10-Q 1 thq10-q063011.htm 10-Q THQ 10-Q 063011
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________________________________________________

 FORM 10-Q 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2011
 
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
___________________________________________________________
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  x  No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  o
 
Accelerated filer  x
 
 
Non-accelerated filer  o
 
Smaller reporting company  o
 
 
(Do not check if a smaller reporting company)
 
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

The number of shares outstanding of the registrant's common stock as of August 5, 2011 was approximately 68,331,246.

THQ INC. AND SUBSIDIARIES
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


Part I — Financial Information

Item 1.  Condensed Consolidated Financial Statements

THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
 
 
June 30,
2011
 
March 31,
2011
 
(Unaudited)
 
(Unaudited)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
119,036

 
$
85,603

Accounts receivable, net of allowances
50,275

 
161,574

Inventory
26,946

 
31,905

Licenses
47,064

 
32,869

Software development
221,850

 
222,631

Deferred income taxes
8,414

 
8,200

Prepaid expenses and other current assets
48,435

 
56,908

Total current assets
522,020

 
599,690

Property and equipment, net
29,414

 
28,960

Licenses, net of current portion
84,530

 
85,367

Software development, net of current portion
37,146

 
49,858

Deferred income taxes
516

 
516

Other long-term assets, net
10,079

 
10,014

TOTAL ASSETS
$
683,705

 
$
774,405

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
77,028

 
$
100,550

Accrued and other current liabilities
159,152

 
137,922

Deferred revenue, net
86,824

 
141,060

Total current liabilities
323,004

 
379,532

Other long-term liabilities
88,217

 
88,042

Convertible senior notes
100,000

 
100,000

Commitments and contingencies (see Note 8)


 


 
 
 
 
Stockholders' equity:
 
 
 
Preferred stock, par value $0.01, 1,000,000 shares authorized
—

 
—

Common stock, par value $0.01, 225,000,000 shares authorized as of June 30, 2011; 68,328,155 and 68,300,482 shares issued and outstanding as of June 30, 2011 and March 31, 2011, respectively
683

 
683

Additional paid-in capital
522,403

 
520,797

Accumulated other comprehensive income
20,052

 
17,560

Accumulated deficit
(370,654
)
 
(332,209
)
Total stockholders' equity
172,484

 
206,831

TOTAL LIABILITIES AND EQUITY
$
683,705

 
$
774,405

 
See notes to condensed consolidated financial statements.

3

THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
 
 
For the Three Months
Ended June 30,
 
(Unaudited)
 
2011
 
2010
Net sales
$
195,153

 
$
149,379

Cost of sales:
 
 

Product costs
67,063

 
60,703

Software amortization and royalties
64,920

 
33,353

License amortization and royalties
8,139

 
20,890

Total cost of sales
140,122

 
114,946

 
 
 
 
Gross profit
55,031

 
34,433

Operating expenses:
 
 
 
Product development
30,189

 
16,475

Selling and marketing
50,676

 
33,626

General and administrative
12,049

 
11,844

Restructuring
(140
)
 
168

Total operating expenses
92,774

 
62,113

 
 
 
 
Operating loss
(37,743
)
 
(27,680
)
Interest and other income (expense), net
443

 
(1,590
)
Loss before income taxes
(37,300
)
 
(29,270
)
Income taxes
1,145

 
840

Net loss
$
(38,445
)
 
$
(30,110
)
 
 
 
 
Loss per share — basic
$
(0.56
)
 
$
(0.44
)
Loss per share — diluted
$
(0.56
)
 
$
(0.44
)
 
 
 
 
Shares used in per share calculation — basic
68,318

 
67,745

Shares used in per share calculation — diluted
68,318

 
67,745

 
See notes to condensed consolidated financial statements.


4

THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF TOTAL EQUITY
(Amounts in thousands, except share data)
 
Three Months Ended June 30, 2011
(Unaudited)
 
Common stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Income
 
Accumulated Deficit
 
Total Equity
 
Shares
 
Amount
Balance at March 31, 2011
68,300,482

 
$
683

 
$
520,797

 
$
17,560

 
$
(332,209
)
 
$
206,831

Exercise of options
5,390

 
—

 
21

 
 
 
 
 
21

Conversion of stock unit awards
22,283

 
—

 
(51
)
 
 
 
 
 
(51
)
Stock-based compensation
 
 
 
 
1,636

 
 
 
 
 
1,636

Comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
 
 
 
 
 
 
 
(38,445
)
 
(38,445
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation gain
 
 
 
 
 
 
2,334

 
 
 
2,334

Unrealized gain on investments, net of tax
 
 
 
 
 
 
158

 
 
 
158

Comprehensive income (loss)
 
 
 
 
 
 
2,492

 
(38,445
)
 
(35,953
)
Balance at June 30, 2011
68,328,155

 
$
683

 
$
522,403

 
$
20,052

 
$
(370,654
)
 
$
172,484


Three Months Ended June 30, 2010
(Unaudited)
 
Common stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Accumulated Deficit
 
Non-Controlling Interest
 
Total Equity
 
Shares
 
Amount
Balance at March 31, 2010
67,729,952

 
$
677

 
$
511,922

 
$
7,867

 
$
(196,111
)
 
$
263

 
$
324,618

Exercise of options
17,555

 
—

 
83

 
 
 
 
 
 
 
83

Cancellation of restricted stock, net
(1,350
)
 
—

 
(7
)
 
 
 
 
 
 
 
(7
)
Conversion of stock unit awards
12,307

 
—

 
(39
)
 
 
 
 
 
 
 
(39
)
Stock-based compensation
 
 
 
 
2,890

 
 
 
 
 
 
 
2,890

Sale of noncontrolling interest
 
 
 
 
 
 
 
 
 
 
(263
)
 
(263
)
Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
 
 
 
 
 
 
 
(30,110
)
 
—

 
(30,110
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation loss
 
 
 
 
 
 
(5,007
)
 
 
 
 
 
(5,007
)
Unrealized loss on investments, net of tax
 
 
 
 
 
 
(95
)
 
 
 
 
 
(95
)
Reclassification of loss on investments included in net loss, net of tax
 
 
 
 
 
 
20

 
 
 
 
 
20

Comprehensive loss
 
 
 
 
 
 
(5,082
)
 
(30,110
)
 
—

 
(35,192
)
Balance at June 30, 2010
67,758,464

 
$
677

 
$
514,849

 
$
2,785

 
$
(226,221
)
 
$
—

 
$
292,090

 
See notes to condensed consolidated financial statements. 

5

THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands) 
 
For the Three Months
Ended June 30,
 
(Unaudited)
 
2011
 
2010
OPERATING ACTIVITIES:
 
 
 
Net loss
$
(38,445
)
 
$
(30,110
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
2,897

 
2,738

Amortization of licenses and software development(1)
69,182

 
36,396

Loss on disposal of property and equipment
16

 
10

Restructuring charges
(140
)
 
168

Changes in deferred net revenue and related expenses
(44,516
)
 
9,636

Amortization of debt issuance costs
37

 
196

Amortization of interest
—

 
471

Gain on investments
—

 
1,737

Stock-based compensation(2)
1,631

 
2,528

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net of allowances
111,772

 
4,651

Inventory
5,124

 
(2,578
)
Licenses
(6,186
)
 
(13,938
)
Software development
(50,995
)
 
(55,080
)
Prepaid expenses and other current assets
(739
)
 
(3,538
)
Accounts payable
(24,141
)
 
10,094

Accrued and other liabilities
8,923

 
(19,947
)
Deferred net revenue
(451
)
 
—

Income taxes
46

 
1,660

Net cash used in (provided by) operating activities
34,015

 
(54,906
)
 
 
 
 
INVESTING ACTIVITIES:
 
 
 
Proceeds from sales and maturities of available-for-sale investments
—

 
18,306

Proceeds from sales and maturities of trading investments
—

 
22,775

Purchases of available-for-sale investments
—

 
(37,695
)
Other long-term assets
355

 
—

Purchases of property and equipment
(3,303
)
 
(2,907
)
Net cash provided by (used in) investing activities
(2,948
)
 
479

 
 
 
 
FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock to employees
21

 
83

Payment of secured credit line
—

 
(13,249
)
Net cash provided by (used in) financing activities
21

 
(13,166
)
Effect of exchange rate changes on cash
2,345

 
(4,797
)
Net increase (decrease) in cash and cash equivalents
33,433

 
(72,390
)
Cash and cash equivalents — beginning of period
85,603

 
188,378

Cash and cash equivalents — end of period
$
119,036

 
$
115,988

________________________________
(1) 
Excludes amortization of capitalized stock-based compensation expense.
(2) 
Includes the net effects of capitalization and amortization of stock-based compensation expense.


See notes to condensed consolidated financial statements. 

6

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

1.   Basis of Presentation
 
The condensed consolidated financial statements included in this Quarterly Report on Form 10-Q ("10-Q") present the results of operations, financial position and cash flows of THQ Inc. and its subsidiaries (collectively "THQ," "we," "us," "our," or the "Company").  In the opinion of management, the accompanying condensed consolidated balance sheets and related interim condensed consolidated statements of operations, condensed consolidated statements of total equity, and condensed consolidated statements of 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.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates relate to accounts receivable allowances, licenses, software development, revenue recognition, stock-based compensation expense and income taxes.  Interim results are not necessarily indicative of results for a full year.  The balance sheet at March 31, 2011 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 10-Q should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011 (the "2011 10-K").

Principles of Consolidation. Our condensed consolidated financial statements include the accounts of THQ Inc. and our wholly-owned subsidiaries.

Prior to April 30, 2010, we consolidated the results of THQ*ICE LLC (a joint venture with ICE Entertainment, Inc.) in the consolidated financial statements as we believed we were the primary beneficiary and would have received the majority of expected returns or absorbed the majority of expected losses of THQ*ICE LLC. We sold our interest in THQ*ICE LLC on April 30, 2010 and recognized an insignificant gain.

Summary of Significant Accounting Policies. In the three months ended June 30, 2011, we did not have any material changes to our significant accounting policies, and we did not adopt any new accounting pronouncements.

In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-05, "Comprehensive Income (Topic 220): Presentation of Comprehensive Income" ("ASU 2011-05"). ASU 2011-05 requires companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements and it eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. ASU 2011-05 does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, which will be our fiscal quarter ending June 30, 2012. The adoption is not expected to have a material impact on our results of operations, financial position or cash flows.

Fiscal Quarter.  We report our fiscal year on a 52/53-week period with our fiscal year ending on the Saturday nearest March 31. For simplicity, all fiscal periods in our condensed consolidated financial statements and accompanying notes are presented as ending on a calendar month end.  The results of operations for the three months ended June 30, 2011 and 2010 contain the following number of weeks:
Fiscal Period
 
Number of Weeks
 
Fiscal Period End Date
Three months ended June 30, 2011
 
13 weeks
 
July 2, 2011
Three months ended June 30, 2010
 
13 weeks
 
July 3, 2010

2.   Balance Sheet Details
 
Inventory.  Inventory at June 30, 2011 and March 31, 2011 consisted of the following (amounts in thousands):
 

7

 
June 30,
2011
 
March 31,
2011
Components
$
6,011

 
$
3,390

Finished goods
20,935

 
28,515

Inventory
$
26,946

 
$
31,905

 
Prepaid expenses and other current assets. Prepaid expenses and other current assets at June 30, 2011 and March 31, 2011 primarily consisted of product costs totaling $22.7 million and $32.0 million, respectively, that were deferred in connection with the changes in deferred net revenue. Also included in prepaid expenses and other current assets at June 30, 2011 and March 31, 2011 were product prepayments of $2.8 million and $4.5 million, respectively.

Property and equipment, net.  Property and equipment, net at June 30, 2011 and March 31, 2011 consisted of the following (amounts in thousands):
 
 
Useful lives
 
June 30,
2011
 
March 31,
2011
Building
30 yrs
 
$
730

 
$
730

Land
-
 
401

 
401

Computer equipment and software
3-10 yrs
 
62,230

 
60,254

Furniture, fixtures and equipment
5 yrs
 
8,952

 
8,880

Leasehold improvements
3-6 yrs
 
16,556

 
15,999

Automobiles
2-5 yrs
 
91

 
88

 
 
 
88,960

 
86,352

Less: accumulated depreciation
 
 
(59,546
)
 
(57,392
)
 Property and equipment, net
 
 
$
29,414

 
$
28,960


Depreciation expense associated with property and equipment amounted to $2.9 million and $2.7 million for the three months ended June 30, 2011 and 2010, respectively.

Accrued and other current liabilities.  Accrued and other current liabilities at June 30, 2011 and March 31, 2011 consisted of the following (amounts in thousands):
 
 
June 30,
2011
 
March 31,
2011
Accrued liabilities
$
39,512

 
$
33,175

Settlement payment
4,000

 
6,000

Accrued compensation
18,920

 
20,093

Accrued third-party software developer milestones
32,085

 
22,951

Accrued royalties
64,635

 
55,703

Accrued and other current liabilities
$
159,152

 
$
137,922

 
Other long-term liabilities.  Other long-term liabilities at June 30, 2011 and March 31, 2011 consisted of the following (amounts in thousands):
 
 
June 30,
2011
 
March 31,
2011
Accrued royalties
$
72,958

 
$
69,209

Deferred rent
7,687

 
7,517

Accrued liabilities
4,283

 
4,215

Settlement payment
3,289

 
7,101

Other long-term liabilities
$
88,217

 
$
88,042

 
Settlement payments included in the tables above are due to JAKKS Pacific, Inc. ("Jakks"). A portion of the settlement payment due to Jakks is reflected in "Accrued and other current liabilities" and a portion is reflected in "Other long-term liabilities" in our

8

condensed consolidated balance sheets at the present value of the consideration payable under the agreement between THQ and Jakks.  See "Note 18 — Joint Venture and Settlement Agreements" in the notes to the consolidated financial statements in our 2011 10-K for a discussion of the Jakks settlement payments.

3. Licenses and Software Development

Licenses. As of June 30, 2011 and March 31, 2011, the net carrying value of our licenses was $131.6 million and $118.2 million, respectively, and was reflected as “Licenses” and “Licenses, net of current portion” in our condensed consolidated balance sheets. At June 30, 2011, we did not have any commitments that are not reflected in our condensed consolidated financial statements due to remaining performance obligations of the licensor.

Software Development. As of June 30, 2011 and March 31, 2011, the net carrying value of our software development was $259.0 million and $272.5 million, respectively, and was reflected as “Software development” and “Software development, net of current portion” in our condensed consolidated balance sheets. At June 30, 2011 we had commitments of $58.6 million that are not reflected in our condensed consolidated financial statements due to remaining performance obligations of the developers. Software amortization and royalties expense in the three months ended June 30, 2011 included a $1.4 million charge related to the write-off of capitalized software development for an unannounced game that was cancelled in connection with the closure of our studio located in the U.K. (see "Note 5 — Restructuring and Other Charges”).

Impairment analysis. We evaluate the future recoverability of our capitalized licenses and software development on a quarterly basis in connection with the preparation of our financial statements.  In this evaluation, we compare the carrying value of such capitalized costs to their net realizable value, on a product-by-product basis.  The net realizable value is determined using Level 3 inputs, specifically, 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 selling and marketing expenses.  Net sales inputs are developed using recent internal sales performance for similar titles, adjusted for current market trends and comparable products. As certain 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. In the three months ended June 30, 2011 we recognized software development impairment charges of $0.6 million and in the same period last fiscal year we recognized software development impairment charges of $2.5 million related to one of our titles.

