10-Q 1 thq10-q093011.htm 10-Q THQ 10-Q 093011
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 September 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 November 4, 2011 was approximately 68,381,994.

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)
 
 
September 30,
2011
 
March 31,
2011
 
(Unaudited)
 
(Unaudited)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
51,055

 
$
85,603

Accounts receivable, net of allowances
27,746

 
161,574

Inventory
21,114

 
31,905

Licenses
35,763

 
32,869

Software development
176,642

 
222,631

Deferred income taxes
7,668

 
8,200

Income tax receivable
1,379

 
—

Prepaid expenses and other current assets
44,836

 
56,908

Total current assets
366,203

 
599,690

Property and equipment, net
26,327

 
28,960

Licenses, net of current portion
79,640

 
85,367

Software development, net of current portion
49,977

 
49,858

Deferred income taxes
516

 
516

Other long-term assets, net
9,710

 
10,014

TOTAL ASSETS
$
532,373

 
$
774,405

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
71,050

 
$
100,550

Accrued and other current liabilities
145,278

 
137,922

Deferred revenue, net
58,933

 
141,060

Total current liabilities
275,261

 
379,532

Other long-term liabilities
83,731

 
88,042

Convertible senior notes
100,000

 
100,000

Commitments and contingencies (see Note 7)


 


 
 
 
 
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 September 30, 2011; 68,376,786 and 68,300,482 shares issued and outstanding as of September 30, 2011 and March 31, 2011, respectively
684

 
683

Additional paid-in capital
523,872

 
520,797

Accumulated other comprehensive income
11,864

 
17,560

Accumulated deficit
(463,039
)
 
(332,209
)
Total stockholders' equity
73,381

 
206,831

TOTAL LIABILITIES AND EQUITY
$
532,373

 
$
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 September 30,
 
For the Six Months
Ended September 30,
 
(Unaudited)
 
(Unaudited)
 
2011
 
2010
 
2011
 
2010
Net sales
$
146,004

 
$
77,053

 
$
341,157

 
$
226,432

Cost of sales:


 


 
 
 

Product costs
57,986

 
35,003

 
125,049

 
95,706

Software amortization and royalties
77,893

 
21,162

 
142,813

 
54,515

License amortization and royalties
23,156

 
9,583

 
31,295

 
30,473

Total cost of sales
159,035

 
65,748

 
299,157

 
180,694

 
 
 
 
 
 
 
 
Gross margin
(13,031
)
 
11,305

 
42,000

 
45,738

Operating expenses:
 
 
 
 
 
 
 
Product development
27,954

 
17,900

 
58,143

 
34,375

Selling and marketing
37,765

 
24,023

 
88,441

 
57,649

General and administrative
12,037

 
11,878

 
24,086

 
23,722

Restructuring
6,082

 
(161
)
 
5,942

 
7

Total operating expenses
83,838

 
53,640

 
176,612

 
115,753

 
 
 
 
 
 
 
 
Operating loss
(96,869
)
 
(42,335
)
 
(134,612
)
 
(70,015
)
Interest and other income (expense), net
2,467

 
(3,991
)
 
2,910

 
(5,581
)
Loss before income taxes
(94,402
)
 
(46,326
)
 
(131,702
)
 
(75,596
)
Income taxes
(2,017
)
 
659

 
(872
)
 
1,499

Net loss
$
(92,385
)
 
$
(46,985
)
 
$
(130,830
)
 
$
(77,095
)
 
 
 
 
 
 
 
 
Loss per share — basic
$
(1.35
)
 
$
(0.69
)
 
$
(1.91
)
 
$
(1.14
)
Loss per share — diluted
$
(1.35
)
 
$
(0.69
)
 
$
(1.91
)
 
$
(1.14
)
 
 
 
 
 
 
 
 
Shares used in per share calculation — basic
68,340

 
67,813

 
68,329

 
67,779

Shares used in per share calculation — diluted
68,340

 
67,813

 
68,329

 
67,779

 
See notes to condensed consolidated financial statements.


4

THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands) 
 
For the Six Months
Ended September 30,
 
(Unaudited)
 
2011
 
2010
OPERATING ACTIVITIES:
 
 
 
Net loss
$
(130,830
)
 
$
(77,095
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
5,564

 
5,616

Amortization of licenses and software development(1)
154,364

 
66,648

Loss on disposal of property and equipment
211

 
10

Restructuring charges
5,942

 
7

Changes in deferred net revenue and related expenses
(52,153
)
 
4,053

Amortization of debt issuance costs
187

 
393

Amortization of interest
—

 
763

Gain on investments
(270
)
 
(332
)
Stock-based compensation(2)
3,339

 
4,357

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net of allowances
132,565

 
30,204

Inventory
10,730

 
(6,992
)
Licenses
(13,902
)
 
(23,940
)
Software development
(97,783
)
 
(116,763
)
Prepaid expenses and other current assets
(4,389
)
 
(24,129
)
Accounts payable
(28,318
)
 
18,202

Accrued and other liabilities
(4,618
)
 
(39,446
)
Income taxes
(3,089
)
 
2,193

Net cash used in operating activities
(22,450
)
 
(156,251
)
 
 
 
 
INVESTING ACTIVITIES:
 
 
 
Proceeds from sales and maturities of available-for-sale investments
—

 
93,248

Proceeds from sales and maturities of trading investments
—

 
22,775

Purchases of available-for-sale investments
—

 
(64,781
)
Other long-term assets
1,186

 
(474
)
Purchases of property and equipment
(5,597
)
 
(8,265
)
Net cash provided by (used in) investing activities
(4,411
)
 
42,503

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

 
520

Payment of debt issuance costs
(1,264
)
 
—

Payment of secured credit line
—

 
(13,249
)
Net cash used in financing activities
(1,243
)
 
(12,729
)
Effect of exchange rate changes on cash
(6,444
)
 
4,490

Net decrease in cash and cash equivalents
(34,548
)
 
(121,987
)
Cash and cash equivalents — beginning of period
85,603

 
188,378

Cash and cash equivalents — end of period
$
51,055

 
$
66,391

________________________________
(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. 

5

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, 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 six months ended September 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 and six months ended September 30, 2011 and 2010 contain the following number of weeks:
Fiscal Period
 
Number of Weeks
 
Fiscal Period End Date
Three months ended September 30, 2011
 
13 weeks
 
October 1, 2011
Three months ended September 30, 2010
 
13 weeks
 
October 2, 2010
Six months ended September 30, 2011
 
26 weeks
 
October 1, 2011
Six months ended September 30, 2010
 
26 weeks
 
October 2, 2010

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

6

 
September 30,
2011
 
March 31,
2011
Finished goods
$
14,940

 
$
28,515

Components
6,174

 
3,390

Inventory
$
21,114

 
$
31,905

 
Prepaid expenses and other current assets. Prepaid expenses and other current assets at September 30, 2011 and March 31, 2011 primarily consisted of product costs totaling $16.2 million and $32.0 million, respectively, that were deferred in connection with the deferral of related net revenue. Also included in prepaid expenses and other current assets at September 30, 2011 and March 31, 2011 were product prepayments of $11.7 million and $4.5 million, respectively.

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

 
$
730

Land
-
 
401

 
401

Computer equipment and software
3-10 yrs
 
60,460

 
60,254

Furniture, fixtures and equipment
5 yrs
 
8,141

 
8,880

Leasehold improvements
3-6 yrs
 
13,192

 
15,999

Automobiles
2-5 yrs
 
82

 
88

 
 
 
83,006

 
86,352

Less: accumulated depreciation
 
 
(56,679
)
 
(57,392
)
 Property and equipment, net
 
 
$
26,327

 
$
28,960


Depreciation expense associated with property and equipment amounted to $2.7 million and $5.6 million for the three and six months ended September 30, 2011, respectively, and $2.9 million and $5.6 million for the three and six months ended September 30, 2010, respectively.

