THQ 2005 Annual Report Download - page 55

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32
Cost of sales primarily consists of direct manufacturing costs net of manufacturer volume rebates and
discounts. Cost of sales as a percentage of net sales decreased for fiscal 2005 as compared to fiscal 2004,
primarily due to lower average manufacturing costs across all platforms and higher average selling price of
Game Boy Advance and PC products. We expect cost of sales as a percentage of net sales for fiscal 2006 to
remain relatively unchanged as compared to fiscal 2005.
License Amortization and Royalties (in thousands)
Year Ended
March 31,2005% of net sales
Year Ended
March 31,2004% of net sales % change
$85,926 11.4 % $71,132 11.1%0.3%
License amortization and royalties expense consists of royalty payments due to licensors, which are
expensed at the higher of (1) the contractual royalty rate based on actual net product sales for such license
or (2) an effective rate based upon total projected revenue for such license.For fiscal 2005, license
amortization and royalties as a percentage of net sales remained relatively flat as compared to fiscal 2004.
This is primarily due to our top three selling brands—Disney/Pixar, SpongeBob SquarePants and WWE
licensing amortization rates by brand remaining relatively constant for fiscal 2005 and 2004. We expect
license amortization and royalties as a percentage of net sales to decrease in fiscal 2006, reflectinggreater
sales mix of games based upon original properties.
Software Development Amortization (in thousands)
Year Ended
March 31, 2005% of net sales
Year Ended
March 31, 2004% of net sales % change
$93,622 12.4 % $ 1 05,632 16.5%(4.1)%
Software development amortization expense consists of amortization of capitalized payments made to
independent software developers and amortization of capitalized internal studio development costs.
Software development costs are expensed at the higher of (1) the contractual rate based on actual net
product sales for such software or (2) an effective rate based upon total projected revenue for such
software. For fiscal 2005 software development amortization as a percentage of net sales decreased as
compared to fiscal 2004 primarily due to our strategy of bringing the development of games based upon
our core franchises, such as Disney/Pixar’s The Incredibles, in-house, as compared to Disney/Pixar’s Finding
Nemo, whichwas externally developed. Also, the effective amortization rate for The SpongeBob
SquarePants Movie released in fiscal 2005 was lower as compared to the amortization rate for SpongeBob
SquarePants: Battle for Bikini Bottomreleased in fiscal 2004 as we were able to leverage the technology
developed on the fiscal 2004 title. Further, in fiscal 2004we had high development costs associated with
creating Sphinx and the Cursed Mummy, an original brand for which we did not develop a title in fiscal
2005. We expect software development amortization as a percentage of net sales to increase in fiscal 2006
as compared to fiscal 2005 which benefited from the internally developed title, The Incredibles. To a lesser
extent, software development for next-generation platforms in fiscal 2006 will be higher than in fiscal 2005.