4.   Other Long-Term Assets
 
Other long-term assets include our investment in Yuke's, a Japanese video game developer.  We own approximately 15% of Yuke's, which is publicly traded on the Nippon New Market in Japan.  This investment is classified as available-for-sale and reported at fair value with unrealized holding gains and losses excluded from earnings and reported as a component of accumulated other comprehensive income until realized.  The pre-tax unrealized holding gain related to our investment in Yuke's for the three months ended June 30, 2011 and 2010 was $0.3 million and $0.1 million, respectively.  As of June 30, 2011, the inception-to-date unrealized holding gain on our investment in Yuke's was $1.8 million.  Due to the long-term nature of this relationship, this investment is included in "Other long-term assets, net" in our condensed consolidated balance sheets.
 
Other long-term assets as of June 30, 2011 and March 31, 2011 consisted of the following (amounts in thousands):
 
 
June 30,
2011
 
March 31,
2011
Investment in Yuke's
$
4,940

 
$
4,686

Deferred financing costs
1,987

 
2,146

Other
3,152

 
3,182

Total other long-term assets
$
10,079

 
$
10,014

 

5.   Restructuring and Other Charges

Fiscal 2012 First Quarter Realignment. In the first quarter of fiscal 2012, we announced the closure of our studio located in the U.K. as we continue to refine our video game line-up and utilize studio locations in more cost effective markets. This resulted in $1.7 million of cash severance and other employee-based charges (recorded within operating expenses in our condensed consolidated statements of operations) and a $1.4 million charge related to the cancellation of an unannounced title in development at this studio (recorded within software development amortization in our condensed consolidated statements of operations). We

9

expect to incur up to an additional $0.9 million in future lease and other contract termination charges during the remainder of fiscal 2012 as the facility is vacated.
 
Fiscal 2011 Fourth Quarter Realignment. In the fourth quarter of fiscal 2011, we performed an assessment of our product development and publishing staffing models. This resulted in a change to our staffing plans to better address peak service periods, as well as better utilize shared-services and more cost-effective locations. In connection with this change, in the three months ended June 30, 2011, we incurred $1.7 million of cash severance and other employee-based charges related to the notification to employees of position eliminations (recorded within operating expenses in our condensed consolidated statements of operations) and $3,000 of lease and other contract termination charges (recorded within "Restructuring" in our condensed consolidated statements of operations). As of June 30, 2011 total restructuring charges under the fiscal 2011 fourth quarter realignment amounted to $3.1 million. We expect to incur up to an additional $0.8 million in future lease and other contract termination charges during the remainder of fiscal 2012 as projects are completed and the facility is vacated.

Fiscal 2009 Realignment. During the twelve months ended March 31, 2009 ("fiscal 2009"), we updated our strategic plan in an effort to increase our profitability and cash flow generation.  We significantly realigned our business to focus on fewer, higher quality games, and established an operating structure that supports our more focused product strategy.  The fiscal 2009 realignment included the cancellation of several titles in development, the closure or spin-off of several of our development studios, and the streamlining of our corporate organization in order to support the new product strategy, including reductions in worldwide personnel. Restructuring charges and adjustments are recorded as "Restructuring" expenses in our condensed consolidated statements of operations and have included the costs associated with lease abandonments less estimates of sublease income, write-off of related long-lived assets due to the studio closures, as well as costs of other non-cancellable contracts.  In the three months ended June 30, 2011 and 2010, restructuring charges and adjustments related to the fiscal 2009 realignment were a gain of $0.1 million and a loss of $0.2 million, respectively. As of June 30, 2011, total restructuring charges under the fiscal 2009 realignment amounted to $18.4 million. We do not expect any future charges under the fiscal 2009 realignment, other than additional facility related charges and adjustments in the event actual and estimated sublease income changes.
 
The following table summarizes the restructuring lease and contract termination activity under the fiscal 2009 realignment for the three months ended June 30, 2011 and 2010, and the related restructuring reserve balances (amounts in thousands):
 
 
 
Three months ended June 30,
 
 
2011
 
2010
Beginning balance
 
$
1,335

 
$
2,392

Charges to operations
 
(143
)
 
168

Cash payments, net of sublease income
 
(173
)
 
(588
)
Foreign currency and other adjustments
 
(4
)
 
113

Ending balance
 
$
1,015

 
$
2,085


As of June 30, 2011, $0.4 million of the restructuring accrual is included in "Accrued and other current liabilities" and $0.6 million is included in "Other long-term liabilities" in our condensed consolidated balance sheets.  As of March 31, 2011, $0.7 million of the restructuring accrual was included in "Accrued and other current liabilities" and $0.6 million was included in "Other long-term liabilities" in our condensed consolidated balance sheets.  The accrual balances at June 30, 2011 and March 31, 2011 related to future lease payments for facilities vacated under the fiscal 2009 realignment, offset by estimates of future sublease income.  We expect the final settlement of this accrual to occur by August 1, 2015, which is the last payment date under our lease agreements that were vacated.

See "Note 14 — Subsequent Event" for information related to a realignment plan that was announced on August 9, 2011.

6.   Debt
 
Convertible Senior Notes

On August 4, 2009, we issued $100.0 million 5% convertible senior notes ("Notes").  After offering costs, the net proceeds to THQ were $96.8 million.  The Notes are due August 15, 2014, unless earlier converted, redeemed or repurchased.  The Notes pay interest semiannually, in arrears on February 15 and August 15 of each year, beginning February 15, 2010, through maturity and are convertible at each holder's option at any time prior to the close of business on the trading day immediately preceding the maturity date.  The Notes are our unsecured and unsubordinated obligations.
 

10

The Notes are initially convertible into shares of our common stock at a conversion rate of 117.4743 shares of common stock per $1,000 principal amount of Notes, equivalent to an initial conversion price of approximately $8.51 per share.  At this conversion rate and upon conversion of 100% of our Notes outstanding at June 30, 2011, our Notes would convert into 11.7 million shares of common stock.  The conversion rate is subject to adjustment in certain events such as a stock split, the declaration of a dividend or the issuance of additional shares.  Also, the conversion rate will be subject to an increase in certain events constituting a make-whole fundamental change; provided, however, that the maximum number of shares to be issued thereunder cannot exceed 14.7 million, subject to adjustment.  The Notes will be redeemable, in whole or in part, at our option, at any time after August 20, 2012 for cash, at a redemption price of 100% of the principal amount of the Notes, plus accrued but unpaid interest, if the price of a share of our common stock has been at least 150% of the conversion price then in effect for specified periods.  In the case of certain events such as the acquisition or liquidation of THQ, or delisting of our common stock from a U.S. national securities exchange, holders may require us to repurchase all or a portion of the Notes for cash at a purchase price of 100% of the principal amount of the Notes, plus accrued and unpaid interest.
 
Costs incurred related to the Notes offering amounted to $3.2 million and are classified as "Other long-term assets, net" in our condensed consolidated balance sheets at June 30, 2011; these costs are being amortized over the term of the Notes.

We capitalize interest expense and amortization of debt costs related to in-process software development costs. Capitalization commences with the first capitalized expenditure for the software development project and continues until the project is completed. We amortize capitalized interest expense and amortization of debt costs to software development amortization as part of the software development costs. The following table summarizes the interest expense and amortization of debt costs that are included in our condensed consolidated balance sheets as a component of software development (amounts in thousands):

Balance at March 31, 2011
$
4,318

Capitalized during the period
1,409

Amortized during the period
(1,195
)
Balance at June 30, 2011
$
4,532


Interest expense and amortization of debt costs related to the Notes that is not capitalized to software development is classified as "Interest and other income (expense), net" in our condensed consolidated statements of operations and was zero and $1.5 million in the three months ended June 30, 2011 and 2010, respectively. We began capitalizing interest expense in the fourth quarter of fiscal 2011; see "Note 25 — Quarterly Financial Data (Unaudited)" in the notes to the consolidated financial statements in our 2011 10-K for a discussion of the impact of this change. The effective interest rate, before capitalization of any interest expense and amortization of debt issuance costs, was 5.65% for the three months ended June 30, 2011 and 2010.

Credit Facility

On June 30, 2009, we entered into a Loan and Security Agreement (the "Credit Facility") with Bank of America, N.A. ("B of A"), as agent, and the lenders party thereto from time to time.  The Credit Facility provides for a $35.0 million revolving credit facility, which can be increased to $50.0 million, subject to lender consent, pursuant to a $15.0 million accordion feature, and includes a $15.0 million letter of credit subfacility.
 
The Credit Facility has a three-year term and bears interest at a floating rate equivalent to, at our option, either the base rate plus a spread of 1.0% to 2.5% or LIBOR plus 2.5% to 4.0%, depending on the fixed charge coverage ratio.  Borrowings under the Credit Facility are conditioned on our maintaining a certain fixed charge coverage ratio and a certain liquidity level, as set forth in the Credit Facility.  The amount we can borrow under the Credit Facility fluctuates based upon our levels of eligible North American accounts receivable.  At June 30, 2011, we had no borrowings under the Credit Facility.
 
The Credit Facility is guaranteed by most of our domestic subsidiaries (each, an "Obligor") and secured by substantially all of our assets.
 
The Credit Facility contains customary affirmative and negative covenants, including, among other terms and conditions, limitations on our and each Obligor's ability to: create, incur, guarantee or be liable for indebtedness (other than certain types of permitted indebtedness); dispose of assets outside the ordinary course (subject to certain exceptions); acquire, merge or consolidate with or into another person or entity (other than certain types of permitted acquisitions); create, incur or allow any lien on any of their respective properties (except for certain permitted liens); make investments or capital expenditures (other than certain types of investments or capital expenditures); or pay dividends or make distributions (each subject to certain limitations).  In addition, the Credit Agreement provides for certain events of default such as nonpayment of principal and interest when due thereunder, breaches

11

of representations and warranties, noncompliance with covenants, acts of insolvency and default on certain material contracts (subject to certain limitations and cure periods).  At June 30, 2011, we were in compliance with all covenants related to the Credit Facility.

7.   Commitments and Contingencies
 
A summary of annual minimum contractual obligations and commercial commitments as of June 30, 2011 is as follows (amounts in thousands):
 
 
 
Contractual Obligations and Commercial Commitments (6)
Fiscal
Years Ending
March 31,
 
License /
Software
Development
Commitments (1)
 
Advertising (2)
 
Leases (3)
 
Debt (4)
 
Other (5)
 
Total
Remainder of 2012
 
$
76,663

 
$
34,280

 
$
12,606

 
$
—

 
$
583

 
$
124,132

2013
 
42,345

 
14,465

 
14,304

 
—

 
4,000

 
75,114

2014
 
19,751

 
5,099

 
12,962

 
—

 
4,000

 
41,812

2015
 
19,833

 
693

 
11,683

 
100,000

 
—

 
132,209

2016
 
11,500

 
500

 
6,535

 
—

 
—

 
18,535

Thereafter
 
20,000

 
875

 
13,414

 
—

 
—

 
34,289

 
 
$
190,092

 
$
55,912

 
$
71,504

 
$
100,000

 
$
8,583

 
$
426,091

 
(1)
Licenses and Software Development.  We enter into contractual arrangements with third parties for the rights to exploit 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 such agreements in place as of June 30, 2011 are $190.1 million.  License/software development commitments in the table above include $131.5 million of commitments to licensors/developers that are included in both current and long-term accrued royalties and accrued liabilities in our condensed consolidated balance sheets as of June 30, 2011 because the licensors/developers do not have any remaining significant performance obligations to us.

(2)
Advertising.  We have certain minimum advertising commitments under many of our major license agreements.  These minimum commitments generally range from 3% to 10% of net sales related to the respective license.

(3)
Leases.  We are committed under operating leases with lease termination dates through 2020.  Most of our leases contain rent escalations.  Of these obligations, $0.4 million and $0.6 million are accrued and classified as "Accrued and other current liabilities" and "Other long-term liabilities," respectively, in our June 30, 2011 condensed consolidated balance sheet due to abandonment of certain lease obligations in connection with our fiscal 2009 realignment (see "Note 5 — Restructuring and Other Charges"). We expect future sublease rental income under non-cancellable agreements of approximately $1.2 million; this income is not contemplated in the lease commitments shown in the table above.

(4)
Debt.  On August 4, 2009 we issued the Notes.  The Notes pay interest semiannually, in arrears on February 15 and August 15 of each year, beginning February 15, 2010, through maturity and are convertible at each holder's option at any time prior to the close of business on the trading day immediately preceding the maturity date.  Absent any conversions, we expect to pay $5.0 million in the remainder of fiscal 2012, $5.0 million in each of the fiscal years 2013 and 2014, and $2.5 million in fiscal 2015, for an aggregate of $17.5 million in interest payments over the remaining term of the Notes (see "Note 6 — Debt").

(5)
Other.  As discussed more fully in "Note 18 — Joint Venture and Settlement Agreements" in the notes to the consolidated financial statements in our 2011 10-K, amounts payable to Jakks totaling $8.0 million are reflected in the table above. The present value of these amounts is included in "Accrued and other current liabilities" and "Other long-term liabilities" in our condensed consolidated balance sheet at June 30, 2011 (see "Note 2 — Balance Sheet Details"). The remaining other commitments included in the table above are also included as current or long-term liabilities in our June 30, 2011 condensed consolidated balance sheet.

(6)
We have omitted unrecognized tax benefits from this table due to the inherent uncertainty regarding the timing and amount of certain payments related to these unrecognized tax benefits.  The underlying positions have not been fully developed under audit to quantify at this time.  At June 30, 2011, we had $3.5 million of unrecognized tax benefits.  See "Note 9 — Income Taxes" for further information regarding the unrecognized tax benefits.
 

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Manufacturer Indemnification. We must indemnify the platform manufacturers (Microsoft, Nintendo, Sony) of our games with respect to all loss, liability and expenses resulting from any claim against such manufacturer involving the development, marketing, sale or use of our games, including any claims for copyright or trademark infringement brought against such manufacturer. As a result, we bear a risk that the properties upon which the titles of our games are based, or that the information and technology licensed from others and incorporated into the products, may infringe the rights of third parties. Our agreements with our third-party software developers and property licensors typically provide indemnification rights for us with respect to certain matters. However, if a manufacturer brings a claim against us for indemnification, the developers or licensors may not have sufficient resources to, in turn, indemnify us.

Indemnity Agreements. We have entered into indemnification agreements with the members of our Board of Directors, our Chief Executive Officer and our Chief Financial Officer, to provide a contractual right of indemnification to such persons to the extent permitted by law against any and all liabilities, costs, expenses, amounts paid in settlement and damages incurred by any such person as a result of any lawsuit, or any judicial, administrative or investigative proceeding in which such person is sued as a result of service as a member of our Board of Directors, as Chief Executive Officer or as Chief Financial Officer. The indemnification agreements provide specific procedures and time frames with respect to requests for indemnification and clarify the benefits and remedies available to the indemnitees in the event of an indemnification request.