Accrued and other current liabilities.  Accrued and other current liabilities at September 30, 2011 and March 31, 2011 consisted of the following (amounts in thousands):
 
 
September 30,
2011
 
March 31,
2011
Accrued liabilities
$
34,090

 
$
33,175

Settlement payment
4,000

 
6,000

Accrued compensation
16,973

 
20,093

Accrued third-party software developer milestones
24,441

 
22,951

Accrued royalties
65,774

 
55,703

Accrued and other current liabilities
$
145,278

 
$
137,922

 
Other long-term liabilities.  Other long-term liabilities at September 30, 2011 and March 31, 2011 consisted of the following (amounts in thousands):
 
 
September 30,
2011
 
March 31,
2011
Minimum license guarantees
$
66,791

 
$
69,209

Deferred rent
7,055

 
7,517

Accrued liabilities
6,480

 
4,215

Settlement payment
3,405

 
7,101

Other long-term liabilities
$
83,731

 
$
88,042

 
Settlement payments included in the tables above are payable to JAKKS Pacific, Inc. ("Jakks"). A portion of the settlement

7

payment due to Jakks is reflected in "Accrued and other current liabilities" and a portion is reflected in "Other long-term liabilities" in our 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 September 30, 2011 and March 31, 2011, the net carrying value of our licenses was $115.4 million and $118.2 million, respectively, and was reflected as “Licenses” and “Licenses, net of current portion” in our condensed consolidated balance sheets. At September 30, 2011, all of our license commitments are reflected in our condensed consolidated balance sheet as the licensors do not have any remaining significant performance obligations. License amortization and royalties expense in the three and six months ended September 30, 2011 included a $16.0 million charge related to the abandonment of a license for an unannounced game that was cancelled in connection with a studio closure (see "Note 5 — Restructuring and Other Charges”).

Software Development. As of September 30, 2011 and March 31, 2011, the net carrying value of our software development was $226.6 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 September 30, 2011 we had commitments of $97.9 million that are not reflected in our condensed consolidated financial statements due to remaining performance obligations of the external developers. Software amortization and royalties expense in the three and six months ended September 30, 2011 included charges of $17.5 million and $18.9 million, respectively, related to the write-offs of capitalized software development for unannounced games that were cancelled in connection with our realignment plans (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 six months ended September 30, 2011 we recorded a software development impairment charge of $0.6 million related to one of our titles. In the three and six months ended September 30, 2010 we recognized software development impairment charges of $4.5 million and $7.0 million, respectively, related to one of our titles. In the three and six months ended September 30, 2010 we recognized license impairment charges of $5.9 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 six months ended September 30, 2011 and 2010 was $0.4 million.  As of September 30, 2011, the inception-to-date unrealized holding gain on our investment in Yuke's was $1.9 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 September 30, 2011 and March 31, 2011 consisted of the following (amounts in thousands):
 
 
September 30,
2011
 
March 31,
2011
Investment in Yuke's
$
5,072

 
$
4,686

Deferred financing costs
1,828

 
2,146

Other
2,810

 
3,182

Total other long-term assets
$
9,710

 
$
10,014

 

5.   Restructuring and Other Charges

8


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. 

Fiscal 2012 Second Quarter Realignment. On August 9, 2011, we announced a plan to realign our internal studio development teams and video games in development in order to better match our resources with our target portfolio of interactive entertainment and continue our transition away from traditional console games based on licensed kids titles and movie entertainment properties.  Under this plan, we closed two studios in Australia and eliminated a game development team at one additional studio. We also cancelled two unannounced titles at these locations that are no longer in line with our strategic business priorities. These actions resulted in a reduction of approximately 200 people on our product development staff. The following table summarizes the components and activity under the fiscal 2012 second quarter realignment, classified as "Restructuring" in our condensed consolidated statements of operations, for the three and six months ended September 30, 2011, and the related restructuring reserve balances (amounts in thousands):
 
 
 
Three and Six Months Ended September 30, 2011
 
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
Beginning balance
 
$
—

 
$
—

 
$
—

Charges to operations
 
2,866

 
1,270

 
4,136

Non-cash write-offs
 
—

 
(1,270
)
 
(1,270
)
Cash payments, net of sublease income
 
—

 
—

 
—

Foreign currency and other adjustments
 
53

 
—

 
53

Ending balance
 
$
2,919

 
$
—

 
$
2,919


Additionally, in connection with these actions we also incurred $4.4 million of cash severance and other employee-based charges (recorded within operating expenses in our condensed consolidated statements of operations); charges of $17.5 million related to the cancellation of two unannounced titles in development at these studios (recorded within software development amortization in our condensed consolidated statements of operations); charges of $16.0 million for an abandoned license (inclusive of $11.0 million in cash charges; all of which are recorded within license amortization and royalties in our condensed consolidated statements of operations); and a $1.2 million gain related to accumulated foreign currency translation adjustments (recorded within "Interest and other income (expense), net" in our condensed consolidated statements of operations). We do not expect any future charges under the fiscal 2012 second quarter realignment, other than additional facility-related charges and adjustments in the event actual and estimated sublease income changes.

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 continued to refine our video game line-up and utilize studio locations in more cost effective markets. The following table summarizes the components and activity under the fiscal 2012 first quarter realignment, classified as "Restructuring" in our condensed consolidated statements of operations, for the three and six months ended September 30, 2011, and the related restructuring reserve balances (amounts in thousands):

 
 
Three and Six Months Ended September 30, 2011
 
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
Beginning balance
 
$
—

 
$
—

 
$
—

Charges to operations
 
618

 
117

 
735

Non-cash write-offs
 
—

 
(117
)
 
(117
)
Cash payments, net of sublease income
 
(103
)
 
—

 
(103
)
Foreign currency and other adjustments
 
117

 
—

 
117

Ending balance
 
$
632

 
$
—

 
$
632


Since the inception of the fiscal 2012 first quarter realignment through September 30, 2011, total restructuring charges amounted to $0.7 million.


9

Additionally, in connection with the U.K. studio closure, in the three and six months ended September 30, 2011, we also incurred $27,000 and $1.7 million, respectively, 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 a $1.6 million loss related to accumulated foreign currency translation adjustments (recorded within "Interest and other income (expense), net" in our condensed consolidated statements of operations). Additionally, in the three months ended June 30, 2011, we incurred 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 do not expect any future charges under the fiscal 2012 first quarter realignment, other than additional facility related charges and adjustments in the event actual and estimated sublease income changes.

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. The following table summarizes the components and activity under the fiscal 2011 fourth quarter realignment, classified as "Restructuring" in our condensed consolidated statements of operations, for the three and six months ended September 30, 2011 and 2010, and the related restructuring reserve balances (amounts in thousands):
 
 
Three Months Ended September 30, 2011
 
Six Months Ended September 30, 2011
 
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
Beginning balance
 
$
19

 
$
—

 
$
19

 
$
41

 
$
—

 
$
41

Charges to operations
 
735

 
90

 
825

 
738

 
90

 
828

Non-cash write-offs
 
—

 
(90
)
 
(90
)
 
—

 
(90
)
 
(90
)
Cash payments, net of sublease income
 
(105
)
 
—

 
(105
)
 
(128
)
 
—

 
(128
)
Foreign currency and other adjustments
 
81

 
—

 
81

 
79

 
—

 
79

Ending balance
 
$
730

 
$
—

 
$
730

 
$
730

 
$
—

 
$
730


Since the inception of the fiscal 2011 fourth quarter realignment through September 30, 2011, total restructuring charges amounted to $3.9 million.

Additionally, in connection with this change, in the three and six months ended September 30, 2011, we also incurred $0.1 million and $1.9 million, respectively, 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 a $0.5 million loss related to accumulated foreign currency translation adjustments (recorded within "Interest and other income (expense), net" in our condensed consolidated statements of operations). We do not expect any future charges under the fiscal 2011 fourth quarter realignment, other than additional facility related charges and adjustments in the event actual and estimated sublease income changes.

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. 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 and six months ended September 30, 2011 and 2010, and the related restructuring reserve balances (amounts in thousands):
 

10

 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2011
 
2010
 
2011
 
2010
Beginning balance
 
$
1,015

 
$
2,085

 
$
1,335

 
$
2,392

Charges to operations
 
386

 
(161
)
 
243

 
7

Cash payments, net of sublease income
 
(153
)
 
(615
)
 
(326
)
 
(1,203
)
Foreign currency and other adjustments
 
48

 
177

 
44

 
290

Ending balance
 
$
1,296

 
$
1,486

 
$
1,296

 
$
1,486


Since the inception of the fiscal 2009 realignment through September 30, 2011, total restructuring charges amounted to $18.8 million.

The aggregated restructuring accrual balances at September 30, 2011 and March 31, 2011 of $5.6 million and $1.3 million, respectively, related to future lease payments for facilities vacated under all of our realignment plans, offset by estimates of future sublease income, as well as accruals for other non-cancellable contracts.  As of September 30, 2011, $2.5 million of the restructuring accrual is included in "Accrued and other current liabilities" and $3.1 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.  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.

