Annual Reports

 
Quarterly Reports

  • 10-Q (Nov 13, 2012)
  • 10-Q (Aug 9, 2012)
  • 10-Q (Feb 9, 2012)
  • 10-Q (Nov 9, 2011)
  • 10-Q (Aug 11, 2011)
  • 10-Q (Feb 10, 2011)

 
8-K

 
Other

THQ 10-Q 2007

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

þ                                 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

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

GRAPHIC

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.)

29903 Agoura Road

 

Agoura Hills, CA

91301

(Address of principal executive offices)

(Zip Code)

 

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


Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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  þ  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): .

Large accelerated filer   þ

 

Accelerated filer   o

 

Non-accelerated filer   o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o  No  þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  As of January 12, 2007, there were 65,462,878 shares of common stock outstanding.

 




THQ INC. AND SUBSIDIARIES

INDEX

Explanatory Note

 

3

 

Part I—Financial Information

 

5

 

Item 1.

 

Condensed Consolidated Financial Statements (Unaudited):

 

5

 

 

 

Condensed Consolidated Balance Sheets—September 30, 2006 and March 31, 2006

 

5

 

 

 

Condensed Consolidated Statements of Operations—for the Three and Six Months Ended September 30, 2006 and 2005 (as restated)

 

6

 

 

 

Condensed Consolidated Statements of Cash Flows—for the Six Months Ended September 30, 2006 and 2005 (as restated)

 

7

 

 

 

Notes to Condensed Consolidated Financial Statements

 

8

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

27

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

46

 

Item 4.

 

Controls and Procedures

 

46

 

Part II—Other Information

 

48

 

Item 1.

 

Legal Proceedings

 

48

 

Item 1A.

 

Risk Factors

 

48

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

48

 

Item 3.

 

Defaults Upon Senior Securities

 

49

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

49

 

Item 5.

 

Other Information

 

49

 

Item 6.

 

Exhibits

 

50

 

Signatures

 

51

 

 

2




EXPLANATORY NOTE

Restatement of Consolidated Financial Results

In this Form 10-Q for the quarterly period ended September 30, 2006, we are presenting restated consolidated statements of operations for the three and six months ended September 30, 2005, and restated consolidated statement of cash flows for the six months ended September 30, 2005. In addition, in Note 2 “Restatement of Consolidated Financial Statements” in Notes to Consolidated Financial Statements we are providing disclosure regarding the restated consolidated statement of operations for the three months ended June 30, 2005. The consolidated statement of operations for the three months ended September 30, 2006 includes a charge of approximately $300,000 for stock-based compensation expense and related tax effects relating to the three months ended June 30, 2006. Due to the immateriality of this amount, we are not restating our results for the three months ended June 30, 2006 and accordingly, we are not amending our June 30, 2006 10-Q.

On August 4, 2006, we received an informal inquiry from the Securities and Exchange Commission (“SEC”) requesting certain documents and information relating to our stock option grant practices from January 1, 1996 to the present. We publicly announced this inquiry on August 7, 2006. Prior to August 4, 2006, we were already conducting an internal review of our historical stock option grant practices with the assistance of outside counsel. We initiated the internal review following extensive news coverage and analyst reports about the option practices of numerous companies across several different industries.

Upon receipt of the notice of informal inquiry from the SEC, our Board of Directors (the “Board”) formed a special committee of one outside director (the “Special Committee”) to conduct an independent and comprehensive investigation of our historical stock option grant practices and to oversee our response to the SEC. The Special Committee retained independent outside legal counsel and forensic accountants (the “Investigative Team”) to aid in its investigation.

Special Committee Findings

The Investigative Team reviewed the facts and circumstances surrounding stock option grants made during the period from January 1996 through September 2006 (the “Period”), which included grants made on 426 dates. The Investigative Team conducted an extensive investigation, incurring over 11,000 person-hours searching millions of physical and electronic documents and interviewing more than 35 current and former directors, officers, employees, and advisors. As part of its investigation, the Special Committee evaluated whether the correct measurement dates had been used under applicable accounting principles for the options granted during the Period. The measurement date as defined under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and related interpretations through March 31, 2006, and Financial Accounting Standards No. 123R, Share-Based Payment (“FAS 123R”) subsequent to that date, is the first date on which all of the following are known: (1) the individual employee who is entitled to receive the option grant, (2) the number of options that an individual employee is entitled to receive, and (3) the option’s exercise price.

The Special Committee concluded its investigation and reported its findings to the full Board on December 2, 2006. The Special Committee concluded that there was no evidence of fraud or misconduct by any person with respect to the Company’s historical stock option grant practices. The Special Committee identified instances where documentation of certain option grants was lacking. The Special Committee also determined that an incorrect measurement date for financial accounting purposes was used on a number of occasions. These errors resulted primarily from misapplication of accounting standards related to certain measurement date selection methods discussed below, which in a number of occasions resulted in employees receiving options with stated exercise prices lower than the market prices as measured based upon the measurement dates as determined by the applicable accounting standards. Most of the additional stock-based compensation expense related to these incorrect measurement dates

3




pertained to grants made to non-executive employees. In connection with the conclusion of its review, the Special Committee recommended to the Board, and its Compensation Committee, that the Board and Compensation Committee consider and adopt certain remedial measures related to the issues raised in the Special Committee’s investigation. See Item 4. “Controls and Procedures” for a complete discussion of our material weakness in internal controls surrounding our stock option grant practices. The Special Committee and its Investigative Team reported the Special Committee’s findings and remedial measures to the SEC on January 8, 2007.

As a result of the internal review and based on the conclusions of the Special Committee following the independent investigation, we have concluded that incorrect measurement dates were previously used for financial accounting and reporting purposes on a number of occasions. Therefore, we have recorded additional non-cash stock-based compensation expense and related tax effects with regard to past stock option grants and we have restated our previously filed financial statements. The adjustments, after tax, for the three and six months ended September 30, 2005 were $0.5 million and $0.8 million, respectively. The adjustment, after tax, for the three months ended June 30, 2005 is $0.3 million. The adjustment, after tax, for the three months ended June 30, 2006 is immaterial and as such it was recorded in the three months ended September 30, 2006.

The nature of our accounting errors were primarily in one of the following three categories of option grants:

Company-Wide Stock Option Grants not Determined with Finality.   The Special Committee determined that, in connection with certain company-wide stock option grants that we made to non-executive employees in various years, we used incorrect measurement dates for accounting and reporting purposes because the list of grantees and the options awarded to each grantee was not determined with finality until a date subsequent to the measurement dates we previously used. In most such situations, our practice was to set the exercise price for the option at the closing price of our common stock on the date the Compensation Committee of the Board delegated authority to our Chief Executive Officer to award up to a specified aggregate number of options, which was prior to the date that the list of grantees and the options awarded to each grantee was finalized by the Chief Executive Officer.