Litigation

We are subject to ordinary routine claims and litigation incidental to our business. We do not believe that any liability from any reasonably foreseeable disposition of such claims and litigation, individually or in the aggregate, would have a material adverse effect on our financial position or results of operations.

8.   Stock-based Compensation
 
In the three months ended June 30, 2011, we began granting performance shares to our executive officers and other senior officers.  These performance shares are earned if certain two-year cumulative performance targets for the Company are attained and vest with respect to 50% of the earned shares on the second anniversary of the grant date and the remaining 50% on the third anniversary of the grant date, subject to the continued employment of the recipient through a vesting date.

Subject to certain adjustments, as of June 30, 2011, the total number of shares of THQ common stock reserved for issuance under the Long-Term Incentive Plan (“LTIP”) was 11.5 million shares.  On July 28, 2011, our stockholders approved an amendment to the LTIP increasing the number of shares reserved for issuance to 18.5 million shares of THQ common stock.

Under our employee stock purchase plan ("ESPP"), shares of our common stock may be purchased by eligible employees during six-month offering periods that commence each March 1 and September 1, or the first business day thereafter (each, an "Offering Period").  At March 1, 2011 we had insufficient shares available for issuance under the ESPP and accordingly we suspended offerings as of that date. On July 28, 2011, our stockholders approved an amendment to the ESPP to increase by 1,000,000 shares, the number of shares of common stock reserved for issuance.  We plan to commence an Offering Period on September 1, 2011.

9.  Income Taxes
 
We evaluate our deferred tax assets on a regular basis to determine if a valuation allowance is required. A cumulative taxable loss in recent years provides significant negative evidence in considering whether deferred tax assets are realizable. As we have had U.S. taxable losses in recent years, we can no longer rely on common tax planning strategies to use our U.S. tax losses and we are precluded from relying on projections of future taxable income to support the recognition of deferred tax assets. As such, the ultimate realization of deferred tax assets is dependent upon the existence of sufficient taxable income generated in the carryforward periods.
 
Our income tax expense for the three months ended June 30, 2011 and 2010 was $1.1 million and $0.8 million, respectively, primarily related to foreign tax jurisdictions. These amounts represent effective tax rates for the three months ended June 30, 2011 and 2010 of 3.1% (provision on a loss) and 2.9% (provision on a loss), respectively. The rate for the three months ended June 30, 2011 differs from the U.S. federal statutory rate of 35% primarily due to the fact that our domestic net operating losses are fully valued.
 
Our unrecognized tax benefits increased by $0.1 million in the three months ended June 30, 2011, from $3.4 million at March 31, 2011 to $3.5 million at June 30, 2011, all of which would impact our effective tax rate if recognized. Due to inherent uncertainty we are not able to determine the timing and recognition of our unrecognized tax benefits. Additionally, due to the valuation of our deferred tax assets, any benefit recognized would not be realized in our effective tax rate for at least the next 12 months.

13

 
We conduct business internationally and, as a result, one or more of our subsidiaries files income tax returns in U.S. Federal, U.S. state, and certain foreign jurisdictions.  Accordingly, we are subject to examination by taxing authorities throughout the world, including Australia, China, France, Germany, Italy, Japan, Korea, Luxembourg, Netherlands, Spain, Switzerland, and the U.K.  Certain state and certain non-U.S. income tax returns are currently under various stages of audit or potential audit by applicable tax authorities and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year.  We are no longer subject to U.S. Federal, state, and local or foreign jurisdiction income tax examinations by tax authorities for years prior to March 31, 2007.    
 
Our policy is to recognize interest and penalty expense, if any, related to uncertain tax positions as a component of income tax expense.  As of June 30, 2011, we had no amounts accrued for interest and for the potential payment of penalties.

10.   Earnings (Loss) Per Share
 
The following table is a reconciliation of the weighted-average shares used in the computation of basic and diluted loss per share for the periods presented (amounts in thousands):
 
 
For the Three Months
Ended June 30,
 
2011
 
2010
Net loss used to compute basic loss per share
$
(38,445
)
 
$
(30,110
)
 
 
 
 
Weighted-average number of shares outstanding — basic
68,318

 
67,745

Dilutive effect of potential common shares
—

 
—

Number of shares used to compute loss per share — diluted
68,318

 
67,745

 
As a result of our net loss for the three months ended June 30, 2011 and 2010, the result of the if-converted calculation applied to the Notes was antidilutive and as such we did not include the potential conversion of 11.7 million shares under our Notes in our diluted earnings per share calculation. 
 
As a result of our net loss for the three months ended June 30, 2011 and 2010, all potential shares were excluded from the computation of diluted loss per share, as their inclusion would have been antidilutive.  As a result, there were 9.6 million and 10.3 million potential common shares that were excluded from the computation of diluted loss per share for the three months ended June 30, 2011 and 2010, respectively.  Had we reported net income for these periods, an additional 0.2 million and 0.5 million shares of common stock would have been included in the number of shares used to calculate diluted loss per share for the three months ended June 30, 2011, and 2010, respectively.

11.   Fair Value
 
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.  There is a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value.  We used the following methods and assumptions to estimate the fair value of our investment securities:
 
•                  Level 1 — Quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.  We do not adjust the quoted prices for these investments.
•                  Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
•                  Level 3 — Discounted cash flow analysis using unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities, as discussed further below.
 
Our policy is to recognize transfers between these levels of the fair value hierarchy as of the beginning of the reporting period.
 

14

The following table summarizes our financial assets measured at fair value on a recurring basis as of June 30, 2011 (amounts in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 

 
 

 
 

 
 

Money market funds
$
16,557

 
$
—

 
$
—

 
$
16,557

Other long-term assets, net:
 

 
 

 
 

 
 

Investment in Yuke's
4,940

 
—

 
—

 
4,940

Total
$
21,497

 
$
—

 
$
—

 
$
21,497

 
The following table summarizes our financial assets measured at fair value on a recurring basis as of March 31, 2011 (amounts in thousands):
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 

 
 

 
 

 
 

Money market funds
$
30,461

 
$
—

 
$
—

 
$
30,461

Other long-term assets, net:
 

 
 

 
 

 
 

Investment in Yuke's
4,686

 
—

 
—

 
4,686

Total
$
35,147

 
$
—

 
$
—

 
$
35,147

 
During the three months ended June 30, 2011 we did not hold any Level 3 financial assets.

Financial Instruments
 
The carrying value of certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, accrued royalties, and secured credit line approximate fair value based on their short-term nature. 
 
The book value and fair value of our convertible senior notes at June 30, 2011 was $100.0 million and $91.3 million, respectively; the fair value was determined using quoted market prices in active markets.
 
We transact business in many different foreign currencies and are exposed to financial market risk resulting from fluctuations in foreign currency exchange rates, particularly the GBP and the Euro, which may result in a gain or loss of earnings to us. We utilize foreign currency exchange forward contracts to mitigate foreign currency risk associated with foreign currency-denominated assets and liabilities, primarily certain inter-company receivables and payables. Our foreign currency exchange forward contracts are not designated as hedging instruments and are accounted for as derivatives whereby the fair value of the contracts are reported as "Prepaid expenses and other current assets" or "Accrued and other current liabilities" in our condensed consolidated balance sheets, and the associated gains and losses from changes in fair value are reported in "Interest and other income (expense), net" in our condensed consolidated statements of operations.
 
Cash Flow Hedging Activities.  From time to time, we may elect to hedge a portion of our foreign currency risk related to forecasted foreign currency-denominated sales and expense transactions by entering into foreign currency exchange forward contracts that generally have maturities of less than 90 days.  Our hedging programs reduce, but do not entirely eliminate, the impact of currency exchange rate movements in net sales and operating expenses.  During the three months ended June 30, 2011 and 2010, we did not enter into any foreign exchange forward contracts related to cash flow hedging activities.
 
Balance Sheet Hedging Activities.  The foreign currency exchange forward contracts related to balance sheet hedging activities generally have a contractual term of one month or less and are transacted near month-end. Therefore, the fair value of the forward contracts are generally not significant at each month-end.
 
At June 30, 2011 and March 31, 2011, we had foreign currency exchange forward contracts related to balance sheet hedging activities in the notional amount of $107.9 million and $100.6 million, respectively, with a fair value that approximates zero at both June 30, 2011 and March 31, 2011.  We estimated the fair value of these contracts using Level 1 inputs, specifically, inputs obtained in quoted public markets.  The net gain recognized from these contracts during the three months ended June 30, 2011 and June 30, 2010 was $1.5 million and $2.7 million respectively, and is included in "Interest and other income (expense), net" in our condensed consolidated statements of operations.



15

12.   Capital Stock Transactions
 
On July 31, 2007 and October 30, 2007, our board authorized the repurchase of up to $25.0 million of our common stock from time to time on the open market or in private transactions, for an aggregate of $50.0 million.  As of June 30, 2011 and March 31, 2011 we had $28.6 million, authorized and available for common stock repurchases.  During the three months ended June 30, 2011, we did not repurchase any shares of our common stock.  There is no expiration date for the authorized repurchases. 

13. Segment and Geographic Information

We operate in one reportable segment in which we are a developer, publisher and distributor of interactive entertainment software for video game consoles, handheld devices and PCs, including via the Internet, and from sales of our uDraw GameTablet. The following information sets forth geographic information on our net sales and total assets for the three months ended June 30, 2011 and 2010 (amounts in thousands):

 
North
America
 
Europe
 
Asia
Pacific
 
Consolidated
Three months ended June 30, 2011
 
 
 
 
 
 
 
Net sales to unaffiliated customers before changes in deferred net revenue
$
87,743

 
$
35,230

 
$
18,266

 
$
141,239

Changes in deferred net revenue
28,516

 
24,259

 
1,139

 
53,914

Net sales to unaffiliated customers
$
116,259

 
$
59,489

 
$
19,405

 
$
195,153

Total assets
$
446,989

 
$
178,842

 
$
57,874

 
$
683,705

Three months ended June 30, 2010
 
 
 
 
 
 
 
Net sales to unaffiliated customers before changes in deferred net revenue
$
108,026

 
$
36,144

 
$
16,099

 
$
160,269

Changes in deferred net revenue
(6,891
)
 
(3,362
)
 
(637
)
 
(10,890
)
Net sales to unaffiliated customers
$
101,135

 
$
32,782

 
$
15,462

 
$
149,379

Total assets
$
546,943

 
$
85,786

 
$
35,865

 
$
668,594


Information about our net sales by platform for the three months ended June 30, 2011 and 2010 is as follows (amounts in thousands):

 
 
Three months ended June 30,
Platform
 
2011
 
2010
Consoles
 
 
 
 
Microsoft Xbox 360
 
$
51,542

 
$
50,215

Nintendo Wii
 
19,024

 
19,160

Sony PlayStation 3
 
35,782

 
52,794

Sony PlayStation 2
 
1,019

 
4,703

 
 
107,367

 
126,872

Handheld
 
 
 
 
Nintendo Dual Screen
 
21,284

 
19,666

Sony PlayStation Portable
 
2,122

 
4,341

Wireless
 
736

 
1,589

 
 
24,142

 
25,596

 
 
 
 
 
PC
 
9,730

 
7,801

Net sales before changes in deferred net revenue
 
141,239

 
160,269

Changes in deferred net revenue
 
53,914

 
(10,890
)
Total net sales
 
$
195,153

 
$
149,379


14.  Subsequent Event

On August 9, 2011, we announced a plan to realign our internal studio development teams and portfolio of video games in development in order to better match our resources with our expected portfolio of interactive entertainment and continue our transition away from licensed kids titles and movie-based entertainment properties for traditional console games.  We are in the

16

process of implementing this plan, which includes (a) the closure of two studios in Australia and the reduction of a game development team at one additional studio, and (b) the cancellation of two unannounced titles at these locations that are no longer in line with our strategic business priorities. These actions will result in a reduction of approximately 200 people on our product development staff and are expected to be completed during our fiscal quarter ending September 30, 2011.

We expect charges related to the cancellation of the two unannounced titles, related license costs and long-lived assets associated with the studio closures of up to $36.0 million, of which we may pay approximately $11.0 million in cash. We also expect to record restructuring charges of up to $5.0 million associated with contract and lease termination costs, most of which will be paid over the term of the existing leases.  Finally, we expect to incur up to $4.0 million in cash charges related to severance and other employee-based costs for terminated employees.  We expect to record these charges of up to $45.0 million, in the aggregate, during the second quarter of fiscal 2012 as actions are completed and facilities vacated.

17



Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
 
The statements contained in this Quarterly Report on Form 10-Q ("10-Q") that are not historical facts may be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to, statements regarding industry prospects, our future economic performance including anticipated revenues and expenditures, results of operations or financial position, and other financial items, our business plans and objectives, including our realignment plan and intended product releases, and may include certain assumptions that underlie the forward-looking statements. We generally use words such as "anticipate," "believe," "could," "estimate," "expect," "forecast," "future," "intend," "may," "plan," "positioned," "potential," "project," "scheduled," "set to," "subject to," "upcoming," and other similar expressions to help identify forward-looking statements. These forward-looking statements are based on current expectations, estimates and projections about the business of THQ Inc. and its subsidiaries and are based upon management's current beliefs and certain assumptions made by management. Our business and such forward-looking statements are subject to risks and uncertainties that may affect our future results. For a discussion of our risk factors, see "Part II, Item 1A. Risk Factors." The forward-looking statements contained herein speak only as of the date on which they were made, and, except as required by law, we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of this 10-Q.

All references to "we," "us," "our," "THQ," or the "Company" in this 10-Q mean THQ Inc. and its subsidiaries. Most of the properties and titles referred to in this 10-Q are subject to trademark protection.

Overview
 
The following is a discussion of our operating results and financial condition, as well as material changes in operating results and financial condition from prior reported periods.  The discussion and analysis herein should be read in conjunction with our consolidated financial statements, notes to the consolidated financial statements, and management's discussion and analysis (which includes additional information about our accounting policies, practices and the transactions that underlie our financial results) contained in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011 (the "2011 10-K").
 
About THQ
We are a leading worldwide developer and publisher of interactive entertainment software for all popular game systems, including:
•
home video game consoles such as the Microsoft Xbox 360 and Xbox 360 Kinect (collectively referred to as "Xbox 360"), Nintendo Wii ("Wii"), and Sony PlayStation 3 and PlayStation Move (collectively referred to as "PS3");
•
handheld platforms such as the Nintendo DS, DSi and 3DS (collectively referred to as "DS"), and Sony PlayStation Portable ("PSP");
•
wireless devices based on the Apple iOS (including the iPhone, iTouch and iPad), Google Android, and Windows Mobile platforms;
•
personal computers ("PCs"), including games played online; and
•
the Internet, including on social networking sites such as Facebook.

In addition to titles published on the wireless devices noted above, we also develop and publish titles (and supplemental downloadable content) for digital distribution via Sony's PlayStation Network ("PSN") and Microsoft's Xbox LIVE Marketplace ("Xbox LIVE") and Xbox LIVE Arcade ("XBLA"), as well as digitally offer our PC titles through online download stores and services such as Digital River, OnLive and Steam.
 