6.   Debt
 
Credit Facility
 
On September 23, 2011, we entered into a Credit Agreement and a Security Agreement (collectively, the “Credit Facility”) with Wells Fargo Capital Finance, LLC (“Wells Fargo”). The Credit Facility provides for a $75.0 million revolving credit facility from October 1, 2011 through December 14, 2011 and $50.0 million revolving facility at all other times during the term of the Credit Facility. The Credit Facility allows for up to $10.0 million to be used as a letter of credit.
The Credit Facility has a four-year term; however, it will terminate on June 16, 2014 if any obligations are still outstanding under the $100.0 million 5% convertible senior notes more fully described below. Borrowings under the Credit Facility bear interest at a rate equal to an applicable margin plus, at our option, either a variable base rate or a LIBOR rate. The applicable margin for base rate loans ranges from 2.25% to 2.5% and for LIBOR rate loans ranges from 3.75% to 4.0%, in each case, depending on the level of our borrowings. Borrowings under the Credit Facility are conditioned on maintaining certain liquidity levels, or in the absence of sufficient liquidity, certain fixed charge coverage ratios, as set forth in the Credit Facility. Debt issuance costs capitalized in connection with the Credit Facility totaled $1.4 million and are being amortized as interest expense over the term of the Credit Facility. We will be required to pay other customary fees, including an unused line fee based on usage under the Credit Facility as well as fees in respect of letters of credit.
There were no outstanding borrowings under the Credit Facility as of September 30, 2011. During the three and six months ended September 30, 2011 there were no borrowings and accordingly no interest expense was recorded in those periods related to the Credit Facility. Amortization of debt costs related to the Credit Facility during the three and six months ended September 30, 2011 was insignificant.

The Credit Facility is guaranteed by most of our domestic subsidiaries and secured by substantially all of our assets. The Credit Facility contains customary affirmative and negative covenants, including, among other terms and conditions, and limitations (subject to certain permitted actions) on our ability to: create, incur, guarantee or be liable for indebtedness; dispose of assets outside the ordinary course; acquire, merge or consolidate with or into another person or entity; create, incur or allow any lien on any of their respective properties; make investments or capital expenditures; or pay dividends or make distributions. In addition, the Credit Facility provides for certain events of default such as nonpayment of principal and interest when due, breaches of representations and warranties, noncompliance with covenants, acts of insolvency, default on certain agreements related to indebtedness, including the $100.0 million 5% convertible senior notes more fully described below, and entry of certain judgments against us. Upon the occurrence of an event of default which is continuing, at the option of the required lenders (as defined in the Credit Facility), all amounts due under the Credit Facility will bear interest at 2.0% above the interest rate otherwise applicable. In addition, we are required to maintain a minimum fixed charge coverage ratio of 1.1 to 1.0 and must achieve a minimum EBITDA as set forth in the Credit Facility.
As of September 30, 2011, we were in compliance with all covenants and requirements in the Credit Facility.

11

 
Prior Credit Facility
 
On September 23, 2011, in conjunction with our entry into the Credit Facility, we terminated the Loan and Security Agreement, dated June 30, 2009, as amended, with Bank of America, N.A (the “Prior Credit Facility”). At the time of termination of the Prior Credit Facility, there were no outstanding borrowings or letters of credit and upon termination all mortgages, deeds of trust, liens and other security interests that we had granted to Bank of America, N.A. under the Prior Credit Facility were released.

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.
 
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 September 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.  We considered all our other commitments that may require the issuance of stock (e.g., stock options, restricted stock units, warrants, and other potential common stock issuances) and have determined that as of September 30, 2011, we have sufficient authorized and unissued shares available for the conversion of the Notes during the maximum period the Notes could remain outstanding. 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 September 30, 2011; these costs are being amortized over the term of the Notes.

In the three and six months ended September 30, 2011 all interest expense and amortization of debt costs related to the Notes were capitalized to software development. 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 $1.5 million and $2.8 million in the three and six months ended September 30, 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 and six months ended September 30, 2011 and 2010.

Capitalization of Interest Expense

We capitalize interest expense and related amortization of debt costs as part of 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 these balances 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
2,830

Amortized during the period
(2,734
)
Balance at September 30, 2011
$
4,414



12

7.   Commitments and Contingencies
 
A summary of annual minimum contractual obligations and commercial commitments as of September 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
 
$
82,997

 
$
27,374

 
$
7,393

 
$
—

 
$
291

 
$
118,055

2013
 
71,532

 
22,195

 
13,811

 
—

 
4,000

 
111,538

2014
 
19,596

 
4,169

 
12,591

 
—

 
4,000

 
40,356

2015
 
18,524

 
570

 
11,166

 
100,000

 
—

 
130,260

2016
 
11,500

 
500

 
6,306

 
—

 
—

 
18,306

Thereafter
 
20,000

 
875

 
12,443

 
—

 
—

 
33,318

 
 
$
224,149

 
$
55,683

 
$
63,710

 
$
100,000

 
$
8,291

 
$
451,833

 
(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 September 30, 2011 are $224.1 million. Of these obligations, $7.0 million is accrued and classified as "Accrued and other current liabilities" in our September 30, 2011 condensed consolidated balance sheet related to the abandonment of a license in connection with our fiscal 2012 second quarter realignment plan (see "Note 5 — Restructuring and Other Charges"). Additionally, license commitments in the table above include $119.3 million of commitments payable to licensors that are included in both "Accrued and other current liabilities" and "Other long-term liabilities" in our September 30, 2011 condensed consolidated balance sheet because the licensors do not have any remaining significant performance obligations.

(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, $2.3 million and $3.1 million are accrued and classified as "Accrued and other current liabilities" and "Other long-term liabilities," respectively, in our September 30, 2011 condensed consolidated balance sheet due to abandonment of certain lease obligations in connection with our realignment plans (see "Note 5 — Restructuring and Other Charges"). We expect future sublease rental income under non-cancellable agreements of approximately $1.1 million; this income is not contemplated in the lease commitments shown in the table above.

(4)
Debt.  We issued the Notes on August 4, 2009.  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 $2.5 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 $15.0 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 September 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 September 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 September 30, 2011, we had $3.5 million of unrecognized tax benefits.  See "Note 9 — Income Taxes" for further information regarding the unrecognized tax benefits.
 
Manufacturer Indemnification. We must indemnify the platform manufacturers (Microsoft, Nintendo, Sony) of our games with

13

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 six months ended September 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 September 30, 2011, the total number of shares of THQ common stock reserved for issuance under our Long-Term Incentive Plan (“LTIP”) was 18.5 million shares. 

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 and an Offering Period commenced 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.

In the three and six months ended September 30, 2011 we had a tax benefit of $2.0 million and $0.9 million, respectively, which primarily related to losses in foreign tax jurisdictions. These losses were generated by deductions at foreign studios due to closures under our business realignment plans (see "Note 5 — Restructuring and Other Charges”). These amounts represent effective tax rates for the three and six months ended September 30, 2011 of 2.1% and 0.7% (benefit on a loss), respectively. In the three and six months ended September 30, 2010 we had tax expense of $0.7 million and $1.5 million, respectively, which primarily related to income in foreign tax jurisdictions. These amounts represent effective tax rates for the three and six months ended September 30, 2010 of 1% and 2% (provision on a loss), respectively. The rates differ 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 six months ended September 30, 2011, from $3.4 million at March 31, 2011 to $3.5 million at September 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

14

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.
 
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.  In October 2011, we received notification that our German tax audit for fiscal years 2005-2009 concluded with no significant adjustments. 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.    

At September 30, 2011, a portion of our cash and cash equivalents were domiciled in foreign tax jurisdictions. In the event we need to repatriate funds outside of the U.S., such repatriation may be subject to local laws and tax consequences including foreign withholding taxes or U.S. income taxes. It is not practicable to estimate the tax liability and we would try to minimize the tax impact to the extent possible. However, any repatriation may not result in actual cash payments as the taxable event would likely be offset by the utilization of the then available net operating losses and tax credits.