Stock Option Grants Priced using Previous Day Closing Price.   The Special Committee determined that in three instances throughout 1998 and 1999, the exercise price was set at the closing price of our common stock on the day prior to the Compensation Committee meeting where such grants were made. Our option plans in effect at the time stated that the grant price could not be less than the fair market value of the option on the date of grant, which was defined in the plans as the closing price of our common stock on the date of grant. The Special Committee therefore determined that the measurement date used for accounting purposes should be the date of the meeting.

Incorrect Measurement Dates for New Hire Stock Option Grants.   The Special Committee also identified accounting errors related to our new hire stock option grant practices. The Special Committee determined that our new hire stock option granting practice, primarily for our international employees, resulted in a measurement date for accounting purposes that was subsequent to the date that we had previously used for accounting purposes. These errors occurred because the details of stock option grants to international employees were not contained in offer letters and in most cases the number of options the individual was entitled to receive was determined after his or her start date. There were also some instances where grants were made to employees prior to the date they started providing services to the Company, generally because the employee had accepted an employment offer and his or her name was placed on a grant list that was then approved prior to his or her actual start date.

We restated the pro forma expense under Statement of Financial Accounting Standards (“SFAS”) No. 123 in Note 11 of the Notes to Condensed Consolidated Financial Statements to reflect the impact of these adjustments.

4




Part I—Financial Information

Item 1.                        Condensed Consolidated Financial Statements

THQ INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

September 30,
2006

 

March 31,
2006

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

74,018

 

 

$

91,517

 

Short-term investments

 

 

209,778

 

 

280,120

 

Cash, cash equivalents and short-term investments

 

 

283,796

 

 

371,637

 

Accounts receivable, net of allowances

 

 

109,921

 

 

78,876

 

Inventory

 

 

42,445

 

 

28,620

 

Licenses

 

 

46,613

 

 

20,849

 

Software development

 

 

123,587

 

 

91,843

 

Income taxes receivable

 

 

6,241

 

 

4,686

 

Prepaid expenses and other current assets

 

 

36,299

 

 

12,420

 

Total current assets

 

 

648,902

 

 

608,931

 

Property and equipment, net

 

 

41,314

 

 

37,485

 

Licenses, net of current portion

 

 

58,169

 

 

60,623

 

Software development, net of current portion

 

 

21,793

 

 

17,236

 

Income taxes receivable, net of current portion

 

 

10,273

 

 

10,273

 

Goodwill

 

 

95,425

 

 

90,872

 

Other long-term assets, net

 

 

20,870

 

 

23,048

 

TOTAL ASSETS

 

 

$

896,746

 

 

$

848,468

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

 

$

58,083

 

 

$

34,871

 

Accrued and other current liabilities

 

 

114,527

 

 

110,924

 

Deferred income taxes

 

 

1,366

 

 

3,578

 

Total current liabilities

 

 

173,976

 

 

149,373

 

Other long-term liabilities

 

 

55,808

 

 

60,323

 

Deferred income taxes, net of current portion

 

 

9,681

 

 

9,681

 

Commitments and contingencies (See Note 10)

 

 

 

 

 

 

 

Minority interest

 

 

1,278

 

 

1,340

 

Stockholders’ equity:

 

 

 

 

 

 

 

Preferred stock, par value $0.01, 1,000,000 shares authorized

 

 

 

 

 

Common stock, par value $0.01, 75,000,000 shares authorized; 65,115,689 and 64,140,977 shares issued and outstanding as of September 30, 2006 and March 31, 2006, respectively

 

 

651

 

 

642

 

Additional paid-in capital

 

 

432,951

 

 

405,425

 

Accumulated other comprehensive income

 

 

11,596

 

 

10,367

 

Retained earnings

 

 

210,805

 

 

211,317

 

Total stockholders’ equity

 

 

656,003

 

 

627,751

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

$

896,746

 

 

$

848,468

 

 

See notes to condensed consolidated financial statements.

5




THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

 

 

For the Three Months Ended
September 30,

 

For the Six Months Ended
September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

As restated(1)

 

 

 

As restated(1)

 

 

 

(Unaudited)

 

(Unaudited)

 

Net sales

 

$

240,197

 

 

$

142,692

 

 

$

379,026

 

 

$

300,659

 

 

Cost and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

77,016

 

 

48,009

 

 

126,007

 

 

103,535

 

 

License amortization and royalties

 

20,831

 

 

10,735

 

 

37,144

 

 

24,459

 

 

Software development amortization

 

43,656

 

 

24,450

 

 

68,947

 

 

47,795

 

 

Product development

 

25,686

 

 

23,871

 

 

51,922

 

 

45,115

 

 

Selling and marketing

 

38,925

 

 

25,780

 

 

65,636

 

 

61,782

 

 

Payment to venture partner

 

773

 

 

677

 

 

1,482

 

 

2,589

 

 

General and administrative

 

19,645

 

 

13,090

 

 

35,171

 

 

27,340

 

 

Total costs and expenses

 

226,532

 

 

146,612

 

 

386,309

 

 

312,615

 

 

Income (loss) from operations

 

13,665

 

 

(3,920

)

 

(7,283

)

 

(11,956

)

 

Interest and other income, net

 

3,736

 

 

1,316

 

 

6,476

 

 

3,406

 

 

Income (loss) before income taxes and minority interest

 

17,401

 

 

(2,604

)

 

(807

)

 

(8,550

)

 

Income taxes

 

5,857

 

 

(663

)

 

(152

)

 

(2,435

)

 

Income (loss) before minority interest

 

11,544

 

 

(1,941

)

 

(655

)

 

(6,115

)

 

Minority interest

 

45

 

 

3

 

 

143

 

 

(54

)

 

Net income (loss)

 

$

11,589

 

 

$

(1,938

)

 

$

(512

)

 

$

(6,169

)

 

Net income (loss) per share—basic

 

$

0.18

 

 

$

(0.03

)

 

$

(0.01

)

 

$

(0.10

)

 

Net income (loss) per share—diluted

 

$

0.17

 

 

$

(0.03

)

 

$

(0.01

)

 

$

(0.10

)

 

Shares used in per share calculation—basic

 

64,513

 

 

62,299

 

 

64,414

 

 

61,904

 

 

Shares used in per share calculation—diluted

 

66,726

 

 

62,299

 

 

64,414

 

 

61,904

 

 


(1)          See Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Condensed Consolidated Financial Statements.