Our titles span a wide range of categories, including action, adventure, fighting, fitness, racing, role-playing, simulation, sports and strategy.  We have created, licensed and acquired a group of highly recognizable brands, which we market to a variety of consumer demographics ranging from products targeted at core gamers to products targeted to children and the mass market.  Our portfolio of key brands includes:
•
games based on our owned intellectual properties including Company of Heroes, Darksiders, Devil's Third, Homefront, inSANE, and Saints Row;
•
core games based on licensed properties including Games Workshop's Warhammer 40,000 universe, Metro, the Ultimate Fighting Championship ("UFC"), and World Wrestling Entertainment ("WWE"); and
•
games based on popular casual and lifestyle brands including Disney, Disney•Pixar, DreamWorks Animation, Jimmy Buffet's Margaritaville, Mattel's Pictionary and Barbie, Nickelodeon, and Sony Pictures Consumer Product's JEOPARDY! and Wheel of Fortune.

To capture new play patterns that have emerged in the casual and lifestyle market, we launched our uDraw GameTablet ("uDraw") in fiscal 2011, a product with innovative gameplay targeted at consumers of all ages and the only creative tool of its kind on game

18

consoles today. We are focused on capitalizing on these new play patterns by developing other casual games for family and social play experiences across multiple platforms.

Trends Affecting Our Business
 
The following trends affect our business:

Increasing Shift to Online Content and Digital Downloads

We provide our products through both the retail channel and through online digital delivery methods. Recently, the interactive entertainment software industry is delivering a growing amount of games, downloadable content and product add-ons by direct digital download through the Internet and gaming consoles. We believe that much of the growth in the industry will continue to come via online distribution such as massively multiplayer games (both subscription and free-to-play), casual micro-transaction based games, paid downloadable content and digital downloads of games, including those on wireless platforms, and conversely, we believe retail sales will continue to be a decreasing revenue source over the next several years. For the six months ended June 30, 2011, retail software sales in the U.S. decreased 7.7% compared to the same period in 2010 according to The NPD Group; for the same period, across the U.K., Germany, France, Spain and Benelux, aggregated retail software sales decreased 6.3% compared to the same six-month period in 2010 according to GfK. Conversely, digital sales are expected to grow over 20% worldwide in calendar 2011 and more than double over the next four years, to over $35.0 billion worldwide according to the International Development Group, Inc.'s Global Video Game Market Update (April 2011). Accordingly, we plan to continue integrating a digital component into our franchises where applicable. As our involvement in the undelivered online service elements within our games increases, more of our revenue will be deferred, which will impact the timing of our revenue recognition but not our cash flow from operations.

Sales Concentration of Top Titles

The majority of money spent by consumers on video game software is spent on select top titles. Because of the demand for select “hit” titles and the costs to develop our games, we believe that it is important to focus our development efforts on bringing a select number of high-quality, competitive products to market.

Shifting Preferences in the Casual and Lifestyle Market

Over the last few years, our industry has seen a shift in preferences in the casual and lifestyle games market away from kids movie-based licensed titles towards games offering more of a family or group play experience, such as party and dance games.  In addition, there has been interest in the new motion-based controllers: Xbox 360 Kinect and PlayStation Move, which were introduced during holiday 2010.  The casual and lifestyle market is also shifting to games with online digital delivery methods, including games played online and on social networking sites such as Facebook, and through wireless devices based on the Apple iOS (including the iPhone, iTouch and iPad), Google Android, and Windows Mobile platforms.  In response to the shifting preferences in this market, we introduced uDraw, a first-of-its kind, innovative gaming accessory for the Wii, during holiday 2010 and plan to bring uDraw to Xbox 360 and PS3 in holiday 2011.  We expect to capitalize on the new platforms, including uDraw and Xbox 360 Kinect, with a casual and lifestyle line-up for these platforms. At the same time, we are transitioning away from licensed kids and movie-based entertainment properties for traditional console games.

Sales of Used Video Games
 
Large retailers, such as GameStop and Best Buy, have increased their focus on selling used video games, which provides higher margins for the retailers than sales of new games. This focus reduces demand for new copies of our games. We believe customer retention through compelling online play and downloadable content offers may reduce consumers' propensity to trade in games. Additionally, certain of our titles include free access to online content through a code on the back of the video game manual for first-time purchasers. This structure creates a new revenue stream by offering second-time buyers of these titles the opportunity to separately purchase the online content.

Our Strategy

Publishing games across multiple platforms has been, and will continue to be, a cornerstone of our product strategy. Additionally, our strategy consists of the following elements:
1.    develop a select number of high quality titles targeted at the core gamer to publish a steady flow of core game franchises;
2.    expand our casual and lifestyle portfolio to focus on new play-patterns; and

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3.    integrate a digital component into our franchises where applicable and increase digital revenues.

Our digital strategy continues to focus on the following four pillars: 1) creating a digital ecosystem around key title console launches such as the expected November 2011 release of Saints Row: The Third, which includes a planned robust downloadable content schedule, online Season Pass, and in-game store for consumables; 2) creating a critical mass of users on social media platforms such as Facebook and mobile platforms including iOS and Android, using owned or branded content, such as the upcoming fall release of Margaritaville Online based on Jimmy Buffett's popular brand; 3) creating an ongoing digital revenue stream with the launch of the company's MMO, Warhammer 40,000: Dark Millennium Online; and 4) continuing to drive digital end-user sales through existing channels as well as through the re-launch of the THQ.com website. 

Fiscal 2012 First Quarter Highlights

During the three months ended June 30, 2011, we continued to execute on our strategies; highlights in the quarter included the following:
•
our line-up featured at the Electronic Entertainment Expo ("E3") garnered 25 awards from more than 50 nominations across the portfolio for upcoming titles such as Saints Row: The Third, Darksiders II, Metro: Last Light, WWE '12, UFC Undisputed 3, Warhammer 40,000: Space Marine, Devil's Third, and inSANE, as well as for uDraw;
•
we announced an agreement with Turtle Rock Studios Inc., the creators of the multiple award-winning “Left 4 Dead,” to develop a new core title scheduled to be released in calendar 2013;
•
on June 15, 2011, top-industry talent Patrice Désilets joined us, working out of our Montreal, Quebec development studio on a new original AAA title; and
•
building on last year's successful launch of uDraw for Wii, we unveiled plans to bring uDraw to Xbox 360 and PlayStation 3 high-definition consoles this fall with new creative functions and touch-screen features. We are in production of a number of new uDraw titles, including Disney Princess, Marvel Super Hero Squad, and upgraded versions of our uDraw Studio software and Pictionary.

Realignment

In order to continue our focus on these key strategic areas, on August 9, 2011, we announced a realignment of our internal studio development teams and portfolio of video games in development as we continue to transition away from licensed kids titles and movie-based entertainment properties for traditional console games (see "Note 14 — Subsequent Event" in the notes to the condensed consolidated financial statements included in Part I, Item 1).

Results of Operations — Comparison of the Three Months Ended June 30, 2011 to the Three Months Ended June 30, 2010

For the three months ended June 30, 2011, we reported a net loss of $38.4 million, or $0.56 per diluted share, compared with a net loss of $30.1 million, or $0.44 per diluted share, in the same period last fiscal year.

Net Sales
 
Our net sales are principally derived from sales of interactive software games designed for play on video game consoles, handheld devices and PCs, including via the Internet, and from sales of uDraw. The following table presents our net sales before changes in deferred net revenue and adjusts those amounts by the changes in deferred net revenue to arrive at consolidated net sales as presented in our condensed consolidated statements of operations for the three months ended June 30, 2011 and 2010 (amounts in thousands):

 
Three months ended June 30,
 
Increase/
(Decrease)
 
% Change
 
2011
 
2010
 
 
Net sales before changes in deferred net revenue
$
141,239

 
72.4
%
 
$
160,269

 
107.3
 %
 
$
(19,030
)
 
(11.9
)%
Changes in deferred net revenue
53,914

 
27.6

 
(10,890
)
 
(7.3
)
 
64,804

 
(595.1
)
Consolidated net sales
$
195,153

 
100.0
%
 
$
149,379

 
100.0
 %
 
$
45,774

 
30.6
 %
 
In the three months ended June 30, 2011, net sales before changes in deferred net revenue were primarily driven by Red Faction: Armageddon, MX vs. ATV Alive and our catalog titles (titles released in fiscal years prior to the respective fiscal year).

Changes in deferred net revenue reflect the deferral and subsequent recognition of net revenue related to the online service that is offered in some of our games. The revenue deferrals are recognized as net sales over the estimated online service period of

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generally six months. The changes in deferred net revenue are driven by the timing of the release of games that offer the online service in which we have continuing involvement. Generally, revenue deferred in the first half of our fiscal year would be recognized by the end of that fiscal year, and revenue deferred in the second half of the fiscal year would be partially recognized in that fiscal year with the remaining amounts of deferred revenue recognized in the following fiscal year. Changes in deferred net revenue in the three months ended June 30, 2011 were primarily driven by the recognition of net sales from Homefront, which was released in March 2011.

Net Sales by New Releases and Catalog Titles
 
The following table presents our net sales of new releases (titles initially released in the respective fiscal year) and catalog titles for the three months ended June 30, 2011 and 2010 (amounts in thousands):
 
 
Three months ended June 30,
 
Increase/
 
%
 
2011
 
2010
 
(Decrease)
 
Change
New releases
$
89,029

 
63.0
%
 
$
101,278

 
63.2
%
 
$
(12,249
)
 
(12.1
)%
Catalog
52,210

 
37.0

 
58,991

 
36.8

 
(6,781
)
 
(11.5
)
Net sales before changes in deferred net revenue
141,239

 
100.0
%
 
160,269

 
100.0
%
 
(19,030
)
 
(11.9
)
Changes in deferred net revenue
53,914

 
 
 
(10,890
)
 
 
 
64,804

 
(595.1
)
Consolidated net sales
$
195,153

 
 
 
$
149,379

 
 
 
$
45,774

 
30.6
 %

Net sales of our new releases decreased $12.2 million in the three months ended June 30, 2011, compared to the same period last fiscal year. The decrease was primarily due to an overall mix of titles released in the current fiscal quarter with lower average net selling prices, compared to the same period last fiscal year, which included sales of UFC Undisputed 2010. New releases in the current fiscal quarter included titles such as MX vs. ATV Alive, which was released at a lower price point than previous installments from this franchise as a test with respect to our digital plan, and kids movie-based titles such as Kung Fu Panda 2 and Rio.

Net sales of our catalog titles decreased $6.8 million in the three months ended June 30, 2011 compared to the same period last fiscal year due to fewer catalog units sold and slightly lower average net selling prices, partially offset by continued sales of uDraw in the current fiscal quarter, which has a high average net selling price.

Net Sales by Territory
 
The following table presents our net sales by territory for the three months ended June 30, 2011 and 2010 (amounts in thousands):
 
 
Three months ended June 30,
 
Increase/
 
%
 
2011
 
2010
 
(Decrease)
 
Change
North America
$
87,743

 
62.1
%
 
$
108,026

 
67.4
%
 
$
(20,283
)
 
(18.8
)%
Europe
35,230

 
25.0

 
36,144

 
22.6

 
(914
)
 
(2.5
)
Asia Pacific
18,266

 
12.9

 
16,099

 
10.0

 
2,167

 
13.5

International
53,496

 
37.9

 
52,243

 
32.6

 
1,253

 
2.4

Net sales before changes in deferred net revenue
141,239

 
100.0
%
 
160,269

 
100.0
%
 
(19,030
)
 
(11.9
)
Changes in deferred net revenue
53,914

 
 
 
(10,890
)
 
 
 
64,804

 
(595.1
)
Consolidated net sales
$
195,153

 
 
 
$
149,379

 
 
 
$
45,774

 
30.6
 %


Net sales in North America in the three months ended June 30, 2011 decreased $20.3 million compared to the same period last fiscal year. The decrease in this territory was primarily due to the release of UFC Undisputed 2010 in the same period last fiscal year, which sold more units at a higher average net selling price than all of our new releases in the current fiscal quarter.

Net sales in Europe in the three months ended June 30, 2011 decreased $0.9 million compared to the same period last fiscal year and we estimate that changes in foreign currency translation rates during the three months ended June 30, 2011 increased our reported net sales in this territory by $3.6 million. The decrease in net sales in this territory was due to lower net sales of catalog titles in the current fiscal quarter, due to fewer catalog units sold and lower average net selling prices. This decrease in the three

21

months ended June 30, 2011 was partially offset by an increase in net sales from new releases, due to an increase in the number of units sold compared to the same period last fiscal year.

Net sales in the Asia Pacific territory in the three months ended June 30, 2011 increased $2.2 million compared to the same period last fiscal year. The increase was due to changes in foreign currency translation rates as we estimate that those rate changes increased our reported net sales in this territory by $3.4 million during the three months ended June 30, 2011, and the number of units sold remained relatively flat in the comparative fiscal quarters.

Cost of Sales
 
Cost of sales increased $25.2 million, or 21.9%, in the three months ended June 30, 2011 compared to the same period last fiscal year.  As a percent of net sales, cost of sales decreased 5.1 points in the three months ended June 30, 2011 compared to the same period last fiscal year.

Cost of Sales - Product Costs (amounts in thousands)
 
June 30, 2011
 
% of net sales
 
June 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$67,063
 
34.4%
 
$60,703
 
40.6%
 
10.5%
 
Product costs primarily consist of direct manufacturing costs, including platform manufacturer license fees, net of manufacturer volume rebates and discounts. In the three months ended June 30, 2011, product costs as a percent of net sales decreased 6.2 points compared to the same period last fiscal year. The decrease as a percent of net sales was primarily due to an increase in the recognition of revenue from the online service component that is present within a number of our games for which there are no related significant product costs.  Also contributing to the decrease was the recognition of revenue in the three months ended June 30, 2011 from titles with lower product costs as a percent of net sales, such as Homefront, compared to the mix of titles recognized in the same period last fiscal year. 

Cost of Sales - Software Amortization and Royalties (amounts in thousands)
 
June 30, 2011
 
% of net sales
 
June 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$64,920
 
33.3%
 
$33,353
 
22.3%
 
94.6%
 
Software amortization and royalties expense consists of amortization of capitalized payments made to third-party software developers and amortization of capitalized internal studio development costs. Commencing upon product release, capitalized software development costs are amortized to software amortization and royalties expense based on the ratio of current gross sales to total projected gross sales. In the three months ended June 30, 2011, software amortization and royalties expense as a percent of net sales increased 11.0 points compared to the same period last fiscal year. The increase was primarily due to the performance of UFC Undisputed 2010 in the three months ended June 30, 2010 with its lower capitalized development costs relative to its sales performance in that period. The titles released in the three months ended June 30, 2011, such as Red Faction: Armageddon, had comparatively higher capitalized development costs relative to their net sales. Additionally, in the three months ended June 30, 2011, we had recognitions of previously deferred net revenue and related software amortization and royalties expense on certain titles that were released late in the fourth quarter of fiscal 2011; these titles also had higher capitalized development costs relative to their sales performance compared to UFC Undisputed 2010 in the same period last fiscal year.