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 September 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 September 30,
 
For the Six Months
Ended September 30,
 
 
2011
 
2010
 
2011
 
2010
Net loss used to compute basic loss per share
 
$
(92,385
)
 
$
(46,985
)
 
$
(130,830
)
 
$
(77,095
)
 
 
 
 
 
 
 
 
 
Weighted-average number of shares outstanding — basic
 
68,340

 
67,813

 
68,329

 
67,779

Dilutive effect of potential common shares
 
—

 
—

 
—

 
—

Number of shares used to compute loss per share — diluted
 
68,340

 
67,813

 
68,329

 
67,779

 
As a result of our net loss for the three and six months ended September 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 and six months ended September 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 9.9 million, 9.7 million, 10.5 million, and 10.4 million potential common shares that were excluded from the computation of diluted loss per share for the three and six months ended September 30, 2011 and 2010, respectively.  Had we reported net income for these periods, an additional 0.2 million shares of common stock would have been outstanding in the number of shares used to calculate diluted loss per share for the three and six months ended September 30, 2011 and the three months ended September 30, 2010. An additional 0.4 million shares of common stock would have been outstanding in the number of shares used to calculate diluted loss per share for the six months ended September 30, 2010.

11. Comprehensive Income

The table below presents the components of our comprehensive income for the three and six months ended September 30, 2011 and 2010 (in thousands):

15

 
 
For the Three Months
Ended September 30,
 
For the Six Months
Ended September 30,
 
 
2011
 
2010
 
2011
 
2010
Net loss
 
$
(92,385
)
 
$
(46,985
)
 
$
(130,830
)
 
$
(77,095
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Foreign currency translation gain (loss)
 
(9,183
)
 
9,541

 
(6,849
)
 
4,534

Reclassification of foreign currency translation adjustments included in net loss
 
913

 
—

 
913

 
—

Unrealized gain on investments, net of tax
 
83

 
2,816

 
241

 
2,721

Reclassification of gain on investments included in net loss, net of tax
 
—

 
(267
)
 
—

 
(247
)
Comprehensive loss
 
$
(100,572
)
 
$
(34,895
)
 
$
(136,525
)
 
$
(70,087
)

The foreign currency translation adjustments relate to indefinite investments in non-U.S. subsidiaries and thus are not adjusted for income taxes.

12.   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 financial assets:
 
•                  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.
 
The following table summarizes our financial assets measured at fair value on a recurring basis as of September 30, 2011(amounts in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents - Money market funds
$
7,710

 
$
—

 
$
—

 
$
7,710

Other long-term assets, net - Investment in Yuke's
5,072

 
—

 
—

 
5,072

Total
$
12,782

 
$
—

 
$
—

 
$
12,782

 
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 six months ended September 30, 2011 we did not hold any Level 3 financial assets.

Financial Instruments
 

16

The carrying value of certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, and accrued royalties approximate fair value based on their short-term nature. 
 
The book value and fair value of our convertible senior notes at September 30, 2011 was $100.0 million and $86.0 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 six months ended September 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 September 30, 2011 and March 31, 2011, we had foreign currency exchange forward contracts related to balance sheet hedging activities in the notional amount of $113.2 million and $100.6 million, respectively, with a fair value that approximates zero at both September 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 loss recognized from these contracts during the three and six months ended September 30, 2011 was $4.2 million and $2.7 million, respectively. The net loss recognized from these contracts during the three months ended September 30, 2010 was $0.4 million and the net gain recognized from these contracts during the six months ended September 30, 2010 was $2.3 million. Net gains and losses recognized from these contracts are included in "Interest and other income (expense), net" in our condensed consolidated statements of operations.

13.   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 September 30, 2011 and March 31, 2011 we had $28.6 million, authorized and available for common stock repurchases.  During the six months ended September 30, 2011, we did not repurchase any shares of our common stock.  There is no expiration date for the authorized repurchases. 

14. 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 and six months ended September 30, 2011 and 2010 (amounts in thousands):


17

 
North
America
 
Europe
 
Asia
Pacific
 
Consolidated
Three months ended September 30, 2011
 
 
 
 
 
 
 
Net sales to unaffiliated customers before changes in deferred net revenue
$
68,757

 
$
40,145

 
$
10,708

 
$
119,610

Changes in deferred net revenue
24,597

 
2,746

 
(949
)
 
26,394

Net sales to unaffiliated customers
$
93,354

 
$
42,891

 
$
9,759

 
$
146,004

Total assets
$
328,720

 
$
161,114

 
$
42,539

 
$
532,373

Six months ended September 30, 2011
 
 
 
 
 
 
 
Net sales to unaffiliated customers before changes in deferred net revenue
$
156,500

 
$
75,375

 
$
28,974

 
$
260,849

Changes in deferred net revenue
53,113

 
27,005

 
190

 
80,308

Net sales to unaffiliated customers
$
209,613

 
$
102,380

 
$
29,164

 
$
341,157

 
 
 
 
 
 
 
 
Three months ended September 30, 2010
 
 
 
 
 
 
 
Net sales to unaffiliated customers before changes in deferred net revenue
$
41,111

 
$
19,750

 
$
9,534

 
$
70,395

Changes in deferred net revenue
4,142

 
2,024

 
492

 
6,658

Net sales to unaffiliated customers
$
45,253

 
$
21,774

 
$
10,026

 
$
77,053

Total assets
$
496,590

 
$
102,967

 
$
43,803

 
$
643,360

Six months ended September 30, 2010
 
 
 
 
 
 
 
Net sales to unaffiliated customers before changes in deferred net revenue
$
149,137

 
$
55,895

 
$
25,632

 
$
230,664

Changes in deferred net revenue
(2,749
)
 
(1,339
)
 
(144
)
 
(4,232
)
Net sales to unaffiliated customers
$
146,388

 
$
54,556

 
$
25,488

 
$
226,432


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

 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
Platform
 
2011
 
2010
 
2011
 
2010
Consoles
 
 
 
 
 
 
 
 
Microsoft Xbox 360
 
$
36,098

 
$
10,996

 
$
87,640

 
$
61,211

Sony PlayStation 3
 
28,115

 
8,953

 
63,897

 
61,747

Nintendo Wii
 
15,503

 
13,011

 
34,527

 
32,171

Sony PlayStation 2
 
1,292

 
1,903

 
2,311

 
6,606

 
 
81,008

 
34,863

 
188,375

 
161,735

Handheld
 
 
 
 
 
 
 
 
Nintendo Dual Screen
 
17,677

 
17,246

 
38,961

 
36,912

Sony PlayStation Portable
 
1,974

 
6,862

 
4,096

 
11,203

Wireless
 
730

 
1,499

 
1,466

 
3,088

 
 
20,381

 
25,607

 
44,523

 
51,203

 
 
 
 
 
 
 
 
 
PC
 
18,221

 
9,925

 
27,951

 
17,726

Net sales before changes in deferred net revenue
 
119,610

 
70,395

 
260,849

 
230,664

Changes in deferred net revenue
 
26,394

 
6,658

 
80,308

 
(4,232
)
Total net sales
 
$
146,004

 
$
77,053

 
$
341,157

 
$
226,432


18


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 financial performance including anticipated revenues and expenditures, results of operations or liquidity/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") and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2011.
 
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, Barbie, Monster High, and Apples to Apples; 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")

19

in fiscal 2011, a product with innovative gameplay targeted at consumers of all ages and the only creative tool of its kind on game consoles today. Originally launched exclusively on the Wii, uDraw is scheduled to be released for the Xbox 360 and PS3 in November 2011 in the U.S., Europe and international territories, along with a diverse software product offering of games. We are focused on capitalizing on these and other 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 began 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, casual free-to-play micro-transaction based games, supplemental paid downloadable content, and digital downloads of full-games, including those on wireless platforms. Conversely, we believe retail sales for the industry will continue to be a decreasing revenue source over the next several years. For the nine months ended September 30, 2011, retail software sales in the U.S. for the industry decreased 8.9% 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 10.3% compared to the same nine-month period in 2010 according to GfK. However, digital sales for the industry are expected to grow over 20% worldwide in calendar 2011 and more than double over the next four years, to over $42.3 billion worldwide according to the International Development Group, Inc.'s Digital Gaming Thought Piece (October 2011). Accordingly, we plan to continue integrating digital components into our franchises where applicable. In the event our games are released with increasingly more undelivered elements at the time of sale, such as the online service present within some of our games, more of our revenue may 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 we plan to bring uDraw to Xbox 360 and PS3 in holiday 2011.  We expect to capitalize on the new motion-based controllers and uDraw, with a casual and lifestyle video game line-up. 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 offerings may reduce consumers' propensity to trade in games. Additionally, certain of our titles include free access to online content through a code (included in the packaging) for initial purchasers. This structure creates a new revenue stream by offering second-hand 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,

20

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.
focus our casual and lifestyle portfolio on new play-patterns; and
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 anticipated release of Saints Row: The Third in November 2011, which includes a planned robust downloadable content release 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 January 2012 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 Second Quarter Highlights

During the three months ended September 30, 2011, we continued to execute on our strategies; highlights in the quarter included the following:
•
We released Warhammer 40,000: Space Marine, which, according to the NPD Group, was a top 10 title in North America in September 2011.
•
We announced the next installment of the Homefront franchise to be developed by Crytek, the creators of multiple award-winning first person shooter games; this sequel is currently scheduled for release in the fiscal year ending March 31, 2014.