See notes to condensed consolidated financial statements.

6




THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

 

 

For the Six Months Ended
September 30,

 

 

 

2006

 

2005

 

 

 

 

 

As restated(1)

 

 

 

(Unaudited)

 

OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net income (loss)

 

$

(512

)

 

$

(6,169

)

 

Adjustments to reconcile net income (loss) to net cash used in operating activities:

 

 

 

 

 

 

 

Minority interest and other

 

48

 

 

54

 

 

Depreciation and amortization

 

6,952

 

 

6,811

 

 

Amortization of licenses and software development

 

75,297

 

 

46,086

 

 

Loss on disposal of property and equipment

 

533

 

 

13

 

 

Stock-based compensation

 

8,414

 

 

1,575

 

 

Tax benefit related to stock-based awards

 

5,254

 

 

4,905

 

 

Excess tax benefit related to stock-based awards

 

(3,384

)

 

 

 

Deferred income taxes

 

12

 

 

631

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable, net of allowances

 

(28,435

)

 

(5,851

)

 

Inventory

 

(13,183

)

 

(13,750

)

 

Licenses

 

(31,070

)

 

(7,668

)

 

Software development

 

(101,146

)

 

(58,526

)

 

Prepaid expenses and other current assets

 

(23,353

)

 

(20,359

)

 

Accounts payable

 

22,006

 

 

(1,846

)

 

Accrued and other liabilities

 

(2,189

)

 

3,307

 

 

Income taxes

 

(291

)

 

(9,891

)

 

Net cash used in operating activities

 

(85,047

)

 

(60,678

)

 

INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Proceeds from sales and maturities of short-term investments

 

302,330

 

 

193,935

 

 

Purchase of short-term investments

 

(231,988

)

 

(180,563

)

 

Other long-term assets

 

(3,409

)

 

(1,844

)

 

Acquisitions, net of cash acquired

 

(4,950

)

 

(4,800

)

 

Purchases of property and equipment

 

(8,231

)

 

(13,228

)

 

Net cash provided by (used in) investing activities

 

53,752

 

 

(6,500

)

 

FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Stock repurchase

 

(10,061

)

 

 

 

Proceeds from exercise of stock options

 

21,753

 

 

23,768

 

 

Excess tax benefit related to stock-based awards

 

3,384

 

 

 

 

Net cash provided by financing activities

 

15,076

 

 

23,768

 

 

Effect of exchange rate changes on cash

 

(1,280

)

 

(266

)

 

Net decrease in cash and cash equivalents

 

(17,499

)

 

(43,676

)

 

Cash and cash equivalents—beginning of period

 

91,517

 

 

98,175

 

 

Cash and cash equivalents—end of period

 

$

74,018

 

 

$

54,499

 

 


(1)          See Note 2, “Restatement of Consolidated Financial Statements,” in Notes to Condensed Consolidated Financial Statements.

See notes to condensed consolidated financial statements.

7




THQ INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.   Basis of Presentation

The consolidated financial statements included in this Form 10-Q present the results of operations, financial position and cash flows of THQ Inc. (together with its subsidiaries, “THQ”, we, us, our or the “Company”). In the opinion of management, the accompanying consolidated balance sheets and related interim consolidated statements of operations and cash flows include all adjustments, consisting only of normal recurring items, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses. Examples include price protection, returns and doubtful accounts. Actual results may differ from these estimates. Interim results are not necessarily indicative of results for a full year. The balance sheet at March 31, 2006 has been derived from the audited financial statements at that date but does not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. The information included in this Form 10-Q should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K/A for the fiscal year ended March 31, 2006.

Reclassifications.

Certain reclassifications have been made to the prior periods consolidated financial statements to conform to current period consolidated financial statements.

In the fourth quarter of fiscal 2006, we reclassified warehousing expenses from selling and marketing to cost of sales. Classification of these expenses as a component of cost of sales is a practice that is consistent with others within our industry. The reclassified warehousing expenses for the three and six months ended September 30, 2005 were $1.2 million and $2.4 million, respectively.

In the first quarter of fiscal 2007, we reclassified certain depreciation and amortization expenses from general and administrative expenses to selling and marketing expenses and to product development expenses. Depreciation and amortization expenses are now classified in our consolidated statement of operations according to the department utilizing the related assets. The reclassified depreciation and amortization expenses for the three and six months ended September 30, 2005 were $197,000 and $413,000, respectively, to selling and marketing expenses and $2.3 million and $4.3 million, respectively, to product development expenses. We also reclassified transactional foreign currency gains and losses from general and administrative expenses to net interest and other income. The reclassified transactional foreign currency gains and losses for the three and six months ended September 30, 2005 were $0.4 million.

8




Fiscal Year and Fiscal Quarter.

Effective April 1, 2006, we began reporting our fiscal year on a 52/53-week period. Beginning with the current fiscal year ending March 31, 2007, we will end our fiscal year on the Saturday nearest March 31. The results of operations for the three and six months ended September 30, 2006 and 2005 contain the following number of weeks:

Fiscal Period

 

 

 

Number of Weeks

 

Fiscal Period End Date

Three months ended September 30, 2006

 

13 weeks

 

September 30, 2006

Three months ended September 30, 2005

 

13 weeks

 

September 30, 2005

Six months ended September 30, 2006

 

27 weeks

 

September 30, 2006

Six months ended September 30, 2005

 

27 weeks

 

September 30, 2005

 

For simplicity, all fiscal periods in our consolidated financial statements and accompanying notes are presented as ending on a calendar month end.

2.   Restatement of Consolidated Financial Statements

Subsequent to the issuance of our fiscal 2006 consolidated financial statements and as a result of an internal review of our historical stock option grant practices and based on the conclusions of an independent investigation by a Special Committee of our Board of Directors, we have concluded that incorrect measurement dates were previously used for financial accounting and reporting purposes on a number of occasions.

As a result, we have restated our consolidated statements of operations for the three and six months ended September 30, 2005, and restated our consolidated statement of cash flows for the six months ended September 30, 2005. In addition, in this note we are providing disclosure regarding the restated consolidated statements of operations for the three months ended June 30, 2005. The consolidated statement of operations for the three months ended September 30, 2006 includes a charge of $300,000 for stock-based compensation expense and related tax effects relating to the three months ended June 30, 2006. Due to the immateriality of this amount, we are not restating our results for the three months ended June 30, 2006 and accordingly, we are not amending our June 30, 2006 10-Q.