Cost of Sales - License Amortization and Royalties (amounts in thousands)
 
June 30, 2011
 
% of net sales
 
June 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$8,139
 
4.2%
 
$20,890
 
14.0%
 
(61.0)%
 
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 net sales for such license.  Net sales from our licensed properties represented 49% and 90% of our total net sales in the three months ended June 30, 2011 and 2010, respectively. License amortization and royalties expense decreased 9.8 points as a percent of net sales in the three months ended June 30, 2011 compared to the same period last fiscal year. The primary driver of the decrease was the change in our sales mix towards more owned intellectual properties such as Homefront, Red Faction: Armageddon, and MX vs. ATV Alive in the current fiscal quarter compared to the same period last fiscal year when a larger portion of our net sales came from licensed titles, primarily UFC Undisputed 2010. Additionally, net sales in the three months ended June 30, 2011 included sales of certain kids movie-based licensed properties with insignificant amounts of license amortization and royalties

22

expense since we incurred license impairment charges on those properties during fiscal 2011.

Operating Expenses

Our operating expenses increased $30.7 million, or 49.4% in the three months ended June 30, 2011 compared to the same period last fiscal year. The increase in operating expenses was due to increases in marketing support and product development expense.

Product Development (amounts in thousands)
 
June 30, 2011
 
% of net sales
 
June 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$30,189
 
15.5%
 
$16,475
 
11.0%
 
83.2%
 
Product development expense primarily consists of expenses incurred by internal development studios and payments made to external development studios prior to products reaching technological feasibility. Once a product has reached technological feasibility the related development costs are capitalized to software development. Product development expense increased $13.7 million in the three months ended June 30, 2011 compared to the same period last fiscal year. The increase was primarily due to a shift in our mix of products under development to a higher portion of products that have not yet reached technological feasibility, including our investment in digital games. Also, product development expense in the three months ended June 30, 2011 includes $3.4 million of cash severance charges and other employee-based costs related to the current quarter notification to employees of position eliminations in connection with the closure of our studio located in the U.K. and previously announced business realignment plans (see "Note 5 — Restructuring and Other Charges” in the notes to the condensed consolidated financial statements included in Part I, Item 1).

Selling and Marketing (amounts in thousands)
 
June 30, 2011
 
% of net sales
 
June 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$50,676
 
26.0%
 
$33,626
 
22.5%
 
50.7%
 
Selling and marketing expenses consist of advertising, promotional expenses, and personnel-related costs. Selling and marketing expenses increased $17.1 million in the three months ended June 30, 2011 compared to the same period last fiscal year. The increase was primarily due to a larger investment in marketing support for our new releases in the current fiscal quarter compared to the same period last fiscal year. Additionally, the increase was due to continued marketing support for uDraw and titles we released late in the fourth quarter of fiscal 2011, primarily Homefront and WWE All Stars.

Excluding the impact of changes in deferred net revenue, selling and marketing expenses as a percent of net sales increased 14.9 points in the three months ended June 30, 2011 compared to the same period last fiscal year. This increase was primarily due to the lower average net selling price of products sold in the three months ended June 30, 2011 compared to the same period last fiscal year as well as the lower net sales basis resulting from fewer catalog units sold in the current fiscal quarter compared to the same period last fiscal year.

General and Administrative (amounts in thousands)
 
June 30, 2011
 
% of net sales
 
June 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$12,049
 
6.2%
 
$11,844
 
7.9%
 
1.7%
 
General and administrative expenses consist of personnel and related expenses of executive and administrative staff and fees for professional services such as legal and accounting. General and administrative expenses were relatively flat in the three months ended June 30, 2011, compared to the same period last fiscal year.
 
Restructuring
 
Restructuring charges include any of the costs associated with lease abandonments (less estimates of sublease income), write-offs of related long-lived assets due to studio closures, as well as costs of other non-cancellable contracts.  In the three months ended June 30, 2011, restructuring charges and adjustments were minimal and primarily reflected facility related charges and adjustments due to changes in actual and estimated sublease income related to our fiscal 2009 realignment.  For further information related to our restructuring plans and charges and the events and decisions that gave rise to such charges, see “Note 5 — Restructuring and Other Charges” in the notes to the condensed consolidated financial statements included in Part I, Item 1.

23

Interest and Other Income (Expense), net
 
Interest and other income (expense), net, consists of interest earned on our investments, gains and losses resulting from exchange rate changes for transactions denominated in currencies other than the functional currency, and interest expense, net of capitalization and amortization of debt issuance costs on our $100.0 million 5% convertible senior notes (“Notes”). For further discussion of the Notes, see “Note 6 — Debt” in the notes to the condensed consolidated financial statements included in Part I, Item 1.

Interest and other income (expense), net in the three months ended June 30, 2011 was income of $0.4 million and primarily consisted of foreign currency gains and interest income as the interest expense under the Notes in the current fiscal quarter were capitalized to software development. In the three months ended June 30, 2010, interest and other income (expense), net was an expense of $1.6 million, which primarily consisted of interest expense under the Notes that was not capitalized, as well as foreign currency losses. We began capitalizing interest expense in the fourth quarter of fiscal 2011; see "Note 25 — Quarterly Financial Data (Unaudited)" in the notes to the consolidated financial statements in our 2011 10-K for a discussion of the impact of this change.
 
Income Taxes
 
Income tax expense for the three months ended June 30, 2011 was $1.1 million, compared to income tax expense of $0.8 million in the same period last fiscal year. Income tax expense in both periods relates primarily to income earned in foreign jurisdictions, which is not reduced by carryforward losses in the U.S.  The effective tax rate differs significantly from the federal statutory rate; this difference is primarily due to taxable losses in the U.S. that are fully offset by a valuation allowance.

Liquidity and Capital Resources
 
(Amounts in thousands)
June 30,
2011
 
March 31,
2011
 
Change
Cash and cash equivalents
$
119,036

 
$
85,603

 
$
33,433

Percentage of total assets
17
%
 
11
%
 
 


 
 
Three months ended June 30,
 
 
(Amounts in thousands)
2011
 
2010
 
Change
Net cash provided by (used in) operating activities
$
34,015

 
$
(54,906
)
 
$
88,921

Net cash provided by (used in) investing activities
(2,948
)
 
479

 
(3,427
)
Net cash provided by (used in) financing activities
21

 
(13,166
)
 
13,187

Effect of exchange rate changes on cash
2,345

 
(4,797
)
 
7,142

Net increase (decrease) in cash and cash equivalents
$
33,433

 
$
(72,390
)
 
$
105,823

 
Generally, our primary sources of liquidity are cash, cash equivalents, and short-term investments. In addition, as further discussed below, we may elect to sell or borrow against certain of our eligible North American accounts receivable and we have external sources of liquidity available to us, including our Credit Facility (as described below). Our principal source of cash is from sales of interactive software games designed for play on video game consoles, handheld devices and PCs, including via the Internet, and from sales of uDraw. Our principal uses of cash are for product purchases of discs and cartridges along with associated manufacturer's royalties, purchases of hardware components for uDraw, payments to external developers and licensors, costs of internal software development, and selling and marketing expenses. In the three months ended June 30, 2011 our cash and cash equivalents increased $33.4 million, from $85.6 million at March 31, 2011 to $119.0 million at June 30, 2011. The increase in our cash balance was primarily due to collections of fiscal 2011 year-end receivables, primarily related to the March 2011 release of Homefront and WWE All Stars.

Purchase Agreement. In November 2010, we entered into a Receivables Purchase Agreement ("Purchase Agreement") with Wells Fargo Bank, N.A. ("Wells Fargo"). The Purchase Agreement gives us the option to sell our receivables from Walmart Stores, Inc. ("Walmart") to Wells Fargo, at our discretion, and significantly expedite our receivables collections from Walmart. Wells Fargo will pay us the value of any receivables we elect to sell, less LIBOR + 1.25% per annum, and then collect the receivables from Walmart.
 
Credit Facility. In June 2009, we entered into a Loan and Security Agreement (the "Credit Facility") with Bank of America, N.A. ("B of A"), as agent, and the lenders party thereto from time to time.  The Credit Facility provides for a $35.0 million revolving

24

credit facility, which can be increased to $50.0 million, subject to lender consent, pursuant to a $15.0 million accordion feature, and includes a $15.0 million letter of credit subfacility.  See "Note 6 — Debt" in the notes to the condensed consolidated financial statements in Part I, Item 1, for additional information regarding the Credit Facility.  We may use the Credit Facility to provide us with working capital and cash for other corporate purposes; however, our ability to borrow, and the lenders' obligation to lend, under the Credit Facility is subject to our compliance with certain terms and conditions, including a requirement that we meet a minimum fixed charge coverage ratio.  The amount we can borrow under the Credit Facility fluctuates based upon our levels of eligible North American accounts receivable.  At June 30, 2011 we had no borrowings under the Credit Facility.

The Credit Facility is guaranteed by most of our domestic subsidiaries (each, an "Obligor") and secured by substantially all of our assets. The Credit Facility contains customary affirmative and negative covenants, including, among other terms and conditions, limitations on our and each Obligor's ability to: create, incur, guarantee or be liable for indebtedness (other than certain types of permitted indebtedness); dispose of assets outside the ordinary course (subject to certain exceptions); acquire, merge or consolidate with or into another person or entity (other than certain types of permitted acquisitions); create, incur or allow any lien on any of their respective properties (except for certain permitted liens); make investments or capital expenditures (other than certain types of investments or capital expenditures); or pay dividends or make distributions (each subject to certain limitations).  In addition, the Credit Agreement provides for certain events of default such as nonpayment of principal and interest when due thereunder, breaches of representations and warranties, noncompliance with covenants, acts of insolvency and default on certain material contracts (subject to certain limitations and cure periods).  At June 30, 2011 we were in compliance with all covenants related to the Credit Facility. 
 
Cash Flow from Operating Activities.  Cash provided by operations was $34.0 million in the three months ended June 30, 2011, compared to $54.9 million cash used in operations in the same period last fiscal year.  The change in cash flow from operations was primarily the result of higher cash collections of receivables during the first quarter of fiscal 2012 compared to the same period last fiscal year. The increase in cash collections was driven by the collection of fiscal 2011 year-end receivables, primarily related to titles that were released late in the fourth quarter of fiscal 2011. The increase in the collection of receivables was partially offset by the larger net loss in the three months ended June 30, 2011 compared to the same period last fiscal year (including adjustment for non-cash reconciling items such as depreciation, amortization, and changes in deferred net revenue and related expenses).
 
Cash Flow from Investing Activities.  Cash used in investing activities was $2.9 million in the three months ended June 30, 2011, compared to $0.5 million cash provided by investing activities in the same period last fiscal year.  The change in cash flow from investing activities was primarily due to investment related activity in the three months ended June 30, 2010 as there was no such activity in the three months ended June 30, 2011.
 
Cash Flow from Financing Activities.  Cash provided by financing activities was $21,000 in the three months ended June 30, 2011, compared to cash used in financing activities of $13.2 million in the same period last fiscal year. The change in cash flow from financing activities was primarily due to the repayment of our secured credit line in the three months ended June 30, 2010 as there was no such activity in the three months ended June 30, 2011.
 
Effect of exchange rate changes on cash.  Changes in foreign currency translation rates increased our reported cash balance by $2.3 million.
 
Key Balance Sheet Accounts
 
At June 30, 2011, our total current assets were $522.0 million, down from $599.7 million at March 31, 2011. In addition to cash and cash equivalents, our current assets primarily consisted of:

Accounts Receivable. Accounts receivable decreased $111.3 million, from $161.6 million at March 31, 2011 to $50.3 million at June 30, 2011. The decrease was primarily due to collections of fiscal 2011 year-end receivables, primarily related to the March 2011 release of Homefront and WWE All Stars. Accounts receivable allowances were $97.1 million at June 30, 2011, a $9.5 million increase from $87.6 million at March 31, 2011. Allowances for price protection and returns as a percentage of trailing nine-month net sales, excluding the impact of changes in deferred net revenue, were 11% and 10% at June 30, 2011 and 2010, respectively. We believe our current allowances are adequate based on historical experience, inventory remaining in the retail channel, and the rate of inventory sell-through in the retail channel.

Inventory. Inventory decreased $5.0 million, from $31.9 million at March 31, 2011 to $26.9 million at June 30, 2011. The decrease in inventory was primarily due to the timing of product purchases. Inventory turns, excluding the impact of changes in deferred costs, on a rolling twelve-month basis were 13 and 14 at June 30, 2011 and March 31, 2011, respectively.


25

Licenses. Our investment in licenses, including the long-term portion, increased $13.4 million, from $118.2 million at March 31, 2011 to $131.6 million at June 30, 2011. The increase was primarily due to investments in new licenses, partially offset by amortization expense.

Software Development. Capitalized software development, including the long-term portion, decreased $13.5 million, from $272.5 million at March 31, 2011 to $259.0 million at June 30, 2011. The decrease in software development is primarily the result of software development amortization of titles released in the three months ended June 30, 2011 as well as titles that were released late in the fourth quarter of fiscal 2011. This decrease was partially offset by our investment in new titles. Approximately 69% of the software development asset balance at June 30, 2011 is for titles that have expected release dates in the remainder of fiscal 2012 and beyond.

Total current liabilities at June 30, 2011, were $323.0 million, down from $379.5 million at March 31, 2011. Current liabilities primarily consisted of:

Accounts Payable. Accounts payable decreased $23.6 million, from $100.6 million at March 31, 2011 to $77.0 million at June 30, 2011. The decrease was primarily due to timing of product purchases.

Accrued and Other Current Liabilities. Accrued and other current liabilities increased $21.3 million, from $137.9 million at March 31, 2011 to $159.2 million at June 30, 2011. The increase was primarily due to accruals of product development milestones to external developers and accruals related to our investments in licenses.

Our liabilities at June 30, 2011 also consisted of:

Other long-term liabilities. Other long-term liabilities increased $0.2 million, from $88.0 million at March 31, 2011 to $88.2 million at June 30, 2011.

Convertible Senior Notes. We issued the Notes on August 4, 2009 and the full principal amount of $100.0 million is outstanding as of June 30, 2011 (see “Note 6 — Debt” in the notes to the condensed consolidated financial statements in Part I, Item 1).
 
Inflation
 
Our management currently believes that inflation has not had, and does not currently have, a material impact on continuing operations.
 
Financial Condition
 
At June 30, 2011, we held cash and cash equivalents of $119.0 million.  We believe that we have sufficient working capital, including cash expected to be generated from operations and external sources of liquidity, to meet our operating requirements for at least the next twelve months. Our business is cyclical and thus our working capital needs are impacted by seasonality, the timing of new product releases, and consumer product acceptance. We expect to use a significant amount of cash in our second and third quarters of fiscal 2012, as we order and pay for products to be shipped during the holiday quarter, which is typically when we receive the largest percentage of our revenues. Accordingly, we intend to use our external sources of liquidity, which may include the Purchase Agreement and Credit Facility, in order to help fund our working capital needs during this period. We expect to generate cash in the second half of fiscal 2012 due to expected cash collections during the third and fourth quarter of fiscal 2012 from sales of our scheduled releases, which include Saints Row: The Third, uDraw, UFC Undisputed 3, and WWE '12.

Our ability to maintain sufficient liquidity could be affected by various risks and uncertainties described in "Part II, Item 1A. Risk Factors."  We continue to focus on managing our development and operating costs to look for additional efficiencies and cost savings in order to improve future earnings. As a result, we may incur future restructuring and other charges if further changes are made to our current operating structure. We may choose at any time to raise or borrow additional capital to strengthen our cash position, facilitate expansion, pursue strategic investments or to take advantage of business opportunities as they arise.

