compared to 2001.

 

Payment to Venture Partner

 

The payment to JAKKS remained relatively constant as apercentage of total net sales for the year ended December 31, 2002 as comparedto the same period of 2001.  The paymentof $10.1 million to JAKKS in 2002 primarily related to *WWE SmackDown! Shut Your Mouth!*, while thepayment of $8.7 million in 2001 primarily related to *WWF SmackDown! Just Bring It*.

 

General and Administrative

 

General and administrative expenses for the year endedDecember 31, 2002 increased $6.5 million from the prior  year, from $28.5 million to $35.0 million;however, as a percentage of net sales remained relatively consistent, at 7% inboth years.  The $6.5 million increase in fiscal 2002 was due to anincrease in the allowance for doubtful accounts related to the Chapter 11bankruptcy filing of Kmart, and the inclusion of ValuSoft’s general andadministrative expenses.

 

Interest Income, net

 

Net interest income increased for the year endedDecember 31, 2002 as compared to 2001 as a result of higher average cash, cashequivalents and short-term investment balances which increased as a result ofour public offering of our common stock in November 2001.

 

Other Expenses

 

Other expenses for the year ended December 31, 2002include a $7.0 million charge related to the settlement of the class actionlawsuit.  This consisted of $2.0 millionfor the portion of the settlement and legal fees that exceeded our directors’and officers’ insurance coverage and $5.0 million as a reserve against areceivable from our insurer due to a dispute in the amount of coverage.  Other expenses also included a $3.0 millionnon-cash charge related to the discontinuation of our online joint venture inthe United Kingdom (Network Interactive Sports, Ltd.).

 

Income Taxes

 

The income tax provision of$6.8 million for the year ended December 31, 2002 reflected our effectiveincome tax rate of 34%, as compared to income taxes of $20.7 million in 2001,or an effective rate of 37%.  The decreasein the effective tax rate was due primarily to tax benefits related to ourinternational business activities.

 

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**QuarterlyOperating Results**

 

Ourquarterly operating results have in the past varied significantly and willlikely vary significantly in the future, depending on numerous factors.  In addition, the timing and impact ofpotential risk factors may further affect quarterly results.  Our business also has experienced and isexpected to continue to experience significant seasonality, largely due toconsumer buying patterns and our product release schedule focusing on thosepatterns.  Net revenues typically are significantly higher during thefourth calendar quarter (our third fiscal quarter), primarily due to the increaseddemand for consumer software during the year-end holiday buying season. Accordingly, we believe that period-to-period comparisons of our operatingresults are not necessarily meaningful and should not be relied upon asindications of future performance.

 

Thefollowing table sets forth certain consolidated statements of operations datafor the fiscal quarters ended March 31, 2004 and 2003 and sets forth such dataas a percentage of total net sales (amounts in thousands, except per sharedata):

 

**Consolidated Statements ofOperations**

(In thousands, except per share data)

 
|                                                 |   | **Three  Months Ended  March 31,** |    |
|------------------------------------------------------|--------|------------------------------------|---------|
|                                                 |   | **2004**                           |    |   |   | **2003** |   |   |   |
| Net sales                                            |   | $                                  | 123,135 |   | 100 | % | $ | 66,800 |   | 100 | % |
|                                                 |   |                               |    |   |   |   |   |   |   |
| Costs and expenses:                                  |   |                               |    |   |   |   |   |   |   |
| Cost of sales                                        |   | 47,630                             |    | 38.7 |   | 26,378 |   | 39.5 |   |
| License amortization and royalties                   |   | 12,317                             |    | 10.0 |   | 5,576 |   | 8.3 |   |
| Software development amortization                    |   | 16,767                             |    | 13.6 |   | 12,018 |   | 18.0 |   |
| Product development                                  |   | 9,414                              |    | 7.6 |   | 8,899 |   | 13.3 |   |
| Selling and marketing                                |   | 17,837                             |    | 14.5 |   | 14,294 |   | 21.4 |   |
| Payment to venture partner                           |   | 858                                |    | 0.7 |   | 644 |   | 1.0 |   |
| General and administrative                           |   | 11,371                             |    | 9.2 |   | 8,442 |   | 12.7 |   |
| Total costs and expenses                             |   | 116,194                            |    | 94.4 |   | 76,251 |   | 114.2 |   |
| Income (loss) from operations                        |   | 6,941                              |    | 5.6 |   | (9,451 | ) | (14.2 | ) |
| Interest income, net                                 |   | 784                                |    | 0.6 |   | 878 |   | 1.3 |   |
| Other income (expense)                               |   | —                             |    | — |   | (2,403 | ) | (3.6 | ) |
| Income (loss) before income taxes                    |   | 7,725                              |    | 6.3 |   | (10,976 | ) | (16.5 | ) |
| Income taxes                                         |   | 2,294                              |    | 1.9 |   | (3,290 | ) | (4.9 | ) |
| Net income (loss)                                    |   | $                                  | 5,431   |   | 4.4 |   | $ | (7,686 | ) | (11.6 | ) |
| Net income (loss) per share – diluted           |   | $                                  | 0.14    |   |   |   | $ | (0.20 | ) |   |   |
| Shares used in per share calculation –  diluted |   | 39,007                             |    |   |   | 38,319 |   |   |   |

 

**Net income for the quarter ended March 31, 2004 was$5.4 million, or $0.14 per diluted share. This compares with a net loss of $7.7 million, or $0.20 per dilutedshare in the same three-month period last year.  Last year’s March quarter included special charges of $0.05 perdiluted share related to a $1.8 million charge due to other than temporary impairmentof our investment in Yuke’s Co., Ltd.**

 

For the fourth quarter of 2004,net sales increased 84% to $123.1 million from $66.8 million in the three-monthperiod ended March 31, 2003.  Newreleased *MX Unleashed*, *Scooby-Doo! Mystery Mayhem* and *Sonic Battle* contributed to our salesgrowth.  International revenues rose to33% of net sales, up from 15% last year, due to the continued strength of *Disney/Pixar’s Finding Nemo* as well as *Tak and the Power of Juju* in Europe.

 

We released a total of ten newSKUs, a balanced mix which comprises two PS2, two Xbox, one GameCube, threeGBA, and two PC titles.

 

In the fourth quarter of fiscal2004, software development amortization decreased to 13.6% of sales from 18% inthe prior-year period, reflecting a greater mix of internally developed titlessuch as *MX Unleashed* and catalogproducts.

 

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General and administrativeexpenses increased in absolute dollars in the fourth quarter of fiscal 2004, ascompared to the same three-month period last year, but decreased as apercentage of net sales.  The decreaseas a percentage of net sales was due to leverage.  $1.2 million of the dollar increase was due to currency exchangeand the balance was primarily investment spending in THQ Wireless.

 

**Liquidity and Capital Resources**

 

Our total assets as of March 31, 2004 were $527.2million, as compared to $472.9 million as of March 31, 2003.  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. Our principal source of cash is from sales of our packaged software forvideo game consoles, handheld game platforms, personal computers and wirelessdevices.  Our principal uses of cash areproduct purchases**of discs andcartridges, payments to developers, the costs of internal software development,selling and marketing expenses, and payments to licensors.  In order to purchase products from themanufacturers, we typically obtain a line of credit from the manufacturers,open letters of credit in their favor or make prepayments for the product.  At March 31, 2004, our total currentliabilities were $87.4 million, which consisted primarily of $41.3 million inaccrued royalties, $22.4 million in accrued expenses and $22.1 million inaccounts payable.

 

Cash and cash equivalents increased in fiscal 2004 by$47.4 million.  This included $71.2million provided by operating activities and $4.1 million increase of cash dueto favorable exchange rates, offset by $24.0 million used in investingactivities and $3.9 million used in financing activities.  In the twelve-month period ended March 31,2003, cash and cash equivalents increased by $12.4 million.  This included $19.9 million provided byoperating activities and $19.1 million provided by investing activities, offsetby $26.9 million used in financing activities. The $51.3 million increase to cash flows provided by operatingactivities in fiscal 2004, as compared to the twelve-month period ended March31, 2003, was primarily due to favorable operating results, favorableamortization on licenses and software development, favorable accrued royaltiespartially offset by unfavorable increase in accounts receivable which declinedand was a source of cash in the twelve months ended March 31, 2003.

 

We spent approximately $24.1 million in fiscal 2004and $19.4 million in the twelve-month period ended March 31, 2003,respectively, in connection with the execution of 19 and 20 new licenseagreements, respectively, granting us rights to intellectual property of thirdparties.  We used approximately $80.8million to fund software development of approximately 176 SKUs during fiscal2004 and used approximately $76.9 million to fund development of approximately224 SKUs during the twelve months ended March 31, 2003.  We expect that we will continue to makesignificant expenditures in fiscal 2005 relating to our investment in softwaredevelopment and intellectual property licenses.

 

The cash used in investing activities during fiscal2004 was primarily attributable to purchases of short-term investments andlong-term marketable securities.  In thetwelve-month period ended March 31, 2003, investing activities provided $19.1million in cash primarily due to proceeds from sales and maturities ofshort-term investments.  We believe thatwe have sufficient working capital ($309.6 million at March 31, 2004) tofinance our operational requirements, including our investments made in Relic($6 million) and Minick ($10.5 million) in April 2004.

 

Cash used in financing activities consisted of $11.0million used to repurchase 709,000 shares of our common stock during fiscal2004 and $32.8 million to repurchase 2,240,000 shares in the twelve-monthperiod ended March 31, 2003.  BetweenSeptember 10, 2002 and February 5, 2004, our Board of Directors authorized therepurchases of up to $75 million of our common stock.  See Item 5 – “Purchases of Equity Securities by the Issuer andAffiliated Purchases”.  As of March 31,2004, we had repurchased 2,949,000 shares of our common stock for $43.8 millionat an average cost of $14.85 per share, leaving $31.2 million available forfuture repurchases.

 

*Cybiko Claim*.  We received a demand from *Motorola*for indemnification related tocertain wireless games distributed in France. The demand arises out of litigation commenced in France against *Motorola* and their distribution partnersfor trademark infringement and unfair competition, which seeks $10.0 million indamages plus an unspecified amount and an accounting.  Although we expect to prevail, at this early stage we cannotpredict the likely outcome of the demand for indemnification.

 

*Guarantees and Commitments.*  In the normal course of business, we enterinto contractual arrangements with third parties for the rights to intellectualproperty and for the development of products. Under these agreements, we commit to provide specified payments to anintellectual property holder or developer, based upon contractual arrangements.  Assuming all contractual provisions are met,the total future minimum contract commitment for contracts in place as of March31, 2004 is approximately $113.8 million.

 

In addition, we have advertising commitments undermost of our major license agreements. These minimum commitments generally range from 2% to 12% of net salesrelated to the respective license.  Weestimate that our

 

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minimum commitment for advertising in fiscal year 2005will be $24.1 million.  We also havevarious operating lease commitments of $27.5 million expiring at various timesthrough 2014.  As of March 31, 2004, wehad approximately $3.1 million in obligations under our credit facilities withrespect to outstanding letters of credit. We also have a commitment for $1.6 million under a sponsorship agreementcontingent upon certain events, the occurrence of which will require us to makepayments over the next year.

 

A summary of minimum contractual obligations andcommercial commitments as of March 31, 2004 (in thousands), are as follows:

 

Contractual Obligations and Commercial Commitments

 
| **Fiscal****Years  Ended  March 31,** |   | **License  Guarantees** |   | **Software  Development  Milestone  Payments** |   | **Advertising** |   | **Leases** |   | **Letters of  Credit** |   | **Other** |   | **Total** |   |
|---------------------------------------|--------|-------------------------|--------|------------------------------------------------|--------|-----------------|--------|------------|--------|------------------------|--------|-----------|--------|-----------|--------|
| 2005                                  |   | $                       | 26,333 |                                           | $      | 59,408          |   | $          | 24,143 |                   | $      | 4,951     |   | $         | 3,125  |   | $ | 1,583 |   | $ | 119,543 |   |
| 2006                                  |   | 22,843                  |   | 701                                            |   | 10,203          |   | 4,751      |   | —                 |   | —    |   | 38,498    |   |
| 2007                                  |   | 4,520                   |   | —                                         |   | 2,856           |   | 3,363      |   | —                 |   | —    |   | 10,739    |   |
| 2008                                  |   | —                  |   | —                                         |   | 2,105           |   | 3,260      |   | —                 |   | —    |   | 5,365     |   |
| 2009                                  |   | —                  |   | —                                         |   | 500             |   | 2,881      |   | —                 |   | —    |   | 3,381     |   |
| Thereafter                            |   | —                  |   | —                                         |   | 1,500           |   | 8,307      |   | —                 |   | —    |   | 9,807     |   |
|                                  |   | $                       | 53,696 |                                           | $      | 60,109          |   | $          | 41,307 |                   | $      | 27,513    |   | $         | 3,125  |   | $ | 1,583 |   | $ | 187,333 |   |

 

On February 27, 2003, weentered into a lease agreement with an entity partially owned by the head ofone of our development studios.  Thelease is for approximately 29,000 square feet of office space which is occupiedby the development studio in Champaign, Illinois.

 

*Warrants. *We are committed under alicense agreement to issue a warrant to purchase a total of 160,000 shares ofcommon stock at $20.23 per share.  Wehave estimated the fair value based on current negotiations as we have shippedproduct related to this license agreement and thus the estimated fair value isbeing amortized to license amortization and royalties over estimated sales forgames that have been released.  We willadjust our estimated fair value and the related amortization when the warrantterms are finalized.

 

*ManufacturerIndemnification. *Wemust indemnify the manufacturers with respect to all loss, liability andexpense resulting from any claim against the manufacturer involving thedevelopment, marketing, sale or use of our games, including any claims forcopyright or trademark infringement brought against the manufacturer.  As a result, we bear a risk that theproperties upon which the titles are based, or that the information andtechnology licensed from others and incorporated in the products, may infringethe rights of third parties.  Ouragreements with our independent software developers and property licensorstypically provide for us to be indemnified with respect to certainmatters.  If any claim is brought by amanufacturer against us for indemnification, however, our developers orlicensors may not have sufficient resources to in turn, indemnify us.  Furthermore, these parties’ indemnificationof us may not cover the matter that gives rise to the manufacturer’s claim.

 

*Credit Facility.*  We have a credit facility that allows us tomaintain outstanding letters of credit up to $20.0 million.  The credit facility is secured by a lien onsubstantially all of our assets and contains customary financial andnon-financial covenants which require us to maintain specified operatingprofits and liquidity and limits our ability to incur additional indebtedness,sell assets, pay cash dividends and enter into certain mergers oracquisitions.  As of March 31, 2004, wewere in compliance with all the covenants under the credit facility.  Amounts outstanding under the creditfacility bear interest, at our choice, at either (a) the bank’s prime rate(4.0% at March 31, 2004) or (b) theLondon Interbank Offered Rate (1.4% at March31, 2004) plus 1.60%.  As ofMarch 31, 2004, we had outstanding letters of credit of approximately $3.1million.

 

*Inflation*

 

Our management currently believes that inflation hasnot had a material impact on continuing operations.

 

Accordingly, we believe that our cash, cashequivalents, short-term investments and long-term marketable securities, fundsprovided by operations and our borrowing capacity will be adequate to meet ouranticipated requirements, on both a short-term and long-term basis, foroperating expenses, product purchases and payments for licenses and softwaredevelopment.

 

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**Risk Factors**

 

Our business is subject to many risks anduncertainties which may affect our future financial performance. Some of thoseimportant risks and uncertainties which may cause our operating results to varyor which may materially and adversely affect our operating results are as follows:

 

**We Must Continue to Develop and SellNew Titles in Order to Remain Profitable.**

 

Our historical profitability has directly resultedfrom our ability to timely develop and sell successful new titles for use onvarious platforms.  We may not be ableto develop and secure the rights to new titles at a rate that will maintain ourcurrent development and release schedule or release new titles by the dates wehave scheduled.  If the revenues fromour new titles fail to replace declining revenues from previously releasedtitles, our revenues and profits would be materially and adversely affected.

 

Consumer preferences for games are difficult topredict, and even the most successful titles remain popular for only limitedperiods of time, often less than six months. The life cycle of a game generally consists of a relatively high levelof sales during the first few months after introduction, followed by a declinein sales.  Accordingly, substantiallyall of our net sales for a particular year are generated by titles released inthat year and in the latter part of the prior year.  In some instances, a sales decline may also be accompanied bydecreasing sales prices, which may result in credits or allowances to our customers.

 

In addition, the development cycle for a new game,including the development of the necessary software, approval by themanufacturer and production of the initial products, typically has ranged from12 to 24 months for console and PC games and seven to 12 months for handheldgames.  In order to distribute aproduct, we must develop the necessary game software, obtain approval from theplatform manufacturer and licensor, if required, and produce the initial orderof cartridges, DVD-ROMs or CD-ROMs.  Duringthe development cycle, the market appeal of a title may decline.

 

**Our Inability To Identify, LicenseAnd Renew Properties Upon Which Our Products Are Based, Or A Sudden Decrease InPopularity Of The Properties We License, Could Harm Us.**

 

Many of our products are based on intellectual propertyowned by others and licensed to us. Examples of properties that we seek to license are entertainment, suchas movies, television programs and arcade games, sports and entertainmentpersonalities, and concepts that have high public visibility or recognition orthat reflect the trends of popular culture. The inability to renew successful licenses, or the inability to renewlicenses with as favorable terms as the initial licenses, the sudden decreasein popularity of the underlying properties of our licenses, or changes inproperty content of our licenses could limit our economic success.

 

We also publish internally developed brands, titlesfor which no license is required.  Thesuccess of internal brands relies heavily on substantial marketing, innovativetechnology and original ideas.  Thesetitles can be expensive to develop and market. Further, it is difficult to determine what level of consumer acceptancewill be achieved, as opposed to licensed titles, which generally have abuilt-in consumer base and licensor support.

 

**We Rely On A Relatively Small NumberOf Brands For A Significant Portion Of Our Net Sales.**

 

A small number of our products make up a substantialportion of our net sales each year, and these products are responsible for adisproportionate amount of our net income. For the fiscal year ended March 31, 2004, sales of titles for our threetop selling brands, Disney/Pixar,WWE and Nickelodeon were 18%, 16% and 16% of net sales, respectively.  For the twelve months ended 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.  For the year ended December 31, 2002, salesof titles for our three top selling brands, WWE, Nickelodeon and Scooby-Doo!were 22%, 18% and 9% of net sales, respectively and for the year ended December31, 2001, sales of our titles for our three top selling brands, WW*E, Red Faction and Championship Motocross/MXfeaturing Ricky Carmichael*were 23%, 9% and 6% of net sales,respectively.  A limited number ofbrands may continue to produce a disproportionately large amount of our netsales.  Due to this dependence on alimited number of brands, the failure of one or more products based on thesebrands to achieve anticipated results may significantly harm our business andfinancial results.