We have recorded additional non-cash stock-based compensation expense and related tax effects with regard to past stock option grants from amounts previously reported. The adjustments, after tax, for the three and six months ended September 30, 2005 were $0.5 million and $0.8 million, respectively. The adjustment, after tax, for the three months ended June 30, 2005 is $0.3 million. The adjustment, after tax, for the three months ended June 30, 2006 is immaterial and as such it was recorded in the three months ended September 30, 2006.

The nature of our accounting errors were primarily in one of the following three categories of option grants:

Company-Wide Stock Option Grants not Determined with Finality.   The Special Committee determined that, in connection with certain company-wide stock option grants that we made to non-executive employees in various years, we used incorrect measurement dates for accounting and reporting purposes because the list of grantees and the options awarded to each grantee was not determined with finality until a date subsequent to the measurement dates we previously used. In most such situations, our practice was to set the exercise price for the option at the closing price of our common stock on the date the Compensation Committee of the Board delegated authority to our Chief Executive Officer to award up to a specified aggregate number of options, which was prior to the date that the list of grantees and the options awarded to each grantee was finalized by the Chief Executive Officer.

9




Stock Option Grants Priced using Previous Day Closing Price.   The Special Committee determined that in three instances throughout 1998 and 1999, the exercise price was set at the closing price of our common stock on the day prior to the Compensation Committee meeting where such grants were made. Our option plans in effect at the time stated that the grant price could not be less than the fair market value of the option on the date of grant, which was defined in the plans as the closing price of our common stock on the date of grant. The Special Committee therefore determined that the measurement date used for accounting purposes should be the date of the meeting.

Incorrect Measurement Dates for New Hire Stock Option Grants.   The Special Committee also identified accounting errors related to our new hire stock option grant practices. The Special Committee determined that our new hire stock option granting practice, primarily for our international employees, resulted in a measurement date for accounting purposes that was subsequent to the date that we had previously used for accounting purposes. These errors occurred because the details of stock option grants to international employees were not contained in offer letters and in most cases the number of options the individual was entitled to receive was determined after his or her start date. There were also some instances where grants were made to employees prior to the date they started providing services to the Company, generally because the employee had accepted an employment offer and his or her name was placed on a grant list that was then approved prior to his or her actual start date.

Additionally, we have restated the pro forma expense under Statement of Financial Accounting Standards (“SFAS”) No. 123 (“FAS 123”) in Note 11 to reflect the impact of these adjustments.

The following table sets forth the effects of the adjustments on our Condensed Consolidated Statements of Operations for the three months ended June 30, 2005 (not otherwise presented herein):

 

 

For the Three Months Ended
June 30, 2005

 

 

 

As previously
reported(1)

 

Adjustments

 

As restated

 

 

 

(In thousands, except per share data)

 

Product development

 

 

$

21,120

 

 

 

$

124

 

 

 

$

21,244

 

 

Selling and marketing

 

 

35,959

 

 

 

43

 

 

 

36,002

 

 

General and administrative

 

 

14,185

 

 

 

65

 

 

 

14,250

 

 

Total costs and expenses

 

 

165,771

 

 

 

232

 

 

 

166,003

 

 

Loss from operations

 

 

(7,804

)

 

 

(232

)

 

 

(8,036

)

 

Interest income

 

 

2,148

 

 

 

(58

)

 

 

2,090

 

 

Loss before income taxes and minority interest

 

 

(5,656

)

 

 

(290

)

 

 

(5,946

)

 

Income taxes

 

 

(1,753

)

 

 

(19

)

 

 

(1,772

)

 

Loss before minority interest

 

 

(3,903

)

 

 

(271

)

 

 

(4,174

)

 

Net Loss

 

 

(3,960

)

 

 

(271

)

 

 

(4,231

)

 

Net loss per share—basic

 

 

$

(0.06

)

 

 

$

(0.01

)

 

 

$

(0.07

)

 

Net loss per share—diluted

 

 

$

(0.06

)

 

 

$

(0.01

)

 

 

$

(0.07

)

 

Shares used in per share calculation—basic

 

 

60,929

 

 

 

 

 

 

60,929

 

 

Shares used in per share calculation—diluted

 

 

60,929

 

 

 

 

 

 

60,929

 

 


(1)          See Note 1, “Basis of Presentation” for description of certain reclassifications made to the prior period consolidated financial statements to conform to the current period consolidated financial statements.

10




The following tables set forth the effects of the adjustments on our Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2005:

 

 

For the Three Months Ended
September 30, 2005

 

For the Six Months Ended
September 30, 2005

 

 

 

As previously
reported(1)

 

Adjustments

 

As restated

 

As previously
reported(1)

 

Adjustments

 

As restated

 

 

 

(In thousands, except per share data)

 

Product development

 

 

$

23,618

 

 

 

$

253

 

 

 

$

23,871

 

 

 

$

44,738

 

 

 

$

377

 

 

 

$

45,115

 

 

Selling and marketing

 

 

25,688

 

 

 

92

 

 

 

25,780

 

 

 

61,647

 

 

 

135

 

 

 

61,782

 

 

General and administrative

 

 

12,949

 

 

 

141

 

 

 

13,090

 

 

 

27,134

 

 

 

206

 

 

 

27,340

 

 

Total costs and expenses

 

 

146,126

 

 

 

486

 

 

 

146,612

 

 

 

311,897

 

 

 

718

 

 

 

312,615

 

 

Loss from operations

 

 

(3,434

)

 

 

(486

)

 

 

(3,920

)

 

 

(11,238

)

 

 

(718

)

 

 

(11,956

)

 

Interest income

 

 

1,379

 

 

 

(63

)

 

 

(1,316

)

 

 

3,527

 

 

 

(121

)

 

 

3,406

 

 

Loss before income taxes and minority interest

 

 

(2,055

)

 

 

(549

)

 

 

(2,604

)

 

 

(7,711

)

 

 

(839

)

 

 

(8,550

)

 

Income taxes

 

 

(637

)

 

 

(26

)

 

 

(663

)

 

 

(2,390

)

 

 

(45

)

 

 

(2,435

)

 

Loss before minority interest

 

 

(1,418

)

 

 

(523

)

 

 

(1,941

)

 

 

(5,321

)

 

 

(794

)

 

 

(6,115

)

 

Net Loss

 

 

(1,415

)

 

 

(523

)

 

 

(1,938

)

 

 

(5,375

)

 

 

(794

)

 

 

(6,169

)

 

Net loss per share—basic

 

 

$

(0.02

)

 

 

$

(0.01

)

 

 

$

(0.03

)

 

 

$

(0.09

)

 

 

$

(0.01

)

 

 

$

(0.10

)

 

Net loss per share—diluted

 

 

$

(0.02

)

 

 

$

(0.01

)

 

 

$

(0.03

)

 

 

$

(0.09

)

 

 

$

(0.01

)

 

 

$

(0.10

)

 

Shares used in per share calculation—basic

 

 

62,299

 

 

 

 

 

 

62,299

 

 

 

61,904

 

 

 

 

 

 

61,904

 

 

Shares used in per share calculation—diluted

 

 

62,299

 

 

 

 

 

 

62,299

 

 

 

61,904

 

 

 

 

 

 

61,904

 

 


(1)          See Note 1, “Basis of Presentation” for description of certain reclassifications made to the prior period consolidated financial statements to conform to the current period consolidated financial statements.