Recent Digital Initiatives Highlights
•
In October 2011 we launched our THQ.com website with new functionalities, user interface, and e-commerce features.
•
The closed beta for Margaritaville Online game for Facebook began in October 2011.
•
We announced the anticipated December 2011 release of our new social/mobile game Apples to Apples, based upon the popular Mattel family game.

Realignment

In order to continue our focus on our key strategic areas, on August 9, 2011, we announced a plan to realign our internal studio development teams and video games in development in order to better match our resources with our target portfolio of interactive entertainment and continue our transition away from traditional console games based on licensed kids titles and movie entertainment properties (see "Note 5 — Restructuring and Other Charges" in the notes to the condensed consolidated financial statements included in Part I, Item 1).

Results of Operations — Comparison of the Three and Six Months Ended September 30, 2011 and 2010

For the three and six months ended September 30, 2011, we reported a net loss of $92.4 million and $130.8 million, respectively, or $1.35 and $1.91 per diluted share, respectively, compared with a net loss of $47.0 million and $77.1 million, respectively, or $0.69 and $1.14 per diluted share, respectively, in the same periods 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 and six months ended September 30, 2011 and 2010 (amounts in thousands):

 
Three Months Ended September 30,
 
Increase/
(Decrease)
 
% Change
 
2011
 
2010
 
 
Net sales before changes in deferred net revenue
$
119,610

 
81.9
%
 
$
70,395

 
91.4
%
 
$
49,215

 
69.9
%
Changes in deferred net revenue
26,394

 
18.1

 
6,658

 
8.6

 
19,736

 
296.4

Consolidated net sales
$
146,004

 
100.0
%
 
$
77,053

 
100.0
%
 
$
68,951

 
89.5
%


21

 
Six Months Ended September 30,
 
Increase/
(Decrease)
 
% Change
 
2011
 
2010
 
 
Net sales before changes in deferred net revenue
$
260,849

 
76.5
%
 
$
230,664

 
101.9
 %
 
$
30,185

 
13.1
 %
Changes in deferred net revenue
80,308

 
23.5

 
(4,232
)
 
(1.9
)
 
84,540

 
(1,997.6
)
Consolidated net sales
$
341,157

 
100.0
%
 
$
226,432

 
100.0
 %
 
$
114,725

 
50.7
 %
 
In the three and six months ended September 30, 2011, net sales before changes in deferred net revenue were primarily driven by Warhammer 40,000: Space Marine 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 undelivered elements at the time of sale such as, online services that are offered in some of our games. The revenue deferrals are recognized as net sales as the undelivered elements are delivered or, over the estimated online service period of generally six months, as applicable. The changes in deferred net revenue are driven by the timing of the release of games that have undelivered elements, and the subsequent timing of the delivery of those undelivered elements. Generally, as it relates to revenue deferrals related to the online services, 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.

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 and six months ended September 30, 2011 and 2010 (amounts in thousands):

 
Three Months Ended September 30,
 
Increase/
 
%
 
2011
 
2010
 
(Decrease)
 
Change
New releases
$
75,448

 
63.1
%
 
$
17,155

 
24.4
%
 
$
58,293

 
339.8
 %
Catalog
44,162

 
36.9

 
53,240

 
75.6

 
(9,078
)
 
(17.1
)
Net sales before changes in deferred net revenue
119,610

 
100.0
%
 
70,395

 
100.0
%
 
49,215

 
69.9

Changes in deferred net revenue
26,394

 
 
 
6,658

 
 
 
19,736

 
296.4

Consolidated net sales
$
146,004

 
 
 
$
77,053

 
 
 
$
68,951

 
89.5
 %

 
 
Six Months Ended September 30,
 
Increase/
 
%
 
2011
 
2010
 
(Decrease)
 
Change
New releases
$
164,477

 
63.1
%
 
$
118,433

 
51.3
%
 
$
46,044

 
38.9
 %
Catalog
96,372

 
36.9

 
112,231

 
48.7

 
(15,859
)
 
(14.1
)
Net sales before changes in deferred net revenue
260,849

 
100.0
%
 
230,664

 
100.0
%
 
30,185

 
13.1

Changes in deferred net revenue
80,308

 
 
 
(4,232
)
 
 
 
84,540

 
(1,997.6
)
Consolidated net sales
$
341,157

 
 
 
$
226,432

 
 
 
$
114,725

 
50.7
 %

Net sales of our new releases increased $58.3 million and $46.0 million in the three and six months ended September 30, 2011, respectively, compared to the same periods last fiscal year. The increase in the three months ended September 30, 2011 was due to the release of Warhammer 40,000: Space Marine; comparatively, there were no major new titles released in the same period last fiscal year. The increase in the six months ended September 30, 2011 was due to an increase in the number units sold of new releases, reflecting the release of a larger number of multi-platform new titles compared to the same period last fiscal year. Partially offsetting this increase were lower average net selling prices in the six months ended September 30, 2011, as net sales from new releases in the same period last year primarily reflected net sales of UFC Undisputed 2010 with a higher average net selling price than the overall mix of new releases in the six months ended September 30, 2011.

Net sales of our catalog titles decreased $9.0 million and $15.9 million in the three and six months ended September 30, 2011, respectively, compared to the same periods last fiscal year. The decreases were primarily due to fewer catalog units sold.


22

Net Sales by Territory
 
The following table presents our net sales by territory for the three and six months ended September 30, 2011 and 2010 (amounts in thousands):

 
Three Months Ended September 30,
 
Increase/
 
%
 
2011
 
2010
 
(Decrease)
 
Change
North America
$
68,757

 
57.5
%
 
$
41,111

 
58.4
%
 
$
27,646

 
67.2
%
Europe
40,145

 
33.6

 
19,750

 
28.1

 
20,395

 
103.3

Asia Pacific
10,708

 
8.9

 
9,534

 
13.5

 
1,174

 
12.3

International
50,853

 
42.5

 
29,284

 
41.6

 
21,569

 
73.7

Net sales before changes in deferred net revenue
119,610

 
100.0
%
 
70,395

 
100.0
%
 
49,215

 
69.9

Changes in deferred net revenue
26,394

 
 
 
6,658

 
 
 
19,736

 
296.4

Consolidated net sales
$
146,004

 
 
 
$
77,053

 
 
 
$
68,951

 
89.5
%
 
 
Six Months Ended September 30,
 
Increase/
 
%
 
2011
 
2010
 
(Decrease)
 
Change
North America
$
156,500

 
60.0
%
 
$
149,137

 
64.7
%
 
$
7,363

 
4.9
 %
Europe
75,375

 
28.9

 
55,895

 
24.2

 
19,480

 
34.9

Asia Pacific
28,974

 
11.1

 
25,632

 
11.1

 
3,342

 
13.0

International
104,349

 
40.0

 
81,527

 
35.3

 
22,822

 
28.0

Net sales before changes in deferred net revenue
260,849

 
100.0
%
 
230,664

 
100.0
%
 
30,185

 
13.1

Changes in deferred net revenue
80,308

 
 
 
(4,232
)
 
 
 
84,540

 
(1,997.6
)
Consolidated net sales
$
341,157

 
 
 
$
226,432

 
 
 
$
114,725

 
50.7
 %

Net sales in North America in the three and six months ended September 30, 2011 increased $27.6 million and $7.4 million, respectively, compared to the same periods last fiscal year. The increase in this territory in the three months ended September 30, 2011 was primarily due to an increase in units sold of new releases and at higher average net selling prices; this was led by the release of Warhammer 40,000: Space Marine in that period. The increase in the six months ended September 30, 2011 was due to an increase in the number of units sold of new releases, reflecting the release of a larger number of multi-platform new titles compared to the same period last fiscal year. Partially offsetting this increase in the six months ended September 30, 2011 were:
•
lower average net selling prices in the six months ended September 30, 2011, as net sales from new releases in the same period last year primarily reflected net sales of UFC Undisputed 2010 with a higher average net selling price than the overall mix of new releases in the six months ended September 30, 2011, and
•
fewer catalog units sold.