 

**We Rely On A Small Number OfCustomers That Account For A Significant Amount Of Our Sales.**

 

Sales to our 10 largest customers collectivelyaccounted for approximately 54% and 60% of our gross sales for the twelvemonths ended March 31, 2004 and March 31, 2003, respectively.  Sales to our 10 largest customerscollectively accounted for approximately 64% and 64% of our gross sales for theyears ended December 31, 2002 and December 31, 2001, respectively.  Our largest single customer in those periodswas Wal-Mart.  Wal-Mart accounted for19% of our gross sales for the fiscal year ended March 31, 2004, 18% of ourgross sales for the twelve

 

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months ended March 31, 2003, 16% of our gross salesfor the year ended December 31, 2002, and 14% of our gross sales for the yearended December 31, 2001.

 

A substantial reduction, termination of purchases, orbusiness failure by any of our largest customers would have a material adverseeffect on us.

 

**Because We Cannot Publish OrManufacture Console Titles Without Platform Manufacturers’ Approval, OurAbility To Continue To Develop And Market Successful Console Titles IsDependent On The Manufacturers Continuing To Do Business With Us.**

 

We are dependent on the platform manufacturers and ournon-exclusive licenses with them, both for the right to publish titles fortheir platforms and for the manufacture of our products for theirplatforms.  Our existing platformlicenses for PS2 and PS1, GameCube, GBA, Game Boy Color, and Xbox require thatwe obtain approval for the publication of new games on a title-by-titlebasis.  As a result, the number oftitles we are able to publish for these platforms, and our revenues from titlesfor these platforms, may be limited. Should any manufacturer choose not to renew or extend our licenseagreement at the end of its current term, or if any manufacturer were toterminate our license for any reason, we would be unable to publish additionaltitles for that manufacturer’s platform, which could negatively affect ouroperating results.

 

Each of the manufacturers or their authorized vendorsis the sole source for the fabrication of the products we publish for thatmanufacturer’s platforms.  Each platformlicense provides that the manufacturer may change prices for products at anytime and includes other provisions that give the manufacturer substantialcontrol over our release of new titles. Since each of the manufacturers is also a publisher of games for its ownplatforms, and also manufactures products for all of its other licensees, amanufacturer may give priority to its own products or those of other publishersin the event of insufficient manufacturing capacity.  Unanticipated delays in the delivery of products could alsonegatively affect our operating results.

 

**If We Needed To Write Down LicensesOr Software Development Costs Below The Current Recorded Value, Our Results OfOperations Could Be Adversely Affected.**

 

We typically enter into agreements with licensors ofproperties that require advance payments of royalties and/or guaranteed minimumroyalty payments.  We also enter intoagreements with developers of titles that require a development fee andadditional compensation based on the respective title sales performance.  Sales of products for which such royaltiesare paid or guaranteed payments are made may not be sufficient to cover theamount of these required payments.  Inaddition, we capitalize our advances to developers as a part of “softwaredevelopment costs.”  When, inmanagement’s opinion, future revenues will not be sufficient to recoverpreviously capitalized costs, we expense these items in the current period.  If we needed to write down licenses orsoftware development costs below the current recorded value, our results ofoperations could be adversely affected.

 

**Increased Foreign Operations SubjectUs To Different Business, Political And Economic Risks.**

 

Foreign sales are subject to inherent risks, includingdifferent consumer preferences, higher distribution and operating expenses,unexpected changes in regulatory requirements, tariffs and other barriers,difficulties in staffing and managing foreign operations, and possibledifficulties collecting foreign accounts receivable.  These factors or others could have an adverse effect on ourfuture foreign sales or the profits generated from these sales.

 

Sales generated by our European and Australian officeswill generally be denominated in the currency of the country in which the salesare made or, if made in Europe, Euros, if made in the United Kingdom, GBP andif made in Australia, the Australian Dollar. To the extent our foreign sales are not denominated in U.S. dollars, oursales and profits could be materially and adversely affected by foreigncurrency fluctuations.

 

**Fluctuations In Our QuarterlyOperating Results Could Result In Substantial Losses To Investors.**

 

We have experienced, and may continue to experience,significant quarterly fluctuations in net sales and operating results.  The interactive software entertainmentmarket is highly seasonal, with sales typically significantly higher during thecalendar fourth quarter, due primarily to the increased demand for games duringthe year-end holiday buying season. Other factors that cause fluctuations include:

 

•                       the timingof our release of new titles;

 

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

 

•                       changes inthe mix of titles with varying profit margins;

 

•                       the timingof release of competitor products;

 

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•                       thecompetition in the industry for retail shelf space;

 

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

 

•                       the timingof the introduction of new platforms and the accuracy of retailers’ forecastsof consumer demand.

 

We believe that quarter-to-quarter comparisons of ouroperating results are not a good indication of our future performance.  We may not be able to maintain consistentprofitability on a quarterly or annual basis. It is likely that in some future quarter, our operating results may bebelow the expectations of public market analysts and investors and as a resultof the factors described above and others described throughout this “RiskFactors” section, the price of our common stock may fall or significantlyfluctuate.

 

**Competition For Qualified PersonnelIs Intense In The Interactive Entertainment Software Industry And Failure ToHire And Retain Qualified Personnel Could Seriously Harm Our Business.**

 

We rely to a substantial extent on the management,marketing, sales, technical and software development skills of a limited numberof employees to formulate and implement our business plan, including thedevelopment of our titles and brands. Our success depends to a significant extent upon our ability to attractand retain key personnel.  Competitionfor employees can be intense and the process of locating key personnel with theright combination of skills is often lengthy. The loss of services of key personnel could have a material adverseeffect on us.

 

**Unauthorized Production And Use OfOur Intellectual Property And Rights Could Cause Us To Lose CompetitiveAdvantage And Any Intellectual Property Litigation Could Be Time Consuming AndExpensive To Prosecute And Defend.**

 

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

 

**Defects In Our Game Software CouldHarm Our Reputation Or Decrease The Market Acceptance Of Our Products.**

 

Our game software may contain defects.  In addition, we may not discover softwaredefects until after our products are in use by retail customers.  Any defects in our software could damage ourreputation, cause our customers to terminate relationships with us or toinitiate product liability suits against us, divert our engineering resources,delay market acceptance of our products, increase our costs or cause ourrevenue to decline.

 

**The Interactive EntertainmentIndustry Is Consolidating. In Making Acquisitions, We Face SignificantCompetition From Other Companies, Some Of Which Have Greater Financial AndOther Resources.  We Also FaceIntegration Challenges With The Companies That We Successfully Acquire.**

 

Consistent with our strategy to enhance ourdistribution and product development capabilities, we intend to continue topursue acquisitions of companies, intellectual property rights and other assetsthat can be acquired on acceptable terms and which we believe can be operatedor exploited profitably.  As theinteractive entertainment industry continues to consolidate, we facesignificant competition in making acquisitions, which may constrain our abilityto complete suitable transactions.  Thisis particularly of concern for us because many of our competitors for potentialacquisitions have greater financial and other resources.

 

Further, as we acquire other companies we are facedwith additional challenges.  Theintegration of newly acquired companies’ operations with our existingoperations takes management time and effort. Additionally, there is a risk of loss of key employees, customers andvendors of the recently-acquired companies. Also, if we issue equity securities to pay for an acquisition, theownership percentage of our existing stockholders would be reduced and thevalue of the shares held by our existing stockholders could be diluted.  If we use cash to pay for an acquisition,the payment could significantly reduce the cash that would be available to fundour operations or to use for other purposes.

 

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Acquisition financing may not be available on favorableterms 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 alsorequire us to assume contingent liabilities that could have a negative effecton our future results of operations.

 

**Competition In The InteractiveEntertainment Software Industry May Lead To Reduced Sales Of Our Products,Reduced Profits And Reduced Market Share.**

 

The interactive entertainment software industry isintensely competitive.  We compete, forboth licenses to properties and the sale of games, with the platformmanufacturers and other third party publishers. As a result of their commandingpositions in the industry, the manufacturers generally have better bargainingpositions with respect to retail pricing, shelf space and retaileraccommodations than do any of their licensees, including us.

 

Some of our competitors have greater name recognitionamong consumers and licensors of properties, a broader product line, or greaterfinancial, marketing and other resources than we do.  Accordingly, these competitors may be able to market theirproducts more effectively or make larger offers or guarantees in connectionwith the acquisition of licensed properties. We also believe that other technology and entertainment companies areincreasing their focus on the interactive entertainment software market, whichmight result in greater competition for us. In addition, many of our competitors are developing wireless interactivegames and interactive networks that will be competitive with our interactiveproducts.

 

As competition for popular properties increases, ourcost of acquiring licenses for such properties may increase, resulting inreduced margins.  In addition, ascompetition for retail shelf space becomes more intense, we may need toincrease our marketing expenditures to maintain sales of our titles.  Prolonged price competition, increasedlicensing costs or reduced profit margins would have a negative effect on ourbusiness and financial results.

 

**We Rely On External Developers ForThe Development Of Many Of Our Titles.**

 

Many of our titles are developed by externaldevelopers.  We have no direct controlover the business, finances and operational practices of these externaldevelopers.  A delay or failure tocomplete the work performed by external developers may result in delays in, orcancellations of, product releases.  Thefuture success of many of our titles will depend on our continued ability tomaintain relationships and obtain developer agreements on favorable terms withskilled external developers.  We cannotguarantee that we will be able to establish or maintain such relationships withexternal developers and failure to do so could result in a material adverseeffect on our business and financial results.

 

**Rating Systems And Future LegislationMay Make It Difficult To Successfully Market And Sell Our Products.**

 

Currently, the video game industry is self-regulatedand rated by the Entertainment Software Rating Board.  Our retail customers take the Entertainment Software Rating Boardrating into consideration when deciding which of our products they willpurchase.  If the Entertainment SoftwareRating Board or a manufacturer determines that a product should have a ratingdirected to an older or more mature consumer, we may be less successful in ourmarketing and sales of a particular product.

 

Recently, legislation has been introduced at thelocal, state and federal levels for the establishment of a government mandatedrating and governing system in the United States and in foreign countries forthe video game industry.  Variousforeign countries already allow government censorship of interactiveentertainment products.  We believe thatif the video game industry were to become subject to a government ratingsystem, our ability to successfully market and sell our products could beadversely affected.

 

**Any Significant Downturn In GeneralEconomic Conditions Which Results In A Reduction In Discretionary SpendingCould Reduce Demand For Our Products And Harm Our Business.**

 

Our product sales are affected by the retailer’scustomer ability and desire to spend disposable income on the purchase of ourgame titles.  Any significant downturnin general economic conditions which results in a reduction in discretionaryspending could result in a reduction in demand for our products and could harmour business.  Such industry downturnshave been, and may continue to be, characterized by diminished product demandand subsequent erosion of average selling prices.

 

Because of these and other factors affecting ouroperating results and financial condition, past financial performance shouldnot be considered a reliable indicator of future performance, and investorsshould not use historical trends to anticipate results or trends in futureperiods.

 

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**Item 7A.**         QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

We are exposed to certain market risks arising fromtransactions in the normal course of business, principally risk associated withinterest rate and foreign currency fluctuations.

 

**Interest Rate Risk**

 

We have interest rate risk primarily related to ourinvestment portfolio.  A substantialportion of our portfolio is in short-term investments made up of floating ratecorporate notes and municipal securities. The value of these investments may fluctuate with changes in interestrates.  However, we believe this risk isimmaterial due to the short-term nature of the investments.  The credit facility is based on variableinterest rates.  At March 31, 2004, wehad outstanding letters of credit of $3.1 million.

 

**Foreign Currency Risk**

 

We transact business in manydifferent foreign currencies and may be exposed to financial market riskresulting from fluctuations in foreign currency exchange rates, particularlythe GBP and the Euro, which may result in a gain or loss of earnings tous.  The volatility of the GBP and theEuro (and all other applicable currencies) is monitored frequently throughoutthe year.  We face two risks related toforeign currency exchange: translation risk and transaction risk. Amountsinvested in our foreign operations are translated into U.S. dollars at theexchange rates in effect at the balance sheet date. The resulting translationadjustments are recorded as a component of accumulated other comprehensiveincome (loss) in the stockholders’ equity section of the Consolidated BalanceSheets. Our foreign subsidiaries generally collect revenues and pay expenses incurrencies other than the United States dollar. Since the functional currenciesof our foreign operations are generally denominated in the local currency ofour subsidiaries, the foreign currency translation adjustments are reflected asa component of stockholders’ equity and do not impact operating results.Revenues and expenses in foreign currencies translate into higher or lowerrevenues and expenses in U.S. dollars as the U.S. dollar weakens or strengthensagainst other currencies. Therefore, changes in exchange rates may negativelyaffect our consolidated revenues and expenses (as expressed in U.S. dollars)from foreign operations. Currency transaction gains or losses arising fromtransactions in currencies other than the functional currency are includedwithin General and Administrative expense within the Consolidated Statements ofOperations.While we have not engaged in foreign currency hedging, we may in thefuture use hedging programs, currency forward contracts, currency optionsand/or other derivative financial instruments commonly utilized to reducefinancial market risks if it is determined that such hedging activities areappropriate to reduce risk.

 

**Item 8.***           *FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

 

The report of Independent Registered Public AccountingFirm, Consolidated Financial Statements and Notes to Consolidated FinancialStatements follow below on pages 44 through 74.

 

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**Report of Independent Registered PublicAccounting Firm**

 

To the Stockholders of THQInc.,

 

Calabasas Hills, California

 

We have audited theaccompanying consolidated balance sheets of THQ Inc. and subsidiaries (the“Company”) as of March 31, 2004 and 2003 and December 31, 2002 and the relatedconsolidated statements of operations, stockholders’ equity and cash flows forthe fiscal year ended March 31, 2004, three months ended March 31, 2003 andeach of the two years in the period ended December 31, 2002.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits inaccordance with standards of the Public Company Accounting Oversight Board(United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of the Company as of March 31, 2004 and 2003 and December31, 2002 and the results of its operations and its cash flows for the fiscalyear ended March 31, 2004, three months ended March 31, 2003 and each of thetwo years in the period ended December 31, 2002, in conformity with accountingprinciples generally accepted in the United States of America.

 

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

 

**DELOITTE& TOUCHE LLP**

 

Los Angeles, California

 

June 14, 2004

 

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**CONSOLIDATEDBALANCE SHEETS**

**(In thousands, except per share data)**

 
|                                                                                                                                                                                               |   | **March 31** |    | **December 31,** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------|---------|------------------|--------|
|                                                                                                                                                                                               |   | **2004**     |    | **2003**         |   | **2002** |   |
| **ASSETS**                                                                                                                                                                                         |   |         |    |             |   |   |   |
| Current assets:                                                                                                                                                                                    |   |         |    |             |   |   |   |
| Cash and cash equivalents                                                                                                                                                                          |   | $            | 247,237 |             | $      | 199,860 |   | $ | 132,898 |   |
| Short-term investments                                                                                                                                                                             |   | 5,802        |    | 16,151           |   | 53,951 |   |
| Cash, cash equivalents and short-term  investments                                                                                                                                                 |   | 253,039      |    | 216,011          |   | 186,849 |   |
| Accounts receivable, net of allowances                                                                                                                                                             |   | 59,088       |    | 35,976           |   | 146,508 |   |
| Inventory                                                                                                                                                                                          |   | 22,303       |    | 24,339           |   | 24,362 |   |
| Licenses                                                                                                                                                                                           |   | 13,172       |    | 15,330           |   | 15,897 |   |
| Software development                                                                                                                                                                               |   | 39,997       |    | 54,824           |   | 45,633 |   |
| Deferred income taxes                                                                                                                                                                              |   | —       |    | —           |   | 1,334 |   |
| Income taxes receivable                                                                                                                                                                            |   | —       |    | 1,116            |   | — |   |
| Prepaid expenses and other current assets                                                                                                                                                          |   | 9,451        |    | 11,316           |   | 12,092 |   |
| Total current assets                                                                                                                                                                               |   | 397,050      |    | 358,912          |   | 432,675 |   |
| Property and equipment, net                                                                                                                                                                        |   | 17,468       |    | 16,408           |   | 16,103 |   |
| Licenses, net of current portion                                                                                                                                                                   |   | 9,068        |    | 20,053           |   | 19,525 |   |
| Software development, net of current  portion                                                                                                                                                      |   | 9,798        |    | 2,640            |   | 1,785 |   |
| Deferred income taxes, net of current  portion                                                                                                                                                     |   | 560          |    | 8,346            |   | — |   |
| Goodwill, net                                                                                                                                                                                      |   | 59,399       |    | 58,609           |   | 58,609 |   |
| Long-term marketable securities                                                                                                                                                                    |   | 24,320       |    | —           |   | — |   |
| Other long-term assets, net                                                                                                                                                                        |   | 9,488        |    | 7,981            |   | 9,163 |   |
| TOTAL ASSETS                                                                                                                                                                                       |   | $            | 527,151 |             | $      | 472,949 |   | $ | 537,860 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                      |   |         |    |             |   |   |   |
| Current liabilities:                                                                                                                                                                               |   |         |    |             |   |   |   |
| Accounts payable                                                                                                                                                                                   |   | $            | 22,147  |             | $      | 21,001 |   | $ | 41,148 |   |
| Accrued expenses                                                                                                                                                                                   |   | 22,361       |    | 20,090           |   | 32,548 |   |
| Accrued payment to venture partner                                                                                                                                                                 |   | 746          |    | 676              |   | 5,845 |   |
| Accrued royalties                                                                                                                                                                                  |   | 41,305       |    | 22,893           |   | 30,215 |   |
| Income taxes payable                                                                                                                                                                               |   | 216          |    | —           |   | 2,331 |   |
| Deferred income taxes                                                                                                                                                                              |   | 642          |    | 7,353            |   | — |   |
| Total current liabilities                                                                                                                                                                          |   | 87,417       |    | 72,013           |   | 112,087 |   |
| Accrued royalties, net of current portion                                                                                                                                                          |   | 1,142        |    | 4,523            |   | 15,373 |   |
| Deferred income taxes                                                                                                                                                                              |   | —       |    | —           |   | 1,534 |   |
| Commitments and contingencies                                                                                                                                                                      |   | —       |    | —           |   | — |   |
| Stockholders’ equity:                                                                                                                                                                         |   |         |    |             |   |   |   |
| Preferred stock, par value $.01, 1,000,000  shares authorized                                                                                                                                      |   | —       |    | —           |   | — |   |
| Common stock, par value $.01, 75,000,000  shares authorized; 38,166,978 38,007,879 and 38,416,002 shares issued and  outstanding as of March 31, 2004 and 2003 and December 31, 2002, respectively |   | 382          |    | 380              |   | 384 |   |
| Additional paid-in capital                                                                                                                                                                         |   | 304,860      |    | 305,328          |   | 310,963 |   |
| Accumulated other comprehensive income                                                                                                                                                             |   | 8,302        |    | 1,496            |   | 624 |   |
| Retained earnings                                                                                                                                                                                  |   | 125,048      |    | 89,209           |   | 96,895 |   |
| Total stockholders’ equity                                                                                                                                                                    |   | 438,592      |    | 396,413          |   | 408,866 |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                    |   | $            | 527,151 |             | $      | 472,949 |   | $ | 537,860 |   |

 

See notes to consolidated financial statements.