The following tables set forth the effects of the adjustments on our Condensed Consolidated Statement of Cash Flows for the six months ended September 30, 2005:

 

 

September 30, 2005

 

 

 

As previously
reported

 

Adjustments

 

As restated

 

 

 

(In thousands)

 

Net income

 

 

$

(5,375

)

 

 

$

(794

)

 

 

$

(6,169

)

 

Stock-based compensation

 

 

1,142

 

 

 

433

 

 

 

1,575

 

 

Tax benefit related to the exercise of stock-based awards

 

 

5,762

 

 

 

(857

)

 

 

4,905

 

 

Deferred income taxes

 

 

485

 

 

 

146

 

 

 

631

 

 

Accrued and other liabilities

 

 

3,003

 

 

 

304

 

 

 

3,307

 

 

Income taxes

 

 

(10,659

)

 

 

768

 

 

 

(9,891

)

 

 

The adjustments recorded as a result of the stock option investigation did not significantly impact the statement of cash flows for the three months ended June 30, 2005 and so it has not been presented herein.

3.   Cash, Cash Equivalents, Short-Term Investments and Financial Instruments

Our investments with maturities beyond one year may be classified as short-term based on their liquid nature and because such securities represent the investment of cash that is available for current operations. All of our short-term investments are classified as available-for-sale and are carried at fair market value with unrealized gains (losses) reported as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity.

11




The following table summarizes our cash, cash equivalents and short-term investments as of September 30, 2006 (in thousands):

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Value

 

Cash and cash equivalents

 

$

74,018

 

 

 

 

 

 

 

$

74,018

 

Short-term investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency securities

 

9,478

 

 

2

 

 

 

(3

)

 

9,477

 

Municipal securities

 

173,207

 

 

2

 

 

 

(8

)

 

173,201

 

Corporate notes

 

27,100

 

 

 

 

 

 

 

27,100

 

Total short-term investments

 

209,785

 

 

4

 

 

 

(11

)

 

209,778

 

Cash, cash equivalents and short-term investments

 

$

283,803

 

 

4

 

 

 

(11

)

 

$

283,796

 

 

The following table summarizes the gross unrealized losses and fair value of our short-term investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2006 (in thousands):

 

 

Unrealized Losses Less

 

Unrealized Losses 12

 

 

 

 

 

 

 

Than 12 Months

 

Months or Greater

 

Total

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

Gross

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

U.S. agency securities

 

$

3,984

 

 

$

 

 

$

5,493

 

 

$

3

 

 

$

9,477

 

 

$

3

 

 

Municipal securities

 

165,909

 

 

2

 

 

7,292

 

 

6

 

 

173,201

 

 

8

 

 

Corporate notes

 

27,100

 

 

 

 

 

 

 

 

27,100

 

 

 

 

Total

 

$

196,993

 

 

$

2

 

 

$

12,785

 

 

$

9

 

 

$

209,778

 

 

$

11

 

 

 

The gross unrealized losses in each of the securities in the above tables were primarily caused by a decrease in the fair value of the investments as a result of an increase in interest rates. The contractual terms of these securities do not permit the issuer to call, prepay or otherwise settle the securities at prices less than the stated par value of the security. Accordingly, we do not consider these investments to be other-than-temporarily impaired as of September 30, 2006.

During the six months ended September 30, 2006 and 2005 there were no realized gains or (losses) from sales of available-for-sale securities. In addition to the net unrealized loss of $7,000 from our short-term investments, we had an unrealized loss on our investment in Yuke’s Co., Ltd. (“Yuke’s”) which is classified as available-for-sale and is included in other long-term assets (see “Note 8—Other Long-Term Assets”).

The following table summarizes the amortized cost and fair value of our short-term investments, classified by stated maturity as of September 30, 2006 (in thousands):

 

 

Amortized
Cost

 

Fair
Value

 

Due in one year or less

 

$

196,995

 

$

196,993

 

Due after one year through two years

 

12,790

 

12,785

 

Total

 

$

209,785

 

$

209,778

 

 

In the fourth quarter of fiscal 2006 we changed the presentation of our proceeds from sales and maturities of short-term investments and purchases of short-term investments in our consolidated statements of cash flows. The statements of cash flows presented in these financial statements present the gross amount of these transactions during each of the six months ended September 30, 2006, and 2005. The previously

12




reported statement of cash flows for the six months ended September 30, 2005 presented these activities at a net transactional level. As a result, the amounts reported in these financial statements for our proceeds from sales and maturities of short-term investments and purchases of short-term investments are higher than previously reported. The change in presentation does not impact the net proceeds from sales and maturities of short-term investments and purchases of short-term investments, our cash flow from investing activities or our overall change in cash and cash equivalents.

Financial Instruments.   As of September 30, 2006 and March 31, 2006, we had foreign exchange forward contracts in the notional amount of $77.6 million and $60.3 million, respectively. The net gain (loss) recognized from foreign currency contracts during the three and six months ended September 30, 2006 was $1.1 million and $(776,000), respectively, and the net (loss) gain recognized from foreign currency contracts during the three and six months ended September 30, 2005 was $(352,000) and $876,000, respectively, both of which are included in interest and other income and expense in our consolidated statements of operations.

4.   Licenses

Minimum guaranteed royalty payments for intellectual property licenses are initially recorded on our balance sheet as an asset (licenses) and as a liability at the contractual amount upon execution of the contract if no significant performance obligation remains with the licensor. When a significant performance obligation remains with the licensor, we record royalty payments as an asset (licenses) when payable rather than upon execution of the contract. Royalty payments for intellectual property licenses are classified as current assets and current liabilities to the extent such royalty payments relate to anticipated sales during the subsequent year and long-term assets and long-term liabilities if such royalty payments relate to anticipated sales after one year.

