THQ 2004 Annual Report Download - page 30

Our sales are made directly to retailers and independent distributors. We distribute our games primarily to mass merchandisers and national retail chain
stores, including Wal-Mart (representing 19% of gross sales in the fiscal year ended March 31, 2004) and Toys “R” Us (representing 7% of gross sales in
the fiscal year ended March 31, 2004). Some of our other retailers include Target, Best Buy, GameStop, Electronics Boutique, KB Toys, and Game
Stores Group Ltd. Sales to our ten largest customers collectively accounted for approximately 54% and 60% of our gross sales in the fiscal year
ended March 31, 2004 and the twelve-month period ended March 31, 2003 (unaudited), respectively; 67% of our gross sales in the three
months ended March 31, 2003; and 64% of our gross sales in each of the years ended December 31, 2002 and 2001. Most of our customers do not have
written agreements or understandings which commit them to make purchases from us.
Revenue Fluctuations and Seasonality. We have experienced, and will likely continue to experience, significant quarterly fluctuations in net sales and
operating results due to a variety of factors. The software market is highly seasonal, with sales typically significantly higher during the quarter ending
December 31st (due primarily to the increased demand for interactive games during the year-end holiday buying season). Other factors that cause
fluctuations include the timing of our release of new titles, the popularity of both new titles and titles released in prior periods, changes in the mix of
titles with varying gross margins, the timing of customer orders, the timing of shipments by the manufacturers, fluctuations in the size and rate of growth
of consumer demand for software for various platforms, the timing of the introduction of new platforms, and the accuracy of retailers’ forecasts of
consumer demand. Our expenses are partially based on our expectations of future sales and, as a result, operating results would be disproportionately
and adversely affected by a decrease in sales or a failure by us to meet our sales expectations. There can be no assurance that we can maintain
consistent profitability on a quarterly or annual basis.
Profit margins may vary over time as a result of a variety of factors. Profit margins for cartridge products for the Game Boy platforms can vary based
on the cost of the memory chip used for a particular title. The other platforms support disc-based products that have significantly lower per unit
manufacturing costs than cartridge-based products; however, they also have higher development costs than cartridge-based products.
SOFTWARE DESIGN AND DEVELOPMENT
We produce products internally based on original and licensed content. Internal, original products include MX Unleashed and Red Faction. Internally
created products based upon licensed materials include Heavy Iron Studios’ development of SpongeBob SquarePants and Scooby-Doo!. The products
produced internally are designed and created by employees at our eight studios: Cranky Pants, Heavy Iron, Helixe, PCP&L, Rainbow, Relic Entertainment
Inc. (“Relic”), THQ Australia Studios, and Volition. Our studios are staffed by producers, game designers, software engineers, artists, animators and game
testers.
For certain internally developed concepts, we contract with independent software developers to conceptualize and develop games under our
supervision and may own the intellectual property. We pay the independent developer a development fee in advance. Once we have recouped the
expenses of the development fee, the independent developers generally receive a contingent compensation based on a percentage of net sales.
We also contract with independent software developers to conceptualize and develop properties, under our supervision, based upon either original
concepts created by the developer or licenses we acquire. For these products, we generally pay either a development fee or royalty compensation based
upon actual sales. The royalty compensation is based upon a percentage of net sales, ranging from 4% to 20%. We typically pay our independent
developers installments of the development fee (and, in the case of royalty compensation, advances against future royalty payments) based either on
specific development milestones or on agreed-upon payment schedules. The intellectual property is owned by either the developer or the licensor.
Whether a game is developed internally or externally, upon completion of development, each game is extensively play-tested by us and sent to the
manufacturer for its review and approval. Related artwork, user instructions, warranty information, brochures and packaging designs are also developed
under our supervision. The development cycle for a new game, including the development of the necessary software, approval by the manufacturer and
production of the initial products, typically has ranged from 12 to 24 months for console games and PC products and seven to 12 months for handheld
games. This relatively long development cycle requires that we assess whether there will be adequate retailer and consumer demand for a game well in
advance of its release.
GEOGRAPHIC INFORMATION
We operate in one reportable segment in which we are a developer and publisher of interactive entertainment software for the leading hardware
platforms in the home video game market. Wireless gaming may become a new reportable segment as our activity in this market increases. The
following information sets forth geographic information on our sales generated by our regional offices for the fiscal years ended March 31, 2004 and 2003
(unaudited), and the years ended December 31, 2002 and 2001 (also See Note 18 to the consolidated financial statements for additional geographic
information on our sales and long-lived assets):