 

45

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**THQ INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(In thousands, except per share data)**

 
|                                                 |   | **Year  Ended  March 31,  2004** |     | **Transition** |     | **Years Ended December 31** |     |
|------------------------------------------------------|--------|----------------------------------|----------|----------------|----------|-----------------------------|----------|
|                                                 |   |                             | **2003** |           | **2002** |                        | **2001** |   |
| Net sales                                            |   | $                                | 640,846  |           | $        | 66,800                      |     | $ | 480,529 |   | $ | 378,992 |   |
| Costs and expenses:                                  |   |                             |     |           |     |                        |     |   |   |
| Cost of sales                                        |   | 229,218                          |     | 26,378         |     | 185,593                     |     | 154,898 |   |
| License amortization and royalties                   |   | 71,132                           |     | 5,576          |     | 40,476                      |     | 33,144 |   |
| Software development amortization                    |   | 105,632                          |     | 12,018         |     | 83,698                      |     | 35,144 |   |
| Product development                                  |   | 36,850                           |     | 8,899          |     | 34,696                      |     | 17,774 |   |
| Selling and marketing                                |   | 92,475                           |     | 14,294         |     | 66,443                      |     | 46,745 |   |
| Payment to venture partner                           |   | 9,675                            |     | 644            |     | 10,146                      |     | 8,673 |   |
| General and administrative                           |   | 47,006                           |     | 8,442          |     | 34,993                      |     | 28,470 |   |
| Total costs and expenses                             |   | 591,988                          |     | 76,251         |     | 456,045                     |     | 324,848 |   |
| Income (loss) from operations                        |   | 48,858                           |     | (9,451         | )        | 24,484                      |     | 54,144 |   |
| Interest income, net                                 |   | 2,378                            |     | 878            |     | 5,277                       |     | 2,572 |   |
| Other income (expense)                               |   | 4,000                            |     | (2,403         | )        | (10,006                     | )        | — |   |
| Income (loss) before income taxes                    |   | 55,236                           |     | (10,976        | )        | 19,755                      |     | 56,716 |   |
| Income taxes                                         |   | 19,397                           |     | (3,290         | )        | 6,761                       |     | 20,703 |   |
| Net income (loss)                                    |   | $                                | 35,839   |           | $        | (7,686                      | )        | $ | 12,994 |   | $ | 36,013 |   |
| Net income (loss) per share – basic             |   | $                                | 0.94     |           | $        | (0.20                       | )        | $ | 0.33 |   | $ | 1.10 |   |
| Net income (loss) per share – diluted           |   | $                                | 0.92     |           | $        | (0.20                       | )        | $ | 0.32 |   | $ | 1.01 |   |
|                                                 |   |                             |     |           |     |                        |     |   |   |
| Shares used in per share calculation –  basic   |   | 38,186                           |     | 38,319         |     | 39,203                      |     | 32,717 |   |
| Shares used in per share calculation –  diluted |   | 39,004                           |     | 38,319         |     | 41,243                      |     | 35,623 |   |

 

See notes to consolidated financial statements.

 

46

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**THQINC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY(In thousands, except per share data)**

 

**Years Ended December 31, 2001 and 2002 andThree Months Ended March 31, 2003 and Fiscal Year Ended March 31, 2004**

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

 

See notes to consolidated financial statements.

 

47

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|                                                                     |   | **Common  Shares** |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Retained  Earnings** |   | **Total** |   |
|--------------------------------------------------------------------------|--------|--------------------|--------|-------------------|--------|----------------------------------|--------|------------------------------------------------------|--------|------------------------|--------|-----------|--------|
| Balance at January 1, 2002                                               |   | 38,979,747         |   | $                 | 390    |                             | $      | 316,758                                              |   | $                      | (2,187 | )         | $      | 83,901 |   | $ | 398,862 |   |
| Exercise of options                                                      |   | 932,234            |   | 9                 |   | 7,741                            |   | —                                               |   | —                 |   | 7,750     |   |
| Issuance of common stock for ValuSoft  acquisition                       |   | 166,600            |   | 2                 |   | 4,626                            |   | —                                               |   | —                 |   | 4,628     |   |
| Issuance of warrants                                                     |   | —             |   | —            |   | 1,214                            |   | —                                               |   | —                 |   | 1,214     |   |
| Repurchase of common stock                                               |   | (1,671,531         | )      | (17               | )      | (24,988                          | )      | —                                               |   | —                 |   | (25,005   | )      |
| Adjustments related to 2001 secondary  offering                          |   | —             |   | —            |   | 52                               |   | —                                               |   | —                 |   | 52        |   |
| Stock compensation                                                       |   | 8,952              |   | —            |   | 436                              |   | —                                               |   | —                 |   | 436       |   |
| Tax benefit related to the exercise of  employee stock options           |   | —             |   | —            |   | 5,124                            |   | —                                               |   | —                 |   | 5,124     |   |
| Comprehensive income:                                                    |   |               |   |              |   |                             |   |                                                 |   |                   |   |      |   |
| Net income                                                               |   | —             |   | —            |   | —                           |   | —                                               |   | 12,994                 |   | 12,994    |   |
| Other comprehensive income                                               |   | —             |   | —            |   | —                           |   | —                                               |   | —                 |   |      |   |
| Foreign currency translation adjustment                                  |   | —             |   | —            |   | —                           |   | 4,318                                                |   | —                 |   | 4,318     |   |
| Unrealized loss on investments                                           |   | —             |   | —            |   | —                           |   | (1,507                                               | )      | —                 |   | (1,507    | )      |
| Comprehensive income                                                     |   |               |   |              |   |                             |   |                                                 |   |                   |   | 15,805    |   |
| Balance at January 1, 2003                                               |   | 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 |   |

 

See notes to consolidated financial statements.

 

48

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|                                                           |   | **Common  Shares** |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Retained  Earnings** |   | **Total** |   |
|----------------------------------------------------------------|--------|--------------------|--------|-------------------|--------|----------------------------------|--------|------------------------------------------------------|--------|------------------------|--------|-----------|--------|
| Balance at April 1, 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   |   |
|                                                                |        |                    |        |                   |        |                                  |        |                                                      |        |                        |        |           |        |  |  |  |  |  |

 

See notes to consolidated financial statements.

 

49

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**THQ INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
|                                                                                             |     | **Year  Ended  March 31,  2004** |     | **Transition  2003** |   | **Years Ended December 31,** |   |
|--------------------------------------------------------------------------------------------------|----------|----------------------------------|----------|----------------------|--------|------------------------------|--------|
|                                                                                             | **2002** |                             | **2001** |                 |
| Cash flows from operating activities:                                                            |     |                             |     |                 |   |                         |   |   |   |
| Net income (loss)                                                                                |     | $                                | 35,839   |                 | $      | (7,686                       | )      | $ | 12,994 |   | $ | 36,013 |   |
|                                                                                             |     |                             |     |                 |   |                         |   |   |   |
| Adjustments to reconcile net income (loss)  to net  cash provided by operating  activities: |     |                             |     |                 |   |                         |   |   |   |
| Depreciation and amortization                                                                    |     | 7,227                            |     | 1,956                |   | 6,385                        |   | 5,416 |   |
| Amortization of licenses and software  development                                               |     | 126,686                          |     | 13,323               |   | 91,677                       |   | 35,335 |   |
| Loss on disposal of property and equipment                                                       |     | 258                              |     | —               |   | 137                          |   | 117 |   |
| Stock compensation                                                                               |     | 84                               |     | 530                  |   | 436                          |   | 299 |   |
| Tax benefit related to the exercise of  employee stock options                              |     | 2,367                            |     | 181                  |   | 5,124                        |   | 10,923 |   |
| Deferred income taxes                                                                            |     | 2,464                            |     | (1,180               | )      | (730                         | )      | 11,338 |   |
| 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                                                                         |     | (21,766                          | )        | 111,022              |   | (15,371                      | )      | (9,709 | ) |
| Inventory                                                                                        |     | 3,427                            |     | 233                  |   | (12,112                      | )      | 743 |   |
| Licenses                                                                                         |     | (24,072                          | )        | (4,027               | )      | (33,918                      | )      | (22,596 | ) |
| Software development                                                                             |     | (80,803                          | )        | (19,305              | )      | (75,049                      | )      | (53,095 | ) |
| Prepaid expenses and other current assets                                                        |     | 2,318                            |     | 771                  |   | (2,101                       | )      | (2,901 | ) |
| Accounts payable                                                                                 |     | (343                             | )        | (20,374              | )      | 11,067                       |   | 5,517 |   |
| Accrued expenses                                                                                 |     | 970                              |     | (12,543              | )      | 14,203                       |   | (1,171 | ) |
| Accrued payment to venture partner                                                               |     | 70                               |     | (5,169               | )      | (626                         | )      | (3,026 | ) |
| Accrued royalties                                                                                |     | 15,012                           |     | (18,181              | )      | 8,834                        |   | 6,952 |   |
| Income taxes                                                                                     |     | 1,416                            |     | (3,479               | )      | 2,374                        |   | (6,336 | ) |
| Net cash provided by operating activities                                                        |     | 71,154                           |     | 38,475               |   | 16,330                       |   | 33,237 |   |
| Cash flows provided by (used in) investing  activities:                                          |     |                             |     |                 |   |                         |   |   |   |
| Proceeds from sale of property and  equipment                                                    |     | —                           |     | —               |   | —                       |   | 65 |   |
| Proceeds from sales and maturities of  short-term investments                                    |     | 42,500                           |     | 65,019               |   | 90,732                       |   | — |   |
| Purchases of short-term investments                                                              |     | (32,155                          | )        | (28,809              | )      | (110,072                     | )      | (35,124 | ) |
| Acquisition of property and equipment                                                            |     | (7,638                           | )        | (2,099               | )      | (7,794                       | )      | (5,750 | ) |
| Acquisitions, net of cash acquired                                                               |     | (2,300                           | )        | —               |   | (9,373                       | )      | — |   |
| Investment in Network Interactive Sports  Ltd.                                                   |     | —                           |     | —               |   | (221                         | )      | (3,325 | ) |
| Purchases of long-term marketable  securities                                                    |     | (24,320                          | )        | —               |   | —                       |   | — |   |
| (Increase) decrease in other long-term  assets                                                   |     | (70                              | )        | 1,510                |   | (1,422                       | )      | 50 |   |
| Net cash provided by (used in) investing  activities                                             |     | (23,983                          | )        | 35,621               |   | (38,150                      | )      | (44,084 | ) |
| Cash flows provided by (used in)  financing  activities:                                    |     |                             |     |                 |   |                         |   |   |   |
| Net decrease in short-term borrowings                                                            |     | —                           |     | —               |   | —                       |   | (15,473 | ) |
| Repurchase of common stock                                                                       |     | (10,994                          | )        | (7,758               | )      | (25,005                      | )      | — |   |
| Principal payments on long-term debt                                                             |     | —                           |     | —               |   | —                       |   | (1,806 | ) |
| Proceeds from issuance of common stock                                                           |     | —                           |     | —               |   | 52                           |   | 154,605 |   |
| Proceeds from exercise of warrants and  options                                             |     | 7,121                            |     | 1,408                |   | 7,750                        |   | 16,721 |   |
| Net cash provided by (used in) financing  activities                                             |     | (3,873                           | )        | (6,350               | )      | (17,203                      | )      | 154,047 |   |
| Effect of exchange rate changes on cash                                                          |     | 4,079                            |     | (784                 | )      | 862                          |   | (139 | ) |
| Net increase (decrease) in cash and cash  equivalents                                            |     | 47,377                           |     | 66,962               |   | (38,161                      | )      | 143,061 |   |
| Cash and cash equivalents — beginning of  period                                            |     | 199,860                          |     | 132,898              |   | 171,059                      |   | 27,998 |   |
| Cash and cash equivalents — end of period                                                   |     | $                                | 247,237  |                 | $      | 199,860                      |   | $ | 132,898 |   | $ | 171,059 |   |

 

See notes to consolidated financial statements.

 

50

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|                             |     | **Year  Ended  March 31,  2004** |     | **Transition  2003** |   | **Years Ended December 31,** |   |
|----------------------------------|----------|----------------------------------|----------|----------------------|--------|------------------------------|--------|
|                             | **2002** |                             | **2001** |                 |
| Cash paid during the period for: |     |                             |     |                 |   |                         |   |   |   |
| Income taxes                     |     | $                                | 15,625   |                 | $      | 2,616                        |   | $ | 3,257 |   | $ | 8,204 |   |
| Interest                         |     | $                                | 144      |                 | $      | 11                           |   | $ | 76 |   | $ | 74 |   |

 

On March 31, 2004, anadjustment to Goodwill of $1.5 million was recorded.  This was based on the determination for future realization ofpreviously acquired Net Operating Losses related to the acquisition of ourGerman subsidiary.

 

On July 1, 2002, we paid $9.6million in cash and issued approximately 167,000 shares of common stock as partof the purchase price of the assets of ValuSoft, Inc. (now referred to as“ValuSoft”), a publisher and developer of value-priced interactiveentertainment and productivity software. The issuance increased common stock and additional paid-in-capital by$2,000 and $4.6 million respectively, and was allocated among the assetsacquired. In addition, the former shareholders of ValuSoft, Inc. are entitledto additional consideration of up to $11.0 million if ValuSoft reaches certainpre-tax income targets in the five years following July 1, 2002.  The annual payments of the additionalconsideration, if any, range from $1.0 million to $2.8 million per year and maybe paid, at our discretion, in cash or shares of our common stock and will beadded to goodwill.  For the twelvemonths ended June 30, 2003, ValuSoft reached its pretax target and we have paid$2.3 million in cash and adjusted goodwill accordingly.  (See Note 3)

 

| Estimated Fair Value (in thousands): |   |   |   |
|--------------------------------------|--------|--------|--------|
| Tangible assets acquired             |   | $      | 2,837  |   |
| Software development acquired        |   | 1,491  |   |
| Licenses acquired                    |   | 1,109  |   |
| Liabilities assumed                  |   | (2,940 | )      |
| Goodwill                             |   | 14,342 |   |
| Purchase price                       |   | $      | 16,839 |   |

 

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

 

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

 

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

 

See notes to consolidated financial statements.

 

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**THQ INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.     Descriptionof Business**

 

*Business*. THQ Inc., a Delaware corporation, is a leading global developer andpublisher of interactive entertainment software for the major hardwareplatforms in the video game market.  Wecurrently develop and publish titles primarily for Sony PlayStation 2,Microsoft Xbox, Nintendo GameCube, Nintendo Game Boy Advance, personalcomputers (“PCs”) and wireless devices. Our titles span most major interactive entertainment software genres, includingaction, adventure, children’s, driving, fighting, puzzle, role playing,simulation, sports and strategy.  Ourcustomers include Wal-Mart, Toys “R” Us, Target, Best Buy, Game Stop,Electronics Boutique, KB Toys, Game Stores Group Ltd and other national andregional retailers, discount store chains and specialty retailers.

 

Unless the context otherwiserequires, references in this document to “THQ” or the “Company” include THQInc. and all of its wholly owned subsidiaries.

 

*Fiscal Year.* Effective January 1, 2003, we changed our fiscal year end from December31 to March 31.  Accordingly, thetransitional period ended March 31, 2003 (Transition 2003) represents threemonths of operations.  The comparisonfor the three months ended March 31, 2003 and 2002 (unaudited) is included inNote 16.

 

*Platform License Agreements.*

* *

*Sony.* We have three license agreements with Sony pursuant to which we have thenon-exclusive right to utilize the Sony name related trademarks, and itsproprietary information and technology in order to develop and market softwarefor use with the 128-bit Sony PlayStation 2. The license agreement for the United States and Canada expires in March2005 (subject to automatic annual renewal unless either party terminates theagreement by January 31 of the applicable year); the license agreement forEurope, Australia, New Zealand, certain countries in Africa and the Middle Eastexpires in March 2005 (subject to automatic renewal unless either partyterminates the agreement by February 28 of the applicable year); and thelicense agreement for Korea expires in March 2006.  We also have two license agreements with Sony pursuant to whichwe have the non-exclusive right to utilize the Sony name, related trademarksand its proprietary information and technology in order to develop and marketsoftware for use with the 32-bit Sony PlayStation.  The license agreement for the United States, Canada, Mexico andLatin America expires in August 2006; and the license agreement for Europe,Australia and New Zealand expires in December 2005.

 

*Nintendo.* We have a license agreement with Nintendo pursuant to which we have thenon-exclusive right to utilize the Nintendo name, related trademarks, and itsproprietary information and technology in order to develop and market softwarefor use with the Game Boy Advance handheld game console in all countries in theWestern Hemisphere which expires in July 2004 and a license agreement forEurope, Australia and New Zealand which expires in April 2006.  We have a license agreement with Nintendopursuant to which we have the non-exclusive right to utilize the Nintendo name,related trademarks, and its proprietary information and technology in order todevelop and market software for use with the 128-bit Nintendo GameCube in allcountries in the Western Hemisphere which expires in April 2005 and a licenseagreement for Europe, Australia and New Zealand which expires in April2006.  We also have a license agreementwith Nintendo pursuant to which we have the non-exclusive right to utilize theNintendo name, related trademarks, and its proprietary information andtechnology in order to develop and market software for use with the Game BoyColor handheld game console in all countries in the Western Hemisphere whichexpires in March 2006.  We also have alicense agreement with Nintendo pursuant to which we have the non-exclusiveright to utilize to Nintendo name, related trademarks, and its proprietaryinformation and technology in order to develop and market software for use withthe Game Boy Color handheld game console in Europe, Australia and New Zealandwhich expires in October 2005.

 

*Microsoft.* We have a license agreement with Microsoft pursuant to which we have thenon-exclusive right to utilize the Microsoft name, related trademarks, and itsproprietary information and technology in order to develop and market softwarefor use with the 128-bit Microsoft Xbox, which expires in November 2004.  The territory is determined on atitle-by-title basis.

 

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

 

In addition, we must indemnifySony, Nintendo and Microsoft, as appropriate, with respect to all loss,liability and expense resulting from any claim against Sony, Nintendo andMicrosoft involving the development, marketing, sale or use of our titles,including any claims for copyright or trademark infringement brought againstSony, Nintendo and Microsoft.  As such,we bear the risk that the properties and information and technology licensedfrom Sony, Nintendo and Microsoft and incorporated in the software may infringethe rights of third parties.  Generally,we are entitled to indemnification from our software developers and propertylicensors to cover our indemnification

 

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obligations to Sony, Nintendoand Microsoft but no assurance can be given that, if any claim is broughtagainst us, the developers and/or licensors will have sufficient resources toindemnify us.

 

**2.     Summaryof Significant Accounting Policies**

 

*Principles of Consolidation.*  The consolidated financial statementsinclude the accounts of THQ Inc. and our wholly owned subsidiaries.  Investments in business entities in which wedo not have control, but have the ability to exercise significant influenceover operating and financial policies (generally 20-50% ownership), areaccounted for by the equity method.  Allmaterial intercompany balances and transactions have been eliminated in consolidation.