Net sales in Europe in the three and six months ended September 30, 2011 increased $20.4 million and $19.5 million, respectively, compared to the same periods last fiscal year. We estimate that changes in foreign currency translation rates during the three and six months ended September 30, 2011 increased our reported net sales in this territory by $1.8 million and $5.9 million, respectively. The increase in net sales in this territory in the three months ended September 30, 2011 was primarily due to an increase in units sold of new releases and at higher average net selling prices; this was led by the release of Warhammer 40,000: Space Marine in that period. The increase in the six months ended September 30, 2011 was primarily due to an increase in the number of units sold of our new releases, partially offset by a decrease in units sold and net average selling prices on catalog titles.

Net sales in the Asia Pacific territory in the three and six months ended September 30, 2011 increased $1.2 million and $3.3 million, respectively, compared to the same periods last fiscal year. These increases were due to changes in foreign currency translation rates as we estimate those changes increased our reported net sales in this territory by $1.2 million and $4.6 million during the three and six months ended September 30, 2011, respectively.


23

Cost of Sales
 
Cost of sales increased $93.3 million, or 141.9%, and $118.5 million, or 65.6%, in the three and six months ended September 30, 2011, respectively, compared to the same periods last fiscal year.  As a percent of net sales, cost of sales decreased 23.6 points and 7.9 points in the three and six months ended September 30, 2011, respectively, compared to the same periods last fiscal year.

Cost of Sales - Product Costs (amounts in thousands)
 
September 30, 2011
 
% of net sales
 
September 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$57,986
 
39.7%
 
$35,003
 
45.4%
 
65.7%
Six Months Ended
$125,049
 
36.7%
 
$95,706
 
42.3%
 
30.7%
 
Product costs primarily consist of direct manufacturing costs, including platform manufacturer license fees, net of manufacturer volume rebates and discounts. In the three and six months ended September 30, 2011, product costs as a percent of net sales decreased 5.7 points and 5.6 points, respectively, compared to the same periods last fiscal year. The decreases as a percent of net sales were primarily due to a change in our title mix in the three and six months ended September 30, 2011 towards more net sales from new releases, which generally have higher average net selling prices compared to catalog titles.

Cost of Sales - Software Amortization and Royalties (amounts in thousands)
 
September 30, 2011
 
% of net sales
 
September 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$77,893
 
53.3%
 
$21,162
 
27.5%
 
268.1%
Six Months Ended
$142,813
 
41.9%
 
$54,515
 
24.1%
 
162.0%
 
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. Excluding charges associated with game cancellations and impairments (see “Note 3 — Licenses and Software Development” in the notes to the condensed consolidated financial statements included in Part I, Item 1 for further information), software amortization and royalties expense as a percent of net sales in the three and six months ended September 30, 2011 increased 19.8 points and 15.1 points, respectively, compared to the same periods last fiscal year. The increases were primarily due to titles such as Homefront, Red Faction: Armageddon and UFC Trainer that were recognized in the three and six months ended September 30, 2011 and had higher capitalized development costs relative to their net sales, compared to the mix of titles included in net sales in the same periods last fiscal year.

Cost of Sales - License Amortization and Royalties (amounts in thousands)
 
September 30, 2011
 
% of net sales
 
September 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$23,156
 
15.9%
 
$9,583
 
12.4%
 
141.6%
Six Months Ended
$31,295
 
9.2%
 
$30,473
 
13.5%
 
2.7%
 
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 47% and 48% of our total net sales in the three and six months ended September 30, 2011, respectively, compared to 63% and 81% of our total net sales in the three and six months ended September 30, 2010.

License amortization and royalties expense in the three months ended September 30, 2011 included a $16.0 million charge related to a license abandoned as part of our fiscal 2012 second quarter business realignment (see “Note 5 — Restructuring and Other Charges” in the notes to the condensed consolidated financial statements included in Part I, Item 1 for further information). In the same period last fiscal year, license amortization and royalties expense included a $5.9 million impairment charge related to one of our titles. Excluding these charges, license amortization and royalties expense as a percent of net sales was relatively flat in the three months ended September 30, 2011, compared to the same period last fiscal year, and decreased 6.4 points as a percent of net sales in the six months ended September 30, 2011, compared to the same period last fiscal year. The primary driver of the decrease in the six month comparative periods was the larger mix of net sales from licensed products in the prior year period, which was primarily due to the release of UFC Undisputed 2010 in that period.

24


Operating Expenses

Our operating expenses increased $30.2 million, or 56.3%, and $60.9 million, or 52.6% in the three and six months ended September 30, 2011, respectively, compared to the same periods last fiscal year. The increases in operating expenses were due to higher non-capitalizable product development spend and increased marketing support for current period releases.

Product Development (amounts in thousands)
 
September 30, 2011
 
% of net sales
 
September 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$27,954
 
19.1%
 
$17,900
 
23.2%
 
56.2%
Six Months Ended
$58,143
 
17.0%
 
$34,375
 
15.2%
 
69.1%
 
Product development expense primarily consists of expenses incurred by internal development studios and payments made to external development studios which are not eligible, or are in a phase of development that is not yet able to be capitalized as part of software development. Product development expense increased $10.1 million and $23.8 million in the three and six months ended September 30, 2011, respectively, compared to the same periods last fiscal year.

Part of the increase in the three and six months ended September 30, 2011 was due to $4.5 million and $7.9 million, respectively, of cash severance charges and other employee-based costs recorded related to our business realignments (see "Note 5 — Restructuring and Other Charges” in the notes to the condensed consolidated financial statements included in Part I, Item 1).

The remaining increases were primarily due to the timing of our development cycle as more of our games during the three and six months ended September 30, 2011 were in a phase of development that was not capitalizable to software development, including increased investments in our social, mobile and digital games, compared to the same periods last fiscal year.

Selling and Marketing (amounts in thousands)
 
September 30, 2011
 
% of net sales
 
September 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$37,765
 
25.9%
 
$24,023
 
31.2%
 
57.2%
Six Months Ended
$88,441
 
25.9%
 
$57,649
 
25.5%
 
53.4%
 
Selling and marketing expenses consist of advertising, promotional expenses, and personnel-related costs. Selling and marketing expenses increased $13.7 million and $30.8 million in the three and six months ended September 30, 2011, respectively, compared to the same periods last fiscal year. The increase on a dollar-basis in the three months ended September 30, 2011 was primarily due to promotional efforts to support the launch of Warhammer 40,000: Space Marine; comparatively, there were no major new titles released in the same period last fiscal year. The increase on a dollar-basis in the six months ended September 30, 2011 was primarily due to higher promotional efforts to support the launch of new releases such as Warhammer 40,000: Space Marine, Red Faction: Armageddon, as well as additional support for new titles released from our portfolio of casual and lifestyle titles. Additionally, selling and marketing expenses were higher on a dollar-basis in the six months ended September 30, 2011 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; and we had an increase in employee-related costs to support a higher level of promotional efforts for our fiscal 2012 releases, compared to fiscal 2011.

Excluding the impact of changes in deferred net revenue, to arrive at a net sales basis that most closely relates to our selling and marketing activities in a given period, selling and marketing expenses as a percent of net sales decreased 2.6 points and increased 9.0 points in the three and six months ended September 30, 2011, respectively, compared to the same periods last fiscal year. The decrease in the three months ended September 30, 2011 was primarily due to the higher net sales basis provided by the release of Warhammer 40,000: Space Marine which was the primary driver of net sales in the period; comparatively, there were no major new titles released in the same period last fiscal year. The increase in the six months ended September 30, 2011 was primarily due to higher marketing support for catalog titles on lower net sales from catalog titles, compared to the same period last fiscal year.


25

General and Administrative (amounts in thousands)
 
September 30, 2011
 
% of net sales
 
September 30, 2010
 
% of net sales
 
% Change
Three Months Ended
$12,037
 
8.2%
 
$11,878
 
15.4%
 
1.3%
Six Months Ended
$24,086
 
7.1%
 
$23,722
 
10.5%
 
1.5%
 
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 and six months ended September 30, 2011, compared to the same periods last fiscal year.
 
Restructuring
 
Restructuring charges include any of the costs associated with lease abandonments (less estimated 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 and six months ended September 30, 2011, restructuring charges and adjustments were $6.1 million and $5.9 million, respectively, and consisted of charges incurred in connection with previously announced business realignment plans. In the three and six months ended September 30, 2010, restructuring charges and adjustments were minimal and 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.