Contractual Obligations
 
Guarantees and Commitments
 
A summary of annual minimum contractual obligations and commercial commitments as of June 30, 2011 is as follows (amounts in thousands):

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Contractual Obligations and Commercial Commitments (6)
Fiscal
Years Ending
March 31,
 
License /
Software
Development
Commitments (1)
 
Advertising (2)
 
Leases (3)
 
Debt (4)
 
Other (5)
 
Total
Remainder of 2012
 
$
76,663

 
$
34,280

 
$
12,606

 
$
—

 
$
583

 
$
124,132

2013
 
42,345

 
14,465

 
14,304

 
—

 
4,000

 
75,114

2014
 
19,751

 
5,099

 
12,962

 
—

 
4,000

 
41,812

2015
 
19,833

 
693

 
11,683

 
100,000

 
—

 
132,209

2016
 
11,500

 
500

 
6,535

 
—

 
—

 
18,535

Thereafter
 
20,000

 
875

 
13,414

 
—

 
—

 
34,289

 
 
$
190,092

 
$
55,912

 
$
71,504

 
$
100,000

 
$
8,583

 
$
426,091

 
(1)
Licenses and Software Development.  We enter into contractual arrangements with third parties for the rights to exploit 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 such agreements in place as of June 30, 2011 are $190.1 million.  License/software development commitments in the table above include $131.5 million of commitments to licensors/developers that are included in both current and long-term accrued royalties and accrued liabilities in our condensed consolidated balance sheet as of June 30, 2011 because the licensors/developers do not have any remaining significant performance obligations to us.

(2)
Advertising.  We have certain minimum advertising commitments under many of our major license agreements.  These minimum commitments generally range from 3% to 10% of net sales related to the respective license.

(3)
Leases.  We are committed under operating leases with lease termination dates through 2020.  Most of our leases contain rent escalations.  Of these obligations, $0.4 million and $0.6 million are accrued and classified as "Accrued and other current liabilities" and "Other long-term liabilities," respectively, in our June 30, 2011 condensed consolidated balance sheet due to abandonment of certain lease obligations in connection with our fiscal 2009 realignment (see "Note 5 — Restructuring and Other Charges" in the notes to the condensed consolidated financial statements included in Part I, Item I). We expect future sublease rental income under non-cancellable agreements of approximately $1.2 million; this income is not contemplated in the lease commitments shown in the table above.

(4)
Debt.  On August 4, 2009 we issued the Notes.  The Notes pay interest semiannually, in arrears on February 15 and August 15 of each year, beginning February 15, 2010, through maturity and are convertible at each holder's option at any time prior to the close of business on the trading day immediately preceding the maturity date.  Absent any conversions, we expect to pay $5.0 million in the remainder of fiscal 2012, $5.0 million in each of the fiscal years 2013 and 2014, and $2.5 million in fiscal 2015, for an aggregate of $17.5 million in interest payments over the remaining term of the Notes (see "Note 6 — Debt" in the notes to the condensed consolidated financial statements included in Part I, Item 1).

(5)
Other.  As discussed more fully in "Note 18 — Joint Venture and Settlement Agreements" in the notes to the consolidated financial statements in our 2011 10-K, amounts payable to Jakks totaling $8.0 million are reflected in the table above. The present value of these amounts is included in "Accrued and other current liabilities" and "Other long-term liabilities" in our condensed consolidated balance sheet at June 30, 2011 (see "Note 2 — Balance Sheet Details" in the notes to the condensed consolidated financial statements included in Part I, Item 1). The remaining other commitments included in the table above are also included as current or long-term liabilities in our June 30, 2011 condensed consolidated balance sheet.

(6)
We have omitted unrecognized tax benefits from this table due to the inherent uncertainty regarding the timing and amount of certain payments related to these unrecognized tax benefits.  The underlying positions have not been fully developed under audit to quantify at this time.  At June 30, 2011, we had $3.5 million of unrecognized tax benefits.  See "Note 9 — Income Taxes" in the notes to the condensed consolidated financial statements included in Part I, Item 1 for further information regarding the unrecognized tax benefits.
 
Manufacturer Indemnification. We must indemnify the platform manufacturers (Microsoft, Nintendo, Sony) of our games with respect to all loss, liability and expenses resulting from any claim against such manufacturer involving the development, marketing, sale or use of our games, including any claims for copyright or trademark infringement brought against such manufacturer. As a result, we bear a risk that the properties upon which the titles of our games are based, or that the information and technology licensed from others and incorporated into the products, may infringe the rights of third parties. Our agreements with our third-party software developers and property licensors typically provide indemnification rights for us with respect to certain matters.

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However, if a manufacturer brings a claim against us for indemnification, the developers or licensors may not have sufficient resources to, in turn, indemnify us.

Indemnity Agreements. We have entered into indemnification agreements with the members of our Board of Directors, our Chief Executive Officer and our Chief Financial Officer, to provide a contractual right of indemnification to such persons to the extent permitted by law against any and all liabilities, costs, expenses, amounts paid in settlement and damages incurred by any such person as a result of any lawsuit, or any judicial, administrative or investigative proceeding in which such person is sued as a result of service as a member of our Board of Directors, as Chief Executive Officer or as Chief Financial Officer. The indemnification agreements provide specific procedures and time frames with respect to requests for indemnification and clarify the benefits and remedies available to the indemnitees in the event of an indemnification request.

Critical Accounting Estimates

There have been no material changes to our critical accounting estimates as described in Part II, Item 7 to our 2011 10-K, under the caption “Critical Accounting Estimates.”

Recently Issued Accounting Pronouncements

See “Note 1 — Basis of Presentation" in the notes to the condensed consolidated financial statements in Part 1, Item 1.



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Item 3.  Quantitative and Qualitative Disclosures About Market Risk
 
Market Risk

We are exposed to certain market risks arising from transactions in the normal course of business, principally risks associated with interest rate and foreign currency fluctuations. Market risk is the potential loss arising from changes in market rates and market prices. We employ established policies and practices to manage these risks. We use foreign currency exchange option and forward contracts to hedge anticipated exposures or mitigate some existing exposures subject to foreign currency exchange rate risk as discussed below. We do not enter into derivatives or other financial instruments for trading or speculative purposes.

Interest Rate Risk

At June 30, 2011, our $119.0 million of cash and cash equivalents were comprised of cash and time deposits and money market funds; none of our cash equivalents are classified as trading securities.  We generally manage our interest rate risk by maintaining an investment portfolio generally consisting of debt instruments of high credit quality and relatively short maturities.  However, because short-term investments mature relatively quickly and are generally reinvested at the then current market rates, interest income on a portfolio consisting of cash equivalents and short-term investments is more subject to market fluctuations than a portfolio of longer-term investments.  The value of these investments may fluctuate with changes in interest rates; however, the contractual terms of the investments do not permit the issuer to call, prepay or otherwise settle the investments at prices less than the stated par value. Interest income recognized in the three months ended June 30, 2011 was $0.2 million and is included in "Interest and other income (expense), net" in our condensed consolidated statements of operations.

At June 30, 2011, we had no outstanding balances under the Bank of America Credit Facility.

Foreign Currency Exchange Rate Risk

We transact business in many different foreign currencies and are exposed to financial market risk resulting from fluctuations in foreign currency exchange rates, particularly Australian Dollars ("AUD"), Euros ("EUR"), and Great British Pounds ("GBP), which may result in a gain or loss of earnings to us. Our international business is subject to risks typical of an international business, including, but not limited to, foreign currency exchange rate volatility. Accordingly, our future results could be materially and adversely affected by changes in foreign currency exchange rates. Throughout the year, we frequently monitor the volatility of the AUD, EUR, and GBP (and all other applicable currencies).

Cash Flow Hedging Activities. From time to time, we hedge a portion of our foreign currency risk related to forecasted foreign currency-denominated sales and expense transactions by entering into foreign exchange forward contracts that generally have maturities less than 90 days. Our hedging programs reduce, but do not entirely eliminate, the impact of currency exchange rate movements in net sales and operating expenses. During the three months ended June 30, 2011 and 2010, we did not enter into any foreign exchange forward contracts related to cash flow hedging activities.

Balance Sheet Hedging Activities. We utilize foreign exchange forward contracts to mitigate foreign currency risk associated with foreign currency-denominated assets and liabilities, primarily certain inter-company receivables and payables. Our foreign currency exchange forward contracts are not designated as hedging instruments and are accounted for as derivatives whereby the fair value of the contracts are reported as "Prepaid expenses and other current assets" or "Accrued and other current liabilities" in our condensed consolidated balance sheets, and the associated gains and losses from changes in fair value are reported in "Interest and other income (expense), net" in our condensed consolidated statements of operations. The forward contracts generally have a contractual term of one month or less and are transacted near month-end. Therefore, the fair value of the forward contracts generally is not significant at each month-end.

At June 30, 2011, we had foreign currency exchange forward contracts related to balance sheet hedging activities in the notional amount of $107.9 million with a fair value that approximates zero. All of the contracts had maturities of one month and consisted primarily of AUD, CAD, EUR, and GBP. The net gain recognized from these contracts during the three months ended June 30, 2011 was $1.5 million and is included in "Interest and other income (expense), net" in our condensed consolidated statements of operations.

Foreign currency exchange forward contracts are designed to offset gains and losses on the underlying foreign currency-denominated assets and liabilities. Any movement in foreign currency exchange rates resulting in a gain or loss on our foreign currency exchange forward contracts are offset by an opposing gain or loss in the underlying foreign currency-denominated assets and liabilities that were hedged and would not have a material impact on our financial position.

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The counterparties to these forward contracts are creditworthy multinational commercial or investment banks. The risks of counterparty non-performance associated with these contracts are not considered to be material. Notwithstanding our efforts to manage foreign currency exchange risks, there can be no assurances that our mitigating or hedging activities will adequately protect us against the risks associated with foreign currency fluctuations.

We do not hedge foreign currency translation risk. A hypothetical 10% adverse change in foreign currency translation rates would result in a reduction of reported net sales of approximately $7.9 million and an increase in reported loss from operations before income taxes of approximately $0.3 million for the three months ended June 30, 2011. A hypothetical 10% adverse change in foreign currency translation rates would result in a reduction of reported total assets of approximately $23.7 million. These estimates assume an adverse shift in all foreign currency exchange rates, which do not always move in the same direction; actual results may differ materially.

Item 4.  Controls and Procedures
 
Definition and limitations of disclosure controls and procedures.  Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.  Disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. 

There are inherent limitations to the effectiveness of any system of disclosure controls and procedures.  These limitations include the possibility of human error, the circumvention or overriding of the controls and procedures and reasonable resource constraints.  In addition, because we have designed our disclosure controls and procedures based on certain assumptions, which we believe are reasonable, about the likelihood of future events, our disclosure controls and procedures may not achieve their desired purpose under all possible future conditions.  Accordingly, our disclosure controls and procedures provide reasonable assurance, but not absolute assurance, of achieving their objectives.

Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures, have concluded that as of July 2, 2011, our disclosure controls and procedures were effective in providing the requisite reasonable assurance that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during our first quarter of fiscal 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II — OTHER INFORMATION

Item 1.  Legal Proceedings

From time to time we are involved in ordinary routine litigation incidental to our business. In the opinion of our management, none of such pending litigation is expected to have a material adverse effect on our financial condition or results of operations.


Item 1A.  Risk Factors

Our business is subject to many risks and uncertainties that may impact our future financial performance. Some of those important risks and uncertainties that may cause our operating results to vary or may materially and adversely impact our operating results are described below. These risks are not presented in order of importance or probability of occurrence.

We must continue to develop and sell new titles in order to generate net sales and remain profitable.
 
We derive almost all of our net sales from sales of interactive software games. Even the most successful video games remain popular for only limited periods of time, often less than six months, and thus the success of our business is dependent upon our ability to continually develop and sell successful new games. Because net sales associated with an initial product launch generally constitutes a high percentage of the total net sales associated with the life of a product, the inability of our products to achieve significant market acceptance, delays in product releases or disruptions following the commercial release of our products may have a material adverse impact on our net sales and profitability.
 
Our business is "hit" driven. If we do not deliver "hit" games, our net sales and profitability can suffer.
 
While many new titles are regularly introduced in our industry, increasingly, only a relatively small number of "hit" titles account for a significant portion of video game sales. If we fail to develop "hit" titles, or if "hit" products published by our competitors take a larger share of consumer spending than we anticipate, our product sales could fall below our expectations, which could negatively impact both our net sales and profitability.
 
We may not be able to adequately adjust our cost structure in a timely fashion in response to a sudden decrease in demand.
 
A significant portion of our selling and marketing and our general and administrative expense is attributable to expenses for personnel and facilities. In the event of a significant decline in net sales, we may not be able to dispose of facilities, reduce personnel or make other changes to our cost structure without disruption to our operations or without significant termination and exit costs. Management may not be able to implement such actions in a timely manner, if at all, to offset an immediate shortfall in net sales and profit. Moreover, reducing costs may impair our ability to produce and develop software titles at sufficient levels in the future.
 
Although we believe our financial condition, including cash expected to be generated from operations and external sources of liquidity, is sufficient to meet our operating requirements for at least the next twelve months; the development and publishing of video games is capital intensive and our capacity to generate cash from our games may be insufficient to meet our anticipated cash requirements in the future.
 
We operate in a capital intensive business. During fiscal 2011, we invested a significant amount of our cash in product development and licenses and thus did not generate positive cash flow from operations in fiscal 2011. At June 30, 2011, we held cash and cash equivalents of $119.0 million.  We expect to use a significant amount of cash in our second and third fiscal quarters of fiscal 2012 in order to meet our working capital needs, including the purchase and payment of our product, for our holiday quarter. Accordingly, we expect to use our external sources of liquidity, which may include our Credit Facility and Wells Fargo Purchase Agreement, in order to help fund our working capital needs during this period. In the event our future net sales and these external liquidity sources are not sufficient to meet our operating requirements, or if required expenditures differ significantly from our expectations, we may need to defer and/or curtail currently-planned expenditures, cancel projects currently in development, and/or pursue additional funding or additional external sources of liquidity to meet our cash needs.

We may not be able to generate sufficient cash to service our convertible senior notes.

On August 4, 2009, we issued $100.0 million 5% convertible senior notes ("Notes"). The Notes pay interest semiannually, in arrears on February 15 and August 15 of each year and are due August 15, 2014, unless earlier converted, redeemed or repurchased. Our ability to make payments on the Notes will depend on our financial and operating performance, which is subject

31

to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may be unable to maintain a level of cash flows from operating activities sufficient to permit us to pay the interest or principal on the Notes.

Failure to appropriately adapt to rapid technological changes or emerging distribution channels may negatively impact our market share and our operating results.
 
Rapid technology changes in our industry require us to anticipate, sometimes years in advance, which technologies we must implement and take advantage of in order to make our products and services competitive. Currently, our industry is experiencing an increasing shift to online content and digital downloads. We believe that much of the growth in the industry will come via online markets or digital distribution such as massively multi-player games (both subscription and free-to-play), casual micro-transaction based games, paid downloadable content and digital downloads of games. Accordingly, we plan to continue integrating a digital component into all of our key franchises. However, if we fail to anticipate and adapt to these and other technological changes, our market share and our operating results may suffer. Our future success in providing online games, wireless games and other content will depend upon our ability to adapt to rapidly-changing technologies, develop applications to accommodate evolving industry standards, and improve the performance and reliability of our applications.