 

*Foreign Currency Translation.*  Assets and liabilities of foreign operationsare translated at current rates of exchange while results of operations aretranslated at average rates in effect for the period.  Translation gains or losses are shown as a separate component ofaccumulated other comprehensive income (loss). The translation gain (loss) on long-term intercompany balances includedin the foreign currency translation was $2.3 million for the fiscal year endedMarch 31, 2004.  The translation gain(loss) on long-term intercompany balances included in the foreign currencytranslation was ($0.4) million, $1.8 million and ($0.6) million for theTransition 2003 and the years ended December 31, 2002 and 2001, respectively.  Foreign currency transaction gains andlosses result from exchange rate changes for transactions denominated incurrencies other than the functional currency. For the fiscal year ended March 31, 2004 foreign currency transactiongain was $1.4 million and is included in general and administrativeexpenses.  For the Transition 2003 andyears ended December 31, 2002 and 2001 foreign currency transaction gains(losses) were not material.

 

*Cash, Cash Equivalents, Short-Term Investments, and Long-TermMarketable Securities*

 
| **(In thousands)**                                                                  |     | **March 31,** |     | **December  31,  2002** |   |
|-------------------------------------------------------------------------------------|----------|---------------|----------|-------------------------|--------|
|                                                                                | **2004** |          | **2003** |                    |   |
| Cash and cash equivalents                                                           |     | $             | 247,237  |                    | $      | 199,860 |   | $ | 132,898 |   |
|                                                                                |     |          |     |                    |   |   |   |
| Short-term investments                                                              |     |          |     |                    |   |   |   |
|                                                                                |     |          |     |                    |   |   |   |
| Available for sale                                                                  |     | —        |     | 12,143                  |   | 44,940 |   |
|                                                                                |     |          |     |                    |   |   |   |
| Held to maturity                                                                    |     | 5,802         |     | 4,008                   |   | 9,011 |   |
|                                                                                |     |          |     |                    |   |   |   |
| Short-term investments                                                              |     | 5,802         |     | 16,151                  |   | 53,951 |   |
|                                                                                |     |          |     |                    |   |   |   |
| Long-term marketable securities                                                     |     | 24,320        |     | —                  |   | — |   |
|                                                                                |     |          |     |                    |   |   |   |
| Cash, cash equivalents, short-term  investments and long-term marketable securities |     | $             | 277,359  |                    | $      | 216,011 |   | $ | 186,849 |   |

 

We consider all highly liquidinvestments purchased with maturities less than three months to be cashequivalents.

 

Investments with a maturitygreater than three months, but less than one year, at the time of purchase areconsidered to be short-term investments. We invest in highly liquid debt instruments with strong creditratings.  The carrying amounts of theinvestments approximate fair value due to their short maturities.  Unrealized gains and (losses) are recordedas a separate component of accumulated other comprehensive income (loss) forinvestments classified as available-for-sale. For the fiscal year ended March 31, 2004 there were no unrealized gainsor (losses) on available-for-sale investments, except our investment in Yuke’sCo., Ltd. (“Yuke’s) which is included in our other long-term assets in theaccompanying balance sheet.  See Note 8.

 

At March 31, 2003 wereclassified $556,000 of unrealized losses to net income (loss).  The unrealized gains and (losses) on theinvestments in securities for the Transition 2003 and years ended December 31,2002 and 2001, were $44,000, ($492,000) and ($20,000), respectively. See Note 8for disclosure of activity related to Yuke’s.

 

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Short-term investments andlong-term marketable securities at March 31, 2004 and 2003 and December 31,2002 were as follows:

 
| **(In thousands)**                            |   | **Amortized  Cost** |   | **Gross  Unrealized  Holding  Gains** |   | **Gross  Unrealized  Holding  Losses** |   | **Fair  Value** |   |
|-----------------------------------------------|--------|---------------------|--------|---------------------------------------|--------|----------------------------------------|--------|-----------------|--------|
| **Available-for-sale:**                       |   |                |   |                                  |   |                                   |   |            |   |
| **March 31, 2004**                            |   |                |   |                                  |   |                                   |   |            |   |
| Corporate notes and bonds                     |   | $                   | — |                                  | $      | —                                 |   | $               | — |   | $ | — |   |
| U.S. government and agencies                  |   | —              |   | —                                |   | —                                 |   | —          |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| Total available-for-sale investments          |   | $                   | — |                                  | $      | —                                 |   | $               | — |   | $ | — |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| **March 31, 2003**                            |   |                |   |                                  |   |                                   |   |            |   |
| Corporate notes and bonds                     |   | $                   | 6,346  |                                  | $      | —                                 |   | $               | — |   | $ | 6,346 |   |
| U.S. government and agencies                  |   | 5,797               |   | —                                |   | —                                 |   | 5,797           |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| Total available-for-sale investments          |   | $                   | 12,143 |                                  | $      | —                                 |   | $               | — |   | $ | 12,143 |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| **December 31, 2002**                         |   |                |   |                                  |   |                                   |   |            |   |
| Corporate notes and bonds                     |   | $                   | 22,953 |                                  | $      | —                                 |   | $               | (259   | ) | $ | 22,694 |   |
| U.S. government and agencies                  |   | 22,499              |   | —                                |   | (253                                   | )      | 22,246          |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| Total available-for-sale investments          |   | $                   | 45,452 |                                  | $      | —                                 |   | $               | (512   | ) | $ | 44,940 |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| **Held-to-maturity (current):**               |   |                |   |                                  |   |                                   |   |            |   |
| **March 31, 2004**                            |   |                |   |                                  |   |                                   |   |            |   |
| Corporate debt securities                     |   | $                   | 4,800  |                                  | $      | —                                 |   | $               | — |   | $ | 4,800 |   |
| Municipal securities                          |   | 1,002               |   | —                                |   | —                                 |   | 1,002           |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| Total current held-to-maturity investments    |   | $                   | 5,802  |                                  | $      | —                                 |   | $               | — |   | $ | 5,802 |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| **March 31, 2003**                            |   |                |   |                                  |   |                                   |   |            |   |
| Municipal securities                          |   | $                   | 4,008  |                                  | $      | —                                 |   | $               | — |   | $ | 4,008 |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| Total held-to-maturity investments            |   | $                   | 4,008  |                                  | $      | —                                 |   | $               | — |   | $ | 4,008 |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| **December 31, 2002**                         |   |                |   |                                  |   |                                   |   |            |   |
| Corporate debt securities                     |   | $                   | 5,000  |                                  | $      | —                                 |   | $               | — |   | $ | 5,000 |   |
| Municipal securities                          |   | 4,011               |   | —                                |   | —                                 |   | 4,011           |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| Total held-to-maturity investments            |   | $                   | 9,011  |                                  | $      | —                                 |   | $               | — |   | $ | 9,011 |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| **Held-to-maturity (long-term):**             |   |                |   |                                  |   |                                   |   |            |   |
| **March 31, 2004**                            |   |                |   |                                  |   |                                   |   |            |   |
| Municipal securities                          |   | $                   | 24,320 |                                  | $      | —                                 |   | $               | — |   | $ | 24,320 |   |
|                                          |   |                |   |                                  |   |                                   |   |            |   |
| Total long-term held-to-maturity  investments |   | $                   | 24,320 |                                  | $      | —                                 |   | $               | — |   | $ | 24,320 |   |

 

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During the current year weacquired municipal bonds with maturities of greater than one year for $24.3million.  These bonds are classified asheld to maturity.  Investments with amaturity greater than one year, at the time of purchase are considered to belong-term assets.  Our long-termmarketable securities have a maturity due date of 1-2 years as of March 31,2004.

 

*Fair Values of Financial Instruments.*  The carrying value of certain financialinstruments, including cash and cash equivalents, short-term investments heldto maturity, accounts receivable, accounts payable, accrued expenses andaccrued royalties approximate fair market value based on their short–termnature.  Short-term investmentsclassified as available for sale are stated at fair value.  The value of short-term investments andlong-term marketable securities are determined using quoted market prices.

 

*Concentrations of Credit Risk.*  Financial instruments which potentiallysubject us to concentration of credit risk consist principally of cash and cashequivalents, short-term investments, accounts receivable and long-termmarketable securities.  We place cashand cash equivalents and short-term investments with high credit-qualityinstitutions and limit the amount of credit exposure to any one institution.  We believe this risk is immaterial due tothe short-term nature of such investments. We place our long-term marketable securities with high credit-qualityinstitutions and limit the amount of credit exposure to any oneinstitution.  Most of our sales are madedirectly to mass merchandisers and national retailers.  Due to the increased volume of sales tothese channels, we have experienced an increased concentration of credit risk,and as a result, may maintain individually significant receivable balances withsuch mass merchandisers and national retailers.  We perform ongoing credit evaluations of our customers andmaintain an allowance for potential credit losses.

 

Sales (before returns andallowances) to a major customer represented 19%, 25%, 16% and 14% of grosssales in the fiscal year ended March 31, 2004, Transition 2003 and the yearsended December 31, 2002, and 2001, respectively.  This customer accounted for approximately 37%, 38% and 17% ofaccounts receivable at March 31, 2004 and 2003 and December 31, 2002,respectively.  Sales (before returns andallowances) to another major customer represented 7%, 11%, 13% and 12% of grosssales in the fiscal year ended March 31, 2004, Transition 2003 and the yearsended December 31, 2002 and 2001, respectively.  This customer accounted for approximately 23%, 39% and 16% ofaccounts receivable at March 31, 2004 and 2003, and December 31, 2002.

 

*Inventory.* Inventory, which consists principally of finished products, are statedat 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.

 

*Property and Equipment.*  Property and equipment are recorded atcost.  Depreciation is computed usingthe straight-line method over the estimated useful lives of the assets.  Leasehold improvements are amortized overthe shorter of their useful lives or the remaining lease term.  Property and equipment consist of thefollowing:

 
| **(In thousands)**                               |     | **Useful  Lives** |     | **March 31,** |   | **December  31,  2002** |   |
|--------------------------------------------------|----------|-------------------|----------|---------------|--------|-------------------------|--------|
|                                             | **2004** |              | **2003** |          |   |
| Building                                         |     | 30 yrs            |     | $             | 719    |                    | $      | 719 |   | $ | 719 |   |
| Land                                             |     | —            |     | 401           |   | 401                     |   | 401 |   |
| Computer equipment and software                  |     | 3-10 yrs          |     | 31,111        |   | 24,795                  |   | 23,138 |   |
| Furniture, fixtures and equipment                |     | 5 yrs             |     | 3,960         |   | 3,535                   |   | 3,375 |   |
| Leasehold improvements                           |     | 3-6 yrs           |     | 2,422         |   | 1,576                   |   | 1,443 |   |
| Automobiles                                      |     | 2-5 yrs           |     | 153           |   | 121                     |   | 74 |   |
|                                             |     |              |     |          |   |                    |   |   |   |
| Less: accumulated depreciation and  amortization |     |              |     | (21,298       | )      | (14,739                 | )      | (13,047 | ) |
|                                             |     |              |     | $             | 17,468 |                    | $      | 16,408 |   | $ | 16,103 |   |

 

*Licenses.* Minimum guaranteed royalty payments for intellectual property licensesare initially recorded as an asset (licenses) and as a liability (accruedroyalties) at the contractual amount upon execution of the contract when nosignificant performance remains with the licensor.  When significant performance remains with the licensor, we recordroyalty payments as an asset (licenses) when actually paid rather than uponexecution 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.

 

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Licenses are expensed tolicense amortization and royalties at the higher of (i) the contractual royaltyrate based on actual net product sales or (ii) the ratio of current units soldto total projected units sold.  When, inmanagement’s estimate, future cash flows will not be sufficient to recoverpreviously capitalized costs, we expense these capitalized costs to licenseamortization and royalties.  See – “*Long-Lived Assets*” below.  If actual revenues, or revised forecastedunits, fall below the initial forecasted units, the charge to licenseamortization and royalties may be larger than anticipated in any givenquarter.  As of March 31, 2004, the netcarrying value of our licenses was $22.2 million.

 

*Software Development*.  We utilize both independent softwaredevelopers and internal development teams to develop our software.  We account for software development costs inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 86,“Accounting for the Costs of Computer Software to be Sold, Leased, or OtherwiseMarketed.”  We capitalize softwaredevelopment costs once technological feasibility is established and wedetermine that such costs are recoverable against future revenues.  For products where proven game enginetechnology exists, this may occur early in the development cycle.  We capitalize the milestone payments made toindependent software developers and the direct payroll costs for our internaldevelopment teams.  We evaluatetechnological feasibility on a product-by-product basis.  Amounts related to software development forwhich technological feasibility is not yet met are charged immediately toproduct development expense.

 

Capitalized softwaredevelopment is expensed to software development amortization at the higher of(i) the contractual rate based on actual net product sales or (ii) the ratio ofcurrent units sold to total projected units sold.  When, in management’s estimate, future cash flows will not besufficient to recover previously capitalized costs, we expense these items tosoftware development amortization.  See– “*Long-Lived Assets*” below.  If actual revenues, or revised forecastedunits, fall below the initial forecasted units, the charge to softwaredevelopment amortization may be larger than anticipated in any givenquarter.  As of March 31, 2004, the netcarrying value of our software development was $49.8 million.

 

*Goodwill and Other Intangible Assets.*  In accordance with the adoption of SFAS No.142, “*Goodwilland Other Intangible Assets*”, on January 1, 2002, we ceasedamortizing goodwill.  According to ouraccounting policy, we performed an annual review during the quarter ended June30, 2003, 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.  Theseestimates are consistent with the plans and estimates that we use to manage theunderlying businesses.  We performedsimilar impairment tests for indefinite-lived intangible assets and found noimpairment. All identifiable intangible assets with finite lives will continueto be amortized over their estimated useful lives and assessed for impairmentunder SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

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The following is areconciliation of previously reported net income and earnings per share to theamounts adjusted for the exclusion of goodwill amortization, including $196,000of goodwill amortization associated with an equity method investment, for theyear ended December 31, 2001.

 
| **(In thousands, except per share  data)**               |   |   |   |   |
|----------------------------------------------------------|--------|--------|--------|--------|
| Reported net income                                      |   | $      | 36,013 |   |
| Add back: Goodwill amortization                          |   | 404    |   |
| Adjusted net income                                      |   | $      | 36,417 |   |
|                                                     |   |   |   |
| **Basic earnings per share:**                            |   |   |   |
| Reported net income per share                            |   | $      | 1.10   |   |
| Effect of Goodwill amortization on net  income per share |   | 0.01   |   |
| Adjusted basic net income per share                      |   | $      | 1.11   |   |
|                                                     |   |   |   |
| **Diluted earnings per share:**                          |   |   |   |
| Reported net income per share                            |   | $      | 1.01   |   |
| Effect of Goodwill amortization on net  income per share |   | 0.01   |   |
| Adjusted diluted net income per share                    |   | $      | 1.02   |   |

 

*Long-Lived Assets.*  We evaluate long-lived assets, including but not limited tolicenses, software development, property and equipment and identifiableintangible assets with finite lives, for impairment whenever events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable.  Potential impairment ofassets is measured by a comparison of the carrying amount of an asset to futureundiscounted net cash flows expected to be generated by the asset.  If such assets are considered to beimpaired, the impairment to be recognized is measured by the amount by whichthe carrying amount of the asset exceeds its fair value.

 

*Revenue Recognition.*  Our revenue recognition policies are in compliance with AmericanInstitute of Certified Public Accountants Statement of Position (“SOP”) 97-2,“Software Revenue Recognition”, as amended by SOP 98-9, “Modification of SOP97-2, Software Revenue Recognition, With Respect to Certain Transactions”,which provide guidance on generally accepted accounting principles forrecognizing revenue on software transactions, and Staff Accounting Bulletin(“SAB”) No. 104, *“Revenue Recognition in FinancialStatements”*, which outlines the basic criteria that must be met torecognize revenue and provides guidance for presentation of revenue and fordisclosure related to revenue recognition policies in financial statementsfiled with the SEC.

 

Product Sales: We recognizerevenue for packaged software when title and risk of loss transfers to thecustomer, provided that no significant vendor support obligations remainoutstanding and that collection of the resulting receivable is deemed probableby management.  Although we generallysell our products on a no-return basis, in certain circumstances we may allowprice protection, returns or other allowances on a negotiated basis.  We estimate such price protection, returnsor other allowances based upon management’s evaluation of our historicalexperience, retailer inventories, the nature of the titles and otherfactors.  Such estimates are deductedfrom gross sales (See Note 5).  Softwareis sold under a limited 90-day warranty against defects in material andworkmanship.  To date, we have notexperienced material warranty claims.

 

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

 

Revenue from the licensing ofsoftware was $8.4 million and $4.1 million for the fiscal year ended March 31,2004 and Transition 2003, respectively, and $2.0 million, and $1.4 million forthe years ended December 31, 2002 and 2001, respectively.

 

*Advertising.* Advertising and sales promotion costs are generally expensed asincurred, except for television airtime and print media costs associated withmedia campaigns, which are deferred and charged to expense in the period theairtime or advertising space is used for the first time.  Advertising costs were $34.0 million and$4.6 million for the fiscal year ended March 31, 2004 and Transition 2003,respectively, and $23.4 million, and $14.8 million in the years ended December31, 2002 and 2001, respectively.

 

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*Employee Stock-Based Compensation.*  We account for our employee stock based compensationplans under the intrinsic value method in accordance with Accounting PrinciplesBulletin (APB) Opinion 25, “Accounting for Stock Issued to Employees,” andrelated interpretations.  No stockoption compensation expense, other than acquisition-related compensation, isrecognized in our Consolidated Statements of Operations because all stockoptions granted had an exercise price equal to the fair value of the underlyingcommon stock on the grant date, except for options issued by Pacific Coast Power& Light Co. and Genetic Anomalies prior to the acquisitions, which wereissued at below market.

 

On November 13, 2003, wecommenced a stock option exchange program (“Exchange Program”) under whicheligible employees holding options to purchase 1,494,614 shares of our commonstock, with a weighted average exercise price of $30.77 per share and a rangeof $27.49 to $39.11 per share, could elect to exchange their options for adesignated fewer number of replacement options with a new exercise price to begranted at least six months and one day from the cancellation date.  Our executive officers and members of ourboard of directors were not eligible to participate in the Exchange Program.  In accordance with the terms of the ExchangeProgram, we canceled 1,216,903 outstanding stock options on December 15, 2003and expect to issue, in exchange for the canceled options, approximately769,000 new options in June 2004. The exercise price of the new stock optionswill be the closing price of our common stock on the Nasdaq Stock Market on thedate the new stock options are granted. In accordance with SFAS No. 123, “Accounting for Stock-BasedCompensation” (SFAS 123), the tables below include a modification of the1,216,903 stock options canceled under the Exchange Program and wereimmediately reissued as approximately 769,000 new options. Accordingly, thesedisclosures include estimates about (1) the risk-free interest rate;(2) the expected life of the new stock options; and (3) the expectedvolatility of our common stock.