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 and six months ended September 30, 2011 was income of $2.5 million and $2.9 million, respectively, and primarily consisted of foreign currency transaction gains. In the three and six months ended September 30, 2010, interest and other income (expense), net was an expense of $4.0 million and $5.6 million, respectively, which primarily consisted of interest expense under the Notes that was not capitalized, and foreign currency transaction 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
 
In the three and six months ended September 30, 2011, we had a tax benefit of $2.0 million and $0.9 million, respectively, which primarily related to losses in foreign tax jurisdictions, generated by deductions at foreign studios due to closures under our 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). In the three and six months ended September 30, 2010, we had tax expense of $0.7 million and $1.5 million, respectively, which primarily related to income in foreign tax jurisdictions. Income taxes in both periods primarily relate to foreign jurisdictions, which are not reduced by carryforward losses in the U.S. 

Liquidity and Capital Resources

Financial Condition
 
At September 30, 2011, we held cash and cash equivalents of $51.1 million.  We believe we have sufficient working capital, including cash expected to be generated from operations and our 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. Cash used in operations tends to be at its highest during the first part of the third fiscal quarter, as we invest heavily in inventory for the holiday buying season. Since September 30, 2011, in order to help fund our working capital needs during the holiday season, we have borrowed $22.0 million under our Credit Facility (as discussed below) and we intend to borrow additional amounts of approximately $35.0 million to $45.0 million over the next several weeks. In addition, we have sold, and expect to continue to sell certain of our accounts receivables from Walmart Stores, Inc. ("Walmart") without recourse, to Wells Fargo Bank, N.A. ("Wells") (as discussed below). Operating cash flow generally turns positive at the end of the third fiscal quarter as we start to collect on accounts receivable that build up during the holiday

26

season. 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. We anticipate repaying all outstanding borrowings under the Credit Facility prior to December 31, 2011.

We operate in a capital intensive business. 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 take advantage of business opportunities as they arise.

Sources and Uses of Cash
(Amounts in thousands)
September 30,
2011
 
March 31,
2011
 
Change
Cash and cash equivalents
$
51,055

 
$
85,603

 
$
(34,548
)
Percentage of total assets
10
%
 
11
%
 
 


 
 
Six Months Ended September 30,
 
 
(Amounts in thousands)
2011
 
2010
 
Change
Net cash used in operating activities
$
(22,450
)
 
$
(156,251
)
 
$
133,801

Net cash provided by (used in) investing activities
(4,411
)
 
42,503

 
(46,914
)
Net cash used in financing activities
(1,243
)
 
(12,729
)
 
11,486

Effect of exchange rate changes on cash
(6,444
)
 
4,490

 
(10,934
)
Net decrease in cash and cash equivalents
$
(34,548
)
 
$
(121,987
)
 
$
87,439

 
Generally, our primary sources of liquidity are cash and cash equivalents. 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 other 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 six months ended September 30, 2011 our cash and cash equivalents decreased $34.5 million, from $85.6 million at March 31, 2011 to $51.1 million at September 30, 2011. The decrease in our cash balance was primarily due to investments in software development, existing licenses, property and equipment, as well as our net loss (adjusted for non-cash reconciling items such as depreciation, amortization, and changes in deferred net revenue and related expenses), and changes in foreign currency exchange rates.  The decrease in our cash balance was partially offset by collections of fiscal 2011 year-end receivables. (For further information regarding the movement in our cash balance during the six months ended September 30, 2011, refer to the Condensed Consolidated Statement of Cash Flows for that period which is included in Part I, Item 1.)

Walmart Purchase Agreement. In November 2010, we entered into a Receivables Purchase Agreement ("Purchase Agreement") with Wells. The Purchase Agreement gives us the option to sell our Walmart receivables to Wells, at our discretion, and significantly expedite our Walmart receivables collections. Wells 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. During the three and six months ended September 30, 2011, to expedite our receivable collections from Walmart, we sold $6.7 million of accounts receivable under the Purchase Agreement, without recourse, that would have otherwise been collected subsequent to September 30, 2011. An insignificant loss related to interest on the transaction was recognized and is classified in "Interest and other income (expense), net" in our condensed consolidated statements of operations. We expect to continue to sell our Walmart accounts receivable pursuant to the Purchase Agreement to further expedite collections.
 
Credit Facility. On September 23, 2011, we entered into the Credit Facility. The Credit Facility provides for a $75.0 million revolving credit facility from October 1, 2011 through December 14, 2011 and $50.0 million revolving facility at all other times during the term of the Credit Facility. The Credit Facility allows up to $10.0 million of the total to be used as a letter of credit subfacility.

The Credit Facility has a four-year term; provided, however, it will terminate on June 16, 2014 if any obligations are still outstanding

27

under the Notes. Borrowings under the Credit Facility bear interest at a rate equal to an applicable margin plus, at our option, either a variable base rate or a LIBOR rate. The applicable margin for base rate loans ranges from 2.25% to 2.5% and for LIBOR rate loans ranges from 3.75% to 4.0%, in each case, depending on the level of our borrowings. Borrowings under the Credit Facility are conditioned on maintaining certain liquidity levels, or in the absence of sufficient liquidity, certain fixed charge coverage ratios, as set forth in the Credit Facility. We will be required to pay other customary fees, including an unused line fee based on usage under the Credit Facility as well as fees in respect of letters of credit.
During the three and six months ended September 30, 2011, there were no borrowings and accordingly no interest expense was recorded in those periods related to the Credit Facility. Amortization of debt costs related to the Credit Facility during the three and six months ended September 30, 2011 was insignificant. Since September 30, 2011, we have borrowed $22.0 million under the Credit Facility and we intend to borrow additional amounts of approximately $35.0 to $45.0 million over the next several weeks.

The Credit Facility is guaranteed by most of our domestic subsidiaries and secured by substantially all of our assets. The Credit Facility contains customary affirmative and negative covenants, including, among other terms and conditions, and limitations (subject to certain permitted actions) on our ability to: create, incur, guarantee or be liable for indebtedness; dispose of assets outside the ordinary course; acquire, merge or consolidate with or into another person or entity; create, incur or allow any lien on any of their respective properties; make investments or capital expenditures; or pay dividends or make distributions. In addition, the Credit Facility provides for certain events of default such as nonpayment of principal and interest when due, breaches of representations and warranties, noncompliance with covenants, acts of insolvency, default on certain agreements related to indebtedness, including the Notes, and entry of certain judgments against us. Upon the occurrence of an event of default which is continuing, at the option of the required lenders (as defined in the Credit Facility), all amounts due under the Credit Facility will bear interest at 2.0% above the interest rate otherwise applicable. In addition, we are required to maintain a minimum fixed charge coverage ratio of 1.1 to 1.0 and must achieve a minimum EBITDA as set forth in the Credit Facility.
As of September 30, 2011, we were in compliance with all covenants and requirements in the Credit Facility.

Prior Credit Facility. On September 23, 2011, in conjunction with our entry into the Credit Facility, we terminated the Prior Credit Facility. At the time of termination of the Prior Credit Facility, there were no outstanding borrowings or letters of credit and upon termination all mortgages, deeds of trust, liens and other security interests that we had granted to Bank of America, N.A. under the Prior Credit Facility were released.
 
At September 30, 2011, a portion of our cash and cash equivalents were domiciled in foreign tax jurisdictions. In the event we need to repatriate funds outside of the U.S., such repatriation may be subject to local laws and tax consequences including foreign withholding taxes or U.S. income taxes. It is not practicable to estimate the tax liability and we would try to minimize the tax impact to the extent possible. However, any repatriation may not result in actual cash payments as the taxable event would likely be offset by the utilization of the then available net operating losses and tax credits.

Cash Flow from Operating Activities.  Cash used in operations was $22.5 million in the six months ended September 30, 2011, compared to $156.3 million 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 half 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.
 
Cash Flow from Investing Activities.  Cash used in investing activities was $4.4 million in the six months ended September 30, 2011, compared to $42.5 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 six months ended September 30, 2010 as there was no such activity in the six months ended September 30, 2011.
 
Cash Flow from Financing Activities.  Cash used in financing activities was $1.2 million in the six months ended September 30, 2011, compared to $12.7 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 six months ended September 30, 2010 as there was no such activity in the six months ended September 30, 2011.
 
Effect of exchange rate changes on cash.  Changes in foreign currency translation rates decreased our reported cash balance by $6.4 million.
 