Connectivity issues related to digital sales and online gameplay could impact our ability to sell and provide online services for our games, and could impact our profitability.

We rely upon various third-party providers, such as PlayStation Network, Microsoft's Xbox Live, Valve's Steam platform, and Facebook, to provide connectivity from the consumer to our digital products and our online services. Connectivity issues could prevent customers from accessing this content and our ability to successfully market and sell our products could be adversely impacted. In addition, we could experience similar issues related to services we host on our internal servers. Such issues also could impact our ability to provide online services, and could impact our business.

Our inability to acquire or create new intellectual property that has a high level of consumer recognition or acceptance could negatively impact our net sales and profitability.
 
We generate a portion of our net sales from wholly-owned intellectual property. The success of our internal brands depends upon our ability to create original ideas that appeal to the core gamer. Titles based on wholly-owned intellectual property can be expensive to develop and market since they do not have a built-in consumer base or licensor support. Our inability to create new products that find consumer acceptance could negatively impact our net sales and profitability.

Since a portion of our net sales is based upon licensed properties, failure to renew such licenses, or renewals of such licenses on less advantageous terms, could cause our net sales and/or our profitability to decline.
 
Games we develop based upon licensed brands make up a portion of our net sales each year. Sales of our games based upon our two top-selling licensed brands, UFC and WWE, excluding the impact of changes in deferred net revenue, comprised approximately 32% of our net sales in fiscal 2011. In fiscal 2010, sales of our games based upon our two top-selling licensed brands, UFC and WWE, excluding the impact of changes in deferred net revenue, comprised 35% of our net sales. A limited number of licensed brands may continue to produce a disproportionately large amount of our sales. Due to the importance to us of a limited number of brands and the intense competition from other video game publishers to publish games based upon these licensed brands, we may not be able to renew our current licenses or may have to renew a brand license on less advantageous terms, which could significantly lower our net sales and/or our profitability. During fiscal 2011, we entered into a multi-year extension of our long-term agreement with Games Workshop to publish games based on the Warhammer 40,000 brand which expires on December 31, 2020. Our licenses with UFC and WWE expire on December 31, 2018. There can be no assurance that we will be able to extend such licenses and if we are not able to extend them, our net sales and/or our profitability may decline significantly.

A decrease in the popularity of our licensed brands or video games based on those brands could materially impact our net sales and financial position.
 
As previously mentioned, a portion of our net sales are derived from products based on popular licensed properties. A decrease in the popularity of the underlying property of our licenses could negatively impact our ability to sell games based on such licenses and could lead to lower net sales, profitability, and/or an impairment of our licenses, which would negatively impact our profitability.
 

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High development costs for games which do not perform as anticipated and failure of platforms to achieve significant market penetration could decrease our profitability and result in potential impairments of capitalized software development costs.
 
Video games played on consoles and certain online games (e.g., multi-player online games) are expensive to develop. If the high development costs are not offset by high net sales and other cost efficiencies, our operating margins and profitability will be negatively impacted. If our internally developed games and/or franchises do not achieve significant market penetration, we may reduce our internal development studio teams which support these games and/or franchises. Additionally, if our games do not achieve significant market penetration, we may not be able to recover our development costs, which could result in the impairment of capitalized software costs, which would negatively impact our profitability.

Video game product development schedules are difficult to predict and can be subject to delays. Postponements in shipments can substantially impact our sales and profitability in any given quarter.
 
Our ability to meet product development schedules is impacted by a number of factors, including the creative processes involved, the coordination of large and sometimes geographically-dispersed development teams required by the complexity of our products, the need to localize certain products for distribution outside of the U.S., the need to refine our products prior to their release, and the time required to manufacture a game once it is submitted to the platform manufacturer. In the past, we have experienced development and manufacturing delays for several of our products. Failure to meet anticipated production schedules may cause a shortfall in our expected sales and profitability and cause our operating results in any given quarter to be materially different from expectations. Delays that prevent release of our products during peak selling seasons or in conjunction with specific events, such as the release of a related movie, could significantly impact the sales of such products and thus our profitability.

We rely on external developers for the development of some of our titles.
 
Some of our games are developed by third-party developers. While we own approximately 15% of Yuke's, the developer of our UFC Undisputed and some of our WWE-based games, we do not have direct control over the business, finances and operational practices of these external developers, including Yuke's. A delay or failure to complete the work performed by external developers has and may in the future result in delays in, or cancellations of, product releases. Additionally, the future success of externally-developed titles will depend on our continued ability to maintain relationships and secure agreements on favorable terms with skilled external developers. Our competitors may acquire the businesses of key developers or sign them to exclusive development arrangements. In either case, we would not be able to continue to engage such developers' services for our products, except for those that they are contractually obligated to complete for us. We cannot guarantee that we will be able to establish or maintain such relationships with external developers, and failure to do so could result in a material adverse impact on our business and financial results.
 
Defects in our game software could harm our reputation or decrease the market acceptance of our products.
 
Our game software may contain defects. In addition, because we do not manufacture our games for console platforms, we may not discover defects until after our products are in use by retail customers. Any defects in our software could damage our reputation, cause our customers to terminate relationships with us or to initiate product liability suits against us, divert our engineering resources, delay market acceptance of our products, increase our costs or cause our net sales to decline.

We are a software company and have limited experience developing hardware products. Our uDraw may experience quality or supply problems or may fail to achieve our sales expectations, which could negatively impact our net sales and profitability.
 
uDraw is our first hardware product. Hardware products can be highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm if we fail to detect or effectively address such issues through design, testing, or warranty repairs. In addition, we obtain some components of our hardware devices from sole suppliers. If a component delivery from a sole-source supplier is delayed or becomes unavailable or industry shortages occur, we may be unable to obtain timely replacement supplies, resulting in reduced sales. Either component shortages or excess or obsolete inventory may increase our cost of sales. uDraw is assembled in China; disruptions in the supply chain may result in console shortages that would affect our net sales and profitability.

Our business is dependent upon the success and availability of the video game platforms on which consumers play our games.
 
We derive most of our net sales from the sale of products for play on video game platforms manufactured by third parties, such as PS3, Xbox 360, and the Wii and DS. The following factors related to such platforms can adversely impact sales of our video games and our profitability:

33

 
Popularity of platforms.  Since the typical development cycle for a console, handheld, or PC game is from 9 to 36 months, we must make decisions about which games to develop on which platforms based on current expectations of what the consumer preference for the platforms will be when the game is finished. Launching a game on a platform that has declined in popularity, or failure to launch a game on a platform that has grown in popularity, could negatively impact our net sales and profitability.
 
Platform pricing.  Platforms can be expensive – in the United States, console pricing ranges from $149.99 for the Wii to $399.99 for the high-end Xbox 360 Kinect and the new Nintendo 3DS is $169.99 The cost of the hardware could impact consumer purchases of such hardware, which could in turn negatively impact sales of our products for these platforms since consumers need a platform in order to play most of our games.
 
Platform shortages.  From time to time, the platforms on which our games are played have experienced shortages. Platform shortages generally negatively impact the sales of video games since consumers do not have consoles on which to play the games.

Our inability to enter into agreements with the manufacturers to develop, publish and distribute titles on their platforms could seriously impact our operations.
 
We are dependent on the platform manufacturers (Microsoft, Nintendo and Sony) and our non-exclusive licenses with them, both for the right to publish titles for their platforms and for the manufacture of our products for their platforms. Our existing platform licenses require that we obtain approval for the publication of new games on a title-by-title basis. As a result, the number of titles we are able to publish for these platforms, and our sales from titles for these platforms, may be limited. Should any manufacturer choose not to renew or extend our license agreement at the end of its current term, or if any license were terminated, we would be unable to publish additional titles for that manufacturer's platform, which could negatively impact our operating results.
 
Additionally, since each of the manufacturers publishes games for its own platform, and also manufactures products for all of its other licensees, a manufacturer may give priority to its own products or those of other publishers in the event of insufficient manufacturing capacity. Unanticipated delays in the delivery of products due to delayed manufacturing could also negatively impact our operating results.

We rely on a small number of customers that account for a significant amount of our sales. If these customers reduce their purchases of our products or become unable to pay for them, our business could be harmed.
 
Our largest customers, Best Buy, GameStop, Target and Wal-Mart, in aggregate accounted for approximately 44% of our gross sales in fiscal 2011. A substantial reduction, termination of purchases, or business failure by any of our largest customers could have a material adverse impact on us.

We may face difficulty obtaining access to retail shelf space necessary to market and sell our products effectively.
 
Retailers typically have a limited amount of shelf space and promotional resources, and there is intense competition among consumer interactive entertainment software products for high quality retail shelf space and promotional support from retailers. To the extent that the number of products and platforms increases, competition for shelf space may intensify and may require us to increase our marketing expenditures. Retailers with limited shelf space typically devote the most and highest quality shelf space to those products expected to be best sellers. We cannot be certain that our new products will consistently achieve such "best seller" status. Due to increased competition for limited shelf space, retailers and distributors are in an increasingly better position to negotiate favorable terms of sale, including price discounts, price protection, marketing and display fees, and product return policies. Our products constitute a relatively small percentage of most retailers' sales volume. We cannot be certain that retailers will continue to purchase our products or to provide those products with adequate levels of shelf space and promotional support on acceptable terms. A prolonged failure in this regard may significantly harm our business and financial results.

Increased sales of used video game products could reduce demand for new copies of our games.
 
Large retailers, including one of our largest customers, GameStop, have increased their focus on selling used video games, which provides higher margins for the retailers than sales of new games. This focus reduces demand for new copies of our games. We believe customer retention through compelling online play and downloadable content offers may reduce consumers' propensity to trade in games; however, continued sales of used games, rather than new games, may negatively impact our ability to sell new games and thus lower our net sales in any given quarter.


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Software pricing and sales allowances may impact our net sales and profitability.
 
Software prices for games sold for play on the PS3 and Xbox 360 are generally higher than prices for games for the Wii, handheld platforms or PC games. Our product mix in any given fiscal quarter or fiscal year may cause our net sales to significantly fluctuate depending on which platforms we release games on in that quarter or year. Additionally, reductions in software pricing on any platform may result in lower net sales, which could materially impact our profitability.
 
In addition, we establish sales allowances based on estimates of future price protection and returns with respect to current period product net sales. While we believe that we can reliably estimate future returns and price protection, if product sell-through does not perform in line with our current expectations, return rates and price protection could exceed our reserves, and our net sales could be negatively impacted in future periods.

Our platform licensors control the fee structures for online distribution of our games on their platforms.
 
Certain platform licensors have retained the right to change the fee structures for online distribution of both paid content and free content (including patches and corrections) on their platforms. Each licensor's ability to set royalty rates makes it difficult for us to forecast our costs. Increased costs could negatively impact our operating margins. We may be unable to distribute our content in a cost-effective or profitable manner through this distribution channel, which could adversely impact our results of operations.
 
Development of software by platform manufacturers may lead to reduced sales of our products.
 
The platform manufacturers, Microsoft, Nintendo and Sony, each develop software for their own hardware platforms. As a result of their commanding positions in the industry, the platform manufacturers may have better bargaining positions with respect to retail pricing, shelf space and retailer accommodations than do any of their licensees, including us. Additionally, the platform manufacturers can bundle their software with their hardware, creating less demand for individual sales of our products. In the twelve month period ended March 31, 2011, Nintendo's market share in the U.S. was nearly 34% on its Wii platform and more than 37% on its DS platforms. Continued or increased dominance of software sales by the platform manufacturers may lead to reduced sales of our products and thus lower net sales.
 
Increased development of software and online games by intellectual property owners and developers may lead to reduced net sales.
 
Some of our games are based upon licensed intellectual properties. In recent years, licensors and independent developers have increased their development of video games in digital and other online distribution channels, which could lead to such licensors not renewing our licenses to publish games based upon their properties that we currently publish, or not granting future licenses to us to develop games based on their other properties. If intellectual property owners continue expanding internal efforts to develop video games based upon properties that they own rather than renewing our licenses or granting us additional licenses, our net sales could be significantly impacted.

Competitive launches may negatively impact the sales of our games.
 
We compete for consumer dollars with several other video game publishers, and consumers must make choices among available games. If we make our games available for sale at the same time as our competitors' games become available, consumers may choose to spend their money on products published by our competitors rather than our products and retailers may choose to give more shelf space to our competitors' products, leaving less space to sell our products. Since the life cycle of a game is short, strong sales of our competitors' games could negatively impact the sales of our games.
 
Competition for licenses may negatively impact our profitability.
 
Some of our competitors have greater name recognition among consumers and licensors of properties, a broader product line, or greater financial, marketing and other resources than we do. Accordingly, these competitors may be able to market their products more effectively or make larger offers or guarantees in connection with the acquisition of licensed properties. As competition for popular properties increases, our cost of acquiring licenses for such properties may increase, which could result in reduced margins and thus negatively impact our profitability.
 
Competition with other forms of home-based entertainment may reduce sales of our products.
 

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We also compete with other forms of entertainment and leisure activities. For example, we believe the overall growth in the use of the Internet and online services, including social networking, by consumers may pose a competitive threat if customers and potential customers spend less of their available time using our video games and more of their time using the Internet, including playing social networking games on Facebook, and online services.
 
Competition for qualified personnel is intense in the interactive entertainment software industry and failure to hire and retain qualified personnel could seriously harm our business.
 
To a substantial extent, we rely on the management, marketing, sales, technical and software development skills of a limited number of employees to formulate and implement our business plan. To a significant extent, our success depends upon our ability to attract and retain key personnel. Competition for employees can be intense and the process of locating key personnel with the right combination of skills is often lengthy. The loss of key personnel could have a material adverse impact on our business.

A significant portion of our net sales is derived from our international operations, which may subject us to economic, currency, political, regulatory and other risks.
 
In fiscal 2011, excluding the impact of changes in deferred net revenue, we derived 34.6% of our consolidated net sales from outside of North America. Our international operations subject us to many risks, including: different consumer preferences; challenges in doing business with foreign entities caused by distance, language and cultural differences; unexpected changes in regulatory requirements, tariffs and other barriers; difficulties in staffing and managing foreign operations; and possible difficulties collecting foreign accounts receivable. These factors or others could have an adverse impact on our future foreign sales or the profits generated from those sales.
 
There are additional risks inherent in doing business in certain international markets, such as China. For example, foreign exchange controls may prevent us from expatriating cash earned in China, and standard business practices in China may increase our risk of violating U.S. laws such as the Foreign Corrupt Practices Act.
 
Additionally, sales generated by our international offices will generally be denominated in the currency of the country in which the sales are made, and may not correlate to the currency in which inventory is purchased, or software is developed. To the extent our foreign sales are not denominated in U.S. dollars, our sales and profits could be materially and adversely impacted by foreign currency fluctuations. Year-over-year changes in foreign currency translation rates had the mathematical effect of increasing our reported net loss by approximately $1.0 million in fiscal 2011.

Adverse macroeconomic conditions could result in a prolonged reduction in discretionary spending by consumers that could reduce demand for our products.
 