 

The following table shows whatour net income (loss) and earnings (loss) per share would have been forthe fiscal year ended March 31, 2004 and Transition 2003 and the years endedDecember 31, 2002 and 2001 had we accounted for our stock-based compensationplans under the fair value method of SFAS 123 using the assumptions in thetable above.  The estimated value of theoptions is amortized ratably to expense over the options’ vesting periods.  Because the value is determined as of thedate of grant, the actual value ultimately realized by the employee may besignificantly different.

 
| **(In thousands, except per share data)**                                                                                                           |     | **Year Ended  March 31,  2004** |     | **Transition  2003** |   | **Years Ended December 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|----------|---------------------------------|----------|----------------------|--------|------------------------------|--------|
|                                                                                                                                                | **2002** |                            | **2001** |                 |
| Net income (loss)-as reported                                                                                                                       |     | $                               | 35,839   |                 | $      | (7,686                       | )      | $ | 12,994 |   | $ | 36,013 |   |
| Add:   Stock-based employee compensation expense included in  reported net income (loss),  net of related tax effects                |     | 54                              |     | 119                  |   | 104                          |   | 182 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all  awards,  net of related tax effects |     | (14,890                         | )        | (4,033               | )      | (19,436                      | )      | (12,269 | ) |
| Net income (loss)-pro forma                                                                                                                         |     | $                               | 21,003   |                 | $      | (11,600                      | )      | $ | (6,338 | ) | $ | 23,926 |   |
| Earnings (loss) per share:                                                                                                                          |     |                            |     |                 |   |                         |   |   |   |
| Basic-as reported                                                                                                                                   |     | $                               | 0.94     |                 | $      | (0.20                        | )      | $ | 0.33 |   | $ | 1.10 |   |
| Basic-pro forma                                                                                                                                     |     | $                               | 0.55     |                 | $      | (0.30                        | )      | $ | (0.16 | ) | $ | 0.73 |   |
|                                                                                                                                                |     |                            |     |                 |   |                         |   |   |   |
| Diluted-as reported                                                                                                                                 |     | $                               | 0.92     |                 | $      | (0.20                        | )      | $ | 0.32 |   | $ | 1.01 |   |
| Diluted-pro forma                                                                                                                                   |     | $                               | 0.54     |                 | $      | (0.30                        | )      | $ | (0.16 | ) | $ | 0.67 |   |

 

The fair market value ofoptions granted under the stock option plans during the fiscal year ended March31, 2004, Transition 2003 and each of the years ended December 31, 2002 and2001, respectively, was determined using the Black-Scholes option pricing modelutilizing the following assumptions:

 

58

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|                                     |   | **Year Ended  March 31,  2004** |   | **Transition  2003** |   | **Years Ended December 31,** |   |
|------------------------------------------|--------|---------------------------------|--------|----------------------|--------|------------------------------|--------|
| **2002**                                 |   | **2001**                        |   |
| Dividend yield                           |   | 0                               | %      | 0                    | %      | 0                            | %      | 0 | % |
| Anticipated volatility                   |   | 69                              | %      | 73                   | %      | 73                           | %      | 74 | % |
| Weighted average risk-free interest rate |   | 2.60                            | %      | 3.46                 | %      | 3.46                         | %      | 4.33 | % |
| Expected lives                           |   | 4 years                         |   | 4 years              |   | 4 years                      |   | 4 years |   |

 

The estimated fair value of theoptions granted in the fiscal year ended March 31, 2004 and Transition 2003 andthe years ended December 31, 2002 and 2001 was $20.6 million, $3.4 million,$31.3 million and $47.0 million, respectively. We apply APB Opinion No. 25 and related Interpretations in accountingfor stock option plans.  Accordingly, nocompensation cost for our stock option plans has been recognized in the fiscalyear ended March 31, 2004, Transition 2003 and the years ended December 31,2002 and 2001 except for options issued by PCP&L and GA prior to theacquisitions, which were issued at below market value.

 

*Income Taxes.* Deferred income taxes are provided for temporary differences between thefinancial statement and income tax bases of our assets and liabilities, basedon enacted tax rates.  A valuationallowance is provided when it is more likely than not that some portion or allof the deferred income tax assets will not be realized.

 

*Basic and Diluted Earnings (Loss) Per Share.*  The following table is a reconciliation ofthe weighted-average shares used in the computation of basic and dilutedearnings (loss) per share for the years presented:

 
| **(In thousands, except per share data)**                                      |   | **Year Ended  March 31,** |     | **Transition  2003** |     | **Years  Ended December 31,** |   |
|--------------------------------------------------------------------------------|--------|---------------------------|----------|----------------------|----------|-------------------------------|--------|
| **2004**                                                                       |   |                      | **2002** |                 | **2001** |                          |
| Net income (loss) used to compute basic and  diluted earnings (loss) per share |   | $                         | 35,839   |                 | $        | (7,686                        | )      | $ | 12,994 |   | $ | 36,013 |   |
| Weighted average number of shares  outstanding — basic                    |   | 38,186                    |     | 38,319               |     | 39,203                        |   | 32,717 |   |
| Dilutive effect of stock options and  warrants                                 |   | 818                       |     | —               |     | 2,040                         |   | 2,906 |   |
| Number of shares used to compute earnings  (loss) per share — diluted     |   | 39,004                    |     | 38,319               |     | 41,243                        |   | 35,623 |   |
|                                                                                |        |                           |          |                      |          |                               |        |  |  |  |  |  |  |

 

Stock options to purchase4,146,000 shares of common stock in the fiscal year ended March 31, 2004 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 share of our common stock during theperiod.   Stock options to purchase600,000, 2,462,000 and 724,500 shares of common stock in Transition 2003 andeach of the years ended December 31, 2002 and 2001, respectively, wereoutstanding but not included in the computation of diluted earnings (loss) percommon share because the option exercise prices for these options were greaterthan the average market price per share of our common stock.

 

59

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*Recently Issued Accounting Pronouncements. *In December 2003, the FinancialAccounting Standards Board issued Interpretation No. 46, “Consolidation ofVariable Interest Entities” (revised in December 2003) (“FIN 46-R”). This interpretationof Accounting Research Bulletin No. 51, “Consolidated FinancialStatements,” addresses consolidation by business enterprises of variableinterest entities (“VIEs”) that either: (i) do not have sufficient equityinvestment at risk to permit the entity to finance its activities withoutadditional subordinated financial support, or (ii) are owned by equityinvestors who lack an essential characteristic of a controlling financialinterest. Generally, application of FIN 46-R is required in financial statementsof public entities that have interests in structures commonly referred to asspecial-purpose entities for periods ending after December 15, 2003, and, forother types of VIEs, for periods ending after March 15, 2004.  We have reviewed this pronouncement anddetermined it is not applicable since we do not own or have an investment inany VIEs.

 

In March 2004, the EmergingIssues Task Force ratified the consensus reached on paragraphs 6 through 23 ofIssue No. 03-01 (“EITF 03-1”),*“The Meaningof Other-Than-Temporary Impairment and Its Application to Certain Investments”*.EITF 03-1 requires that certain quantitative and qualitative disclosures shouldbe required for debt and marketable equity securities classified asavailable-for-sale or held-to-maturity under SFAS No. 115,*“Accounting for Certain Investments in Debt andEquity Securities”* and SFAS No. 124, *“Accounting for Certain Investments Held by Not-for-ProfitOrganizations”*that are impaired at the balance sheet date but forwhich an other-than-temporary impairment has not been recognized. We adoptedEITF 03-1 in the year ended March 31, 2004; however, it did not have a materialimpact on the disclosures in our Consolidated Financial Statements.

 

*Pervasiveness of Estimates.*  The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.  The most significantestimates relate to licenses, software development, and the allowance for priceprotection, returns and doubtful accounts.

 

*Reclassifications.*  Certain reclassifications have been made to the prior periodsconsolidated financial statements to conform to current period consolidatedfinancial statements.

 

**3.     BusinessCombinations**

 

*ValuSoft.* On July 1, 2002, we completed the acquisition of substantially all theassets of ValuSoft, a publisher and developer of value-priced interactiveentertainment and productivity software. The results of ValuSoft’s operations have been included in theconsolidated financial statements since that date.  This acquisition has provided us with a channel for value-pricedpersonal computer products.  We paid$9.6 million in cash and issued approximately 167,000 shares of our commonstock valued at $4.6 million as the initial purchase price.  In addition, former shareholders ofValuSoft, Inc. are entitled to additional consideration of up to $11.0 millionif ValuSoft reaches certain pre-tax income targets in the five years followingJuly 1, 2002.  The annual payments ofthe additional consideration, if any, range from $1.0 million to $2.8 millionper year and may be paid, at our discretion, in cash or shares of our commonstock and will be added to goodwill. For the twelve months ended June 30, 2003, ValuSoft reached its pretaxtarget and we paid $2.3 million in cash and adjusted goodwill accordingly.

 

The acquisition has beenaccounted for using the purchase method under SFAS No. 141, “*BusinessCombinations*”. The purchase price includes the cash paid, the fairvalue of our common stock issued, transaction costs and an adjustment forValuSoft’s accounts receivable and net book value at July 1, 2002.  The total amount of goodwill is expected tobe deductible for income tax purposes. The allocation of the purchase price is as follows:

 

| Estimated Fair Value (in thousands): |   |   |   |
|--------------------------------------|--------|--------|--------|
| Tangible assets acquired             |   | $      | 2,837  |   |
| Software development acquired        |   | 1,491  |   |
| Licenses acquired                    |   | 1,109  |   |
| Liabilities assumed                  |   | (2,940 | )      |
| Goodwill                             |   | 14,342 |   |
| Purchase price                       |   | $      | 16,839 |   |

 

60

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**4.****              Credit Facility**

 

We have a credit facility that allows us to maintain outstandingletters of credit up to $20.0 million. The credit facility is secured by a lien on substantially all of ourassets and contains customary financial and non-financial covenants whichrequire us to maintain specified operating profits and liquidity and limits ourability to incur additional indebtedness, sell assets, pay cash dividends andenter into certain mergers or acquisitions. As of March 31, 2004, we were in compliance with all the covenantsunder the credit facility.  Amountsoutstanding under the credit facility bear interest, at our choice, at either(a) the bank’s prime rate (4.0% at March 31,2004) or (b) the London Interbank Offered Rate (1.4% at March 31, 2004) plus 1.60%.  As of March 31, 2004 we had no amountsoutstanding under the credit facility. As of March 31, 2004, we had outstanding letters of credit ofapproximately $3.1 million.

 

**5.****              Allowance for PriceProtection, Returns and Doubtful Accounts**

 

The allowance for price protection, returns and doubtful accounts atMarch 31, 2004, and 2003 and December 31, 2002 consists of thefollowing:

 
| **(In thousands)**                                                     |   | **Year Ended  March 31, 2004** |    | **Transition  2003** |   | **Year Ended  December 31, 2002** |   |
|------------------------------------------------------------------------|--------|-------------------------------------|---------|----------------------|--------|----------------------------------------|--------|
| Beginning balance                                                      |   | $                                   | (43,406 | )                    | $      | (59,919                                | )      | $ | (40,616 | ) |
| Provision for price protection, returns and  doubtful accounts         |   | (120,982                            | )       | (10,046              | )      | (69,641                                | )      |
| Actual deductions for price protection,  returns and doubtful accounts |   | 111,962                             |    | 26,559               |   | 50,338                                 |   |
| Ending balance                                                         |   | $                                   | (52,426 | )                    | $      | (43,406                                | )      | $ | (59,919 | ) |

 

**6.****              Goodwill**

 

The changes in the carrying amount of goodwill for the fiscal yearended March 31, 2004 and Transition 2003 and the year endedDecember 31, 2002 are as follows:

 
| **(In thousands)**                         |   | **Year  Ended  March 31,  2004** |   | **Transition  2003** |   | **Year Ended****December 31, 2002** |   |
|--------------------------------------------|--------|---------------------------------------|--------|----------------------|--------|------------------------------------------|--------|
| Balance at beginning of period             |   | $                                     | 58,609 |                 | $      | 58,609                                   |   | $ | 48,202 |   |
| Goodwill acquired during the period        |   | —                                |   | —               |   | 12,042                                   |   |
| Adjustments to goodwill during the period  |   | (1,510                                | )*     | —               |   | (1,716                                   | )      |
| Additional consideration paid for ValuSoft |   | 2,300                                 |   | —               |   | —                                   |   |
| Effect of foreign currency exchange rates  |   | —                                |   | —               |   | 81                                       |   |
| Balance at end of period                   |   | $                                     | 59,399 |                 | $      | 58,609                                   |   | $ | 58,609 |   |

 

----

*****We recorded an adjustment to Goodwill relatedto acquired net operating losses in Germany that were not recorded at the timeof acquisition due to uncertainties about the realization of the net operatinglosses.  Due to recent clarification inthe tax law, we now expect to realize the net operating losses.

 

**7.****              Intangible Assets**

 

Intangible assets include licenses, software development and otherintangible assets.  Other intangibleassets are included in other long-term assets, net, except licenses andsoftware development, which are reported separately in the accompanying balancesheets.  Intangible assets are asfollows:

 

61

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|                                  |   |              |   | **March 31,  2004**    |    | **March 31,  2003**      |   |
|---------------------------------------|--------|-------------------|--------|-----------------------------|---------|-------------------------------|--------|
| **Intangible Assets  (In thousands)** |   | **Useful  Lives** |   | **Gross  Carrying  Amount** |    | **Accumulated  Amortization** |   | **Net  Amount** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   | **Net  Amount** |   |
| Amortized intangible assets           |   |              |   |                        |    |                          |   |   |   |   |   |   |   |   |   |
| Licenses                              |   | Varies            |   | $                           | 113,118 |                          | $      | (90,878 | ) | $ | 22,240 |   | $ | 100,065 |   | $ | (64,682 | ) | $ | 35,383 |   |
|                                  |   |              |   |                        |    |                          |   |   |   |   |   |   |   |   |   |
| Software development                  |   | Varies            |   | 198,659                     |    | (148,864                      | )      | 49,795 |   | 171,335 |   | (113,871 | ) | 57,464 |   |
|                                  |   |              |   |                        |    |                          |   |   |   |   |   |   |   |   |   |
| Trade secrets                         |   | 5 years           |   | 1,800                       |    | (810                          | )      | 990 |   | 1,800 |   | (450 | ) | 1,350 |   |
| Non-compete/Employment contracts      |   | 6.5 years         |   | 706                         |    | (244                          | )      | 462 |   | 706 |   | (136 | ) | 570 |   |
| Subtotal                              |   |              |   | 2,506                       |    | (1,054                        | )      | 1,452 |   | 2,506 |   | (586 | ) | 1,920 |   |
| Total amortized intangible assets     |   |              |   | 314,283                     |    | (240,796                      | )      | 73,487 |   | 273,906 |   | (179,139 | ) | 94,767 |   |
|                                  |   |              |   |                        |    |                          |   |   |   |   |   |   |   |   |   |
| Unamortized intangible assets         |   |              |   |                        |    |                          |   |   |   |   |   |   |   |   |   |
| Trade name                            |   | indefinite        |   | 1,025                       |    | N/A                           |   | 1,025 |   | 1,025 |   | N/A |   | 1,025 |   |
| Total                                 |   |              |   | $                           | 315,308 |                          | $      | (240,796 | ) | 74,512 |   | $ | 274,931 |   | $ | (179,139 | ) | $ | 95,792 |   |
|                                       |        |                   |        |                             |         |                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

|                                  |   |              |   | **December 31,  2002** |    |
|---------------------------------------|--------|-------------------|--------|-----------------------------|---------|
| **Intangible Assets  (In thousands)** |   | **Useful  Lives** |   | **Gross  Carrying  Amount** |    | **Accumulated  Amortization** |   | **Net  Amount** |   |
| Amortized intangible assets           |   |              |   |                        |    |   |   |   |   |
| Licenses                              |   | Varies            |   | $                           | 95,299  |   | $ | (59,877 | ) | $ | 35,422 |   |
|                                  |   |              |   |                        |    |   |   |   |   |
| Software development                  |   | Varies            |   | 152,263                     |    | (104,845 | ) | 47,418 |   |
|                                  |   |              |   |                        |    |   |   |   |   |
| Trade secrets                         |   | 5 years           |   | 1,800                       |    | (360 | ) | 1,440 |   |
| Non-compete / Employment contracts    |   | 6.5 years         |   | 706                         |    | (109 | ) | 597 |   |
| Subtotal, other                       |   |              |   | 2,506                       |    | (469 | ) | 2,037 |   |
| Total amortized intangible assets     |   |              |   | 250,068                     |    | (165,191 | ) | 84,877 |   |
|                                  |   |              |   |                        |    |   |   |   |   |
| Unamortized intangible assets         |   |              |   |                        |    |   |   |   |   |
| Trade name                            |   | indefinite        |   | 1,025                       |    | N/A |   | 1,025 |   |
| Total                                 |   |              |   | $                           | 251,093 |   | $ | (165,191 | ) | $ | 85,902 |   |

 

The useful lives of licenses and software development are based onunits of product sold and therefore not disclosed in years.  The estimated amortization expense forlicenses and software development is based on anticipated release dates andforecasts of units to be sold.  For thefiscal year ended March 31, 2004 and Transition 2003 and the years endedDecember 31, 2002 and 2001, our aggregate amortization expense related tointangible assets was $126.7 million, $13.3 million, $91.7 million and $35.3million, respectively.

 

62

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**EstimatedAmortization Expense**

**(Inthousands):**

 

| **Fiscal****Years  Ended  March 31,** |   |   |   |
|--------------------------------------------|--------|--------|--------|
| 2005                                       |   | $      | 53,638 |   |
| 2006                                       |   | 13,899 |   |
| 2007                                       |   | 3,136  |   |
| 2008                                       |   | 1,476  |   |
| 2009                                       |   | 887    |   |
| Thereafter                                 |   | 451    |   |
| Total                                      |   | $      | 73,487 |   |

 

**8.****              Other Long-TermAssets**

 

On March 21, 2000, we acquired less than a 20% interest inJapanese developer, Yuke’s, which was privately held.  In December 2001, Yuke’s had an initial public offering ofits common stock that is traded on the Nippon New Market in Japan.  Accordingly, we account for this investmentunder SFAS No. 115 “Accounting for Certain Investments in Debt and EquitySecurities” as available-for-sale. Unrealized holding gains and losses are excluded from earnings and areincluded as a component of other comprehensive income until realized.  The original cost of this investment was$5.0 million.  At March 31, 2003the investment in Yuke’s was written down to $3.2 million due to an other thantemporary decline in the fair value of the investment.  For the fiscal year ended March 31,2004, the unrealized holding gain was $1.4 million which brings the carryingvalue of the investment to $4.6 million at March 31, 2004.  Due to the long-term nature of thisrelationship, this investment is included in other long-term assets in theaccompanying balance sheets.  For theTransition 2003 and the years ended December 31, 2002 and 2001, theunrealized holding gain (loss) on the investment in Yuke’s Co., Ltd. was $1.1million,  ($1.0) million and $249,000,respectively.  Under separatedevelopment agreements, Yuke’s will create exclusively for us certain *WorldWrestling Entertainment* wrestling games for the PlayStation 2 andGameCube.