Key Balance Sheet Accounts

28

 
At September 30, 2011, our total current assets were $366.2 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 $133.8 million, from $161.6 million at March 31, 2011 to $27.7 million at September 30, 2011. The decrease was primarily due to collections of fiscal 2011 year-end receivables, primarily related to the March 2011 release Homefront and WWE All Stars. Accounts receivable allowances were $80.1 million at September 30, 2011, a $7.5 million decrease 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 13% and 11% at September 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 $10.8 million, from $31.9 million at March 31, 2011 to $21.1 million at September 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 September 30, 2011 and March 31, 2011, respectively.

Licenses. Our investment in licenses, including the long-term portion, decreased $2.8 million, from $118.2 million at March 31, 2011 to $115.4 million at September 30, 2011.

Software Development. Capitalized software development, including the long-term portion, decreased $45.9 million, from $272.5 million at March 31, 2011 to $226.6 million at September 30, 2011. The decrease in software development is primarily the result of software development amortization of titles released in the six months ended September 30, 2011 as well as titles that were released late in the fourth quarter of fiscal 2011. This decrease was partially offset by our continued investment in future titles. Approximately 74% of the software development asset balance at September 30, 2011 is for titles that have expected release dates in the remainder of fiscal 2012 and beyond.

Total current liabilities at September 30, 2011, were $275.3 million, down from $379.5 million at March 31, 2011. Current liabilities primarily consisted of:

Accounts Payable. Accounts payable decreased $29.5 million, from $100.6 million at March 31, 2011 to $71.1 million at September 30, 2011. The decrease was primarily due to timing of product purchases and payments for advertising support for titles released late in the fourth quarter of fiscal 2011.

Accrued and Other Current Liabilities. Accrued and other current liabilities increased $7.4 million, from $137.9 million at March 31, 2011 to $145.3 million at September 30, 2011. The increase was primarily due to accruals related to our investments in licenses.

Our liabilities at September 30, 2011 also consisted of:

Other long-term liabilities. Other long-term liabilities decreased $4.3 million, from $88.0 million at March 31, 2011 to $83.7 million at September 30, 2011. The decrease was primarily due to movements of accrued royalties and a portion of the settlement payment due to Jakks, from long-term into current liabilities.

Convertible Senior Notes. We issued the Notes on August 4, 2009 and the full principal amount of $100.0 million is outstanding as of September 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. 

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

29

 
 
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
 
$
82,997

 
$
27,374

 
$
7,393

 
$
—

 
$
291

 
$
118,055

2013
 
71,532

 
22,195

 
13,811

 
—

 
4,000

 
111,538

2014
 
19,596

 
4,169

 
12,591

 
—

 
4,000

 
40,356

2015
 
18,524

 
570

 
11,166

 
100,000

 
—

 
130,260

2016
 
11,500

 
500

 
6,306

 
—

 
—

 
18,306

Thereafter
 
20,000

 
875

 
12,443

 
—

 
—

 
33,318

 
 
$
224,149

 
$
55,683

 
$
63,710

 
$
100,000

 
$
8,291

 
$
451,833

 
(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 September 30, 2011 are $224.1 million. Of these obligations, $7.0 million is accrued and classified as "Accrued and other current liabilities" in our September 30, 2011 condensed consolidated balance sheet related to the abandonment of a license in connection with our fiscal 2012 second quarter realignment plan (see "Note 5 — Restructuring and Other Charges" in the notes to the condensed consolidated financial statements included in Part I, Item I). Additionally, license commitments in the table above include $119.3 million of commitments payable to licensors that are included in both "Accrued and other current liabilities" and "Other long-term liabilities" in our September 30, 2011 condensed consolidated balance sheet because the licensors do not have any remaining significant performance obligations.

(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, $2.3 million and $3.1 million are accrued and classified as "Accrued and other current liabilities" and "Other long-term liabilities," respectively, in our September 30, 2011 condensed consolidated balance sheet due to abandonment of certain lease obligations in connection with our realignment plans (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 $1.1 million; this income is not contemplated in the lease commitments shown in the table above.

(4)
Debt.  We issued the Notes on August 4, 2009.  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 $2.5 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 $15.0 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 September 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 September 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 September 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,

30

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.

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.



31

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 September 30, 2011, our $51.1 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 and six months ended September 30, 2011 was $0.2 million and $0.3 million, respectively, and is included in "Interest and other income (expense), net" in our condensed consolidated statements of operations.

At September 30, 2011, we had no outstanding balances under the 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 six months ended September 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 September 30, 2011, we had foreign currency exchange forward contracts related to balance sheet hedging activities in the notional amount of $113.2 million with a fair value that approximates zero. The contracts consisted primarily of AUD, CAD, EUR, and GBP. The net loss recognized from these contracts during the three and six months ended September 30, 2011 was $4.2 and $2.7 million, respectively, 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

32

and liabilities that were hedged and would not have a material impact on our financial position.

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 $13.2 million and an increase in reported loss from operations before income taxes of approximately $1.1 million for the six months ended September 30, 2011. A hypothetical 10% adverse change in foreign currency translation rates would result in a reduction of reported total assets of approximately $22.0 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 October 1, 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 second 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 and our external sources of liquidity may be insufficient to meet our anticipated cash requirements in the future.
 
We operate in a capital intensive business. At September 30, 2011, we held cash and cash equivalents of $51.1 million.  Cash used in operations tends to be at its highest during the first part of the third fiscal quarter, as we invest heavily in inventory for the holiday buying season. Operating cash flow generally turns positive at the end of the third fiscal quarter as we start to collect on these accounts receivable. Subsequent to September 30, 2011, in order to help fund our working capital needs during this period, we borrowed under our Credit Facility and have sold accounts receivable under our Purchase Agreement. We intend to borrow additional funds under our Credit Facility and sell additional Walmart accounts receivables under our Purchase Agreement over the next several weeks. We anticipate repaying all outstanding borrowings under the Credit Facility prior to December 31, 2011. In the event our future net sales or required expenditures differ from our expectations and these external liquidity sources are not sufficient to meet our operating requirements, 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, which may not be available on financially attractive terms, if at all, 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

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repurchased. Our ability to make payments on the Notes will depend on our financial and operating performance, which is subject 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

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video games and our profitability:
 
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.  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.

Software pricing and sales allowances may impact our net sales and profitability.

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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.
 
We also compete with other forms of entertainment and leisure activities. For example, we believe the overall growth

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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;
•
fluctuations in the size and rate of growth of consumer demand for titles for different platforms; and

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•
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 commitments including contractual provisions under various license arrangements. If we are required to enter into such agreements

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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 carryforwards of $25.5 million. Under applicable tax rules, we may "carry forward" these NOLs in certain circumstances to offset

41

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 September 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


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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).
 
 
 
10.1

 
THQ Inc. Amended and Restated 2006 Long-Term Incentive Plan dated as of July 28, 2011 (incorporated by reference to Exhibit A to the Company's Proxy Statement on Schedule 14A filed on June 30, 2011).
 
 
 
10.2

 
THQ Inc. Amended and Restated Employee Stock Purchase Plan dated as of July 28, 2011 (incorporated by reference to Exhibit B to the Company's Proxy Statement on Schedule 14A filed on June 30, 2011).
 
 
 
10.3

 
Credit Agreement dated as of September 23, 2011 by and between the Company and Wells Fargo Capital Finance, LLC (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on September 28, 2011).
 
 
 
10.4

 
Security Agreement dated as of September 23, 2011 by and between the Company and Wells Fargo Capital Finance, LLC (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed on September 28, 2011).
 
 
 

43

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
 
 
 
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.


44

SIGNATURES
 
Pursuant to the requirements 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.
 
11/9/2011
THQ INC.
 
 
 
 
 
 
 
By:
/s/ Brian J. Farrell
 
 
 
Brian J. Farrell,
 
 
 
Chairman of the Board, President and Chief Executive Officer
 
 
 
 
 
 
 
 
 
11/9/2011
THQ INC.
 
 
 
 
 
 
 
By:
/s/ Paul J. Pucino
 
 
 
Paul J. Pucino,
 
 
 
Executive Vice President, Chief Financial Officer
 
 
 
 
 
 
 
 
 
11/9/2011
THQ INC.
 
 
 
 
 
 
 
By:
/s/ Teri J. Manby
 
 
 
Teri J. Manby,
 
 
 
Vice President, Chief Accounting Officer
 


45