THQ 2010 Annual Report Download - page 45

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Licenses. Minimum guaranteed royalty payments for intellectual property licenses are initially recorded on our
balance sheet as an asset (licenses) and as a liability (accrued royalties) 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) and as a
liability (accrued royalties) 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 product sales during the subsequent year and long-term assets and long-term
liabilities if such royalty payments relate to anticipated product 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 cost of sales—license amortization and royalties,
capitalized license costs when we estimate such amounts are not recoverable.
Licenses are expensed to cost of sales—license amortization and royalties at the higher of (i) the contractual
royalty rate based on actual net product sales related to such license, or (ii) an effective rate based upon
total projected net sales 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 cost of sales—
license amortization and royalties. If actual net sales or revised forecasted net sales fall below the initial
forecasted net sales for a particular license, the charge to cost of sales—license amortization and royalties
expense may be larger than anticipated in any given quarter. At March 31, 2010, the net carrying value of
our licenses was $140.3 million and is reflected as “Licenses” and “Licenses, net of current portion” in the
consolidated financial statements included in Item 8. Additionally, as of March 31, 2010 we had commitments
of $122.3 million that are not reflected in our consolidated financial statements due to remaining performance
obligations of the licensor. If we were required to impair these licenses, due to changes in market conditions
or product acceptance, our results of operations could be materially adversely affected.
Software Development. We utilize both internal development teams and third-party software developers to
develop our software. We capitalize software development costs once technological feasibility is established
and we determine that such costs are recoverable against future net sales. We evaluate technological
feasibility on a product-by-product basis. For products where proven game engine technology exists, the
establishment of technological feasibility 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. 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 cost of sales—software amortization and royalties. The net realizable value
is the estimated future net sales 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 cost of sales—
software amortization and royalties based on the ratio of current gross sales to total projected gross sales. In
fiscal 2010, we recorded $10.8 million of additional amortization expense related to the cancellation of
certain games. As of March 31, 2010, the net carrying value of our software development was $159.0 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 cost of sales—software amortization and royalties as earned. Additionally, we have a studio
bonus plan that allows for our internal product development staff to participate in the success of the games
they develop. As certain performance targets are reached, any additional compensation earned under the
studio bonus plan is expensed to cost of sales—software amortization and royalties.