 

During 2002, we loaned Minick Holding AG (“Minick”) $1.5 million.  On January 24, 2003, the loan wasconverted to an equity investment in Minick. As of March 31, 2004 we owned approximately 25% of the outstandingcommon stock of Minick.  This investmentis accounted for under the equity method. Equity in net income for the fiscal year ended March 31, 2004 was$63,000.  In April 2004 wepurchased a controlling interest in Minick for an additional $10.5million.  We will begin consolidatingthe balance sheet, statement of operations, stockholders’ equity and cash flowsbeginning in the June 30, 2004 quarter. Minick develops and operates interactive software applications forwireless devices such as Short Messaging Service (“SMS”), Enhanced MessagingService (“EMS”), and Multimedia Messaging Service (“MMS”), information,multimedia and voting applications.  Wewill work with Minick to expand licensed wireless gaming through their softwareapplications.  See Note 17.

 

On September 4, 2003 THQ Wireless launched Madtap.com, amulti-country portal enabling mobile phone users to download the latest Javagames.  The portal is designed to handlemulti-country billing options. Madtap.com was created and continues to be supported by Minick.  In relation to this agreement, THQ Wirelesshas paid Minick $33,000 from launch through March 31, 2004.

 

On June 13, 2001, T.HQ International Ltd. and HotGen Studios Ltd.entered into a Joint Venture Agreement pursuant to which T.HQ InternationalLtd. acquired a 44% interest in Network Interactive Sports Limited (“NISports”), formerly wholly owned by HotGen Studios Ltd.  In exchange for this interest, T.HQInternational Ltd. agreed to invest $3.3 million in cash.  Goodwill, which resulted from the investment,net of accumulated amortization was $1.9 million at December 31, 2001.  In July 2002, we announced plans todiscontinue operations and took a charge of $3.0 million, including thewrite-off of associated goodwill of $1.9 million, in June 2002 for thewrite-off of this investment, which is included in other expenses in the accompanyingstatements of operations.  Prior to thewrite-off, this investment was included in other long-term assets in theaccompanying balance sheet and was accounted for using the equity method.  For the year ended December 31, 2001,our equity in the net loss of the joint venture was immaterial and was includedin general and administrative expenses in the accompanying statements ofoperations.  The financial statements ofthe joint venture are immaterial and have therefore not been included.

 

63

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**9.****              Income Taxes**

 

Income (loss) before provision (benefit) for income taxes consisted of:

 
| **(In thousands)** |   | **Fiscal  Year  Ended  March 31,  2004** |   | **Transition  2003** |   | **Years Ended December 31,** |   |
|--------------------|--------|-----------------------------------------------|--------|----------------------|--------|-----------------------------------|--------|
| **2002**           |   | **2001**                                      |   |
| United States      |   | $                                             | 46,115 |                 | $      | (5,871                            | )      | $ | 16,471 |   | $ | 52,569 |   |
| Foreign            |   | 9,121                                         |   | (5,105               | )      | 3,284                             |   | 4,147 |   |
|               |   | $                                             | 55,236 |                 | $      | (10,976                           | )      | $ | 19,755 |   | $ | 56,716 |   |

 

The provision (benefit) for income taxes consists of the following:

 
| **(In thousands)**                   |     | **Fiscal  Year Ended  March 31,  2004** |     | **Transition  2003** |   | **Years Ended December 31,** |   |
|--------------------------------------|----------|----------------------------------------------|----------|----------------------|--------|-----------------------------------|--------|
|                                 | **2002** |                                         | **2001** |                 |
| **Current**                          |     |                                         |     |                 |   |                              |   |   |   |
| Federal                              |     | $                                            | 11,112   |                 | $      | (139                              | )      | $ | 6,742 |   | $ | 8,000 |   |
| State                                |     | 2,716                                        |     | —               |   | 814                               |   | 434 |   |
| Foreign                              |     | 4,495                                        |     | (1,960               | )      | 1,765                             |   | 1,231 |   |
|                                 |     | 18,323                                       |     | (2,099               | )      | 9,321                             |   | 9,665 |   |
| **Deferred**                         |     |                                         |     |                 |   |                              |   |   |   |
| Federal                              |     | 2,775                                        |     | (1,295               | )      | (1,940                            | )      | 9,223 |   |
| State                                |     | 319                                          |     | (125                 | )      | (194                              | )      | 1,524 |   |
| Foreign                              |     | (2,020                                       | )        | 229                  |   | (426                              | )      | 291 |   |
|                                 |     | 1,074                                        |     | (1,191               | )      | (2,560                            | )      | 11,038 |   |
| Provision (benefit) for income taxes |     | $                                            | 19,397   |                 | $      | (3,290                            | )      | $ | 6,761 |   | $ | 20,703 |   |

 

64

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A reconciliation of the provision (benefit) for income taxes at thefederal statutory rate to the provision (benefit) recorded in the accompanyingfinancial statements is as follows:

 
| **(In thousands)**                                        |   | **Fiscal  Year  Ended  March 31,  2004** |   | **Transition  2003** |   | **Years Ended December 31,** |   |
|-----------------------------------------------------------|--------|-----------------------------------------------|--------|----------------------|--------|-----------------------------------|--------|
| **2002**                                                  |   | **2001**                                      |   |
| Federal provision (benefit) at statutory  rate            |   | 35.0                                          | %      | (35.0                | )%     | 35.0                              | %      | 35.0 | % |
| State taxes (net of Federal benefit)                      |   | 3.6                                           |   | (1.1                 | )      | 2.0                               |   | 2.2 |   |
| Other than temporary impairment in Yuke’s  Co., Ltd. |   | —                                        |   | 5.9                  |   | —                            |   | — |   |
| Rate differences in foreign taxes and  other, net         |   | (3.5                                          | )      | —               |   | (2.8                              | )      | (0.7 | ) |
|                                                      |   | 35.1                                          | %      | (30.0                | )%     | 34.2                              | %      | 36.5 | % |

 

Deferred income taxes were:

 
|                                                           |   | **March 31,  2004** |   |
|----------------------------------------------------------------|--------|--------------------------|--------|
| **(In thousands)**                                             |   | **Federal**              |   | **State** |   | **Foreign** |   |
| **Current**                                                    |   |                     |   |   |   |   |   |
| Deferred income tax assets:                                    |   |                     |   |   |   |   |   |
| Allowance for price protection, returns and  doubtful accounts |   | $                        | 8,697  |   | $ | 1,242 |   | $ | 821 |   |
| Accrued expenses                                               |   | 1,653                    |   | 237 |   | — |   |
| State income taxes                                             |   | 687                      |   | — |   | — |   |
| Other — net                                               |   | 703                      |   | 109 |   | (551 | ) |
| Total deferred income tax assets                               |   | 11,740                   |   | 1,588 |   | 270 |   |
|                                                           |   |                     |   |   |   |   |   |
| Deferred income tax liabilities:                               |   |                     |   |   |   |   |   |
| Software development costs                                     |   | (12,291                  | )      | (1,756 | ) | — |   |
| Other — net                                               |   | (169                     | )      | (24 | ) | — |   |
| Deferred income taxes                                          |   | $                        | (720   | ) | $ | (192 | ) | $ | 270 |   |
|                                                           |   |                     |   |   |   |   |   |
| **Non-Current**                                                |   |                     |   |   |   |   |   |
| Deferred income tax assets:                                    |   |                     |   |   |   |   |   |
| Net operating loss                                             |   | $                        | — |   | $ | 124 |   | $ | 1,951 |   |
| Other — net                                               |   | 2,163                    |   | 322 |   | — |   |
| Valuation reserve                                              |   | (854                     | )      | (79 | ) | — |   |
| Net deferred tax assets                                        |   | 1,309                    |   | 367 |   | 1,951 |   |
|                                                           |   |                     |   |   |   |   |   |
| Deferred income tax liabilities                                |   |                     |   |   |   |   |   |
| Software development costs                                     |   | (768                     | )      | (110 | ) | — |   |
| Depreciation and amortization                                  |   | (397                     | )      | — |   | — |   |
| Identifiable intangible assets                                 |   | (825                     | )      | (118 | ) | — |   |
| Other — net                                               |   | (743                     | )      | (106 | ) | — |   |
| Deferred income taxes                                          |   | $                        | (1,424 | ) | $ | 33 |   | $ | 1,951 |   |

 

The valuation reserve decreased by $83,000 during the fiscal year endedMarch 31, 2004.

 

As of March 31, 2004 we had no federal, $2.5 million state and$4.8 million foreign net operating loss carryforwards.  The state net operating loss carryforwardexpires in 2013, and the foreign net operating loss carryforward is indefinite.

 

65

----

 

Total deferred tax assets and total deferred tax liabilities atMarch 31, 2004 were $17.2 million and $17.3 million, respectively.

 

At March 31, 2004 we had accumulated foreign earnings of $10.9million.  We do not plan to repatriatethese earnings, therefore, no United States income tax has been provided on theforeign earnings.  Additionally, we havenot tax effected the cumulative translation adjustment as we have no intentionof repatriating foreign earnings.

 
|                                                           |   | **March 31,  2003** |   | **December 31,  2002** |   |
|----------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| **(In thousands)**                                             |   | **Federal**              |   | **State**                   |   | **Foreign** |   | **Federal** |   | **State** |   | **Foreign** |   |
| **Current**                                                    |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Deferred income tax assets:                                    |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Allowance for price protection, returns and  doubtful accounts |   | $                        | 9,756  |                        | $      | 906 |   | $ | 201 |   | $ | 12,065 |   | $ | 1,120 |   | $ | 430 |   |
| Litigation reserve                                             |   | —                   |   | —                      |   | — |   | 3,553 |   | 330 |   | — |   |
| Accrued expenses                                               |   | 2,814                    |   | 249                         |   | — |   | 106 |   | — |   |   |   |
| Net operating loss                                             |   | —                   |   | —                      |   | — |   | 1,023 |   | 3 |   | — |   |
| Credits                                                        |   | —                   |   | —                      |   | — |   | — |   | 109 |   | — |   |
| Other — net                                               |   | 2,650                    |   | 246                         |   | — |   | 3,126 |   | 290 |   | — |   |
|                                                           |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Total deferred income tax assets                               |   | 15,220                   |   | 1,401                       |   | 201 |   | 19,873 |   | 1,852 |   | 430 |   |
|                                                           |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Deferred income tax liabilities:                               |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Software development costs                                     |   | (19,089                  | )      | (1,772                      | )      | — |   | (16,029 | ) | (1,477 | ) | — |   |
| Other — net                                               |   | (3,039                   | )      | (275                        | )      | — |   | (3,039 | ) | (276 | ) | — |   |
|                                                           |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Deferred income taxes                                          |   | $                        | (6,908 | )                           | $      | (646 | ) | $ | 201 |   | $ | 805 |   | $ | 99 |   | $ | 430 |   |
|                                                           |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| **Non-Current**                                                |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Deferred income tax assets:                                    |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Net operating loss                                             |   | $                        | 9,046  |                        | $      | 748 |   | $ | — |   |   |   |   |   |   |   |
| Credits                                                        |   | —                   |   | 109                         |   | — |   |   |   |   |   |   |   |
| Other — net                                               |   | 2,197                    |   | 211                         |   | — |   | $ | 1,287 |   | $ | 123 |   | $ | — |   |
| Valuation reserve                                              |   | (930                     | )      | (86                         | )      | — |   | (284 | ) | (26 | ) | — |   |
|                                                           |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Net deferred tax assets                                        |   | 10,313                   |   | 982                         |   | — |   | 1,003 |   | 97 |   | — |   |
|                                                           |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Deferred income tax liabilities                                |   |                     |   |                        |   |   |   |   |   |   |   |   |   |
| Software development costs                                     |   | (919                     | )      | (85                         | )      | — |   | (622 | ) | (69 | ) | — |   |
| Depreciation and amortization                                  |   | (417                     | )      | —                      |   | — |   | (575 | ) | (12 | ) | — |   |
| Identifiable intangible assets                                 |   | (825                     | )      | (77                         | )      | — |   | (1,276 | ) | (80 | ) | — |   |
| Other — net                                               |   | (613                     | )      | (13                         | )      | — |   | — |   |   |   |   |   |
| Deferred income taxes                                          |   | $                        | 7,539  |                        | $      | 807 |   | $ | — |   | $ | (1,470 | ) | $ | (64 | ) | $ | — |   |

 

The valuation reserve increased by $706,000 and $310,000 duringTransition 2003 and the year ended December 31, 2002, respectively.

 

Total deferred tax assets and total deferred tax liabilities atMarch 31, 2003 were $28.1 and $27.1, respectively.  Total deferred tax assets and total deferredtax liabilities at December 31, 2002 were $23.2 and $23.5, respectively.

 

66

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**10.****       Employee Pension Plan**

 

We sponsor for our United States employees a defined contribution planunder Section 401(k) of the Internal Revenue Code.  The plan provides that employees may deferup to 12% of annual compensation, and that we will make a matching contributionequal to each employee’s deferral, up to 4% of eligible compensation.  We may also contribute funds to the plan inthe form of a discretionary profit-sharing contribution.  Expenses under the plan were $1.7 million,$389,000, $1.5 million, and $1.3 million in the fiscal year endedMarch 2004 and Transition 2003 and the years ended December 31, 2002 and2001, respectively.

 

**11.****       Stock Option Plans**

 

As of March 31, 2004, we have three stock option plans (the 1990Plan, the 1997 Amended Plan and Non-executive Employee Stock Option Plan (the“NEEP Plan”)).

 

The 1990 Plan and the 1997 Amended Plan provide for the issuance of upto 2,193,750 and 14,537,500 shares, respectively, available for employees,consultants and non-employee directors.

 

As of March 31, 2004, no options under the 1990 Plan and 5,793,627options under the 1997 Plan were available for grant.  Stock options granted under the option plans may be incentivestock options or non-statutory stock options. Options may be granted under the option plans to, in the case ofincentive stock options, all employees (including officers) of THQ; or, in thecase of non-statutory stock options, all employees (including officers),consultants and non-employee directors of THQ.

 

On August 12, 2003,a proposal to amend our 1997 Stock Option Plan to increase the authorizednumber of shares of common stock available for issuance to our directors,officers and key employees under such plan from 10,537,500 to 14,537,500 wasapproved by the shareholders.  Thepurchase price per share of common stock purchasable upon exercise of eachoption may not be less than the fair market value of such share of common stockon the date that such option is granted. Generally, options granted under this plan become exercisable over threeyears and expire within five years from the date of grant.

 

The NEEP Plan has primarily the same attributes as the 1990 Plan andthe 1997 Plan, but participation is reserved for employees who are notexecutive officers and under the NEEP Plan only nonqualified options will begranted.  The NEEP Plan provides for theissuance of up to 2,142,000 shares, of which no more than 20% is available forawards to our non-executive officers and no more than 15% is available forawards to the non-executive officers or general managers of our subsidiaries ordivisions.  As of March 31, 2004,110,005 options were available for grant.

 

The exercise price per share of all options granted under the plans inthe years ended December 31, 2001 and 2002, Transition 2003 and the fiscalyear ended March 31, 2004 has been the closing market price of the stockon the date of the grant.

 
| **Stock Options**                              |   | **Weighted  Average  Exercise Price** |   | **Number of  Shares** |       |
|------------------------------------------------|--------|---------------------------------------|--------|-----------------------|------------|
| Balance at January 1, 2001                |   | $                                     | 10.61  |                  | 5,119,955  |   |
| Granted                                        |   | $                                     | 26.01  |                  | 3,206,811  |   |
| Exercised                                      |   | $                                     | 9.43   |                  | (1,628,538 | ) |
| Canceled                                       |   | $                                     | 13.47  |                  | (331,016   | ) |
| Balance at December 31, 2001              |   | $                                     | 18.42  |                  | 6,367,212  |   |
| Granted                                        |   | $                                     | 26.54  |                  | 2,192,639  |   |
| Exercised                                      |   | $                                     | 9.58   |                  | (545,937   | ) |
| Canceled                                       |   | $                                     | 24.54  |                  | (1,042,064 | ) |
| Balance at December 31, 2002              |   | $                                     | 20.93  |                  | 6,971,850  |   |
| 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  |   |
| Options exercisable at December 31,  2001 |   | $                                     | 11.51  |                  | 1,759,140  |   |
| 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  |   |

 

67

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Options granted and shares exercised relating to options grantedoutside of our stock option plans during the years ended December 31, 2002and 2001, Transition 2003 and the fiscal year ended March 31, 2004 are listedbelow.  Share exercise prices for theseoptions equal the market price of our common stock at the date of the grantexcept for options issued by Pacific Coast Power &Light and GeneticAnomalies prior to the acquisitions, which were issued at below market value.  These options were accounted for under APBOpinion No. 25 and we have recognized stock compensation of $84,000, $189,000,$169,000, and $299,000 for the fiscal year ended March 31, 2004,Transition 2003 and for the years ended December 31, 2002 and 2001,respectively.  Generally, optionsgranted outside of our stock option plans become exercisable over three yearsand expire within five years from the date of grant.

 

| **Stock Options**                              |   | **Weighted  Average  Exercise Price** |   | **Number of  Shares** |      |
|------------------------------------------------|--------|---------------------------------------|--------|-----------------------|-----------|
| Balance at January 1, 2001                |   | $                                     | 4.07   |                  | 1,071,755 |   |
| Granted                                        |   | $                                     | 13.78  |                  | 159,398   |   |
| Exercised                                      |   | $                                     | 3.17   |                  | (436,737  | ) |
| Canceled                                       |   | $                                     | 0.57   |                  | (932      | ) |
| Balance at December 31, 2001              |   | $                                     | 6.53   |                  | 793,484   |   |
| Granted                                        |   | $                                     | — |                  | —    |   |
| Exercised                                      |   | $                                     | 6.95   |                  | (386,297  | ) |
| Canceled                                       |   | $                                     | 11.00  |                  | (8,554    | ) |
| Balance at December 31, 2002              |   | $                                     | 6.05   |                  | 398,633   |   |
| 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   |   |
|                                           |   |                                  |   |                  |      |
| Options exercisable at December 31,  2001 |   | $                                     | 6.83   |                  | 755,777   |   |
| 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   |   |

 

The following table summarizes information about stock optionsoutstanding at March 31, 2004:

 

| **Range of  Exercise Price** |   | **Number  Outstanding at  March 31, 2004** |   | **Weighted  Average  Remaining  Contractual Life** |   | **Weighted  Average Exercise  Price** |   |
|------------------------------|--------|-------------------------------------------------|--------|----------------------------------------------------|--------|---------------------------------------|--------|
| $ 0.25 - $10.25              |   | 758,413                                         |   | 2                                                  |   | $                                     | 6.96   |   |
| $ 10.67 - $16.70             |   | 2,130,762                                       |   | 3                                                  |   | $                                     | 13.65  |   |
| $ 16.82 - $22.08             |   | 2,627,089                                       |   | 3                                                  |   | $                                     | 18.35  |   |
| $ 22.30 - $30.04             |   | 1,175,544                                       |   | 3                                                  |   | $                                     | 28.65  |   |
| $ 30.93 - $38.53             |   | 93,037                                          |   | 3                                                  |   | $                                     | 34.35  |   |
|                         |   | 6,784,845                                       |   | 3                                                  |   | $                                     | 17.60  |   |

 

68

----

 

The following table summarizes information about stock optionsexercisable at March 31, 2004:

 

| **Range of  Exercise Price** |   | **Shares  Exercisable at  March 31, 2004** |   | **Weighted  Average Exercise  Price** |   |
|------------------------------|--------|-------------------------------------------------|--------|---------------------------------------|--------|
| $0.25 - $10.25               |   | 758,413                                         |   | $                                     | 6.96   |   |
| $10.67 - $16.70              |   | 932,393                                         |   | $                                     | 13.58  |   |
| $16.82 - $22.08              |   | 1,009,201                                       |   | $                                     | 18.43  |   |
| $22.30 - $30.04              |   | 788,260                                         |   | $                                     | 28.64  |   |
| $30.93 - $38.53              |   | 80,622                                          |   | $                                     | 34.35  |   |
|                         |   | 3,568,889                                       |   | $                                     | 17.34  |   |

 

**12.****       Capital Stock Transactions**

 

On September 10, 2002, we announced that our Board of Directorsauthorized the repurchase of up to $25.0 million of our common stock from timeto time on the open market or in private transactions.  On November 21, 2002, we announced thatour Board of Directors authorized the repurchase 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 thatour Board of Directors authorized the repurchase of an additional $25.0 millionbringing the total authorized to $75.0 million.  As of March 31, 2004, we have repurchased 2,949,000 sharesof our common stock for $43.8 million leaving $31.2 million available forfuture repurchases.