Our products involve discretionary spending on the part of consumers. Consumers are generally more willing to make discretionary purchases, including purchases of products like ours, during periods in which favorable economic conditions prevail. As a result, our products may be sensitive to general economic conditions and economic cycles. Declining consumer confidence, inflation, recession and rising unemployment may lead consumers to delay or reduce purchases of our products. Reduced consumer spending may also require us to incur increased selling and promotional expenses. Additionally, a reduction or shift in domestic or international consumer due to regional macroeconomic spending could negatively impact our business, results of operations and financial condition.
 
Fluctuations in our quarterly operating results due to seasonality in the interactive entertainment software industry and other factors related to our business operations could result in substantial losses to investors.
 
We have experienced, and may continue to experience, significant quarterly fluctuations in sales and operating results. The interactive entertainment software industry is highly seasonal, with sales typically significantly higher during the year-end holiday buying season. Other factors that cause fluctuations in our sales and operating results include:
 
•
the timing of our release of new titles as well as the release of our competitors' products;
•
the popularity of both new titles and titles released in prior periods;
•
the deferral or subsequent recognition of net sales and costs related to certain of our products which contain online functionality;
•
the profit margins for titles we sell;
•
the competition in the industry for retail shelf space;

36

•
fluctuations in the size and rate of growth of consumer demand for titles for different platforms; and
•
the timing of the introduction of new platforms and the accuracy of retailers' forecasts of consumer demand.
 
We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. We may not be able to maintain consistent profitability on a quarterly or annual basis. It is likely that in some future quarter, our operating results may be below the expectations of public market analysts and investors as a result of the factors described above and others described throughout this "Risk Factors" section, which may in turn cause the price of our common stock to fall or significantly fluctuate.

Our stock price has been volatile and may continue to fluctuate significantly.
 
The market price of our common stock historically has been, and may continue to be, subject to significant fluctuations. These fluctuations may be due to factors specific to us (including those discussed in this "Risk Factors" section, as well as others not currently known to us or that we currently do not believe are material), to changes in securities analysts' earnings estimates or ratings, to our results or future financial guidance falling below our expectations and analysts' and investors' expectations, to factors impacting the entertainment, computer, software, Internet, media or electronics industries, to our ability to successfully integrate any acquisitions we may make, or to national or international economic conditions. In particular, economic downturns may contribute to the public stock markets' experiencing extreme price and trading volume volatility. These broad market fluctuations have and could continue to adversely impact the market price of our common stock.

We may not be able to protect our intellectual property rights against piracy, infringement by third parties, or declining legal protection for intellectual property.
 
We defend our intellectual property rights and combat unlicensed copying and use of software and intellectual property rights through a variety of techniques. Preventing unauthorized use or infringement of our rights is difficult. Unauthorized production occurs in the computer software industry generally, and if a significant amount of unauthorized production of our products were to occur, it could materially and adversely impact our results of operations. We hold copyrights on the products, manuals, advertising and other materials owned by us and we maintain certain trademark rights. We regard our titles, including the underlying software, as proprietary and rely on a combination of trademark, copyright and trade secret laws as well as employee and third-party nondisclosure and confidentiality agreements, among other methods, to protect our rights. We include with our products a "shrink-wrap" or "click-wrap" license agreement which imposes limitations on use of the software. It is uncertain to what extent these agreements and limitations are enforceable, especially in foreign countries. Policing unauthorized use of our products is difficult, and software piracy is a persistent problem, especially in some international markets. Further, the laws of some countries where our products are or may be distributed, either do not protect our products and intellectual property rights to the same extent as the laws of the U.S., or are poorly enforced. Legal protection of our rights may be ineffective in such countries. We cannot be certain that existing intellectual property laws will provide adequate protection for our products.
 
Software piracy may negatively impact our business.
 
Software piracy is increasing rapidly in the video game industry. The growth in peer-to-peer networks and other channels to download pirated copies of our products, the increasing availability of broadband access to the Internet and the proliferation of technology designed to circumvent the protection measures used with our products all have contributed to an expansion in piracy. While we are taking various steps to protect our intellectual property and prevent illegal downloading of our video games, we may not be successful in preventing or controlling such piracy, which may negatively impact our business.
While legal protections exist to combat piracy, preventing and curbing infringement through enforcement of our intellectual property rights may be difficult, costly and time consuming, particularly in countries where laws are less protective of intellectual property rights. Further, the scope of the legal protection of copyright and prohibitions against the circumvention of technological protection measures to protect copyrighted works are often under scrutiny by courts and governing bodies. The repeal or weakening of laws intended to combat piracy, protect intellectual property and prohibit the circumvention of technological protection measures could make it more difficult for us to adequately protect against piracy. These factors could have a negative effect on our growth and profitability in the future.

Third parties may claim we infringe their intellectual property rights.
 
Although we believe that we make reasonable efforts to ensure our products do not violate the intellectual property rights of others, from time to time, we receive notices from others claiming we have infringed their intellectual property rights. The number of these claims may grow. Responding to these claims may require us to enter into royalty and licensing agreements on unfavorable terms, require us to stop selling or to redesign impacted products, or pay damages or satisfy indemnification

37

commitments including contractual provisions under various license arrangements. If we are required to enter into such agreements or take such actions, our operating margins may decline as a result.

If one or more of our titles were found to contain objectionable undisclosed content, our business could suffer.

Throughout the history of our industry, many video games have been designed to include certain hidden content and gameplay features that are accessible through the use of in-game cheat codes or other technological means that are intended to enhance the gameplay experience. However, in some cases, objectionable undisclosed content or features, which were placed in games without the publishers' knowledge, have been found in interactive entertainment software products. In a few cases, the Entertainment Software Ratings Board (“ESRB”) has reacted to discoveries of undisclosed content and features in other publisher's products by changing the rating that was originally assigned to the product, requiring the publisher to change the game and/or game packaging and/or fining the publisher. Retailers have on occasion reacted to the discovery of such undisclosed content by removing these games from their shelves, refusing to sell them, and demanding that the publishers accept them as product returns. Likewise, some consumers have reacted to the revelation of undisclosed content by refusing to purchase such games, demanding refunds for games they have already purchased, refraining from buying other games published by the company whose game contained the objectionable material, and, on at least one occasion, filing a lawsuit against the publisher of the product containing such content.

We have implemented preventive measures designed to reduce the possibility of objectionable undisclosed content from appearing in the video games we publish. Nonetheless, these preventive measures are subject to human error, circumvention, overriding, and reasonable resource constraints. If a video game we publish is found to contain undisclosed content, we could be subject to any of these consequences and our reputation could be harmed, which could have a negative impact on our operating results and financial condition, and our business and financial performance could be significantly harmed.
 
Rating systems and future legislation may make it difficult to successfully market and sell our products.
 
Currently, the interactive entertainment software industry is self-regulated and products are rated by the ESRB. Our retail customers take the ESRB rating into consideration when deciding which of our products they will purchase. If the ESRB or a manufacturer determines that a product should have a rating directed to an older or more mature consumer, we may be less successful in our marketing and sales of a particular product.
 
From time to time, legislation has been introduced for the establishment of a government mandated rating and governing system in the U.S. and in foreign countries for our industry. In April 2010, the U.S. Supreme Court granted the state of California's certiorari petition in connection with the constitutionality of California's proposed legislation (“Brown v. EMEA/ESA”) to regulate the sale of violent video games to minors. In June 2011, the U.S. Supreme Court ruled on Brown v. EMEA/ESA, declaring that content-based restrictions on video games are unconstitutional. Outside of the U.S., various foreign countries already allow government censorship of interactive entertainment products. We believe that if our industry were to become subject to a government rating system or other regulation, our ability to successfully market and sell our products could be adversely impacted.

Breaches of our security measures and unintended disclosures of our intellectual property or our customer data could adversely affect our business.

We take measures to prevent our source code, and other confidential information, from unauthorized access. A security breach that results in the disclosure of our source code, other confidential assets, or pre-release software could lead to piracy of our software or otherwise compromise our product plans. When we conduct business online directly with consumers, we may be the victim of fraudulent transactions, including credit card fraud, which presents a risk to our revenues and potentially disrupts service to our customers. As we increase our online businesses, we are also collecting and storing an increasing amount of customer data, some of it personally identifiable information including credit card data. It is possible that our security controls over customer data may not prevent the improper disclosure of personally identifiable information. A security breach that leads to disclosure of customer account information (including personally identifiable information) could harm our reputation and subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. A resulting perception that our products or services do not adequately protect the privacy of personal information could result in a loss of current or potential customers for our online offerings that require the collection of customer data.

We have significant net operating loss and tax credit carryforwards ("NOLs"). If we are unable to use our NOLs, our future profitability may be significantly impacted.
 
As of March 31, 2011, we had federal net operating loss carryforwards of $509.2 million and federal R&D tax credit

38

carryforwards of $25.5 million. Under applicable tax rules, we may "carry forward" these NOLs in certain circumstances to offset any current and future taxable income and thus reduce our income tax liability, subject to certain requirements and restrictions. Therefore, we believe that these NOLs could be a substantial asset. However, if we experience an "ownership change," as defined in Section 382 of the Internal Revenue Code, our ability to use the NOLs could be substantially limited, which could significantly increase our future income tax liability. On May 12, 2010, we entered into a Section 382 Rights Agreement with Computershare Trust Company, N.A., as rights agent, in an effort to prevent an "ownership change" from occurring and thereby protect the value of the NOLs. There can be no assurance, however, that the Section 382 Rights Plan will prevent an ownership change from occurring or protect the value of the NOLs.
 
We cannot be certain of the future effectiveness of our internal control over financial reporting or the impact of the same on our operations and the market price for our common stock.
 
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to include in our 10-K our assessment of the effectiveness of our internal control over financial reporting. Furthermore, our independent registered public accounting firm is required to report on whether it believes we maintain, in all material respects, effective internal control over financial reporting. Although we believe that we currently have adequate internal control procedures in place, we cannot be certain that our internal control over financial reporting will be effective in the future. If we cannot adequately maintain the effectiveness of our internal control over financial reporting, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC. Any such action could adversely impact our financial results and the market price of our common stock.

Catastrophic events or geo-political conditions may disrupt our business.
 
Our net sales are derived from sales of our games, which are developed within a relatively small number of studio facilities located throughout the world. If a fire, flood, earthquake or other disaster, condition or event such as political instability, civil unrest or a power outage, adversely affected any of these facilities while personnel were finishing development of a game, it could significantly delay the release of the game, which could result in a substantial loss of sales in any given quarter and cause our operating results to differ materially from expectations.


Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
 
There were no repurchases of our common stock by the Company during the quarter ended June 30, 2011.
 
Limitations upon Payment of Dividends
 
Our Credit Facility contains limitations on our ability to pay cash dividends. 

Item 3.   Defaults Upon Senior Securities
 
None

Item 4.   (Removed and Reserved)

Item 5.   Other Information
 
None


39

Item 6.    Exhibits
 
Exhibit
Number
 
Title
 
 
 
3.1

 
Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to Post-Effective Amendment No. 1 to the Registration Statement on Form S-3 filed on January 9, 1998 (File No. 333-32221) (the "S-3 Registration Statement")).
 

 
 
3.2

 
Amendment to Certificate of Incorporation (incorporated by reference to Exhibit 3.2 to Post-Effective Amendment No. 1 to the S-3 Registration Statement).
 

 
 
3.3

 
Amendment to Certificate of Incorporation (incorporated by reference to Exhibit 3.3 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2001).
 

 
 
3.4

 
Amendment to Certificate of Incorporation (incorporated by reference to Exhibit 3.4 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2007).
 

 
 
3.5

 
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed on March 12, 2009).
 

 
 
3.6

 
Amended and Restated Certificate of Designation, Preferences, and Rights of Series A Junior Participating Preferred Stock of THQ Inc. (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form 8-A filed on May 13, 2010 (File No. 001-15959) (the "May 2010 8-A")).
 

 
 
4.1

 
Rights Agreement dated as of May 12, 2010, by and between the Company and Computershare Trust Company, N.A., as rights agent, which includes as Exhibit B the Form of Rights Certificate (incorporated by reference to Exhibit 4.1 to the May 2010 8-A).
 

 
 
4.2

 
First Amendment to the Rights Agreement dated February 18, 2011, by and between the Company and Computershare Trust Company, N.A., as rights agent (incorporated by reference to Exhibit 4.2 to the Company's Registration Statement, as amended, on Form 8-A/A filed on February 24, 2011 (File No. 001-15959)).
 
 
 
4.3

 
Amended and Restated Rights Agreement, dated as of August 22, 2001 between the Company and Computershare Investor Services, LLC, as Rights Agent (incorporated by reference to Exhibit 1 to Amendment No. 2 to the Company's August 2001 8-A).
 

 
 
4.4

 
First Amendment to Amended and Restated Rights Agreement, dated April 9, 2002 between the Company and Computershare Investor Services, LLC, as Rights Agent (incorporated by reference to Exhibit 2 to Amendment No. 3 to the Company's Registration Statement on Form 8-A filed on April 12, 2002 (file No. 000-18813)).
 

 
 
4.5

 
Second Amendment to Amended and Restated Rights Agreement, dated as of May 12, 2010 between the Company and Computershare Investor Services, LLC (incorporated by reference to Exhibit 10.1 to the Form 8‑K filed with the SEC on May 13, 2010).
 

 
 
4.6

 
Indenture dated as of August 4, 2009, between the Company and Union Bank, N.A., as trustee (incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on August 4, 2009).
 

 
 
4.7

 
Form of 5.00% Convertible Senior Note (incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on August 4, 2009).
 
 
 
31.1

*
Certification of Brian J. Farrell, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2

*
Certification of Paul J. Pucino, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32

*
Certification of Brian J. Farrell, Chief Executive Officer, and Paul J. Pucino, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101.INS

* †
XBRL Instance Document
 
 
 
101.SCH

* †
XBRL Taxonomy Extension Schema Document
 
 
 

40

101.CAL

* †
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.DEF

* †
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
101.LAB

* †
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
101.PRE

* †
XBRL Taxonomy Extension Presentation Linkbase Document


*    Filed herewith.

†    Pursuant to Rule 406T of Regulation S-T, these interactive data files are furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended; are deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended; and otherwise are not subject to liability under these sections. We are deemed to have complied with the reporting obligation relating to the submission of interactive data files in these exhibits and are not subject to liability under the anti-fraud provisions of the Securities Act of 1933 or any other liability provision as long as we make a good faith attempt to comply with the submission requirements and promptly amend the interactive data files after becoming aware that the interactive data files fail to comply with the submission requirements.


41

SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
Dated: August 10, 2011
THQ INC.
 
 
 
 
 
 
 
By:
/s/ Brian J. Farrell
 
 
 
Brian J. Farrell,
 
 
 
Chairman of the Board, President and Chief Executive Officer
 
 
 
 
 
 
 
 
 
Dated: August 10, 2011
THQ INC.
 
 
 
 
 
 
 
By:
/s/ Paul J. Pucino
 
 
 
Paul J. Pucino,
 
 
 
Executive Vice President, Chief Financial Officer
 
 
 
 
 
 
 
 
 
Dated: August 10, 2011
THQ INC.
 
 
 
 
 
 
 
By:
/s/ Teri J. Manby
 
 
 
Teri J. Manby,
 
 
 
Vice President, Chief Accounting Officer
 


42