We evaluate the future recoverability of our capitalized licenses on a quarterly basis. The recoverability of capitalized license costs is evaluated based on the expected performance of the specific products in which the licensed trademark or copyright is to be used. As many of our licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized license costs based on certain qualitative factors such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned theatrical releases or television series based on the intellectual property and the rights holder’s continued promotion and exploitation of the intellectual property. Prior to the related product’s release, we expense, as part of license amortization and royalties, capitalized license costs when we believe such amounts are not recoverable.

Licenses are expensed to license amortization and royalties at the higher of (1) the contractual royalty rate based on actual net product sales related to such license or (2) an effective rate based upon total projected revenue related to such license. When, in management’s estimate, future cash flows will not be sufficient to recover previously capitalized costs, we expense these capitalized costs to license amortization and royalties. If actual revenues or revised forecasted revenues fall below the initial forecasted revenue for a particular license, the charge to license amortization and royalties expense may be larger than anticipated in any given quarter. As of September 30, 2006, the net carrying value of our licenses was $104.8 million. If we were required to write off licenses, due to changes in market conditions or product acceptance, our results of operations could be materially adversely affected.

5.   Software Development

We utilize both internal development teams and third-party software developers to develop our software. We account for software development costs in accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed” (“FAS 86”). We capitalize software

13




development costs once technological feasibility is established and we determine that such costs are recoverable against future revenues. For products where proven game engine technology exists, this may occur early in the development cycle. We capitalize the milestone payments made to third-party software developers and the direct payroll and overhead costs for our internal development teams. We evaluate technological feasibility on a product-by-product basis. Amounts related to software development for which technological feasibility is not yet met are charged as incurred to product development expense in our consolidated statements of operations.

On a quarterly basis, we compare our unamortized software development costs to net realizable value, on a product-by-product basis. The amount by which any unamortized software development costs exceed their net realizable value is charged to software development amortization. The net realizable value is the estimated future net revenues from the product, reduced by the estimated future direct costs associated with the product such as completion costs, cost of sales and advertising.

Commencing upon product release, capitalized software development costs are amortized to software development amortization based on the ratio of current gross revenues to total projected gross revenues. If actual gross revenues, or revised projected gross revenues, fall below the initial projections, the charge to software development amortization may be larger than anticipated in any given quarter. As of September 30, 2006, the net carrying value of our software development was $145.4 million.

The milestone payments made to our third-party developers during their development of our games are typically considered non-refundable advances against the total compensation they can earn based upon the sales performance of the products. Any additional compensation earned beyond the milestone payments is expensed to software development amortization as earned.

6.   Goodwill

In accordance with our accounting policy, we performed an annual review of goodwill for impairment during the quarter ended June 30, 2006, and found no impairment. Our impairment review process is based on a discounted future cash flow approach that uses our estimates of revenue for the reporting units, driven by assumed success of our products and product release schedules, and estimated costs as well as appropriate discount rates. These estimates are consistent with the plans and estimates that we use to manage the underlying businesses.

The changes in the carrying amount of goodwill for the six months ended September 30, 2006 are as follows (in thousands):

Balance at March 31, 2006

 

$

90,872

 

Additional consideration paid for ValuSoft acquisition

 

1,800

 

Goodwill acquired

 

1,343

 

Effect of foreign currency translation

 

1,410

 

Balance at September 30, 2006

 

$

95,425

 

 

14




7.                 Other Intangible Assets

Other intangible assets are included in other long-term assets, net, and are as follows (in thousands):

 

 

 

 

September 30, 2006

 

March 31, 2006

 

 

 

Useful
Lives

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Amount

 

Software technology

 

2-3 years

 

 

$

2,272

 

 

 

$

(1,641

)

 

 

$

631

 

 

$

3,055

 

 

$

(2,085

)

 

 

$

970

 

 

Trade secrets

 

5 years

 

 

1,800

 

 

 

(1,709

)

 

 

91

 

 

1,800

 

 

(1,530

)

 

 

270

 

 

Customer list

 

4-5 years

 

 

1,493

 

 

 

(747

)

 

 

746

 

 

1,414

 

 

(550

)

 

 

864

 

 

Trade names

 

3-10 years

 

 

3,394

 

 

 

(1,048

)

 

 

2,346

 

 

3,196

 

 

(739

)

 

 

2,457

 

 

Non-compete / Employment
contracts

 

3-7 years

 

 

998

 

 

 

(712

)

 

 

286

 

 

1,055

 

 

(656

)

 

 

399

 

 

Total

 

 

 

 

$

9,957

 

 

 

$

(5,857

)

 

 

$

4,100

 

 

$

10,520

 

 

$

(5,560

)

 

 

$

4,960

 

 

 

Amortization of other intangible assets was $560,000 and $1.2 million for the three and six months ended September 30, 2006, respectively, and $643,000 and $1.3 million for the three and six months ended September 30, 2005, respectively. Finite-lived other intangible assets are amortized using the straight-line method over the lesser of their estimated useful lives or the agreement terms, typically from two to ten years, and assessed for impairment under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

As of September 30, 2006, future amortization of other finite-lived intangible assets was estimated as follows (in thousands):

Fiscal Year Ending March 31,

 

 

 

 

 

Remainder of 2007

 

$

1,032

 

2008

 

1,077

 

2009

 

631

 

2010

 

257

 

2011

 

244

 

Thereafter

 

859

 

 

 

$

4,100

 

 

8.                 Other Long-Term Assets

In addition to other intangible assets, other long-term assets include our investment in Yuke’s. For the six months ended September 30, 2006, the unrealized holding loss related to our investment in Yuke’s was $3.7 million. For the six months ended September 30, 2005, the unrealized holding gain related to our investment in Yuke’s was $1.7 million.