 

In connection with a licensing agreement, in September 2003, weissued a warrant to purchase 100,000 shares of common stock at $15.68 per sharehaving an estimated fair value of $1.0 million.  The estimated fair value was determined using the Black Scholesoption pricing model with the following assumptions: an anticipated volatilityof 71%, a weighted average risk-free interest rate of 3.43%, and a term of 10years.  The fair value of the warrant isincluded in licenses in the accompanying balance sheet.  The warrant expires December 31,2013.  As of March 31, 2004, thesewarrants have not been exercised and are all outstanding.

 

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

 

In connection with obtaining a license agreement, inFebruary 2002, we issued a warrant to purchase 75,000 shares of commonstock at $29.13 per share having a fair value of $1.2 million at the time ofissuance.  The estimated fair value wasdetermined using the Black Scholes option pricing model.  The estimated fair value was determined usingthe Black Scholes option pricing model with the following assumptions: ananticipated volatility of 71%, a weighted average risk-free interest rate of4.38%, and a term of 4 years.  The fairvalue of the warrants is included in licenses in the accompanying balancesheet.  The warrants expireDecember 31, 2005.  As ofMarch 31, 2004, these warrants have not been exercised and are alloutstanding.

 

On November 13, 2001, we issued 4,125,000 shares of our commonstock in a secondary public offering. As part of the offering, on December 12, 2001, the underwritersexercised their right to purchase an additional 471,222 shares.  The net proceeds from these issuances were$154.6 million.

 

**13.****       Agreement with JAKKSPacific, Inc.**

 

In June 1999 we entered into an agreement with JAKKS Pacific, Inc.(“JAKKS”), that governs our relationship with respect to the World WrestlingEntertainment license we jointly obtained from World Wrestling Entertainment,Inc. (the “WWE”).  This agreement wasamended in January 2002.  Our relationshipwith JAKKS was established to develop, manufacture, distribute, market and sellvideo games, as well as sublicense products pursuant to the license from theWWE.  The principal terms of thisoperating agreement are as follows:

 

We are responsible for funding all operations of the venture, includingall payments owed to the WWE.

 

For the period commencing November 16, 1999 and endingJune 30, 2006, JAKKS is entitled to receive a preferred payment equal tothe greater of a fixed guarantee, payable quarterly, or specified percentagesof the net sales from

 

69

----

 

the WWE-licensed games (as defined) in amounts that vary based on theplatform.  The payment of these amountsis guaranteed by us.  We are entitled tothe profits and cash distributions remaining after the payment of theseamounts.

 

For periods after June 30, 2006, the amount of the preferredpayment will be subject to renegotiation between the parties.  An arbitration procedure is specified in theevent the parties do not reach agreement.

 

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

 

For financial reporting purposes, we are deemed to control the venture;therefore, all venture operating results are consolidated with our results.

 

In November 2001, through the venture with JAKKS, we entered intoan amendment to expand the WWE license to include exclusive rights to otherwrestling content produced by the WWE. In exchange for these rights we have agreed to increase the minimumguarantee payable to WWE through December 31, 2013.

 

**14.****       Stockholders Rights Plan**

 

On August 15, 2001, the Board of Directors (the Board) approved anamended and restated Stockholders Rights Plan (the Plan).  Each share of common stock has one preferredstock purchase right (“Right”) associated with it.  Pursuant to the Plan, each Right entitles the holder to buy oneone-thousandth (1/1000) of a share of a new series of preferred stock at anexercise price of $10, subject to adjustment. The Rights become exercisable 10 days after any person or groupacquires, or 10 business days after any person or group has announced itsintention to commence a tender offer for, 15% or more of the outstanding commonstock.

 

In the event that any person or group acquires 15% or more of ouroutstanding common stock, each holder of a Right (other than such person orgroup) will be entitled to purchase, at the exercise price, the number ofshares of common stock having a current market value equal to two times theexercise price of the Right.

 

If we are acquired in a merger or other business combination, eachholder of a Right will be entitled to purchase, at the exercise price, a numberof shares of common stock of the acquirer having a current market value equalto two times the exercise price of the Right.

 

We may redeem the Rights at a redemption price of $.001 per right atany time until 10 days after the acquisition of 15% of our common stock.  At any time after a person or group hasacquired 15% or more but less than 50% of our common stock, we may exchange allor part of the Rights for shares of common stock at an exchange ratio of oneshare of common stock for each Right or 1/1000 of such new series of preferredstock per Right, subject to adjustment. The rights expire on June 21, 2010.

 

**15.****       Commitments andContingencies**

 

*Licenses andSoftware Development.* We enter into contractual arrangements with third parties for the rightsto intellectual property and for the development of products.  Under these agreements, we commit to providespecified payments to an intellectual property holder or developer.  Assuming all contractual provisions are met,the total future minimum contract commitment for contracts in place as ofMarch 31, 2004 is approximately $113.8 million.

 

*Advertising.*  We have certain minimum advertisingcommitments under most of our major license agreements.  These minimum commitments generally rangefrom 2% to 12% of net sales related to the respective license.  We estimate that our minimum commitment foradvertising in fiscal 2005 will be $24.1 million.

 

*Leases.*  We are committed under operating leases withlease termination dates to 2014. Certain leases contain rent escalations.  Minimum future rent payments pursuant to these leases as ofMarch 31, 2004 are as follows:

 

| **Fiscal Year  Ended March 31,  (In thousands)** |   | **Facilities** |   | **Equipment** |   |
|-------------------------------------------------------|--------|----------------|--------|---------------|--------|
| 2005                                                  |   | $              | 4,395  |          | $      | 556 |   |
| 2006                                                  |   | 4,422          |   | 329           |   |
| 2007                                                  |   | 3,157          |   | 206           |   |
| 2008                                                  |   | 3,223          |   | 37            |   |
| 2009                                                  |   | 2,866          |   | 15            |   |
| Thereafter                                            |   | 8,307          |   | —        |   |
|                                                  |   | $              | 26,370 |          | $      | 1,143 |   |

 

70

----

 

Rent expense was $4.5 million, $1.1 million, $3.4 million and $2.7million for the fiscal years ended March 31, 2004, Transition 2003 and theyears ended December 31, 2002 and 2001, respectively.

 

Summary of minimum contractual obligations and commercial commitmentsas of March 31, 2004 (in thousands), are as follows:

 
|                                       |   | **Contractual  Obligations and Commercial Commitments** |   |
|--------------------------------------------|--------|---------------------------------------------------------|--------|
| **Fiscal****Years  Ended  March 31,** |   | **License  Guarantees**                                 |   | **Software  Development  Milestone  Payments** |   | **Advertising** |   | **Leases** |   | **Letters of  Credit** |   | **Other** |   | **Total** |   |
| 2005                                       |   | $                                                       | 26,333 |   | $ | 59,408 |   | $ | 24,143 |   | $ | 4,951 |   | $ | 3,125 |   | $ | 1,583 |   | $ | 119,543 |   |
| 2006                                       |   | 22,843                                                  |   | 701 |   | 10,203 |   | 4,751 |   | — |   | — |   | 38,498 |   |
| 2007                                       |   | 4,520                                                   |   | — |   | 2,856 |   | 3,363 |   | — |   | — |   | 10,739 |   |
| 2008                                       |   | —                                                  |   | — |   | 2,105 |   | 3,260 |   | — |   | — |   | 5,365 |   |
| 2009                                       |   | —                                                  |   | — |   | 500 |   | 2,881 |   | — |   | — |   | 3,381 |   |
| Thereafter                                 |   | —                                                  |   | — |   | 1,500 |   | 8,307 |   | — |   | — |   | 9,807 |   |
|                                       |   | $                                                       | 53,696 |   | $ | 60,109 |   | $ | 41,307 |   | $ | 27,513 |   | $ | 3,125 |   | $ | 1,583 |   | $ | 187,333 |   |

 

On February 27, 2003, we entered into a lease agreement with anentity partially owned by the head of one of our development studios.  The lease is for approximately 29,000 squarefeet of office space which will be occupied by the development studio inChampaign, Illinois.

 

*Warrants. *We are committed under a license agreement toissue a warrant to purchase a total of 160,000 shares of common stock at $20.23per share.  We have estimated the fairvalue based on current negotiations as we have shipped product related to thislicense agreement and thus the estimated fair value is being amortized tolicense amortization and royalties over estimated sales for games that havebeen released.  We will adjust ourestimated fair value and the related amortization when the warrant terms arefinalized.

 

*Manufacturer Indemnification. *We must indemnify the manufacturers of ourgames with respect to all loss, liability and expense resulting from any claimagainst the manufacturer involving the development, marketing, sale or use ofour games, including any claims for copyright or trademark infringement broughtagainst the manufacturer.  As a result,we bear a risk that the properties upon which the titles are based, or that theinformation and technology licensed from others and incorporated in theproducts, may infringe the rights of third parties.  Our agreements with our independent software developers andproperty licensors typically provide for us to be indemnified with respect tocertain matters.  If any claim isbrought by a manufacturer against us for indemnification, however, ourdevelopers or licensors may not have sufficient resources to in turn, indemnifyus.  Furthermore, parties’indemnification of us may not cover the matter that gives rise to themanufacturer’s claim.

 

We received a demand fromMotorola for indemnification under our license to it of certain wireless gamesdistributed in France.  The demandarises out of litigation commenced in France in January 2003 againstMotorola and their distribution partners for trademark infringement and unfaircompetition, which seeks $10.0 million in damages plus an unspecified amountand an accounting.  In April 2003,we joined the action as a necessary party. Although we expect to prevail, at this early stage we cannot predict thelikely outcome of the demand for indemnification.

 

*Legal and Regulatory Proceedings. *On July 11, 2003 wewere informed by the staff of the Securities and Exchange Commission (the“SEC”) that the SEC is conducting a non-public formal investigation entitled“In the Matter of Certain Video Game Manufacturers and Distributors.”  In connection with the investigation, theSEC requested information from us.  TheSEC staff has informed us that other companies in the video game industry havereceived similar requests for information. The investigation appears to be focused on certain accounting practices,with specific emphasis on revenue recognition. The SEC has advised us that its investigation is non-public and shouldnot be construed as an indication from the SEC or its staff that any violationsof the law have occurred, no should it reflect negatively upon any person, entityor security.  We responded to the SEC’srequest for information in September 2003 and intend to cooperate fully withany further requests from the SEC in its investigation.

 

We are involved in routine litigation arising in the ordinary course ofour business.  In the opinion of ourmanagement, none of the pending litigation will have a material adverse effecton our consolidated financial condition or results of operations.

 

71

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**16.**       FiscalYear Change

 

Effective January 1, 2003, we changed ourfiscal year from December 31 to March 31.  The table below summarizes the selected data for the three monthsended 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, net                                 |   | 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  | ) | $ | .07 |   |
| Shares used in per share calculation –  diluted |   | 38,319                                  |   | 41,725 |   |

 

**17.**       Subsequent Events

 

**In April 2004, we completedthe acquisition of substantially all the assets of Relic Entertainment Inc., adevelopment studio located in Canada. We paid $6.0 million in cash and will pay an additional $4 million overthe next two years.**

 

**Additionally, in April 2004 wepurchased a controlling interest in Minick Holding AG (“Minick”) for $10.5million.  Minick is a European-basedcompany which develops and operates interactive software applications forwireless devices such as SMS, EMS, and MMS messaging information, multimediaand voting applications.  See Note 8.**

 

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**18.**       Segment and Geographic Information

 

We operate in one reportable segment in which we are a developer,publisher and distributor of interactive entertainment software for the leadinghardware platforms in the home video game market.  The following information sets forth geographic information onour sales and long-lived assets for the fiscal year ended March 2004,Transition 2003 and the years ended December 31, 2002 and 2001:

 
| **(In thousands of dollars)**               |   | **North  America** |    | **United  Kingdom** |   | **Germany** |   | **France** |   | **Asia****Pacific** |   | **Consolidated** |   |
|---------------------------------------------|--------|--------------------|---------|---------------------|--------|-------------|--------|------------|--------|---------------------|--------|------------------|--------|
|                                        |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Year ended December 31, 2001:          |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Sales to unaffiliated Customers             |   | $                  | 262,676 |                | $      | 60,240      |   | $          | 25,517 |                | $      | 18,185           |   | $ | 12,374 |   | $ | 378,992 |   |
|                                        |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Long-lived assets at December 31, 2001 |   | $                  | 80,289  |                | $      | 3,541       |   | $          | 2,370  |                | $      | 267              |   | $ | 196 |   | $ | 86,663 |   |
|                                        |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Year ended December 31, 2002:          |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Sales to unaffiliated Customers             |   | $                  | 358,124 |                | $      | 67,218      |   | $          | 26,051 |                | $      | 14,556           |   | $ | 14,580 |   | $ | 480,529 |   |
|                                        |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Long-lived assets at December 31, 2002 |   | $                  | 101,105 |                | $      | 759         |   | $          | 2,721  |                | $      | 356              |   | $ | 244 |   | $ | 105,185 |   |
|                                        |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Transition 2003:                            |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Sales to unaffiliated Customers             |   | $                  | 56,649  |                | $      | 4,361       |   | $          | 2,802  |                | $      | 1,259            |   | $ | 1,729 |   | $ | 66,800 |   |
|                                        |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Long-lived assets at March 31, 2003    |   | $                  | 109,779 |                | $      | 2,323       |   | $          | 1,236  |                | $      | 392              |   | $ | 307 |   | $ | 114,037 |   |
|                                        |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Fiscal Year ended March 31, 2004:      |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Sales to unaffiliated Customers             |   | $                  | 453,426 |                | $      | 88,325      |   | $          | 44,571 |                | $      | 28,961           |   | $ | 25,563 |   | $ | 640,846 |   |
|                                        |   |               |    |                |   |        |   |       |   |                |   |             |   |
| Long-lived assets at March 31, 2004    |   | $                  | 125,128 |                | $      | 2,749       |   | $          | 1,211  |                | $      | 556              |   | $ | 457 |   | $ | 130,101 |   |

 

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

 

*Twelve Months Ended March 31, 2004*

 
|                                               |   | **Quarters  Ended**     |   |
|----------------------------------------------------|--------|-------------------------|--------|
| **(Amounts in thousands,  except per share data)** |   | **June 30,  2003** |   | **September 30,  2003** |   | **December 31,  2003** |   | **March 31,  2004** |   |
|                                               |   |                    |   |   |   |   |   |   |   |
| Revenues                                           |   | $                       | 98,095 |   | $ | 126,517 |   | $ | 293,099 |   | $ | 123,135 |   |
| Expenses and Other                                 |   | 103,742                 |   | 120,816 |   | 245,642 |   | 115,410 |   |
| Income (loss) before income taxes                  |   | (5,647                  | )      | 5,701 |   | 47,457 |   | 7,725 |   |
| Income taxes                                       |   | (2,090                  | )      | 2,109 |   | 17,084 |   | 2,294 |   |
| Net income (loss)                                  |   | $                       | (3,557 | ) | $ | 3,592 |   | $ | 30,373 |   | $ | 5,431 |   |
|                                               |   |                    |   |   |   |   |   |   |   |
| Net income (loss) per share                        |   |                    |   |   |   |   |   |   |   |
| Basic                                              |   | $                       | (0.09  | ) | $ | 0.09 |   | $ | 0.80 |   | $ | 0.14 |   |
| Diluted                                            |   | $                       | (0.09  | ) | $ | 0.09 |   | $ | 0.78 |   | $ | 0.14 |   |

 

*Three Months Ended March 31, 2002 andTwelve Months Ended March 31, 2003*

 
| **(Amounts in thousands,  except per share data)** |   | **March 31,  2002** |   | **June 30,  2002** |   | **September 30,  2002** |   | **December 31,  2002** |   | **March 31,  2003** |   |
|----------------------------------------------------|--------|--------------------------|--------|-------------------------|--------|------------------------------|--------|-----------------------------|--------|--------------------------|--------|
|                                               |   |                     |   |                    |   |                         |   |                        |   |                     |   |
| Revenues                                           |   | $                        | 79,682 |                    | $      | 85,762                       |   | $                           | 97,335 |                     | $      | 217,750 |   | $ | 66,800 |   |
| Expenses and Other                                 |   | 75,258                   |   | 80,893                  |   | 89,895                       |   | 214,728                     |   | 77,776                   |   |
| Income (loss) before income taxes                  |   | 4,424                    |   | 4,869                   |   | 7,440                        |   | 3,022                       |   | (10,976                  | )      |
| Income taxes                                       |   | 1,659                    |   | 2,578                   |   | 2,636                        |   | (112                        | )      | (3,290                   | )      |
| Net income (loss)                                  |   | $                        | 2,765  |                    | $      | 2,291                        |   | $                           | 4,804  |                     | $      | 3,134 |   | $ | (7,686 | ) |
|                                               |   |                     |   |                    |   |                         |   |                        |   |                     |   |
| Net income (loss) per share                        |   |                     |   |                    |   |                         |   |                        |   |                     |   |
| Basic                                              |   | $                        | 0.07   |                    | $      | 0.06                         |   | $                           | 0.12   |                     | $      | 0.08 |   | $ | (0.20 | ) |
| Diluted                                            |   | $                        | 0.07   |                    | $      | 0.05                         |   | $                           | 0.12   |                     | $      | 0.08 |   | $ | (0.20 | ) |

 

Due to rounding some of the figures above may differ slightly from the10-Q’s previously filed.

 

For the quarter ended June 30, 2002, net income included anon-cash charge of $3.0 million for the discontinuation of the NIS online jointventure.

 

For the quarter ended December 31, 2002, 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 have beenprevented from shipping pursuant to an action by the World Wide Fund for Natureagainst World Wrestling Entertainment, Inc.

 

For the quarter ended March 31, 2003, net loss includes a chargeof $1.8 million due to the other than temporary impairment of our investment inYuke’s Co., Ltd.

