THQ 2007 Annual Report Download - page 26

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Operating agreement with JAKKS Pacific, Inc.
In June 1999 we entered into an operating agreement with JAKKS that governs our relationship with
respect to the WWE videogame license. Pursuant to the terms of this agreement, JAKKS is entitled to a
preferred payment from revenues derived from exploitation of theWWE videogame license. Theamount
of thepreferredpayment to JAKKS for theperiod beginning July 1, 2006 and ending December 31, 2009
(the “First Subsequent Distribution Period”)is to be determined by agreement or, failing that, by
arbitration.
Theparties have not reached agreement on thepreferred payment for theFirst SubsequentDistribution
Period. Accordingly, as provided in the operating agreement, theparties are in the process of selecting an
arbitrator to resolve this dispute. Although we believe continuation of the previous preferred payment
would represent significantly excessive compensationto JAKKS for the First Subsequent Distribution
Period, we arenot able to predict the outcome of the arbitration or otherwise estimate the amount of the
preferred payment for the First Subsequent Distribution Period. Accordingly, we are currently accruingfor
apreferred payment to JAKKS at the previous rate. However, we have advised JAKKS that we do not
intend to make any paymentuntil the amount of the preferred payment payable to JAKKS for theFirst
Subsequent DistributionPeriod is agreedor otherwise determined as provided in the operating agreement.
On April 30, 2007, we filed apetition to compel arbitration and appoint an arbitrator in theSuperior Court
of the State of California for theCountyof LosAngeles, West District. Our petition seeks a court order
compelling JAKKS to comply with thearbitration provisions in the operating agreement and establishing a
process and timelineforselecting an arbitrator. On or about May 22, 2007, JAKKS filed a responseto our
petition, as wellas an application for provisionalreliefrequesting that, pending conclusion of the
arbitration, THQ either be enjoined fromdistributing to itself anyproceeds from thejoint venturesince
June 2006 or be compelled to resume payments to JAKKS at the samerate that was in effect prior to
June 2006. A hearing on thepetition is scheduled for June19, 2007.
We do not expect the resolution of this dispute to have amaterial adverseimpacton our resultsof
operations, financial position or cash flows.
SEC Informal Inquiry
On August 4, 2006,we received an informalinquiry from theSecurities andExchange 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 conductingan internal review of our historical stock optiongrant practices with the
assistance of outside counsel. We initiated the internalreview following extensive news coverage and
analyst reports about the option practices of numerous companies across several different industries. The
Company hascooperated fullywith the SEC’s inquiry.
Upon receipt of thenotice of informal inquiry from the SEC, our Boardof Directors (the “Board”)
formed a special committee consisting of one outside director, Jeffrey Griffiths (the “Special Committee”),
to conduct an independent and comprehensive investigation of our stock option practices and to oversee
our response to the SEC. TheSpecial Committee retained independent outsidelegal counsel and forensic
accountants (the “Investigative Team”) to aid in its investigation.
TheSpecial Committee concluded its investigation and reported its findings to the full Board on
December 2, 2006. The Special Committee found no evidence of fraud or misconduct by any person with
respect to thecompany’s historical stock option grant practices. The Special Committeedid identify
instances where documentation of certain option grants waslacking. The Special Committee also
determined that an incorrect measurement date for financial accounting purposes was used on anumber
of occasions. These errors resulted primarily from misapplication of accounting standards related to
certainmeasurement date selectionmethodsdiscussed in detail in Note2totheNotes to the Consolidated