Other long-term assets as of September 30, 2006 and March 31, 2006 are as follows (in thousands):

 

 

September 30,
2006

 

March 31,
2006

 

Investment in Yuke’s

 

 

$

5,488

 

 

 

$

9,217

 

 

Other intangible assets (see Note 7)

 

 

4,100

 

 

 

4,960

 

 

Other

 

 

11,282

 

 

 

8,871

 

 

Total other long-term assets

 

 

$

20,870

 

 

 

$

23,048

 

 

 

15




9.                 Balance Sheet Details

Inventory.   Inventory at September 30, 2006 and March 31, 2006 consists of the following (in thousands):

 

 

September 30,

 

March 31,

 

 

 

2006

 

2006

 

Components

 

 

$

7,224

 

 

 

$

1,530

 

 

Finished goods

 

 

35,221

 

 

 

27,090

 

 

Inventory

 

 

$

42,445

 

 

 

$

28,620

 

 

 

Property and Equipment, net.   Property and equipment at September 30, 2006 and March 31, 2006 consists of the following (in thousands):

 

 

Useful

 

September 30,

 

March 31,

 

 

 

Lives

 

2006

 

2006

 

Building

 

30 yrs

 

 

$

719

 

 

$

719

 

Land

 

 

 

401

 

 

401

 

Computer equipment and software

 

3-10 yrs

 

 

50,633

 

 

44,776

 

Furniture, fixtures and equipment

 

5 yrs

 

 

8,580

 

 

7,324

 

Leasehold improvements

 

3-6 yrs

 

 

10,462

 

 

7,847

 

Automobiles

 

2-5 yrs

 

 

98

 

 

128

 

 

 

 

 

 

70,893

 

 

61,195

 

Less: accumulated depreciation

 

 

 

 

(29,579

)

 

(23,710

)

 

 

 

 

 

$

41,314

 

 

$

37,485

 

 

Depreciation expense associated with property and equipment amounted to $3.2 million and $6.3 million, respectively, for the three and six months ended September 30, 2006, and $2.9 million and $5.5 million, respectively, for the three and six months ended September 30, 2005.

Accrued and Other Current Liabilities.   Accrued and other current liabilities at September 30, 2006 and March 31, 2006 consist of the following (in thousands):

 

 

September 30,

 

March 31,

 

 

 

2006

 

2006

 

Accrued liabilities

 

 

$

47,738

 

 

$

34,194

 

Accrued compensation

 

 

25,071

 

 

23,367

 

Accrued payment to venture partner

 

 

814

 

 

1,419

 

Accrued royalties

 

 

40,904

 

 

51,944

 

Accrued and other current liabilities

 

 

$

114,527

 

 

$

110,924

 

 

Other Long-Term Liabilities.   Other long-term liabilities at September 30, 2006 and March 31, 2006 consist of the following (in thousands):

 

 

September 30,

 

March 31,

 

 

 

2006

 

2006

 

Accrued royalties

 

 

$

52,945

 

 

 

$

58,025

 

 

Accrued liabilities

 

 

2,863

 

 

 

2,298

 

 

Other long-term liabilities

 

 

$

55,808

 

 

 

$

60,323

 

 

 

16




10.          Commitments and Contingencies

A summary of annual minimum contractual obligations and commercial commitments as of September 30, 2006 is as follows (in thousands):

 

 

Contractual Obligations and Commercial Commitments

 

 

 

License /

 

 

 

 

 

 

 

 

 

Fiscal

 

Software

 

 

 

 

 

 

 

 

 

Years Ending

 

Development

 

 

 

 

 

Letters of

 

 

 

March 31,

 

 

 

Commitments(1)

 

Advertising(2)

 

Leases(3)

 

Credit(4)

 

Total

 

Remainder of 2007

 

 

$

31,721

 

 

 

$

14,518

 

 

 

$

6,818

 

 

 

$

15,153

 

 

$

68,210

 

2008

 

 

47,949

 

 

 

14,920

 

 

 

13,083

 

 

 

 

 

75,952

 

2009

 

 

40,883

 

 

 

11,907

 

 

 

12,573

 

 

 

 

 

65,363

 

2010

 

 

38,000

 

 

 

13,530

 

 

 

12,248

 

 

 

 

 

63,778

 

2011

 

 

23,000

 

 

 

8,372

 

 

 

11,711

 

 

 

 

 

43,083

 

Thereafter

 

 

 

 

 

 

 

 

32,658

 

 

 

 

 

32,658

 

 

 

 

$

181,553

 

 

 

$

63,247

 

 

 

$

89,091

 

 

 

$

15,153

 

 

$

349,044

 


(1)          Licenses and Software Development.   We enter into contractual arrangements with third parties for the rights to intellectual property and for the development of products. Under these agreements, we commit to provide specified payments to an intellectual property holder or developer. Assuming all contractual provisions are met, the total future minimum contract commitments for contracts in place as of September 30, 2006 are approximately $181.6 million.

License/software development commitments in the table above include $64.9 million of commitments to licensors that are included in our consolidated balance sheet as of September 30, 2006 because the licensors do not have any significant performance obligations to us. These commitments were included in both current and long-term licenses and accrued royalties.

(2)          Advertising.   We have certain minimum advertising commitments under most of our major license agreements. These minimum commitments generally range from 2% to 12% of net sales related to the respective license.

(3)          Leases.   We are committed under operating leases with lease termination dates through 2015. Most of our leases contain rent escalations.

(4)          Letters of Credit.   As of September 30, 2006, we were in compliance with all the covenants under our credit facility, had outstanding letters of credit of approximately $15.2 million and no borrowings. This credit facility expired on November 29, 2006 and we did not renew it. On October 3, 2006, we entered into an agreement with a bank primarily to provide stand-by letters of credit to a platform manufacturer from whom we purchase products. We pledged cash equivalents and investments to the bank as collateral in an amount equal to 110% of the amount of the outstanding stand-by letters of credit.

Other contingencies relate to the following:

SEC Informal Inquiry.   On August 4, 2006, we received an informal inquiry from the Securities and Exchange Commission (“SEC”) requesting certain documents and information relating to our stock option grant practices from January 1, 1996 to the present. We publicly announced this inquiry on August 7, 2006. Prior to August 4, 2006, we were already conducting an internal review of our historical stock option grant practices with the assistance of outside counsel. We initiated the internal review following extensive news coverage and analyst reports about the option practices of numerous companies across several different industries.

17




Upon receipt of the notice of informal inquiry from the SEC, our Board of Directors (the “Board”) formed a special committee consisting of one outside directors (the “Special Committee”) to conduct an independent and comprehensive investigation of our stock option practices and to oversee our response to the SEC. The Special Committee retained independent outside legal counsel and forensic accountants (the “Investigative Team”) to aid in its investigation.

The Special Committee concluded its investigation and reported its findings to the full Board on December 2, 2006. The Special Committee concluded that there was no evidence of fraud or misconduct by any person with respect to the Company’s historical stock option grant practices. The Special Committee identified instances where documentation of certain option grants was lacking. The Special Committee also determined that an incorrect measurement date for financial accounting purposes was used on a number of occasions. These errors resulted primarily from misapplication of accounting standards related to certain measurement date selection methods discussed in detail in Note 2, which in a number of occasions resulted in employees receiving options with stated exercise prices lower than the market prices as measured based upon the measurement dates as determined by the applicable accounting standards. The Special Committee and its Investigative Team reported the Special Committee’s findings and remedial measures to the SEC on January 8, 2007. We do not know when this SEC inquiry will be resolved or what actions, if any, the SEC may take as a result of this inquiry.