 

For the quarter ended September 30, 2003, net income included a$4.0 million benefit for a settlement of a dispute with our directors’ andofficers’ insurance carrier related to a previous securities litigationsettlement.

 

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**Item 9.**                                                           CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

**Item 9A.** CONTROLS AND PROCEDURES

 

We have establisheddisclosure controls and procedures that are designed to ensure that theinformation we are required to disclose in our reports filed under theSecurities Exchange Act of 1934, as amended (the “Act”), is recorded,processed, summarized and reported in a timely manner. Specifically, thesecontrols and procedures ensure that the information is accumulated andcommunicated to our executive management team, including our chief executiveofficer and our chief financial officer, to allow timely decisions regardingrequired disclosure.

 

Management, with theassistance of internal audit, conducted an evaluation, as of March 31,2004, of the effectiveness and design of our disclosure controls andprocedures, under the supervision and with the participation of our chiefexecutive officer and chief financial officer. Based upon that evaluation, ourchief executive officer and chief financial officer have concluded that ourdisclosure controls and procedures are effective in alerting them in a timelymanner to material Company information required to be disclosed by us inreports filed under the Act.

 

In addition, there havebeen no significant changes in our internal control over financial reportingduring the quarter ended March 31, 2004 or subsequently that havematerially affected, or are reasonably likely to materially affect, theCompany’s internal control.

 

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**PART III**

 

**Item 10.**                                                    DIRECTORS ANDEXECUTIVE OFFICERS OF THE REGISTRANT

 

The information requiredunder this Item relating to members of our Board of Directors and ExecutiveOfficers will be included in our 2004 Notice of Annual Meeting of Shareholdersand Proxy Statement under the headings “Election of Directors,” “ExecutiveOfficers,” “Key Employees,” “Compliance with Section 16 of the SecuritiesExchange Act of 1934” and “Director and Officer Holdings,” which will be filedwithin 120 days after the close of our fiscal year, and is incorporated hereinby reference.

 

**Item 11.***                                                   *EXECUTIVE COMPENSATION

 

The information requiredunder this Item relating to executive compensation will be included in our 2004Notice of Annual Meeting of Shareholders and Proxy Statement under the heading“Executive Compensation,” which will be filed within 120 days after the closeof our fiscal year, and is incorporated herein by reference.

 

**Item 12.***                                                   *SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The information requiredunder this Item relating to security ownership of certain beneficial owners andmanagement will be included in our 2004 Notice of Annual Meeting ofShareholders and Proxy Statement under the heading “Principal Shareholders,”which will be filed within 120 days after the close of our fiscal year, and isincorporated herein by reference.

 

**Item 13.**                                                    CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS

 

There were no reportablerelationships or transactions with management during the three months endedMarch 31, 2004.

 

**Item 14.***                                                   *PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The information regardingprincipal accounting fees and services and the Company’s pre-approval policiesand procedures for audit and non-audit services provided by the Company’sindependent accountant is incorporated by reference to the Company’s ProxyStatement for its 2004 Annual Meeting of Shareholders under the caption“Principal Accountant Fees and Services.”

 

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**PARTIV**

 

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

 

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

 

The following financialstatements of the Company are included in Part II Item 8:

 
|                                                                                                                                                                                                                           |   |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| INDEPENDENT REGISTERED PUBLIC ACCOUNTING  FIRM’S REPORT                                                                                                                                                                   |   | 44     |
|                                                                                                                                                                                                                           |   |   |
| CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                              |   |   |
| Consolidated Balance Sheets — March 31, 2004 and 2003 and December 31,  2002                                                                                                                                    |   | 45     |
|                                                                                                                                                                                                                           |   |   |
| Consolidated Statements of Operations for  the Twelve months ended March 31, 2004, the Three Month Period Ended  March 31, 2003 and Each of the Two Years in the Period Ended  December 31, 2002                |   | 46     |
|                                                                                                                                                                                                                           |   |   |
| Consolidated Statements of Stockholders’  Equity for the Twelve months ended March 31, 2004, the Three Month  Period Ended March 31, 2003 and Each of the Two Years in the Period  Ended December 31, 2002 |   | 47     |
|                                                                                                                                                                                                                           |   |   |
| Consolidated Statements of Cash Flows for  the Twelve months ended March 31, 2004, the Three Month Period Ended  March 31, 2003 and Each of the Two Years in the Period Ended  December 31, 2002                |   | 50     |
|                                                                                                                                                                                                                           |   |   |
| NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                     |   | 52     |

 

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

 

The following Reports onForm 8-K were filed by the Registrant during the fourth quarter of Fiscal 2004:

 

(i)                                     CurrentReport on Form 8-K dated February 5, 2004 reporting under Items 7 and12.  The Current Report was anannouncement of earnings for the third quarter of Fiscal 2004 and includedCondensed Statements of Operations, Reconciliation of Net Income to Non-GAAPIncome, Balance Sheets as of December 31, 2003, and Supplementary Tables.

 

(ii)                                  Current Report onForm 8-K dated March 26, 2004 reporting under Item 9.  The attached press release announced a revenueand net income guidance.

 

**(c)**          *Exhibits.*

 

The following exhibitsare filed herewith or are incorporated by reference to exhibits previouslyfiled with the SEC.  We will furnishcopies of the exhibits for a reasonable fee (covering the expense of furnishingcopies) 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).                                                                                                    |

 

77

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| **Exhibit  Number** |   | **Title**                                                                                                                                                                                                                                                                                                                                          |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.5                 |   | Certificate of Designation of Series A Junior Participating Preferred  Stock of THQ Inc. (incorporated by reference to Exhibit A of Exhibit 1 of  Amendment No. 2 to the Registrant’s Registration Statement on Form 8-A filed  on August 28, 2001 (File No. 001-15959) (the “August 2001 Form  8-A”)).                   |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 3.6                 |   | Amendment to Certificate of Designation of Series A Junior  Participating Preferred Stock of THQ Inc. (incorporated by reference to  Exhibit 3.6 to the Registrant’s Quarterly Report on Form 10-Q for the  quarterly period ended September 30, 2001 (the “September 2001  10-Q”)).                                      |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 4.1                 |   | Amended and Restated Rights Agreement, dated as of August 22, 2001  between the Registrant and Computershare Investor Services, LLC, as Rights  Agent (incorporated by reference to Exhibit 1 to Amendment No. 2 to the  Registrant’s August 2001 Form 8-A).                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 4.2                 |   | First Amendment to Amended and Restated Rights Agreement, dated  April 9, 2002 between the Registrant and Computershare Investor  Services, LLC, as Rights Agent (incorporated by reference to Exhibit 2 to  Amendment No.3 to the Registrant’s Registration Statement on Form 8-A filed  on April 12, 2002 (file No. 000-18813)).  |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.1                |   | Amended and Restated Employment Agreement dated as of January 1,  2001, between the Company and Brian J. Farrell (incorporated by reference to  Exhibit 10.1 to the Registrant’s Annual Report on Form 10-K for the fiscal  year ended December 31, 2000 (the “December 2000 10-K”)).                                |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.2*               |   | Severance Agreement between Fred A. Gysi and the Company and  Confidential Separation Agreement and General Release, dated March 31, 2004.                                                                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.3                |   | Form of Severance Agreement with Executive Officers (incorporated by  reference to Exhibit 10.7 to the December 1998 10-K).                                                                                                                                                                                                                   |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.4                |   | Amended and Restated 1990 Stock Option Plan (incorporated by  reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form  S-2 filed on December 23, 1996 (File No. 333-18641)).                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.5                |   | 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).                                                                                      |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.6                |   | 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.                                                                                                                                                                          |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.7                |   | Form of Stock Option Agreement for the Amended and Restated 1997  Stock Option Plan (incorporated by reference to Exhibit 10.8 to the  Registrant’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2001 (the “December 2001 10-K”)).                                                                  |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.8                |   | Form of Stock Option Agreement dated as of December 23, 1998,  between the Company and each of Messrs. Lawrence Burstein and James Whims  (incorporated by reference to Exhibit 10.9 to the Registrant’s June 1999  10-Q).                                                                                                          |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.9                |   | Third Amended and Restated Nonexecutive Employee Stock Option Plan  (incorporated by reference to Appendix C to Registrant’s Proxy Statement  filed on Schedule 14A filed July 3, 2003.                                                                                                                                             |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.10               |   | Form of Nonexecutive Employee Stock Option Agreement for the Third  Amended and Restated Nonexecutive Employee Stock Option Plan (incorporated by  reference to Exhibit 4.10 to the Registrant’s Registration Statement on Form  S-8 filed on June 21, 2002 (File No. 333-90986)).                                                       |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.11               |   | Second Amendment to Revolving Credit Agreement, dated as of  February 20, 2001, between the Company, Union Bank as Agent and as  Lender, BNP Paribas, and Pacific Century Bank, N.A. (incorporated by  reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q  for the quarterly period ended March 30, 2001). |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.12               |   | Third Amendment to Revolving Credit Agreement, dated as of  June 12, 2001, between the Company, Union Bank as Agent and as Lender,  BNP Paribas, and Pacific Century Bank, N.A. (incorporated by reference to  Exhibit 10.2 to the Registrant’s June 2001 10-Q).                                                                    |
|                |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.13               |   | Fourth Amendment to Revolving Credit Agreement, dated as of July 31,  2001, between the Company, Union Bank as Agent and as Lender and BNP Paribas  (incorporated by reference to Exhibit 10.3 to the Registrant’s June 2001  10-Q).                                                                                                |

 

78

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| **Exhibit  Number** |   | **Title**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|---------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.14               |   | Fifth Amendment to Revolving Credit Agreement, dated as of  August 28, 2001, between the Company, Union Bank as Agent and as Lender  and BNP Paribas (incorporated by reference to Exhibit 10.1 to the  Registrant’s September 2001 10-Q).                                                                                                                                                                                                                                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.15               |   | Sixth Amendment to Revolving Credit Agreement, dated as of  October 26, 2001, between the Company, Union Bank as Agent and as Lender  and BNP Paribas (incorporated by reference to Exhibit 10.2 to the  Registrant’s September 2001 10-Q).                                                                                                                                                                                                                                                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.16               |   | Seventh Amendment to Revolving Credit Agreement and First Amendment  to Security Agreement, dated as of January 8, 2002, between the Company,  Union Bank as Agent and as Lender and BNP Paribas (incorporated by reference  to Exhibit 10.18 to the Registrant’s December 2001 10-K).                                                                                                                                                                                                                                                                                                            |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.17               |   | Eighth Amendment to Revolving Credit Agreement, dated as of May 1,  2002, between the Company, Union Bank as Agent and as Lender and BNP Paribas  (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly  Report on Form 10-Q for the quarterly period ended June 30, 2002 (the  “June 2002 10-Q”)).                                                                                                                                                                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.18               |   | Ninth Amendment to Revolving Credit Agreement, dated as of  July 26, 2002, between the Company, Union Bank as Agent and as Lender  and BNP Paribas (incorporated by reference to Exhibit 10.2 to the  Registrant’s June 2002 10-Q).                                                                                                                                                                                                                                                                                                                                                               |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.19               |   | Waiver under Revolving Credit Agreement, dated as of  September 10, 2002 by and between the Company and Union Bank  (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly  Report on Form 10-Q for the quarterly period ended September 30, 2002  (the “September 2002 10-Q”)).                                                                                                                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.20               |   | 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).                                                                                                                                                                                                                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.21               |   | 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 December 2002  10-K).                                                                                                                                                                                                                                                                                                                                                                |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.22               |   | Waiver under Amended and Restated Revolving Credit Agreement, dated  February 21, 2003, by and between the Company and Union Bank  (incorporated by reference to Exhibit 10.25 to the Registrant’s  December 2002 10-K).                                                                                                                                                                                                                                                                                                                                                                          |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.23               |   | Second Amendment to Security Agreement,  dated as of September 27, 2002 between the Company and Union Bank  (incorporated by reference to Exhibit 10.3 to the Registrant’s September 2002  10-Q).                                                                                                                                                                                                                                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.24               |   | Confidential License Agreement for Game Boy, Game Boy Color and Game  Boy Pocket Handheld Video Game Systems (Western Hemisphere), dated as of  March 9, 1999, between Nintendo of America Inc. (“NOA”) and the Company  (incorporated by reference to Exhibit 10.4 to the Registrant’s  September 2002 10-Q).  (Portions  have been omitted and filed separately with the Securities and Exchange  Commission pursuant to a request for confidential treatment in accordance  with Rule 24b-2 under the Securities Exchange Act of 1934, as amended  (“Exchange Act”)). |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.25               |   | First Amendment to the Confidential License  Agreement for Game Boy, Game Boy Color and Game Boy Pocket Handheld Video  Game Systems (Western Hemisphere) dated as of March 8, 2002, between NOA  and the Company (incorporated by reference to Exhibit 10.5 to  the Registrant’s September 2002 10-Q).                                                                                                                                                                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.26*              |   | Second Amendment to the Confidential License Agreement for Game Boy,  Game Boy Color and Game Boy Pocket Handheld Video Game Systems (Western  Hemisphere), dated as of March 8, 2004, between NOA and the Company.                                                                                                                                                                                                                                                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.27               |   | Confidential License Agreement for Game Boy Advance (Western  Hemisphere), dated as of July 18, 2001, between NOA and the Company  (incorporated by reference to Exhibit 10.6 to the Registrant’s  September 2002 10-Q).  (Portions  have been omitted and filed separately with the Securities and Exchange  Commission pursuant to a request for confidential treatment in accordance  with Rule 24b-2 under the Exchange Act.).                                                                                                                                                           |

 

79

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| **Exhibit  Number** |   | **Title**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|---------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.28               |   | Confidential License Agreement for Nintendo  GameCube (Western Hemisphere), dated as of April 5, 2002, between NOA  and the Company (Western Hemisphere) (incorporated by reference  to Exhibit 10.7 to the Registrant’s September 2002 10-Q).   (Portions have been omitted and filed separately with the Securities  and Exchange Commission pursuant to a request for confidential treatment in  accordance with Rule 24b-2 under the Exchange Act.).                   |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.29               |   | Microsoft Corporation Xbox TM Publisher License Agreement, dated as of  March 20, 2001, between Microsoft Corporation and the Company (incorporated by reference to Exhibit  10.8 to the Registrant’s September 2002 10-Q).  (Portions have been omitted and filed separately with the  Securities and Exchange Commission pursuant to a request for confidential  treatment in accordance with Rule 24b-2 under the Exchange Act.)                                    |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.30*              |   | Amendment to the XboxTM Publisher Licensing  Agreement (Platinum Hits Family Programs), dated as of March 15, 2004                                                                                                                                                                                                                                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.31               |   | Licensed Publisher Agreement, dated as of  August 28, 2002, by and between Sony Computer Entertainment America Inc.  (“Sony”) and the Company (incorporated by reference to Exhibit  10.9 to the Registrant’s September 2002 10-Q).  (Portions have been omitted  and filed separately with the Securities and Exchange Commission pursuant to  a request for confidential treatment in accordance with Rule 24b-2 under the  Exchange Act.)                     |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.32               |   | PlayStation ® 2 CD-Rom/ DVD-Rom Licensed Publisher Agreement, dated  as of April 1, 2000, between Sony and the Company (incorporated by reference to Exhibit  10.10 to the Registrant’s September 2002 10-Q).  (Portions have been omitted and filed  separately with the Securities and Exchange Commission pursuant to a request  for confidential treatment in accordance with Rule 24b-2 under the Exchange  Act.)                                                |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.33               |   | PlayStation® Licensed Publisher Agreement, dated as of June 25,  1998, between Sony Computer Entertainment Europe and THQ International  Limited (incorporated by reference  to Exhibit 10.11 to the Registrant’s September 2002 10-Q).  (Portions have been omitted and filed  separately with the Securities and Exchange Commission pursuant to a request  for confidential treatment in accordance with Rule 24b-2 under the Exchange  Act.)                      |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.34               |   | PlayStation® Licensed Publisher — Supplemental Agreement, dated as of  June 25, 1998, between Sony Computer Entertainment Europe and THQ  International Limited (incorporated  by reference to Exhibit 10.12 to the Registrant’s September 2002  10-Q).  (Portions have been omitted  and filed separately with the Securities and Exchange Commission pursuant to  a request for confidential treatment in accordance with Rule 24b-2 under the  Exchange Act.) |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.35               |   | 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 10.24 to the Registrant’s  December 2002 10-K).                                                                                       |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.36               |   | 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 June 30,  2003 10-Q).                                                                                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.37               |   | 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 30, 2003 10-Q).                                                                                                                                                                                |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.38               |   | 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 10.3 to the Registrant’s  June 30, 2003 10-Q).                                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.39               |   | 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 30, 2003 10-Q).                                                                                                                                                                                                                       |

 

80

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| **Exhibit  Number** |   | **Title**                                                                                                                                                                                                                                                                                                           |
|---------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.40               |   | 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 September 30,  2003 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, 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, pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                                                                                                                                                                                        |

 

----

*                                         Filedherewith.

 

81

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
| Dated:  June 14, 2004 | THQ INC. |
|---------------------------------|----------|
|                            | By:      | /s/Brian J. Farrell |   |
|                            |     | Brian J. Farrell,  Chairman of the Board, President and Chief Executive Officer |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the dates indicated.

 
| **Signature**                      |   | **Title**                                  |                                                           | **Date** |
|------------------------------------|--------|--------------------------------------------|----------------------------------------------------------------|----------|
|                               |   |                                       |                                                           |     |
| /s/   Brian J. Farrell   |   |                                       | Director, Chairman of the Board, President and Chief Executive |     | June 14, 2004 |
| Brian J. Farrell                   |   | Officer (Principal Executive Officer)      |                                                           |     |
|                               |   |                                       |                                                           |     |
| /s/   Edward Zinser      |   |                                       | Executive Vice President, Chief Financial Officer              |     | June 14, 2004 |
| Edward Zinser                      |   | (Principal Financial Officer and Principal |                                                           |     |
|                               |   | Accounting Officer)                        |                                                           |     |
|                               |   |                                       |                                                           |     |
| /s/   L. Gregory Ballard |   |                                       | Director                                                       |     | June 14, 2004 |
| L. Gregory Ballard                 |   |                                       |                                                           |     |
|                               |   |                                       |                                                           |     |
| /s/   Lawrence Burstein  |   |                                       | Director                                                       |     | June 14, 2004 |
| Lawrence Burstein                  |   |                                       |                                                           |     |
|                               |   |                                       |                                                           |     |
| /s/   Henry DeNero       |   |                                       | Director                                                       |     | June 14, 2004 |
| Henry DeNero                       |   |                                       |                                                           |     |
|                               |   |                                       |                                                           |     |
| /s/   Brian Dougherty    |   |                                       | Director                                                       |     | June 14, 2004 |
| Brian Dougherty                    |   |                                       |                                                           |     |
|                               |   |                                       |                                                           |     |
| /s/  James L. Whims           |   |                                       | Director                                                       |     | June 14, 2004 |
| James K. Whims                     |   |                                       |                                                           |     |
|                                    |        |                                            |                                                                |          |  |  |  |  |  |

 

82

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