Lawsuits related to our historical stock option granting practices.   On August 25, 2006, a shareholder action captioned Ramsey v. Haller et al. was filed against certain of our current and former officers and directors in the California Superior Court, Los Angeles County. The complaint alleges, among other things, purported improprieties in our issuance of stock options, breach of fiduciary duty and unjust enrichment. We have been served with one other shareholder derivative complaint, based on substantially the same allegations, which was filed in California federal court. A third shareholder derivative complaint, filed in California Superior Court, Los Angeles County, has not yet been served on the defendants, but we expect to accept service shortly. Although litigation is subject to inherent uncertainties, we do not believe the results of these pending actions will, individually or in the aggregate, have a material adverse impact on our consolidated financial position or results of operations.

WWE Lawsuit.   On October 12, 2006, World Wrestling Entertainment, Inc. filed a lawsuit against the Company and THQ / JAKKS Pacific, LLC (the “LLC”), involving a claim previously reported in our SEC filings concerning allegedly improper sales of WWE video games in Japan and other countries in Asia. The lawsuit seeks, among other things, a declaration that the WWE is entitled to terminate the video game license and seek monetary damages. The Company and the LLC believe the lawsuit is without merit and we intend to defend ourselves vigorously. Due to the early status of this litigation as well as the litigation disclosed in Note 18, “Commitments and Contingencies” of our Form 10-K/A for the fiscal year ended March 31, 2006, we cannot estimate a possible loss, if any. Games we develop based upon our WWE license have contributed to approximately 15% of our net sales during each of the three years in the period ended March 31, 2006. The loss of the WWE license would have a negative impact on our future financial results.

See Note 17, “Subsequent Events Related to the Special Committee and Company Investigation and the Restatement,” for more information regarding legal and regulatory proceedings that arose following September 30, 2006.

11.          Stock-based Compensation

Prior to July 20, 2006, we utilized two stock option plans:  the THQ Inc. Amended and Restated 1997 Stock Option Plan (the “1997 Plan”) and the THQ Inc. Third Amended and Restated Nonexecutive Employee Stock Option Plan (the “NEEP Plan”). The 1997 Plan provided for the issuance of up to 14,357,500 shares available for employees, consultants and non-employee directors, and the NEEP plan

18




provided for the issuance of up to 2,142,000 shares available for nonexecutive employees of THQ of which no more than 20% was available for awards to our nonexecutive officers and no more than 15% was available for awards to the nonexecutive officers or general managers of our subsidiaries or divisions. The 1997 Plan and the NEEP Plan were cancelled on July 20, 2006, the same day THQ’s stockholders approved the THQ Inc. 2006 Long-Term Incentive Plan (“LTIP”).

Under the 1997 Plan, we granted incentive stock options, non-qualified stock options, Performance Accelerated Restricted Stock (“PARS”) and Performance Accelerated Restricted Stock Units (“PARSUs”). The NEEP Plan provided for the grant of only non-qualified stock options to non-executive officers of the Company. The LTIP provides for the grant of stock options (including incentive stock options), Stock Appreciation Rights (SARs), Restricted Stock Awards, Other Stock Unit Awards, and Performance Awards (in the form of Performance Shares or Performance Units) to eligible directors and employees of, and consultants or advisors to, the Company. Subject to certain adjustments, the total number of shares of THQ common stock that may be issued under the LTIP shall not exceed 6,000,000 shares. Shares subject to awards of stock options or SARs will count as one share for every one share granted against the share limit, and all other awards will count as 1.6 shares for every one granted against the share limit. As of September 30, 2006, we had 5,752,525 shares under the LTIP available for grant.

The purchase price per share of common stock purchasable upon exercise of each option granted under the 1997 Plan, the NEEP Plan and the LTIP may not be less than the fair market value of such share of common stock on the date that such option is granted. Generally, options granted under the 1997 Plan and the NEEP Plan become exercisable over three years and expire on the fifth anniversary of the grant date. PARS and PARSUs that have been granted to our officers under the 1997 Plan vest with respect to 100% of the shares subject to the award on the fifth anniversary of the grant date; provided, however, 20% of the shares subject to each award will vest on each of the first through fourth anniversaries of the grant date if certain performance targets for the Company are attained each fiscal year. To date, no vesting of PARS or PARSUs has been accelerated. PARSUs granted to our non-employee directors vest one year after their grant date. The fair value of our nonvested restricted stock is determined based on the closing trading price of our common stock on the grant date. The fair value of PARS and PARSUs granted is amortized over the period(s) in which the related services are rendered.

Any references we make to unspecified “stock-based compensation” and “stock-based awards” are intended to represent the collective group of all our awards:  stock options, PARS and PARSUs. Any references we make to “nonvested shares” are intended to represent our PARS and PARSU awards.

Prior to April 1, 2006, we accounted for our stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended (“FAS 123”). Effective April 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), “Share-Based Payment,” (“FAS 123R”) using the modified prospective transition method. FAS 123R applies to all unvested options outstanding on April 1, 2006 and all future awards. The adoption of this accounting pronouncement had a material impact on our consolidated statement of operations and our cash flows from operating and financing activities for the three and six months ended September 30, 2006. Under that transition method, results for prior periods have not been restated as a result of adopting FAS 123R.

The compensation expense related to stock-based compensation was $5.3 million and $8.4 million, respectively, for the three and six months ended September 30, 2006, and $1.0 million and $1.6 million, respectively, for the three and six months ended September 30, 2005. The total income tax benefit recognized in the statement of operations for stock-based compensation was $1.2 million and $2.7 million, respectively, for the three and six months ended September 30, 2006, and $0.3 million and $0.5 million, respectively, for the three and six months ended September 30, 2005. Stock-based compensation cost

19




capitalized during the six months ended September 30, 2006 and 2005, was $2.5 million and zero, respectively, and is included in software development in the consolidated balance sheet.

For the three and six months ended September 30, 2006, stock-based compensation expense recognized in the statement of operations was as follows (in thousands):

 

 

Three Months Ended
September 30,

 

Six Months Ended
September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

As restated(1)

 

 

 

As restated(1)

 

Software development amortization

 

$

163

 

 

$

 

 

$

163

 

 

$

 

 

Product development

 

981

 

 

135

 

 

1,776

 

 

282

 

 

Selling and marketing

 

831

 

 

701

 

 

1,224

 

 

763

 

 

General and administrative